Back to GetFilings.com

Table of Contents

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

For the quarterly period ended September 30, 2004

or

For the transition period from              to             

Commission File Number 33-58936

Dimeco, Inc.

(Exact name of registrant as specified in its charter)

820 Church Street

Honesdale, PA 18431

(Address of principal executive offices)

(570) 253-1970

(Issuer’s Telephone Number)

Not Applicable

(Former name, former address and former fiscal year, if changed since last report)

Check whether the issuer (1) filed all reports required to be filed by Sections 13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

Indicate by check mark whether the registrant is an accelerated filer (as defined by Rule 12b-2 of the Exchange Act)    Yes  ¨    No  x

As of October 31, 2004, the registrant had outstanding 1,545,994 shares of its common stock, par value $.50 share.

Table of Contents

Dimeco, Inc.

INDEX

–2–

Table of Contents

Dimeco, Inc.

CONSOLIDATED BALANCE SHEET (unaudited)

See accompanying notes to the unaudited consolidated financial statements.

–3–

Table of Contents

Dimeco, Inc.

CONSOLIDATED STATEMENT OF INCOME (unaudited)

(in thousands, except per share)

See accompanying notes to unaudited consolidated financial statements.

–4–

Table of Contents

Dimeco, Inc.

CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME (unaudited)

See accompanying notes to the unaudited consolidated financial statements.

–5–

Table of Contents

Dimeco, Inc.

CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS’ EQUITY (unaudited)

See accompanying notes to the unaudited consolidated financial statements.

–6–

Table of Contents

Dimeco, Inc.

CONSOLIDATED STATEMENT OF CASH FLOWS (unaudited)

(in thousands)

See accompanying notes to unaudited consolidated financial statements.

–7–

Table of Contents

Dimeco, Inc.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

NOTE 1 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Basis of Presentation

The consolidated financial statements include the accounts of Dimeco, Inc. (the “Company”) and its wholly-owned subsidiary The Dime Bank (the “Bank”). The financial statements of The Dime Bank include the consolidated financial statements of the Bank’s wholly-owned subsidiary, TDB Insurance Services, LLC. All significant intercompany balances and transactions have been eliminated in the consolidation.

The accompanying unaudited consolidated financial statements have been prepared in accordance with the instructions to Form 10-Q and, therefore, do not necessarily include all information that would be included in audited financial statements. The information furnished reflects all adjustments which are, in the opinion of management, necessary for a fair statement of the results of operations. All such adjustments are of a normal recurring nature. The results of operations for the interim periods are not necessarily indicative of the results to be expected for the full year.

Certain comparative amounts for prior periods have been reclassified to conform to current year presentation. The reclassifications did not affect net income or equity capital.

Recent Accounting Pronouncements

In December 2003, the Financial Accounting Standards Board (“FASB”) issued a revision to Interpretation 46, Consolidation of Variable Interest Entities, which established standards for identifying a variable interest entity (VIE) and for determining under what circumstances a VIE should be consolidated with its primary beneficiary. Application of this Interpretation is required in financial statements of public entities that have interests in special-purpose entities for periods ending after December 15, 2003. Application by public entities, other than small business issuers, for all other types of VIEs is required in financial statements for periods ending after March 15, 2004. Small business issuers must apply this Interpretation to all other types of VIEs at the end of the first reporting period ending after December 15, 2004. The adoption of this interpretation has not and is not expected to have a material effect on the Company’s financial position or results of operations.

The Company accounts for interest rate lock commitments (IRLCs) for mortgage loans which it intends to sell, as derivatives, in accordance with the requirements of SFAS No. 133. In March 2004, the SEC staff released Staff Accounting Bulletin (SAB) No. 105 that requires all registrants to exclude the future cash flows for servicing loans from the fair value of IRLCs. The Company enters into such commitments with customers in connection with residential mortgage loan applications. This statement delays the recognition of any servicing revenues related to these commitments until such time as the loan is sold, however, the pronouncement would have no effect on the ultimate amount of revenue or cash flows recognized over time. This pronouncement was effective April 1, 2004. The adoption of SAB 105 has not and is not expected to have a material impact on the Company’s financial condition or results of operations.

In March 2004, the Financial Accounting Standards Board (“FASB”) reached consensus on the guidance provided by Emerging Issues Task Force Issue 03-1 (“EITF 03-1”), The Meaning of Other-Than-Temporary Impairment and its Application to Certain Investments. The guidance is applicable to debt and equity securities that are within the scope of FASB Statement of Financial Accounting Standard (“SFAS”) No. 115, Accounting for Certain Investments In Debt and Equity Securities and certain other investments. EITF 03-1 specifies that an impairment would be considered other-than temporary unless (a) the investor has the ability and intent to hold an investment for a

–8–

Table of Contents

reasonable period of time sufficient for the recovery of the fair value up to (or beyond) the cost of the investment and (b) evidence indicating the cost of the investment is recoverable within a reasonable period of time outweighs evidence to the contrary. EITF 03-1 cost method investment and disclosure provisions were effective for reporting periods ending after June 15, 2004. The measurement and recognition provisions relating to debt and equity securities have been delayed until the FASB issues additional guidance. The Company adopted cost method investment and disclosure provisions of EITF 03-1 on June 30, 2004. The adoption did not have a material impact on the consolidated financial statements, results of operations or liquidity of the Company

Stock Options

As permitted under Statement of Financial Accounting Standards (“FAS”) No. 123 “Accounting for Stock-based Compensation,” the Company has elected to continue following Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” (“APB 25”), and related Interpretations, in accounting for stock-based awards to employees. Under APB 25, because the exercise price of the Company’s employee stock options equals the market price of the underlying stock on the date of the grant, no compensation expense is recognized in the Company’s financial statements. The following table represents pro forma net income and earnings per share had compensation expense been included in stock option plan costs as determined based on the fair value at the grant dates for options granted under these plans consistent with FAS No. 123:

NOTE 2 – EARNINGS PER SHARE

There are no convertible securities which would affect the numerator in calculating basic and diluted earnings per share; therefore, net income as presented on the Consolidated Statement of Income (unaudited) will be used as the numerator. The following table sets forth the composition of the weighted-average common shares (denominator) used in the basic and diluted earnings per share computation.

–9–

Table of Contents

The 2003 numbers have been adjusted to reflect the 100% stock split effected in the form of a dividend on December 1, 2003.

–10–

Table of Contents

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Forward Looking Statement

The Private Securities Litigation Act of 1995 contains safe harbor provisions regarding forward-looking statements. When used in this discussion, the words, “believes,” “anticipates,” “contemplated,” “expects,” and similar expressions are intended to identify forward-looking statements. Such statements are subject to certain risks and uncertainties that could cause actual results to differ materially from those projected. Those risks and uncertainties include changes in interest rates, the ability to control costs and expenses, and general economic conditions. The Company undertakes no obligation to publicly release the results of any revisions to those forward-looking statements which may be made to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events.

Sarbanes-Oxley Act of 2002

On July 30, 2002 the President signed into law the Sarbanes-Oxley Act of 2002 (the Act), following an investigative order proposed by the SEC on chief financial officers and chief executive officers of 947 large public companies on June 27, 2002. As a result of the accounting restatements by large public companies, the passage of the Act and regulations expected to be implemented by the SEC, publicly-registered companies, such as the Company, will be subject to additional reporting regulations and disclosure. These new regulations, which are intended to curtail corporate fraud, will require certain officers to personally certify certain SEC filings and financial statements and may require additional measures to be taken by our outside auditors, officers and directors. The loss of investor confidence in the stock market and the new laws and regulations will increase non-interest expenses of the Company and could adversely affect the prices of publicly-traded stocks, such as the Company.

Financial Condition

Total assets increased $17,250,000 or 5.7% from December 31, 2003 to September 30, 2004.

Cash and cash equivalent increased $3,098,000 or 30.3% due mainly to larger balances in federal funds sold. The Company uses these interest-bearing overnight investments for liquidity purposes.

Due to the Company’s continued loan demand, investment securities available for sale at September 30, 2004 decreased $20,511,000 or 31.9% from December 31, 2003. Deposits growth has not matched the activity in loan demand necessitating the use of funds from investment maturities for loan originations. The loan portfolio does return higher interest yields than investment grade securities and management feels that it is appropriate to use proceeds of investment maturities for this purpose in anticipation of increased deposits with the opening of a new branch in the fourth quarter of 2004. We believe that the ideal ratio of loans to deposits should be approximately 85% in order to manage risk and contribute to profitability and will strive to approach this ratio as deposit growth increases. This philosophy will include investment in securities available for sale as deposits grow.

Loans increased $32,903,000 or 15.0% from December 31, 2003 to September 30, 2004. Commercial real estate loans accounted for the majority of growth, increasing by $23,235,000 or 20.7% with the majority attributable to the origination of several large loans in the sporting/recreational and camping segment. Loans

–11–

Table of Contents

have been granted to businesses in other industries along with these loans but are concentrated in this type loan because the Company has developed an expertise in developing relationships in camping related industries. Commercial loans increased $7,252,000 or 22.5% over the period due to a municipal authority loan, construction equipment loans and increases in various business lines of credit.

Premises and equipment balances have grown by $980,000 or 23.5% due mainly to the construction of the fifth branch office in Dingmans Ferry, PA. In addition the Company has invested funds in computer hardware during the period as is normal in order to improve business operation through investment in technological advances such as microcomputer networks.

Total deposits increased $7,860,000 or 3.0% from December 31, 2003 to September 30, 2004. These increases were in both interest-bearing and noninterest bearing products. Noninterest bearing balances increased due to the development of new customer relationships combined with higher balances required for several products in order to waive service fees. Balances in our money market and interest-bearing checking accounts have increased $23,383,000 or 42.7% during the period which we believe is due to offering more competitive interest rates resulting in both new bank customers and additional deposits from existing customers while some fluctuation is due to customer’s seasonal activity. Certificates of deposit balances have declined $19,395,000 or 14.2% with customers using the aforementioned higher yielding deposit types along with traditional seasonal maturities for certain high-balance customers. Growth of deposits has not been as quick as we anticipated, we believe due to the trend for customers to re-enter equity markets or the use of insurance products to replace traditional bank deposits. We will continue our concentrated efforts to attract additional deposits with increased rates and targeted marketing programs. In addition, we expect to see an upsurge in deposits with the opening of a new branch in the fourth quarter of 2004.

Other borrowed funds increased $8,845,000 due to borrowings from the FHLB to fund specific long term loans. Customers have requested fixed rate loan commitments and in order to maintain customer relationships and offset interest rate risk, management has used fixed rate financing to achieve this goal.

Stockholders’ equity increased $1,477,000 or 5.4% from December 31, 2003 to September 30, 2004. Net income of $2,672,000 was offset by dividend declarations of $1,061,000. Officers’ and directors’ exercise of stock options represented $209,000 of additional increases. Available for sale investments declined in market value, representing a decrease of $343,000 during the period. Regulatory capital ratios of 12.1% total risk-based capital and 10.8% Tier I capital greatly exceeded the regulatory guidelines of 8.0% and 4.0%. The Company’s leverage ratio was 9.1% at September 30, 2004 and compared favorably to the regulatory minimum of 3.0%.

Results of Operations

Comparison of the three months ended September 30, 2004 and 2003

Net income for the three months ended September 30, 2004 was $1,038,000 representing an increase of $18,000 or 1.8% over net income in the third quarter of 2003.

Net interest income increased $260,000 or 9.7% in the current year third quarter as compared to the same period in 2003. Interest and fees on loans increased $283,000 or 8.6% in 2004 as compared to 2003. The average balance of loans increased $32,027,000 or 15.1% in 2004 as compared to 2003 while the average interest rate received decreased from 6.14% in the third quarter of 2003 to 5.86% in the current year. As noted above, the Company has seen substantial growth in the loan portfolio during the current year. Commercial real estate loans are typically granted with a fixed rate of interest for a two to three year period converting to an adjustable

–12–

Table of Contents

interest rate for future periods, generally based on the prime rate. Along with the lower market interest rates on new loan originations in general during the past few years, variable rate loans comprise approximately 68% of the loan portfolio. Due to lower market interest rates, the majority of these loans repriced downward over the past few years.

Interest earned on taxable investment securities decreased $66,000 or 13.6% in the third quarter of 2004 as compared to 2003. The average size of the portfolio decreased $5,132,000 or 9.6% while the average interest rate declined 12 basis points from 3.57% to 3.45%. Maturities and calls of investments which were purchased while interest rates were higher than current rates were not able to be reinvested at similar rates without longer durations. With the current rising interest rates management has invested mainly in short term commercial paper which will be available to reprice upward as rates increase.

Interest expense on deposits decreased $98,000 or 9.1% in 2004 as compared to 2003. The average balance of interest-bearing deposits increased $12,341,000 or 5.7% while the average interest rate paid declined 29 basis points to 1.70% in 2004 from 1.99% in 2003. Interest expense in relation to other borrowed funds increased $44,000 or 80.0% in relation to an average increase of $7,415,000 or 171.6% in FHLB borrowings used to provide fixed rate financing to our commercial customers while managing interest rate risk as noted above.

The provision for loan losses is charged to operations to bring the total allowance for loan losses to a level that represents management’s best estimates of the losses inherent in the portfolio, based on:

The provision for loan losses increased $31,000 or 13.5% from 2003 to 2004. Growth of $33,252,000 or 15.2% in the loan portfolio was recorded from September 30, 2003 to September 30, 2004, which is one of the primary reasons for larger provision expense.

Noninterest income decreased slightly in the third quarter of 2004 as compared to the same period in 2003. Service charge income continued to increase during the current year with $64,000 or 25.2% greater income in the third quarter of 2004 as compared to the same quarter of 2003 due to a larger number of eligible accounts combined with greater utilization of the payment privilege feature. Gains on mortgage loans held for sale declined $113,000 or 45.7% in 2004 as compared to 2003. As anticipated, sales volume of mortgage loans has slowed in 2004 from the high levels experienced in 2003.

Salaries and employee benefits increased $60,000 or 6.6% in the third quarter of 2004 as compared to 2003. Normal annual salary adjustments and the associated increases in the cost of employee benefits were the primary cause of this increase.

Other expense increased $79,000 or 9.6% in the third quarter of 2004 as compared to 2003. Furniture and equipment expense increased $26,000 or 23.7% due to costs associated with computer equipment Occupancy expense increased $16,000 or 11.6% due mainly to a one-time depreciation adjustment in September 2003. Advertising expense increased $18,000 or 37.8% due to increased costs associated with marketing to our newest location which will open in the fourth quarter of 2004 as compared to a period of low activity in 2003.

–13–

Table of Contents

Comparison of the nine months ended September 30, 2004 and 2003

Net income for the nine months ended September 30, 2004 was $2,672,000 as compared to $2,866,000 for the same period in 2003. An increase in the provision for loan losses combined with lower income recognized on the sale of loans in the secondary market were the largest events contributing to this decline.

Interest and fees on loans increased $471,000 or 4.9% in 2004 as compared to 2003 as a result of an increase in the average loan balance of $30,406,000 or 15.0% from 2003 to 2004. The average interest rate earned on these loans declined from 6.35% in 2003 to 5.77% due to lower offering rates in recent years combined with repricing of the variable portion of the portfolio. As a result of recent increases in the prime rate of interest, we expect to see a gradual increase in interest earned based upon repricing of variable interest rate loans along with higher rates for new loan originations.

Interest earned on taxable investment securities declined $347,000 or 21.2% in 2004 as compared to 2003 due to a combination of a smaller volume of investments and lower interest rates earned. The average size of the portfolio decreased $8,342,000 or 14.5% over the period while the average interest rate earned declined 30 basis points to 3.45% in 2004. Due to the investment strategy of purchasing short term investments or U.S. Government step up bonds, management is willing to accept lower interest rates while maintaining liquidity and allowing for reinvestment in higher yielding securities in the current rising interest rate environment.

Interest expense relating to deposits declined $427,000 or 12.7% in 2004 as compared to the same period in 2003. This decrease in expense is directly related to a decrease of 100 basis points in average interest rates paid in 2004 as compared to the average rate paid in 2003. During this period average deposits increased $14,691,000 or 6.8%. As a result of lower market interest rates in recent years, the average rate has declined as management has lowered rates for specific products resulting in a direct decrease in expense for immediately repricing deposits combined with lower expense paid on time deposits which have matured and are repriced at current rates. Management does expect to see an increase in the average interest rates paid for deposits in the near future as a result of recent and anticipated increases in market interest rates and special promotions in relation to our new branch opening.

As a result of the aforementioned changes in interest earned and interest paid, net interest income increased $529,000 or 6.7% in 2004 as compared to 2003.

The provision for loan loss was $446,000 or 65.6% greater in 2004 as compared to 2003. This increase is due to normal increases in the allowance for loan loss as a result of changes in the loan portfolio, including growth in the total loan portfolio and other considerations along with greater provision expense in the first and second quarter of 2004 related to a decline in the collateral value of a commercial real estate loan which caused a charge-off and additions to the allowance for loan loss as a result of the lower value.

Service charges on deposit accounts increased $183,000 or 24.1% to equal $942,000 in 2004 as compared to 2003. A combination of a larger number of deposit accounts on which to earn this income, one more month of the payment privilege product income in 2004 as compared to 2003, and greater customer utilization of the product contributed to larger revenues.

Gains on mortgage loans held for sale declined $367,000 or 55.4% in 2004 as compared to 2003 with a 64.8% decline in the number of loans sold in 2004 as compared to 2003. Although fewer loans were originated and

–14–

Table of Contents

sold in 2004 as compared to 2003, similar gains are being recognized per loan sale in 2004. Management did anticipate that this activity would show a substantial decrease in 2004 since so many residential mortgages were booked due to refinancing or new purchase in the low interest rate period of 2003.

Brokerage commissions increased $244,000 in 2004 as compared to 2003 mainly due to the commencement of this activity at the end of the second quarter of 2003, generating five more months of this activity in 2004 as compared to 2003. Income generated from this department is expected to be lower for the remainder of 2004 as the first quarter included one-time fees earned on the transfer of accounts to the new program. Management has discussed the disintermediation of deposits as a result of activity in the investment department but believe that the majority of activity in these products will come from outside sources, although loss of a small portion of the current deposit base has been anticipated.

Salaries and employee benefits increased $299,000 or 11.6% for the first half of 2004 as compared to 2003. Larger salaries with the addition of officers and nonexempt employees throughout 2003 due to growth of the Company, higher benefit expenses for health insurance and a greater number of employees eligible for the 401(k) plan all contributed to this increase.

Other noninterest expense increased $266,000 or 11.2% in 2004 as compared to 2003. In particular, donations have increased $40,000 or 90.2% due to the timing of certain donations and a greater number of recipients with our entry into a new market; costs associated with new computer software platforms installed in 2004 were $39,000 or 21.3% greater than in 2003; the Company has increased advertising by $29,000 or 22.1% in an effort to increase market share of deposits and introduce the Company in our new market area; a one-time expense relating the discontinuation of an agreement for trust services of $17,000; an increase of $18,000 or 20.2% in expenses relating to the ATM network due to increased usage and generation of new cards. Other changes of smaller magnitudes are responsible for the remaining increases.

–15–

Table of Contents

Liquidity and Cash Flows

To ensure that the Company can satisfy customer credit needs for current and future commitments and deposit withdrawal requirements, the Bank manages the liquidity position by ensuring that there are adequate short-term funding sources available for those needs. Liquid assets consist of cash and due from banks, federal funds sold, interest-bearing deposits with other banks and investment securities maturing in one year or less. The following table shows these liquidity sources, minus short-term borrowings, as of September 30, 2004 compared to December 31, 2003:

Other sources of liquidity are cash flows from regularly scheduled and prepayments of loans, sales or maturities in the investment portfolio, sales of residential mortgages in the secondary market, operating income and deposit growth. The Consolidated Statement of Cash Flows specifically details the contribution of each source. In addition, the Bank has the ability to borrow from the Federal Home Loan Bank of Pittsburgh with the maximum borrowing capacity at September 30, 2004 of $55 million.

Management monitors liquidity on a consistent basis and feels that liquidity levels are adequate. We are not aware of any known trends, events or uncertainties that will have or is reasonably likely to have a material effect on the Company’s liquidity, capital resources or operations nor is management aware of any current recommendations by regulatory authorities, which if implemented, would have such an effect.

Risk Elements

The table below presents information concerning nonperforming assets including nonaccrual loans, renegotiated loans, loans 90 days or more past due, other real estate loans and repossessed assets at September 30, 2004 and December 31, 2003. A loan is classified as nonaccrual when, in the opinion of management, there are doubts about collectability of interest and principal. At the time the accrual of interest is discontinued, future income is recognized only when cash is received. Renegotiated loans are those loans which terms have been renegotiated to provide a reduction or deferral of principal or interest as a result of the deterioration of the borrower.

–16–

Table of Contents

Management believes the level of the allowance for loan losses at September 30, 2004 is adequate to cover probable losses inherent in the loan portfolio. The relationship between the allowance for loan losses and outstanding loans is a function of the credit quality and known risk attributed to the loan portfolio. The on-going loan review program and management analysis is used to determine the adequacy of the allowance for loan losses.

Included in total loans are loans of $1,184,000 which management has classified as impaired under the terms of FAS No. 114, “Accounting by Creditors for Impairment of a Loan – Income Recognition and Disclosure”. The related allowance for loan losses on these loans amounted to $375,000. There were no impaired loans without a related allowance for loan losses. The average balance of impaired loans for the year to date was $2,131,000.

–17–

Table of Contents

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

A key function of management in its role as the Asset/Liability Committee (“ALCO”) is to evaluate the Company’s exposure to interest rate risk. The primary business of the Company in the financial services industry is to act as a depository financial intermediary. In this role, an integral element of risk involves the chance that prevailing interest rates will adversely affect assets, liabilities, capital, income and/or expense at different times and in different amounts. The ALCO is comprised of all senior officers of the Bank. This committee reports directly to the Board of Directors on at least a quarterly basis.

Two separate reports are used to assist in measuring interest rate risk. The first is the Statement of Interest Sensitivity Gap report. This report matches all interest-earning assets and all interest-bearing liabilities by the time frame, or bucket, in which funds can be reinvested or repriced. The second report is the Interest Rate Shock Analysis discussed in more detail below. In both reports, there are inherent assumptions that must be used in the evaluation. These assumptions include the maturity or repricing times of deposits, even though all deposits, other than time deposits, have no stated maturity and the reference that interest rate shifts will be parallel, with the rates of assets and liabilities shifting in the same amount in the same time frame. In reality, various assets and various liabilities will react differently to changes in interest rates, with some lagging behind the change and some anticipating the upcoming change and reacting before any actual change occurs. Each tool also suggests that there is a propensity to replace assets and liabilities with similar assets and liabilities rather than taking into consideration management’s ability to reallocate the Balance Sheet. In addition, the models used do not include any elements to determine how an action by management to increase or decrease interest rates charged on loans or paid on deposits or to increase borrowings at the FHLB will affect the results of the analysis. In spite of these limitations, these analyses are still very good tools to assist in management of the Company and similar versions of these same reports are used by all financial institutions.

–18–

Table of Contents

Statement of Interest Sensitivity Gap

As this report shows, the Company was nearly balanced with a slight asset sensitive position at September 30, 2004. This means that in the one year time frame, or bucket, there were more interest-sensitive assets than liabilities. Management feels that the optimal position in a rising interest rate scenario is to be asset sensitive since assets tend to reprice quicker than liabilities. The Company has classified its callable, step-up U.S. Government Agency bonds in the periods in which the bonds will next reprice versus the period in which they mature since, in management’s judgment, these repricing events will occur either through the purchase terms or through the call functions inherent in the bonds.

The second report used to monitor interest rate risk is the Interest Rate Shock Analysis. This tool attempts to

–19–

Table of Contents

determine the affect on income of various shifts in the interest rate environment. In particular, a shift of 200 basis points, or 2% in interest rates, is the industry standard. Given the downward shift of 200 basis points, net interest income would decrease by $454,000 or 5.4% while net income would decrease $281,000 or 10.5%. Given the current low interest rate environment, management feels that a general decrease in interest rates of this magnitude is not feasible. The results of a potential shift of 200 basis points in either direction are well within internal policy guidelines. If the results were not tolerable, our policy would determine that management should reallocate the Balance Sheet in order to maintain compliance with the policy.

–20–

Table of Contents

CONTROLS AND PROCEDURES

Evaluation of disclosure controls and procedures

Based on their evaluation as of a date within 90 days of the filing date of this Quarterly Report on Form 10-Q, the Registrant’s principal executive officer and principal financial officer have concluded that the Registrant’s disclosure controls and procedures (as defined in Rules 13a-14(c) and 15d-14(c) under the Securities Exchange Act of 1934 (the “Exchange Act”)) are effective to ensure that information required to be disclosed by the Company in reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms.

Changes in internal controls

There were no significant changes in the Registrant’s internal controls or in other factors that could significantly affect these controls subsequent to the date of their evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.

–21–

Table of Contents

PART II - OTHER INFORMATION