10-Q 1 v359230_10q.htm FORM 10-Q
 
 
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 September 30, 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  o
 
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 o
 
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 November 12, 2013)
 
 
 
 
 
 
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 Income
5
Consolidated Statements of Changes in Shareholder’s 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
39
Item 3 - Quantitative And Qualitative Disclosures About Market Risk
60
Item 4 - Controls and Procedures
60
Part II Other Information
60
Item 1 - Legal Proceedings 
 60
Item 1A. - Risk Factors
61
Item 2 - Unregistered Sales of Equity Securities and Use of Proceeds
61
Item 3 - Defaults upon Senior Securities
61
Item 4 - Mine Safety Disclosures
61
Item 5 - Other Information
61
Item 6 - Exhibits
62
 
 
2

 

Part I - Financial Information

 

Item 1 - Financial Statements

 
FIRST NATIONAL COMMUNITY BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
(unaudited)
 
 
 
September 30,
 
December 31,
 
(in thousands, except share data)
 
2013
 
2012
 
Assets
 
 
 
 
 
 
 
Cash and cash equivalents:
 
 
 
 
 
 
 
Cash and due from banks
 
$
22,858
 
$
21,710
 
Interest-bearing deposits in other banks
 
 
63,528
 
 
93,561
 
Total cash and cash equivalents
 
 
86,386
 
 
115,271
 
Securities available for sale at fair value
 
 
185,614
 
 
185,361
 
Securities held to maturity at amortized cost (fair value $2,420 and $2,483)
 
 
2,280
 
 
2,198
 
Stock in Federal Home Loan Bank of Pittsburgh, at cost
 
 
2,550
 
 
5,957
 
Loans held for sale
 
 
884
 
 
1,615
 
Loans, net of allowance for loan and lease losses of $17,618 and $18,536
 
 
638,872
 
 
579,396
 
Bank premises and equipment, net
 
 
16,731
 
 
18,937
 
Accrued interest receivable
 
 
2,320
 
 
2,199
 
Refundable federal income taxes
 
 
55
 
 
11,637
 
Intangible assets
 
 
509
 
 
632
 
Bank-owned life insurance
 
 
27,992
 
 
27,461
 
Other real estate owned
 
 
4,405
 
 
3,983
 
Other assets
 
 
9,927
 
 
13,627
 
Total Assets
 
$
978,525
 
$
968,274
 
 
 
 
 
 
 
 
 
Liabilities
 
 
 
 
 
 
 
Deposits
 
 
 
 
 
 
 
Demand (non-interest-bearing)
 
$
141,321
 
$
131,476
 
Interest-bearing
 
 
712,489
 
 
723,137
 
Total deposits
 
 
853,810
 
 
854,613
 
Borrowed funds
 
 
 
 
 
 
 
Federal Home Loan Bank of Pittsburgh advances
 
 
37,213
 
 
18,593
 
Subordinated debentures
 
 
25,000
 
 
25,000
 
Junior subordinated debentures
 
 
10,310
 
 
10,310
 
Total borrowed funds
 
 
72,523
 
 
53,903
 
Accrued interest payable
 
 
8,234
 
 
6,427
 
Other liabilities
 
 
11,161
 
 
16,406
 
Total liabilities
 
 
945,728
 
 
931,349
 
 
 
 
 
 
 
 
 
Shareholders' Equity
 
 
 
 
 
 
 
Preferred shares ($1.25 par)
 
 
 
 
 
 
 
Authorized: 20,000,000 shares at September 30, 2013 and December 31, 2012
 
 
 
 
 
 
 
Issued and outstanding: 0 shares at September 30, 2013 and December 31, 2012
 
 
-
 
 
-
 
Common shares ($1.25 par)
 
 
 
 
 
 
 
Authorized: 50,000,000 shares at September 30, 2013 and December 31, 2012
 
 
 
 
 
 
 
Issued and outstanding: 16,457,169 shares at September 30, 2013 and December 31, 2012
 
 
20,571
 
 
20,571
 
Additional paid-in capital
 
 
61,584
 
 
61,584
 
Accumulated deficit
 
 
(47,590)
 
 
(51,928)
 
Accumulated other comprehensive (loss) income
 
 
(1,768)
 
 
6,698
 
Total shareholders' equity
 
 
32,797
 
 
36,925
 
Total Liabilities and Shareholders’ Equity
 
$
978,525
 
$
968,274
 
 
The accompanying notes to consolidated financial statements are an integral part of these statements.
 
 
3

 
FIRST NATIONAL COMMUNITY BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(unaudited)
 
 
 
Three Months Ended
 
Nine Months Ended
 
 
 
September 30,
 
September 30,
 
(in thousands, except share data)
 
2013
 
2012
 
2013
 
2012
 
Interest income
 
 
 
 
 
 
 
 
 
 
 
 
 
Interest and fees on loans
 
$
6,833
 
$
7,148
 
$
20,158
 
$
22,466
 
Interest and dividends on securities
 
 
 
 
 
 
 
 
 
 
 
 
 
U.S. government agencies
 
 
429
 
 
289
 
 
1,331
 
 
994
 
State and political subdivisions, tax-free
 
 
743
 
 
985
 
 
2,539
 
 
2,948
 
State and political subdivisions, taxable
 
 
116
 
 
117
 
 
348
 
 
366
 
Other securities
 
 
51
 
 
403
 
 
120
 
 
1,236
 
Total interest and dividends on securities
 
 
1,339
 
 
1,794
 
 
4,338
 
 
5,544
 
Interest on interest-bearing deposits and federal funds sold
 
 
17
 
 
43
 
 
70
 
 
143
 
Total interest income
 
 
8,189
 
 
8,985
 
 
24,566
 
 
28,153
 
Interest expense
 
 
 
 
 
 
 
 
 
 
 
 
 
Deposits
 
 
 
 
 
 
 
 
 
 
 
 
 
Interest-bearing demand
 
 
124
 
 
172
 
 
432
 
 
512
 
Savings
 
 
21
 
 
41
 
 
75
 
 
131
 
Time ($100,000 and over)
 
 
339
 
 
345
 
 
982
 
 
1,145
 
Other time
 
 
553
 
 
711
 
 
1,736
 
 
2,390
 
Total interest on deposits
 
 
1,037
 
 
1,269
 
 
3,225
 
 
4,178
 
Interest on borrowed funds
 
 
 
 
 
 
 
 
 
 
 
 
 
Interest on Federal Home Loan Bank of Pittsburgh advances
 
 
149
 
 
307
 
 
403
 
 
1,061
 
Interest on subordinated debentures
 
 
575
 
 
574
 
 
1,706
 
 
1,712
 
Interest on junior subordinated debentures
 
 
51
 
 
56
 
 
153
 
 
171
 
Total interest on borrowed funds
 
 
775
 
 
937
 
 
2,262
 
 
2,944
 
Total interest expense
 
 
1,812
 
 
2,206
 
 
5,487
 
 
7,122
 
Net interest income before (credit) provision for loan and lease losses
 
 
6,377
 
 
6,779
 
 
19,079
 
 
21,031
 
(Credit) provision for loan and lease losses
 
 
(1,159)
 
 
3,792
 
 
(2,385)
 
 
3,376
 
Net interest income after (credit) provision for loan and lease losses
 
 
7,536
 
 
2,987
 
 
21,464
 
 
17,655
 
Non-interest income
 
 
 
 
 
 
 
 
 
 
 
 
 
Deposit service charges
 
 
758
 
 
740
 
 
2,159
 
 
2,233
 
Net gain on the sale of securities
 
 
817
 
 
88
 
 
2,558
 
 
96
 
Gross other-than-temporary impairment ("OTTI") gains
 
 
-
 
 
2,345
 
 
-
 
 
2,565
 
Portion of gain recognized in OCI (before taxes)
 
 
-
 
 
(2,345)
 
 
-
 
 
(2,661)
 
Other-than-temporary-impairment losses recognized in earnings
 
 
-
 
 
-
 
 
-
 
 
(96)
 
Net gain on the sale of loans held for sale
 
 
81
 
 
249
 
 
241
 
 
739
 
Net gain on the sale of other real estate owned
 
 
5
 
 
106
 
 
94
 
 
260
 
Loan-related fees
 
 
87
 
 
115
 
 
284
 
 
364
 
Income from bank-owned life insurance
 
 
176
 
 
171
 
 
531
 
 
523
 
Other
 
 
491
 
 
190
 
 
1,288
 
 
534
 
Total non-interest income
 
 
2,415
 
 
1,659
 
 
7,155
 
 
4,653
 
Non-interest expense
 
 
 
 
 
 
 
 
 
 
 
 
 
Salaries and employee benefits
 
 
3,223
 
 
3,733
 
 
9,786
 
 
10,992
 
Occupancy expense
 
 
529
 
 
586
 
 
1,663
 
 
1,683
 
Equipment expense
 
 
369
 
 
444
 
 
1,125
 
 
1,310
 
Advertising expense
 
 
146
 
 
102
 
 
402
 
 
390
 
Data processing expense
 
 
499
 
 
517
 
 
1,567
 
 
1,587
 
FDIC assessment
 
 
493
 
 
603
 
 
1,519
 
 
1,806
 
Bank shares tax
 
 
241
 
 
59
 
 
723
 
 
610
 
Expense of other real estate
 
 
318
 
 
1,049
 
 
768
 
 
1,453
 
(Credit) provision for off-balance sheet commitments
 
 
(56)
 
 
147
 
 
(232)
 
 
334
 
Legal expense
 
 
657
 
 
1,330
 
 
1,838
 
 
2,792
 
Professional fees
 
 
351
 
 
1,231
 
 
1,228
 
 
3,752
 
Insurance expenses
 
 
279
 
 
210
 
 
898
 
 
677
 
Loan collection expense
 
 
58
 
 
183
 
 
305
 
 
548
 
Other operating expenses
 
 
957
 
 
973
 
 
2,691
 
 
3,027
 
Total non-interest expense
 
 
8,064
 
 
11,167
 
 
24,281
 
 
30,961
 
Income (loss) before income taxes
 
 
1,887
 
 
(6,521)
 
 
4,338
 
 
(8,653)
 
Provision for income taxes
 
 
-
 
 
-
 
 
-
 
 
-
 
Net income (loss)
 
$
1,887
 
$
(6,521)
 
$
4,338
 
$
(8,653)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Earnings (loss) per share
 
 
 
 
 
 
 
 
 
 
 
 
 
Basic
 
$
0.11
 
$
(0.40)
 
$
0.26
 
$
(0.53)
 
Diluted
 
$
0.11
 
$
(0.40)
 
$
0.26
 
$
(0.53)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Cash dividends declared per common share
 
$
-
 
$
-
 
$
-
 
$
-
 
WEIGHTED AVERAGE NUMBER OF SHARES OUTSTANDING:
 
 
 
 
 
 
 
 
 
 
 
 
 
Basic
 
 
16,457,169
 
 
16,442,119
 
 
16,457,169
 
 
16,442,119
 
Diluted
 
 
16,457,169
 
 
16,442,119
 
 
16,457,169
 
 
16,442,119
 
 
The accompanying notes to consolidated financial statements are an integral part of these statements.
 
 
4

 
FIRST NATIONAL COMMUNITY BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE (LOSS) INCOME
(unaudited)
 
 
 
Three Months Ended
 
Nine Months Ended
 
 
 
September 30,
 
September 30,
 
(in thousands)
 
2013
 
2012
 
2013
 
2012
 
Net income (loss)
 
$
1,887
 
$
(6,521)
 
$
4,338
 
$
(8,653)
 
Other comprehensive (loss) income, net of tax:
 
 
 
 
 
 
 
 
 
 
 
 
 
Unrealized (losses) gains on securities available-for-sale
 
 
(132)
 
 
4,652
 
 
(10,270)
 
 
9,769
 
Taxes
 
 
45
 
 
(1,583)
 
 
3,492
 
 
(3,321)
 
Net of tax amount
 
 
(87)
 
 
3,069
 
 
(6,778)
 
 
6,448
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Non-credit related gains on OTTI securities not expected to be sold
 
 
-
 
 
2,345
 
 
-
 
 
2,565
 
Taxes
 
 
-
 
 
(797)
 
 
-
 
 
(873)
 
Net of tax amount
 
 
-
 
 
1,548
 
 
-
 
 
1,692
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Reclassification adjustment for gains included in net income (loss)
 
 
(817)
 
 
(88)
 
 
(2,558)
 
 
(96)
 
Taxes
 
 
278
 
 
30
 
 
870
 
 
33
 
Net of tax amount
 
 
(539)
 
 
(58)
 
 
(1,688)
 
 
(63)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Total other comprehensive (loss) income
 
 
(626)
 
 
4,559
 
 
(8,466)
 
 
8,077
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Total comprehensive income (loss)
 
$
1,261
 
$
(1,962)
 
$
(4,128)
 
$
(576)
 
 
The accompanying notes to consolidated financial statements are an integral part of these statements.
 
 
5

 
FIRST NATIONAL COMMUNITY BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
For the Nine Months Ended September 30, 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
 
 
Income (Loss)
 
 
Equity
 
Balances, December 31, 2011
 
16,442,119
 
$
20,552
 
$
61,557
 
$
(38,217)
 
$
(3,967)
 
$
39,925
 
Net loss for the period
 
-
 
 
-
 
 
-
 
 
(8,653)
 
 
-
 
 
(8,653)
 
Other comprehensive income, net of tax of $4,161
 
-
 
 
-
 
 
-
 
 
-
 
 
8,077
 
 
8,077
 
Balances, Sepetmber 30, 2012
 
16,442,119
 
$
20,552
 
$
61,557
 
$
(46,870)
 
$
4,110
 
$
39,349
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Balances, December 31, 2012
 
16,457,169
 
$
20,571
 
$
61,584
 
$
(51,928)
 
$
6,698
 
$
36,925
 
Net income for the period
 
-
 
 
-
 
 
-
 
 
4,338
 
 
-
 
 
4,338
 
Other comprehensive loss, net of tax of $4,362
 
-
 
 
-
 
 
-
 
 
-
 
 
(8,466)
 
 
(8,466)
 
Balances, September 30, 2013
 
16,457,169
 
$
20,571
 
$
61,584
 
$
(47,590)
 
$
(1,768)
 
$
32,797
 
 
The accompanying notes to consolidated financial statements are an integral part of these statements.
 
 
6

 
FIRST NATIONAL COMMUNITY BANCORP, INC AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
 
 
 
Nine Months Ended September 30,
 
(in thousands)
 
2013
 
2012
 
Cash flows from operating activities:
 
 
 
 
 
 
 
Net income (loss)
 
$
4,338
 
$
(8,653)
 
Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities:
 
 
 
 
 
 
 
Investment securities amortization (accretion), net
 
 
240
 
 
(1,308)
 
Equity in trust
 
 
(5)
 
 
(3)
 
Depreciation and amortization
 
 
924
 
 
920
 
(Credit) provision for loan and lease losses
 
 
(2,385)
 
 
3,376
 
Valuation adjustment for off balance sheet commitments
 
 
(232)
 
 
334
 
Gain on sale of investment securities
 
 
(2,558)
 
 
(96)
 
Other-than-temporary-impairment losses
 
 
-
 
 
96
 
Gain on the sale of loans held for sale
 
 
(241)
 
 
(739)
 
Gain on the sale of other real estate owned
 
 
(94)
 
 
(260)
 
Valuation adjustment, other real estate owned
 
 
257
 
 
808
 
Income from bank-owned life insurance
 
 
(531)
 
 
(523)
 
Proceeds from the sale of loans held for sale
 
 
9,238
 
 
23,940
 
Funds used to originate loans held for sale
 
 
(8,266)
 
 
(23,679)
 
Increase in interest receivable
 
 
(121)
 
 
(325)
 
Decrease (increase) in refundable federal income taxes
 
 
11,582
 
 
(76)
 
Decrease in prepaid expenses and other assets
 
 
4,418
 
 
1,856
 
Increase in accrued interest payable
 
 
1,807
 
 
1,560
 
Decrease in accrued expenses and other liabilities
 
 
(1,562)
 
 
(2,138)
 
Total adjustments
 
 
12,471
 
 
3,743
 
Net cash provided by (used in) operating activities
 
 
16,809
 
 
(4,910)
 
 
 
 
 
 
 
 
 
Cash flows from investing activities:
 
 
 
 
 
 
 
Maturities, calls, and principal payments of securities available for sale
 
 
12,086
 
 
26,861
 
Sales of securities available for sale
 
 
51,066
 
 
-
 
Purchases of securities available for sale
 
 
(73,997)
 
 
(21,358)
 
Purchases of Federal Reserve Bank stock
 
 
-
 
 
(90)
 
Redemption of Federal Home Loan Bank of Pittsburgh stock
 
 
3,407
 
 
1,545
 
Net (increase) decrease in loans to customers
 
 
(56,979)
 
 
43,181
 
Proceeds from the sale of other real estate owned
 
 
1,489
 
 
2,723
 
Purchases of property and equipment
 
 
(583)
 
 
(1,443)
 
Net cash (used in) provided by investing activities
 
 
(63,511)
 
 
51,419
 
 
 
 
 
 
 
 
 
Cash flows from financing activities:
 
 
 
 
 
 
 
Net decrease in total deposits
 
 
(803)
 
 
(100,702)
 
Proceeds from Federal Home Loan Bank of Pittsburgh advances
 
 
32,250
 
 
-
 
Repayment of Federal Home Loan Bank of Pittsburgh advances
 
 
(13,630)
 
 
(15,640)
 
Net cash provided by (used in) financing activities
 
 
17,817
 
 
(116,342)
 
Net decrease in cash and cash equivalents
 
 
(28,885)
 
 
(69,833)
 
Cash and cash equivalents at beginning of period
 
 
115,271
 
 
168,646
 
Cash and cash equivalents at end of period
 
$
86,386
 
$
98,813
 
 
 
 
 
 
 
 
 
Supplemental cash flow information
 
 
 
 
 
 
 
Cash paid (received) during the period for:
 
 
 
 
 
 
 
Interest
 
$
3,680
 
$
5,562
 
Income taxes
 
 
(11,582)
 
 
-
 
Other transactions:
 
 
 
 
 
 
 
Securities purchased, not settled
 
 
-
 
 
29,665
 
Securities sold, not settled
 
 
-
 
 
(6,596)
 
Principal balance of loans transferred to OREO
 
 
255
 
 
1,385
 
Transfer of bank premises and equipment to OREO
 
 
1,819
 
 
-
 
 
The accompanying notes to consolidated financial statements are an integral part of these statements.
 
 
 
7

 
FIRST NATIONAL COMMUNITY BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
 
Notes to Consolidated Financial Statements
 
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 three and nine month periods ended September 30, 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 an impact on the operating results or financial position of the Company. The operating results and financial position of the Company for the three and nine months ended September 30, 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 in the near term 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 and the March 31, 2013 and June 30, 2013 quarterly reports filed on Form 10-Q. 

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.
 
 
8

 
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 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 to the consolidated financial statements 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 ongoing 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. The Committee has submitted each of the required monthly progress reports with the OCC. 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 set forth below with a description of the status of the Bank’s effort to comply with such provisions:
 
(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;
 
The Bank has developed a Strategic Plan that it believes complies with the Order requirements. A three-year Strategic Plan for the period January 1, 2011 to December 31, 2013 was prepared and submitted to the OCC for review. On an annual basis, the Bank prepares an updated and revised Strategic Plan. Strategic Plans for the periods January 1, 2012 to December 31, 2014 and January 1, 2013 to December 31, 2015 were submitted to the OCC for review.
 
(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;
 
The Bank has developed a Capital Plan that it believes complies with the Order requirements to ensure that the Bank’s leverage ratio equals or exceeds 9% and the Bank’s total risk-based capital ratio equals or exceeds 13%. This Capital Plan for the period January 1, 2011 through December 31, 2013 and its annual update and revisions for 2012 and 2013 were submitted to the OCC for review.
 
(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;
 
The Bank’s total risk-based capital ratio was 12.62% at September 30, 2013, which was below the 13% required by the Order. The Bank’s leverage capital ratio was 7.99% at September 30, 2013, which was below the 9% required by the Order. The Bank is in the process of executing its Capital Plan and has engaged an outside financial advisory firm to assist the Bank in taking appropriate actions to achieve and maintain compliance with the capital requirements of the Order. Appropriate actions or combinations of actions may include raising additional capital, reducing the Bank’s assets through sales of branch offices, loans or other real estate owned, or pursuing other strategic transactions.
 
(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;
 
  
9

 
The Board has acknowledged the prohibition on payment of dividends or any other capital distributions without the prior written consent of the OCC. The Bank has not paid any dividends or capital distributions since the effective date of the Order.
 
(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;
 
The Committee completed its review of the Board and the Board committee structure on November 10, 2010 by reviewing the Board Structure Study report completed by an independent consultant engaged by the Committee. The report was forwarded to the OCC on November 24, 2010. The Company is in the process of implementing those recommendations.
 
The Board completed its assessment of the capabilities of the Bank’s executive officers upon receipt of a Management Study, completed by an independent consultant, on October 13, 2010. The Management Study was forwarded to the OCC on October 29, 2010. The Board of Directors completed a successful search for President and Chief Executive Officer in December 2011. Since the effective date of the Order, other changes have been made to the executive management team related to the size and complexity of the organization.
 
Annual performance appraisals are prepared for each officer based on established and timely management goals to confirm that each officer is performing the duties outlined in his or her job description.
 
(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;
 
The Bank’s Conflict of Interest policy has been revised to provide comprehensive guidance and a review was conducted of existing relationships to ensure compliance with the policy. The revised policy was approved by the Board on September 29, 2010 and forwarded to the OCC on October 7, 2010. Additional revisions were approved by the Board on April 29, 2011, October 24, 2012 and May 22, 2013.
 
(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;
 
The Board believes it has developed and implemented a written program of policies and procedures to provide for compliance with the requirements of the Bank Secrecy Act as well as compliance with account opening and monitoring procedures.
 
(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;
 
The Board believes that the Bank’s BSA audit function is adequately staffed; and the BSA Officer and staff have been assessed to determine their ability to implement and maintain compliance with the BSA policies and programs detailed above.
 
(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;
 
The Bank’s written Loan Policy has been revised to improve guidance and control over the Bank’s lending functions. The revised policy was approved by the Board on October 27, 2010. Additional revisions were approved by the Board on November 24, 2010, July 27, 2011, October 27, 2011, March 28, 2012, June 27, 2012, October 11, 2012 and July 24, 2013.
 
(x) the Board was required to take certain actions to resolve certain credit and collateral exceptions;
 
The Board believes that it has taken action to appropriately address the credit and collateral exceptions concerns detailed in the Order.
 
(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;
 
 
10

  
The Board has established an independent and ongoing loan review program on a quarterly basis that it believes provides for the timely identification and categorization of problem credits.
 
The ALLL policy and methodologies have been reviewed and revised to determine the appropriate level of the ALLL, including documenting the analysis in accordance with GAAP and other applicable regulatory guidelines. The revised policy was approved by the Board on October 27, 2010 and is updated on an annual basis. The Board reviews the ALLL methodology analysis on a quarterly basis as part of the financial reporting process.
 
(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;
 
The Board committed to a program to reduce the Bank’s risk exposure to criticized assets by implementing a detailed monthly reporting and monitoring process. The Board believes that this program has resulted in a reduction in criticized assets.
 
In accordance with the requirements of the Order, the Bank has not extended any additional credit to, or for the benefit of, any borrower who has a loan or other extension of credit that either has been charged off or criticized without the prior approval of the Bank’s Board, or loan committee under specified circumstances, since the date of the Order.
 
(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;
 
The Board committed to action plans for each piece of other real estate owned centered around a robust reporting and monitoring process. The Board believes that this program has resulted in a substantial reduction in other real estate owned balances.
 
(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;
 
The Board believes it developed and implemented a written concentration management program consistent with OCC Bulletin 2006-46 on November 24, 2010. This program was forwarded to the OCC on November 30, 2010. Loan concentration analysis reports are prepared and reviewed quarterly by the Board as part of the Bank’s loan portfolio management practices.
 
(xv) by October 31, 2010, the Board was required to revise and implement the Bank’s other than temporary impairment policy;
 
The Board believes that the Other Than Temporary Impairment Policy has been reviewed and revised so that the quarterly other-than-temporary impairment ("OTTI") analysis process identifies and measures OTTI in accordance with GAAP and supervisory guidance, including Financial Accounting Standards Board Accounting Standards Codification 320-10-35 (Recognition and Presentation of Other-than-Temporary Impairments), OCC Bulletin 2009-11 dated April 17, 2009, "Other-than-Temporary Impairment Accounting" and OCC Call Report Instructions.
 
(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
 
A Liquidity Funding policy that addresses liquidity needs, funding sources and contingency funding was approved by the Board on November 24, 2010 and has been implemented. Additional policies related to liquidity, funding and contingency funding have since been created and are updated annually since the Order was executed.
 
The Board believes that it has taken appropriate steps to adopt, implement and comply with an independent adequately staffed internal audit program.
 
(xvii) take actions to correct cited violations of law; and adopt procedures to prevent future violations and address compliance management.
 
 
11

 
The Board and management believe that they have taken appropriate action to correct cited violations and adopted procedures designed 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 those set forth below including a description of the status of the Company’s efforts to comply with such provision:
 
(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;
 
The Company has taken, and continues to take, steps the Board believes are appropriate to use the Company’s financial and managerial resources to serve as a source of strength to the Bank. The steps the Bank has taken to comply with the Order are discussed above.
 
(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;
 
The Company has acknowledged the prohibition on payment of dividends without the prior written consent of the Reserve Bank and Director of the Division of Banking Supervision and Regulation. The Company has not paid any dividends since the effective date of the Agreement.
 
(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;
 
The Company has acknowledged the prohibition on taking dividends or any other capital distributions from the Bank without the prior written consent of the Reserve Bank. The Bank has not paid and the Company has not received any dividends or capital distributions from the Bank since the effective date of the Agreement.
 
(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;
 
The Company has acknowledged the prohibition on any payment related to the Company’s subordinated debentures and trust preferred securities without the written approval of the Reserve Bank and Director. The Company has not made any payments of interest, principal or other amounts on the Company’s subordinated debentures or trust preferred securities since the effective date of the Agreement.
 
(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;
 
The Company has acknowledged the prohibition on any payment related to the debt owed to insiders of the Company without the written approval of the Reserve Bank and Director. The Company has not made any payments related to debt owed to insiders since the effective date of the Agreement.
 
(vi) the Company and its nonbank subsidiary may not incur, increase or guarantee any debt without the prior written approval of the Reserve Bank;
 
The Company has acknowledged the prohibition on incurring, increasing or guaranteeing any debt without the written approval of the Reserve Bank. The Company has not incurred, increased or guaranteed any debt since the effective date of the Agreement.
 
(vii) the Company may not purchase or redeem any shares of its stock without the prior written approval of the Reserve Bank;
 
The Company has acknowledged the prohibition on purchasing or redeeming any shares of its stock without the written approval of the Reserve Bank. The Company has not purchased or redeemed any shares of its stock since the effective date of the Agreement.
 
(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;
 
 
12

 
The Company has developed a Capital Plan that it believes is acceptable and maintains sufficient capital at the Company on a consolidated basis. The Capital Plan was submitted to the Reserve Bank on January 11, 2011. The Capital Plan has since been updated at least annually and forwarded to the Reserve Bank.
 
Given the inability to achieve the minimum capital requirements of the Order at the Bank level, the Company continues to update the Reserve Bank on a quarterly basis of its plans to increase its capital ratios above the Capital Plan minimums.
 
(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;
 
The Company believes that it has taken actions to ensure that all required regulatory reports are filed to accurately reflect its financial condition on the date filed, are prepared in accordance with instructions and that records detailing how the reports were filed are maintained and available 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;
 
The Company believes that it has designed effective written procedures and strengthened internal controls so that all required Board of Governors reports and notices filed are accurate and in accordance with instructions. The written procedures were provided to the Reserve Bank on January 21, 2011.
 
(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;
 
The Company created a cash flow projection for 2011 and submitted it to the Reserve Bank on January 7, 2011 in accordance with requirements of the Agreement. Similar projections for 2012 and 2013 were provided to the Reserve Bank within the time requirements prescribed in the Agreement.
 
(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
 
The Company has acknowledged the notice requirements on the appointment of any new director or senior executive officer. The Company has filed the appropriate notice on any new director or senior executive officer since the date of the Agreement.
 
The Company acknowledges the restriction on indemnification and severance payments. The Company has not made any such indemnification or severance payments since the effective date of the Agreement.
 
(xiii) the Board must submit written progress reports within 30 days of the end of each calendar quarter.
 
The Company’s Board has filed each of the required written progress reports with the Reserve Bank since the Agreement was executed.
 
During the nine months ended September 30, 2013, and the year ended December 31, 2012, the Company incurred approximately $292 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 continue to decrease from the 2012 level.
 
 
13

 
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 is expected 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 November 12, 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.
 
In July 2013, the Federal Reserve, the OCC and the FDIC approved the final Basel III capital framework for U.S. banking organizations (the “Regulatory Capital Rules”) implementing regulatory capital reforms and changes required by the Dodd-Frank Act.
 
The Regulatory Capital Rules are effective on January 1, 2014; however, the mandatory compliance date for the Company and the Bank as “standardized approach” banking organizations begins on January 1, 2015 and is subject to transitional provisions extending to January 1, 2019. The Regulatory Capital Rules include new risk-based capital and leverage ratios and refine the definition of what constitutes “capital” for purposes of calculating those ratios. The new minimum capital level requirements applicable to the Company and the Bank under the Regulatory Capital Rules will be:
 
·      a new common equity Tier 1 capital ratio of 4.5%;
·      a Tier 1 capital ratio of 6% (increased from 4%);
·      a total capital ratio of 8% (unchanged from current rules); and
·      a Tier 1 leverage ratio of 4% for all institutions.
 
The Regulatory Capital Rules also establish a “capital conservation buffer” of 2.5% above the new regulatory minimum capital requirements, which must consist entirely of common equity Tier 1 capital and result in the following minimum ratios:
 
·      a common equity Tier 1 capital ratio of 7.0%;
·      a Tier 1 capital ratio of 8.5%; and
·      a total capital ratio of 10.5%.
 
The new capital conservation buffer requirement will be phased in beginning in January 2016 at 0.625% of risk-weighted assets and will increase by that amount each year until fully implemented in January 2019. An institution will be subject to limitations on paying dividends, engaging in share repurchases, and paying discretionary bonuses if its capital level falls below the buffer amount. These limitations will establish a maximum percentage of eligible retained income that could be utilized for such actions.
 
The Regulatory Capital Rules also implement revisions and clarifications consistent with Basel III regarding the various components of Tier 1 capital, including common equity, unrealized gains and losses, as well as certain instruments that will no longer qualify as Tier 1 capital, some of which will be phased out over time.
 
The Regulatory Capital Rules also revise the prompt corrective action framework, which is designed to place restrictions on insured depository institutions, including the Bank, if their capital levels begin to show signs of weakness. These revisions will take effect January 1, 2015. Under the prompt corrective action requirements, which are designed to complement the capital conservation buffer, insured depository institutions will be required to meet the following increased capital level requirements in order to qualify as “well capitalized:”
·      a new common equity Tier 1 risk-based capital ratio of 6.5%;
·      a Tier 1 risk-based capital ratio of 8% (increased from 6%);
·      a total risk-based capital ratio of 10% (unchanged from current rules); and
·      a Tier 1 leverage ratio of 5% (increased from 4%).
 
  
14

 
The Regulatory Capital Rules set forth certain changes for the calculation of risk-weighted assets, which we will be required to utilize beginning January 1, 2015. The provisions applicable to banking organizations under the “standardized approach” include changes with respect to risk weights for commercial real estate loans, past due exposures and conversion factors for commitments with an original maturity of one year or less.
 
Current 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 September 30, 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 September 30, 2013 and December 31, 2012 are presented in the following table:
 
Capital Analysis
 
 
 
September 30,
 
December 31,
 
(in thousands)
 
2013
 
2012
 
Company
 
 
 
 
 
 
 
Tier I capital:
 
 
 
 
 
 
 
Total tier I capital
 
$
44,025
 
$
39,587
 
Tier II capital:
 
 
 
 
 
 
 
Subordinated notes
 
 
22,015
 
 
19,796
 
Allowable portion of allowance for loan losses
 
 
8,528
 
 
8,452
 
Total tier II capital
 
 
30,543
 
 
28,248
 
Total risk-based capital
 
 
74,568
 
 
67,835
 
Total risk-weighted assets
 
$
672,645
 
$
665,323
 
 
 
 
 
 
 
 
 
Bank
 
 
 
 
 
 
 
Tier I capital:
 
 
 
 
 
 
 
Total tier I capital
 
$
76,307
 
$
69,963
 
Tier II capital:
 
 
 
 
 
 
 
Allowable portion of allowance for loan losses
 
 
8,523
 
 
8,447
 
Total tier II capital
 
 
8,523
 
 
8,447
 
Total risk-based capital
 
 
84,830
 
 
78,410
 
Total risk-weighted assets
 
$
672,231
 
$
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
 
September 30, 2013
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Total capital
    (to risk-weighted assets)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Company
 
$
74,568
 
11.09
%
 
$
>53,812
 
8.00
%
 
 
N/A
 
N/A
 
Bank
 
$
84,830
 
12.62
%
 
$
>53,779
 
8.00
%
 
$
>67,223
 
10.00
%
Tier I capital
    (to risk-weighted assets)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Company
 
$
44,025
 
6.55
%
 
$
>26,906
 
4.00
%
 
 
N/A
 
N/A
 
Bank
 
$
76,307
 
11.35
%
 
$
>26,889
 
4.00
%
 
$
>40,334
 
6.00
%
Tier I capital
    (to average assets)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Company
 
$
44,025
 
4.61
%
 
$
>38,194
 
4.00
%
 
 
N/A
 
N/A
 
Bank
 
$
76,307
 
7.99
%
 
$
>38,179
 
4.00
%
 
$
>47,724
 
5.00
%
 
 
15

 
 
 
 
 
 
 
 
 
 
 
 
 
 
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
 
Loans receivable, net, consists of the following at September 30, 2013 and December 31, 2012:
 
 
 
September 30,
 
December 31,
 
(in thousands)
 
2013
 
2012
 
Residential real estate
 
$
115,645
 
$
90,228
 
Commercial real estate
 
 
238,492
 
 
221,591
 
Construction, land acquisition, and development
 
 
29,290
 
 
32,502
 
Commercial and industrial
 
 
114,096
 
 
109,693
 
Consumer
 
 
117,552
 
 
109,783
 
State and political subdivisions
 
 
41,021
 
 
33,978
 
Total loans, gross
 
 
656,096
 
 
597,775
 
Unearned discount
 
 
(159)
 
 
(103)
 
Net deferred loan fees and costs
 
 
553
 
 
260
 
Allowance for loan and lease losses
 
 
(17,618)
 
 
(18,536)
 
Loans, net
 
$
638,872
 
$
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 three and nine month periods ended September 30, 2013, the Company sold $2.5 and $9.0 million, respectively, of one-to-four family mortgages. The Company retains servicing rights on these mortgages.
 
The Company had $884 thousand and $1.6 million in loans held-for-sale at September 30, 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, and 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.
 
 
16

 
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-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 types of 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.
 
 
17

 
The following tables present the activity in the ALLL by loan category for the three and nine months ended September 30, 2013 and 2012:
 
 
 
Real Estate
 
 
 
 
 
 
 
 
 
 
 
 
 
(in thousands)
 
Residential
Real Estate
 
Commercial
Real Estate
 
Construction, Land
Acquisition and
Development
 
Commercial and
Industrial
 
Consumer
 
State and Political
Subdivisions
 
Total
 
Three months ended September 30, 2013:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Allowance for loan losses:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Beginning balance, July 1, 2013
 
$
2,145
 
$
7,823
 
$
2,390
 
$
3,487
 
$
1,760
 
$
983
 
$
18,588
 
Charge-offs
 
 
(98)
 
 
-
 
 
(65)
 
 
(116)
 
 
(74)
 
 
-
 
 
(353)
 
Recoveries
 
 
9
 
 
362
 
 
5
 
 
71
 
 
95
 
 
-
 
 
542
 
Provisions
 
 
215
 
 
(869)
 
 
(141)
 
 
(225)
 
 
105
 
 
(244)
 
 
(1,159)
 
Ending balance, September 30, 2013
 
$
2,271
 
$
7,316
 
$
2,189
 
$
3,217
 
$
1,886
 
$
739
 
$
17,618
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Three months ended September 30, 2012:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Allowance for loan losses:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Beginning balance, July 1, 2012
 
$
2,005
 
$
9,792
 
$
1,665
 
$
4,058
 
$
1,624
 
$
456
 
$
19,600
 
Charge-offs
 
 
(92)
 
 
(144)
 
 
-
 
 
(3,185)
 
 
(198)
 
 
-
 
 
(3,619)
 
Recoveries
 
 
14
 
 
627
 
 
5
 
 
28
 
 
80
 
 
-
 
 
754
 
Provisions
 
 
22
 
 
(708)
 
 
62
 
 
4,294
 
 
126
 
 
(4)
 
 
3,792
 
Ending balance, September 30, 2012
 
$
1,949
 
$
9,567
 
$
1,732
 
$
5,195
 
$
1,632
 
$
452
 
$
20,527
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Nine months ended September 30, 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
 
 
(445)
 
 
(48)
 
 
(175)
 
 
(244)
 
 
(433)
 
 
-
 
 
(1,345)
 
Recoveries
 
 
190
 
 
471
 
 
124
 
 
1,656
 
 
371
 
 
-
 
 
2,812
 
Provisions
 
 
762
 
 
(1,169)
 
 
78
 
 
(2,362)
 
 
240
 
 
66
 
 
(2,385)
 
Ending balance, Setpember 30, 2013
 
$
2,271
 
$
7,316
 
$
2,189
 
$
3,217
 
$
1,886
 
$
739
 
$
17,618
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Nine months ended September 30, 2012
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Allowance for loan losses:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Beginning balance, January 1, 2012
 
$
1,823
 
$
11,151
 
$
2,590
 
$
3,292
 
$
1,526
 
$
452
 
$
20,834