10-Q 1 f10q063011.htm f10q063011.htm


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

[X] Quarterly Report Pursuant to Section 13 or 15(d)
of the Securities Exchange Act of 1934

For the quarterly period ended June 30, 2011

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

For the transition period from ____________ to _____________

Commission File Number:  0-27622

HIGHLANDS BANKSHARES, INC.
(Exact name of registrant as specified in its charter)


Virginia
(State or other jurisdiction of
incorporation or organization)
54-1796693
(I.R.S. Employer
Identification No.)
 
P.O. Box 1128
Abingdon, Virginia
(Address of principal executive offices)
 
 
24212-1128
(Zip Code)

276-628-9181
(Registrant’s telephone number, including area code)

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

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§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 smaller reporting company (See definition of “large accelerated filer, accelerated filer and smaller reporting company” in Rule 12b-2 of the Act). Large Accelerated Filer  [  ]   Accelerated Filer  [  ]    Non-Accelerated Filer [  ]  Smaller Reporting Company  [X]

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

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.
 
5,011,152 shares of common stock, par value $0.625 per share,
outstanding as of August 12, 2011
 
 



 
 

 
Highlands Bankshares, Inc.
 
FORM 10-Q
For the Quarter Ended June 30, 2011

INDEX
   
PART I. FINANCIAL INFORMATION                                                                                                                      
PAGE
   
Item 1.  Financial Statements
 
   
Consolidated Balance Sheets
  at June 30, 2011 (Unaudited) and December 31, 2010
 
3
 
 
Consolidated Statements of Income (Unaudited)
  for the Three Months and Six Months Ended June 30, 2011 and 2010
4
   
Consolidated Statements of Cash Flows (Unaudited)
  for the Six Months Ended June 30, 2011 and 2010
5
   
Consolidated Statements of Changes in
  Stockholders’ Equity (Unaudited) for the Three Months and Six Months
  Ended June 30, 2011 and 2010
6
   
Notes to Consolidated Financial Statements (Unaudited)
8-30
   
Item 2. Management’s Discussion and Analysis of
              Financial Condition and Results of Operations
33-38
   
Item 3. Quantitative and Qualitative Disclosures About Market Risk
40
   
Item 4.  Controls and Procedures
40
 
 
PART II.  OTHER INFORMATION
 
   
Item 1.  Legal Proceedings
40
   
Item 1A. Risk Factors
40
   
Item 2.  Unregistered Sales of Equity Securities and Use of Proceeds
40
   
Item 3.  Defaults Upon Senior Securities
40
   
Item 4.  Removed and Reserved
40
   
Item 5.  Other Information
41
   
Item 6.  Exhibits
41
   
SIGNATURES AND CERTIFICATIONS
42

 
 
2

 
PART I.
FINANCIAL INFORMATION
ITEM 1.  Financial Statements

Consolidated Balance Sheets
(Amounts in thousands)
 
ASSETS
 
June 30, 2011
(Unaudited)
   
December 31, 2010
(Note 1)
 
             
Cash and due from banks
  $ 16,829     $ 15,693  
Federal funds sold
    54,379       66,459  
                 
   Total Cash and Cash Equivalents
    71,208       82,152  
                 
Investment securities available for sale  (amortized cost $71,095 at June 30, 2011, $62,093 at December 31, 2010)
    66,418       56,096  
Other investments, at cost
    5,674       6,026  
Loans, net of allowance for loan losses of $11,157 at June 30, 2011, $10,320 at December 31, 2010
    418,757       440,274  
Premises and equipment, net
    22,931       23,509  
Deferred tax assets
    12,638       11,887  
Interest receivable
    2,695       2,544  
Bank owned life Insurance
    13,001       12,777  
Other real estate owned
    16,917       15,316  
Other assets
    4,572       4,927  
                 
    Total Assets
  $ 634,811     $ 655,508  
                 
                     LIABILITIES AND STOCKHOLDERS’ EQUITY
               
                 
                                                  LIABILITIES
               
                 
Deposits:
               
  Non-interest bearing
  $ 93,538     $ 85,923  
  Interest bearing
    433,362       450,849  
                 
    Total Deposits
    526,900       536,772  
                 
Interest, taxes and other liabilities
    1,386       1,786  
Other short-term borrowings
    57,670       65,952  
Long-term debt
    14,058       14,968  
Capital securities
    3,150       3,150  
                 
    Total Other Liabilities
    76,264       85,856  
                 
    Total Liabilities
    603,164       622,628  
                 
                                                  STOCKHOLDERS’ EQUITY
               
                 
Common stock (5,011 shares issued and outstanding)
    3,132       3,132  
Additional paid-in capital
    7,783       7,783  
Retained earnings
    23,822       25,923  
Accumulated other comprehensive income (loss)
    (3,090 )     (3,958 )
                 
  Total Stockholders’ Equity
    31,647       32,880  
                 
    Total Liabilities and Stockholders’ Equity
  $ 634,811     $ 655,508  
See accompanying Notes to Consolidated Financial Statements

 
3

 

Consolidated Statements of Income
(Amounts in thousands, except per share data)
(Unaudited)
   
Six Months Ended June 30, 2011
   
Six Months Ended June 30, 2010
   
Three Months
Ended June 30, 2011
   
Three Months
Ended June 30, 2010
 
INTEREST INCOME
                       
Loans receivable and fees on loans
  $ 12,728     $ 14,442     $ 6,301     $ 7,223  
Securities available for sale:
                               
  Taxable
    410       365       126       157  
  Exempt from taxable income
    656       1,057       431       512  
Other investment income
    35       55       18       34  
Federal funds sold
    73       12       37       7  
                                 
    Total Interest Income
    13,902       15,931       6,913       7,933  
                                 
INTEREST EXPENSE
                               
Deposits
    3,438       4,581       1,640       2,259  
Federal funds purchased
    -       1       -       -  
Other borrowed funds
    1,765       1,829       858       932  
                                 
    Total Interest Expense
    5,203       6,411       2,498       3,191  
                                 
    Net Interest Income
    8,699       9,520       4,415       4,742  
                                 
Provision for Loan Losses
    3,789       1,891       186       679  
                                 
    Net Interest Income after Provision for Loan Losses
    4,910       7,629       4,229       4,063  
                                 
NON-INTEREST INCOME
                               
Securities gains, losses, net
    143       171       114       172  
Service charges on deposit accounts
    1,031       972       537       515  
Other service charges, commissions and fees
    895       723       499       385  
Other operating income
    345       320       179       164  
Other than temporary impairment
    (269 )     (724 )     (155 )     (724 )
    Total Non-Interest Income
    2,145       1,462       1,174       512  
                                 
NON-INTEREST EXPENSE
                               
Salaries and employee benefits
    5,062       5,235       2,534       2,599  
Occupancy expense of bank premises
    520       579       260       277  
Furniture and equipment expense
    699       834       361       434  
Other operating expense
    2,863       2,392       1,526       1,222  
Foreclosed Assets – Loss on Sale / Write-down
    717       407       464       218  
Foreclosed Assets – Operating Expenses
    695       271       383       197  
    Total Non-Interest Expense
    10,556       9,718       5,528       4,947  
                                 
    Income (Loss) Before Income Taxes
    (3,501 )     (627 )     (125 )     (372 )
                                 
Income Tax Expense (Benefit)
    (1,400 )     (633 )     (147 )     (334 )
                                 
    Net Income (Loss)
  $ (2,101 )   $ 6     $ 22     $ (38 )
                                 
Basic Earnings Per Common Share – Weighted Average
  $ (0.42 )   $ -     $ -     $ (0.01 )
                                 
Earnings Per Common Share – Assuming Dilution
  $ (0.42 )   $ -     $ -     $ (0.01 )

See accompanying Notes to Consolidated Financial Statements


 
4

 



Consolidated Statements of Cash Flows
(Amounts in thousands)
(Unaudited)
   
Six Months Ended
   
Six Months Ended
 
   
June 30, 2011
   
June 30, 2010
 
CASH FLOWS FROM OPERATING  ACTIVITIES:
           
Net income (loss)
  $ (2,101 )   $ 6  
Adjustments to reconcile net income  (loss) to net cash provided by operating activities
               
Provision for loan losses
    3,789       1,891  
Depreciation and amortization
    576       666  
Net realized (gains) losses on available for sale securities
    (143 )     (171 )
Net amortization on securities
    242       93  
             Other than temporary impairment charge
    269       724  
Amortization of Capital issue costs
    3       3  
            (Increase) decrease in interest receivable
    (151 )     120  
Valuation adjustment of other real estate owned
    601       365  
(Increase) decrease in other assets
    (955 )     (1,772 )
Increase (decrease) in interest, taxes and other liabilities
    (400 )     886  
                 
Net cash provided by operating activities
     1,730       2,811  
                 
CASH FLOWS FROM INVESTING ACTIVITIES:
               
Securities available for sale:
               
       Proceeds from sale of securities
    6,776       19,156  
Proceeds from maturities of debt and equity securities
    2,914       2,081  
Purchase of debt and equity securities
    (19,175 )     (12,418 )
     Redemption of other investments
    352       2,034  
Net (increase) decrease in loans
    14,057       (5,434 )
Proceeds from sales of other real estate owned
    1,466       927  
Premises and equipment expenditures
    -       (53 )
                 
Net cash provided by investing activities
    6,390       6,293  
                 
CASH FLOWS FROM FINANCING ACTIVITIES:
               
Net increase (decrease) in time deposits
    (21,773 )     304  
Net increase in demand, savings and other deposits
    11,901       5,437  
Decrease in short-term borrowings
    (8,282 )     (8,100 )
Increase (decrease) in long-term debt
    (910 )     4,359  
                 
Net cash provided by (used in) financing activities
    (19,064 )     2,000  
                 
Net (decrease) increase in cash and cash equivalents
    (10,944 )     11,104  
CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR
    82,152       29,337  
                 
CASH AND CASH EQUIVALENTS AT END OF PERIOD
  $ 71,208     $ 40,441  
                 
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
               
Cash paid during the year for:
               
Interest
  $ 5,305     $ 6,031  
Income taxes
  $ -     $ -  
                 
     SUPPLEMENTAL DISCLOSURE OF NONCASH TRANSACTIONS
               
Transfer of loans to other real estate owned
  $ 3,670     $ 6,873  

See accompanying Notes to Consolidated Financial Statements


 
5

 





Consolidated Statements of Changes in Stockholders’ Equity
(Amounts in thousands)
(Unaudited)
 
 
    Common Stock
 
  Paid-in
 
  Retained
 
Comprehensive
 
Stockholders’
   
Shares
   
Par Value
   
Capital
   
Earnings
   
Income
   
Equity
 
                                     
Balance, March 31, 2010
    5,011     $ 3,132     $ 7,783     $ 28,107     $ (3,462 )   $ 35,560  
                                                 
Comprehensive income:
                                               
Net income /  (loss)
    -       -       -       (38 )     -       (38 )
Change in unrealized loss on securities available for sale, net of deferred income tax expense of
   $311
    -       -       -       -       604       604  
Less: reclassification adjustment
  net of deferred tax expense of $58
    -       -       -       -       (113 )     (113 )
    Total comprehensive income
    -       -       -       -       -       453  
                                                 
                                                 
Balance, June 30, 2010
    5,011     $ 3,132     $ 7,783     $ 28,069     $ (2,971 )   $ 36,013  
                                                 
                                                 
Balance, March 31, 2011
    5,011     $ 3,132     $ 7,783     $ 23,800     $ (3,702 )   $ 31,013  
                                                 
Comprehensive income:
                                               
Net income
    -       -       -       22       -       22  
Change in unrealized loss on securities available for sale, net of deferred income tax expense of
   $354
    -       -       -       -       687       687  
Less: reclassification adjustment
  net of deferred tax expense of $39
    -       -       -       -       (75 )     (75 )
    Total comprehensive income
    -       -       -       -       -       634  
                                                 
                                                 
Balance, June 30, 2011
    5,011     $ 3,132     $ 7,783     $ 23,822     $ (3,090 )   $ 31,647  
                                                 
                                                 

See accompanying Notes to Consolidated Financial Statements



 
6

 

Consolidated Statements of Changes in Stockholders’ Equity
(Amounts in thousands)
(Unaudited)

                     
Accumulated
       
         
Additional
         
Other
   
Total
 
   
Common Stock
   
Paid-in
   
Retained
   
Comprehensive
   
Stockholders’
 
   
Shares
   
Par Value
   
Capital
   
Earnings
   
Income
   
Equity
 
                                     
Balance, December 31, 2009
    5,011     $ 3,132     $ 7,783     $ 28,063     $ (3,550 )   $ 35,428  
                                                 
Comprehensive income:
                                               
Net income
    -       -       -       6       -       6  
Change in unrealized (loss) on securities available for sale, net of deferred income tax expense of $356
    -       -       -       -       692       692  
Less: reclassification adjustment
  net of deferred tax expense of $58
    -       -       -       -       (113 )     (113 )
    Total comprehensive income
    -       -       -       -       -       585  
                                                 
                                                 
 
Balance, June 30, 2010
    5,011     $ 3,132     $ 7,783     $ 28,069     $ (2,971 )   $ 36,013  
                                                 
                                                 
Balance, December 31, 2010
    5,011     $ 3,132     $ 7,783     $ 25,923     $ (3,958 )   $ 32,880  
                                                 
Comprehensive income:
                                               
Net income (loss)
    -       -       -       (2,101 )     -       (2,101 )
Change in unrealized (loss) on securities available for sale, net of deferred income tax expense of $495
    -       -       -       -       962       962  
Less: reclassification adjustment
  net of deferred tax expense of $49
    -       -       -       -       (94 )     (94 )
    Total comprehensive income (loss)
    -       -       -       -       -       (1,233 )
                                                 
                                                 
Balance, June 30, 2011
    5,011     $ 3,132     $ 7,783     $ 23,822     $ (3,090 )   $ 31,647  


See accompanying Notes to Consolidated Financial Statements



 
7

 

 
Notes to Consolidated Financial Statements
(Unaudited)
(in thousands, except share, per share and percentage data)
 
 
Note 1  -  General

The consolidated financial statements of Highlands Bankshares, Inc. (the “Company”) conform to United States Generally Accepted Accounting Principles and to banking industry practices. The accompanying consolidated interim financial statements are unaudited. In the opinion of management, all adjustments necessary for a fair presentation of the consolidated financial statements have been included.  The consolidated balance sheet as of December 31, 2010 has been extracted from the audited financial statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2010 (the “2010 Form 10-K”). The notes included herein should be read in conjunction with the notes to consolidated financial statements included in the 2010 Form 10-K. The results of operations for the three-month and six month periods ended June 30, 2011 are not necessarily indicative of the results to be expected for the full year.

The preparation of financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.





 
8

 
 
 
Notes to Consolidated Financial Statements
(Unaudited)
(in thousands, except share, per share and percentage data)

Note 2  -  Loans and Allowance for Loan Losses  (amounts in thousands)


A summary of transactions in the consolidated allowance for loan losses for the six months ended June 30 is as follows:


   
2011
   
2010
 
Allowance for loan losses at beginning of year
  $ 10,320     $ 11,681  
 
Loans charged off:
               
  Residential 1-4 Family
    291       286  
  Multifamily
    40       175  
  Construction and Land Loans
    1,242       877  
  Commercial, Owner Occupied
    135       -  
  Commercial, Non-owner occupied
    89       -  
  Second Mortgages
    271       306  
  Equity Lines of Credit
    10       28  
  Farmland
    143       -  
                 
  Secured (other ) and unsecured
               
   Personal
    233       269  
  Commercial
    502       571  
  Agricultural
    28       24  
 
  Overdrafts
    88       75  
          Total
    3,072       2,611  
 
Recoveries of loans previously
  charged off:
               
                 
  Residential 1-4 Family
    5       -  
  Multifamily
    -       -  
  Construction and Land Loans
    50       -  
  Commercial, Owner Occupied
    -       -  
  Commercial, Non-owner occupied
    -       -  
  Second Mortgages
    10       -  
  Equity Lines of Credit
    -       -  
  Farmland
    20       -  
                 
  Secured (other ) and unsecured
               
  Personal
    25       37  
 Commercial
    9       4  
 Agricultural
    1       3  
 Overdrafts
    -          
                 
            Total
    120       44  
 
               
Net loans charged off
    2,952       2,567  
Provision for loan losses
    3,789       1,891  
 
Allowance for loan losses end of period
  $ 11,157     $ 11,005  



 
9

 


Notes to Consolidated Financial Statements
(Unaudited)
(in thousands, except share, per share and percentage data)


The composition of net loans is as follows:

   
June 30,
2011
   
December 31,
2010
 
       Real Estate Secured:
           
Residential 1-4 family
  $ 172,693     $ 175,522  
Multifamily
    15,079       15,593  
Construction and Land Loans
    27,048       30,901  
Commercial, Owner Occupied
    78,975       78,279  
Commercial, Non-owner occupied
    36,962       43,652  
Second mortgages
    12,960       14,132  
Equity lines of credit
    10,055       10,016  
Farmland
    12,220       12,790  
      365,992       380,885  
                 
       Secured (other) and unsecured
               
Personal
    24,657       26,773  
Commercial
    36,043       40,471  
Agricultural
    3,430       2,848  
      64,130       70,092  
                 
Overdrafts
    359       214  
                 
      430,481       451,191  
Less:
               
  Allowance for loan losses
    11,157       10,320  
  Net deferred fees
    567       597  
      11,724       10,917  
                 
Loans, net
  $ 418,757     $ 440,274  



 
10

 

Notes to Consolidated Financial Statements
(Unaudited)
(in thousands, except share, per share and percentage data)

The following table is an analysis of past due loans as of June 30, 2011:
 
   
30-59 Days Past Due
   
60-89 Days Past Due
   
Greater Than 90 Days
   
Total Past Due
   
Current
   
Total Financing Receivables
   
Recorded Investment > 90 Days and Accruing
 
                                           
    Real Estate Secured
                                         
Residential 1-4 family
  $ 3,302     $ 1,917     $ 5,186     $ 10,405     $ 162,288     $ 172,693     $ 332  
Equity lines of credit
    35       165       110       310       9,745       10,055       110  
Multifamily
    -       1,632       -       1,632       13,447       15,079       -  
Farmland
    -       -       -       -       12,220       12,220       -  
Construction, Land Development, Other Land Loans
    1,144       63       2,291       3,498       23,550       27,048       423  
Commercial Real Estate- Owner Occupied
    1,343       -       6,383       7,726       71,249       78,975       328  
Commercial Real Estate- Non Owner Occupied
    296       -       452       748       36,214       36,962       -  
Second Mortgages
    244       -       339       583       12,377       12,960       -  
    Non Real Estate Secured
                                                       
Personal
    267       65       206       538       24,478       25,016       61  
Business
    265       94       1,356       1,715       34,328       36,043       161  
Agricultural
    20       76       -       96       3,334       3,430       -  
                                                         
          Total
  $ 6,916     $ 4,012     $ 16,323     $ 27,251     $ 403,230     $ 430,481     $ 1,415  
                                                         


The following table is an analysis of past due loans as of December 31, 2010:
 
   
30-59 Days Past Due
   
60-89 Days Past Due
   
Greater Than 90 Days
   
Total Past Due
   
Current
   
Total Financing Receivables
   
Recorded Investment > 90 Days and Accruing
 
                                           
    Real Estate Secured
                                         
Residential 1-4 family
  $ 3,780     $ 1,245     $ 4,937     $ 9,962     $ 165,560     $ 175,522     $ 1,726  
Equity lines of credit
    -       99       -       99       9,917       10,016       -  
Multifamily
    -       -       40       40       15,553       15,593       -  
Farmland
    348       -       774       1,122       11,668       12,790       -  
Construction, Land Development, Other Land Loans
    825       152       3,153       4,130       26,771       30,901       53  
Commercial Real Estate- Owner Occupied
    1,612       105       6,301       8,018       70,260       78,278       1,776  
Commercial Real Estate- Non Owner Occupied
    -       165       1,520       1,685       41,967       43,652       602  
Second Mortgages
    234       -       529       763       13,369       14,132       -  
     Non Real Estate Secured
                                                       
Personal
    303       101       74       478       26,510       26,988       14  
Business
    190       406       1,456       2,052       38,419       40,471       289  
Agricultural
    7       -       96       103       2,745       2,848       68  
                                                         
          Total
  $ 7,299     $ 2,273     $ 18,880     $ 28,452     $ 422,739     $ 451,191     $ 4,528  
                                                         

 
11

 

Notes to Consolidated Financial Statements
(Unaudited)
(in thousands, except share, per share and percentage data)

The accrual of interest on loans is discontinued at the time the loan is 90 days delinquent unless the credit is well-secured and in process of collection.  Credit card loans and other personal loans are typically charged off no later than 180 days past due.   In all cases, loans are placed on non-accrual or charged-off at an earlier date if collection of principal or interest is considered doubtful. The June 30, 2011 total includes approximately $4,366 of loans that are current and paying under the terms of their existing loan agreement but are included due to regulatory guidelines.

The following is a summary of non-accrual loans at June 30, 2011 and December 31, 2010:
 
   
June 30, 2011
   
December 31, 2010
 
Real Estate Secured
           
Residential 1-4 Family
  $ 5,054     $ 3,211  
Multifamily
    1,632       40  
Construction and Land Loans
    2,868       3,100  
Commercial-Owner Occupied
    6,055       4,525  
Commercial- Non Owner Occupied
    4,818       918  
Second Mortgages
    339       529  
Equity Lines of Credit
    -       -  
Farmland
    630       774  
Secured (other) and Unsecured
               
Personal
    145       60  
Commercial
    1,195       1,167  
Agricultural
    -       29  
                 
Total
  $ 22,736     $ 14,353  





 
12

 

Notes to Consolidated Financial Statements
(Unaudited)
(in thousands, except share, per share and percentage data)

The following tables represent a summary of credit quality indicators of the Bank’s loan portfolio at June 30, 2011 and December 31, 2010: The grades are assigned and / or modified by the Company’s credit review and credit analysis departments based on the creditworthiness of the borrower and the overall strength of the loan.

Credit Risk Profile by Internally Assigned Grade as of June 30, 2011
Grade (1)
 
Residential 1-4 Family
   
Multifamily
   
Farmland
   
Construction,
Land Loans
   
Commercial
Real Estate-
Owner Occupied
   
Commercial
Real Estate
Non-Owner Occupied
 
                                     
Quality
    38,901       1,258       883       4,283       7,123       2,322  
Satisfactory
    78,233       9,474       3,973       6,816       26,058       14,486  
Acceptable
    35,579       1,782       4,987       5,955       25,897       9,354  
Special Mention
    3,620       -       2,007       2,224       5,483       1,500  
Substandard
    15,992       2,565       370       7,770       13,999       9,300  
Doubtful
    368       -       -       -       415       -  
                                                 
     Total
  $ 172,693     $ 15,079     $ 12,220     $ 27,048     $ 78,975     $ 36,962  



Credit Risk Profile by Internally Assigned Grade as of December 31, 2010
Grade (1)
 
Residential 1-4 Family
   
Multifamily
   
Farmland
   
Construction,
Land Loans
   
Commercial
 Real Estate- Owner Occupied
   
Commercial
Real Estate
 Non-Owner Occupied
 
                                     
Quality
    40,371       1,911       977       4,298       7,102       3,604  
Satisfactory
    80,759       9,258       4,399       7,355       26,055       16,729  
Acceptable
    36,411       1,806       4,285       5,585       27,878       13,013  
Special Mention
    4,778       946       178       2,346       5,430       304  
Substandard
    12,832       1,672       2,951       11,317       11,390       10,002  
Doubtful
    371       -       -       -       424       -  
                                                 
     Total
  $ 175,522     $ 15,593     $ 12,790     $ 30,901     $ 78,279     $ 43,652  

(1)  Quality-This grade is reserved for the Bank’s top quality loans. These loans have excellent sources of repayment, with no significant identifiable risk of collection.  Generally, loans assigned this rating will demonstrate the following characteristics:
 
 
·  
Conformity in all respects with Bank policy, guidelines, underwriting standards, and Federal and State regulations (no exceptions of any kind).
 
 
·  
Documented historical cash flow that meets or exceeds required minimum Bank guidelines, or that can be supplemented with verifiable cash flow from other sources.
 
 
·  
Adequate secondary sources to liquidate the debt, including combinations of liquidity, liquidation of collateral, or liquidation value to the net worth of the borrower or guarantor.
 
 
For existing loans, all of the requirements above apply plus all payments have been made as agreed, current financial information on all borrowers and guarantors has been obtained and analyzed, and overall business operating trends are either stable or improving.
 
 
   Satisfactory-This grade is given to performing loans. These loans have adequate sources of repayment, with little identifiable risk of collection. Loans assigned this rating will demonstrate the following characteristics:
 
 
·  
General conformity to the Bank's policy requirements, product guidelines and underwriting standards.  Any exceptions that are identified during the underwriting and approval process have been adequately mitigated by other factors.
 
 
·  
Documented historical cash flow that meets or exceeds required minimum Bank guidelines, or that can be supplemented with verifiable cash flow from other sources.  
 
 

 
13

 
 

Notes to Consolidated Financial Statements
(Unaudited)
(in thousands, except share, per share and percentage data)
 
·  
Adequate secondary sources to liquidate the debt, including combinations of liquidity, liquidation of collateral, or liquidation value to the net worth of the borrower or guarantor
 
 
For existing loans, all of the requirements outlined above will apply, plus all payments have been made as agreed, current financial information on all borrowers and guarantors has been obtained and analyzed, and overall business operating trends are stable with any declines considered minor and temporary.
 
 
Acceptable-This grade is given to loans that show signs of weakness in either adequate sources of repayment or collateral, but have demonstrated mitigating factors that minimize the risk of delinquency or loss.  Loans assigned this rating may demonstrate some or all of the following characteristics:
 
 
·  
Additional exceptions to the Bank's policy requirements, product guidelines or underwriting standards that present a higher degree of risk to the Bank.  Although the combination and/or severity of identified exceptions is greater, all exceptions have been properly mitigated by other factors.
 
 
·  
Unproved, insufficient or marginal primary sources of repayment that appear sufficient to service the debt at this time.  Repayment weaknesses may be due to minor operational issues, financial trends, or reliance on projected (not historic) performance.
 
 
·  
Marginal or unproven secondary sources to liquidate the debt, including combinations of liquidation of collateral and liquidation value to the net worth of the borrower or guarantor.
 
 
For existing loans, payments have generally been made as agreed with only minor and isolated delinquencies.
 
 
Special Mention -This grade is given to Watch List loans that include the following characteristics:
 
 
·  
Loans with underwriting guideline tolerances and/or exceptions with no identifiable mitigating factors.
 
 
·  
Extending loans that are currently performing satisfactorily but with potential weaknesses that may, if not corrected, weaken the asset or inadequately protect the Bank's position at some future date. Potential weaknesses are the result of deviations from prudent lending practices.
 
 
·  
Loans where adverse economic conditions that develop subsequent to the loan origination do not jeopardize liquidation of the debt, but do substantially increase the level of risk may also warrant this rating.
 
 
  Substandard-Loans in this category are characterized by deterioration in quality exhibited by any number of well-defined weaknesses requiring corrective action. A substandard loan is inadequately protected by the current sound net worth and paying capacity of the obligor or of the collateral pledged, if any. Loans classified as substandard must have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt; they are characterized by the distinct possibility that the institution will sustain some loss if the deficiencies are not corrected.
 
 
 The weaknesses may include, but are not limited to:
 
 
·  
High debt to worth ratios and or declining or negative earnings trends
 
 
·  
Declining or inadequate liquidity
 
 
·  
Improper loan structure  or questionable repayment sources
 
 
·  
Lack of well-defined secondary repayment source, and
 
 
·  
Unfavorable competitive comparisons.
 
 
Such loans are no longer considered to be adequately protected due to the borrower's declining net worth, lack of earnings capacity, declining collateral margins and/or unperfected collateral positions. A possibility of loss of a portion of the loan balance cannot be ruled out. The repayment ability of the borrower is marginal or weak and the loan may have exhibited excessive overdue status or extensions and/or renewals.
 
 

 
14

 
 
Notes to Consolidated Financial Statements
(Unaudited)
(in thousands, except share, per share and percentage data)
 

 
Doubtful -Loans classified Doubtful have all the weaknesses inherent in loans classified Substandard, plus 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. The ability of the borrower to service the debt is extremely weak, overdue status is constant, the debt has been placed on non-accrual status, and no definite repayment schedule exists.
 
However, these loans are not yet rated as loss because certain events may occur which would salvage the debt. Among these events are:
 
 
·  
Injection of capital
 
 
·  
Alternative financing
 
 
·  
Liquidation of assets or the pledging of additional collateral.
 
Credit Risk Profile based on payment activity as of  June 30, 2011:
   
Consumer -
Non Real Estate
   
Equity Line of Credit / Second Mortgages
   
Commercial -
Non Real Estate
   
Agricultural -
Non Real Estate
 
                         
Performing
  $ 24,451     $ 22,566     $ 34,687     $ 3,430  
Nonperforming (>90 days past due)
    206       449       1,356       -  
                                 
     Total
  $ 24,657     $ 23,015     $ 36,043     $ 3,430  
                                 


Credit Risk Profile based on payment activity as of December 31, 2010:
   
Consumer -
Non Real Estate
   
Equity Line of Credit / Second Mortgages
   
Commercial -
Non Real Estate
   
Agricultural -
 Non Real Estate
 
                         
Performing
  $ 26,699     $ 23,619     $ 39,015     $ 2,751  
Nonperforming (>90 days past due)
    74       529       1,456       97  
                                 
     Total
  $ 26,773     $ 24,148     $ 40,471     $ 2,848  
                                 

 
15

 
Notes to Consolidated Financial Statements
(Unaudited)
(in thousands, except share, per share and percentage data)

The following tables reflect the Bank’s impaired loans at June 30, 2011:
 
 
   
Recorded Investment
   
Unpaid
Principal
Balance
   
Related
Allowance
   
Average
Recorded Investment
   
Interest
 Income Recognized
 
With No Related Allowance
                             
Real Estate Secured
                             
Residential 1-4 family
  $ 8,315     $ 8,694     $ -     $ 7,883     $ 135  
Equity lines of credit
    -       -       -       -       -  
Multifamily
    933       933       -       487       32  
Farmland
    -       -       -       387       -  
Construction, Land Development, Other Land Loans
    2,708       2,708       -       3,281       67  
Commercial Real Estate- Owner Occupied
    9,698       9,698       -       7,598       66  
Commercial Real Estate- Non Owner Occupied
    3,359       3,420       -       3,433       106  
Second Mortgages
    619       619       -       660       15  
Non Real Estate Secured
                                       
Personal /Consumer
    34       34       -       28       1  
Business Commercial
    2,013       2,682       -       1,640       8  
Agricultural
    -       -       -       -       -  
Credit Cards
    -       -       -       -       -  
                                         
          Total
  $ 27,679     $ 28,788     $ -     $ 25,397     $ 430  

   
Recorded Investment
   
Unpaid
 Principal
Balance
   
Related
Allowance
   
Average
Recorded Investment
   
Interest
Income Recognized
 
With an Allowance Recorded
                             
Real Estate Secured
                             
Residential 1-4 family
  $ 5,554     $ 5,757     $ 922     $ 5,035     $ 64  
Equity lines of credit
    -       -       -       -       -  
Multifamily
    1,632       1,652       278       1,632       11  
Farmland
    310       310       40       311       10  
Construction, Land Development, Other Land Loans
    3,759       5,012       697       5,397       50  
Commercial Real Estate- Owner Occupied
    3,063       3,063       965       3,670       67  
Commercial Real Estate- Non Owner Occupied
    4,485       4,485       845       4,759       68  
Second Mortgages
    313       313       92       199       -  
Non Real Estate Secured
                                       
Personal /Consumer
    94       94       35       72       2  
Business Commercial
    2,892       2,985       1,112       2,512       40  
Agricultural
    -       -       -       14       -  
Credit Cards
    -       -       -       -       -  
                                         
          Total
  $ 22,102     $ 23,671     $ 4,986     $ 23,601     $