10-Q 1 mbc_10q-063012.htm FORM 10-Q mbc_10q-063012.htm
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20552
       
FORM 10 - Q
       
x      QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
       
For the quarterly period ended June 30, 2012
 
Commission File Number 000-32561
       
       
Middlefield Banc Corp.
(Exact name of registrant as specified in its charter)
 
Ohio   34 - 1585111
(State or other jurisdiction of incorporation or organization)    (IRS Employer Identification No.)
     
15985 East High Street, Middlefield, Ohio 44062-9263
(Address of principal executive offices)
 
(440) 632-1666
(Registrant's telephone number, including area code)
 
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  YES [] 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 (Section 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  YES [√] NO [ ]
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definition 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 [ ] Small reporting company []
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).   YES [ ] NO []
 
State the number of shares outstanding of each of the issuer's classes of common equity as of the latest practical date:
 
Class: Common Stock, without par value Outstanding at August 14, 2012: 1,977,321
 
 
1

 
 
MIDDLEFIELD BANC CORP.
 
INDEX
 
    Page
Number
     
PART I - FINANCIAL INFORMATION  
     
Item 1.
Financial Statements
 
     
 
Consolidated Balance Sheet (Unaudited) as of June 30, 2012 and December 31, 2011
 
     
 
Consolidated Statement of Income (Unaudited) for the Three and Six Months ended June 30, 2012 and 2011
 
     
 
Consolidated Statement of Comprehensive Income (Unaudited) for the Three and Six Months ended June 30, 2012
 
     
 
Consolidated Statement of Changes in Stockholders' Equity (Unaudited) for the Six Months ended June 30, 2012
     
 
Consolidated Statement of Cash Flows (Unaudited) for the Six Months ended June 30, 2012 and 2011
 
     
 
Notes to Unaudited Consolidated Financial Statements
 
     
Item 2.
Management's Discussion and Analysis of Financial Condition and Results of Operations
 
     
Item 3.
Quantitative and Qualitative Disclosures About Market Risk
     
Item 4.
Controls and Procedures
 
     
PART II - OTHER INFORMATION  
     
Item 1.
Legal Proceedings
 
     
Item 1A.
Risk Factors
 
     
Item 2.
Unregistered sales of equity securities and use of proceeds
     
Item 3.
Default Upon Senior Securities
 
     
Item 4.
Mine Safety Disclosures
 
     
Item 5.
Other Information
 
     
Item 6.
Exhibits and Reports on Form 8 - K
 
     
SIGNATURES  
     
Exhibit 31.1  
Exhibit 31.2  
Exhibit 32  
 
 
2

 
 
MIDDLEFIELD BANC CORP.
CONSOLIDATED BALANCE SHEET
(Dollar amounts in thousands)
(Unadited)
 
   
June 30,
2012
   
December 31
2011
 
ASSETS
           
Cash and due from banks
  $ 30,908     $ 15,730  
Federal funds sold
    11,953       18,660  
Cash and cash equivalents
    42,861       34,390  
Investment securities available for sale
    173,446       193,977  
Loans
    410,868       401,880  
Less allowance for loan losses
    7,752       6,819  
Net loans
    403,116       395,061  
Premises and equipment
    8,598       8,264  
Goodwill
    4,559       4,559  
Bank-owned life insurance
    8,394       8,257  
Accrued interest and other assets
    8,866       10,043  
                 
TOTAL ASSETS
  $ 649,840     $ 654,551  
                 
LIABILITIES
               
Deposits:
               
Noninterest-bearing demand
  $ 65,969     $ 63,348  
Interest-bearing demand
    61,935       55,853  
Money market
    67,533       75,621  
Savings
    171,150       167,207  
Time
    205,142       218,933  
Total deposits
    571,729       580,962  
Short-term borrowings
    6,959       7,392  
Other borrowings
    16,363       16,831  
Accrued interest and other liabilities
    1,631       2,113  
TOTAL LIABILITIES
    596,682       607,298  
                 
STOCKHOLDERS' EQUITY
               
Common stock, no par value; 10,000,000 shares authorized, 2,166,851 and 1,951,869 shares issued
    33,944       31,240  
Retained earnings
    20,399       18,206  
Accumulated other comprehensive income
    5,549       4,541  
Treasury stock, at cost; 189,530 shares
    (6,734 )     (6,734 )
TOTAL STOCKHOLDERS' EQUITY
    53,158       47,253  
                 
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY
  $ 649,840     $ 654,551  
 
See accompanying unaudited notes to the consolidated financial statements.
 
 
3

 
 
MIDDLEFIELD BANC CORP.
CONSOLIDATED STATEMENT OF INCOME
(Dollar amounts in thousands, except per share data)
(Unaudited)
 
   
Three Months Ended
June 30,
   
Six Months Ended
June 30,
 
    2012     2011     2012    
2011
 
INTEREST INCOME
                       
Interest and fees on loans
  $ 5,641     $ 5,399     $ 11,178     $ 10,700  
Interest-bearing deposits in other institutions
    8       2       12       4  
Federal funds sold
    4       4       7       13  
Investment securities:
                               
Taxable interest
    791       1,289       1,706       2,612  
Tax-exempt interest
    753       702       1,500       1,400  
Dividends on stock
    26       25       52       51  
Total interest income
    7,223       7,421       14,455       14,780  
INTEREST EXPENSE
                               
Deposits
    1,434       2,004       2,931       4,041  
Short-term borrowings
    99       59       158       118  
Other borrowings
    82       104       166       213  
Trust preferred securities
    31       137       77       273  
Total interest expense
    1,646       2,304       3,332       4,645  
NET INTEREST INCOME
    5,577       5,117       11,123       10,135  
Provision for loan losses
    450       700       1,050       1,565  
NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES
    5,127       4,417       10,073       8,570  
NONINTEREST INCOME
                               
Service charges on deposit accounts
    471       416       902       844  
Investment securities gains (losses), net
    296       (37 )     296       (22 )
Earnings on bank-owned life insurance
    69       66       137       139  
Other income
    181       149       476       332  
Total noninterest income
    1,017       594       1,811       1,293  
NONINTEREST EXPENSE
                               
Salaries and employee benefits
    1,800       1,944       3,550       3,634  
Occupancy expense
    222       223       470       495  
Equipment expense
    201       155       371       313  
Data processing costs
    191       173       390       353  
Ohio state franchise tax
    128       97       257       225  
Federal deposit insurance expense
    258       272       501       497  
Professional fees
    186       185       400       396  
Losses on other real estate owned
    32       323       50       303  
Other expense
    1,023       920       1,834       1,781  
Total noninterest expense
    4,041       4,292       7,823       7,997  
Income before income taxes
    2,103       719       4,061       1,866  
Income taxes (benefit)
    463       (1 )     898       144  
NET INCOME
  $ 1,640     $ 720     $ 3,163     $ 1,722  
EARNINGS PER SHARE
                               
Basic
  $ 0.85     $ 0.44     $ 1.72     $ 1.05  
Diluted
    0.85       0.44       1.72       1.05  
DIVIDENDS DECLARED PER SHARE
  $ 0.26     $ 0.26     $ 0.52     $ 0.52  
 
See accompanying notes to the unaudited consolidated financial statements.
 
 
4

 
 
MIDDLEFIELD BANC CORP.
CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME
(Dollar amounts in thousands)
(Unaudited)
 
   
Three Months Ended
June 30
   
Six Months Ended
June 30
 
    2012     2011     2012     2011  
Net income
  $ 1,640     $ 720     $ 3,163     $ 1,722  
Other comprehensive income:
                               
Net unrealized holding gain on available for sale securities
    1,884       3,754       1,824       3,508  
Tax effect
    (640 )     (1,252 )     (620 )     (1,170 )
Reclassification adjustment for (gains) losses included in net income
    (296 )     37       (296 )     22  
Tax effect
    100       (12 )     100       (7 )
Total other comprehensive income
    1,048       2,527       1,008       2,353  
Comprehensive income
  $ 2,688     $ 3,247     $ 4,171     $ 4,075  
 
See accompanying notes to the unaudited consolidated financial statements.
 
 
5

 
 
MIDDLEFIELD BANC CORP.
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
(Dollar amounts in thousands, except dividend per share amount)
(Unaudited)
 
   
Common
Stock
   
Retained
Earnings
   
Accumulated
Other
Comprehensive
Income
   
Treasury Stock
   
Total
Stockholders'
Equity
 
Balance, December 31, 2011
  $ 31,240     $ 18,206     $ 4,541     $ (6,734 )   $ 47,253  
Net income
            3,163                       3,163  
Comprehensive income
                    1,008               1,008  
Stock-based compensation expense (1,722 shares)
    32                               32  
Common stock issuance (196,635 shares), net of issuance costs of $816,446
    2,329                               2,329  
Dividend reinvestment and purchase plan (16,625 shares)
    343                               343  
Cash dividends ($0.52 per share)
            (970 )                     (970 )
Balance, June 30, 2012
  $ 33,944     $ 20,399     $ 5,549     $ (6,734 )   $ 53,158  
 
See accompanying notes to the unaudited consolidated financial statements.
 
 
6

 
 
MIDDLEFIELD BANC CORP.
CONSOLIDATED STATEMENT OF CASH FLOWS
(Dollar amounts in thousands)
(Unaudited)
 
   
Six Months Ended
June 30,
 
    2012     2011  
OPERATING ACTIVITIES
           
Net income
  $ 3,163     $ 1,722  
Adjustments to reconcile net income to net cash provided by operating activities:
         
Provision for loan losses
    1,050       1,565  
Investment securities (gains) losses, net
    (296 )     22  
Depreciation and amortization
    442       425  
Amortization of premium and discount on investment securities
    477       151  
Amortization of deferred loan fees, net
    (93 )     (80 )
Earnings on bank-owned life insurance
    (137 )     (139 )
Deferred income taxes
    (58 )     (329 )
Stock-based compensation expense
    32       59  
Losses on other real estate owned
    50       303  
Gain on sale of loans
    (85 )     -  
Decrease in accrued interest receivable
    111       118  
Decrease in accrued interest payable
    (97 )     (35 )
Decrease in prepaid federal deposit insurance
    422       423  
Other, net
    (473 )     (715 )
Net cash provided by operating activities
    4,508       3,490  
                 
INVESTING ACTIVITIES
               
Investment securities available for sale:
               
Proceeds from repayments and maturities
    34,731       21,260  
Proceeds from sale of securities
    21,804       10,072  
Purchases
    (34,657 )     (19,989 )
Increase in loans, net
    (9,328 )     (14,080 )
Proceeds from the sale of other real estate owned
    476       414  
Purchase of premises and equipment
    (631 )     (66 )
Net cash provided by (used for) investing activities
    12,395       (2,389 )
                 
FINANCING ACTIVITIES
               
Net (decrease) increase in deposits
    (9,233 )     4,494  
Decrease in short-term borrowings, net
    (433 )     (845 )
Repayment of other borrowings
    (468 )     (627 )
Common stock issuance
    2,329       716  
Proceeds from dividend reinvestment & purchase plan
    343       281  
Cash dividends
    (970 )     (850 )
Net cash (used for) provided by financing activities
    (8,432 )     3,169  
                 
Increase in cash and cash equivalents
    8,471       4,270  
                 
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD
    34,390       30,635  
                 
CASH AND CASH EQUIVALENTS AT END OF PERIOD
  $ 42,861     $ 34,904  
                 
SUPPLEMENTAL INFORMATION
               
Cash paid during the year for:
               
Interest on deposits and borrowings
  $ 3,429     $ 4,681  
Income taxes
    950       515  
                 
Non-cash investing transactions:
               
Transfers from loans to other real estate owned
  $ 316     $ 560  
 
See accompanying notes to the unaudited consolidated financial statements.
 
 
7

 

MIDDLEFIELD BANC CORP.
 
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
 
 
NOTE 1 - BASIS OF PRESENTATION
 
The consolidated financial statements of Middlefield Banc Corp. ("Company") include its two bank subsidiaries, The Middlefield Banking Company (“MB”) and Emerald Bank (“EB”), and a non-bank asset resolution subsidiary EMORECO, Inc. All significant inter-company items have been eliminated.

The accompanying financial statements have been prepared in accordance with U.S. generally accepted accounting principles and the instructions for Form 10-Q and Article 10 of Regulation S-X.  In management’s opinion, the financial statements include all adjustments, consisting of normal recurring adjustments, that the Company considers necessary to fairly state the Company’s financial position and the results of operations and cash flows.  The consolidated balance sheet at December 31, 2011, has been derived from the audited financial statements at that date but does not include all of the necessary informational disclosures and footnotes as required by U. S. generally accepted accounting principles.  The accompanying consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto included with Middlefield’s Form 10-K for the year ended December 31, 2011 (File No. 000-32561). The results of Middlefield’s operations for any interim period are not necessarily indicative of the results of Middlefield’s operations for any other interim period or for a full fiscal year.
 
Recent Accounting Pronouncements
 
In May 2011, the FASB issued ASU 2011-04, Fair Value Measurement (Topic 820):  Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs.  The amendments in this Update result in common fair value measurement and disclosure requirements in U.S. GAAP and IFRSs.  Consequently, the amendments change the wording used to describe many of the requirements in U.S. GAAP for measuring fair value and for disclosing information about fair value measurements.  The amendments in this Update are to be applied prospectively.  For public entities, the amendments are effective during interim and annual periods beginning after December 15, 2011.  For nonpublic entities, the amendments are effective for annual periods beginning after December 15, 2011.  Early application by public entities is not permitted. The Company has provided the necessary disclosures in Note 4.
 
In June 2011, the FASB issued ASU 2011-05, Comprehensive Income (Topic 220):  Presentation of Comprehensive Income.  The amendments in this Update improve the comparability, clarity, consistency, and transparency of financial reporting and increase the prominence of items reported in other comprehensive income.  To increase the prominence of items reported in other comprehensive income and to facilitate convergence of U.S. GAAP and IFRS, the option to present components of other comprehensive income as part of the statement of changes in stockholders’ equity was eliminated.  The amendments require that all non-owner changes in stockholders’ equity be presented either in a single continuous statement of comprehensive income or in two separate but consecutive statements.  In the two-statement approach, the first statement should present total net income and its components followed consecutively by a second statement that should present total other comprehensive income, the components of other comprehensive income, and the total of comprehensive income.  All entities that report items of comprehensive income, in any period presented, will be affected by the changes in this Update.  For public entities, the amendments are effective for fiscal years, and interim periods within those years, beginning after December 15, 2011.  For nonpublic entities, the amendments are effective for fiscal years ending after December 15, 2012, and interim and annual periods thereafter.  The amendments in this Update should be applied retrospectively, and early adoption is permitted. The Company has provided the necessary disclosure in the Consolidated Statement of Comprehensive Income.
 
 
8

 
 
In September 2011, the FASB issued ASU 2011-08, Intangibles – Goodwill and Other Topics (Topic 350), Testing Goodwill for Impairment.  The objective of this Update is to simplify how entities, both public and nonpublic, test goodwill for impairment.  The amendments in the Update permit an entity to first assess qualitative factors to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount as a basis for determining whether it is necessary to perform the two-step goodwill impairment test described in Topic 350.  The more-likely-than-not threshold is defined as having a likelihood of more than 50 percent.  Under the amendments in this Update, an entity is not required to calculate the fair value of a reporting unit unless the entity determines that it is more likely than not that its fair value is less than its carrying amount.  The amendments in this Update apply to all entities, both public and nonpublic, that have goodwill reported in their financial statements and are effective for interim and annual goodwill impairment tests performed for fiscal years beginning after December 15, 2011.  Early adoption is permitted, including for annual and interim goodwill impairment tests performed as of a date before September 15, 2011, if an entity’s financial statements for the most recent annual or interim period have not yet been issued or, for nonpublic entities, have not yet been made available for issuance.  This ASU did not have a significant impact on the Company’s financial statements.
 
In December 2011, the FASB issued ASU 2011-11, Balance Sheet (Topic 210):  Disclosures about Offsetting Assets and Liabilities.  The amendments in this Update affect all entities that have financial instruments and derivative instruments that are either (1) offset in accordance with either Section 210-20-45 or Section 815-10-45 or (2) subject to an enforceable master netting arrangement or similar agreement.  The requirements amend the disclosure requirements on offsetting in Section 210-20-50.  This information will enable users of an entity's financial statements to evaluate the effect or potential effect of netting arrangements on an entity's financial position, including the effect or potential effect of rights of setoff associated with certain financial instruments and derivative instruments in the scope of this Update.  An entity is required to apply the amendments for annual reporting periods beginning on or after January 1, 2013, and interim periods within those annual periods.  An entity should provide the disclosures required by those amendments retrospectively for all comparative periods presented.  This ASU is not expected to have a significant impact on the Company’s financial statements.
 
In December 2011, the FASB issued ASU 2011-12, Comprehensive Income (Topic 220):  Deferral of the Effective Date for Amendments to the Presentation of Reclassifications of Items Out of Accumulated Other Comprehensive Income in Accounting Standards Update No. 2011-05.  In order to defer only those changes in Update 2011-05 that relate to the presentation of reclassification adjustments, the paragraphs in this Update supersede certain pending paragraphs in Update 2011-05.  Entities should continue to report reclassifications out of accumulated other comprehensive income consistent with the presentation requirements in effect before Update 2011-05.  All other requirements in Update 2011-05 are not affected by this Update, including the requirement to report comprehensive income either in a single continuous financial statement or in two separate but consecutive financial statements. Public entities should apply these requirements for fiscal years, and interim periods within those years, beginning after December 15, 2011. Nonpublic entities should begin applying these requirements for fiscal years ending after December 15, 2012, and interim and annual periods thereafter.  This ASU is not expected to have a significant impact on the Company’s financial statements.
 
 
9

 
 
NOTE 2 - STOCK-BASED COMPENSATION
 
The Company has no unvested stock options outstanding and no unrecognized stock-based compensation costs outstanding as of June 30, 2012.
 
Stock option activity during the six months ended June 30, 2012 and 2011 is as follows:
 
    2012     Weighted-average Exercise Price     2011     Weighted-average Exercise Price  
                         
Outstanding, January 1
  $ 88,774       26.81       89,077     $ 27.87  
Granted
    -       -       9,000       17.55  
Exercised
    -       -       -       -  
Forfeited
    (420 )     36.86       (7,549 )     29.22  
Outstanding, June 30
    88,354       26.76       90,528       26.73  
 
 
10

 
 
NOTE 3 - EARNINGS PER SHARE
 
The Company provides dual presentation of Basic and Diluted earnings per share.  Basic earnings per share uses net income as reported as the numerator and the actual average shares outstanding as the denominator.  Diluted earnings per share includes any dilutive effects of options, warrants, and convertible securities.
 
There are no convertible securities that would affect the denominator in calculating basic and diluted earnings per share. The following tables set forth the composition of the weighted-average common shares (denominator) used in the basic and diluted earnings per share computation.
 
   
For the Three
Months Ended
June 30,
   
For the Six
Months Ended
June 30,
 
   
2012
   
2011
   
2012
   
2011
 
Weighted average common shares outstanding
    2,108,863       1,837,301       2,031,187       1,824,431  
Average treasury stock shares
    (189,530 )     (189,530 )     (189,530 )     (189,530 )
Weighted average common shares and common stock equivalents used to calculate basic earnings per share
    1,919,333       1,647,771       1,841,657       1,634,901  
Additional common stock equivalents (stock options) used to calculate diluted earnings per share
    1,872       149       1,208       75  
Weighted average common shares and common stock equivalents used to calculate diluted earnings per share
    1,921,205       1,647,920       1,842,865       1,634,976  
 
Options to purchase 88,354 shares of common stock, at prices ranging from $17.55 to $40.24, were outstanding during the three and six months ended June 30, 2012.  Of those options, 9,000 were considered dilutive based on the market price exceeding the strike price.  The remaining 79,354 options had no dilutive effect on the earnings per share.
 
During the three and six months ended June 30, 2011, the remaining options to purchase 81,528 shares of common stock at prices ranging from $22.33 to $40.24 were outstanding but were not included in the computation of diluted earnings per share as they were anti-dilutive due to the strike price being greater than the average market price for the six months ended June 30, 2011. Total options to purchase shares of common stock were 90,528 at prices ranging from $17.55 to $40.24 for the six months ended June 30, 2011.
 
 
11

 

NOTE 4 - FAIR VALUE MEASUREMENTS
 
Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in the principal or most advantageous market for an asset or liability in an orderly transaction between market participants at the measurement date. The three broad levels defined by U.S. generally accepted accounting principles are as follows:
 
Level I:       Quoted prices are available in active markets for identical assets or liabilities as of the reported date.
 
Level II:      Pricing inputs are other than the quoted prices in active markets, which are either directly or indirectly observable as of the reported date.  The nature of these assets and liabilities includes items for which quoted prices are available but traded less frequently and items that are fair-valued using other financial instruments, the parameters of which can be directly observed.
 
Level III:    Assets and liabilities that have little to no pricing observability as of the reported date.  These items do not have two-way markets and are measured using management’s best estimate of fair value, where the inputs into the determination of fair value require significant management judgment or estimation.
 
The following tables present the assets measured on a recurring basis on the Consolidated Balance Sheet at their fair value as of June 30, 2012 and December 31, 2011 by level within the fair value hierarchy. Financial assets and liabilities are classified in their entirety based on the lowest level of input that is significant to the fair value measurement.
 
         
June 30, 2012
       
                   
   
Level I
    Level II     Level III    
Total
 
(Dollar amounts in thousands)
                       
                         
Assets Measured on a Recurring Basis:
                       
U.S. government agency securities
  $ -     $ 13,572     $ -     $ 13,572  
Obligations of states and political subdivisions
    -       88,587       -       88,587  
Mortgage-backed securities in government-sponsored entities
            64,274               64,274  
Private-label mortgage-backed securities
    -       6,262       -       6,262  
Total debt securities
    -       172,695       -       172,695  
Equity securities in financial institutions
    5       746       -       751  
Total
  $ 5     $ 173,441     $ -     $ 173,446  
 
 
12

 
 
          December 31, 2011        
                   
   
Level I
   
Level II
   
Level III
   
Total
 
Assets Measured on a Recurring Basis:
                       
U.S. government agency securities
  $ -     $ 31,933     $ -     $ 31,933  
Obligations of states and political subdivisions
    -       88,400       -       88,400  
Mortgage-backed securities in government-sponsored entities
            65,573       -       65,573  
Private-label mortgage-backed securities
    -       7,321       -       7,321  
Total debt securities
    -       193,227       -       193,227  
Equity securities in financial institutions
    5       745       -       750  
Total
  $ 5     $ 193,972     $ -     $ 193,977  
 
The Company obtains fair values from an independent pricing service which represent either quoted market prices for the identical securities (Level 1 inputs) or fair values determined by pricing models using a market approach that considers observable market data, such as interest rate volatilities, LIBOR yield curve, credit spreads and prices from market makers and live trading systems (Level 2).
 
Financial instruments are considered Level III when their values are determined using pricing models, discounted cash flow methodologies or similar techniques and at least one significant model assumption or input is unobservable.  In addition to these unobservable inputs, the valuation models for Level III financial instruments typically also rely on a number of inputs that are readily observable either directly or indirectly.  Level III financial instruments also include those for which the determination of fair value requires significant management judgment or estimation.  The Company has no securities considered to be Level III as of June 30, 2012.
 
The Company uses prices compiled by third party vendors due to the recent stabilization in the markets along with improvements in third party pricing methodology that have narrowed the variances between third party vendor prices and actual market prices.
 
The following tables present the assets measured on a nonrecurring basis on the Consolidated Balance Sheet at their fair value as of June 30, 2012 and December 31, 2011, by level within the fair value hierarchy. Impaired loans that are collateral dependent are written down to fair value through the establishment of specific reserves. Techniques used to value the collateral that secure the impaired loan include: quoted market prices for identical assets classified as Level I inputs; observable inputs, employed by certified appraisers, for similar assets classified as Level II inputs. In cases where valuation techniques included inputs that are unobservable and are based on estimates and assumptions developed by management based on the best information available under each circumstance, the asset valuation is classified as Level III inputs.
 
 
13

 

         
June 30, 2012
       
                         
(Dollar amounts in thousands)
 
Level I
   
Level II
   
Level III
   
Total
 
                         
Assets Measured on a non-recurring Basis:
                       
Impaired loans
  $ -     $ -     $ 6,061     $ 6,061  
Other real estate owned
    -       -       1,986       1,986  
 
           
December 31, 2011
         
                                 
   
Level I
   
Level II
   
Level III
   
Total
 
                                 
Assets Measured on a non-recurring Basis:
                               
Impaired loans
  $ -     $ -     $ 13,581     $ 13,581  
Other real estate owned
    -       -       2,196       2,196  

The following table presents additional quantitative information about assets measured at fair value on a non-recurring basis and for which the Company uses Level III inputs to determine fair value:
 
   
Quantitative Information about Level III Fair Value Measurements
(unaudited, in thousands)
 
Estimate
  Valuation Techniquest
Unobservable Input
Range (Weighted Average)
June 30, 2012
                 
Impaired loans
  $ 6,061  
Appraisal of collateral (1)
Appraisal adjustments (2)
0% to -75.0% (-36.4%)
           
Liquidation expenses (2)
0% to
-21.9%
(-2.2%)
Other real estate owned
  $ 1,986  
Appraisal of collateral (1), (3)
         
 
(1) Fair value is generally determined through independent appraisals of the underlying collateral, which generally include various level 3 inputs which are not identifiable.
(2) Appraisals may be adjusted by management for qualitative factors such as economic conditions and estimated liquidation expenses. The range and weighted average of liquidation expenses and other appraisal adjustments are presented as a percent of the appraisal.
(3) Includes qualitative adjustments by management and estimated liquidation expenses.
 
 
14

 
 
The estimated fair value of the Company’s financial instruments is as follows:
 
    June 30, 2012  
   
Carrying
Value
   
Level I
    Level II    
Level III
   
Total
Fair Value
 
   
(in thousands)
 
Financial assets:
     
Cash and cash equivalents
  $ 42,861     $ 42,861     $ -     $ -     $ 42,861  
Investment securities Available for sale
    173,446       5       173,441       -       173,446  
Net loans
    403,116       -       -       394,490       394,490  
Bank-owned life insurance
    8,394       8,394               -       8,394  
Federal Home Loan Bank stock
    1,887       1,887               -       1,887  
Accrued interest receivable
    2,123       2,123       -       -       2,123  
                                         
Financial liabilities:
                                       
Deposits
  $ 571,729     $ 366,587     $ -     $ 210,321     $ 576,908  
Short-term borrowings
    6,959       6,959       -       -       6,959  
Other borrowings
    16,363       -       -       16,769       16,769  
Accrued interest payable
    548       548       -       -       548  

   
June 30, 2012
   
December 31, 2011
 
   
Carrying
Value
   
Fair Value
   
Carrying
Value
   
Fair Value
 
    (in thousands)  
Financial assets:
                       
Cash and cash equivalents
  $ 42,861     $ 42,861     $ 34,390     $ 34,390  
Investment securities Available for sale
    173,446       173,446       193,977       193,977  
Net loans
    403,116       394,490       395,061       382,542  
Bank-owned life insurance
    8,394       8,394       8,257       8,257  
Federal Home Loan Bank stock
    1,887       1,887       1,887       1,887  
Accrued interest receivable
    2,123       2,123       2,234       2,234  
                                 
Financial liabilities:
                               
Deposits
  $ 571,729     $ 576,908     $ 580,962     $ 587,178  
Short-term borrowings
    6,959       6,959       7,392       7,392  
Other borrowings
    16,363       16,769       16,831       17,327  
Accrued interest payable
    548       548       645       645  
 
Financial instruments are defined as cash, evidence of ownership interest in an entity, or a contract which creates an obligation or right to receive or deliver cash or another financial instrument from/to a second entity on potentially favorable or unfavorable terms.
 
Fair value is defined as the amount at which a financial instrument could be exchanged in a current transaction between willing parties other than in a forced liquidation sale.  If a quoted market price is available for a financial instrument, the estimated fair value would be calculated based upon the market price per trading unit of the instrument.
 
 
15

 
 
If no readily available market exists, the fair value estimates for financial instruments should be based upon management’s judgment regarding current economic conditions, interest rate risk, expected cash flows, future estimated losses, and other factors as determined through various option pricing formulas or simulation modeling.  Since many of these assumptions result from judgments made by management based upon estimates which are inherently uncertain, the resulting estimated fair values may not be indicative of the amount realizable in the sale of a particular financial instrument.  In addition, changes in assumptions on which the estimated fair values are based may have a significant impact on the resulting estimated fair values.
 
As certain assets such as deferred tax assets and premises and equipment are not considered financial instruments, the estimated fair value of financial instruments would not represent the full value of the Company.
 
The Company employed simulation modeling in determining the estimated fair value of financial instruments for which quoted market prices were not available based upon the following assumptions:
 
Cash and Cash Equivalents, Federal Home Loan Bank Stock, Accrued Interest Receivable, Accrued Interest Payable, and Short-Term Borrowings
The fair value is equal to the current carrying value.

Bank-Owned Life Insurance
The fair value is equal to the cash surrender value of the life insurance policies.
 
Investment Securities Available-for-sale
The fair value of investment securities is equal to the available quoted market price.  If no quoted market price is available, fair value is estimated using the quoted market price for similar securities.  Fair value for certain private-label collateralized mortgage obligations was determined utilizing discounted cash flow models, due to the absence of a current market to provide reliable market quotes for the instruments.
 
Loans
The fair value is estimated by discounting future cash flows using current market inputs at which loans with similar terms and qualities would be made to borrowers of similar credit quality.  Where quoted market prices were available, primarily for certain residential mortgage loans, such market rates were used as estimates for fair value.
 
Deposits and Other Borrowings
The fair values of certificates of deposit and other borrowed funds are based on the discounted value of contractual cash flows.  The discount rates are estimated using rates currently offered for similar instruments with similar remaining maturities.  Demand, savings, and money market deposits are valued at the amount payable on demand as of year-end.
 
Commitments to Extend Credit
These financial instruments are generally not subject to sale, and estimated fair values are not readily available. The carrying value, represented by the net deferred fee arising from the unrecognized commitment or letter of credit, and the fair value, determined by discounting the remaining contractual fee over the term of the commitment using fees currently charged to enter into similar agreements with similar credit risk, are not considered material for disclosure.
 
 
16

 

NOTE 5 - INVESTMENT SECURITIES AVAILABLE-FOR-SALE
The amortized cost and fair values of securities available-for-sale are as follows:
 
   
June 30, 2012
 
   
Amortized
Cost
   
Gross
Unrealized
Gains
   
Gross
Unrealized
Losses
   
Fair
Value
 
(Dollar amounts in thousands)                        
                         
U.S. government agency securities
  $ 12,989     $ 583     $ -     $ 13,572  
Obligations of states and political subdivisions:
                               
Taxable
    8,201       956       -       9,157  
Tax-exempt
    74,842       4,611       (23 )     79,430  
Mortgage-backed securities in government-sponsored entities
    62,437       1,863       (26 )     64,274  
Private-label mortgage-backed securities
    5,819       484       (41 )     6,262  
Total debt securities
    164,288       8,497       (90 )     172,695  
Equity securities in financial institutions
    750       1       -       751  
Total
  $ 165,038     $ 8,498     $ (90 )   $ 173,446  

   
December 31, 2011
 
   
Amortized
Cost
   
Gross
Unrealized
Gains
   
Gross
Unrealized
Losses
   
Fair
Value
 
                         
U.S. government agency securities
  $ 31,520     $ 427     $ (14 )   $ 31,933  
Obligations of states and political subdivisions:
                               
Taxable
    8,207       766       -       8,973  
Tax-exempt
    75,807       3,681       (61 )     79,427  
Mortgage-backed securities in government-sponsored entities
    63,808       1,819       (54 )     65,573  
Private-label mortgage-backed securities
    7,005       411       (95 )     7,321  
Total debt securities
    186,347       7,104       (224 )     193,227  
Equity securities in financial institutions
    750       -       -       750  
Total
  $ 187,097     $ 7,104     $ (224 )   $ 193,977  
 
 
17

 

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

   
Amortized
Cost
   
Fair
Value
 
(Dollar amounts in thousands)
       
 
 
             
Due in one year or less
  $ 2,784     $ 2,842  
Due after one year through five years
    5,809       6,149  
Due after five years through ten years
    15,903       16,866  
Due after ten years
    139,792       146,838  
                 
Total
  $ 164,288     $ 172,695  

Proceeds from the sales of securities available-for-sale and the gross realized gains and losses are as follows:

   
For the Three Months Ended June 30,
   
For the Six Months Ended June 30,
 
   
2012
   
2011
   
2012
   
2011
 
Proceeds from sales
  $ 21,804     $ -     $ 21,804     $ 10,072  
Gross realized gains
    308       -       308       15  
Gross realized losses
    (12 )     (37 )     (12 )     (37 )
 
Gross realized losses for the three and six months ended June 30, 2011 were the result of OTTI taken on equity securities.
 
Investment securities with an approximate carrying value of $52,927,000 and $55,809,000 at June 30, 2012 and 2011, respectively, were pledged to secure deposits and other purposes as required by law.
 
The following tables show the Company’s gross unrealized losses and fair value, aggregated by investment category and length of time that the individual securities have been in a continuous unrealized loss position.
 
   
June 30, 2012
 
   
Less than Twelve Months
   
Twelve Months or Greater
   
Total
 
   
Fair
Value
   
Gross
Unrealized
Losses
   
Fair
Value
   
Gross
Unrealized
Losses
   
Fair
Value
   
Gross
Unrealized
Losses
 
(Dollar amounts in thousands)
             
 
   
 
   
 
   
 
 
                                     
Obligations of states and political subdivisions
  $ 742     $ (12 )   $ 289     $ (11 )   $ 1,031     $ (23 )
Mortgage-backed securities in government-sponsored entities
    8,523       (26 )     -       -       8,523       (26 )
Private-label mortgage-backed securities
    335       (6 )     358       (35 )     693       (41 )
Total
  $ 9,600     $ (44 )   $ 647     $ (46 )   $ 10,247     $ (90 )
 
 
18

 

   
December 31, 2011
 
   
Less than Twelve Months
   
Twelve Months or Greater
   
Total
 
   
Fair
Value
   
Gross
Unrealized
Losses
   
Fair
Value
   
Gross
Unrealized
Losses
   
Fair
Value
   
Gross
Unrealized
Losses
 
                                     
U.S. government agency securities
  $ 1,986     $ (14 )   $ -     $ -     $ 1,986     $ (14 )
Obligations of states and political subdivisions
    2,707       (40 )     919       (21 )     3,626       (61 )
Mortgage-backed securities in government-sponsored entities
    8,992       (54 )     -       -       8,992       (54 )
Private-label mortgage-backed securities
    1,628       (42 )     398       (53 )     2,026       (95 )
Total
  $ 15,313     $ (150 )   $ 1,317     $ (74 )   $ 16,630     $ (224 )
 
There were 10 and 51 securities that were considered temporarily impaired at June 30, 2012 and 2011.
 
On a quarterly basis, the Company performs an assessment to determine whether there have been any events or economic circumstances indicating that a security with an unrealized loss has suffered other-than-temporary impairment (“OTTI”)A debt security is considered impaired if the fair value is less than its amortized cost basis at the reporting date. OTTI losses are recognized in earnings when the Company has the intent to sell the debt security or it is more likely than not that it will be required to sell the debt security before recovery of its amortized cost basis. However, even if the Company does not expect to sell a debt security, it must evaluate expected cash flows to be received and determine if a credit loss has occurred.
 
An unrealized loss is generally deemed to be other than temporary and a credit loss is deemed to exist if the present value of the expected future cash flows is less than the amortized cost basis of the debt security. As a result the credit loss component of an OTTI is recorded as a component of investment securities gains (losses) in the accompanying Consolidated Statement of Income, while the remaining portion of the impairment loss is recognized in other comprehensive income, provided the Company does not intend to sell the underlying debt security and it is “more likely than not” that the Company will not have to sell the debt security prior to recovery.
 
Debt securities issued by U.S. government agencies, U.S. government-sponsored enterprises, and state and political subdivisions accounted for more than 96% of the total available-for-sale portfolio as of June 30, 2012 and no credit losses are expected, given the explicit and implicit guarantees provided by the U.S. federal government and the lack of significant unrealized loss positions within the obligations of state and political subdivisions security portfolio. The Company’s assessment was concentrated mainly on private-label collateralized mortgage obligations of approximately $6.3 million for which the Company evaluates credit losses on a quarterly basis. The gross unrealized gain position related to these private-label collateralized mortgage obligations amounted to $484,000 and the gross unrealized loss position was $41,000 on June 30, 2012. The Company considered the following factors in determining whether a credit loss exists and the period over which the debt security is expected to recover:
 
 
 
The length of time and the extent to which the fair value has been less than the amortized cost basis.
       
 
 
Changes in the near term prospects of the underlying collateral of a security such as changes in default rates, loss severity given default and significant changes in prepayment assumptions;
       
 
 
The level of cash flows generated from the underlying collateral supporting the principal and interest payments of the debt securities; and
       
 
 
Any adverse change to the credit conditions and liquidity of the issuer, taking into consideration the latest information available about the overall financial condition of the issuer, credit ratings, recent legislation and government actions affecting the issuer’s industry and actions taken by the issuer to deal with the present economic climate.

 
19

 
 
For the three and six months ended June 30, 2012, there were no available-for-sale debt securities with an unrealized loss that suffered OTTI.

NOTE 6 - LOANS AND RELATED ALLOWANCE FOR LOAN LOSSES
 
Major classifications of loans are summarized as follows (in thousands):
 
   
June 30,
2012
   
December 31,
2011
 
             
Commercial and industrial
  $ 65,651     $ 59,185  
Real estate - construction
    20,409       21,545  
Real estate - mortgage:
               
Residential
    207,080       208,139  
Commercial
    113,383       108,502  
Consumer installment
    4,345       4,509  
      410,868       401,880  
Less allowance for loan losses
    (7,752 )     (6,819 )
                 
Net loans
  $ 403,116     $ 395,061  
 
The Company’s primary business activity is with customers located within its local trade area, eastern Geauga County, and contiguous counties to the north, east, and south.  The Company also serves the central Ohio market with offices in Dublin and Westerville, Ohio.  Commercial, residential, consumer, and agricultural loans are granted.  Although the Company has a diversified loan portfolio, loans outstanding to individuals and businesses are dependent upon the local economic conditions in the Company’s immediate trade area.
 
The following tables summarize the primary segments of the loan portfolio and allowance for loan losses (in thousands):
 
               
Real Estate- Mortgage
             
June 30, 2012
 
Commercial and industrial
   
Real estate- construction
   
Residential
   
Commercial
   
Consumer installment
   
Total
 
Loans:                                    
Individually evaluated for impairment
  $ 4,065     $ 649     $ 4,619     $ 6,420     $ -     $ 15,753  
Collectively evaluated for impairment
    61,586       19,760       202,461       106,963       4,345       395,115  
Total loans
  $ 65,651     $ 20,409     $ 207,080     $ 113,383     $ 4,345     $ 410,868  
 
 
20

 
 
               
Real estate- Mortgage
             
December 31, 2011
 
Commercial and industrial
   
Real estate- construction
   
Residential
   
Commercial
   
Consumer installment
   
Total
 
Loans:                                    
Individually evaluated for impairment
  $ 4,492     $ 867     $ 4,882     $ 6,491     $ -     $ 16,732  
Collectively evaluated for impairment
    54,693       20,678       203,257       102,011       4,509       385,148  
Total loans
  $ 59,185     $ 21,545     $ 208,139     $ 108,502     $ 4,509     $ 401,880  
 
               
Real Estate- Mortgage
             
June 30, 2012
 
Commercial and industrial
   
Real estate- construction
   
Residential
   
Commercial
   
Consumer installment
   
Total
 
Allowance for loan losses:
                                   
Ending allowance balance attributable to loans:
                                   
Individually evaluated for impairment
  $ 680     $ 237     $ 691     $ 59     $ -     $ 1,667  
Collectively evaluated for impairment
    946       267       3,418       1,433       21       6,085  
Total ending allowance balance
  $ 1,626     $ 504     $ 4,109     $ 1,492     $ 21     $ 7,752  
 
               
Real Estate- Mortgage
             
December 31, 2011
 
Commercial and industrial
   
Real estate- construction
   
Residential
   
Commercial
   
Consumer installment
   
Total
 
Allowance for loan losses:
                                   
Ending allowance balance attributable to loans:
                                   
Individually evaluated for impairment
  $ 595     $ 237     $ 685     $ 185     $ -     $ 1,702  
Collectively evaluated for impairment
    701       201       3,046       1,121       48       5,117  
Total ending allowance balance
  $ 1,296     $ 438     $ 3,731     $ 1,306     $ 48     $ 6,819  
 
The Company’s loan portfolio is segmented to a level that allows management to monitor risk and performance.  The portfolio is segmented into Commercial and Industrial (“C&I”), Real Estate Construction, Real Estate - Mortgage which is further segmented into Residential and Commercial real estate, and Consumer Installment Loans.  The C&I loan segment consists of loans made for the purpose of financing the activities of commercial customers.  The residential mortgage loan segment consists of loans made for the purpose of financing the activities of residential homeowners.  The commercial mortgage loan segment consists of loans made for the purposed of financing the activities of commercial real estate owners and operators. The consumer loan segment consists primarily of installment loans and overdraft lines of credit connected with customer deposit accounts.
 
Management evaluates individual loans in all of the commercial segments for possible impairment if the loan is greater than $150,000 and if the loan either is in nonaccrual status, or is risk rated Special Mention or Substandard.  Loans are considered to be impaired when, based on current information and events, it is probable that the Company will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement.  Factors considered by management in evaluating impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due.  Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record, and the amount of the shortfall in relation to the principal and interest owed.  The Company does not separately evaluate individual consumer and residential mortgage loans for impairment, unless such loans are part of a larger relationship that is impaired.
 
Once the determination has been made that a loan is impaired, the determination of whether a specific allocation of the allowance is necessary is measured by comparing the recorded investment in the loan to the fair value of the loan using one of three methods:  (a) the present value of expected future cash flows discounted at the loan’s effective interest rate; (b) the loan’s observable market price; or (c) the fair value of the collateral less selling costs.  The method is selected on a loan-by loan basis, with management primarily utilizing the fair value of collateral method.  The evaluation of the need and amount of a specific allocation of the allowance and whether a loan can be removed from impairment status is made on a quarterly basis.  The Company’s policy for recognizing interest income on impaired loans does not differ from its overall policy for interest recognition.
 
 
21

 
 
The following tables present impaired loans by class, segregated by those for which a specific allowance was required and those for which a specific allowance was not necessary (in thousands):
 
June 30, 2012
 
Impaired Loans
 
   
Recorded
Investment
    Unpaid Principal Balance    
Related
Allowance
 
With no related allowance recorded:
             
Commercial and industrial
  $ 742     $ 742     $ -  
Real estate - construction
    203       203       -  
Real estate - mortgage:
                       
Residential
    2,667       2,668       -  
Commercial
    1,653       1,661       -  
Consumer installment
    26       26       -  
With an allowance recorded:
                       
Commercial and industrial
  $ 453     $ 453     $ 248  
Real estate - construction
    217       217       125  
Real estate - mortgage:
                       
Residential
    267       269       266  
Commercial
    711       712       239  
Consumer installment
    -       -       -  
Total:
                       
Commercial and industrial
  $ 1,195     $ 1,195     $ 248  
Real estate - construction
    420       420       125  
Real estate - mortgage:
                       
Residential
    2,934       2,937       266  
Commercial
    2,364       2,373       239  
Consumer installment
    26       26       -  
 
 
22

 

December 31, 2011
                 
Impaired Loans
 
   
Recorded
Investment
    Unpaid Principal Balance    
Related
Allowance
 
With no related allowance recorded:
             
Commercial and industrial
  $ 1,172     $ 1,172     $ -  
Real estate - construction
    4,250       4,250       -  
Real estate - mortgage:
                       
Residential
    3,188       3,193       -  
Commercial
    2,528       2,536       -  
Consumer installment
    24       24       -  
With an allowance recorded:
                       
Commercial and industrial
  $ 465     $ 465     $ 196  
Real estate - construction
    271       271       125  
Real estate - mortgage:
                       
Residential
    -       -       -  
Commercial
    2,555       2,560       551  
Total:
                       
Commercial and industrial
  $ 1,637     $ 1,637     $ 196  
Real estate - construction
    4,521       4,521       125  
Real estate - mortgage:
                       
Residential
    3,188       3,193       -  
Commercial
    5,083       5,096       551  
Consumer installment
    24       24       -  
 
The following tables present average recorded investment and related interest income recognized for impaired loans by class, segregated by those for which a specific allowance was required and those for which a specific allowance was not necessary (in thousands):
 
   
For the Three Months Ended
June 30, 2012
   
For the Three Months Ended
June 30, 2011
 
                         
    Average Recorded Investment     Interest Income Recognized     Average Recorded Investment     Interest Income Recognized  
Total:                        
Commercial and industrial
  $ 1,488     $ 21     $ 4,337     $ 80  
Real estate - construction
    446       -       616       -  
Real estate - mortgage:
                               
Residential
    2,872       61       574       33  
Commercial
    2,124       98       3,762       35  
Consumer installment
    27       -       -       -  
 
 
23

 

   
For the Six Months Ended
June 30, 2012
   
For the Six Months Ended
June 30, 2011
 
                         
    Average Recorded Investment     Interest Income Recognized     Average Recorded Investment     Interest Income Recognized  
Total:
                       
Commercial and industrial
  $ 1,440     $ 33     $ 3,604       -  
Real estate - construction
    1,796       1       617       82  
Real estate - mortgage:
                               
Residential
    2,998       88       583       -  
Commercial
    3,190       124       3,430       45  
Consumer installment
    26       1       -       102  
 
Management uses a nine point internal risk rating system to monitor the credit quality of the overall loan portfolio. The first five categories are considered not criticized, and are aggregated as “Pass” rated. The criticized rating categories used by management generally follow bank regulatory definitions. The Special Mention category includes assets that are currently protected but are potentially weak, resulting in an undue and unwarranted credit risk, but not to the point of justifying a Substandard classification.  Loans in the Substandard category have well-defined weaknesses that jeopardize the liquidation of the debt, and have a distinct possibility that some loss will be sustained if the weaknesses are not corrected.  All loans greater than 90 days past due are considered Substandard.   Any portion of a loan that has been charged off is placed in the Loss category.
 
To help ensure that risk ratings are accurate and reflect the present and future capacity of borrowers to repay a loan as agreed, the Company has a structured loan rating process with several layers of internal and external oversight.  Generally, consumer and residential mortgage loans are included in the Pass categories unless a specific action, such as bankruptcy, repossession, or death occurs to raise awareness of a possible credit event.  The Company’s Commercial Loan Officers are responsible for the timely and accurate risk rating of the loans in their portfolios at origination and on an ongoing basis.  The Credit Department performs an annual review of all commercial relationships $200,000 or greater.  Confirmation of the appropriate risk grade is included in the review on an ongoing basis.  The Company has an experienced Loan Review Department that continually reviews and assesses loans within the portfolio.  The Company engages an external consultant to conduct loan reviews on a semi-annual basis. Generally, the external consultant reviews commercial relationships greater than $250,000 and/or criticized relationships greater than $125,000.  Detailed reviews, including plans for resolution, are performed on loans classified as Substandard on a quarterly basis.  Loans in the Special Mention and Substandard categories that are collectively evaluated for impairment are given separate consideration in the determination of the allowance.
 
 
24

 
 
The following table presents the classes of the loan portfolio summarized by the aggregate Pass and the criticized categories of Special Mention, Substandard and Doubtful within the internal risk rating system (in thousands):
 
   
Pass
   
Special Mention
   
Substandard
    Doubtful    
Total Loans
 
June 30, 2012
                             
                               
Commercial and industrial
  $ 61,224     $ 634     $ 3,793     $ -     $ 65,651  
Real estate - construction
    19,734       -       675       -       20,409  
Real estate - mortgage:
                                       
Residential
    192,198       910       13,972       -       207,080  
Commercial
    104,925       2,165       6,293       -       113,383  
Consumer installment
    4,318       3