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United States

Securities and Exchange Commission

Washington, D.C. 20549

 

 

Form 10-Q

 

 

 

x	Quarterly Report Under Section 13 or 15(d) of the Securities Exchange Act of 1934

For the quarterly period ended March 31, 2010

 

¨	Transition Report Under Section 13 or 15(d) of the Securities Exchange Act of 1934

For the transition period ended                     

Commission File Number 000-49848

 

 

MidCarolina Financial Corporation

(Exact name of registrant as specified in its charter)

 

 

 

North Carolina		55-6144577
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)

 

3101 South Church Street Burlington, North Carolina		27216
(Address of principal executive offices)		(Zip Code)

(336) 538-1600

(Registrant’s telephone number, including area code)

 

 

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

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (Section 223.405 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 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		¨		Smaller reporting company		x

Indicated by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    ¨  yes    no  x

As of May 10, 2010, the registrant had outstanding 4,927,828 shares of Common Stock, no par value.

 

 

 

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Table of Contents

				Page No.
Part I.		FINANCIAL INFORMATION
Item 1 -		Financial Statements (Unaudited)
		Consolidated Balance Sheets March 31, 2010 and December 31, 2009		3
		Consolidated Statements of Operations Three Months Ended March 31, 2010 and 2009		4
		Consolidated Statements of Comprehensive Income (Loss) Three Months Ended March 31, 2010 and 2009		5
		Consolidated Statement of Shareholders’ Equity Three Months Ended March 31, 2010		6
		Consolidated Statements of Cash Flows Three Months Ended March 31, 2010 and 2009		7
		Notes to Consolidated Financial Statements		8
Item 2 -		Management’s Discussion and Analysis of Financial Condition and Results of Operations		22
Item 3 -		Quantitative and Qualitative Disclosures About Market Risk		29
Item 4 -		Controls and Procedures		29
Part II.		OTHER INFORMATION
Item 1-		Legal Proceedings		30
Item 6 -		Exhibits		30

 

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Part I. FINANCIAL INFORMATION

Item 1 - Financial Statements

MIDCAROLINA FINANCIAL CORPORATION

CONSOLIDATED BALANCE SHEETS

 

 

		March 31, 2010 (Unaudited)				December 31, 2009(*)
		(Dollars in thousands except Share data)
ASSETS
Cash and due from banks		$	1,571			$	1,581
Federal funds sold and interest-earning deposits			36,012				7,848
Investment securities:
Available for sale			71,508				70,719
Loans held for sale			1,093				228
Loans			432,668				438,087
Allowance for loan losses			(8,225	)			(7,307	)
NET LOANS			424,443				430,780
Investment in stock of Federal Home Loan Bank of Atlanta			2,322				2,322
Investment in life insurance			8,278				8,179
Premises and equipment, net			6,946				7,063
Other assets			12,911				12,284
TOTAL ASSETS		$	565,084			$	541,004
LIABILITIES AND SHAREHOLDERS’ EQUITY
LIABILITIES
Noninterest-bearing demand deposits		$	56,847			$	41,655
Interest-bearing demand deposits			178,778				144,839
Savings			9,931				8,266
Time			248,674				270,260
TOTAL DEPOSITS			494,230				465,020
Short-term borrowings			—				520
Long-term borrowings			29,764				33,764
Accrued expenses and other liabilities			1,331				1,515
TOTAL LIABILITIES			525,325				500,819
Shareholders’ equity:
Noncumulative, perpetual preferred stock, no par value, 20,000,000 shares authorized; 5,000 shares issued and outstanding at March 31, 2010 and December 31, 2009			4,819				4,819
Common stock, no par value; 80,000,000 shares authorized; 4,927,828 shares issued and outstanding at March 31, 2010 and December 31, 2009, respectively			15,015				14,958
Retained earnings			20,467				20,805
Accumulated other comprehensive loss			(542	)			(397	)
TOTAL SHAREHOLDERS’ EQUITY			39,759				40,185
TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY		$	565,084			$	541,004

 

*	Derived from audited consolidated financial statements.

See accompanying notes.

 

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MIDCAROLINA FINANCIAL CORPORATION

CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited)

 

 

		Three Months Ended March 31,
		2010				2009
		(Amounts in thousands, except per share data)
INTEREST INCOME
Loans and loan fees		$	5,856			$	5,913
Investment securities:
Taxable			442				709
Tax-exempt			301				212
Federal funds sold and interest-earning deposits			5				2
TOTAL INTEREST INCOME			6,604				6,836
INTEREST EXPENSE
Demand deposits			617				274
Savings			13				6
Time			1,270				2,390
Short-term borrowings			—				9
Long-term borrowings			290				322
TOTAL INTEREST EXPENSE			2,190				3,001
NET INTEREST INCOME			4,414				3,835
PROVISION FOR LOAN LOSSES			2,600				1,135
NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES			1,814				2,700
NON-INTEREST INCOME
Service charges on deposits accounts			194				270
Gain on sale of loans			118				169
Income from brokerage activities			60				42
Increase in cash surrender value of life insurance			99				71
Gain on sale of available for sale investments			45				134
Total other-than-temporary impairment loss			(443	)			(990	)
Portion of loss recognized in other comprehensive income			425				958
Net impairment loss recognized in earnings			(18	)			(32	)
Other (Note F)			183				80
TOTAL NON-INTEREST INCOME			681				734
NON-INTEREST EXPENSE
Salaries and employee benefits			1,280				1,540
Occupancy and equipment			380				368
Other outside services			122				75
Data processing			260				206
Office supplies and postage			99				82
Deposit and other insurance			215				177
Professional and other services			197				109
Advertising			87				115
(Gain) loss on sale of foreclosed real estate			9				(28	)
Other (Note F)			193				143
TOTAL NON-INTEREST EXPENSE			2,842				2,787
INCOME (LOSS) BEFORE INCOME TAXES			(347	)			647
INCOME TAXES			(113	)			202
NET INCOME (LOSS)			(234	)			445
Dividends on preferred stock			(104	)			(104	)
Net income (loss) to common shareholders		$	(338	)		$	341
NET INCOME (LOSS) PER COMMON SHARE
Basic		$	(.07	)		$	.07
Diluted		$	(.07	)		$	.07

See accompanying notes.

 

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MIDCAROLINA FINANCIAL CORPORATION

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS) (Unaudited)

 

 

		Three Months Ended March 31,
		2010				2009
		(Amounts in thousands)
Net income (loss)		$	(234	)		$	445
Other comprehensive income (loss):
Securities available for sale:
Unrealized holding gains (losses) on available-for-sale securities			216				(343	)
Tax effect			(83	)			133
Reclassification of net (gains) losses recognized in net income			(45	)			(134	)
Tax effect			17				52
Reclassification of impairment loss recognized in net income			18				32
Tax effect			(7	)			(12	)
Portion of other-than-temporary impairment loss recognized in other comprehensive income			(425	)			(958	)
Tax effect			164				369
Total other comprehensive income (loss)			(145	)			(841	)
COMPREHENSIVE INCOME (LOSS)		$	(379	)		$	(396	)

See accompanying notes.

 

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MIDCAROLINA FINANCIAL CORPORATION

CONSOLIDATED STATEMENT OF SHAREHOLDERS’ EQUITY (Unaudited)

 

 

		Preferred stock					Common stock					Retained				Accumulated other comprehensive				Total shareholders’
		Shares		Amount			Shares		Amount			earnings				income (loss)				equity
		(Amounts in thousands, except share data)
Balance at December 31, 2009		5,000		$	4,819		4,927,828		$	14,958		$	20,805			$	(397	)		$	40,185
Net loss		—			—		—			—			(234	)			—				(234	)
Other comprehensive income		—			—		—			—			—				(145	)			(145	)
Stock based compensation		—			—		—			57			—				—				57
Preferred dividends paid		—			—		—			—			(104	)			—				(104	)
Balance at March 31, 2010		5,000		$	4,819		4,927,828		$	15,015		$	20,467			$	(542	)		$	39,759

 

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MIDCAROLINA FINANCIAL CORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)

 

 

		Three Months Ended March 31,
		2010				2009
		(Amounts in thousands)
Operating Activities
Net income (loss)		$	(234	)		$	445
Adjustments to reconcile net income (loss) to net cash provided (used) by operating activities:
Depreciation and amortization			226				238
Provision for loan losses			2,600				1,135
Gain on sale of available for sale investments			(45	)			(134	)
Other-than-temporary impairment on available for sale securities			18				32
Deferred tax expense (benefit)			(91	)			(529	)
Gain on sale of loans			(118	)			(169	)
Origination of loans held for sale			(6,511	)			(9,150	)
Proceeds from sales of loans held for sale			5,764				7,416
Increase in cash surrender value life insurance			(99	)			(71	)
Net (gain) loss on sale of foreclosed real estate			9				(28	)
Stock based compensation expense			57				213
Changes in assets and liabilities:
(Increase) decrease in other assets			(342	)			(142	)
Increase (decrease) in accrued expenses and other liabilities			(93	)			17
NET CASH PROVIDED (USED) BY OPERATING ACTIVITIES			1,141				(727	)
Investing Activities
Purchases of investment securities available for sale			(21,772	)			(8,137	)
Maturities and calls of investment securities available for sale			—				750
Principal paydowns on investment securities available for sale			2,015				2,263
Sales of investment securities available for sale			18,666				13,167
Net (increase) decrease in loans from originations and principal repayments			3,331				(13,296	)
(Purchase) redemption of FHLB stock			—				(579	)
Purchases of premises and equipment			(27	)			(56	)
Proceeds from sale of foreclosed real estate			214				885
NET CASH PROVIDED (USED) BY INVESTING ACTIVITIES			2,427				(5,003	)
Financing Activities
Net increase in deposits			29,210				12,879
Net decrease in short-term borrowings			(520	)			—
Net decrease in long-term borrowings			(4,000	)			—
Preferred stock dividends paid			(104	)			(104	)
NET CASH PROVIDED BY FINANCING ACTIVITIES			24,586				12,775
NET INCREASE IN CASH AND CASH EQUIVALENTS			28,154				7,045
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD			9,429				15,734
CASH AND CASH EQUIVALENTS, END OF PERIOD		$	37,583			$	22,779
Supplemental disclosure of cash flow information
Cash paid for interest		$	2,175			$	2,999
Loans transferred to foreclosed real estate		$	406			$	—

 

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MIDCAROLINA FINANCIAL CORPORATION

Notes to Consolidated Financial Statements

 

NOTE A - BASIS OF PRESENTATION

The consolidated financial statements include the accounts and transactions of MidCarolina Financial Corporation (the “Company”) and its wholly-owned subsidiary MidCarolina Bank (the “Bank”). All intercompany transactions and balances have been eliminated in consolidation. In management’s opinion, the financial information, which is unaudited, reflects all adjustments (consisting solely of normal recurring adjustments) necessary for a fair presentation of the financial information as of March 31, 2010 and for the three month periods ended March 31, 2010 and 2009, in conformity with accounting principles generally accepted in the United States of America.

The preparation of the consolidated financial statements requires management to make estimates and assumptions that affect reported amounts of assets and liabilities at the date of the financial statements, as well as the amounts of income and expense during the reporting period. Actual results could differ from those estimates. Operating results for the three month period ended March 31, 2010 are not necessarily indicative of the results that may be expected for the fiscal year ending December 31, 2010.

The organization and business of the Company, accounting policies followed by the Company and other information are contained in the notes to the consolidated financial statements filed as part of the Company’s annual report on Form 10-K. This quarterly report should be read in conjunction with such annual report.

Prior period amounts may have been reclassified for proper presentation. The Company reclassified $28,000 of net gain on sale of foreclosed real estate for the three month period ended March 31, 2009, respectively, from non-interest income to non-interest expense. The reclassification did not impact net income for the period.

NOTE B - COMMITMENTS

At March 31, 2010, loan commitments were as follows (in thousands):

 

Commitments to extend credit		$	28,753
Undisbursed lines of credit			32,870
Standby letters of credit			2,800
Commitments to sell loans held for sale			1,093

NOTE C - PER SHARE DATA

Diluted earnings per share reflect additional shares of common stock that would have been outstanding if dilutive potential shares had been issued. For the three month period ended March 31, 2010 all options were antidilutive due to the net loss. For the three month period ended March 31, 2009 there were 356,429 options that were antidilutive.

 

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MIDCAROLINA FINANCIAL CORPORATION

Notes to Consolidated Financial Statements

 

 

NOTE C - PER SHARE DATA (Continued)

 

The weighted average number of shares of common stock outstanding or assumed to be outstanding are summarized below:

 

		Three Months Ended March 31,
		2010		2009
Weighted average number of common shares used in computing basic net income per share		4,927,828		4,927,828
Effect of dilutive stock options		—		4,499
Weighted average number of common shares and dilutive potential common shares used in computing diluted net income per share		4,927,828		4,932,327

NOTE D - INVESTMENT SECURITIES

The following is a summary of investment securities by major classification at March 31, 2010 and December 31, 2009:

 

		March 31, 2010
		Amortized cost			Gross unrealized gains			Gross unrealized losses			Fair value
		(Amounts in thousands)
Securities available for sale:
U.S. government agency securities		$	3,656		$	1		$	29		$	3,628
Mortgage-backed securities			32,393			895			49			33,239
GSE CMO’s			1,635			—			43			1,592
Private Label CMO’s			4,383			—			524			3,859
State and municipal			29,823			183			1,136			28,870
Subordinated debentures			500			—			180			320
Total		$	72,390		$	1,079		$	1,961		$	71,508
		December 31, 2009
		Amortized cost			Gross unrealized gains			Gross unrealized losses			Fair value
		(Amounts in thousands)
Securities available for sale:
U.S. government agency securities		$	12,113		$	13		$	69		$	12,057
Mortgage-backed securities			23,690			1,246			19			24,917
Private label CMO’s			5,683			6			713			4,976
State and municipal			29,379			191			1,121			28,449
Subordinated debentures			500			—			180			320
Total		$	71,365		$	1,456		$	2,102		$	70,719

 

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MIDCAROLINA FINANCIAL CORPORATION

Notes to Consolidated Financial Statements

 

 

NOTE D - INVESTMENT SECURITIES (Continued)

 

The following tables show investments’ 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, at March 31, 2010 and December 31, 2009. Except as noted in the table below, all unrealized losses on investment securities are considered by management to be temporarily impaired given the credit ratings on these investment securities and/or the short duration of the unrealized loss.

 

		March 31, 2010
		Less Than 12 Months						12 Months or More						Total
		Fair value			Unrealized losses			Fair value			Unrealized losses			Fair value			Unrealized losses
		(Amounts in thousands)
Securities available for sale:
U.S. government agency securities		$	2,621		$	29		$	—		$	—		$	2,621		$	29
Mortgage-backed securities			12,278			49			—			—			12,278			49
CMO’s			1,592			43			—			—			1,592			43
Private label CMO’s			—			—			2,218			99			2,218			99
State and municipal			13,446			337			6,316			799			19,762			1,136
Subordinated debentures			—			—			320			180			320			180
Total temporarily impaired securities		$	29,937		$	458		$	8,854		$	1,078		$	38,791		$	1,536
Other than temporary impairment
Private label CMO’s		$	—		$	—		$	1,622		$	443		$	1,622		$	425
Total other than temporarily impaired securities		$	—		$	—		$	1,622		$	425		$	1,622		$	425
		December 31, 2009
		Less Than 12 Months						12 Months or More						Total
		Fair value			Unrealized losses			Fair value			Unrealized losses			Fair value			Unrealized losses
		(Amounts in thousands)
Securities available for sale:
U.S. government agency securities		$	7,095		$	69		$	—		$	—		$	7,095		$	69
Mortgage-backed securities			2,039			19			—			—			2,039			19
Private label CMO’s			—			—			2,295			405			2,295			405
State and municipal			9,042			273			7,384			848			16,426			1,121
Subordinated debentures			—			—			320			180			320			180
Total temporarily impaired securities		$	18,176		$	361		$	9,999		$	1,433		$	28,175		$	1,794
Other than temporary impairment
Private label CMO’s		$	1,051		$	153		$	729		$	155		$	1,780		$	308
Total other than temporarily impaired securities		$	1,051		$	153		$	729		$	155		$	1,780		$	308

The aggregate amortized cost and fair value of debt securities at March 31, 2010, by remaining contractual maturity, are shown below. Actual expected maturities may differ from contractual maturities because issuers may have the right to call or prepay obligations.

 

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MIDCAROLINA FINANCIAL CORPORATION

Notes to Consolidated Financial Statements

 

 

NOTE D - INVESTMENT SECURITIES (Continued)

 

		Available for Sale
		Amortized cost			Fair value
		(Amounts in thousands)
U.S. Agency securities:
Due within 1 year		$	1,006		$	1,006
Due in 1 year through 5 years			2,650			2,621
Due after 5 years through 10 years			—			—
Due after 10 years			—			—
State and municipal securities:
Due within 1 year			1,001			956
Due in 1 year through 5 years			3,965			3,965
Due after 5 years through 10 years			11,525			11,018
Due after 10 years			13,332			12,932
Other:
Due in 1 year through 5 years			—			—
Due after 10 years			500			320
GSE CMOs			1,635			1,592
Private label CMOs			4,383			3,859
Mortgage-backed securities			32,393			33,239
Total		$	72,390		$	71,508

Proceeds from sales of investment securities available for sale amounted to $18.7 million and $13.2 million, for the three months ended March 31, 2010 and March 31, 2009, respectively. Aggregate gross realized gains from the sales of investment securities available for sale amounted to $45,000 and $134,000 for the three months ended March 31, 2010 and March 31, 2009, respectively. Realized losses from the impairment of private label mortgage backed securities amounted to $18,000 for the three months ended March 31,2010 and $32,000 for the three months ended March 31, 2009 resulting from increased default rates on underlying collateral payments and credit rating deterioration.

Investment securities with amortized cost of $23.7 million and fair value of $24.0 million at March 31, 2010 were pledged to secure public monies on deposit as required by law.

Debt securities were divided into two groups, those rated investment grade by at least one nationally-recognized rating agency and those rated below investment grade by all nationally-recognized agencies. Impairment of debt securities consistently rated investment grade is considered temporary unless specific contrary information is identified. None of the debt securities consistently rated investment grade were considered to be other-than-temporarily impaired at March 31, 2010. Two debt securities rated below investment grade, (two private label CMO’s) were considered to be other-than-temporarily impaired at March 31, 2010.

At March 31, 2010, the aggregate unrealized loss on the two private label mortgage-backed securities, totaled $443,000 before recognition of any other-than-temporary impairment charges. Impairment of these securities were evaluated to determine if we expect to not recover the entire amortized cost basis of the security. This evaluation was based on projections of estimated cash flows on individual loans underlying each security using current and anticipated changes in unemployment and default rates, decreases in housing prices and increases in loss severity at foreclosure. Impairment charges totaled $18,000 for the period ended March 31, 2010.

 

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MIDCAROLINA FINANCIAL CORPORATION

Notes to Consolidated Financial Statements

 

 

NOTE D - INVESTMENT SECURITIES (Continued)

 

The primary assumptions used in this evaluation were:

Prepayments - starting with current refinancing and payoff prepayment vector statistics based on information derived from the trustee. The bonds’ prepayment vectors anticipates 6- 8 VPR for 9 months and then returning to historical norms of 4-5 VPR to maturity

Loss severity – estimated lifetime foreclosure rates are 35% - 45%. Loss severity includes estimated holding and disposal expenses.

Default rate – The model takes the consumer default rate from the mortgage backed bonds 2 month average default rate from 7.5% to 15.8% over the next 24 months and down to 3.8% through maturity.

Discount rates - estimated cash flows were discounted at rates that range from 5.50% to 6.00% based on our purchase yields.

The evaluation uses an adjusted loan to value ratio as part of our evaluation of whether the unrealized losses on these securities are temporary or other-than-temporary. The adjusted loan to value ratio is based on the original loan to value ratio inherent in the security, adjusted for changes in housing prices, prepayment speeds, default rates and credit enhancements. A higher adjusted loan to value ratio indicates a greater likelihood that projected cash flows may result in losses. A shortfall between our current amortized cost and the present value of expected cash flows we are likely to collect, based on all available information, is referred to as the credit loss, which is the amount recognized in net income.

Based on our evaluation, a portion of the unrealized loss for one security was identified as credit impairment and charged to earnings for the three months ended March 31, 2010.

The following table shows a roll forward of the amount related to credit losses recognized on debt securities held by the Company for which a portion of an other-than-temporary impairment was recognized in other comprehensive income.

 

		Three Months Ended March 31,
		2010			2009
		(Amounts in thousands)
Balance of credit losses on debt securities at the beginning of the period		$	148		$	—
Additional increase related to the credit loss for which an other-than-temporary impairment was previously recognized			18			32
Balance of credit losses on debt securities at the end of the current period		$	166		$	32

At March 31, 2010, the balance of Federal Home Loan Bank (“FHLB”) of Atlanta stock held by the Company is $2.4 million. On March 25, 2010 the FHLB announced that it would pay a dividend for the fourth quarter of 2009. Given this, management believes that its investment in FHLB stock was not other-than-temporarily impaired as of March 31, 2010. However, there can be no assurance that the impact of recent or future legislation on the Federal Home Loan Banks will not also cause a change in the value of the FHLB stock held by the Company.

 

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MIDCAROLINA FINANCIAL CORPORATION

Notes to Consolidated Financial Statements

 

 

NOTE E - LOANS

Following is a summary of loans at each of the balance sheet dates presented (Dollars in thousands):

 

		At March 31, 2010							At December 31, 2009
		Amount				Percent of Total			Amount				Percent of Total
		(In thousands)
Construction loans		$	64,392			14.89	%		$	67,635			15.44	%
Commercial mortgage loans			172,432			39.85	%			174,926			39.93	%
Home equity lines of credit			44,745			10.34	%			44,627			10.19	%
Residential mortgage loans			82,310			19.02	%			81,377			18.57	%
Total real estate			363,879							368,565
Commercial and industrial loans			63,347			14.64	%			64,173			14.65	%
Loans to individuals			5,460			1.26	%			5,383			1.22	%
Subtotal			432,686			100.00	%			438,121			100.00	%
Net deferred loan fees			(18	)						(34	)
Loans		$	432,668						$	438,087

NOTE F - NON-INTEREST INCOME AND NON-INTEREST EXPENSE

The major components of other non-interest income are as follows:

 

		Three Months Ended March 31,
		2010			2009
		(In thousands)
Debit card income		$	63		$	51
ATM interchange income			1			2
Safe deposit rent			3			3
Check upcharge			7			6
Income from rental property			13			7
Insurance claim proceeds			80			—
Other			16			11
Total		$	183		$	80

 

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MIDCAROLINA FINANCIAL CORPORATION

Notes to Consolidated Financial Statements

 

 

NOTE F - NON-INTEREST INCOME AND NON-INTEREST EXPENSE (Continued)

 

The major components of other non-interest expense are as follows:

 

		Three Months Ended March 31,
		2010			2009
		(In thousands)
Travel		$	12		$	20
Contributions			10			1
Director fees			46			36
Dues and memberships			3			7
Credit reports and filing fees			5			5
Franchise tax			30			21
Appraisals			20			9
Deposit charge offs			1			2
Loan collection expense			46			13
CDARS expense			18			21
Filing and recording fees			—			6
Other			2			2
Total		$	193		$	143

NOTE G - FAIR VALUE MEASUREMENTS

The Company adopted FASB’s Accounting Standards Codification (ASC) Topic 820, Fair Value Measurements and Disclosures, effective January 1, 2009, which defines fair value, establishes a framework for measuring fair value in GAAP, and expands disclosures about fair value measurements. The Company utilizes fair value measurements to record fair value adjustments to certain assets and liabilities and to determine fair value disclosures. Securities available-for-sale are recorded at fair value on a recurring basis. From time to time, the Company may be required to record at fair value other assets on a nonrecurring basis, such as loans held for sale and other certain assets. These nonrecurring fair value adjustments typically involve application of lower of cost or market accounting write-downs of individual assets.

The following is a description of valuation methodologies used for assets and liabilities recorded at fair value.

Investment Securities Available-for-Sale

Investment securities available-for-sale are recorded at fair value on a recurring basis. Fair value measurement is based upon quoted prices, if available. If quoted prices are not available, fair values are measured using independent pricing models or other model-based valuation techniques such as present value of future cash flows, adjusted for the security’s credit rating, prepayment assumptions and other factors such as credit loss assumptions. Level 1 securities include those traded on an active exchange, such as the New York Stock Exchange, U.S. Treasury securities that are traded by dealers or brokers in active over-the-counter markets and money market funds. Level 2 securities include mortgage-backed securities issued by government sponsored entities, municipal bonds, private label collateralized mortgage obligations and corporate debt securities.

 

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MIDCAROLINA FINANCIAL CORPORATION

Notes to Consolidated Financial Statements

 

 

NOTE G - FAIR VALUE MEASUREMENTS (Continued)

 

Securities classified as Level 3 include asset-backed securities and corporate debt securities in less liquid markets.

Loans Held for Sale

Loans held for sale are carried at the lower of cost or market value. The fair value of loans held for sale is based on what secondary markets are currently offering for portfolios with similar characteristics. As such, the Company classifies loans subject to nonrecurring fair value adjustments as Level 2.

Loans

The Company does not record loans at fair value on a recurring basis. However, from time to time, a loan is considered impaired and an allowance for loan losses is established. Loans for which it is probable that payment of interest and principal will not be made in accordance with the contractual terms of the loan agreement are considered impaired. Once a loan is identified as impaired, management measures impairment on an individual basis. The fair value of impaired loans is estimated using one of several methods, including collateral value, market value of similar debt, enterprise value, liquidation value and discounted cash flows. Those impaired loans not requiring an allowance represent loans for which the fair value of the expected repayments or collateral exceed the recorded investments in such loans. As of March 31, 2010, the Bank identified $40.3 million in impaired loans. Of these impaired loans, $18.7 million were identified to have impairment of $1.3 million, for a net fair value of $17.4 million. At December 31, 2009, the Company identified impaired loans of $11.0 million. Of this total, $8.2 million required a specific allowance totaling $1.2 million for a net fair value of $7.0 million. The determination of impairment was based on the estimated fair market value of collateral for each loan determined through the use of appraisals and subjected to further discounts by management for age of appraisals, geopraphy of the collateral and historical experience in selling similar types of collateral, which are considered to be Level 3 inputs.

Foreclosed Real Estate

Foreclosed real estate is initially recorded at fair value less cost to sell, at the date of foreclosure. Fair value is based upon independent market prices, appraised values of the collateral or management’s estimation of the value of the collateral. When fair value of the collateral is based on an observable market price or a current appraised value, the Company records the foreclosed real estate as nonrecurring Level 2. In situations where current appraised values are unavailable or it is determined that the fair value of the collateral is further impaired below the appraised value and there is no observable market price, management will rely on significant discounts to account for the age of the most current appraised value available, geography of the foreclosed real estate and historical experience in selling similar types of foreclosed real estate. The Company records the foreclosed real estate under these significant unobservable inputs as nonrecurring Level 3.

Their were no significant transfers between the valuation of financial assets or liabilities between Levels 1 and 2 in the valuation hierarchy below. The following table summarizes quantitative disclosures about the fair value measurement for each category of assets carried at fair value as of March 31, 2010 (Dollars in thousands):

 

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MIDCAROLINA FINANCIAL CORPORATION

Notes to Consolidated Financial Statements

 

 

NOTE G - FAIR VALUE MEASUREMENTS (Continued)

 

					Fair Value Measurements at March 31, 2010
Description		March 31, 2010			Quoted Prices in Active Markets for Identical Assets (Level 1)			Significant Other Observable Input (Level 2)			Significant Unobservable Inputs (Level 3)
Available for sale securities:
U.S Agency securities		$	3,628		$	—		$	3,628		$	—
Mortgage backed securities			33,239			—			33,239			—
GSE CMO’s			1,592			—			1,592			—
Private label CMO’s			3,859			—			3,859			—
State and municipal securities			28,870			—			28,870			—
Subordinated debenture			320			—			—			320
			71,508			—			71,188			320
Impaired loans			17,391			—			—			17,391
Foreclosed real estate			3,046			—			—			3,046

The table below presents the balances of assets and liabilities measured at fair value, as of December 31, 2009 (Dollars in thousands):

 

					Fair Value Measurements at December 31, 2009
Description		December 31, 2009			Quoted Prices in Active Markets for Identical Assets (Level 1)			Significant Other Observable Input (Level 2)			Significant Unobservable Inputs (Level 3)
Available for sale securities:
U.S Agency securities		$	12,057		$	—		$	12,057		$	—
Mortgage backed securities			24,917			—			24,917			—
CMO’s			4,976			—			4,976			—
State and municipal securities			28,449			—			28,449			—
Subordinated debenture			320			—			—			320
			70,719			—			70,399			320
Impaired loans			7,042			—			—			7,042
Foreclosed real estate			2,876			—			—			2,876

 

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MIDCAROLINA FINANCIAL CORPORATION

Notes to Consolidated Financial Statements

 

 

NOTE G - FAIR VALUE MEASUREMENTS (Continued)

 

The table below presents reconciliation for the period of December 31, 2009 to March 31, 2010 for all Level 3 assets that are measured at fair value on a recurring basis.

 

		Available-for-sale securities
		(Dollars in thousands)
Beginning Balance December 31, 2009		$	320
Total realized and unrealized gains or losses:
Included in earnings			—
Included in other comprehensive income			—
Purchases, issuances and settlements			—
Transfers in (out) of Level 3			—
Ending Balance March 31, 2010		$	320

NOTE H - FAIR VALUE OF FINANCIAL INSTRUMENTS

ASC TOPIC 825 Financial Instruments, requires a company to disclose on an interim and annual basis the fair value of its financial instruments whether or not recognized in the balance sheet, where it is practical to estimate that value.

Fair value estimates are made at a specific point in time based on relevant market information about the financial instrument. These estimates do not reflect any premium or discount that could result from offering for sale at one time the Company’s entire holding of a particular financial instrument. In cases where quoted market prices are not available, fair value estimates are based on judgments regarding future expected loss experience, current economic conditions, risk characteristics of various financial instruments and other factors. These estimates are subjective in nature and involve uncertainties and matters of significant judgment and, therefore, cannot be determined with precision. Changes in assumptions could significantly affect the estimates. In addition, the tax ramifications related to the realization of the unrealized gains and losses can have a significant effect on fair value estimates and have not been considered in the estimates. Finally, the fair value estimates presented herein are based on pertinent information available to management as of March 31, 2010 and December 31, 2009, respectively.

The following methods and assumptions were used to estimate the fair value of each class of financial instruments for which it is practicable to estimate that value:

Cash and Due from Banks, Federal Funds Sold and Interest-Earning Deposits

The carrying amounts for cash and due from banks, federal funds sold and interest-earning deposits approximate fair value because of the short maturities of those instruments. These instruments are considered cash and cash equivalents.

 

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MIDCAROLINA FINANCIAL CORPORATION

Notes to Consolidated Financial Statements

 

 

NOTE H - FAIR VALUE OF FINANCIAL INSTRUMENTS (Continued)

 

Investment Securities

Fair value for investment securities is based on quoted market price if such information is available. If a quoted market price is not available, fair value is estimated using quoted market prices for similar securities. The carrying value of Federal Home Loan Bank stock approximates fair value based on the redemption provisions.

Loans Held for Sale

Fair values of mortgage loans held for sale are based on commitments on hand from investors or prevailing market prices.

Loans

For certain homogeneous categories of loans, such as residential mortgages, fair value is estimated using the quoted market prices for securities backed by similar loans, adjusted for differences in loan characteristics. The fair value of other types of loans is estimated by discounting the future cash flows using the current rates at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities. However, the values derived likely do not represent exit prices due to the distressed market conditions; therefore, incremental market risks and liquidity discounts of approximately 2% were subtracted to reflect the illiquid and distressed conditions at March 31, 2010 and December 31, 2009.

Investment in Life Insurance

The carrying value of life insurance approximates fair value because this investment is carried at cash surrender value, as determined by the insurer.

Deposits, Short-term Borrowings and Long-term Debt

Deposits and short-term borrowings without a stated maturity, or insignificant term to maturity, including demand, interest bearing demand, savings accounts and FHLB borrowings are reported at their carrying value. No value has been assigned to the franchise value of deposits. For other types of deposits and long-term debt, with fixed rates and longer maturities is estimated based upon the discounted value of projected future cash outflows using the rates currently offered for instruments of similar remaining maturities.

Accrued Interest Receivable and Accrued Interest Payable

The carrying amounts of accrued interest receivable and accrued interest payable are assumed to approximate fair values.

Financial Instruments with Off-Balance Sheet Risk

With regard to financial instruments with off-balance sheet risk discussed in Note B, it is not practicable to estimate the fair value of future financing commitments.

 

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MIDCAROLINA FINANCIAL CORPORATION

Notes to Consolidated Financial Statements

 

 

NOTE H - FAIR VALUE OF FINANCIAL INSTRUMENTS (Continued)

 

The following table presents the carrying values and estimated fair values of the Company’s financial instruments at March 31, 2010 and December 31, 2009:

 

		Carrying value			Estimated fair value
		(Amounts in thousands)
As of March 31, 2010
Financial assets:
Cash and cash equivalents		$	37,583		$	37,583
Investment securities available for sale			71,508			71,508
Loans held for sale			1,093			1,093
Loans, net of allowance			424,443			418,151
Federal Home Loan Bank stock			2,322			2,322
Investment in life insurance			8,278			8,278
Accrued interest receivable			2,061			2,061
Financial liabilities:
Deposits		$	494,230		$	492,826
Long-term debt			29,764			30,317
Accrued interest payable			500			500
As of December 31, 2009
Financial assets:
Cash and cash equivalents		$	9,429		$	9,429
Investment securities available for sale			70,719			70,719
Loans held for sale			228			228
Loans, net			430,780			424,087
Federal Home Loan Bank stock			2,322			2,322
Investment in life insurance			8,179			8,179
Accrued interest receivable			2,150			2,150
Financial liabilities:
Deposits		$	465,020		$	462,740
Short-term borrowings			520			520
Long-term debt			33,674			34,684
Accrued interest payable			485			485

 

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MIDCAROLINA FINANCIAL CORPORATION

Notes to Consolidated Financial Statements

 

 

NOTE I - RECENT ACCOUNTING PRONOUNCEMENTS

In June 2009, the FASB issued guidance “Accounting for Transfers of Financial Assets – an amendment of the FASB Statement No. 140” (“ASC 860”), which eliminates the concept of a qualifying special purpose entity (QSPE), changes the requirements for derecognizing financial assets, and requires additional disclosures including information about continuing exposure to risks related to transferred financial assets. ASC 860 is effective for financial asset transfers occurring after the beginning of fiscal years beginning after November 15, 2009. The disclosure requirements must be applied to transfers that occurred before and after the effective date. The provisions of ASC 860 did not have a material impact have on the Company’s consolidated financial statements.

In June 2009, the FASB issued guidance on consolidation. The guidance (“ASC 810”), contains new criteria for determining the primary beneficiary, eliminates the exception to consolidating QSPEs, requires continual reconsideration of conclusions reached in determining the primary beneficiary, and requires additional disclosures. ASC 810 is effective as of the beginning of fiscal years beginning after November 15, 2009 and is applied using a cumulative effect adjustment to retained earnings for any carrying amount adjustments (e.g., for newly-consolidated VIEs). The provisions of ASC 810 did not have a material impact have on the Company’s consolidated financial statements.

The FASB has issued the following updates since January 1, 2010:

ASU No. 2010-13, Compensation—Stock Compensation (“ASC 718”): Effect of Denominating the Exercise Price of a Share-Based Payment Award in the Currency of the Market in Which the Underlying Equity Security Trades. This ASU codifies the consensus reached in EITF Issue No. 09-J, “Effect of Denominating the Exercise Price of a Share-Based Payment Award in the Currency of the Market in Which the Underlying Equity Security Trades.” The amendments to the Codification clarify that an employee share-based payment award with an exercise price denominated in the currency of a market in which a substantial portion of the entity’s equity shares trades should not be considered to contain a condition that is not a market, performance, or service condition. Therefore, an entity would not classify such an award as a liability if it otherwise qualifies as equity. Management is currently evaluating the effect that the provisions of ASC 718 may have on the Company’s consolidated financial statements.

Accounting Standards Update (ASU) No. 2010-09, Subsequent Events (“ASC 855”): Amendments to Certain Recognition and Disclosure Requirements. The amendments in the ASU remove the requirement for an SEC filer to disclose a date through which subsequent events have been evaluated in both issued and revised financial statements. Revised financial statements include financial statements revised as a result of either correction of an error or retrospective application of U.S. GAAP. The FASB also clarified that if the financial statements have been revised, then an entity that is not an SEC filer should disclose both the date that the financial statements were issued or available to be issued and the date the revised financial statements were issued or available to be issued. The FASB believes these amendments remove potential conflicts with the SEC’s literature.

ASU No. 2010-06, Fair Value Measurements and Disclosures (“ASC 820”): Improving Disclosures about Fair Value Measurements. This ASU requires some new disclosures and clarifies some existing disclosure requirements about fair value measurement as set forth in Codification Subtopic 820-10. The FASB’s objective is to improve these disclosures and, thus, increase the transparency in financial reporting. Specifically, ASU 2010-06 amends Codification Subtopic 820-10 to now require:

 

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MIDCAROLINA FINANCIAL CORPORATION

Notes to Consolidated Financial Statements

 

 

NOTE I - RECENT ACCOUNTING PRONOUNCEMENTS (Continued)

 

A reporting entity should disclose separately the amounts of significant transfers in and out of Level 1 and Level 2 fair value measurements and describe the reasons for the transfers; and

In the reconciliation for fair value measurements using significant unobservable inputs, a reporting entity should present separately information about purchases, sales, issuances, and settlements.

In addition, ASU 2010-06 clarifies the requirements of the following existing disclosures:

For purposes of reporting fair value measurement for each class of assets and liabilities, a reporting entity needs to use judgment in determining the appropriate classes of assets and liabilities; and

A reporting entity should provide disclosures about the valuation techniques and inputs used to measure fair value for both recurring and nonrecurring fair value measurements.

ASU 2010-06 is effective for interim and annual reporting periods beginning after December 15, 2009, except for the disclosures about purchases, sales, issuances, and settlements in the roll forward of activity in Level 3 fair value measurements. Those disclosures are effective for fiscal years beginning after December 15, 2010, and for interim periods within those fiscal years. Early application is permitted. Management is currently evaluating the effect that the provisions of ASC 820 may have on the Company’s consolidated financial statements.

Other accounting standards that have been issued by the FASB or other standards-setting bodies are not expected to have a material impact on the Company’s financial position, results of operations and cash flows.

 

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Item 2.

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

Statements in this Report and its exhibits relating to plans, strategies, economic performance and trends, projections of results of specific activities or investments, expectations or beliefs about future events or results, and other statements that are not descriptions of historical facts, may be forward-looking statements as defined in Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Forward-looking information is inherently subject to risks and uncertainties, and actual results could differ materially from those currently anticipated due to a number of factors which include, but are not limited to, factors discussed in our Annual Report on Form 10-K and in other documents we file with the Securities and Exchange Commission from time to time. Copies of those reports are available directly through the SEC’s Internet website at www.sec.gov or through our Internet website at www.midcarolinabank.com. Forward-looking statements may be identified by terms such as “may,” “will,” “should,” “could,” “expects,” “plans,” “intends,” “anticipates,” “believes,” “estimates,” “predicts,” “forecasts,” “potential” or “continue,” or similar terms or the negative of these terms, or other statements concerning opinions or judgments of our management about future events. Factors that could influence the accuracy of forward-looking statements include, but are not limited to, (a) pressures on the earnings, capital and liquidity of financial institutions resulting from current and future adverse conditions in the credit and capital markets and the banking industry in general,(b) the financial success or changing strategies of our customers, actions of government regulators, the level of market interest rates, and changes in general economic conditions and real estate values in our banking market (particularly changes that affect our loan portfolio, the abilities of our borrowers to repay their loans, and the values of loan collateral). Although we believe that the expectations reflected in the forward-looking statements are reasonable, they represent our management’s judgments only as of the date they are made, and we cannot guarantee future results, levels of activity, performance or achievements. As a result, readers are cautioned not to place undue reliance on these forward-looking statements. All forward-looking statements attributable to us are expressly qualified in their entirety by the cautionary statements in this paragraph. We have no obligation, and do not intend, to update these forward-looking statements.

In response to the challenges facing the financial services sector, several regulatory and governmental actions have recently been announced:

The Bank’s deposits are insured by the FDIC to the full extent provided in the Federal Deposit Insurance Act, and the Bank pays assessments to the FDIC for that insurance coverage. Under the Act, the FDIC may terminate the Bank’s deposit insurance if it finds that the Bank has engaged in unsafe and unsound practices, is in an unsafe or unsound condition to continue operations, or has violated applicable laws, regulations, rules or orders.

The FDIC uses a risk-based assessment system to determine the amount of the Bank’s deposit insurance assessment based on an evaluation of the probability that the Bank will cause a loss to the fund. That evaluation takes into consideration risks attributable to different categories and concentrations of the Bank’s assets and liabilities and any other factors the FDIC considers relevant, including information obtained from the Commissioner. A higher assessment rate results in an increase in the deposit insurance assessments paid by the Bank.

The FDIC is responsible for maintaining the adequacy of the fund, and the amount the Bank pays for deposit insurance is influenced not only by the assessment of the risk it poses to the fund, but also by the adequacy of the insurance fund at any time to cover the risk posed by all insured institutions. FDIC insurance assessments could be increased substantially in the future if the FDIC finds such an increase to be necessary in order to adequately maintain the insurance fund.

During 2008, and because the reserve ratio had fallen below the minimum of 1.15% mandated by FDIRA, the Board of Directors of the FDIC adopted a restoration plan to return the reserve ratio to that

 

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minimum level required by FDIRA within five years. During February 2009, the Board amended its restoration plan to provide for the minimum DIF reserve ratio to be restored within seven years and voted to impose a special assessment on insured institutions of 20 basis points, and to increase regular assessment rates for 2009. However, during May 2009, the special assessment was reduced to 5 basis points on each insured institution’s assets minus its Tier 1 capital as of June 30, 2009, but not more than 10 basis points of the institution’s assessment base for the second quarter of 2009. The special assessment was payable on September 30, 2009.

During October 2009, the FDIC again amended its restoration plan to provide for the minimum reserve ratio to be restored within eight years, and adopted a uniform 3 basis point increase in regular assessment rates effective January 1, 2011. During November 2009, the FDIC amended its regulations to require that insured institutions prepay their estimated quarterly risk-based assessments for the fourth quarter of 2009 and for all of 2010, 2011 and 2012 on December 30, 2009. The Company’s prepaid premium was $2.7 million and was paid in December 2009.

Financial Condition at March 31, 2010 and December 31, 2009

During the three-month period ending March 31, 2010, our total assets increased by $24.1 million to $565.1 million from $541.0 million at December 31, 2009. At March 31, 2010, loans totaled $432.7 million, a decrease of $5.4 million, or 1.24%, for the three months. Our loan portfolio experienced decreases in real estate and commercial loans in the amount of $4.7 million and $826,000 respectively. Consumer loans moderately increased by $77,000 to $5.5 million. Federal funds sold and interest-earning deposits increased by $28.2 million, to $36.0 million.

Our total liquid assets, which include cash and due from banks, federal funds sold and interest-earning deposits at Federal Home Loan Bank (“FHLB”) of Atlanta, investment securities available for sale and loans held for sale increased $29.8 million during the three months, to $110.2 million or 19.49% of total assets at March 31, 2010 versus $80.4 million, or 14.85% of total assets, at December 31, 2009. At March 31, 2010, investment securities available for sale, totaled $71.5 million, an increase of $789,000, or 1.12% compared to December 31, 2009.

Deposits continue to be our primary funding source. At March 31, 2010, deposits totaled $494.2 million, an increase of $29.2 million, or 6.28%, from year-end 2009. Included in the deposit balances are $101.3 million of brokered certificates of deposit, a decrease of $1.2 million, or 1.08%, from year-end. We also utilize borrowings from the FHLB and Federal Reserve Bank (“FRB”) to support balance sheet management and growth. Borrowings from the FHLB decreased $4 million or 16.0% to $21.0 million at March 31, 2010, from $25 million at year-end 2009. We had no outstanding balances with the FRB at March 31, 2010 or December 31, 2009.

Our capital position remains strong, with all of our regulatory capital ratios at levels that categorize us as “well capitalized” under federal bank regulatory capital guidelines. At March 31, 2010, our shareholders’ equity totaled $39.8 million, a decrease of $426,000 from the December 31, 2009 balance. The decrease resulted primarily from net loss available to common shareholders of $338,000 and recognition of $57,000 in stock based compensation for the three months ended March 31, 2010. Accumulated other comprehensive loss in the amount of $542,000 resulted from the Company’s unrealized losses on available-for-sale securities.

 

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Comparison of Results of Operations for the

Three Months Ended March 31, 2010 and 2009

Net Income (loss). Our net loss to common shareholders for the three months ended March 31, 2010 was $338,000, a decrease of $679,000, or 199.12%, from net income available to common shareholders of $341,000 for the same three-month period in 2009. Net loss per diluted share of $0.07 for the three month period ended March 31, 2010 decreased $0.14 when compared to the prior period. Our average balances remain nearly unchanged as total assets averaging $544.7 million during the current three-month period compared to $545.6 million in the comparative prior year period, a $649,000 decrease or 0.11%. Our interest rate spread and net yield on average interest-earning assets increased 55 basis points and 47 basis points respectively. Net interest income increased $579,000, non-interest income for the quarter ended March 31, 2010 decreased in the amount of $53,000, the provision for loan losses increased $1.5 million, and non-interest expenses increased $55,000 as compared to the amounts of those expenses for the comparative period.

Net Interest Income. Net interest income increased by $579,000, or 15.10%, to $4.4 million for the three months ended March 31, 2010. Our increase in net interest income reflects a $232,000 decrease in interest income off-set by a $811,000 decrease in interest expense. The rates earned on a significant portion of our loans adjust immediately when index rates such as prime rate change. Conversely, most of our interest-bearing liabilities, including certificates of deposit and borrowings, have rates fixed until maturity. As a result, interest rate reductions will generally result in an immediate drop in our interest income on loans, with a more delayed impact on interest expense because reductions in interest costs will only occur upon renewals of certificates of deposit or fixed rate FHLB advances. Conversely, interest rate increases should result in an immediate increase in our interest income on loans, with a more delayed impact on interest expense because increases in interest costs will occur upon renewals of certificates of deposits or borrowings. Average interest-earning assets during the first quarter of 2010 decreased $1.5 million, or 0.29%, as compared with the same period in 2009. Our average yield on total interest-earning assets decreased by 15 basis points from 5.31% to 5.16%. Our average total interest-bearing liabilities decreased by $3.3 million, or 0.70%. Our average cost of total interest-bearing liabilities decreased 70 basis points from 2.63% to 1.93%. Our markets are extremely competitive for deposits. For the three months ended March 31, 2010, our net interest spread was 3.23% and our net interest margin was 3.45%. For the three months ended March 31, 2009, our net interest rate spread was 2.68% and our net interest margin was 2.98%.

Provision for Loan Losses. The Bank recorded $2.6 million in the provision for loan losses for the period ended March 31, 2010, an increase of $1.5 million from the $1.1 million provision made in the first quarter of 2009. Provisions for loan losses are charged to income to bring the allowance for loan losses to a level deemed appropriate by management. In evaluating the allowance for loan losses, management considers factors that include growth, composition and industry diversification of the portfolio, historical loan loss experience, current delinquency levels, adverse situations that may affect a borrower’s ability to repay, estimated value of any underlying collateral, prevailing economic conditions and other relevant factors. The 2010 provision was significantly impacted by the on-going weakened economy and real estate market. Specifically, builder/construction loans continue to experience a significant deterioration in their collateral values as developers experience decreased rates of building lot inventory turn-over. Although the Bank reduced its total exposure to construction loans by $3.2 million or 4.8% from $67.6 million at December 31, 2009 to $61.4 million at March 31, 2010, significant risk to property value depreciation continues to persist in the Bank’s construction loan portfolio. Real estate developers’ ability to service debt for extended time periods remains tentative as cash flows have deteriorated. Total loans outstanding, net of loans held for sale, decreased by $5.4 million in 2010 compared to December 31, 2009. At March 31, 2010, the allowance for loan losses was $8.2 million, an increase of $1.0 million, or 12.56%, from the $7.3 million at the end of 2009. The allowance represented 1.90% and 1.67%, respectively, of loans outstanding at March 31, 2010 and December 31, 2009, net of

 

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loans held for sale. The increase in the allowance is reflective of the on going economic and real estate market deterioration experienced locally as well as nationally. At March 31, 2010, the Bank had $9.7 million in non-accrual loans. At year-end 2009, the Bank had $7.3 million in non-accrual loans.

Non-Interest Income. For the first quarter of 2010, non-interest income decreased $53,000, or 7.22%, to $681,000 from $734,000 for the same period the prior year. Changes for the three months ended March 31, 2010 include a decrease of $76,000 in service charges and fees on deposits, reflecting the movement in the industry to reduce service charge fees on certain debit card and ATM transactions, a decrease of $89,000 in gain on sale of investments, an increase in cash value of life insurance of $28,000 resulting from moving several insurance policies to a higher rated carrier, an decrease in gains on sale of loan activities of $51,000 which is a reflection of the real estate market in general, an increase in income from brokerage services of $18,000, an increase of $14,000 resulting from a decrease in impairment on available for sale securities and an increase in all other non-interest income of $103,000 which is primarily the result of proceeds received from insurance claims.

Non-Interest Expense. For the first quarter of 2010, non-interest expense increased $55,000, or 1.97%, to $2.842 million from $2.787 million for the same period the prior year. Changes for the three months ended March 31, 2010 include a decrease of $260,000 in salaries and employee benefits resulting from downsizing of several positions, an increase of $12,000 in occupancy expense, an increase in other outside service expense of $47,000 reflecting increased information technology consulting expenses, an increase of $54,000 in data processing expense, an increase in deposit and other insurance expense of $38,000 primarily related to increases in FDIC premiums, an increase in professional and other services of $88,000 related to increased attorney and accounting fees, an increase of $37,000 in net losses on sale of foreclosed real estate, a decrease in advertising expense of $28,000 and an increase in all other non-interest expense of $50,000.

Provision for Income Taxes. Our provision for income tax expense or benefit, as a percentage of income before income taxes, was 32.6% and 31.2%, respectively, for the three months ended March 31, 2010 and 2009.

Financial Condition

Allowance for loan losses and problem loans. Determining the allowance for loan losses is based on a number of factors, many of which are subject to judgements made by management. At the origination of each commercial loan, management assesses the relative risk of the loan and assigns a corresponding risk grade. To ascertain that the credit quality is maintained after the loan is booked, a loan review officer performs an annual review of all unsecured loans over a predetermined amount, a sample of loans within a lender’s authority, and a sample of the entire loan pool. Loans are reviewed for credit quality, sufficiency of credit and collateral documentation, proper loan approval, covenant, policy and procedure adherence and continuing accuracy of the loan grade. The Loan Review Manager reports directly to the Chief Credit Officer and the Audit Committee of the Company’s Board of Directors.

The allowance for loan losses is an amount that management believes will be adequate to absorb estimated losses estimated inherent in existing loans, based on evaluations of the collectability of loans and prior loan loss experience. The allowance calculation consists of two primary components: (1) a component for individual impairment and (2) components for collective reserve, including a qualitative portion. The allowance is established through a provision for loan losses charged to expense. Loans are charged against the allowance for loan losses when management believes that the collectability of the principal is unlikely.

Based on the quarterly allowance calculation, management recorded a provision of $2.6 million for the three months ended March 31, 2010 compared to $1.1 million for the three months ended March 31,

 

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2009. Net charge-offs for the three months ended March 31, 2010 were $1.7 million or 0.39% of average loans, compared to $569,00, or 0.13% of average loans, for the three months ended March 31, 2009.

An analysis of the allowance for loan losses is as follows:

 

		Three Months Ended March 31,
		2010				2009
		(In thousands)
Balance at beginning of period		$	7,307			$	5,632
Provision charged to operations			2,600				1,135
Net charge-offs:
Loans charged off:
Construction loans			1,013				576
Commercial mortgage loans			541				—
Home equity lines of credit			132				—
Residential mortgage loans			25				—
Commercial and industrial loans			10				—
Consumer loans			13				—
Total charge-offs			1,734				576
Recoveries of loans previously charged-off:
Construction loans			—				7
Commercial mortgage loans			1				—
Home equity lines of credit			—				—
Residential mortgage loans			25				—
Commercial and industrial loans			6				—
Consumer loans			20				—
Total recoveries			52				7
Net charge-offs			(1,682	)			(569	)
Balance at end of period		$	8,225			$	6,198
Net charge-offs to average loans during the period			0.39	%			0.13	%
Allowance to gross loans			1.90	%			1.67	%

The evaluation of the allowance for loan losses is inherently subjective. Management uses the best information available to establish this estimate. However, if factors such as economic conditions differ substantially from assumptions, or if amounts and timing of future cash flows expected to be received on impaired loans vary substantially from estimates, future adjustments to the allowance for loan losses may be necessary. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Company’s allowance for loan losses. These agencies may require the Company to recognize additions to the allowance for loan losses based on their judgements about all relevant information available to them at the time of their examination. Any adjustments to original estimates are made in the period in which the factors and other considerations indicate that adjustments to the allowance for loan losses are necessary.

 

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The following is a summary of nonperforming assets and past due loans for the periods ended as presented:

 

		March 31, 2010				December 31, 2009
		(In thousands)
Nonaccrual loans
Construction		$	6,155			$	4,301
Commercial mortgage			2,629				2,557
Home equity lines			58				—
Residential mortgage			839				486
Commercial and industrial			—				—
Loans to individuals			—				—
			9,681				7,344
Foreclosed real estate
Construction			1,202				1,018
Commercial mortgage			1,510				1,510
Home equity lines			—				—
Residential mortgage			177				177
Commercial and industrial			157				157
Loans to individuals			—				—
			3,046				2,862
Repossessed Assets			—				14
Total nonperforming assets		$	12,727			$	10,220
Past due loans 1
Construction		$	2,048			$	2,515
Commercial mortgage			1,241				329
Home equity lines			357				176
Residential mortgage			1,765				531
Commercial and industrial			618				109
Loans to individuals			166				11
Total past due loans		$	6,195			$	3,671
Nonperforming loans to gross loans			2.24	%			1.68	%
Nonperforming assets to total assets			2.25	%			1.89	%
Past due loans to gross loans			1.43	%			0.83	%
Allowance coverage of nonperforming assets			64.63	%			99.50	%

 

1	Past due loans include all loans that are 30 days or more past due

Foreclosed assets which includes foreclosed real estate and other real property held for sale, increased to $3.0 million at March 31, 2010, from $2.9 million at December 31, 2009. The Company is actively marketing all of its foreclosed real properties. Foreclosed assets are initially recorded at fair value less costs to sell at date of foreclosure. Subsequent declines in fair value are charged to earnings. The Company obtains updated appraisals and/or valuations for all foreclosed assets.

Impaired loans primarily consist of nonperforming loans and troubled debt restructurings (“TDRs”) but can include other loans identified by management as being impaired. As of March 31, 2010, the Bank identified impaired loans of $40.3 million. Of these impaired loans, $18.7 million were identified to have a specific allowance impairment of $1.3 million. At December 31, 2009, $11.0 million of loans were

 

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determined to be impaired. Of this total, $8.2 million required a specific allowance totaling $1.2. The increase in impaired loans is due to the ongoing weakness experienced in the economy and real estate markets. For impaired loans where legal action has been taken to foreclose, the loan is charged down to estimated fair value, and a specific reserve is not established

The following table summarizes performing TDRs, which are all classified as impaired loans for purposes of the loan loss allowance calculation, as of March 31, 2010 and December 31, 2009.

 

		March 31, 2010			December 31, 2009
		(In thousands)
Performing TDRs
Construction		$	9,107		$	1,901
Commercial mortgage			717			—
Home equity lines			—			—
Residential mortgage			—			—
Commercial and industrial			—			718
Loans to individuals			—			—
Total performing TDRs		$	9,824		$	2,619
Non-performing TDRs
Construction		$	3,364		$	—
Commercial mortgage			—			—
Home equity lines			—			—
Residential mortgage			—			—
Commercial and industrial			—			—
Individual			—			—
Total non-performing TDRs		$	3,364		$	—
Total TDRs		$	13,188		$	2,619

Loans are classified as TDRs by the Company when certain modifications are made to the loan terms and concessions are granted to the borrowers due to financial difficulty experienced by those borrowers. Of the $13.2 million of TDRs at March 31, 2010, loans totaling $9.8 million were accruing interest and were not included in nonperforming loans. The Company only restructures loans for borrowers in financial difficulty that have a designed viable business plan to fully pay off all obligations, including outstanding debt, interest and fees, either by generating additional revenue from the business or through liquidation of assets. Generally these are restructured to provide the borrower additional time to execute their plans. The performing TDRs were performing prior to restructuring. They were not not placed in nonaccrual status prior to the restructuring, and since the Company expects the borrowers to perform after the restructuring (based on modified note terms), the loans continue to accrue interest at the restructured rate. The Company will continue to closely monitor these loans and will cease accruing interest on them if management believes that the borrowers may not continue to perform based on the restructured note terms. All TDRs are considered to be impaired and are evaluated as such in the quarterly allowance calculation.

Liquidity and Capital Resources

Market and public confidence in our financial strength and in the strength of financial institutions in general will largely determine our access to appropriate levels of liquidity. This confidence is significantly dependent on our ability to maintain sound asset quality and appropriate levels of capital resources.

 

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Liquidity is defined as our ability to meet anticipated customer demands for funds under credit commitments and deposit withdrawals at a reasonable cost and on a timely basis. Management measures our liquidity position by giving consideration to both on-and off-balance sheet sources of, and demands for, funds on a daily and weekly basis.

Sources of liquidity include cash and cash equivalents, net of federal requirements to maintain reserves against deposit liabilities; investment securities eligible for pledging to secure borrowings from dealers and customers pursuant to securities sold under repurchase agreements; investments available for sale; loan repayments; loan sales; deposits; and borrowings from the FHLB and FRB and from correspondent banks under overnight federal funds credit lines. In addition to interest rate-sensitive deposits, the Bank’s primary demand for liquidity is anticipated fundings under credit commitments to customers as well as meeting the fluctuations of normal deposit withdrawals.

We have maintained an adequate position of liquidity in the form of cash, interest-earning bank deposits, federal funds sold, investment securities and loans held for sale. These aggregated $110.2 million at March 31, 2010 compared to $80.4 million at December 31, 2009. Supplementing customer deposits as a source of funding, we have the ability to borrow up to $169.5 million from the FHLB, subject to collateral constraints, with $21 million outstanding at March 31, 2010 and $25 million outstanding at December 31, 2009. All borrowings with FHLB must be adequately collateralized. We also have the ability to borrow up to $52.9 million from the FRB, subject to collateral constraints. We had no borrowings outstanding with the FRB at March 31, 2010 or December 31, 2009. We believe that our combined aggregate liquidity position is sufficient to meet the funding requirements of loan demand and deposit maturities and withdrawals in the near term.

At March 31, 2010, the Company’s average equity to average asset ratio was 7.42%, and all of the Bank’s capital ratios exceeded the minimums established for a well-capitalized bank by regulatory measures. The Bank’s total risk-based capital ratio at March 31, 2010 was 11.77%.

 

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

We believe there has not been any significant change in the overall analysis of financial instruments considered market risk sensitive, as measured by the factors of contractual maturities, average interest rates and the difference between estimated fair values and book values, since the analysis prepared and presented in conjunction with our Annual Report on Form 10-K for the fiscal year ended December 31, 2009.

 

Item 4.

Controls and Procedures

MidCarolina Financial Corporation’s management, with the participation of the Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of the Company’s disclosure controls and procedures as of March 31, 2010. Based on that evaluation, the Company’s Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures where effective, as of March 31, 2010, to provide reasonable assurance that information required to be disclosed by the Company in the reports filed or submitted by it under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms.

In conjunction with the above evaluation of the Company’s disclosure controls and procedures, no change in our internal control over financial reporting was identified that occurred during the quarterly period ended March 31, 2010, and that has materially affected, or that is reasonably likely to materially affect, our internal control over financial reporting.

 

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Part II. OTHER INFORMATION

 

Item 1.

Legal Proceedings

None

 

Item 6.

Exhibits

An Exhibit Index listing exhibits that are being filed or furnished with, or incorporated by reference into, this Report appears immediately following the signature page and is incorporated herein by reference.

 

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SIGNATURES

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

 

		MIDCAROLINA FINANCIAL CORPORATION
Date: May 13, 2010		By:		/s/ Charles T. Canaday, Jr.
				Charles T. Canaday, Jr.
				President and Chief Executive Officer
Date: May 13, 2010		By:		/s/ Christopher B. Redcay
				Christopher B. Redcay
				Chief Financial Officer

 

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Exhibit Index

 

Exhibit 31.1		Rule 13a-14(a)/15d-14(a) Certification by Chief Executive Officer (filed herewith)
Exhibit 31.2		Rule 13a-14(a)/15d-14(a) Certification by Chief Financial Officer (filed herewith)
Exhibit 32.1		Section 1350 Certification by Chief Executive Officer (filed herewith)
Exhibit 32.2		Section 1350 Certification by Chief Financial Officer (filed herewith)