10-Q 1 d729696d10q.htm 10-Q 10-Q
Table of Contents

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-Q

 

 

(Mark One)

x Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934.
  For the quarterly period ended June 30, 2014

 

[   ] Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934.
  For the transition period                  to                 

Commission File Number: 0-26486

 

 

Auburn National Bancorporation, Inc.

(Exact Name of Registrant as Specified in Its Charter)

 

 

 

Delaware   63-0885779

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification No.)

100 N. Gay Street

Auburn, Alabama 36830

(334) 821-9200

(Address and telephone number of principal executive offices)

(Former Name, Former Address and Former Fiscal Year, if Changed Since Last Report)

 

 

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

Yes x                                         No ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

Yes x                                         No ¨

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. (Check one):

 

    Large Accelerated filer ¨

  Accelerated filer ¨   Non-accelerated filer ¨   Smaller reporting company x
  (Do not check if a smaller reporting company)

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).    Yes  ¨    No  x

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

 

Class

 

Outstanding at July 31, 2014

Common Stock, $0.01 par value per share

 

3,643,328 shares

 

 


Table of Contents

AUBURN NATIONAL BANCORPORATION, INC. AND SUBSIDIARIES

INDEX

 

      PAGE  

PART I. FINANCIAL INFORMATION

  

Item 1  Financial Statements

  

Consolidated Balance Sheets (Unaudited) as of June 30, 2014 and December 31, 2013

     3   

Consolidated Statements of Earnings (Unaudited) for the quarter and six months ended June  30, 2014 and 2013

     4   

Consolidated Statements of Comprehensive Income (Unaudited) for the quarter and six months ended June  30, 2014 and 2013

     5   

Consolidated Statements of Stockholders’ Equity (Unaudited) for the six months ended June  30, 2014 and 2013

     6   

Consolidated Statements of Cash Flows (Unaudited) for the six months ended June 30, 2014 and 2013

     7   

Notes to Consolidated Financial Statements (Unaudited)

     8   

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

     30   

Table 1 – Explanation of Non-GAAP Financial Measures

     48   

Table 2 – Selected Quarterly Financial Data

     49   

Table 3 – Selected Financial Data

     50   

Table 4 – Average Balances and Net Interest Income Analysis – for the quarter ended June  30, 2014 and 2013

     51   

Table 5 – Average Balances and Net Interest Income Analysis – for the six months ended June  30, 2014 and 2013

     52   

Table 6 – Loan Portfolio Composition

     53   

Table 7 – Allowance for Loan Losses and Nonperforming Assets

     54   

Table 8 – Allocation of Allowance for Loan Losses

     55   

Table 9 – CDs and Other Time Deposits of $100,000 or more

     56   

Item 3  Quantitative and Qualitative Disclosures About Market Risk

     57   

Item 4  Controls and Procedures

     57   

PART II. OTHER INFORMATION

  

Item 1  Legal Proceedings

     57   

Item 1A  Risk Factors

     57   

Item 2  Unregistered Sales of Equity Securities and Use of Proceeds

     57   

Item 3  Defaults Upon Senior Securities

     57   

Item 4  Mine Safety Disclosures

     57   

Item 5  Other Information

     58   

Item 6  Exhibits

     58   


Table of Contents

PART 1. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

AUBURN NATIONAL BANCORPORATION, INC. AND SUBSIDIARIES

Consolidated Balance Sheets

(Unaudited)

 

(Dollars in thousands, except share data)   

June 30,

2014

     December 31,
2013
 

 

 

Assets:

     

Cash and due from banks

   $ 14,966       $ 13,437   

Federal funds sold

     43,311         26,965   

Interest bearing bank deposits

     11,933         13,820   

 

 

Cash and cash equivalents

     70,210         54,222   

 

 

Securities available-for-sale

     276,953         271,219   

Loans held for sale

     7,200         2,296   

Loans, net of unearned income

     385,826         383,339   

Allowance for loan losses

     (4,728)         (5,268)   

 

 

Loans, net

     381,098         378,071   

 

 

Premises and equipment, net

     10,269         10,442   

Bank-owned life insurance

     17,754         17,503   

Other real estate owned

     1,584         3,884   

Other assets

     10,060         13,706   

 

 

Total assets

   $ 775,128       $ 751,343   

 

 

Liabilities:

     

Deposits:

     

Noninterest-bearing

   $ 130,355       $ 125,740   

Interest-bearing

     553,826         543,104   

 

 

Total deposits

     684,181         668,844   

Federal funds purchased and securities sold under agreements to repurchase

     3,316         3,363   

Long-term debt

     12,217         12,217   

Accrued expenses and other liabilities

     3,123         2,434   

 

 

Total liabilities

     702,837         686,858   

 

 

Stockholders’ equity:

     

Preferred stock of $.01 par value; authorized 200,000 shares; no issued shares

               

Common stock of $.01 par value; authorized 8,500,000 shares; issued 3,957,135 shares

     39         39   

Additional paid-in capital

     3,763         3,759   

Retained earnings

     73,992         71,879   

Accumulated other comprehensive income (loss), net

     1,136         (4,552)   

Less treasury stock, at cost - 313,807 shares and 314,017 shares at June 30, 2014 and December 31, 2013, respectively

     (6,639)         (6,640)   

 

 

Total stockholders’ equity

     72,291         64,485   

 

 

Total liabilities and stockholders’ equity

   $         775,128       $         751,343   

 

 

See accompanying notes to consolidated financial statements

 

 

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AUBURN NATIONAL BANCORPORATION, INC. AND SUBSIDIARIES

Consolidated Statements of Earnings

(Unaudited)

 

     Quarter ended June 30,      Six Months Ended June 30,  
(In thousands, except share and per share data)    2014      2013      2014      2013  

 

 

Interest income:

           

Loans, including fees

   $ 4,766       $ 5,224       $ 9,556       $ 10,552   

Securities:

           

Taxable

     1,214         899         2,390         1,773   

Tax-exempt

     607         708         1,234         1,450   

Federal funds sold and interest bearing bank deposits

     30         29         72         60   

 

 

Total interest income

     6,617         6,860         13,252         13,835   

 

 

Interest expense:

           

Deposits

     1,255         1,349         2,512         2,753   

Short-term borrowings

     5         3         9         7   

Long-term debt

     104         276         208         702   

 

 

Total interest expense

     1,364         1,628         2,729         3,462   

 

 

Net interest income

     5,253         5,232         10,523         10,373   

Provision for loan losses

                     (400)         400   

 

 

Net interest income after provision for loan losses

     5,253         5,232         10,923         9,973   

 

 

Noninterest income:

           

Service charges on deposit accounts

     219         234         432         483   

Mortgage lending

     348         837         734         1,647   

Bank-owned life insurance

     125         101         251         196   

Other

     377         381         715         721   

Securities gains, net:

           

Realized gains, net

     12         518         38         679   

Total other-than-temporary impairments

                     (333)           

 

 

Total securities gains (losses), net

     12         518         (295)         679   

 

 

Total noninterest income

     1,081         2,071         1,837         3,726   

 

 

Noninterest expense:

           

Salaries and benefits

     2,221         2,114         4,502         4,364   

Net occupancy and equipment

     341         333         693         664   

Professional fees

     225         209         431         385   

FDIC and other regulatory assessments

     129         143         274         337   

Other real estate owned, net

     (62)         20         56         43   

Prepayment penalties on long-term debt

             1,046                 1,471   

Other

     938         859         1,784         1,686   

 

 

Total noninterest expense

     3,792         4,724         7,740         8,950   

 

 

Earnings before income taxes

     2,542         2,579         5,020         4,749   

Income tax expense

     683         672         1,340         1,153   

 

 

Net earnings

   $ 1,859       $ 1,907       $ 3,680       $ 3,596   

 

 

Net earnings per share:

           

Basic and diluted

   $ 0.51       $ 0.52       $ 1.01       $ 0.99   

 

 

Weighted average shares outstanding:

           

Basic and diluted

        3,643,295            3,642,955            3,643,228            3,642,936   

 

 

See accompanying notes to consolidated financial statements

 

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AUBURN NATIONAL BANCORPORATION, INC. AND SUBSIDIARIES

Consolidated Statements of Comprehensive Income

(Unaudited)

 

         Quarter ended June 30,              Six Months Ended June 30,      
(Dollars in thousands)    2014      2013      2014      2013  

 

 

Net earnings

   $ 1,859       $ 1,907       $ 3,680       $ 3,596   

Other comprehensive income (loss), net of tax:

           

Unrealized net holding gain (loss) on securities

     2,937         (5,821)         5,502         (6,577)   

Reclassification adjustment for net (gain) loss on securities recognized in net earnings

     (8)         (327)         186         (428)   

 

 

Other comprehensive income (loss)

     2,929         (6,148)         5,688         (7,005)   

 

 

Comprehensive income (loss)

   $ 4,788       $ (4,241)       $ 9,368       $ (3,409)   

 

 

See accompanying notes to consolidated financial statements

 

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AUBURN NATIONAL BANCORPORATION, INC. AND SUBSIDIARIES

Consolidated Statements of Stockholders’ Equity

(Unaudited)

 

                                 Accumulated         
                   Additional             other         
     Common Stock      paid-in      Retained      comprehensive      Treasury         
(Dollars in thousands, except share data)    Shares      Amount      capital      earnings      income (loss)      stock      Total  

 

 

Balance, December 31, 2012

     3,957,135       $ 39       $ 3,756       $ 67,821       $ 5,174       $ (6,641)       $ 70,149   

Net earnings

                             3,596                         3,596   

Other comprehensive loss

                                     (7,005)                 (7,005)   

Cash dividends paid ($0.42 per share)

                             (1,530)                         (1,530)   

Sale of treasury stock (90 shares)

                     1                                 1   

 

 

Balance, June 30, 2013

     3,957,135       $ 39       $ 3,757       $ 69,887       $ (1,831)       $ (6,641)       $ 65,211   

 

 

Balance, December 31, 2013

     3,957,135       $ 39       $ 3,759       $ 71,879       $ (4,552)       $ (6,640)       $ 64,485   

Net earnings

                             3,680                         3,680   

Other comprehensive income

                                     5,688                 5,688   

Cash dividends paid ($0.43 per share)

                             (1,567)                         (1,567)   

Sale of treasury stock (210 shares)

                     4                         1         5   

 

 

Balance, June 30, 2014

     3,957,135       $ 39       $ 3,763       $ 73,992       $ 1,136       $ (6,639)       $ 72,291   

 

 

See accompanying notes to consolidated financial statements

 

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AUBURN NATIONAL BANCORPORATION, INC. AND SUBSIDIARIES

Consolidated Statements of Cash Flows

(Unaudited)

 

     Six Months Ended June 30,  
(In thousands)    2014      2013  

 

 

Cash flows from operating activities:

     

Net earnings

   $ 3,680       $ 3,596   

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

     

Provision for loan losses

     (400)         400   

Depreciation and amortization

     366         448   

Premium amortization and discount accretion, net

     776         1,143   

Net loss (gain) on securities available-for-sale

     295         (679)   

Net gain on sale of loans held for sale

     (494)         (1,258)   

Increase (decrease) in MSR valuation allowance

     43         (201)   

Net loss (gain) on other real estate owned

     42         (47)   

Loss on prepayment of long-term debt

             1,471   

Loans originated for sale

     (29,459)         (61,382)   

Proceeds from sale of loans

     24,847         60,225   

Increase in cash surrender value of bank owned life insurance

     (251)         (196)   

Net decrease in other assets

     71         1,262   

Net increase in accrued expenses and other liabilities

     694         916   

 

 

Net cash provided by operating activities

     210         5,698   

 

 

Cash flows from investing activities:

     

Proceeds from sales of securities available-for-sale

     18,354         37,859   

Proceeds from maturities of securities available-for-sale

     18,127         39,179   

Purchase of securities available-for-sale

     (34,273)         (99,923)   

(Increase) decrease in loans, net

     (3,021)         6,159   

Net purchases of premises and equipment

     (19)         (471)   

Decrease in FHLB stock

     235         1,153   

Proceeds from sale of other real estate owned

     2,652         1,999   

 

 

Net cash provided by (used in) investing activities

     2,055         (14,045)   

 

 

Cash flows from financing activities:

     

Net increase in noninterest-bearing deposits

     4,615         9,175   

Net increase in interest-bearing deposits

     10,722         20,498   

Net (decrease) increase in federal funds purchased and securities sold under agreements to repurchase

     (47)         2,264   

Repayments or retirement of long-term debt

             (21,471)   

Dividends paid

     (1,567)         (1,530)   

 

 

Net cash provided by financing activities

     13,723         8,936   

 

 

Net change in cash and cash equivalents

     15,988         589   

Cash and cash equivalents at beginning of period

     54,222         61,949   

 

 

Cash and cash equivalents at end of period

   $ 70,210       $ 62,538   

 

 

 

 

Supplemental disclosures of cash flow information:

     

Cash paid during the period for:

     

Interest

   $ 2,777       $ 3,548   

Income taxes

     506         254   

Supplemental disclosure of non-cash transactions:

     

Real estate acquired through foreclosure

     394         642   

 

 

See accompanying notes to consolidated financial statements

 

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AUBURN NATIONAL BANCORPORATION, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(Unaudited)

NOTE 1: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

General

Auburn National Bancorporation, Inc. (the “Company”) provides a full range of banking services to individual and corporate customers in Lee County, Alabama and surrounding counties through its wholly owned subsidiary, AuburnBank (the “Bank”). The Company does not have any segments other than banking that are considered material.

Basis of Presentation and Use of Estimates

The unaudited consolidated financial statements in this report have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) for interim financial information. Accordingly, these financial statements do not include all of the information and footnotes required by U.S. GAAP for complete financial statements. The unaudited consolidated financial statements include, in the opinion of management, all adjustments necessary to present a fair statement of the financial position and the results of operations for all periods presented. All such adjustments are of a normal recurring nature. The results of operations in the interim statements are not necessarily indicative of the results of operations that the Company and its subsidiaries may achieve for future interim periods or the entire year. For further information, refer to the consolidated financial statements and footnotes included in the Company’s annual report on Form 10-K for the year ended December 31, 2013.

The unaudited consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. Auburn National Bancorporation Capital Trust I is an affiliate of the Company and was included in these unaudited consolidated financial statements pursuant to the equity method of accounting. Significant intercompany transactions and accounts are eliminated in consolidation.

The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities as of the balance sheet date and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Material estimates that are particularly susceptible to significant change in the near term include other-than-temporary impairment on investment securities, the determination of the allowance for loan losses, fair value of financial instruments, and the valuation of deferred tax assets and other real estate owned.

Reclassifications

Certain amounts reported in prior periods have been reclassified to conform to the current-period presentation. These reclassifications had no impact on the Company’s previously reported net earnings or total stockholders’ equity.

Subsequent Events

The Company has evaluated the effects of events and transactions through the date of this filing that have occurred subsequent to June 30, 2014. The Company does not believe there were any material subsequent events during this period that would have required further recognition or disclosure in the unaudited consolidated financial statements included in this report.

Accounting Developments

In the first quarter of 2014, the Company adopted new guidance related to the following Accounting Standards Update (“Update” or “ASU”):

 

   

ASU 2013-11, Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists.

 

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Information about this pronouncement is described in more detail below.

ASU 2013-11, Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists, is expected to eliminate diversity in practice as it provides guidance on financial statement presentation of an unrecognized tax benefit when a net operating loss (NOL) carryforward, a similar tax loss, or a tax credit carryforward exists. The changes were effective for the Company during the first quarter of 2014. Adoption of this ASU had no impact on the financial statements of the Company.

NOTE 2: BASIC AND DILUTED EARNINGS PER SHARE

Basic net earnings per share is computed by dividing net earnings by the weighted average common shares outstanding for the respective period. Diluted net earnings per share reflect the potential dilution that could occur upon exercise of securities or other rights for, or convertible into, shares of the Company’s common stock. At June 30, 2014 and 2013, respectively, the Company had no such securities or rights issued or outstanding, and therefore, no dilutive effect to consider for the diluted earnings per share calculation.

The basic and diluted earnings per share computations for the respective periods are presented below.

 

     Quarter ended June 30,      Six Months Ended June 30,  
(In thousands, except share and per share data)    2014      2013      2014      2013  

 

 

Basic and diluted:

           

Net earnings

   $ 1,859       $ 1,907       $ 3,680       $ 3,596   

Weighted average common shares outstanding

         3,643,295             3,642,955             3,643,228             3,642,936   

 

 

Earnings per share

   $ 0.51       $ 0.52       $ 1.01       $ 0.99   

 

 

NOTE 3: VARIABLE INTEREST ENTITIES

Generally, a variable interest entity (“VIE”) is a corporation, partnership, trust or other legal structure that does not have equity investors with substantive or proportional voting rights or has equity investors that do not provide sufficient financial resources for the entity to support its activities.

At June 30, 2014, the Company did not have any consolidated VIEs to disclose but did have one nonconsolidated VIE, discussed below.

Trust Preferred Securities

The Company owns the common stock of a subsidiary business trust, Auburn National Bancorporation Capital Trust I, which issued mandatorily redeemable preferred capital securities (“trust preferred securities”) in the aggregate of approximately $7.0 million at the time of issuance. This trust meets the definition of a VIE of which the Company is not the primary beneficiary; the trust’s only assets are junior subordinated debentures issued by the Company, which were acquired by the trust using the proceeds from the issuance of the trust preferred securities and common stock. The junior subordinated debentures of approximately $7.2 million are included in long-term debt and the Company’s equity interest of $0.2 million in the business trust is included in other assets. Interest expense on the junior subordinated debentures is included in interest expense on long-term debt.

The following table summarizes VIEs that are not consolidated by the Company as of June 30, 2014.

 

(Dollars in thousands)    Maximum
Loss Exposure
    

Liability

        Recognized

     Classification            

 

Type:

        

Trust preferred issuances

     N/A         $   7,217       Long-term debt            

 

 

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NOTE 4: SECURITIES

At June 30, 2014 and December 31, 2013, respectively, all securities within the scope of ASC 320, Investments – Debt and Equity Securities, were classified as available-for-sale. The fair value and amortized cost for securities available-for-sale by contractual maturity at June 30, 2014 and December 31, 2013, respectively, are presented below.

 

     1 year      1 to 5      5 to 10      After 10      Fair      Gross Unrealized      Amortized  
(Dollars in thousands)    or less          years              years              years              Value              Gains          Losses      Cost  

 

 

June 30, 2014

                       

Agency obligations (a)

   $         —         13,306         34,535         22,910         70,751         293         1,914       $ 72,372   

Agency RMBS (a)

                     7,535         133,470         141,005         2,009         1,523         140,519   

State and political subdivisions

             679         17,898         46,620         65,197         2,977         42         62,262   

 

 

Total available-for-sale

   $         13,985         59,968         203,000         276,953         5,279         3,479       $ 275,153   

 

 

December 31, 2013

                       

Agency obligations (a)

   $                 23,247         21,275         44,522                 4,557       $ 49,079   

Agency RMBS (a)

                     8,306         154,052         162,358         976         4,733         166,115   

State and political subdivisions

             1,735         21,366         41,238         64,339         1,560         459         63,238   

 

 

Total available-for-sale

   $         1,735         52,919         216,565         271,219         2,536         9,749       $ 278,432   

 

 

 

(a) Includes securities issued by U.S. government agencies or government sponsored entities.

Securities with aggregate fair values of $137.4 million and $120.5 million at June 30, 2014 and December 31, 2013, respectively, were pledged to secure public deposits, securities sold under agreements to repurchase, Federal Home Loan Bank (“FHLB”) advances, and for other purposes required or permitted by law.

Included in other assets are cost-method investments. The carrying amounts of cost-method investments were $1.6 million and $1.8 million at June 30, 2014 and December 31, 2013, respectively. Cost-method investments primarily include non-marketable equity investments, such as FHLB of Atlanta stock and Federal Reserve Bank (“FRB”) stock.

Gross Unrealized Losses and Fair Value

The fair values and gross unrealized losses on securities at June 30, 2014 and December 31, 2013, respectively, segregated by those securities that have been in an unrealized loss position for less than 12 months and 12 months or longer, are presented below.

 

     Less than 12 Months      12 Months or Longer      Total  
(Dollars in thousands)   

Fair

Value

    

Unrealized

Losses

    

Fair

Value

    

Unrealized

Losses

    

Fair

Value

    

Unrealized

Losses

 

 

 

June 30, 2014:

                 

Agency obligations

   $                 42,172         1,914       $ 42,172         1,914   

Agency RMBS

                     67,063         1,523         67,063         1,523   

State and political subdivisions

     1,892         25         2,290         17         4,182         42   

 

 

Total

   $ 1,892         25         111,525         3,454       $ 113,417         3,479   

 

 

December 31, 2013:

                 

Agency obligations

   $ 35,933         3,182         8,590         1,376       $ 44,523         4,558   

Agency RMBS

     109,774         4,393         7,683         339         117,457         4,732   

State and political subdivisions

     9,575         459                         9,575         459   

 

 

Total

   $       155,282                 8,034                 16,273                 1,715       $       171,555                 9,749   

 

 

 

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For the securities in the previous table, the Company does not have the intent to sell and has determined it is not more likely than not that the Company will be required to sell the security before recovery of the amortized cost basis, which may be maturity. On a quarterly basis, the Company assesses each security for credit impairment. For debt securities, the Company evaluates, where necessary, whether credit impairment exists by comparing the present value of the expected cash flows to the securities’ amortized cost basis. For cost-method investments, the Company evaluates whether an event or change in circumstances has occurred during the reporting period that may have a significant adverse effect on the fair value of the investment.

In determining whether a loss is temporary, the Company considers all relevant information including:

 

   

the length of time and the extent to which the fair value has been less than the amortized cost basis;

 

   

adverse conditions specifically related to the security, an industry, or a geographic area (for example, changes in the financial condition of the issuer of the security, or in the case of an asset-backed debt security, in the financial condition of the underlying loan obligors, including changes in technology or the discontinuance of a segment of the business that may affect the future earnings potential of the issuer or underlying loan obligors of the security or changes in the quality of the credit enhancement);

 

   

the historical and implied volatility of the fair value of the security;

 

   

the payment structure of the debt security and the likelihood of the issuer being able to make payments that increase in the future;

 

   

failure of the issuer of the security to make scheduled interest or principal payments;

 

   

any changes to the rating of the security by a rating agency; and

 

   

recoveries or additional declines in fair value subsequent to the balance sheet date.

Agency obligations

The unrealized losses associated with agency obligations were primarily driven by changes in interest rates and not due to the credit quality of the securities. These securities were issued by U.S. government agencies or government-sponsored entities and did not have any credit losses given the explicit government guarantee or other government support.

Agency RMBS

The unrealized losses associated with agency RMBS were primarily driven by changes in interest rates and not due to the credit quality of the securities. These securities were issued by U.S. government agencies or government-sponsored entities and did not have any credit losses given the explicit government guarantee or other government support.

Securities of U.S. states and political subdivisions

The unrealized losses associated with securities of U.S. states and political subdivisions were primarily driven by changes in interest rates and were not due to the credit quality of the securities. Some of these securities are guaranteed by a bond insurer, but management did not rely on the guarantee in making its investment decision. These securities will continue to be monitored as part of the Company’s quarterly impairment analysis, but are expected to perform even if the rating agencies reduce the credit rating of the bond insurers. As a result, the Company expects to recover the entire amortized cost basis of these securities.

Cost-method investments

At June 30, 2014, cost-method investments with an aggregate cost of $1.6 million were not evaluated for impairment because the Company did not identify any events or changes in circumstances that may have a significant adverse effect on the fair value of these cost-method investments.

The carrying values of the Company’s investment securities could decline in the future if the financial condition of an issuer deteriorates and the Company determines it is probable that it will not recover the entire amortized cost basis for the security. As a result, there is a risk that other-than-temporary impairment charges may occur in the future.

 

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Other-Than-Temporarily Impaired Securities

The following table presents a roll-forward of the credit loss component of the amortized cost of debt securities that the Company has written down for other-than-temporary impairment and has recognized the credit component of the loss in earnings (referred to as “credit-impaired” debt securities). Other-than-temporary impairments recognized in earnings for credit-impaired debt securities are presented as additions in two components based upon whether the current period is the first time the debt security was credit-impaired (initial credit impairment) or is not the first time the debt security was credit-impaired (subsequent credit impairments). The credit loss component is reduced if the Company sells, intends to sell, or believes it will be required to sell previously credit-impaired debt securities. Additionally, the credit loss component is reduced if the Company receives cash flows in excess of what it expected to receive over the remaining life of the credit-impaired debt security, the security matures or the security is fully written-down and deemed worthless. Changes in the credit loss component of credit-impaired debt securities for the respective periods are presented below.

 

     Quarter ended June 30,      Six Months Ended June 30,  
(Dollars in thousands)    2014      2013      2014      2013  

 

 

Balance, beginning of period

   $             —       $             1,257       $             —       $             1,257   

Reductions:

           

Securities fully written down and deemed worthless

             500                 500   

 

 

Balance, end of period

   $       $ 757       $       $ 757   

 

 

Other-Than-Temporary Impairment

The following table presents details of the other-than-temporary impairment related to securities.

 

     Quarter ended June 30,      Six Months Ended June 30,  
(Dollars in thousands)    2014      2013      2014      2013  

 

 

Other-than-temporary impairment charges

           

Debt securities:

           

Agency RMBS

   $             —       $             —       $             333       $             —   

 

 

Total debt securities

                     333           

 

 

Total other-than-temporary impairment charges

   $       $       $ 333       $   

 

 

Other-than-temporary impairment on debt securities:

           

Recorded as part of gross realized losses:

           

Securities with intent to sell

                     333           

 

 

Total other-than-temporary impairment on debt securities

   $       $       $ 333       $   

 

 

Realized Gains and Losses

The following table presents the gross realized gains and losses on sales and other-than-temporary impairment charges related to securities.

 

     Quarter ended June 30,      Six Months Ended June 30,  
(Dollars in thousands)    2014      2013      2014      2013  

 

 

Gross realized gains

   $             12       $           524       $             38       $           685   

Gross realized losses

             (6)                 (6)   

Other-than-temporary impairment charges

                     (333)           

 

 

Realized gains (losses), net

   $ 12       $ 518       $ (295)       $ 679   

 

 

 

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NOTE 5: LOANS AND ALLOWANCE FOR LOAN LOSSES

 

     June 30,      December 31,  
(In thousands)    2014      2013  

Commercial and industrial

   $ 52,054       $ 57,780   

Construction and land development

     32,461         36,479   

Commercial real estate:

     

Owner occupied

     52,571         56,102   

Other

     134,670         118,818   

 

 

Total commercial real estate

     187,241         174,920   

Residential real estate:

     

Consumer mortgage

     59,257         57,871   

Investment property

     43,664         43,835   

 

 

Total residential real estate

     102,921         101,706   

Consumer installment

     11,686         12,893   

 

 

Total loans

     386,363         383,778   

Less: unearned income

     (537)         (439)   

 

 

Loans, net of unearned income

   $         385,826       $         383,339   

 

 

Loans secured by real estate were approximately 83.5% of the Company’s total loan portfolio at June 30, 2014. At June 30, 2014, the Company’s geographic loan distribution was concentrated primarily in Lee County, Alabama and surrounding areas.

In accordance with ASC 310, a portfolio segment is defined as the level at which an entity develops and documents a systematic method for determining its allowance for loan losses. As part of the Company’s quarterly assessment of the allowance, the loan portfolio is disaggregated into the following portfolio segments: commercial and industrial, construction and land development, commercial real estate, residential real estate and consumer installment. Where appropriate, the Company’s loan portfolio segments are further disaggregated into classes. A class is generally determined based on the initial measurement attribute, risk characteristics of the loan, and an entity’s method for monitoring and determining credit risk.

The following describe the risk characteristics relevant to each of the portfolio segments and classes.

Commercial and industrial (“C&I”) — includes loans to finance business operations, equipment purchases, or other needs for small and medium-sized commercial customers. Also included in this category are loans to finance agricultural production. Generally the primary source of repayment is the cash flow from business operations and activities of the borrower.

Construction and land development (“C&D”) — includes both loans and credit lines for the purpose of purchasing, carrying and developing land into commercial developments or residential subdivisions. Also included are loans and lines for construction of residential, multi-family and commercial buildings. Generally the primary source of repayment is dependent upon the sale or refinance of the real estate collateral.

Commercial real estate (“CRE”) — includes loans disaggregated into two classes: (1) owner occupied and (2) other.

Owner occupied – includes loans secured by business facilities to finance business operations, equipment and owner-occupied facilities primarily for small and medium-sized commercial customers. Generally the primary source of repayment is the cash flow from business operations and activities of the borrower, who owns the property.

Other – primarily includes loans to finance income-producing commercial and multi-family properties that are not owner occupied. Loans in this class include loans for neighborhood retail centers, hotels, medical and professional offices, single retail stores, industrial buildings, warehouses and apartments leased generally to local businesses and residents. Generally the primary source of repayment is dependent upon income generated from the real estate collateral. The underwriting of these loans takes into consideration the occupancy and rental rates, as well as the financial health of the borrower.

 

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Residential real estate (“RRE”) — includes loans disaggregated into two classes: (1) consumer mortgage and (2) investment property.

Consumer mortgage – primarily includes first or second lien mortgages and home equity lines of credit to consumers that are secured by a primary residence or second home. These loans are underwritten in accordance with the Bank’s general loan policies and procedures which require, among other things, proper documentation of each borrower’s financial condition, satisfactory credit history and property value.

Investment property – primarily includes loans to finance income-producing 1-4 family residential properties. Generally the primary source of repayment is dependent upon income generated from leasing the property securing the loan. The underwriting of these loans takes into consideration the rental rates and property value, as well as the financial health of the borrower.

Consumer installment — includes loans to individuals both secured by personal property and unsecured. Loans include personal lines of credit, automobile loans, and other retail loans. These loans are underwritten in accordance with the Bank’s general loan policies and procedures which require, among other things, proper documentation of each borrower’s financial condition, satisfactory credit history, and if applicable, property value.

The following is a summary of current, accruing past due and nonaccrual loans by portfolio segment and class as of June 30, 2014, and December 31, 2013.

 

            Accruing      Accruing      Total                
            30-89 Days      Greater than      Accruing      Non-      Total  
(In thousands)    Current      Past Due      90 days      Loans      Accrual      Loans  

 

    

 

 

 

June 30, 2014:

                 

Commercial and industrial

   $ 51,725         277                 52,002         52       $ 52,054   

Construction and land development

     31,306         192                 31,498         963         32,461   

Commercial real estate:

                 

Owner occupied

     52,295                         52,295         276         52,571   

Other

     134,460                         134,460         210         134,670   

Total commercial real estate

     186,755                         186,755         486         187,241   

Residential real estate:

                 

Consumer mortgage

     57,582         715         71         58,368         889         59,257   

Investment property

     43,133         117                 43,250         414         43,664   

Total residential real estate

     100,715         832         71         101,618         1,303         102,921   

Consumer installment

     11,576         110                 11,686                 11,686   

Total

   $ 382,077         1,411         71         383,559         2,804       $ 386,363   
                                                       

December 31, 2013:

                 

Commercial and industrial

   $ 57,558         167                 57,725         55       $ 57,780   

Construction and land development

     34,883         14                 34,897         1,582         36,479   

Commercial real estate:

                 

Owner occupied

     54,214         861                 55,075         1,027         56,102   

Other

     118,389                         118,389         429         118,818   

Total commercial real estate

     172,603         861                 173,464         1,456         174,920   

Residential real estate:

                 

Consumer mortgage

     56,191         745         69         57,005         866         57,871   

Investment property

     42,935         598                 43,533         302         43,835   

Total residential real estate

     99,126         1,343         69         100,538         1,168         101,706   

Consumer installment

     12,789         100         4         12,893                 12,893   

Total

   $     376,959                 2,485                     73         379,517               4,261       $     383,778   
                                                       

 

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Allowance for Loan Losses

The Company assesses the adequacy of its allowance for loan losses prior to the end of each calendar quarter. The level of the allowance is based upon management’s evaluation of the loan portfolio, past loan loss experience, current asset quality trends, known and inherent risks in the portfolio, adverse situations that may affect a borrower’s ability to repay (including the timing of future payment), the estimated value of any underlying collateral, composition of the loan portfolio, economic conditions, industry and peer bank loan loss rates and other pertinent factors, including regulatory recommendations. This evaluation is inherently subjective as it requires material estimates including the amounts and timing of future cash flows expected to be received on impaired loans that may be susceptible to significant change. Loans are charged off, in whole or in part, when management believes that the full collectability of the loan is unlikely. A loan may be partially charged-off after a “confirming event” has occurred which serves to validate that full repayment pursuant to the terms of the loan is unlikely.

The Company deems loans impaired when, based on current information and events, it is probable that the Company will be unable to collect all amounts due according to the contractual terms of the loan agreement. Collection of all amounts due according to the contractual terms means that both the interest and principal payments of a loan will be collected as scheduled in the loan agreement.

An impairment allowance is recognized if the fair value of the loan is less than the recorded investment in the loan. The impairment is recognized through the allowance. Loans that are impaired are recorded at the present value of expected future cash flows discounted at the loan’s effective interest rate, or if the loan is collateral dependent, impairment measurement is based on the fair value of the collateral, less estimated disposal costs.

The level of allowance maintained is believed by management to be adequate to absorb probable losses inherent in the portfolio at the balance sheet date. The allowance is increased by provisions charged to expense and decreased by charge-offs, net of recoveries of amounts previously charged-off.

In assessing the adequacy of the allowance, the Company also considers the results of its ongoing internal and independent loan review processes. The Company’s loan review process assists in determining whether there are loans in the portfolio whose credit quality has weakened over time and evaluating the risk characteristics of the entire loan portfolio. The Company’s loan review process includes the judgment of management, the input from our independent loan reviewers, and reviews that may have been conducted by bank regulatory agencies as part of their examination process. The Company incorporates loan review results in the determination of whether or not it is probable that it will be able to collect all amounts due according to the contractual terms of a loan.

As part of the Company’s quarterly assessment of the allowance, management divides the loan portfolio into five segments: commercial and industrial, construction and land development, commercial real estate, residential real estate, and consumer installment loans. The Company analyzes each segment and estimates an allowance allocation for each loan segment.

The allocation of the allowance for loan losses begins with a process of estimating the probable losses inherent for these types of loans. The estimates for these loans are established by category and based on the Company’s internal system of credit risk ratings and historical loss data. The estimated loan loss allocation rate for the Company’s internal system of credit risk grades is based on its experience with similarly graded loans. For loan segments where the Company believes it does not have sufficient historical loss data, the Company may make adjustments based, in part, on loss rates of peer bank groups. At June 30, 2014 and December 31, 2013, and for the periods then ended, the Company adjusted its historical loss rates for the commercial real estate portfolio segment based, in part, on loss rates of peer bank groups.

The estimated loan loss allocation for all five loan portfolio segments is then adjusted for management’s estimate of probable losses for several “qualitative and environmental” factors. The allocation for qualitative and environmental factors is particularly subjective and does not lend itself to exact mathematical calculation. This amount represents estimated probable inherent credit losses which exist, but have not yet been identified, as of the balance sheet date, and are based upon quarterly trend assessments in delinquent and nonaccrual loans, credit concentration changes, prevailing economic conditions, changes in lending personnel experience, changes in lending policies or procedures and other influencing factors. These qualitative and environmental factors are considered for each of the five loan segments and the allowance allocation, as determined by the processes noted above, is increased or decreased based on the incremental assessment of these factors.

The Company regularly re-evaluates its practices in determining the allowance for loan losses. During 2014 and 2013, the Company implemented certain refinements to its allowance for loan losses methodology, specifically the way that historical loss factors are calculated. Beginning with the quarter ended June 30, 2014, the Company calculated average losses for all loan segments using a rolling 20 quarter historical period in order to better capture the effects of the most

 

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recent economic cycle on the Company’s loan loss experience. Beginning with the quarter ended June 30, 2013, the Company calculated average losses for all loan segments using a rolling 8 quarter historical period (except for the commercial real estate loan segment, which used a 6 quarter historical period) and continued this methodology through March 31, 2014. Prior to June 30, 2013, the Company calculated average losses for all loan segments using a rolling 6 quarter historical period.

If the Company continued to calculate average losses for all loan segments other than commercial real estate using a rolling 8 quarter historical period and for the commercial real estate segment using a rolling 6 quarter historical period, the Company’s calculated allowance for loan loss allocation would have decreased by approximately $1.0 million at June 30, 2014. Other than the changes discussed above, the Company has not made any changes to its calculation of historical loss periods that would impact the calculation of the allowance for loan losses or provision for loan losses for the periods included in the accompanying consolidated balance sheets and statements of earnings.

The following table details the changes in the allowance for loan losses by portfolio segment for the respective periods.

 

     June 30, 2014  
(In thousands)    Commercial and
industrial
     Construction
and land
development
     Commercial
real estate
     Residential
real estate
     Consumer
installment
     Total  

Quarter ended:

                 

Beginning balance

   $ 482         214         2,493         1,256         266       $ 4,711   

Charge-offs

     (46)                         (41)         (8)         (95)   

Recoveries

     32         1                 74         5         112   

 

 

Net (charge-offs) recoveries

     (14)         1                 33         (3)         17   

Provision for loan losses

     171         692         (580)         (194)         (89)           

 

 

Ending balance

   $ 639         907         1,913         1,095         174       $ 4,728   

 

 

Six months ended:

                 

Beginning balance

   $ 386         366         3,186         1,114         216       $ 5,268   

Charge-offs

     (46)         (236)                 (72)         (44)         (398)   

Recoveries

     36         3         118         91         10         258   

 

 

Net (charge-offs) recoveries

     (10)         (233)         118         19         (34)         (140)   

Provision for loan losses

     263         774         (1,391)         (38)         (8)         (400)   

 

 

Ending balance

   $         639                 907                 1,913                 1,095                 174       $         4,728   

 

 
     June 30, 2013  
(In thousands)    Commercial and
industrial
     Construction
and land
development
     Commercial
real estate
     Residential
real estate
     Consumer
installment
     Total  

Quarter ended:

                 

Beginning balance

   $ 569         1,619         3,571         885         125         6,769   

Charge-offs

                     (118)         (189)         (45)       $ (352)   

Recoveries

     5         2                 28         5       $ 40   

 

 

Net recoveries (charge-offs)

     5         2         (118)         (161)         (40)         (312)   

Provision for loan losses

     101         (167)         (342)         401         7       $   

 

 

Ending balance

   $ 675         1,454         3,111         1,125         92       $ 6,457   

 

 

Six months ended:

              

Beginning balance

   $ 812         1,545         3,137         1,126         103       $ 6,723   

Charge-offs

     (68)         (39)         (118)         (455)         (62)         (742)   

Recoveries

     17         3        4         41         11         76   

 

 

Net charge-offs

     (51)         (36)         (114)         (414)         (51)         (666)   

Provision for loan losses

     (86)         (55)         88         413         40         400   

 

 

Ending balance

   $         675                   1,454                 3,111                 1,125                 92       $         6,457   

 

 

 

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Table of Contents

The following table presents an analysis of the allowance for loan losses and recorded investment in loans by portfolio segment and impairment methodology as of June 30, 2014 and 2013.

 

             Collectively evaluated (1)                       Individually evaluated (2)               Total  
(In thousands)   

    Allowance

    for loan

    losses

    

    Recorded

    investment

    in loans

    

    Allowance

    for loan

    losses

    

    Recorded

    investment

    in loans

    

    Allowance

    for loan

    losses

    

    Recorded

    investment

    in loans

 

June 30, 2014:

                 

Commercial and industrial

   $ 639         51,959                 95         639         52,054   

Construction and land development

     907         31,498                 963         907         32,461   

Commercial real estate

     1,744         185,302         169         1,939         1,913         187,241   

Residential real estate

     1,095         102,040                 881         1,095         102,921   

Consumer installment

     174         11,686                         174         11,686   

 

 

Total

   $ 4,559         382,485         169         3,878         4,728         386,363   

 

 

June 30, 2013:

                 

Commercial and industrial

   $ 675         55,882                 148         675         56,030   

Construction and land development

     1,347         44,285         107         1,601         1,454         45,886   

Commercial real estate

     2,991         174,922         120         2,369         3,111         177,291   

Residential real estate

     1,069         97,732         56         1,289         1,125         99,021   

Consumer installment

     92         12,747                         92         12,747   

 

 

Total

   $ 6,174         385,568         283         5,407         6,457         390,975   

 

 

 

(1) Represents loans collectively evaluated for impairment in accordance with ASC 450-20, Loss Contingencies (formerly FAS 5), and pursuant to amendments by ASU 2010-20 regarding allowance for unimpaired loans.
(2) Represents loans individually evaluated for impairment in accordance with ASC 310-30, Receivables (formerly FAS 114), and pursuant to amendments by ASU 2010-20 regarding allowance for impaired loans.

 

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Credit Quality Indicators

The credit quality of the loan portfolio is summarized no less frequently than quarterly using categories similar to the standard asset classification system used by the federal banking agencies. The following table presents credit quality indicators for the loan portfolio segments and classes. These categories are utilized to develop the associated allowance for loan losses using historical losses adjusted for qualitative and environmental factors and are defined as follows:

Pass—loans which are well protected by the current net worth and paying capacity of the obligor (or guarantors, if any) or by the fair value, less cost to acquire and sell, of any underlying collateral.

Special Mention—loans with potential weakness that may, if not reversed or corrected, weaken the credit or inadequately protect the Company’s position at some future date. These loans are not adversely classified and do not expose an institution to sufficient risk to warrant an adverse classification.

Substandard Accruing—loans that exhibit a well-defined weakness which presently jeopardizes debt repayment, even though they are currently performing. These loans are characterized by the distinct possibility that the Company may incur a loss in the future if these weaknesses are not corrected

Nonaccrual—includes loans where management has determined that full payment of principal and interest is not expected.

 

(In thousands)    Pass      Special
Mention
     Substandard
Accruing
     Nonaccrual      Total
loans
 

June 30, 2014:

              

Commercial and industrial

   $ 47,157         4,448         397         52       $ 52,054   

Construction and land development

     30,285         638         575         963         32,461   

Commercial real estate:

              

Owner occupied

     50,904         1,206         185         276         52,571   

Other

     133,581         89         790         210         134,670   

Total commercial real estate

     184,485         1,295         975         486         187,241   

Residential real estate:

              

Consumer mortgage

     51,424         3,426         3,518         889         59,257   

Investment property

     40,702         1,312         1,236         414         43,664   

Total residential real estate

     92,126         4,738         4,754         1,303         102,921   

Consumer installment

     11,547         28         111                 11,686   

Total

   $ 365,600         11,147         6,812         2,804       $ 386,363   
                                              

December 31, 2013:

              

Commercial and industrial

   $ 53,060         4,183         482         55       $ 57,780   

Construction and land development

     33,616         180         1,101         1,582         36,479   

Commercial real estate:

              

Owner occupied

     53,430         770         875         1,027         56,102   

Other

     117,490         91         808         429         118,818   

Total commercial real estate

     170,920         861         1,683         1,456         174,920   

Residential real estate:

              

Consumer mortgage

     50,392         1,137         5,476         866         57,871   

Investment property

     40,517         1,310         1,706         302         43,835   

Total residential real estate

     90,909         2,447         7,182         1,168         101,706   

Consumer installment

     12,713         34         146                 12,893   

Total

   $         361,218         7,705         10,594         4,261       $ 383,778   
                                              

 

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Table of Contents

Impaired loans

The following tables present details related to the Company’s impaired loans. Loans which have been fully charged-off do not appear in the following table. The related allowance generally represents the following components which correspond to impaired loans:

Individually evaluated impaired loans equal to or greater than $500,000 secured by real estate (nonaccrual construction and land development, commercial real estate, and residential real estate loans).

Individually evaluated impaired loans equal to or greater than $250,000 not secured by real estate (nonaccrual commercial and industrial and consumer installment loans).

The following tables set forth certain information regarding the Company’s impaired loans that were individually evaluated for impairment at June 30, 2014 and December 31, 2013.

 

     June 30, 2014  
(In thousands)    Unpaid principal
balance (1)
    

Charge-offs and

payments applied (2)

    

Recorded

investment (3)

     Related allowance  

 

    

 

 

 

With no allowance recorded:

  

Commercial and industrial

   $ 95                 95      

Construction and land development

     2,960         (1,997)         963      

Commercial real estate:

           

Owner occupied

     337         (61)         276      

Other

     300         (90)         210      

 

    

Total commercial real estate

     637         (151)         486      

Residential real estate:

           

Consumer mortgages

     941         (224)         717      

Investment property

     206         (42)         164      

 

    

Total residential real estate

     1,147         (266)         881      

 

    

Total

   $ 4,839         (2,414)         2,425      

 

    

With allowance recorded:

           

Commercial real estate:

           

Owner occupied

     861                 861         117   

Other

     592                 592         52   

 

    

 

 

 

Total commercial real estate

     1,453                 1,453         169   

 

    

 

 

 

Total

   $ 1,453                 1,453       $ 169   

 

    

 

 

 

Total impaired loans

   $             6,292         (2,414)         3,878       $                 169   

 

    

 

 

 

 

(1) Unpaid principal balance represents the contractual obligation due from the customer.
(2) Charge-offs and payments applied represents cumulative charge-offs taken, as well as interest payments that have been applied against the outstanding principal balance subsequent to the loans being placed on nonaccrual status.
(3) Recorded investment represents the unpaid principal balance less charge-offs and payments applied; it is shown before any related allowance for loan losses.

 

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     December 31, 2013  
(In thousands)   

Unpaid principal

balance (1)

    

Charge-offs and

payments applied (2)

    

Recorded

investment (3)

     Related allowance  

 

    

 

 

 

With no allowance recorded:

  

Commercial and industrial

   $ 124                 124      

Construction and land development

     2,879         (1,682)         1,197      

Commercial real estate:

           

Owner occupied

     1,217         (190)         1,027      

Other

     518         (89)         429      

 

    

Total commercial real estate

     1,735         (279)         1,456      

Residential real estate:

           

Consumer mortgages

     952         (198)         754      

Investment property

     207         (35)         172      

 

    

Total residential real estate

     1,159         (233)         926      

 

    

Total

   $ 5,897         (2,194)         3,703      

 

    

With allowance recorded:

           

Construction and land development

     452         (67)         385         88   

Commercial real estate:

           

Owner occupied

     875                 875         110   

Other

     602                 602         62   

 

    

 

 

 

Total commercial real estate

     1,477                 —         1,477         172   

 

    

 

 

 

Total

   $ 1,929         (67)         1,862       $ 260   

 

    

 

 

 

Total impaired loans

   $             7,826         (2,261)                     5,565       $             260   

 

    

 

 

 

 

(1) Unpaid principal balance represents the contractual obligation due from the customer.
(2) Charge-offs and payments applied represents cumulative charge-offs taken, as well as interest payments that have been applied against the outstanding principal balance subsequent to the loans being placed on nonaccrual status.
(3) Recorded investment represents the unpaid principal balance less charge-offs and payments applied; it is shown before any related allowance for loan losses.

The following table provides the average recorded investment in impaired loans and the amount of interest income recognized on impaired loans after impairment by portfolio segment and class during the respective periods.

 

     Quarter ended June 30, 2014      Six months ended June 30, 2014  
(In thousands)   

Average

recorded

investment

    

Total interest

income

recognized

    

Average

recorded

investment

    

Total interest

income

recognized

 

 

 

Impaired loans:

  

Commercial and industrial

   $ 103         2         111         4   

Construction and land development

     1,098                 1,343           

Commercial real estate:

           

Owner occupied

     1,142         9         1,468         21   

Other

     949         8         994         17   

 

 

Total commercial real estate

     2,091         17         2,462         38   

Residential real estate:

           

Consumer mortgages

     724                 736           

Investment property

     165                 168           

 

 

Total residential real estate

     889                 904           

 

 

Total

   $             4,181                     19                     4,820                     42   

 

 

 

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Table of Contents
     Quarter ended June 30, 2013      Six months ended June 30, 2013  
     Average      Total interest      Average      Total interest  
     recorded      income      recorded      income  
(In thousands)    investment      recognized      investment      recognized  

 

 

Impaired loans:

  

Commercial and industrial

   $ 150         2         158         5   

Construction and land development

     1,607                 1,614           

Commercial real estate:

           

Owner occupied

     1,984         14         2,019         29   

Other

     430                 1,902           

 

 

Total commercial real estate

     2,414         14         3,921         29   

Residential real estate:

           

Consumer mortgages

     789                 801           

Investment property

     348                 323           

 

 

Total residential real estate

     1,137                 1,124           

 

 

Total

   $             5,308                     16                     6,817                     34   

 

 

Troubled Debt Restructurings

Impaired loans also include troubled debt restructurings (“TDRs”). In the normal course of business, management may grant concessions to borrowers that are experiencing financial difficulty. A concession may include, but is not limited to, delays in required payments of principal and interest for a specified period, reduction of the stated interest rate of the loan, reduction of accrued interest, extension of the maturity date or reduction of the face amount or maturity amount of the debt. A concession has been granted when, as a result of the restructuring, the Bank does not expect to collect all amounts due, including interest at the original stated rate. A concession may have also been granted if the debtor is not able to access funds elsewhere at a market rate for debt with similar risk characteristics as the restructured debt. The Company’s determination of whether a loan modification is a TDR, the Company considers the individual facts and circumstances surrounding each modification. As part of the credit approval process, the restructured loans are evaluated for adequate collateral protection in determining the appropriate accrual status at the time of restructure.

Similar to other impaired loans, TDRs are measured for impairment based on the present value of expected payments using the loan’s original effective interest rate as the discount rate, or the fair value of the collateral, less selling costs if the loan is collateral dependent. If the recorded investment in the loan exceeds the measure of fair value, impairment is recognized by establishing a valuation allowance as part of the allowance for loan losses or a charge-off to the allowance for loan losses. In periods subsequent to the modification, all TDRs are individually evaluated for possible impairment.

 

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The following is a summary of accruing and nonaccrual TDRs, which are included in impaired loan totals, and the related allowance for loan losses, by portfolio segment and class as of June 30, 2014, and December 31, 2013.

 

     TDRs  
(In thousands)    Accruing      Nonaccrual      Total     

Related

Allowance

 

 

    

 

 

 

June 30, 2014

           

Commercial and industrial

   $ 95                 95       $   

Construction and land development

             963         963           

Commercial real estate:

           

Owner occupied

     861         276         1,137         117   

Other

     592         210         802         52   

 

    

 

 

 

Total commercial real estate

     1,453         486         1,939         169   

Residential real estate:

           

Consumer mortgages

             717         717           

Investment property

             164         164           

 

    

 

 

 

Total residential real estate

             881         881           

 

    

 

 

 

Total

   $ 1,548         2,330         3,878       $ 169   

 

    

 

 

 

December 31, 2013

           

Commercial and industrial

   $ 124                 124       $   

Construction and land development

             1,582         1,582         88   

Commercial real estate:

           

Owner occupied

     875         285         1,160         110   

Other

     602         429         1,031         62   

 

    

 

 

 

Total commercial real estate

     1,477         714         2,191         172   

Residential real estate:

           

Consumer mortgages

             754         754           

Investment property

             172         172           

 

    

 

 

 

Total residential real estate

             926         926           

 

    

 

 

 

Total

   $         1,601                 3,222                 4,823       $             260   

 

    

 

 

 

At June 30, 2014, there were no significant outstanding commitments to advance additional funds to customers whose loans had been restructured.

The following table summarizes loans modified in a TDR during the respective periods both before and after their modification.

 

     Quarter ended June 30,      Six months ended June 30,  
            Pre-      Post -             Pre-      Post -  
            modification      modification             modification      modification  
     Number      outstanding      outstanding      Number      outstanding      outstanding  
     of      recorded      recorded      of      recorded      recorded  
(Dollars in thousands)    contracts      investment      investment      contracts      investment      investment  

 

 

2013:

  

              

Commercial real estate:

                 

Other

           $                 1       $ 431         431   

 

 

Total commercial real estate

                             1         431         431   

Residential real estate:

                 

Consumer mortgages

                             1         131         131   

 

 

Total residential real estate

                             1         131         131   

 

 

Total

                 —       $         —                     —                     2       $         562                 562   

 

 

 

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There were no loans modified in a TDR during the six months ended June 30, 2014. The majority of the loans modified in a TDR during the six months ended June 30, 2013 included permitting delays in required payments of principal and/or interest or where the only concession granted by the Company was that the interest rate at renewal was considered to be less than a market rate.

The following table summarizes the recorded investment in loans modified in a TDR within the previous 12 months for which there was a payment default (defined as 90 days or more past due) during the respective periods. There were no loans modified in a TDR which had a payment default during the six months ended June 30, 2014.

 

     Quarter ended June 30,    Six months Ended June 30,
(Dollars in thousands)   

Number of

Contracts

    

Recorded

investment(1)

           Number of
Contracts
    

Recorded

investment(1)

       

2013:

                 

Construction and land development

                 —       $         —                        1       $         1,197      

 

       

 

 

    

Total

           $            1       $ 1,197      

 

       

 

 

    

 

(1) Amount as of applicable month end during the respective period for which there was a payment default.

NOTE 6: MORTGAGE SERVICING RIGHTS, NET

Mortgage servicing rights (“MSRs”) are recognized based on the fair value of the servicing rights on the date the corresponding mortgage loans are sold. An estimate of the fair value of the Company’s MSRs is determined using assumptions that market participants would use in estimating future net servicing income, including estimates of prepayment speeds, discount rate, default rates, cost to service, escrow account earnings, contractual servicing fee income, ancillary income, and late fees. Subsequent to the date of transfer, the Company has elected to measure its MSRs under the amortization method. Under the amortization method, MSRs are amortized in proportion to, and over the period of, estimated net servicing income.

The Company has recorded MSRs related to loans sold without recourse to Fannie Mae. The Company generally sells conforming, fixed-rate, closed-end, residential mortgages to Fannie Mae. MSRs are included in other assets on the accompanying consolidated balance sheets.

The Company evaluates MSRs for impairment on a quarterly basis. Impairment is determined by stratifying MSRs into groupings based on predominant risk characteristics, such as interest rate and loan type. If, by individual stratum, the carrying amount of the MSRs exceeds fair value, a valuation allowance is established. The valuation allowance is adjusted as the fair value changes. Changes in the valuation allowance are recognized in earnings as a component of mortgage lending income.

The following table details the changes in amortized MSRs and the related valuation allowance for the respective periods.

 

     Quarter ended June 30,      Six Months Ended June 30,  
(Dollars in thousands)    2014      2013      2014      2013  

 

 

MSRs, net:

           

Beginning balance

   $ 2,368       $ 1,728       $ 2,350       $ 1,526   

Additions, net

     105         218         203         478   

Amortization expense

     (84)         (102)         (164)         (226)   

(Increase) decrease in valuation allowance

     (43)         135         (43)         201   

 

 

Ending balance

   $ 2,346       $ 1,979       $ 2,346       $ 1,979   

 

 

Valuation allowance included in MSRs, net:

           

Beginning of period

   $       $ 320       $       $ 386   

End of period

     43         185         43         185   

 

 

Fair value of amortized MSRs:

           

Beginning of period

   $ 3,386       $ 1,994       $ 3,452       $ 1,526   

End of period

             3,228                 2,453                 3,228                 2,453   

 

 

 

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NOTE 7: DERIVATIVE INSTRUMENTS

Financial derivatives are reported at fair value in other assets or other liabilities on the accompanying Consolidated Balance Sheets. The accounting for changes in the fair value of a derivative depends on whether it has been designated and qualifies as part of a hedging relationship. For derivatives not designated as part of a hedging relationship, the gain or loss is recognized in current earnings within other noninterest income on the accompanying Consolidated Statements of Earnings. From time to time, the Company may enter into interest rate swaps (“swaps”) to facilitate customer transactions and meet their financing needs. Upon entering into these swaps, the Company enters into offsetting positions in order to minimize the risk to the Company. These swaps qualify as derivatives, but are not designated as hedging instruments. At June 30, 2014 and December 31, 2013, the Company had no derivative contracts to assist in managing its own interest rate sensitivity.

Interest rate swap agreements involve the risk of dealing with counterparties and their ability to meet contractual terms. When the fair value of a derivative instrument is positive, this generally indicates that the counterparty or customer owes the Company, and results in credit risk to the Company. When the fair value of a derivative instrument is negative, the Company owes the customer or counterparty and therefore, has no credit risk.

A summary of the Company’s interest rate swap agreements at June 30, 2014 and December 31, 2013 is presented below.

 

             Other Assets      Other Liabilities  
(Dollars in thousands)    Notional      Estimated
Fair Value
    

Estimated

Fair Value

 

 

 

June 30, 2014:

        

Pay fixed / receive variable

   $ 4,842                 756   

Pay variable / receive fixed

     4,842         756           

 

 

Total interest rate swap agreements

   $ 9,684         756         756   

 

 

December 31, 2013:

        

Pay fixed / receive variable

   $ 5,017                 844   

Pay variable / receive fixed

     5,017         844           

 

 

Total interest rate swap agreements

   $               10,034                       844                       844   

 

 

 

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NOTE 8: FAIR VALUE

Fair Value Hierarchy

“Fair value” is defined by ASC 820, Fair Value Measurements and Disclosures, as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction occurring in the principal market (or most advantageous market in the absence of a principal market) for an asset or liability at the measurement date. GAAP 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 to the valuation methodology are quoted prices, unadjusted, for identical assets or liabilities in active markets.

Level 2—inputs to the valuation methodology include quoted prices for similar assets and liabilities in active markets, quoted prices for identical or similar assets or liabilities in markets that are not active, or inputs that are observable for the asset or liability, either directly or indirectly.

Level 3—inputs to the valuation methodology are unobservable and reflect the Company’s own assumptions about the inputs market participants would use in pricing the asset or liability.

Level changes in fair value measurements

Transfers between levels of the fair value hierarchy are generally recognized at the end of the reporting period. The Company monitors the valuation techniques utilized for each category of financial assets and liabilities to ascertain when transfers between levels have been affected. The nature of the Company’s financial assets and liabilities generally is such that transfers in and out of any level are expected to be infrequent. For the six months ended June 30, 2014, there were no transfers between levels and no changes in valuation techniques for the Company’s financial assets and liabilities.

Assets and liabilities measured at fair value on a recurring basis

Securities available-for-sale

Fair values of securities available for sale were primarily measured using Level 2 inputs. For these securities, the Company obtains pricing from third party pricing services. These third party pricing services consider observable data that may include broker/dealer quotes, market spreads, cash flows, market consensus prepayment speeds, benchmark yields, reported trades for similar securities, market consensus prepayment speeds, credit information and the securities’ terms and conditions. On a quarterly basis, management reviews the pricing received from the third party pricing services for reasonableness given current market conditions. As part of its review, management may obtain non-binding third party broker quotes to validate the fair value measurements. In addition, management will periodically submit pricing provided by the third party pricing services to another independent valuation firm on a sample basis. This independent valuation firm will compare the price provided by the third party pricing service with its own price and will review the significant assumptions and valuation methodologies used with management.

Interest rate swap agreements

The carrying amount of interest rate swap agreements was included in other assets and accrued expenses and other liabilities on the accompanying consolidated balance sheets. The fair value measurements for our interest rate swap agreements were based on information obtained from a third party bank. This information is periodically tested by the Company and validated against other third party valuations. If needed, other third party market participants may be utilized to corroborate the fair value measurements for our interest rate swap agreements. The Company classified these derivative assets and liabilities within Level 2 of the valuation hierarchy. These swaps qualify as derivatives, but are not designated as hedging instruments.

 

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Table of Contents

The following table presents the balances of the assets and liabilities measured at fair value on a recurring basis as of June 30, 2014 and December 31, 2013, respectively, by caption, on the accompanying consolidated balance sheets by ASC 820 valuation hierarchy (as described above).

 

            Quoted Prices in      Significant         
            Active Markets      Other      Significant  
            for      Observable      Unobservable  
            Identical Assets      Inputs      Inputs  
(Dollars in thousands)    Amount          (Level 1)      (Level 2)              (Level 3)           

June 30, 2014:

           

Securities available-for-sale:

           

Agency obligations

   $ 70,751                 70,751           

Agency RMBS

     141,005                 141,005           

State and political subdivisions

     65,197                 65,197           

 

 

Total securities available-for-sale

     276,953                 276,953           

Other assets (1)

     756                 756           

 

 

Total assets at fair value

   $ 277,709                 277,709           

 

 

Other liabilities(1)

   $ 756                 756           

 

 

Total liabilities at fair value

   $ 756                 756           

 

 

December 31, 2013:

           

Securities available-for-sale:

           

Agency obligations

   $ 44,522                 44,522           

Agency RMBS

     162,358                 162,358           

State and political subdivisions

     64,339                 64,339           

 

 

Total securities available-for-sale

     271,219                 271,219           

Other assets (1)

     844                 844           

 

 

Total assets at fair value

   $         272,063                         272,063                     —   

 

 

Other liabilities(1)

   $ 844                 844           

 

 

Total liabilities at fair value

   $ 844                         —         844           

 

 

 

(1) 

Represents the fair value of interest rate swap agreements.

Assets and liabilities measured at fair value on a nonrecurring basis

Loans held for sale

Loans held for sale are carried at the lower of cost or fair value. Fair values of loans held for sale are determined using quoted market secondary market prices for similar loans. Loans held for sale are classified within Level 2 of the fair value hierarchy.

Impaired Loans

Loans considered impaired under ASC 310-10-35, Receivables, are loans for which, based on current information and events, it is probable that the Company will be unable to collect all principal and interest payments due in accordance with the contractual terms of the loan agreement. Impaired loans can be measured based on the present value of expected payments using the loan’s original effective rate as the discount rate, the loan’s observable market price, or the fair value of the collateral less selling costs if the loan is collateral dependent.

The fair value of impaired loans were primarily measured based on the value of the collateral securing these loans. Impaired loans are classified within Level 3 of the fair value hierarchy. Collateral may be real estate and/or business assets including equipment, inventory, and/or accounts receivable. The Company determines the value of the collateral based on independent appraisals performed by qualified licensed appraisers. These appraisals may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach. Appraised values are discounted for costs to sell and may be discounted further based on management’s historical knowledge, changes in market conditions

 

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from the date of the most recent appraisal, and/or management’s expertise and knowledge of the customer and the customer’s business. Such discounts by management are subjective and are typically significant unobservable inputs for determining fair value. Impaired loans are reviewed and evaluated on at least a quarterly basis for additional impairment and adjusted accordingly, based on the same factors discussed above.

Other real estate owned

Other real estate owned, consisting of properties obtained through foreclosure or in satisfaction of loans, are initially recorded at the lower of the loan’s carrying amount or the fair value less costs to sell upon transfer of the loans to other real estate. Subsequently, other real estate is carried at the lower of carrying value or fair value less costs to sell. Fair values are generally based on third party appraisals of the property and are classified within Level 3 of the fair value hierarchy. The appraisals are sometimes further discounted based on management’s historical knowledge, and/or changes in market conditions from the date of the most recent appraisal, and/or management’s expertise and knowledge of the customer and the customer’s business. Such discounts are typically significant unobservable inputs for determining fair value. In cases where the carrying amount exceeds the fair value, less costs to sell, a loss is recognized in noninterest expense.

Mortgage servicing rights, net

Mortgage servicing rights, net, included in other assets on the accompanying consolidated balance sheets, are carried at the lower of cost or estimated fair value. MSRs do not trade in an active market with readily observable prices. To determine the fair value of MSRs, the Company engages an independent third party. The independent third party’s valuation model calculates the present value of estimated future net servicing income using assumptions that market participants would use in estimating future net servicing income, including estimates of prepayment speeds, discount rate, default rates, cost to service, escrow account earnings, contractual servicing fee income, ancillary income, and late fees. Periodically, the Company will review broker surveys and other market research to validate significant assumptions used in the model. The significant unobservable inputs include prepayment speeds or the constant prepayment rate (“CPR”) and the weighted average discount rate. Because the valuation of MSRs requires the use of significant unobservable inputs, all of the Company’s MSRs are classified within Level 3 of the valuation hierarchy.

The following table presents the balances of the assets and liabilities measured at fair value on a nonrecurring basis as of June 30, 2014 and December 31, 2013, respectively, by caption, on the accompanying consolidated balance sheets and by FASB ASC 820 valuation hierarchy (as described above):

 

            Quoted Prices in                
            Active Markets      Other      Significant  
            for      Observable      Unobservable  
     Carrying          Identical Assets      Inputs      Inputs  
(Dollars in thousands)    Amount          (Level 1)      (Level 2)      (Level 3)  

June 30, 2014:

           

Loans held for sale

   $ 7,200                 7,200           

Loans, net(1)

     3,709                         3,709   

Other real estate owned

     1,584                         1,584   

Other assets (2)

     2,346                         2,346   

Total assets at fair value

   $ 14,839                 7,200         7,639   
   

December 31, 2013:

           

Loans held for sale

   $ 2,296                 2,296           

Loans, net(1)

     5,305                         5,305   

Other real estate owned

     3,884                         3,884   

Other assets (2)

     2,350                         2,350   

Total assets at fair value

   $ 13,835             —             2,296             11,539   
   

 

(1) 

Loans considered impaired under ASC 310-10-35 Receivables. This amount reflects the recorded investment in impaired loans, net of any related allowance for loan losses.

(2) 

Represents MSRs, net, carried at lower of cost or estimated fair value.

 

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Table of Contents

Quantitative Disclosures for Level 3 Fair Value Measurements

The following is a reconciliation of the beginning and ending balances of recurring fair value measurements for trust preferred securities recognized in the accompanying consolidated balance sheets using Level 3 inputs:

 

       Six Months Ended June 30,    
(Dollars in thousands)    2014      2013  

Beginning balance

   $       $ 652   

Total realized and unrealized gains and (losses):

     

Included in other comprehensive income

             42   

 

 

Ending balance

   $                 —       $                 694   
   
   

At June 30, 2014, the Company had no Level 3 assets measured at fair value on a recurring basis. For Level 3 assets measured at fair value on a non-recurring basis at June 30, 2014, the significant unobservable inputs used in the fair value measurements are presented below.

 

                    Weighted  
    Carrying               Average  

(Dollars in thousands)

  Amount     

Valuation Technique

  

    Significant Unobservable Input    

      of Input      

Nonrecurring:

         

Impaired loans

  $             3,709        Appraisal    Appraisal discounts (%)     17.7%     

Other real estate owned

    1,584        Appraisal    Appraisal discounts (%)     13.4%     

Mortgage servicing rights, net

    2,346        Discounted cash flow    Prepayment speed or CPR (%)     9.6%     
        Discount rate (%)     10.0%     

 

 

Fair Value of Financial Instruments

ASC 825, Financial Instruments, requires disclosure of fair value information about financial instruments, whether or not recognized on the face of the balance sheet, for which it is practicable to estimate that value. The assumptions used in the estimation of the fair value of the Company’s financial instruments are explained below. Where quoted market prices are not available, fair values are based on estimates using discounted cash flow analyses. Discounted cash flows can be significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. The following fair value estimates cannot be substantiated by comparison to independent markets and should not be considered representative of the liquidation value of the Company’s financial instruments, but rather are a good–faith estimate of the fair value of financial instruments held by the Company. ASC 825 excludes certain financial instruments and all nonfinancial instruments from its disclosure requirements.

The following methods and assumptions were used by the Company in estimating the fair value of its financial instruments:

Loans, net

Fair values for loans were calculated using discounted cash flows. The discount rates reflected current rates at which similar loans would be made for the same remaining maturities. This method of estimating fair value does not incorporate the exit-price concept of fair value prescribed by ASC 820 and generally produces a higher value than an exit-price approach. Expected future cash flows were projected based on contractual cash flows, adjusted for estimated prepayments.

Loans held for sale

Fair values of loans held for sale are determined using quoted market secondary market prices for similar loans.

 

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Time Deposits

Fair values for time deposits were estimated using discounted cash flows. The discount rates were based on rates currently offered for deposits with similar remaining maturities.

Long-term debt

The fair value of the Company’s fixed rate long-term debt is estimated using discounted cash flows based on estimated current market rates for similar types of borrowing arrangements. The carrying amount of the Company’s variable rate long-term debt approximates its fair value.

The carrying value, related estimated fair value, and placement in the fair value hierarchy of the Company’s financial instruments at June 30, 2014 and December 31, 2013 are presented below. This table excludes financial instruments for which the carrying amount approximates fair value. Financial assets for which fair value approximates carrying value included cash and cash equivalents. Financial liabilities for which fair value approximates carrying value included noninterest-bearing demand, interest-bearing demand, and savings deposits due to these products having no stated maturity. In addition, financial liabilities for which fair value approximates carrying value included overnight borrowings such as federal funds purchased and securities sold under agreements to repurchase.

 

                   Fair Value Hierarchy  
(Dollars in thousands)   

Carrying

amount

    

Estimated

fair value

    

Level 1

inputs

    

Level 2

inputs

    

Level 3

Inputs

 

June 30, 2014:

              

Financial Assets:

              

Loans, net (1)

   $ 381,098       $ 381,014       $       $                 —       $             381,014   

Loans held for sale

     7,200         7,340                 7,340           

Financial Liabilities:

              

Time Deposits

   $             258,356       $             261,410       $                 —       $ 261,410       $   

Long-term debt

     12,217         12,615                 12,615           

December 31, 2013:

              

Financial Assets:

              

Loans, net (1)

   $ 378,071       $ 387,180       $       $       $ 387,180   

Loans held for sale

     2,296         2,310                 2,310           

Financial Liabilities:

              

Time Deposits

   $ 261,199       $ 263,985       $       $ 263,985       $   

Long-term debt

     12,217         12,569                 12,569           

 

(1) Represents loans, net of unearned income and the allowance for loan losses.

 

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ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

General

The following discussion and analysis is designed to provide a better understanding of various factors related to the results of operations and financial condition of the Auburn National Bancorporation, Inc. (the “Company”) and its wholly owned subsidiary, AuburnBank (the “Bank”). This discussion is intended to supplement and highlight information contained in the accompanying unaudited condensed consolidated financial statements and related notes for the quarters and six months ended June 30, 2014 and 2013, as well as the information contained in our annual report on Form 10-K for the year ended December 31, 2013 and our quarterly report on Form 10-Q for the quarter ended March 31, 2014.

Special Notice Regarding Forward-Looking Statements

Certain of the statements made in this discussion and analysis and elsewhere, including information incorporated herein by reference to other documents, are “forward-looking statements” within the meaning of, and subject to, the protections of Section 27A of the Securities Act of 1933, as amended, (the “Securities Act”) and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”).

Forward-looking statements include statements with respect to our beliefs, plans, objectives, goals, expectations, anticipations, assumptions, estimates, intentions and future performance, and involve known and unknown risks, uncertainties and other factors, which may be beyond our control, and which may cause the actual results, performance, achievements, or financial condition of the Company to be materially different from future results, performance, achievements, or financial condition expressed or implied by such forward-looking statements. You should not expect us to update any forward-looking statements.

All statements other than statements of historical fact are statements that could be forward-looking statements. You can identify these forward-looking statements through our use of words such as “may,” “will,” “anticipate,” “assume,” “should,” “indicate,” “would,” “believe,” “contemplate,” “expect,” “estimate,” “continue,” “plan,” “point to,” “project,” “could,” “intend,” “target” and other similar words and expressions of the future. These forward-looking statements may not be realized due to a variety of factors, including, without limitation:

 

   

the effects of future economic, business and market conditions and changes, domestic and foreign, including seasonality;

 

   

governmental monetary and fiscal policies;

 

   

legislative and regulatory changes, including changes in banking, securities and tax laws, regulations and rules and their application by our regulators, including capital and liquidity requirements, and changes in the scope and cost of FDIC insurance;

 

   

changes in accounting policies, rules and practices;

 

   

the risks of changes in interest rates on the levels, composition and costs of deposits, loan demand, and the values and liquidity of loan collateral, securities, and interest sensitive assets and liabilities, and the risks and uncertainty of the amounts realizable and the timing of dispositions of assets by the FDIC where we may have a participation or other interest;

 

   

changes in borrower credit risks and payment behaviors;

 

   

changes in the availability and cost of credit and capital in the financial markets, and the types of instruments that may be included as capital for regulatory purposes;

 

   

changes in the prices, values and sales volumes of residential and commercial real estate;

 

   

the effects of competition from a wide variety of local, regional, national and other providers of financial, investment and insurance services;

 

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the failure of assumptions and estimates underlying the establishment of allowances for possible loan and other asset impairments, losses and other estimates;

 

   

the risks of mergers, acquisitions and divestitures, including, without limitation, the related time and costs of implementing such transactions, integrating operations as part of these transactions and possible failures to achieve expected gains, revenue growth and/or expense savings from such transactions;

 

   

changes in technology or products that may be more difficult, costly, or less effective than anticipated;

 

   

the effects of war or other conflicts, acts of terrorism or other catastrophic events that may affect general economic conditions;

 

   

the failure of assumptions and estimates, as well as differences in, and changes to, economic, market and credit conditions, including changes in borrowers’ credit risks and payment behaviors from those used in our loan portfolio stress tests and other evaluations;

 

   

the risks that our deferred tax assets could be reduced if estimates of future taxable income from our operations and tax planning strategies are less than currently estimated, and sales of our capital stock could trigger a reduction in the amount of net operating loss carry-forwards that we may be able to utilize for income tax purposes; and

 

   

the other factors and information in this report and other filings that we make with the SEC under the Exchange Act, including our annual report on Form 10-K for the year ended December 31, 2013 and subsequent quarterly and current reports. See Part II, Item 1A, “RISK FACTORS”.

All written or oral forward-looking statements that are made by or attributable to us are expressly qualified in their entirety by this cautionary notice. We have no obligation and do not undertake to update, revise or correct any of the forward-looking statements after the date of this report, or after the respective dates on which such statements otherwise are made.

Business

The Company was incorporated in 1990 under the laws of the State of Delaware and became a bank holding company after it acquired its Alabama predecessor, which was a bank holding company established in 1984. The Bank, the Company’s principal subsidiary, is an Alabama state-chartered bank that is a member of the Federal Reserve System and has operated continuously since 1907. Both the Company and the Bank are headquartered in Auburn, Alabama. The Bank conducts its business primarily in East Alabama, including Lee County and surrounding areas. The Bank operates full-service branches in Auburn, Opelika, Valley, Hurtsboro, and Notasulga, Alabama. In-store branches are located in the Kroger and Wal-Mart SuperCenter stores in both Auburn and Opelika. The Bank also operates commercial loan production offices in Montgomery and Phenix City, Alabama.

Summary of Results of Operations

 

       Quarter ended June 30,          Six Months Ended June 30,    
(Dollars in thousands, except per share amounts)      2014      2013          2014      2013    

Net interest income (a)

   $         5,565       $         5,597       $       11,159       $       11,120   

Less: tax-equivalent adjustment

     312         365         636         747   

Net interest income (GAAP)

     5,253         5,232         10,523         10,373   

Noninterest income

     1,081         2,071         1,837         3,726   

Total revenue

     6,334         7,303         12,360         14,099   

Provision for loan losses

                   (400)         400   

Noninterest expense

     3,792         4,724         7,740         8,950   

Income tax expense

     683         672         1,340         1,153   

Net earnings

   $ 1,859       $ 1,907       $ 3,680       $ 3,596   

 

 

Basic and diluted earnings per share

   $ 0.51       $ 0.52       $ 1.01       $ 0.99   

 

 

 

(a) Tax-equivalent. See “Table 1—Explanation of Non-GAAP Financial Measures.”

 

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Financial Summary

The Company’s net earnings were $3.7 million for the first six months of 2014, compared to $3.6 million for the first six months of 2013. Basic and diluted earnings per share were $1.01 per share for the first six months of 2014, compared to $0.99 per share for the first six months of 2013.

Net interest income (tax-equivalent) was $11.2 million for the first six months of 2014, compared to $11.1 million for the first six months of 2013. Despite downward pressure on yields for earning assets, net interest income (tax-equivalent) increased slightly due to continued improvement in the Company’s cost of funds.

The Company recorded a negative provision for loan losses of $0.4 million for the first six months of 2014 compared to a charge of $0.4 million for the first six months of 2013. The decrease in the provision for loan losses was primarily due to improvement in the overall credit quality of the loan portfolio, including declining historical loss rates used in the calculation of our allowance for loan losses, and lower levels of adversely classified and nonperforming loans.

Noninterest income was $1.8 million for the first six months of 2014, compared to $3.7 million in the first six months of 2013. The decrease was primarily due to a decrease in mortgage lending income of $0.9 million as higher interest rates for mortgage loans negatively impacted refinance activity and a decrease in net securities gains (losses) of $1.0 million that was primarily due to a decrease in the volume and price of securities sold.

Noninterest expense was approximately $7.7 million in the first six months of 2014, compared to $9.0 million in the first six months of 2013. The decrease was primarily due to a decrease in prepayment penalties on long-term debt. The Company incurred no prepayment penalties during the first six months of 2014, compared to $1.5 million during the first six months of 2013 when the Company repaid a $20.0 million of FHLB advances with a weighted average interest rate of 3.38%.

Income tax expense was approximately $1.3 million for the first six months of 2014, compared to $1.2 million in the first six months of 2013. The Company’s effective tax rate for the first six months of 2014 was 26.69%, compared to 24.28% in the first six months of 2013. The increase in the Company’s effective tax rate was primarily due to decreases in tax exempt interest income as our holdings of municipal securities have declined. In addition, as earnings before income taxes increases, the impact of tax preference items, such as tax exempt interest income, on the Company’s effective tax rate is reduced.

In the first six months of 2014, the Company paid cash dividends of $1.6 million, or $0.43 per share. The Company’s balance sheet remains “well capitalized” under current regulatory guidelines with a total risk-based capital ratio of 18.53% and a Tier 1 leverage ratio of 10.07% at June 30, 2014.

In the second quarter of 2014, net earnings were $1.9 million, of $0.51 per share, compared to $1.9 million, or $0.52 per share for the second quarter of 2013. Net interest income (tax-equivalent) was $5.6 million for the second quarter of 2014 and 2013. Despite downward pressure on yields for earning assets, net interest income (tax-equivalent) was unchanged due to continued improvement in the Company’s cost of funds. There was no provision for loan losses in the second quarter of 2014 and 2013, primarily due to improvement in the overall credit quality of the loan portfolio, including declining historical loss rates used in the calculation of our allowance for loan losses, and lower levels of adversely classified and nonperforming loans. Noninterest income was $1.1 million in the second quarter of 2014, compared to $2.1 million in the second quarter of 2013. The decrease was primarily due to declines in mortgage lending income of $0.5 million and net securities gains of $0.5 million. Noninterest expense was $3.8 million in the second quarter of 2014, compared to $4.7 million in the second quarter of 2013. The decrease was primarily due to $1.0 million of prepayment penalties on long-term debt incurred during the second quarter of 2013, when the Company repaid $10.0 million of long-term debt with a weighted average interest rate of 3.59%. Income tax expense was approximately $0.7 million for the second quarter of 2014 and 2013. The Company’s effective tax rate for the second quarter of 2014 was 26.87%, compared to 26.06% in the second quarter of 2013. The Company’s effective tax rate increased due to the same factors described above.

 

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CRITICAL ACCOUNTING POLICIES

The accounting and financial reporting policies of the Company conform with U.S. generally accepted accounting principles and with general practices within the banking industry. In connection with the application of those principles, we have made judgments and estimates which, in the case of the determination of our allowance for loan losses, our assessment of other-than-temporary impairment, recurring and non-recurring fair value measurements, the valuation of other real estate owned, and the valuation of deferred tax assets, were critical to the determination of our financial position and results of operations. Other policies also require subjective judgment and assumptions and may accordingly impact our financial position and results of operations.

Except as discussed below, there have been no material changes to the Company’s critical accounting policies, estimates, and assumptions, or the judgments affecting the application of these estimates and assumptions in 2014.

The Company regularly re-evaluates its practices in determining the allowance for loan losses. During 2014, the Company implemented certain refinements to its allowance for loan losses methodology, specifically the way that historical loss factors are calculated. Beginning with the quarter ended June 30, 2014, the Company calculated average losses for all loan segments using a rolling 20 quarter historical period in order to better capture the effects of the most recent economic cycle on the Company’s loan loss experience. Prior to June 30, 2014 the Company calculated average losses for all loan segments using a rolling 8 quarter historical period (except for the commercial real estate loan segment, which used a 6 quarter historical period).

If the Company continued to calculate average losses for all loan segments other than commercial real estate using a rolling 8 quarter historical period and for the commercial real estate segment using a rolling 6 quarter historical period, the Company’s calculated allowance for loan loss allocation would have decreased by approximately $1.0 million at June 30, 2014. Other than the changes discussed above, the Company has not made any changes to its calculation of historical loss periods that would impact the calculation of the allowance for loan losses or provision for loan losses for the periods included in the accompanying consolidated balance sheets and statements of earnings.

Allowance for Loan Losses

The Company assesses the adequacy of its allowance for loan losses prior to the end of each calendar quarter. The level of the allowance is based upon management’s evaluation of the loan portfolio, past loan loss experience, current asset quality trends, known and inherent risks in the portfolio, adverse situations that may affect a borrower’s ability to repay (including the timing of future payment), the estimated value of any underlying collateral, composition of the loan portfolio, economic conditions, industry and peer bank loan loss rates and other pertinent factors, including regulatory recommendations. This evaluation is inherently subjective as it requires material estimates including the amounts and timing of future cash flows expected to be received on impaired loans that may be susceptible to significant change. Loans are charged off, in whole or in part, when management believes that the full collectability of the loan is unlikely. A loan may be partially charged-off after a “confirming event” has occurred which serves to validate that full repayment pursuant to the terms of the loan is unlikely.

The Company deems loans impaired when, based on current information and events, it is probable that the Company will be unable to collect all amounts due according to the contractual terms of the loan agreement. Collection of all amounts due according to the contractual terms means that both the interest and principal payments of a loan will be collected as scheduled in the loan agreement.

An impairment allowance is recognized if the fair value of the loan is less than the recorded investment in the loan. The impairment is recognized through the allowance. Loans that are impaired are recorded at the present value of expected future cash flows discounted at the loan’s effective interest rate, or if the loan is collateral dependent, impairment measurement is based on the fair value of the collateral, less estimated disposal costs.

The level of allowance maintained is believed by management to be adequate to absorb probable losses inherent in the portfolio at the balance sheet date. The allowance is increased by provisions charged to expense and decreased by charge-offs, net of recoveries of amounts previously charged-off.

In assessing the adequacy of the allowance, the Company also considers the results of its ongoing internal and independent loan review processes. The Company’s loan review process assists in determining whether there are loans in the portfolio whose credit quality has weakened over time and evaluating the risk characteristics of the entire loan portfolio. The Company’s loan review process includes the judgment of management, the input from our independent loan reviewers, and reviews that may have been conducted by bank regulatory agencies as part of their examination process. The Company incorporates loan review results in the determination of whether or not it is probable that it will be able to collect all amounts due according to the contractual terms of a loan.

 

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As part of the Company’s quarterly assessment of the allowance, management divides the loan portfolio into five segments: commercial and industrial, construction and land development, commercial real estate, residential real estate, and consumer installment loans. The Company analyzes each segment and estimates an allowance allocation for each loan segment.

The allocation of the allowance for loan losses begins with a process of estimating the probable losses inherent for these types of loans. The estimates for these loans are established by category and based on the Company’s internal system of credit risk ratings and historical loss data. The estimated loan loss allocation rate for the Company’s internal system of credit risk grades is based on its experience with similarly graded loans. For loan segments where the Company believes it does not have sufficient historical loss data, the Company may make adjustments based, in part, on loss rates of peer bank groups. At June 30, 2014 and December 31, 2013, and for the periods then ended, the Company adjusted its historical loss rates for the commercial real estate portfolio segment based, in part, on loss rates of peer bank groups.

The estimated loan loss allocation for all five loan portfolio segments is then adjusted for management’s estimate of probable losses for several “qualitative and environmental” factors. The allocation for qualitative and environmental factors is particularly subjective and does not lend itself to exact mathematical calculation. This amount represents estimated probable inherent credit losses which exist, but have not yet been identified, as of the balance sheet date, and are based upon quarterly trend assessments in delinquent and nonaccrual loans, credit concentration changes, prevailing economic conditions, changes in lending personnel experience, changes in lending policies or procedures and other influencing factors. These qualitative and environmental factors are considered for each of the five loan segments and the allowance allocation, as determined by the processes noted above, is increased or decreased based on the incremental assessment of these factors.

Assessment for Other-Than-Temporary Impairment of Securities

On a quarterly basis, management makes an assessment to determine whether there have been events or economic circumstances to indicate that a security on which there is an unrealized loss is other-than-temporarily impaired. For equity securities with an unrealized loss, the Company considers many factors including the severity and duration of the impairment; the intent and ability of the Company to hold the security for a period of time sufficient for a recovery in value; and recent events specific to the issuer or industry. Equity securities for which there is an unrealized loss that is deemed to be other-than-temporary are written down to fair value with the write-down recorded as a realized loss in securities gains (losses).

For debt securities with an unrealized loss, an other-than-temporary impairment write-down is triggered when (1) the Company has the intent to sell a debt security, (2) it is more likely than not that the Company will be required to sell the debt security before recovery of its amortized cost basis, or (3) the Company does not expect to recover the entire amortized cost basis of the debt security. If the Company has the intent to sell a debt security or if it is more likely than not that it will be required to sell the debt security before recovery, the other-than-temporary write-down is equal to the entire difference between the debt security’s amortized cost and its fair value. If the Company does not intend to sell the security or it is not more likely than not that it will be required to sell the security before recovery, the other-than-temporary impairment write-down is separated into the amount that is credit related (credit loss component) and the amount due to all other factors. The credit loss component is recognized in earnings and is the difference between the security’s amortized cost basis and the present value of its expected future cash flows. The remaining difference between the security’s fair value and the present value of future expected cash flows is due to factors that are not credit related and is recognized in other comprehensive income, net of applicable taxes.

Fair Value Determination

U.S. GAAP requires management to value and disclose certain of the Company’s assets and liabilities at fair value, including investments classified as available-for-sale and derivatives. ASC 820, Fair Value Measurements and Disclosures, which defines fair value, establishes a framework for measuring fair value in accordance with U.S. GAAP and expands disclosures about fair value measurements. For more information regarding fair value measurements and disclosures, please refer to Note 8, Fair Value, of the consolidated financial statements that accompany this report.

Fair values are based on active market prices of identical assets or liabilities when available. Comparable assets or liabilities or a composite of comparable assets in active markets are used when identical assets or liabilities do not have readily available active market pricing. However, some of the Company’s assets or liabilities lack an available or comparable trading market characterized by frequent transactions between willing buyers and sellers. In these cases, fair value is estimated using pricing models that use discounted cash flows and other pricing techniques. Pricing models and their underlying assumptions are based upon management’s best estimates for appropriate discount rates, default rates, prepayments, market volatility and other factors, taking into account current observable market data and experience.

 

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These assumptions may have a significant effect on the reported fair values of assets and liabilities and the related income and expense. As such, the use of different models and assumptions, as well as changes in market conditions, could result in materially different net earnings and retained earnings results.

Other Real Estate Owned

Other real estate owned (“OREO”), consists of properties obtained through foreclosure or in satisfaction of loans and is reported at the lower of cost or fair value, less estimated costs to sell at the date acquired with any loss recognized as a charge-off through the allowance for loan losses. Additional OREO losses for subsequent valuation adjustments are determined on a specific property basis and are included as a component of other noninterest expense along with holding costs. Any gains or losses on disposal of OREO are also reflected in noninterest expense. Significant judgments and complex estimates are required in estimating the fair value of OREO, and the period of time within which such estimates can be considered current is significantly shortened during periods of market volatility. As a result, the net proceeds realized from sales transactions could differ significantly from appraisals, comparable sales, and other estimates used to determine the fair value of other OREO.

Deferred Tax Asset Valuation

A valuation allowance is recognized for a deferred tax asset if, based on the weight of available evidence, it is more-likely-than-not that some portion or the entire deferred tax asset will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. Management considers the scheduled reversal of deferred tax liabilities, projected future taxable income and tax planning strategies in making this assessment. Based upon the level of taxable income over the last three years and projections for future taxable income over the periods in which the deferred tax assets are deductible, management believes it is more likely than not that we will realize the benefits of these deductible differences at June 30, 2014. The amount of the deferred tax assets considered realizable, however, could be reduced if estimates of future taxable income are reduced.

RESULTS OF OPERATIONS

Average Balance Sheet and Interest Rates

 

     Six Months Ended June 30,  
     2014      2013      
(Dollars in thousands)   

Average

Balance

    

Yield/    

Rate    

    

Average    

Balance    

    

Yield/    

Rate    

 

 

  

 

 

    

 

 

 

Loans and loans held for sale

     $         380,449             5.07%         $     396,498             5.37%   

Securities - taxable

     210,223         2.29%         194,205         1.84%   

Securities - tax-exempt

     60,954         6.19%         70,369         6.30%   

 

  

 

 

    

 

 

 

Total securities

     271,177         3.17%         264,574         3.03%   

Federal funds sold

     59,385         0.19%         55,881         0.22%   

Interest bearing bank deposits

     5,171         0.66%         892         —       

 

  

 

 

    

 

 

 

Total interest-earning assets

     716,182         3.91%         717,845         4.10%   

 

  

 

 

    

 

 

 

Deposits:

           

NOW

     106,812         0.32%         104,851         0.32%   

Savings and money market

     189,830         0.51%         168,263         0.52%   

Certificates of deposits less than $100,000

     104,079         1.20%         105,533         1.42%   

Certificates of deposits and other time deposits of $100,000 or more

     157,509         1.59%         154,745         1.83%   

 

  

 

 

    

 

 

 

Total interest-bearing deposits

     558,230         0.91%         533,392         1.04%   

Short-term borrowings

     3,440         0.53%         2,754         0.51%   

Long-term debt

     12,217         3.43%         39,095         3.62%   

 

  

 

 

    

 

 

 

Total interest-bearing liabilities

     573,887         0.96%         575,241         1.21%   

 

  

 

 

    

 

 

 

Net interest income and margin (tax-equivalent)

     $ 11,159         3.14%         $ 11,120         3.12%   

 

  

 

 

    

 

 

 

 

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Net Interest Income and Margin

Net interest income (tax-equivalent) was $11.2 million for the first six months of 2014, compared to $11.1 million for the first six months of 2013. Despite downward pressure on yields for earning assets, net interest income (tax-equivalent) increased slightly due to continued improvement in the Company’s cost of funds.

The tax-equivalent yield on total interest-earning assets decreased by 19 basis points in the first six months of 2014 from the first six months of 2013 to 3.91%. The decrease was primarily due to a decrease in average loans and loan yields as reduced loan demand and increased pricing competition for quality loan opportunities in our markets has limited the Company’s ability to increase loans generally, as well as a decrease in the yields on new and renewed loans over the last several quarters.

The cost of total interest-bearing liabilities decreased 25 basis points in the first six months of 2014 from the first six months of 2013 to 0.96%. The net decrease was largely a result of the continued shift in our funding mix, as we increased our savings and money market accounts and concurrently reduced balances of higher-cost long-term debt, such as wholesale borrowings.

The Company continues to deploy various asset liability management strategies to manage its risk to interest rate fluctuations. The Company’s net interest margin could experience pressure due to lower reinvestment yields in the securities portfolio given the current interest rate environment, increased competition for quality loan opportunities, and fewer opportunities to reduce our cost of funds due to the low level of deposit rates currently.

Provision for Loan Losses

The provision for loan losses represents a charge to earnings necessary to provide an allowance for loan losses that management believes, based on its processes and estimates, should be adequate to provide for the probable losses on outstanding loans. The Company recorded a negative provision for loan losses of $0.4 million for the first six months of 2014 compared to a charge of $0.4 million for the first six months of 2013. The decrease in the provision for loan losses was primarily due to improvement in the overall credit quality of the loan portfolio, including declining historical loss rates used in the calculation of our allowance for loan losses, and lower levels of adversely classified and nonperforming loans.

Based upon its assessment of the loan portfolio, management adjusts the allowance for loan losses to an amount it believes should be appropriate to adequately cover its estimate of probable losses in the loan portfolio. The Company’s allowance for loan losses as a percentage of total loans was 1.23% at June 30, 2014, compared to 1.37% at December 31, 2013. While the policies and procedures used to estimate the allowance for loan losses, as well as the resulting provision for loan losses charged to operations, are considered adequate by management and are reviewed from time to time by our regulators, they are based on estimates and judgments and are therefore approximate and imprecise. Factors beyond our control (such as conditions in the local and national economy, local real estate markets, or industry conditions) may have a material adverse effect on our asset quality and the adequacy of our allowance for loan losses resulting in significant increases in the provision for loan losses.

Noninterest Income

 

         Quarter ended June 30,              Six Months Ended June 30,      
(Dollars in thousands)    2014      2013      2014      2013  

 

 

Service charges on deposit accounts

   $ 219       $ 234       $ 432       $ 483   

Mortgage lending income

     348         837         734         1,647   

Bank-owned life insurance

     125         101         251         196   

Securities gains, net

     12         518         (295)         679   

Other

     377         381         715         721   

 

 

Total noninterest income

   $         1,081       $         2,071       $         1,837       $         3,726   

 

 

Service charges on deposit accounts decreased primarily due to a decline in insufficient funds charges, reflecting changes in customer behavior and spending patterns.

 

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The Company’s income from mortgage lending was primarily attributable to the (1) origination and sale of new mortgage loans and (2) servicing of mortgage loans. Origination income, net, is comprised of gains or losses from the sale of the mortgage loans originated, origination fees, underwriting fees and other fees associated with the origination of loans, which are netted against the commission expense associated with these originations. The Company’s normal practice is to originate mortgage loans for sale in the secondary market and to either sell or retain the associated mortgage servicing rights (“MSRs”) when the loan is sold.

MSRs are recognized based on the fair value of the servicing right on the date the corresponding mortgage loan is sold. Subsequent to the date of transfer, the Company has elected to measure its MSRs under the amortization method. Servicing fee income is reported net of any related amortization expense.

MSRs are also evaluated for impairment on a quarterly basis. Impairment is determined by grouping MSRs by common predominant characteristics, such as interest rate and loan type. If the aggregate carrying amount of a particular group of MSRs exceeds the group’s aggregate fair value, a valuation allowance for that group is established. The valuation allowance is adjusted as the fair value changes. An increase in mortgage interest rates typically results in an increase in the fair value of the MSRs while a decrease in mortgage interest rates typically results in a decrease in the fair value of MSRs.

The following table presents a breakdown of the Company’s mortgage lending income.

 

         Quarter ended June 30,              Six Months Ended June 30,      
(Dollars in thousands)    2014      2013      2014      2013  

 

 

Origination income

   $ 254       $ 591       $ 494       $ 1,258   

Servicing fees, net

     137         111         283         188   

(Increase) decrease in MSR valuation allowance

     (43)         135         (43)         201   

 

 

Total mortgage lending income

   $         348       $         837       $         734       $         1,647   

 

 

The decrease in mortgage lending income was due to a decline in origination income as refinance activity slowed significantly and changes in the MSR valuation allowance. These decreases were partially offset by an increase in servicing fees, net of related amortization expense. Servicing fees increased due to an increase in the unpaid principal balance of loans serviced and amortization expense decreased as prepayment speeds slowed.

The increase in income from bank-owned life insurance was primarily due to improved policy returns. During the fourth quarter of 2013, the Bank exchanged certain bank-owned life insurance policies with a cash surrender value of approximately $5.9 million. These policies were exchanged for policies from two new carriers with better credit ratings and policy returns. The assets that support these policies are administered by the life insurance carriers and the income we receive (i.e. increases or decreases in the cash surrender value of the policies) on these policies is dependent upon the returns the insurance carriers are able to earn on the underlying investments that support these policies. Earnings on these policies are generally not taxable.

Net securities gains (losses) consist of realized gains and losses on the sale of securities and other-than-temporary impairment charges. Net gains realized on the sale of securities were $12,000 and $38,000, respectively, for the second quarter and first six months of 2014, compared to net gains on the sale of securities of $518,000 and $679,000, respectively, for the second quarter and first six months of 2013. The Company recorded an other-than-temporary impairment charge of $333,000 in the first quarter of 2014 related to securities management intended to sell at March 31, 2014. Subsequent to March 31, 2014, the Company sold available-for-sale Agency RMBS with a fair value of $18.9 million and realized the expected loss of approximately $333,000. The Company incurred no other-than-temporary impairment charges in the first six months of 2013.

 

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Noninterest Expense

 

     Quarter ended June 30,      Six Months Ended June 30,  
(Dollars in thousands)    2014          2013          2014          2013      

 

 

Salaries and benefits

   $ 2,221       $ 2,114       $ 4,502       $ 4,364   

Net occupancy and equipment

     341         333         693         664   

Professional fees

     225         209         431         385   

FDIC and other regulatory assessments

     129         143         274         337   

Other real estate owned, net

     (62)         20         56         43   

Prepayment penalty on long-term debt

             1,046                 1,471   

Other

     938         859         1,784         1,686   

 

 

Total noninterest expense

   $         3,792       $         4,724       $         7,740       $         8,950   

 

 

The increase in salaries and benefits expense reflected routine annual increases.

The increase in net occupancy and equipment expense was primarily due to a decrease in rental income. During the fourth quarter of 2013, the Company sold an office building in downtown Auburn that was leased to third party tenants.

The decrease in FDIC and other regulatory assessments expense was primarily due to a decrease in the Bank’s quarterly assessment rate as several variables utilized by the FDIC in calculating our deposit insurance assessments improved.

The decrease in OREO expense, net for the second quarter of 2014 compared to the second quarter of 2013 was primarily due to gains realized on the sale of certain OREO properties.

During the second quarter and first six months of 2013, respectively, the Company repaid $10.0 million and $20.0 million of FHLB advances with weighted average interest rates of 3.59% and 3.38% and incurred prepayment penalties of $1.0 million and $1.5 million.

Income Tax Expense

Income tax expense was approximately $1.3 million for the first six months of 2014, compared to $1.2 million in the first six months of 2013. The Company’s effective tax rate for the first six months of 2014 was 26.69%, compared to 24.28% in the first six months of 2013. The increase in the Company’s effective tax rate was primarily due to decreases in tax exempt interest income as our holdings of municipal securities have declined. In addition, as earnings before income taxes increases, the impact of tax preference items, such as tax exempt interest income, on the Company’s effective tax rate is reduced.

BALANCE SHEET ANALYSIS

Securities

Securities available-for-sale were $277.0 million at June 30, 2014, an increase of $5.7 million, or 2%, compared to $271.2 million at December 31, 2013. This increase was primarily due to changes in unrealized gains (losses) on securities available-for-sale of $9.0 million, reflecting price gains as long-term interest rates fell during the first six months of 2014. This increase was partially offset by a decrease in the amortized cost basis of securities available-for-sale of $3.3 million.

The average tax-equivalent yields earned on total securities were 3.17% in the first six months of 2014 and 3.03% in the first six months of 2013.

 

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Loans  
     2014      2013  
(In thousands)   

Second

Quarter

     First
    Quarter    
     Fourth
    Quarter    
     Third
    Quarter    
     Second
    Quarter    
 

 

 

Commercial and industrial

   $ 52,054         54,632         57,780         58,766         56,030   

Construction and land development

     32,461         31,275         36,479         37,062         45,886   

Commercial real estate

     187,241         178,721         174,920         170,520         177,291   

Residential real estate

     102,921         101,433         101,706         102,565         99,021   

Consumer installment

     11,686         11,766         12,893         12,170         12,747   

 

 

Total loans

     386,363         377,827         383,778         381,083         390,975   

Less: unearned income

     (537)         (477)         (439)         (378)         (249)   

 

 

Loans, net of unearned income

   $         385,826         377,350         383,339         380,705         390,726   

 

 

Total loans, net of unearned income, were $385.8 million at June 30, 2014, compared to $383.3 million at December 31, 2013. The increase was primarily due to growth in commercial real estate loans of $12.3 million. This increase was partially offset by decreases in construction and land development loans and commercial and industrial loans of $4.0 million and $5.7 million, respectively. Four loan categories represented the majority of the loan portfolio at June 30, 2014: commercial real estate (49%), residential real estate (27%), construction and land development (8%) and commercial and industrial (14%). Approximately 28% of the Company’s commercial real estate loans were classified as owner-occupied at June 30, 2014.

Within the residential real estate portfolio segment, the Company had junior lien mortgages of approximately $15.9 million, or 4% of total loans, at June 30, 2014, compared to $15.8 million, or 4% of total loans, at December 31, 2013. For residential real estate mortgage loans with a consumer purpose, approximately $1.8 million and $1.2 million required interest-only payments at June 30, 2014 and December 31, 2013, respectively. The Company’s residential real estate mortgage portfolio does not include any option ARM loans, subprime loans, or any material amount of other high-risk consumer mortgage products.

Purchased loan participations included in the Company’s loan portfolio were approximately $1.4 million at both June 30, 2014 and December 31, 2013. All purchased loan participations are underwritten by the Company independent of the selling bank. In addition, all loans, including purchased participations, are evaluated for collectability during the course of the Company’s normal loan review procedures. If the Company deems a participation loan impaired, it applies the same accounting policies and procedures described under “CRITICAL ACCOUNTING POLICIES – Allowance for Loan Losses”.

The average yield earned on loans and loans held for sale was 5.07% in the first six months of 2014 and 5.37% in the first six months of 2013.

The specific economic and credit risks associated with our loan portfolio include, but are not limited to, the effects of current economic conditions on our borrowers’ cash flows, real estate market sales volumes, valuations, availability and cost of financing properties, real estate industry concentrations, deterioration in certain credits, interest rate fluctuations, reduced collateral values or non-existent collateral, title defects, inaccurate appraisals, financial deterioration of borrowers, fraud, and any violation of applicable laws and regulations.

The Company attempts to reduce these economic and credit risks by adhering to loan to value guidelines for collateralized loans, investigating the creditworthiness of borrowers and monitoring borrowers’ financial position. Also, we establish and periodically review our lending policies and procedures. Banking regulations limit a bank’s credit exposure by prohibiting unsecured loan relationships that exceed 10% of its capital accounts; or 20% of capital accounts if loans in excess of 10% are fully secured. Under these regulations, we are prohibited from having unsecured loan relationships in excess of approximately $16.3 million. Furthermore, we have an internal limit for aggregate credit exposure (loans outstanding plus unfunded commitments) to a single borrower of $14.7 million. Our loan policy requires that the Loan Committee of the Board of Directors approve any loan relationships that exceed this internal limit. At June 30, 2014, the Bank had no loan relationships exceeding these limits.

 

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We periodically analyze our commercial loan portfolio to determine if a concentration of credit risk exists in any one or more industries. We use classification systems broadly accepted by the financial services industry in order to categorize our commercial borrowers. Loan concentrations to borrowers in the following classes exceeded 25% of the Bank’s total risk-based capital at June 30, 2014 (and related balances at December 31, 2013).

 

(In thousands)   

June 30,

2014

    

December 31,

2013

 

 

 

Lessors of 1 to 4 family residential properties

   $                 43,664       $                 43,835   

Multi-family residential properties

     35,538         27,673   

Shopping centers

     30,834         29,953   

 

 

Allowance for Loan Losses

The Company maintains the allowance for loan losses at a level that management believes appropriate to adequately cover the Company’s estimate of probable losses inherent in the loan portfolio. At June 30, 2014 and December 31, 2013, the allowance for loan losses was $4.7 million and $5.3 million, respectively, which management believed to be adequate at each of the respective dates. The judgments and estimates associated with the determination of the allowance for loan losses are described under “CRITICAL ACCOUNTING POLICIES.”

A summary of the changes in the allowance for loan losses and certain asset quality ratios for the second quarter of 2014 and the previous four quarters is presented below.

 

    2014     2013  
    Second     First     Fourth     Third     Second  
(Dollars in thousands)   Quarter         Quarter             Quarter             Quarter             Quarter      

 

 

Balance at beginning of period

  $             4,711        5,268        5,946        6,457        6,769   

Charge-offs:

         

Commercial and industrial

    (46)               (269)        (177)          

Construction and land development

           (236)                        

Commercial real estate

                         (144)        (118)   

Residential real estate

    (41)        (31)        (250)        (103)        (189)   

Consumer installment

    (8)        (36)        (198)        (137)        (45)   

 

 

Total charge-offs

    (95)        (303)        (717)        (561)        (352)   

Recoveries

    112        146        39        50        40   

 

 

Net recoveries (charge-offs)

    17        (157)        (678)        (511)        (312)   

Provision for loan losses

           (400)                        

 

 

Ending balance

  $ 4,728        4,711        5,268        5,946        6,457   

 

 

as a % of loans

    1.23%        1.25        1.37        1.56        1.65   

as a % of nonperforming loans

    169%        148        124        134        138   

Net (recoveries) charge-offs as % of average loans (a)

    (0.02)%        0.17        0.71        0.53        0.32   

 

 

 

(a) Net (recoveries) charge-offs are annualized.

As described under “CRITICAL ACCOUNTING POLICIES,” management assesses the adequacy of the allowance prior to the end of each calendar quarter. The level of the allowance is based upon management’s evaluation of the loan portfolios, past loan loss experience, known and inherent risks in the portfolio, adverse situations that may affect the borrower’s ability to repay (including the timing of future payment), the estimated value of any underlying collateral, composition of the loan portfolio, economic conditions, industry and peer bank loan loss rates and other pertinent factors. This evaluation is inherently subjective as it requires various material estimates and judgments, including the amounts and timing of future cash flows expected to be received on impaired loans that may be susceptible to significant change. The ratio of our allowance for loan losses to total loans outstanding was 1.23% at June 30, 2014, compared to 1.37% at December 31, 2013. In the future, the allowance to total loans outstanding ratio will increase or decrease to the extent the factors that influence our quarterly allowance assessment in their entirety either improve or weaken. In addition, our regulators, as an integral part of their examination process, will periodically review the Company’s allowance for loan losses, and may require the Company to make additional provisions to the allowance for losses based on their judgement about information available to them at the time of their examinations.

 

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At June 30, 2014, the ratio of our allowance for loan losses as a percentage of nonperforming loans was 169%, compared to 124% at December 31, 2013. The increase primarily relates to a $1.7 million decrease in the recorded investment of nonperforming loans with a related allowance for loan losses of $0.1 million at December 31, 2013.

At June 30, 2014, the Company’s recorded investment in loans considered impaired was $3.9 million, with a corresponding valuation allowance (included in the allowance for loan losses) of $0.2 million. At December 31, 2013, the Company’s recorded investment in loans considered impaired was $5.6 million, with a corresponding valuation allowance (included in the allowance for loan losses) of $0.3 million.

Nonperforming Assets

At June 30, 2014, the Company had $4.4 million in nonperforming assets, compared to $8.1 million at December 31, 2013. The decrease was primarily due to a decline in nonperforming loans and other real estate owned of $1.4 million and $2.3 million, respectively.

The table below provides information concerning total nonperforming assets and certain asset quality ratios for the second quarter of 2014 and the previous four quarters.

 

     2014      2013  
     Second      First      Fourth      Third      Second  
(Dollars in thousands)    Quarter          Quarter              Quarter              Quarter              Quarter      

 

 

Nonperforming assets:

              

Nonaccrual loans

   $         2,804         3,188         4,261         4,425         4,664   

Other real estate owned

     1,584         3,111         3,884         4,585         3,609   

 

 

Total nonperforming assets

   $ 4,388         6,299         8,145         9,010         8,273   

 

 

as a % of loans and other real estate owned

     1.13%         1.66         2.10         2.34         2.10   

as a % of total assets

     0.57%         0.81         1.08         1.21         1.08   

Nonperforming loans as a % of total loans

     0.73%         0.84         1.11         1.16         1.19   

Accruing loans 90 days or more past due

   $ 71         131         73         99           

 

 

The table below provides information concerning the composition of nonaccrual loans for the second quarter of 2014 and the previous four quarters.

 

     2014      2013  
     Second      First      Fourth      Third      Second  
(In thousands)    Quarter          Quarter              Quarter              Quarter              Quarter      

 

 

Nonaccrual loans:

              

Commercial and industrial

   $ 52         54         55         56         57   

Construction and land development

     963         1,371         1,582         1,592         1,601   

Commercial real estate

     486         710         1,456         1,467         1,484   

Residential real estate

     1,303         1,046         1,168         1,310         1,520   

Consumer installment

             7                         2   

 

 

Total nonaccrual loans

   $         2,804         3,188         4,261         4,425         4,664   

 

 

The Company discontinues the accrual of interest income when (1) there is a significant deterioration in the financial condition of the borrower and full repayment of principal and interest is not expected or (2) the principal or interest is 90 days or more past due, unless the loan is both well-secured and in the process of collection. At June 30, 2014, the Company had $2.8 million in loans on nonaccrual, compared to $4.3 million at December 31, 2013.

At June 30, 2014, there were $71,000 in loans 90 days or more past due and still accruing interest compared to $73,000 at December 31, 2013.

 

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The table below provides information concerning the composition of other real estate owned for the second quarter of 2014 and the previous four quarters.

 

     2014      2013  
     Second      First      Fourth      Third      Second  
(In thousands)    Quarter          Quarter              Quarter              Quarter              Quarter      

 

 

Other real estate owned:

              

Commercial:

              

Buildings

   $         1,515         1,772         1,829         535   

Developed lots

     1,260         1,260         1,260         1,275         1,275   

Residential

     324         336         852         1,481         1,799   

 

 

Total other real estate owned

   $         1,584         3,111         3,884         4,585         3,609   

 

 

At June 30, 2014 and December 31, 2013, respectively, the Company held $1.6 million and $3.9 million in OREO, which we acquired from borrowers. At June 30, 2014, approximately 80% of the total balance in OREO related to properties acquired from one borrower.

Potential Problem Loans

Potential problem loans represent those loans with a well-defined weakness and where information about possible credit problems of borrowers has caused management to have serious doubts about the borrower’s ability to comply with present repayment terms. This definition is believed to be substantially consistent with the standards established by the Federal Reserve, the Company’s primary regulator, for loans classified as substandard, excluding nonaccrual loans. Potential problem loans, which are not included in nonperforming assets, amounted to $6.8 million, or 1.8% of total loans at June 30, 2014, compared to $10.6 million, or 2.7% of total loans at December 31, 2013.

The table below provides information concerning the composition of performing potential problem loans for the second quarter of 2014 and the previous four quarters.

 

     2014      2013  
     Second      First      Fourth      Third      Second  
(In thousands)    Quarter          Quarter              Quarter              Quarter              Quarter      

 

 

Potential problem loans:

              

Commercial and industrial

   $ 397         449         482         750         884   

Construction and land development

     575         678         1,101         1,118         1,201   

Commercial real estate

     975         1,211         1,683         1,700         1,833   

Residential real estate

     4,754         5,913         7,182         7,417         7,772   

Consumer installment

     111         106         146         161         146   

 

 

Total potential problem loans

   $         6,812         8,357         10,594         11,146         11,836   

 

 

At June 30, 2014, approximately $0.6 million or 8.9% of total potential problem loans were past due at least 30 days but less than 90 days. At June 30, 2014, the remaining balance of potential problem loans were current or past due less than 30 days.

The following table is a summary of the Company’s performing loans that were past due at least 30 days but less than 90 days for the second quarter of 2014 and the previous four quarters.

 

     2014      2013  
     Second      First      Fourth      Third      Second  
(In thousands)    Quarter          Quarter              Quarter              Quarter              Quarter      

 

 

Performing loans past due 30 to 89 days:

              

Commercial and industrial

   $ 277         191         167         444         329   

Construction and land development

     192         157         14                   

Commercial real estate

             461         861         49         1,498   

Residential real estate

     832         1,834         1,343         489         501   

Consumer installment

     110         86         100         40         147   

 

 

Total

   $         1,411         2,729         2,485         1,022         2,475   

 

 

 

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Deposits

Total deposits were $684.2 million at June 30, 2014, compared to $668.8 million at December 31, 2013. Noninterest bearing deposits were $130.4 million, or 19.1% of total deposits, at June 30, 2014, compared to $125.7 million, or 18.8% of total deposits at December 31, 2013.

The average rate paid on total interest-bearing deposits was 0.91% in the first six months of 2014 and 1.04% in the first six months of 2013.

Other Borrowings

Other borrowings consist of short-term borrowings and long-term debt. Short-term borrowings consist of federal funds purchased and securities sold under agreements to repurchase with an original maturity less than one year. The Bank had available federal funds lines totaling $38.0 million with none outstanding at June 30, 2014, compared to $41.0 million and none outstanding at December 31, 2013. Securities sold under agreements to repurchase totaled $3.3 million and $3.4 million at June 30, 2014 and December 31, 2013, respectively.

The average rate paid on short-term borrowings was 0.53% in the first six months of 2014 and 0.51% in the first six months of 2013.

Long-term debt includes FHLB advances with an original maturity greater than one year and subordinated debentures related to trust preferred securities. The Bank had $5.0 million in long-term FHLB advances at both June 30, 2014 and December 31, 2013. At both June 30, 2014 and December 31, 2013, the Bank had $7.2 million in junior subordinated debentures related to trust preferred securities outstanding.

The average rate paid on long-term debt was 3.43% in the first six months of 2014 and 3.62% in the first six months of 2013.

CAPITAL ADEQUACY

The Company’s consolidated stockholders’ equity was $72.3 million and $64.5 million as of June 30, 2014 and December 31, 2013, respectively. The change from December 31, 2013 was primarily driven by other comprehensive income due to the change in unrealized gains (losses) on securities available-for-sale, net-of-tax, of $5.7 million and net earnings of $3.7 million, partially offset by cash dividends paid of $1.6 million.

The Company’s tier 1 leverage ratio was 10.07%, tier 1 risk-based capital ratio was 17.45% and total risk-based capital ratio was 18.53% at June 30, 2014. These ratios exceed the minimum regulatory capital percentages of 5.0% for tier 1 leverage ratio, 6.0% for tier 1 risk-based capital ratio and 10.0% for total risk-based capital ratio to be considered “well-capitalized.” Based on current regulatory standards, the Company is classified as “well capitalized.”

MARKET AND LIQUIDITY RISK MANAGEMENT

Management’s objective is to manage assets and liabilities to provide a satisfactory, consistent level of profitability within the framework of established liquidity, loan, investment, borrowing, and capital policies. The Bank’s Asset Liability Management Committee (“ALCO”) is charged with the responsibility of monitoring these policies, which are designed to ensure acceptable composition of asset/liability mix. Two critical areas of focus for ALCO are interest rate sensitivity and liquidity risk management.

Interest Rate Sensitivity Management

In the normal course of business, the Company is exposed to market risk arising from fluctuations in interest rates. ALCO measures and evaluates interest rate risk so that the Bank can meet customer demands for various types of loans and deposits. Measurements used to help manage interest rate sensitivity include an earnings simulation model and an economic value of equity model.

Management uses earnings simulation modeling to estimate and manage interest rate risk. Forecasted levels of earning assets, interest-bearing liabilities, and off-balance sheet financial instruments are combined with ALCO forecasts of market interest rates for the next 12 months and are combined with other factors in order to produce various earnings simulations and estimates. To limit interest rate risk, we have guidelines for earnings at risk which seek to limit the variance of net interest income to less than a 10% decline for a 200 basis point change up or down in rates from management’s flat interest rate forecast over the next twelve months. The results of our current simulation model indicate that we were in compliance with our current guidelines at June 30, 2014.

 

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Economic value of equity measures the extent that estimated economic values of our assets, liabilities and off-balance sheet items will change as a result of interest rate changes. Economic values are estimated by discounting expected cash flows from assets, liabilities and off-balance sheet items, which establishes a base case economic value of equity. To help limit interest rate risk, we have a guideline stating that for a 200 basis point instantaneous change in interest rates up or down, the economic value of equity should not decrease by more than 25%. The results of our current economic value of equity model indicate that we were in compliance with our guidelines at June 30, 2014.

Each of the above analyses may not, on its own, be an accurate indicator of how our net interest income will be affected by changes in interest rates. Income associated with interest-earning assets and costs associated with interest-bearing liabilities may not be affected uniformly by changes in interest rates. In addition, the magnitude and duration of changes in interest rates may have a significant impact on net interest income. For example, although certain assets and liabilities may have similar maturities or periods of repricing, they may react in different degrees to changes in market interest rates, and other economic and market factors, including market perceptions. Interest rates on certain types of assets and liabilities fluctuate in advance of changes in general market rates, while interest rates on other types of assets and liabilities may lag behind changes in general market rates. In addition, certain assets, such as adjustable rate mortgage loans, have features (generally referred to as “interest rate caps and floors”) which limit changes in interest rates. Prepayment and early withdrawal levels also could deviate significantly from those assumed in calculating the maturity of certain instruments. The ability of many borrowers to service their debts also may decrease during periods of rising interest rates or economic stress, which may differ across industries and economic sectors. ALCO reviews each of the above interest rate sensitivity analyses along with several different interest rate scenarios in seeking satisfactory, consistent levels of profitability within the framework of the Company’s established liquidity, loan, investment, borrowing, and capital policies.

The Company may also use derivative financial instruments to improve the balance between interest-sensitive assets and interest-sensitive liabilities and as one tool to manage interest rate sensitivity while continuing to meet the credit and deposit needs of our customers. From time to time, the Company may enter into interest rate swaps (“swaps”) to facilitate customer transactions and meet their financing needs. These swaps qualify as derivatives, but are not designated as hedging instruments. At June 30, 2014 and December 31, 2013, the Company had no derivative contracts designated as part of a hedging relationship to assist in managing its interest rate sensitivity.

Liquidity Risk Management

Liquidity is the Company’s ability to convert assets into cash equivalents in order to meet daily cash flow requirements, primarily for deposit withdrawals, loan demand and maturing obligations. Without proper management of its liquidity, the Company could experience higher costs of obtaining funds due to insufficient liquidity, while excessive liquidity can lead to a decline in earnings due to the cost of foregoing alternative higher-yielding investment opportunities.

Liquidity is managed at two levels. The first is the liquidity of the Company. The second is the liquidity of the Bank. The management of liquidity at both levels is essential, because the Company and the Bank are separate legal entities with different funding needs and sources, and each are subject to regulatory guidelines and requirements.

The primary source of funding and the primary source of liquidity for the Company include dividends received from the Bank, and secondarily proceeds from the possible issuance of common stock or other securities. Primary uses of funds for the Company include dividends paid to stockholders, stock repurchases, and interest payments on junior subordinated debentures issued by the Company in connection with trust preferred securities. The junior subordinated debentures are presented as long-term debt in the accompanying consolidated balance sheets and the related trust preferred securities are currently includible in Tier 1 Capital for regulatory capital purposes.

Primary sources of funding for the Bank include customer deposits, other borrowings, repayment and maturity of securities, sales of securities, and sale and repayment of loans. The Bank has access to federal funds lines from various banks and borrowings from the Federal Reserve discount window. In addition to these sources, the Bank has participated in the FHLB’s advance program to obtain funding for its growth. Advances include both fixed and variable terms and are taken out with varying maturities. At June 30, 2014, the Bank had a remaining available line of credit with the FHLB totaling $222.3 million. At June 30, 2014, the Bank also had $38.0 million of available federal funds lines with none outstanding. Primary uses of funds include repayment of maturing obligations and growing the loan portfolio.

Management believes that the Company and the Bank have adequate sources of liquidity to meet all known contractual obligations and unfunded commitments, including loan commitments and reasonable borrower, depositor, and creditor requirements over the next twelve months.

 

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Off-Balance Sheet Arrangements, Commitments and Contingencies

At June 30, 2014, the Bank had outstanding standby letters of credit of $8.2 million and unfunded loan commitments outstanding of $39.9 million. Because these commitments generally have fixed expiration dates and many will expire without being drawn upon, the total commitment level does not necessarily represent future cash requirements. If needed to fund these outstanding commitments, the Bank could liquidate federal funds sold or a portion of securities available-for-sale, or draw on its available credit facilities.

Mortgage lending activities

Since 2009, we have primarily sold residential mortgage loans in the secondary market to Fannie Mae while retaining the servicing of these loans. The sale agreements for these residential mortgage loans with Fannie Mae and other investors include various representations and warranties regarding the origination and characteristics of the residential mortgage loans. Although the representations and warranties vary among investors, they typically cover ownership of the loan, validity of the lien securing the loan, the absence of delinquent taxes or liens against the property securing the loan, compliance with loan criteria set forth in the applicable agreement, compliance with applicable federal, state, and local laws, among other matters.

As of June 30, 2014, the unpaid principal balance of the residential mortgage loans, which we have originated and sold, but retained the servicing rights was $359.5 million. Although these loans are generally sold on a non-recourse basis, except for breaches of customary seller representations and warranties, we may have to repurchase residential mortgage loans in cases where we breach such representations or warranties or the other terms of the sale, such as where we fail to deliver required documents or the documents we deliver are defective. Investors also may require the repurchase of a mortgage loan when an early payment default underwriting review reveals significant underwriting deficiencies, even if the mortgage loan has subsequently been brought current. Repurchase demands are typically reviewed on an individual loan by loan basis to validate the claims made by the investor and to determine if a contractually required repurchase event has occurred. We seek to reduce and manage the risks of potential repurchases or other claims by mortgage loan investors through our underwriting, quality assurance and servicing practices, including good communications with our residential mortgage investors.

We were not required to repurchase any residential mortgage loans in the first six months of 2014 or during the full year 2013.

We service all residential mortgage loans originated and sold by us to Fannie Mae. As servicer, our primary duties are to: (1) collect payments due from borrowers; (2) advance certain delinquent payments of principal and interest; (3) maintain and administer any hazard, title, or primary mortgage insurance policies relating to the mortgage loans; (4) maintain any required escrow accounts for payment of taxes and insurance and administer escrow payments; and (5) foreclose on defaulted mortgage loans or take other actions to mitigate the potential losses to investors consistent with the agreements governing our rights and duties as servicer.

The agreement under which we act as servicer generally specifies a standard of responsibility for actions taken by us in such capacity and provides protection against expenses and liabilities incurred by us when acting in compliance with the respective servicing agreements. However, if we commit a material breach of our obligations as servicer, we may be subject to termination if the breach is not cured within a specified period following notice. The standards governing servicing and the possible remedies for violations of such standards are determined by servicing guides issued by Fannie Mae as well as the contract provisions established between Fannie Mae and the Bank. Remedies could include repurchase of an affected loan.

Although to date repurchase requests related to representation and warranty provisions, and servicing activities have been limited, it is possible that requests to repurchase mortgage loans may increase in frequency if investors more aggressively pursue all means of recovering losses on their purchased loans. As of June 30, 2014, we believe that this exposure is not material due to the historical level of repurchase requests and loss trends, in addition to the fact that 99.4% of our residential mortgage loans serviced for Fannie Mae were current as of such date. We maintain ongoing communications with our investors and will continue to evaluate this exposure by monitoring the level and number of repurchase requests as well as the delinquency rates in our investor portfolios.

 

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Effects of Inflation and Changing Prices

The Condensed Consolidated Financial Statements and related consolidated financial data presented herein have been prepared in accordance with U.S. generally accepted accounting principles and practices within the banking industry which require the measurement of financial position and operating results in terms of historical dollars without considering the changes in the relative purchasing power of money over time due to inflation. Unlike most industrial companies, virtually all the assets and liabilities of a financial institution are monetary in nature. As a result, interest rates have a more significant impact on a financial institution’s performance than the effects of general levels of inflation.

CURRENT ACCOUNTING DEVELOPMENTS

The following Accounting Standards Updates (“Updates” or “ASUs”) have been issued by the FASB but are not yet effective.

 

   

ASU 2014-01, Accounting for Investments in Qualified Affordable Housing Projects;

 

   

ASU 2014-04, Reclassification of Residential Real Estate Collateralized Consumer Mortgage Loans upon Foreclosure;

 

   

ASU 2014-08, Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity;

 

   

ASU 2014-09, Revenue from Contracts with Customers (Topic 606); and

 

   

ASU 2014-11, Repurchase-to-Maturity Transactions, Repurchase Financings, and Disclosures.

Information about these pronouncements is described in more detail below.

ASU 2014-01, Accounting for Investments in Qualified Affordable Housing Projects, amends the criteria a company must meet to elect to account for investments in qualified affordable housing projects using a method other than the cost or equity methods. If the criteria are met, a company is permitted to amortize the initial investment cost in proportion to and over the same period as the total tax benefits the company expects to receive. The amortization of the initial investment cost and tax benefits are to be recorded in the income tax expense line. The Update also requires new disclosures about all investments in qualified affordable housing projects regardless of the accounting method used. These changes are effective for the Company in the first quarter of 2015 with retrospective application. Early adoption is permitted. The Company is evaluating the impact this ASU will have on our consolidated financial statements.

ASU 2014-04, Reclassification of Residential Real Estate Collateralized Consumer Mortgage Loans upon Foreclosure, clarifies the timing of when a creditor is considered to have taken physical possession of residential real estate collateral for a consumer mortgage loan, resulting in the reclassification of the loan receivable to real estate owned. A creditor has taken physical possession of the property when either (1) the creditor obtains legal title through foreclosure, or (2) the borrower transfers all interests in the property to the creditor via a deed in lieu of foreclosure or a similar legal agreement. The Update also requires disclosure of the amount of foreclosed residential real estate property held by the creditor and the recorded investment in residential real estate mortgage loans that are in process of foreclosure. These changes are effective for the Company in the first quarter of 2015 with retrospective application. Early adoption is permitted. Adoption of this ASU will not have a significant impact on the consolidated financial statements of the Company.

ASU 2014-08, Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity, changes the definition and reporting requirements for discontinued operations. Under the new guidance, an entity’s disposal of a component or group of components must be reported in discontinued operations if the disposal is a strategic shift that has or will have a significant effect on the entity’s operations and financial results. Major strategic shifts include disposals of a major geographic area or line of business. This guidance also requires new disclosures on discontinued operations. These changes are effective for the Company in the first quarter 2015 with prospective application. Early adoption is permitted for disposals that have not been previously reported. Adoption of this ASU will not have a significant impact on the consolidated financial statements of the Company.

 

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ASU 2014-09, Revenue from Contracts with Customers (Topic 606), provides a comprehensive and converged standard on revenue recognition. The new guidance is intended to improve comparability of revenue recognition practices across entities, industries, jurisdictions, and capital markets. The core principle of the guidance is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects consideration to which the entity expects to be entitled in exchange for those goods and services. This guidance also requires new qualitative and quantitative disclosures related to revenue from contracts with customers. These changes are effective for the Company in the first quarter 2017 with retrospective application to each prior reporting period or with the cumulative effect of initially applying this Update recognized at the date of initial application. Early adoption is not permitted. The Company is evaluating the impact this ASU will have on our consolidated financial statements.

ASU 2014-11, Repurchase-to-Maturity Transactions, Repurchase Financings, and Disclosures, changes current accounting and expands secured borrowing accounting for repurchase-to-maturity transactions and repurchase financings. This guidance requires new disclosures for certain repurchase agreements and similar transactions that identify which items are accounted for as secured borrowings and which items are accounted for as sales. These changes are effective for the Company in the first quarter 2015. The Company will be required to present changes in accounting for transactions outstanding as of January 1, 2015 as a cumulative-effect adjustment to retained earnings at the same date. Early adoption is not permitted. The Company is evaluating the impact this ASU will have on our consolidated financial statements.

 

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Table 1—Explanation of Non-GAAP Financial Measures

In addition to results presented in accordance with U.S. generally accepted accounting principles (GAAP), this quarterly report on Form 10-Q includes certain designated net interest income amounts presented on a tax-equivalent basis, a non-GAAP financial measure, including the presentation of total revenue and the calculation of the efficiency ratio.

The Company believes the presentation of net interest income on a tax-equivalent basis provides comparability of net interest income from both taxable and tax-exempt sources and facilitates comparability within the industry. Although the Company believes these non-GAAP financial measures enhance investors’ understanding of its business and performance, these non-GAAP financial measures should not be considered an alternative to GAAP. The reconciliations of these non-GAAP financial measures to their most directly comparable GAAP financial measures are presented below.

 

     2014      2013  
     Second      First      Fourth      Third      Second  
(In thousands)    Quarter          Quarter              Quarter              Quarter              Quarter      

 

 

Net interest income (GAAP)

   $ 5,253         5,270         5,279         5,270         5,232   

Tax-equivalent adjustment

     312         324         342         351         365   

 

 

Net interest income (Tax-equivalent)

   $         5,565         5,594         5,621         5,621         5,597   

 

 

 

         Six Months Ended June 30,      
(In thousands)    2014      2013  

 

 

Net interest income (GAAP)

   $ 10,523         10,373   

Tax-equivalent adjustment

     636         747   

 

 

Net interest income (Tax-equivalent)

   $         11,159                 11,120   

 

 

 

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Table 2—Selected Quarterly Financial Data

 

     2014     2013  
     Second     First     Fourth      Third      Second  
(Dollars in thousands, except per share amounts)    Quarter     Quarter     Quarter      Quarter      Quarter  

 

 

Results of Operations

            

Net interest income (a)

   $ 5,565        5,594        5,621         5,621         5,597   

Less: tax-equivalent adjustment

     312        324        342         351         365   

 

 

Net interest income (GAAP)

     5,253        5,270        5,279         5,270         5,232   

Noninterest income

     1,081        756        2,140         1,432         2,071   

 

 

Total revenue

     6,334        6,026        7,419         6,702         7,303   

Provision for loan losses

     —            (400     —             —             —       

Noninterest expense

     3,792        3,948        5,188         4,274         4,724   

Income tax expense

     683        657        501         636         672   

 

 

Net earnings

   $ 1,859        1,821        1,730         1,792         1,907   

 

 

Per share data:

            

Basic and diluted net earnings

   $ 0.51        0.50        0.47         0.49         0.52   

Cash dividends declared

     0.215        0.215        0.210         0.210         0.210   

Weighted average shares outstanding:

            

Basic and diluted

     3,643,295        3,643,161        3,643,110         3,643,028         3,642,955   

Shares outstanding

     3,643,328        3,643,173        3,643,118         3,643,058         3,642,993   

Book value

   $ 19.84        18.74        17.70         18.06         17.90   

Common stock price

            

High

   $ 25.00        25.80        25.75         24.71         22.33   

Low

     22.90        23.20        23.93         22.00         21.54   

Period end

     24.02        23.20        25.00         24.40         22.00   

To earnings ratio

     12.19x        11.72        12.89         12.64         11.70   

To book value

     121     124        141         135         123   

Performance ratios:

            

Return on average equity

     10.72     11.11        10.33         10.78         10.74   

Return on average assets

     0.96     0.96        0.92         0.95         1.00   

Dividend payout ratio

     42.16     43.00        44.68         42.86         40.38   

Asset Quality:

            

Allowance for loan losses as a % of:

            

Loans

     1.23     1.25        1.37         1.56         1.65   

Nonperforming loans

     169     148        124         134         138   

Nonperforming assets as a % of:

            

Loans and other real estate owned

     1.13     1.66        2.10         2.34         2.10   

Total assets

     0.57     0.81        1.08         1.21         1.08   

Nonperforming loans as a % of total loans

     0.73     0.84        1.11         1.16         1.19   

Net (recoveries) charge-offs as a % of average loans (c)

     (0.02 )%      0.17        0.71         0.53         0.32   

Capital Adequacy:

            

Tier 1 risk-based capital ratio

     17.45     17.55        17.19         17.29         16.45   

Total risk-based capital ratio

     18.53     18.64        18.40         18.55         17.70   

Tier 1 Leverage Ratio

     10.07     10.03        10.10         9.96         9.76   

Other financial data:

            

Net interest margin (a)

     3.09     3.20        3.20         3.19         3.16   

Effective income tax rate

     26.87     26.51        22.46         26.19         26.06   

Efficiency ratio (b)

     57.06     62.17        66.85         60.60         61.61   

Selected average balances:

            

Securities

   $ 274,305        268,013        260,091         265,380         266,056   

Loans, net of unearned income

     378,994        377,322        379,450         383,460         389,402   

Total assets

     772,326        762,153        748,894         751,311         761,534   

Total deposits

     684,613        678,324        653,825         651,334         652,952   

Long-term debt

     12,217        12,217        21,347         26,782         31,613   

Total stockholders’ equity

     69,367        65,556        67,015         66,485         71,006   

Selected period end balances:

            

Securities

   $ 276,953        279,989        271,219         259,467         270,794   

Loans, net of unearned income

     385,826        377,350        383,339         380,705         390,726   

Allowance for loan losses

     4,728        4,711        5,268         5,946         6,457   

Total assets

     775,128        773,333        751,343         744,602         767,747   

Total deposits

     684,181        687,088        668,844         650,421         666,490   

Long-term debt

     12,217        12,217        12,217         22,217         27,217   

Total stockholders’ equity

     72,291        68,284        64,485         65,807         65,211   

 

 

 

(a) Tax-equivalent. See “Table 1—Explanation of Non-GAAP Financial Measures.”
(b) Efficiency ratio is the result of noninterest expense divided by the sum of noninterest income and tax-equivalent net interest income.
(c) Net (recoveries) charge-offs are annualized.

 

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Table 3—Selected Financial Data

 

     Six Months Ended June 30,  
(Dollars in thousands, except per share amounts)    2014     2013  

 

 

Results of Operations

    

Net interest income (a)

   $ 11,159        11,120   

Less: tax-equivalent adjustment

     636        747   

 

 

Net interest income (GAAP)

     10,523        10,373   

Noninterest income

     1,837        3,726   

 

 

Total revenue

     12,360        14,099   

Provision for loan losses

     (400     400   

Noninterest expense

     7,740        8,950   

Income tax expense

     1,340        1,153   

 

 

Net earnings

   $ 3,680        3,596   

 

 

 

 

Per share data:

    

Basic and diluted net earnings

   $ 1.01        0.99   

Cash dividends declared

     0.43        0.42   

Weighted average shares outstanding:

    

Basic and diluted

     3,643,228        3,642,936   

Shares outstanding, at period end

     3,643,328        3,642,993   

Book value

   $ 19.84        17.90   

Common stock price

    

High

   $ 25.80        22.60   

Low

     22.90        20.80   

Period end

     24.02        22.00   

To earnings ratio

     12.19x        11.70   

To book value

     121     123   

Performance ratios:

    

Return on average equity

     10.91     10.11   

Return on average assets

     0.96     0.93   

Dividend payout ratio

     42.57     42.42   

Asset Quality:

    

Allowance for loan losses as a % of:

    

Loans

     1.23     1.65   

Nonperforming loans

     169     138   

Nonperforming assets as a % of:

    

Loans and other real estate owned

     1.13     2.10   

Total assets

     0.57     1.08   

Nonperforming loans as a % of total loans

     0.73     1.19   

Annualized net charge-offs as a % of average loans

     0.07     0.34   

Capital Adequacy:

    

Tier 1 risk-based capital ratio

     17.45     16.45   

Total risk-based capital ratio

     18.53     17.70   

Tier 1 Leverage Ratio

     10.07     9.76   

Other financial data:

    

Net interest margin (a)

     3.14     3.12   

Effective income tax rate

     26.69     24.28   

Efficiency ratio (b)

     59.56     60.29   

Selected average balances:

    

Securities

   $ 271,177        264,574   

Loans, net of unearned income

     378,163        392,899   

Total assets

     767,268        769,602   

Total deposits

     681,487        653,375   

Long-term debt

     12,217        39,095   

Total stockholders’ equity

     67,472        71,162   

Selected period end balances:

    

Securities

   $ 276,953        270,794   

Loans, net of unearned income

     385,826        390,726   

Allowance for loan losses

     4,728        6,457   

Total assets

     775,128        767,747   

Total deposits

     684,181        666,490   

Long-term debt

     12,217        27,217   

Total stockholders’ equity

     72,291        65,211   

 

 

 

(a) Tax-equivalent. See “Table 1—Explanation of Non-GAAP Financial Measures.”
(b) Efficiency ratio is the result of noninterest expense divided by the sum of noninterest income and tax-equivalent net interest income.

 

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Table 4—Average Balances and Net Interest Income Analysis

 

     Quarter ended June 30,  
     2014      2013  
            Interest                    Interest         
     Average      Income/      Yield/      Average      Income/      Yield/  
(Dollars in thousands)    Balance      Expense      Rate      Balance      Expense      Rate  

 

  

 

 

    

 

 

 

Interest-earning assets:

                 

Loans and loans held for sale (1)

   $     382,100       $     4,766             5.00%       $     392,973       $     5,224             5.33%   

Securities - taxable

     213,777         1,214         2.28%         197,165         899         1.83%   

Securities - tax-exempt (2)

     60,528         919         6.09%         68,891         1,073         6.25%   

 

  

 

 

    

 

 

 

Total securities

     274,305         2,133         3.12%         266,056         1,972         2.97%   

Federal funds sold

     63,604         30         0.19%         51,004         29         0.23%   

Interest bearing bank deposits

     2,670         —             —             1,187         —             —       

 

  

 

 

    

 

 

 

Total interest-earning assets

     722,679       $ 6,929         3.85%         711,220       $ 7,225         4.07%   

Cash and due from banks

     12,690               13,932         

Other assets

     36,957               36,382         

 

  

 

 

          

 

 

       

Total assets

   $ 772,326             $ 761,534         

 

  

 

 

          

 

 

       

Interest-bearing liabilities:

                 

Deposits:

                 

NOW

   $ 107,287       $ 86         0.32%       $ 104,132       $ 83         0.32%   

Savings and money market

     190,057         243         0.51%         168,594         217         0.52%   

Certificates of deposits less than $100,000

     103,518         305         1.18%         105,613         364         1.38%   

Certificates of deposits and other time deposits of $100,000 or more

     157,585         622         1.58%         153,644         685         1.79%   

 

  

 

 

    

 

 

 

Total interest-bearing deposits

     558,447         1,256         0.90%         531,983         1,349         1.02%   

Short-term borrowings

     3,404         4         0.47%         2,647         3         0.45%   

Long-term debt

     12,217         104         3.41%         31,613         276         3.50%   

 

  

 

 

    

 

 

 

Total interest-bearing liabilities

     574,068       $ 1,364         0.95%         566,243       $ 1,628         1.15%   

Noninterest-bearing deposits

     126,166               120,969         

Other liabilities

     2,725               3,316         

Stockholders’ equity

     69,367               71,006         

 

  

 

 

          

 

 

       

Total liabilities and stockholders’ equity

   $ 772,326             $ 761,534         

 

  

 

 

          

 

 

       

Net interest income and margin (tax-equivalent)

      $ 5,565         3.09%          $ 5,597         3.16%   

 

     

 

 

       

 

 

 

 

(1) Average loan balances are shown net of unearned income and loans on nonaccrual status have been included in the computation of average balances.
(2) Yields on tax-exempt securities have been computed on a tax-equivalent basis using an income tax rate of 34%.

 

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Table 5—Average Balances and Net Interest Income Analysis

 

     Six Months Ended June 30,  
     2014      2013  
            Interest                    Interest         
     Average      Income/      Yield/      Average      Income/      Yield/  
(Dollars in thousands)    Balance      Expense      Rate      Balance      Expense      Rate  

 

  

 

 

    

 

 

 

Interest-earning assets:

                 

Loans and loans held for sale (1)

   $     380,449       $     9,556             5.07%       $     396,498         $     10,552             5.37%   

Securities - taxable

     210,223         2,390         2.29%         194,205         1,773         1.84%   

Securities - tax-exempt (2)

     60,954         1,870         6.19%         70,369         2,197         6.30%   

 

  

 

 

    

 

 

 

Total securities

     271,177         4,260         3.17%         264,574         3,970         3.03%   

Federal funds sold

     59,385         55         0.19%         55,881         60         0.22%   

Interest bearing bank deposits

     5,171         17         0.66%         892         —             —       

 

  

 

 

    

 

 

 

Total interest-earning assets

     716,182       $ 13,888         3.91%         717,845         $ 14,582         4.10%   

Cash and due from banks

     12,762               15,217         

Other assets

     38,324               36,540         

 

  

 

 

          

 

 

       

Total assets

   $ 767,268             $ 769,602         

 

  

 

 

          

 

 

       

Interest-bearing liabilities:

                 

Deposits:

                 

NOW

   $ 106,812       $ 170         0.32%       $ 104,851       $ 166         0.32%   

Savings and money market

     189,830         480         0.51%         168,263         434         0.52%   

Certificates of deposits less than $100,000

     104,079         617         1.20%         105,533         745         1.42%   

Certificates of deposits and other time deposits of $100,000 or more

     157,509         1,245         1.59%         154,745         1,408         1.83%   

 

  

 

 

    

 

 

 

Total interest-bearing deposits

     558,230         2,512         0.91%         533,392         2,753         1.04%   

Short-term borrowings

     3,440         9         0.53%         2,754         7         0.51%   

Long-term debt

     12,217         208         3.43%         39,095         702         3.62%   

 

  

 

 

    

 

 

 

Total interest-bearing liabilities

     573,887       $ 2,729         0.96%         575,241       $ 3,462         1.21%   

Noninterest-bearing deposits

     123,257               119,983         

Other liabilities

     2,652               3,216         

Stockholders’ equity

     67,472               71,162         

 

  

 

 

          

 

 

       

Total liabilities and stockholders’ equity

   $ 767,268             $ 769,602         

 

  

 

 

          

 

 

       

Net interest income and margin (tax-equivalent)

      $ 11,159         3.14%          $ 11,120         3.12%   

 

     

 

 

       

 

 

 

 

(1) Average loan balances are shown net of unearned income and loans on nonaccrual status have been included in the computation of average balances.
(2) Yields on tax-exempt securities have been computed on a tax-equivalent basis using an income tax rate of 34%.

 

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Table 6—Loan Portfolio Composition

 

     2014      2013  
     Second      First      Fourth      Third      Second  
(In thousands)    Quarter          Quarter              Quarter              Quarter              Quarter      

 

 

Commercial and industrial

   $ 52,054         54,632         57,780         58,766         56,030   

Construction and land development

     32,461         31,275         36,479         37,062         45,886   

Commercial real estate

     187,241         178,721         174,920         170,520         177,291   

Residential real estate

     102,921         101,433         101,706         102,565         99,021   

Consumer installment

     11,686         11,766         12,893         12,170         12,747   

 

 

Total loans

     386,363         377,827         383,778         381,083         390,975   

Less: unearned income

     (537)         (477)         (439)         (378)         (249)   

 

 

Loans, net of unearned income

     385,826         377,350         383,339         380,705         390,726   

Less: allowance for loan losses

     (4,728)         (4,711)         (5,268)         (5,946)         (6,457)   

 

 

Loans, net

   $         381,098         372,639         378,071         374,759         384,269   

 

 

 

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Table 7—Allowance for Loan Losses and Nonperforming Assets

 

    2014     2013  
    Second     First     Fourth     Third     Second  
(Dollars in thousands)       Quarter             Quarter             Quarter             Quarter             Quarter      

 

 

Allowance for loan losses:

         

Balance at beginning of period

  $ 4,711        5,268        5,946        6,457        6,769   

Charge-offs:

         

Commercial and industrial

    (46)               (269)        (177)          

Construction and land development

           (236)                        

Commercial real estate

                         (144)        (118)   

Residential real estate

    (41)        (31)        (250)        (103)        (189)   

Consumer installment

    (8)        (36)        (198)        (137)        (45)   

 

 

Total charge-offs

    (95)        (303)        (717)        (561)        (352)   

Recoveries

    112        146        39        50        40   

 

 

Net recoveries (charge-offs)

    17        (157)        (678)        (511)        (312)   

Provision for loan losses

           (400)                        

 

 

Ending balance

  $ 4,728        4,711        5,268        5,946        6,457   

 

 

as a % of loans

    1.23%        1.25        1.37        1.56        1.65   

as a % of nonperforming loans

    169%        148        124        134        138   

Net (recoveries) charge-offs as % of average loans (a)

    (0.02)%        0.17        0.71        0.53        0.32   

 

 

Nonperforming assets:

         

Nonaccrual loans

  $ 2,804        3,188        4,261        4,425        4,664   

Other real estate owned

    1,584        3,111        3,884        4,585        3,609   

 

 

Total nonperforming assets

  $ 4,388        6,299        8,145        9,010        8,273   

 

 

as a % of loans and other real estate owned

    1.13%        1.66        2.10        2.34        2.10   

as a % of total assets

    0.57%        0.81        1.08        1.21        1.08   

Nonperforming loans as a % of total loans

    0.73%        0.84        1.11        1.16        1.19   

Accruing loans 90 days or more past due

  $ 71        131        73        99          

 

 

 

(a) Net (recoveries) charge-offs are annualized.

 

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Table 8—Allocation of Allowance for Loan Losses

 

    2014     2013  
      Second Quarter         First Quarter           Fourth Quarter             Third Quarter             Second Quarter      
(Dollars in thousands)   Amount     %*     Amount     %*     Amount     %*     Amount     %*     Amount     %*  

 

 

Commercial and industrial

  $ 639          13.5        $ 482          14.5        $ 386          15.1        $ 546          15.4        $ 675          14.3     

Construction and land
development

    907          8.4          214          8.3          366          9.5          1,189          9.7          1,454          11.7     

Commercial real estate

    1,913          48.5          2,493          47.3          3,186          45.6          3,104          44.7          3,111          45.3     

Residential real estate

    1,095          26.6          1,256          26.8          1,114          26.5          982          26.9          1,125          25.3     

Consumer installment

    174          3.0          266          3.1          216          3.4          125          3.2          92          3.3     

 

 

Total allowance for loan losses

  $     4,728          $     4,711          $     5,268          $       5,946        $       6,457       

 

 

 

* Loan balance in each category expressed as a percentage of total loans.

 

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Table 9—CDs and Other Time Deposits of $100,000 or More

 

(Dollars in thousands)            June 30, 2014  

 

 

Maturity of:

  

3 months or less

   $ 16,475   

Over 3 months through 6 months

     26,130   

Over 6 months through 12 months

     31,103   

Over 12 months

     82,431   

 

 

Total CDs and other time deposits of $100,000 or more

   $ 156,139   

 

 

 

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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

The information called for by ITEM 3 is set forth in ITEM 2 under the caption “MARKET AND LIQUIDITY RISK MANAGEMENT” and is incorporated herein by reference.

ITEM 4. CONTROLS AND PROCEDURES

The Company, with the participation of its management, including its Chief Executive Officer and Principal Financial and Accounting Officer, carried out an evaluation of the effectiveness of the design and operation of its disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended) as of the end of the period covered by this report. Based upon that evaluation and as of the end of the period covered by this report, the Company’s Chief Executive Officer and Principal Financial and Accounting Officer concluded that the Company’s disclosure controls and procedures were effective to allow timely decisions regarding disclosure in its reports that the Company files or submits to the Securities and Exchange Commission under the Securities Exchange Act of 1934, as amended. There have been no changes in the Company’s internal control over financial reporting that occurred during the period covered by this report that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

PART II. OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

In the normal course of business, the Company and the Bank from time to time are involved in legal proceedings. The Company and Bank management believe there are no pending or threatened legal, governmental, or regulatory proceedings that upon resolution are expected to have a material adverse effect upon the Company’s or the Bank’s financial condition or results of operations. See also, Part I, Item 3 of the Company’s annual report on Form 10-K for the year ended December 31, 2013.

ITEM 1A. RISK FACTORS

In addition to the other information set forth in this report, you should carefully consider the factors discussed in Part I “Item 1A. Risk Factors” in our annual report on Form 10-K for the year ended December 31, 2013, which could materially affect our business, financial condition or future results. The risks described in our annual report on Form 10-K are not the only the risks facing our Company. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial also may materially adversely affect our business, financial condition and/or operating results in the future. .

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

ISSUER PURCHASES OF EQUITY SECURITIES

 

Period(1)  

Total Number of  

Shares

Purchased  

 

Average Price Paid  

per Share  

 

 

Total Number of Shares  

Purchased as Part of  

Publicly Announced  

Plans or Programs  

 

Maximum Number of

Shares that May Yet Be

Purchased Under the Plans

or Programs

April 1 - April 30               ––   ––   ––   ––

May 1 - May 31

  ––   ––   ––   ––

June 1 - June 30

  ––   ––   ––   ––

Total

  ––   ––   ––   ––

 

(1) Based on trade date, not settlement date.

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

Not applicable.

ITEM 4. MINE SAFETY DISCLOSURES

Not applicable.

 

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ITEM 5. OTHER INFORMATION

Not applicable.

ITEM 6. EXHIBITS

 

Exhibit

Number

  

Description

     
3.1    Certificate of Incorporation of Auburn National Bancorporation, Inc. and all amendments thereto.*
3.2    Amended and Restated Bylaws of Auburn National Bancorporation, Inc., adopted as of November 13, 2007. **
31.1    Certification Pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934, As Adopted Pursuant To Section 302 of the Sarbanes-Oxley Act of 2002, by E.L. Spencer, Jr., President, Chief Executive Officer and Chairman of the Board.
31.2    Certification Pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934, As Adopted Pursuant To Section 302 of the Sarbanes-Oxley Act of 2002, by David A. Hedges, Senior Vice President, Controller and Chief Financial Officer (Principal Financial and Accounting Officer).
32.1    

Certification Pursuant to 18 U.S.C. Section 1350, As Adopted Pursuant To Section 906 of the Sarbanes-Oxley Act of 2002, by E.L. Spencer, Jr., President, Chief Executive Officer and Chairman of the Board.***

32.2   

Certification Pursuant to 18 U.S.C. Section 1350, As Adopted Pursuant To Section 906 of the Sarbanes-Oxley Act of 2002, by David A. Hedges, Senior Vice President, Controller and Chief Financial Officer (Principal Financial and Accounting Officer).***

101.INS    XBRL Instance Document
101.SCH    XBRL Taxonomy Extension Schema Document
101.CAL    XBRL Taxonomy Extension Calculation Linkbase Document
101.LAB    XBRL Taxonomy Extension Label Linkbase Document
101.PRE    XBRL Taxonomy Extension Presentation Linkbase Document
101.DEF    XBRL Taxonomy Extension Definition Linkbase Document

 

* Incorporated by reference from Registrant’s Form 10-Q dated September 30, 2002.
** Incorporated by reference from Registrant’s Form 10-K dated March 31, 2008.
*** The certifications attached as exhibits 32.1 and 32.2 to this quarterly report on Form 10-Q are “furnished” to the Securities and Exchange Commission pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 and shall not be deemed “filed” by the Company for purposes of Section 18 of the Securities Exchange Act of 1934, as amended.

 

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

   

AUBURN NATIONAL BANCORPORATION, INC.

                (Registrant)

Date: August 1, 2014     By:   /s/ E. L. Spencer, Jr.
      E. L. Spencer, Jr.
     

President, Chief Executive Officer and

Chairman of the Board

   
Date: August 1, 2014     By:   /s/ David A. Hedges
      David A. Hedges
     

SVP, Controller and Chief Financial Officer

(Principal Financial and Accounting Officer)