10-Q 1 v386007_10q.htm FORM 10-Q

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

 

(Mark One)

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

 

For the quarterly period ended June 30, 2014

OR

¨ 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                                                      000-13232                                               

Juniata Valley Financial Corp.
(Exact name of registrant as specified in its charter)

 

Pennsylvania 23-2235254
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
   
Bridge and Main Streets, Mifflintown, Pennsylvania 17059
(Address of principal executive offices) (Zip Code)

 

(717) 436-8211
(Registrant’s telephone number, including area code)

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

 x  Yes               ¨ No

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).                                                                                                                            x  Yes               ¨ 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  x
Non-accelerated filer    ¨ (Do not check if a smaller reporting company) Smaller reporting company  ¨

 

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

¨  Yes  x  No

 

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

 

Class   Outstanding as of August 8, 2014
Common Stock ($1.00 par value)   4,190,107 shares

 

 
 

 

TABLE OF CONTENTS

 

PART I - FINANCIAL INFORMATION

 

Item 1. Financial Statements  
     
  Consolidated Statements of Financial Condition as of June 30, 2014 and December 31, 2013 (Unaudited) 3
     
  Consolidated Statements of Income for the Three and Six  Months Ended June 30, 2014 and 2013 (Unaudited) 4
     
  Consolidated Statements of Comprehensive Income (Loss) for the Three and Six  Months Ended June 30, 2014 and 2013 (Unaudited) 5
     
  Consolidated Statements of Stockholders’ Equity  for the Six Months Ended June 30, 2014 and 2013 (Unaudited) 6
     
  Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2014 and 2013 (Unaudited) 7
     
  Notes to Consolidated Financial Statements (Unaudited) 8
     
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations 30
     
Item 3. Quantitative and Qualitative Disclosures about Market Risk 41
     
Item 4. Controls and Procedures 42
     
  PART II - OTHER INFORMATION  
     
Item 1. Legal Proceedings 43
     
Item 1A. Risk Factors 43
     
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 43
     
Item 3. Defaults upon Senior Securities 44
     
Item 4. Mine Safety Disclosures 44
     
Item 5. Other Information 44
     
Item 6. Exhibits 44
     
  Signatures

 

2
 

 

PART I - FINANCIAL INFORMATION

Item 1. Financial Statements

 

 

Juniata Valley Financial Corp. and Subsidiary

Consolidated Statements of Financial Condition

( Unaudited, in thousands, except share data)

 

   June 30,   December 31, 
   2014   2013 
ASSETS          
Cash and due from banks  $8,617   $8,570 
Interest bearing deposits with banks   40    43 
Cash and cash equivalents   8,657    8,613 
Interest bearing time deposits with banks   249    249 
Securities available for sale   154,198    126,046 
Restricted investment in Federal Home Loan Bank (FHLB) stock   2,621    1,967 
Investment in unconsolidated subsidiary   4,250    4,172 
Total loans   278,344    277,798 
Less: Allowance for loan losses   (2,358)   (2,287)
Total loans, net of allowance for loan losses   275,986    275,511 
Premises and equipment, net   6,162    6,330 
Other real estate owned   381    281 
Bank owned life insurance and annuities   14,601    14,848 
Investment in low income housing partnership   4,086    3,990 
Core deposit intangible   97    119 
Goodwill   2,046    2,046 
Mortgage servicing rights   175    167 
Accrued interest receivable and other assets   4,616    4,443 
Total assets  $478,125   $448,782 
LIABILITIES AND STOCKHOLDERS' EQUITY          
Liabilities:          
Deposits:          
Non-interest bearing  $78,138   $74,611 
Interest bearing   315,191    305,034 
Total deposits   393,329    379,645 
Securities sold under agreements to repurchase   3,561    5,397 
Short-term borrowings   2,500    8,400 
Long-term debt   22,500    - 
Other interest bearing liabilities   1,381    1,356 
Accrued interest payable and other liabilities   3,808    4,000 
Total liabilities   427,079    398,798 
Stockholders' Equity:          
Preferred stock, no par value:          
Authorized - 500,000 shares, none issued   -    - 
Common stock, par value $1.00 per share:          
Authorized - 20,000,000 shares          
Issued - 4,745,826 shares          
Outstanding -          
4,190,107 shares at June 30, 2014;          
4,196,266 shares at December 31, 2013   4,746    4,746 
Surplus   18,385    18,370 
Retained earnings   39,337    39,118 
Accumulated other comprehensive loss   (725)   (1,659)
Cost of common stock in Treasury:          
555,719 shares at June 30, 2014;          
549,560 shares at December 31, 2013   (10,697)   (10,591)
Total stockholders' equity   51,046    49,984 
Total liabilities and stockholders' equity  $478,125   $448,782 

 

See Notes to Consolidated Financial Statements

 

3
 

 

Juniata Valley Financial Corp. and Subsidiary

Consolidated Statements of Income

(Unaudited, in thousands, except share and per share data)

 

   Three Months Ended   Six Months Ended 
   June 30,   June 30, 
   2014   2013   2014   2013 
Interest income:                    
Loans, including fees  $3,662   $3,707   $7,212   $7,397 
Taxable securities   535    312    890    609 
Tax-exempt securities   126    147    256    298 
Other interest income   2    7    3    13 
Total interest income   4,325    4,173    8,361    8,317 
Interest expense:                    
Deposits   608    736    1,229    1,493 
Securities sold under agreements to repurchase   1    1    2    2 
Short-term borrowings   1    -    2    - 
Long-term debt   69    -    69    - 
Other interest bearing liabilities   4    4    8    9 
Total interest expense   683    741    1,310    1,504 
Net interest income   3,642    3,432    7,051    6,813 
Provision for loan losses   117    86    137    166 
Net interest income after provision for loan losses   3,525    3,346    6,914    6,647 
Non-interest income:                    
Customer service fees   290    310    558    620 
Debit card fee income   215    205    418    399 
Earnings on bank-owned life insurance and annuities   94    108    191    205 
Trust fees   131    85    207    174 
Commissions from sales of non-deposit products   88    103    200    219 
Income from unconsolidated subsidiary   57    50    94    104 
Fees derived from loan activity   32    52    70    112 
Gain on sales of loans   56    85    85    181 
Gain on sales and calls of securities   2    -    7    1 
Gain from life insurance proceeds   165    -    165    - 
Other non-interest income   40    57    95    117 
Total non-interest income   1,170    1,055    2,090    2,132 
Non-interest expense:                    
Employee compensation expense   1,497    1,387    2,849    2,610 
Employee benefits   363    384    766    846 
Occupancy   237    240    519    485 
Equipment   116    114    230    234 
Data processing expense   370    361    750    715 
Director compensation   51    56    108    113 
Professional fees   99    91    198    186 
Taxes, other than income   77    119    184    242 
FDIC Insurance premiums   74    82    155    172 
Loss (gain) on sales of other real estate owned   29    (8)   11    (34)
Amortization of intangibles   11    11    22    22 
Amortization of investment in low-income housing partnership   119    145    239    145 
Other non-interest expense   358    348    706    629 
Total non-interest expense   3,401    3,330    6,737    6,365 
Income before income taxes   1,294    1,071    2,267    2,414 
Provision for income taxes   131    62    201    399 
Net income  $1,163   $1,009   $2,066   $2,015 
Earnings per share                    
Basic  $0.28   $0.24   $0.49   $0.48 
Diluted  $0.28   $0.24   $0.49   $0.48 
Cash dividends declared per share  $0.22   $0.22   $0.44   $0.44 
Weighted average basic shares outstanding   4,195,491    4,218,206    4,195,876    4,218,283 
Weighted average diluted shares outstanding   4,195,749    4,219,606    4,196,136    4,219,570 

 

See Notes to Consolidated Financial Statements

 

4
 

 

Juniata Valley Financial Corp. and Subsidiary

Consolidated Statements of Comprehensive Income (Loss)

(Unaudited, in thousands)

 

   Three Months Ended June 30, 2014   Three Months Ended June 30, 2013 
   Before       Net of   Before       Net of 
   Tax   Tax   Tax   Tax   Tax   Tax 
   Amount   Effect   Amount   Amount   Effect   Amount 
Net income  $1,294   $(131)  $1,163   $1,071   $(62)  $1,009 
Other comprehensive income (loss):                              
                               
Unrealized gains (losses) on available for sale securities:                              
                               
Unrealized holding gains (losses) arising during the period   832    (283)   549    (2,215)   754    (1,461)
Unrealized holding gains (losses) from unconsolidated subsidiary   4    -    4    (11)   -    (11)
Less reclassification adjustment for gains included in net income (1) (3)   (2)   -    (2)   -    -    - 
                               
Amortization of pension net actuarial cost (2) (3)   10    (3)   7    51    (17)   34 
                               
Other comprehensive income (loss)   844    (286)   558    (2,175)   737    (1,438)
                               
Total comprehensive income (loss)  $2,138   $(417)  $1,721   $(1,104)  $675   $(429)

 

   Six Months Ended June 30, 2014   Six Months Ended June 30, 2013 
   Before       Net of   Before       Net of 
   Tax   Tax   Tax   Tax   Tax   Tax 
   Amount   Effect   Amount   Amount   Effect   Amount 
Net income  $2,267   $(201)  $2,066   $2,414   $(399)  $2,015 
Other comprehensive income (loss):                              
                               
Unrealized gains (losses) on available for sale securities:                              
                               
Unrealized holding gains (losses) arising during the period   1,387    (471)   916    (2,254)   768    (1,486)
Unrealized holding gains (losses) from unconsolidated subsidiary   10    -    10    (16)   -    (16)
Less reclassification adjustment for gains included in net income (1) (3)   (7)   2    (5)   (1)   -    (1)
                               
Amortization of pension net actuarial cost (2) (3)   20    (7)   13    102    (35)   67 
                               
Other comprehensive income (loss)   1,410    (476)   934    (2,169)   733    (1,436)
                               
Total comprehensive income  $3,677   $(677)  $3,000   $245   $334   $579 

 

See Notes to Consolidated Financial Statements

 

(1)Amounts are included in gain on calls of securities on the Consolidated Statements of Income as a separate element within total non-interest income.
(2)Amounts are included in the computation of net periodic benefit cost and are included in employee benefits expense on the Consolidated Statements of Income as a separate element within total non-interest expense.
(3)Income tax amounts are included in the provision for income taxes on the Consolidated Statements of Income.

 

5
 

 

Juniata Valley Financial Corp. and Subsidiary

Consolidated Statements of Stockholders' Equity

(Unaudited, in thousands, except share data) 

Six Months Ended June 30, 2014
                             
   Number               Accumulated         
   of               Other       Total 
   Shares   Common       Retained   Comprehensive   Treasury   Stockholders' 
   Outstanding   Stock   Surplus   Earnings   Loss   Stock   Equity 
Balance at January 1, 2014   4,196,266   $4,746   $18,370   $39,118   $(1,659)  $(10,591)  $49,984 
Net income                  2,066              2,066 
Other comprehensive income                       934         934 
Cash dividends at $0.44 per share                  (1,847)             (1,847)
Stock-based compensation             23                   23 
Purchase of treasury stock   (9,656)                       (173)   (173)
Treasury stock issued for  stock purchase plans   3,497         (8)             67    59 
                                    
Balance at June 30, 2014   4,190,107   $4,746   $18,385   $39,337   $(725)  $(10,697)  $51,046 

 

Six Months Ended June 30, 2013
                             
   Number               Accumulated         
   of               Other       Total 
   Shares   Common       Retained   Comprehensive   Treasury   Stockholders' 
   Outstanding   Stock   Surplus   Earnings   Loss   Stock   Equity 
Balance at January 1, 2013   4,218,361   $4,746   $18,346   $38,824   $(1,419)  $(10,200)  $50,297 
Net income                  2,015              2,015 
Other comprehensive loss                       (1,436)        (1,436)
Cash dividends at $0.44 per share                  (1,857)             (1,857)
Stock-based compensation             14                   14 
Purchase of treasury stock   (6,000)                       (108)   (108)
Treasury stock issued for  stock purchase plans   2,823         (6)             54    48 
                                    
Balance at June 30, 2013   4,215,184   $4,746   $18,354   $38,982   $(2,855)  $(10,254)  $48,973 

 

See Notes to Consolidated Financial Statements

 

6
 

 

Juniata Valley Financial Corp. and Subsidiary

Consolidated Statements of Cash Flows

(Unaudited, in thousands)

 

   Six Months Ended June 30, 
   2014   2013 
Operating activities:          
Net income  $2,066   $2,015 
Adjustments to reconcile net income to net cash provided by operating activities:          
Provision for loan losses   137    166 
Depreciation   240    255 
Net amortization of securities premiums   266    222 
Net amortization of loan origination (fees) costs   (16)   35 
Deferred net loan origination costs   (52)   (38)
Amortization of core deposit intangible   22    22 
Amortization of investment in low income housing partnership   239    145 
Net realized gain on calls and sales of securities   (7)   (1)
Net loss (gain) on sales of other real estate owned   11    (34)
Earnings on bank owned life insurance and annuities   (191)   (205)
Deferred income tax expense   48    230 
Equity in earnings of unconsolidated subsidiary, net of dividends of $27 and $25   (67)   (79)
Stock-based compensation expense   23    14 
Mortgage loans originated for sale   (1,325)   (5,952)
Proceeds from loans sold to others   1,402    5,709 
Gains on sales of loans   (85)   (181)
Gain from life insurance proceeds   (165)   - 
(Increase) decrease in accrued interest receivable and other assets   (678)   147 
Decrease in accrued interest payable and other liabilities   (148)   (500)
Net cash provided by operating activities   1,720    1,970 
Investing activities:          
Purchases of:          
Securities available for sale   (52,832)   (34,280)
FHLB stock   (654)   (7)
Premises and equipment   (72)   (40)
Bank owned life insurance and annuities   (35)   (43)
Proceeds from:          
Sales of securities available for sale   7,120    - 
Maturities of and principal repayments on securities available for sale   18,681    25,042 
Bank owned life insurance and annuities   4    4 
Life insurance claim   615    - 
Sale of other real estate owned   167    423 
Sale of other assets   -    18 
Investment in low income housing partnership   (335)   (317)
Net (increase) decrease in loans   (822)   1,075 
Net cash used in investing activities   (28,163)   (8,125)
Financing activities:          
Net increase in deposits   13,684    3,965 
Net change in short-term borrowings and securities sold under agreements to repurchase   (7,736)   (1,081)
Issuance of long-term debt   22,500    - 
Cash dividends   (1,847)   (1,857)
Purchase of treasury stock   (173)   (108)
Treasury stock issued for employee stock plans   59    48 
Net cash provided by financing activities   26,487    967 
Net increase (decrease) in cash and cash equivalents   44    (5,188)
Cash and cash equivalents at beginning of year   8,613    14,397 
Cash and cash equivalents at end of period  $8,657   $9,209 
Supplemental information:          
Interest paid  $1,277   $1,546 
Income taxes paid   50    695 
Supplemental schedule of noncash investing and financing activities:          
Transfer of loans to other real estate owned  $278   $78 
Transfer of loans to other assets   -    18 

 

See Notes to Consolidated Financial Statements

 

7
 

 

JUNIATA VALLEY FINANCIAL CORP. AND SUBSIDIARY

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

 

1. Basis of Presentation and Accounting Policies

 

The consolidated financial statements include the accounts of Juniata Valley Financial Corp. (the “Company”) and its wholly owned subsidiary, The Juniata Valley Bank (the “Bank”). All significant intercompany accounts and transactions have been eliminated.

 

The accompanying unaudited consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles for interim financial information. Accordingly, they do not include all of the information and footnotes required by U.S. generally accepted accounting principles (U.S. GAAP) for complete consolidated financial statements. In the opinion of management, all adjustments considered necessary for fair presentation have been included. Operating results for the three month and six month periods ended June 30, 2014 are not necessarily indicative of the results for the year ending December 31, 2014. For further information, refer to the consolidated financial statements and notes thereto included in Juniata Valley Financial Corp.’s Annual Report on Form 10-K for the year ended December 31, 2013.

 

The Company has evaluated events and transactions occurring subsequent to the consolidated statement of financial condition date of June 30, 2014 for items that should potentially be recognized or disclosed in these consolidated financial statements. The evaluation was conducted through the date these consolidated financial statements were issued.

 

2. Recent Accounting Standards Updates (ASU)

 

Accounting Standards Update 2014-01, Investments – Equity Method and Joint Ventures (Topic 323): Accounting for Investments in Qualified Affordable Housing Projects (a consensus of the FASB Emerging Issues Task Force)

Issued: January 2014

Summary:  The Low Income Housing Tax Credit is a program designed to encourage investment of private capital for use in the construction and rehabilitation of low income housing, which provides certain tax benefits to investors in those projects.  The amendments in this Update permit a reporting entity that invests in qualified affordable housing projects to account for the investments using a proportional amortization method if certain conditions are met.  If an entity elects the proportional amortization method, it will amortize the initial cost of the investment in proportion to the tax credits and other tax benefits received and recognize the net investment performance in the income statement as a component of income tax expense.  Otherwise, the entity would apply either the equity method or the cost method, as appropriate.

Effective Date and Transition:  The amendments in this Update are effective for public business entities for annual periods and interim reporting periods within those annual periods, beginning after December 15, 2014. Early adoption is permitted.  If adopted, the amendments should be applied retrospectively to all periods presented.  A reporting entity that uses the effective yield method to account for its investments in qualified affordable housing projects before the date of adoption may continue to apply the effective yield method for those preexisting investments. The Company is currently evaluating the impact of this Update on its consolidated financial statements.

 

8
 

 

Accounting Standards Update 2014-04, Receivables – Troubled Debt Restructurings by Creditors (Subtopic 310-40): Reclassification of Residential Real Estate Collateralized Consumer Mortgage Loans upon Foreclosure (a consensus of the FASB Emerging Issues Task Force)

Issued: January 2014

Summary:  The Update clarifies that when an in substance repossession or foreclosure occurs, and a creditor is considered to have received physical possession of residential real estate property collateralizing a consumer mortgage loan, upon either (1) the creditor obtaining legal title to the residential real estate property upon completion of a foreclosure or (2) the borrower conveying all interest in the residential real estate property to the creditor to satisfy that loan through completion of a deed in lieu of foreclosure or through a similar legal agreement.

Effective Date and Transition:  The Amendments in this Update are effective for public business entities for annual periods and interim periods within those annual periods, beginning after December 15, 2014. Early adoption is permitted. If adopted, an entity can elect to adopt the amendments in this update using either a modified retrospective transition method or a prospective transition method. The Company is evaluating the effects this Update will have on its consolidated financial condition or results of operation.

 

3. Accumulated other Comprehensive loss

 

Components of accumulated other comprehensive loss, net of tax consisted of the following (in thousands):

 

   6/30/2014  12/31/2013
           
Unrealized gains (losses) on available for sale securities  $170   $(751)
           
Unrecognized expense for defined benefit pension   (895)   (908)
           
Accumulated other comprehensive loss  $(725)  $(1,659)

 

4. Earnings Per Share

 

Basic earnings per share (EPS) is computed by dividing net income by the weighted average number of common shares outstanding for the period. Diluted EPS reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock or resulted in the issuance of common stock that then shared in the earnings of the Company. Potential common shares that may be issued by the Company relate solely to outstanding stock options and are determined using the treasury stock method. The following table sets forth the computation of basic and diluted earnings per share:

 

(Amounts, except earnings per share, in thousands) 
         
   Three Months   Three Months 
   Ended   Ended 
   June 30, 2014   June 30, 2013 
         
Net income  $1,163   $1,009 
Weighted-average common shares outstanding   4,195    4,218 
Basic earnings per share  $0.28   $0.24 
           
Weighted-average common shares outstanding   4,195    4,218 
Common stock equivalents due to effect of stock options   1    2 
Total weighted-average common shares and equivalents   4,196    4,220 
Diluted earnings per share  $0.28   $0.24 

 

   Six Months   Six Months 
   Ended   Ended 
   June 30, 2014   June 30, 2013 
         
Net income  $2,066   $2,015 
Weighted-average common shares outstanding   4,196    4,218 
Basic earnings per share  $0.49   $0.48 
           
Weighted-average common shares outstanding   4,196    4,218 
Common stock equivalents due to effect of stock options   -    2 
Total weighted-average common shares and equivalents   4,196    4,220 
Diluted earnings per share  $0.49   $0.48 

 

9
 

 

5.   Securities

 

The Company’s investment portfolio includes primarily bonds issued by U.S. Government sponsored agencies (approximately 42%), mortgage-backed securities issued by Government-sponsored agencies and backed by residential mortgages (approximately 31%) and municipal bonds (approximately 26%) as of June 30, 2014. Most of the municipal bonds are general obligation bonds with maturities or pre-refunding dates within 5 years. The remaining 1% of the portfolio includes and a group of equity investments in other financial institutions.

 

The amortized cost and fair value of securities as of June 30, 2014 and December 31, 2013, by contractual maturity, are shown below (in thousands). Expected maturities may differ from contractual maturities because the securities may be called or prepaid with or without prepayment penalties.

 

   June 30, 2014 
Securities Available for Sale          Gross   Gross 
   Amortized   Fair   Unrealized   Unrealized 
Type and maturity  Cost   Value   Gains   Losses 
Obligations of U.S. Government agencies and corporations                    
Within one year  $2,024   $2,042   $18   $- 
After one year but within five years   50,647    50,283    164    (528)
After five years but within ten years   12,516    12,267    5    (254)
    65,187    64,592    187    (782)
Obligations of state and political subdivisions                    
Within one year   8,817    8,854    37    - 
After one year but within five years   23,123    23,252    152    (23)
After five years but within ten years   7,233    7,342    121    (12)
After ten years   345    340    -    (5)
    39,518    39,788    310    (40)
                     
Mortgage-backed securities   48,196    48,352    213    (57)
Equity securities   1,055    1,466    442    (31)
Total  $153,956   $154,198   $1,152   $(910)

 

   December 31, 2013 
Securities Available for Sale          Gross   Gross 
   Amortized   Fair   Unrealized   Unrealized 
Type and maturity  Cost   Value   Gains   Losses 
Obligations of U.S. Government agencies and corporations                    
Within one year  $4,177   $4,192   $15   $- 
After one year but within five years   48,011    47,578    203    (636)
After five years but within ten years   27,615    26,508    -    (1,107)
    79,803    78,278    218    (1,743)
Obligations of state and political subdivisions                    
Within one year   8,260    8,314    55    (1)
After one year but within five years   26,027    26,098    133    (62)
After five years but within ten years   7,224    7,182    56    (98)
After ten years   350    338    -    (12)
    41,861    41,932    244    (173)
                     
Mortgage-backed securities   4,465    4,469    7    (3)
Equity securities   1,055    1,367    366    (54)
Total  $127,184   $126,046   $835   $(1,973)

 

Certain obligations of the U.S. Government and state and political subdivisions are pledged to secure public deposits, securities sold under agreements to repurchase and for other purposes as required or permitted by law. The carrying value of the pledged assets was $28,941,000 and $31,921,000 at June 30, 2014 and December 31, 2013, respectively.

 

10
 

 

In addition to cash received from the scheduled maturities of securities, some investment securities available for sale are sold or called at current market values during the course of normal operations.

 

Following is a summary of proceeds received from sales or calls of investment securities transactions and the resulting realized gains and losses (in thousands):

 

   Three Months Ended   Six Months Ended 
   June 30,   June 30, 
   2014   2013   2014   2013 
Gross proceeds from sales of securities  $4,970   $-   $7,120   $- 
Securities available for sale:                    
Gross realized gains from sold and called securities  $2   $-   $7   $1 
Gross realized losses from sold and called securities   -    -    -    - 

 

Accounting Standards Codification (ASC) Topic 320, Investments – Debt and Equity Securities, clarifies the interaction of the factors that should be considered when determining whether a debt security is other-than-temporarily impaired. For debt securities, management must assess whether (a) it has the intent to sell the security and (b) it is more likely than not that it will be required to sell the security prior to its anticipated recovery. These steps are taken before an assessment is made as to whether the entity will recover the cost basis of the investment. For equity securities, consideration is given to management’s intention and ability to hold the securities until recovery of unrealized losses in assessing potential other-than-temporary impairment. More specifically, factors considered to determine other-than-temporary impairment status for individual equity holdings include the length of time the stock has remained in an unrealized loss position, the percentage of unrealized loss compared to the carrying cost of the stock, dividend reduction or suspension, market analyst reviews and expectations, and other pertinent factors that would affect expectations for recovery or further decline.

 

In instances when a determination is made that an other-than-temporary impairment exists and the entity does not intend to sell the debt security and it is not more likely than not that it will be required to sell the debt security prior to its anticipated recovery, the other-than-temporary impairment is separated into the amount of the total other-than-temporary impairment related to a decrease in cash flows expected to be collected from the debt security (the credit loss) and the amount of the total other-than-temporary impairment related to all other factors. The amount of the total other-than-temporary impairment related to the credit loss is recognized in earnings. The amount of the total other-than-temporary impairment related to all other factors is recognized in other comprehensive (loss) income.

 

The following table shows gross unrealized losses and fair value, aggregated by category and length of time that individual securities have been in a continuous unrealized loss position, at June 30, 2014 and December 31, 2013 (in thousands):

 

   Unrealized Losses at June 30, 2014 
   Less Than 12 Months   12 Months or More   Total 
   Fair   Unrealized   Fair   Unrealized   Fair   Unrealized 
   Value   Losses   Value   Losses   Value   Losses 
Obligations of U.S. Government agencies and corporations  $6,006   $(19)  $36,334   $(763)  $42,340   $(782)
Obligations of state and political subdivisions   3,859    (9)   4,823    (31)   8,682    (40)
Mortgage-backed securities   11,008    (56)   96    (1)   11,104    (57)
Debt securities   20,873    (84)   41,253    (795)   62,126    (879)
                               
Equity securities   -    -    283    (31)   283    (31)
                               
Total temporarily impaired securities  $20,873   $(84)  $41,536   $(826)  $62,409   $(910)
11
 

 

   Unrealized Losses at December 31, 2013 
   Less Than 12 Months   12 Months or More   Total 
   Fair   Unrealized   Fair   Unrealized   Fair   Unrealized 
   Value   Losses   Value   Losses   Value   Losses 
Obligations of U.S. Government agencies and corporations  $53,438   $(1,664)  $1,921   $(79)  $55,359   $(1,743)
Obligations of state and political subdivisions   11,496    (130)   4,301    (43)   15,797    (173)
Mortgage-backed securities   308    (3)   -    -    308    (3)
Debt securities   65,242    (1,797)   6,222    (122)   71,464    (1,919)
                               
Equity securities   -    -    266    (54)   266    (54)
                               
Total temporarily impaired securities  $65,242   $(1,797)  $6,488   $(176)  $71,730   $(1,973)

 

At June 30, 2014, 33 U.S. Government agency and corporations securities had unrealized losses that, in the aggregate, totaled 1.8% of amortized cost. Twenty-eight of these securities have been in a continuous loss position for 12 months or more.

 

At June 30, 2014, 23 obligations of state and political subdivisions had unrealized losses that, in the aggregate, totaled 0.5% of amortized cost. Twelve of these securities have been in a continuous loss position for 12 months or more.

 

At June 30, 2014, five mortgage-backed securities had an unrealized loss that totaled 0.5% of amortized cost. One of these securities has been in a continuous loss position for 12 months or more.

 

The mortgage-backed securities in the Company’s portfolio are government sponsored enterprise (GSE) pass-through instruments issued by the Federal National Mortgage Association (FNMA) or Federal Home Loan Mortgage Corporation (FHLMC), which guarantees the timely payment of principal on these investments.

 

The unrealized losses noted above are considered to be temporary impairments. The decline in the values of the debt securities is due only to interest rate fluctuations, rather than erosion of issuer credit quality. As a result, the payment of contractual cash flows, including principal repayment, is not at risk. As the Company does not intend to sell the securities, does not believe the Company will be required to sell the securities before recovery and expects to recover the entire amortized cost basis, none of the debt securities are deemed to be other-than-temporarily impaired.

 

Equity securities owned by the Company consist of common stock of various financial services providers and are evaluated quarterly for evidence of other-than-temporary impairment. There were four equity securities that were in an unrealized loss position on June 30, 2014, and have carried unrealized losses for 12 months or more. Individually, none of these four equity securities have significant unrealized losses. All of these securities have increased in fair value in the preceding twelve months, and therefore are deemed to be temporarily impaired. Management has identified no other-than-temporary impairment as of, or for the periods ended June 30, 2014, June 30, 2013 and December 31, 2013 in the equity portfolio. Management continues to track the performance of each stock owned to determine if it is prudent to deem any further other-than-temporary impairment charges. The Company has the ability and intent to hold its equity securities until recovery of unrealized losses.

 

12
 

 

6. Loans and Related Allowance for Credit Losses

 

Loans that the Company has the intent and ability to hold for the foreseeable future or until maturity or payoff are stated at the outstanding unpaid principal balances, net of any deferred fees or costs and the allowance for loan losses. Interest income on all loans, other than nonaccrual loans, is accrued over the term of the loans based on the amount of principal outstanding. Unearned income is amortized to income over the life of the loans, using the interest method.

 

The loan portfolio is segmented into commercial and consumer loans. Commercial loans are comprised of the following classes of loans: (1) commercial, financial and agricultural, (2) commercial real estate, (3) real estate construction, a portion of (4) mortgage loans and (5) obligations of states and political subdivisions. Consumer loans are comprised of a portion of (4) mortgage loans and (6) personal loans.

 

Loans on which the accrual of interest has been discontinued are designated as non-accrual loans. Accrual of interest on loans is generally discontinued when the contractual payment of principal or interest has become 90 days past due or reasonable doubt exists as to the full, timely collection of principal or interest. However, it is the Company’s policy to continue to accrue interest on loans over 90 days past due as long as (1) they are guaranteed or well secured and (2) there is an effective means of timely collection in process. When a loan is placed on non-accrual status, all unpaid interest credited to income in the current year is reversed against current period income, and unpaid interest accrued in prior years is charged against the allowance for loan losses. Interest received on nonaccrual loans generally is either applied against principal or reported as interest income, according to management’s judgment as to the collectability of principal. Generally, accruals are resumed on loans only when the obligation is brought fully current with respect to interest and principal, has performed in accordance with the contractual terms for a reasonable period of time and the ultimate collectability of the total contractual principal and interest is no longer in doubt.

 

The Company originates loans in the portfolio with the intent to hold them until maturity. At the time the Company no longer intends to hold loans to maturity based on asset/liability management practices, the Company transfers loans from its portfolio to held for sale at fair value. Any write-down recorded upon transfer is charged against the allowance for loan losses. Any write-downs recorded after the initial transfers are recorded as a charge to other non-interest expense. Gains or losses recognized upon sale are included in gains on sales of loans which is a component of non-interest income.

 

The Company also originates residential mortgage loans with the intent to sell. These individual loans are normally funded by the buyer immediately. The Company maintains servicing rights on these loans. Mortgage servicing rights are recognized as an asset upon the sale of a mortgage loan. A portion of the cost of the loan is allocated to the servicing right based upon relative fair value. Servicing rights are intangible assets and are carried at estimated fair value. Adjustments to fair value are recorded as non-interest income and included in gain on sales of loans in the consolidated statements of income.

 

The allowance for credit losses consists of the allowance for loan losses and the reserve for unfunded lending commitments. The allowance for loan losses (“allowance”) represents management’s estimate of losses inherent in the loan portfolio as of the consolidated statement of financial condition date and is recorded as a reduction to loans. The reserve for unfunded lending commitments represents management’s estimate of losses inherent in its unfunded lending commitments and is recorded in other liabilities on the consolidated statement of financial condition, when necessary. The amount of the reserve for unfunded lending commitments is not material to the consolidated financial statements. The allowance for loan losses is increased by the provision for loan losses, and decreased by charge-offs, net of recoveries. Loans deemed to be uncollectible are charged against the allowance for loan losses, and subsequent recoveries, if any, are credited to the allowance.

 

For financial reporting purposes, the provision for loan losses charged to current operating income is based on management's estimates, and actual losses may vary from estimates. These estimates are reviewed and adjusted at least quarterly and are reported in earnings in the periods in which they become known.

 

13
 

 

Loans included in any class are considered for charge-off when:

 

·principal or interest has been in default for 120 days or more and for which no payment has been received during the previous four months;
·all collateral securing the loan has been liquidated and a deficiency balance remains;
·a bankruptcy notice is received for an unsecured loan;
·a confirming loss event has occurred; or
·the loan is deemed to be uncollectible for any other reason.

 

The allowance for loan losses is maintained at a level considered adequate to offset probable losses on the Company’s existing loans. The analysis of the allowance for loan losses relies heavily on changes in observable trends that may indicate potential credit weaknesses. Management’s periodic evaluation of the adequacy of the allowance is based on the Company’s past loan loss experience, known and inherent risks in the portfolio, adverse situations that may affect the borrower’s ability to repay, the estimated value of any underlying collateral, composition of the loan portfolio, current economic conditions and other relevant factors. This evaluation is inherently subjective as it requires material estimates that may be susceptible to significant revision as more information becomes available.

 

In addition, regulatory agencies, as an integral part of their examination process, periodically review the Company’s allowance for loan losses and may require the Company to recognize additions to the allowance for loan losses based on their judgments about information available to them at the time of their examination, which may not be currently available to management. Based on management’s comprehensive analysis of the loan portfolio, management believes the level of the allowance for loan losses as of June 30, 2014 was adequate.

 

There are two components of the allowance: a specific component for loans that are deemed to be impaired; and a general component for contingencies.

 

A loan is considered to be impaired when, based on current information and events, it is probable that the Company will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loans and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record and the amount of the shortfall in relation to the principal and interest owed. Impairment is measured on a loan by loan basis by the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s observable market price or the fair value of the collateral if the loan is collateral dependent.

 

The estimated fair values of substantially all of the Company’s impaired loans are measured based on the estimated fair value of the loan’s collateral. For commercial loans secured with real estate, estimated fair values are determined primarily through third-party appraisals. When a real estate secured loan becomes impaired, a decision is made regarding whether an updated certified appraisal of the real estate is necessary. This decision is based on various considerations, including the age of the most recent appraisal, the loan-to-value ratio based on the current appraisal and the condition of the property. Appraised values may be discounted to arrive at the estimated selling price of the collateral, which is considered to be the estimated fair value. The discounts also include the estimated costs to sell the property. For commercial loans secured by non-real estate collateral, estimated fair values are determined based on the borrower’s financial statements, inventory reports, aging accounts receivable, equipment appraisals or invoices. Indications of value from these sources are generally discounted based on the age of the financial information or the quality of the assets. For such loans that are classified as impaired, an allowance is established when the discounted cash flows (or collateral value or observable market price) of the impaired loan is lower than the carrying value of that loan. The Company generally does not separately identify individual consumer segment loans for impairment disclosures, unless such loans are subject to a restructuring agreement.

 

Loans whose terms are modified are classified as troubled debt restructurings if the Company grants borrowers concessions and it is deemed that those borrowers are experiencing financial difficulty. Concessions granted under a troubled debt restructuring generally involve a below-market interest rate based on the loan’s risk characteristics or an extension of a loan’s stated maturity date. Nonaccrual troubled debt restructurings are restored to accrual status if principal and interest payments, under the modified terms, are current for a sustained period of time after modification. Loans classified as troubled debt restructurings are designated as impaired.

 

14
 

 

The component of the allowance for contingencies relates to other loans that have been segmented into risk rated categories. The borrower’s overall financial condition, repayment sources, guarantors and value of collateral, if appropriate, are evaluated quarterly or when credit deficiencies arise, such as delinquent loan payments. Credit quality risk ratings include regulatory classifications of special mention, substandard, doubtful and loss. Loans classified as special mention have potential weaknesses that deserve management’s close attention. If uncorrected, the potential weaknesses may result in deterioration of the repayment prospects. Loans classified as substandard have one or more well-defined weaknesses that jeopardize the liquidation of the debt. Substandard loans include loans that are inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any. Loans classified doubtful have all the weaknesses inherent in loans classified substandard with the added characteristic that collection or liquidation in full, on the basis of current conditions and facts, is highly improbable. Loans classified as a loss are considered uncollectible and are charged to the allowance for loan losses. Loans not classified are rated pass. Specific reserves may be established for larger, individual classified loans as a result of this evaluation, as discussed above. Remaining loans are categorized into large groups of smaller balance homogeneous loans and are collectively evaluated for impairment. This computation is generally based on historical loss experience adjusted for qualitative factors. The historical loss experience is averaged over a ten-year period for each of the portfolio segments. The ten-year timeframe was selected in order to capture activity over a wide range of economic conditions and has been consistently used by the Company for the past seven years. Qualitative risk factors are reviewed for relevancy each quarter and include:

 

·National, regional and local economic and business conditions, as well as the condition of various market segments, including the underlying collateral for collateral dependent loans;
·Nature and volume of the portfolio and terms of loans;
·Experience, ability and depth of lending and credit management and staff;
·Volume and severity of past due, classified and nonaccrual loans, as well as other loan modifications;
·Existence and effect of any concentrations of credit and changes in the level of such concentrations; and
·Effect of external factors, including competition.

 

Each factor is assigned a value to reflect improving, stable or declining conditions based on management’s best judgment using relevant information available at the time of the evaluation. Adjustments to the factors are supported through documentation of changes in conditions in a narrative accompanying the allowance for loan loss calculation.

 

Commercial, Financial and Agricultural Lending

 

The Company originates commercial, financial and agricultural loans primarily to businesses located in its primary market area and surrounding areas. These loans are used for various business purposes, which include short-term loans and lines of credit to finance machinery and equipment purchases, inventory and accounts receivable. Generally, the maximum term for loans extended on machinery and equipment is shorter and does not exceed the projected useful life of such machinery and equipment. Most business lines of credit are written with a five year maturity, subject to an annual credit review.

 

Commercial loans are generally secured with short-term assets; however, in many cases, additional collateral, such as real estate, is provided as additional security for the loan. Loan-to-value maximum values have been established by the Company and are specific to the type of collateral. Collateral values may be determined using invoices, inventory reports, accounts receivable aging reports, collateral appraisals, etc.

 

In underwriting commercial loans, an analysis of the borrower’s character, capacity to repay the loan, the adequacy of the borrower’s capital and collateral, as well as an evaluation of conditions affecting the borrower, is performed. Analysis of the borrower’s past, present and future cash flows is also an important aspect of the Company’s analysis.

 

15
 

 

Concentration analysis assists in identifying industry specific risk inherent in commercial, financial and agricultural lending. Mitigants include the identification of secondary and tertiary sources of repayment and appropriate increases in oversight.

 

Commercial, financial and agricultural loans generally present a higher level of risk than certain other types of loans, particularly during slow economic conditions.

 

Commercial Real Estate Lending

 

The Company engages in commercial real estate lending in its primary market area and surrounding areas. The Company’s commercial real estate portfolio is secured primarily by residential housing, commercial buildings, raw land and hotels. Generally, commercial real estate loans have terms that do not exceed 20 years, have loan-to-value ratios of up to 80% of the appraised value of the property and are typically secured by personal guarantees of the borrowers.

 

As economic conditions deteriorate, the Company reduces its exposure in real estate loans with higher risk characteristics. In underwriting these loans, the Company performs a thorough analysis of the financial condition of the borrower, the borrower’s credit history, and the reliability and predictability of the cash flow generated by the property securing the loan. Appraisals on properties securing commercial real estate loans originated by the Company are performed by independent appraisers.

 

Commercial real estate loans generally present a higher level of risk than certain other types of loans, particularly during slow economic conditions.

 

Real Estate Construction Lending

 

The Company engages in real estate construction lending in its primary market area and surrounding areas. The Company’s real estate construction lending consists of commercial and residential site development loans, as well as commercial building construction and residential housing construction loans.

 

The Company’s commercial real estate construction loans are generally secured with the subject property, and advances are made in conformity with a pre-determined draw schedule supported by independent inspections. Terms of construction loans depend on the specifics of the project, such as estimated absorption rates, estimated time to complete, etc.

 

In underwriting commercial real estate construction loans, the Company performs a thorough analysis of the financial condition of the borrower, the borrower’s credit history, the reliability and predictability of the cash flow generated by the project using feasibility studies, market data, etc. Appraisals on properties securing commercial real estate loans originated by the Company are performed by independent appraisers.

 

Real estate construction loans generally present a higher level of risk than certain other types of loans, particularly during slow economic conditions. The difficulty of estimating total construction costs adds to the risk as well.

 

Mortgage Lending

 

The Company’s real estate mortgage portfolio is comprised of consumer residential mortgages and business loans secured by one-to-four family properties. One-to-four family residential mortgage loan originations, including home equity installment and home equity lines of credit loans, are generated by the Company’s marketing efforts, its present customers, walk-in customers and referrals. These loans originate primarily within the Company’s market area or with customers primarily from the market area.

 

The Company offers fixed-rate and adjustable rate mortgage loans with terms up to a maximum of 25-years for both permanent structures and those under construction. The Company’s one-to-four family residential mortgage originations are secured primarily by properties located in its primary market area and surrounding areas. The majority of the Company’s residential mortgage loans originate with a loan-to-value of 80% or less. Home equity installment loans are secured by the borrower’s primary residence with a maximum loan-to-value of 80% and a maximum term of 15 years. Home equity lines of credit are secured by the borrower’s primary residence with a maximum loan-to-value of 90% and a maximum term of 20 years.

 

16
 

 

In underwriting one-to-four family residential real estate loans, the Company evaluates the borrower’s ability to make monthly payments, the borrower’s repayment history and the value of the property securing the loan. The ability to repay is determined by the borrower’s employment history, current financial conditions, and credit background. The analysis is based primarily on the customer’s ability to repay and secondarily on the collateral or security. Most properties securing real estate loans made by the Company are appraised by independent fee appraisers. The Company generally requires mortgage loan borrowers to obtain an attorney’s title opinion or title insurance, and fire and property insurance (including flood insurance, if necessary) in an amount not less than the amount of the loan. The Company does not engage in sub-prime residential mortgage originations.

 

Residential mortgage loans and home equity loans generally present a lower level of risk than certain other types of consumer loans because they are secured by the borrower’s primary residence. Risk is increased when the Company is in a subordinate position for the loan collateral.

 

Obligations of States and Political Subdivisions

 

The Company lends to local municipalities and other tax-exempt organizations. These loans are primarily tax-anticipation notes and, as such, carry little risk. Historically, the Company has never had a loss on any loan of this type.

 

Personal Lending

 

The Company offers a variety of secured and unsecured personal loans, including vehicle loans, mobile home loans and loans secured by savings deposits as well as other types of personal loans.

 

Personal loan terms vary according to the type and value of collateral and creditworthiness of the borrower. In underwriting personal loans, a thorough analysis of the borrower’s willingness and financial ability to repay the loan as agreed is performed. The ability to repay is determined by the borrower’s employment history, current financial conditions and credit background.

 

Personal loans may entail greater credit risk than do residential mortgage loans, particularly in the case of personal loans which are unsecured or are secured by rapidly depreciable assets, such as automobiles or recreational equipment. In such cases, any repossessed collateral for a defaulted personal loan may not provide an adequate source of repayment of the outstanding loan balance as a result of the greater likelihood of damage, loss or depreciation. In addition, personal loan collections are dependent on the borrower’s continuing financial stability, and thus are more likely to be affected by adverse personal circumstances. Furthermore, the application of various federal and state laws, including bankruptcy and insolvency laws, may limit the amount which can be recovered on such loans.

 

Loan Portfolio Classification

 

The following tables present the classes of the loan portfolio summarized by the aggregate pass rating and the classified ratings of special mention, substandard and doubtful within the Company’s internal risk rating system as of June 30, 2014 and December 31, 2013 (in thousands):

 

As of June 30, 2014  Pass   Special
Mention
   Substandard   Doubtful   Total 
                     
Commercial, financial and agricultural  $17,835   $5,667   $219   $-   $23,721 
Real estate - commercial   64,716    12,806    5,150    1,535    84,207 
Real estate - construction   15,037    454    2,258    525    18,274 
Real estate - mortgage   125,844    5,377    3,664    1,955    136,840 
Obligations of states and political subdivisions   10,879    25    -    -    10,904 
Personal   4,335    63    -    -    4,398 
Total  $238,646   $24,392   $11,291   $4,015   $278,344 

 

17
 

 

As of December 31, 2013  Pass   Special
Mention
   Substandard   Doubtful   Total 
                     
Commercial, financial and agricultural  $20,388   $5,658   $235   $-   $26,281 
Real estate - commercial   56,867    11,706    5,620    278    74,471 
Real estate - construction   15,803    292    1,754    1,832    19,681 
Real estate - mortgage   130,706    3,995    4,272    1,486    140,459 
Obligations of states and political subdivisions   12,674    28    -    -    12,702 
Personal   4,204    -    -    -    4,204 
Total  $240,642   $21,679   $11,881   $3,596   $277,798 

 

The Company has certain loans in its portfolio that are considered to be impaired. It is the policy of the Company to recognize income on impaired loans that have been transferred to nonaccrual status on a cash basis, only to the extent that it exceeds principal balance recovery. Until an impaired loan is placed on nonaccrual status, income is recognized on the accrual basis. Collateral analysis is performed on each impaired loan at least quarterly, and results are used to determine if a specific reserve is necessary to adjust the carrying value of each individual loan down to the estimated fair value. Generally, specific reserves are carried against impaired loans based upon estimated collateral value until a confirming loss event occurs or until termination of the credit is scheduled through liquidation of the collateral or foreclosure. Charge off will occur when a confirmed loss is identified. Professional appraisals of collateral, discounted for expected selling costs, appraisal age, economic conditions and other known factors are used to determine the charge-off amount. The following tables summarize information regarding impaired loans by portfolio class as of June 30, 2014 and December 31, 2013 (in thousands):

 

   As of June 30, 2014   As of December 31, 2013 
         
   Recorded
Investment
   Unpaid
Principal
Balance
   Related
Allowance
   Recorded
Investment
   Unpaid
Principal
Balance
   Related
Allowance
 
Impaired loans                              
With no related allowance recorded:                              
Commercial, financial and agricultural  $6   $6   $-   $94   $94   $- 
Real estate - commercial   998    1,005    -    2,017    2,142    - 
Real estate - construction   1    64    -    504    813    - 
Real estate - mortgage   3,126    4,382    -    3,353    4,751    - 
                               
With an allowance recorded:                              
Real estate - commercial  $1,535   $1,535   $112   $238   $238   $26 
Real estate - construction   524    802    76    1,478    1,502    93 
Real estate - mortgage   351    391    36    365    394    45 
                               
Total:                              
Commercial, financial and agricultural  $6   $6   $-   $94   $94   $- 
Real estate - commercial   2,533    2,540    112    2,255    2,380    26 
Real estate - construction   525    866    76    1,982    2,315    93 
Real estate - mortgage   3,477    4,773    36    3,718    5,145    45 
   $6,541   $8,185   $224   $8,049   $9,934   $164 

 

18
 

 

   Three Months Ended June 30, 2014   Three Months Ended June 30, 2013 
   Average
Recorded
Investment
   Interest
Income
Recognized
   Cash
Basis
Interest
Income
   Average
Recorded
Investment
   Interest
Income
Recognized
   Cash Basis
Interest
Income
 
Impaired loans                              
With no related allowance recorded:                              
Commercial, financial and agricultural  $7   $11   $1   $144   $2   $- 
Real estate - commercial   917    1    21    2,598    15    8 
Real estate - construction   1    -    -    734    -    2 
Real estate - mortgage   3,348    9    41    2,749    11    12 
                               
With an allowance recorded:                              
Real estate - commercial  $1,767   $-   $2   $124   $-   $- 
Real estate - construction   526    -    -    1,547    -    - 
Real estate - mortgage   355    -    -    186    -    3 
                               
Total:                              
Commercial, financial and agricultural  $7   $11   $1   $144   $2   $- 
Real estate - commercial   2,684    1    23    2,722    15    8 
Real estate - construction   527    -    -    2,281    -    2 
Real estate - mortgage   3,703    9    41    2,935    11    15 
   $6,921   $21   $65   $8,082   $28   $25 

 

   Six Months Ended June 30, 2014   Six Months Ended June 30, 2013 
   Average
Recorded
Investment
   Interest
Income
Recognized
   Cash
Basis
Interest
Income
   Average
Recorded
Investment
   Interest
Income
Recognized
   Cash Basis
Interest
Income
 
Impaired loans                              
With no related allowance recorded:                              
Commercial, financial and agricultural  $50   $11   $1   $151   $5   $- 
Real estate - commercial   1,508    12    24    2,641    42    8 
Real estate - construction   253    -    -    1,087    -    2 
Real estate - mortgage   3,240    24    56    2,023    11    12 
                               
With an allowance recorded:                              
Real estate - commercial  $887   $-   $11   $124   $-   $- 
Real estate - construction   1,001    -    -    1,196    -    - 
Real estate - mortgage   358    -    -    1,256    -    3 
                               
Total:                              
Commercial, financial and agricultural  $50   $11   $1   $151   $5   $- 
Real estate - commercial   2,395    12    35    2,765    42    8 
Real estate - construction   1,254    -    -    2,283    -    2 
Real estate - mortgage   3,598    24    56    3,279    11    15 
   $7,297   $47   $92   $8,478   $58   $25 

 

19
 

 

The following table presents nonaccrual loans by classes of the loan portfolio as of June 30, 2014 and December 31, 2013 (in thousands):

 

  June 30, 2014   December 31, 2013 
Nonaccrual loans:        
Commercial, financial and agricultural  $6   $10 
Real estate - commercial   1,967    1,331 
Real estate - construction   525    1,982 
Real estate - mortgage   2,744    2,629 
Total  $5,242   $5,952 

 

The performance and credit quality of the loan portfolio is also monitored by analyzing the age of the loans receivable as determined by the length of time a recorded payment is past due. The following table presents the classes of the loan portfolio summarized by the past due status as of June 30, 2014 and December 31, 2013 (in thousands):

 

As of June 30, 2014  30-59
Days
Past Due
   60-89
Days
Past Due
   Greater
than 90
Days
   Total
Past
Due
   Current   Total
Loans
   Loans Past
Due
greater
than 90
Days and
Accruing
 
                             
Commercial, financial and agricultural  $2   $29   $6   $37   $23,684   $23,721   $- 
Real estate - commercial   368    550    1,966    2,884    81,323    84,207    - 
Real estate - construction   22    105    356    483    17,791    18,274    1 
Real estate - mortgage   866    1,192    2,820    4,878    131,962    136,840    435 
Obligations of states and political subdivisions   -    -    -    -    10,904    10,904    - 
Personal   5    11    -    16    4,382    4,398    - 
Total  $1,263   $1,887   $5,148   $8,298   $270,046   $278,344   $436 

 

As of December 31, 2013  30-59
Days
Past Due
   60-89
Days
Past Due
   Greater
than 90
Days
   Total
Past
Due
   Current   Total
Loans
   Loans Past
Due
greater
than 90
Days and
Accruing
 
                             
Commercial, financial and agricultural  $19   $-   $10   $29   $26,252   $26,281   $- 
Real estate - commercial   35    1,092    947    2,074    72,397    74,471    61 
Real estate - construction   239    7    1,801    2,047    17,634    19,681    - 
Real estate - mortgage   1,239    2,130    2,585    5,954    134,505    140,459    251 
Obligations of states and political subdivisions   -    -    -    -    12,702    12,702    - 
Personal   23    1    -    24    4,180    4,204    - 
Total  $1,555   $3,230   $5,343   $10,128   $267,670   $277,798   $312 

 

20
 

 

The following table summarizes information regarding troubled debt restructurings by loan portfolio class at June 30, 2014 and December 31, 2013, in thousands of dollars.

 

   Number of
Contracts
   Pre-Modification
Outstanding
Recorded
Investment
   Post-Modification
Outstanding
Recorded
Investment
   Recorded
Investment
 
As of June 30, 2014                    
Accruing troubled debt restructurings:                    
Real estate - mortgage   6   $723   $758   $737 
    6   $723   $758   $737 
As of December 31, 2013                    
Accruing troubled debt restructurings:                    
Real estate - commercial   1   $64   $64   $61 
Real estate - mortgage   6    694    729    714 
    7   $758   $793   $775 

 

The Company’s troubled debt restructurings are also impaired loans, which may result in a specific allocation and subsequent charge-off if appropriate. As of June 30, 2014, there were no specific reserves or charge-offs relating to the troubled debt restructurings. The amended terms of the restructured loans vary, whereby interest rates have been reduced, principal payments have been reduced or deferred for a period of time and/or maturity dates have been extended.

 

The following table summarizes loans whose terms have been modified resulting in troubled debt restructurings during the three and six months ended June 30, 2014 and June 30, 2013, in thousands of dollars:

 

   Number of
Contracts
   Pre-Modification
Outstanding
Recorded
Investment
   Post-Modification
Outstanding
Recorded
Investment
   Recorded
Investment
 
Three months ended June 30, 2014                    
Accruing troubled debt restructurings:                    
Real estate - mortgage   1   $49   $49   $47 
    1   $49   $49   $47 
Six months ended June 30, 2014                    
Accruing troubled debt restructurings:                    
Real estate - mortgage   1   $49   $49   $47 
    1   $49   $49   $47 

 

   Number of
Contracts
   Pre-Modification
Outstanding
Recorded
Investment
   Post-Modification
Outstanding
Recorded
Investment
   Recorded
Investment
 
Three months ended June 30, 2013                    
Accruing troubled debt restructurings:                    
Real estate - commercial   1   $64   $64   $61 
Real estate - mortgage   3    136    158    148 
    4   $200   $222   $209 
Six months ended June 30, 2013                    
Accruing troubled debt restructurings:                    
Real estate - commercial   1   $64   $64   $61 
Real estate - mortgage   4    500    529    519 
    5   $564   $593   $580 

 

21
 

 

One restructured loan with a balance of $370,000 was delinquent in excess of 90 days with respect to the terms of the restructuring as of June 30, 2014 and has been placed in non-accrual status. There have been no defaults of troubled debt restructurings that took place during the three or six months ended June 30, 2014 and 2013 within 12 months of restructure.

 

The following tables summarize the activity in the allowance for loan losses and related investments in loans receivable (in thousands):

 

As of, and for the period ended, June 30, 2014

 

   Commercial,
financial and
agricultural
   Real estate -
commercial
   Real estate -
construction
   Real estate -
mortgage
   Obligations
of states and
political
subdivisions
   Personal   Total 
Allowance for loan losses:                                   
Beginning balance, April 1, 2014  $250   $615   $172   $1,223   $-   $40   $2,300 
Charge-offs   (1)   (5)   -    (58)   -    -    (64)
Recoveries   1    4    -    -    -    -    5 
Provisions   (25)   75    23    43    -    1    117 
Ending balance, June 30, 2014  $225   $689   $195   $1,208   $-   $41   $2,358 
                                    
Beginning balance, January 1, 2014  $253   $534   $212   $1,246   $-   $42   $2,287 
Charge-offs   (2)   (5)   -    (63)   -    (3)   (73)
Recoveries   3    4    -    -    -    -    7 
Provisions   (29)   156    (17)   25    -    2    137 
Ending balance, June 30, 2014  $225   $689   $195   $1,208   $-   $41   $2,358 

 

   Commercial,
financial and
agricultural
   Real estate -
commercial
   Real estate -
construction
   Real estate -
mortgage
   Obligations
of states and
political
subdivisions
   Personal   Total 
Allowance for loan losses:                                   
Ending balance  $225   $689   $195   $1,208   $-   $41   $2,358 
evaluated for impairment                                   
individually  $-   $112   $76   $36   $-   $-   $224 
collectively  $225   $577   $119   $1,172   $-   $41   $2,134 
                                    
Loans:                                   
Ending balance  $23,721   $84,207   $18,274   $136,840   $10,904   $4,398   $278,344 
evaluated for impairment                                   
individually  $6   $2,533   $525   $3,477   $-   $-   $6,541 
collectively  $23,715   $81,674   $17,749   $133,363   $10,904   $4,398   $271,803 

 

22
 

 

As of, and for the period ended, June 30, 2013

 

   Commercial,
financial and
agricultural
   Real estate -
commercial
   Real estate -
construction
   Real estate -
mortgage
   Obligations
of states and
political
subdivisions
   Personal   Total 
Allowance for loan losses:                                   
Beginning balance, April 1, 2013  $193   $470   $221   $1,385   $-   $47   $2,316 
Charge-offs   (4)   -    -    (22)   -    (3)   (29)
Recoveries   -    -    -    -    -    2    2 
Provisions   11    84    37    (46)   -    -    86 
Ending balance, June 30, 2013  $200   $554   $258   $1,317   $-   $46   $2,375 
                                    
Beginning balance, January 1, 2013  $179   $463   $202   $2,387   $-   $50   $3,281 
Charge-offs   (4)   -    -    (1,060)   -    (13)   (1,077)
Recoveries   -    -    -    -    -    5    5 
Provisions   25    91    56    (10)   -    4    166 
Ending balance, June 30, 2013  $200   $554   $258   $1,317   $-   $46   $2,375 

 

   Commercial,
financial and
agricultural
   Real estate -
commercial
   Real estate -
construction
   Real estate -
mortgage
   Obligations
of states and
political
subdivisions
   Personal   Total 
Allowance for loan losses:                                   
Ending balance  $200   $554   $258   $1,317   $-   $46   $2,375 
evaluated for impairment                                   
individually  $-   $72   $149   $118   $-   $-   $339 
collectively  $200   $482   $109   $1,199   $-   $46   $2,036 
                                    
                                    
Loans:                                   
Ending balance  $20,336   $72,146   $20,094   $147,038   $10,953   $4,693   $275,260 
evaluated for impairment                                   
individually  $142   $2,858   $2,363   $3,930   $-   $-   $9,293 
collectively  $20,194   $69,288   $17,731   $143,108   $10,953   $4,693   $265,967 

 

As of December 31, 2013

 

   Commercial,
financial and
agricultural
   Real estate -
commercial
   Real estate -
construction
   Real estate -
mortgage
   Obligations
of states and
political
subdivisions
   Personal   Total 
As of December 31, 2013                                   
Allowance for loan losses:                                   
Ending balance  $253   $534   $212   $1,246   $-   $42   $2,287 
evaluated for impairment                                   
individually  $-   $26   $93   $45   $-   $-   $164 
collectively  $253   $508   $119   $1,201   $-   $42   $2,123 
                                    
                                    
Loans:                                   
Ending balance  $26,281   $74,471   $19,681   $140,459   $12,702   $4,204   $277,798 
evaluated for impairment                                   
individually  $94   $2,255   $1,982   $3,718   $-   $-   $8,049 
collectively  $26,187   $72,216   $17,699   $136,741   $12,702   $4,204   $269,749 

 

                                   

 

23
 

 

7. Acquisition

 

On September 8, 2006, the Company completed the acquisition of a branch office in Richfield, PA. The acquisition included real estate, deposits and loans. The assets and liabilities of the acquired branch office were recorded on the consolidated statement of financial condition at their estimated fair values as of September 8, 2006, and its results of operations have been included in the consolidated statements of income since such date.

 

Included in the purchase price of the branch was goodwill and core deposit intangible of $2,046,000 and $449,000, respectively. The core deposit intangible is being amortized over a ten-year period on a straight line basis. Core deposit amortization expense was $11,000 and $22,000 in each three and six month periods ending June 30, 2014 and 2013, respectively. Accumulated amortization of core deposit intangible through June 30, 2014 was $352,000. The goodwill is not amortized, but is measured annually for impairment or more frequently if certain events occur which might indicate goodwill has been impaired. There was no impairment of goodwill during either of the six month periods ended June 30, 2014 or 2013.

 

 

8. Investment in Unconsolidated Subsidiary

 

The Company owns 39.16% of the outstanding common stock of Liverpool Community Bank (LCB), Liverpool, PA. This investment is accounted for under the equity method of accounting and is being carried at $4,250,000 as of June 30, 2014. The Company increases its investment in LCB for its share of earnings and decreases its investment by any dividends received from LCB. The investment is evaluated quarterly for impairment. A loss in value of the investment which is determined to be other than a temporary decline would be recognized as a loss in the period in which such determination is made. Evidence of a loss in value might include, but would not necessarily be limited to, absence of an ability to recover the carrying amount of the investment or inability of LCB to sustain an earnings capacity which would justify the current carrying value of the investment. There was no impairment of goodwill during either of the six month periods ended June 30, 2014 or 2013.

 

9. Fair Value Measurement

 

Fair value measurement and disclosure guidance defines fair value as the price that would be received to sell an asset or transfer a liability in an orderly transaction (that is, not a forced liquidation or distressed sale) between market participants at the measurement date under current market conditions. Additional guidance is provided on determining when the volume and level of activity for the asset or liability has significantly decreased. The guidance also includes guidance on identifying circumstances when a transaction may not be considered orderly.

 

Fair value measurement and disclosure guidance provides a list of factors that a reporting entity should evaluate to determine whether there has been a significant decrease in the volume and level of activity for the asset or liability in relation to normal market activity for the asset or liability. When the reporting entity concludes there has been a significant decrease in the volume and level of activity for the asset or liability, further analysis of the information from that market is needed, and significant adjustments to the related prices may be necessary to estimate fair value in accordance with fair value measurement and disclosure guidance.

 

This guidance clarifies that, when there has been a significant decrease in the volume and level of activity for the asset or liability, some transactions may not be orderly. In those situations, the entity must evaluate the weight of the evidence to determine whether the transaction is orderly. The guidance provides a list of circumstances that may indicate that a transaction is not orderly. A transaction price that is not associated with an orderly transaction is given little, if any, weight when estimating fair value.

 

Fair value measurement and disclosure guidance defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. A fair value measurement assumes that the transaction to sell the asset or transfer the liability occurs in the principal market for the asset or liability or, in the absence of a principal market, the most advantageous market for the asset or liability. The price in the principal (or most advantageous) market used to measure the fair value of the asset or liability is not adjusted for transaction costs. An orderly transaction is a transaction that assumes exposure to the market for a period prior to the measurement date to allow for marketing activities that are usual and customary for transactions involving such assets and liabilities; it is not a forced transaction. Market participants are buyers and sellers in the principal market that are (i) independent, (ii) knowledgeable, (iii) able to transact and (iv) willing to transact.

 

24
 

 

Fair value measurement and disclosure guidance requires the use of valuation techniques that are consistent with the market approach, the income approach and/or the cost approach. The market approach uses prices and other relevant information generated by market transactions involving identical or comparable assets and liabilities. The income approach uses valuation techniques to convert future amounts, such as cash flows or earnings, to a single present amount on a discounted basis. The cost approach is based on the amount that currently would be required to replace the service capacity of an asset (replacement cost). Valuation techniques should be consistently applied. Inputs to valuation techniques refer to the assumptions that market participants would use in pricing the asset or liability. Inputs may be observable, meaning those that reflect the assumptions market participants would use in pricing the asset or liability developed based on market data obtained from independent sources, or unobservable, meaning those that reflect the reporting entity’s own assumptions about the assumptions market participants would use in pricing the asset or liability developed based on the best information available in the circumstances. In that regard, the guidance establishes a fair value hierarchy for valuation inputs that gives the highest priority to quoted prices in active markets for identical assets or liabilities and the lowest priority to unobservable inputs. The fair value hierarchy is as follows:

 

Level 1 Inputs – Unadjusted quoted prices in active markets for identical assets or liabilities that the reporting entity has the ability to access at the measurement date.

 

Level 2 Inputs – Inputs other than quoted prices included in Level 1 that are observable for the asset or liability, either directly or indirectly. These might include quoted prices for similar assets or liabilities in active markets, quoted prices for identical or similar assets or liabilities in markets that are not active, inputs other than quoted prices that are observable for the asset or liability (such as interest rates, volatilities, prepayment speeds, credit risks, etc.) or inputs that are derived principally from or corroborated by market data by correlation or other means.

 

Level 3 Inputs – Unobservable inputs for determining the fair values of assets or liabilities that reflect an entity’s own assumptions about the assumptions that market participants would use in pricing the assets or liabilities.

 

An asset’s or liability’s placement in the fair value hierarchy is based on the lowest level of input that is significant to the fair value measurement.

 

A description of the valuation methodologies used for assets and liabilities measured at fair value, as well as the general classification of such assets and liabilities pursuant to the valuation hierarchy, is set forth below.

 

In general, fair value is based upon quoted market prices, where available. If such quoted market prices are not available, fair value is based upon internally developed models that primarily use, as inputs, observable market-based parameters. Valuation adjustments may be made to ensure that financial instruments are recorded at fair value. These adjustments may include amounts to reflect counterparty credit quality and the Company’s creditworthiness, among other things, as well as unobservable parameters. Any such valuation adjustments are applied consistently over time. The Company’s valuation methodologies may produce a fair value calculation that may not be indicative of net realizable value or reflective of future fair values. While management believes the Company’s valuation methodologies are appropriate and consistent with other market participants, the use of different methodologies or assumptions to determine the fair value of certain financial instruments could result in a different estimate of fair value at the reporting date.

 

Securities Available for Sale. Debt securities classified as available for sale are reported at fair value utilizing Level 2 inputs. For these securities, the Company obtains fair value measurement from an independent pricing service. The fair value measurements consider observable data that may include dealer quotes, market spreads, cash flows, the U.S. Treasury yield curve, live trading levels, trade execution data, market consensus prepayment speeds, credit information and the bond’s terms and conditions, among other things. Equity securities classified as available for sale are reported at fair value using Level 1 inputs.

 

25
 

 

Impaired Loans. Certain impaired loans are reported on a non-recurring basis at the fair value of the underlying collateral since repayment is expected solely from the collateral. Fair value is generally determined based upon independent third-party appraisals of the properties, or discounted cash flows based upon the expected proceeds. These assets are included as Level 3 fair values, based upon the lowest level of input that is significant to the fair value measurements.

 

Other Real Estate Owned. Certain assets included in other real estate owned are carried at fair value as a result of impairment and accordingly, are presented as measured on a non-recurring basis. Values are estimated using Level 3 inputs, based on appraisals that consider the sales prices of property in the proximate vicinity.

 

Mortgage Servicing Rights. The fair value of servicing assets is based on the present value of estimated future cash flows on pools of mortgages stratified by rate and maturity date and are considered Level 3 inputs.

 

The following table summarizes financial assets and financial liabilities measured at fair value as of June 30, 2014 and December 31, 2013, segregated by the level of the valuation inputs within the fair value hierarchy utilized to measure fair value (in thousands). There were no transfers of assets between fair value Level 1 and Level 2 during the six months ended June 30, 2014.

 

       (Level 1)   (Level 2)   (Level 3) 
       Quoted Prices in   Significant   Significant 
       Active Markets   Other   Other 
   June 30,   for Identical   Observable   Unobservable 
   2014   Assets   Inputs   Inputs 
Measured at fair value on a recurring basis:                    
Debt securities available-for-sale:                    
Obligations of U.S. Government agencies and corporations  $64,592   $-   $64,592   $- 
Obligations of state and political subdivisions   39,788    -    39,788    - 
Mortgage-backed securities   48,352    -    48,352    - 
Equity securities available-for-sale   1,466    1,466    -    - 
                     
Measured at fair value on a non-recurring basis:                    
Impaired loans   3,120    -    -    3,120 
Other real estate owned   50    -    -    50 
Mortgage servicing rights   175    -    -    175 

 

       (Level 1)   (Level 2)   (Level 3) 
       Quoted Prices in   Significant   Significant 
       Active Markets   Other   Other 
   December 31,   for Identical   Observable   Unobservable 
   2013   Assets   Inputs   Inputs 
Measured at fair value on a recurring basis:                    
Debt securities available-for-sale:                    
Obligations of U.S. Government agencies and corporations  $78,278   $-   $78,278   $- 
Obligations of state and political subdivisions   41,932    -    41,932    - 
Mortgage-backed securities   4,469    -    4,469    - 
Equity securities available-for-sale   1,367    1,367    -    - 
                     
Measured at fair value on a non-recurring basis:                    
Impaired loans   3,300    -    -    3,300 
Other real estate owned   50    -    -    50 
Mortgage servicing rights   167    -    -    167 

 

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The following table presents additional quantitative information about assets measured at fair value on a nonrecurring basis and for which Level 3 inputs have been used to determine fair value:

 

June 30, 2014  Fair Value
Estimate
   Valuation Technique  Unobservable Input  Range   Weighted
Average
 
                   
Impaired loans  $3,120   Appraisal of collateral (1)  Appraisal and liquidation adjustments (2)   (7)% - (15)%    (12)%
                      
Other real estate owned   50   Appraisal of collateral (1)  Appraisal and liquidation adjustments (2)   0%   0%
                      
Mortgage servicing rights   175   Multiple of annual servicing fee  Estimated pre-payment speed, based on rate and term   300% - 400%    354%

 

 

December 31, 2013  Fair Value
Estimate
   Valuation Technique  Unobservable Input  Range   Weighted Average 
Impaired loans  $3,300   Appraisal of collateral (1)  Appraisal and liquidation adjustments (2)   (7)% - (10)%    (9.0)%
                      
Other real estate owned   50   Appraisal of collateral (1)  Appraisal and liquidation adjustments (2)   0%   0%
                      
Mortgage servicing rights   167   Multiple of annual servicing fee  Estimated pre-payment speed, based on rate and term   300% - 400%    326%

 

(1)         Fair value is generally determined through independent appraisals of the underlying collateral that generally include various level 3 inputs which are not identifiable.

(2)         Appraisals may be adjusted downward by management for qualitative factors such as economic conditions and estimated liquidation expenses. The range of liquidation expenses and other appraisal adjustments are presented as a percent of the appraisal.

 

Fair Value of Financial Instruments

Management uses its best judgment in estimating the fair value of the Company’s financial instruments; however, there are inherent weaknesses in any estimation technique. Therefore, the fair value estimates herein are not necessarily indicative of the amounts the Company could have realized in sales transactions on the dates indicated. The estimated fair value amounts have been measured as of their respective year ends and have not been re-evaluated or updated for purposes of these consolidated financial statements subsequent to those respective dates. As such, the estimated fair values of these financial instruments subsequent to the respective reporting dates may be different from the amounts reported at each quarter end.

 

The information presented below should not be interpreted as an estimate of the fair value of the entire Company since a fair value calculation is provided only for a limited portion of the Company’s assets and liabilities. Due to a wide range of valuation techniques and the degree of subjectivity used in making the estimates, comparisons between the Company’s disclosures and those of other companies may not be meaningful.

 

The following describes the estimated fair value of the Company’s financial instruments as well as the significant methods and assumptions not previously disclosed used to determine these estimated fair values.

 

Carrying values approximate fair value for cash and due from banks, interest-bearing demand deposits with banks, restricted stock in the Federal Home Loan Bank, loans held for sale, interest receivable, mortgage servicing rights, non-interest bearing deposits, securities sold under agreements to repurchase, short-term borrowings and interest payable. Other than cash and due from banks, which are considered Level 1 inputs, and mortgage servicing rights, which are Level 3 inputs, these instruments are Level 2 inputs.

 

Interest bearing time deposits with banks - The estimated fair value is determined by discounting the contractual future cash flows, using the rates currently offered for deposits of similar remaining maturities.

 

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 Loans – For variable-rate loans that reprice frequently and which entail no significant changes in credit risk, carrying values approximated fair value. Substantially all commercial loans and real estate mortgages are variable rate loans. The fair value of other loans (i.e. consumer loans and fixed-rate real estate mortgages) is estimated by calculating the present value of the cash flow difference between the current rate and the market rate, for the average maturity, discounted quarterly at the market rate.

 

Fixed rate time deposits - The estimated fair value is determined by discounting the contractual future cash flows, using the rates currently offered for deposits of similar remaining maturities.

 

Long term debt and other interest bearing liabilities – The fair value is estimated using discounted cash flow analysis, based on incremental borrowing rates for similar types of arrangements.

 

Commitments to extend credit and letters of credit – The fair value of commitments to extend credit is estimated using the fees currently charged to enter into similar agreements, taking into account market interest rates, the remaining terms and present credit-worthiness of the counterparties. The fair value of guarantees and letters of credit is based on fees currently charged for similar agreements.

 

The estimated fair values of the Company’s financial instruments are as follows (in thousands):

 

Financial Instruments

(in thousands)

 

   June 30, 2014   December 31, 2013 
   Carrying   Fair   Carrying   Fair 
   Value   Value   Value   Value 
Financial assets:                    
Cash and due from banks  $8,617   $8,617   $8,570   $8,570 
Interest bearing deposits with banks   40    40    43    43 
Interest bearing time deposits with banks   249    249    249    250 
Securities   154,198    154,198    126,046    126,046 
Restricted investment in FHLB stock   2,621    2,621    1,967    1,967 
Loans, net of allowance for loan losses   275,986    282,431    275,511    282,226 
Mortgage servicing rights   175    175    167    167 
Accrued interest receivable   1,552    1,552    1,529    1,529 
                     
Financial liabilities:                    
Non-interest bearing deposits   78,138    78,138    74,611    74,611 
Interest bearing deposits   315,191    317,929    305,034    308,414 
Securities sold under agreements to repurchase   3,561    3,561    5,397    5,397 
Short-term borrowings   2,500    2,500    8,400    8,400 
Long-term debt   22,500    22,655    -    - 
Other interest bearing liabilities   1,381    1,391    1,356    1,358 
Accrued interest payable   320    320    287    287 
                     
Off-balance sheet financial instruments:                    
Commitments to extend credit   -    -    -    - 
Letters of credit   -    -    -    - 

 

The following presents the carrying amount, fair value and placement in the fair value hierarchy of the Company’s financial instruments not previously disclosed as of June 30, 2014 and December 31, 2013. This table excludes financial instruments for which the carrying amount approximates fair value (in thousands).

 

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           (Level 1)   (Level 2)   (Level 3) 
           Quoted Prices in         
           Active Markets   Significant   Significant 
           for Identical   Other   Other 
   Carrying       Assets or   Observable   Unobservable 
   Amount   Fair Value   Liabilities   Inputs   Inputs 
June 30, 2014                         
Financial instruments - Assets                         
Interest bearing time deposits with banks  $249   $249   $-   $249   $- 
Loans, net of allowance for loan losses   275,986    282,431    -    -    282,431 
Financial instruments - Liabilities                         
Interest bearing deposits   315,191    317,929    -    317,929    - 
Long-term debt   22,500    22,655         22,655      
Other interest bearing liabilities   1,381    1,391    -    1,391    - 

 

           (Level 1)   (Level 2)   (Level 3) 
           Quoted Prices in         
           Active Markets   Significant   Significant 
           for Identical   Other   Other 
   Carrying       Assets or   Observable   Unobservable 
   Amount   Fair Value   Liabilities   Inputs   Inputs 
December 31, 2013                         
Financial instruments - Assets                         
Interest bearing time deposits with banks  $249   $250   $-   $250   $- 
Loans, net of allowance for loan losses   275,511    282,226    -    -    282,226 
Financial instruments - Liabilities                         
Interest bearing deposits   305,034    308,414    -    308,414    - 
Other interest bearing liabilities   1,356    1,358    -    1,358    - 

  

10. Defined Benefit Retirement Plan

The Company sponsors a defined benefit retirement Plan (the “Plan”) which covers substantially all of its employees employed prior to December 31, 2007. As of January 1, 2008, the Plan was amended to close the Plan to new entrants. All active participants as of December 31, 2007 became 100% vested in their accrued benefit and, as long as they remained eligible, continued to accrue benefits until December 31, 2012. The benefits are based on years of service and the employee’s compensation. Effective December 31, 2012, the Plan was amended (frozen) to cease future service accruals after that date. The Company’s funding policy is to contribute annually no more than the maximum amount that can be deducted for federal income tax purposes. Contributions are intended to provide for benefits attributed to service through December 31, 2012. The Company has made no contributions in the first six months of 2014 and does not expect to contribute to the Plan in the remainder of 2014. Pension expense included the following components for the three and six month periods ended June 30, 2014 and 2013:

 

(Dollars in thousands)

 

   Three Months Ended   Six Months Ended 
   June 30,   June 30, 
   2014   2013   2014   2013 
Components of net periodic pension cost                
Interest cost  $107   $99   $213   $198 
Expected return on plan assets  (130)   (140)   (259)   (280)
Recognized net actuarial loss   10    51    20    102 
Net periodic pension (income) cost   (13)   10    (26)   20 
                     
Amortization of net actuarial loss recognized   in other comprehensive income (loss)  $(10)  $(51)  $(20)  $(102)
                     
Total recognized in net periodic pension cost and other comprehensive income (loss)  $(23)  $(41)  $(46)  $(82)

 

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11. Commitments, Contingent Liabilities and Guarantees

 

In the ordinary course of business, the Company makes commitments to extend credit to its customers through letters of credit, loan commitments and lines of credit. At June 30, 2014, the Company had $38,846,000 outstanding in loan commitments and other unused lines of credit extended to its customers as compared to $40,989,000 at December 31, 2013.

 

The Company does not issue any guarantees that would require liability recognition or disclosure, other than its letters of credit. Letters of credit are conditional commitments issued by the Company to guarantee the performance of a customer to a third party. Generally, letters of credit have expiration dates within one year of issuance. The credit risk involved in issuing letters of credit is essentially the same as the risks that are involved in extending loan facilities to customers. The Company generally holds collateral and/or personal guarantees supporting these commitments. The Company had outstanding $1,166,000 and $1,199,000 of letters of credit commitments as of June 30, 2014 and December 31, 2013, respectively. Management believes that the proceeds obtained through a liquidation of collateral and the enforcement of guarantees would be sufficient to cover the potential amount of future payments required under the corresponding guarantees. The current amount of the liability as of June 30, 2014 for payments under letters of credit issued was not material. Because these instruments have fixed maturity dates, and because many of them will expire without being drawn upon, they do not generally present any significant liquidity risk.

 

Additionally, the Company has committed to fund and sell qualifying residential mortgage loans to the Federal Home Loan Bank of Pittsburgh in the total amount of $15,000,000. As of June 30, 2014, $12,886,000 remains to be delivered on that commitment, of which $97,000 has been committed to borrowers.

  

12. Subsequent Event

 

In July 2014, the Board of Directors declared a dividend of $0.22 per share to shareholders of record on August 15, payable on September 2, 2014.

 

Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

Forward Looking Statements:

 

The information contained in this Quarterly Report on Form 10-Q contains forward looking statements (as such term is defined in the Securities Exchange Act of 1934 and the regulations thereunder) including statements which are not historical facts or address trends or management's intentions, plans, beliefs, expectations or opinions.  Such forward looking statements are subject to risks and uncertainties and may be affected by various factors which may cause actual results to differ materially from those in the forward looking statements including, without limitation:

 

·the impact of adverse changes in the economy and real estate markets, including protracted periods of low-growth and sluggish loan demand;
·the effect of market interest rates, particularly a continuing period of low market interest rates, and relative balances of rate-sensitive assets to rate-sensitive liabilities, on net interest margin and net interest income; the effect of competition on rates of deposit and loan growth and net interest margin;
·increases in non-performing assets, which may result in increases in the allowance for credit losses, loan charge-offs and elevated collection and carrying costs related to such non-performing assets;

 

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·other income growth, including the impact of regulatory changes which have reduced debit card interchange revenue;
·investment securities gains and losses, including other than temporary declines in the value of securities which may result in charges to earnings;
·the level of other expenses, including salaries and employee benefit expenses;
·the increasing time and expense associated with regulatory compliance and risk management;
·the uncertainty and lack of clear regulatory guidance associated with the delay in implementing many of the regulations mandated by the Dodd Frank Act; and
·capital and liquidity strategies, including the expected impact of the capital and liquidity requirements proposed by the Basel III standards.  

 

Juniata Valley undertakes no obligation to publicly update or revise forward looking information, whether as a result of new or updated information, future events or otherwise.  For a more complete discussion of certain risks, uncertainties and other factors affecting the Company, refer to the Company’s Risk Factors, contained in Item 1A of the Company’s Annual Report on Form 10-K for the year ended December 31, 2013, and Item 1A of Part II of this Quarterly Report on Form 10-Q, a copy of which may be obtained from the Company upon request and without charge (except for the exhibits thereto).

 

Critical Accounting Policies:

 

Disclosure of the Company’s significant accounting policies is included in the notes to the consolidated financial statements of the Company’s Annual Report on Form 10-K for the year ended December 31, 2013. Some of these policies require significant judgments, estimates, and assumptions to be made by management, most particularly in connection with determining the provision for loan losses and the appropriate level of the allowance for loan losses, as well as management’s evaluation of the investment portfolio for other-than-temporary impairment, the assessment of goodwill for impairment and the valuation of deferred tax assets. There have been no changes in critical accounting policies since December 31, 2013.

 

General:

 

The following discussion relates to the consolidated financial condition of the Company as of June 30, 2014, as compared to December 31, 2013, and the consolidated results of operations for the three and six months ended June 30, 2014, compared to the same periods in 2013. This discussion should be read in conjunction with the interim consolidated financial statements and related notes included herein.

 

Overview:

 

Juniata Valley Financial Corp. is a Pennsylvania corporation organized in 1983 to be the holding company of The Juniata Valley Bank. The Bank is a state-chartered bank headquartered in Mifflintown, Pennsylvania. Juniata Valley Financial Corp. and its subsidiary bank derive substantially all of their income from banking and bank-related services, including interest earned on residential real estate, commercial mortgage, commercial and consumer loans, interest earned on investment securities and fee income from deposit services and other financial services to its customers through 12 locations in central Pennsylvania. Juniata Valley Financial Corp. also owns 39.16% of Liverpool Community Bank (LCB), located in Liverpool, Pennsylvania. The Company accounts for LCB as an unconsolidated subsidiary using the equity method of accounting.

 

Financial Condition:

 

Total assets as of June 30, 2014, were $478.1 million, an increase of 6.5% compared to December 31, 2013. Comparing the balances at June 30, 2014 and December 31, 2013, deposits increased by $13.7 million, with non-interest bearing deposits increasing by $3.5 million and interest-bearing deposits increasing by $10.2 million. The Company’s investment portfolio grew by $28.2 million and borrowings increased by $14.8 million.

 

The table below shows changes in deposit volumes by type of deposit (in thousands of dollars) between December 31, 2013 and June 30, 2014.

 

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   June 30,   December 31,   Change 
   2014   2013   $   % 
Deposits:                    
Demand, non-interest bearing  $78,138   $74,611   $3,527    4.7%
NOW and money market   100,358    89,867    10,491    11.7 
Savings   66,395    60,761    5,634    9.3 
Time deposits, $100,000 and more   29,514    30,995    (1,481)   (4.8)
Other time deposits   118,924    123,411    (4,487)   (3.6)
Total deposits  $393,329   $379,645   $13,684    3.6%

  

Overall, total loans increased only slightly, between December 31, 2013 and June 30, 2014, as shown in the table below (in thousands of dollars). Increases in commercial real estate activity somewhat offset the reduction that continued to occur in the residential and construction portfolios.

 

   June 30,   December 31,   Change 
   2014   2013   $   % 
Loans:                    
Commercial, financial and agricultural  $23,721   $26,281   $(2,560)   (9.7)%
Real estate - commercial   84,207    74,471    9,736    13.1 
Real estate - construction   18,274    19,681    (1,407)   (7.1)
Real estate - mortgage   136,840    140,459    (3,619)   (2.6)
Obligations of states and political subdivisions   10,904    12,702    (1,798)   (14.2)
Personal   4,398    4,204    194    4.6 
Total loans  $278,344   $277,798   $546    0.2%

 

A summary of the activity in the allowance for loan losses for each of the six-month periods ended June 30, 2014 and 2013 (in thousands) is presented below.

 

   Periods Ended June 30, 
   2014   2013 
Balance of allowance - January 1  $2,287   $3,281 
Loans charged off   (73)   (1,077)
Recoveries of loans previously charged off   7    5 
Net charge-offs   (66)   (1,072)
Provision for loan losses   137    166 
Balance of allowance - end of period  $2,358   $2,375 
           
Ratio of net charge-offs during period to average loans outstanding   0.02%   0.39%

 

During the first six months of 2014, the Company recorded charge-offs of $73,000, slightly offset by $7,000 in recoveries.

 

As of June 30, 2014, 45 loans, with aggregate outstanding balances of $6,541,000, were individually evaluated for impairment. A collateral analysis was performed on each of these 45 loans in order to establish a portion of the reserve needed to carry impaired loans at fair value. As a result, six loans were determined to have insufficient collateral, and specific reserves, totaling $224,000, were established for the six impaired loans.

 

Management believes that the specific reserves carried are adequate to cover potential future losses related to these relationships. There are no other material loans classified as loss, doubtful, substandard, or special mention which management expects to significantly impact future operating results, liquidity or capital resources.

 

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Following is a summary of the Bank’s non-performing loans on June 30, 2014 as compared to December 31, 2013. Included with the non-accrual loans as of June 30, 2014 is one restructured loan with a balance of $370,000.

 

(Dollar amounts in thousands)

 

   As of and for the   As of and for the 
   six months ended   year ended 
   June 30, 2014   December 31, 2013 
Non-performing loans          
Non-accrual loans  $5,242   $5,952 
Accruing loans past due 90 days or more   436    251 
Total  $5,678   $6,203 
           
Average loans outstanding  $275,888   $276,737 
           
Ratio of non-performing loans to average loans outstanding   2.06%   2.24%

 

During the second quarter of 2014, the Company issued long-term debt in the amount of $22,500,000, with maturities ranging from two years to five years, at rates ranging from 0.63% to 2.0%. The funds were used to purchase investment securities with similar projected average lives.

 

Stockholders’ equity increased from December 31, 2013 to June 30, 2014 by $1,062,000, or 2.1%. The market value of securities available for sale increased on June 30, 2014 compared to December 31, 2013, resulting in an increase of $921,000, net of taxes. Additionally, there was an adjustment to other comprehensive income of $13,000 to record the amortization of the net actuarial loss of the Company’s defined benefit retirement plan. Treasury shares repurchased, net of shares reissued, reduced shareholders’ equity by $114,000. The Company’s net income exceeded dividends paid by $219,000.

 

Subsequent to June 30, 2014, the following event took place:

 

On July 15, 2013, the Board of Directors declared a cash dividend of $0.22 per share to shareholders of record on August 15, 2014, payable on September 2, 2014.

 

Comparison of the Three Months Ended June 30, 2014 and 2013

 

Operations Overview:

Net income for the second quarter of 2014 was $1,163,000, an increase of $154,000, or 15.2% when compared to the second quarter of 2013. The increase was due primarily to higher net interest income and non-interest income recorded in the second quarter of 2014 as compared to the same period in 2013, partially offset by higher provision for loan losses, non-interest expense and provision for taxes recorded during the 2014 period. Basic and diluted earnings per share were $0.28 in the second quarter of 2014, as compared to the $0.24 reported in the second quarter of 2013, representing a 16.7% increase. Presented below are selected key ratios for the two periods:

  

   Three Months Ended 
   June 30, 
   2014   2013 
Return on average assets (annualized)   0.97%   0.89%
Return on average equity (annualized)   9.23%   8.03%
Average equity to average assets   10.56%   11.14%
           
Non-interest income, excluding securities gains, as a percentage of average assets (annualized)   0.98%   0.94%
Non-interest expense as a percentage of average assets (annualized)   2.85%   2.95%

 

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The discussion that follows further explains changes in the components of net income when comparing the second quarter of 2014 with the second quarter of 2013.

 

Net Interest Income: 

Net interest income was $3,642,000 for the second quarter of 2014, as compared to $3,432,000 in the same quarter in 2013. Average earning assets increased by 6.8%, and the net interest margin, on a fully tax equivalent basis, decreased by 3 basis points.

 

Interest on loans decreased $45,000, or 1.2%, in the second quarter of 2014 as compared to the same period in 2013. A decrease of 16 basis points in the average weighted yield on loans reduced interest income by approximately $90,000. An increase in average loans outstanding of $4.6 million increased interest income by $45,000.

 

Interest earned on investment securities increased $202,000 in the second quarter of 2014 as compared to the second quarter of 2013, with average balances increasing $23.7 million during the period. Of the $202,000 increase, $92,000 was due to the increase in average balances, while $110,000 was due to yield increases. The overall pre-tax yield on the investment securities portfolio increased during the period by 31 basis points.

 

Total average earning assets during the second quarter of 2014 were $436.3 million, compared to $408.6 million during the second quarter of 2013, yielding 3.97% in 2014 versus 4.09% in 2013. Average interest-bearing liabilities increased by $18.3 million, and average non-interest bearing deposits increased by $8.7 million. The increase in average interest-bearing liabilities was the result of adding long-term debt during the quarter. The cost to fund interest bearing liabilities dropped by 12 basis points, to 0.79%, in the second quarter of 2014 compared to the second quarter of 2013.

 

Net interest margin on a fully tax-equivalent basis for the second quarter of 2014 was 3.47%. For the same period in 2013, the fully-tax equivalent net interest margin was 3.50%.

 

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AVERAGE BALANCE SHEETS AND NET INTEREST INCOME ANALYSIS

(Dollars in thousands)

 

   Three Months Ended   Three Months Ended             
   June 30, 2014   June 30, 2013    
   Average       Yield/   Average       Yield/   Increase (Decrease) Due To (6) 
   Balance (1)   Interest   Rate   Balance (1)   Interest   Rate   Volume   Rate   Total 
ASSETS                                             
Interest earning assets:                                             
Taxable loans (5)  $256,094   $3,508    5.48%  $254,433   $3,571    5.62%  $23   $(86)  $(63)
Tax-exempt loans   20,346    154    3.04    17,456    136    3.13    22    (4)   18 
Total loans   276,440    3,662    5.30    271,889    3,707    5.46    45    (90)   (45)
Taxable investment securities   121,234    535    1.77    93,301    312    1.34    108    115    223 
Tax-exempt investment securities   33,696    126    1.50    37,880    147    1.56    (16)   (5)   (21)
Total investment securities   154,930    661    1.71    131,181    459    1.40    92    110    202 
                                       -    - 
Interest bearing deposits   3,393    1    0.12    5,564    7    0.50    (1)   (5)   (6)
Federal funds sold   1,521    1    0.26    -    -         -    1    1 
Total interest earning assets   436,284    4,325    3.97    408,634    4,173    4.09    136    16    152 
                                              
Other assets (7)   41,296              42,471                     
Total assets  $477,580             $451,105                          
                                              
LIABILITIES AND STOCKHOLDERS' EQUITY                                             
Interest bearing liabilities:                                             
Interest bearing demand deposits (2)  $99,085    44    0.18   $96,421    42    0.17    1    1    2 
Savings deposits   66,848    16    0.10    60,546    15    0.10    2    (1)   1 
Time deposits   149,674    548    1.47    163,455    679    1.67    (54)   (77)   (131)
Short-term and long-term borrowings and other interest bearing liabilities   28,642    75    1.05    5,540    5    0.37    48    22    70 
Total interest bearing liabilities   344,249    683    0.79    325,962    741    0.91    (3)   (55)   (58)
                                              
Non-interest bearing liabilities:                                             
Demand deposits   78,970              70,316                          
Other   3,937              4,586                          
Stockholders' equity   50,424              50,241                          
Total liabilities and stockholders' equity  $477,580             $451,105                          
Net interest income and net interest rate spread       $3,642    3.18%       $3,432    3.18%  $139   $71   $210 
Net interest margin on interest earning assets (3)             3.34%             3.36%               
Net interest income and net interest margin-Tax equivalent basis (4)       $3,786    3.47%       $3,578    3.50%               

 

Notes:

1) Average balances were calculated using a daily average.

2) Includes SuperNOW and money market accounts.

3) Net margin on interest earning assets is net interest income divided by average interest earning assets.

4) Interest on obligations of states and municipalities is not subject to federal income tax. In order to make the net yield comparable on a fully taxable basis, a tax equivalent adjustment is applied against the tax-exempt income utilizing a federal tax rate of 34%.

5) Non-accruing loans are included in the above table until they are charged off.

6) The change in interest due to rate and volume has been allocated to volume and rate changes in proportion to the relationship of the absolute dollar amounts of the change in each.

(7) Includes gross unrealized gains (losses) on securities available for sale.

 

Provision for Loan Losses:

In the second quarter of 2014, the provision for loan losses was $117,000, as compared to a provision of $86,000 in the second quarter of 2013. Management regularly reviews the adequacy of the loan loss reserve and makes assessments as to specific loan impairment, historical charge-off expectations, general economic conditions in the Bank’s market area, specific loan quality and other factors. As of June 30, 2014, non-performing loans as a percentage of average outstanding loans was 2.06%, improved from 2.24% on December 31, 2013 and from 2.88% one year ago on June 30, 2013. The improvement in non-performing loans has had a positive effect on the adequacy of the allowance for loan losses, but was offset by specific reserves assigned to two impaired loans due to aging collateral appraisals. It is the Company’s policy to discount appraisals on collateral securing impaired loans, based on the age of the valuation. See the earlier discussion in the Financial Condition section, explaining the information used to determine the provision.

 

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Non-interest Income:

Non-interest income in the second quarter of 2014 was $1,170,000, compared to $1,055,000 in the second quarter of 2013, representing an increase of $115,000, or 10.9%.

 

Most significantly impacting non-interest income in the second quarter of 2014 was a gain of $165,000 from death benefits related to bank-owned life insurance. There was no such occurrence in the second quarter of 2013. Another non-recurring item in the second quarter of 2014 was a lump-sum fee of $40,000 collected on a terminated trust relationship, resulting in elevated trust fees for that period.

 

The Company began originating mortgages to sell on the secondary market while retaining the servicing rights as a strategic objective early in 2012 and has been successful in building a servicing portfolio of approximately $19.4 million as of June 30, 2014. The mortgage servicing right asset, as of June 30, 2014, was $175,000. Gains on the sale of mortgage loans is made up of origination and servicing fees collected from the buyer, origination points collected from the borrower and an adjustment to the fair value of the mortgage servicing rights asset. In the second quarter of 2014, the total net gain on the sale of mortgage loans was $56,000, a decrease of $29,000, or 34.1%, from the second quarter of 2013, when origination activity was higher. Fees derived from loan activity was likewise lower in the second quarter of 2014 as compared to the same period one year ago, as the number of consumer loans originated for sale declined.

 

Commissions from sales of non-deposit products in the second quarter of 2014 were $15,000, or 14.6%, less than in the same quarter of the previous year. Trust fee income was $46,000, or 54.1%, higher in the second quarter of 2014 as compared to the second quarter of 2013, due to the aforementioned fee collected from a trust account termination. Investment management and trust services revenue is impacted by fluctuations in the securities market, as trust revenues are based on the value of the underlying investment portfolios. In a sustained low-rate environment, trust revenues may be adversely affected.

 

Fees derived from electronic payment activity through the use of debit cards increased in the second quarter of 2014 by 4.9% over the second quarter of 2013, while other customer service fees declined by 6.5%. The decline in customer service fees relates to fewer occurrences of customer deposit account overdrafts. Earnings on bank-owned life insurance (BOLI) and annuities declined in the second quarter of 2014 by 13%, due to the reduction in BOLI policies and matured annuities.

 

As a percentage of average assets, annualized non-interest income, exclusive of net gains on the sale of securities, was 0.98% in the second quarter of 2014 as compared to 0.94% in the second quarter of 2013.

 

Non-interest Expense:

Total non-interest expense was $3,401,000 in the second quarter of 2014, an increase of $71,000, or 2.1%, as compared to the second quarter of 2013. The increase in non-interest expense related primarily to increased compensation expense. Full-time equivalent employment increased slightly in the second quarter of 2014 as compared to the previous year’s second quarter, and company-wide annual salary adjustments occurred early in the second quarter. Employee compensation expense increased by 7.9% in the second quarter of 2014 compared to the previous year’s second quarter. Employee benefits decreased by 5.5% in the second quarter of 2014, due primarily to decreased costs related to the defined benefit retirement plan that was frozen as of December 31, 2012 and reduced accruals for claims in the Company’s self-funded medical insurance plan. Losses on sales of properties carried as other real estate owned was $29,000 in the second quarter of 2014, as compared to a net gain in the second quarter of 2013 of $8,000. Costs associated with assets in foreclosure, included in other non-interest expense, increased by $12,000, or 50.0%, in the second quarter of 2014 as compared to the same period in 2013.

 

As a percentage of average assets, annualized non-interest expense was 2.85% in the second quarter of 2014 compared to 2.95% in the second quarter of 2013.

 

Provision for income taxes:

Income tax expense in the second quarter of 2014 was $131,000 as compared to the $62,000 recorded in the second quarter of 2013. Beginning in the second quarter of 2013, the Company qualified for a federal tax credit for its low-income housing project investment, and the tax provisions for each period reflect the application of the tax credit. The tax credit recorded in the second quarter of 2014 was $144,000, offsetting $275,000 in regular tax expense; in the second quarter of 2013, the tax credit applied was $185,000, offsetting $247,000 in regular tax expense. For the second quarter of 2014, the tax credit lowered the effective tax rate from 21.2% to 10.1%. In the second quarter of 2013, when earnings from tax-exempt sources were lower, the effective tax rate was lowered from 23.1% to 5.8%.

 

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Comparison of the Six Months Ended June 30, 2014 and 2013

Operations Overview:

Net income for the first six months of 2014 was $2,066,000, an increase of $51,000, or 2.5%, compared to the first six months of 2013. The increase was due primarily to higher net interest income and lower provision for loan losses and income tax expense recorded in the first half of 2014 as compared to the same period in 2013, offset partially by lower non-interest income and higher non-interest expense recorded during the 2014 period. Basic and diluted earnings per share were $0.49 in the first six months of 2014, representing an increase of 2.1% from the $0.48 earned in the first six months of 2013. Annualized return on average equity for the first six months in 2014 was 8.20%, compared to the ratio for the same period in the prior year of 8.04%, an increase of 2.0%. For the six months ended June 30, annualized return on average assets was 0.89% in 2014, versus 0.90% in 2013.

 

Presented below are selected key ratios for the two periods:

 

   Six Months Ended 
   June 30, 
   2014   2013 
Return on average assets (annualized)   0.89%   0.90%
Return on average equity (annualized)   8.20%   8.04%
Average equity to average assets   10.91%   11.18%
           
Non-interest income, excluding securities gains, as a percentage of average assets (annualized)   0.90%   0.95%
Non-interest expense as a percentage of average assets (annualized)   2.92%   2.84%

 

The discussion that follows explains changes in the components of net income when comparing the first six months of 2014 with the first six months of 2013.

 

Net Interest Income:

Net interest income was $7,051,000 for the first six months of 2014, as compared to $6,813,000 in the same period in 2013. Average earning assets increased by $14.4 million, or 3.5%, while the net interest margin on a fully tax equivalent basis decreased by 1 basis point.

 

On average, loans outstanding increased by $2.5 million, or 0.9%. Interest on loans decreased $185,000, or 2.5%, in the first six months of 2014 as compared to the same period in 2013. An average weighted yield decrease of 19 basis points lowered interest income by approximately $217,000, while the higher volume of loans partially offset that decrease by $32,000. 

 

Interest earned on investment securities increased $239,000 in the first six months of 2014 as compared to 2013, with average balances increasing $13.7 million during the period. The overall pre-tax yield on the investment securities portfolio increased during the period by 20 basis points.

 

Average interest-bearing liabilities increased by $5.8 million, and average non-interest bearing deposits grew by $8.7 million. The cost of interest bearing liabilities fell by 13 basis points as a result of the lower general rate environment and the shift in the mix of interest bearing liabilities.

 

Total average earning assets during the first six months of 2014 were $420.7 million, compared to $406.3 million during the first six months of 2013, yielding 3.98% in 2014 versus 4.10% in 2013. Funding costs for the earning assets were 0.63% and 0.75% for the first six months of 2014 and 2013, respectively. Net interest margin on a fully tax-equivalent basis for the first six months of 2014 was 3.49%. For the same period in 2013, the fully-tax equivalent net interest margin was 3.50%.

 

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AVERAGE BALANCE SHEETS AND NET INTEREST INCOME ANALYSIS

(Dollars in thousands)

 

   Six Months Ended   Six Months Ended             
   June 30, 2014   June 30, 2013    
   Average       Yield/   Average       Yield/   Increase (Decrease) Due To (6) 
   Balance (1)   Interest   Rate   Balance (1)   Interest   Rate   Volume   Rate   Total 
ASSETS                                             
Interest earning assets:                                             
Taxable loans (5)  $254,815   $6,900    5.42%  $255,246   $7,118    5.59%  $(12)  $(206)  $(218)
Tax-exempt loans   21,073    312    2.99    18,134    279    3.10    44    (11)   33 
Total loans   275,888    7,212    5.23    273,380    7,397    5.42    32    (217)   (185)
Taxable investment securities   106,995    890    1.66    90,596    609    1.35    121    161    282 
Tax-exempt investment securities   34,361    256    1.49    37,107    298    1.61    (21)   (22)   (43)
Total investment securities   141,356    1,146    1.62    127,703    907    1.42    100    139    239 
                                       -    - 
Interest bearing deposits   2,498    2    0.16    5,194    13    0.48    (5)   (5)   (10)
Federal funds sold   917    1    0.22    -    -         -    -    1 
Total interest earning assets   420,659    8,361    3.98    406,277    8,317    4.10    127    (83)   44 
                                              
Other assets (7)   41,447              41,968                          
Total assets  $462,106             $448,245                          
                                              
LIABILITIES AND STOCKHOLDERS' EQUITY                                             
Interest bearing liabilities:                                             
Interest bearing demand deposits (2)  $95,299    80    0.17   $94,370    79    0.17    1    -    1 
Savings deposits   65,012    32    0.10    59,331    38    0.13    3    (9)   (6)
Time deposits   151,402    1,117    1.49    165,141    1,376    1.68    (109)   (150)   (259)
Short-term and long term borrowings and other interest bearing liabilities   18,433    81    0.89    5,501    11    0.40    47    23    70 
Total interest bearing liabilities   330,146    1,310    0.81    324,343    1,504    0.94    (58)   (136)   (194)
                                              
Non-interest bearing liabilities:                                             
Demand deposits   77,558              68,904                          
Other   4,001              4,874                          
Stockholders' equity   50,401              50,124                          
Total liabilities and stockholders' equity  $462,106             $448,245                          
Net interest income and net interest rate spread       $7,051    3.17%       $6,813    3.16%  $185   $53   $238 
Net interest margin on interest earning assets (3)             3.35%             3.35%               
Net interest income and net interest margin-Tax equivalent basis (4)