10-Q 1 t76370_10q.htm FORM 10-Q t76370_10q.htm


  UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C.  20549
     
 
 
FORM 10-Q
 
 
x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.
 
For the quarterly period ended March 31, 2013
 
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the transition period from___________ to___________
 
Commission file number 333-90052
NICOLET BANKSHARES, INC.
(Exact name of registrant as specified in its charter)
 
WISCONSIN
(State or other jurisdiction of incorporation or organization)
47-0871001
(I.R.S. Employer Identification No.)
 
111 North Washington Street
Green Bay, Wisconsin 54301
(920) 430-1400
(Address, including zip code, and telephone number, including area code, of
Registrant’s principal executive offices)
 
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 o No x
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Date File required to be submitted and posted pursuant to Rule 405 of Regulation S-T 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 o (Do not check if a smaller reporting company) Smaller reporting company x
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No x
 
As of May 10, 2013 there were 4,269,119 shares of $0.01 par value common stock outstanding.
 
 
 

 
 
Nicolet Bankshares, Inc.
 
TABLE OF CONTENTS
         
PART I
FINANCIAL INFORMATION
 
PAGE
         
 
Item 1.
Financial Statements:
   
         
   
Consolidated Balance Sheets
   
   
March 31, 2013 (unaudited) and December 31, 2012
 
3
         
   
Consolidated Statements of Income
   
   
Three Months Ended March  31, 2013 and 2012 (unaudited)
 
4
         
   
Consolidated Statements of Comprehensive Income
   
   
Three Months Ended March  31, 2013 and 2012 (unaudited)
 
5
         
   
Consolidated Statements of Changes in Stockholders’ Equity
   
   
Three Months Ended March  31, 2013 and 2012 (unaudited)
 
6
         
   
Consolidated Statements of Cash Flows
   
   
Three Months Ended March  31, 2013 and 2012 (unaudited)
 
7
         
   
Notes to Consolidated Financial Statements
 
8-23
         
 
Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
 
24-43
         
 
Item 3.
Quantitative and Qualitative Disclosures About Market Risk
 
43
         
 
Item 4.
Controls and Procedures
 
43
         
PART II
OTHER INFORMATION
   
         
 
Item 1.
Legal Proceedings
 
44
         
 
Item 1A.
Risk Factors
 
44
         
 
Item 2.
Unregistered Sales of Equity Securities and Use of  Proceeds
 
44
         
 
Item 3.
Defaults Upon Senior Securities
 
44
         
 
Item 4.
Mine Safety Disclosures
 
44
         
 
Item 5.
Other Information
 
44
         
 
Item 6.
Exhibits
 
45
         
   
Signatures
 
45-49
 
 
 

 
 
PART I – FINANCIAL INFORMATION
Item 1. Financial Statements:
 
NICOLET BANKSHARES, INC. AND SUBSIDIARIES
Consolidated Balance Sheets
(In thousands, except share and per share data)
 
   
March 31, 2013
(Unaudited)
   
December 31, 2012
(Audited)
 
Assets
           
Cash and due from banks
  $ 3,189     $ 26,988  
Interest-earning deposits
    23,895       54,516  
Federal funds sold
    500       499  
Cash and cash equivalents
    27,584       82,003  
Securities available for sale
    60,355       55,901  
Other investments
    5,229       5,221  
Loans held for sale
    2,608       7,323  
Loans
    542,124       552,601  
Allowance for loan losses
    (7,540 )     (7,120 )
Loans, net
    534,584       545,481  
Premises and equipment, net
    19,687       19,602  
Bank owned life insurance
    18,866       18,697  
Accrued interest receivable and other assets
    13,138       11,027  
Total assets
  $ 682,051     $ 745,255  
                 
    Liabilities and Stockholders’ Equity
               
Liabilities:
               
Demand
  $ 91,487     $ 108,234  
Money market and NOW accounts
    291,749       322,507  
Savings
    52,312       46,907  
Time
    127,650       138,445  
Total deposits
    563,198       616,093  
Short-term borrowings
    3,129       4,035  
Notes payable
    25,096       35,155  
Junior subordinated debentures
    6,186       6,186  
Accrued interest payable and other liabilities
    6,040       6,408  
     Total liabilities
    603,649       667,877  
                 
Stockholders’ Equity:
               
Preferred equity
    24,400       24,400  
Common stock
    34       34  
Additional paid-in capital
    36,484       36,243  
Retained earnings
    15,423       14,973  
Accumulated other comprehensive income
    1,997       1,683  
Total Nicolet Bankshares Inc. stockholders’ equity
    78,338       77,333  
Noncontrolling interest
    64       45  
Total stockholders’ equity and noncontrolling interest
    78,402       77,378  
                 
 Total liabilities, noncontrolling interest and stockholders’ equity
  $ 682,051     $ 745,255  
                 
Preferred shares authorized (no par value)
    10,000,000       10,000,000  
Preferred shares issued
    24,400       24,400  
Common shares authorized (par value $0.01 per share)
    30,000,000       30,000,000  
Common shares outstanding
    3,432,783       3,425,413  
Common shares issued
    3,494,328       3,479,888  
 
See accompanying notes to consolidated financial statements.
 
 
3

 
 
ITEM 1.  Financial Statements Continued:
 
NICOLET BANKSHARES, INC. AND SUBSIDIARIES
Consolidated Statements of Income
(in thousands, except share and per share data) (Unaudited)
 
   
Three Months Ended
March 31,
 
   
2013
   
2012
 
Interest income:
           
   Loans, including loan fees
  $ 6,781     $ 6,456  
   Investment securities:
               
     Taxable
    127       162  
     Non-taxable
    173       214  
   Federal funds sold
    -       1  
   Other interest income
    80       71  
        Total interest income
    7,161       6,904  
Interest expense:
               
   Money market and NOW accounts
    514       406  
   Savings and time deposits
    487       966  
   Short term borrowings
    1       1  
   Junior subordinated debentures
    124       125  
   Notes payable
    283       337  
       Total interest expense
    1,409       1,835  
                Net interest income
    5,752       5,069  
Provision for loan losses
    975       1,250  
        Net interest income after provision for loan losses
    4,777       3,819  
Noninterest income:
               
    Service charges on deposit accounts
    284       287  
    Trust services fee income
    802       730  
    Mortgage income
    872       737  
    Brokerage fee income
    102       84  
    Gain on sale, disposal and writedown of assets, net
    4       146  
    Bank owned life insurance
    169       153  
    Rent income
    250       240  
    Investment advisory fees
    86       86  
    Other
    187       161  
        Total noninterest income
    2,756       2,624  
Noninterest expense:
               
    Salaries and employee benefits
    3,559       3,273  
    Occupancy, equipment and office
    1,104       1,139  
    Business development and marketing
    425       345  
    Data processing
    423       402  
 FDIC assessments
    110       136  
    Core deposit intangible amortization
    148       168  
    Other
    571       322  
        Total noninterest expense
    6,340       5,785  
                 
        Income before income tax expense
    1,193       658  
Income tax expense
    419       143  
        Net income
    774       515  
Less: Net income attributable to noncontrolling interest
    19       13  
        Net income attributable to Nicolet Bankshares, Inc.
    755       502  
Less:  Preferred stock dividends and discount accretion
    305       305  
        Net income available to common shareholders
  $ 450     $ 197  
                 
Basic earnings per common share
  $ 0.13     $ 0.06  
Diluted earnings per common share
  $ 0.13     $ 0.06  
                 
Weighted average common shares outstanding:
               
     Basic
    3,432,387       3,480,355  
     Diluted
    3,445,664       3,494,795  
 
See accompanying notes to consolidated financial statements.
 
 
4

 
 
ITEM 1.  Financial Statements Continued:
 
NICOLET BANKSHARES, INC. AND SUBSIDIARIES
Consolidated Statements of Comprehensive Income
(in thousands) (Unaudited)
 
   
Three Months Ended
 
   
March 31,
 
   
2013
   
2012
 
Net income
  $ 774     $ 515  
Other comprehensive income, net of tax:
               
Securities available for sale (“AFS”):
               
  Net unrealized holding gains arising during the period
    515       514  
  Less: reclassification adjustment for net gains realized in net income
    -       (208 )
    Net unrealized gains on securities before tax expense
    515       306  
  Income tax expense
    (201 )     (104 )
Total other comprehensive income
    314       202  
Comprehensive income
  $ 1,088     $ 717  
 
See accompanying notes to consolidated financial statements.
 
 
5

 
 
ITEM 1.  Financial Statements Continued:
 
NICOLET BANKSHARES, INC. AND SUBSIDIARIES
Consolidated Statements of Stockholders’ Equity
(in thousands) (Unaudited)
 
   
Nicolet Bankshares, Inc. Stockholders’ Equity
             
   
Preferred
Equity
   
Common
Stock
   
Additional
Paid-In
Capital
   
Retained
Earnings
   
Accumulated
Other
Comprehensive
Income (“AOCI”)
   
Noncontrolling
Interest
   
Total
 
                                           
Balance, December 31, 2011
  $ 24,400     $ 35     $ 36,741     $ 13,157     $ 1,690     $ 190     $ 76,213  
Comprehensive income
    -       -       -       502       202       13       717  
Stock compensation expense
    -       -       69       -       -       -       69  
Preferred stock dividends
    -       -       -       (305 )     -       -       (305 )
Distribution from noncontrolling interest
    -       -       -       -       -       (100 )     (100 )
Balance, March 31, 2012
  $ 24,400     $ 35     $ 36,810     $ 13,354     $ 1,892     $ 103     $ 76,594  
                                                         
   
Preferred
Equity
   
Common
Stock
   
Additional
Paid-In
Capital
   
Retained
Earnings
   
Accumulated
Other
Comprehensive
Income
   
Noncontrolling
Interest
   
Total
 
Balance, December 31, 2012
  $ 24,400     $ 34     $ 36,243     $ 14,973     $ 1,683     $ 45     $ 77,378  
Comprehensive income
    -       -       -       755       314       19       1,088  
Stock compensation expense
    -       -       198       -       -       -       198  
Exercise of stock options
    -       -       62       -       -       -       62  
Purchase and retirement of common stock
    -       -       (19 )     -       -       -       (19 )
Preferred stock dividends
    -       -       -       (305 )     -       -       (305 )
Balance, March 31, 2013
  $ 24,400     $ 34     $ 36,484     $ 15,423     $ 1,997     $ 64     $ 78,402  
 
See accompanying notes to consolidated financial statements.
 
 
6

 
 
ITEM 1.  Financial Statements Continued:
 
NICOLET BANKSHARES, INC. AND SUBSIDIARIES
Consolidated Statement of Cash Flows
(In thousands) (Unaudited)
 
   
Three Months
Ended March 31,
2013
   
Three Months
Ended March 31,
2012
 
Cash Flows From Operating Activities:
           
Net income
  $ 774     $ 515  
Adjustments to reconcile net income to net cash provided by operating activities:
               
     Depreciation, amortization, and accretion
    636       607  
     Provision for loan losses
    975       1,250  
     Provision for deferred taxes
    0       0  
     Increase in cash surrender value of life insurance
    (169 )     (153 )
     Stock compensation expense
    198       69  
     Gain on sale or disposal of assets, net
    (4 )     (146 )
     Gain on sale of loans held for sale, net
    (872 )     (737 )
     Proceeds from sale of loans held for sale
    48,338       48,894  
     Origination of loans held for sale
    (42,751 )     (45,273 )
     Net change in:
               
          Accrued interest receivable and other assets
    (419 )     74  
          Accrued interest payable and other liabilities
    (569 )     (1,004 )
          Net cash provided by operating activities
    6,137       4,096  
Cash Flows From Investing Activities:
               
Net decrease in certificates of deposit in other banks
    -       248  
Net decrease (increase) in loans
    7,972       (12,975 )
Purchases of securities available for sale
    (5,992 )     (5,851 )
Proceeds from sales of securities available for sale
    -       2,917  
Proceeds from calls and maturities of securities available for sale
    1,961       1,923  
Purchase of other investments
    (8 )     (2 )
Purchase of bank owned life insurance
    -       (3,750 )
Purchase of premises and equipment
    (476 )     (1,547 )
Proceeds from sale of other real estate and other assets
    109       744  
          Net cash provided (used) by investing activities
    3,566       (18,293 )
                 
Cash Flows From Financing Activities:
Net decrease in deposits
    (52,895 )     (37,399 )
Net (decrease) increase  in short term borrowings
    (906 )     1,288  
Repayments of notes payable
    (59 )     (54 )
Repayments of Federal Home Loan Bank advances
    (10,000 )     -  
Purchase of common stock
    (19 )     -  
Proceeds from exercise of common stock options
    62       -  
Noncontrolling interest in joint venture
    -       (100 )
Cash dividends paid on preferred stock
    (305 )     (305 )
          Net cash used by financing activities
    (64,122 )     (36,570 )
        Net decrease in cash and cash equivalents
    (54,419 )     (50,767 )
Cash and cash equivalents:
               
Beginning
  $ 82,003     $ 92,129  
Ending
  $ 27,584     $ 41,362  
                 
Supplemental Disclosures of Cash Flow Information:
               
Cash paid for interest
  $ 1,374     $ 1,889  
Cash paid for taxes
    770       -  
Transfer of loans to other real estate owned
    1,950       425  
Change in AOCI for unrealized gains on AFS, net of tax
    314       (202 )
 
See accompanying notes to consolidated financial statements.
 
 
7

 
 
NICOLET BANKSHARES, INC. AND SUBSIDIARIES
 
Notes to Unaudited Consolidated Financial Statements
 
Note 1 – Basis of Presentation
 
General
 
In the opinion of management, the accompanying unaudited consolidated financial statements contain all adjustments necessary to present fairly Nicolet Bankshares, Inc. (the “Company”) and its subsidiaries, consolidated balance sheets, income statement, comprehensive income, changes in stockholders’ equity and cash flows statements for the periods presented, and all such adjustments are of a normal recurring nature.  All material intercompany transactions and balances are eliminated.  The results of operations for the interim periods are not necessarily indicative of the results to be expected for the entire year.
 
These interim consolidated financial statements have been prepared according to the rules and regulations of the Securities and Exchange Commission and, therefore, certain information and footnote disclosures normally presented in accordance with generally accepted accounting principles in the United States of America (“U.S. GAAP”) have been omitted or abbreviated.  These financial statements should be read in conjunction with the Company’s audited consolidated financial statements and footnotes for the year ended December 31, 2012 which is contained in the Joint Proxy Statement-Prospectus dated March 26, 2013, as filed with the Securities and Exchange Commission pursuant to Rule 424(b)(5) under the Securities Act of 1933, as amended (the “Securities Act”) on March 27, 2013.
 
Preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying disclosures. These estimates are based on management’s best knowledge of current events and actions the Company may undertake in the future. Estimates are used in accounting for, among other items, the allowance for loan losses, useful lives for depreciation and amortization, fair value of financial instruments, deferred tax assets, uncertain income tax positions and contingencies.  Estimates that are particularly susceptible to significant change for the Company include the determination of the allowance for loan losses and the assessment of deferred tax assets and liabilities, and therefore are critical accounting policies.  Management does not anticipate any material changes to estimates in the near term. Factors that may cause sensitivity to the aforementioned estimates include but are not limited to:  external market factors such as market interest rates and employment rates, changes to operating policies and procedures, and changes in applicable banking regulations. Actual results may ultimately differ from estimates, although management does not generally believe such differences would materially affect the consolidated financial statements in any individual reporting period presented.
 
Recent Accounting Pronouncements
 
In January 2013, the FASB issued Accounting Standards Update No. 2013-01, Clarifying the Scope of Disclosures about Offsetting Assets and Liabilities.  This ASU limits the scope of the new balance sheet offsetting disclosures to derivatives, repurchase agreements, and securities lending transactions to the extent that they are (1) offset in the financial statements or (2) subject to an enforceable master netting agreement.  The disclosure requirements are effective for annual reporting periods beginning on or after January 1, 2013 and interim periods within those annual periods.  The Company adopted this as required in the first quarter 2013 with no material impact on the Company’s financial position, results of operations, or disclosures.
 
In February 2013, the FASB issued Accounting Standards Update No. 2013-02, Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income.  The amendments in this update require an entity to provide information about the amounts reclassified out of accumulated other comprehensive income by component and by the respective line items of net income.  The disclosure requirements are effective for interim and annual periods beginning after December 15, 2012.  The Company adopted this as required in the first quarter of 2013 with no material impact on the Company’s financial position, results of operations, or disclosures.
 
 
8

 
 
Note 2 – Earnings per Common Share
 
Earnings per common share are calculated by dividing net income available to common shareholders by the weighted average number of common shares outstanding during the period.  Diluted earnings per share is calculated by dividing net income available to common shareholders by the weighted average number of shares adjusted for the dilutive effect of common stock awards, if any.  Presented below are the calculations for basic and diluted earnings per common share.
 
   
Three Months Ended March 31,
 
   
2013
   
2012
 
(In thousands except per share data)
           
Net income, net of noncontrolling interest
  $ 755     $ 502  
Less: preferred stock dividends
    305       305  
Net income available to common shareholders
  $ 450     $ 197  
Weighted average common shares outstanding
    3,432       3,472  
Effect of dilutive stock instruments
    14       23  
Diluted weighted average common shares outstanding
    3,446       3,495  
Basic earnings per common share
  $ 0.13     $ 0.06  
Diluted earnings per common share
  $ 0.13     $ 0.06  
 
Note 3 – Stock-based compensation
 
Activity of the Company’s Stock Incentive Plans is summarized in the following tables:
 
Stock Options
 
Weighted-
Average Fair
Value of Options
Granted
   
 
Option Shares
Outstanding
   
Weighted-
Average
Exercise Price
   
 
 
Exercisable
Shares
 
Balance – December 31, 2011
          702,907       17.78       533,074  
  Granted
  $ 4.87       184,625       16.50          
  Exercise of stock options
            (25,750 )     12.50          
  Forfeited
            (36,250 )     16.84          
Balance – December 31, 2012
            825,532       17.70       548,623  
  Granted
    -       -       -          
  Exercise of stock options
            (5,000 )     12.50          
  Forfeited
            (3,000 )     12.50          
Balance – March 31, 2013
            817,532     $ 17.75       545,122  
                                 
Options outstanding at March 31, 2013 are exercisable at option prices ranging from $12.50 to $26.00.  There are 374,208 options outstanding in the range from $12.50 - $17.00, 396,824 options outstanding in the range from $17.01 - $22.00, and 46,500 options outstanding in the range from $22.01 - $26.00.  The exercisable options have a weighted average remaining contractual life of approximately 4 years as of March 31, 2013.
 
Intrinsic value represents the amount by which the fair market value of the underlying stock exceeds the exercise price of the stock options.  The total intrinsic value of options exercised in the first three months of 2013, and full year of  2012 was approximately $20,000, and $103,000, respectively. The weighted average exercise price of stock options exercisable at March 31, 2013 was $18.24.
 
 
9

 
 
Note 3 – Stock-based compensation, continued
 
Restricted Stock
 
Weighted-
Average Grant
Date Fair Value
   
Restricted
Shares
Outstanding
 
Balance – December 31, 2011
  $ -       -  
   Granted
    16.50       54,725  
   Vested
    -       -  
   Forfeited
    16.50       (250 )
Balance – December 31, 2012
    16.50       54,475  
   Granted
    16.50       10,606  
   Vested
    16.50       (3,536 )
   Forfeited
    -       -  
Balance – March 31, 2013
  $ 16.50       61,545  
 
The Company recognized approximately $198,000, and $69,000 of stock-based employee compensation expense during the three months ended March 31, 2013 and 2012, respectively, associated with its stock equity awards.  As of March 31, 2013, there was approximately $1.9 million of unrecognized compensation cost related to equity award grants.  The cost is expected to be recognized over the remaining vesting period of approximately five years.
 
Note 4- Securities Available for Sale
 
Amortized costs and fair values of securities available for sale are summarized as follows:
 
   
March 31, 2013
 
(in thousands)
 
Amortized Cost
   
Gross
Unrealized
Gains
   
Gross
Unrealized
Losses
   
Fair Value
 
State, county and municipals
  $ 31,701     $ 1,052     $ 11     $ 32,742  
Mortgage-backed securities
    23,756       725       14       24,467  
Equity securities
    1,624       1,522       -       3,146  
    $ 57,081     $ 3,299     $ 25     $ 60,355  
                                 
   
December 31, 2012
 
(in thousands)
 
Amortized Cost
   
Gross
Unrealized
Gains
   
Gross
Unrealized
Losses
   
Fair Values
 
State, county and municipals
  $ 31,642     $ 1,079     $ 34     $ 32,687  
Mortgage-backed securities
    19,876       803       11       20,668  
Equity securities
    1,624       922       -       2,546  
    $ 53,142     $ 2,804     $ 45     $ 55,901  
 
 
10

 
 
Note 4- Securities Available for Sale, continued
 
The following table represents gross unrealized losses and the related fair value of investment securities available for sale, aggregated by investment category and length of time individual securities have been in a continuous unrealized loss position, at March 31, 2013 and December 31, 2012.
 
   
March 31, 2013
 
   
Less than 12 months
   
12 months or more
   
Total
 
(in thousands)
 
Fair Value
   
Unrealized
Losses
   
Fair Value
   
Unrealized
Losses
   
Fair Value
   
Unrealized
Losses
 
State, county and municipals
  $ 2,160     $ 11     $ -     $ -     $ 2,160     $ 11  
Mortgage-backed securities
    3,439       14       -       -       3,439       14  
    $ 5,599     $ 25     $ -     $ -     $ 5,599     $ 25  
       
   
December 31, 2012
 
   
Less than 12 months
   
12 months or more
   
Total
 
(in thousands)
 
Fair Value
   
Unrealized
Losses
   
Fair Value
   
Unrealized
Losses
   
Fair Value
   
Unrealized
Losses
 
State, county and municipals
  $ 4,250     $ 34     $ -     $ -     $ 4,250     $ 34  
Mortgage-backed securities
    3,507       11       -       -       3,507       11  
    $ 7,757     $ 45     $ -     $ -     $ 7,757     $ 45  
 
As of March 31, 2013 the Company does not consider securities with unrealized losses to be other-than-temporarily impaired.  The unrealized losses in each category have occurred as a result of changes in interest rates, market spreads and market conditions subsequent to purchase. The Company has the ability and intent to hold its securities to maturity.  There were no other-than-temporary impairments charged to earnings during the three months ended March 31, 2013 or 2012.
 
The amortized cost and fair values of securities available for sale at March 31, 2013 by contractual maturity are shown below.  Expected maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.  Fair values of securities are estimated based on financial models or prices paid for the same or similar securities.  It is possible interest rates could change considerably, resulting in a material change in estimated fair value.
 
   
March 31, 2013
 
(in thousands)
 
Amortized Cost
   
Fair Value
 
Due in less than one year
  $ 4,415     $ 4,482  
Due in one year through five years
    26,911       27,885  
Due after five years through ten years
    -       -  
Due after ten years
    375       375  
      31,701       32,742  
Mortgage-backed securities
    23,756       24,467  
Equity securities
    1,624       3,146  
   Securities available for sale
  $ 57,081     $ 60,355  
 
 
11

 
 
Note 5 – Loans, Allowance for Loan Losses, and Credit Quality
 
The loan composition as of March 31, 2013 and December 31, 2012 is summarized as follows.
 
   
2013
         
2012
       
(in thousands)
 
Amount
   
% of
Total
   
Amount
   
% of
Total
 
Commercial & industrial
  $ 193,508       35.7 %   $ 197,516       35.7 %
Owner-occupied commercial real estate (“CRE”)
    117,389       21.7       118,242       21.4  
CRE investment
    73,410       13.5       76,618       13.9  
Construction & land development
    22,285       4.1       21,791       3.9  
Residential construction
    7,445       1.4       7,957       1.4  
Residential first mortgage
    86,202       15.9       85,588       15.5  
Residential junior mortgage
    39,026       7.2       39,352       7.1  
Retail & other
    2,859       0.5       5,537       1.1  
    Loans
    542,124       100.0 %     552,601       100.0 %
Less allowance for loan losses
    7,540               7,120          
    Loans, net
  $ 534,584             $ 545,481          
Allowance for loan losses to loans
    1.39 %             1.29 %        
 
Practically, all of the Company’s loans, commitments, and standby letters of credit have been granted to customers in the Company’s market area.  Although the Company has a diversified loan portfolio, the credit risk in the loan portfolio is largely influenced by general economic conditions and trends of the counties and markets in which the debtors operate, and the resulting impact on the operations of borrowers or on the value of underlying collateral, if any.
 
The allowance for loan and lease losses (“ALLL”) represents management’s estimate of probable and inherent credit losses in the Company’s loan portfolio at the balance sheet date. In general, estimating the amount of the ALLL is a function of a number of factors, including but not limited to changes in the loan portfolio, net charge-offs, trends in past due and impaired loans, and the level of potential problem loans, all of which may be susceptible to significant change.  To the extent actual outcomes differ from management estimates, additional provisions for loan losses could be required that could adversely affect our earnings or financial position in future periods. Allocations to the ALLL may be made for specific loans but the entire ALLL is available for any loan that, in management’s judgment, should be charged-off or for which an actual loss is realized.
 
The allocation methodology used by the Company includes specific allocations for impaired loans evaluated individually for impairment based on collateral values and for the remaining loan portfolio collectively evaluated for impairment primarily based on historical loss rates and other qualitative factors.  Loan charge-offs and recoveries are based on actual amounts charged-off or recovered by loan category.  Management allocates the ALLL by pools of risk within each loan portfolio.
 
 
12

 
 
Note 5 – Loans, Allowance for Loan Losses, and Credit Quality, continued
 
The following table presents the balance and activity in the ALLL by portfolio segment and the recorded investment in loans by portfolio segment based on the impairment method for the periods indicated:
 
   
Three Months ended March 31, 2013
 
(in thousands)
ALLL:
 
Commercial &
industrial
   
Owner-
occupied
CRE
   
CRE
investment
   
Construction &
land
development
   
Residential
construction
   
Residential
first
mortgage
   
Residential
junior
mortgage
   
Retail &
other
   
Total
 
Beginning balance
  $ 1,969     $ 1,069     $ 337     $ 2,580     $ 137     $ 685     $ 312     $ 31     $ 7,120  
Provision
    7       230       (144 )     894       (11 )     30       (12 )     (19 )     975  
Charge-offs
    (475 )     (56 )     -       (36 )     -       -       -       -       (567 )
Recoveries
    5       1       -       -       -       5       1       -       12  
Ending balance
  $ 1,506     $ 1,244     $ 193     $ 3,438     $ 126     $ 720     $ 301     $ 12     $ 7,540  
As percent of ALLL
    20.0 %     16.5 %     2.6 %     45.6 %     1.7 %     9.5 %     4.0 %     0.1 %     100.0 %
                                                                         
ALLL:
Individually evaluated
  $ -     $ -     $ -     $ -     $ -     $ -     $ -     $ -     $ -  
Collectively evaluated
    1,506       1,244       193       3,438       126       720       301       12       7,540  
Ending balance
  $ 1,506     $ 1,244     $ 193     $ 3,438     $ 126     $ 720     $ 301     $ 12     $ 7,540  
                                                                         
Loans:
                                                                       
Individually evaluated
  $ 93     $ 1,857     $ -     $ -     $ -     $ 628     $ -     $ 149     $ 2,727  
Collectively evaluated
    193,415       115,532       73,410       22,285       7,445       85,574       39,026       2,710       539,397  
Total loans
  $ 193,508     $ 117,389     $ 73,410     $ 22,285     $ 7,445     $ 86,202     $ 39,026     $ 2,859     $ 542,124  
                                                                         
Less ALLL
  $ 1,506     $ 1,244     $ 193     $ 3,438     $ 126     $ 720     $ 301     $ 12     $ 7,540  
Net loans
  $ 192,002     $ 116,145     $ 73,217     $ 18,847     $ 7,319     $ 85,482     $ 38,725     $ 2,847     $ 534,584  
 
   
Three Months ended March 31, 2012
 
(in thousands)
ALLL:
 
Commercial &
industrial
   
Owner-
occupied
CRE
   
CRE
investment
   
Construction &
land
development
   
Residential
construction
   
Residential
first mortgage
   
Residential
junior
mortgage
   
Retail &
other
   
Total
 
Beginning balance
  $ 1,965     $ 347     $ 393     $ 2,035     $ 311     $ 405     $ 419     $ 24     $ 5,899  
Provision
    207       751       9       (22 )     101       104       98       2       1,250  
Charge-offs
    -       (358 )     (155 )     (129 )     (365 )     (98 )     (102 )     -       (1,207 )
Recoveries
    19       6       -       3       -       1       1       1       31  
Ending balance
  $ 2,191     $ 746     $ 247     $ 1,887     $ 47     $ 412     $ 416     $ 27     $ 5,973  
As percent of ALLL
    36.7 %     12.5 %     4.1 %     31.6 %     0.8 %     6.9 %     7.0 %     0.4 %     100.0 %
                                                                         
ALLL:
Individually evaluated
  $ -     $ 408     $ -     $ -     $ -     $ -     $ 18     $ -     $ 426  
Collectively evaluated
    2,191       338       247       1,887       47       412       398       27       5,547  
Ending balance
  $ 2,191     $ 746     $ 247     $ 1,887     $ 47     $ 412     $ 416     $ 27     $ 5,973  
                                                                         
Loans:
                                                                       
Individually evaluated
  $ 4,872     $ 941     $ 555     $ 8,820     $ 823     $ 1,308     $ -     $ 151     $ 17,470  
Collectively evaluated
    164,543       113,096       62,242       18,508       3,320       57,067       40,484       7,132       466,392  
Total loans
  $ 169,415     $ 114,037     $ 62,797     $ 27,328     $ 4,143     $ 58,375     $ 40,484     $ 7,283     $ 483,862  
                                                                         
Less ALLL
  $ 2,191     $ 746     $ 247     $ 1,887     $ 47     $ 412     $ 416     $ 27     $ 5,973  
Net loans
  $ 167,224     $ 113,291     $ 62,550     $ 25,441     $ 4,096     $ 57,963     $ 40,068     $ 7,256     $ 477,889  
                                                                         
Loans are generally placed on nonaccrual status when management has determined collection of the interest on a loan is doubtful or when a loan is contractually past due 90 days or more as to interest or principal payments.  When loans are placed on nonaccrual status or charged-off, all current year unpaid accrued interest is reversed against interest income. The interest on these loans is subsequently accounted for on the cash basis until qualifying for return to accrual status.  If collectability of the principal is in doubt, payments received are applied to loan principal.  Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured.   Management considers a loan to be impaired when it is probable the Company will be unable to collect all contractual principal and interest payments due in accordance with the terms of the loan agreement.
 
 
13

 
 
Note 5 – Loans, Allowance for Loan Losses, and Credit Quality, continued
 
The following table presents nonaccrual loans by portfolio segment as of March 31, 2013 and December 31, 2012:
 
(in thousands)
 
2013
   
% to Total
   
2012
   
% to Total
 
Commercial & industrial
  $ 93       3.4 %   $ 784       11.2 %
Owner-occupied CRE
    1,857       68.1       1,960       27.9  
CRE investment
    -       -       -       -  
Construction & land development
    -       -       2,560       36.4  
Residential construction
    -       -       -       -  
Residential first mortgage
    628       23.0       1,580       22.5  
Residential junior mortgage
    -       -       -       -  
Retail & other
    149       5.5       142       2.0  
    Nonaccrual loans
  $ 2,727       100.0 %   $ 7,026       100.0 %
 
The following tables present past due loans by portfolio segment:
 
   
March 31, 2013
   
(in thousands)
 
30-89 Days
Past Due
(accruing)
   
90 Days &
Over or non-
accrual
   
Current
   
Total
Commercial & industrial
  $ 70     $ 93     $ 193,345     $ 193,508  
Owner-occupied CRE
    75       1,857       115,457       117,389  
CRE investment
    -       -       73,410       73,410  
Construction & land development
    -       -       22,285       22,285  
Residential construction
    -       -       7,445       7,445  
Residential first mortgage
    -       628       85,574       86,202  
Residential junior mortgage
    10       -       39,016       39,026  
Retail & other
    10       149       2,700       2,859  
Total loans
  $ 165     $ 2,727     $ 539,232     $ 542,124  
As a percent of total loans
    0.0 %     0.5 %     99.5 %     100.0 %
 
   
December 31, 2012
   
(in thousands)
 
30-89 Days
Past Due
(accruing)
   
90 Days &
Over or non-
accrual
   
Current
   
Total
Commercial & industrial
  $ -     $ 784     $ 196,732     $ 197,516  
Owner-occupied CRE
    -       1,960       116,282       118,242  
CRE investment
    -       -       76,618       76,618  
Construction & land development
    -       2,560       19,231       21,791  
Residential construction
    -       -       7,957       7,957  
Residential first mortgage
    -       1,580       84,008       85,588  
Residential junior mortgage
    -       -       39,352       39,352  
Retail & other
    6       142       5,389       5,537  
Total loans
  $ 6     $ 7,026     $ 545,569     $ 552,601  
As a percent of total loans
    0.0 %     1.3 %     98.7 %     100.0 %
 
A description of the loan risk categories used by the Company follows:
 
1-4  Pass:  Credits exhibit adequate cash flows, appropriate management and financial ratios within industry norms and/or are supported by sufficient collateral.  Some credits in these rating categories may require a need for monitoring but elements of concern are not severe enough to warrant an elevated rating.
 
5  Watch:  Credits with this rating are adequately secured and performing but are being monitored due to the presence of various short term weaknesses which may include unexpected, short term adverse financial performance, managerial problems, potential impact of a decline in the entire industry or local economy and delinquency issues.  Loans to individuals or loans supported by guarantors with marginal net worth or collateral may be included in this rating category.
 
 
14

 
 
Note 5 – Loans, Allowance for Loan Losses, and Credit Quality, continued
 
6  Special Mention:  Credits with this rating have potential weaknesses that, without the Company’s attention and correction may result in deterioration of repayment prospects.  These assets are considered Criticized Assets.  Potential weaknesses may include adverse financial trends for the borrower or industry, repeated lack of compliance with Company requests, increasing debt to worth, serious management conditions and decreasing cash flow.
 
7  Substandard:  Assets with this rating are characterized by the distinct possibility the Company will sustain some loss if deficiencies are not corrected.  All foreclosures, liquidations, and non-accrual loans are considered to be categorized in this rating, regardless of collateral sufficiency.
 
8  Doubtful:   Assets with this rating exhibit all the weaknesses as one rated Substandard with the added characteristic that such weaknesses make collection or liquidation in full highly questionable.
 
9  Loss:  Assets in this category are considered uncollectible.  Pursuing any recovery or salvage value is impractical but does not preclude partial recovery in the future.
 
The following tables present loans by loan grade:
 
   
March 31, 2013
 
(in thousands)
 
Grades 1- 4
   
Grade 5
   
Grade 6
   
Grade 7
   
Grade 8
   
Grade 9
   
Total
 
Commercial & industrial
  $ 188,276     $ 2,528     $ 637     $ 2,067     $ -     $ -     $ 193,508  
Owner-occupied CRE
    96,957       15,134       1,809       3,489       -       -       117,389  
CRE investment
    63,571       8,134       -       1,705       -       -       73,410  
Construction & land development
    15,463       812       868       5,142       -       -       22,285  
Residential construction
    6,171       -       -       1,274       -       -       7,445  
Residential first mortgage
    84,525       1,088       -       589       -       -       86,202  
Residential junior mortgage
    38,580       197       249       -       -       -       39,026  
Retail & other
    2,720       -       -       139       -       -       2,859  
Total loans
  $ 496,263     $ 27,893     $ 3,563     $ 14,405     $ -     $ -     $ 542,124  
 
   
December 31, 2012
 
(in thousands)
 
Grades 1- 4
   
Grade 5