10-Q 1 v351862_10q.htm FORM 10-Q

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 


 

FORM 10-Q

(Mark One)

 

xQuarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

 

For the quarterly period ended June 30, 2013

 

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: 000-49929

 

ACCESS NATIONAL CORPORATION

(Exact name of registrant as specified in its charter)

 

Virginia 82-0545425
(State or other jurisdiction of
incorporation or organization)
(I.R.S. Employer
Identification No.)

 

1800 Robert Fulton Drive, Suite 300, Reston, Virginia 20191

(Address of principal executive offices) (Zip Code)

 

(703) 871-2100

(Registrant's telephone number, including area code)

N/A

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

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x  No ¨

 

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

 

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

 

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

 

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 outstanding of Access National Corporation’s common stock, par value $0.835, as of August 6, 2013 was 10,308,483 shares.

 

 
 

 

Table of Contents

ACCESS NATIONAL CORPORATION

FORM 10-Q

 

INDEX

 

PART I FINANCIAL INFORMATION  
     
Item 1. Financial Statements (Unaudited)  
  Consolidated Balance Sheets, June 30, 2013 and December 31, 2012 Page 2
  Consolidated Statements of Income, three and six months ended June 30, 2013 and 2012 Page 3
  Consolidated Statements of Comprehensive Income, three and six months ended June 30, 2013 and 2012 Page 4
  Consolidated Statements of Changes in Shareholders' Equity, six months ended June 30, 2013 and 2012 Page 5
  Consolidated Statements of Cash Flows, six months ended June 30, 2013 and 2012 Page 6
  Notes to Consolidated Financial Statements (Unaudited) Page 7
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations Page 35
Item 3. Quantitative and Qualitative Disclosures About Market Risk       Page 51
Item 4. Controls and Procedures Page 52
     
PART II OTHER INFORMATION  
     
Item 1. Legal Proceedings Page 52
Item1A. Risk Factors Page 53
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds Page 54
Item 3. Defaults Upon Senior Securities Page 54
Item 4. Mine Safety Disclosures Page 54
Item 5. Other Information Page 54
Item 6. Exhibits Page 55
     
  Signatures Page 57

 

- 1 -
 

 

PART I - FINANCIAL INFORMATION

 

Item 1.  Financial Statements

 

ACCESS NATIONAL CORPORATION

Consolidated Balance Sheets

(In Thousands, Except for Share and Per Share Data)

 

   June 30,   December 31, 
   2013   2012 
ASSETS  (Unaudited)     
Cash and due from banks  $11,499   $15,735 
Interest-bearing deposits in other banks and federal funds sold   35,123    22,206 
Securities:          
Securities available-for-sale, at fair value   69,427    35,759 
Securities held-to-maturity, at amortized cost (fair value of $15,530 and $45,308)   15,861    44,952 
Total investment securities   85,288    80,711 
           
Restricted stock   4,284    4,237 
Loans held for sale, at fair value   48,887    111,542 
Loans   641,464    616,978 
Allowance for loan losses   (13,007)   (12,500)
Net loans   628,457    604,478 
Premises and equipment, net   8,434    8,517 
Accrued interest receivable   2,480    2,408 
Other assets   17,231    14,080 
Total assets  $841,683   $863,914 
           
LIABILITIES AND SHAREHOLDERS' EQUITY          
Deposits          
Noninterest-bearing deposits  $220,474   $164,161 
Savings and interest-bearing deposits   190,179    187,997 
Time deposits   249,205    319,338 
Total deposits   659,858    671,496 
Other liabilities          
Short-term borrowings   70,161    83,091 
Subordinated debentures   6,186    6,186 
Other liabilities and accrued expenses   10,898    11,874 
Total liabilities  $747,103   $772,647 
           
SHAREHOLDERS' EQUITY          
Common stock, par value, $0.835; authorized, 60,000,000 shares; issued and outstanding, 10,285,212 shares at June 30, 2013 and 10,317,767 shares at December 31, 2012  $8,588   $8,615 
Additional paid in capital   16,719    17,155 
Retained earnings   70,653    65,404 
Accumulated other comprehensive income, net   (1,380)   93 
Total shareholders' equity   94,580    91,267 
Total liabilities and shareholders' equity  $841,683   $863,914 

 

See accompanying notes to consolidated financial statements (Unaudited).

 

- 2 -
 

 

ACCESS NATIONAL CORPORATION

Consolidated Statements of Income

(In Thousands, Except for Share and Per Share Data)

(Unaudited)

 

   Three Months Ended June 30,   Six Months Ended June 30, 
   2013   2012   2013   2012 
Interest and Dividend Income                    
Interest and fees on loans  $8,611   $8,369   $17,206   $17,040 
Interest on deposits in other banks   28    19    54    50 
Interest and dividends on securities   447    614    982    1,263 
Total interest and dividend income   9,086    9,002    18,242    18,353 
                     
Interest Expense                    
Interest on deposits   966    1,150    1,967    2,423 
Interest on short-term borrowings   15    33    28    145 
Interest on long-term borrowings   -    31    -    72 
Interest on subordinated debentures   53    56    106    113 
Total interest expense   1,034    1,270    2,101    2,753 
                     
Net interest income   8,052    7,732    16,141    15,600 
Provision for loan losses   -    472    225    1,190 
Net interest income after provision for loan losses   8,052    7,260    15,916    14,410 
                     
Noninterest Income                    
Service fees on deposit accounts   138    160    307    337 
Gain on sale of loans   7,120    14,738    15,001    25,682 
Mortgage broker fee income   29    20    47    27 
Other income   736    (1,186)   3,512    (213)
Total noninterest income   8,023    13,732    18,867    25,833 
                     
Noninterest Expense                    
Salaries and employee benefits   6,799    7,474    14,868    15,809 
Occupancy and equipment   616    579    1,320    1,230 
Other operating expenses   3,118    6,358    7,000    11,136 
Total noninterest expense   10,533    14,411    23,188    28,175 
                     
Income before income taxes   5,542    6,581    11,595    12,068 
                     
Income tax expense   2,018    2,691    4,387    4,741 
NET INCOME  $3,524   $3,890   $7,208   $7,327 
                     
Earnings per common share:                    
Basic  $0.34   $0.38   $0.70   $0.72 
Diluted  $0.34   $0.38   $0.69   $0.71 
                     
Average outstanding shares:                    
Basic   10,306,561    10,237,515    10,314,592    10,219,085 
Diluted   10,379,870    10,350,214    10,408,735    10,331,529 

 

See accompanying notes to consolidated financial statements (Unaudited).

 

- 3 -
 

 

ACCESS NATIONAL CORPORATION

Consolidated Statements of Comprehensive Income

(In Thousands)

(Unaudited)

 

   Three Months Ended June 30,   Six Months Ended June 30, 
   2013   2012   2013   2012 
Net income  $3,524   $3,890   $7,208   $7,327 
                     
Other comprehensive income:                    
Unrealized gains (losses) on securities                    
Unrealized holding gains (losses) arising during period   (1,999)   67    (2,267)   6 
Tax effect   700    (23)   794    (2)
Net of tax amount   (1,299)   44    (1,473)   4 
                     
Comprehensive income  $2,225   $3,934   $5,735   $7,331 

 

See accompanying notes to consolidated financial statements (Unaudited).

 

- 4 -
 

 

ACCESS NATIONAL CORPORATION

Consolidated Statements of Changes in Shareholders' Equity

(In Thousands, Except for Share Data)

(Unaudited)

 

               Accumulated     
               Other     
       Additional       Compre-     
   Common   Paid in   Retained   hensive     
   Stock   Capital   Earnings   Income (Loss)   Total 
Balance, December 31, 2012  $8,615   $17,155   $65,404   $93   $91,267 
Net income   -    -    7,208    -    7,208 
Other comprehensive income   -    -    -    (1,473)   (1,473)
Stock option exercises (28,899 shares)   24    169    -    -    193 
Repurchased under share repurchase program (61,454 shares)   (51)   (715)   -    -    (766)
Excess tax benefits from stock based payment arrangements   -    6    -    -    6 
Cash dividend   -    -    (1,959)   -    (1,959)
Stock-based compensation expense recognized in earnings   -    104    -    -    104 
                          
Balance, June 30, 2013  $8,588   $16,719   $70,653   $(1,380)  $94,580 
                          
Balance, December 31, 2011  $8,511   $16,716   $57,529   $59   $82,815 
Net income   -    -    7,327    -    7,327 
Other comprehensive income   -    -    -    4    4 
Stock option exercises (132,453 shares)   110    613    -    -    723 
Repurchased under share repurchase program (74,300 shares)   (62)   (708)   -    -    (770)
Cash dividend   -    -    (1,183)   -    (1,183)
Stock-based compensation expense recognized in earnings   -    132    -    -    132 
                          
Balance, June 30, 2012  $8,559   $16,753   $63,673   $63   $89,048 

 

See accompanying notes to consolidated financial statements (Unaudited).

 

- 5 -
 

 

ACCESS NATIONAL CORPORATION

Consolidated Statements of Cash Flows

(In Thousands)

(Unaudited)

 

   Six Months Ended June 30, 
   2013   2012 
Cash Flows from Operating Activities          
Net income  $7,208   $7,327 
Adjustments to reconcile net income to net cash provided by (used in) operating activities:          
Provision for loan losses   225    1,190 
Provision for losses on mortgage loans sold   388    1,600 
Provision for off-balance sheet losses   65    52 
Excess tax benefits   6    - 
Deferred tax benefit   (8)   (183)
Stock-based compensation   104    132 
Valuation allowance on derivatives   (330)   (898)
Amortization of premiums and discount accretion on securities, net   195    6 
Depreciation and amortization   239    209 
Changes in assets and liabilities:          
Decrease (increase) in valuation of loans held for sale carried at fair value   4,765    (994)
Decrease (increase) in loans held for sale   57,889    (4,190)
Increase in other assets   (1,492)   (3,181)
(Decrease) increase in other liabilities   (2,036)   458 
Net cash provided by operating activities   67,218    1,528 
Cash Flows from Investing Activities          
Proceeds from maturities and calls of securities available-for-sale   21,452    31,248 
Proceeds from maturities and calls of securities held-to-maturity   30,000    15,000 
Purchases of securities available-for-sale   (57,650)   (20,013)
Purchases of securities held-to-maturity   (889)   (44,947)
Net increase in loans   (24,204)   (14,097)
Proceeds from sale of equipment   10    - 
Purchases of premises and equipment   (156)   (60)
Net cash used in investing activities   (31,437)   (32,869)
Cash Flows from Financing Activities          
Net  increase in demand, interest-bearing demand and savings deposits   58,496    34,878 
Net (decrease) increase in time deposits   (70,134)   1,040 
Decrease in securities sold under agreement to repurchase   (17,930)   (5,493)
Net increase (decrease) in other short-term borrowings   5,000    (7,000)
Net decrease in long-term borrowings   -    (1,107)
Proceeds from issuance of common stock   193    724 
Repurchase of common stock   (766)   (770)
Dividends paid   (1,959)   (1,183)
Net cash (used in) provided by financing activities   (27,100)   21,089 
           
Increase (decrease) in cash and cash equivalents   8,681    (10,252)
Cash and Cash Equivalents          
Beginning   37,941    43,909 
Ending  $46,622   $33,657 
Supplemental Disclosures of Cash Flow Information          
Cash payments for interest  $1,969   $3,069 
Cash payments for income taxes  $5,965   $4,695 
Supplemental Disclosures of Noncash Investing Activities          
Unrealized (loss) gain on securities available-for-sale  $(2,267)  $6 

 

See accompanying notes to consolidated financial statements (Unaudited).

 

- 6 -
 

  

Notes to Consolidated Financial Statements (Unaudited)

 

NOTE 1 – BASIS OF PRESENTATION

 

Access National Corporation (the “Corporation”) is a bank holding company incorporated under the laws of the Commonwealth of Virginia. The Corporation has two wholly-owned subsidiaries, Access National Bank (the “Bank”), which is an independent commercial bank chartered under federal laws as a national banking association, and Access National Capital Trust II, which was formed for the purpose of issuing redeemable capital securities. The Bank has three active subsidiaries, Access Real Estate LLC (“Access Real Estate”), ACME Real Estate LLC (“ACME”), and Access Capital Management Holding LLC (“ACM”).

 

The accompanying unaudited interim consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) for interim financial information and with rules and regulations of the Securities and Exchange Commission (“SEC”). The statements do not include all of the information and footnotes required by GAAP for complete financial statements. All adjustments have been made which, in the opinion of management, are necessary for a fair presentation of the results for the interim periods presented. Such adjustments are all of a normal and recurring nature. All significant inter-company accounts and transactions have been eliminated in consolidation. Certain prior period amounts have been reclassified to conform to the current period presentation. The results of operations for the three and six months ended June 30, 2013 are not necessarily indicative of the results that may be expected for the entire year ending December 31, 2013. These consolidated financial statements should be read in conjunction with the Corporation’s audited financial statements and the notes thereto as of December 31, 2012, included in the Corporation’s Annual Report on Form 10-K for the fiscal year ended December 31, 2012.

 

NOTE 2 – STOCK-BASED COMPENSATION PLANS

 

During the first six months of 2013, the Corporation granted 141,584 stock options to officers, directors, and employees under the 2009 Stock Option Plan (the “Plan”). Options granted under the Plan have an exercise price equal to the fair market value as of the grant date. Options granted vest over various periods ranging from two and one-half years to four years and expire one year after the full vesting date. Stock–based compensation expense recognized in other operating expense during the first six months of 2013 and 2012 was $104 thousand and $132 thousand, respectively. The fair value of options is estimated on the date of grant using a Black Scholes option-pricing model with the assumptions noted below.

 

The total unrecognized compensation cost related to non-vested share based compensation arrangements granted under the Plan as of June 30, 2013 was $554,319. The cost is expected to be recognized over a weighted average period of 1.56 years.

 

- 7 -
 

 

NOTE 2 – STOCK-BASED COMPENSATION PLANS (continued)

 

A summary of stock option activity under the Plan for the six months ended June 30, 2013 and 2012 is presented as follows:

 

   Six Months Ended 
   June 30, 2013 
     
Expected life of options granted, in years   4.61 
Risk-free interest rate   0.36%
Expected volatility of stock   42%
Annual expected dividend yield   3%
      
Fair Value of Granted Options  $435,473 
Non-Vested Options   331,477 

 

           Weighted Avg.     
   Number of   Weighted Avg.   Remaining Contractual   Aggregate Intrinsic 
   Options   Exercise Price   Term, in years   Value 
                 
Outstanding at beginning of year   274,800   $7.72    2.59   $1,450,016 
Granted   141,584    15.31    4.61    - 
Exercised   (28,899)   6.67    0.95    205,275 
Lapsed or Canceled   (5,759)  $9.09    2.58   $- 
                     
Outstanding at June 30, 2013   381,726   $10.59    3.11   $1,237,911 
                     
Exercisable at June 30, 2013   50,249   $7.56    1.84   $272,275 

 

   Six Months Ended 
   June 30, 2012 
     
Expected life of options granted, in years   4.60 
Risk-free interest rate   0.39%
Expected volatility of stock   43%
Annual expected dividend yield   2%
      
Fair value of granted options  $327,368 
Non-vested options   324,650 

 

           Weighted Avg.     
   Number of   Weighted Avg.   Remaining Contractual   Aggregate Intrinsic 
   Options   Exercise Price   Term, in years   Value 
                 
Outstanding at beginning of year   385,450   $6.04    1.63   $1,064,115 
Granted   106,350    9.30    4.60    - 
Exercised   (132,453)   5.47    0.03    674,588 
Lapsed or canceled   (8,992)  $6.65    2.08   $- 
                     
Outstanding at June 30, 2012   350,355   $7.23    2.64   $2,055,653 
                     
Exercisable at June 30, 2012   25,705   $3.99    0.07   $234,173 

 

NOTE 3 – SECURITIES

The following table provides the amortized cost and fair value for the categories of available-for-sale securities and held-to-maturity securities at June 30, 2013 and December 31, 2012. Held-to-maturity securities are carried at amortized cost, which reflects historical cost, adjusted for amortization of premiums and accretion of discounts. Available-for-sale securities are carried at estimated fair value with net unrealized gains or losses reported on an after tax basis as a component of accumulated other comprehensive income in shareholders’ equity. The estimated fair value of available-for-sale securities is impacted by interest rates, credit spreads, market volatility, and liquidity.

 

- 8 -
 

 

NOTE 3 – SECURITIES (continued)

 

   June 30, 2013 
   Amortized Cost   Gross
Unrealized
Gains
   Gross
Unrealized
(Losses)
   Estimated
Fair Value
 
   (In Thousands) 
Available-for-sale:                    
U.S. Government agencies  $31,280   $15   $(1,144)  $30,151 
Mortgage backed securities   28,870    65    (947)   27,988 
Corporate bonds   6,019    93    (128)   5,984 
Other AFS   3,882    -    (9)   3,873 
CRA mutual fund   1,500    -    (69)   1,431 
Total  $71,551   $173   $(2,297)  $69,427 
                     
Held-to-maturity:                    
U.S. Government agencies  $14,982   $-   $(283)  $14,699 
Municipals - non taxable   879    -    (48)   831 
Total  $15,861   $-   $(331)  $15,530 

  

   December 31, 2012 
   Amortized Cost   Gross
Unrealized
Gains
   Gross
Unrealized
(Losses)
   Estimated
Fair Value
 
   (In Thousands) 
Available-for-sale:                    
U.S. Government agencies  $15,000   $16   $-   $15,016 
Mortgage backed securities   15,103    100    (26)   15,177 
Corporate bonds   4,012    92    (25)   4,079 
CRA mutual fund   1,500    -    (13)   1,487 
Total  $35,615   $208   $(64)  $35,759 
                     
Held-to-maturity:                    
U.S. Government agencies  $44,952   $356   $-   $45,308 
Total  $44,952   $356   $-   $45,308 

 

- 9 -
 

 

NOTE 3 – SECURITIES (continued)

 

The amortized cost and estimated fair value of securities available-for-sale and held-to-maturity as of June 30, 2013 and December 31, 2012 by contractual maturity are shown below. Actual maturities may differ from contractual maturities because some of the securities may be called or prepaid without any penalties.

 

   June 30, 2013   December 31, 2012 
       Estimated       Estimated 
   Amortized   Fair   Amortized   Fair 
   Cost   Value   Cost   Value 
   (In Thousands) 
Available-for-sale:                    
U.S. Government agencies:                    
Due after one through five years  $4,367   $4,335   $5,000   $5,003 
Due after five through ten years   18,998    18,075    5,000    5,008 
Due after ten through fifteen years   4,391    4,406    5,000    5,005 
Due after fifteen years   3,524    3,335    -    - 
Mortgage backed securities:                    
Due after five through ten years   5,989    5,848    3,696    3,745 
Due after ten through fifteen years   19,457    18,768    10,918    10,893 
Due after fifteen years   3,424    3,372    489    539 
Corporate bonds:                    
Due after one through five years   4,011    4,104    4,012    4,079 
Due after five through ten years   2,008    1,880    -    - 
Other-AFS:                    
Due after five through ten years   1,000    1,000    -    - 
Due after fifteen years   2,882    2,873    -    - 
CRA Mutual Fund   1,500    1,431    1,500    1,487 
Total  $71,551   $69,427   $35,615   $35,759 
                     
Held-to-maturity:                    
U.S. Government agencies:                    
Due after one through five years  $4,998   $4,997   $24,981   $25,085 
Due after five through ten years   5,000    4,961    5,000    5,175 
Due after ten through fifteen years   4,984    4,741    14,971    15,048 
Municipals non-taxable:                    
Due after ten through fifteen years   879    831    -    - 
Total  $15,861   $15,530   $44,952   $45,308 

 

The estimated fair value of securities pledged to secure public funds, securities sold under agreements to repurchase, and for other purposes amounted to $47.0 million at June 30, 2013 and $60.7 million at December 31, 2012.

 

- 10 -
 

 

NOTE 3 – SECURITIES (continued)

 

Securities available-for-sale and held-to-maturity that have an unrealized loss position at June 30, 2013 and December 31, 2012 are as follows:

 

   Securities in a loss   Securities in a loss         
   Position for less than   Position for 12 Months         
   12 Months   or Longer   Total 
June 30, 2013  Estimated       Estimated       Estimated     
   Fair   Unrealized   Fair   Unrealized   Fair   Unrealized 
   Value   Losses   Value   Losses   Value   Losses 
Investment securities available-for-sale:  (In Thousands) 
                         
Mortgage backed securities  $24,443   $(947)  $-   $-   $24,443   $(947)
U.S. Government agencies   25,746    (1,144)   -    -    25,746    (1,144)
Other AFS   2,873    (9)   -    -    2,873    (9)
Corporate bonds   1,880    (128)   -    -    1,880    (128)
CRA Mutual fund   1,431    (69)   -    -    1,431    (69)
Total  $56,373   $(2,297)  $-   $-   $56,373   $(2,297)
                               
Investment securities held-to-maturity:                              
                               
U.S. Government agencies  $14,699   $(283)  $-   $-   $14,699   $(283)
Municipals - non taxable   831    (48)   -    -    831    (48)
Total  $15,530   $(331)  $-   $-   $15,530   $(331)

 

   Securities in a loss   Securities in a loss         
   Position for less than   Position for 12 Months         
   12 Months   or Longer   Total 
   Estimated       Estimated       Estimated     
December 31, 2012  Fair   Unrealized   Fair   Unrealized   Fair   Unrealized 
   Value   Losses   Value   Losses   Value   Losses 
Investment securities available-for-sale:  (In Thousands) 
                         
Mortgage backed securities  $6,361   $(26)  $-   $-   $6,361   $(26)
Corporate bonds   -    -    1,967    (25)   1,967    (25)
CRA Mutual fund   1,487    (13)   -    -    1,487    (13)
Total  $7,848   $(39)  $1,967   $(25)  $9,815   $(64)

 

The Corporation evaluates securities for other than temporary impairment (“OTTI”) on a quarterly basis and more frequently when economic or market conditions warrant such evaluation. Consideration is given to various factors in determining whether the Corporation anticipates a recovery in fair value such as: the length of time and extent to which the fair value has been less than cost, and the financial condition and underlying credit quality of the issuer. When analyzing an issuer’s financial condition, the Corporation may consider whether the securities are issued by the federal government or its agencies, the sector or industry trends affecting the issuer, and whether any recent downgrades by bond rating agencies have occurred.

 

U.S. Government agencies

The Corporation’s unrealized losses on U.S. Government Agency obligations were caused by interest rate fluctuations. On June 30, 2013, three held-to-maturity securities had unrealized losses of $283,319 while seven available for sale securities has unrealized losses of $1,143,620. The severity and duration of these unrealized losses will fluctuate with interest rates in the economy. As the securities are obligations of government agencies, it is the Corporation’s intent to hold these securities until a market price recovery or maturity, and it is more likely than not that the Corporation will not be required to sell the securities before their anticipated recovery, the Corporation does not consider these investments other than temporarily impaired.

 

- 11 -
 

 

NOTE 3 – SECURITIES (continued)

 

Corporate bonds

The Corporation’s unrealized losses on corporate obligations were caused by interest rate fluctuations. At June 30, 2013, one security had an unrealized loss of $127,924. Based on the credit quality of the issuers, the Corporation’s intent to hold this security until a market price recovery or maturity, and the determination that it is more likely than not that the Corporation will not be required to sell the security before its anticipated recovery, the Corporation does not consider this investment other than temporarily impaired.

 

Mortgage-backed

The Corporation’s unrealized losses on mortgage backed securities were caused by interest rate fluctuations. At June 30, 2013, seven securities had unrealized losses of $947,216. As these securities are Ginnie Mae and government sponsored entity securities backed by the United States Government, the Corporation’s intent to hold these securities until a market price recovery or maturity, and the determination that it is more likely than not that the Corporation will not be required to sell these securities before their anticipated recoveries, the Corporation does not consider these investments other than temporarily impaired.

 

Mutual fund

The Corporation’s unrealized loss on its mutual fund investment was caused by interest rate fluctuations. At June 30, 2013, this one security had an unrealized loss of $68,881. Based on the credit quality of the issuers, the Corporation’s intent to hold this security until a market price recovery, and the determination that it is more likely than not that the Corporation will not be required to sell this security before its anticipated recovery, the Corporation does not consider this investment other than temporarily impaired.

 

Other Securities

The Corporation’s unrealized loss on its other investments was caused by interest rate fluctuations. At June 30, 2013, one security had an unrealized loss of $8,613. Based on the credit quality of the issuers, the Corporation’s intent to hold this security until a market price recovery, and the determination that it is more likely than not that the Corporation will not be required to sell the security before its anticipated recovery, the Corporation does not consider this investment other than temporarily impaired.

 

Municipal

The Corporation’s unrealized loss on its held to maturity municipal investment was caused by interest rate fluctuations. At June 30, 2013, this one security had an unrealized loss of $48,106. Based on the credit quality of the issuers, the Corporation’s intent to hold this security until a market price recovery, and the determination that it is more likely than not that the Corporation will not be required to sell the security before its anticipated recovery, the Corporation does not consider this investment other than temporarily impaired.

 

Restricted Stock

 

The Corporation’s restricted stock consists of Federal Home Loan Bank of Atlanta (“FHLB”) stock and Federal Reserve Bank (“FRB”) stock. The amortized costs of the restricted stock as of June 30, 2013 and December 31, 2012 are as follows:

 

   June 30, 2013   December 31, 2012 
Restricted Stock:  (In Thousands) 
         
Federal Reserve Bank stock  $999   $999 
           
FHLB stock   3,285    3,238 
   $4,284   $4,237 

 

- 12 -
 

 

NOTE 4 – LOANS AND THE ALLOWANCE FOR LOAN LOSSES

 

The following table presents the composition of the loans held for investment portfolio at June 30, 2013 and December 31, 2012:

 

   Composition of Loan Portfolio 
     
   June 30, 2013   December 31, 2012 
   Amount   Percentage of Total   Amount   Percentage of Total 
   (Dollars In Thousands) 
Commercial real estate  - owner occupied  $189,648    29.56%  $182,655    29.60%
Commercial real estate - non-owner occupied   98,694    15.39    107,213    17.38 
Residential real estate   157,253    24.51    144,521    23.43 
Commercial   156,563    24.41    149,389    24.21 
Real estate construction   35,396    5.52    30,038    4.87 
Consumer   3,910    0.61    3,162    0.51 
Total loans  $641,464    100.00%  $616,978    100.00%
Less allowance for loan losses   13,007         12,500      
Net loans  $628,457        $604,478      

 

Unearned income and net deferred loan fees and costs totaled $1.6 and $1.7 million at June 30, 2013 and December 31, 2012, respectively. Loans pledged to secure borrowings at the FHLB totaled $218.9 million and $215.4 million at June 30, 2013 and December 31, 2012, respectively.

 

Allowance for Loan Losses

 

The allowance for loan losses totaled $13.0 million at June 30, 2013 compared to $12.5 million at year end December 31, 2012. The allowance for loan losses was equivalent to 2.03% of total loans held for investment at June 30, 2013 and December 31, 2012. Adequacy of the allowance is assessed and the allowance is increased by provisions for loan losses charged to expense no less than quarterly. Charge-offs are taken when a loan is identified as uncollectible.

 

The methodology by which we systematically determine the amount of our allowance is set forth by the Board of Directors in our Loan Policy and implemented by management. The results of the analysis are documented, reviewed, and approved by the Board of Directors no less than quarterly.

 

- 13 -
 

 

NOTE 4 – LOANS AND THE ALLOWANCE FOR LOAN LOSSES (continued)

 

The level of the allowance for loan losses is determined by management through an ongoing, detailed analysis of historical loss rates and risk characteristics. During each quarter, management evaluates the collectability of all loans in the portfolio and ensures an accurate risk rating is assigned to each loan. The risk rating scale and definitions commonly adopted by the Federal Banking Agencies is contained within the framework prescribed by the Bank’s Loan Policy. Any loan that is deemed to have potential or well defined weaknesses that may jeopardize collection in full is then analyzed to ascertain its level of weakness. If appropriate, the loan may be charged-off or a specific reserve may be assigned if the loan is deemed to be impaired.

 

During the risk rating verification process, each loan identified as inadequately protected by the current sound worth and paying capacity of the obligor or of the collateral pledged is considered impaired and is placed on non-accrual status. On these loans, management analyzes the potential impairment of the individual loan and may set aside a specific reserve. Any amounts deemed uncollectible during that analysis are charged-off.

 

For the remaining loans in each segment, the Bank calculates the probability of loss as a group using the risk rating for each of the following loan types: Commercial Real Estate - Owner Occupied, Commercial Real Estate - Non-Owner Occupied, Residential Real Estate, Commercial, Real Estate Construction, and Consumer. Management calculates the historical loss rate in each group by risk rating using a period of at least five years. This historical loss rate may then be adjusted based on management’s assessment of internal and external environmental factors. While management may consider other factors, the analysis generally includes factors such as unemployment, office vacancy rates, and any concentrations that exist within the portfolio. This adjustment is meant to account for changes between the historical economic environment and current conditions and for changes in the ongoing management of the portfolio which affects the loans’ potential losses.

 

Once complete, management compares the condition of the portfolio using several different characteristics, as well as its experience, to the experience of other banks in its peer group in order to determine if it is directionally consistent with others’ experience in our area and line of business. Based on that analysis, management aggregates the probabilities of loss of the remaining portfolio based on the specific and general allowances and may provide additional amounts to the allowance for loan losses as needed. Since this process involves estimates, the allowance for loan losses may also contain an amount that is non-material which is not allocated to a specific loan or to a group of loans but is deemed necessary to absorb additional losses in the portfolio.

 

Management and the Board of Directors subject the reserve adequacy and methodology to a review on a regular basis by internal auditors, external auditors and bank regulators, and such reviews have not resulted in any material adjustment to the allowance.

 

- 14 -
 

 

NOTE 4 – LOANS AND THE ALLOWANCE FOR LOAN LOSSES (continued)

 

The following tables provide detailed information about the allowance for loan losses as of and for the periods indicated.

 

   Allowance for Loan Losses 
     
Three months ended June 30, 2013  Commercial real
estate - owner
occupied
   Commercial real
estate - non-owner
occupied
   Residential
real estate
   Commercial   Real estate
construction
   Consumer   Total 
Allowance for credit losses:  (In Thousands) 
Beginning Balance  $3,725   $2,099   $3,020   $3,220   $709   $87   $12,860 
Charge-offs   -    -    -    -    -    -    - 
Recoveries   -    115    15    7    -    10    147 
Provisions   349    (390)   185    (179)   81    (46)   - 
Ending Balance  $4,074   $1,824   $3,220   $3,048   $790   $51   $13,007 
                                    
Six months ended June 30, 2013                                   
Allowance for credit losses:                                   
Beginning Balance  $3,701   $2,173   $2,924   $3,028   $610   $64   $12,500 
Charge-offs   -    -    -    -    -    -    - 
Recoveries   -    171    78    21    -    12    282 
Provisions   373    (520)   218    (1)   180    (25)   225 
Ending Balance  $4,074   $1,824   $3,220   $3,048   $790   $51   $13,007 

 

Three months ended June 30, 2012  Commercial real
estate - owner
occupied
   Commercial real
estate - non-owner
occupied
   Residential
real estate
   Commercial   Real estate
construction
   Consumer   Total 
Allowance for credit losses:  (In Thousands) 
Beginning Balance  $3,544   $2,227   $2,652   $2,885   $564   $69   $11,941 
Charge-offs   -    -    (30)   (411)   -    -    (441)
Recoveries   -    23    18    17    -    1    59 
Provisions   176    (73)   (24)   406    (9)   (4)   472 
Ending Balance  $3,720   $2,177   $2,616   $2,897   $555   $66   $12,031 
                                    
Six months ended June 30, 2012                                   
Allowance for credit losses:                                   
Beginning Balance  $3,634   $1,747   $2,874   $3,021   $423   $39   $11,738 
Charge-offs   (202)   -    (494)   (694)   -    (35)   (1,425)
Recoveries   -    56    229    242    -    1    528 
Provisions   288    374    7    328    132    61    1,190 
Ending Balance  $3,720   $2,177   $2,616   $2,897   $555   $66   $12,031 

 

   Recorded Investment in Loans 
                             
June 30, 2013  Commercial real
estate - owner
occupied
   Commercial real
estate - non-owner
occupied
   Residential
real estate
   Commercial   Real estate
construction
   Consumer   Total 
Allowance  (In Thousands) 
Ending balance:  $4,074   $1,824   $3,220   $3,048   $790   $51   $13,007 
Ending balance: individually evaluated for impairment  $95   $-   $117   $252   $-   $-   $464 
Ending balance: collectively evaluated for impairment  $3,979   $1,824   $3,103   $2,796   $790   $51   $12,543 
Ending balance: loans acquired with deteriorated credit quality  $-   $-   $-   $-   $-   $-   $- 
                                    
Loans                                   
Ending balance  $189,648   $98,694   $157,253   $156,563   $35,396   $3,910   $641,464 
Ending balance: individually evaluated for impairment  $-   $-   $555   $1,744   $-   $-   $2,299 
Ending balance: collectively evaluated for impairment  $189,648   $98,694   $156,698   $154,819   $35,396   $3,910   $639,165 
Ending balance: loans acquired with deteriorated credit quality  $-   $-   $-   $-   $-   $-   $- 

 

 

December 31, 2012  Commercial real
estate - owner
occupied
   Commercial real
estate - non-owner
occupied
   Residential
real estate
   Commercial   Real estate
construction
   Consumer   Total 
Allowance  (In Thousands) 
Ending balance:  $3,701   $2,173   $2,924   $3,028   $610   $64   $12,500 
Ending balance: individually evaluated for impairment  $98   $-   $230   $277   $-   $-   $605 
Ending balance: collectively evaluated for impairment  $3,603   $2,173   $2,694   $2,751   $610   $64   $11,895 
Ending balance: loans acquired with deteriorated credit quality  $-   $-   $-   $-   $-   $-   $- 
                                    
Loans                                   
Ending balance:  $182,655   $107,213   $144,521   $149,389   $30,038   $3,162   $616,978 
Ending balance: individually evaluated for impairment  $370   $-   $922   $1,937   $-   $-   $3,229 
Ending balance: collectively evaluated for impairment  $182,285   $107,213   $143,599   $147,452   $30,038   $3,162   $613,749 
Ending balance: loans acquired with deteriorated credit quality  $-   $-   $-   $-   $-   $-   $- 

 

 

- 15 -
 

 

NOTE 4 – LOANS AND THE ALLOWANCE FOR LOAN LOSSES (continued)

 

Identifying and Classifying Portfolio Risks by Risk Rating

 

At origination, loans are categorized into risk categories based upon original underwriting. Subsequent to origination, management evaluates the collectability of all loans in the portfolio and assigns a proprietary risk rating. Ratings range from the highest to lowest quality based on factors including measurements of ability to pay, collateral type and value, borrower stability, management experience, and credit enhancements. These ratings are consistent with the bank regulatory rating system.

 

A loan may have portions of its balance in one rating and other portions in a different rating. The Bank may use these “split ratings” when factors cause loan loss risk to exist for part but not all of the principal balance. Split ratings may also be used where cash collateral or a government agency has provided a guaranty that partially covers a loan.

 

For clarity of presentation, the Corporation’s loan portfolio is profiled below in accordance with the risk rating framework that has been commonly adopted by the federal banking agencies. The definitions of the various risk rating categories are as follows:

 

Pass - The condition of the borrower and the performance of the loan is satisfactory or better.

 

Special mention - A special mention asset has one or more potential weaknesses that deserve management’s close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the asset or in the institution’s credit position at some future date.

 

Substandard - A substandard asset is inadequately protected by the current sound worth and paying capacity of the obligor or of the collateral pledged, if any. Assets 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.

 

Doubtful - An asset classified doubtful has all the weaknesses inherent in one classified 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.

 

Loss - Assets classified loss are considered uncollectible and their continuance as bankable assets is not warranted. This classification does not mean that the asset has absolutely no recovery or salvage value, and a partial recovery may be effected in the future.

 

The Bank did not have any loans classified as loss at June 30, 2013 or December 31, 2012. It is the Bank’s policy to charge-off any loan once the risk rating is classified as loss.

 

The profile of the loan portfolio, as indicated by risk rating, as of June 30, 2013 and December 31, 2012 is shown below.

 

   Credit Quality Indicators 
   For the Period Ended, June 30, 2013 
Credit Risk Profile by Regulatory Risk Rating                                            
                                                         
   Commercial
real estate -
owner occupied
   Commercial
real estate -
non-owner occupied
   Residential real estate   Commercial   Real estate construction   Consumer   Totals 
   6/30/13   12/31/12   6/30/13   12/31/12   6/30/13   12/31/12   6/30/13   12/31/12   6/30/13   12/31/12   6/30/13   12/31/12   6/30/13   12/31/12 
   (In Thousands) 
Pass  $171,577   $159,413   $91,266   $100,443   $151,585   $138,388   $141,423   $130,885   $35,573   $30,202   $3,909   $3,162   $595,333   $562,493 
Special mention   6,689    11,897    2,370    2,402    3,593    3,902    9,327    12,225    -    -    -    -    21,979    30,426 
Substandard   11,843    11,852    5,403    4,725    2,289    2,420    6,167    6,724    -    -    -    -    25,702    25,721 
Doubtful   -    -    -    -    -    -    -    -    -    -    -    -    -    - 
Loss   -    -    -    -    -    -    -    -    -    -    -    -    -    - 
Unearned income   (461)   (507)   (345)   (357)   (214)   (189)   (354)   (445)   (177)   (164)   1    -    (1,550)   (1,662)
Total  $189,648   $182,655   $98,694   $107,213   $157,253   $144,521   $156,563   $149,389   $35,396   $30,038   $3,910   $3,162   $641,464   $616,978 

 

- 16 -
 

 

NOTE 4 – LOANS AND THE ALLOWANCE FOR LOAN LOSSES (continued)

 

Loans listed as non-performing are also placed on non-accrual status. The accrual of interest is discontinued at the time a loan is 90 days delinquent or when the credit deteriorates and there is doubt that the credit will be paid as agreed, unless the credit is well-secured and in process of collection. Once the loan is on non-accrual status, all accrued but unpaid interest is also charged-off, and all payments are used to reduce the principal balance. Once the principal balance is repaid in full, additional payments are taken into income. A loan may be returned to accrual status if the borrower shows renewed willingness and ability to repay under the term of the loan agreement. The risk profile based upon payment activity is shown below.

 

   Commercial
real estate -
owner occupied
   Commercial
real estate -
non-owner occupied
   Residential real estate   Commercial   Real estate construction   Consumer   Totals 
   6/30/13   12/31/12   6/30/13   12/31/12   6/30/13   12/31/12   6/30/13   12/31/12   6/30/13   12/31/12   6/30/13   12/31/12   6/30/13   12/31/12 
   (In Thousands) 
Performing  $189,648   $182,655   $98,694   $107,213   $156,698   $143,599   $154,819   $147,568   $35,396   $30,038   $3,910   $3,162   $639,165   $614,235 
Non-performing   -    -    -    -    555    922    1,744    1,821    -    -    -    -    2,299    2,743 
Total  $189,648   $182,655   $98,694   $107,213   $157,253   $144,521   $156,563   $149,389   $35,396   $30,038   $3,910   $3,162   $641,464   $616,978 

 

Loans are considered past due if a contractual payment is not made by the calendar day after the payment is due. However, for reporting purposes loans past due 1 to 29 days are excluded from loans past due and are included in the total for current loans in the table below. The delinquency status of the loans in the portfolio is shown below as of June 30, 2013 and December 31, 2012. Loans that were on non-accrual status are not included in any past due amounts.

 

   Age Analysis of Past Due Loans 
     
   June 30, 2013 
   30-59 Days
Past Due
   60-89 Days
Past Due
   Greater than
90 Days
   Total Past
Due
   Non-accrual
Loans
   Current
Loans
   Total
Loans
 
   (In Thousands) 
Commercial real estate - owner occupied  $-   $-   $-   $-   $-   $189,648   $189,648 
Commercial real estate - non-owner occupied   345    -    -    345    -    98,349    98,694 
Residential real estate   -    725    -    725    555    155,973    157,253 
Commercial   -    -    -    -    1,744    154,819    156,563 
Real estate construction   -    -    -    -    -    35,396    35,396 
Consumer   -    -    -    -    -    3,910    3,910 
Total  $345   $725   $-   $1,070   $2,299   $638,095   $641,464 

 

   December 31, 2012 
   30-59 Days
Past Due
   60-89 Days
Past Due
   Greater than
90 Days
   Total Past
Due
   Non-accrual
Loans
   Current
Loans
   Total
Loans
 
   (In Thousands) 
Commercial real estate - owner occupied  $-   $-   $-   $-   $-   $182,655   $182,655 
Commercial real estate - non-owner occupied   -    -    -    -    -    107,214    107,214 
Residential real estate   -    -    -    -    922    143,600    144,522 
Commercial   -    -    -    -    1,821    147,568    149,389 
Real estate construction   -    -    -    -    -    30,038    30,038 
Consumer   -    -    -    -    -    3,160    3,160 
Total  $-   $-   $-   $-   $2,743   $614,235   $616,978 

 

- 17 -
 

 

NOTE 4 – LOANS AND THE ALLOWANCE FOR LOAN LOSSES (continued)

 

Troubled Debt Restructurings

 

A troubled debt restructuring ("TDR") is a formal restructure of a loan when the Bank, for economic or legal reasons related to the borrower's financial difficulties, grants a concession to a borrower. The Bank classifies these transactions as a TDR if the transaction meets the following conditions: an existing credit agreement must be formally renewed, extended and/or modified; the borrower must be experiencing financial difficulty; and the Bank has granted a concession that it would not otherwise consider. ASU 2011-02 requires public companies to identify and account for TDRs for interim and annual periods beginning on or after June 15, 2011.

 

Once identified as a TDR, a loan is considered to be impaired, and an impairment analysis is performed for the loan individually, rather than under a general loss allowance based on the loan type and risk rating. Any resulting shortfall is charged-off. This method is used consistently for all segments of the portfolio.

 

Normally, loans identified as TDRs would be placed on non-accrual status and considered non-performing until sufficient history of timely collection or payment has occurred that allows them to return to performing status, generally 6 months.

 

One residential real estate loan totaling $210 thousand was modified in connection with a troubled debt restructuring during the six month period ended June 30, 2013. The modification granted the borrower reduced payments for a period of one year. There were no material financial effects as a direct result of this modification. No loans were modified in connection with a troubled debt restructuring during the three month period ended June 30, 2013.

 

No loans were modified during the first and second quarter of 2012 in connection with a trouble debt restructuring. There was one commercial loan previously restructured no more than 12 months prior to June 30, 2012 with a recorded balance of $95,990 that subsequently defaulted in the three month period ended June 30, 2012. No payment defaults occurred during the first quarter of 2012 for loans restructured within the last 12 months.

 

Impaired Loans

 

A loan is classified as impaired when it is deemed probable by management’s analysis that the Bank will be unable to collect all amounts due according to the contractual terms of the loan agreement, or the recorded investment in the impaired loan is greater than the present value of expected future cash flows, discounted at the loan's effective interest rate. In the case of an impaired loan, management conducts an analysis which identifies if a quantifiable potential loss exists, and takes the necessary steps to record that loss when it has been identified as uncollectible.

 

As the ultimate collectability of the total principal of an impaired loan is in doubt, the loan is placed on nonaccrual status with all payment applied to principal under the cost-recovery method. As such, the Bank did not recognize any interest income on its impaired loans for the three and six month periods ended June 30, 2013 and 2012.

 

- 18 -
 

 

NOTE 4 – LOANS AND THE ALLOWANCE FOR LOAN LOSSES (continued)

 

The table below shows the results of management’s analysis of impaired loans as of June 30, 2013 and December 31, 2012.

 

   Impaired Loans 
                         
   June 30, 2013   December 31, 2012 
   Recorded
investment
   Unpaid
principal
balance
   Related
allowance
   Recorded
investment
   Unpaid
principal
balance
   Related
allowance
 
With no specific related allowance recorded:  (In Thousands) 
Commercial real estate - owner occupied  $-   $-   $-   $-   $-   $- 
Commercial real estate - non-owner occupied   -    -    -    -    -    - 
Residential real estate   -    -    -    -    -    - 
Commercial   1,083    1,230    -    154    165    - 
Real estate construction   -    -    -    -    -    - 
Consumer   -    -    -    -    -    - 
With a specific related allowance recorded:                              
Commercial real estate - owner occupied   366    366   $95   $370   $370   $98 
Commercial real estate - non-owner occupied   -    -    -    -    -    - 
Residential real estate   555    710    117    922    1,068    230 
Commercial   754    982    252    1,783    2,099    277 
Real estate construction   -    -    -    -    -    - 
Consumer   -    -    -    -    -    - 
Total:                              
Commercial real estate - owner occupied  $366   $366   $95   $370   $370   $98 
Commercial real estate - non-owner occupied   -    -    -    -    -    - 
Residential real estate   555    710    117    922    1,068    230 
Commercial   1,837    2,212    252    1,937    2,264    277 
Real estate construction   -    -    -    -    -    - 
Consumer   -    -    -    -    -    - 
   $2,758   $3,288   $464   $3,229   $3,702   $605 

 

The table below shows the average recorded investment in impaired loans for the periods presented.

 

   Three Months Ended   Six Months Ended 
   June 30, 2013   June 30, 2012   June 30, 2013   June 30, 2012 
                 
   Average Recorded
Investment
   Average Recorded
Investment
   Average Recorded
Investment
   Average Recorded
Investment
 
     
Commercial real estate - owner occupied  $367   $1,691   $368   $1,677 
Commercial real estate - non-owner occupied   -    315    -    315 
Residential real estate   560    2,068    563    2,062 
Commercial   1,861    1,205    1,889    1,303 
Real estate construction   -    -    -    - 
Consumer   -    -    -    - 
Total  $2,788   $5,279   $2,820   $5,357 

 

NOTE 5 – SEGMENT REPORTING

 

The Corporation has two reportable segments: traditional commercial banking and mortgage banking. Revenues from commercial banking operations consist primarily of interest earned on loans and securities and fees from deposit services. Mortgage banking operating revenues consist principally of interest earned on mortgage loans held for sale, gains on sales of loans in the secondary mortgage market, and loan origination fee income.

 

- 19 -
 

 

NOTE 5 – SEGMENT REPORTING (continued)

 

The commercial banking segment provides the mortgage banking segment with the short-term funds needed to originate mortgage loans through a warehouse line of credit and charges the mortgage banking segment interest based on the prime rate. These transactions are eliminated in the consolidation process.

 

The “Other” column in the following table includes the operations of the Corporation, Access Real Estate, and ACM. The primary source of income for the Corporation is derived from dividends from the Bank and its primary expense relates to interest on subordinated debentures. The primary source of income for Access Real Estate is derived from rents received from the Bank. ACM’s primary source of income is derived from fees related to its wealth management services.

 

The following table presents segment information for the three months ended June 30, 2013 and 2012:

 

   Commercial   Mortgage           Consolidated 
June 30, 2013  Banking   Banking   Other   Eliminations   Totals 
   (In Thousands) 
Revenues:                         
Interest income  $8,915   $430   $4   $(263)  $9,086 
Gain on sale of loans   -    7,356    -    (236)   7,120 
Other revenues   751    (269)   603    (182)   903 
Total revenues   9,666    7,517    607    (681)   17,109 
                          
Expenses:                         
Interest expense   986    159    152    (263)   1,034 
Salaries and employee benefits   2,888    3,654    257    -    6,799 
Other expenses   1,565    1,817    770    (418)   3,734 
Total operating expenses   5,439    5,630    1,179    (681)   11,567 
                          
Income (loss) before income taxes  $4,227   $1,887   $(572)  $-   $5,542 
                          
Total assets  $785,158   $56,761   $9,674   $(9,910)  $841,683 

 

   Commercial   Mortgage           Consolidated 
June 30, 2012  Banking   Banking   Other   Eliminations   Totals 
   (In Thousands) 
Revenues:                         
Interest income  $8,915   $510   $3   $(426)  $9,002 
Gain on sale of loans   -    14,202    -    536    14,738 
Other revenues   699    (1,311)   604    (998)   (1,006)
Total revenues   9,614    13,401    607    (888)   22,734 
                          
Expenses:                         
Interest expense   1,231    308    158    (427)   1,270 
Salaries and employee benefits   2,810    4,342    322    -    7,474 
Other expenses   2,071    5,036    763    (461)   7,409 
Total operating expenses   6,112    9,686    1,243    (888)   16,153 
                          
Income (loss) before income taxes  $3,502   $3,715   $(636)  $-   $6,581 
                          
Total assets  $749,588   $108,078   $10,409   $(26,366)  $841,709 

 

- 20 -
 

 

NOTE 5 – SEGMENT REPORTING (continued)

 

The following table presents segment information for the six months ended June 30, 2013 and 2012:

 

   Commercial   Mortgage           Consolidated 
June 30, 2013  Banking   Banking   Other   Eliminations   Totals 
   (In Thousands) 
Revenues:                         
Interest income  $17,898   $1,044   $7   $(707)  $18,242 
Gain on sale of loans   -    15,237    -    (236)   15,001 
Other revenues   1,385    1,922    1,146    (587)   3,866 
Total revenues   19,283    18,203    1,153    (1,530)   37,109 
                          
Expenses:                         
Interest expense   2,003    502    303    (707)   2,101 
Salaries and employee benefits   5,778    8,598    492    -    14,868 
Other expenses   3,477    4,408    1,483    (823)   8,545 
Total operating expenses   11,258    13,508    2,278    (1,530)   25,514 
                          
Income (loss) before income taxes  $8,025   $4,695   $(1,125)  $-   $11,595 
                          
Total assets  $785,158   $56,761   $9,674   $(9,910)  $841,683 

 

 

   Commercial   Mortgage           Consolidated 
June 30, 2012  Banking   Banking   Other   Eliminations   Totals 
   (In Thousands) 
Revenues:                         
Interest income  $18,004   $1,360   $5   $(1,016)  $18,353 
Gain on sale of loans   -    26,561    -    (879)   25,682 
Other revenues   1,318    (2,250)   1,129    (46)   151 
Total revenues   19,322    25,671    1,134    (1,941)   44,186 
                          
Expenses:                         
Interest expense   2,659    793    318    (1,017)   2,753 
Salaries and employee benefits   5,645    9,546    618    -    15,809 
Other expenses   4,276    8,785    1,419    (924)   13,556 
Total operating expenses   12,580    19,124    2,355    (1,941)   32,118 
                          
Income (loss) before income taxes  $6,742   $6,547   $(1,221)  $-   $12,068 
                          
Total assets  $749,588   $108,078   $10,409   $(26,366)  $841,709 

 

- 21 -
 

 

NOTE 6 – EARNINGS PER SHARE

 

The following table shows the calculation of both basic and diluted earnings per share (“EPS”) for the three and six months ended June 30, 2013 and 2012, respectively. The numerator of both the basic and diluted EPS is equivalent to net income. The weighted average number of shares outstanding used as the denominator for diluted EPS is increased over the denominator used for basic EPS by the effect of potentially dilutive common stock options utilizing the treasury stock method.

 

   Three Months   Three Months 
   Ended   Ended 
   June 30, 2013   June 30, 2012 
   (In Thousands, Except for Share and Per Share Data) 
         
BASIC EARNINGS PER SHARE:          
Net income  $3,524   $3,890 
Weighted average shares outstanding   10,306,561    10,237,515 
           
Basic earnings per share  $0.34   $0.38 
           
DILUTED EARNINGS PER SHARE:          
Net income  $3,524   $3,890 
Weighted average shares outstanding   10,306,561    10,237,515 
Dilutive stock options   73,309    112,699 
Weighted average diluted shares outstanding   10,379,870    10,350,214 
           
Diluted earnings per share  $0.34   $0.38 

 

   Six Months   Six Months 
   Ended   Ended 
   June 30, 2013   June 30, 2012 
   (In Thousands, Except for Share and Per Share Data) 
         
BASIC EARNINGS PER SHARE:          
Net income  $7,208   $7,327 
Weighted average shares outstanding   10,314,592    10,219,085 
           
Basic earnings per share  $0.70   $0.72 
           
DILUTED EARNINGS PER SHARE:          
Net income  $7,208   $7,327 
Weighted average shares outstanding   10,314,592    10,219,085 
Dilutive stock options   94,143    112,444 
Weighted average diluted shares outstanding   10,408,735    10,331,529 
           
Diluted earnings per share  $0.69   $0.71 

 

- 22 -
 

 

NOTE 7 - DERIVATIVES

 

As part of its mortgage banking activities, the Bank enters into interest rate lock commitments, which are commitments to originate loans where the interest rate on the loan is determined prior to funding and the customers have locked into that interest rate. The Bank then locks in the loan and interest rate with an investor and commits to deliver the loan if settlement occurs (“best efforts”) or commits to deliver the locked loan in a binding (“mandatory”) delivery program with an investor. Certain loans under interest rate lock commitments are covered under forward sales contracts of mortgage backed securities (“MBS”). Forward sales contracts of MBS are recorded at fair value with changes in fair value recorded in noninterest income. Interest rate lock commitments and commitments to deliver loans to investors are considered derivatives. The market value of interest rate lock commitments and best efforts contracts are not readily ascertainable with precision because they are not actively traded in stand-alone markets. The Bank determines the fair value of interest rate lock commitments and delivery contracts by measuring the fair value of the underlying asset, which is impacted by current interest rates, taking into consideration the probability that the interest rate lock commitments will close or will be funded.

 

Certain additional risks arise from these forward delivery contracts in that the counterparties to the contracts may not be able to meet the terms of the contracts. The Bank does not expect any counterparty to any MBS to fail to meet its obligation. Additional risks inherent in mandatory delivery programs include the risk that, if the Bank does not close the loans subject to interest rate risk lock commitments, it will still be obligated to deliver MBS to the counterparty under the forward sales agreement. Should this be required, the Bank could incur significant costs in acquiring replacement loans or MBS and such costs could have an adverse effect on mortgage banking operations.

 

Since the Bank’s derivative instruments are not designated as hedging instruments, the fair value of the derivatives are recorded as a freestanding asset or liability with the change in value being recognized in current earnings during the period of change. The Bank has not elected to apply hedge accounting to its derivative instruments as provided in Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 815, Derivatives and Hedging.

 

At June 30, 2013 and December 31, 2012, the Bank had derivative financial instruments with a notional value of $80.2 million and $217.4 million, respectively. The fair value of these derivative instruments at June 30, 2013 and December 31, 2012 was $795 thousand and $465 thousand, respectively, and was included in other assets and other liabilities.

 

Included in other noninterest income for the six months ended June 30, 2013 and June 30, 2012 was a net loss of $1.8 million and a net loss of $2.3 million, respectively, relating to derivative instruments.

 

NOTE 8 – RECENT ACCOUNTING PRONOUNCEMENTS

 

In April 2011, the Financial Accounting Standards Board (the “FASB”) issued Accounting Standards Update (“ASU”) No. 2011-03, “Reconsideration of Effective Control for Repurchase Agreements.” ASU No. 2011-03 modifies the criteria for determining when repurchase agreements would be accounted for as a secured borrowing rather than as a sale. Currently, an entity that maintains effective control over transferred financial assets must account for the transfer as a secured borrowing rather than as a sale. The provisions of ASU No. 2011-03 removes from the assessment of effective control the criterion requiring the transferor to have the ability to repurchase or redeem the financial assets on substantially the agreed terms, even in the event of default by the transferee. The FASB believes that contractual rights and obligations determine effective control and that there does not need to be a requirement to assess the ability to exercise those rights. ASU No. 2011-03 does not change the other existing criteria used in the assessment of effective control. The provisions of ASU No. 2011-03 were effective prospectively for transactions, or modifications of existing transactions, that occur on or after January 1, 2012. The adoption of this ASU did not have a material impact on the Corporation’s financial statements.

 

- 23 -
 

 

NOTE 8 – RECENT ACCOUNTING PRONOUNCEMENTS (continued)

 

In April 2011, the FASB issued ASU No. 2011-03, “Transfers and Servicing (Topic 860): Reconsideration of Effective Control for Repurchase Agreements”. The guidance simplifies the accounting for financial assets transferred under repurchase agreements and similar arrangements and increases the number of transfers to be accounted for as secured borrowings as opposed to sales. The amended guidance is effective prospectively for new transfers and existing transactions modified as of the first interim or annual period beginning on or after December 15, 2011. Repurchase agreements are offered through a commercial banking sweep product as a short-term investment opportunity for customers. All such arrangements are considered typical of the banking industry and are accounted for as borrowings. The Corporation adopted this guidance beginning with first quarter 2012 financial reporting; there was no material impact upon adoption.

 

In May 2011, the FASB issued ASU No. 2011-04, “Fair Value Measurement (Topic 820): Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs”. The Corporation did adopt ASU 2011-04, which generally aligns the principles of fair value measurements with International Financial Reporting Standards (IFRSs), in its consolidated financial statements in the first quarter 2012. The provisions of ASU 2011-04 clarify the application of existing fair value measurement requirements, and expand the disclosure requirements for fair value measurements. While the provisions of ASU 2011-04 did increase the Corporation’s fair value disclosures the adoption of ASU 2011-04 did not have a material effect on the Corporation’s financial condition and results of operations.

 

In June 2011, the FASB issued ASU No. 2011-5, “Presentation of Comprehensive Income” (Topic 220): This update amended existing guidance relating to presentation of other comprehensive income in a convergence effort with international accounting standards. This guidance eliminates the option to present the components of comprehensive income as a part of the statement of changes in stockholders’ equity and requires a consecutive presentation of net income and other comprehensive income, and a reconciliation of the components of other comprehensive income. Similar to the requirements of existing guidance, entities are required to present on the face of the financial statements reclassification adjustments for items that are reclassified from other comprehensive income to net income in the statements where the components of net income and other comprehensive income are presented. Although portions of this update related to the reclassification of adjustments out of other comprehensive income were deferred in December 2011, the amendments in this guidance should be applied retrospectively and are effective for fiscal years, and interim periods within those years, beginning after December 15, 2011. Early adoption is permitted and the amendments do not require any transition disclosures. The adoption of this guidance did not have a material effect on the Corporation’s consolidated financial statements or results of operations.

 

In December 2011, the FASB issued ASU No. 2011-11, “Balance Sheet (Topic 210): Disclosures about Offsetting Assets and Liabilities”. This guidance eliminates offsetting of financial instruments disclosure differences between GAAP and IFRS. New disclosures will be required for recognized financial instruments, such as derivatives, repurchase agreements, and reverse repurchase agreements, that are either (1) offset on the balance sheet in accordance with the FASB’s offsetting guidance or (2) subject to an enforceable master netting arrangement or similar agreement, regardless of whether they are offset in accordance with the FASB’s offsetting guidance. The objective of the new disclosure requirements is to enable users of the financial statements to evaluate the effect or potential effect of netting arrangements on an entity’s financial position, including the effect or potential effect of rights of setoff associated with certain financial instruments and derivative instruments. This amended guidance will be applied retrospectively and is effective for fiscal years, and interim periods within those years, beginning on or after January 1, 2013. The adoption of this guidance, which involves disclosure only, did not impact the Corporation’s consolidated financial position, results of operations, or cash flows.

 

In July 2012, the FASB issued ASU 2012-02, “Intangibles – Goodwill and Other (Topic 350): Testing Indefinite-Lived Intangible Assets for Impairment” which is related to the impairment of indefinite-lived intangible assets. The guidance simplifies how entities test indefinite-lived intangible assets, other than goodwill, and is similar to the new qualitative impairment test for goodwill. The guidance allows entities to elect to first perform qualitative tests to determine the likelihood that the indefinite-lived intangible asset’s fair value is less than its carrying value. If it is determined that it is more likely than not that the fair value of the indefinite-lived intangible asset is less than its carrying amount, the entity would then perform the first step of the goodwill impairment test. The guidance is effective for annual and interim impairment tests performed for fiscal years beginning after September 15, 2012. The adoption of this guidance has not had a material impact to the consolidated financial statements.

 

- 24 -
 

 

NOTE 8 – RECENT ACCOUNTING PRONOUNCEMENTS (continued)

 

In February 2013, the FASB issued ASU 2013-02, “Comprehensive Income: Reporting of Amounts Reclassified out of Accumulated Other Comprehensive Income”. ASU 2013-02 requires an entity to report the effect of significant reclassifications out of accumulated other comprehensive income on the respective line items in net income if the amount being reclassified is required under U.S. GAAP to be reclassified in its entirety to net income. For other amounts that are not required under U.S. GAAP to be reclassified in their entirety to net income in the same reporting period, an entity is required to cross-reference other disclosures required under U.S. GAAP that provide additional detail about those amounts. ASU 2013-02 does not change the current requirements for reporting net income or other comprehensive income in financial statements. The provisions of ASU 2013-02 are effective for periods beginning after December 15, 2012, with prospective application to transactions or modifications of existing transactions that occur on or after the effective date. The adoption of this guidance had no impact to the consolidated financial statements as the Corporation did not have any reclassifications out of accumulated other comprehensive income during the first quarter 2013.

 

NOTE 9 - FAIR VALUE

 

Fair value pursuant to FASB ASC 820-10, Fair Value Measurements and Disclosures, is the exchange price, in an orderly transaction that is not a forced liquidation or distressed sale, between market participants to sell an asset or transfer a liability in the market in which the reporting entity would transact for the asset or liability, that is, the principal or most advantageous market for the asset or liability.  The transaction to sell the asset or transfer the liability is a hypothetical transaction at the measurement date, considered from the perspective of a market participant that holds the asset or liability. FASB ASC 820-10 provides a consistent definition of fair value which focuses on exit price and prioritizes, within a measurement of fair value, the use of market-based inputs over entity specific inputs.  In addition, FASB ASC 820-10 provides a framework for measuring fair value and establishes a three-level hierarchy for fair value measurements based upon the transparency of inputs to the valuation of an asset or liability as of the measurement date. The standard describes three levels of inputs that may be used to measure fair values:

 

Level 1 - Quoted prices (unadjusted) for identical assets or liabilities in active markets that the entity has the ability to access as of the measurement date.

 

Level 2 - Significant other observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities, quoted prices in markets that are not active, or other inputs that are observable or can be corroborated by observable market data.

 

Level 3 - Significant unobservable inputs that reflect a company’s own assumptions about the assumptions that market participants would use in pricing an asset or liability.

 

The Corporation used the following methods to determine the fair value of each type of financial instrument:

 

Securities: Fair values for securities available-for-sale are obtained from an independent pricing service. The prices are not adjusted. The independent pricing service uses industry-standard models to price U.S. Government agency obligations and mortgage backed securities that consider various assumptions, including time value, yield curves, volatility factors, prepayment speeds, default rates, loss severity, current market and contractual prices for the underlying financial instruments, as well as other relevant economic measures. Securities of obligations of state and political subdivisions are valued using a type of matrix, or grid, pricing in which securities are benchmarked against the treasury rate based on credit rating. Substantially all assumptions used by the independent pricing service are observable in the marketplace, can be derived from observable data, or are supported by observable levels at which transactions are executed in the marketplace (Level 2).

 

Residential loans held for sale: The fair value of loans held for sale is determined using quoted prices for similar assets, adjusted for specific attributes of that loan (Level 2).

 

- 25 -
 

 

NOTE 9 - FAIR VALUE (continued)

 

Derivative financial instruments: Derivative instruments are used to hedge residential mortgage loans held for sale and the related interest-rate lock commitments and include forward commitments to sell mortgage loans and mortgage-backed securities as further described in Note 7. The fair values of derivative financial instruments are based on derivative market data inputs as of the valuation date and the underlying value of mortgage loans for interest rate lock commitments (Level 3).

 

Impaired loans: The fair values of impaired loans are measured on a nonrecurring basis as the fair value of the loan’s collateral for collateral-dependent loans.  Collateral may be in the form of real estate or business assets including equipment, inventory, and accounts receivable.  The use of discounted cash flow models and management’s best judgment are significant inputs in arriving at the fair value measure of the underlying collateral (Level 3).

 

Other real estate owned: The fair value of other real estate owned, which consists of real estate that has been foreclosed, is recorded at the lower of fair value less selling expenses or the book balance prior to foreclosure. Write downs are provided for subsequent declines in value and are recorded in other operating expenses (Level 2).

 

Assets and liabilities measured at fair value under FASB ASC 820-10 on a recurring and non-recurring basis, including financial assets and liabilities for which the Corporation has elected the fair value option as of June 30, 2013 and December 31, 2012, are summarized below:

 

   Fair Value Measurement 
   at June 30, 2013 Using 
Description  Carrying
Value
   Quoted Prices in
Active Markets
for Identical
Assets (Level 1)
   Other
Observable
Inputs (Level 2)
   Significant
Unobservable
Inputs   (Level 3)
 
Financial Assets-Recurring  (In Thousands) 
Available-for-sale investment securities                    
US Government agency  $30,151   $-   $30,151   $- 
Mortgage backed   27,988    -    27,988    - 
Corporate bonds   5,984    -    5,984    - 
Other AFS   3,873    -    3,873    - 
CRA Mutual fund   1,431    -    1,431    - 
Total available-for-sale investment securities   69,427    -    69,427    - 
                     
Residential loans held for sale   48,887    -    48,887    - 
Derivative assets   1,273    -    -    1,273 
Total Financial Assets-Recurring  $119,587   $-   $118,314   $1,273 
                     
Financial Liabilities-Recurring                    
Derivative liabilities  $478   $-   $-   $478 
Total Financial Liabilities-Recurring  $478   $-   $-   $478 
                     
Financial Assets-Non-Recurring                    
Impaired loans (1)  $2,299   $-   $-   $2,299 
Total Financial Assets-Non-Recurring  $2,299   $-   $-   $2,299 

 

(1)Represents the carrying value of loans for which adjustments are based on the appraised value of the collateral.

 

- 26 -
 

 

NOTE 9 - FAIR VALUE (continued)

 

   Fair Value Measurement 
   at December 31, 2012 Using 
Description  Carrying
Value
   Quoted Prices in
Active Markets
for Identical
Assets (Level 1)
   Other
Observable
Inputs (Level 2)
   Significant
Unobservable
Inputs (Level 3)
 
Financial Assets-Recurring  (In Thousands) 
Available-for-sale investment securities                    
US Government agency  $15,016   $-   $15,016   $- 
Mortgage backed   15,177    -    15,177    - 
Corporate bonds   4,079    -    4,079    - 
CRA Mutual fund   1,487    -    1,487    - 
Total available-for-sale investment securities   35,759    -    35,759    - 
                     
Residential loans held for sale   111,542    -    111,542    - 
Derivative assets   1,091    -    -    1,091 
Total Financial Assets-Recurring  $148,392   $-   $147,301   $1,091 
                     
Financial Liabilities-Recurring                    
Derivative liabilities  $626   $-   $-   $626 
Total Financial Liabilities-Recurring  $626   $-   $-   $626 
                     
Financial Assets-Non-Recurring                    
Impaired loans (1)  $3,229   $-   $-   $3,229 
Total Financial Assets-Non-Recurring  $3,229   $-   $-   $3,229 

  

(1)Represents the carrying value of loans for which adjustments are based on the appraised value of the collateral.

 

It is the Corporation’s policy to recognize transfers between levels as of the actual date of the event or change in circumstances that caused the transfer. There were no transfers between Level 1 and Level 2 during the six month periods ended June 30, 2013 and 2012.

 

The changes in Level 3 net derivatives measured at fair value on a recurring basis are summarized as follows:

 

   Three Months Ended June 30, 
   2013   2012 
   (In Thousands) 
Balance, beginning of period  $237   $481 
Realized and unrealized gains (losses) included in earnings   558    356 
Unrealized gains (losses) included in other comprehensive income   -    - 
Purchases, settlements, paydowns, and maturities   -    - 
Transfer into Level 3   -    - 
Balance, end of period  $795   $837 

 

- 27 -
 

 

NOTE 9 - FAIR VALUE (Continued)

 

   Six Months Ended June 30, 
   2013   2012 
   (In Thousands) 
Balance, beginning of period  $465   $(61)
Realized and unrealized gains (losses) included in earnings   330    898 
Unrealized gains (losses) included in other comprehensive income   -    - 
Purchases, settlements, paydowns, and maturities   -    - 
Transfer into Level 3   -    - 
Balance, end of period  $795   $837 

 

The following table presents qualitative information about level 3 fair value measurements for financial instruments measured at fair value at June 30, 2013:

  

Description  Fair Value
Estimate
   Valuation
Techniques
  Unobservable
Input
  Range (Weighted
Average)
   (In Thousands)
Financial Assets - Recurring              
Derivative assets  $1,273   Market pricing (3)  Estimated pullthrough  75% - 90%
Derivative liabilities  $478   Market pricing (3)  Estimated pullthrough  75% - 90%
               
Financial Assets - Non-recurring              
Impaired loans - Real estate secured  $555   Appraisal of collateral (1)  Liquidation expenses (2)  20% - 30%
Impaired loans - Non-real estate secured  $1,744   Cash flow basis  Liquidation expenses (2)  10% - 20%

  

 

(1)Fair value is generally determined through independent appraisals of the underlying collateral on real estate secured loans, which generally include various level 3 inputs which are not identifiable.
(2)Valuations of impaired loans may be adjusted by management for qualitative factors such as liquidation expenses.  The range and weighted average of liquidation expense adjustments are presented as a percent of the appraisal.
(3)Market pricing on derivative assets and liabilities is adjusted by management for the anticipated percent of derivative assets and liabilities that will create a realized gain or loss. The range and weighted average of estimated pull-through is presented as a percent of the volume.

 

Financial instruments recorded using FASB ASC 825-10

 

Under FASB ASC 825-10, Financial Instruments, the Corporation may elect to report most financial instruments and certain other items at fair value on an instrument-by-instrument basis with changes in fair value reported in net income. After the initial adoption the election is made at the acquisition of an eligible financial asset, financial liability or firm commitment or when certain specified reconsideration events occur. The fair value election, with respect to an item, may not be revoked once an election is made.

 

- 28 -
 

 

NOTE 9 - FAIR VALUE (Continued)

 

The following table reflects the differences between the fair value carrying amount of residential mortgage loans held for sale at June 30, 2013, measured at fair value under FASB ASC 825-10, and the aggregate unpaid principal amount the Corporation is contractually entitled to receive at maturity.

 

(In Thousands)  Aggregate
Fair Value
   Difference   Contractual
Principal
 
Residential mortgage loans held for sale  $48,887   $85   $48,802 

 

The Corporation has elected to account for residential loans held for sale at fair value to eliminate the mismatch that would occur by recording changes in market value on derivative instruments used to hedge loans held for sale while carrying the loans at the lower of cost or market.

 

The following methods and assumptions not previously presented were used in estimating the fair value of financial assets and financial liabilities that are not measured and reported at fair value on a recurring basis or non-recurring basis:

 

Cash and Short-Term Investments

 

For those short-term instruments, the carrying amount is a reasonable estimate of fair value. As such they are classified as Level 1 for noninterest-bearing deposits and Level 2 for interest-bearing deposits due from banks or federal funds sold.

 

Restricted Stock

 

It is not practical to determine the fair value of restricted stock due to the restrictions placed on its transferability.

 

Loans, Net of Allowance

 

For certain homogeneous categories of loans, such as some residential mortgages, and other consumer loans, fair value is estimated using the quoted market prices for securities backed by similar loans, adjusted for differences in loan characteristics resulting in a Level 3 classification. The fair value of other types of loans is estimated by discounting the future cash flows using the current rates at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities resulting in a Level 3 classification.

 

Accrued Interest

 

The carrying amounts of accrued interest approximate fair value resulting in a Level 2 or Level 3 classification depending upon the level of the asset or liability, with which, the accrual is associated.

 

Deposits and Borrowings

 

The fair value of demand deposits, savings accounts, and certain money market deposits is the amount payable on demand at the reporting date resulting in a Level 1 classification. The fair value of fixed-maturity certificates of deposit is estimated using the rates currently offered for deposits of similar remaining maturities also resulting in a Level 1 classification. The fair value of all other deposits and borrowings is determined using the discounted cash flow method thereby resulting in a Level 2 classification. The discount rate was equal to the rate currently offered on similar products.

 

Subordinated debentures

 

Due to the pooled nature of these instruments, which are not actively traded, estimated fair value is based on broker prices from recent similar sales resulting in a Level 2 classification.

 

- 29 -
 

 

NOTE 9 - FAIR VALUE (Continued)

 

Off-Balance-Sheet Financial Instruments

 

The fair value of commitments to extend credit is estimated using the fees currently charged to enter similar agreements, taking into account the remaining terms of the agreements and the present creditworthiness of the counterparties. For fixed-rate loan commitments, fair value also considers the difference between current levels of interest rates and the committed interest rates. The fair value of stand-by letters of credit is based on fees currently charged for similar agreements or on the estimated cost to terminate them or otherwise settle the obligations with the counterparties at the reporting date.

 

At June 30, 2013 and December 31, 2012, the majority of off-balance-sheet items are variable rate instruments or convert to variable rate instruments if drawn upon. Therefore, the fair value of these items is largely based on fees, which are nominal and immaterial.

 

The carrying amounts and estimated fair values of financial instruments at June 30, 2013 and December 31, 2012 were as follows:

 

   June 30, 2013   December 31, 2012 
       Estimated       Estimated 
   Carrying   Fair   Carrying   Fair 
   Amount   Value   Amount   Value 
Financial assets:  (In Thousands) 
Cash and short-term investments  $46,622   $46,622   $37,941   $37,941 
Securities available-for-sale   69,427    69,427    35,759    35,759 
Securities held-to-maturity   15,861    15,530    45,308    45,308 
Restricted stock   4,284    4,284    4,237    4,237 
Loans, net of allowance   677,344    675,586    716,020    742,255 
Derivatives   1,273    1,273    1,091    1,091 
Total financial assets  $814,811   $812,722   $840,356   $866,591 
                     
Financial liabilities:                    
Deposits  $659,858   $612,652   $671,496   $650,619 
Short-term borrowings   70,161    70,137    83,091    83,515 
Subordinated debentures   6,186    6,240    6,186    6,187 
Derivatives   478    478    626    626 
Total financial liabilities  $736,683   $689,507   $761,399   $740,947 

 

- 30 -
 

 

NOTE 10 – FINANCIAL INSTRUMENTS WITH OFF-BALANCE-SHEET RISK

 

The Corporation 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. These financial instruments consist primarily of commitments to extend credit. These instruments involve, to varying degrees, elements of credit risk in excess of the amount recognized in the balance sheet. The contract or notional amounts of those instruments reflect the extent of involvement the Corporation has in particular classes of financial instruments.

 

Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee by the customer. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Corporation evaluates each customer’s creditworthiness on a case-by-case basis. The amount of collateral, if any, deemed necessary by the Corporation upon extension of credit is based on management’s credit evaluation of the counterparty. Collateral normally consists of real property, liquid assets or business assets. The Corporation had $30.2 million and $9.7 million in outstanding commitments at June 30, 2013 and December 31, 2012, respectively.

 

The Corporation’s exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit is represented by the contractual notional amount of those instruments. The Corporation uses the same credit policies in making commitments and conditional obligations as it does for on-balance-sheet instruments. The Corporation had $173.9 million and $174.8 million in unfunded lines of credit whose contract amounts represent credit risk at June 30, 2013 and December 31, 2012, respectively.

 

Standby letters of credit are conditional commitments issued by the Corporation to guarantee the performance of a customer to a third party. Those letters of credit are primarily issued to support public and private borrowing arrangements. Essentially all letters of credit issued have expiration dates within one year. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. The Corporation generally holds collateral supporting those commitments if deemed necessary. The Corporation had standby letters of credit outstanding in the amount of $4.4 million and $6.4 million at June 30, 2013 and December 31, 2012, respectively.

 

The Bank maintains a reserve for potential off-balance sheet credit losses that is included in other liabilities on the balance sheet. At June 30, 2013 and December 31, 2012 the balance in this account totaled $548 thousand and $483 thousand, respectively.

 

The mortgage division of the Bank makes representations and warranties that loans sold to investors meet its program’s guidelines and that the information provided by the borrowers is accurate and complete. In the event of a default on a loan sold, the investor may make a claim for losses due to document deficiencies, program compliance, early payment default, and fraud or borrower misrepresentations. The mortgage division maintains a reserve in other liabilities for potential losses on mortgage loans sold. At June 30, 2013, December 31, 2012, and June 30, 2012, the balance in this reserve totaled $4.6 million, $4.4 million, and $4.2 million, respectively.

 

- 31 -
 

 

NOTE 10 – FINANCIAL INSTRUMENTS WITH OFF-BALANCE-SHEET RISK

 

The following table shows the changes to the Allowance for Losses on Mortgage Loans Sold.

 

   Six Months ended June 30,   Year ended  
   2013   2012   December 31, 2012 
   (In Thousands)     
Allowance for losses on mortgage loans sold - beginning of period  $4,376   $2,616   $2,616 
                
Provision charged to operating expense   388    1,600    2,510 
Recoveries   -    -    - 
Charge-offs   (119)   -    (750)
Allowance for losses on mortgage loans sold - end of period  $4,645   $4,216   $4,376 

 

NOTE 11 – CLOSING OF MORTGAGE PRODUCTION BRANCH

 

In April 2013 management made the decision to close its Mortgage Production Branch (Branch) located in Denver, Colorado. The Branch ceased taking loan applications during April 2013 with all obligations and activities terminated as of April 30, 2013. The closure was expected to and has reduced mortgage banking revenue beginning with the second quarter of 2013. Management did not incur any operating losses associated with the closure process.

 

- 32 -
 

 

NOTE 11 – CLOSING OF MORTGAGE PRODUCTION BRANCH (Continued)

 

In order to evaluate the impact of this change on the overall Corporation’s financial performance, condensed consolidated pro forma financial statements are presented below. The pro forma information is presenting results as if the Branch, which closed in the second quarter of 2013, had not been in existence during the three month periods ending June 30, 2013 and 2012. The adjustment for Branch closure does not reflect indirect overhead reductions management plans to make on a go-forward basis.

 

   Access National Corporation 
   Condensed Consolidated Statement of Income 
   Three Months Ended June 30, 2013 
   (In Thousands, Except for Share Data) 
             
   As Reported   Adjustment for
Mortgage
Production Branch
Closure
   Pro Forma Totals 
Interest and dividend income  $9,086   $(55)  $9,031 
                
Interest expense   1,034    -    1,034 
                
Net interest income   8,052    (55)   7,997 
Provision for loan losses   -    -    - 
Net interest income after provision for loan losses   8,052    (55)   7,997 
                
Noninterest income   8,023    (1,075)   6,948 
                
Noninterest expense   10,533    (636)   9,897 
                
Income before income taxes   5,542    (494)   5,048 
                
Provision for income taxes   2,018    (193)   1,825 
                
Net income  $3,524   $(302)  $3,222 
                
Earnings per common share:               
Basic  $0.34   $(0.03)  $0.31 
Diluted  $0.34   $(0.03)  $0.31 
                
Average outstanding shares:               
Basic   10,306,561    -    10,306,561 
Diluted   10,379,870    -    10,379,870 
                
                
Average total assets (in thousands)  $850,200   $(302)  $849,898 
Average shareholders' equity (in thousands)  $94,735   $(100)  $94,635 
                
Return on average assets (annualized)   1.66%   (0.14)%   1.52%
Return on average shareholders' equity (annualized)   14.88%   (1.26)%   13.62%
                
Total loan volume (in thousands)  $171,427   $(35,407)  $136,020 
Purchase loan units as a percentage of business   44.82%   7.55%   52.37%

 

- 33 -
 

 

NOTE 11 – CLOSING OF MORTGAGE PRODUCTION BRANCH (Continued)

 

   Access National Corporation 
   Condensed Consolidated Statement of Income 
   Three Months Ended June 30, 2012 
   (In Thousands, Except for Share Data) 
             
   As Reported   Adjustment for
Mortgage
Production Branch
Closure
   Pro Forma Totals 
Interest and dividend income  $9,002   $(197)  $9,199 
                
Interest expense   1,270    -    1,270 
                
Net interest income   7,732    (197)   7,929 
Provision for loan losses   472    -    472 
Net interest income after provision for loan losses   7,260    -    7,457 
                
Noninterest income   13,732    (5,519)   8,213 
                
Noninterest expense   14,411    (3,601)   10,810 
                
Income before income taxes   6,581    (1,918)   4,860 
                
Provision for income taxes   2,691    (748)   1,943 
                
Net income  $3,890   $(1,170)  $2,917 
                
Earnings per common share:               
Basic  $0.38   $(0.11)  $0.27 
Diluted  $0.38   $(0.11)  $0.27 
                
Average outstanding shares:               
Basic   10,237,515    -    10,237,515 
Diluted   10,349,704    -    10,349,704 
                
                
Average total assets (in thousands)  $798,272   $(1,085)  $797,187 
Average shareholders' equity (in thousands)  $88,648   $(398)  $88,250 
                
Return on average assets (annualized)   1.95%   (0.49)%   1.46%
Return on average shareholders' equity (annualized)   17.55%   (4.33)%   13.22%
                
Total loan volume (in thousands)  $266,850   $(102,715)  $164,135 
Purchase loan units as a percentage of business   28.77%  $22.87%   51.64%

 

NOTE 12 – SUBSEQUENT EVENT

 

On July 8, 2013, the Corporation redeemed its Floating Rate Capital Securities (Preferred) and its Floating Rate Common Securities (Common) with shareholders in the amount of $6.1 million and $187.6 thousand, respectively. Included in the redemption values were interest payments in the amounts of $52,736 and $1,635 for the Preferred and Common shareholders, respectively.

 

- 34 -
 

 

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

 

The following discussion and analysis should be read in conjunction with Access National Corporation’s (“Corporation”, “we”, “us”) consolidated financial statements, and notes thereto, included in the Corporation’s Annual Report on Form 10-K for the fiscal year ended December 31, 2012. Operating results for the three months ended June 30, 2013 are not necessarily indicative of the results for the year ending December 31, 2013 or any future period.

 

CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS

 

In addition to historical information, this Quarterly Report on Form 10-Q contains forward-looking statements. For this purpose, any statements contained herein, including documents incorporated by reference, that are not statements of historical fact may be deemed to be forward-looking statements. Examples of forward-looking statements include discussions as to our expectations, beliefs, plans, goals, objectives and future financial or other performance or assumptions concerning matters discussed in this document. Forward-looking statements often use words such as “believes,” “expects,” “plans,” “may,” “will,” “should,” “projects,” “contemplates,” “ anticipates,” “forecasts,” “intends” or other words of similar meaning. Forward-looking statements in this Quarterly Report on Form 10-Q include, without limitation, statements regarding the Corporation’s beliefs regarding the future strength of the economy and labor markets and anticipated interest rates and the effect of such rates on the Corporation’s performance and net interest margin and the volume of future mortgage refinancing, as well as the Corporation’s expectations concerning operating losses and the profitability of its mortgage segment after the closure of the Mortgage Production Branch.. You can also identify them by the fact that they do not relate strictly to historical or current facts. Forward-looking statements are subject to numerous assumptions, risks and uncertainties, and actual results could differ materially from historical results or those anticipated by such statements. Factors that could have a material adverse effect on the operations and future prospects of the Corporation include, but are not limited to, changes in: collateral values, especially in the real estate market; continued challenging economic conditions or deterioration in general business and economic conditions and in the financial markets; the impact of any laws, regulations, policies or programs implemented pursuant to the Dodd-Frank Act, the Emergency Economic Stabilization Act of 2008, as amended by the American Recovery and Reinvestment Act of 2009; branch expansion plans; interest rates; monetary and fiscal policies of the U.S. Government, including policies of the Office of the Comptroller of the Currency (“Comptroller”), the U.S. Department of the Treasury and the Board of Governors of the Federal Reserve System and the Federal Reserve Bank of Richmond; the economy of Northern Virginia, including governmental spending and commercial and residential real estate markets; the quality or composition of the loan or investment portfolios; demand for loan products; deposit flows; competition; the liquidity of the Corporation; the impact that the closure of the Mortgage Production Branch has on the Corporation’s operating losses and profitability; and accounting principles, policies and guidelines. These risks and uncertainties should be considered in evaluating the forward-looking statements contained herein, and readers are cautioned not to place undue reliance on such statements. Any forward-looking statement speaks only as of the date on which it is made, and we undertake no obligation to update any forward-looking statement to reflect events or circumstances after the date on which it is made.

 

For additional discussion of risk factors that may cause our actual future results to differ materially from the results indicated within forward looking statements, please see “Item 1A – Risk Factors” of the Corporation’s Annual Report on Form 10-K for the fiscal year ended December 31, 2012.

 

CRITICAL ACCOUNTING POLICIES

 

The Corporation’s consolidated financial statements have been prepared in accordance with GAAP. In preparing the Corporation’s financial statements management makes estimates and judgments that affect the reported amounts of assets, liabilities, revenues, and expenses. Management believes that the most significant subjective judgments that it makes include the following:

- 35 -
 

 

Allowance for Loan Losses

 

The allowance for loan losses is an estimate of the losses that may be sustained in our loan portfolio. The allowance is based on two basic principles of accounting: (i) FASB ASC 450-10, which requires that losses be accrued when they are probable of occurring and can be estimated, and (ii) FASB ASC 310-10, which requires that losses be accrued based on the differences between the value of collateral, present value of future cash flows or values that are observable in the secondary market and the loan balance. An allowance for loan losses is established through a provision for loan losses based upon industry standards, known risk characteristics, management’s evaluation of the risk inherent in the loan portfolio, and changes in the nature and volume of loan activity. Such evaluation considers, among other factors, the estimated market value of the underlying collateral and current economic conditions. For further information about our practices with respect to allowance for loan losses, please see Note 4 to the consolidated financial statements.

 

Other Than Temporary Impairment of Securities

 

Securities in the Corporation’s securities portfolio are classified as either available-for-sale or held-to-maturity. At June 30, 2013, there were no non-agency mortgage backed securities or trust preferred securities in the portfolio. The estimated fair value of the portfolio fluctuates due to changes in market interest rates and other factors. Changes in estimated fair value are recorded in shareholders’ equity as a component of other comprehensive income. Securities are monitored to determine whether a decline in their value is other than temporary. Management evaluates the securities portfolio on a quarterly basis to determine the collectability of amounts due per the contractual terms of each security. Once a decline in value is determined to be other than temporary, the value of the security is reduced and a corresponding charge to net income is recognized. At June 30, 2013, there were no securities with other than temporary impairment.

 

Income Taxes

 

The Corporation uses the liability method of accounting for income taxes. This method results in the recognition of deferred tax assets and liabilities that are reflected at currently enacted income tax rates applicable to the period in which the deferred tax assets or liabilities are expected to be realized or settled. As changes in tax laws or rates are enacted, deferred tax assets and liabilities are adjusted through the provision for income taxes. The deferred provision for income taxes is the result of the net change in the deferred tax asset and deferred tax liability balances during the year. This amount combined with the current taxes payable or refundable results in the income tax expense for the current year. The Corporation’s evaluation of the deductibility or taxability of items included in the Corporation’s tax returns has not resulted in the identification of any material, uncertain tax positions.

 

Fair Value

Fair values of financial instruments are estimated using relevant market information and other assumptions. Fair value estimates involve uncertainties and matters of significant judgment regarding interest rates, credit risk, prepayments and other factors, especially in the absence of broad markets for particular items. Changes in assumptions or in market conditions could significantly affect the estimates. The fair value estimates of existing on and off-balance sheet financial instruments do not include the value of anticipated future business or the values of assets and liabilities not considered financial instruments. For additional information about our financial assets carried at fair value, please see Note 9 to the consolidated financial statements.

 

- 36 -
 

 

FINANCIAL CONDITION

 

Executive Summary

 

At June 30, 2013, the Corporation’s assets totaled $841.7 million, compared to $863.9 million at December 31, 2012, a decrease of $22.2 million. Lower activity in the mortgage segment fueled by an increase in interest rates as well as the closing of our Denver Mortgage Production Branch caused loans held for sale to decrease $62.7 million. This decrease in loans held for sale was positively offset by an increase in interest-bearing balances of $12.9 million as well as growth in the commercial banking segment of $24.5. The increase in loans held for investment at June 30, 2013 in comparison with December 31, 2012 is primarily attributable to a $7.2 million or 4.8% growth in commercial loans, a $12.7 million or 8.8% increase in residential real estate loans, and a $5.4 million or 17.8% increase in real estate construction loans. At June 30, 2013, loans secured by real estate collateral comprised 75.0% of our total loan portfolio, with loans secured by commercial real estate contributing 45.0% of our total loan portfolio, loans secured by residential real estate contributing 24.5% and real estate construction loans contributing 5.5%. Loans held for sale totaled $48.9 million at June 30, 2013, compared to $111.5 million at December 31, 2012. Loans held for sale fluctuates with the volume of loans originated during any given month and the length of time the loans are held prior to selling them in the secondary market. Deposits totaled $659.9 million at June 30, 2013, compared to $671.5 million at December 31, 2012, down $11.6 million. Management has utilized CDARS reciprocal balances and brokered deposits as a cost effective way to fund certain asset portfolio classes, namely the loans held for sale and the investment portfolio. With the overall reduction in mortgage banking activity during the first half of 2013, management’s utilization of CDARS reciprocal balances and brokered deposits was reduced as noted by a $59.3 million decrease in those balances. Noninterest-bearing deposits increased $56.3 million from $164.2 million at December 31, 2012 to $220.5 million at June 30, 2013, and when coupled with the decrease in time deposits of $11.0 million from December 31, 2012 to June 30, 2013 as well as the CDARS balance reduction, accounts for the overall decrease in deposits.

 

Net income for the second quarter of 2013 totaled $3.5 million compared to $3.9 million for the same period in 2012. Earnings per diluted share were $0.34 for the second quarter of 2013, compared to $0.38 per diluted share in the same period of 2012. Net income continued to remain stable even with a $95.4 million decrease in loan origination volume for the three month period ended June 30, 2013 in comparison with the same period in 2012. This decreased volume as well as the rise in current interest rates led to the $7.6 million decrease in gain on sale of loans when comparing the three month period ending June 2013 to the same period ending June 2012. The decreased income on loans held for sale was favorably offset by a $1.5 million reduction in salaries and management fees related to the production of loans when comparing the three month period ended June 2013 to the same period in 2012. Also mitigating the impact of the reduced loan volume was the gain on hedging activity of $2.8 million in the second quarter of 2013 compared to the $2.0 million loss for the same period in 2012. The growth in our loans held for investment portfolio as well as favorable changes in our deposit mix attributed to the increase in net interest income for the three month period ended June 30, 2013 of $320 thousand when compared to the same period in 2012. The reduction in the provision for loan loss as well as the income tax expense of $472 thousand and $673 thousand, respectively, further mitigated the impact of the reduced loan volume on net income.

 

Net income for the six months ended June 30, 2013 totaled $7.2 million compared to $7.3 million for the same period in 2012. Earnings per diluted share were $0.69 for the first six months of 2013, compared to $0.71 per diluted share in the same period of 2012. Even with a $135.0 million decrease in loan origination volume for the six month period ended June 30, 2013 in comparison with the same period in 2012, net income remained stable. This decreased volume as well as the rise in current interest rates led to the $10.7 million decrease in gain on sale of loans when comparing the six month period ending June 2013 to the same period ending June 2012. The decreased income on loans held for sale was favorably offset by a $2.5 million reduction in salaries and management fees related to the production of loans when comparing the six month period ended June 2013 to the same period in 2012. Also mitigating the impact of the reduced loan volume was the gain on hedging activity of $3.9 million for the six month period ended June 30, 2013 compared to the $3.1 million loss for the same period in 2012. The growth in our loans held for investment portfolio as well as favorable changes in our deposit mix attributed to the increase in net interest income for the six month period ended June 30, 2013 of $541 thousand when compared to the same period in 2012. The reduction in the provision for loan loss as well as the income tax expense of $965 thousand and $354 thousand, respectively, further mitigated the impact of the reduced loan volume on net income.

 

- 37 -
 

 

Non-performing assets (“NPA”) totaled $2.3 million, or 0.27%, of total assets at June 30, 2013, down from $2.7 million, or 0.32%, of total assets at December 31, 2012. NPA are comprised solely of non-accrual loans at June 30, 2013.

 

As noted in Note 11 of the consolidated financial statements, management closed its Mortgage Production Branch (Branch) located in Denver, Colorado. The Branch ceased taking loan applications during April 2013 with all obligations and activities terminated as of April 30, 2013. The closure has reduced mortgage banking revenue beginning in the second quarter of 2013 and will continue to impact future periods. Management did not incur any operating losses associated with the closure process and expects the continuing mortgage segment to be a profitable and meaningful contributor to consolidated earnings.

 

In order to evaluate the impact of this change on the overall Corporation’s financial performance, condensed consolidated pro forma financial statements have been presented in Note 11 of the consolidated financial statements. The pro forma information is presenting results as if the Branch, which closed in the second quarter of 2013, had not been in existence during the second quarter of 2013 and 2012. The adjustment for the Branch closure does not reflect indirect overhead reductions management has made or will continue to make on a go-forward basis.

 

We believe the economic recovery is continuing to strengthen and the labor market is improving. The U.S. Bureau of Labor Statistics reported an increase in labor productivity in the nonfarm business sector for the first quarter of 2013. The unemployment rate for Fairfax County, Virginia at the end of June 2013 was 4.5% compared to 6.0% for the state of Virginia and 7.8% for the nation. Information reviewed at the Federal Open Market Committee’s June 2013 meeting suggested economic activity was expanding at a modest pace during the first half of 2013. The historically low interest rate environment continues to negatively impact yields of variable loans and the securities portfolio. Recent upward movement in interest rates during the second quarter 2013 has slowed the loan origination volume for refinances and caused the investment portfolio to incur negative market adjustments on its available-for-sale securities. The Corporation’s net interest margin for the three months ended June 30, 2013 decreased to 3.64% from the June 30, 2012 percentage of 3.74% as a result of the decrease in yields across the majority of interest earning asset segments. While there is no certainty to the magnitude of any impact, the continued extended period of low interest rates, as presently forecasted by the Federal Reserve, will continue to have an adverse effect on the net interest margin.

 

While the economy continues to show signs of improvement with unemployment rates declining, and we are beginning to see price appreciation in the local residential real estate market, there is no guarantee that these positive trends will continue. As such, we remain cautious as to the macro-economic risks, many openly identified by the Federal Open Market Committee, including persistently high rates of unemployment and underemployment, adverse impact of the higher Federal Tax Rates, and automatic reductions of Federal Expenditures that became effective beginning in the first quarter of 2013. As a consequence, we have generally retained more cautious loan underwriting criteria established during the financial crisis period of 2007 – 2009. In spite of these challenges, we are proactive in seeking new client relationships driven by our target market profile: business-to-business and business-to-government companies with annual revenue of $1 million to $100 million and the various banking services needed by the business and the professionals associated with the businesses. With the aforementioned macro-economic uncertainty, we are finding most desirable clients and prospects carrying higher cash reserves and weary of increasing debt loads. These behaviors in our target market have elevated the levels of our short-term deposit balances while loan balance growth is muted by tepid utilization of loan commitments.

 

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Securities

 

The Corporation’s securities portfolio is comprised of U.S. government agency securities, mortgage backed securities, corporate bonds, a CRA mutual fund, and other available-for-sale securities as well as a non-taxable municipal bond. The portfolio does not have any non-agency mortgage backed securities or trust preferred securities.

 

At June 30, 2013 the fair value of the securities portfolio totaled $85.0 million, compared to $81.1 million at December 31, 2012. Included in the fair value totals are held-to-maturity securities with an amortized cost of $15.9 million (fair value of $15.5 million) and $45.0 million (fair value of $45.3 million) at June 30, 2013 and December 31, 2012, respectively. Securities classified as available-for-sale are accounted for at fair market value with unrealized gains and losses recorded directly to a separate component of shareholders' equity, net of associated tax effect while held-to-maturity securities are carried at amortized cost. Investment securities are used to provide liquidity, to generate income, and to temporarily supplement loan growth as needed.

 

Restricted Stock

 

Restricted stock consists of FHLB stock and FRB stock. These stocks are classified as restricted stocks because their ownership is restricted to certain types of entities and they lack a market. Restricted stock is carried at cost on the Corporation’s financial statements. Dividends are paid semiannually on FRB stock and quarterly on FHLB stock.

 

Loans

 

The loan portfolio constitutes the largest component of earning assets and is comprised of commercial real estate – owner occupied, commercial real estate – non-owner occupied, residential real estate, commercial, real estate construction, and consumer loans. All lending activities of the Bank and its subsidiaries are subject to the regulations and supervision of the Comptroller. The loan portfolio does not have any pay option adjustable rate mortgages, loans with teaser rates or subprime loans or any other loans considered “high risk loans”. Loans totaled $641.5 million at June 30, 2013 compared to $617.0 million at December 31, 2012, an increase of $24.5 million. Comprising the majority of the growth, commercial loans increased $7.2 million, residential real estate loans increased $12.7 million and real estate construction loans increased $5.4 million. The overall increase in loans reflects a continued improvement in loan demand by local businesses, as seen through the increase in commercial segments of the loan portfolio, and is principally due to improvement in economic conditions in Northern Virginia. Please see Note 4 to the consolidated financial statements for a table that summarizes the composition of the Corporation’s loan portfolio. The following is a summary of the loan portfolio at June 30