PINX:FNRN First Northern Community Bancorp Quarterly Report 10-Q Filing - 3/31/2012

Effective Date 3/31/2012

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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
———————————
FORM 10-Q

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

For the Quarterly Period Ended March 31, 2012

OR

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

Commission File Number 000-30707

First Northern Community Bancorp
(Exact name of registrant as specified in its charter)

California
68-0450397
(State or other jurisdiction of incorporation or organization)
(I.R.S. Employer Identification Number)

195 N. First Street, Dixon, California
95620
(Address of principal executive offices)
(Zip Code)


707-678-3041
(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 Section 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days.
Yes  x
No  ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
Yes  x
No  r

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

Large accelerated filer   ¨
Accelerated filer  ¨
Non-accelerated filer  ¨ (Do not check if a smaller reporting company)
  Smaller reporting company x

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

Yes  ¨
No  x

The number of shares of Common Stock outstanding as of May 10, 2012 was 9,248,449.


 
1

 
 
FIRST NORTHERN COMMUNITY BANCORP
 
INDEX
 
 
Page
PART I – Financial Information
 
ITEM I – Financial Statements (Unaudited)
3
 
Condensed Consolidated Balance Sheets (Unaudited) 
3
 
Condensed Consolidated Statements of Income (Unaudited) 
4
 
Condensed Consolidated Statements of Comprehensive Income (Unaudited) 
5
 
Condensed Consolidated Statement of Stockholders’ Equity (Unaudited) 
6
 
Condensed Consolidated Statements of Cash Flows (Unaudited) 
7
 
Notes to Condensed Consolidated Financial Statements 
8
ITEM 2.– MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
34
ITEM 3.– QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK 
50
ITEM 4.– CONTROLS AND PROCEDURES 
50
PART II – OTHER INFORMATION 
50
ITEM 1 – LEGAL PROCEEDINGS 
50
ITEM 1A. – RISK FACTORS 
50
ITEM 2. – UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS 
51
ITEM 3.– DEFAULTS UPON SENIOR SECURITIES 
51
ITEM 4. – MINE SAFETY DISCLOSURES 
51
ITEM 5. – OTHER INFORMATION 
51
ITEM 6. – EXHIBITS 
52
SIGNATURES 
53
 
 
2

 

PART I – FINANCIAL INFORMATION
 
FIRST NORTHERN COMMUNITY BANCORP
 
ITEM I    – FINANCIAL STATEMENTS (UNAUDITED)
 
CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED)
 

   
March 31,
   
December 31,
 
(in thousands, except shares and share amounts)
 
2012
   
2011
 
   
(unaudited)
       
Assets
           
             
Cash and cash equivalents
  $ 142,573     $ 140,172  
Investment securities – available-for-sale
    187,580       160,241  
Loans, net of allowance for loan losses of $10,357 at March 31, 2012
               
   and $10,408 at December 31, 2011
    416,705       432,789  
Loans held-for-sale
    2,779       2,832  
Stock in Federal Home Loan Bank and other equity securities, at cost
    3,075       3,075  
Premises and equipment, net
    8,072       8,054  
Other real estate owned
    1,618       1,325  
Interest receivable and other assets
    31,124       32,662  
                 
                 Total Assets
  $ 793,526     $ 781,150  
                 
Liabilities and Stockholders’ Equity
               
                 
Liabilities:
               
                 
         Demand deposits
  $ 203,898     $ 201,865  
         Interest-bearing transaction deposits
    164,726       160,956  
         Savings and MMDA's
    216,494       209,853  
         Time, under $100,000
    37,705       38,395  
         Time, $100,000 and over
    67,400       67,889  
                 Total deposits
    690,223       678,958  
                 
         Federal Home Loan Bank advances and other borrowings
    7,000       7,000  
         Interest payable and other liabilities
    7,180       7,490  
                 
                 Total Liabilities
    704,403       693,448  
                 
Stockholders' Equity:
               
         Preferred stock, no par value; $1,000 per share liquidation preference,
               
22,847 shares authorized; 22,847 issued and outstanding at
               
March 31, 2012 and December 31, 2011
    22,847       22,847  
        Common stock, no par value; 16,000,000 shares authorized;
               
            9,248,449 shares issued and outstanding at March 31, 2012 and
               
            9,144,998 shares issued and outstanding at December 31, 2011
    63,233       62,751  
        Additional paid in capital
    977       977  
        Retained earnings
    1,217       864  
        Accumulated other comprehensive income, net
    849       263  
                 Total Stockholders’ Equity
    89,123       87,702  
                 
                 Total Liabilities and Stockholders’ Equity
  $ 793,526     $ 781,150  

See notes to unaudited condensed consolidated financial statements.

 
3

 

 
FIRST NORTHERN COMMUNITY BANCORP
 
 
CONDENSED CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
 

   
Three months
   
Three months
 
   
ended
   
ended
 
(in thousands, except per share amounts)
 
March 31,
2012
   
March 31,
2011
 
Interest and dividend income:
           
     Loans
  $ 5,990     $ 6,257  
     Due from banks interest bearing accounts
    79       85  
     Investment securities
               
          Taxable
    780       570  
          Non-taxable
    104       111  
     Other earning assets
    4        
               Total interest and dividend income
    6,957       7,023  
Interest expense:
               
     Deposits
    492       571  
     Other borrowings
    72       90  
               Total interest expense
    564       661  
Net interest income
    6,393       6,362  
Provision for loan losses
    550       990  
 Net interest income after provision
    for loan losses
    5,843       5,372  
Other operating income:
               
     Service charges on deposit accounts
    653       693  
     Gains on sales of other real estate owned
          196  
     Gains on sales of loans held-for-sale
    395       137  
     Investment and brokerage services income
    221       245  
     Mortgage brokerage income
    30       12  
     Loan servicing income
    142       335  
     Fiduciary activities income
    107       97  
     ATM fees
    129       101  
     Signature based transaction fees
    248       210  
     Gains on sales of available-for-sale
       securities
    1        
     Other income
    199       161  
               Total other operating income
    2,125       2,187  
Other operating expenses:
               
     Salaries and employee benefits
    3,847       3,773  
     Occupancy and equipment
    736       823  
     Data processing
    385       384  
     Stationery and supplies
    80       75  
     Advertising
    110       137  
     Directors’ fees
    55       64  
     Other real estate owned expense and impairment
    22       206  
     Other expense
    1,257       1,222  
               Total other operating expenses
    6,492       6,684  
               Income before income tax expense
    1,476       875  
Income tax expense
    384       109  
                 
               Net  income
  $ 1,092     $ 766  
                 
Preferred stock dividends and accretion
    (285 )     (249 )
Net  income available to common stockholders
  $ 807     $ 517  
                 
Basic income per share 
  $ 0.09     $ 0.06  
Diluted income per share
  $ 0.09     $ 0.06  

See notes to unaudited condensed consolidated financial statements.

 
4

 



FIRST NORTHERN COMMUNITY BANCORP
 
 
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (UNAUDITED)
 


   
Three months
   
Three months
 
   
ended
   
ended
 
(in thousands)
 
March 31,
2012
   
March 31,
2011
 
Net income
  $ 1,092     $ 766  
Other comprehensive income, net of tax:
               
Unrealized holding gains on securities:
               
Unrealized holding gains arising during the period, net of tax effect of $391 at March 31, 2012 and $26 at March 31, 2011
    587       40  
Less: reclassification adjustment due to gains realized on sales of securities, net of tax effect of $0 at March 31, 2012 and March 31, 2011
    (1 )      
Other comprehensive income
  $ 586     $ 40  
                 
Comprehensive income
  $ 1,678     $ 806  

See notes to unaudited condensed consolidated financial statements.

 
5

 

FIRST NORTHERN COMMUNITY BANCORP
 
 
CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY (UNAUDITED)
 

(in thousands, except share data)
 
   
                                       
Accumulated
       
                           
Additional
         
Other
       
   
Preferred Stock
   
Common Stock
   
Paid-in
   
Retained
   
Comprehensive
       
   
Shares
   
Amounts
   
Shares
   
Amounts
   
Capital
   
Earnings
   
Income
   
Total
 
                                                 
Balance at December 31, 2011
    22,847     $ 22,847       9,144,998     $ 62,751     $ 977     $ 864     $ 263     $ 87,702  
                                                                 
Net income
                                            1,092               1,092  
                                                                 
Other comprehensive income
                                                    586       586  
                                                                 
1% stock dividend
                    91,052       451               (451 )              
Dividend on preferred stock
                                            (285 )             (285 )
Cash in lieu of fractional shares
                                            (3 )             (3 )
Stock-based compensation and related tax benefits
                            31                               31  
Common shares issued related to restricted stock grants
                    12,399                                        
                                                                 
Balance at March 31, 2012
    22,847     $ 22,847       9,248,449     $ 63,233     $ 977     $ 1,217     $ 849     $ 89,123  

See notes to unaudited condensed consolidated financial statements.

 
6

 
 

FIRST NORTHERN COMMUNITY BANCORP
 
 
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
 

   
(in thousands)
 
   
Three months ended March 31, 2012
   
Three months ended March 31, 2011
 
Cash Flows From Operating Activities
           
          Net Income
  $ 1,092     $ 766  
          Adjustments to reconcile net income to net cash provided by 
               
       operating activities:
               
 Depreciation and amortization
    174       183  
 Provision for loan losses
    550       990  
 Stock plan accruals
    31       40  
 Gains on sales of available-for-sale securities
    (1 )      
 Gains on sales of other real estate owned
          (196 )
 Impairment on other real estate owned
          71  
 Gains on sales of loans held-for-sale
    (395 )     (137 )
 Proceeds from sales of loans held-for-sale
    18,880       6,259  
 Originations of loans held-for-sale
    (18,432 )     (6,815 )
          Changes in assets and liabilities:
               
 Decrease (increase) in interest receivable and other assets
    1,147       (1,127 )
 Decrease in interest payable and other liabilities
    (310 )     (3 )
                    Net cash provided by operating activities
    2,736       31  
                 
Cash Flows From Investing Activities
               
          Net increase in investment securities
    (26,361 )     (18,425 )
          Net decrease in loans
    15,241       19,629  
          Proceeds from the sale of other real estate owned
          841  
          Purchases of premises and equipment, net
    (192 )     (178 )
                    Net cash (used in) provided by investing activities
    (11,312 )     1,867  
                 
Cash Flows From Financing Activities
               
          Net increase in deposits
    11,265       11,009  
          Net decrease in FHLB advances and other borrowings
          (29 )
          Cash dividends paid in lieu of fractional shares
    (3 )      
          Cash dividends paid on preferred stock
    (285 )     (217 )
                    Net cash provided by financing activities
    10,977       10,763  
   
               
Net increase in Cash and Cash Equivalents
    2,401       12,661  
Cash and Cash Equivalents, beginning of period
    140,172       139,707  
Cash and Cash Equivalents, end of period
  $ 142,573     $ 152,368  
                 
Supplemental Disclosures of Cash Flow Information:
               
Cash paid during the period for:
               
                    Interest
  $ 577     $ 663  
                 
Supplemental disclosures of non-cash investing and financing activities:
               
Preferred stock accretion
  $     $ 32  
Stock dividend distributed
  $ 451     $  
   Transfer of loans held-for-investment to other real estate owned
  $ 293     $ 894  
   Unrealized holding gains on available for sale securities, net of taxes
  $ 586     $ 40  

See notes to unaudited condensed consolidated financial statements.

 
7

 


FIRST NORTHERN COMMUNITY BANCORP
 
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 
March 31, 2012 and 2011 and December 31, 2011
 

1.
BASIS OF PRESENTATION

The accompanying unaudited condensed consolidated financial statements of First Northern Community Bancorp (the “Company”) have been prepared in accordance with accounting principles generally accepted in the United States of America (GAAP) for interim financial information and with the instructions to Form 10-Q and Articles 9 and 10 of Regulation S-X.  Accordingly, they do not include all of the information and notes required by GAAP for complete financial statements.  In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included.  The results of operations for any interim period are not necessarily indicative of results expected for the full year.  These condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto contained in the Company’s Annual Report on Form 10-K for the year ended December 31, 2011 as filed with the Securities and Exchange Commission.  The preparation of financial statements in conformity with GAAP also requires management to make estimates and assumptions that 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 revenue and expense during the reporting period.  Actual results could differ from those estimates.  All material intercompany balances and transactions have been eliminated in consolidation.

Recently Issued Accounting Pronouncements:

In May 2011, the Financial Accounting Standards Board (“FASB”) issued ASU 2011-04.  This update represents the converged guidance of the FASB and the International Accounting Standards Board (the Boards) on fair value measurement.  The collective efforts of the Boards and their staffs have resulted in common requirements for measuring fair value and for disclosing information about fair value measurements, including a consistent meaning of the term “fair value.”  The amendments in this ASU are to be applied prospectively and are effective during interim and annual periods beginning after December 15, 2011.  Adoption of the new guidance did not have a significant impact on the Company’s consolidated financial statements.

In June 2011, FASB issued ASU 2011-05.  This update allows an entity the option to present the total of comprehensive income, the components of net income, and the components of other comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements.  In both choices, an entity is required to present each component of net income along with total net income, each component of other comprehensive income along with a total for other comprehensive income, and a total amount for comprehensive income.  This update eliminates the option to present the components of other comprehensive income as part of the statement of changes in stockholders’ equity.  The amendments in this ASU are to be applied retrospectively and are effective for fiscal years, and interim periods within those years, beginning after December 15, 2011. Adoption of the new guidance did not have a significant impact on the Company’s consolidated financial statements.  In December 2011, FASB issued ASU 2011-12.  This update defers the effective date for amendments to the presentation of reclassifications of items out of accumulated other comprehensive income in ASU 2011-05.

In December 2011, FASB issued ASU 2011-11.  The amendments in this ASU require an entity to disclose information about offsetting and related arrangements to enable users of its financial statements to understand the effect of those arrangements on its financial position.  The amendments in this ASU are required for annual reporting periods beginning on or after January 1, 2013, and interim periods within those annual periods.  The disclosures required by those amendments should be provided retrospectively for all comparative periods presented.  The Company does not expect the adoption of this update to have a significant impact on its consolidated financial statements.

 
8

 
 
Reclassifications

Certain reclassifications have been made to prior period balances in order to conform to the current year presentation.


 
9

 
2.           LOANS

The composition of the Company’s loan portfolio, by loan class, is as follows:
 

 
($ in thousands)
 
March 31,
2012
   
December 31,
2011
 
             
Commercial
  $ 88,970     $ 91,914  
Commercial Real Estate
    177,258       175,793  
Agriculture
    38,013       52,064  
Residential Mortgage
    51,988       51,586  
Residential Construction
    7,815       7,492  
Consumer
    62,805       64,150  
                 
      426,849       442,999  
Allowance for loan losses
    (10,357 )     (10,408 )
Net deferred origination fees and costs
    213       198  
                 
Loans, net
  $ 416,705     $ 432,789  


The Company manages asset quality and credit risk by maintaining diversification in its loan portfolio and through review processes that include analysis of credit requests and ongoing examination of outstanding loans and delinquencies, with particular attention to portfolio dynamics and loan mix.  The Company strives to identify loans experiencing difficulty early enough to correct the problems, to record charge-offs promptly based on realistic assessments of collectability and current collateral values and to maintain an adequate allowance for loan losses at all times.   Asset quality reviews of loans and other non-performing assets are administered using credit risk rating standards and criteria similar to those employed by state and federal banking regulatory agencies.
 
 
Residential mortgage loans, which are secured by real estate, are primarily susceptible to four risks; non-payment due to diminished or lost income, over-extension of credit, a lack of borrower’s cash flow to sustain payments, and shortfalls in collateral value.  In general, non-payment is usually due to loss of employment and follows general economic trends in the economy, particularly the upward movement in the unemployment rate, loss of collateral value, and demand shifts.

Commercial real estate loans generally fall into two categories, owner-occupied and non-owner occupied.  Loans secured by owner occupied real estate are primarily susceptible to changes in the market conditions of the related business.  This may be driven by, among other things, industry changes, geographic business changes, changes in the individual financial capacity of the business owner, general economic conditions and changes in business cycles. These same risks apply to commercial loans whether secured by equipment, receivables or other personal property or unsecured.  Losses on loans secured by owner occupied real estate, equipment, or other personal property generally are dictated by the value of underlying collateral at the time of default and liquidation of the collateral.  When default is driven by issues related specifically to the business owner, collateral values tend to provide better repayment support and may result in little or no loss. Alternatively, when default is driven by more general economic conditions, underlying collateral generally has devalued more and results in larger losses due to default.  Loans secured by non-owner occupied real estate are primarily susceptible to risks associated with swings in occupancy or vacancy and related shifts in lease rates, rental rates or room rates. Most often, these shifts are a result of changes in general economic or market conditions or overbuilding and resulting over-supply of space.  Losses are dependent on the value of underlying collateral at the time of default.  Values are generally driven by these same factors and influenced by interest rates and required rates of return as well as changes in occupancy costs.  Collateral values may be determined by appraisals obtained through Bank approved, licensed appraisers, qualified independent third parties, sales invoices, or other appropriate means.  Collateral valuations are obtained at origination of the credit and periodically thereafter (generally every 3 – 6 months depending on the collateral type), once repayment is questionable, and the loan has been deemed classified.

Construction loans, whether owner occupied or non-owner occupied residential development loans, are not only susceptible to the related risks described above but the added risks of construction, including cost over-runs, mismanagement of the project, or lack of demand and market changes experienced at time of completion.  Losses are primarily related to underlying collateral value and changes therein as described above.  Problem construction loans are generally identified by periodic review of financial information that may include financial statements, tax returns and payment history of the borrower.  Based on this information the Company may decide to take any of several courses of action including demand for repayment, requiring the borrower to provide a significant principal payment and/or additional collateral or requiring similar support from guarantors, or repossession or foreclosure of the underlying collateral.  Collateral values may be determined by appraisals obtained through Bank approved, licensed appraisers, qualified independent third parties, purchase invoices, or other appropriate documentation.  Collateral valuations are obtained at origination of the credit and periodically thereafter (generally every 3 – 6 months depending on the collateral type), once repayment is questionable, and the loan has been deemed classified.

 
10

 
Agricultural loans, whether secured or unsecured, generally are made to producers and processors of crops and livestock.  Repayment is primarily from the sale of an agricultural product or service.  Agricultural loans are generally secured by inventory, receivables, equipment, and other real property.  Agricultural loans primarily are susceptible to changes in market demand for specific commodities.  This may be exacerbated by, among other things, industry changes, changes in the individual financial capacity of the business owner, general economic conditions and changes in business cycles, as well as adverse weather conditions.  Problem agricultural loans are generally identified by periodic review of financial information that may include financial statements, tax returns, crop budgets, payment history, and crop inspections.  Based on this information, the Company may decide to take any of several courses of action including demand for repayment, requiring the borrower to provide a significant principal payment and/or additional collateral or requiring similar support from guarantors. Notwithstanding, when repayment becomes unlikely based on the borrower’s income and cash flow, repossession or foreclosure of the underlying collateral may become necessary.  Collateral values may be determined by appraisals obtained through Bank approved, licensed appraisers, qualified independent third parties, purchase invoices, or other appropriate documentation.  Collateral valuations are obtained at origination of the credit and periodically thereafter (generally every 3 – 6 months depending on the collateral type), once repayment is questionable, and the loan has been deemed classified.

Commercial loans, whether secured or unsecured, generally are made to support the short-term operations and other needs of small businesses.  These loans are generally secured by the receivables, equipment, and other real property of the business and are susceptible to the related risks described above.  Problem commercial loans are generally identified by periodic review of financial information that may include financial statements, tax returns, and payment history of the borrower.  Based on this information, the Company may decide to take any of several courses of action including demand for repayment, requiring the borrower to provide a significant principal payment and/or additional collateral or requiring similar support from guarantors. Notwithstanding, when repayment becomes unlikely based on the borrower’s income and cash flow, repossession or foreclosure of the underlying collateral may become necessary.  Collateral values may be determined by appraisals obtained through Bank approved, licensed appraisers, qualified independent third parties, purchase invoices, or other appropriate documentation.  Collateral valuations are obtained at origination of the credit and periodically thereafter (generally every 3 – 6 months depending on the collateral type), once repayment is questionable, and the loan has been deemed classified.

Consumer loans, whether unsecured or secured are primarily susceptible to four risks; non-payment due to diminished or lost income, over-extension of credit, a lack of borrower’s cash flow to sustain payments, and shortfall in collateral value.  In general, non-payment is usually due to loss of employment and will follow general economic trends in the economy, particularly the upward movements in the unemployment rate, loss of collateral value, and demand shifts.

As of March 31, 2012, approximately 41% in principal amount of the Company’s loans were secured by commercial real estate, which consists of construction and land development loans and real estate loans.  Approximately 12% of the Company’s loans were residential mortgage loans.  Approximately 2% of the Company’s loans were residential construction loans.  Approximately 9% of the Company’s loans were for agriculture and 21% of the Company’s loans were for general commercial uses including professional, retail and small businesses.  Approximately 15% of the Company’s loans were consumer loans.

Once a loan becomes delinquent and repayment becomes questionable, a Company collection officer will address collateral shortfalls with the borrower and attempt to obtain additional collateral or a principal payment.  If this is not forthcoming and payment in full is unlikely, the Company will estimate its probable loss, using a recent valuation as appropriate to the underlying collateral less estimated costs of sale, and charge-off the loan down to the estimated net realizable amount.  Depending on the length of time until final collection, the Company may periodically revalue the underlying collateral and take additional charge-offs as warranted. Revaluations may occur as often as every 3-12 months depending on the underlying collateral and volatility of values.  Final charge-offs or recoveries are taken when collateral is liquidated and actual loss is known.  Unpaid balances on loans after or during collection and liquidation may also be pursued through legal action and attachment of wages or judgment liens on the borrower's other assets.

 
11

 
All loans at March 31, 2012 and December 31, 2011 were pledged under a blanket collateral lien to secure actual and potential borrowings from the Federal Home Loan Bank and Federal Reserve.

Non-accrual and Past Due Loans

The Company’s non-accrual loans by loan class, as of March 31, 2012 and December 31, 2011 were as follows:


 
($ in thousands)
 
March 31,
2012
   
December 31,
2011
 
             
Commercial
  $ 3,123     $ 2,905  
Commercial Real Estate
    3,481       3,071  
Agriculture
    991       992  
Residential Mortgage
    995       1,334  
Residential Construction
    203       48  
Consumer
    422       360  
                 
    $ 9,215     $ 8,710  


Non-accrual loans amounted to $9,215,000 at March 31, 2012 and were comprised of three residential mortgage loans totaling $995,000, one residential construction loan totaling $203,000, seven commercial real estate loans totaling $3,481,000, one agricultural loan totaling $991,000, thirteen commercial loans totaling $3,123,000 and six consumer loans totaling $422,000.  Non-accrual loans amounted to $8,710,000 at December 31, 2011 and were comprised of four residential mortgage loans totaling $1,334,000, one residential construction loan totaling $48,000, six commercial real estate loans totaling $3,071,000, one agricultural loan totaling $992,000, twelve commercial loans totaling $2,905,000 and five consumer loans totaling $360,000.  It is generally the Company’s policy to charge-off the portion of any non-accrual loan that the Company does not expect to collect by writing the loan down to the estimated net realizable value of the underlying collateral.

 
12

 
   An age analysis of past due loans, segregated by loan class, as of March 31, 2012 and December 31, 2011 is as follows:
 

 
($ in thousands)
 
30-59 Days Past Due
   
60-89 Days Past Due
   
90 Days or more Past Due
   
Total Past Due
   
Current
   
Total Loans
 
March 31, 2012
                                   
Commercial
  $ 663     $ 2,954     $ 223     $ 3,840     $ 85,130     $ 88,970  
Commercial Real Estate
    1,194       681       2,926       4,801       172,457       177,258  
Agriculture
    280             991       1,271       36,742       38,013  
Residential Mortgage
    1,671             132       1,803       50,185       51,988  
Residential Construction
    694       203             897       6,918       7,815  
Consumer
    200       77       234       511       62,294       62,805  
    Total
  $ 4,702     $ 3,915     $ 4,506     $ 13,123     $ 413,726     $ 426,849  
                                                 
December 31, 2011
                                               
Commercial
  $ 1,051     $ 166     $ 113     $ 1,330     $ 90,584     $ 91,914  
Commercial Real Estate
          2,746       446       3,192       172,601       175,793  
Agriculture
                991       991       51,073       52,064  
Residential Mortgage
    792       420       426       1,638       49,948       51,586  
Residential Construction
    273             48       321       7,171       7,492  
Consumer
    20       212       225       457       63,693       64,150  
    Total
  $ 2,136     $ 3,544     $ 2,249     $ 7,929     $ 435,070     $ 442,999  

 
The Company had one loan with a balance of $29,000 that was 90 days or more past due and still accruing at March 31, 2012 and no loans 90 days or more past due and still accruing at December 31, 2011.
 
 
13

 
 
Impaired Loans
 
Impaired loans, segregated by loan class, as of March 31, 2012 and December 31, 2011 were as follows:
 

 
($ in thousands)
 
Unpaid Contractual Principal Balance
   
Recorded Investment with no Allowance
   
Recorded Investment with Allowance
   
Total Recorded Investment
   
Related Allowance
 
March 31, 2012
                             
Commercial
  $ 4,321     $ 2,820     $ 1,020     $ 3,840     $ 368  
Commercial Real Estate
    5,257       2,984       1,686       4,670       199  
Agriculture
    1,820       1,570             1,570        
Residential Mortgage
    3,774       995       2,539       3,534       636  
Residential Construction
    1,294             1,294       1,294       737  
Consumer
    1,018       301       641       942       394  
    Total
  $ 17,484     $ 8,670     $ 7,180     $ 15,850     $ 2,334  
                                         
December 31, 2011
                                       
Commercial
  $ 4,694     $ 2,919     $ 569     $ 3,488     $ 101  
Commercial Real Estate
    4,856       3,071       1,198       4,269       22  
Agriculture
    3,847       3,598             3,598        
Residential Mortgage
    5,336       1,875       3,194       5,069       731  
Residential Construction
    1,147       48       1,099       1,147       668  
Consumer
    985       309       346       655       126  
    Total
  $ 20,865     $ 11,820     $ 6,406     $ 18,226     $ 1,648  

 
Interest income on impaired loans recognized using a cash-basis method of accounting during the three-month periods ended March 31, 2012 and 2011 was as follows:
 

 
($ in thousands)
 
Three Months Ended
March 31, 2012
   
Three Months Ended
March 31, 2011
 
   
Average Recorded Investment
   
Interest Income Recognized
   
Average Recorded Investment
   
Interest Income Recognized
 
Commercial
  $ 3,642     $ 10     $ 2,865     $ 17  
Commercial Real Estate
    7,175       23       7,030       56  
Agriculture
    1,823       25       2,133       5  
Residential Mortgage
    4,878       29       6,213       47  
Residential Construction
    1,318       13       1,805       17  
Consumer
    622       7       358       3  
    Total
  $ 19,458     $ 107     $ 20,404     $ 145  

 
 
14

 
 
Troubled Debt Restructurings
 
The Company’s loan portfolio includes certain loans that have been modified in a Troubled Debt Restructuring (“TDR”), which are loans on which concessions in terms have been granted because of the borrowers’ financial difficulties.  These concessions typically result from the Company’s loss mitigation activities and could include reductions in the interest rate, payment extensions, forgiveness of principal, forbearance, or other actions.  Certain TDRs are placed on non-accrual status at the time of restructure and may only be returned to accruing status after considering the borrower’s sustained repayment performance for a reasonable period, generally six months.
 
When a loan is modified, it is measured based upon the present value of future cash flows discounted at the contractual interest rate of the original loan agreement, or the fair value of collateral less selling costs if the loan is collateral dependent.  If the value of the modified loan is less than the recorded investment in the loan, impairment is recognized through a specific allowance or a charge-off of the loan.
 
The Company had $6,959,000 and $9,410,000 in TDR loans as of March 31, 2012 and December 31, 2011, respectively.  Specific reserves for TDR loans totaled $1,468,000 and $1,596,000 as of March 31, 2012 and December 31, 2011, respectively.  TDR loans performing in compliance with modified terms totaled $4,091,000 and $7,471,000 as of March 31, 2012 and December 31, 2011, respectively.
 
Loans modified as troubled debt restructurings during the three-month periods ended March 31, 2012 and March 31, 2011 were as follows:
 
($ in thousands)
 
Three Months Ended March 31, 2012
 
   
Number of Contracts
   
Pre-modification outstanding recorded investment
   
Post-modification outstanding recorded investment
 
Commercial
    2     $ 220     $ 220  
Consumer
    2       151       151  
    Total
    4     $ 371     $ 371  

 
($ in thousands)
 
Three Months Ended March 31, 2011
 
   
Number of Contracts
   
Pre-modification outstanding recorded investment
   
Post-modification outstanding recorded investment
 
Commercial
    1     $ 48     $ 48  
Residential Mortgage
    1       404       404  
Residential Construction
    1       135       135  
    Total
    3     $ 587     $ 587  

 
The loan modifications generally involved reductions in the interest rate, payment extensions, forgiveness of principal, and forbearance.  There was one commercial loan with a recorded investment of $136,000 that was modified as a troubled debt restructuring within the previous 12 months and for which there was a payment default during the three-month period ended March 31, 2012.  There was one consumer loan with a recorded investment of $25,000 that was modified as a troubled debt restructuring within the previous 12 months and for which there was a payment default during the three-month period ended March 31, 2011.
 
 
15

 
 
Credit Quality Indicators
 
All new loans are rated using the credit risk ratings and criteria adopted by the Company.  Risk ratings are adjusted as future circumstances warrant.  All credits risk rated 1, 2, 3 or 4 equate to a Pass as indicated by Federal and State regulatory agencies; a 5 equates to a Special Mention; a 6 equates to Substandard; a 7 equates to Doubtful; and 8 equates to a Loss.  General definitions for each risk rating are as follows:
 
Risk Rating “1” – Pass (High Quality):  This category is reserved for loans fully secured by Company CD’s or savings and properly margined (as defined in the Company’s Credit Policy) and actively traded securities (including stocks, as well as corporate, municipal and U.S. Government bonds).
 
Risk Rating “2” – Pass (Above Average Quality):  This category is reserved for borrowers with strong balance sheets that are well structured with manageable levels of debt and good liquidity.  Cash flow is sufficient to service all debt as agreed.  Historical earnings, cash flow, and payment performance have all been strong and trends are positive and consistent.  Collateral protection is better than the Company’s Credit Policy guidelines.
 
Risk Rating “3” – Pass (Average Quality):  Credits within this category are considered to be of average, but acceptable, quality.  Loan characteristics, including term and collateral advance rates, meet the Company’s Credit Policy guidelines; unsecured lines to borrowers with above average liquidity and cash flow may be considered for this category; the borrower’s financial strength is well documented, with adequate, but consistent, cash flow to meet all obligations.  Liquidity should be sufficient and leverage should be moderate. Monitoring of collateral may be required, including a borrowing base or construction budget.  Alternative financing is typically available.
 
Risk Rating “4” – Pass (Below Average Quality):  Credits within this category are considered sound, but merit additional attention due to industry concentrations within the borrower’s customer base, problems within their industry, deteriorating financial or earnings trends, declining collateral values, increased frequency of past due payments and/or overdrafts, discovery of documentation deficiencies which may impair our borrower’s ability to repay, or the Company’s ability to liquidate collateral.  Financial performance is average but inconsistent.  There also may be changes of ownership, management or professional advisors, which could be detrimental to the borrower’s future performance.
 
Risk Rating “5” – Special Mention (Criticized):  Loans in this category are currently protected by their collateral value and have no loss potential identified, but have potential weaknesses which may, if not monitored or corrected, weaken our ability to collect payments from the borrower or satisfactorily liquidate our collateral position.  Loans where terms have been modified due to their failure to perform as agreed may be included in this category.  Adverse trends in the borrower’s operation, such as reporting losses or inadequate cash flow, increasing and unsatisfactory leverage, or an adverse change in economic or market conditions may have weakened the borrower’s business and impaired their ability to repay based on original terms.  The condition or value of the collateral has deteriorated to the point where adequate protection for our loan may be jeopardized in the future. Loans in this category are in transition and, generally, do not remain in this category beyond 12 months.  During this time, efforts are focused on strategies aimed at upgrading the credit or locating alternative financing.
 
Risk Rating “6” – Substandard (Classified):  Loans in this category are inadequately protected by the borrower’s net worth, capacity to repay or collateral pledged, if any.  Loans so classified have a well-defined weakness or weaknesses that jeopardize the repayment of the debt.  There exists a strong possibility of loss if the deficiencies are not corrected.  Loans that are dependent on the liquidation of collateral to repay are included in this category, as well as borrowers in bankruptcy or where legal action is required to effect collection of our debt.
 
Risk Rating “7” – Doubtful (Classified):  Loans in this category indicate all of the weaknesses of a Substandard classification, however, collection of loan principal, in full, is highly questionable and improbable; possibility of loss is very high, but there is still a possibility that certain collection strategies may, yet, be successful, rendering a definitive loss difficult to estimate, at the time.  Loans in this category are in transition and, generally, do not remain in this category more than 6 months.
 
Risk Rating “8” – Loss (Classified):
 
Active Charge-Off.  Loans in this category are considered uncollectible and of such little value that their removal from the Company’s books is required.  The charge-off is pending or already processed.  Collateral positions have been or are in the process of being liquidated and the borrower/guarantor may or may not be cooperative in repayment of the debt.  Recovery prospects are unknown at the time, but we are still actively engaged in the collection of the loan.
 
Inactive Charge-Off.  Loans in this category are considered uncollectible and of such little value that their removal from the Company’s books is required.  The charge-off is pending or already processed.  Collateral positions have been liquidated and the borrower/guarantor has nothing of any value remaining to apply to the repayment of our loan.  Any further collection activities would be of little value.
 
 
16

 
 
The following table presents the risk ratings by loan class as of March 31, 2012 and December 31, 2011.
 

 
($ in thousands)
 
Pass
   
Special Mention
   
Substandard
   
Doubtful
   
Loss
   
Total
 
March 31, 2012
                                   
Commercial
  $ 72,570     $ 3,879     $ 12,224     $ 297     $     $ 88,970  
Commercial Real Estate
    151,941       13,210       12,107                   177,258  
Agriculture
    35,349       802       1,862                   38,013  
Residential Mortgage
    44,604       2,578       4,806                   51,988  
Residential Construction
    5,763       481       1,571                   7,815  
Consumer
    56,711       2,527       3,493       74             62,805  
    Total
  $ 366,938     $ 23,477     $ 36,063     $ 371     $     $ 426,849  
                                                 
December 31, 2011
                                               
Commercial
  $ 71,229     $ 8,444     $ 11,804     $ 437     $     $ 91,914  
Commercial Real Estate
    148,317       16,492       10,984                   175,793  
Agriculture
    48,330             3,734                   52,064  
Residential Mortgage
    42,845       1,830       6,911                   51,586  
Residential Construction
    5,140       927       1,425                   7,492  
Consumer
    58,239       2,824       3,087                   64,150  
    Total
  $ 374,100     $ 30,517     $ 37,945     $ 437     $     $ 442,999  


 
17

 
 
Allowance for Loan Losses

The following table details activity in the allowance for loan losses by loan class for the three-month periods ended March 31, 2012 and March 31, 2011.

Three-month period ended March 31, 2012
 
($ in thousands)
 
Commercial
   
Commercial Real Estate
   
Agriculture
   
Residential Mortgage
   
Residential Construction
   
Consumer
   
Unallocated
   
Total
 
Balance as of December 31, 2011
  $ 3,598     $ 1,747     $ 1,934     $ 1,135     $ 1,198     $ 796     $     $ 10,408  
Provision for loan losses
    320       (32 )     (769 )     90       (74 )     781       234       550  
                                                                 
Charge-offs
    (542 )                 (31 )           (264 )           (837 )
Recoveries
    206             2             1       27             236  
Net charge-offs
    (336 )           2       (31 )     1       (237 )           (601 )
Balance as of March 31, 2012
    3,582       1,715       1,167       1,194       1,125       1,340       234       10,357  
Period-end amount allocated to:
                                                               
Loans individually evaluated for impairment
    368       199             636       737       394             2,334  
Loans collectively evaluated for impairment
    3,214       1,516       1,167       558       388       946       234       8,023  
Ending Balance
  $ 3,582     $ 1,715     $ 1,167     $ 1,194     $ 1,125     $ 1,340     $ 234     $ 10,357  


Three-month period ended March 31, 2011
 
($ in thousands)
 
Commercial
   
Commercial Real Estate
   
Agriculture
   
Residential Mortgage
   
Residential Construction
   
Consumer
   
Unallocated
   
Total
 
Balance as of December 31, 2010
  $ 3,761     $ 1,957     $ 2,141     $ 830     $ 1,719     $ 556     $ 75     $ 11,039  
Provision for loan losses
    (199 )     920       (21 )     217       (318 )     267       124       990  
                                                                 
Charge-offs
    (178 )     (7 )           (18 )           (220 )           (423 )
Recoveries
    19                   1             86             106  
Net charge-offs
    (159 )     (7 )           (17 )           (134 )           (317 )
Balance as of March 31, 2011
    3,403       2,870       2,120       1,030       1,401       689       199       11,712  
Period-end amount allocated to:
                                                               
Loans individually evaluated for impairment
    60       22       41       622       604       115             1,464  
Loans collectively evaluated for impairment
    3,343       2,848       2,079       408       797       574       199       10,248  
Ending Balance
  $ 3,403     $ 2,870     $ 2,120     $ 1,030     $ 1,401     $ 689     $ 199     $ 11,712  


 
18

 

The following table details activity in the allowance for loan losses and the amount allocated to loans individually and collectively evaluated for impairment as of and for the period ended December 31, 2011.


($ in thousands)
 
Commercial
   
Commercial Real Estate
   
Agriculture
   
Residential Mortgage
   
Residential Construction
   
Consumer
   
Unallocated
   
Total
 
Balance as of December 31, 2010
  $ 3,761     $ 1,957     $ 2,141     $ 830     $ 1,719     $ 556     $ 75     $ 11,039  
Provision for loan losses
    2,033       1,502       511       566       (395 )     996       (75 )     5,138  
                                                                 
Charge-offs
    (2,381 )     (2,000 )     (860 )     (272 )     (197 )     (932 )           (6,642 )
Recoveries
    185       288       142       11       71       176             873  
Net charge-offs
    (2,196 )     (1,712 )     (718 )     (261 )     (126 )     (756 )           (5,769 )
Balance as of December 31, 2011
    3,598       1,747       1,934       1,135       1,198       796             10,408  
Period-end amount allocated to:
                                                               
Loans individually evaluated for impairment
    101       22             731       668       126             1,648  
Loans collectively evaluated for impairment
    3,497       1,725       1,934       404       530       670             8,760  
Ending Balance
  $ 3,598     $ 1,747     $ 1,934     $ 1,135     $ 1,198     $ 796     $     $ 10,408  


The Company’s investment in loans as of March 31, 2012, March 31, 2011, and December 31, 2011 related to each balance in the allowance for loan losses by loan class and disaggregated on the basis of the Company’s impairment methodology was as follows:


($ in thousands)
 
Commercial
   
Commercial Real Estate
   
Agriculture
   
Residential Mortgage
   
Residential Construction
   
Consumer
   
Total
 
March 31, 2012
 
Loans individually evaluated for impairment
  $ 3,840     $ 4,670     $ 1,570     $ 3,534     $ 1,294     $ 942     $ 15,850  
Loans collectively evaluated for impairment
    85,130       172,588       36,443       48,454       6,521       61,863       410,999  
Ending Balance
  $ 88,970     $ 177,258     $ 38,013     $ 51,988     $ 7,815     $ 62,805     $ 426,849  
                                                         
March 31, 2011
 
Loans individually evaluated for impairment
  $ 2,736     $ 6,971     $ 2,133     $ 6,393     $ 1,989     $ 421     $ 20,643  
Loans collectively evaluated for impairment
    73,443       179,849       39,294       45,027       6,830       67,438       411,881  
Ending Balance
  $ 76,179     $ 186,820     $ 41,427     $ 51,420     $ 8,819     $ 67,859     $ 432,524  
                                                         
December 31, 2011
 
Loans individually evaluated for impairment
  $ 3,488     $ 4,269     $ 3,598     $ 5,069     $ 1,147     $ 655     $ 18,226  
Loans collectively evaluated for impairment
    88,426       171,524       48,466       46,517       6,345       63,495       424,773  
Ending Balance
  $ 91,914     $ 175,793     $ 52,064     $ 51,586     $ 7,492     $ 64,150     $ 442,999  
 
 
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3.           MORTGAGE OPERATIONS

Transfers and servicing of financial assets and extinguishments of liabilities are accounted for and reported based on consistent application of a financial-components approach that focuses on control.  Transfers of financial assets that are sales are distinguished from transfers that are secured borrowings.  Retained interests (mortgage servicing rights) in loans sold are measured by allocating the previous carrying amount of the transferred assets between the loans sold and retained interests, if any, based on their relative fair value at the date of transfer.  Fair values are estimated using discounted cash flows based on a current market interest rate.

The Company recognizes a gain and a related asset for the fair value of the rights to service loans for others when loans are sold.  The Company sold substantially its entire portfolio of conforming long-term residential mortgage loans originated during the three months ended March 31, 2012 for cash proceeds equal to the fair value of the loans.

The recorded value of mortgage servicing rights is included in other assets, and is amortized in proportion to, and over the period of, estimated net servicing revenues.  The Company assesses capitalized mortgage servicing rights for impairment based upon the fair value of those rights at each reporting date. For purposes of measuring impairment, the rights are stratified based upon the product type, term and interest rates.  Fair value is determined by discounting estimated net future cash flows from mortgage servicing activities using discount rates that approximate current market rates and estimated prepayment rates, among other assumptions.  The amount of impairment recognized, if any, is the amount by which the capitalized mortgage servicing rights for a stratum exceeds their fair value.  Impairment, if any, is recognized through a valuation allowance for each individual stratum.

At March 31, 2012, the Company had $2,779,000 of mortgage loans held-for-sale.  At March 31, 2012 and December 31, 2011, the Company serviced real estate mortgage loans for others of $213,015,000 and $211,535,000, respectively.

The following table summarizes the Company’s mortgage servicing rights assets as of March 31, 2012 and December 31, 2011.

   
(in thousands)
 
   
December 31, 2011
   
Additions
   
Reductions
   
March 31, 2012
 
                         
Mortgage servicing rights
  $ 1,636     $ 164     $ 119     $ 1,681  
Valuation allowance
    (347 )     (38 )           (385 )
Mortgage servicing rights, net of valuation allowance
  $ 1,289     $ 126     $ 119     $ 1,296  
                                 



 
20

 

4.           OUTSTANDING SHARES AND EARNINGS PER SHARE

On January 26, 2012, the Board of Directors of the Company declared a 1% stock dividend payable as of March 30, 2012.  All income per share amounts have been adjusted to give retroactive effect to stock dividends.

Earnings Per Share (EPS)

Basic EPS includes no dilution and is computed by dividing net income available to common shareholders by the weighted average number of common shares outstanding for the period.  Diluted EPS includes all common stock equivalents (“in-the-money” stock options, unvested restricted stock, stock units, warrants and rights, convertible bonds and preferred stock), which reflects the potential dilution of securities that could share in the earnings of an entity.


The following table presents a reconciliation of basic and diluted EPS for the three-month periods ended March 31, 2012 and 2011.

   
Three months ended
 
   
March 31,
 
   
2012
   
2011
 
Basic earnings per share:
           
Net income
  $ 1,092     $ 766  
Preferred stock dividend and accretion
    (286 )     (249 )
Net income available to common shareholders
  $ 806     $ 517  
                 
Weighted average common shares outstanding
    9,193,057       9,148,178  
Basic EPS
  $ 0.09     $ 0.06  
                 
Diluted earnings per share:
               
Net income
  $ 1,092     $ 766  
Preferred stock dividend and accretion
    (286 )     (249 )
Net income available to common shareholders