XNAS:FSBK First South Bancorp, Inc. Quarterly Report 10-Q Filing - 3/31/2012

Effective Date 3/31/2012

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

(Mark One)

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

 

For the quarterly period ended March 31, 2012.

 

OR

 

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

For the transition period from _____ to _____ .

 

Commission File Number: 0-22219

 

FIRST SOUTH BANCORP, INC.

(Exact name of registrant as specified in its charter)

 

Virginia   56-1999749
(State or other jurisdiction of   (IRS Employer
incorporation or organization)   Identification No.)

 

1311 Carolina Avenue, Washington, North Carolina 27889

(Address of principal executive offices)

(Zip Code)

 

(252) 946-4178

(Registrant's telephone number, including area code)

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes x           No ¨

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

Yes x           No ¨

 

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

 

Large Accelerated Filer ¨   Accelerated Filer £
Non-Accelerated Filer ¨   Smaller Reporting Company x
(Do not check if a Smaller Reporting Company)    

 

Indicate by check mark whether registrant is a shell company (as defined by Rule 12b-2 of the Exchange Act).

Yes ¨           No x

 

Number of shares of common stock outstanding as of May 14, 2012: 9,751,271.

 

 
 

 

CONTENTS

 

  PAGE
PART I. FINANCIAL INFORMATION  
     
Item 1. Financial Statements  
     
  Consolidated Statements of Financial Condition as of March 31, 2012 (unaudited) and December 31, 2011 1
     
  Consolidated Statements of Operations and Comprehensive Income for the Three Months Ended March 31, 2012 and 2011 (unaudited) 2
     
  Consolidated Statements of Changes in Stockholders' Equity for the Three Months Ended March 31, 2012 and 2011 (unaudited) 3
     
  Consolidated Statements of Cash Flows for the Three Months  Ended March 31, 2012 and 2011 (unaudited) 4
     
  Selected Financial Data (unaudited) 5
     
  Notes to Consolidated Financial Statements (unaudited) 6
     
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 26
     
Item 3. Quantitative and Qualitative Disclosures about Market Risk 34
     
Item 4. Controls and Procedures 34
     
PART II. OTHER INFORMATION  
     
Item 1. Legal Proceedings 35
     
Item 1A. Risk Factors 35
     
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 35
     
Item 3. Defaults upon Senior Securities 35
     
Item 4. Mine Safety Disclosures 35
     
Item 5. Other Information 35
     
Item 6. Exhibits 35
     
Signatures 36 
     
Exhibits    

 

 
 

 

Item 1. Financial Statements

 

 First South Bancorp, Inc. and Subsidiary

Consolidated Statements of Financial Condition

 

   March 31,   December 31, 
   2012   2011*
   (unaudited)     
Assets          
Cash and due from banks  $15,568,565   $14,298,146 
Interest-bearing deposits in financial institutions   49,093,447    18,476,173 
Mortgage-backed securities - available for sale, at fair value   123,036,373    138,515,210 
Loans and leases receivable:          
Held for sale   9,361,702    6,435,983 
Held for investment   516,419,348    533,960,226 
Allowance for loan and lease losses   (14,396,097)   (15,194,014)
Loans and leases receivable, net   511,384,953    525,202,195 
Premises and equipment, net   12,984,563    11,679,430 
Other real estate owned   17,323,798    17,004,874 
Stock in Federal Home Loan Bank of Atlanta, at cost which approximates market   1,886,900    1,886,900 
Accrued interest receivable   2,451,090    2,210,314 
Goodwill   4,218,576    4,218,576 
Mortgage servicing rights   1,267,504    1,237,161 
Identifiable intangible assets   62,880    70,740 
Income tax receivable   3,118,961    2,194,677 
Prepaid expenses and other assets   7,952,387    9,946,459 
           
Total assets  $750,349,997   $746,940,855 
           
Liabilities and Stockholders' Equity          
           
Deposits:          
Demand  $262,500,055   $243,719,526 
Savings   31,068,007    28,988,522 
Large denomination certificates of deposit   188,266,783    195,429,182 
Other time   166,513,496    174,479,477 
Total deposits   648,348,341    642,616,707 
Borrowed money   1,680,899    2,096,189 
Junior subordinated debentures   10,310,000    10,310,000 
Other liabilities   5,667,512    7,804,687 
Total liabilities   666,006,752    662,827,583 
           
Common stock, $.01 par value, 25,000,000 shares authorized; 11,254,222 shares issued; 9,751,271 shares outstanding   97,513    97,513 
Additional paid-in capital   35,816,901    35,815,098 
Retained earnings, substantially restricted   76,971,977    76,510,081 
Treasury stock, at cost   (31,967,269)   (31,967,269)
Accumulated other comprehensive income, net   3,424,123    3,657,849 
Total stockholders' equity   84,343,245    84,113,272 
           
Total liabilities and stockholders' equity  $750,349,997   $746,940,855 

 

*Derived from audited consolidated financial statements

 

The accompanying notes are an integral part of these consolidated financial statements.

 

1
 

 

First South Bancorp, Inc. and Subsidiary

Consolidated Statements of Operations and Comprehensive Income

(unaudited)

 

   Three Months Ended 
   March 31, 
   2012   2011 
         
Interest income:          
Interest and fees on loans  $7,666,575   $8,823,994 
Interest and dividends on investments and deposits   1,246,961    1,067,205 
Total interest income   8,913,536    9,891,199 
           
Interest expense:          
Interest on deposits   1,321,195    1,976,869 
Interest on borrowings   1,116    27,414 
Interest on junior subordinated notes   92,193    81,320 
Total interest expense   1,414,504    2,085,603 
Net interest income   7,499,032    7,805,596 
Provision for credit losses   1,840,000    2,450,011 
Net interest income after provision for credit losses   5,659,032    5,355,585 
           
Non-interest income:          
Fees and service charges   1,480,136    1,486,702 
Loan servicing fees   212,801    198,084 
Loss on sale of other real estate, net   (28,964)   (82,095)
Gain on sale of mortgage loans   304,608    119,982 
Gain on sale of mortgage-backed securities   1,033,857    52,146 
Other income   240,311    207,131 
Total non-interest income   3,242,749    1,981,950 
           
Non-interest expense:          
Compensation and fringe benefits   4,157,612    3,789,679 
Federal deposit insurance premiums   252,400    291,500 
Premises and equipment   428,468    423,280 
Advertising   66,034    47,105 
Payroll and other taxes   405,795    401,628 
Data processing   598,149    600,541 
Amortization of intangible assets   100,556    147,202 
Other real estate owned expense   1,278,300    219,518 
Other   951,631    865,760 
Total non-interest expense   8,238,945    6,786,213 
           
Income before income tax expense   662,836    551,322 
Income tax expense   200,940    224,540 
           
NET INCOME  $461,896   $326,782 
           
Other comprehensive loss, net of taxes   (233,726)   (220,247)
Comprehensive income  $228,170   $106,535 
           
Per share data:          
Basic earnings per share  $0.05   $0.03 
Diluted earnings per share  $0.05   $0.03 
Average basic shares outstanding   9,751,271    9,751,271 
Average diluted shares outstanding   9,751,271    9,751,271 

 

The accompanying notes are an integral part of these consolidated financial statements.

 

2
 

 

First South Bancorp, Inc. and Subsidiary

Consolidated Statements of Changes in Stockholders' Equity

Three Months Ended March 31, 2012 and 2011

(unaudited)

 

                   Accumulated     
           Retained       Other     
       Additional   Earnings,       Comprehensive     
   Common   Paid-in   Substantially   Treasury   Income,     
   Stock   Capital   Restricted   Stock   Net   Total 
                         
Balance at December 31, 2011  $97,513   $35,815,098   $76,510,081   $(31,967,269)  $3,657,849   $84,113,272 
                               
Net income             461,896              461,896 
                               
Other comprehensive loss, net of taxes                       (233,726)   (233,726)
                               
Stock based compensation        1,803                   1,803 
                               
Balance at March 31, 2012  $97,513   $35,816,901   $76,971,977   $(31,967,269)  $3,424,123   $84,343,245 

 

                   Accumulated     
           Retained       Other     
       Additional   Earnings,       Comprehensive     
   Common   Paid-in   Substantially   Treasury   Income,     
   Stock   Capital   Restricted   Stock   Net   Total 
                         
Balance at December 31, 2010  $97,513   $35,795,586   $74,956,772   $(31,967,269)  $630,602   $79,513,204 
                               
Net income             326,782              326,782 
                               
Other comprehensive loss, net of taxes                       (220,247)   (220,247)
                               
Stock based compensation        28,617                   28,617 
                               
Balance at March 31, 2011  $97,513   $35,824,203   $75,283,554   $(31,967,269)  $410,355   $79,648,356 

 

The accompanying notes are an integral part of these consolidated financial statements.

 

3
 

 

First South Bancorp, Inc. and Subsidiary

Consolidated Statements of Cash Flows

(unaudited)

 

   Three Months Ended 
   March 31, 
   2012   2011 
         
Cash flows from operating activities:          
Net income  $461,896   $326,782 
Adjustments to reconcile net income to net cash provided by (used in) operating activities:          
Provision for credit losses   1,840,000    2,450,011 
Depreciation   196,159    182,250 
Amortization of intangibles   100,556    147,202 
Accretion of discounts and premiums on securities, net   -    250,213 
Gain on disposal of premises and equipment   (7,468)   - 
Loss on sale of other real estate owned   28,964    82,095 
Gain on sale of loans held for sale   (304,608)   (119,982)
Gain on sale of mortgage-backed securities available for sale   (1,033,857)   (52,146)
Stock based compensation expense   1,803    28,617 
Originations of loans held for sale, net   (21,901,305)   (8,023,804)
Proceeds from sale of loans held for sale   5,800,213    6,262,085 
Other operating activities   (120,052)   (675,686)
Net cash provided by (used in) operating activities   (14,937,699)   857,637 
           
Cash flows from investing activities:          
Proceeds from sale of mortgage-backed securities available for sale   23,548,721    2,369,759 
Proceeds from principal repayments of mortgage-backed securities available for sale   5,793,875    2,799,945 
Proceeds from principal repayments of mortgage-backed securities held for investment   -    146,607 
Originations of loans held for investment, net of principal repayments   12,667,905    10,800,268 
Proceeds from disposal of other real estate owned   992,371    2,408,250 
Proceeds from disposal of premises and equipment   18,128    - 
Purchase of mortgage-backed securities   -    (23,087,178)
Purchase of premises and equipment   (1,511,952)   (1,215,567)
Net cash provided by (used in) investing activities   41,509,048    (5,777,916)
           
Cash flows from financing activities:          
Net increase in deposit accounts   5,731,634    4,163,092 
Net decrease in FHLB borrowings   -    (10,000,000)
Net change in repurchase agreements   (415,290)   860,268 
Net cash provided by (used in) financing activities   5,316,344    (4,976,640)
           
Increase (decrease) in cash and cash equivalents   31,887,693    (9,896,919)
Cash and cash equivalents, beginning of period   32,774,319    44,433,613 
Cash and cash equivalents, end of period  $64,662,012   $34,536,694 
           
Supplemental disclosures:          
Other real estate acquired in settlement of loans  $2,235,056   $3,620,405 
Exchange of loans for mortgage-backed securities   13,479,981    3,884,196 
Cash paid for interest   1,298,964    2,036,329 
Cash paid for income taxes   75,000    75,000 

 

The accompanying notes are an integral part of these consolidated financial statements.

 

4
 

 

Part 1. Financial Information - Selected Financial Data (Unaudited)

 

   At or for the Quarter Ended 
   3/31/2012   12/31/2011   9/30/2011   6/30/2011   3/31/2011 
  (dollars in thousands except per share data) 
Consolidated Balance Sheet Data:     
Total assets  $750,350   $746,941   $768,411   $784,538   $791,154 
Loans receivable (net):                         
Mortgage  $80,263   $66,249   $80,453   $56,564   $53,925 
Commercial   352,459    378,823    405,712    428,141    445,930 
Consumer   71,270    72,821    74,097    76,459    79,517 
Leases   7,393    7,309    7,972    7,825    7,829 
Total loans (net)  $511,385   $525,202   $568,234   $568,989   $587,201 
                          
Cash and investments  $64,662   $32,774   $32,909   $44,565   $34,537 
Mortgage-backed securities   123,036    138,515    119,764    124,539    120,565 
                          
Deposits:                         
Savings  $31,068   $28,988   $27,551   $26,999   $26,251 
Checking   262,500    243,720    243,582    240,048    237,605 
Certificates   354,780    369,909    394,007    416,855    429,772 
Total deposits  $648,348   $642,617   $665,140   $683,902   $693,628 
Stockholders' equity   84,343    84,113    82,061    80,894    79,648 
                          
Operating Data:                         
Interest income  $8,914   $9,363   $9,861   $10,188   $9,891 
Interest expense   1,415    1,608    1,852    2,010    2,086 
Net interest income   7,499    7,755    8,009    8,178    7,805 
Provision for credit losses   1,840    2,640    2,643    3,080    2,450 
Noninterest income   3,243    2,648    2,292    2,498    1,982 
Noninterest expense   8,239    7,180    6,999    6,988    6,786 
Income tax expense   201    142    256    226    225 
Net income  $462   $441   $403   $382   $326 
                          
Per Share Data:                         
Basic earnings per share  $0.05   $0.05   $0.04   $0.04   $0.03 
Diluted earnings per share  $0.05   $0.05   $0.04   $0.04   $0.03 
Book value per share  $8.65   $8.63   $8.42   $8.30   $8.17 
Average basic shares   9,751,271    9,751,271    9,751,271    9,751,271    9,751,271 
Average diluted shares   9,751,271    9,751,271    9,751,271    9,751,271    9,751,271 
                          
Selected Performance ratios:                         
Yield on average earning assets   5.26%   5.44%   5.64%   5.78%   5.59%
Cost of funds   0.87%   0.96%   1.08%   1.14%   1.18%
Net interest spread   4.39%   4.48%   4.56%   4.64%   4.41%
Net interest margin/average earning assets   4.42%   4.51%   4.58%   4.64%   4.41%
Earning assets/total assets   90.90%   91.09%   90.47%   88.61%   89.85%
                          
Return on average assets (annualized)   0.25%   0.23%   0.21%   0.19%   0.16%
Return on average equity (annualized)   2.18%   2.13%   1.97%   1.90%   1.63%
Efficiency ratio   76.63%   68.95%   67.77%   65.38%   69.25%
Equity/Assets   11.24%   11.26%   10.68%   10.31%   10.07%
Tangible Equity/Assets   10.67%   10.69%   10.12%   9.76%   9.52%
                          
Asset Quality Data and Ratios:                         
Loans on non-accrual status:                         
Nonaccrual loans                         
Earning  $2,255   $10,601   $3,179   $3,853   $4,954 
Non-Earning   8,757    11,007    15,107    15,657    11,769 
Total Non-Accrual Loans  $11,012   $21,608   $18,286   $19,510   $16,723 
Non-accrual restructured loans                         
Past Due TDRs  $6,029   $9,170   $12,568   $11,228   $15,024 
Current TDRs   20,456    12,247    11,172    10,421    8,780 
Total TDRs  $26,485   $21,417   $23,740   $21,649   $23,804 
Total loans on non-accrual status  $37,497   $43,025   $42,026   $41,159   $40,527 
Other real estate owned   17,324    17,005    12,886    11,387    12,069 
Total non-performing assets  $54,821   $60,030   $54,912   $52,546   $52,596 
                          
Non-accrual loans/loans   7.33%   8.19%   7.40%   7.23%   6.90%
Non-performing assets/assets   7.31%   8.06%   7.15%   6.70%   6.65%
                          
Allowance for credit losses  $14,637   $15,448   $18,563   $18,918   $19,551 
Allowance for credit losses/loans   2.78%   2.85%   3.16%   3.21%   3.22%
Allowance for credit losses/loans on non-accrual status   39.04%   35.90%   44.17%   45.96%   48.24%
Net charge-offs  $2,638   $5,752   $3,018   $3,713   $1,966 
Net charge-offs/loans   0.52%   1.10%   0.53%   0.65%   0.32%
                          
Regulatory Capital Ratios:                         
Total Risk-Based Capital Ratio   15.80%   15.22%   14.60%   14.15%   13.68%
Tier 1 Risk-Based Capital Ratio   14.53%   13.95%   13.33%   12.87%   12.41%
Tier 1 Leverage Ratio   10.18%   10.02%   9.80%   9.46%   9.36%

 

5
 

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

 

Note 1. Basis of Presentation. The accompanying unaudited consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States of America and with the instructions to Form 10-Q of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements. In the opinion of management, all adjustments necessary for fair presentation of the financial position and results of operations for the periods presented are included, none of which are other than normal recurring accruals. The financial statements of First South Bancorp, Inc. (the “Company”) and First South Bank (the “Bank”) are presented on a consolidated basis. The results of operations for the three months ended March 31, 2012 are not necessarily indicative of the results of operations that may be expected for the year ended December 31, 2012.

 

Note 2. Earnings Per Share. Basic and diluted earnings per share for the three months ended March 31, 2012 are based on weighted average shares of common stock outstanding, excluding treasury shares. Diluted earnings per share include the potentially dilutive effects of the Company’s stock option plan. For both the three months ended March 31, 2012 and 2011, there were no stock options that were dilutive because their exercise prices exceed the average market price of the Company’s common stock.

 

Note 3. Comprehensive Income. Comprehensive income includes net income and all other changes to the Company's equity, with the exception of transactions with stockholders ("other comprehensive income"). The Company's other comprehensive income is primarily unrealized gains and losses on available for sale securities. Unrealized gains and losses on available for sale securities is impacted by purchases and sales of available for sale securities and changes in interest rates between the respective reporting periods.

 

Information concerning other comprehensive income for the three months ended March 31, 2012 and 2011 is presented below:

 

   Three Months Ended 3/31/12   Three Months Ended 3/31/11 
Net income  $461,896   $326,782 
Increase (decrease) in unrealized holding gains during the periods   (650,079)   225,801 
Net increase (decrease) in deferred income tax asset   416,353    (79,637)
Reclassification of unrealized holding losses transferred to held for investment   -    (366,411)
Other comprehensive loss, net   (233,726)   (220,247)
Comprehensive income  $228,170   $106,535 

 

Note 4. Mortgage-Backed Securities. The amortized cost and fair value of mortgage-backed securities, with gross unrealized gains and losses at March 31, 2012 and December 31, 2011, were as follows:

 

   March 31, 2012 
       Gross   Gross     
   Amortized   Unrealized   Unrealized   Fair 
   Cost   Gains   Losses   Value 
   (In thousands) 
Mortgage-backed securities                    
Available for sale, maturing in:                    
One to five years  $375   $20   $-   $395 
Five to ten years   805    61    -    866 
After ten years   116,289    5,486    -    121,775 
Total  $117,469   $5,567   $-   $123,036 
                     

 

6
 

 

   December 31, 2011 
       Gross   Gross     
   Amortized   Unrealized   Unrealized   Fair 
   Cost   Gains   Losses   Value 
   (In thousands) 
Mortgage-backed securities                    
Available for sale, maturing in:                    
One to five years  $481   $29   $-   $510 
Five to ten years   835    62    -    897 
After ten years   130,981    6,127    -    137,108 
Total  $132,297   $6,218   $-   $138,515 

 

The Bank had no mortgage-backed securities with an unrealized loss position at March 31, 2012 or at December 31, 2011. Mortgage-backed securities with an amortized cost of $4,952,978 and $5,103,314 were pledged as collateral for public deposits and repurchase agreements at March 31, 2012 and December 31, 2011, respectively.

 

Note 5. Loans Receivable. Following is a summary of loans receivable at March 31, 2012 and December 31, 2011:

 

   March 31, 2012   December 31, 2011 
   Amount   Percent
of total
   Amount   Percent
of total
 
   (Dollars in thousands) 
Mortgage loans:                    
Residential mortgage loans  $82,170    15.6%  $68,240    12.6%
                     
Total mortgage loans   82,170    15.6%   68,240    12.6%
                     
Commercial loans and leases:                    
Commercial real estate   330,284    62.7%   346,088    63.9%
Commercial construction   17,446    3.3%   25,441    4.7%
Commercial non-real estate   11,256    2.1%   14,851    2.8%
Commercial unsecured   2,750    0.5%   2,832    0.5%
Lease receivables   7,662    1.5%   7,578    1.4%
                     
Total commercial loans and leases   369,398    70.1%   396,790    73.3%
                     
Consumer loans:                    
Consumer real estate   41,165    7.8%   41,046    7.6%
Home equity lines of credit   29,204    5.6%   30,479    5.6%
Consumer non-real estate   2,341    0.4%   2,500    0.5%
Consumer unsecured   2,522    0.5%   2,403    0.4%
                     
Total consumer loans   75,232    14.3%   76,428    14.1%
                     
Gross loans   526,800    100.0%   541,458    100.0%
                     
Less deferred loan origination fees, net   1,019         1,062      
Less allowance for loan and lease losses   14,396         15,194      
                     
Total loans, net  $511,385        $525,202      

 

The Bank has pledged its eligible real estate loans as collateral for potential borrowings from the Federal Home Loan Bank of Atlanta in the amount of $100.0 million and $101.2 million at March 31, 2012 and December 31, 2011, respectively. The Bank's lending is concentrated primarily in central, eastern, northeastern and southeastern North Carolina. At March 31, 2012, the Bank had pre-approved but unused lines of credit totaling $64.8 million.

 

7
 

 

The table below details non-accrual loans, including troubled debt restructured loans accounted for on a non-accrual basis, segregated by class of loans, at March 31, 2012 and December 31, 2011.

 

   March 31, 2012   December 31, 2011 
   (Dollars in thousands) 
Loans accounted for on a non-accrual basis:          
Residential mortgage  $1,351   $701 
Commercial real estate   6,991    18,059 
Commercial construction   507    633 
Commercial non-real estate   474    17 
Commercial unsecured   44    44 
Consumer real estate   1,345    1,866 
Home equity lines of credit   299    287 
Consumer non-real estate   -    - 
Consumer unsecured   1    1 
Total loans accounted for on a non-accrual basis   11,012    21,608 
           
Troubled debt restructured loans accounted for on a non-accrual basis:          
Past Due TDRs:          
Residential mortgage   -    414 
Commercial real estate   4,964    6,888 
Commercial construction   157    157 
Commercial non-real estate   908    1,509 
Consumer real estate   -    202 
Total Past Due TDRs   6,029    9,170 
Current TDRs:          
Residential mortgage   -    - 
Commercial real estate   17,859    9,406 
Commercial construction   2,250    2,704 
Commercial non-real estate   28    19 
Commercial unsecured   15    16 
Consumer real estate   304    102 
Total Current TDRs   20,456    12,247 
Total TDR loans accounted for on a non-accrual basis   26,485    21,417 
Total non-performing loans  $37,497   $43,025 
Percentage of total loans, net   7.3%   8.2%
Other real estate owned  $17,324   $17,005 
Total non-performing assets  $54,821   $60,030 

 

Cumulative interest income not recorded on loans accounted for on a non-accrual basis was $1,472,205 and $1,480,906 at March 31, 2012 and December 30, 2011, respectively.

 

8
 

 

The following tables present an age analysis of past due loans, segregated by class of loans as of March 31, 2012 and December 31, 2011, respectively:

 

   30-59
Days
Past Due
   60-89
Days
Past Due
   Greater
Than
90 Days
   Total
Past
Due
   Current   Total
Financing
Receivables
   Over 90 
Days and
Accruing
 
  (In thousands) 
March 31, 2012    
Residential mortgage  $1,448   $940   $780   $3,168   $79,002   $82,170   $- 
Commercial real estate   10,363    4,455    10,444    25,262    305,022    330,284    120 
Commercial construction   528    -    664    1,192    16,254    17,446    - 
Commercial non-real estate   606    96    908    1,610    9,646    11,256    - 
Commercial unsecured   127    56    -    183    2,567    2,750    - 
Lease receivables   301    52    -    353    7,309    7,662    - 
Consumer real estate   1,610    530    1,132    3,272    37,893    41,165    - 
Home equity lines of credit   140    457    192    789    28,416    29,205    - 
Consumer non-real estate   45    -    -    45    2,295    2,340    - 
Consumer unsecured   23    2    -    25    2,497    2,522    - 
Total  $15,191   $6,588   $14,120   $35,899   $490,901   $526,800   $120 

 

   30-59
Days
Past Due
   60-89
Days
Past Due
   Greater
Than
90 Days
   Total
Past
Due
   Current   Total
Financing
Receivables
   Over 90
Days and
Accruing
 
  (In thousands) 
December 31, 2011     
Residential mortgage  $2,998   $2,040   $1,626   $6,664   $61,576   $68,240   $511 
Commercial real estate   6,626    5,240    15,372    27,238    318,850    346,088    520 
Commercial construction   -    -    790    790    24,651    25,441    - 
Commercial non-real estate   -    534    1,514    2,048    12,803    14,851    - 
Commercial unsecured   4    -    -    4    2,828    2,832    - 
Lease receivables   169    -    5    174    7,404    7,578    - 
Consumer real estate   1,322    494    379    2,195    38,851    41,046    - 
Home equity lines of credit   204    198    181    583    29,896    30,479    - 
Consumer non-real estate   2    -    -    2    2,498    2,500    - 
Consumer unsecured   4    1    -    5    2,398    2,403    - 
Total  $11,329   $8,507   $19,867   $39,703   $501,755   $541,458   $1,031 

 

9
 

 

The following tables present information on loans that were considered impaired as of March 31, 2012 and December 31, 2011. Impaired loans include loans modified in a TDR, whether on accrual or nonaccrual status. At March 31, 2012, impaired loans included $59.4 million of impaired TDRs, compared to $36.8 million at December 31, 2011.

 

March 31, 2012  Recorded
Investment
   Contractual
Unpaid
Principal
Balance
   Related
Allowance
   YTD
Average
Recorded
Investment
   Interest Income
Recognized on
Impaired Loans
 
   (In thousands) 
With no related allowance recorded:                         
Commercial real estate  $56,971   $67,336   $-   $59,738   $627 
Commercial construction   3,142    3,227    -    3,505    16 
Commercial non-real estate   1,422    2,661    -    1,826    27 
Commercial unsecured   273    273    -    242    2 
Consumer real estate   1,639    2,359    -    1,591    10 
Home equity lines of credit   197    197    -    233    2 
Consumer non-real estate   28    32    -    28    - 
Consumer unsecured   75    251    -    38    3 
Subtotal:   63,747    76,336    -    67,201    687 
                          
With an allowance recorded:                         
Commercial real estate   9,773    10,433    1,048    8,462    87 
Commercial unsecured   12    12    12    31    1 
Consumer real estate   1,148    1,148    484    1,043    12 
Home equity lines of credit   179    179    179    179    - 
Consumer unsecured   48    48    1    71    1 
Subtotal:   11,160    11,820    1,724    9,786    101 
                          
Totals:                         
Commercial   71,593    83,942    1,060    73,804    760 
Consumer   3,314    4,214    664    3,183    28 
Grand Total:  $74,907   $88,156   $1,724   $76,987   $788 

 

December 31, 2011  Recorded
Investment
   Contractual
Unpaid
Principal
Balance
   Related
Allowance
   YTD
Average
Recorded
Investment
   Interest Income
Recognized on
Impaired Loans
 
   (In thousands) 
With no related allowance recorded:                         
Commercial real estate  $62,505   $74,021   $-   $70,143   $3,177 
Commercial construction   3,868    4,159    -    4,008    121 
Commercial non-real estate   2,230    2,900    -    2,395    85 
Commercial unsecured   211    247    -    235    11 
Consumer real estate   1,543    2,253    -    1,716    93 
Home equity lines of credit   270    270    -    271    14 
Consumer non-real estate   28    35    -    35    2 
Consumer unsecured   1    179    -    2    5 
Subtotal:   70,656    84,064    -    78,805    3,508 
                          
With an allowance recorded:                         
Commercial real estate   7,152    7,152    1,158    7,210    328 
Commercial unsecured   50    50    1    50    2 
Consumer real estate   937    937    451    947    47 
Consumer unsecured   95    95    1    95    2 
Subtotal:   8,234    8,234    1,611    8,302    379 
                          
Totals:                         
Commercial   76,016    88,529    1,159    84,041    3,724 
Consumer   2,874    3,769    452    3,066    163 
Grand Total:  $78,890   $92,298   $1,611   $87,107   $3,887 

 

10
 

 

Credit Quality Indicators. The Bank assigns a risk grade to each loan in the portfolio as part of the on-going monitoring of the credit quality of the loan portfolio.

 

Commercial loans are graded on a scale of 1 to 9. A description of the general characteristics of the 9 risk grades follows:

 

    Risk Grade 1 (Excellent) - Loans in this category are considered to be of the highest quality. The borrower(s) has significant financial strength, stability, and liquidity. Proven cash flow is significantly more than required to service current and proposed debt with consistently strong earnings. Collateral position is very strong and a secondary source of repayment is self-evident. Guarantors may not be necessary to support the debt.

 

    Risk Grade 2 (Above Average) - Loans are supported by above average financial strength and stability. Cash flow is more than sufficient to meet current demands. Earnings are strong and reliable, but may differ from year to year. Collateral is highly liquid and sufficient to repay the debt in full. Guarantors may qualify for the loan on a direct basis.

 

    Risk Grade 3 (Average) - Credits in this group are supported by upper tier industry-average financial strength and stability. Liquidity levels fluctuate and need for short-term credit is demonstrated. Cash flow is steady and adequate to meet demands but can fluctuate. Earnings should be consistent but operating losses have not occurred recently. Collateral is generally pledged at an acceptable loan to value, but the credit can support some level of unsecured exposure. Guarantors with demonstrable financial strength are typically required on loans to business entities, but may not be on loans to individual borrowers.

  

    Risk Grade 4 (Acceptable) - Credits in this group are supported by lower end industry-average financial strength and stability. Liquidity levels fluctuate but are acceptable and need for short term credit is demonstrated. Cash flow is adequate to meet demands but can fluctuate. Earnings may be inconsistent but operating losses have not occurred recently. Collateral is generally pledged at an acceptable loan to value. Guarantors with demonstrable financial strength are required on loans to business entities, but may not be on loans to individual borrowers.

  

    Risk Grade 5 (Watch) - An asset in this category is one that has been identified by the lender, or credit administration as a loan that has shown some degree of deterioration from its original status. These loans are typically protected by collateral but have potential weaknesses that deserve management’s close attention, but are not yet at a point to become a classified asset. There may be unsecured loans that are included in this category. These are loans that management feels need to be watched more closely than those rated as acceptable and if left uncorrected, these potential weaknesses may result in the deterioration of the repayment prospects for the asset to warrant including them as classified assets.

 

    Risk Grade 6 (Special Mention) - An asset in this category is currently protected by collateral but has potential weaknesses that deserve management’s close attention. If left uncorrected, these potential weaknesses may result in the deterioration of the repayment prospects for the asset or in the Bank’s credit position at some future date.

 

    Risk Grade 7 (Substandard) - A Substandard loan is inadequately protected by the current sound net worth and paying capacity of the debtor(s) or of the collateral pledged, if any. These credits have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. There is a distinct possibility the Bank will sustain some loss if the deficiencies are not corrected.

 

    Risk Grade 8 (Doubtful) - A loan graded in this category has all the weaknesses inherent in one graded Substandard with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions, and values highly questionable and improbable.

 

    Risk Grade 9 (Loss) - A loan graded as Loss is considered uncollectible and of such little value that continuance as a bankable asset is not warranted. This grade does not mean that the loan has absolutely no recovery or salvage value, but rather it is not practical or desirable to defer writing off this basically worthless asset even though partial recovery may be affected in the future.

 

Consumer loans are graded on a scale of 1 to 9. A description of the general characteristics of the 9 risk grades follows:

 

    Risk Grades 1 - 5 (Pass) - Loans in this category generally show little to no signs of weakness or have adequate mitigating factors that minimize the risk of loss.  Some of the characteristics of these loans include, but are not limited to, adequate financial strength and stability, adequate cash flow, collateral with acceptable loan to value, additional repayment sources, and reliable earnings.

 

11
 

 

    Risk Grade 6 (Special Mention) - An asset in this category is currently protected by collateral but has potential weaknesses that deserve management’s close attention. If left uncorrected, these potential weaknesses may result in the deterioration of the repayment prospects for the asset or in the Bank’s credit position at some future date.

 

    Risk Grade 7 (Substandard) - A Substandard loan is inadequately protected by the current sound net worth and paying capacity of the debtor(s) or of the collateral pledged, if any. These credits have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. There is a distinct possibility the Bank will sustain some loss if the deficiencies are not corrected.

 

    Risk Grade 8 (Doubtful) - A loan graded in this category has all the weaknesses inherent in one graded Substandard with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions, and values highly questionable and improbable.

 

    Risk Grade 9 (Loss) - A loan graded as Loss is considered uncollectible and of such little value that continuance as a bankable asset is not warranted. This grade does not mean that the loan has absolutely no recovery or salvage value, but rather it is not practical or desirable to defer writing off this basically worthless asset even though partial recovery may be affected in the future.

 

Mortgage loans are graded on a scale of 1 to 9. A description of the general characteristics of the 9 risk grades follows:

 

    Risk Grades 1 - 5 (Pass) - Loans in this category generally show little to no signs of weakness or have adequate mitigating factors that minimize the risk of loss.  Some of the characteristics of these loans include, but are not limited to, adequate financial strength and stability, acceptable credit history, adequate cash flow, collateral with acceptable loan to value, additional repayment sources, and reliable earnings. 

 

    Risk Grade 6 (Special Mention) – Special Mention loans are currently protected by collateral but have potential weaknesses that deserve management’s close attention. If left uncorrected, these potential weaknesses may result in the deterioration of the repayment prospects for the asset or in the Bank’s credit position at some future date.

 

    Risk Grade 7 (Substandard) - Substandard loans are inadequately protected by the sound net worth and paying capacity of the borrower(s). Loans so classified must have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. They are characterized by the distinct possibility that the Bank will sustain some loss if the deficiencies are not corrected.

 

    Risk Grade 8 (Doubtful) - Loans classified Doubtful have all the weaknesses inherent in those classified Substandard with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently known facts, conditions, and values, highly questionable and improbable.

 

    Risk Grade 9 (Loss) - Loans classified Loss are considered uncollectible and of such little value that their continuance as bankable assets is not warranted. This classification does not mean that the loan has absolutely no recovery or salvage value, but rather it is not practical or desirable to defer writing off this basically worthless asset even though partial recovery may be affected in the future.

 

12
 

 

The following tables present information on risk ratings of the commercial and consumer loan portfolios, segregated by loan class as of March 31, 2012 and December 31, 2011, respectively:

 

March 31, 2012
Commercial Credit Exposure by Internally Assigned Grade  Commercial
Real Estate
   Commercial Construction   Commercial
Non-Real
Estate
   Commercial Unsecured 
       (In thousands)         
1-Excellent  $-   $-   $-   $- 
2-Above Average   1,370    2    479    44 
3-Average   25,295    1,825    1,683    501 
4-Acceptable   159,695    9,019    6,307    1,173 
5-Watch   55,644    1,586    1,213    525 
6-Special Mention   35,393    1,202    152    352 
7-Substandard   52,887    3,812    1,422    155 
8-Doubtful   -    -    -    - 
9-Loss   -    -    -    - 
Total  $330,284   $17,446   $11,256   $2,750 

 

March 31, 2012
Consumer Credit Exposure by Internally Assigned Grade  Consumer
Real Estate
   Home Equity
Line of Credit
   Consumer Non-Real
Estate
   Consumer Unsecured 
       (In thousands)         
Pass  $35,442   $28,420   $2,310   $2,147 
6-Special Mention   3,027    289    4    277 
7-Substandard   2,696    495    27    98 
8-Doubtful   -    -    -    - 
9-Loss   -    -    -    - 
Total  $41,165   $29,204   $2,341   $2,522 

 

March 31, 2012
Mortgage and Lease Receivable Credit Exposure by Internally Assigned Grade  Mortgage   Lease Receivable 
   (In thousands) 
Pass  $80,819   $7,584 
6-Special Mention   -    - 
7-Substandard   1,351    78 
8-Doubtful   -    - 
9-Loss   -    - 
Total  $82,170   $7,662 

 

December 31, 2011
Commercial Credit Exposure by Internally Assigned Grade  Commercial
Real Estate
   Commercial Construction   Commercial
Non-Real
Estate
   Commercial Unsecured 
       (In thousands)         
1-Excellent  $-   $-   $-   $- 
2-Above Average   1,481    -    581    45 
3-Average   25,660    2,506    1,581    451 
4-Acceptable   166,476    11,727    9,109    1,638 
5-Watch   62,543    4,417    1,221    324 
6-Special Mention   32,009    1,928    130    216 
7-Substandard   57,919    4,863    2,229    158 
8-Doubtful   -    -    -    - 
9-Loss   -    -    -    - 
Total  $346,088   $25,441   $14,851   $2,832 

 

13
 

 

December 31, 2011
Consumer Credit Exposure by Internally Assigned Grade  Consumer
Real Estate
   Home Equity
Line of Credit
   Consumer Non-Real
Estate
   Consumer Unsecured 
       (In thousands)         
Pass  $35,931   $29,902   $2,472   $2,285 
6-Special Mention   2,814    115    -    22 
7-Substandard   2,301    462    28    96 
8-Doubtful   -    -    -    - 
9-Loss   -    -    -    - 
Total  $41,046   $30,479   $2,500   $2,403 

 

December 31, 2011
Mortgage and Lease Receivable Credit Exposure by Internally Assigned Grade  Mortgage   Lease Receivable 
   (In thousands) 
Pass  $67,034   $7,500 
6-Special Mention   91    - 
7-Substandard   1,115    78 
8-Doubtful   -    - 
9-Loss   -    - 
Total  $68,240   $7,578 

 

Note 6. Allowance for Credit Losses. Following is a summary of activity in the allowance for credit losses with charge-off and recovery by class of financing receivable for the three month periods ended March 31, 2012 and 2011:

   March 31,
2012
   March 31,
2011
 
   (In thousands) 
Allowance for loan and lease losses at beginning of period  $15,194   $18,830 
Allowance for unfunded commitments at beginning of period   254    237 
Total allowance for credit losses at beginning of period   15,448    19,067 
           
Provision for loan and lease losses   1,840    2,450 
Provision for unfunded commitments   (13)   - 
           
Loans charged-off:          
Residential mortgage   (177)   (89)
Commercial real estate   (2,600)   (1,685)
Commercial construction   -    (194)
Commercial non-real estate   (631)   (19)
Commercial unsecured   (1)   (54)
Consumer real estate   (247)   (61)
Home equity lines of credit   (163)   (65)
Consumer unsecured   (2)   (1)
Total charge-offs   (3,821)   (2,168)
Recoveries of loans previously charged-off:          
Commercial real estate   1,028    7 
Commercial construction   101    54 
Commercial non-real estate   20    12 
Commercial unsecured   17    29 
Consumer real estate   4    34 
Home equity lines of credit   1    63 
Consumer non-real estate   11    - 
Consumer unsecured   1    3 
Total recoveries   1,183    202 
Net charge-offs   (2,638)   (1,966)
           
Allowance for loan and lease losses at end of period   14,396    19,320 
Allowance for unfunded commitments at end of period   241    231 
Total allowance for credit losses at end of period  $14,637   $19,551 

 

14
 

 

The following table presents a roll forward of the Bank’s allowance for loan and lease losses by loan category for the periods ended March 31, 2012 and December 31, 2011, respectively:

 

   March 31, 2012 
   Beginning   Charge-           Ending   Total 
   Balance   Offs   Recoveries   Provisions   Balance   Loans 
   (In thousands) 
Allowance for collectively evaluated for impairment                              
Residential mortgage  $2,004   $(177)  $-   $(530)  $1,297   $82,170 
Commercial real estate   8,117    (66)   18    (1,177)   6,892    263,540 
Commercial construction   633    -    1    (96)   538    14,304 
Commercial non-real estate   371    (24)   -    (32)   315    9,834 
Commercial unsecured   75    (1)   2    (12)   64    2,465 
Lease receivables   223    -    -    46    269    7,662 
Consumer real estate   1,132    -    4    592    1,728    38,378 
Home equity lines of credit   887    -    1    466    1,354    28,828 
Consumer non-real estate   73    -    8    30    111    2,313 
Consumer unsecured   68    (2)   1    37    104    2,399 
Total   13,583    (270)   35    (676)   12,672    451,893 
Allowance for individually evaluated for impairment                              
Commercial real estate   1,160    (2,534)   1,010    1,412    1,048    66,744 
Commercial construction   -    -    100    (100)   -    3,142 
Commercial non-real estate   -    (607)   20    587    -    1,422 
Commercial unsecured   -    -    15    (3)   12    285 
Consumer real estate   450    (247)   -    281    484    2,787 
Home equity lines of credit   -    (163)   -    162    1    376 
Consumer non-real estate   -    -    3    (2)   -    28 
Consumer unsecured   1    -    -    179    179    123 
Total   1,611    (3,551)   1,148    2,516    1,724    74,907 
Grand Total  $15,194   $(3,821)  $1,183   $1,840   $14,396   $526,800 

 

   December 31, 2011 
   Beginning   Charge-           Ending   Total 
   Balance   Offs   Recoveries   Provisions   Balance   Loans 
   (In thousands) 
Allowance for collectively evaluated for impairment                              
Residential mortgage  $358   $(445)  $1   $2,090   $2,004   $68,240 
Commercial real estate   10,718    (256)   66    (2,411)   8,117    276,431 
Commercial construction   1,192    (34)   3    (528)   633    21,573 
Commercial non-real estate   316    -    6    49    371    12,621 
Commercial unsecured   74    (37)   32    6    75    2,571 
Lease receivables   148    (207)   -    282    223    7,578 
Consumer real estate   1,653    (130)   23    (414)   1,132    38,566 
Home equity lines of credit   1,102    (86)   64    (193)   887    30,209 
Consumer non-real estate   29    (6)   4    46    73    2,472 
Consumer unsecured   52    (70)   8    78    68    2,307 
Total   15,642    (1,271)   207    (995)   13,583    462,568 
Allowance for individually evaluated for impairment                              
Commercial real estate   2,846    (11,773)   304    9,783    1,160    69,657 
Commercial construction   95    (487)   109    283    -    3,868 
Commercial non-real estate   19    (179)   9    151    -    2,230 
Commercial unsecured   54    (82)   1    27    -    261 
Consumer real estate   91    (782)   19    1,122    450    2,480 
Home equity lines of credit   83    (398)   3    312    -    270 
Consumer non-real estate   -    (12)   4    8    -    28 
Consumer unsecured   -    (122)   1    122    1    96 
Total   3,188    (13,835)   450    11,808    1,611    78,890 
Grand Total  $18,830   $(15,106)  $657   $10,813   $15,194   $541,458 

 

15
 

 

Historical Loss and Qualitative Analysis. The assessment of the adequacy of the allowance for credit losses includes an analysis of actual historical loss percentages of both classified and pass loans and qualitative factors allocated among specific categories of loans. In developing this analysis, the Bank relies on actual loss history for the most recent eight quarters and exercises management’s best judgment in assessing credit risk. There were no changes in the Bank’s accounting policy and methodology used to estimate the allowance for credit losses during this reporting period. The following table sets forth information with respect to the Bank’s allocation of historical loss percentages used in determining the allowance for credit losses (ACL) for each of the loan categories and risk grades at March 31, 2012.

 

   Historical Loss Percentage by Assigned Risk Grade 
Category – Commercial Loans  9   8   7   6   5   4   3   2   1 
Commercial Real Estate   100.00%   97.940%   19.211%   0.579%   0.052%   0.013%   0.013%   0.013%   0.00%
Commercial Non-Real Estate Secured   100.00%   98.090%   12.197%   14.699%   1.380%   0.000%   0.000%   0.000%   0.00%
Commercial Non-Real Estate Unsecured   100.00%   98.060%   19.514%   0.366%   1.485%   0.330%   0.330%   0.330%   0.00%

 

Category – Other Loans   9    8    7    6    Pass 
Consumer Real Estate   100.00%   98.340%   80.862%   26.621%   0.245%
Consumer Non-Real Estate Secured   100.00%   98.430%   61.293%   98.430%   0.000%
Consumer Non-Real Estate Unsecured   100.00%   98.390%   98.390%   7.464%   1.783%
Residential Real Estate   100.00%   98.750%   16.478%   0.633%   0.000%
Lease Receivables   100.00%   98.280%   45.773%   98.280%   0.994%

 

Unfunded Commitments    
Commercial Real Estate Lines of Credit   0.200%
Commercial Non-Real Estate Lines of Credit   0.200%
Commercial Standby Letters of Credit   0.200%
Home Equity Lines of Credit   0.200%
Consumer Real Estate Lines of Credit   0.200%
Consumer Non-Real Estate Lines of Credit   0.200%
Work-in-Process   0.200%

 

The following table sets forth information with respect to the Bank’s allocation of qualitative factors, including various subjective areas assessed in terms of basis points used in determining the overall adequacy of the ACL as of March 31, 2012. The determination of risk will result in a positive or negative adjustment to the ACL evaluation and validation. Adjustments for each component may range from -10 basis points to +25 basis points. A component score of 0 basis points indicates no effect on the ACL. A component rating of +25 basis points indicates the assessed maximum potential of increased risk to the adequacy of the ACL. A -10 basis point component rating indicates the most positive effect on the ACL.

 

   Allocation of Qualitative Factors 
Category  CML Real Estate   CML Non Real Estate   CML Unsecured   Mortgage 
                 
Loans and Leases:                    
Changes in Economic and Business Conditions   0.23%   0.22%   0.22%   0.11%
Interest Rate Risk   0.22%   0.21%   0.21%   0.11%
Effect of Concentrations of Credit   0.23%   0.20%   0.21%   0.11%
Changes in Nature and Volume of the Loan Portfolio Mix   0.23%   0.20%   0.21%   0.11%
Seasoning of the Loan Portfolio   0.23%   0.20%   0.21%   0.11%
Changes in the Volume/Severity of Past Due Loans, Nonaccrual Loans, and Classified Loans   0.23%   0.21%   0.21%   0.14%
Changes in Lending Policies and Procedures   0.15%   0.15%   0.15%   0.15%
Changes in the Quality of the Loan Review System   0.15%   0.15%   0.15%   0.14%
Changes in Experience, Ability and Depth of Lending Management and Staff   0.16%   0.16%   0.16%   0.14%
Changes in the Value of the Underlying Collateral   0.23%   0.21%   0.21%   0.13%

 

16
 

 

   Allocation of Qualitative Factors 
Category  CNS Real Estate   CNS Non Real Estate   CNS Unsecured   Leases 
                 
Loans and Leases:                    
Changes in Economic and Business Conditions   0.18%   0.16%   0.16%   0.18%
Interest Rate Risk   0.17%   0.16%   0.16%   0.17%
Effect of Concentrations of Credit   0.17%   0.15%   0.16%   0.17%
Changes in Nature and Volume of the Loan Portfolio Mix   0.17%   0.15%   0.16%   0.17%
Seasoning of the Loan Portfolio   0.17%   0.15%   0.16%   0.18%
Changes in the Volume/Severity of Past Due Loans, Nonaccrual Loans, and Classified Loans   0.17%   0.17%   0.17%   0.18%
Changes in Lending Policies and Procedures   0.15%   0.15%   0.15%   0.15%
Changes in the Quality of the Loan Review System   0.14%   0.14%   0.14%   0.16%
Changes in Experience, Ability and Depth of Lending Management and Staff   0.16%   0.16%   0.16%   0.18%
Changes in the Value of the Underlying Collateral   0.18%   0.18%   0.19%   0.18%

 

Category  CML Non Real Estate   CML Real Estate   CML Line
of Credit
   Home Equity Line   CNS Non Real Estate   CNS Real Estate 
Unfunded Commitments:                              
Changes in Economic and Business Conditions   0.03%   0.03%   0.02%   0.04%   0.02%   0.01%
Interest Rate Risk   0.03%   0.03%   0.02%   0.04%   0.02%   0.01%
Effect of Concentrations of Credit   0.02%   0.02%   0.02%   0.02%   0.02%   0.01%
Changes in Nature and Volume of the Loan Portfolio Mix   0.03%   0.03%   0.03%   0.03%   0.03%   0.02%
Seasoning of the Loan Portfolio   0.01%   0.01%   0.02%   0.02%   0.02%   0.01%
Changes in the Volume/Severity of Past Due Loans, Nonaccrual Loans, and Classified Loans   0.03%   0.03%   0.03%   0.03%   0.02%   0.01%
Changes in Lending Policies and Procedures   0.01%   0.01%   0.01%   0.01%   0.01%   0.01%
Changes in the Quality of the Loan Review System   0.02%   0.02%   0.02%   0.02%   0.01%   0.01%
Changes in Experience, Ability and Depth of Lending Management and Staff   0.01%   0.02%   0.02%   0.02%   0.01%   0.01%
Changes in the Value of the Underlying Collateral   0.02%   0.02%   0.02%   0.02%   0.02%   0.01%

 

Note 7. Troubled Debt Restructurings. The following table details performing TDR loans at March 31, 2012 and December 31, 2011 segregated by class of financing receivables:

 

   March 31, 2012   December 31, 2011 
   (Dollars in thousands) 
Performing TDR loans accounted for on an accrual basis:          
Residential mortgage  $-   $- 
Commercial real estate   8,665    22,489 
Commercial construction   129    1,401 
Commercial non-real estate   -    15 
Commercial unsecured   -    49 
Consumer real estate   138    1,406 
Home equity lines of credit   175    - 
Consumer non-real estate   27    28 
Total performing TDR loans accounted for on an accrual basis  $9,134   $25,388 
Percentage of total loans, net   1.7%   4.8%

 

17
 

 

The following table presents a roll forward of the Bank’s performing TDR loans for the three months ended March 31, 2012:

 

Performing TDRs  Beginning
Balance
   Additions
(1)
   Charge-
offs (2)
   Other (3)   Ending
Balance
 
   (In Thousands) 
March 31, 2012                         
Residential mortgage  $-   $-   $-   $-   $- 
Commercial   23,954    633    -    (15,793)   8,794 
Consumer   1,434    -    -    (1,094)   340 
Total  $25,388   $633   $-   $(16,887)  $9,134 

 

1.Includes new TDRs and increases to existing TDRs.
2.Post modification charge-offs.
3.Includes principal payments, paydowns and performing loans previously restructured at market rates that are no longer reported as TDRs.

 

The following table presents a roll forward of the Bank’s non-performing TDR loans for the three months ended March 31, 2012:

 

Non-Performing TDRs  Beginning
Balance
   Additions
(1)
   Charge-
offs (2)
   Other (3)   Ending
Balance
 
   (In Thousands) 
March 31, 2012                         
Residential mortgage  $414   $-   $-   $(414)  $- 
Commercial   20,699    9,199    (1,541)   (2,176)   26,181 
Consumer   304    -    -    -    304 
Total  $21,417   $9,199   $(1,541)  $(2,590)  $26,485 

 

1.Includes new TDRs and increases to existing TDRs.
2.Post modification charge-offs.
3.Includes principal payments, paydowns and loans previously designated as non-performing that are now current and performing in compliance with their modified terms.

 

During the three months ended March 31, 2012, none of those loans modified as TDRs listed as additions in the tables above subsequently defaulted during the period.

 

In determination of the allowance for loan losses, the Bank considers TDRs and subsequent defaults in restructuring in its estimate. As a result, the allowance may be increased, adjustments may be made in the allocation of the allowance, or charge-offs may be taken to further writedown the carrying value of the loan.

 

The Bank’s primary objective in granting concessions to borrowers having financial difficulties is an attempt to protect as much of its investment as possible. The Bank faces significant challenges when working with borrowers who are experiencing diminished operating cash flows, depreciated collateral values, or prolonged sales and rental absorption periods. While borrowers may experience deterioration in their financial condition, many continue to be creditworthy customers who have the willingness and capacity to repay their debts. In such cases, the Bank finds it mutually beneficial to work constructively together with its borrowers, and that prudent restructurings are often in the best interest of the Bank and the borrower.

 

The Bank offers a variety of TDR programs on a loan-by-loan basis in which, for economic or legal reasons related to an individual borrower’s financial condition, it grants a concession to the borrower that would not otherwise be considered. The restructuring of a troubled loan may include, but is not limited to any one or combination of the following: a modification of the loan terms such as a reduction of the contractual interest rate, principal, payment amount or accrued interest; an extension of the maturity date at a stated interest rate lower than the current market rate for a new debt with similar risks; a change in payment type, e.g. from principal and interest, to interest only with all principal and interest due at maturity; a substitution or acceptance of additional collateral; and a substitution or addition of new debtors for the original borrower.

 

The Bank’s restructuring success includes but is not limited to any one or combination of the following: improves the prospects for repayment of principal and interest; reduces the prospects of further write downs and charge-offs; reduces the prospects of potential additional foreclosures; helps borrowers to maintain a creditworthy status; and ultimately will reduce the volume of classified, criticized and/or nonaccrual loans.

 

18
 

 

The Bank identifies loans for potential restructuring on a loan-by-loan basis using a variety of sources which may include, but is not limited to any one or combination of the following: being approached or contacted by the borrower to modify loan terms; review of borrower’s financial statements indicates borrower may be experiencing financial difficulties; past due payment reports; loans extending past their stated maturity date; and nonaccrual loan reports.

 

On a loan-by-loan basis, the Bank restructures loans that were either on nonaccrual basis prior to restructuring or on accrual basis prior to restructuring. If a loan was on nonaccrual basis prior to restructuring, it remains on nonaccrual basis until the borrower has demonstrated a willingness and ability to meet the terms and conditions of the restructuring and to make the restructured loan payments, generally for a period of at least six months. The Bank has not immediately placed any restructured loan on accrual status that was on nonaccrual status prior to restructuring.

 

If a restructured loan was on accrual basis prior to restructuring and the Bank expects the borrower to perform to the terms and conditions of the loan after restructuring (i.e. the loan was current, on accrual basis, the monthly payment is not significantly larger than the contractual payment before restructuring, and the borrower has the ability to make the restructured loan payments), the loan remains on an accrual basis and placement on nonaccrual is not required.

 

The Bank has performed restructurings on certain troubled loan workouts, whereby existing loans are restructured into a multiple note structure (i.e., A Note and B Note structure). The Bank separates a portion of the current outstanding debt into a new legally enforceable note (Note A) that is reasonably assured of repayment and performance according to prudently modified terms. The portion of the debt that is not reasonably assured of repayment (Note B) is adversely classified and charged-off as appropriate.

 

The following table includes the amount of multiple note restructures for certain commercial real estate loan workouts at March 31, 2012 and December 31, 2011, respectively:

 

   March 31, 2012   December 31, 2011 
   (In thousands) 
Note A Structure          
Commercial real estate (1)  $3,810   $3,832 
Note B Structure          
Commercial real estate (2)   1,796    1,796 
Total  $5,606   $5,628 

 
 
(1)Note A may be placed back on accrual status based on sustained historical payment performance, generally six months.
(2)Note B is immediately charged-off upon restructuring; however, payment in full is due at maturity of the note.
(3)During the three months ended March 31, 2012, interest income was reduced by $31,959 as a result of multiple note restructures, compared to none for the three months ended March 31, 2011.

 

The benefit of this workout strategy is for the A note to remain a performing asset for which the borrower has the willingness and ability to meet the restructured payment terms and conditions. In addition, this workout strategy reduces the prospects of further write downs and charge offs, and also reduces the prospects of a potential foreclosure. Following this restructuring, the Note A credit classification generally improves from “substandard” to “pass”.

 

The general terms of the new loans restructured under the Note A and Note B structure differ as follows:

 

Note A: First lien position; fixed or adjustable current market interest rate; fixed month term to maturity; payments – interest only to maturity, or full principal and interest to maturity. Note A is underwritten in accordance with the Bank’s customary underwriting standards and is on an accrual basis.

 

Note B: Second lien position; fixed or adjustable below current market interest rate; fixed month term to maturity; payments – due in full at maturity. Note B is underwritten in accordance with the Bank’s customary underwriting standards, except for the below market interest rate and payment terms, and is on a nonaccrual basis.

 

Note 8. Other Real Estate Owned. The following table reflects the changes in other real estate owned during the three months ended March 31, 2012:

 

   Balance               Balance 
   December 31,           Fair Value   March 31, 
   2011   Additions   Sales, net   Adjustments   2012 
   (In thousands) 
Other Real Estate Owned  $17,005   $2,235   $(1,013)  $(903)  $17,324 

 

19
 

 

The following table reflects changes in other real estate owned during the three months ended March 31, 2011.

 

   Balance                 Transfer to    Balance 
   December 31,           Fair Value     Premises and    March 31, 
   2010   Additions   Sales, net   Adjustments     Equipment    2011 
   (In thousands) 
Other Real Estate Owned  $11,616   $3,593   $(1,746)  $(643)  (751   $12,069 

 

Fair value adjustments to other real estate owned (“OREO”) are recorded to adjust the carrying values of these properties to their estimated fair market values. In most cases, the estimated fair market values are derived from an initial appraisal, an updated appraisal or a broker’s price opinion (“BPO”). In certain instances when a listing agreement is renewed for a lesser amount, management will adjust the recorded estimated fair value of the subject property accordingly. Additionally, in certain instances when the Bank receives an offer to purchase near the end of a quarterly accounting period for less than the current carrying value and the sale does not consummate until the next accounting period, management will adjust the recorded estimated fair value of the subject property accordingly.

 

Note 9. Fair Value Measurement. Fair value is defined as the price that would be received on the sale of an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. A fair value hierarchy prioritizes the inputs of valuation techniques used to measure fair value of nonfinancial assets and liabilities. The inputs are evaluated and an overall level for the fair value measurement is determined. This overall level is an indication of the market observability of the fair value measurement. In order to determine the fair value, the Bank must determine the unit of account, highest and best use, principal market, and market participants. These determinations allow the Bank to define the inputs for fair value and level of hierarchy. Outlined below is the application of the fair value hierarchy to the Bank’s financial assets that are carried at fair value.

 

Level 1-inputs to the valuation methodology are quoted prices (unadjusted) in active markets for identical assets or liabilities that the reporting entity has the ability to access at the measurement date. A quoted price in an active market provides the most reliable evidence of fair value and shall be used to measure fair value whenever available. The type of assets carried at Level 1 fair value includes investments such as U. S. Treasury and U. S. government agency securities.

 

Level 2-inputs to the valuation methodology include quoted prices for similar assets or liabilities in active markets and price quotations can vary substantially either over time or among market makers. The type of assets carried at Level 2 fair value generally includes investment securities such as Government Sponsored Enterprises (“GSEs”) and the Bank’s investment in other real estate owned.

 

Level 3-inputs to the valuation methodology are unobservable to the extent that observable inputs are not available. Unobservable inputs are developed based on the best information available in the circumstances and might include the Bank’s own assumptions. The Bank shall not ignore information about market participant assumptions that is reasonably available without undue cost and effort. The type of assets carried at Level 3 fair value generally include investments backed by non-traditional mortgage loans or certain state or local housing agency obligations, of which the Bank has no such assets or liabilities.

 

Assets measured at fair value on a recurring basis as of March 31, 2012 and December 31, 2011:

 

   Fair Value   Quoted Prices In
Active Markets
for Identical Assets
   Significant
Observable
Inputs-Other
   Significant
Unobservable
Inputs
 
   (In thousands) 
Description  3/31/12   (Level 1)   (Level 2)   (Level 3) 
Securities available for sale:                    
Mortgage-backed  $123,036   $-   $123,036   $- 
Total March 31, 2012  $123,036   $-   $123,036   $- 

 

Description  12/31/11   (Level 1)   (Level 2)   (Level 3) 
Securities available for sale:                    
Mortgage-backed  $138,515   $-   $138,515   $- 
Total December 31, 2011  $138,515   $-   $138,515   $- 

 

20
 

 

Quoted market price for similar assets in active markets is the valuation technique for determining fair value of available for sale securities. Unrealized gains on available for sale securities are included in the “accumulated other comprehensive income” component of the Stockholders’ Equity section of the Consolidated Statements of Financial Condition.

 

Assets measured at fair value on a non-recurring basis as of March 31, 2012 and December 31, 2011:

 

   Fair Value   Quoted Prices In
Active Markets for
Identical Assets
   Significant
Observable
Inputs-Other
   Significant
Unobservable
Inputs
 
   (In thousands) 
Description  3/31/12   (Level 1)   (Level 2)   (Level 3) 
Impaired loans, net (1)  $73,183   $-   $73,183   $- 
Other real estate owned   17,324    -    -    17,324 
Total March 31, 2012  $90,507   $-   $73,183   $17,324 

 

Description  12/31/11   (Level 1)   (Level 2)   (Level 3) 
Impaired loans, net (1)  $77,279   $-   $77,279   $- 
Other real estate owned   17,005    -    -    17,005 
Total December 31, 2011  $94,284   $-   $77,279   $17,005 

_

 

(1)At March 31, 2012 and December 31, 2011, includes $52.8 million and $53.2 million, respectively, of loans identified as impaired, even though an impairment analysis calculated pursuant to ASC 310-10-35 (formerly FAS 114) resulted in no impairment loss recognition.

 

The Bank does not record loans at fair value on a recurring basis. However, when a loan is considered impaired, an impairment write down is taken, based on the estimated fair value of the loan. The fair value of impaired loans is estimated using one of several methods, including collateral value, market value of similar debt, enterprise value, liquidation value and discounted cash flows. Those loans not requiring a write down represent loans for which the fair value of the expected repayments or collateral exceed the recorded investments in such loans, and are not included above. Impaired loans where a write down is taken based on fair value of collateral require classification in the fair value hierarchy. When the fair value of the collateral is based on an observable market price or a current appraised value, the Bank records the impaired loan as non-recurring Level 2. When an appraised value is not available or management determines the fair value of the collateral is further impaired below the appraised value and there is no observable market price, the Bank classifies the impaired loan as non-recurring Level 3.

 

Other real estate owned acquired through loan foreclosure is recorded at lower of cost or fair value upon transfer of the loans to foreclosed assets, based on the appraised market value of the property. Subsequently, foreclosed assets are carried at the lower of carrying value or fair value. Fair value is based upon independent market prices, appraised values of the collateral or management’s estimation of the value of the collateral. When an appraised value is not available or management determines the fair value of the collateral is impaired below the appraised value and there is no observable market price, the Company classifies the foreclosed asset as non-recurring Level 3. Fair value adjustments of $902,945 were made to OREO during the three months ended March 31, 2012, compared to $643,705 made during the three months ended March 31, 2011.

 

Net losses realized and included in earnings for the three months ended March 31, 2012 and 2011 are reported in other revenues as follows:

 

  

Three Months

Ended

3/31/12

  

Three Months

Ended

3/31/11

 
Loss on sale of real estate, net  $28,964   $82,095 

 

No liabilities were measured at fair value on a recurring or non-recurring basis at March 31, 2012 or December 31, 2011.

 

21
 

 

Note 10. Fair Value of Financial Instruments. The following table represents the recorded carrying values and estimated fair values of the Company’s financial instruments at March 31, 2012 and December 31, 2011:

 

   March 31, 2012   December 31, 2011 
   Estimated   Carrying   Estimated   Carrying 
   Fair Value   Amount   Fair Value   Amount 
   (In thousands) 
Financial assets:                    
Cash and due from banks  $15,569   $15,569   $14,298   $14,298 
Interest-bearing deposits in other banks   49,093    49,093    18,476    18,476 
Mortgage-backed securities available for sale   123,036    123,036    138,515    138,515 
Loans and leases, net   515,725    511,385    529,736    525,202 
Stock in Federal Home Loan Bank of Atlanta   1,887    1,887    1,887    1,887 
Accrued interest receivable   2,451    2,451    2,210    2,210 

 

   March 31, 2012   December 31, 2011 
   Estimated   Carrying   Estimated   Carrying 
   Fair Value   Amount   Fair Value   Amount 
   (In thousands) 
Financial liabilities:                    
Deposits  $653,136   $648,348   $648,403   $642,617 
Borrowed money:                    
Repurchase agreements   1,681    1,681    2,096    2,096 
Junior subordinated debentures   10,310    10,310    10,310    10,310 

 

Fair values have been estimated using data which management considers as the best available, and estimation methodologies deemed suitable for the pertinent category of financial instrument. The estimation methodologies used by the Bank were as follows:

 

Cash and Due from Banks and Interest –Bearing Deposits in Other Banks. The carrying amounts for cash and due from banks and interest bearing deposits in other banks approximate their fair value because of the short maturities of these financial instruments.

 

Mortgage-Backed Securities Available for Sale. The estimated fair value of mortgage-backed securities is provided in Note 4 above of Notes to Consolidated Financial Statements. These are based on quoted market prices, when available. If a quoted market price is not available, fair value is estimated using quoted market prices for similar securities.

 

Loans and Leases, Net. Fair values are estimated for portfolios of loans and leases with similar financial characteristics, such as residential mortgage. Loans and leases are segregated by type of loan, fixed and variable interest rate terms. The fair value of each category is determined by discounting scheduled future cash flows using current interest rates offered on loans or leases with similar characteristics. Fair values for impaired loans and leases are estimated based on discounted cash flows or underlying collateral values, where applicable.

 

Stock in Federal Home Loan Bank of Atlanta. The fair value for FHLB stock approximates carrying value, based on the redemption provisions of the Federal Home Loan Bank.

 

Deposits. The fair value of demand deposits is the amount payable on demand at the reporting date. The fair values of certificates of deposits are estimated using the rates currently offered for similar instruments with similar remaining maturities.

 

Accrued Interest Receivable, Repurchase Agreements and Junior Subordinated Debentures. The carrying amount of accrued interest receivable, repurchase agreements, and junior subordinated debentures approximates fair value because of the short maturities of these instruments.

 

Financial Instruments with Off-Balance Sheet Risk. With regard to financial instruments with off-balance sheet risk, it is not practicable to estimate the fair value of future financing commitments.

 

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Note 11. Stock-Based Compensation. The Company had two stock-based compensation plans at March 31, 2012. The shares outstanding are for grants under the Company’s 1997 Stock Option Plan (the “1997 Plan”) and the 2008 Equity Incentive Plan (the “2008 Plan”). The 1997 Plan matured on April 8, 2008 and no additional options may be granted under the 1997 Plan. At March 31, 2012, the 1997 Plan had 80,271 granted unexercised shares, and the 2008 Plan had 101,000 granted unexercised shares and 857,000 shares available to be granted. No restricted shares were granted under the 2008 Plan during the three months ended March 31, 2012.

 

Stock options expire ten years from the date of grant and vest over service periods ranging from one year to five years. Options granted under the 2008 Plan are granted at the closing sales price of the Company’s common stock on the NASDAQ Stock Market on the date of grant. The Company settles stock option exercises with treasury shares.

 

A summary of option activity under the Plans as of March 31, 2012 and 2011, and changes during the three month periods ended March 31, 2012 and 2011 is presented below:

 

  

Options

Outstanding

   Price  

Aggregate

Intrinsic Value

 
Three Months Ended  March 31, 2012:               
Outstanding at December 31, 2011   166,833   $15.26      
Granted   20,000   $4.12      
Forfeited   (5,562)  $15.13      
Exercised   0   $.00      
Outstanding at March 31, 2012   181,271   $14.03   $(1,818,929)
Vested and Exercisable at March 31, 2012   131,789   $16.71   $(1,674,501)
                
Three Months Ended March 31, 2011:               
Outstanding at December 31, 2010   181,441   $15.60      
Granted   21,000   $5.40      
Forfeited   (1,500)  $26.97      
Exercised   0   $.00      
Outstanding at March 31, 2011   200,941   $14.45   $(1,900,166)
Vested and Exercisable at March 31, 2011   136,326   $16.20   $(1,527,614)

 

The average fair value per share of options granted in the three months ended March 31, 2012 was $1.59, compared to $2.23 per share of options granted in the three months ended March 31, 2011. The fair value of each option grant is estimated on the date of grant using the Black-Scholes option-pricing model.

 

The following weighted-average assumptions were used for grants awarded in the three months ended March 31, 2012 and 2011:

 

  

Three Months

Ended 

3/31/12

  

Three Months

Ended 

3/31/11

 
Dividend growth rate   0.0%   0.0%
Expected volatility   37.4%   37.8%
Average risk-free interest rate   1.7%   2.8%
Expected lives - years   6    6 

 

There were no stock options exercised during the three months ended March 31, 2012 or 2011. Consequently, there were no income tax benefits realized and no intrinsic value for options exercised during the three months ended March 31, 2012 or 2011.

 

The following table summarizes additional information about the Company’s outstanding options and exercisable options as of March 31, 2012, including weighted-average remaining contractual term expressed in years ("Life") and weighted average exercise price (“Price”):

 

   Outstanding   Exercisable 
Range of Exercise Price  Shares   Life   Price   Shares   Price 
$4.12 – 10.91   76,000    8.55   $7.14    34,668   $9.29 
$11.80 – 16.49   47,396    2.80   $15.17    40,896   $15.50 
$17.27 – 25.07   46,625    5.07   $20.61    45,125   $20.58 
$26.17 – 33.27   11,250    4.74   $28.62    11,100   $28.57 
    181,271    5.92   $14.03    131,789   $16.71 

 

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A summary of nonvested option shares as of March 31, 2012 and 2011, and changes during the three months ended March 31, 2012 and 2011, is presented below:

 

   Shares   Price 
Three Months Ended March 31, 2012:          
Nonvested at December 31, 2011   54,316   $9.43 
Granted   20,000   $4.12 
Forfeited   (2,000)  $12.95 
Vested   (22,834)  $9.89 
Nonvested at March 31, 2012   49,482   $6.92 
           
Three Months Ended March 31, 2011:          
Nonvested at December 31, 2010   63,116   $13.04 
Granted   21,000   $5.40 
Forfeited   0   $.00 
Vested   (19,501)  $12.37 
Nonvested at March 31, 2011   64,615   $10.76 

 

Net compensation cost charged against income was $1,803 for the three months ended March 31, 2012, compared to $28,617 of cost charged against income for the three months ended March 31, 2011. Total recapture credits against compensation expense on forfeited options was $16,977 for the three months ended March 31, 2012, compared to $7,578 for the three months ended March 31, 2011. As of March 31, 2012, total unrecognized compensation cost on granted unexercised shares was $102,875, and is expected to be recognized over the next three years.

 

Fair value compensation cost recognition provisions for share-based payments is different from the recognition provisions of the intrinsic value method for recording compensation cost. The following table reflects the impact of fair value compensation cost recognition on income before income taxes, net income, basic earnings per share and diluted earnings per share for the three month periods ended March 31, 2012 and 2011:

 

  

Three Months

Ended

3/31/12

  

Three Months

Ended

3/31/11

 
Reduce net income before income taxes  $1,803   $28,617 
Reduce net income  $1,657   $28,202 
Reduce basic earnings per share  $0.00   $0.01 
Reduce diluted earnings per share  $0.00   $0.01 

 

Note 12. Recent Accounting Pronouncements.

 

The following summarizes recent accounting pronouncements and their expected impact on the Company.

 

In April 2011, the FASB issued new guidance on Reconsideration of Effective Control for Repurchase Agreements. This guidance improves the accounting for repurchase agreements and other agreements that entitle and obligate a transferor to repurchase or redeem financial assets before their maturity. This guidance is effective for reporting periods beginning after December 15, 2011. The adoption of this guidance was not material to the Company’s consolidated financial statements.

 

In May 2011, the FASB issued new guidance on Fair Value Measurement. This guidance results in common fair value measurement and disclosure requirements in U.S. GAAP and IFRSs. The amendments change the wording used to describe many of the requirements in U.S. GAAP for measuring fair value and for disclosing information about fair value measurements. This guidance is effective for reporting periods beginning after December 15, 2011. The adoption of this guidance was not material to the Company’s consolidated financial statements.

 

In June 2011, the FASB issued new guidance on Comprehensive Income. This guidance improves the comparability, consistency and transparency of financial reporting and increases the prominence of items reported in other comprehensive income. This guidance is effective for reporting periods beginning after December 15, 2011. The adoption of this guidance was not material to the Company’s consolidated financial statements.

 

In September 2011, the FASB issued new guidance on Testing Goodwill for Impairment. This guidance simplifies how an entity tests goodwill for impairment and allows an option to first assess qualitative factors to determine whether it is necessary to perform the two-step qualitative goodwill impairment test. Under that option, an entity no longer would be required to calculate the fair value of a reporting unit unless the entity determines, based on that qualitative assessment, that it is more likely than not that its fair value is less than its carrying amount. This guidance is effective for reporting periods beginning after December 15, 2011. The adoption of this guidance was not material to the Company’s consolidated financial statements.

 

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In December 2011, the FASB issued new guidance on Derecognition of in Substance Real Estate – a Scope Clarification. This guidance provides clarification for when a parent company ceases to have a controlling financial interest in a subsidiary that is in substance real estate as a result of default on the subsidiary’s nonrecourse debt. This guidance is effective for reporting periods beginning after June 15, 2012. The Company will evaluate the impact this guidance may have on its consolidated financial statements.

 

In December 2011, the FASB issued new guidance on Disclosures about Offsetting Assets and Liabilities. This guidance requires an entity to disclose information about offsetting (netting assets and liabilities) and related arrangements to enable users of its financial statements to understand the effect of those arrangements on its financial position. This guidance is effective for reporting periods beginning on or after January 1, 2013. The Company will evaluate the impact this guidance may have on its consolidated financial statements.

 

In December 2011, the FASB issued new guidance on Deferral of the Effective Date for Amendments to the Presentation of Reclassifications of Items out of Accumulated Other Comprehensive Income in Accounting Standards Update No. 2011-05. This guidance is being made to allow the FASB time to redeliberate whether to present on the face of the financial statements the effects of reclassifications out of accumulated other comprehensive income on the components of net income and other comprehensive income for all periods presented. All other requirements in ASU 2011-05 are effective for reporting periods beginning after December 15, 2011. The adoption of this guidance was not material to the Company’s consolidated financial statements.

 

Other accounting standards that have been issued or proposed by the FASB or other standards-setting bodies are not expected to have a material impact on the Company’s financial position, results of operations or cash flows.

 

From time to time the FASB issues exposure drafts for proposed statements of financial accounting standards.  Such exposure drafts are subject to comment from the public, to revisions by the FASB and to final issuance by the FASB as statements of financial accounting standards.  Management considers the effect of the proposed statements and SEC Staff Accounting Bulletins on the consolidated financial statements of the Company and monitors the status of changes to and proposed effective dates of exposure drafts.

 

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Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.

First South Bancorp, Inc. (the "Company") was formed for the purpose of issuing common stock and owning 100% of the stock of First South Bank (the "Bank") and operating through the Bank a commercial banking business. Therefore, the discussion below focuses primarily on the Bank's results of operations. The Bank has one significant operating segment, the providing of general commercial banking services to its markets located in the state of North Carolina. The Company’s common stock is traded on the NASDAQ Global Select Market under the symbol "FSBK".

 

Comparison of Financial Condition at March 31, 2012 and December 31, 2011. Total assets increased to $750.3 million at March 31, 2012, from $746.9 million at December 31, 2011. Earning assets increased to $682.1 million at March 31, 2012, from $681.5 million at December 31, 2011, reflecting the net change in the composition of earning assets, as further discussed below. The ratio of earning assets to total assets was 90.9% at March 31, 2012, compared to 91.2% at December 31, 2011.

 

Interest-bearing overnight deposits in financial institutions increased to $49.1 million at March 31, 2012, from $18.5 million at December 31, 2011. Overnight deposits are available to fund loan originations, deposit withdrawals, securities purchases, liquidity management activities and daily operations of the Bank.

 

Mortgage-backed securities available for sale declined to $123.0 million at March 31, 2012, from $138.5 million at December 31, 2011. The Bank may sell mortgage-backed securities to support a more balanced sensitivity to future interest rate changes and may securitize mortgage loans held for sale into mortgage-backed securities to support adequate liquidity levels. During the three months ended March 31, 2012, the Bank sold $23.5 million of mortgage-backed securities available for sale, compared to $2.4 million sold in the three months ended March 31, 2011. Also, during the three months ended March 31, 2012, $13.5 million of mortgage loans held for sale were securitized into mortgage-backed securities available for sale, compared to $3.9 million securitized in the three months ended March 31, 2011. See “Note 4. Mortgage-Backed Securities” of “Notes to Consolidated Financial Statements (Unaudited)” for additional information.

 

Loans held for sale increased to $9.4 million at March 31, 2012, from $6.4 million at December 31, 2011. Proceeds from loan sales were $5.8 million for the three months ended March 31, 2012, compared to $6.3 million for the three months ended March 31, 2011. Proceeds from loan sales are primarily used to fund liquidity needs of the Bank, including loan originations, deposit withdrawals, repayment of borrowings, investment security purchases and general banking operations. Loans serviced for others declined to $316.3 million at March 31, 2012, from $319.4 million at December 31, 2011.

 

Loans and leases receivable held for investment declined to $516.4 million at March 31, 2012 from $534.0 million at December 31, 2011. During the three months ended March 31, 2012, certain loans held for investment were subjects of foreclosure and transferred to other real estate owned, as discussed below. In addition, a portion of the proceeds from principal repayments on loans held for investment is used to fund the liquidity needs of the Bank, including those discussed above.

 

Total loans on non-accrual status and restructured loans (TDRs) on non-accrual status declined to $37.5 million at March 31, 2012, from $43.0 million at December 31, 2011. Loans on non-accrual status declined to $11.0 million at March 31, 2012, from $21.6 million at December 31, 2011. At March 31, 2012, $2.3 million of these loans were earning interest, compared to $10.6 million at December 31, 2011. TDRs on non-accrual status increased to $26.5 million at March 31, 2012, from $21.4 million at December 31, 2011. At March 31, 2012, $20.5 million of TDRs on non-accrual status were making payments according to the terms of their restructure, compared to $12.2 million at December 31, 2011. Past due TDRs on non-accrual status declined to $6.0 million at March 31, 2012, from $9.2 million at December 31, 2011.

 

Performing TDRs on full accrual status declined to $9.1 million at March 31, 2012, from $25.4 million at December 31, 2011. Certain performing TDRs have been restored to full accrual status, as they need not continue to be reported as a restructure in calendar years after the year in which the restructuring took place, if the loan is in compliance with its modified terms and yields a market rate.

 

26
 

 

The economy continues to present a challenging credit environment for the Bank and its customers. Economic pressure continues to impact market values of housing and other real estate property in the Bank’s market area and credit quality of certain borrowers. Management believes it has thoroughly evaluated its non-performing loans and they are either well collateralized or adequately reserved. However, there can be no assurance in the future that regulators, increased risks in the loan portfolio, adverse changes in economic conditions or other factors will not require further adjustments to the allowance for credit losses.

 

Aside from the loans defined as nonaccrual, over 90 days past due, classified, or restructured, there were no loans at March 31, 2012, where known information about possible credit problems of borrowers caused management to have serious concerns as to the ability of the borrowers to comply with their current loan repayment terms. There were $120,000 of loans that were accruing interest and contractually over 90 days past due at March 31, 2012. Additional gross interest income of $2,000 was recorded on these loans in the three months ended March 31, 2012.

 

Loans are generally placed on nonaccrual status, and accrued but unpaid interest is reversed, when in management’s judgment, it is determined that the collectability of interest, but not necessarily principal, is doubtful. Generally, this occurs when payment is delinquent in excess of 90 days. Consumer loans that have become more than 180 days past due are generally charged off or a specific allowance may be provided for any expected loss. All other loans are charged off when management concludes that they are uncollectible.

 

Based on an impairment analysis of the Bank’s loan and lease portfolio, there were $74.9 million of loans classified as impaired at March 31, 2012, net of $13.2 million in write-downs compared to $78.9 million classified as impaired at December 31, 2011, net of $13.4 million in write-downs. At March 31, 2012 and December 31, 2011, the allowance for loan and leases losses included $1.7 million and $1.6 million specifically provided for impaired loans, respectively. A loan is considered impaired, based on current information and events, if it is probable that the Bank will be unable to collect the scheduled payments of principal and interest when due according to the contractual terms of the loan arrangement. All collateral-dependent loans are measured for impairment based on the fair value of the collateral, while uncollateralized loans and other loans determined not to be collateral dependent are measured for impairment based on the present value of expected future cash flows discounted at the historical effective interest rate. The Bank uses several factors in determining if a loan is impaired. The internal asset classification procedures include a thorough review of significant loans and lending relationships and include the accumulation of related data. This data includes loan payments status, borrowers’ financial data and borrowers’ operating factors such as cash flows, operating income or loss, and various other matters.

 

See “Note 5. Loans Receivable”, “Note 6. Allowance for Credit Losses” and “Note 7. Troubled Debt Restructurings” of “Notes to Consolidated Financial Statements (Unaudited)” for additional information.

 

Other real estate owned acquired from foreclosures increased to $17.3 million at March 31, 2012, from $17.0 million at December 31, 2011, reflecting the net of additions, disposals and fair value adjustments. During the three months ended March 31, 2012 there were $2.2 million of additions, $1.0 million of disposals, and $903,000 of fair value adjustments. Other real estate owned consists of residential and commercial properties, developed lots and three residential subdivisions containing developed lots and raw land. The Bank believes the adjusted carrying values of these properties are representative of their fair market values, although there can be no assurances that the ultimate sales will be equal to or greater than the carrying values. See “Note 8. Other Real Estate Owned” and “Note 9. Fair Value Measurement” of “Notes to Consolidated Financial Statements (Unaudited)” for additional information.

 

Total deposits increased to $648.3 million at March 31, 2012, from $642.6 million at December 31, 2011. Demand accounts (personal and business checking accounts and money market accounts) increased to $262.5 million at March 31, 2012, from $243.7 million at December 31, 2011.

 

Time deposits declined to $354.8 million at March 31, 2012, from $369.9 million at December 31, 2011. The Bank attempts to manage its cost of deposits by monitoring the volume and rates paid on maturing certificates of deposits in relationship to current funding needs and market interest rates. The Bank did not renew certain higher rate maturing time deposits during the three months ended March 31, 2012 and was able to reprice new and maturing time deposits at lower rates. See “Interest Expense” below for additional information regarding the Bank’s cost of funds.

 

27
 

 

Borrowed money consisting primarily of repurchase agreements declined to $1.7 million at March 31, 2012, from $2.1 million at December 31, 2011. Repurchase agreements represent funds held in cash management accounts for commercial banking customers. There were no FHLB advances outstanding at March 31, 2012 or December 31, 2011. The Bank may also use lower costing FHLB borrowings as a funding source, providing an effective means of managing its overall cost of funds.

 

Stockholders' equity increased to $84.3 million at March 31, 2012, from $84.1 million at December 31, 2011, reflecting the net effect of earnings and changes in accumulated other comprehensive income. The equity to assets ratio was 11.2% at March 31, 2012, compared to 11.3% at December 31, 2011. See "Consolidated Statements of Changes in Stockholders' Equity" for additional information.

 

Accumulated other comprehensive income was $3.4 million at March 31, 2012, compared to $3.7 million at December 31, 2011, reflecting the net unrealized gains in the available for sale mortgage-backed securities portfolio based on current market prices. See “Note 3. Comprehensive Income” of “Notes to Consolidated Financial Statements (Unaudited)” for additional information.

 

The Bank is subject to various capital requirements administered by federal and state banking agencies. As of March 31, 2012, the Bank's regulatory capital ratios were in excess of all regulatory requirements and are listed as follows: Total Risk-Based Capital – 15.8%; Tier 1 Risk-Based Capital – 14.5%; and Tier 1 Leverage Capital – 10.2%. See “Part 1. Financial Information - Selected Financial Data (Unaudited)” above, and "Liquidity and Capital Resources" below for additional information.

 

There were 1,502,951 treasury shares held totaling $32.0 million at both March 31, 2012 and December 31, 2011. Treasury shares are used for general purposes including the exercise of stock options and providing shares for potential future stock splits.

 

Comparison of Operating Results – Three months ended March 31, 2012 and 2011. Net income for the three months ended March 31, 2012 increased to $462,000, compared to $327,000 for the three months ended March 31, 2011. Net income per diluted common share increased to $0.05 per share for the three months ended March 31, 2012, from $0.03 per share for the three months ended March 31, 2011.

 

Net earnings during the three months ended March 31, 2012 were influenced by the amount of provisions for credit losses required to replenish net charge-offs; a decline in the volume of average earning assets; expenses attributable to other real estate owned properties; while being partially offset by a reduction in interest funding expense and gains on mortgage-backed securities sales. The current economy continues to present a challenging credit environment for the Bank and for some of its customers. As the Bank addresses and manages through these challenges, it remains focused on long-term strategies. These strategies include remediating problem assets, maintaining adequate levels of capital and liquidity, improving efficiency in operations, building core customer relationships and improving franchise value along with stockholder value. The Bank continues to maintain a strong capital position in excess of the well-capitalized regulatory guidelines, and combined with strengthening of the allowance for credit losses should enhance future earnings as the current economic conditions substantially improve.

 

Key performance ratios are return on average assets (ROA), return on average equity (ROE), and efficiency. ROA was .3% for the three months ended March 31, 2012, compared to .2% for the three months ended March 31, 2011. ROE was 2.2% for the three months ended March 31, 2012, compared to 1.6% for the three months ended March 31, 2011. The efficiency ratio was 76.6% for the three months ended March 31, 2012, compared to 69.3% for the three months ended March 31, 2011.

 

Interest Income. Interest income declined to $8.9 million for the three months ended March 31, 2012, from $9.9 million for the three months ended March 31, 2011. The reduction in the amount of interest income is primarily due to lower interest rates during the comparative reporting periods and a decline in the volume of average interest-earning assets. Average interest-earning assets declined to $678.0 million for the three months ended March 31, 2012, from $708.0 million for the three months ended March 31, 2011. The reduction in average interest-earning assets reflects the net impact of the decrease in loans and leases receivable; sales, purchases and maturities of mortgage-backed securities; and the volume of other real estate owned and non-performing loans. The yield on average interest-earning assets declined to 5.3% for the three months ended March 31, 2012, from 5.6% for the three months ended March 31, 2011. The yield on average interest-earning assets has also been impacted by the decline in interest rates and average interest-earning assets during the comparative reporting periods.

 

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Interest Expense. Interest expense declined to $1.4 million for the three months ended March 31, 2012, from $2.1 million for the three months ended March 31, 2011, reflecting lower interest rates between the comparative reporting periods and a decline in the volume of average interest-bearing liabilities. The cost of funds improved to .9% for the three months ended March 31, 2012, from 1.2% for the three months ended March 31, 2011. The Company was able to improve its cost of funds by a combination of the growth in lower costing demand accounts, new time deposit pricing and the repricing of maturing time deposits within the lower interest rate environment. Average deposits and borrowings declined to $652.3 million for the three months ended March 31, 2012, from $708.1 million for the three months ended March 31, 2011.

 

Net Interest Income. Net interest income declined to $7.5 million for the three months ended March 31, 2012, from $7.8 million for the three months ended March 31, 2011. The interest rate spread (the difference between the effective yield on average earning assets and the effective cost of average deposits and borrowings) remained constant at 4.4% for both the three months ended March 31, 2012 and 2011. The net yield on interest-earning assets (net interest income divided by average interest-earning assets) also remained constant at 4.4% for both the three months ended March 31, 2012 and 2011. The consistency of the interest rate spread and net yield on interest-earning assets is a result of the interest rate environment and volumes of interest-earning assets and interest-bearing liabilities during the comparative reporting periods.

 

The following tables contain information relating to the Company’s average statement of financial condition and reflect the yield on average earning assets and the average cost of funds for the three months ended March 31, 2012 and 2011. Average balances are derived from month end balances. The Company does not believe that using month end balances rather than average daily balances has caused any material difference in the information presented. The average loan balances listed in interest earning assets do not include nonaccrual loan balances. The interest rate spread represents the difference between the yield on earning assets and the average cost of funds. The net yield on earning assets represents net interest income divided by average earning assets.

 

29
 

 

Yield/Cost Analysis  Quarter Ended March 31, 2012   Quarter Ended March 31,  2011 
   (Dollars in thousands) 
           Average           Average 
   Average       Yield/   Average       Yield/ 
   Balance   Interest   Cost   Balance   Interest   Cost 
Interest earning assets:                              
Loans receivable  $515,700   $7,667    5.95%  $575,876   $8,824    6.13%
Investments and deposits   162,343    1,247    3.07%   132,106    1,067    3.23%
Total earning assets   678,043    8,914    5.26%   707,982    9,891    5.59%
Nonearning assets   66,352              86,633           
Total assets  $744,395             $794,615           
                               
Interest bearing liabilities:                              
Deposits  $543,210    1,322    0.97%  $593,348    1,977    1.33%
Borrowings   1,759    1    0.23%   4,396    27    2.46%
Junior subordinated debentures   10,310    92    3.57%   10,310    81    3.14%
Total interest-bearing liabilities   555,279    1,415    1.02%   608,054    2,085    1.37%
Noninterest bearing demand deposits   97,027    0    0.00%   100,043    0    0.00%
Total sources of funds   652,306    1,415    0.87%   708,097    2,085    1.18%
Other liabilities and stockholders’ equity:                              
Other liabilities   7,507              6,540           
Stockholders' equity   84,582              79,978           
Total liabilities and stockholders' equity  $744,395             $794,615           
Net interest income       $7,499             $7,806      
Interest rate spread             4.29%             4.41%
Net yield on earning assets             4.42%             4.41%
Ratio of earning assets to interest bearing liabilities             122.11%             116.43%

 

Provision for Credit Losses. The Bank's methodology for determining its provision for credit losses includes amounts specifically allocated to credits that are individually determined to be impaired, as well as general provisions allocated to groups of loans that have not been individually assessed for impairment. The Bank recorded $1.8 million of provisions for credit losses in the three months ended March 31, 2012, compared to $2.5 million in the three months ended March 31, 2011. The provision for credit losses was necessary to replenish net charge offs of $2.6 million recorded in the three months ended March 31, 2012, compared to $2.0 million in the three months ended March 31, 2011, and to maintain the allowance for credit losses at a level that management believes is adequate to absorb probable future losses in the loan portfolio. See “Note 6. Allowance for Credit Losses” of “Notes to Consolidated Financial Statements (Unaudited)” and “Allowance for Credit Losses” and “Critical Accounting Policies - Loan Impairment and Allowance for Credit Losses” below for additional disclosure information.

 

Allowance for Credit Losses. The Bank maintains allowances for loan and lease losses and unfunded loan commitments (collectively the “allowance for credit losses”) at levels management believes are adequate to absorb probable losses inherent in the loan and lease portfolio and in unfunded loan commitments. The Bank has developed policies and procedures for assessing the adequacy of the allowance for credit losses that reflect the assessment of credit risk and impairment analysis. This assessment includes an analysis of qualitative and quantitative trends in the levels of classified loans. In developing this analysis, the Bank relies on historical loss experience, estimates and exercises judgment in assessing credit risk. Future assessments of credit risk may yield different results, depending on changes in the qualitative and quantitative trends, which may require adjustments in the allowance for credit losses.

 

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The Bank uses a variety of modeling, calculation methods and estimation tools for measuring credit risk and performing impairment analysis, which is the basis used in developing the allowance for credit losses. The factors supporting the allowance do not diminish the fact that the entire allowance for credit losses is available to absorb probable losses in both the loan and leases portfolio and in unfunded loan commitments. The Bank’s principal focus is on the adequacy of the total allowance for credit losses. Based on the overall credit quality of the loan and lease receivable portfolio, management believes the Bank has established the allowance for credit losses pursuant to generally accepted accounting principles, and has taken into account the views of its regulators and the current economic environment. Management reassesses the information upon which it bases the allowance for credit losses not greater than quarterly and believes their accounting decisions remain accurate. However, there can be no assurance in the future that regulators, increased risks in the loan and lease portfolio, changes in economic conditions and other factors will not require additional adjustments to the allowance for credit losses.

 

The allowance for credit losses was $14.6 million at March 31, 2012, compared to $15.4 million December 31, 2011. The ratio of the allowance for credit losses to loans and leases was 2.8% at March 31, 2012, compared to 2.9% at December 31, 2011. See “Note 6. Allowance for Credit Losses” of “Notes to Consolidated Financial Statements (Unaudited)”and “Critical Accounting Policies - Loan Impairment and Allowance for Credit Losses” below for additional information.

 

Noninterest Income. Total noninterest income increased to $3.2 million for the three months ended March 31, 2012, from $2.0 million for the three months ended March 31, 2011. Noninterest income consists of fees, service charges and servicing fees earned on loans, service charges and insufficient funds fees collected on deposit accounts, gains from loan and securities sales and other miscellaneous income.

 

The Bank strives to maintain a consistent level of revenue across both loan and deposit service offerings. Fees, service charges and loan servicing fees collected remained constant at $1.7 million for both the three months ended March 31, 2012 and 2011. Fees, service charges and loan servicing fees are influenced by the volume of loans receivable and deposits outstanding, the volume of various types of loan and deposit account transactions processed, the volume of loans serviced for others and the collection of related fees and service charges.

 

Gains from sales of mortgage loans held for sale increased to $305,000 for the three months ended March 31, 2012, compared to $120,000 for the three months ended March 31, 2011. The Bank sells certain held for sale fixed-rate residential mortgage loans to reduce its exposure to future interest rate and credit risk, while retaining certain other held for sale mortgage loans for future securitization into available for sale mortgage-backed securities. Proceeds from mortgage loan sales provide additional liquidity to support the Bank’s operating, financing and lending activities.

 

Gains from sales of mortgage-backed securities available for sale increased to $1.0 million for the three months ended March 31, 2012, from $52,000 for the three months ended March 31, 2011. Proceeds from mortgage-backed securities sales also provide additional liquidity to support the Bank’s operating, financing and lending activities.

 

In its efforts of mitigating nonperforming assets, the Bank recognized $29,000 of net losses on sales of other real estate owned properties in the three months ended March 31, 2012, compared to $82,000 of net losses recognized in the three months ended March 31, 2011. See “Note 8. Other Real Estate Owned” of “Notes to Consolidated Financial Statements (Unaudited)” for additional information.

 

Noninterest Expense. Total noninterest expenses increased to $8.2 million for the three months ended March 31, 2012, from $6.8 million for the three months ended March 31, 2011. Compensation and fringe benefits, the largest component of these expenses, increased to $4.2 million for the three months ended March 31, 2012, from $3.8 million for the three months ended March 31, 2011, reflecting an increase in retirement benefits and management’s efforts to maintain sufficient staffing levels necessary to support commercial and retail customer service activities, credit administration and banking operations.

 

FDIC insurance premiums declined to $252,000 for the three months ended March 31, 2012, from $292,000 for the three months ended March 31, 2011, reflecting the volume of insured deposit account balances during the respective periods, and changes in the FDIC’s deposit insurance assessment calculation. The FDIC changed their deposit insurance assessment calculation during 2011 to be based on assets and Tier 1 capital versus on deposits.

 

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Expenses attributable to valuation adjustments, renovating, maintenance and property taxes paid for the current volume of other real estate owned properties increased to $1.3 million for the three months ended March 31, 2012, from $220,000 for the three months ended March 31, 2011. See “Note 8. Other Real Estate Owned” and “Note 9. Fair Value Measurement” of “Notes to Consolidated Financial Statements (Unaudited)” for additional information.

 

Other noninterest expenses including premises and equipment, advertising, data processing, repairs and maintenance, office supplies, professional fees, taxes and insurance, etc., have remained relatively consistent during the respective periods.

 

Income Taxes. Income tax expense was $201,000 for the three months ended March 31, 2012, compared $225,000 for the three months ended March 31, 2011. Changes in the amount of income tax expense reflects changes in pretax income, deductible expenses, the application of permanent and temporary differences and the applicable income tax rates in effect during each period. The effective income tax rates were 30.3% for the three months ended March 31, 2012, compared to 40.7% for the three months ended March 31, 2011. See “Critical Accounting Policies” below for additional information.

 

Liquidity and Capital Resources. Liquidity generally refers to the Bank's ability to generate adequate amounts of funds to meet its funding needs. Adequate liquidity guarantees that sufficient funds are available to meet deposit withdrawals, fund future loan commitments, maintain adequate reserve requirements, pay operating expenses, provide funds for debt service, and meet other general commitments. FDIC policy requires banks to maintain an average daily balance of liquid assets in an amount which it deems adequate to protect the safety and soundness of the bank. The FDIC currently has no specific level which it requires. At March 31, 2012, the Bank had cash, deposits in banks, mortgage-backed securities and loans held for sale totaling $197.1 million, compared to $177.7 million at December 31, 2011. The Bank calculates its liquidity position under policy guidelines based on liquid assets in relationship to deposits and short-term borrowings. Based on its policy calculation guidelines, the Bank’s calculated liquidity ratio was 29.0% and 25.8% at March 31, 2012 and December 31, 2011, respectively, which management believes is adequate.

 

Management believes the Bank can meet future liquidity needs with existing funding sources. The Bank's primary sources of funds are deposits, payments on loans and mortgage-backed securities, earnings and funds provided from operations, the ability to borrow from the FHLB of Atlanta and the availability of loans held for sale. While scheduled repayments of loans and mortgage-backed securities are relatively predictable sources of funds, deposit flows and general market interest rates, economic conditions and competition substantially influence loan prepayments. In addition, the Bank strives to manage its deposit pricing in order to maintain a desired deposit mix.

 

The FDIC requires the Bank to meet a minimum leverage capital requirement of Tier 1 capital (consisting of retained earnings and common stockholders’ equity, less any intangible assets) to assets ratio of 4%. The FDIC also requires the Bank to meet a ratio of total capital to risk-weighted assets of 8%, of which at least 4% must be in the form of Tier 1 capital. The North Carolina Office of the Commissioner of Banks requires the Bank to maintain a capital surplus of not less than 50% of common capital stock. The Bank was in compliance with all regulatory capital requirements at March 31, 2012 and December 31, 2011.

 

Critical Accounting Policies. The Company has identified the policies below as critical to its business operations and the understanding of its results of operations. The impact and any associated risks related to these policies on the Company’s business operations is discussed throughout Management’s Discussion and Analysis of Financial Condition and Results of Operations where such policies affect reported and expected financial results.

 

Use of Estimates. The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions. Estimates affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

 

32
 

 

Loan Impairment and Allowance for Credit Losses. A loan or lease is considered impaired, based on current information and events, if 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 or lease agreement. Uncollateralized loans are measured for impairment based on the present value of expected future cash flows discounted at the historical effective interest rate, while all collateral-dependent loans are measured for impairment based on the fair value of the collateral. The Bank uses several factors in determining if a loan or lease is impaired. The internal asset classification procedures include a thorough review of significant loans, leases and lending relationships and include the accumulation of related data. This data includes loan and lease payment status, borrowers' financial data and borrowers' operating factors such as cash flows, operating income or loss, etc.

 

The allowance for credit losses is increased by charges to income and decreased by charge-offs (net of recoveries). Management's periodic evaluation of the adequacy of the allowance for credit losses is based on past loan and lease loss experience, known and inherent risks in loans and leases and unfunded loan commitments, adverse situations that may affect the borrower's ability to repay, the estimated value of any underlying collateral, and current economic conditions. While management believes that it has established the allowance for credit losses in accordance with accounting principles generally accepted in the United States of America and has taken into account the views of its regulators and the current economic environment, there can be no assurance in the future that regulators or risks in its loans and leases and unfunded loan commitments will not require additional adjustments to the allowance for credit losses.

 

Income Taxes. Deferred tax asset and liability balances are determined by application to temporary differences in the tax rate expected to be in effect when taxes will become payable or receivable. Temporary differences are differences between the tax basis of assets and liabilities and their reported amounts in the financial statements that will result in taxable or deductible amounts in future years. The effect on deferred taxes of a change in tax rates is recognized in income in the period that includes the enactment date.

 

Off-Balance Sheet Arrangements. The Company is a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers and to reduce its own exposure to fluctuations in interest rates. These financial instruments include commitments to extend credit and involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the balance sheet. The Company's exposure to credit loss in the event of non-performance by the other party to the financial instrument for commitments to extend credit is represented by the contractual amount of those instruments. The Company uses the same credit policies in making commitments and conditional obligations as it does for on-balance sheet instruments.

 

Forward Looking Statements. The Private Securities Litigation Reform Act of 1995 states that disclosure of forward looking information is desirable for investors and encourages such disclosure by providing a safe harbor for forward looking statements by corporate management. This Form 10-Q, including Management’s Discussion and Analysis of Financial Condition and Results of Operations, contains forward looking statements that involve risk and uncertainty. In order to comply with terms of the safe harbor, the Company notes that a variety of risks and uncertainties could cause its actual results and experience to differ materially from anticipated results or other expectations expressed in the Company's forward looking statements. There are risks and uncertainties that may affect the operations, performance, development, growth projections and results of the Company's business. They include, but are not limited to, economic growth, interest rate movements, timely development of technology enhancements for products, services and operating systems, the impact of competitive products, services and pricing, customer requirements, regulatory changes and similar matters. Readers of this report are cautioned not to place undue reliance on forward looking statements that are subject to influence by these risk factors and unanticipated events, as actual results may differ materially from management's expectations.

 

33
 

 

Item 3. Quantitative and Qualitative Disclosures about Market Risk. Smaller reporting companies are not required to provide information required by this item.

 

Item 4.  Controls and Procedures. As of the end of the period covered by this report, management of the Company carried out an evaluation, under the supervision and with the participation of the Company’s principal executive officer and principal financial officer, of the effectiveness of the Company’s disclosure controls and procedures. Based on this evaluation, the Company’s principal executive officer and principal financial officer concluded that the Company’s disclosure controls and procedures are effective in ensuring that information required to be disclosed by the Company in reports that it files or submits under the Securities Exchange Act of 1934, as amended, is recorded, processed, summarized and reported, within the time periods specified in the Securities and Exchange Commission’s rules and forms. It should be noted that the design of the Company’s disclosure controls and procedures is based in part upon certain reasonable assumptions about the likelihood of future events, and there can be no reasonable assurance that any design of disclosure controls and procedures will succeed in achieving its stated goals under all potential future conditions, regardless of how remote, but the Company’s principal executive and financial officers have concluded that the Company’s disclosure controls and procedures are, in fact, effective at a reasonable assurance level.

 

In addition, there have been no changes in the Company’s internal control over financial reporting (to the extent that elements of internal control over financial reporting are subsumed within disclosure controls and procedures) identified in connection with the evaluation described in the above paragraph that occurred during the Company’s last fiscal quarter, that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

 

34
 

 

PART II. OTHER INFORMATION

 

Item l. Legal Proceedings: The Company is currently not engaged in any material legal proceedings. From time to time, the Bank is a party to legal proceedings within the ordinary course of business wherein it enforces its security interest in loans, and other matters of similar nature.

 

Item 1A. Risk Factors: Smaller reporting companies are not required to provide information required by this item.

 

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds: Not applicable

 

Item 3. Defaults Upon Senior Securities: Not applicable

 

Item 4. Mine Safety Disclosures: Not applicable

 

Item 5. Other Information: Not applicable

 

Item 6. Exhibits: The following exhibits are filed herewith:

 

Number   Title
10.2(b)   Amendment dated March 30, 2012, to the Change-in-Control Protective Agreement between First South Bank, First South Bancorp, Inc., and Sherry L. Correll dated January 14, 1997 (Incorporated herein by reference from Exhibit 10.2(b) to the Company’s Current Report on Form 8-K filed on March 30, 2012 (File No. 0-22219))
     
10.11(a)   Amendment dated February 29, 2012, to the Change-in-Control Protective Agreement between First South Bank, First South Bancorp, Inc., and J. Randall Woodson dated October 3, 2008 (Incorporated herein by reference from Exhibit 10.11(a) to the Company’s Current Report on Form 8-K filed on March 5, 2012 (File No. 0-22219))
     
10.15(b)   Amendment dated March 30, 2012, to the Change-in-Control Protective Agreement between First South Bank, First South Bancorp, Inc., and Paul S. Jaber dated July 8, 2002 (Incorporated herein by reference from Exhibit 10.15(b) to the Company’s Current Report on Form 8-K filed on March 30, 2012 (File No. 0-22219))
     
10.16   Change-in-Control Protective Agreement between First South Bank, First South Bancorp, Inc., and John F. Nicholson dated February 29, 2012 (Incorporated herein by reference from Exhibit 10.16 to the Company’s Current Report on Form 8-K filed on March 5, 2012 (File No. 0-22219))
     
31.1   Rule 13a-14(a) Certification of Chief Executive Officer
     
31.2   Rule 13a-14(a) Certification of Chief Financial Officer
     
32   Section 1350 Certification
     
101   Interactive data files providing financial information from the Company’s Quarterly Report on Form 10-Q for the quarterly period ended March 31, 2012, in XBRL (eXtensible Business Reporting Language)*

________________

* Pursuant to Regulation 406T of Regulation S-T, these interactive data files are furnished and not filed or part of a registration statement or prospectus for purposes of Section 11 or 12 of the Securities Act of 1933, as amended, or Section 18 of the Securities Exchange Act of 1934, as amended, and are otherwise not subject to liability.

 

35
 

 

SIGNATURES

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

  FIRST SOUTH BANCORP, INC.
         
  By: /s/ William L. Wall   By: /s/ Kristie W. Hawkins  
    William L. Wall   Kristie W. Hawkins
    Executive Vice President   Controller
    Chief Financial Officer   Treasurer
    (Principal Financial Officer)   (Principal Accounting Officer)

 

    Date: May 14, 2012   Date: May 14, 2012

 

36

XNAS:FSBK First South Bancorp, Inc. Quarterly Report 10-Q Filling

First South Bancorp, Inc. XNAS:FSBK Stock - Get Quarterly Report SEC Filing of First South Bancorp, Inc. XNAS:FSBK stocks, including company profile, shares outstanding, strategy, business segments, operations, officers, consolidated financial statements, financial notes and ownership information.

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XNAS:FSBK First South Bancorp, Inc. Quarterly Report 10-Q Filing - 3/31/2012
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