10-Q 1 form10q-124289_vcbp.htm 10-Q

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C.  20549

 

FORM 10-Q

 

  (Mark One)
   
ý QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2012
   
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 NUMBER: 000-51949

 

VALLEY COMMERCE BANCORP

(Name of small business issuer as specified in its charter)

 

California 46-1981399
(State or other jurisdiction of incorporation or organization) (I.R.S. Employer Identification No.)
   

701 W. Main Street

Visalia, California 93291

(Address of principal executive offices)

 

   

(559) 622-9000

(Issuer’s telephone number)

 

Indicated 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  ý   No  £

 

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

 

Large Accelerated Filer ¨ Accelerated Filer ¨
Non-Accelerated Filer ¨ Smaller Reporting Company ý

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes o  No ý

 

The number of shares outstanding of the issuer’s Common Stock was 2,784,593 as of August 14, 2012.

 

 
 

 

INDEX

 

PART I - FINANCIAL INFORMATION 3
   
ITEM 1 - FINANCIAL STATEMENTS (UNAUDITED) 4
   
ITEM 2 - MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATONS 34
   
ITEM 3 – QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK 50
   
ITEM 4 – CONTROLS AND PROCEDURES 50
   
PART II - OTHER INFORMATION 51
   
ITEM 1 LEGAL PROCEEDINGS 51
   
ITEM 1A  RISK FACTORS 51
   
ITEM 2 UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS 51
   
ITEM 3 DEFAULTS UPON SENIOR SECURITIES 51
   
ITEM 4 MINE SAFETY DISCLOSURES 52
   
ITEM 5 OTHER INFORMATION 52
   
ITEM 6 EXHIBITS 52
   
SIGNATURES 53
   
EXHIBIT INDEX 54

 

2

PART I

Forward-Looking Information

Certain matters discussed in this Quarterly Report on Form 10-Q including, but not limited to, those described in Item 2 - Management’s Discussion and Analysis of Financial Condition and Results of Operations, are forward-looking statements that are subject to risks and uncertainties that could cause actual results to differ materially from those projected in the forward-looking statements. Such risks and uncertainties include, among others: (1) significant increases in competitive pressure in the banking and financial services industries; (2) changes in the interest rate environment, which could reduce anticipated or actual margins; (3) changes in the regulatory environment; (4) general economic conditions, either nationally or regionally and especially in the Company’s primary service area failing to improve or continuing to deteriorate and resulting in, among other things, a deterioration in credit quality and increases in the provision for loan loss; (5) operational risks, including data processing systems failures or fraud; (6) changes in business conditions and inflation; (7) changes in technology; (8) changes in monetary and tax policies; and (9) changes in the securities markets; (10) civil disturbances or terrorist threats or acts, or apprehension about the possible future occurrences or acts of this type; (11) outbreak or escalation of hostilities in which the United States is involved, any declaration of war by the U.S. Congress or any other national or international calamity, crisis or emergency; (12) changes in laws and regulations; (13) new or recently issued accounting pronouncements; (14) government policies, regulations, and their enforcement (including Bank Secrecy Act-related matters, taxing statutes and regulations; (15) restrictions on dividends that our subsidiaries are allowed to pay to us; (16) the ability to satisfy requirements related to the Sarbanes-Oxley Act and other regulation on internal control; and (17) management’s ability to manage these and other risks. Therefore, the information set forth in such forward-looking statements should be carefully considered when evaluating the business prospects of the Company.

 

When the Company uses in this Quarterly Report on Form 10-Q the words “anticipate,” “estimate,” “expect,” “project,” “intend,” “commit,” “believe” and similar expressions, the Company intends to identify forward-looking statements.  Such statements are not guarantees of performance and are subject to certain risks, uncertainties and assumptions, including those described in this Quarterly Report on Form 10-Q.  Should one or more of these risks or uncertainties materialize, or should underlying assumptions prove incorrect, actual results may vary materially from those anticipated, estimated, expected, projected, intended, committed or believed.  The future results and shareholder values of the Company may differ materially from those expressed in these forward-looking statements.  Many of the factors that will determine these results and values are beyond the Company’s ability to control or predict. The Company undertakes no obligation to revise or publicly release the results of any revision to these forward-looking statements. For those statements, the Company claims the protection of the safe harbor for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995.

3

 

PART 1 – FINANCIAL INFORMATION

ITEM 1 – FINANCIAL STATEMENTS (UNAUDITED)

 

VALLEY COMMERCE BANCORP

CONDENSED CONSOLIDATED BALANCE SHEET

(UNAUDITED)

 

  June 30,
2012
   December 31,
2011
 
        
Assets          
Cash and due from banks  $44,630,469   $60,421,044 
Available-for-sale investment securities, at fair value (Notes 3 and 11)   57,149,000    56,705,000 
Loans, less allowance for loan and lease losses of $5,275,733 at June 30, 2012 and $5,468,758 at December 31, 2011 (Note 4, 5, and 11)   219,515,598    224,531,870 
Bank premises and equipment, net   8,036,642    8,167,976 
Cash surrender value of bank-owned life insurance   7,847,247    7,693,480 
Other real estate owned   1,505,047    1,140,547 
Accrued interest receivable and other assets   7,052,288    7,860,783 
Total assets  $345,736,291   $366,520,700 
Liabilities and Shareholders’ Equity          
Deposits:          
Noninterest-bearing  $106,042,180   $128,453,106 
Interest-bearing   196,715,470    187,424,263 
Total deposits   302,757,650    315,877,369 
Accrued interest payable and other liabilities   3,779,943    4,044,919 
Short-term debt       1,000,000 
Junior subordinated deferrable interest debentures   3,093,000    3,093,000 
Total liabilities   309,630,593    324,015,288 
Commitments and contingencies (Note 6)          
Shareholders’ equity:          
Serial preferred stock - no par value; 10,000,000 shares authorized, issued and outstanding – none at June 30, 2012 and 7,700 shares class B and 385 shares class C at December 31, 2011 (Note 4)       7,898,800 
Common stock - no par value; 30,000,000 shares authorized; issued and outstanding – 2,784,593 shares at June 30, 2012 and December 31, 2011   27,657,558    27,534,291 
Retained earnings   7,618,261    6,257,800 
Accumulated other comprehensive income, net of taxes (Note 3)   829,879    814,521 
Total shareholders’ equity   36,105,698    42,505,412 
Total liabilities and shareholders’ equity  $345,736,291   $366,520,700 

 

See notes to unaudited condensed consolidated financial statements.

4

 

VALLEY COMMERCE BANCORP

CONDENSED CONSOLIDATED STATEMENT OF INCOME

(UNAUDITED)

 

  For the Three Months     For the Six Months 
  Ended June 30,     Ended June 30, 
  2012   2011   2012   2011 
Interest Income:                    
Interest and fees on loans  $3,276,640   $3,421,278   $6,573,562   $6,933,030 
Interest on investment securities:                    
Taxable   184,021    263,475    372,855    470,937 
Exempt from Federal income taxes   185,087    170,552    408,663    323,693 
Interest on deposits in banks   20,055    13,634    44,909    33,933 
Total interest income   3,665,803    3,868,939    7,399,989    7,761,593 
Interest Expense:                    
Interest on deposits   248,974    383,019    502,106    780,587 
Interest on term debt       30,916    168    62,709 
Interest on junior subordinated deferrable interest debentures   29,513    27,989    59,681    55,842 
          Total interest expense   278,487    441,924    561,955    899,138 
             Net interest income before provision for loan losses   3,387,316    3,427,015    6,838,034    6,862,455 
Provision for loan losses               225,000 
             Net interest income after provision for loan losses   3,387,316    3,427,015    6,838,034    6,637,455 
Non-Interest Income:                    
Service charges   174,994    177,203    353,667    346,298 
Gain on sale of available-for-sale investment securities, net   124,267    23,846    152,224    37,466 
Mortgage loan brokerage fees   15,002    7,336    21,002    29,119 
Earnings on cash surrender value of life insurance policies   81,688    73,391    167,644    145,842 
Other   65,321    51,942    125,406    101,772 
        Total non-interest income   461,272    333,718    819,943    660,497 
Non-Interest Expense:                    
Salaries and employee benefits   1,441,762    1,322,843    3,027,416    2,772,998 
Occupancy and equipment   317,084    348,323    637,977    669,786 
Other   771,327    813,285    1,394,330    1,617,922 
        Total non-interest expense   2,530,173    2,484,451    5,059,723    5,060,706 
        Income before provision for income taxes   1,318,415    1,276,282    2,598,254    2,237,246 
Provision for income taxes   426,000    417,000    847,000    753,000 
           Net income  $892,415   $859,282   $1,751,254   $1,484,246 
           Dividends accrued and discount accreted on preferred
                shares (Note 10)
  $   $106,053   $93,209   $207,519 
           Net income available to common shareholders  $892,415   $753,229   $1,658,045   $1,276,727 
Cash dividends per share  $.04   $   $.04   $ 
Basic earnings per share (Note 8)  $0.32   $0.27   $0.60   $0.46 
Diluted earnings per share (Note 8)  $0.32   $0.27   $0.59   $0.46 

 

See notes to unaudited condensed consolidated financial statements.

5

 

VALLEY COMMERCE BANCORP

CONDENSED CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME

(UNAUDITED)

 

  For the Six Months     For the Three Months 
  Ended June 30,     Ended June 30, 
  2012   2011   2012   2011 
                
Net Income  $1,751,254   $1,484,246   $892,415   $859,282 
Other Comprehensive Income:                    
Unrealized Gains on Investment Securities:                    
Unrealized holding gains arising during the period, net of income tax expense of $73,380 and $400,344 for the six months ended June 30, 2012 and 2011, respectively and 134,596 and 399,927 for the quarters ended June 30, 2012 and 2011, respectively.   104,942    572,545    137,590    578,937 
Less: Reclassification adjustment for realized gains included in net income, net of related income tax effects of  $62,640 and $15,417 for the six months ended June 30, 2012 and 2011, respectively and 74,144 and $9,812 for the quarters ended June 30, 2012 and 2011, respectively.   89,584    22,049    51,136    21,022 
Other Comprehensive Income   15,358    550,496    86,454    557,915 
Total Comprehensive Income  $1,766,612   $2,034,742   $978,869   $1,417,197 

 

See notes to unaudited condensed consolidated financial statements. 

6

 

VALLEY COMMERCE BANCORP

CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS

(UNAUDITED)

 

  For the Six Months 
  Ended June 30, 
  2012   2011 
Cash Flows from Operating Activities:          
Net income  $1,751,254   $1,484,246 
Adjustments to reconcile net income to net cash provided by operating activities:          
Provision for loan losses       225,000 
Decrease in deferred loan origination fees, net   (7,767)   (72,061)
Depreciation   273,362    272,395 
Gain on sale of available-for-sale investment securities, net   (152,224)   (37,466)
Amortization of premiums on investment securities, net   254,095    201,877 
Increase in cash surrender value of bank-owned life insurance   (153,767)   (133,338)
Stock-based compensation expense, net   123,267    84,219 
Loss (gain) on disposition of premises and equipment   517    (158)
(Increase) decrease in accrued interest receivable and other assets   (487,156)   409,834 
Increase (decrease) in accrued interest payable and other liabilities   962,336    (65,822)
        Net cash provided by operating activities   2,563,917    2,368,726 
Cash Flows from Investing Activities:          
Proceeds from matured and called available-for-sale investment securities   1,075,000    20,000 
Proceeds from sales of available-for-sale investment securities   3,558,372    5,910,430 
Purchases of available-for-sale investment securities   (9,163,522)   (16,341,087)
Proceeds from principal repayments from available-for-sale
mortgage-backed securities
   4,010,376    2,608,669 
Redemption (purchase) of Federal Home Loan Bank Stock, net   57,600    (95,600)
Net decrease in loans   4,659,539    2,118,836 
Purchase of premises and equipment   (143,545)   (93,461)
Proceeds from sale of premises and equipment   1,000    600 
       Net cash provided by (used in) investing activities   4,054,820    (5,871,613)

 

 

Continued on next page.

 

7

 

VALLEY COMMERCE BANCORP

CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS

(UNAUDITED)

(Continued)

 

  For the Six Months 
  Ended June 30, 
  2012   2011 
Cash Flows from Financing Activities:          
Net decrease in noninterest-bearing and interest-bearing deposits  $(11,417,876)  $(1,819,531)
Net decrease in time deposits   (1,701,843)   (2,504,480)
Redemption of preferred stock   (8,085,000)    
Cash dividends paid on preferred stock   (93,209)   (207,520)
Cash dividends paid on common stock   (111,384)    
Principal payments on short-term debt   (1,000,000)   (204,636)
Cash paid to repurchase fractional shares       (2,529)
Net cash used in financing activities   (22,409,312)   (4,738,696)
Decrease in cash and cash equivalents   (15,790,575)   (8,241,583)
Cash and Cash Equivalents at Beginning of Year   60,421,044    32,667,967 
Cash and Cash Equivalents at End of Period  $44,630,469   $24,426,384 
Supplemental Disclosure of Cash Flow Information:          
Cash paid during the period for:          
Interest expense  $595,712   $905,906 
Income taxes  $460,000   $785,000 

 

 

 

See notes to unaudited condensed consolidated financial statements.

 

8

 

 

VALLEY COMMERCE BANCORP

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

1.          GENERAL

 

On February 2, 2002, Valley Commerce Bancorp (the “Company”) was incorporated as a bank holding company for the purpose of acquiring Valley Business Bank (the “Bank”) in a one bank holding company reorganization intended to provide the Company and the Bank greater flexibility to expand and diversify. The reorganization was completed on November 21, 2002, subsequent to which the Bank continued its operations as previously conducted, but as a wholly owned subsidiary of the Company.

 

The Bank commenced operations in 1996 and currently operates branches in Visalia, Fresno, Woodlake and Tipton, and Tulare. The Bank’s primary source of revenue is generated from providing loans to customers who are predominately small and middle market businesses and individuals residing in the surrounding areas. The Bank’s deposits are insured by the Federal Deposit Insurance Corporation (FDIC) up to applicable legal limits. The Bank’s participation in the FDIC Transaction Account Guarantee Program expired on December 31, 2011. The Dodd-Frank Act extends unlimited deposit insurance to non-interest bearing transaction accounts through December 31, 2012. Under the Dodd-Frank Act, Negotiable Order of Withdrawal (“NOW”) accounts not paying more than 0.25% interest per annum are not included in the definition of non-interest bearing transaction accounts. These accounts and any other interest-bearing accounts will be insured based on the depositor’s ownership capacity, but not to exceed $250,000.

 

2.           BASIS OF PRESENTATION

 

The interim unaudited condensed consolidated financial statements of Valley Commerce Bancorp and subsidiary have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission (the “SEC”). These interim condensed consolidated financial statements include the accounts of Valley Commerce Bancorp and its wholly owned subsidiary Valley Business Bank (the “Bank”) (collectively, the “Company”). Valley Commerce Trust I, a wholly-owned subsidiary formed for the exclusive purpose of issuing trust preferred securities, is not consolidated into the Company’s consolidated financial statements and, accordingly, is accounted for under the equity method. The Company’s investment in the Trust is included in accrued interest receivable and other assets on the consolidated balance sheet. All significant intercompany accounts and transactions have been eliminated in consolidation. All adjustments (consisting only of normal recurring adjustments) which, in the opinion of Management, are necessary for a fair presentation of the Company’s consolidated financial position at June 30, 2012 and December 31, 2011, the results of its operations for the three and six month periods ended June 30, 2012 and 2011 and its cash flows for the six months ended June 30, 2012 and 2011 have been included therein.  Certain information and footnote disclosures normally included in the annual consolidated financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been omitted, however, the Company believes that the following disclosures are adequate to make the information not misleading.  These interim condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in the Company’s 2011 Annual Report on Form 10-K.  The results of operations and cash flows for the interim periods presented are not necessarily indicative of the results for a full year.

 

The preparation of these condensed consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions. These estimates and assumptions affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ significantly from those estimates.

 

Management has determined that because all of the commercial banking products and services offered by the Company are available in each branch of the Bank, all branches are located within the same economic environment and management does not allocate resources based on the performance of different lending or transaction activities, it is appropriate to aggregate the Bank branches and report them as a single operating segment. No single customer accounts for more than 10% of the revenues of the Company or the Bank.

 

On May 22, 2012 the Company declared a $0.04 cash dividend payable on June 28, 2012 for all shareholders of record on June 17, 2012.

9

 

3.          AVAILABLE-FOR-SALE INVESTMENT SECURITIES

 

The investment portfolio consists entirely of investment securities that were classified as available for sale at date of acquisition. The Company has established investment policies that are designed primarily to manage interest rate and liquidity risk, and secondarily to achieve income. Each impaired investment security is evaluated quarterly for other-than-temporary impairment, relying primarily on industry analyst reports, observation of market conditions and interest rate fluctuations.

 

The amortized cost and estimated fair value of available-for-sale investment securities at the dates indicated consisted of the following:

 

   June 30, 2012 
       Gross   Gross   Estimated 
   Amortized   Unrealized   Unrealized   Fair 
   Cost   Gains   Losses   Value 
                 
Debt securities:                    
U.S. Government sponsored entities and agencies  $6,339,424   $191,576   $   $6,531,000 
Mortgage-backed securities:                    
U.S. Government sponsored entities and agencies   18,782,045    352,613    (4,658)   19,130,000 
Small Business Administration   11,395,161    211,839        11,607,000 
Obligations of states and political subdivisions   19,222,210    716,494    (57,704)   19,881,000 
   $55,738,840   $1,472,522   $(62,362)  $57,149,000 

 

Net unrealized gains on available-for-sale investment securities totaling $1,410,160 were recorded, net of $580,281 in income taxes, as accumulated other comprehensive income within shareholders’ equity at June 30, 2012. Proceeds and gross realized gains from the sale of available-for-sale investment securities for the three month period ended June 30, 2012 totaled $2,040,084 and $124,267, respectively. Proceeds and gross realized gains from the sale of available-for-sale investment securities for the six month period ended June 30, 2012 totaled $3,558,372 and $152,224, respectively. There were no investment securities sold at a loss during the six months ended June 30, 2011.

 

   December 31, 2011 
       Gross   Gross   Estimated 
   Amortized   Unrealized   Unrealized   Fair 
   Cost   Gains   Losses   Value 
                 
Debt securities:                    
U.S. Government sponsored entities and agencies  $5,867,720   $177,121   $(6,841)  $6,038,000 
Mortgage-backed securities:                    
U.S. Government sponsored entities and agencies   17,680,491    352,314    (15,805)   18,017,000 
Small Business Administration   12,345,495    284,505        12,630,000 
Obligations of states and political subdivisions   19,427,232    643,745    (50,977)   20,020,000 
   $55,320,938   $1,457,685   $(73,623)  $56,705,000 

 

10
Index

3.          AVAILABLE-FOR-SALE INVESTMENT SECURITIES (Continued)

Net unrealized losses on available-for-sale investment securities totaling $1,384,062 were recorded, net of $569,541 in tax benefits, as accumulated other comprehensive loss within shareholders’ equity at December 31, 2011. Proceeds and gross realized gains from the sale of available-for-sale investment securities for the three month period ended June 30, 2011 totaled $4,966,930 and $23,846, respectively. Proceeds and gross realized gains from the sale of available-for-sale investment securities for the six month period ended June 30, 2011 totaled $5,910,430 and $37,466, respectively.

 

Investment securities with unrealized losses at June 30, 2012 are summarized and classified according to the duration of the loss period as follows:

 

   Less than 12 Months   12 Months or More   Total 
   Fair   Unrealized   Fair   Unrealized   Fair   Unrealized 
   Value   Losses   Value   Losses   Value   Losses 
                         
Debt securities:                              
Mortgage-backed securities:                              
U.S. Government sponsored entities and agencies  $917,000   $(4,658)  $   $   $917,000   $(4,658)
Obligations of states and political subdivisions   2,416,000    (48,821)   180,000    (8,883)   2,596,000    (57,704)
   $3,333,000   $(53,479)  $180,000   $(8,883)  $3,513,000   $(62,362)

 

Investment securities with unrealized losses at December 31, 2011 are summarized and classified according to the duration of the loss period as follows:

 

   Less than 12 Months   12 Months or More   Total 
   Fair   Unrealized   Fair   Unrealized   Fair   Unrealized 
   Value   Losses   Value   Losses   Value   Losses 
                         
Debt securities:                              
U.S. Government sponsored entities and agencies  $   $   $691,000   $(6,841)  $691,000   $(6,841)
Mortgage-backed securities:                              
U.S. Government sponsored entities and agencies   5,580,000    (15,805)           5,580,000    (15,805)
Obligations of states and political subdivisions   1,087,000    (5,480)   1,762,000    (45,497)   2,849,000    (50,977)
   $6,667,000   $(21,285)  $2,453,000   $(52,338)  $9,120,000   $(73,623)

 

Management periodically evaluates each investment security for other-than-temporary impairment, relying primarily on industry analyst reports, observation of market conditions and interest rate fluctuations. As of June 30, 2012, the Company performed an analysis of the investment portfolio to determine whether any of the investments held in the portfolio had other-than-temporary impairment (OTTI). When analyzing the issuer’s financial condition, management considers the length of time and extent to which the market value has been less than cost; the historical and implied volatility of the security; the financial condition of the issuer of the security; and the Company’s intent and ability to hold the security to recovery. Management evaluated all available-for-sale investment securities with an unrealized loss at June 30, 2012 and identified those that had an unrealized loss for at least a consecutive 12 month period, which had an unrealized loss at June 30, 2012 greater than 10% of the recorded book value on that date, or which had an unrealized loss of more than $15,000.  Management also analyzed any securities that may have been down graded by credit rating agencies. For those bonds that were municipal debt securities, the Company conducted a search for any recent information relevant to the financial condition of the municipality and any applicable municipal bond insurance provider.

 

11
Index

3.          AVAILABLE-FOR-SALE INVESTMENT SECURITIES (Continued)

OTTI that is credit-related is recognized in earnings while noncredit-related OTTI on securities not expected to be sold is recognized in other comprehensive income. An unrealized loss may eventually be realized if it is probable that either (1) the Company will not collect the entire contractual or estimated cash flow from that interest, or (2) the Company lacks the intent and ability to hold the interest until it is expected to recover. As discussed below, the Company’s impairment analysis as of June 30, 2012 resulted in all unrealized losses in the investment portfolio being recognized in other comprehensive income.

 

Mortgage-backed Securities

 

At June 30, 2012, the Company held 41 mortgage-backed obligations of which one was in a loss position for less than twelve months and none were in a loss position for twelve months or more. Management believes the unrealized losses on the Company’s investments in mortgage obligations were caused primarily by limited market liquidity and perceived credit risk on the part of investors. The contractual cash flows of these investments are guaranteed by an agency of the U.S. government. Accordingly, it is expected that the securities will not be settled at a price less than the amortized cost of the Company’s investment. Because the Company has the ability and intent to hold those investments until a recovery of fair value, which may be maturity, the Company does not consider those investments to be other-than-temporarily impaired at June 30, 2012.

 

 

12
Index

3.          AVAILABLE-FOR-SALE INVESTMENT SECURITIES (Continued)

Obligations of States and Political Subdivisions

 

At June 30, 2012, the Company held 51 obligations of states and political subdivision securities of which five were in a loss position for less than twelve months and one was in a loss position and had been in a loss position for twelve months or more. Management believes the unrealized losses on the Company’s investments in obligations of states and political subdivision securities were due to the continued dislocation of the securities market and changes in market interest rates. All of these securities have continued to pay as scheduled despite their impairment due to current market conditions and there has been no observable deterioration in the credit rating or financial performance of the underlying municipality that in the opinion of management would impact the ultimate repayment of the security.

 

Municipal securities with unrealized losses as of June 30, 2012 are summarized in the table below.

 

  Book   Market   Unrealized      State       Moody’s    S&P 
Description  Value   Value   Loss   Type   Issued   Insurer   Rating   Rating 
Barstow USD  $408,874   $409,000   $(126)   GO    CA    MBIA    A1    NR 
Rocklin USD   330,499    331,000    (501)   GO    CA    AGM    Aa2    AA- 
Du Page County SD   568,895    582,000    (13,105)   GO    IL    AGC    Aa    AA- 
Grand Lakes Util Dist   516,942    542,000    (24,894)   GO    TX    AGM    Aa3    AA- 
Gonzales USD   171,281    180,000    (8,883)   ZGO    CA    AGM    Aa3    AA+ 
Mecklenburg Cnty PU   541,805    552,000    (10,195)   GO2    NC    None    Aaa    AAA 
   $2,538,296   $2,596,000   $(57,704)                         

 

Management’s periodic evaluation of municipal investments includes a determination that a withdrawn rating (WR) or no rating (NR) by a rating agency is not attributable to increased credit risk. The Company has established risk parameters within its investment policy that limits the Company’s exposure to the municipal market and serves to promote diversification and low risk within the municipal segment of the portfolio. Municipal investment purchases are designed primarily to manage interest rate risk and secondarily to achieve income. In addition, the Company has the ability and intent to hold those investments until a recovery of fair value, which may be maturity. Therefore, the Company does not consider those investments to be other-than-temporarily impaired at June 30, 2012.

 

The amortized cost and estimated fair value of investment securities at June 30, 2012 by contractual maturity are shown below. Expected maturities will differ from contractual maturities because the issuers of the securities may have the right to call or prepay obligations with or without call or prepayment penalties.

 

       Estimated 
   Amortized   Fair 
   Cost   Value 
         
Within one year  $   $ 
After one year through five years    3,461,949    3,564,000 
After five years through ten years   3,631,642    3,682,000 
After ten years   18,468,043    19,166,000 
    25,561,634    26,412,000 
Investment securities not due at a single maturity date:          
          Mortgage-backed securities   30,177,206    30,737,000 
           
   $55,738,840   $57,149,000 

 

There were $37,231,000 and $38,367,000 of investment securities pledged to secure public deposits at June 30, 2012 and December 31, 2011, respectively.

 

13

 

 

4.          LOANS

 

Outstanding loans are summarized below, in thousands:

   June 30,
2012
   December 31,
2011
 
Commercial  $38,737,726   $39,379,268 
Real estate – mortgage   164,980,288    165,685,966 
Real estate – construction   15,870,040    19,499,158 
Agricultural   3,966,101    3,730,466 
Consumer and other   1,575,094    2,051,455 
    225,129,249    230,346,313 
           
Deferred loan fees,  net   (337,918)   (345,685)
Allowance for loan and lease losses   (5,275,733)   (5,468,758)
   $219,515,598   $224,531,870 

 

 

 

14

5.          ALLOWANCE FOR LOAN AND LEASE LOSSES

 

The following tables show the allocation of the allowance for loan and lease losses at June 30, 2012 and December 31, 2011, and for the three and six months ended June 30, 2012 and 2011 by portfolio segment and by impairment methodology:

 

As of and for the three months ended June 30, 2012

 

       Real   Real       Consumer     
       Estate -   Estate -       And     
   Commercial   Mortgage   Construction   Agricultural   Other   Total 
                         
Allowance for Credit Losses                              
                               
Beginning balance:  $1,564,397   $640,051   $3,149,076   $72,914   $45,320   $5,471,758 
 Charge-offs   (950)   (85,782)   (233,095)           (319,827)
 Recoveries   123,802                    123,802 
 Provision                        
Ending balance allocated to portfolio segments  $1,687,249   $554,269   $2,915,981   $72,914   $45,320   $5,275,733 

 

As of and for the three months ended June 30, 2011

 

       Real   Real       Consumer     
       Estate -   Estate -       And     
   Commercial   Mortgage   Construction   Agricultural   Other   Total 
                         
Allowance for Credit Losses                              
                               
Beginning balance:  $2,773,473   $698,069   $3,341,076   $72,914   $45,320   $6,930,852 
 Charge-offs   (4,356)                   (4,356)
 Recoveries   5,278    99,990                105,267 
 Provision                        
Ending balance allocated to portfolio segments  $2,774,394   $798,059   $3,341,076   $72,914   $45,320   $7,031,763 

 

As of and for the six months ended June 30, 2012

 

       Real   Real       Consumer     
       Estate -   Estate -       And     
   Commercial   Mortgage   Construction   Agricultural   Other   Total 
                         
Allowance for Credit Losses                              
                               
Beginning balance:  $1,561,397   $640,051   $3,149,076   $72,914   $45,320   $5,468,758 
 Charge-offs   (950)   (85,782)   (233,095)           (319,827)
 Recoveries   126,802                    126,802 
 Provision                        
Ending balance allocated to  portfolio segments  $1,687,249   $554,269   $2,915,981   $72,914   $45,320   $5,275,733 
                               
Individually evaluated                              
for impairment  $330,260   $260,304   $227,152   $   $   $817,716 
Collectively evaluated                              
for impairment   1,356,989    293,965    2,688,829    72,914    45,320    4,458,017 
                                Total  $1,687,249   $554,269   $2,915,981   $72,914   $45,320   $5,275,733 
                               
                               
                               
Loans                              
                               
Ending balance: individually                              
   evaluated for impairment  $2,391,368   $6,016,897   $1,396,904   $   $95,000   $9,805,169 
                               
Ending balance: collectively                              
   evaluated for impairment   36,346,358    159,058,391    14,473,136    3,966,101    1,575,094    215,324,0805 
                               
                                    Total  $38,737,726   $164,980,288   $15,870,040   $3,966,101   $1,575,094   $225,129,249 

 

15
Index

5.          ALLOWANCE FOR LOAN AND LEASE LOSSES (Continued)

As of and for the six months ended June 30, 2011

 

       Real   Real   Consumer         
       Estate -   Estate -   And         
   Commercial   Mortgage   Construction   Other   Agriculture   Total 
                         
Allowance for Credit Losses                              
                               
Beginning balance:  $2,641,106   $308,792   $3,327,863   $40,409   $80,782   $6,698,952 
 Charge-offs   (4,356)                   (4,356)
 Recoveries   12,177    99,990                112,167 
 Provision   125,467    89,277    13,213    4,911    (7,863)   225,000 
Ending balance allocated to  portfolio segments  $2,774,394   $798,1059   $3,341,076   $45,320   $72,914   $7,031,763 
                               
Individually evaluated                              
for impairment  $1,197,282   $488,927   $301,852   $   $   $1,988,061 
Collectively evaluated                              
for impairment   1,577,112    309,132    3,039,224    45,320    72,914    5,043,702 
                                Total  $2,774,394   $798,059   $3,341,076   $45,320   $72,914   $7,031,763 
                               
                               
                               
Loans                              
                               
Ending balance: individually                              
   evaluated for impairment  $2,736,316   $9,139,305   $4,067,686   $   $   $15,943,307 
                               
Ending balance: collectively                              
   evaluated for impairment   47,375,062    153,084,208    16,305,366    4,420,746    2,250,166    223,435,548 
                               
                                    Total  $50,111,378   $162,223,513   $20,373,052   $4,420,746   $2,250,166   $239,378,855 
16
Index

5.          ALLOWANCE FOR LOAN AND LEASE LOSSES (Continued)

As of December 31, 2011

 

       Real   Real             
       Estate -   Estate -       Consumer     
   Commercial   Mortgage   Construction   Agricultural   And Other   Total 
                         
Allowance for Credit Losses                              
                               
Individually evaluated                              
for impairment  $230,074   $169,013   $129,260   $   $   $528,347 
                               
Collectively evaluated                              
for impairment  $1,331,323   $471,038   $3,019,816   $72,914   $45,320   $4,940,411 
                               
                             Total  $1,561,397   $640,051   $3,149,076   $72,914   $45,320   $5,468,758 
                               
Loans                              
                               
Individually evaluated                              
for impairment  $2,021,574   $6,086,817   $2,702,100   $   $   $10,810,491 
                               
Collectively evaluated                              
for impairment  $37,357,694   $159,599,149   $16,797,058   $3,730,466   $2,051,455   $219,535,822 
                               
                             Total  $39,379,268   $165,685,966   $19,499,158   $3,730,466   $2,051,455   $230,346,313 

 

 

17
Index

5.          ALLOWANCE FOR LOAN AND LEASE LOSSES (Continued)

Credit Quality Indicators

 

The Company assigns a risk rating to all loans except pools of homogeneous loans and periodically performs detailed reviews of all such loans over a certain threshold to identify credit risks and to assess the overall collectability of the portfolio. These risk ratings are also subject to examination by independent specialists engaged by the Company and by the Company’s regulators. During these internal reviews, management monitors and analyzes the financial condition of borrowers and guarantors, trends in the industries in which borrowers operate and the fair values of collateral securing these loans. These credit quality indicators are used to assign a risk rating to each individual loan. The risk ratings are grouped into five major categories as follows: Pass, Watch, Special Mention, Substandard and Doubtful.

 

The following table shows the loan portfolio allocated by management’s internal risk ratings at June 30, 2012 and December 31, 2011:

 

  Commercial Credit Exposure 
  Credit Risk Profile by Internally Assigned Grade 
As of June 30, 2012  Commercial   Real Estate –
Mortgage
   Real Estate –
Construction
   Agriculture   Consumer and
Other
   Total 
Grade:                              
Pass  $29,745,576   $138,263,412   $8,231,875   $3,966,101   $1,337,669   $181,544,633 
Watch   3,091,543    4,380,029    4,107,745        142,425    11,721,742 
Special Mention   3,154,300    6,245,297    1,254,356            10,653,953 
Substandard   2,746,307    16,091,550    2,276,064            21,113,921 
Doubtful                   95,000    95,000 
Total  $38,737,726   $164,980,288   $15,870,040   $3,966,101   $1,575,094   $225,129,249 

 

 

  Commercial Credit Exposure 
  Credit Risk Profile by Internally Assigned Grade 
As of December 31, 2011  Commercial   Real Estate –
Mortgage
   Real Estate –
Construction
   Agriculture   Consumer and
Other
   Total 
Grade:                              
Pass  $30,098,949   $140,475,243   $7,585,992   $3,730,466   $1,905,542   $183,796,192 
Watch   713,005    479,319    8,107,973        145,913    9,446,210 
Special Mention   5,335,791    7,486,780    1,381,626            14,204,197 
Substandard   3,231,523    17,244,624    2,423,567            22,899,714 
Doubtful                        
Total  $39,379,268   $165,685,966   $19,499,158   $3,730,466   $2,051,455   $230,346,313 

 

 

18
Index

5.          ALLOWANCE FOR LOAN AND LEASE LOSSES (Continued)

The following tables show an aging analysis of the loan portfolio at June 30, 2012 and December 31, 2011:

 

  30-89 Days
Past Due
   90 Days and
Still
Accruing
   Nonaccrual   Total
Past Due
   Current   Total 
As of June 30, 2012                        
Commercial:                              
Commercial and  industrial  $142   $   $970,452   $970,594   $17,585,315   $18,555,909 
Commercial lines                   18,059,809    18,059,809 
Commercial guaranteed                   2,122,008    2,122,008 
Agricultural:                              
Agricultural                   3,597,045    3,597,045 
Agricultural Capital    assets                   369,056    369,056 
Real Estate-Construction:                              
Construction                   9,889,527    9,889,527 
Construction 1-4 family                   2,537,664    2,537,664 
Construction loan others           560,846    560,846    2,882,003    3,442,849 
Real Estate-Mortgage:                              
Mortgage 1-4 family                   7,880,820    7,880,820 
Real Estate   752,396        2,675,539    3,427,935    146,463,582    149,891,517 
Real Estate – Ag                   3,904,544    3,904,544 
Home Equity loans                   3,303,407    3,303,407 
Consumer and Other:                              
Auto                   120,256    120,256 
Consumer           95,000    95,000    55,487    150,487 
Other                   1,304,351    1,304,351 
Total  $752,538   $   $4,301,837   $5,054,375   $220,074,874   $225,129,249 

 

 

  30-89 Days
Past Due
   90 Days and
Still
Accruing
   Nonaccrual   Total
Past Due
   Current   Total 
As of December 31, 2011                              
Commercial:                              
Commercial and  industrial  $121,350   $   $1,005,338   $1,126,688   $18,370,667   $19,497,355 
Commercial lines                   17,900,083    17,900,083 
Commercial guaranteed                   1,981,830    1,981,830 
Agricultural:                              
Agricultural                   3,221,108    3,221,108 
Agricultural Capital    assets                   509,358    509,358 
Real Estate-Construction:                              
Construction                   13,323,442    13,323,442 
Construction 1-4 family           556,172    556,172    1,735,736    2,291,908 
Construction loan others           1,278,332    1,278,332    2,605,476    3,883,808 
Real Estate-Mortgage:                              
Mortgage 1-4 family   200,000            200,000    10,062,785    10,262,85 
Real Estate   218,970        2,806,286    3,025,256    145,824,876    148,850,132 
Real Estate – Ag                   2,889,375    2,889,375 
Home Equity loans                   3,683,674    3,683,674 
Consumer and Other:                              
Auto                   103,046    103,046 
Consumer   9,112            9,112    347,664    356,776 
Other                   1,591,633    1,591,633 
Total  $549,432   $   $5,646,129   $6,195,560   $224,150,753   $230,346,313 

 

19
Index

5.          ALLOWANCE FOR LOAN AND LEASE LOSSES (Continued)

The following tables show information related to impaired loans for the period ended June 30, 2012 and for the year ended December 31, 2011:

 

       Unpaid     
   Recorded   Principal   Related 
   Investment   Balance   Allowance 
Impaired loans as of June 30, 2012
 
          
With no related allowance recorded:               
Commercial  $1,775,071   $1,795,746   $ 
Agriculture            
Real estate – mortgage   4,254,824    5,824,262     
Real estate – construction   560,846    600,366     
Consumer and other            
                
With an allowance recorded:               
Commercial  $616,297   $622,326   $330,260 
Agriculture            
Real estate – mortgage   1,667,073    1,709,289    165,304 
Real estate – construction   836,058    1,905,058    227,152 
Consumer and other   95,000    95,000    95,000 
                
Total:               
Commercial  $2,391,368   $2,418,072   $330,260 
Agriculture            
Real estate – mortgage   5,921,897    7,533,551    165,304 
Real estate – construction   1,396,904    2,505,424    227,152 
Consumer and other   95,000    95,000    95,000 

 

       Unpaid     
   Recorded   Principal   Related 
   Investment   Balance   Allowance 
Impaired loans as of December 31, 2011
 
          
With no related allowance recorded:               
Commercial  $1,542,086   $1,542,086   $ 
Agriculture            
Real estate – mortgage   5,390,510    6,708,381     
Real estate – construction   2,473,029    3,832,712     
Consumer and other            
                
With an allowance recorded:               
Commercial  $479,488   $482,274   $230,074 
Agriculture            
Real estate – mortgage   696,307    732,848    169,013 
Real estate – construction   229,071    229,071    129,260 
Consumer and other            
                
Total:               
Commercial  $2,021,574   $2,024,360   $230,074 
Agriculture            
Real estate – mortgage   6,086,817    7,431,229    169,013 
Real estate – construction   2,702,100    4,061,783    129,260 
Consumer and other            

 

20
Index

5.          ALLOWANCE FOR LOAN AND LEASE LOSSES (Continued)

  For the three
months ended
June 30, 2012
   For the six
months ended
June 30, 2012
 
                
  Average   Interest   Average   Interest 
  Recorded   Income   Recorded   Income 
  Investment   Recognized   Investment   Recognized 
With no related allowance recorded:                    
Commercial  $1,803,706   $13,530   $1,801,928   $27,041 
Agriculture                
Real estate – mortgage   1,202,197    129,389    1,093,422    129,389 
Real estate – construction   5,878,420    43,103    5,864,542    71,836 
Consumer and other                
                     
With an allowance recorded:                    
Commercial  $653,132   $7,603   $645,282   $16,342 
Agriculture                
Real estate – construction   1,931,230    36,920    1,926,776    56,048 
Real estate – mortgage   1,720,100    19,898    1,717,956    39,678 
Consumer and other   95,000    383    95,000    1,508 
                     
Total: (Impaired Loans only)                    
Commercial  $2,456,838   $21,133   $2,447,210   $43,383 
Agriculture                
Real estate – construction   3,133,427    166,309    3,020,198    185,437 
Real estate – mortgage   7,598,520    63,001    7,582,498    111,514 
Consumer and other   95,000    383    95,000    1,508 

 

  For the three
months ended
June 30, 2011
   For the six
months ended
June 30, 2011
 
                
  Average   Interest   Average   Interest 
  Recorded   Income   Recorded   Income 
  Investment   Recognized   Investment   Recognized 
With no related allowance recorded:                    
Commercial  $1,603,287   $428   $1,470,817   $919 
Agriculture                
Real estate – mortgage   3,023,802    26,182    3,023,447    51,795 
Real estate – construction   7,409,775    8,338    7,403,545    10,820 
Consumer and other                
                     
With an allowance recorded:                    
Commercial  $2,359,046   $31,650   $2,352,302   $76,117 
Agriculture                
Real estate – construction   1,049,582    1,878    1,048,962    5,794 
Real estate – mortgage   1,012,577    16,474    1,011,771    32,642 
Consumer and other                
                     
Total: (Impaired Loans only)                    
Commercial  $3,962,333   $32,078   $3,823,119   $77,038 
Agriculture                
Real estate – construction   4,073,384    28,060    4,072,409    57,589 
Real estate – mortgage   8,422,352    24,812    8,415,316    43,462 
Consumer and other                

 

21
Index

5.          ALLOWANCE FOR LOAN AND LEASE LOSSES (Continued)

In the table above, the first column titled Recorded Investment includes the balance due on the loan less any interest payments received and applied to principal while on nonaccrual status and any partial charge offs. In the next column the Unpaid Principal Balance includes the actual contractual loan balance due from the borrower plus calculated accrued interest, which would normally be accrued and due, if the loan was not on nonaccrual status.

 

Troubled Debt Restructurings

 

The modifications and concessions granted to troubled debt restructures generally consist of 6 to 12 months deferral of principal payments or an interest rate reduction or a lengthened amortization, or a combination thereof. Of the twelve loans identified as troubled debt restructures at June 30, 2012, two were granted deferral of principal payments, five had interest rate reductions and lengthened amortization, one had deferral of principal payment and a rate reduction, and four were concessions related to below market interest rates. When a troubled loan is restructured it is normally placed in nonaccrual status until it is evident that the borrower will perform in accordance with the modified terms. The Company’s policy is to require satisfactory payments for a minimum of six months before the loan will be considered for reinstatement to accrual status. The Company does not have commitments to lend additional funds to borrowers with loans whose terms have been modified in troubled debt restructurings.

 

Management identifies the early onset of borrower financial difficulties via the utilization of various indicators. Chief of these indicators would simply be the review of the borrower’s repayment pattern. When repayment patterns begin to exhibit practices that are less than what is allowed within the contractual allowance, an indication of early difficulties emerges. If this pattern continues, the Bank will document collection efforts via on-site visits to the borrower’s premises whereby providing further, observable input into the borrower’s financial condition. Furthermore, the Bank makes a consistent practice to require the submission of periodic interim and annual financial information of the borrowers, guarantors and co-signors. This information is obtained to determine the borrower’s historical debt serviceability and to make judgments’ concerning future repayment. Should financial information be denied, the Bank will utilize various options to encourage compliance. If the financial information and repayment practices with other lenders remains uncollectible, the Bank will utilize the review of updated credit reports to determine debt levels.

 

A summary of loan modifications that meet the definition of troubled debt restructurings and the related reserves as of June 30, 2012 and December 31, 2011 is set forth below:

 

   June 30, 2012   December 31, 2011 
   No. of
Loans
   Amount   Specific
loan loss
reserves
   No. of
Loans
   Amount   Specific
loan loss
reserves
 
                         
Nonperforming Loans   5   $2,224,869   $73,637    5   $2,031,624   $85,528 
Performing Loans   7    2,180,315    472,558    6    1,809,850    273,806 
Total troubled debt restructured loans   12   $4,405,184   $546,195    11   $3,841,474   $359,334 
                               

 

22
Index

5.          ALLOWANCE FOR LOAN AND LEASE LOSSES (Continued)

The following table presents loans by class modified as troubled debt restructuring that occurred during the six month period ended June 30, 2012:

 

Modifications

During the Six Months ended June 30, 2012

 

Dollars in thousands            
             
       Pre-Modification   Post-Modification 
       Outstanding Recorded   Outstanding Recorded 
   Number of Contracts   Investments   Investments 
             
Troubled Debt Restructuring:               
     Commercial   3   $1,502,798   $1,469,778 
     Real Estate – Mortgage   2    2,194,217    2,194,217 
     Real Estate-Construction   1    837,058    836,058 

 

Modifications

During the Three Months ended June 30, 2012

 

Dollars in thousands            
             
       Pre-Modification   Post-Modification 
       Outstanding Recorded   Outstanding Recorded 
   Number of Contracts   Investments   Investments 
                
Troubled Debt Restructuring:               
     Real Estate – Mortgage   1   $2,194,217   $2,194,217 
     Real Estate-Construction   2    837,058    836,058 

 

A loan is considered to be in payment default once it is 90 days past due under the modified terms. There were no payment defaults during the six months ended June 30, 2012 for loans modified as troubled debt restructurings within the twelve months ended June 30, 2012.

 

The troubled debt restructuring described above increased specific reserves on impaired loans by $256,000 and resulted in no charge offs during the six months ended June 30, 2012.

 

The Bank has granted concessions on loans that do not meet the definition of a troubled debt restructure. The loan terms were modified due to competitive pressures. The customers involved were highly creditworthy and were determined by management to be likely and able to move their business to a competing financial institution if their loan terms were not modified.

 

23
Index

5.          ALLOWANCE FOR LOAN AND LEASE LOSSES (Continued)

Loans modified during the three and six month periods ending June 30, 2012 that do not meet the definition of troubled debt restructures are summarized below:

 

   For the six
months ended
   For the three
months ended
 
   June 30, 2012   June 30, 2012 
         
Commercial  $4,669,507   $ 
Real Estate-Mortgage   153,874     
Real Estate-Construction   876,187    184,603 
Agricultural   560,000     
Consumer and Other   83,451    84,451 
           
Total  $6,343,019   $268,054 

 

Foregone interest on nonaccrual loans totaled $456,635 for the six-month periods ended June 30, 2012, and $468,737 for June 30, 2011. Foregone interest on nonaccrual loans totaled $248,770 for the three-month period ended June 30, 2012, and $235,643 for June 30,2011.There were no accruing loans past due 90 days or more at June 30, 2012 or December 31, 2011.

 

 

6.           COMMITMENTS AND CONTINGENCIES

 

The Company is party to claims and legal proceeding arising in the ordinary course of business. In the opinion of the Company’s management, the amount of ultimate liability with respect to such proceedings will not have a material adverse effect on the financial condition or result of operations of the Company taken as a whole.

 

In the normal course of business, the Company has various outstanding commitments to extend credit which are not reflected in the financial statements, including loan commitments of $23.6 million and $31.8 million and letters of credit of $475,000 at June 30, 2012 and December 31, 2011.

 

At June 30, 2012, consumer loan commitments, which are generally unsecured, represent approximately 11% of total commitments. Agricultural loan commitments represent approximately 9% of total commitments and are generally secured by crops and/or real estate. Commercial loan commitments represent approximately 61% of total commitments and are generally secured by various assets of the borrower. Real estate loan commitments represent the remaining 19% of total commitments and are generally secured by property with a loan-to-value not to exceed 80%. In addition, the majority of the Bank’s commitments have variable interest rates. Total commitments do not necessarily represent future cash requirements. Each loan commitment and the amount and type of collateral obtained, if any, are evaluated on an individual basis. Collateral held varies, but may include real property, bank deposits, debt or equity securities or business assets.

 

Stand-by letters of credit are conditional commitments written to guarantee the performance of a customer to a third party. These guarantees are primarily related to the purchases of inventory by commercial customers and are typically short-term in nature. Credit risk is similar to that involved in extending loan commitments to customers and, accordingly, evaluation and collateral requirements similar to those for loan commitments are used. The deferred liability related to the Company’s stand-by letters of credit was not significant at June 30, 2012 or December 31, 2011.

 

24

 

 

 

7.          STOCK BASED COMPENSATION

 

The Company has two active share based compensation plans; the Valley Commerce Bancorp 2007 Equity Incentive Plan (“Incentive Plan”) for which 92,490 shares of common stock are reserved for issuance to employees and directors under incentive and non-statutory agreements and the Valley Commerce Bancorp Amended and Restated 1997 Stock Option Plan (“Prior Plan”) for which 102,656 shares of common stock are reserved for issuance, however, no further grants may be made under this plan as it expired in February 2007. The Incentive Plan provides for awards of stock options, restricted stock awards, qualified performance-based awards and stock grants. The purpose of the Incentive Plan is to promote the long-term success of the Company and the creation of shareholder value. The Board of Directors believes that the availability of stock options and other forms of stock awards will be a key factor in the ability of the Company to attract and retain qualified individuals.

 

During the six-month period ended June 30, 2011, the Company awarded 1,050 shares of restricted stock. The restricted stock will vest in two-years from the date of grant. There was no restricted stock granted during the 2012 period.

 

During the six-month period ended June 30, 2012, the company awarded 23,461 incentive stock options and 57,500 nonqualified stock options to its officers and directors, respectively, at an average price of $8.40 per option. There were no options issued during the three month period ended June 30, 2012.

 

During the six-month period ended June 30, 2011 there were 2,100 incentive stock options and 8,400 non-qualified stock options granted to the Company’s officers and directors, respectively, at a price of $7.81 per option. There were no stock options issued in the three month period ended June 30, 2011.

 

The fair value of each award granted is estimated on the grant date using the Black-Scholes option pricing model. Fair value of the grant is based on the weighted-average assumptions show in the table below.

 

  Six Months Ended   Six Months Ended 
  June 30, 2012   June 30, 2011 
Dividend yield   N/A    N/A 
Expected option life   9.28 years    8.83 years 
Expected volatility   50.4%   46.9%
Risk-free interest rate   0.84%   1.23%
Weighted average          
  fair value of options granted  $4.81   $5.02 

 

The expected life of awards granted represents the period of time that awards are expected to be outstanding. Expected volatility is based on historical volatility of the Company’s stock and other factors. The risk-free rate for periods within the contractual life of the option is based on the U.S. Treasury yield curve in effect at the time of grant.

 

Compensation expense is recognized over the vesting period on a straight line accounting basis. Compensation cost related to stock options recognized in operating results was $97,770 and $84,219 for the six month periods ended June 30, 2012 and 2011, respectively. Compensation cost related to stock options recognized in operating results was $38,406 and $7,956 for the three month periods ended June 30, 2012 and 2011, respectively. The tax benefits resulting from tax deductions in excess of the compensation cost recognized for those options (excess tax benefits) are classified as cash flow from financing activities in the statement of cash flows. There were no excess tax benefits during the six-month periods ended June 30, 2012 or 2011.

 

25
Index

7.          STOCK BASED COMPENSATION (Continued)

The following table summarizes information about stock option activity for the six months ended June 30, 2012:

 

  

For the Six Months Ended June 30, 2012

 
  

Shares

  

Weighted
Average
Exercise Price

  

Weighted
Average
Remaining
Contractual
Term

  

Aggregate
Intrinsic
Value

 
Incentive:                    
Options outstanding at January 1, 2012   45,631   $11.12           
Options granted   23,461    8.46           
Options exercised                  
Options cancelled                  
Options outstanding at June 30, 2012   69,092    10.21    6.13 years   $99,280(1)
Options vested or expected to vest
   after June 30, 2012
   47,716    10.14    4.70 years   $224,448(1)
Options exercisable at June 30, 2012   47,097    10.42    4.98 years   $60,640(1)
                     
Nonstatutory:                    
Options outstanding at January 1, 2012   68,554   $10.62           
Options granted   57,500    8.38           
Options exercised                  
Options cancelled                  
Options outstanding at June 30, 2012   126,054    9.60    6.14 years   $246,939(1)
Options vested or expected to vest
   after June 30, 2012
   88,926    8.22    3.70 years   $328,773(1)
Options exercisable at June 30, 2012   87,770    9.98    4.62 years   $157,831(1)

 

(1)17,943 non-statutory options and 29,519 incentive options are excluded from intrinsic value from table above because the exercise price is greater than the stock price at June 30, 2012.

 

The aggregate intrinsic value is calculated as the difference between the exercise price of the underlying awards and the quoted price of the Company’s common stock for options that were in-the-money at June 30, 2012. There were no options exercised during the six months ended June 30, 2012 and 2011. There were no shares of restricted stock issued during the six months ended June 30, 2012 and 1,050 during the 2011 period. There were 80,961 and 10,500 options granted during the periods ended June 30, 2012 and 2011, respectively. The total fair value of shares vested during the three months ended June 30, 2012 and 2011 was $170,642 and $0, respectively. The total fair value of shares vested during the six months ended June 30, 2012 and 2011 was $557,430 and $173,386, respectively.

 

Management estimates expected forfeitures and recognizes compensation costs only for those equity awards expected to vest. As of June 30, 2012, there was $306,992 of total unrecognized compensation cost related to non-vested share-based compensation arrangements granted under the Plan. The cost is expected to be realized over a weighted average period of 6.14 years and will be adjusted for subsequent changes in estimated forfeitures.

 

26

8.          EARNINGS PER SHARE COMPUTATION

 

Basic earnings per share are computed by dividing income available to common shareholders by the weighted average common shares outstanding for the period. Diluted earnings per share reflect the potential dilution that could occur if outstanding stock options were exercised. Diluted earnings per share are computed by dividing income available to common shareholders by the weighted average common shares outstanding for the period plus the dilutive effect of options.

 

  For the Three Months     For the Six Months 
  Ended June 30,     Ended June 30, 
  2012   2011   2012   2011 
Net Income:                    
Net income  $892,415   $859,282   $1,751,254   $1,484,246 
Dividends accrued and discounts                    
      accreted on preferred shares       106,053    93,209    207,519 
Net income allocated to common                    
      shareholders  $892,415   $753,229   $1,658,045   $1,276,727 
Earnings Per Share:                    
Basic earnings per share  $0.32   $0.27   $0.60   $0.46 
Diluted earnings per share  $0.32   $0.27   $0.59   $0.46 
Weighted Average Number of Shares Outstanding:                    
Basic shares   2,784,593    2,762,723    2,784,593    2,762,469 
Diluted shares   2,793,799    2,774,847    2,789,570    2,771,802 

 

There were 47,462 options excluded from the computation of diluted earnings per share for the three and six month periods ended June 30, 2012, respectively, and 98,409 excluded from the computation of diluted earnings per share for the three and six month periods ended June 30, 2011, respectively, as they were identified as anti-dilutive.

 

27

9.          INCOME TAXES

 

The Company files its income taxes on a consolidated basis with its subsidiaries. The allocation of income tax expense represents each entity’s proportionate share of the consolidated provision for income taxes. Differences arise between the Company’s effective tax rate and applicable statutory rates due primarily to non-taxable sources of income and non-deductible sources of expenses.

 

Deferred tax assets and liabilities are recognized for the tax consequences of temporary differences between the reported amounts of assets and liabilities and their tax bases. Deferred tax assets and liabilities are adjusted for the effects of changes in tax laws and rates on the date of enactment. On the condensed consolidated balance sheet, net deferred tax assets are included in accrued interest receivable and other assets.

 

When tax returns are filed, it is highly certain that some positions taken would be sustained upon examination by the taxing authorities, while others are subject to uncertainty about the merits of the position taken or the amount of the position that would be ultimately sustained. The benefit of a tax position is recognized in the financial statements in the period during which, based on all available evidence, management believes it is more likely than not that the position will be sustained upon examination, including the resolution of appeals or litigation processes, if any. Tax positions that meet the more-likely-than-not recognition threshold are measured as the largest amount of tax benefit that is more than 50 percent likely of being realized upon settlement with the applicable taxing authority. The portion of the benefits associated with tax positions taken that exceeds the amount measured as described above is reflected as a liability for unrecognized tax benefits in the accompanying condensed consolidated balance sheet along with any associated interest and penalties that would be payable to the taxing authorities upon examination. The Company recognizes accrued interest and penalties, if any, related to unrecognized tax benefits as a component of tax expense in the condensed consolidated statements of income. There have been no significant changes to unrecognized tax benefits or accrued interest and penalties for the six months ended June 30, 2012.

 

10.          SHAREHOLDERS’ EQUITY

Common Stock

On May 22, 2012, the Company’s Board of Directors authorized a common stock repurchase plan. The plan provides for the repurchase of up to $3,000,000 of the Company’s Common Stock. The number price and timing of the repurchase is at the Company’s sole discretion. The stock repurchase plan will expire on May 22, 2013. There were no shares repurchased during the quarter ended June 30, 2012.

Preferred Stock

On January 30, 2009, the Company entered into a letter Agreement (the “Purchase Agreement”) with the United States Department of the Treasury (“Treasury”), pursuant to which the Company issued and sold (i) 7,700 shares of the Company’s Fixed Rate Cumulative Preferred Stock, Series B (the “Series B Preferred Stock”) and (ii) a warrant to purchase 385 shares of the Company’s Fixed Rate Cumulative Perpetual Preferred Stock Series C stock, (the “Warrant Preferred” or “Series C Preferred Stock”) for a combined purchase price of $7,700,000 and were recorded net of $20,793 in offering costs. The Treasury exercised the Warrant immediately upon issuance.

On March 21, 2012, the Company repurchased all of the Series B and Series C Preferred stock from the Treasury for a total of $8,126,965, which includes the redemption amount of $8,085,000 plus accrued but unpaid dividends of $41,965. The repurchase of the Preferred shares terminated the Company’s continuing obligations under the Purchase Agreement.

 

28

 

11.          Fair Value Measurement

 

The Company measures fair value under the fair value hierarchy described below.

 

Level 1: Quoted prices for identical instruments traded in active exchange markets.

 

Level 2: Quoted prices (unadjusted) for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active and model-based valuation techniques for which all significant assumptions are observable or can be corroborated by observable market data.

 

Level 3: Model based techniques that use one significant assumption not observable in the market. These unobservable assumptions reflect the Company’s estimates of assumptions that market participants would use on pricing the asset or liability. Valuation techniques include management judgment and estimation which may be significant.

 

In certain cases, the inputs used to measure fair value may fall into different levels of the fair value hierarchy. In such cases, the level in the fair value hierarchy within which the fair value measurement in its entirety falls has been determined based on the lowest level input that is significant to the fair value measurement in its entirety. The Company’s assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment, and considers factors specific to the asset or liability.

 

Management monitors the availability of observable market data to assess the appropriate classification of financial instruments within the fair value hierarchy. Changes in economic conditions or model-based valuation techniques may require the transfer of financial instruments from one fair value level to another. In such instances, the transfer is reported at the beginning of the reporting period.

 

Management evaluates the significance of transfers between levels based upon the nature of the financial instrument and size of the transfer relative to total assets, total liabilities or total earnings.

 

Assets and liabilities measured at fair value on a recurring basis as of June 30, 2012 and December 31, 2011 are summarized below:

 

   June 30, 2012 
Description  Fair Value   Level 1   Level 2   Level 3 
                 
Available-for-sale investment securities                    
Debt securities:                    
      U.S. Government sponsored entities and agencies  $6,531,000   $   $6,531,000   $ 
Mortgage-backed securities:                    
      U.S. Government sponsored agencies – residential   19,130,000        19,130,000     
      Small Business Administration   11,607,000        11,607,000     
Obligations of states and political subdivisions   19,881,000        19,881,000     
             Total assets measured at fair value  $57,149,000   $   $57,149,000   $ 

 

   December 31, 2011 
Description  Fair Value   Level 1   Level 2   Level 3 
                 
Available-for-sale investment securities                    
Debt securities:                    
      U.S. Government sponsored entities and agencies  $6,038,000   $   $6,038,000   $ 
Mortgage-backed securities:                    
      U.S. Government sponsored agencies – residential   18,017,000        18,017,000     
      Small Business Administration   12,630,000        12,630,000     
Obligations of states and political subdivisions   20,020,000        20,020,000     
             Total assets measured at fair value  $56,705,000   $   $56,705,000   $ 

 

29
Index

11.          FAIR VALUE MEASUREMENT (Continued)

During the six month period ended June 30, 2012 and year ended December 31, 2011, there were no transfers in or out of Levels 1, 2, or 3.

 

The fair value of investment securities available for sale equals quoted market price, if available. If quoted market prices for identical securities are not available then fair value are estimated by independent sources using pricing models and/or quoted prices of investment securities with similar characteristics or discounted cash flows. The Company has categorized all of its investment securities available-for-sale as level 2, since U.S. Agency MBS are mainly priced in this manner. Changes in fair market value are recorded in other comprehensive income.

 

The Company had no liabilities measured at fair value on a recurring basis as of June 30, 2012 or December 31, 2011.

 

Assets measured at fair value on a non-recurring basis as of June 30, 2012 and December 31, 2011 are summarized below:

 

  Fair Value Measurements at June 30, 2012 Using 
     Quoted Prices in   Significant Other    Significant     
     Active Markets for   Observable    Unobservable     
     Identical Assets   Inputs   Inputs    Total Gains 
  Total Fair Value   (Level 1)   (Level 2)   (Level 3)   (Losses) 
Assets:                    
Impaired loans:                         
Commercial  $753,775   $   $   $753,775   $(101,000)
Real estate – mortgage   2,755,501            2,755,501    (83,000)
Real estate – construction   602,000            602,000    (98,000)
Consumer and other                   (95,000)
Other real estate owned   1,505,000            1,505,000     
   $5,616,276   $   $   $5,616,276   $(377,000)

 

 

  Fair Value Measurements at December 31, 2011 Using 
     Quoted Prices in   Significant Other    Significant     
     Active Markets for   Observable    Unobservable     
     Identical Assets   Inputs   Inputs    Total Gains 
  Total Fair Value   (Level 1)   (Level 2)   (Level 3)   (Losses) 
Assets:                         
Impaired loans: