10-Q 1 d391615d10q.htm 10-Q 10-Q
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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, 2012

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
incorporation or organization)
  (I.R.S. Employer
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, 2012

Common Stock ($1.00 par value)

   4,237,711 shares

 

 

 


Table of Contents

TABLE OF CONTENTS

 

PART I - FINANCIAL INFORMATION   

Item 1. Financial Statements

  

Consolidated Statements of Financial Condition as of June 30, 2012 and December 31, 2011 (Unaudited)

     3   

Consolidated Statements of Income for the Three and Six Months Ended June 30, 2012 and 2011 (Unaudited)

     4   

Consolidated Statements of Comprehensive Income for the Three and Six Months Ended June 30, 2012 and 2011 (Unaudited)

     5   

Consolidated Statements of Changes in Stockholders’ Equity for the Six Months Ended June 30, 2012 and 2011 (Unaudited)

     6   

Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2012 and 2011 (Unaudited)

     7   

Notes to Consolidated Financial Statements (Unaudited)

     8   

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

     26   

Item 3. Quantitative and Qualitative Disclosures about Market Risk

     33   

Item 4. Controls and Procedures

     35   
PART II - OTHER INFORMATION   

Item 1. Legal Proceedings

     36   

Item 1A. Risk Factors

     36   

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

     36   

Item 3. Defaults upon Senior Securities

     36   

Item 4. Mine Safety Disclosures

     36   

Item 5. Other Information

     36   

Item 6. Exhibits

     37   

   Signatures

     37   


Table of Contents

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,
2012
    December 31,
2011
 
ASSETS   

Cash and due from banks

   $ 10,387      $ 12,074   

Interest bearing deposits with banks

     14,215        2,100   
  

 

 

   

 

 

 

Cash and cash equivalents

     24,602        14,174   

Interest bearing time deposits with banks

     1,096        1,096   

Securities available for sale

     125,223        111,281   

Restricted investment in Federal Home Loan Bank (FHLB) stock

     1,534        1,700   

Investment in unconsolidated subsidiary

     3,888        3,796   

Total loans

     280,442        289,681   

Less: Allowance for loan losses

     (3,933     (2,931
  

 

 

   

 

 

 

Total loans, net of allowance for loan losses

     276,509        286,750   

Premises and equipment, net

     6,542        6,710   

Other real estate owned

     516        427   

Bank owned life insurance and annuities

     14,155        14,069   

Equity investment in low income housing project

     1,317        393   

Core deposit intangible

     187        209   

Goodwill

     2,046        2,046   

Accrued interest receivable and other assets

     4,982        4,782   
  

 

 

   

 

 

 

Total assets

   $ 462,597      $ 447,433   
  

 

 

   

 

 

 
LIABILITIES AND STOCKHOLDERS’ EQUITY   

Liabilities:

    

Deposits:

    

Non-interest bearing

   $ 65,055      $ 64,751   

Interest bearing

     337,423        321,914   
  

 

 

   

 

 

 

Total deposits

     402,478        386,665   

Securities sold under agreements to repurchase

     3,075        3,500   

Other interest bearing liabilities

     1,271        1,244   

Accrued interest payable and other liabilities

     5,939        6,304   
  

 

 

   

 

 

 

Total liabilities

     412,763        397,713   

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 -

    

4,237,711 shares at June 30, 2012;

    

4,228,218 shares at December 31, 2011

     4,746        4,746   

Surplus

     18,334        18,363   

Retained earnings

     38,671        38,900   

Accumulated other comprehensive loss

     (2,068     (2,256

Cost of common stock in Treasury:

    

508,115 shares at June 30, 2012;

    

517,608 shares at December 31, 2011

     (9,849     (10,033
  

 

 

   

 

 

 

Total stockholders’ equity

     49,834        49,720   
  

 

 

   

 

 

 

Total liabilities and stockholders’ equity

   $ 462,597      $ 447,433   
  

 

 

   

 

 

 

See accompanying notes to consolidated financial statements.

 

3


Table of Contents

Juniata Valley Financial Corp. and Subsidiary

Consolidated Statements of Income

(Unaudited)

(in thousands, except share data)

 

     Three Months Ended
June 30,
     Six Months Ended
June 30,
 
     2012     2011      2012     2011  

Interest income:

         

Loans, including fees

   $ 4,074      $ 4,484       $ 8,269      $ 9,076   

Taxable securities

     337        313         667        566   

Tax-exempt securities

     186        234         364        467   

Federal funds sold

     —          2         —          4   

Other interest income

     8        7         16        15   
  

 

 

   

 

 

    

 

 

   

 

 

 

Total interest income

     4,605        5,040         9,316        10,128   
  

 

 

   

 

 

    

 

 

   

 

 

 

Interest expense:

         

Deposits

     918        1,191         1,883        2,366   

Securities sold under agreements to repurchase

     —          —           1        1   

Other interest bearing liabilities

     6        7         12        14   
  

 

 

   

 

 

    

 

 

   

 

 

 

Total interest expense

     924        1,198         1,896        2,381   
  

 

 

   

 

 

    

 

 

   

 

 

 

Net interest income

     3,681        3,842         7,420        7,747   

Provision for loan losses

     69        116         1,177        204   
  

 

 

   

 

 

    

 

 

   

 

 

 

Net interest income after provision for loan losses

     3,612        3,726         6,243        7,543   
  

 

 

   

 

 

    

 

 

   

 

 

 

Non-interest income:

         

Trust fees

     114        94         220        207   

Customer service fees

     321        349         634        661   

Debit card fee income

     205        206         409        399   

Earnings on bank-owned life insurance and annuities

     105        124         211        243   

Commissions from sales of non-deposit products

     73        65         160        168   

Income from unconsolidated subsidiary

     61        66         118        131   

Gain on sale or call of securities

     2        1         2        6   

Gain from life insurance proceeds

     53        —           53        —     

Other non-interest income

     261        97         430        196   
  

 

 

   

 

 

    

 

 

   

 

 

 

Total non-interest income

     1,195        1,002         2,237        2,011   
  

 

 

   

 

 

    

 

 

   

 

 

 

Non-interest expense:

         

Employee compensation expense

     1,289        1,337         2,567        2,592   

Employee benefits

     478        423         1,013        824   

Occupancy

     229        252         458        495   

Equipment

     126        146         259        301   

Data processing expense

     354        337         710        659   

Director compensation

     60        70         119        147   

Professional fees

     93        91         181        230   

Taxes, other than income

     113        124         231        251   

FDIC Insurance premiums

     81        85         160        218   

Loss (gain) on sales of other real estate owned

     (3     1         (1     (14

Amortization of intangibles

     11        11         22        22   

Other non-interest expense

     389        423         746        738   
  

 

 

   

 

 

    

 

 

   

 

 

 

Total non-interest expense

     3,220        3,300         6,465        6,463   
  

 

 

   

 

 

    

 

 

   

 

 

 

Income before income taxes

     1,587        1,428         2,015        3,091   

Provision for income taxes

     372        337         382        761   
  

 

 

   

 

 

    

 

 

   

 

 

 

Net income

   $ 1,215      $ 1,091       $ 1,633      $ 2,330   
  

 

 

   

 

 

    

 

 

   

 

 

 

Earnings per share

         

Basic

   $ 0.29      $ 0.26       $ 0.39      $ 0.55   

Diluted

   $ 0.29      $ 0.26       $ 0.39      $ 0.55   

Cash dividends declared per share

   $ 0.22      $ 0.21       $ 0.44      $ 0.42   

Weighted average basic shares outstanding

     4,231,690        4,237,886         4,229,954        4,246,884   

Weighted average diluted shares outstanding

     4,234,321        4,240,781         4,232,842        4,249,900   

See accompanying notes to consolidated financial statements.

 

4


Table of Contents

Juniata Valley Financial Corp. and Subsidiary

Consolidated Statements of Comprehensive Income

(Unaudited, in thousands)

 

     Three Months Ended June 30, 2012     Three Months Ended June 30, 2011  
     Before
Tax
Amount
    Tax Expense
or

(Benefit)
    Net-of-Tax
Amount
    Before
Tax
Amount
    Tax Expense
or

(Benefit)
     Net-of-Tax
Amount
 

Net income

   $ 1,587      $ 372      $ 1,215      $ 1,428      $ 337       $ 1,091   

Other comprehensive income:

             

Unrealized gains on available for sale securities:

             

Unrealized gains arising during the period

     163        57        106        588        200         388   

Unrealized gains from unconsolidated subsidiary

     —          —          —          3        —           3   

Less reclassification adjustment for gains included in net income

     (2     (1     (1     (1     —           (1

Change in pension liability

     74        25        49        39        13         26   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

Other comprehensive income

     235        81        154        629        213         416   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

Total comprehensive income

   $ 1,822      $ 453      $ 1,369      $ 2,057      $ 550       $ 1,507   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

 

     Six Months Ended June 30, 2012     Six Months Ended June 30, 2011  
     Before
Tax
Amount
    Tax Expense
or

(Benefit)
    Net-of-Tax
Amount
    Before
Tax
Amount
    Tax Expense
or

(Benefit)
    Net-of-Tax
Amount
 

Net income

   $ 2,015      $ 382      $ 1,633      $ 3,091      $ 761      $ 2,330   

Other comprehensive income:

            

Unrealized gains (losses) on available for sale securities:

            

Unrealized gains arising during the period

     141        49        92        408        138        270   

Unrealized gains (losses) from unconsolidated subsidiary

     (1     —          (1     5        —          5   

Less reclassification adjustment for:
gains included in net income

     (2     (1     (1     (6     (2     (4

Change in pension liability

     148        50        98        79        27        52   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Other comprehensive income

     286        98        188        486        163        323   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total comprehensive income

   $ 2,301      $ 480      $ 1,821      $ 3,577      $ 924      $ 2,653   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

See accompanying notes to consolidated financial statements.

 

5


Table of Contents

Juniata Valley Financial Corp. and Subsidiary

Consolidated Statements of Changes in Stockholders’ Equity

(Unaudited)

(in thousands, except share data)

 

Six Months Ended June 30, 2012

 
     Number
of
Shares
Outstanding
     Common
Stock
     Surplus     Retained
Earnings
    Accumulated
Other

Comprehensive
Loss
    Treasury
Stock
    Total
Stockholders’
Equity
 

Balance at January 1, 2012

     4,228,218       $ 4,746       $ 18,363      $ 38,900      $ (2,256   $ (10,033   $ 49,720   

Net income

             1,633            1,633   

Other comprehensive income

               188          188   

Cash dividends at $0.44 per share

             (1,862         (1,862

Stock-based compensation activity

           11              11   

Treasury stock issued for stock option and stock purchase plans

     9,493            (40         184        144   
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance at June 30, 2012

     4,237,711       $ 4,746       $ 18,334      $ 38,671      $ (2,068   $ (9,849   $ 49,834   
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

Six Months Ended June 30, 2012

 
     Number
of
Shares
Outstanding
    Common
Stock
     Surplus      Retained
Earnings
    Accumulated
Other

Comprehensive
Loss
    Treasury
Stock
    Total
Stockholders’
Equity
 

Balance at January 1, 2011

     4,257,765      $ 4,746       $ 18,354       $ 37,868      $ (1,465   $ (9,527   $ 49,976   

Net income

             2,330            2,330   

Other comprehensive income

               323          323   

Cash dividends at $0.42 per share

             (1,784         (1,784

Stock-based compensation

          12               12   

Purchase of treasury stock

     (24,500               (417     (417

Treasury stock issued for stock option and stock purchase plans

     2,903     

 

 

       (10)      

 

 

   

 

 

      56        46   

Balance at June 30, 2011

     4,236,168      $ 4,746       $ 18,356       $ 38,414      $ (1,142   $ (9,888   $ 50,486   
  

 

 

   

 

 

    

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 

See accompanying notes to consolidated financial statements.

 

6


Table of Contents

Juniata Valley Financial Corp. and Subsidiary

Consolidated Statements of Cash Flows

(Unaudited)

(in thousands)

 

     Six Months Ended June 30,  
     2012     2011  

Operating activities:

    

Net income

   $ 1,633      $ 2,330   

Adjustments to reconcile net income to net cash provided by operating activities:

    

Provision for loan losses

     1,177        204   

Depreciation

     265        302   

Net amortization of securities premiums

     195        175   

Net amortization of loan origination costs

     4        26   

Deferred net loan origination fees (costs)

     (22     3   

Amortization of core deposit intangible

     22        22   

Net realized gains on sales or calls of securities

     (2     (6

Net gains on sales of other real estate owned

     (1     (14

Earnings on bank owned life insurance and annuities

     (211     (243

Deferred income tax expense (benefit)

     (184     49   

Equity in earnings of unconsolidated subsidiary, net of dividends of $25 and $20

     (93     (111

Stock-based compensation expense

     11        12   

Mortgage loans originated for sale

     (4,674     —     

Proceeds from loans sold to others

     4,674        —     

Increase in accrued interest receivable and other assets

     (116     (474

Decrease in accrued interest payable and other liabilities

     (175     (149
  

 

 

   

 

 

 

Net cash provided by operating activities

     2,503        2,126   
  

 

 

   

 

 

 

Investing activities:

    

Purchases of:

    

Securities available for sale

     (48,868     (43,484

Premises and equipment

     (97     (125

Bank owned life insurance and annuities

     (40     (44

Proceeds from:

    

Maturities of and principal repayments on:

    

Securities available for sale

     34,871        11,646   

Redemption of FHLB stock

     166        204   

Bank owned life insurance and annuities

     4        13   

Proceeds from life insurance claim

     147        —     

Sale of other real estate owned

     502        411   

Sale of other assets

     2        —     

Investment in low income housing partnership

     (924     —     

Net decrease in interest bearing time deposits

     —          249   

Net decrease in loans receivable

     8,492        5,760   
  

 

 

   

 

 

 

Net cash used in investing activities

     (5,745     (25,370
  

 

 

   

 

 

 

Financing activities:

    

Net increase in deposits

     15,813        16,763   

Net decrease in securities sold under agreements to repurchase

     (425     (861

Cash dividends

     (1,862     (1,784

Purchase of treasury stock

     —          (417

Treasury stock issued for employee stock plans

     144        46   
  

 

 

   

 

 

 

Net cash provided by financing activities

     13,670        13,747   
  

 

 

   

 

 

 

Net increase (decrease) in cash and cash equivalents

     10,428        (9,497

Cash and cash equivalents at beginning of year

     14,174        25,276   
  

 

 

   

 

 

 

Cash and cash equivalents at end of year

   $ 24,602      $ 15,779   
  

 

 

   

 

 

 

Supplemental information:

    

Interest paid

   $ 1,894      $ 2,368   

Income taxes paid

     825        875   

Supplemental schedule of noncash investing and financing activities:

    

Transfer of loans to other real estate owned

   $ 590      $ 148   

Transfer of loans to other assets

     —          9   

See accompanying notes to consolidated financial statements.

 

7


Table of Contents

Juniata Valley Financial Corp. and Subsidiary

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

NOTE 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 financial statements. In the opinion of management, all adjustments considered necessary for fair presentation have been included. For comparative purposes, whenever necessary, the 2011 balances have been reclassified to conform to the 2012 presentation. Such reclassifications, if any, had no impact on net income. Operating results for the three and six month periods ended June 30, 2012, are not necessarily indicative of the results for the year ended December 31, 2012. For further information, refer to the consolidated financial statements and footnotes thereto included in Juniata Valley Financial Corp.’s Annual Report on Form 10-K for the year ended December 31, 2011.

The Company has evaluated events and transactions occurring subsequent to the statement of financial condition date of June 30, 2012 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.

NOTE 2 – Recent Accounting Pronouncements

There were no new accounting pronouncements affecting the Company during the reporting periods.

NOTE 3 – Accumulated Other Comprehensive Loss

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

 

     6/30/2012     12/31/2011  

Unrealized gains on available for sale securities

   $ 913      $ 823   

Unrecognized expense for defined benefit pension

     (2,981     (3,079
  

 

 

   

 

 

 

Accumulated other comprehensive loss

   $ (2,068   $ (2,256
  

 

 

   

 

 

 

NOTE 4 – Earnings per Share

The following table sets forth the computation of basic and diluted earnings per share:

 

8


Table of Contents

(Amounts, except earnings per share, in thousands)

 

     Three Months      Three Months  
     Ended      Ended  
     June 30, 2012      June 30, 2011  

Net income

   $ 1,215       $ 1,091   

Weighted-average common shares outstanding

     4,232         4,238   
  

 

 

    

 

 

 

Basic earnings per share

   $ 0.29       $ 0.26   
  

 

 

    

 

 

 

Weighted-average common shares outstanding

     4,232         4,238   

Common stock equivalents due to effect of stock options

     3         3   

Total weighted-average common shares and equivalents

     4,235         4,241   
  

 

 

    

 

 

 

Diluted earnings per share

   $ 0.29       $ 0.26   
  

 

 

    

 

 

 
     Six Months      Six Months  
     Ended      Ended  
     June 30, 2012      June 30, 2011  

Net income

   $ 1,633       $ 2,330   

Weighted-average common shares outstanding

     4,230         4,247   
  

 

 

    

 

 

 

Basic earnings per share

   $ 0.39       $ 0.55   
  

 

 

    

 

 

 

Weighted-average common shares outstanding

     4,230         4,247   

Common stock equivalents due to effect of stock options

     3         3   
  

 

 

    

 

 

 

Total weighted-average common shares and equivalents

     4,233         4,250   
  

 

 

    

 

 

 

Diluted earnings per share

   $ 0.39       $ 0.55   
  

 

 

    

 

 

 

NOTE 5 – 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, 2012, the Company had $41,904,000 outstanding in loan commitments and other unused lines of credit extended to its customers as compared to $38,033,000 at December 31, 2011.

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 $1,181,000 and $1,067,000 of letters of credit commitments as of June 30, 2012 and December 31, 2011, 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, 2012 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.

 

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NOTE 6 – Defined Benefit Retirement Plan

The Company had a defined benefit retirement plan covering substantially all of its employees, prior to January 1, 2008. Effective January 1, 2008, the plan was amended to close the plan to new entrants. The benefits under the plan are based on years of service and the employees’ compensation. The Company’s funding policy allows contributions annually up to the maximum amount that can be deducted for federal income taxes purposes. Contributions are intended to provide not only for benefits attributed to service to date but also for those expected to be earned in the future. The Company has made no contributions in the first six months of 2012 and does not expect to contribute to the defined benefit plan in the remainder of 2012. Pension expense included the following components for the three and six month periods ended June 30, 2012 and 2011:

(Dollars in thousands)

 

     Three Months Ended     Six Months Ended  
     June 30,     June 30,  
     2012     2011     2012     2011  

Components of net periodic pension cost

        

Service cost

   $ 56      $ 48      $ 111      $ 96   

Interest cost

     113        118        226        236   

Expected return on plan assets

     (148     (158     (296     (316

Additional recognized amounts

     74        39        148        79   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net periodic pension cost

   $ 95      $ 47      $ 189      $ 95   
  

 

 

   

 

 

   

 

 

   

 

 

 

NOTE 7– Acquisition

In 2006, the Company acquired a branch office in Richfield, PA. The acquisition included real estate, deposits and loans. The assets and liabilities of the acquired business were recorded on the consolidated statement of financial condition at their estimated fair values as of September 8, 2006, and their 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. During the first six months of 2012 and 2011, amortization expense was $22,000. Accumulated amortization of core deposit intangible through June 30, 2012 was $262,000. 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 the six month periods ended June 30, 2012 or 2011.

NOTE 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. The investment is being carried at $3,888,000 as of June 30, 2012. The Company increases its investment in LCB for its share of earnings and decreases its investment by any dividends received from LCB. A loss in value of the investment which is other than a temporary decline would be recognized in earnings. Evidence of a loss in value that is other than temporary 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 carrying amount of the investment.

NOTE 9 – Securities

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 done before assessing 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, considerations used 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 developments that would affect expectations for recovery or further decline.

 

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In instances when a determination is made that an other-than-temporary impairment exists and the investor 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 impaired 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 income.

The Company’s investment portfolio includes primarily bonds issued by U.S. Government sponsored agencies (approximately 61%) and municipalities (approximately 36%) as of June 30, 2012. Most of the municipal bonds are general obligation bonds with maturities or pre-refunding dates within 5 years. The remaining 3% of the portfolio includes mortgage-backed securities issued by Government-sponsored agencies and backed by residential mortgages and a group of equity investments in other financial institutions. The amortized cost and fair value of securities as of June 30, 2012 and December 31, 2011, 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.

Securities Available for Sale

 

     June 30, 2012  
                   Gross      Gross  
     Amortized      Fair      Unrealized      Unrealized  

Type and maturity

   Cost      Value      Gains      Losses  

Obligations of U.S. Government agencies and corporations

           

Within one year

   $ 5,416       $ 5,482       $ 66       $ —     

After one year but within five years

     57,079         57,691         614         (2

After five years but within ten years

     13,499         13,563         64         —     
  

 

 

    

 

 

    

 

 

    

 

 

 
     75,994         76,736         744         (2

Obligations of state and political subdivisions

           

Within one year

     11,482         11,553         71         —     

After one year but within five years

     26,590         26,880         308         (18

After five years but within ten years

     5,213         5,428         224         (9

After ten years

     1,301         1,294         —           (7
  

 

 

    

 

 

    

 

 

    

 

 

 
     44,586         45,155         603         (34

Mortgage-backed securities

     2,299         2,335         36         —     

Equity securities

     985         997         142         (130
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 123,864       $ 125,223       $ 1,525       $ (166
  

 

 

    

 

 

    

 

 

    

 

 

 
Securities Available for Sale            
     December 31, 2011  
                   Gross      Gross  
     Amortized      Fair      Unrealized      Unrealized  

Type and maturity

   Cost      Value      Gains      Losses  

Obligations of U.S. Government agencies and corporations

           

Within one year

   $ 2,918       $ 2,947       $ 29       $ —     

After one year but within five years

     51,629         52,202         584         (11

After five years but within ten years

     12,497         12,539         42         —     
  

 

 

    

 

 

    

 

 

    

 

 

 
     67,044         67,688         655         (11

Obligations of state and political subdivisions

           

Within one year

     11,076         11,154         78         —     

After one year but within five years

     21,944         22,289         369         (24

After five years but within ten years

     3,976         4,147         173         (2
  

 

 

    

 

 

    

 

 

    

 

 

 
     36,996         37,590         620         (26

Corporate notes

           

After one year but within five years

     1,000         1,004         4         —     
  

 

 

    

 

 

    

 

 

    

 

 

 
     1,000         1,004         4         —     

Mortgage-backed securities

     4,035         4,109         74         —     

Equity securities

     985         890         97         (192
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 110,060       $ 111,281       $ 1,450       $ (229
  

 

 

    

 

 

    

 

 

    

 

 

 

 

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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, 2012 and December 31, 2011 (in thousands):

 

            Unrealized Losses at June 30, 2012         
     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

   $ 5,506       $ (2   $ —         $ —        $ 5,506       $ (2

Obligations of state and political subdivisions

     9,170         (34     —           —          9,170         (34
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Debt securities

     14,676         (36     —           —          14,676         (36

Equity securities

     324         (30     199         (100     523         (130
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total temporarily impaired securities

   $ 15,000       $ (66   $ 199       $ (100   $ 15,199       $ (166
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 
            Unrealized Losses at December 31, 2011         
     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

   $ 6,489       $ (11   $ —         $ —        $ 6,489       $ (11

Obligations of state and political subdivisions

     4,321         (26     —           —          4,321         (26
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Debt securities

     10,810         (37     —           —          10,810         (37

Equity securities

     423         (80     232         (112     655         (192
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total temporarily impaired securities

   $ 11,233       $ (117   $ 232       $ (112   $ 11,465       $ (229
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

The unrealized losses noted above are considered to be temporary impairments. There are 30 debt securities that were in an unrealized loss position on June 30, 2012, but none that have had unrealized losses for more than 12 months. We believe that the decline in the value of our debt securities is due only to interest rate fluctuations, rather than erosion of quality. As a result, we also believe that the payment of contractual cash flows, including principal repayment, is not at risk. As management 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 (“Bank Stocks”) and are evaluated quarterly for evidence of other-than-temporary impairment. There were 10 equity securities that were in an unrealized loss position on June 30, 2012, and seven of those that comprise a group of securities with unrealized losses for 12 months or more. Individually, none of these seven equity securities have significant unrealized losses. Of the seven equity securities that have sustained unrealized losses for more than 12 months, five have increased in fair value during the first six months of 2012, indicating the possibility of full recovery and therefore are deemed to be temporarily impaired. Of the two remaining stocks experiencing sustained unrealized losses, the amount of individual loss is not material and increases in value were noted, at times, in 2012. Management has identified no new other-than-temporary impairment as of June 30, 2012 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. Management has the ability and intent to hold its equity securities until recovery of unrealized losses.

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 fair value of the pledged assets amounted to $30,973,000 and $25,953,000 at June 30, 2012 and December 31, 2011, respectively.

 

 

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In addition to cash received from the scheduled maturities of securities, some investment securities available for sale are sold at current market values during the course of normal operations, and some securities are called pursuant to call features built into the bonds. Following is a summary of proceeds received from all investment securities transactions, and the resulting realized gains and losses (in thousands):

 

     Three Months Ended      Six Months Ended  
     June 30,      June 30,  
     2012      2011      2012      2011  

Gross proceeds from sales of securities

   $ —         $ —         $ —         $ —     

Securities available for sale:

           

Gross realized gains from called securities

   $ 2       $ 1       $ 2       $ 6   

Gross realized losses

     —           —           —           —     

NOTE 10 – Loans and Related Allowance for Credit Losses

Loans that management 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 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 they are (1) guaranteed or well secured and (2) there is an effective means of 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 other non-interest 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 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.

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

 

  1. 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;

 

  2. all collateral securing the loan has been liquidated and a deficiency balance remains;

 

  3. a bankruptcy notice is received for an unsecured loan;

 

  4. a confirming loss event has occurred; or

 

  5. the loan is deemed to be uncollectible for any other reason.

 

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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 Bank’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, 2012 to be 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 large commercial loan is considered impaired when, based on current information and events, it is probable that the Bank will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. (A “large” loan, or group of like-loans within one relationship, is defined as a commercial/business loan, including business loans secured by 1-4 family properties included in the real estate-mortgage category, with an aggregate outstanding balance in excess of $150,000, or any other loan that management deems to have similar characteristics to an impaired large loan.) 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 for commercial segment loans by either the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s obtainable 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 Bank 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 such 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 period of time after modification. Loans classified as troubled debt restructurings are designated as impaired.

 

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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 substandard have one or more well-defined weaknesses that jeopardize the liquidation of the debt. They 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 for the past six years. The qualitative risk factors are reviewed for relevancy each quarter and include:

 

  1. 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;

 

  2. Nature and volume of the portfolio and terms of loans;

 

  3. Experience, ability and depth of lending and credit management and staff;

 

  4. Volume and severity of past due, classified and nonaccrual loans, as well as other loan modifications;

 

  5. Existence and effect of any concentrations of credit and changes in the level of such concentrations; and

 

  6. 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 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. 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 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.

 

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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.

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.

 

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Table of Contents

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, mobile homes 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.

The following table presents 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, 2012 and December 31, 2011 (in thousands):

 

As of June 30, 2012    Pass      Special
Mention
     Substandard      Doubtful      Total  

Commercial, financial and agricultural

   $ 17,894       $ 1,580       $ 695       $ —         $ 20,169   

Real estate—commercial

     53,440         7,815         4,807         40         66,102   

Real estate—construction

     10,003         635         170         2,411         13,219   

Real estate—mortgage

     150,350         6,506         2,077         3,671         162,604   

Obligations of states and political subdivisions

     12,384         —           —           —           12,384   

Personal

     5,950         10         4         —           5,964   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 250,021       $ 16,546       $ 7,753       $ 6,122       $ 280,442   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

As of December 31, 2011    Pass      Special
Mention
     Substandard      Doubtful      Total  

Commercial, financial and agricultural

   $ 17,657       $ 671       $ 1,089       $ —         $ 19,417   

Real estate—commercial

     48,108         8,898         3,768         —           60,774   

Real estate—construction

     14,616         1,022         720         1,150         17,508   

Real estate—mortgage

     161,607         7,513         3,758         3,666         176,544   

Obligations of states and political subdivisions

     8,780         —           —           —           8,780   

Personal

     6,640         18         —           —           6,658   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 257,408       $ 18,122       $ 9,335       $ 4,816       $ 289,681   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

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 rather than recording partial charge-offs until termination of the credit is scheduled through liquidation of the collateral or foreclosure. In the case of a foreclosure, professional appraisals of collateral, discounted for expected selling costs, are used to determine the charge-off amount. The following tables summarize information regarding impaired loans by portfolio class as of June 30, 2012 and December 31, 2011 (in thousands):

 

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Table of Contents
     As of June 30, 2012      As of December 31, 2011  
     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

   $ 197       $ 197       $ —         $ 238       $ 238      $ —     

Real estate—commercial

     2,747         2,747         —           2,312         2,312        —     

Real estate—construction

     1,297         1,297         —           720         720        —     

Real estate—mortgage

     541         541         —           2,254         2,254        —     

With an allowance recorded:

                

Real estate—construction

   $ 1,114       $ 1,114       $ 295       $ 1,150       $ 1,150      $ 343   

Real estate—mortgage

     3,053         3,053         1,571         2,865         2,865        432   

Total:

                

Commercial, financial and agricultural

   $ 197       $ 197       $ —         $ 238       $ 238      $ —     

Real estate—commercial

     2,747         2,747         —           2,312         2,312        —     

Real estate—construction

     2,411         2,411         295         1,870         1,870        343   

Real estate—mortgage

     3,594         3,594         1,571         5,119         5,119        432   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 
   $ 8,949       $ 8,949       $ 1,866       $ 9,539       $ 9,539      $ 775   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 
     Three Months Ended June 30, 2012      Three Months Ended June 30, 2011  
     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

   $ 207       $ 3       $ —         $ 281       $ 5      $ —     

Real estate—commercial

     2,764         40         —           2,348         35        2   

Real estate—construction

     649         —           —           125         —          —     

Real estate—mortgage

     550         —           —           1,906         (10     3   

With an allowance recorded:

                

Real estate—construction

   $ 1,007       $ 3       $ —         $ 1,025       $ —        $ —     

Real estate—mortgage

     3,724         —           —           1,143         —          —     

Total:

                

Commercial, financial and agricultural

   $ 207       $ 3       $ —         $ 281       $ 5      $ —     

Real estate—commercial

     2,764         40         —           2,348         35        2   

Real estate—construction

     1,656         3         —           1,150         —          —     

Real estate—mortgage

     4,274         —           —           3,049         (10     3   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 
   $ 8,901       $ 46       $ —         $ 6,828       $ 30      $ 5   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

 

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Table of Contents
     Six Months Ended June 30, 2012      Six Months Ended June 30, 2011  
     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

   $ 218       $ 7       $ —         $ 290       $ 10       $ —     

Real estate—commercial

     2,530         81         —           2,363         68         2   

Real estate—construction

     1,009         —           —           167         —           —     

Real estate—mortgage

     1,398         —           —           2,154         13         3   

With an allowance recorded:

                 

Real estate—construction

   $ 1,132       $ 3       $ —         $ 983       $ —         $ —     

Real estate—mortgage

     2,959         —           —           1,174         —           —     

Total:

                 

Commercial, financial and agricultural

   $ 218       $ 7       $ —         $ 290       $ 10       $ —     

Real estate—commercial

     2,530         81         —           2,363         68         2   

Real estate—construction

     2,141         3         —           1,150         —           —     

Real estate—mortgage

     4,357         —           —           3,328         13         3   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
   $ 9,246       $ 91       $ —         $ 7,131       $ 91       $ 5   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

The following table presents nonaccrual loans by classes of the loan portfolio as of June 30, 2012 and December 31, 2011 (in thousands):

 

     June 30, 2012      December 31, 2011  

Nonaccrual loans:

     

Commercial, financial and agricultural

   $ —         $ 2   

Real estate—commercial

     492         520   

Real estate—construction

     2,411         1,497   

Real estate—mortgage

     4,732         5,928   
  

 

 

    

 

 

 

Total

   $ 7,635       $ 7,947   
  

 

 

    

 

 

 

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, 2012 and December 31, 2011 (in thousands):

 

As of June 30, 2012    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

   $ 177       $ —         $ 26       $ 203       $ 19,966       $ 20,169       $ 26   

Real estate—commercial

     541         646         1,809         2,996         63,106         66,102         1,317   

Real estate—construction

     365         —           2,569         2,934         10,285         13,219         158   

Real estate—mortgage

     2,256         447         4,521         7,224         155,380         162,604         726   

Obligations of states and political subdivisions

     —           —           —           —           12,384         12,384         —     

Personal

     31         4         5         40         5,924         5,964         5   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 3,370       $ 1,097       $ 8,930       $ 13,397       $ 267,045       $ 280,442       $ 2,232   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

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Table of Contents
As of December 31, 2011    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

   $ 220       $ 2       $ 30       $ 252       $ 19,165       $ 19,417       $ 30   

Real estate—commercial

     245         466         1,319         2,030         58,744         60,774         799   

Real estate—construction

     278         32         2,030         2,340         15,168         17,508         533   

Real estate—mortgage

     2,871         145         7,303         10,319         166,225         176,544         1,375   

Obligations of states and political subdivisions

     —           —           —           —           8,780         8,780         —     

Personal

     50         11         6         67         6,591         6,658         6   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 3,664       $ 656       $ 10,688       $ 15,008       $ 274,673       $ 289,681       $ 2,743   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

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

 

As of, and for the periods ended June 30, 2012

 
     Commercial,
financial and
agricultural
    Real estate -
commercial
    Real estate
construction
    Real estate -
mortgage
    Personal     Total  

Allowance for loan losses:

            

Beginning Balance, April 1, 2012

   $ 194      $ 403      $ 271      $ 2,951      $ 64      $ 3,883   

Charge-offs

     (2     —          —          (21     —          (23

Recoveries

     4        —          —          —          —          4   

Provisions

     7        29        93        (57     (3     69   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ending balance, June 30, 2012

   $ 203      $ 432      $ 364      $ 2,873      $ 61      $ 3,933   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Beginning Balance, January 1, 2012

   $ 195      $ 455      $ 442      $ 1,771      $ 68      $ 2,931   

Charge-offs

     (4     —          —          (176     (1     (181

Recoveries

     5        —          —          —          1        6   

Provisions

     7        (23     (78     1,278        (7     1,177   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ending balance, June 30, 2012

   $ 203      $ 432      $ 364      $ 2,873      $ 61      $ 3,933   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

     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

   $ 203       $ 432       $ 364       $ 2,873       $ —         $ 61       $ 3,933   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Ending balance: individually evaluated for impairment

   $ —         $ —         $ 295       $ 1,571       $ —         $ —         $ 1,866   

Ending balance: collectively evaluted for impairment

   $ 203       $ 432       $ 69       $ 1,302       $ —         $ 61       $ 2,067   

Loans, net of unearned interest:

                    

Ending balance

   $ 20,169       $ 66,102       $ 13,219       $ 162,604       $ 12,384       $ 5,964       $ 280,442   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Ending balance: individually evaluated for impairment

   $ 197       $ 2,747       $ 2,411       $ 3,594       $ —         $ —         $ 8,949   

Ending balance: collectively evaluated for impairment

   $ 19,972       $ 63,355       $ 10,808       $ 159,010       $ 12,384       $ 5,964       $ 271,493   

 

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Table of Contents

 

As of, and for the periods ended June 30, 2011

 
     Commercial,
financial and
agricultural
    Real estate -
commercial
    Real estate -
construction
    Real estate -
mortgage
    Personal     Total  

Allowance for loan losses:

            

Beginning Balance, April 1, 2011

   $ 146      $ 462      $ 434      $ 1,796      $ 63      $ 2,901   

Charge-offs

     (4     —          —          (127     (5     (136

Provisions

     3        (3     (3     115        4        116   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ending balance, June 30, 2011

   $ 145      $ 459      $ 431      $ 1,784      $ 62      $ 2,881   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Beginning Balance, January 1, 2011

   $ 163      $ 442      $ 336      $ 1,810      $ 73      $ 2,824   

Charge-offs

     (8     —          —          (143     (5     (156

Recoveries

     —          —          —          —          9        9   

Provisions

     (10     17        95        117        (15     204   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ending balance, June 30, 2011

   $ 145      $ 459      $ 431      $ 1,784      $ 62      $ 2,881   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

     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

   $ 145       $ 459       $ 431       $ 1,784       $ —         $ 62       $ 2,881   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Ending balance: individually evaluated for impairment

   $ —         $ —         $ 303       $ 325       $ —         $ —         $ 628   

Ending balance: collectively evaluted for impairment

   $ 145       $ 459       $ 128       $ 1,459       $ —         $ 62       $ 2,253   

Loans, net of unearned interest:

                    

Ending balance

   $ 17,562       $ 58,950       $ 18,014       $ 181,431       $ 8,433       $ 7,619       $ 292,009   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Ending balance: individually evaluated for impairment

   $ 274       $ 2,322       $ 1,150       $ 3,059       $ —         $ —         $ 6,805   

Ending balance: collectively evaluated for impairment

   $ 17,288       $ 56,628       $ 16,864       $ 178,372       $ 8,433       $ 7,619       $ 285,204   

 

 

As of December 31, 2011  
     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, 2011

                    

Allowance for loan losses:

                    

Ending balance

   $ 195       $ 455       $ 442       $ 1,771       $ —         $ 68       $ 2,931   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Ending balance: individually evaluated for impairment

   $ —         $ —         $ 343       $ 432       $ —         $ —         $ 775   

Ending balance: collectively evaluted for impairment

   $ 195       $ 455       $ 99       $ 1,339       $ —         $ 68       $ 2,156   

Loans, net of unearned interest:

                    

Ending balance

   $ 19,417       $ 60,774       $ 17,508       $ 176,544       $ 8,780       $ 6,658       $ 289,681   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Ending balance: individually evaluated for impairment

   $ 238       $ 2,312       $ 1,870       $ 5,119       $ —         $ —         $ 9,539   

Ending balance: collectively evaluated for impairment

   $ 19,179       $ 58,462       $ 15,638       $ 171,425       $ 8,780       $ 6,658       $ 280,142   

The Company identified no loans that we determined were considered troubled debt restructurings during the period, and did not have any troubled debt restructurings as of June 30, 2012.

NOTE 11 – Fair Value Measurements

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.

 

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Table of Contents

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.

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 or liabilities placement in the fair value hierarchy is based on the lowest level of input that is significant to the fair value measurement.

 

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A description of the valuation methodologies used for instruments measured at fair value, as well as the general classification of such instruments 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, 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.

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.

The following table summarizes financial assets and financial liabilities measured at fair value as of June 30, 2012 and December 31, 2011, 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 for the quarter ended June 30, 2012.

 

            (Level 1)      (Level 2)      (Level 3)  
     June 30, 2012      Quoted Prices in
Active Markets
for Identical
Assets
     Significant
Other
Observable
Inputs
     Significant
Other
Unobservable
Inputs
 

Measured at fair value on a recurring basis:

           

Debt securities available-for-sale:

           

Obligations of U.S. Government agencies and corporations

   $ 76,736       $ —         $ 76,736       $ —     

Obligations of state and political subdivisions

     45,155         —           45,155         —     

Mortgage-backed securities

     2,335         —           2,335         —     

Equity securities available-for-sale

     997         997         —           —     

Measured at fair value on a non-recurring basis:

           

Impaired loans

     2,301         —           —           2,301   

 

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     December 31,
2011
     (Level 1)
Quoted Prices in
Active Markets
for Identical
Assets
     (Level 2)
Significant
Other
Observable
Inputs
     (Level 3)
Significant
Other
Unobservable
Inputs
 

Measured at fair value on a recurring basis:

           

Debt securities available-for-sale:

           

Obligations of U.S. Government agencies and corporations

   $ 67,688       $ —         $ 67,688       $ —     

Obligations of state and political subdivisions

     37,590         —           37,590         —     

Corporate notes

     1,004         —           1,004         —     

Mortgage-backed securities

     4,109         —           4,109         —     

Equity securities available-for-sale

     890         890         —           —     

Measured at fair value on a non-recurring basis:

           

Impaired loans

     3,240         —           —           3,240   

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:

 

     Fair Value             

June 30, 2012

   Estimate    Valuation Technique   Unobservable Input   Range

Impaired loans

   $2,301    Appraisal of collateral (1)   Appraisal and liquidation adjustments (2)   0% - (7)%

 

(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 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 used to determine these estimated fair values.

Carrying values approximate fair value for cash and due from banks, interest-bearing demand deposits with other banks, federal funds sold, restricted stock in the Federal Home Loan Bank, interest receivable, non-interest bearing demand deposits, securities sold under agreements to repurchase, and interest payable.

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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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.

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) are 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 values of long-term debt are estimated using discounted cash flow analysis, based on incremental borrowing rates for similar types of borrowing 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, 2012      December 31, 2011  
     Carrying      Fair      Carrying      Fair  
     Value      Value      Value      Value  

Financial assets:

           

Cash and due from banks

   $ 10,387       $ 10,387       $ 12,074       $ 12,074   

Interest bearing deposits with banks

     14,215       $ 14,215         2,100         2,100   

Interest bearing time deposits with banks

     1,096         1,097         1,096         1,111   

Securities

     125,223         125,223         111,281         111,281   

Restricted investment in FHLB stock

     1,534         1,534         1,700         1,700   

Total loans, net of allowance for loan losses

     276,509         285,124         286,750         296,891   

Accrued interest receivable

     1,710         1,710         1,811         1,811   

Financial liabilities:

           

Non-interest bearing deposits

     65,055         65,055         64,751         64,751   

Interest bearing deposits

     337,423         342,325         321,914         327,857   

Securities sold under agreements to repurchase

     3,075         3,075         3,500         3,500   

Other interest bearing liabilities

     1,271         1,277         1,244         1,251   

Accrued interest payable

     423         423         421         421   

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, 2012. This table excludes financial instruments for which the carrying amount approximates fair value.

 

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                   (Level 1)      (Level 2)      (Level 3)  
June 30, 2012    Carrying
Amount
     Fair Value      Quoted Prices in
Active Markets
for Identical
Assets or
Liabilities
     Significant
Other
Observable
Inputs
     Significant
Other
Unobservable
Inputs
 

Financial instruments—Assets

              

Interest bearing time deposits with banks

   $ 1,096       $ 1,097       $ —         $ 1,097       $ —     

Loans, net of allowance for loan losses

     276,509         285,123         —           —           285,123   

Financial instruments—Liabilities

              

Interest bearing deposits

     337,423         342,325         —           342,325         —     

Other interest bearing liabilities

     1,271         1,277         —           1,277         —     

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

Forward Looking Statements:

The Private Securities Litigation Reform Act of 1995 contains safe harbor provisions regarding forward-looking statements. When used in this discussion, the words “believes,” “anticipates,” “contemplates,” “expects,” and similar expressions are intended to identify forward-looking statements. Such statements are subject to certain risks and uncertainties which could cause actual results, performance or achievements expressed or implied by such forward-looking statements to differ materially from those projected. Those risks and uncertainties include changes in interest rates and their impact on the level of deposits, loan demand and value of loan collateral, changes in the market value of the securities portfolio, increased competition from other financial institutions, governmental monetary policy, legislation and changes in banking regulations, changes in levels of FDIC deposit insurance premiums and assessments, risks associated with the effect of opening a new branch, the ability to control costs and expenses, and general economic conditions. The Company undertakes no obligation to update such forward-looking statements to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events.

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, 2011. 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. There have been no changes in critical accounting policies since December 31, 2011.

General:

The following discussion relates to the consolidated financial condition of the Company as of June 30, 2012, as compared to December 31, 2011, and the consolidated results of operations for the three and six months ended June 30, 2012, compared to the same periods in 2011. 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 become 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 the Liverpool Community Bank (LCB), located in Liverpool, Pennsylvania. The Company accounts for LCB as an unconsolidated subsidiary using the equity method of accounting.

 

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Table of Contents

Financial Condition:

As of June 30, 2012, total assets increased by $15.2 million, or 3.4%, as compared to December 31, 2011. Deposits increased by $15.8 million, with non-interest bearing deposits increasing by $0.3 million and interest-bearing deposits increasing by $15.5 million.

The table below shows changes in deposit volumes by type of deposit (in thousands of dollars) between December 31, 2011 and June 30, 2012.

 

     June 30,      December 31,      Change  
     2012      2011      $     %  

Deposits:

          

Demand, non-interest bearing

   $ 65,055       $ 64,751       $ 304        0.5

NOW and money market

     103,985         93,056         10,929        11.7

Savings

     59,336         50,715         8,621        17.0

Time deposits, $100,000 and more

     33,615         33,033         582        1.8

Other time deposits

     140,487         145,110         (4,623     (3.2 %) 
  

 

 

    

 

 

    

 

 

   

 

 

 

Total deposits

   $ 402,478       $ 386,665       $ 15,813        4.1
  

 

 

    

 

 

    

 

 

   

 

 

 

Overall, total loans decreased by $9.2 million, between December 31, 2011 and June 30, 2012, as shown in the table below (in thousands of dollars). The largest dollar reduction by class occurred in the real estate – mortgage category, as more individual borrowers were attracted to the secondary market by preferential loan rates.

 

     June 30,      December 31,      Change  
     2012      2011      $     %  

Loans:

          

Commercial, financial and agricultural

   $ 20,169       $ 19,417       $ 752        3.9

Real estate—commercial

     66,102         60,774         5,328        8.8

Real estate—construction

     13,219         17,508         (4,289     (24.5 %) 

Real estate—mortgage

     162,604         176,544         (13,940     (7.9 %) 

Obligations of states and political subdivisions

     12,384         8,780         3,604        41.0

Personal

     5,964         6,658         (694     (10.4 %) 
  

 

 

    

 

 

    

 

 

   

 

 

 

Total loans

   $ 280,442       $ 289,681       ($ 9,239     (3.2 %) 
  

 

 

    

 

 

    

 

 

   

 

 

 

A summary of the activity in the allowance for loan losses for each of the six-month periods ended June 30, 2012 and 2011 (in thousands) are presented below.

 

     Periods Ended June 30,  
     2012     2011  

Balance of allowance—January 1

   $ 2,931      $ 2,824   

Loans charged off

     (181     (156

Recoveries of loans previously charged off

     6        9   
  

 

 

   

 

 

 

Net charge-offs

     (175     (147

Provision for loan losses

     1,177        204   
  

 

 

   

 

 

 

Balance of allowance—end of period

   $ 3,933      $ 2,881   
  

 

 

   

 

 

 

Ratio of net charge-offs during period to average loans outstanding

     0.06     0.05
  

 

 

   

 

 

 

As of June 30, 2012, the Company evaluated its large commercial loan relationships and other significant loans for impairment. Of the eleven loan relationships considered to be impaired, there were three loan relationships with respect to which management determined that it is probable that principal and interest will not be collected in full and for which specific reserves are deemed necessary. These conclusions were based upon the receipt of updated appraisals on real estate collateral-dependent loans within these relationships. Following is a discussion describing the situation surrounding each.

 

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One loan relationship has an aggregate outstanding balance of $1,949,000 and has been recognized as being impaired for over a year. Based upon recent appraisals that have been appropriately discounted, a specific reserve of $726,000 has been established. Accordingly, a specific allocation has been included within the allowance for loan losses, adjusting the carrying value of these loans to a fair value of $1,223,000.

 

   

The second loan relationship with a balance of $2,004,000, was newly identified as impaired as of December 31, 2011. Collateral includes two residential properties along with raw land. The borrower purchased the raw land in 2005 with the intention to sub-divide and develop. While the property had not yet been developed, the borrower was servicing the debt satisfactorily until late in 2011, when financial constraints prevented the borrower from making scheduled payments, and the loan became more than 90 days past due at December 31, 2011. A collateral analysis was performed at that time, using certified appraisals dated two years earlier. It was determined, based on appropriate discounting against those appraisals, that a specific reserve of $107,000 was necessary. New appraisals were ordered in the first quarter of 2012 and received in early April. Because development has not begun on this property and there are no immediate plans to begin development, the updated appraisal determined that the property's highest and best use is as farmland, instead of as development property as set forth in the previous appraisal; as a result, the appraised value of the property declined significantly. Based on this updated information, and the value of the residential properties, it was determined that it would be prudent to recognize an additional specific reserve of $976,000 with respect to this relationship as of the end of the first quarter 2012. During the second quarter of 2012, the borrower has made payments on the loan, reducing the level of specific reserve needed by $45,000, resulting in a total specific reserve on this loan relationship to $1,038,000. Management believes that, based on the commitment and character of the borrower, the location of the property and other observable factors, the property will eventually be developed, although it is not certain when development will occur, or whether the ultimate loss on the relationship will be less than the amount of the specific reserve.

 

   

The third loan relationship has an aggregate outstanding balance of $214,000, with the amount of the impairment measured at $102,000, based a current offer on the property held for collateral.

Management believes that the specific reserves carried are adequate to cover potential future losses related to these relationships. Other loans evaluated for impairment have an aggregate outstanding balance of $4,782,000, but it was determined that there is sufficient collateral to expect full repayment, and no specific reserves were recorded. 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. Following is a summary of the Bank’s non-performing loans on June 30, 2012 as compared to December 31, 2011.

 

(Dollar amounts in thousands)

   June 30, 2012     December 31, 2011  

Non-performing loans

    

Nonaccrual loans

   $ 7,635      $ 7,947   

Accruing loans past due 90 days or more

     2,232        2,743   

Restructured loans

     —          —     
  

 

 

   

 

 

 

Total

   $ 9,867      $ 10,690   
  

 

 

   

 

 

 

Average loans outstanding

   $ 285,865      $ 293,319   

Ratio of non-performing loans to average loans outstanding

     3.45     3.64

Stockholders’ equity increased by $114,000, or 0.2%, from December 31, 2011 to June 30, 2012. Cash dividends of $1,862,000 exceeded net income of $1,633,000 by $229,000. Securities available for sale increased slightly in market value, representing an increase in equity of $90,000, net of taxes, while cash received for treasury stock issued for stock option and stock purchase plans added $144,000 and accounting for stock-based compensation activity increased equity by $11,000. An adjustment of $98,000 was made to equity to record the amortization of the net actuarial loss of the Company’s defined benefit retirement plan.

 

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Management is not aware of any current recommendations of applicable regulatory authorities that, if implemented, would have a material effect on the Company's liquidity, capital resources or operations.

Subsequent to June 30, 2012, the following events took place:

On July 17, 2012, the Board of Directors declared a cash dividend for the third quarter of 2012 of $0.22 per share to shareholders of record on August 15, 2012, payable on September 3, 2012.

Comparison of the Three Months Ended June 30, 2012 and 2011

Operations Overview:

Net income for the second quarter of 2012 was $1,215,000, an increase of $124,000 when compared to the second quarter of 2011. Basic and diluted earnings per share, at $0.29 in the second quarter of 2012, were 11.5% higher than in the same quarter in 2011. Presented below are selected key ratios for the two periods:

 

     Three Months Ended  
     June 30,  
     2012     2011  

Return on average assets (annualized)

     1.06     0.99

Return on average equity (annualized)

     9.87     8.68

Average equity to average assets

     10.73     11.36

Non-interest income, excluding securities gains, as a percentage of average assets (annualized)

     1.04     0.91

Non-interest expense as a percentage of average assets (annualized)

     2.88     2.98

Net Interest Income:

Net interest income was $3,681,000 for the second quarter of 2012, as compared to $3,842,000 in the same quarter in 2011. Average earning assets grew by 2.3%, while the net interest margin on a fully tax equivalent basis decreased by 25 basis points.

Interest on loans decreased $410,000, or 9.1%, in the second quarter of 2012 as compared to the same period in 2011. An average weighted yield decrease of 36 basis points lowered interest income by approximately $195,000, with the remaining decrease attributable to a lower volume of loans.

Interest earned on investment securities and money market investments decreased $25,000 in the second quarter of 2012 as compared to the second quarter of 2011, with average balances increasing $19.8 million during the period. The yield on money market investments (federal funds and interest bearing deposits) decreased by 5 basis points in the second quarter of 2012 as compared to the second quarter of 2011, due to a reduction in average balances of overnight federal funds sold. The overall pre-tax yield on the investment securities portfolio decreased during that same timeframe by 41 basis points.

Average interest-bearing deposits increased by $3.1 million, while average non-interest bearing deposits grew by $5.6 million. This increase in deposits, which was more than offset by the low general rate environment, contributed to the reduction in the cost to fund earning assets, which was reduced by 28 basis points, to 0.89%, in the second quarter of 2012.

Total average earning assets during the second quarter of 2012 were $419.8 million, compared to $410.6 million during the second quarter of 2011, yielding 4.39% in 2012 versus 4.91% in 2011. Funding costs for the earning assets were 0.89% and 1.17% for the second quarters of 2012 and 2011, respectively. Net interest margin on a fully tax-equivalent basis for the second quarter of 2012 was 3.68%. For the same period in 2011, the fully-tax equivalent net interest margin was 3.93%.

 

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Provision for Loan Losses:

In the second quarter of 2012, the provision for loan losses was $69,000, as compared to a provision of $116,000 in the second quarter of 2011. 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. The reduced provision was primarily the result of lower loan balances outstanding. See the earlier discussion in the Financial Condition section, explaining the information used to formulate the significant increase in the provision.

Non-interest Income:

Non-interest income in the second quarter of 2012 was $1,195,000, compared to $1,002,000 in the second quarter of 2011, representing an increase of 19.3%.

Trust fee income was $20,000, or 21.3%, higher in the second quarter of 2012 as compared to the second quarter of 2011, due to a higher level of estate settlements. Commissions from sales of non-deposit products in the second quarter of 2012 were $8,000, or 12.3%, higher than in the same quarter of the previous year.

Reduced fee income from overdraft fees in the second quarter of 2012 as compared to the second quarter of 2011 caused customer service fees to decline by 8%. Fees derived from electronic payment activity through the use of debit cards remained steady in the two comparative periods.

A gain of $53,000 was recorded in the second quarter of 2012 as a result of a life insurance claim. No such activity occurred in the same quarter of the previous year.

Other non-interest income increased by $164,000, or 169.1%, primarily due to an increase in the production and sale of secondary market mortgage loans.

As a percentage of average assets, annualized non-interest income, exclusive of net gains on the sale of securities, was 1.04% in the second quarter of 2012 versus 0.91% in the same quarter of 2011.

Non-interest Expense:

Total non-interest expense was $3,220,000 in the second quarter of 2012, a decrease of $80,000, or 2.4%, as compared to the second quarter of 2011.

Employee compensation expense decreased by 3.6% in the second quarter of 2012 compared to the previous year’s second quarter, while expense related to employee benefits increased by 13.0%. The increase in benefits expense related to increased costs for employee medical insurance and the Company’s defined benefit retirement plan. Most other non-interest expense categories declined during the second quarter of 2012 versus the second quarter of 2011, including occupancy, equipment, director compensation and FDIC insurance premiums. A decrease in other non-interest expense of $34,000 was primarily due to decreased costs associated with assets in foreclosure.

As a percentage of average assets, annualized non-interest expense was 2.88% and 2.98% in the second quarter of 2012 and 2011, respectively.

Provision for income taxes:

Income tax expense in the second quarter of 2012 was $35,000 higher than in the same time period in 2011, resulting from higher income before income taxes in the 2012 period. The effective tax rate in the second quarter of 2012 was 23.4% versus 23.6% in 2011.

Comparison of the Six Months Ended June 30, 2012 and 2011

Operations Overview:

Net income for the first six months of 2012 was $1,633,000, a decrease of $697,000, or 29.9%, compared to the first six months of 2011. A large provision for loan losses was recorded in the first quarter of 2012, reflecting specific reserves recorded on three loan relationships, causing the negative variance to the prior year. Basic and diluted earnings per share were $0.39 in the first six months of 2012, representing a decrease of 29.1% from the $0.55 earned in the first six months of 2011. Annualized return on average equity for the first six months in 2012 was 6.59%, compared to the ratio for the same period in the prior year of 9.32%, a decrease of 29.3%. For the six months ended June 30, annualized return on average assets was 0.72% in 2012, versus 1.05% in 2011.

 

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Presented below are selected key ratios for the two periods:

 

     Six Months Ended  
     June 30,  
     2012     2011  

Return on average assets (annualized)

     0.72     1.05

Return on average equity (annualized)

     6.59     9.32

Average equity to average assets

     10.93     11.28

Non-interest income, excluding securities gains, as a percentage of average assets (annualized)

     0.99     0.91

Non-interest expense as a percentage of average assets (annualized)

     2.85     2.92

Despite a reduction in net income resulting from an increase in the provision for loan losses, core earnings remained strong in the first half of 2012. The loan loss provision for the first six months of 2012, exclusive of the specific reserves identified in the first quarter, was approximately $169,000. Applying a 34% tax rate to the $1,008,000 additional provision and excluding the after-tax impact of the specific reserves, net income would have been approximately $2,298,000, return on average assets would have been 1.01%, return on average equity would have been 9.28% and earnings per share would have been $0.54. The discussion that follows explains changes in the components of net income when comparing the first six months of 2012 with the first six months of 2011.

Net Interest Income:

Net interest income was $7,420,000 for the first six months of 2012, as compared to $7,747,000 in the same period in 2011. Average earning assets grew by 2.4%, while the net interest margin on a fully tax equivalent basis decreased by 26 basis points.

Interest on loans decreased $807,000, or 8.9%, in the first half of 2012 as compared to the same period in 2011. An average weighted yield decrease of 37 basis points lowered interest income by approximately $423,000, with the remaining decrease attributable to a lower volume of loans.

Interest earned on investment securities and money market investments decreased $5,000 in the first half of 2012 as compared to 2011, despite average balances increasing $19.3 million during the period. The yield on money market investments (federal funds and interest bearing deposits) decreased by 2 basis points in the first half of 2012 as compared to the first half of 2011, due to the reduction in rates earned on interest bearing balances with other financial institutions. Likewise, the overall pre-tax yield on the investment securities portfolio decreased during that same timeframe by 36 basis points.

Average interest-bearing deposits increased by $3.8 million, while average non-interest bearing deposits grew by $7.9 million. Increases in deposits, in addition to the lower general rate environment, contributed to the reduction in the cost to fund earning assets, which was reduced by 27 basis points, to 0.92%, in the second half of 2012.

Total average earning assets during the first half of 2012 were $413.7 million, compared to $404.1 million during the first half of 2011, yielding 4.51% in 2012 versus 5.02% in 2011. Funding costs for the earning assets were 0.92% and 1.19% for the first six months of 2012 and 2011, respectively. Net interest margin on a fully tax-equivalent basis for the first six months of 2012 was 3.76%. For the same period in 2011, the fully-tax equivalent net interest margin was 4.02%.

Provision for Loan Losses:

In the first six months of 2012, the provision for loan losses was $1,177,000, as compared to a provision of $204,000 in the first six months of 2011. 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. The increased provision was primarily the result of analysis of the values of collateral securing certain impaired loans. See the earlier discussion in the Financial Condition section, explaining the information used to formulate the significant increase in the provision.

 

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Non-interest Income:

Non-interest income in the first six months of 2012 was $2,237,000, $226,000 higher than the $2,011,000 recorded in the first six months of 2011.

Trust fee income was $13,000, or 6.3%, higher in the first half of 2012 as compared to the first half of 2011, due primarily to estate settlement fees. Commissions from sales of non-deposit products in the first half of 2012 were 4.8%, or $8,000, less than in the same period of the previous year.

Customer service fees declined by $27,000, or 4.1%, in the first six months of 2012 compared to the same period in 2011 as a direct result of fewer overdraft fees assessed on deposit accounts.

An increase of $219,000 in fees derived from the origination and sale of residential mortgage loans was primarily responsible for the increase in other noninterest income in the first half of 2012 compared to the first half of 2011. Income recorded from the equity investment in an unconsolidated subsidiary was $13,000 lower in the current year six month period than in the previous year to date. A gain of $53,000 was recorded in the first six months of 2012 as a result of a life insurance claim. No such activity occurred in the previous year.

As a percentage of average assets, annualized non-interest income, exclusive of net gains on the sale of securities, was 0.99% in the first half of 2012 versus 0.91% in the prior year through June.

Non-interest Expense:

Total non-interest expense was maintained at essentially the same level in the first six months of 2012 as compared to 2011, varying by only $2,000.

An increase in employee benefits expense, due to higher medical insurance and defined benefit costs, was offset by decreases in occupancy, equipment, director compensation, professional fees and FDIC insurance. FDIC insurance premiums decreased by $58,000 as a result of the re-formulation of assessments by the FDIC, beginning in the second quarter of 2011, effectively reducing costs for well-capitalized banks. Sales of properties carried as other real estate generated net gains of $1,000 in the first six months of 2012, as compared to a net gain of $14,000 during the same period one year earlier.

As a percentage of average assets, annualized non-interest expense was 2.85% in the first six months of 2012 as compared to 2.92% in the same period of 2011, a decrease of 7 basis points.

Provision for income taxes:

Income tax expense in the first six months of 2012 was $382,000, versus $761,000 in the same time period in 2011. The reduction in tax expense related to the reduced pre-tax income. The effective tax rate in the first half of 2012 was 18.9% versus 24.6% in 2011. The reduction in the effective rate is attributed to the higher percentage of tax-exempt income relative to pre-tax earnings in the first half of 2012.

Liquidity:

The objective of liquidity management is to ensure that sufficient funding is available, at a reasonable cost, to meet the ongoing operational cash needs of the Company and to take advantage of income producing opportunities as they arise. While the desired level of liquidity will vary depending upon a variety of factors, it is the primary goal of the Company to maintain a high level of liquidity in all economic environments. Principal sources of asset liquidity are provided by securities maturing in one year or less, other short-term investments such as federal funds sold and cash and due from banks. Liability liquidity, which is more difficult to measure, can be met by attracting deposits and maintaining the core deposit base. The Company is a member of the Federal Home Loan Bank of Pittsburgh for the purpose of providing short-term liquidity when other sources are unable to fill these needs. During the first six months of 2012, there were no borrowings from the Federal Home Loan Bank. As of June 30, 2012, the Company had no long-term debt and had unused borrowing capacity with the Federal Home Loan Bank of $136 million.

Funding derived from securities sold under agreements to repurchase (accounted for as collateralized financing transactions) is available through corporate cash management accounts for business customers. This product gives the Company the ability to pay interest on corporate checking accounts.

 

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In view of the sources previously mentioned, management believes that the Company's liquidity is capable of providing the funds needed to meet loan demand.

Off-Balance Sheet Arrangements:

The Company’s consolidated financial statements do not reflect various off-balance sheet arrangements that are made in the normal course of business, which may involve some liquidity risk, credit risk, and interest rate risk. These commitments consist mainly of loans approved but not yet funded, unused lines of credit and outstanding letters of credit. These commitments were made using the same credit standards as on-balance sheet instruments. Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the commitment terms. Letters of credit are conditional commitments issued to guarantee the financial performance obligation of a customer to a third party. Unused commitments and letters of credit at June 30, 2012 were $41,904,000 and $1,181,000, respectively. 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 to the Company. Management believes that any amounts actually drawn upon can be funded in the normal course of operations. The Company has no investment in or financial relationship with any unconsolidated entities that are reasonably likely to have a material effect on liquidity or the availability of capital resources.

Interest Rate Sensitivity:

Interest rate sensitivity management is the responsibility of the Asset/Liability Management Committee. This process involves the development and implementation of strategies to maximize net interest margin, while minimizing the earnings risk associated with changing interest rates. Traditional gap analysis identifies the maturity and re-pricing terms of all assets and liabilities. A simulation analysis is used to assess earnings and capital at risk from movements in interest rates. See Item 3 for a description of the complete simulation process and results.

Capital Adequacy:

Bank regulatory authorities in the United States issue risk-based capital standards. These capital standards relate a banking company’s capital to the risk profile of its assets and provide the basis by which all banking companies and banks are evaluated in terms of capital adequacy. The risk-based capital standards require all banks to have Tier 1 capital of at least 4% and total capital, including Tier 1 capital, of at least 8% of risk-adjusted assets. Tier 1 capital includes common stockholders’ equity and qualifying perpetual preferred stock together with related surpluses and retained earnings. Total capital is comprised of Tier 1 capital, limited life preferred stock, qualifying debt instruments, and the reserves for possible loan losses. Banking regulators have also issued leverage ratio requirements. The leverage ratio requirement is measured as the ratio of Tier 1 capital to adjusted average assets. At June 30, 2012, the Bank exceeded the regulatory requirements to be considered a "well capitalized" financial institution, i.e., a leverage ratio exceeding 5%, Tier 1 capital exceeding 6% and total capital exceeding 10%.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

Market risk is the exposure to economic loss that arises from changes in the values of certain financial instruments. The types of market risk exposures generally faced by financial institutions include equity market price risk, interest rate risk, foreign currency risk and commodity price risk. Due to the nature of its operations, only equity market price risk and interest rate risk are significant to the Company.

Equity market price risk is the risk that changes in the values of equity investments could have a material impact on the financial position or results of operations of the Company. The Company’s equity investments consist of common stocks of publicly traded financial institutions.

Recent declines and volatility in the values of financial institution stocks have significantly reduced the likelihood of realizing significant gains in the near-term. Although the Company has realized occasional gains from this portfolio in the past, the primary objective of the portfolio is to achieve value appreciation in the long term while earning consistent attractive after-tax yields from dividends. The carrying value of the financial institutions stocks accounted for 0.2% of the Company’s total assets as of June 30, 2012. Management performs an impairment analysis on the entire investment portfolio, including the financial institutions stocks, on a quarterly basis. For the six months ended June 30, 2012, no “other-than-temporary” impairment was identified. There is no assurance that further declines in market values of the common stock portfolio in the future will not result in “other-than-temporary” impairment charges, depending upon facts and circumstances present.

 

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The equity investments in the Company’s portfolio had an adjusted cost basis of approximately $985,000 and a fair value of $997,000 at June 30, 2012. Net unrealized gains in this portfolio were approximately $12,000 at June 30, 2012.

In addition to its equity portfolio, the Company’s investment management and trust services revenue could be impacted by fluctuations in the securities markets. A portion of the Company’s trust revenue is based on the value of the underlying investment portfolios. If securities values decline, the Company’s trust revenue could be negatively impacted.

Interest rate risk creates exposure in two primary areas. First, changes in rates have an impact on the Company’s liquidity position and could affect its ability to meet obligations and continue to grow. Second, movements in interest rates can create fluctuations in the Company’s net interest income and changes in the economic value of equity.

The primary objective of the Company’s asset-liability management process is to maximize current and future net interest income within acceptable levels of interest rate risk while satisfying liquidity and capital requirements. Management recognizes that a certain amount of interest rate risk is inherent, appropriate and necessary to ensure profitability. A simulation analysis is used to assess earnings and capital at risk from movements in interest rates. The model considers three major factors of (1) volume differences, (2) repricing differences, and (3) timing in its income simulation. As of the most recent model run, data was disseminated into appropriate repricing buckets, based upon the static position at that time. The interest-earning assets and interest-bearing liabilities were assigned a multiplier to simulate how much that particular balance sheet item would re-price when interest rates change. Finally, the estimated timing effect of rate changes is applied, and the net interest income effect is determined on a static basis (as if no other factors were present). As the table below indicates, based upon rate shock simulations on a static basis, the Company’s balance sheet is relatively rate-neutral as rates decline. Each 100 basis point increase results in approximately $372,000 decline in net interest income in the static environment. This negative effect of rising rates is offset to a large degree by the positive effect of imbedded options that include loans floating above their floors and likely internal deposit pricing strategies. After applying the effects of options, over a one-year period, the net effect of an immediate 100, 200, 300 and 400 basis point rate increase would change net interest income by $28,000, $79,000, $(964,000) and $(1,080,000), respectively. Rate shock modeling was done for a declining rate of 25 basis points only, as the federal funds target rate currently is between zero and 0.25%. As the table below indicates, the net effect of interest rate risk on net interest income is essentially neutral in a rising rate environment through a 200 basis point increase. Juniata’s rate risk policies provide for maximum limits on net interest income that can be at risk for 100 through 400 basis point changes in interest rates.

 

Effect of Interest Rate Risk on Net Interest Income

(Dollars in thousands)

 
     Change in Net     Change in Net        
Change in    Interest Income     Interest Income     Total Change in  
Interest Rates    Due to Interest     Due to Imbedded     Net Interest  

(Basis Points)

   Rate Risk (Static)     Options     Income  

400

   $ (1,487   $ 407      $ (1,080

300

     (1,115     151        (964

200

     (743     822        79   

100

     (372     400        28   

    0

     —          —          —     

-25

     93        (50     43   

The net interest income at risk position remained within the guidelines established by the Company’s asset/liability policy.

No material change has been noted in the Bank’s equity value at risk. Please refer to the Annual Report on Form 10-K as of December 31, 2011 for further discussion of this topic.

 

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Item 4. Controls and Procedures

Disclosure Controls and Procedures

As of June 30, 2012, the Company carried out an evaluation, under the supervision and with the participation of the Company’s management, including the Company’s Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures as defined by the Securities Exchange Act of 1934 (“Exchange Act”), Rule 13a-15(e). Disclosure controls and procedures are controls and procedures that are designed to ensure that information required to be disclosed in Company reports filed or submitted under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms. These controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by an issuer in the reports that it files under the Exchange Act is accumulated and communicated to the issuer’s management, including its principal executive and principal financial officers, or persons performing similar functions, as appropriate, to allow timely decisions regarding required disclosure. Based upon that evaluation, the Company’s Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures were effective as of the end of the period covered by this quarterly report.

It should be noted that any system of controls, however well designed and operated, can provide only reasonable, and not absolute, assurance that the objectives of the system are met. In addition, the design of any control system is based in part upon certain assumptions about the likelihood of future events. Because of these and other inherent limitations of control systems, there can be no assurance that any design will succeed in achieving its stated goals under all potential conditions, regardless of how remote.

Attached as Exhibits 31 and 32 to this quarterly rep