0000946275-13-000353.txt : 20131114 0000946275-13-000353.hdr.sgml : 20131114 20131114172638 ACCESSION NUMBER: 0000946275-13-000353 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 9 CONFORMED PERIOD OF REPORT: 20130930 FILED AS OF DATE: 20131114 DATE AS OF CHANGE: 20131114 FILER: COMPANY DATA: COMPANY CONFORMED NAME: CECIL BANCORP INC CENTRAL INDEX KEY: 0000926865 STANDARD INDUSTRIAL CLASSIFICATION: SAVINGS INSTITUTION, FEDERALLY CHARTERED [6035] IRS NUMBER: 521883546 STATE OF INCORPORATION: MD FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: 1934 Act SEC FILE NUMBER: 000-24926 FILM NUMBER: 131221591 BUSINESS ADDRESS: STREET 1: 127 NORTH STREET CITY: ELKTON STATE: MD ZIP: 21921 BUSINESS PHONE: 4103981650 MAIL ADDRESS: STREET 1: 127 NORTH STREET CITY: ELKTON STATE: MD ZIP: 21922-0568 10-Q 1 f10q_093013-0424.htm FORM 10-Q 9-30-13 - CECIL BANCORP, INC. f10q_093013-0424.htm
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
_____________________________________
 
FORM 10-Q

 
  x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
   
SECURITIES EXCHANGE ACT OF 1934
   
For the quarterly period ended September 30, 2013.
 
OR
 
 
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
   
SECURITIES EXCHANGE ACT OF 1934
   
For the transition period from __________ to __________
 
Commission File Number   0-24926

CECIL BANCORP, INC.
(Name of registrant as specified in its charter)
 
Maryland
52-1883546
(State or other jurisdiction of
(I.R.S. Employer
incorporation or organization)
Identification Number)
   
127 North Street, P.O. Box 568 Elkton, Maryland
21921
(Address of principal executive office)
(Zip Code)
 
Registrant’s telephone number, including area code:  (410) 398-1650

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
[ x ] YES                      [   ] NO

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
[ x ] YES                   [   ] NO

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

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
[    ] YES                      [ x ] NO

APPLICABLE ONLY TO CORPORATE ISSUERS:  Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

At October 31, 2013, there were 7,425,869 shares of common stock outstanding


 
1

 


CECIL BANCORP, INC. AND SUBSIDIARIES


CONTENTS
 

   
PAGE
 
PART I.   FINANCIAL INFORMATION      
       
    ITEM 1.   Financial Statements (unaudited)      
       
          Consolidated Balance Sheets -      
          September 30, 2013 and December 31, 2012     3  
         
          Consolidated Statements of Operations and Comprehensive Loss
       
          for the Three and Nine Months Ended September 30, 2013 and 2012
    4-5  
         
          Consolidated Statements of Cash Flows
       
          for the Nine Months Ended Sepember 30, 2013 and 2012
    6  
         
          Notes to Consolidated Financial Statements
    7-28  
         
         
    ITEM 2.   Management’s Discussion and Analysis of Financial Condition
       
           and Results of Operations
    29-39  
         
    ITEM 3.    Qantitative and Qualitative Disclosures About Market Risk
    39  
         
    ITEM 4.    Controls and Procedures
    39  
         
PART II.   OTHER INFORMATION
    39-41  
         
SIGNATURES
    42  
         
 


 
2

 

PART I.                                                                                     FINANCIAL INFORMATION
ITEM 1.                                                                                     FINANCIAL STATEMENTS

CECIL BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
 (dollars in thousands, except per share data)

   
September 30,
   
December 31,
 
   
2013
   
2012
 
   
(Unaudited)
       
ASSETS:
           
Cash and due from banks
  $ 1,382     $ 2,012  
Interest bearing deposits with banks
    26,687       39,188  
Federal funds sold
    251       606  
  Total cash and cash equivalents
    28,320       41,806  
Investment securities:
               
  Securities available-for-sale at fair value
    44,421       33,504  
  Securities held-to-maturity (fair value of $2,268
               
   in 2013 and $3,927 in 2012)
    2,250       3,887  
Restricted investment securities – at cost
    3,977       4,204  
Loans receivable
    245,775       306,751  
  Less: allowance for loan losses
    (8,919 )     (10,297 )
    Net loans receivable
    236,856       296,454  
Other real estate owned
    34,945       33,871  
Premises and equipment, net
    8,458       9,679  
Accrued interest receivable
    1,064       1,323  
Mortgage servicing rights
    381       441  
Bank owned life insurance
    8,561       8,465  
Income taxes receivable
    3,770       3,770  
Other assets
    3,936       2,417  
    TOTAL ASSETS
  376,939     439,821  
LIABILITIES:
               
Deposits
  285,475     341,219  
Other liabilities
    15,305       12,863  
Junior subordinated debentures
    17,000       17,000  
Advances from Federal Home Loan Bank of Atlanta
    53,500       53,500  
Other borrowed funds
    -       1,088  
    Total liabilities
    371,280       425,670  
STOCKHOLDERS’ EQUITY:
               
Preferred stock, $.01 par value; authorized 1,000,000 shares
               
  Series A issued and outstanding 11,560 shares, liquidation
               
   preference $1,000 per share, in 2013 and 2012
    11,481       11,356  
  Series B issued and outstanding 164,450 shares, liquidation
               
   preference $17.20 per share, in 2013 and 164,575 in 2012
    2,794       2,796  
Common stock, $.01 par value; authorized 100,000,000
               
  shares, issued and outstanding 7,425,869 shares in
               
  2013 and 7,424,572 in 2012
    75       75  
Additional paid in capital
    12,302       12,300  
Accumulated deficit
    (19,555 )     (12,556 )
Accumulated other comprehensive (loss) income
    (1,438 )     180  
    Total stockholders’ equity
    5,659       14,151  
    TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY
  $ 376,939     $ 439,821  

See accompanying notes to consolidated financial statements.
 
 
3

 
 
CECIL BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS (UNAUDITED)
(dollars in thousands, except per share data)

   
Three Months Ended
September 30,
   
Nine Months Ended
September 30,
 
   
2013
   
2012
   
2013
   
2012
 
INTEREST INCOME:
                       
  Interest and fees on loans
  $ 3,111     $ 4,425     $ 11,170     $ 13,570  
  Interest on investment securities
    212       111       504       294  
  Dividends on FHLB and FRB stock
    34       27       100       83  
  Other interest income
    20       16       67        45  
    Total interest income
    3,377       4,579       11,841       13,992  
                                 
INTEREST EXPENSE:
                               
  Interest expense on deposits
    709       935       2,349       2,845  
  Interest expense on junior subordinated debentures
    89       96       256       354  
  Interest expense on advances from FHLB
    493       493       1,463       1,649  
  Interest expense on other borrowed funds
    -       -       -       20  
    Total interest expense
     1,291       1,524       4,068       4,868  
                                 
NET INTEREST INCOME
    2,086       3,055       7,773       9,124  
                                 
PROVISION FOR LOAN LOSSES
    2,900       2,850       4,350       5,910  
                                 
NET INTEREST (LOSS) INCOME AFTER
                               
  PROVISION FOR LOAN LOSSES
    (814 )     205       3,423       3,214  
                                 
NONINTEREST INCOME:
                               
  Deposit account fees
    113       125       357       361  
  ATM fees
    119       117       347       355  
  Commission income
    -       -       1       1  
  Gain on sale of loans
    24       28       200       1,381  
  Loss on sale of other real estate owned
    (331 )     -       (312 )     (225 )
  Gain on sale of investments
    -       -       375       -  
  Income from bank owned life insurance
    23       46       95       138  
  Premium received on sale of deposits
    240       -       240       -  
  Other
    59       147       134        399  
    Total noninterest income
    247       463       1,437       2,410  
                                 
NONINTEREST EXPENSE:
                               
  Salaries and employee benefits
    1,276       1,307       3,892       3,789  
  Occupancy expense
    187       184       635       543  
  Equipment and data processing expense
    312       310       952       944  
  FDIC deposit insurance premiums
    215       272       689       802  
  Other real estate owned expense and valuation
    1,063       4,520       1,862       6,362  
  Professional fees
    461       413       1,196       1,327  
  Loan collection expense
    109       86       491       516  
  Provision for off-balance sheet credit losses
    -       -       323       -  
  Other
    383       350       1,154       1,113  
    Total noninterest expense
    4,006       7,442       11,194       15,396  
                                 
NET LOSS BEFORE INCOME TAXES
    (4,573 )     (6,774 )     (6,334 )     (9,772 )
INCOME TAX EXPENSE
    -       9,081       -       7,869  
NET LOSS (CARRIED FORWARD)
  $ (4,573 )   $ (15,855 )   $ (6,334 )   $ (17,641 )


 
4

 


CECIL BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS (UNAUDITED)
(dollars in thousands, except per share data)

(Continued)

    
Three Months Ended
September 30,
   
Nine Months Ended
September 30,
 
   
2013
   
2012
   
2013
   
2012
 
                         
NET LOSS (BROUGHT FORWARD)
  $ (4,573 )   $ (15,855 )   $ (6,334 )   $ (17,641 )
                                 
OTHER COMPREHENSIVE (LOSS) GAIN
                               
  Amounts reclassified to gain on sale of investments
    -       -       (375 )     -  
  Unrealized (losses) gains on
                               
   investment securities,
                               
   net of taxes of $0 and $60 for the quarter
                               
   ended September 30, 2013 and 2012, respectively,
                               
   and $0 and $121 for the nine months ended
                               
   September 30, 2013 and 2012, respectively
    (120 )     100       (1,243 )     202  
 
                               
TOTAL COMPREHENSIVE LOSS
  $ (4,693 )   $ (15,755 )   $ (7,952 )   $ (17,439 )
                                 
NET LOSS
  $ (4,573 )   $ (15,855 )   $ (6,334 )   $ (17,641 )
                                 
PREFERRED STOCK DIVIDENDS
                               
  AND DISCOUNT ACCRETION
    (222 )     (359 )     (664 )     (726 )
                                 
NET LOSS AVAILABLE TO
                               
  COMMON STOCKHOLDERS
  $ (4,795 )   $ (16,214 )   $ (6,998 )   $ (18,367 )
                                 
Loss per common share - basic
  $ (0.65 )   $ (2.18 )   $ (0.94 )   $ (2.47 )
                                 
Loss per common share - diluted
  $ (0.65 )   $ (2.18 )   $ (0.94 )   $ (2.47 )
                                 
Dividends declared per common share
  $ 0.00     $ 0.00     $ 0.00     $ 0.00  

See accompanying notes to consolidated financial statements.














 
5

 

CECIL BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2013 AND 2012
 (dollars in thousands)

    
2013
   
2012
 
             
CASH FLOWS FROM OPERATING ACTIVITIES:
           
  Net loss
  $ (6,334 )   $ (17,641 )
  Adjustments to reconcile net loss to net cash
               
    provided by operating activities:
               
   Depreciation and amortization
    892       1,014  
   Provision for loan losses
    4,350       5,910  
   Gain on sale of loans
    (200 )     (1,381 )
   Loss on sale of other real estate owned
    312       225  
   Gain on sale of investments
    (375 )     -  
   Loss on premises and equipment
    10       6  
   Gain on assets held for sale
    -       (18 )
   Increase in cash surrender value of bank owned life insurance
    (95 )     (138 )
   Valuation allowance on other real estate owned
    992       5,338  
   Valuation allowance on deferred tax assets
    -       9,187  
   Excess servicing rights
    (47 )     (58 )
   Origination of loans held for sale
    (5,296 )     (19,427 )
   Proceeds from sales of loans held for sale
    5,454       20,789  
   Net change in:
               
     Accrued interest receivable and other assets
    (1,058 )     (323 )
     Other liabilities
    1,903       913  
       Net cash provided by operating activities
    508       4,396  
CASH FLOWS FROM INVESTING ACTIVITIES:
               
  Purchases of investment securities available-for-sale
    (25,050 )     (13,692 )
  Purchases of investment securities held-to-maturity
    (500 )     (500 )
  Net redemption of restricted investment securities
    226       92  
  Proceeds from sales, maturities, calls and principal payments of
               
   investment securities available-for-sale
    12,493       8,054  
  Proceeds from maturities, calls and principal payments of
               
   investment securities held-to-maturity
    2,092       5,253  
  Proceeds received from sale of branch
    1,869       -  
  Net decrease (increase) in loans
    9,090       (10,728 )
  Proceeds from sale of other real estate owned
    6,547       2,768  
  Proceeds from sale of premises and equipment
    975       25  
  Proceeds from sale of assets held for sale
    -       5,911  
  Purchases of premises and equipment
    (106 )     (143 )
       Net cash provided by (used in) investing activities
    7,636       (2,960 )
CASH FLOWS FROM FINANCING ACTIVITIES:
               
  Net (decrease) increase in deposits
    (20,561 )     3,039  
  Net decrease in advances from Federal Home Loan Bank of Atlanta
    -       (10,000 )
  Net decrease in other borrowed funds
    (1,069 )     -  
  Proceeds from issuance of preferred stock
    -       2,796  
       Net cash used in financing activities
    (21,630 )     (4,165 )
DECREASE IN CASH AND CASH EQUIVALENTS
    (13,486 )     (2,729 )
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD
    41,806       34,411  
CASH AND CASH EQUIVALENTS AT END OF PERIOD
  $ 28,320     $ 31,682  
                 
Supplemental disclosures of cash flows information:
               
  Cash paid for interest
  $ 3,820     $ 4,595  
  Transfer of loans to other real estate owned
  $ 9,146     $ 18,044  


See accompanying notes to consolidated financial statements.

 
6

 

CECIL BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2013 AND 2012

1.       GENERAL

In the opinion of the Company, the accompanying unaudited consolidated financial statements contain all adjustments (consisting of only normal recurring adjustments) necessary to present fairly the Company’s financial position as of September 30, 2013, the results of its operations and comprehensive loss and cash flows for the three and nine months ended September 30, 2013 and 2012.  These statements are condensed and therefore do not include all of the information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements.  The statements should be read in conjunction with the consolidated financial statements and footnotes included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2012.  The results of operations for the three and nine months ended September 30, 2013 are not necessarily indicative of the results to be expected for the full year or for any other period.

2.       FINANCIAL STATEMENT PREPARATION

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period.  Estimates are used when accounting for uncollectible loans, depreciation and amortization, intangible assets, deferred income taxes, and contingencies, among others.  Actual results could differ from those estimates.

3.       GOING CONCERN CONSIDERATION

Due to our elevated level of nonperforming assets and recurring operating losses, there is substantial doubt regarding our ability to continue as a going concern.  Management is taking steps to improve our financial condition.  The financial statements and the accompanying footnotes have been prepared on a going concern basis, which contemplates the realization of assets and the discharge of liabilities in the normal course of business for the foreseeable future, and does not include any adjustment to reflect the possible future effects on the recoverability and classification of assets, or the amounts and classification of liabilities that may result from the outcome of any extraordinary regulatory action, which would affect our ability to continue as a going concern.

4.       BRANCH SALE

On August 16, 2013, the Bank sold its Aberdeen, Maryland branch office to Howard Bank (“Howard”), Ellicott City, Maryland.  As part of the transaction, Howard acquired a pool of loans with an unpaid principal balance of approximately $37.1 million at book value.  Under the agreement, Howard paid a 5.0% premium on the balance of non-interest bearing deposits and 4.0% on all other transaction accounts assumed.  Certificates of deposit were assumed at the current balance on the closing date, with no premium or discount applied.  As part of the transaction, the deposits assumed by Howard totaled approximately $35.2 million.  The premium received on the assumption of deposits totaled approximately $240,000 and is included in other noninterest income on the consolidated statement of operations and comprehensive loss.  Howard also purchased the branch premises and selected equipment at their book value, which totaled approximately $977,000.

 
7

 
 
The following table shows the composition of the loans (in thousands) sold as part of the agreement.

Real estate loans:    
     
Construction and land development    
  $ 870  
1-4 family residential and home equity     
    6,755  
Multi-family residential    
    394  
Commercial    
    27,779  
Total real estate loans     
    35,798  
Commercial business loans    
    1,228  
Consumer loans
    26  
     Total loans sold
  $ 37,052  

The following table shows the composition of the premises and equipment (in thousands) sold as part of the agreement.

Land    
  $ 190  
Building and improvements     
    948  
Furniture, fixtures and equipment    
    96  
    
    1,234  
Less: accumulated depreciation    
    257  
Total premises and equipment sold
  $ 977  

The following table shows the composition of the deposits (in thousands) sold as part of the agreement.

Regular checking    
  $ 1,707  
NOW accounts
    1,323  
Passbook savings
    48  
Statement savings
    238  
Money market     
    2,254  
Certificates of deposit    
    24,397  
IRA certificates of deposit     
    2,866  
Money market certificates    
    2,351  
Total deposits sold
  $ 35,184  

5.       RECENT ACCOUNTING PRONOUNCEMENTS
 
FASB ASU 2013-02, “Comprehensive Income – Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income”
 
The objective of this ASU, issued in February 2013, is to improve the transparency of reporting reclassifications out of accumulated other comprehensive income (“OCI”) by requiring entities to present in one place information about significant amounts reclassifies and, in some cases, to provide cross references to related footnote disclosures.  The amendments do not change the current requirements for reporting net income or OCI, nor do they require new information to be disclosed.  The amendments were applied prospectively and were effective for public entities in both interim and annual reporting periods beginning after December 15, 2012.

6.       EARNINGS PER SHARE

Basic earnings per common share are computed by dividing net income available to common stockholders by the weighted average number of shares of common stock outstanding during the period.  Diluted earnings per share are computed after adjusting the denominator of the basic earnings per share computation for the effects of all dilutive potential common shares outstanding during the period.  The dilutive effects of options, warrants, and their equivalents are computed using the “treasury stock” method.  For the three and nine months ended September 30, 2013 and 2012, all 523,076 options and warrants were excluded from the diluted earnings per share calculation because their effect was antidilutive.  The calculation of net loss per common share for the three and nine months ended September 30, 2013 and 2012 is as follows:
 
8

 
 
 
 
      
Three Months Ended 
September 30,
   
Nine Months Ended 
September 30,
 
     
2013
   
2012
   
2013
   
2012
 
                           
Basic and diluted:                        
  Net loss   $ (4,573,000 )   $ (15,855,000 )   $ (6,334,000 )   $ (17,641,000 )
  Preferred stock dividends and discount accretion     (222,000 )     (359,000 )     (664,000 )     (7,26,000 )
  Net loss available to common stockholders   $ (4,795,000 )   $ (16,214,000 )   $ (6,998,000 )   $ (18,367,000 )
                                   
  Average common shares outstanding     7,425,869       7,422,164       7,425,864       7,422,164  
                                   
  Basic and diluted loss per common share   $ (0.65 )   $ (2.18 )   $ (0.94 )   $ (2.47 )
 
7.       ACCOUNTING FOR STOCK BASED COMPENSATION PLANS

In November 2009, the Company approved the granting of 120,250 restricted stock awards with a fair market value of $2.00 per share.  The awards vest over a period of five years, with 2,408 shares vesting in November 2013 and 2,412 shares vesting in November 2014.  The vesting of the remaining 103,686 shares is restricted due to the Company’s participation in the Department of Treasury’s Troubled Asset Relief Program Capital Purchase Program.  A summary of the Company’s activity and related information for restricted stock for the periods indicated is as follows:

  
Nine Months Ended
 
Year Ended
 
September 30, 2013
 
December 31, 2012
     
Weighted-
     
Weighted-
     
Average
     
Average
 
Shares
 
Exercise Price
 
Shares
 
Exercise Price
                   
Unvested at beginning of period
108,506
 
$
2.00
 
111,694
 
$
 2.00
Forfeited
   
 
(780
)
 
2.00
Awarded
 —
   
 
   
Released
 —
   
 —
 
(2,408
)
 
 2.00
Unvested at end of period
108,506
 
$
2.00
 
108,506
 
$
2.00


8.       ASSETS MEASURED AT FAIR VALUE

In September 2006, the Financial Accounting Standards Board (“FASB”) issued ASC Topic 820. ASC Topic 820 establishes a framework for measuring fair value in generally accepted accounting principles (“GAAP”), and expands disclosures about fair value measurements. While the Statement applies under other accounting pronouncements that require or permit fair value measurements, it does not require any new fair value measurements. ASC Topic 820 defines fair value as the price that would be received to sell an asset or paid to transfer a liability (an exit price) in an orderly transaction between market participants at the measurement date. In addition, the Statement establishes a fair value hierarchy, which prioritizes the inputs to valuation techniques used to measure fair value into three broad levels. Lastly, ASC Topic 820 requires additional disclosures for each interim and annual period separately for each major category of assets and liabilities.  For Level 2 assets, the Company uses information from a third party pricing service, which is estimated using market prices of comparable instruments or other methods, such as the present value of future cash flows.  The following table shows the value (in thousands) at September 30, 2013 and December 31, 2012 of each major category of assets measured on a recurring basis at fair value on the consolidated balance sheets, which consists of investment securities available-for-sale.  The changes in fair value were reflected as a component of other comprehensive income and did not affect net income.

 
9

 


   
Fair Value Measurements at Reporting Date Using
 
Description
 
Carrying
Value
   
Quoted Prices
in Active
Markets For
Identical
Assets
(Level 1)
   
Significant
Other
Observable
Inputs
(Level 2)
   
Significant
Unobservable
Inputs
(Level 3)
 
September 30, 2013
                       
Investment securities available-for-sale
                       
Mutual funds – mortgage securities
  $ 708     $ 708     $     $  
Mutual funds – U.S. Government
                               
   securities
    662       662              
SBA securitized loan pools
    4,324             4,324        
Other debt securities
    599             599        
Residential mortgage-backed securities
    38,128             38,128        
Total investment securities available-for-sale
  $ 44,421     $ 1,370     $ 43,051     $  
                                 
December 31, 2012
                               
Investment securities available-for-sale
                               
Mutual funds – mortgage securities
  $ 709     $ 709     $     $  
Mutual funds – U.S. Government
                               
   securities
    673       673              
Equity securities
    482       482              
SBA securitized loan pools
    3,658             3,658        
Other debt securities
    732             732        
Mortgage-backed securities
    27,250             27,250        
Total investment securities available-for-sale
  $ 33,504     $ 1,864     $ 31,640     $  

We may be required from time to time to measure certain other financial assets and liabilities at fair value on a nonrecurring basis.  These adjustments to fair value usually result from application of lower of cost or market accounting or write-downs of individual assets.  For assets measured at fair value on a nonrecurring basis at September 30, 2013 and December 31, 2012, the following table provides (in thousands) the level of valuation assumptions used to determine each adjustment and the carrying value of the assets.  For both other real estate owned and impaired loans, Level 3 assets are valued at the lesser of the unpaid principal balance of the loan, or the appraised value of the underlying collateral, net of estimated selling costs, as determined by a third party appraiser.  There were no transfers between valuation levels for any assets during the nine months ended September 30, 2013 or the year ended December 31, 2012.
 
 
10

 


   
Fair Value Measurements at Reporting Date Using
 
         
Quoted Prices
             
         
In Active
   
Significant
       
         
Markets for
   
Other
   
Significant
 
         
Identical
   
Observable
   
Unobservable
 
   
Carrying
   
Assets
   
Inputs
   
Inputs
 
Description
 
Value
   
(Level 1)
   
(Level 2)
   
(Level 3)
 
September 30, 2013
                       
Other real estate owned:
                       
  Construction & Land Development
  $ 24,332     $ 0     $ 0     $ 24,332  
  1-4 Family Residential
    3,308       0       0       3,308  
  Commercial Real Estate
    7,305       0       0       7,305  
     Total
  $ 34,945     $ 0     $ 0     $ 34,945  
                                 
Impaired loans:
                               
  Construction & Land Development
  $ 13,616     $ 0     $ 0     $ 13,616  
  1-4 Family Residential
    12,981       0       0       12,981  
  Commercial Real Estate
    27,114       0       0       27,114  
  Commercial Business
    48       0       0       48  
     Total
  $ 53,759     $ 0     $ 0     $ 53,759  
 
 
December 31, 2012
                               
Other real estate owned:
                               
  Construction & Land Development
  $ 19,915     $ 0     $ 0     $ 19,915  
  1-4 Family Residential
    6,070       0       0       6,070  
  Commercial Real Estate
    7,886       0       0       7,886  
     Total
  $ 33,871     $ 0     $ 0     $ 33,871  
                                 
Impaired loans:
                               
  Construction & Land Development
  $ 19,674     $ 0     $ 0     $ 19,674  
  1-4 Family Residential
    14,386       0       0       14,386  
  Commercial Real Estate
    18,139       0       0       18,139  
  Commercial Business
    6       0       0       6  
     Total
  $ 52,205     $ 0     $ 0     $ 52,205  

9.           FAIR VALUE OF FINANCIAL INSTRUMENTS

FASB ASC 825-10-50 requires that the Company disclose estimated fair values for both its on and off-balance-sheet financial instruments. The following methods and assumptions were used to estimate the fair value of the Company’s financial instruments. Changes in estimates and assumptions could have a significant impact on these fair values.

Investment Securities - The fair values of investment securities are based on quoted market prices, where available. If a quoted market price is not available, fair value is estimated using quoted market prices of comparable instruments.

Loans Receivable - The fair value of the loan portfolio is estimated by evaluating homogeneous categories of loans with similar financial and credit risk characteristics. Loans are segregated by types, such as residential mortgage, commercial real estate and consumer. Each loan category is further segmented into fixed and adjustable-rate interest terms.

 
11

 
The fair values of each loan category are estimated by discounting contractual cash flows adjusted for estimated prepayments. Assumptions regarding prepayment estimates and discount rates are judgmentally determined by using available market information.

Restricted Investment Securities - The fair value of the Company’s investment in stock of the FHLB and FRB approximates its carrying value.

Deposits - The fair values of deposits are estimated using a discounted cash flow calculation, adjusted for estimated decay rates, that applies interest rates currently offered for funding sources with similar maturities. Assumptions regarding discount rates and decay estimates are judgmentally determined by using available market information.

Junior Subordinated Debentures – The fair value was estimated by computing the discounted value of contractual cash flows payable at current interest rates for obligations with similar remaining terms.

Advances from the FHLB - The fair value of FHLB advances was estimated by computing the discounted value of contractual cash flows payable at current interest rates for obligations with similar remaining terms.

Other Borrowed Funds – The fair value was estimated by computing the discounted value of contractual cash flows at current interest rates for obligations with similar remaining terms.

Commitments to Extend Credit - The Company charges fees for commitments to extend credit. Interest rates on loans for which these commitments are extended are normally committed for periods of less than one month. Fees charged on standby letters of credit and other financial guarantees are deemed to be immaterial and these guarantees are expected to be settled at face amount or expire unused. It is impractical to assign any fair value to these commitments.

The estimated fair values of financial instruments (in thousands) at September 30, 2013 are as follows:

         
Fair Value Measurements at Reporting Date Using
 
         
Quoted Prices
         
         
In Active
 
Significant
     
         
Markets for
 
Other
 
Significant
 
         
Identical
 
Observable
 
Unobservable
 
 
Carrying
     
Assets
 
Inputs
 
Inputs
 
 
Value
 
Fair Value
 
(Level 1)
 
(Level 2)
 
(Level 3)
 
Financial assets:
                             
  Investment securities:
                             
      Available-for-sale
  $ 44,421     $ 44,421     $ 1,370     $ 43,051     $  
      Held-to-maturity
    2,250       2,268             2,268        
  Loans receivable
    245,775       268,685                   268,685  
  Restricted investment securities
    3,977       3,977             3,977        
Financial liabilities:
                                       
  Deposits
    285,475       252,649                   252,649  
  Junior subordinated debentures
    17,000       17,000             17,000        
  Advances from FHLB
    53,500       53,494             53,494        



 
12

 

The estimated fair values of financial instruments (in thousands) at December 31, 2012 are as follows:
 
 
          
Fair Value Measurements at Reporting Date Using
 
         
Quoted Prices
         
         
In Active
 
Significant
     
         
Markets for
 
Other
 
Significant
 
         
Identical
 
Observable
 
Unobservable
 
 
Carrying
     
Assets
 
Inputs
 
Inputs
 
 
Value
 
Fair Value
 
(Level 1)
 
(Level 2)
 
(Level 3)
 
Financial assets:
                             
  Investment securities:
                             
      Available-for-sale
  $ 33,504     $ 33,504     $ 1,864     $ 31,640     $  
      Held-to-maturity
    3,887       3,927             3,927        
  Loans receivable
    306,751       337,044                   337,044  
  Restricted investment securities
    4,204       4,204             4,204        
Financial liabilities:
                                       
  Deposits
    341,219       325,272                   325,272  
  Junior subordinated debentures
    17,000       17,000             17,000        
  Advances from FHLB
    53,500       53,558             53,558        
  Other borrowed funds
    1,088       1,088             1,088        

10.           INVESTMENT SECURITIES

Investment securities have been classified in the consolidated balance sheets according to management’s intent and ability to hold the investment.  Investment securities at September 30, 2013 and December 31, 2012 are summarized in the following table (in thousands).

    September 30, 2013  
           Gross      Gross      Estimated  
    Amortized      Unrealized      Unrealized      Fair  
    Cost      Gains      Losses      Value  
Available-for-Sale:
                       
Mutual funds - mortgage securities
  $ 747     $ 5     $ 44     $ 708  
Mutual funds - U.S. Government securities
    686             24       662  
SBA securitized loan pools
    4,402       12       90       4,324  
Other debt securities
    595       4             599  
Residential mortgage-backed securities
    39,312       77       1,261       38,128  
    $ 45,742     $ 98     $ 1,419     $ 44,421  
                                 
Held-to-Maturity:
                               
SBA securitized loan pools
  $ 940     $     $ 8     $ 932  
Other debt securities
    500       5             505  
Residential mortgage-backed securities
    560       21             581  
U. S. Treasury securities and obligations
    250                   250  
    $ 2,250     $ 26     $ 8     $ 2,268  
 
 
13

 

    September 30, 2013  
           Gross      Gross      Estimated  
     Amortized      Unrealized      Unrealized      Fair  
     Cost      Gains      Losses      Value  
Available-for-Sale:
                       
Mutual funds - mortgage securities
  $ 747     $ 2     $ 40     $ 709  
Mutual funds - U.S. Government securities
    686             13       673  
Equity securities
    226       256             482  
SBA securitized loan pools
    3,658       10       10       3,658  
Other debt securities
    732                   732  
Residential mortgage-backed securities
    27,159       192       101       27,250  
    $ 33,208     $ 460     $ 164     $ 33,504  
                                 
Held-to-Maturity:
                               
SBA securitized loan pools
  $ 1,389     $       17     $ 1,372  
Other debt securities
    500       9             509  
Residential mortgage-backed securities
    1,748       51       3       1,796  
U. S. Treasury securities and obligations
    250                   250  
    $ 3,887     $ 60     $ 20     $ 3,927  

As of September 30, 2013, unrealized losses (in thousands) on securities were comprised of the following based on the length of time that the securities have been in a continuous loss position:

    
Less than 12 Months
   
More than 12 Months
   
Total
 
   
Fair
   
Unrealized
   
Fair
   
Unrealized
   
Fair
   
Unrealized
 
   
Value
   
Losses
   
Value
   
Losses
   
Value
   
Losses
 
Available-for-Sale:
                                   
  Mutual funds – mortgage securities
  $     $     $ 132     $ 44     $ 132     $ 44  
  Mutual funds – US Govt securities
                662       24       662       24  
  SBA securitized loan pools
    1,883       82       399       8       2,282       90  
  Residential mortgage-backed securities
    29,548       1,202       2,644       59       32,192       1,261  
Held-to-Maturity:
                                               
  SBA securitized loan pools
                887       8       887       8  
    $ 31,431     $ 1,284     $ 4,724     $ 143     $ 36,155     $ 1,427  

As of December 31, 2012, unrealized losses (in thousands) on securities were comprised of the following based on the length of time that the securities have been in a continuous loss position:

    
Less than 12 Months
   
More than 12 Months
   
Total
 
   
Fair
   
Unrealized
   
Fair
   
Unrealized
   
Fair
   
Unrealized
 
   
Value
   
Losses
   
Value
   
Losses
   
Value
   
Losses
 
Available-for-Sale:
                                   
  Mutual funds – mortgage securities
  $     $     $ 136     $ 40     $ 136     $ 40  
  Mutual funds – US Govt securities
                673       13       673       13  
  SBA securitized loan pools
                480       10       480       10  
  Residential mortgage-backed securities
    13,554       98       95       3       13,649       101  
Held-to-Maturity:
                                               
  SBA securitized loan pools
    275       2       1,017       15       1,292       17  
  Residential mortgage-backed securities
                270       3       270       3  
    $ 13,829     $ 100     $ 2,671     $ 84     $ 16,500     $ 184  

Management has the intent to hold the securities classified as held-to-maturity in the table above until they mature, at which time the Company will receive full value for the securities.  Furthermore, as of September 30, 2013 and December 31, 2012, management does not have the intent to sell any of the securities classified as available-for-sale in the table above and
 
 
14

 
believes that it is more likely than not that the Company will not have to sell any such securities before a recovery of cost.  Management does not believe that any of the securities are impaired due to reasons of credit quality.  Accordingly, as of September 30, 2013 and December 31, 2012, management believes the impairments detailed in the table above are temporary and no impairment loss has been realized in the Company’s consolidated income statement.

11.           CREDIT QUALITY OF LOANS RECEIVABLE AND ALLOWANCE FOR LOAN LOSSES

The Company has segregated its loan portfolio into six segments, including construction and land development, 1-4 family residential, multi-family residential, commercial real estate, commercial business, and consumer.  The Company’s primary market area is in Northeastern Maryland in Cecil and Harford Counties, so exposure to credit risk is significantly affected by changes in these counties.

Construction lending primarily involves lending for construction of single family residences, although the Bank does lend funds for the construction of commercial properties and multi-family real estate.  All loans for the construction of speculative sale homes have a loan-to-value ratio of not more than 80%.  The Bank has financed the construction of non-residential properties on a case by case basis.  Loan proceeds are disbursed during the construction phase according to a draw schedule based on the stage of completion.  Construction projects are inspected by contracted inspectors or bank personnel.  Construction loans are underwritten on the basis of the estimated value of the property as completed. The Bank originates loans secured by raw land, which are generally granted to developers have terms of up to three years.  The substantial majority of land loans have a loan-to-value ratio not exceeding 75%.  Land loans have a higher level of risk than loans for the purchase of existing homes since collateral values can only be estimated at the time the loan is approved.  The Bank has sought to minimize this risk by offering such financing primarily to builders and developers to whom the Bank has loaned funds in the past and to persons who have previous experience in such projects.

The Bank offers fixed and adjustable rate conventional mortgage loans on one-to-four family residential dwellings.  Most loans are originated in amounts up to $350,000 on properties located in the Bank’s primary market area.  These loans are generally for terms of 15, 20 and 30 years amortized on a monthly basis with interest and principal due each month.  The Bank retains all adjustable rate mortgage loans it originates and sells the majority of fixed rate loans, primarily to FHLMC, with servicing retained by the Bank.  The retention of adjustable rate loans helps reduce the Bank’s exposure to rising interest rates.  However, it is possible that during periods of rising interest rates, the risk of default on adjustable rate mortgage loans may increase due to the upward adjustment of the interest cost to the borrower.

The Bank originates multi-family residential loans in its market area.  These loans are generally larger and involve greater risks than one-to-four family residential loans.  Because payments on these loans are often dependent on the successful operation or management of the property, repayment of such loans may be subject to a greater extent to adverse conditions in the real estate market or the economy.  The Bank seeks to minimize these risks in a variety of ways, including limiting the size and loan-to-value ratios.  The loans typically have terms of 20 to 40 years, with rate adjustments every one, three, or five years.  They generally have imbedded interest rate floors, with no interest rate ceilings, and have no interest rate change limitations.

The Bank primarily originates commercial real estate loans in its market area.  These loans are generally larger and involve greater risks that one-to-four family residential loans.  Because payments on these loans are often dependent on the successful operation or management of the property, repayment of such loans may be subject to a greater extent to adverse conditions in the real estate market or the economy.  The Bank seeks to minimize these risks in a variety of ways, including limiting the size and loan-to-value ratios.  The loans typically have terms of 20 to 40 years, with rate adjustments every one, three, or five years.  They generally have imbedded interest rate floors, with no interest rate ceilings, and have no interest rate change limitations.  The Bank’s commercial real estate loans are typically secured by retail or wholesale establishments, motels/hotels, service industries, and industrial or warehouse facilities.  During 2011, the Bank began making loans under the Small Business Administration (“SBA”) Section 7(a) program, under which the SBA guarantees up to 75% of loans of up to $5 million for the purchase or expansion of small businesses.  The Bank may sell the guaranteed portion of SBA loans into the secondary market and retain the unguaranteed portion in its portfolio.

The Bank offers secured and unsecured commercial business loans and lines of credit to businesses located in its primary market area.  Most business loans have a one-year term, while lines of credit can remain open for longer periods.  All owners, partners, and officers must sign the loan agreement.  The security for a business loan depends on the amount borrowed, the business involved, and the strength of the borrower’s firm.  Commercial business lending entails significant risk, as the payments on such loans may depend upon the successful operation or management of the business involved.  Although the Bank
 
 
15

 
attempts to limit its risk of loss on such loans by limiting the amount and the term, and by requiring personal guarantees of the principals of the business, the risk of loss on these loans is substantially greater than the risk of loss from residential real estate lending.

The Bank’s consumer loans consist of automobile loans, deposit account loans, home improvement loans, and other consumer loans.  The loans are generally offered for terms of up to five years at fixed interest rates.  Consumer loans are generally originated at higher interest rates than residential mortgage loans because of their higher risk.  Repossessed collateral for a defaulted loan may not provide an adequate source of repayment as a result of damage, loss, or depreciation.  In addition, collections are dependent on the borrower’s continuing financial stability, and thus are more likely to be adversely affected by job loss, divorce, illness, or personal bankruptcy.

On an ongoing basis, the Bank assigns a grade to each of its loans.  The internal grades are pass, special mention, substandard, doubtful, and loss.  Loans graded pass are loans where the borrower exhibits a strong balance sheet position and good earnings and cash flow history.  Loans graded special mention show potential weaknesses that deserve the Bank’s close attention.  If these potential weaknesses are not corrected, they may result in deterioration of the repayment prospects for the loan in the Bank’s credit position at some future date.  Substandard loans are inadequately protected by the current sound worth and paying capacity of the borrower or of the collateral pledged, if any.  Substandard loans have a well defined weakness that could jeopardize the liquidation of the debt.  They are characterized by the distinct possibility that the Bank will sustain some loss if the weaknesses are not corrected.  Loans graded doubtful have all the weaknesses inherent in substandard loans with the added characteristic that the weaknesses make collection or liquidation in full highly improbable.  Assets graded loss are considered uncollectible and of such little value that their continuance as an asset is not warranted.  The classification does not mean the loan has absolutely no recovery value, but that it is not practical to defer charging off the loan even though partial recovery may be effected in the future.

The following table shows the composition of the loan portfolio held for investment (in thousands) at September 30, 2013 and December 31, 2012.

   
2013
   
2012
 
Real estate loans:    
           
Construction and land development    
  $ 38,586     $ 57,731  
1-4 family residential and home equity     
    82,768       90,406  
Multi-family residential    
    4,845       5,306  
Commercial    
    111,140       143,263  
    Total real estate loans     
    237,339       296,706  
Commercial business loans    
    6,806       7,879  
Consumer loans    
    1,630       2,166  
    Gross loans    
    245,775       306,751  
Less allowance for loan losses    
    (8,919 )     (10,297 )
    Net loans     
  $ 236,856     $ 296,454  
 

 
16

 


In accordance with the standards issued under the Disclosures of Credit Quality of Financing Receivables and the Allowance for Loan Losses, the following tables show credit quality indicators, the aging of receivables, and disaggregated balances of loans receivable and the allowance for loan losses (in thousands) as of September 30, 2013 and December 31, 2012.

Credit Quality Indicators
 
As of September 30, 2013
 
   
Construction
                                     
   
& Land
   
1-4 Family
   
Multi-Family
   
Commercial
   
Commercial
             
   
Development
   
Residential
   
Residential
   
Real Estate
   
Business
   
Consumer
   
Total
 
                                           
Credit risk profile by internally assigned grade:
                                         
                                           
Pass
  $ 7,524     $ 65,010     $ 4,567     $ 87,669     $ 6,644     $ 1,610     $ 173,024  
Special mention
    15,935       6,086       278       11,286       61       20       33,666  
Substandard
    15,127       11,672       -       12,185       101       -       39,085  
Total
  $ 38,586     $ 82,768     $ 4,845     $ 111,140     $ 6,806     $ 1,630     $ 245,775  
                                                         
Credit risk profile based on payment activity:
                     </