10-Q 1 a13-10484_110q.htm 10-Q

Table of Contents

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C.  20549

 


 

FORM 10-Q

 

(Mark One)

 

x

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

 

For the quarterly period ended March 31, 2013

 

OR

 

o

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

 

For the transition period from         to         

 

Commission File No. 000-53869

 

FIRST NATIONAL COMMUNITY BANCORP, INC.

(Exact Name of Registrant as Specified in Its Charter)

 

Pennsylvania

 

23-2900790

(State or Other Jurisdiction
of Incorporation or Organization)

 

(I.R.S. Employer
Identification No.)

 

 

 

102 E. Drinker St., Dunmore, PA

 

18512

(Address of Principal Executive Offices)

 

(Zip Code)

 

Registrant’s telephone number, including area code  (570) 346-7667

 

 

(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 o

 

Accelerated Filer o

 

 

 

Non-Accelerated Filer x

 

Smaller reporting company o

 

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

 

Indicate the number of shares outstanding of each of the issuer’s classes of common stock as of the latest practicable date:

 

Common Stock, $1.25 par value

 

16,457,169 shares

(Title of Class)

 

(Outstanding at May 14, 2013)

 

 

 



Table of Contents

 

Contents

 

PART I. Financial Information

3

Item 1. Financial Statements

3

Consolidated Statements of Financial Condition

3

Consolidated Statements of Operations

4

Consolidated Statements of Comprehensive (Loss) Income

5

Consolidated Statements of Changes in Shareholders’ Equity

6

Consolidated Statements of Cash Flows

7

Notes to Consolidated Financial Statements

8

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

34

Item 3. Quantitative and Qualitative Disclosures about Market Risk

51

Item 4. Controls and Procedures

51

PART II.  Other Information

51

Item 1. Legal Proceedings

51

Item 1A. Risk Factors

52

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

52

Item 3. Defaults upon Senior Securities

52

Item 4. Mine Safety Disclosures

52

Item 5. Other Information

52

Item 6. Exhibits

52

 

2



Table of Contents

 

PART I.  Financial Information

Item 1.  Financial Statements

 

FIRST NATIONAL COMMUNITY BANCORP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION

(unaudited)

 

 

 

March 31,

 

December 31,

 

(in thousands, except share data)

 

2013

 

2012

 

Assets

 

 

 

 

 

Cash and cash equivalents:

 

 

 

 

 

Cash and due from banks

 

$

11,451

 

$

21,710

 

Interest-bearing deposits in other banks

 

20,892

 

93,561

 

Total cash and cash equivalents

 

32,343

 

115,271

 

Securities

 

 

 

 

 

Available-for-sale at fair value

 

216,849

 

185,361

 

Held-to-maturity at amortized cost (fair value $2,501 and $2,483)

 

2,225

 

2,198

 

Stock in Federal Home Loan Bank of Pittsburgh, at cost

 

5,081

 

5,957

 

Loans held for sale

 

847

 

1,615

 

Loans, net of allowance for loan and lease losses of $18,473 and $18,536

 

597,682

 

579,396

 

Bank premises and equipment, net

 

18,658

 

18,937

 

Accrued interest receivable

 

2,618

 

2,199

 

Refundable federal income taxes

 

11,637

 

11,637

 

Intangible assets

 

591

 

632

 

Bank-owned life insurance

 

27,633

 

27,461

 

Other real estate owned

 

3,910

 

3,983

 

Other assets

 

9,453

 

13,627

 

Total Assets

 

$

929,527

 

$

968,274

 

 

 

 

 

 

 

Liabilities

 

 

 

 

 

Deposits

 

 

 

 

 

Demand (non-interest-bearing)

 

$

121,187

 

$

131,476

 

Interest-bearing

 

702,559

 

723,137

 

Total deposits

 

823,746

 

854,613

 

Borrowed funds

 

 

 

 

 

FHLB advances

 

12,388

 

18,593

 

Subordinated debentures

 

25,000

 

25,000

 

Junior subordinated debentures

 

10,310

 

10,310

 

Total borrowed funds

 

47,698

 

53,903

 

Accrued interest payable

 

7,001

 

6,427

 

Other liabilities

 

14,264

 

16,406

 

Total liabilities

 

892,709

 

931,349

 

 

 

 

 

 

 

Shareholders’ Equity

 

 

 

 

 

Preferred Shares ($1.25 par)

 

 

 

 

 

Authorized: 20,000,000 shares at March 31, 2013 and December 31, 2012

Issued and outstanding: 0 shares at March 31, 2013 and December 31, 2012

 

 

 

Common Shares ($1.25 par)

 

 

 

 

 

Authorized: 50,000,000 shares at March 31, 2013 and December 31, 2012

Issued and outstanding: 16,457,169 shares at March 31, 2013 and December 31, 2012

 

20,571

 

20,571

 

Additional paid-in capital

 

61,584

 

61,584

 

Accumulated deficit

 

(50,197

)

(51,928

)

Accumulated other comprehensive income

 

4,860

 

6,698

 

Total shareholders’ equity

 

36,818

 

36,925

 

Total Liabilities and Shareholders’ Equity

 

$

929,527

 

$

968,274

 

 

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

 

3



Table of Contents

 

FIRST NATIONAL COMMUNITY BANCORP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

(unaudited)

 

 

 

Three months ended

 

 

 

March 31,

 

(in thousands, except share data)

 

2013

 

2012

 

Interest income

 

 

 

 

 

Interest and fees on loans

 

$

6,607

 

$

7,789

 

Interest and dividends on securities:

 

 

 

 

 

U.S. government agencies

 

423

 

380

 

State and political subdivisions, tax-free

 

990

 

980

 

State and political subdivisions, taxable

 

116

 

130

 

Other securities

 

35

 

409

 

Total interest and dividends on securities

 

1,564

 

1,899

 

Interest on interest-bearing deposits and federal funds sold

 

39

 

56

 

Total interest income

 

8,210

 

9,744

 

Interest expense

 

 

 

 

 

Deposits:

 

 

 

 

 

Interest-bearing demand

 

159

 

183

 

Savings

 

26

 

46

 

Time ($100,000 and over)

 

317

 

415

 

Other time

 

616

 

888

 

Total interest on deposits

 

1,118

 

1,532

 

Interest on borrowed funds:

 

 

 

 

 

Interest on FHLB advances

 

126

 

414

 

Interest on subordinated debentures

 

562

 

569

 

Interest on junior subordinated debentures

 

51

 

58

 

Total interest on borrowed funds

 

739

 

1,041

 

Total interest expense

 

1,857

 

2,573

 

Net interest income before credit for loan and lease losses

 

6,353

 

7,171

 

Credit for loan and lease losses

 

(1,224

)

(136

)

Net interest income after credit for loan and lease losses

 

7,577

 

7,307

 

Non-interest income

 

 

 

 

 

Deposit service charges

 

678

 

737

 

Net gain on the sale of securities

 

842

 

8

 

Gross other-than-temporary impairment gains

 

 

175

 

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

 

 

(175

)

Other-than-temporary-impairment losses recognized in earnings

 

 

 

Net gain on the sale of loans held for sale

 

110

 

243

 

Net gain on the sale of other real estate owned

 

13

 

9

 

Loan related fees

 

108

 

124

 

Income from bank-owned life insurance

 

172

 

185

 

Other

 

536

 

144

 

Total non-interest income

 

2,459

 

1,450

 

Non-interest expense

 

 

 

 

 

Salaries and employee benefits

 

3,320

 

3,638

 

Occupancy expense

 

584

 

598

 

Equipment expense

 

376

 

420

 

Advertising expense

 

77

 

148

 

Data processing expense

 

564

 

474

 

FDIC assessment

 

532

 

600

 

Bank shares tax

 

241

 

276

 

Expense of other real estate

 

218

 

178

 

Credit for off-balance sheet commitments

 

(121

)

(65

)

Legal expense

 

615

 

724

 

Professional fees

 

551

 

1,518

 

Insurance expense

 

323

 

232

 

Loan collection expense

 

227

 

229

 

Other operating expenses

 

798

 

952

 

Total non-interest expense

 

8,305

 

9,922

 

Income (loss) before income taxes

 

1,731

 

(1,165

)

Provision for income taxes

 

 

 

Net income (loss)

 

$

1,731

 

$

(1,165

)

 

 

 

 

 

 

Income (loss) Per Share:

 

 

 

 

 

Basic

 

$

0.11

 

$

(0.07

)

Diluted

 

$

0.11

 

$

(0.07

)

 

 

 

 

 

 

Cash dividends declared per common share

 

 

 

 

 

 

 

 

 

Weighted average number of shares outstanding:

 

 

 

 

 

Basic

 

16,457,169

 

16,442,119

 

Diluted

 

16,457,169

 

16,442,119

 

 

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

 

4



Table of Contents

 

FIRST NATIONAL COMMUNITY BANCORP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF COMPREHENSIVE (LOSS) INCOME

(unaudited)

 

 

 

Three months ended

 

 

 

March 31,

 

(in thousands)

 

2013

 

2012

 

Net income (loss)

 

$

1,731

 

$

(1,165

)

Other comprehensive (loss) income, net of tax:

 

 

 

 

 

Unrealized (losses) gains on securities available-for-sale

 

(1,943

)

3,494

 

Taxes

 

661

 

(1,188

)

Net of tax amount

 

(1,282

)

2,306

 

 

 

 

 

 

 

Non-credit related gains on OTTI securities not expected to be sold

 

 

175

 

Taxes

 

 

(60

)

Net of tax amount

 

 

115

 

 

 

 

 

 

 

Reclassification adjustment for gains included in net income (loss)

 

(842

)

(8

)

Taxes

 

286

 

3

 

Net of tax amount

 

(556

)

(5

)

 

 

 

 

 

 

Total other comprehensive (loss) income

 

(1,838

)

2,416

 

 

 

 

 

 

 

Total comprehensive (loss) income

 

$

(107

)

$

1,251

 

 

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

 

5



Table of Contents

 

FIRST NATIONAL COMMUNITY BANCORP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY

For the Three Months Ended March 31, 2013 and 2012

(unaudited)

 

 

 

 

 

 

 

 

 

 

 

Accumulated

 

 

 

 

 

Number

 

 

 

Additional

 

 

 

Other

 

Total

 

 

 

of Common

 

Common

 

Paid-in

 

Accumulated

 

Comprehensive

 

Shareholders’

 

(in thousands, except per share data)

 

Shares

 

Stock

 

Capital

 

Deficit

 

Loss

 

Equity

 

BALANCES, DECEMBER 31, 2011

 

16,442,119

 

$

20,552

 

$

61,557

 

$

(38,217

)

$

(3,967

)

$

39,925

 

Net loss for the period

 

 

 

 

 

 

 

(1,165

)

 

 

(1,165

)

Other comprehensive income, net of tax of $1,245

 

 

 

 

 

 

 

 

 

2,416

 

2,416

 

Balances, March 31, 2012

 

16,442,119

 

$

20,552

 

$

61,557

 

$

(39,382

)

$

(1,551

)

$

41,176

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

BALANCES, DECEMBER 31, 2012

 

16,457,169

 

$

20,571

 

$

61,584

 

$

(51,928

)

$

6,698

 

$

36,925

 

Net income for the period

 

 

 

 

 

 

 

1,731

 

 

 

1,731

 

Other comprehensive loss, net of tax of $947

 

 

 

 

 

 

 

 

 

(1,838

)

(1,838

)

Balances, March 31, 2013

 

16,457,169

 

$

20,571

 

$

61,584

 

$

(50,197

)

$

4,860

 

$

36,818

 

 

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

 

6



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FIRST NATIONAL COMMUNITY BANCORP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(unaudited)

 

 

 

Three Months Ended

 

 

 

March 31,

 

(in thousands)

 

2013

 

2012

 

Cash flows from operating activities:

 

 

 

 

 

Net income (loss)

 

$

1,731

 

$

(1,165

)

Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities:

 

 

 

 

 

Investment securities accretion, net

 

(207

)

(400

)

Equity in trust

 

(1

)

(1

)

Depreciation and amortization

 

329

 

274

 

Credit for loan and lease losses

 

(1,224

)

(136

)

Credit for off balance sheet commitments

 

(121

)

(65

)

Gain on sale of investment securities

 

(842

)

(8

)

Gain on the sale of loans held for sale

 

(110

)

(243

)

Gain on the sale of other real estate owned

 

(13

)

(9

)

Recovery of other real estate owned

 

 

(26

)

Income from bank-owned life insurance

 

(172

)

(185

)

Proceeds from the sale of loans held for sale

 

4,542

 

8,739

 

Funds used to originate loans held for sale

 

(3,664

)

(10,188

)

Increase in interest receivable

 

(419

)

(109

)

Decrease (increase) in prepaid expenses and other assets

 

4,108

 

(240

)

Increase in interest payable

 

574

 

591

 

(Decrease) increase in accrued expenses and other liabilities

 

(1,074

)

80

 

Total Adjustments

 

1,706

 

(1,926

)

Net cash provided by (used in) operating activities

 

3,437

 

(3,091

)

 

 

 

 

 

 

Cash flows from investing activities:

 

 

 

 

 

Maturities, calls, and principal payments of investment securities available-for-sale

 

3,581

 

8,361

 

Sales of securities available-for-sale

 

17,121

 

 

Purchases of securities available-for-sale

 

(53,953

)

(19,850

)

Redemption of Federal Home Loan Bank of Pittsburgh stock

 

876

 

420

 

Net increase in loans to customers

 

(16,950

)

(8,583

)

Proceeds from the sale of other real estate owned

 

86

 

1,106

 

Purchases of property and equipment

 

(54

)

(712

)

Net cash used in investing activities

 

(49,293

)

(19,258

)

 

 

 

 

 

 

Cash flows from financing activities:

 

 

 

 

 

Net decrease in total deposits

 

(30,867

)

(66,898

)

Proceeds from FHLB advances

 

 

5,313

 

Repayment of FHLB advances

 

(6,205

)

(8,988

)

Net cash used in financing activities

 

(37,072

)

(70,573

)

Net decrease in cash and cash equivalents

 

(82,928

)

(92,922

)

Cash & cash equivalents at beginning of period

 

115,271

 

168,646

 

Cash & cash equivalents at end of period

 

$

32,343

 

$

75,724

 

Supplemental cash flow information

 

 

 

 

 

Cash paid during the period for:

 

 

 

 

 

Interest

 

$

1,283

 

$

1,982

 

Income taxes

 

 

25

 

Other transactions:

 

 

 

 

 

Settlement of security recorded on trade date

 

 

5,120

 

Principal balance of loans transferred to OREO

 

 

239

 

Transfer from loans held for sale to loans, net

 

 

95

 

 

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

 

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FIRST NATIONAL COMMUNITY BANCORP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

Note 1.         Basis of Presentation

 

The consolidated financial statements are comprised of the accounts of First National Community Bancorp, Inc., and its wholly owned subsidiary, First National Community Bank (the “Bank”), as well as the Bank’s wholly owned subsidiaries (collectively, the “Company”).  The accounting and reporting policies of the Company conform to accounting principles generally accepted in the United States of America (“GAAP”) and general practices within the banking industry.  In the opinion of management, all adjustments necessary for a fair presentation of the results for the quarterly period ended March 31, 2013 have been included in the consolidated financial statements. All intercompany balances and transactions have been eliminated in consolidation. Prior period amounts have been reclassified when necessary to conform to the current period’s presentation. These reclassifications did not have a material effect on the operating results or financial position of the Company. The operating results and financial position of the Company for the three months ended March 31, 2013, may not be indicative of future results of operations and financial position.

 

The preparation of financial statements in accordance with GAAP 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 consolidated financial statements and the reported amounts of revenues and expenses during the reporting period.  Actual results could differ significantly from those estimates.  Material estimates that are particularly susceptible to change are the allowance for loan and lease losses (“ALLL”), investment security valuations, the evaluation of investment securities and other real estate owned (“OREO”) for impairment, and the evaluation of deferred income taxes.

 

These financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in the Company’s audited financial statements, included in our Annual Report filed on Form 10-K as of and for the year ended December 31, 2012.

 

Note 2.         New Authoritative Accounting Guidance

 

Accounting Standards Update (“ASU”) No. 2011-11, Balance Sheet (Topic 210): “Disclosures about Offsetting Assets and Liabilities” requires enhanced disclosures that will enable users of its financial statements to evaluate the effect or potential effect of netting arrangements on an entity’s financial position. This includes the effect or potential effect of rights of setoff associated with an entity’s recognized assets and recognized liabilities within the scope of this update. The amendments require enhanced disclosures by requiring improved information about financial instruments and derivative instruments that are either (1) offset in accordance with either Accounting Standards Codification Topic (“ASC”) 210-20-45 or ASC 815-10-45 or (2) subject to an enforceable master netting arrangement or similar agreement, irrespective of whether they are offset in accordance with either ASC 210-20-45 or ASC 815-10-45. The Company adopted ASU No. 2011-11 on January 1, 2013. The adoption of this new guidance did not have an effect on the operating results or financial position of the Company.

 

ASU No. 2012-02, Intangibles-Goodwill and Other (Topic 350): “Testing Indefinite-Lived Intangible Assets for Impairment” simplifies the guidance for testing the decline in realizable value (impairment) of indefinite-lived intangible assets other than goodwill. ASU No. 2012-02 allows an entity the option to first assess qualitative factors to determine whether it is necessary to perform the quantitative impairment test.  An organization electing to perform a qualitative assessment is no longer required to calculate the fair value of an indefinite-lived intangible asset unless the organization determines, based on a qualitative assessment, that it is “more likely than not” that the asset is impaired. The Company adopted ASU 2012-02 on January 1, 2013. The adoption of this new guidance did not have an effect on the operating results or financial position of the Company.

 

ASU No. 2013-01, Balance Sheet (Topic 210): “Clarifying the Scope of Disclosures about Offsetting Assets and Liabilities” clarifies the scope of transactions that are subject to the disclosures about offsetting, specifically that ordinary trade receivables and receivables are not in the scope of ASU No. 2011-11. This update applies only to derivatives, repurchase agreements and reverse purchase agreements, and securities borrowing and securities lending transactions that are offset in accordance with specific criteria contained in FASB Accounting Standards Codification or subject to a master netting arrangement or similar agreement. The Company adopted ASU 2013-01 on January 1, 2013. The adoption of this new guidance did not have an effect on the operating results or financial position of the Company.

 

ASU No. 2013-02, Comprehensive Income (Topic 220): “Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income” improves the transparency of reporting these reclassifications. The new amendments require an organization to: present either on the face of the statement where income is presented or in the notes to the financial statements the effects on the line items of net income of significant amounts reclassified out of accumulated other comprehensive income; or cross reference to

 

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other disclosures currently required under GAAP for other reclassification items to be reclassified directly to income in their entirety in the same reporting period. The amendments apply to all public and private companies that report other comprehensive income. The Company adopted ASU 2013-02 on January 1, 2013. The adoption of this new guidance did not have an effect on the operating results or financial position of the Company, however see Note 9 for additional disclosures related to the adoption of ASU No. 2013-02.

 

Note 3.         Regulatory Matters

 

The Bank is under a Consent Order (the “Order”) from the Office of the Comptroller of the Currency (“OCC”) dated September 1, 2010. The Company is also subject to a Written Agreement (the “Agreement”) with the Federal Reserve Bank of Philadelphia (the “Reserve Bank”) dated November 24, 2010.

 

OCC Consent Order. The Bank, pursuant to a Stipulation and Consent to the Issuance of a Consent Order dated September 1, 2010, without admitting or denying any wrongdoing, consented and agreed to the issuance of the Order by the OCC, the Bank’s primary regulator. The Order requires the Bank to undertake certain actions within designated timeframes, and to operate in compliance with the provisions thereof during its term. The Order is based on the results of an examination of the Bank as of March 31, 2009. Since the examination, management has engaged in discussions with the OCC and has taken steps to improve the condition, policies and procedures of the Bank. Compliance with the Order is monitored by a committee (the “Committee”) of at least three directors, none of whom is an employee or controlling shareholder of the Bank or its affiliates or a family member of any such person. The Committee is required to submit written progress reports on a monthly basis to the OCC and the Agreement requires the Bank to make periodic reports and filings with the Reserve Bank. The members of the Committee are John P. Moses, Joseph Coccia, Joseph J. Gentile and Thomas J. Melone. The material provisions of the Order are as follows:

 

(i) By October 31, 2010, the Board of Directors of the Bank (the “Board”) was required to adopt and implement a three-year strategic plan which must be submitted to the OCC for review and prior determination of no supervisory objection; the strategic plan must establish objectives for the Bank’s overall risk profile, earnings performance, growth, balance sheet mix, off-balance sheet activities, liability structure, capital adequacy, reduction in the volume of nonperforming assets, product line development, and market segments that the Bank intends to promote or develop, and is to include strategies to achieve those objectives; if the strategic plan involves the sale or merger of the Bank, it must address the timeline and steps to be followed to provide for a definitive agreement within 90 days after the receipt of a determination of no supervisory objection;

 

(ii) by October 31, 2010, the Board was required to adopt and implement a three year capital plan, which must be submitted to the OCC for review and prior determination of no supervisory objection;

 

(iii) by November 30, 2010, the Bank was required to achieve and thereafter maintain a total risk-based capital equal to at least 13% of risk-weighted assets and a Tier 1 capital equal to at least 9% of adjusted total assets;

 

(iv) the Bank may not pay any dividend or capital distribution unless it is in compliance with the higher capital requirements required by the Order, the Capital Plan, applicable legal requirements and, then only after receiving a determination of no supervisory objection from the OCC;

 

(v) by November 15, 2010, the Committee must have reviewed the Board and the Board’s committee structure; by November 30, 2010, the Board was required to prepare or cause to be prepared an assessment of the capabilities of the Bank’s executive officers to perform their past and current duties, including those required to respond to the most recent examination report, and to perform annual performance appraisals of each officer;

 

(vi) by October 31, 2010, the Board was required to adopt, implement and thereafter ensure compliance with a comprehensive conflict of interest policy applicable to the Bank’s and the Company’s directors, executive officers, principal shareholders and their affiliates and such person’s immediate family members and their related interests, employees, and by November 30, 2010, was required to review existing relationships with such persons to identify those, if any, not in compliance with the policy; and review all subsequent proposed transactions with such persons or modifications of transactions;

 

(vii) by October 31, 2010, the Board was required to develop, implement and ensure adherence to policies and procedures for Bank Secrecy Act (“BSA”) compliance; and account opening and monitoring procedures compliance;

 

(viii) by October 31, 2010, the Board was required to ensure the BSA audit function is supported by an adequately staffed department or third party firm; to adopt, implement and ensure compliance with an independent BSA audit; and to assess the capabilities of the BSA officer and supporting staff to perform present and anticipated duties;

 

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Table of Contents

 

(ix) by October 31, 2010, the Board was required to adopt, implement and ensure adherence to a written credit policy, including specified features, to improve the Bank’s loan portfolio management;

 

(x) the Board was required to take certain actions to resolve certain credit and collateral exceptions;

 

(xi) by October 31, 2010, the Board was required to establish an effective, independent and ongoing loan review system to review, at least quarterly, the Bank’s loan and lease portfolios to assure the timely identification and categorization of problem credits; by October 31, 2010, to adopt and adhere to a program for the maintenance of an adequate ALLL, and to review the adequacy of the Bank’s ALLL at least quarterly;

 

(xii) by October 31, 2010, the Board was required to adopt and the Bank implement and adhere to a program to protect the Bank’s interest in criticized assets; and the Bank may only extend additional credit (including renewals) to a borrower whose loans are criticized under specified circumstances;

 

(xiii) by October 31, 2010, the Board was required to adopt and ensure adherence to action plans for each piece of other real estate owned;

 

(xiv) by November 30, 2010, the Board was required to develop, implement and ensure adherence to a policy for effective monitoring and management of concentrations of credit;

 

(xv) by October 31, 2010, the Board was required to revise and implement the Bank’s other than temporary impairment policy;

 

(xvi) by October 31, 2010, the Board was required to take action to maintain adequate sources of stable funding and liquidity and a contingency funding plan; by October 31, 2010, the Board was required to adopt, implement and ensure compliance with an independent, internal audit program; and

 

(xvii) take actions to correct cited violations of law; and adopt procedures to prevent future violations and address compliance management.

 

Federal Reserve Agreement. On November 24, 2010, the Company entered into the Agreement with the Reserve Bank. The Agreement requires the Company to undertake certain actions within designated timeframes, and to operate in compliance with the provisions thereof during its term. The material provisions of the Agreement include the following:

 

(i) the Company’s Board was required to take appropriate steps to fully utilize the Company’s financial and managerial resources to serve as a source of strength to the Bank, including taking steps to ensure that the Bank complies with its Consent Order entered into with the OCC;

 

(ii) the Company may not declare or pay any dividends without the prior written approval of the Reserve Bank and the Director of the Division of Banking Supervision and Regulation (the “Director”) of the Federal Reserve Board;

 

(iii) the Company may not take dividends or other payments representing a reduction of the Bank’s capital without the prior written approval of the Reserve Bank;

 

(iv) the Company and its nonbank subsidiary may not make any payment of interest, principal or other amounts on the Company’s subordinated debentures or trust preferred securities without the prior written approval of the Reserve Bank and the Director;

 

(v) the Company may not make any payment of interest, principal or other amounts on debt owed to insiders of the Company without the prior written approval of the Reserve Bank and Director;

 

(vi) the Company and its nonbank subsidiary may not incur, increase or guarantee any debt without the prior written approval of the Reserve Bank;

 

(vii) the Company may not purchase or redeem any shares of its stock without the prior written approval of the Reserve Bank;

 

(viii) the Company was required to submit to the Reserve Bank, by January 23, 2011, an acceptable written plan to maintain sufficient capital at the Company on a consolidated basis. Thereafter, the Company must notify the Reserve Bank within 45 days of the end of any quarter in which the Company’s capital ratios fall below the approved capital plan’s minimum ratios, and submit an acceptable written plan to increase the Company’s capital ratios above the capital plan’s minimums;

 

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Table of Contents

 

(ix) the Company was required to immediately take all actions necessary to ensure that: (1) each regulatory report accurately reflects the Company’s condition on the date for which it is filed and all material transactions between the Company and its subsidiaries; (2) each such report is prepared in accordance with its instructions; and (3) all records indicating how the report was prepared are maintained for supervisory review;

 

(x) the Company was required to submit to the Reserve Bank, by January 23, 2011, acceptable written procedures to strengthen and maintain internal controls to ensure all required regulatory reports and notices filed with the Board of Governors are accurate and filed in accordance with the instructions for preparation;

 

(xi) the Company was required to submit to the Reserve Bank, by January 8, 2011, a cash flow projection for 2011, reflecting the Company’s planned sources and uses of cash, and submit a cash flow projection for each subsequent calendar year at least one month prior to the beginning of such year;

 

(xii) the Company must comply with: (1) the notice provisions of Section 32 of the FDI Act and Subpart H of Regulation Y in appointing any new director or senior executive officer or changing the duties of any senior executive officer; and (2) the restrictions on indemnification and severance payments of Section 18(k) of the FDI Act and Part 359 of the FDIC’s regulations; and

 

(xiii) the Board must submit written progress reports within 30 days of the end of each calendar quarter.

 

During the three months ended March 31, 2013, and the year ended December 31, 2012, the Company incurred approximately $45 thousand and $585 thousand, respectively, of expenses related to complying with these regulatory agreements, consisting primarily of professional and consulting fees.  In addition, the Order and the Agreement place restrictions on the Company’s ability to borrow funds and to pay interest and dividends to its security holders.  In the future, the Company may continue to experience increased costs related to compliance with these regulatory agreements and also expects to face certain restrictions on its operations for as long as it continues to operate under the Order and the Agreement.  The Company expects, however, that future compliance expenses will decrease from the 2012 level.

 

The Order and Agreement have not and are not expected to have an impact on the Company’s ability to attract and maintain deposits or the Company’s cost of funds.  In order to meet the increased capital requirements imposed under the Order and the Agreement, however, unless the Company is able to raise additional capital, the Company could be limited in the aggregate amount of loans it can have outstanding, which may constrain loan growth.  While it is not anticipated that the Order and the Agreement will have an impact on the Company’s net interest margin, the overall cost of compliance with the Order and the Agreement will continue to impact profitability at least through the end of 2013.

 

Banking regulations also limit the amount of dividends that may be paid without prior approval of the Bank’s regulatory agency.  As of May 14, 2013, the Company and the Bank are restricted from paying any dividends without regulatory approval.

 

The Company is subject to various regulatory capital requirements administered by the federal banking agencies.  Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material adverse effect on the Company’s financial statements.  Under capital adequacy guidelines and the regulatory framework for prompt corrective action, specific capital guidelines that involve quantitative measures of assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices must be met.  Capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors.

 

Quantitative measures established by regulation to ensure capital adequacy require the Company to maintain minimum amounts and ratios (set forth in the table below) of total and Tier I capital (as defined in the regulations) to risk-weighted assets (as defined), and of Tier I capital (as defined) to average assets (as defined).

 

In accordance with the Order, the Bank is required to achieve and thereafter maintain total risk-based capital equal to at least 13% of risk-weighted assets and Tier 1 capital equal to at least 9% of adjusted total assets.  At March 31, 2013 and December 31, 2012, the Bank was not in compliance with these requirements.  The minimum capital requirements under the Order take precedence over the standard regulatory capital adequacy definitions described in the tables below. The Company’s and the Bank’s actual capital positions and ratios at March 31, 2013 and December 31, 2012 are presented in the following table:

 

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Table of Contents

 

Capital Analysis

 

 

 

March 31,

 

December 31,

 

(in thousands)

 

2013

 

2012

 

Company

 

 

 

 

 

Tier I capital:

 

 

 

 

 

Total tier I capital

 

$

41,356

 

$

39,587

 

Tier II capital:

 

 

 

 

 

Subordinated notes

 

20,679

 

19,796

 

Allowable portion of allowance for loan losses

 

8,367

 

8,452

 

Total tier II capital

 

29,046

 

28,248

 

Total risk-based capital

 

70,402

 

67,835

 

Total risk-weighted assets

 

$

658,621

 

$

665,323

 

 

 

 

 

 

 

Bank

 

 

 

 

 

Tier I capital:

 

 

 

 

 

Total tier I capital

 

$

72,343

 

$

69,963

 

Tier II capital:

 

 

 

 

 

Allowable portion of allowance for loan losses

 

8,362

 

8,447

 

Total tier II capital

 

8,362

 

8,447

 

Total risk-based capital

 

80,705

 

78,410

 

Total risk-weighted assets

 

$

658,210

 

$

664,914

 

 

 

 

 

 

 

 

 

 

 

 

To Be Well

 

 

 

 

 

 

 

 

 

 

 

Capitalized

 

 

 

 

 

 

 

 

 

 

 

Under Prompt

 

 

 

 

 

 

 

For Capital

 

Corrective

 

 

 

Actual

 

Adequacy Purposes

 

Action Provision

 

(dollars in thousands)

 

Amount

 

Ratio

 

Amount

 

Ratio

 

Amount

 

Ratio

 

March 31, 2013

 

 

 

 

 

 

 

 

 

 

 

 

 

Total capital

 

 

 

 

 

 

 

 

 

 

 

 

 

(to risk-weighted assets)

 

 

 

 

 

 

 

 

 

 

 

 

 

Company

 

$

70,402

 

10.69

%

$

>52,690

 

>8.00

%

N/A

 

N/A

 

Bank

 

$

80,705

 

12.26

%

$

>52,657

 

>8.00

%

$

>65,821

 

>10.00

%

Tier I capital

 

 

 

 

 

 

 

 

 

 

 

 

 

(to risk-weighted assets)

 

 

 

 

 

 

 

 

 

 

 

 

 

Company

 

$

41,356

 

6.28

%

$

>26,345

 

>4.00

%

N/A

 

N/A

 

Bank

 

$

72,343

 

10.99

%

$

>26,328

 

>4.00

%

$

>39,493

 

>6.00

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Tier I capital

 

 

 

 

 

 

 

 

 

 

 

 

 

(to average assets)

 

 

 

 

 

 

 

 

 

 

 

 

 

Company

 

$

41,356

 

4.42

%

$

>37,449

 

>4.00

%

N/A

 

N/A

 

Bank

 

$

72,343

 

7.73

%

$

>37,434

 

>4.00

%

$

>46,793

 

>5.00

%

 

12



Table of Contents

 

 

 

 

 

 

 

 

 

 

 

To Be Well

 

 

 

 

 

 

 

 

 

 

 

Capitalized

 

 

 

 

 

 

 

 

 

 

 

Under Prompt

 

 

 

 

 

 

 

For Capital

 

Corrective

 

 

 

Actual

 

Adequacy Purposes

 

Action Provision

 

(dollars in thousands)

 

Amount

 

Ratio

 

Amount

 

Ratio

 

Amount

 

Ratio

 

December 31, 2012

 

 

 

 

 

 

 

 

 

 

 

 

 

Total capital

 

 

 

 

 

 

 

 

 

 

 

 

 

(to risk-weighted assets)

 

 

 

 

 

 

 

 

 

 

 

 

 

Company

 

$

67,835

 

10.20

%

$

>53,226

 

>8.00

%

N/A

 

N/A

 

Bank

 

$

78,410

 

11.79

%

$

>53,193

 

>8.00

%

$

>66,491

 

>10.00

%

Tier I capital

 

 

 

 

 

 

 

 

 

 

 

 

 

(to risk-weighted assets)

 

 

 

 

 

 

 

 

 

 

 

 

 

Company

 

$

39,587

 

5.95

%

$

>26,613

 

>4.00

%

N/A

 

N/A

 

Bank

 

$

69,963

 

10.52

%

$

>26,597

 

>4.00

%

$

>39,895

 

>6.00

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Tier I capital

 

 

 

 

 

 

 

 

 

 

 

 

 

(to average assets)

 

 

 

 

 

 

 

 

 

 

 

 

 

Company

 

$

39,587

 

4.07

%

$

>38,879

 

>4.00

%

N/A

 

N/A

 

Bank

 

$

69,963

 

7.20

%

$

>38,865

 

>4.00

%

$

>48,581

 

>5.00

%

 

Note 4.         LOANS

 

The following table presents a summary of loans receivable, net, by category at March 31, 2013 and December 31, 2012:

 

(in thousands)

 

March 31,
2013

 

December 31,
2012

 

Residential real estate

 

$

98,273

 

$

90,228

 

Commercial real estate

 

248,455

 

231,835

 

Construction, land acquisition, and development

 

22,363

 

32,502

 

Commercial and industrial loans

 

112,176

 

110,073

 

Consumer loans

 

109,378

 

109,783

 

State and political subdivisions

 

25,278

 

23,354

 

Total loans, gross

 

615,923

 

597,775

 

Unearned discount

 

(89

)

(103

)

Net deferred loan fees and costs

 

321

 

260

 

Allowance for loan and lease losses

 

(18,473

)

(18,536

)

Loans, net

 

$

597,682

 

$

579,396

 

 

The Company has granted loans, letters of credit and lines of credit to certain executive officers and directors of the Company as well as to certain related parties of executive officers and directors.  See Note 10 to these consolidated financial statements for more information about related party transactions.

 

The Company originates one-to-four family mortgage loans primarily for sale in the secondary market.  During the quarter ended March 31, 2013, the Company sold $3.7 million of one-to-four family mortgages.  The Company retains servicing rights on these mortgages.

 

The Company had $847 thousand and $1.6 million in loans held-for-sale at March 31, 2013 and December 31, 2012, respectively.  All loans held for sale are one-to-four family residential mortgage loans.

 

The Company does not have any lending programs commonly referred to as subprime lending.  Subprime lending generally targets borrowers with weakened credit histories typically characterized by payment delinquencies, previous charge-offs, judgments, bankruptcies, or borrowers with questionable repayment capacity as evidenced by low credit scores or high debt-burden ratios.

 

See Note 2 to the Company’s consolidated financial statements included in the 2012 Form 10-K for the risk characteristics related to the Company’s loan segments.

 

The Company provides for loan losses based on the consistent application of its documented ALLL methodology.  Loan losses are charged to the ALLL and recoveries are credited to it.  Additions to the ALLL are provided by charges against income based on various factors which, in management’s judgment, deserve current recognition of estimated probable losses.  Loan losses are charged-

 

13



Table of Contents

 

off in the period the loans, or portions thereof, are deemed uncollectible.  Generally, the Company will record a loan charge-off (including a partial charge-off) to reduce a loan to the estimated recoverable amount based on its methodology detailed below.  The Company regularly reviews the loan portfolio and makes adjustments for loan losses in order to maintain the ALLL in accordance with GAAP. The ALLL consists primarily of the following two components:

 

(1)         Specific allowances are established for impaired loans, which are defined by the Company as all loan relationships with an aggregate outstanding balance greater than $100 thousand that are rated substandard and on non-accrual status, rated doubtful or loss, and all troubled debt restructured loans (“TDRs”).  The amount of impairment provided for as an allowance is represented by the deficiency, if any, between the carrying value of the loan and either (a) the present value of expected future cash flows discounted at the loan’s effective interest rate, (b) the loan’s observable market price, or (c) the fair value of the underlying collateral, less estimated costs to sell, for collateral dependent loans.  Impaired loans that have no impairment losses are not considered for general valuation allowances described below.  If the Company determines that collection of the impairment amount is remote, the Company will record a charge-off.

 

(2)         General allowances are established for loan losses on a portfolio basis for loans that do not meet the definition of impaired.  The Company divides its portfolio into loan segments, with loans exhibiting similar characteristics.  Loans rated special mention or substandard and accruing which are embedded in these loan segments are then separated from these loan segments.  These loans are then subject to an analysis placing increased emphasis on the credit risk associated with these specific loans.  The Company applies an estimated loss rate to each loan group.  The loss rates applied are based on the Company’s own historical loss experience based on the loss rate for each segment of loans with similar risk characteristics in its portfolio.  In addition, management evaluates and applies certain qualitative or environmental factors that are likely to cause estimated credit losses associated with the Company’s existing portfolio to differ from historical experience, which are discussed below.  This evaluation is inherently subjective, as it requires material estimates that may be susceptible to significant revisions based upon changes in economic and real estate market conditions.  Actual loan losses may be significantly more than the ALLL that is established, which could have a material negative effect on the Company’s operating results or financial condition.

 

Management makes adjustments for loan losses based on its evaluation of several qualitative and environmental factors, including but not limited to:

 

·                  Changes in national, local, and business economic conditions and developments, including the condition of various market segments;

·                  Changes in the nature and volume of the Company’s loan portfolio;

·                  Changes in the Company’s lending policies and procedures, including underwriting standards, collection, charge-off and recovery practices and results;

·                  Changes in the experience, ability and depth of the Company’s lending management and staff;

·                  Changes in the quality of the Company’s loan review system and the degree of oversight by the Company’s Board of Directors;

·                  Changes in the trend of the volume and severity of past due and classified loans, including trends in the volume of non-accrual loans, troubled debt restructurings and other loan modifications;

·                  The existence and effect of any concentrations of credit and changes in the level of such concentrations;

·                  The effect of external factors such as competition and legal and regulatory requirements on the level of estimated credit losses in the Company’s current loan portfolio; and

·                  Analysis of customers’ credit quality, including knowledge of their operating environment and financial condition.

 

Management evaluates the ALLL based on the combined total of the impaired and general components. Generally, when the loan portfolio increases, absent other factors, the ALLL methodology results in a higher dollar amount of estimated probable losses. Conversely, when the loan portfolio decreases, absent other factors, the ALLL methodology results in a lower dollar amount of estimated probable losses.

 

Each quarter, management evaluates the ALLL and adjusts the ALLL as appropriate through a provision for loan losses. While the Company uses the best information available to make evaluations, future adjustments to the ALLL may be necessary if conditions differ substantially from the information used in making the evaluations. In addition, as an integral part of its examination process, the OCC periodically reviews the Company’s ALLL. The OCC may require the Company to adjust the ALLL based on its analysis of information available to it at the time of its examination.

 

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Table of Contents

 

The following table sets forth activity in the ALLL, by loan category, for the three months ended March 31, 2013 and 2012.

 

 

 

Real Estate

 

 

 

 

 

 

 

 

 

(in thousands)

 

Residential Real
Esate

 

Commercial Real
Estate

 

Construction, Land
Acquisition and
Development

 

Commercial and
Industrial

 

Consumer

 

State and Political
Subdivisions

 

Total

 

Three months ended March 31, 2013:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Allowance for loan losses:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Beginning balance, January 1, 2013

 

$

1,764

 

$

8,062

 

$

2,162

 

$

4,167

 

$

1,708

 

$

673

 

$

18,536

 

Charge-offs

 

(159

)

(48

)

(110

)

(45

)

(194

)

 

(556

)

Recoveries

 

8

 

45

 

5

 

1,516

 

143

 

 

1,717

 

Provisions (credits)

 

271

 

823

 

(381

)

(2,033

)

82

 

14

 

(1,224

)

Ending balance, March 31, 2013

 

$

1,884

 

$

8,882

 

$

1,676

 

$

3,605

 

$

1,739

 

$

687

 

$

18,473

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three months ended March 31, 2012:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Allowance for loan losses:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Beginning balance, January 1, 2012

 

$

1,823

 

$

11,151

 

$

2,590

 

$

3,292

 

$

1,526

 

$

452

 

$

20,834

 

Charge-offs

 

(312

)

(154

)

 

(49

)

(79

)

 

(594

)

Recoveries

 

19

 

317

 

21

 

125

 

78

 

 

560

 

Provisions (credits)

 

269

 

(573

)

234

 

37

 

(68

)

(35

)

(136

)

Ending balance, March 31, 2012

 

$

1,799

 

$

10,741

 

$

2,845

 

$

3,405

 

$

1,457

 

$

417

 

$

20,664

 

 

The following table represents the allocation of the allowance for loan losses and the related loan by loan portfolio segment disaggregated based on the impairment methodology at March 31, 2013 and December 31, 2012:

 

 

 

Real Estate

 

 

 

 

 

 

 

 

 

(in thousands)

 

Residential Real
Esate

 

Commercial Real
Estate

 

Construction, Land
Acquisition and
Development

 

Commercial and
Industrial

 

Consumer

 

State and Political
Subdivisions

 

Total

 

March 31, 2013

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Allowance for loan losses:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Individually evaluated for impairment

 

$

26

 

$

408

 

$

84

 

$

 

$

 

$

 

$

518

 

Collectively evaluated for impairment

 

1,858

 

8,474

 

1,592

 

3,605

 

1,739

 

687

 

17,955

 

Total

 

$

1,884

 

$

8,882

 

$

1,676

 

$

3,605

 

$

1,739

 

$

687

 

$

18,473

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Loans receivable:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Individually evaluated for impairment

 

$

2,158

 

$

10,857

 

$

943

 

$

 

$

 

$

 

$

13,958

 

Collectively evaluated for impairment

 

96,115

 

237,598

 

21,420

 

112,176

 

109,378

 

25,278

 

601,965

 

Total

 

$

98,273

 

$

248,455

 

$

22,363

 

$

112,176

 

$

109,378

 

$

25,278

 

$

615,923

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

December 31, 2012

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Allowance for loan losses:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Individually evaluated for impairment

 

$

40

 

$

268

 

$

2

 

$

 

$

 

$

 

$

310

 

Collectively evaluated for impairment

 

1,724

 

7,794

 

2,160

 

4,167

 

1,708

 

673

 

18,226

 

Total

 

$

1,764

 

$

8,062

 

$

2,162

 

$

4,167

 

$

1,708

 

$

673

 

$

18,536

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Loans receivable:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Individually evaluated for impairment

 

$

2,773

 

$

11,459

 

$

993

 

$

 

$

 

$

 

$

15,225

 

Collectively evaluated for impairment

 

87,455

 

220,376

 

31,509

 

110,073

 

109,783

 

23,354

 

582,550

 

Total

 

$

90,228

 

$

231,835

 

$

32,502

 

$

110,073

 

$

109,783

 

$

23,354

 

$

597,775

 

 

Credit Quality Indicators — Commercial Loans

 

The Company continuously monitors the credit quality of its commercial loans.  Credit quality is monitored by reviewing certain credit quality indicators. Management has determined that credit risk ratings are the key credit quality indicator that best help management monitor the credit quality of the Company’s loan receivables.

 

The Bank’s commercial loan classification and credit grading processes are part of the lending, underwriting, and credit administration functions to ensure an ongoing assessment of credit quality. Accurate and timely loan classification or credit grading is a critical component of loan portfolio management. Loan officers are required to review their loan portfolio risk ratings regularly for accuracy. The loan review function uses the same risk rating system in the loan review process. This allows an independent third party to assess the quality of the portfolio and compare the accuracy of ratings with the loan officer’s and management’s assessment.

 

A formal loan classification and credit grading system reflects the risk of default and credit losses.  A written description of the risk ratings is maintained that includes a discussion of the factors used to assign appropriate classifications of credit grades to loans.  The process identifies groups of loans that warrant the special attention of management.  The risk grade groupings provide a mechanism to identify risk within the loan portfolio and provide management and the Board with periodic reports by risk category.  The credit risk ratings play an important role in the establishment and evaluation of the provision for loan and lease losses and the ALLL.  After determining the historical loss factor which is adjusted for qualitative and environmental factors for each portfolio segment, the portfolio segment balances that have been collectively evaluated for impairment are multiplied by the general reserve loss factor for the respective portfolio segments to determine the general reserve.  Loans that have an internal credit rating of special mention or substandard follow the same process; however, the qualitative and environmental factors are further adjusted for the increased risk.

 

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The Company utilizes a loan rating system that assigns a degree of risk to commercial loans based on relevant information about the ability of borrowers to service their debt such as: current financial information, historical payment experience, credit documentation, public information and current economic trends, among other factors.  The Company analyzes these non-homogeneous loans individually by grading the loans as to credit risk and probability of collection for each type of loan. Commercial loans include commercial indirect auto loans which are not individually risk rated, and Construction, Land Acquisition and Development Loans include residential construction loans which are also not individually risk rated.  These loans are monitored on a pool basis due to their homogeneous nature as described in “Credit Quality Indicators — Other Loans” below. The Company risk rates certain residential real estate loans and consumer loans that are part of a larger commercial relationship using its credit grading system. These loans are described in “Credit Quality Indicators — Commercial Loans.”  The grading system contains the following basic risk categories:

 

1. Minimal Risk

2. Above Average Credit Quality

3. Average Risk

4. Acceptable Risk

5. Pass - Watch

6. Special Mention

7. Substandard - Accruing

8. Substandard - Non-Accrual

9. Doubtful

10. Loss

 

This analysis is performed on a quarterly basis using the following definitions for risk ratings:

 

Pass - Assets rated 1 through 5 are considered pass ratings. These assets show no current or potential problems and are considered fully collectible. All such loans are considered collectively for ALLL calculation purposes.  However, accruing TDRs that have been performing for an extended period of time, do not represent a higher risk of loss, and have been upgraded to a pass rating are evaluated individually for impairment.

 

Special Mention — Assets classified as special mention assets do not currently expose the Company to a sufficient degree of risk to warrant an adverse classification but do possess credit deficiencies or potential weaknesses deserving close attention.  Special Mention assets have a potential weakness or pose an unwarranted financial risk which, if not corrected, could weaken the asset and increase risk in the future.

 

Substandard - Assets classified as substandard have well defined weaknesses based on objective evidence, and are characterized by the distinct possibility that the Company will sustain some loss if the deficiencies are not corrected.

 

Doubtful - Assets classified as doubtful have all of the weaknesses inherent in those classified substandard with the added characteristic that the weaknesses present make collection or liquidation in full highly questionable and improbable based on current circumstances.

 

Loss - Assets classified as loss are those considered uncollectible and of such little value that their continuance as assets is not warranted.

 

The following tables detail the recorded investment in loans receivable by the aforementioned class of loan and credit quality indicator at March 31, 2013 and December 31, 2012.

 

Commercial Credit Quality Indicators

March 31, 2013

 

 

 

Real Estate

 

 

 

 

 

 

 

 

 

(in thousands)

 

Residential Real
Esate

 

Commercial
Real Estate

 

Construction, Land
Acquisition and
Development

 

Commercial and
Industrial

 

Consumer

 

State and Political
Subdivisions

 

Total

 

Internal risk rating

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Pass

 

$

18,943

 

$

214,785

 

$

13,622

 

$

97,101

 

$

2,445

 

$

19,962

 

$

366,858

 

Special mention

 

1,234

 

12,174

 

56

 

6,985

 

 

819

 

21,268

 

Substandard

 

1,714

 

21,496

 

7,221

 

2,804

 

171

 

4,497

 

37,903

 

Doubtful

 

 

 

 

 

 

 

 

Loss

 

 

 

 

 

 

 

 

Total

 

$

21,891

 

$

248,455

 

$

20,899

 

$

106,890

 

$

2,616

 

$

25,278

 

$

426,029

 

 

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Table of Contents

 

Commercial Credit Quality Indicators

December 31, 2012

 

 

 

Real Estate

 

 

 

 

 

 

 

 

 

(in thousands)

 

Residential Real
Esate

 

Commercial Real
Estate

 

Construction, Land
Acquisition and
Development

 

Commercial and
Industrial

 

Consumer

 

State and Political
Subdivisions

 

Total

 

Internal risk rating

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Pass

 

$

17,138

 

$

200,147

 

$

23,052

 

$

93,864

 

$

3,324

 

$

17,580

 

$

355,105

 

Special mention

 

564

 

8,587

 

57

 

7,437

 

 

849

 

17,494

 

Substandard

 

2,309

 

23,101

 

7,395

 

3,395

 

143

 

4,925

 

41,268

 

Doubtful

 

 

 

 

 

 

 

 

Loss

 

 

 

 

 

 

 

 

Total

 

$

20,011

 

$

231,835

 

$

30,504

 

$

104,696

 

$

3,467

 

$

23,354

 

$

413,867

 

 

Credit Quality Indicators — Other Loans

 

Residential, consumer and commercial indirect auto loans are monitored on a pool basis due to their homogeneous nature. Loans that are delinquent 90 days or more are considered to be non-accrual. The Company utilizes accruing versus non-accruing status as the credit quality indicator for these loan pools.  The following table presents the recorded investment in residential, consumer and indirect auto loans based on payment activity as of March 31, 2013 and December 31, 2012.

 

 

 

March 31, 2013

 

December 31, 2012

 

 

 

Accruing

 

Non-Accruing

 

 

 

Accruing

 

Non-Accruing

 

 

 

(in thousands)

 

Loans

 

Loans

 

Total

 

Loans

 

Loans

 

Total

 

Construction, land acquisition and development - residential

 

$

1,464

 

$

 

$

1,464

 

$

1,998

 

$

 

$

1,998

 

Residential real estate

 

74,544

 

1,838

 

76,382

 

68,446

 

1,771

 

70,217

 

Commercial - indirect auto

 

5,268

 

18

 

5,286

 

5,377

 

 

5,377

 

Consumer

 

106,708

 

54

 

106,762

 

106,272

 

44

 

106,316

 

Total

 

$

187,984

 

$

1,910

 

$

189,894

 

$

182,093

 

$

1,815

 

$

183,908

 

 

Included in loans receivable are loans for which the accrual of interest income has been discontinued due to deterioration in the financial condition of the borrowers. The recorded investment in these non-accrual loans was $8.8 million and $9.7 million at March 31, 2013 and December 31, 2012, respectively. Included in non-accrual loans at March 31, 2013 and December 31, 2012 was one loan in the amount of $4.4 million which was 90.0% guaranteed by a United States government agency. Generally, loans are placed on non-accruing status when they become 90 days or more delinquent, and remain on non-accrual status until they are brought current, have six months of performance under the loan terms, and factors indicating reasonable doubt about the timely collection of payments no longer exist.  Therefore, loans may be current in accordance with their loan terms, or may be less than 90 days delinquent and still be on a non-accrual status.  Loans past due 90 days or more and still accruing interest were $0 and $57 thousand at March 31, 2013 and December 31, 2012, respectively, and consisted of loans that are well secured and are in the process of renewal.

 

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Table of Contents

 

The following tables set forth the detail, and delinquency status, of past due and non-accrual loans at March 31, 2013 and December 31, 2012:

 

 

 

March 31, 2013

 

 

 

Delinquency Status

 

(in thousands)

 

0-29 Days Past
Due

 

30-59 Days Past
Due

 

60-89 Days Past
Due

 

>/= 90 Days Past
Due

 

Total

 

Performing (accruing) loans

 

 

 

 

 

 

 

 

 

 

 

Real estate:

 

 

 

 

 

 

 

 

 

 

 

Residential real estate

 

$

94,950

 

$

260

 

$

136

 

$

 

$

95,346

 

Commercial real estate

 

242,848

 

481

 

 

 

243,329

 

Construction, land acquisition and development

 

21,909

 

 

 

 

21,909

 

Total real estate

 

359,707

 

741

 

136

 

 

360,584

 

 

 

 

 

 

 

 

 

 

 

 

 

Commercial and industrial

 

111,511

 

503

 

15

 

 

112,029

 

 

 

 

 

 

 

 

 

 

 

 

 

Consumer

 

107,487

 

1,329

 

384

 

 

109,200

 

 

 

 

 

 

 

 

 

 

 

 

 

State and political subdivisions

 

25,278

 

 

 

 

25,278

 

 

 

 

 

 

 

 

 

 

 

 

 

Total performing (accruing) loans

 

603,983

 

2,573

 

535

 

 

607,091

 

 

 

 

 

 

 

 

 

 

 

 

 

Non-accrual loans

 

 

 

 

 

 

 

 

 

 

 

Real estate:

 

 

 

 

 

 

 

 

 

 

 

Residential real estate

 

1,194

 

4

 

 

1,729

 

2,927

 

Commercial real estate

 

90

 

184

 

 

4,852

 

5,126

 

Construction, land aquisition and development

 

53

 

382

 

 

19

 

454

 

Total real estate

 

1,337

 

570

 

 

6,600

 

8,507

 

 

 

 

 

 

 

 

 

 

 

 

 

Commercial and industrial

 

48

 

5

 

64

 

30

 

147

 

 

 

 

 

 

 

 

 

 

 

 

 

Consumer

 

95

 

9

 

6

 

68

 

178

 

 

 

 

 

 

 

 

 

 

 

 

 

State and political subdivisions