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EX-32.2 - CFO CERTIFICATION PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 - TRINITY CAPITAL CORPexhibit322.htm
EX-32.1 - CEO CERTIFICATION PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 - TRINITY CAPITAL CORPexhibit321.htm
EX-31.1 - CEO CERTIFICATION PURSUANT TO RULE 13A-14(A)/15D-14(A) - TRINITY CAPITAL CORPexhibit311.htm
EX-31.2 - CFO CERTIFICATION PURSUANT TO RULE 13A-14(A)/15D-14(A) - TRINITY CAPITAL CORPexhibit312.htm

 
 

 

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
FORM 10-Q

(Mark One)
   
[ X ] Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
     
for the quarterly period ended March 31, 2011.
 
Or
     
[ ]Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
 
for the transition period from                                                       to                                               
     
Commission File Number 000-50266
   

[TCC LOGO
TRINITY CAPITAL CORPORATION
(Exact name of registrant as specified in its charter)

New Mexico
 
85-0242376
(State or other jurisdiction of incorporation of organization)
 
(I.R.S. Employer Identification No.)
     
1200 Trinity Drive, Los Alamos, New Mexico 87544
(Address of principal executive offices)
     
(505) 662-5171
(Registrant’s telephone number, including Area Code)

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [ X ] No [ ]
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes [ ] No [ ]
 



[
 
 

 
 


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

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act)
[ ]  Yes  [ X ]  No
APPLICABLE ONLY TO CORPORATE ISSUERS:
 
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date: 6,449,726 shares of common stock, no par value, outstanding as of May 10, 2011.
 


 

 
 

 
 






 

 
 


 
 
TRINITY CAPITAL CORPORATION & SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
March 31, 2011 and December 31, 2010
(Amounts in thousands, except share data)

   
March 31, 2011
   
December 31, 2010
 
   
(Unaudited)
       
ASSETS
           
Cash and due from banks
 
$
18,305
   
$
16,765
 
Interest-bearing deposits with banks
   
101,062
     
89,316
 
Federal funds sold and securities purchased under resell agreements
   
393
     
110
 
Cash and cash equivalents
   
119,760
     
106,191
 
Investment securities available for sale
   
134,728
     
162,591
 
Investment securities held to maturity, at amortized cost (fair value of $10,786 at March 31, 2011 and $10,951 at  December 31, 2010)
   
11,026
     
11,107
 
Other investments
   
9,218
     
9,335
 
Loans held for sale
   
5,174
     
25,080
 
Loans (net of allowance for loan losses of $28,384 at March 31, 2011 and $28,722 at December 31, 2010)
   
1,157,520
     
1,161,216
 
Premises and equipment, net
   
29,734
     
30,264
 
Leased property under capital leases, net
   
2,211
     
2,211
 
Accrued interest receivable
   
6,736
     
6,736
 
Mortgage servicing rights, net
   
8,155
     
7,960
 
Other intangible assets
   
383
     
546
 
Other real estate owned
   
21,218
     
21,860
 
Prepaid expenses
   
5,158
     
6,076
 
Net deferred tax assets
   
5,737
     
5,587
 
Other assets
   
6,178
     
8,682
 
Total assets
 
$
1,522,936
   
$
1,565,442
 

(Continued on following page)
 


TRINITY CAPITAL CORPORATION & SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
March 31, 2011 and December 31, 2010
(Amounts in thousands, except share and per share data)
(Continued from prior page)

   
March 31, 2011
   
December 31, 2010
 
   
(Unaudited)
       
LIABILITIES AND STOCKHOLDERS' EQUITY
           
Liabilities
           
Deposits:
           
Noninterest-bearing
 
$
114,053
   
$
109,891
 
Interest-bearing
   
1,202,399
     
1,248,454
 
Total deposits
   
1,316,452
     
1,358,345
 
Short-term borrowings
   
10,000
     
1,152
 
Long-term borrowings
   
22,300
     
32,300
 
Long-term capital lease obligations
   
2,211
     
2,211
 
Junior subordinated debt owed to unconsolidated trusts
   
37,116
     
37,116
 
Accrued interest payable
   
2,696
     
4,873
 
Other liabilities
   
7,130
     
5,990
 
Total liabilities
   
1,397,905
     
1,441,987
 
                 
Stock owned by Employee Stock Ownership Plan (ESOP) participants; 628,914 shares, at fair value
 
$
5,817
   
$
6,132
 
               
Stockholders’ equity
               
Preferred stock, no par, authorized 1,000,000 shares
               
Series A, 5% cumulative perpetual, 35,539 shares issued and outstanding, $1,000 liquidation value per share, at amortized cost
 
$
33,860
   
$
33,808
 
Series B, 9% cumulative perpetual, 1,777 shares issued and outstanding, $1,000 liquidation value per share, at amortized cost
   
2,036
     
2,044
 
Common stock, no par, authorized 20,000,000 shares; issued 6,856,800 shares, shares outstanding 6,449,726
   
6,836
     
6,836
 
Additional paid-in capital
   
1,918
     
1,899
 
Retained earnings
   
84,878
     
83,018
 
Accumulated other comprehensive gain
   
660
     
692
 
Total stockholders' equity before treasury stock
   
130,188
     
128,297
 
Treasury stock, at cost, 407,074 shares at March 31, 2011 and December 31, 2010
   
(10,974
)
   
(10,974
)
Total stockholders' equity
   
119,214
     
117,323
 
Total liabilities and stockholders' equity
 
$
1,522,936
   
$
1,565,442
 

The accompanying notes are an integral part of these unaudited consolidated financial statements.
 

 
 
 
 


TRINITY CAPITAL CORPORATION & SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
For the Three Months Ended March 31, 2011 and 2010
(Amounts in thousands except share and per share data)
(Unaudited)

   
Three Months Ended March 31,
 
   
2011
   
2010
 
Interest income:
           
Loans, including fees
 
$
15,797
   
$
17,272
 
Investment securities:
               
Taxable
   
463
     
633
 
Nontaxable
   
281
     
298
 
Other interest-bearing deposits
   
54
     
105
 
Investment in unconsolidated trusts
   
22
     
20
 
Total interest income
   
16,617
     
18,328
 
Interest expense:
               
Deposits
   
2,353
     
3,963
 
Short-term borrowings
   
40
     
216
 
Long-term borrowings
   
214
     
128
 
Long-term capital lease obligations
   
67
     
67
 
Junior subordinated debt owed to unconsolidated trusts
   
723
     
683
 
Total interest expense
   
3,397
     
5,057
 
Net interest income
   
13,220
     
13,271
 
Provision for loan losses
   
1,450
     
4,257
 
Net interest income after provision for loan losses
   
11,770
     
9,014
 
Other income:
               
Mortgage loan servicing fees
   
667
     
646
 
Trust fees
   
460
     
355
 
Loan and other fees
   
752
     
666
 
Service charges on deposits
   
383
     
408
 
Net gain on sale of loans
   
1,280
     
720
 
Net gain on sale of securities
   
171
     
47
 
Title insurance premiums
   
164
     
188
 
Other operating income
   
107
     
26
 
Total other income
   
3,984
     
3,056
 

 (Continued on following page)
 


TRINITY CAPITAL CORPORATION & SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
For the Three Months Ended March 31, 2011 and 2010
(Amounts in thousands except share and per share data)
(Unaudited)
(Continued from prior page)

   
Three Months Ended March 31,
 
   
2011
   
2010
 
Other expenses:
           
Salaries and employee benefits
 
$
5,501
   
$
5,078
 
Occupancy
   
934
     
977
 
Data processing
   
788
     
724
 
Marketing
   
455
     
356
 
Amortization and valuation of mortgage servicing rights
   
303
     
309
 
Amortization and valuation of other intangible assets
   
163
     
125
 
Supplies
   
361
     
91
 
Loss on sale of other real estate owned
   
658
     
432
 
Postage
   
177
     
161
 
Bankcard and ATM network fees
   
343
     
163
 
Legal, professional and accounting fees
   
725
     
753
 
FDIC insurance premiums
   
761
     
898
 
Collection expenses
   
434
     
380
 
Other
   
1,027
     
538
 
Total other expense
   
12,630
     
10,985
 
Income before provision for income taxes
   
3,124
     
1,085
 
Provision for income taxes
   
1,038
     
649
 
Net income
 
$
2,086
   
$
436
 
Dividends and discount accretion on preferred shares
   
542
     
529
 
Net income (loss) available to common shareholders
 
$
1,544
   
$
(93
)
Basic earnings (loss) per common share
 
$
0.24
   
$
(0.01
)
Diluted earnings (loss) per common share
 
$
0.24
   
$
(0.01
)

The accompanying notes are an integral part of these unaudited consolidated financial statements.


 
 
 
 


TRINITY CAPITAL CORPORATION & SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the Three Months Ended March 31, 2011 and 2010
(Amounts in thousands)
(Unaudited)

   
Three Months Ended March 31,
 
   
2011
   
2010
 
Cash Flows From Operating Activities
       
Net income
 
$
2,086
   
$
436
 
Adjustments to reconcile net income to net cash provided by operating activities:
 
Depreciation and amortization
   
759
     
778
 
Net amortization of:
               
Mortgage servicing rights
   
383
     
502
 
Other intangible assets
   
163
     
125
 
Premium and discounts on investment securities, net
   
526
     
118
 
Junior subordinated debt owed to unconsolidated trusts issuance costs
   
3
     
3
 
Provision for loan losses
   
1,450
     
4,257
 
Change in mortgage servicing rights valuation allowance
   
(80
)
   
(193
)
Loss on disposal of premises and equipment
   
-
     
9
 
Net gain on sale of investment securities
   
(171
)
   
(47
)
Federal Home Loan Bank (FHLB) stock dividends received
   
(3
)
   
(3
)
Loss on venture capital investments
   
291
     
90
 
Net gain on sale of loans
   
(1,280
)
   
(720
)
Loss on disposal of other real estate owned
   
136
     
103
 
Write-down of value of other real estate owned
   
526
     
339
 
Decrease in other assets
   
3,288
     
449
 
Decrease in other liabilities
   
(1,534
)
   
(585
)
Stock options and stock appreciation rights expenses
   
19
     
36
 
Net cash provided by operating activities before originations and gross sales of loans held for sale
   
6,562
     
5,697
 
Gross sales of loans held for sale
   
51,190
     
30,695
 
Origination of loans held for sale
   
(30,502
)
   
(28,930
)
Net cash provided by operating activities
   
27,250
     
7,462
 

(Continued on following page)


 
 
 
 


TRINITY CAPITAL CORPORATION & SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the Three Months Ended March 31, 2011 and 2010
(Amounts in thousands)
(Unaudited)
(Continued from prior page)

   
Three Months Ended March 31,
 
   
2011
   
2010
 
Cash Flows From Investing Activities
       
Proceeds from maturities and paydowns of investment securities, available for sale
 
$
28,718
   
$
19,505
 
Proceeds from maturities and paydowns of investment securities, held to maturity
   
81
     
83
 
Proceeds from maturities and paydowns of investment securities, other
   
-
     
171
 
Proceeds from sale of investment securities, available for sale
   
4,432
     
3,422
 
Purchase of investment securities, available for sale
   
(5,693
)
   
(10,867
)
Purchase of investment securities, other
   
(171
)
   
(26
)
Proceeds from sale of other real estate owned
   
1,176
     
1,698
 
Net decrease in loans
   
1,050
     
8,912
 
Purchases of premises and equipment
   
(229
)
   
(239
)
Net cash provided by investing activities
   
29,364
     
22,659
 
Cash Flows From Financing Activities
         
Net (decrease) in demand deposits, NOW accounts and savings accounts
   
(4,908
)
   
(78,456
)
Net (decrease) increase in time deposits
   
(36,985
)
   
7,464
 
Proceeds from issuances of borrowings
   
-
     
20,000
 
Repayment of borrowings
   
(1,152
)
   
(20,010
)
Common shares dividend payments
   
-
     
(1,739
)
Preferred shares dividend payments
   
-
     
(488
)
Net cash (used in) financing activities
   
(43,045
)
   
(73,229
)
Net increase (decrease) in cash and cash equivalents
   
13,569
     
(43,108
)
Cash and cash equivalents:
               
Beginning of period
   
106,191
     
207,495
 
End of period
 
$
119,760
   
$
164,387
 
                 
Supplemental Disclosures of Cash Flow Information
 
Cash payments for:
               
Interest
 
$
5,574
   
$
5,581
 
Income taxes
 
$
238
   
$
72
 
Non-cash investing and financing activities:
 
Transfers from loans to other real estate owned
 
$
1,196
   
$
5,415
 
Dividends declared, not yet paid
 
$
1,720
   
$
240
 
Change in unrealized gain on investment securities, net of taxes
 
$
(32
)
 
$
(274
)

The accompanying notes are an integral part of these unaudited consolidated financial statements.


 
 
 
 


TRINITY CAPITAL CORPORATION & SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
 
Note 1. Basis of Presentation
 
The accompanying unaudited consolidated financial statements include the consolidated balances and results of operations of Trinity Capital Corporation (“Trinity”) and its wholly owned subsidiaries: Los Alamos National Bank (the “Bank”), Title Guaranty & Insurance Company (“Title Guaranty”), TCC Advisors Corporation (“TCC Advisors”) and TCC Funds, collectively referred to as the “Company.”  Trinity Capital Trust I (“Trust I”), Trinity Capital Trust III (“Trust III”), Trinity Capital Trust IV (“Trust IV”) and Trinity Capital Trust V (“Trust V”), collectively referred to as the “Trusts,” are trust subsidiaries of Trinity but are not consolidated in these financial statements (see consolidation accounting policy below).  The Bank holds a 24% interest in Cottonwood Technology Group, LLC (“Cottonwood”).  Cottonwood is owned by the Bank, the Los Alamos Commerce & Development Corporation and an individual not otherwise associated with Trinity or the Bank.  Cottonwood completed the initial close on a pre-seed and seed-stage investment fund in October 2009 and is focused on assisting new technologies, primarily those developed at New Mexico’s research and educational institutions, reaching the market by providing management advice and capital consulting.  The Bank’s full capital investment of $150 thousand was made in July 2009 and is reflected in these consolidated financial statements.  In October 2008, the Bank purchased the assets of Allocca & Brunett, Inc., an investment advisory company in Santa Fe, New Mexico.  As of March 31, 2011, all assets have been transferred to the Bank.  In 2009, the Bank created Finance New Mexico Investment Fund IV, LLC (“FNM Investment Fund IV”) and is the only member. FNM Investment Fund IV was created to acquire a 99.99% interest in FNM Investor Series IV, LLC (“FNM Investor Series IV”), 0.01% interest in which is held by Finance New Mexico, a governmental instrumentality.  These entities were both created to enable the funding of loans to, and investments in, a New Market Tax Credit project.  The initial value of these tax credits was $1.9 million.  As of March 31, 2011 and December 31, 2010, the unamortized amount of the new market tax credit was $1.4 million and $1.5 million, respectively, and is included in “other investments” on the consolidated balance sheet.  The initial amount of the loan was $5.2 million.  As of March 31, 2011 and December 31, 2011, the current outstanding loan amount was $5.2 million and is included in “loans, net” on the consolidated balance sheet.  In April 2010, the Bank activated TCC Advisors as a business unit operating one of the Bank’s foreclosed properties, Santa Fe Equestrian Center, in Santa Fe, New Mexico.  The size of the initial investment was $322 thousand.  As of March 31, 2011, the total investment was $474 thousand and is included in “other investments” on the consolidated balance sheet.  In September of 2010, the Bank joined Southwest Medical Technologies, LLC (“SWMT”) as a 20% member.  Participation in this entity is part of the Bank's venture capital investments.  This entity is owned by the Bank (20%), Southwest Medical Ventures, Inc. (60%), and New Mexico Co-Investment Fund II, L.P. (20%).  SWMT is focused on assisting new medical and life science technologies identify investment and financing opportunities.  The Bank’s total capital investment is expected to be $250 thousand.  As of March 31, 2011, the investment in SWMT was $67 thousand and is included in “other investments” on the consolidated balance sheet. 
 
The business activities of the Company consist solely of the operations of its wholly owned subsidiaries.  All significant inter-company balances and transactions have been eliminated in consolidation.  In the opinion of management, all adjustments (consisting only of normal recurring adjustments) necessary for a fair presentation of the consolidated financial position, results of operations and cash flows for the interim periods have been made.  The results of operations for the three months ended March 31, 2011, are not necessarily indicative of the results to be expected for the entire fiscal year.
 
The unaudited consolidated interim financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America and industry practice.  Certain information in footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America and industry practice has been condensed or omitted pursuant to rules and regulations of the Securities and Exchange Commission.  These financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in the Company’s December 31, 2010 audited financial statements in its Form 10-K, filed with the SEC on March 10, 2011.
 

 


The consolidated financial statements include the accounts of the Company.  The accounting and reporting policies of the Company conform to generally accepted accounting principles (“GAAP”) in the United States of America and general practices within the financial services industry.  In preparing the financial statements, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the balance sheet and revenues and expenses for the year.  Actual results could differ from those estimates.  Areas involving the use of management’s estimates and assumptions, and which are more susceptible to change in the near term, include the allowance for loan losses, valuation of other real estate owned, valuation of deferred tax assets and initial recording and subsequent valuation for impairment of mortgage servicing rights.
 
Certain items have been reclassified from prior period presentations in conformity with the current classification.  These reclassifications did not result in any changes to previously reported net income (loss) or stockholders’ equity.
 
Note 2. Comprehensive Income
 
Comprehensive income includes net income, as well as the change in net unrealized gain on investment securities available for sale, net of tax.  Comprehensive income is presented in the following table:
 
   
Three Months Ended March 31,
 
   
2011
   
2010
 
   
(Unaudited; in thousands)
 
Net income
 
$
2,086
   
$
436
 
Securities available for sale:
               
Net unrealized gains (losses) arising during the period
   
122
     
(395
)
Related income tax (expense) benefit
   
(40
)
   
140
 
Net securities gains reclassified into earnings
   
(171
)
   
(47
)
Related income tax benefit
   
57
     
28
 
Net effect on other comprehensive income for the period
   
(32
)
   
(274
)
Comprehensive income
 
$
2,054
   
$
162
 

 
Note 3. Earnings (Loss) Per Share Data
 
The following table sets forth the computation of basic and diluted earnings (loss) per share for the periods indicated:
 
   
Three Months Ended March 31,
 
   
2011
   
2010
 
   
(In thousands, except share and per share data)
 
             
Net income
 
$
2,086
   
$
436
 
Dividends and discount accretion on preferred shares
   
542
     
529
 
Net income (loss) available to common shareholders
 
$
1,544
   
$
(93
)
Weighted average common shares issued
   
6,856,800
     
6,856,800
 
LESS: Weighted average treasury stock shares
   
(407,074
)
   
(416,016
)
Weighted average common shares outstanding, net
   
6,449,726
     
6,440,784
 
Basic earnings per common share
 
$
0.24
   
$
(0.01
)
Weighted average common shares outstanding including dilutive shares
   
6,449,726
     
6,440,784
 
Diluted earnings per common share
 
$
0.24
   
$
(0.01
)



Certain stock options were not included in the above calculation, as these stock options would have an anti-dilutive effect as the exercise price is greater than current market price.  The total number of shares excluded was 304,000 and 314,500 as of March 31, 2011 and March 31, 2010, respectively.
 
Note 4. Recent Accounting Pronouncements and Regulatory Developments
 
ASC Topic 820, “Fair Value Measurements and Disclosures.” New authoritative accounting guidance under ASC Topic 820, “Fair Value Measurements and Disclosures,” amends prior accounting guidance to amend and expand disclosure requirements about transfers in and out of Levels 1 and 2, clarified existing fair value disclosure requirements about the appropriate level of disaggregation, and clarified that a description of valuation techniques and inputs used to measure fair value was required for recurring and nonrecurring Level 2 and 3 fair value measurements.  The new authoritative accounting guidance under ASC Topic 820 became effective for the Company on January 1, 2010, 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.  The new required disclosures are included in Note 16 – Fair Value Measurements.
 
ASC Topic 310 “Receivables.”  New authoritative accounting guidance under ASC Topic 310, “Receivables,” amended prior guidance to provide a greater level of disaggregated information about the credit quality of loans and leases and the Allowance for Loan and Lease Losses (the “Allowance”).  The new authoritative guidance also requires additional disclosures related to credit quality indicators, past due information, and information related to loans modified in a troubled debt restructuring.  The new authoritative guidance amends only the disclosure requirements for loans and leases and the allowance.  The Company adopted the period end disclosures provisions of the new authoritative guidance under ASC Topic 310 in the reporting period ending December 31, 2010.  Adoption of the new guidance did not have an impact on the Company’s statements of income and financial condition.  The Company adopted the disclosures provisions of the new authoritative guidance about activity that occurs during a reporting period on January 1, 2011; the adoption did not have an impact on the Company’s statements of income and financial condition.  The disclosures related to loans modified in a troubled debt restructuring will be effective for the reporting periods after June 15, 2011 and will have no impact on the Company’s statements of income and financial condition.
 
ASC Topic 310 “Receivables,” Subtopic 310-40 “Troubled Debt Restructurings by Creditors.”  New authoritative accounting guidance under Subtopic 310-40, “Receivables — Troubled Debt Restructurings by Creditors” amended prior guidance to provide assistance in determining whether a modification of the terms of a receivable meets the definition of a troubled debt restructuring.  The new authoritative guidance provides clarification for evaluating whether a concession has been granted and whether a debtor is experiencing financial difficulties.  The new authoritative guidance will be effective for the reporting periods after June 15, 2011 and should be applied retrospectively to restructurings occurring on or after the beginning of the fiscal year of adoption.  Adoption of the new guidance will have no significant impact on the Company’s statements of income and financial condition.
 


Note 5. Investment Securities
 
Amortized cost and fair values of investment securities are summarized as follows:
 
AVAILABLE FOR SALE
 
Amortized Cost
   
Gross Unrealized Gains
   
Gross Unrealized Losses
   
Fair Value
 
   
(In thousands)
 
March 31, 2011
                       
U.S. Government sponsored agencies
 
$
32,346
   
$
148
   
$
-
   
$
32,494
 
States and political subdivisions
   
22,454
     
581
     
-
     
23,035
 
Residential mortgage-backed securities
   
78,892
     
1,035
     
(728
)
   
79,199
 
Totals
 
$
133,692
   
$
1,764
   
$
(728
)
 
$
134,728
 
                                 
December 31, 2010
                               
U.S. Government sponsored agencies
 
$
42,551
   
$
184
   
$
-
   
$
42,735
 
States and political subdivisions
   
20,263
     
402
     
(81
)
   
20,584
 
Residential mortgage-backed securities
   
98,692
     
1,194
     
(614
)
   
99,272
 
Totals
 
$
161,506
   
$
1,780
   
$
(695
)
 
$
162,591
 

HELD TO MATURITY
 
Amortized Cost
   
Gross Unrealized Gains
   
Gross Unrealized Losses
   
Fair Value
 
   
(In thousands)
 
March 31, 2011
                       
States and political subdivisions
 
$
11,026
   
$
13
   
$
(253
)
 
$
10,786
 
Totals
 
$
11,026
   
$
13
   
$
(253
)
 
$
10,786
 
                                 
December 31, 2010
                               
States and political subdivisions
 
$
11,107
   
$
91
   
$
(247
)
 
$
10,951
 
Totals
 
$
11,107
   
$
91
   
$
(247
)
 
$
10,951
 

Realized net gains on sale of securities available for sale are summarized as follows:
 
   
Three Months Ended March 31,
 
   
2011
 
2010
 
   
(In thousands)
 
Gross realized gains
 
$
174
   
$
47
 
Gross realized losses
   
(3
)
   
-
 
Net gains
 
$
171
   
$
47
 



A summary of unrealized loss information for investment securities, categorized by security type, at March 31, 2011 and December 31, 2010, is as follows:
 
   
Less than 12 Months
   
12 Months or Longer
   
Total
 
AVAILABLE FOR SALE
 
Fair Value
   
Unrealized Losses
   
Fair Value
   
Unrealized Losses
   
Fair Value
   
Unrealized Losses
 
   
(In thousands)
 
March 31, 2011
                                   
Residential mortgage-backed securities
 
43,214
   
(728
)
 
-
   
-
   
43,214
   
(728
)
Totals
 
$
43,214
   
$
(728
)
 
$
-
   
$
-
   
$
43,214
   
$
(728
)
                                                 
December 31, 2010
                                               
States and political subdivisions
 
3,682
   
(81
)
 
-
     
-
   
3,682
   
(81
)
Residential mortgage-backed securities
   
38,796
     
(614
)
   
-
     
-
     
38,796
     
(614
)
Totals
 
$
42,478
   
$
(695
)
 
$
-
   
$
-
   
$
42,478
   
$
(695
)

   
Less than 12 Months
   
12 Months or Longer
   
Total
 
HELD TO MATURITY
 
Fair Value
   
Unrealized Losses
   
Fair Value
   
Unrealized Losses
   
Fair Value
   
Unrealized Losses
 
   
(In thousands)
 
March 31, 2011
                                   
States and political subdivisions
 
$
-
   
$
-
   
$
1,298
   
$
(253
)
 
$
1,298
   
$
(253
)
Totals
 
$
-
   
$
-
   
$
1,298
   
$
(253
)
 
$
1,298
   
$
(253
)
                                                 
December 31, 2010
                                               
States and political subdivisions
 
$
-
   
$
-
   
$
1,089
   
$
(247
)
 
$
1,089
   
$
(247
)
Totals
 
$
-
   
$
-
   
$
1,089
   
$
(247
)
 
$
1,089
   
$
(247
)
 
At March 31, 2011, $45.5 million in amortized cost of debt securities (representing a total of 37 different securities) had unrealized losses with aggregate depreciation of 2.2% of the Company’s amortized cost basis.  Of these securities, $1.5 million (representing a single security) had a continuous unrealized loss position for twelve months or longer with an aggregate depreciation of 16.3%.  The unrealized losses relate principally to the general change in interest rates and illiquidity, and not credit quality, that has occurred since the securities purchase dates, and such unrecognized losses or gains will continue to vary with general interest rate level fluctuations in the future.  As management does not intend to sell the securities, and it is unlikely that the Company will be required to sell the securities before their anticipated recovery, no declines are deemed to be other-than-temporary.
 


The amortized cost and fair value of investment securities, as of March 31, 2011, by contractual maturity are shown below. Maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without penalties.
 
   
Available for Sale
   
Held to Maturity
   
Other Investments
 
   
Amortized Cost
   
Fair Value
   
Amortized Cost
   
Fair Value
   
Amortized Cost
   
Fair Value
 
   
(In thousands)
 
One year or less
 
$
19,526
   
$
19,601
   
$
-
   
$
-
   
$
150
   
$
150
 
One to five years
   
29,911
     
30,253
     
-
     
-
     
-
     
-
 
Five to ten years
   
31,061
     
31,347
     
1,299
     
1,045
     
-
     
-
 
Over ten years
   
53,194
     
53,527
     
9,727
     
9,741
     
1,116
     
1,116
 
Equity investments with no stated maturity
   
-
     
-
     
-
     
-
     
7,952
     
7,952
 
   
$
133,692
   
$
134,728
   
$
11,026
   
$
10,786
   
$
9,218
   
$
9,218
 
 
Securities with carrying amounts of $30.7 million and $36.9 million at March 31, 2011 and December 31, 2010, respectively, were pledged as collateral on public deposits and for other purposes as required or permitted by law.
 
Note 6. Loans
 
Loans consisted of:

   
March 31,
   
December 31,
 
   
2011
   
2010
 
   
(In thousands)
 
Commercial
 
$
145,559
   
$
149,987
 
Commercial real estate
   
423,820
     
425,172
 
Residential real estate
   
401,036
     
400,713
 
Construction real estate
   
168,835
     
164,721
 
Installment and other
   
48,922
     
51,632
 
Total loans
   
1,188,172
     
1,192,225
 
Unearned income
   
(2,268
)
   
(2,287
)
Gross loans
   
1,185,904
     
1,189,938
 
Allowance for loan losses
   
(28,384
)
   
(28,722
)
Net loans
 
$
1,157,520
   
$
1,161,216
 

Loan Origination/Risk Management. The Company has certain lending policies and procedures in place that are designed to maximize loan income within an acceptable level of risk.  Management and the board of directors reviews and approves these policies and procedures on a regular basis.  A reporting system supplements the review process by providing management with frequent reports related to loan production, loan quality, concentrations of credit, loan delinquencies and non-performing and potential problem loans.
 


Commercial loans are underwritten after evaluating and understanding the borrower’s ability to operate profitably and prudently expand its business.  Underwriting standards are designed to promote relationship banking rather than transactional banking.  Once it is determined that the borrower’s management possesses sound ethics and solid business acumen, the Company’s management examines current and projected cash flows to determine the ability of the borrower to repay their obligations as agreed.  Commercial loans are primarily made based on the identified cash flows of the borrower and secondarily on the underlying collateral provided by the borrower.  The cash flows of borrowers, however, may not be as expected and the collateral securing these loans may fluctuate in value.  Most commercial and industrial loans are secured by the assets being financed or other business assets such as accounts receivable or inventory and may incorporate a personal guarantee; however, some short-term loans may be made on an unsecured basis.  In the case of loans secured by accounts receivable, the availability of funds for the repayment of these loans may be substantially dependent on the ability of the borrower to collect amounts due from its customers.
 
Commercial real estate loans are subject to underwriting standards and processes similar to commercial non-real estate loans, in addition to those of other real estate loans.  These loans are viewed primarily as cash flow loans and secondarily as loans secured by real estate.  Commercial real estate lending typically involves higher loan principal amounts and the repayment of these loans is generally largely dependent on the successful operation of the property securing the loan or the business conducted on the property securing the loan.  Commercial real estate loans may be more adversely affected by conditions in the real estate markets or in the general economy.  The properties securing the Company’s commercial real estate portfolio are geographically concentrated in the markets in which the Company operates.  Management monitors and evaluates commercial real estate loans based on collateral, location and risk grade criteria.  The Company also utilizes third-party sources to provide insight and guidance about economic conditions and trends affecting market areas it serves.  In addition, management tracks the level of owner-occupied commercial real estate loans versus non-owner occupied loans.  At March 31, 2011 and December 31, 2010, approximately 26.3% and 29.3%, respectively, of the outstanding principal balance of the Company’s commercial real estate loans were secured by owner-occupied properties.
 
With respect to loans to developers and builders that are secured by non-owner occupied properties that the Company may originate from time to time, the Company generally requires the borrower to have had an existing relationship with the Company and have a proven record of success.  Construction loans are underwritten utilizing feasibility studies, independent appraisal reviews, sensitivity analysis of absorption and lease rates and financial analysis of the developers and property owners.  Construction loans are generally based upon estimates of costs and value associated with the complete project.  These estimates may be inaccurate.  Construction loans often involve the disbursement of substantial funds with repayment substantially dependent on the success of the ultimate project.  Sources of repayment for these types of loans may be pre-committed permanent loans from approved long-term lenders, sales of developed property or an interim loan commitment from the Company until permanent financing is obtained.  These loans are closely monitored by on-site inspections and are considered to have higher risks than other real estate loans due to their ultimate repayment being sensitive to interest rate changes, governmental regulation of real property, general economic conditions and the availability of long-term financing.
 
The Company originates consumer loans utilizing a credit scoring analysis to supplement the underwriting process.  To monitor and manage consumer loan risk, policies and procedures are developed and modified, as needed, jointly by line and staff personnel.  This activity, coupled with relatively small loan amounts that are spread across many individual borrowers, minimizes risk.  Additionally, trend and outlook reports are reviewed by management on a regular basis.  Underwriting standards for residential real estate and home equity loans are heavily influenced by statutory requirements, which include, but are not limited to, maximum loan-to-value levels, debt-to-income levels, collection remedies, the number of such loans a borrower can have at one time and documentation requirements.
 
The Company maintains an independent loan review department that reviews and validates the credit risk program on a periodic basis.  Results of these reviews are presented to management.  The loan review process complements and reinforces the risk identification and assessment decisions made by lenders and credit personnel, as well as the Company’s policies and procedures.  In addition, the Company utilizes a third-party to periodically review loans to supplement the Company’s internal review process.
 


Non-performing Loans. Non-performing loans include (i) loans accounted for on a non-accrual basis and (ii) accruing loans contractually past due 90 days or more as to interest and principal.  Management reviews the loan portfolio for problem loans on an ongoing basis.  During the ordinary course of business, management may become aware of borrowers who may not be able to meet the contractual requirements of loan agreements.  Such loans are placed under close supervision with consideration given to placing the loan on a non-accrual status, increasing the allowance for loan losses, and (if appropriate) partial or full charge-off.  After a loan is placed on non-accrual status, any interest previously accrued, but not yet collected, is reversed against current income.  When payments are received on non-accrual loans, such payments will be applied to principal and any interest portion included in the payments are not included in income, but rather are applied to the principal balance of the loan.  Loans will not be placed back on accrual status unless all back interest and principal payments are made.  Our policy is to place loans 90 days past due on non-accrual status.  An exception is made when management believes a loan is well secured and in the process of collection.
 
There were no significant changes in the Company’s credit policy in the first quarter of 2011.
 
The following table presents the contractual aging of the recorded investment in current and past due loans by class of loans as of March 31, 2011 and December 31, 2010, including non-performing loans:
 
   
Current
 
30-59 Days Past Due
 
60-89 Days Past Due
 
Loans past due 90 days or more
 
Total Past Due
 
Total
 
March 31, 2011:
 
(In thousands)
 
Commercial
 
$
142,420
   
$
456
   
$
-
   
$
2,683
   
$
3,139
   
$
145,559
 
Commercial real estate
   
404,946
     
-
     
-
     
18,874
     
18,874
     
423,820
 
Residential real estate
   
386,190
     
488
     
358
     
14,000
     
14,846
     
401,036
 
Construction real estate
   
144,625
     
950
     
-
     
23,260
     
24,210
     
168,835
 
Installment and other
   
45,708
     
69
     
295
     
2,850
     
3,214
     
48,922
 
Total loans
 
$
1,123,889
   
$
1,963
   
$
653
   
$
61,667
   
$
64,283
   
$
1,188,172
 
                                                 
Nonperforming loan classification
 
$
-
   
$
-
   
$
-
   
$
61,667
   
$
61,667
   
$
61,667
 
                                                 
December 31, 2010:
 
Commercial
 
$
146,875
   
$
759
   
$
83
   
$
2,270
   
$
3,112
   
$
149,987
 
Commercial real estate
   
405,393
     
808
     
-
     
18,971
     
19,779
     
425,172
 
Residential real estate
   
388,898
     
2,422
     
1,038
     
8,355
     
11,815
     
400,713
 
Construction real estate
   
141,126
     
717
     
9,628
     
13,250
     
23,595
     
164,721
 
Installment and other
   
47,974
     
156
     
38
     
3,464
     
3,658
     
51,632
 
Total loans
 
$
1,130,266
   
$
4,862
   
$
10,787
   
$
46,310
   
$
61,959
   
$
1,192,225
 
                                                 
Nonperforming loan classification
 
$
1,772
   
$
600
   
$
1,286
   
$
46,130
   
$
48,196
   
$
49,968
 


 
 
 
 


The following table presents the recorded investment in nonaccrual loans and loans past due ninety days or more and still accruing by class of loans as of March 31, 2011 and December 31, 2010:
 
   
March 31, 2011
   
December 31, 2010
 
   
Nonaccrual
   
Loans past due 90 days or more and still accruing interest
   
Nonaccrual
   
Loans past due 90 days or more and still accruing interest
 
   
(In thousands)
 
Commercial
 
$
2,683
   
$
-
   
$
2,598
   
$
-
 
Commercial real estate
   
18,874
     
-
     
19,419
     
-
 
Residential real estate
   
14,000
     
-
     
10,951
     
-
 
Construction real estate
   
23,260
     
-
     
13,908
     
-
 
Installment and other
   
2,850
     
-
     
3,092
     
-
 
Total
 
$
61,667
   
$
-
   
$
49,968
   
$
-
 

The Company utilizes an internal asset classification system as a means of reporting problem and potential problem loans.  Under the Company’s risk rating system, the Company classifies problem and potential problem loans as “Special Mention,” “Substandard,” and “Doubtful”.  Substandard loans include those characterized by the distinct possibility that the Company will sustain some loss if credit deficiencies are not corrected.  Loans classified as Doubtful have all the weaknesses inherent in those classified Substandard with the added characteristic that the weaknesses present make collection or liquidation in full, on the basis of currently existing facts, conditions and values, highly questionable and improbable.  Loans that do not currently expose the Company to sufficient risk to warrant classification in one of the aforementioned categories, but possess weaknesses that deserve management’s close attention are deemed to be Special Mention.  Risk ratings are updated any time the situation warrants.
 
Loans not meeting the criteria above that are analyzed individually as part of the above described process are considered to be pass-rated loans.  Loans listed as not rated are included in groups of homogeneous loans with similar risk and loss characteristics.  The following tables present the risk category of loans by class of loans based on the most recent analysis performed and the contractual aging as of March 31, 2011 and December 31, 2010:
 
   
Pass
 
Special Mention
 
Substandard
 
Doubtful
 
Total
 
March 31, 2011:
 
(In thousands)
 
Commercial
 
$
141,620
   
$
136
   
$
3,803
   
$
-
   
$
145,559
 
Commercial real estate
   
394,467
     
762
     
28,591
     
-
     
423,820
 
Residential real estate
   
384,074
     
694
     
16,268
     
-
     
401,036
 
Construction real estate
   
142,395
     
-
     
26,440
     
-
     
168,835
 
Installment and other
   
45,875
     
49
     
2,998
     
-
     
48,922
 
Total
 
$
1,108,431
   
$
1,641
   
$
78,100
   
$
-
   
$
1,188,172
 
                                         
December 31, 2010:
 
Commercial
 
$
146,162
   
$
682
   
$
3,143
   
$
-
   
$
149,987
 
Commercial real estate
   
394,673
     
258
     
30,241
     
-
     
425,172
 
Residential real estate
   
387,636
     
151
     
12,926
     
-
     
400,713
 
Construction real estate
   
138,624
     
-
     
26,097
     
-
     
164,721
 
Installment and other
   
48,404
     
-
     
3,228
     
-
     
51,632
 
Total
 
$
1,115,499
   
$
1,091
   
$
75,635
   
$
-
   
$
1,192,225
 
 
The following table shows all loans, including non-performing loans, by classification and aging, as of March 31, 2011 and December 31, 2010:
 
   
Pass
 
Special Mention
 
Substandard
 
Doubtful
 
Total
 
March 31, 2011:
 
(In thousands)
 
Current
 
$
1,106,961
   
$
1,098
   
$
15,830
   
$
-
   
$
1,123,889
 
Past due 30-59 days
   
1,175
     
543
     
245
     
-
     
1,963
 
Past due 60-89 days
   
295
     
-
     
358
     
-
     
653
 
Past due 90 days or more
   
-
     
-
     
61,667
     
-
     
61,667
 
Total
 
$
1,108,431
   
$
1,641
   
$
78,100
   
$
-
   
$
1,188,172
 
                                         
December 31, 2010:
 
Current
 
$
1,111,092
   
$
1,091
   
$
18,083
   
$
-
   
$
1,130,266
 
Past due 30-59 days
   
3,903
     
-
     
959
     
-
     
4,862
 
Past due 60-89 days
   
504
     
-
     
10,283
     
-
     
10,787
 
Past due 90 days or more
   
-
     
-
     
46,310
     
-
     
46,310
 
Total
 
$
1,115,499
   
$
1,091
   
$
75,635
   
$
-
   
$
1,192,225
 


 
 
 
 


The following table presents loans individually evaluated for impairment by class of loans as of March 31, 2011 and December 31, 2010, showing the amount of principal charged-off (if any); the amount of allowance for loan losses specifically allocated for these impaired loans (if any).  The table also presents, for the three months ended March 31, 2011 and December 31,2010, the average recorded investment and the interest income recognized:
 
   
Unpaid Principal Balance
 
Recorded Investment
 
Partial Charge-offs
 
Allowance for Loan Losses Allocated
 
Average Recorded Investment
 
Interest Income Recognized
 
March 31, 2011:
 
(In thousands)
 
With no related allowance recorded:
 
Commercial
 
$
4,835
   
$
2,862
   
$
1,973
   
$
-
   
$
2,734
   
$
5
 
Commercial real estate
   
20,154
     
19,588
     
566
     
-
     
21,745
     
14
 
Residential real estate
   
15,632
     
14,781
     
851
     
-
     
13,258
     
14
 
Construction real estate
   
26,445
     
22,308
     
4,137
     
-
     
19,589
     
3
 
Installment and other
   
4,456
     
2,885
     
1,571
     
-
     
3,001
     
6
 
With an allowance recorded:
 
Commercial
   
1,114
     
1,114
     
-
     
49
   
$
797
   
$
7
 
Commercial real estate
   
379
     
379
     
-
     
44
     
380
     
5
 
Residential real estate
   
3,669
     
3,669
     
-
     
605
     
3,549
     
34
 
Construction real estate
   
-
     
-
     
-
     
-
     
-
     
-
 
Installment and other
   
1,162
     
1,162
     
-
     
104
     
812
     
7
 
Total
 
$
77,846
   
$
68,748
   
$
9,098
   
$
802
   
$
65,865
   
$
95
 
                                                 
December 31, 2010:
 
With no related allowance recorded:
 
Commercial
 
$
4,484
   
$
2,606
   
$
1,878
   
$
-
   
$
2,509
   
$
24
 
Commercial real estate
   
24,442
     
23,901
     
541
     
-
     
21,609
     
212
 
Residential real estate
   
12,381
     
11,734
     
647
     
-
     
11,624
     
114
 
Construction real estate
   
19,124
     
15,918
     
3,206
     
-
     
16,008
     
157
 
Installment and other
   
4,460
     
3,117
     
1,343
     
-
     
3,430
     
34
 
With an allowance recorded:
 
Commercial
   
479
     
479
     
-
     
15
     
479
     
4
 
Commercial real estate
   
380
     
380
     
-
     
45
     
380
     
5
 
Residential real estate
   
3,429
     
3,429
     
-
     
338
     
3,429
     
37
 
Construction real estate
   
-
     
-
     
-
     
-
     
-
     
-
 
Installment and other
   
461
     
461
     
-
     
80
     
460
     
16
 
Total
 
$
69,640
   
$
62,025
   
$
7,615
   
$
478
   
$
59,928
   
$
603
 

Allowance for Loan Losses: The Company has established an internal policy to estimate the allowance for loan losses.  This policy is periodically reviewed by management and the board of directors.  No significant changes have been made in this policy during the first quarter of 2011.
 
The allowance for loan losses is that amount which, in management’s judgment, is considered appropriate to provide for probable losses in the loan portfolio. In analyzing the adequacy of the allowance for loan losses, management uses a comprehensive loan grading system to determine risk potential in the portfolio, and considers the results of periodic internal and external loan reviews.  Historical loss experience factors and specific reserves for impaired loans, combined with other considerations, such as delinquency, non-accrual, trends on criticized and classified loans, economic conditions, concentrations of credit risk, and experience and abilities of lending personnel, are also considered in analyzing the adequacy of the allowance.  Management uses a systematic methodology, which is applied at least quarterly, to determine the amount of allowance for loan losses and the resultant provisions for loan losses it considers adequate to provide for probable loan losses.  In the event that different assumptions or conditions were to prevail, and depending upon the severity of such changes, the possibility of materially different financial condition or results of operations is a reasonable likelihood.
 

 
 
 
 


Three methods are used to evaluate the adequacy of the allowance for loan losses: (1) specific identification, based on management’s assessment of loans in our portfolio and the probability that a charge-off will occur in the upcoming quarter; (2) losses probable in the loan portfolio besides those specifically identified, based upon a migration analysis of the percentage of loans currently performing that have probable losses; and (3) qualitative adjustments based on management’s assessment of certain risks such as delinquency trends, watch-list and classified trends, changes in concentrations, economic trends, industry trends, non-accrual trends, exceptions and loan-to-value guidelines, management and staff changes and policy or procedure changes.
 
While management uses the best information available to make its evaluation, future adjustments to the allowance may be necessary if there are significant changes in economic conditions.  In addition, as an integral part of their examination process regulatory agencies periodically review our allowance for loan losses and may require us to make additions to the allowance based on their evaluation of information available at the time of their examinations.
 
Activity in the allowance for loan losses was as follows:
 
   
Commercial
 
Commercial real estate
 
Residential real estate
 
Construction real estate
 
Installment and other
 
Unallocated
 
Total
 
March 31, 2011
 
(In thousands)
 
Allowance for loan losses:
 
                                           
Beginning balance
 
$
5,857
   
$
7,011
   
$
4,093
   
$
7,322
   
$
4,122
   
$
317
   
$
28,722
 
Provision for possible loan losses
   
28
     
599
     
1,580
     
(520
)
   
215
     
(452
)
   
1,450
 
Charge-offs
   
(285
)
   
(240
)
   
(1,106
)
   
(89
)
   
(302
)
   
-
     
(2,022
)
Recoveries
   
9
     
9
     
179
     
14
     
23
     
-
     
234
 
Net charge-offs
   
(276
)
   
(231
)
   
(927
)
   
(75
)
   
(279
)
   
-
     
(1,788
)
Ending balance
 
$
5,609
   
$
7,379
   
$
4,746
   
$
6,727
   
$
4,058
   
$
(135
)
 
$
28,384
 
Period-end amount allocated to:
 
Loans individually evaluated for impairment
 
$
49
   
$
44
   
$
605
   
$
-
   
$
104
   
$
-
   
$
802
 
Loans collectively evaluated for impairment
   
5,560
     
7,335
     
4,141
     
6,727
     
3,954
     
(135
)
   
27,582
 
Ending balance
 
$
5,609
   
$
7,379
   
$
4,746
   
$
6,727
   
$
4,058
   
$
(135
)
 
$
28,384
 
                                                         
Loans:
                                         
Individually evaluated for impairment
 
$
3,976
   
$
19,967
   
$
18,450
   
$
22,308
   
$
4,047
   
$
-
   
$
68,748
 
Collectively evaluated for impairment
   
141,583
     
403,853
     
382,586
     
146,527
     
44,875
     
-
     
1,119,424
 
Total ending loans balance
 
$
145,559
   
$
423,820
   
$
401,036
   
$
168,835
   
$
48,922
   
$
-
   
$
1,188,172
 
 
 
 

 
 
 
 



   
Commercial
 
Commercial real estate
 
Residential real estate
 
Construction real estate
 
Installment and other
 
Unallocated
 
Total
 
March 31, 2010
 
(In thousands)
 
                                           
Beginning balance
 
$
4,182
   
$
6,316
   
$
2,100
   
$
8,637
   
$
3,080
   
$
189
   
$
24,504
 
Provision for possible loan losses
   
3,152
     
(127
)
   
2,106
     
(1,550
)
   
865
     
(189
)
   
4,257
 
Charge-offs
   
(1,310
)
   
(112
)
   
(1,501
)
   
(452
)
   
(684
)
   
-
     
(4,059
)
Recoveries
   
23
     
0
     
8
     
60
     
29
     
-
     
120
 
Net charge-offs
   
(1,287
)
   
(112
)
   
(1,493
)
   
(392
)
   
(655
)
   
-
     
(3,939
)
Ending balance
 
$
6,047
   
$
6,077
   
$
2,713
   
$
6,695
   
$
3,290
   
$
-
   
$
24,822
 
Period-end amount allocated to:
 
Loans individually evaluated for impairment
 
$
10
   
$
-
   
$
88
   
$
90
   
$
75
   
$
-
   
$
263
 
Loans collectively evaluated for impairment
   
6,037
     
6,077
     
2,625
     
6,605
     
3,215
     
-
     
24,559
 
Ending balance
 
$
6,047
   
$
6,077
   
$
2,713
   
$
6,695
   
$
3,290
   
$
-
   
$
24,822
 
                                                         
Loans:
                                         
Individually evaluated for impairment
 
$
4,922
   
$
28,559
   
$
14,150
   
$
22,919
   
$
3,840
   
$
-
   
$
74,390
 
Collectively evaluated for impairment
   
130,159
     
407,065
     
405,363
     
157,736
     
49,022
     
-
     
1,149,345
 
Total ending loans balance
 
$
135,081
   
$
435,624
   
$
419,513
   
$
180,655
   
$
52,862
   
$
-
   
$
1,223,735
 
 
Note 7. Other Real Estate Owned
 
Other real estate owned consists of property acquired due to foreclosure on real estate loans. Total other real estate owned consisted of:
 
   
At
March 31, 2011
   
At
December 31, 2010
 
   
(In thousands)
 
Construction property
 
$
14,682
   
$
14,872
 
Residential real estate
   
2,176
     
3,427
 
Commercial real estate
   
4,360
     
3,561
 
Total
 
$
21,218
   
$
21,860
 

Note 8. Short-Term Borrowings
 
The Company had a Federal Home Loan Bank (FHLB) advance with a maturity date of less than one year of $10.0 million as of March 31, 2011 and $1.2 million as of December 31, 2010.  As of March 31, 2011, the advance had a fixed interest rate of 2.565%.
 

 
 
 
 


Note 9. Long-Term Borrowings
 
The Company had FHLB advances with original maturity dates greater than one year of $22.3 million as of March 31, 2011 and $32.3 million as of December 31, 2010.  As of March 31, 2011, long-term borrowings consisted of the following fixed-rate advances:
 
Maturity Date
 
Rate
 
Principal due
 
Amount
 
(Dollars in thousands)
 
03/23/2015
   
3.05
At maturity
 
$
20,000
 
04/27/2021
   
6.34
At maturity
   
2,300
 
             
$
22,300
 

Note 10. Long-term Capital Lease Obligations
 
The Company is leasing land in Santa Fe and built a Bank office on the site. In July of 2009, Trinity sold the improvements to the Bank and entered into a sublease with the Bank.  The construction of the office was completed in October of 2009, and the new office opened on October 19, 2009.  The ground lease has an 8-year term, expiring in 2014, and contains an option to purchase the land for a price certain at the termination of the initial term of the lease.  The ground lease is classified as a capital lease.  The Company also holds a note and mortgage on this land, and the interest payments received on the note are approximately equal to the payments made on the lease.  The principal due on the note at maturity (simultaneous with the lease maturity) will largely offset the option purchase price.  Lease payments for each of the three-month periods ended March 31, 2011 and 2010 were $46 thousand.
 
Note 11. Junior Subordinated Debt Owed to Unconsolidated Trusts
 
The following table presents details on the junior subordinated debt owed to unconsolidated trusts as of March 31, 2011.
 
   
Trust I
   
Trust III
   
Trust IV
   
Trust V
 
   
(Dollars in thousands)
 
Date of Issue
 
March 23, 2000
   
May 11, 2004
   
June 29, 2005
   
September 21, 2006
 
Amount of trust preferred securities issued
 
$
10,000
   
$
6,000
   
$
10,000
   
$
10,000
 
Rate on trust preferred securities
   
10.875
%
 
3.01% (variable)
     
6.88
%
   
6.83
%
Maturity
 
March 8, 2030
   
September 8, 2034
   
November 23, 2035
   
December 15, 2036
 
Date of first redemption
 
March 8, 2010
   
September 8, 2009
   
August 23, 2010
   
September 15, 2011
 
Common equity securities issued
 
$
310
   
$
186
   
$
310
   
$
310
 
Junior subordinated deferrable interest debentures owed
 
$
10,310
   
$
6,186
   
$
10,310
   
$
10,310
 
Rate on junior subordinated deferrable interest debentures
   
10.875
%
 
3.01% (variable)
     
6.88
%
   
6.83
%


 
 
 
 


On the dates of issue indicated above, the Trusts, being Delaware statutory business trusts, issued trust preferred securities (the “trust preferred securities”) in the amount and at the rate indicated above.  These securities represent preferred beneficial interests in the assets of the Trusts.  The trust preferred securities will mature on the dates indicated, and are redeemable in whole or in part at the option of Trinity at any time after the date of first redemption indicated above, with the approval of the Federal Reserve Board and in whole at any time upon the occurrence of certain events affecting their tax or regulatory capital treatment.  The Trusts also issued common equity securities to Trinity in the amounts indicated above.  The Trusts used the proceeds of the offering of the trust preferred securities to purchase junior subordinated deferrable interest debentures (the “debentures”) issued by Trinity, which have terms substantially similar to the trust preferred securities.  Trinity has the right to defer payments of interest on the debentures at any time or from time to time for a period of up to ten consecutive semi-annual periods (or twenty consecutive quarterly periods in the case of Trusts with quarterly interest payments) with respect to each interest payment deferred.  Under the terms of the debentures, under certain circumstances of default or if Trinity has elected to defer interest on the debentures, Trinity may not, with certain exceptions, declare or pay any dividends or distributions on its capital stock or purchase or acquire any of its capital stock.  Trinity used the majority of the proceeds from the sale of the debentures to add to Tier 1 and Tier 2 capital in order to support its growth and to purchase treasury stock.
 
Trinity owns all of the outstanding common securities of the Trusts.  The Trusts are considered variable interest entities (VIEs).  Because Trinity is not the primary beneficiary of the Trusts, the financial statements of the Trusts are not included in the consolidated financial statements of the Company.
 
In March 2005, the Board of Governors of the Federal Reserve System issued a final rule allowing bank holding companies to continue to include qualifying trust preferred securities in their Tier 1 Capital for regulatory capital purposes, subject to a 25% limitation to all core (Tier I) capital elements, net of goodwill less any associated deferred tax liability.  The final rule provides a five-year transition period, ending March 31, 2009, for application of the aforementioned quantitative limitation.  In April 2009, this five-year transition period was extended.  As of March 31, 2011, 100% of the trust preferred securities noted in the table above qualified as Tier 1 capital under the final rule adopted in March 2005.
 
Payments of distributions on the trust preferred securities and payments on redemption of the trust preferred securities are guaranteed by Trinity on a limited basis.  Trinity also entered into an agreement as to expenses and liabilities with the Trusts pursuant to which it agreed, on a subordinated basis, to pay any costs, expenses or liabilities of the Trusts other than those arising under the trust preferred securities.  The obligations of Trinity under the junior subordinated debentures, the related indenture, the trust agreement establishing the Trusts, the guarantee and the agreement as to expenses and liabilities, in the aggregate, constitute a full and unconditional guarantee by Trinity of the Trusts’ obligations under the trust preferred securities.
 
Issuance costs of $615 thousand related to Trust I and Trust III were deferred and are being amortized over the period until mandatory redemption of the securities in March 2030 and September 2034, respectively.  During each of the three-month periods ended March 31, 2011 and 2010, $3 thousand of these issuance costs were amortized.  Unamortized issuance costs were $267 thousand and $270 thousand at March 31, 2011 and December 31, 2010, respectively.  There were no issuance costs associated with the other trust preferred security issues.
 
As of March 31, 2011, a total of $184 thousand of interest had been prepaid to the Trusts.  Interest accrued and unpaid to securities holders totaled $1.9 million on December 31, 2010.
 
Under the terms of the securities purchase agreement between the Company and the U.S. Treasury pursuant to which the Company issued its Series A and Series B Preferred Stock as part of the TARP Capital Purchase Program, prior to the earlier of (i) March 27, 2012 and (ii) the date on which all of the shares of the Series A and Series B Preferred Stock have been redeemed by us or transferred by Treasury to third parties, we may not redeem our trust preferred securities (or the related junior subordinated notes), without the consent of Treasury.
 
On March 17, 2011, Trinity paid all interest payments on the trust preferred securities issues that were previously deferred.  These payments totaled $2.7 million, including both deferred interest and interest accrued since the latest deferral date.
 

 
 
 
 


 
Credit-related financial instruments: The Company is a party to credit-related commitments with off-balance-sheet risk in the normal course of business to meet the financing needs of its customers.  These credit-related commitments include commitments to extend credit, standby letters of credit and commercial letters of credit.  Such credit-related commitments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the consolidated balance sheets.
 
The Company’s exposure to credit loss is represented by the contractual amount of these credit-related commitments.  The Company follows the same credit policies in making credit-related commitments as it does for on-balance-sheet instruments.
 
At March 31, 2011 and December 31, 2010, the following credit-related commitments were outstanding:
 
   
Contract Amount
 
   
March 31, 2011
   
December 31, 2010
 
   
(In thousands)
 
Unfunded commitments under lines of credit
 
$
161,167
   
$
164,850
 
Commercial and standby letters of credit
 
$
13,210
   
$
14,051
 
 
Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require a payment of a fee.  The commitments for equity lines of credit may expire without being drawn upon.  Therefore, the total commitment amounts do not necessarily represent future cash requirements.  The amount of collateral obtained, if deemed necessary by the Bank, is based on management’s credit evaluation of the customer.  Unfunded commitments under commercial lines of credit, revolving credit lines and overdraft protection agreements are commitments for possible future extensions of credit to existing customers.  Overdraft protection agreements are uncollateralized, but most other unfunded commitments have collateral.  These unfunded lines of credit usually do not contain a specified maturity date and may not necessarily be drawn upon to the total extent to which the Bank is committed.
 
Commercial and standby letters of credit are conditional credit-related commitments issued by the Bank to guarantee the performance of a customer to a third party.  Those letters of credit are primarily issued to support public and private borrowing arrangements.  Essentially all letters of credit issued have expiration dates within one year.  The credit risk involved in issuing letters of credit is the same as that involved in extending loans to customers.  The Bank generally holds collateral supporting those credit-related commitments, if deemed necessary.  In the event the customer does not perform in accordance with the terms of the agreement with the third party, the Bank would be required to fund the credit-related commitment.  The maximum potential amount of future payments the Bank could be required to make is represented by the contractual amount shown in the summary above.  If the credit-related commitment is funded, the Bank would be entitled to seek recovery from the customer.  At March 31, 2011 and December 31, 2010, no amounts have been recorded as liabilities for the Company’s potential obligations under these credit-related commitments.  The fair value of these credit-related commitments is approximately equal to the fees collected when granting these letters of credit.  These fees collected were $15 thousand as of March 31, 2011 and $13 thousand December 31, 2010, respectively, and are included in “other liabilities” on the Company’s balance sheet.
 
Concentrations of credit risk: The majority of the loans, commitments to extend credit, and standby letters of credit have been granted to customers in Los Alamos, Santa Fe and surrounding communities.  Although the Bank has a diversified loan portfolio, a substantial portion of its loans are made to businesses and individuals associated with, or employed by, Los Alamos National Laboratory (the “Laboratory”).  The ability of such borrowers to honor their contracts is predominately dependent upon the continued operation and funding of the Laboratory.  Investments in securities issued by state and political subdivisions involve governmental entities within the state of New Mexico.  The distribution of commitments to extend credit approximates the distribution of loans outstanding. Standby letters of credit are granted primarily to commercial borrowers. 
 

 
 
 
 


Note 13. Preferred Equity Issues
 
On March 27, 2009, the Company issued two series of preferred shares to the Treasury under the Capital Purchase Program (“CPP”). Below is a table disclosing the information on these two series:
 
 
Number of
shares issued
Dividend rate
 
Liquidation value per share
   
Original cost, in thousands
 
Series A cumulative perpetual preferred shares
35,539
5 % for the first 5 years, thereafter 9%
 
$
1,000
   
$
33,437
 
Series B cumulative perpetual preferred shares
1,777
9%
   
1,000
     
2,102
 
 
Dividends are paid quarterly to Treasury, and the amount of any unpaid dividends outstanding at the end of the quarter is an outstanding liability in “other liabilities” on the balance sheet.  The amount of dividends accrued and unpaid were $1.7 million and $1.2 million as of March 31, 2011 and December 31, 2010, respectively.
 
The difference between the liquidation value of the preferred shares and the original cost is accreted (for Series B) or amortized (for Series A) over 10 years. The net difference of this amortization and accretion is posted directly to capital.  During both of the three-month periods ended March 31, 2011 and March 31, 2010, a net amount of $44 thousand was accreted to equity.
 
Both the dividends and net accretion on the preferred shares reduce the amount of net income available to common shareholders.  During the three months ended March 31, 2011 and March 31, 2010, the total of these two amounts was $542 thousand and $529 thousand, respectively.
 
On April 26, 2011, the Board of Directors of the Company declared a dividend to pay all preferred dividends that were previously deferred.  All deferred and current dividends to be paid on May 16, 2011 total $2.0 million.
 
Note 14. Litigation
 
Trinity, the Bank, Title Guaranty, Cottonwood, FNM Investment Fund IV, FNM Investor Series IV, TCC Advisors, SWMT and TCC Funds were not involved in any pending legal proceedings, other than routine legal proceedings occurring in the normal course of business, which, in the opinion of management, in the aggregate, would be considered material to the Company's consolidated financial condition. 
 
 
In the normal course of business, the Bank uses a variety of financial instruments to service the financial needs of customers and to reduce its exposure to fluctuations in interest rates.  Derivative instruments that the Bank uses as part of its interest rate risk management strategy include mandatory forward delivery commitments and rate lock commitments.
 
As a result of using over-the-counter derivative instruments, the Bank has potential exposure to credit loss in the event of nonperformance by the counterparties.  The Bank manages this credit risk by selecting only well established, financially strong counterparties, spreading the credit risk amongst many such counterparties and by placing contractual limits on the amount of unsecured credit risk from any single counterparty.  The Bank’s exposure to credit risk in the event of default by a counterparty is the current cost of replacing the contracts net of any available margins retained by the Bank.  However, if the borrower defaults on the commitment, the Bank requires the borrower to cover these costs.
 
The Company’s derivative instruments outstanding at March 31, 2011, include commitments to fund loans held for sale.  The interest rate lock commitment was valued at fair market value at inception.  The rate locks will continue to be adjusted for changes in value resulting from changes in market interest rates.
 

 
 
 
 


The Company originates single-family residential loans for sale pursuant to programs with the Federal National Mortgage Association (“FNMA”).  At the time the interest rate is locked in by the borrower, the Bank concurrently enters into a forward loan sale agreement with respect to the sale of such loan at a set price in an effort to manage the interest rate risk inherent in the locked loan commitment.  Any change in the fair value of the loan commitment after the borrower locks in the interest rate is substantially offset by the corresponding change in the fair value of the forward loan sale agreement related to such loan.  The period from the time the borrower locks in the interest rate to the time the Bank funds the loan and sells it to FNMA is generally 60 days.  The fair value of each instrument will rise or fall in response to changes in market interest rates subsequent to the dates the interest rate locks and forward loan sale agreements are entered into.  In the event that interest rates rise after the Bank enters into an interest rate lock, the fair value of the loan commitment will decline.  However, the fair value of the forward loan sale agreement related to such loan commitment should increase by substantially the same amount, effectively eliminating the Company’s interest rate and price risk.
 
At March 31, 2011, the Company had notional amounts of $3.7 million in contracts with customers and $8.8 million in contracts with FNMA for interest rate lock commitments outstanding related to loans being originated for sale.  The related fair values of these commitments were an asset of $80 thousand as of March 31, 2011.  At December 31, 2010 the Company had notional amounts of $8.1 million in contracts with customers and $33.2 million in contracts with FNMA for interest rate lock commitments outstanding related to loans being originated for sale.  The related fair values of these commitments were an asset of $567 thousand and a liability of $25 thousand as of December 31, 2010.  For the three months ending March 31, 2011 and March 31, 2010, expenses relating to the valuation of these derivative instruments totaled $461 thousand and $21 thousand, respectively.  These amounts are included under “Other” in “Other expenses” on the consolidated statements of operations.
 
Note 16. Fair Value Measurements
 
ASC Topic 820 defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. A fair value measurement assumes that the transaction to sell the asset or transfer the liability occurs in the principal market for the asset or liability or, in the absence of a principal market, the most advantageous market for the asset or liability. The price in the principal (or most advantageous) market used to measure the fair value of the asset or liability shall not be adjusted for transaction costs. An orderly transaction is a transaction that assumes exposure to the market for a period prior to the measurement date to allow for marketing activities that are usual and customary for transactions involving such assets and liabilities; it is not a forced transaction. Market participants are buyers and sellers in the principal market that are (i) independent, (ii) knowledgeable, (iii) able to transact and (iv) willing to transact.
 
ASC Topic 820 requires the use of valuation techniques that are consistent with the market approach, the income approach and/or the cost approach. The market approach uses prices and other relevant information generated by market transactions involving identical or comparable assets and liabilities. The income approach uses valuation techniques to convert expected future amounts, such as cash flows or earnings, to a single present value amount on a discounted basis. The cost approach is based on the amount that currently would be required to replace the service capacity of an asset (replacement cost). Valuation techniques should be consistently applied. Inputs to valuation techniques refer to the assumptions that market participants would use in pricing the asset or liability. Inputs may be observable, meaning those that reflect the assumptions market participants would use in pricing the asset or liability developed based on market data obtained from independent sources, or unobservable, meaning those that reflect the reporting entity's own assumptions about the assumptions market participants would use in pricing the asset or liability developed based on the best information available in the circumstances. In that regard, ASC Topic 820 establishes a fair value hierarchy for valuation inputs that gives the highest priority to quoted prices in active markets for identical assets or liabilities and the lowest priority to unobservable inputs. The fair value hierarchy is as follows:
 
·
Level 1: Quoted prices (unadjusted) for identical assets or liabilities in active markets that the entity has the ability to access as of the measurement date.
 
·
Level 2: Significant other observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data.

·
Level 3: Significant unobservable inputs that reflect a reporting entity’s own assumptions about the assumptions that market participants would use in pricing an asset or liability.
 
A description of the valuation methodologies used for instruments measured at fair value, as well as the general classification of such instruments pursuant to the valuation hierarchy, is set forth below.
 
In general, fair value is based upon quoted market prices, where available. If such quoted market prices are not available, fair value is based upon internally developed models that primarily use observable market-based parameters as inputs. Valuation adjustments may be made to ensure that financial instruments are recorded at fair value. These adjustments may include amounts to reflect counterparty credit quality, the Company's creditworthiness, among other things, as well as unobservable parameters. Any such valuation adjustments are applied consistently over time. Our valuation methodologies may produce a fair value calculation that may not be indicative of net realizable value or reflective of future fair values. While management believes the Company’s valuation methodologies are appropriate and consistent with other market participants, the use of different methodologies or assumptions to determine the fair value of certain financial instruments could result in a different estimate of fair value at the reporting date. Transfers between levels of the fair value hierarchy are recognized on the actual date of the event or circumstances that caused the transfer, which generally coincides with the Company’s monthly and/or quarterly valuation process.
 
Financial Instruments Recorded at Fair Value on a Recurring Basis
 
Securities Available for Sale. The fair values of securities available for sale are determined by quoted prices in active markets, when available.  If quoted market prices are not available, the fair value is determined by a matrix pricing, which is a mathematical technique, widely used in the industry to value debt securities without relying exclusively on quoted prices for the specific securities but rather by relying on the securities’ relationship to other benchmark quoted securities and are classified as Level 2.  The fair values consider observable data that may include dealer quotes, market spreads, cash flows, the U.S. Treasury yield curve, live trading levels, trade execution data, market consensus prepayment speeds, credit information and the bond’s terms and conditions, among other factors.
 
Derivatives. Derivative assets and liabilities represent interest rate contracts between the Company and loan customers, and between the Company and outside parties to whom we have made a commitment to sell residential mortgage loans at a set interest rate.  These are valued based upon the differential between the interest rates upon the inception of the contract and the current market interest rates for similar products and similar remaining commitment terms, and are classified as Level 2.  Changes in market value are recorded in current earnings. 
 

 

 
 
 
 


The following table summarizes financial assets and financial liabilities measured at fair value on a recurring basis as of March 31, 2011 and December 31, 2010, segregated by the level of the valuation inputs within the fair value hierarchy utilized to measure fair value (in thousands):
 
March 31, 2011
 
Total
   
Quoted Prices in Active Markets for Identical Assets (Level 1)
   
Significant Other Observable Inputs (Level 2)
   
Significant Unobservable Inputs (Level 3)
 
   
(In thousands)
 
Financial Assets:
                       
Investment securities available for sale:
                       
U.S. Government sponsored agencies
 
$
32,494
   
$
-
   
$
32,494
   
$
-
 
States and political subdivisions
   
23,035
     
-
     
23,035
     
-
 
Residential mortgage-backed securities
   
79,199
     
-
     
79,199
     
-
 
Interest rate lock commitments, mandatory forward delivery commitments and pair-offs
   
80
     
-
     
80
     
-
 
                                 
Financial Liabilities:
                               
Interest rate lock commitments, mandatory forward delivery commitments and pair-offs
 
$
-
   
$
-
   
$
-
   
$
-
 
                                 
Off-balance-sheet instruments:
                               
Loan commitments and standby letters of credit
 
$
15
   
$
-
   
$
15
   
$
-
 
                                 
December 31, 2010
                               
                                 
Financial Assets:
                               
Investment securities available for sale:
                               
U.S. Government sponsored agencies
 
$
42,735
   
$
-
   
$
42,735
   
$
-
 
States and political subdivisions
   
20,584
     
-
     
20,584
     
-
 
Residential mortgage-backed securities
   
99,272
     
-
     
99,272
     
-
 
Interest rate lock commitments, mandatory forward delivery commitments and pair-offs, net asset
   
567
     
-
     
567
     
-
 
                                 
Financial Liabilities:
                               
Interest rate lock commitments, mandatory forward delivery commitments and pair-offs, net liability
 
$
25
   
$
-
   
$
25
   
$
-
 
                                 
Off-balance-sheet instruments:
                               
Loan commitments and standby letters of credit
 
$
13
   
$
-
   
$
13
   
$
-
 

There were no financial assets measured at fair value on a recurring basis for which the Company used significant unobservable inputs (Level 3) during the periods presented in these consolidated financial statements.
 
Financial Instruments Recorded at Fair Value on a Nonrecurring Basis
 
The Company may be required, from time to time, to measure certain financial assets and financial liabilities at fair value on a nonrecurring basis in accordance with U.S. generally accepted accounting principles. These include assets that are measured at the lower of cost or market value that were recognized at fair value below cost at the end of the period.
 
 
 

 
 
 
 


Impaired Loans. 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 the amount of that impairment in accordance with ASC Topic 310.  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.  At March 31, 2011, substantially all of the total impaired loans were evaluated based on the fair value of the collateral.  In accordance with ASC Topic 820, impaired loans where an allowance is established based on the fair value of collateral require classification in the fair value hierarchy.  Collateral values are estimated using Level 3 inputs based on customized discounting criteria.  For a majority of impaired loans, the Company obtains a current independent appraisal of loan collateral.  Other valuation techniques are used as well, including internal valuations, comparable property analysis and contractual sales information.  For substantially all impaired loans with an appraisal more than 6 months old, the Company further discounts market prices by 10% to 30% and in some cases, up to an additional 50%.  This discount is based on our evaluation of related market conditions and is in addition to a reduction in value for potential sales costs and discounting that has been incorporated in the independent appraisal.
 
Loans held for sale. Loans held for sale are valued based upon open market quotes obtained from FNMA.  Market pricing is based upon mortgage loans with similar terms and interest rates.  The change in market value (up to the amortized value of the loans held for sale) is recorded as an adjustment to the loans held for sale valuation allowance, with the offset being recorded as an addition or a reduction to current earnings.
 
Mortgage Servicing Rights. Mortgage servicing rights (“MSRs”) are valued based upon the value of MSRs that are traded on the open market and a current market value for each risk tranche in our portfolio is assigned.  We then compare that market value to the current amortized book value for each tranche.  The change in market value (up to the amortized value of the MSR) is recorded as an adjustment to the MSR valuation allowance, with the offset being recorded as an addition or a reduction to current earnings.  Only the tranches deemed impaired are included in the table below.
 
Non-Financial Assets and Non-Financial Liabilities Recorded at Fair Value
 
Application of ASC Topic 820 to non-financial assets and non-financial liabilities became effective January 1, 2009.  The Company has no non-financial assets or non-financial liabilities measured at fair value on a recurring basis.  Certain non-financial assets and non-financial liabilities measured at fair value on a non-recurring basis include foreclosed assets.
 
Other Real Estate and Other Repossessed Assets (Foreclosed Assets). Foreclosed assets, upon initial recognition, are measured and reported at fair value through a charge-off to the allowance for possible loan losses based upon the fair value of the foreclosed asset.  The fair value of foreclosed assets, upon initial recognition, are estimated using Level 3 inputs based on customized discounting criteria.
 
During the first quarter of 2011 and the year ended December 31, 2010, certain foreclosed assets, upon initial recognition, were remeasured and reported at fair value through a charge-off to the allowance for loan losses based upon the fair value of the foreclosed asset, less estimated costs of disposal.  The fair value of foreclosed asset, upon initial recognition, is estimated using Level 2 inputs based on observable market data or Level 3 inputs based on customized discounting criteria.  Foreclosed assets measured at fair value (less estimated disposal costs) upon initial recognition totaled $386 thousand and $25.2 million (utilizing Level 3 valuation inputs) during the three months ended March 31, 2011 and the year ended December 31, 2010, respectively.  Of these, $251 thousand and $13.8 million, respectively, were written down upon initial recognition or subsequent revaluation.  In connection with the measurement and initial recognition of the foregoing foreclosed assets, the Company recognized charge-offs of the allowance for loan losses totaling $91 thousand and $1.8 million, during the three months ended March 31, 2011 and the year ended December 31, 2010, respectively.  Other than foreclosed assets measured at fair value (less estimated disposal costs) upon initial recognition, a total of $3.6 million and $13.2 million in foreclosed assets were remeasured at fair value during the three months ended March 31, 2011 and the year ended December 31, 2010, respectively, resulting in a charge of $526 thousand and $1.9 million to current earnings, respectively.
 

 
 
 
 


Assets measured at fair value on a nonrecurring basis as of March 31, 2011 and December 31, 2010 are included in the table below (in thousands):
 
March 31, 2011
 
Total
   
Quoted Prices in Active Markets for Identical Assets (Level 1)
   
Significant Other Observable Inputs (Level 2)
   
Significant Unobservable Inputs (Level 3)
 
   
(In thousands)
 
Financial Assets:
                       
Impaired loans
 
$
9,190
   
$
-
   
$
-
   
$
9,190
 
Loans held for sale
   
-
     
-
     
-
     
-
 
Mortgage servicing rights
   
2,123
     
-
     
-
     
2,123
 
Non-Financial Assets:
                               
Foreclosed assets
   
14,156
     
-
     
-
     
14,156
 
                                 
December 31, 2010
                               
                                 
Financial Assets:
                               
Impaired loans
 
$
13,971
   
$
-
   
$
-
   
$
13,971
 
Loans held for sale
   
12,786
     
-
     
12,786
     
-
 
Mortgage servicing rights
   
2,182
     
-
     
-
     
2,182
 
Non-Financial Assets:
                               
Foreclosed assets
   
13,794
     
-
     
-
     
13,794
 

ASC Topic 825 requires disclosure of the fair value of financial assets and financial liabilities, including those financial assets and financial liabilities that are not measured and reported at fair value on a recurring basis or non-recurring basis.  The methodologies for estimating the fair value of financial assets and financial liabilities that are measured at fair value on a recurring or non-recurring basis are discussed above.  The estimated fair value approximates carrying value for cash and cash equivalents and accrued interest.  The methodologies for other financial assets and financial liabilities are discussed below:
 
The following methods and assumptions were used by the Company in estimating the fair values of its other financial instruments:
 
Cash and due from banks and interest-bearing deposits with banks: The carrying amounts reported in the balance sheet approximate fair value.
 
Non-marketable securities, including FHLB and FRB Stock: The carrying amounts reported in the balance sheet approximate fair value.
 
Federal funds sold and securities purchased under resell agreements: The carrying amounts reported in the balance sheet approximate fair value.
 
Loans: Most commercial loans and some real estate mortgage loans are made on a variable rate basis.  For those variable-rate loans that reprice frequently with no significant change in credit risk, fair values are based on carrying values.  The fair values for fixed rate and all other loans are estimated using discounted cash flow analyses, using interest rates currently being offered for loans with similar terms to borrowers with similar credit quality.
 
Non-interest-bearing deposits: The fair values disclosed are equal to their balance sheet carrying amounts, which represent the amount payable on demand.
 

 
 
 
 


Interest-bearing deposits: The fair values disclosed for deposits with no defined maturities are equal to their carrying amounts, which represent the amounts payable on demand.  The carrying amounts for variable-rate, fixed-term money market accounts and certificates of deposit approximate their fair values at the reporting date.  Fair values for fixed-rate certificates of deposit are estimated using a discounted cash flow calculation that applies interest rates currently being offered on similar certificates to a schedule of aggregated expected monthly maturities on time deposits.
 
Short-term borrowings: The carrying amounts of federal funds purchased, borrowings under repurchase agreements and other short-term borrowings with maturities of 90 days or less approximate their fair values.  The fair value of short-term borrowings greater than 90 days is based on the discounted value of contractual cash flows.
 
Long-term borrowings: The fair values of the Company's long-term borrowings (other than deposits) are estimated using discounted cash flow analyses, based on the Company's current incremental borrowing rates for similar types of borrowing arrangements.
 
Junior subordinated notes issued to capital trusts: The fair values of the Company’s junior subordinated notes issued to capital trusts are estimated based on the quoted market prices, when available, of the related trust preferred security instruments, or are estimated based on the quoted market prices of comparable trust preferred securities.
 
Off-balance-sheet instruments: Fair values for the Company's off-balance-sheet lending commitments in the form of letters of credit are based on fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements.
 
Accrued interest: The carrying amounts reported in the balance sheet approximate fair value.
 

 
 
 
 


The estimated fair values of financial instruments are as follows:
 
   
March 31, 2011
   
December 31, 2010
 
   
Carrying amount
   
Fair value
   
Carrying amount
   
Fair value
 
   
(In thousands)
 
Financial assets:
                       
Cash and due from banks
 
$
18,305
   
$
18,305
   
$
16,765
   
$
16,765
 
Interest-bearing deposits with banks
   
101,062
     
101,062
     
89,316
     
89,316
 
Federal funds sold and securities purchased under resell agreements
   
393
     
393
     
110
     
110
 
Investments:
                               
Available for sale
   
134,728
     
134,728
     
162,591
     
162,591
 
Held to maturity
   
11,026
     
10,786
     
11,107
     
10,951
 
Other investments
   
9,218
     
9,218
     
9,335
     
9,335
 
Loans, net
   
1,157,520
     
1,189,069
     
1,161,216
     
1,170,701
 
Loans held for sale
   
5,174
     
5,242
     
25,080
     
25,223
 
Accrued interest receivable
   
6,736
     
6,736
     
6,736
     
6,736
 
Mortgage servicing rights
   
8,155
     
9,368
     
7,960
     
8,585
 
Derivative financial instruments
   
80
     
80
     
567
     
567
 
                                 
Financial liabilities:
                               
Non-interest-bearing deposits
 
$
114,053
   
$
114,053
   
$
109,891
   
$
109,891
 
Interest-bearing deposits
   
1,202,399
     
1,190,689
     
1,248,454
     
1,253,836
 
Short-term borrowings
   
10,000
     
10,173
     
1,152
     
1,155
 
Long-term borrowings
   
22,300
     
23,354
     
32,300
     
33,886
 
Junior subordinated debt owed to unconsolidated trusts
   
37,116
     
19,580
     
37,116
     
18,506
 
Accrued interest payable
   
2,696
     
2,696
     
4,873
     
4,873
 
Derivative financial instruments
   
-
     
-
     
25
     
25
 
                                 
Off-balance sheet instruments:
                               
Standby letters of credit
 
$
15
   
$
15
   
$
13
   
$
13
 

 

 

 
 
 
 


 
This discussion is intended to focus on certain financial information regarding the Company and is written to provide the reader with a more thorough understanding of its financial statements.  The following discussion and analysis of the Company’s financial position and results of operations should be read in conjunction with the information set forth in Item 3, Quantitative and Qualitative Disclosures about Market Risk and the annual audited consolidated financial statements filed on Form 10-K for the year ended December 31, 2010.
 
This report contains certain financial information determined by methods other than in accordance with GAAP.  These measures include net operating income before provision for loan losses, income taxes and dividends and discount accretion on preferred shares; net interest margin on a fully tax-equivalent basis and net interest income on a fully tax-equivalent basis.  Management uses these non-GAAP measures in its analysis of the Company’s performance.  Net operating income before provision for loan losses, income taxes and dividends and discount accretion on preferred shares represents net income on the core operations of the Company.  The tax-equivalent adjustment to net interest margin and net interest income recognizes the income tax savings when comparing taxable and tax-exempt assets and adjusting for federal and state exemption of interest income and certain other permanent income tax differences.  Management believes that it is a standard practice in the banking industry to present net interest income and net interest margin on a fully tax-equivalent basis, and accordingly believes the presentation of the financial measures may be useful for peer comparison purposes.  This disclosure should not be viewed as a substitute for the results determined to be in accordance with GAAP, nor is it necessarily comparable to non-GAAP performance measures that may be presented by other companies.  Reconciliations of net interest income on a fully tax-equivalent basis to net interest income and net interest margin on a fully tax-equivalent basis to net interest margin are contained in tables under “Net Interest Income.”
 
Special Note Concerning Forward-Looking Statements
 
This document (including information incorporated by reference) contains, and future oral and written statements of the Company and its management may contain, forward-looking statements, within the meaning of such term in the Private Securities Litigation Reform Act of 1995, with respect to the financial condition, results of operations, plans, objectives, future performance and business of the Company.  Forward-looking statements, which may be based upon beliefs, expectations and assumptions of the Company’s management and on information currently available to management, are generally identifiable by the use of words such as “believe,” “expect,” “anticipate,” “plan,” “intend,” “estimate,” “may,” “will,” “would,” “could,” “should” or other similar expressions.  Additionally, all statements in this document, including forward-looking statements, speak only as of the date they are made, and the Company undertakes no obligation to update any statement in light of new information or future events.
 
The Company’s ability to predict results or the actual effect of future plans or strategies is inherently uncertain. The factors, which could have a material adverse effect on the operations and future prospects of the Company and its subsidiaries are detailed in the “Risk Factors” section included under Item 1A of Part I of the Company’s Form 10-K for the year ended December 31, 2010.  In addition to the risk factors described in that section, there are other factors that may impact any public company, including ours, which could have a material adverse effect on the operations and future prospects of the Company and its subsidiaries.  These risks and uncertainties should be considered in evaluating forward-looking statements and undue reliance should not be placed on such statements.
 

 
 
 
 


Recent Regulatory Developments. On July 21, 2010, President Obama signed into law the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Act”), which is perhaps the most significant financial reform since the Great Depression.  While the provisions of the Act receiving the most public attention have generally been those more likely to affect larger institutions, the Act also contains many provisions which will affect smaller institutions such as the Company in substantial and unpredictable ways.  Consequently, compliance with the Act’s provisions may curtail the Company’s revenue opportunities, increase its operating costs, require it to hold higher levels of regulatory capital and/or liquidity or otherwise adversely affect the Company’s business or financial results in the future.  The Company’s management is actively reviewing the provisions of the Act and assessing its probable impact on the Company’s business, financial condition, and result of operations. However, because many aspects of the Act are subject to future rulemaking, it is difficult to precisely anticipate its overall financial impact on the Company and the Bank at this time.
 
Critical Accounting Policies
 
Allowance for Loan Losses: The allowance for loan losses is that amount which, in management’s judgment, is considered appropriate to provide for probable losses in the loan portfolio.  In analyzing the adequacy of the allowance for loan losses, management uses a comprehensive loan grading system to determine risk potential in the portfolio, and considers the results of periodic internal and external loan reviews.  Historical loss experience factors and specific reserves for impaired loans, combined with other considerations, such as delinquency, non-accrual, trends on criticized and classified loans, economic conditions, concentrations of credit risk, and experience and abilities of lending personnel, are also considered in analyzing the adequacy of the allowance.  Management uses a systematic methodology, which is applied at least quarterly, to determine the amount of allowance for loan losses and the resultant provisions for loan losses it considers adequate to provide for anticipated loan losses.  This methodology includes a periodic detailed analysis of the loan portfolio, a systematic loan grading system and a periodic review of the summary of the allowance for loan and lease loss balance.  In the event that different assumptions or conditions were to prevail, and depending upon the severity of such changes, the possibility of materially different financial condition or results of operations is a reasonable likelihood.
 
Three methods are used to evaluate the adequacy of the allowance for loan losses: (1) specific identification, based on management’s assessment of loans in our portfolio and the probability that a charge-off will occur in the upcoming quarter; (2) losses probable in the loan portfolio besides those specifically identified, based upon a migration analysis of the percentage of loans currently performing that have probable losses; and (3) qualitative adjustments based on management’s assessment of certain risks such as delinquency trends, watch-list and classified trends, changes in concentrations, economic trends, industry trends, non-accrual trends, exceptions and loan-to-value guidelines, management and staff changes and policy or procedure changes.
 
While management uses the best information available to make its evaluation, future adjustments to the allowance may be necessary if there are significant changes in economic conditions.  In addition, as an integral part of their examination process regulatory agencies periodically review our allowance for loan losses and may require us to make additions to the allowance based on their evaluation of information available at the time of their examinations.
 
Management analyzed projected growth, anticipated charge-offs and recoveries along with probable risk rating changes to adequately fund an appropriate reserve for the quarter.  Management will continue to closely monitor asset quality in general, and real estate loan quality in particular, and is committed to act aggressively to minimize further losses.
 

 
 
 
 


Mortgage Servicing Right (MSR) Assets: Servicing residential mortgage loans for third-party investors represents a significant business activity of the Bank.  As of March 31, 2011, mortgage loans serviced for others totaled $1.0 billion.  The net carrying amount of the MSRs on these loans total $8.2 million as of March 31, 2011.  The expected and actual rates of mortgage loan prepayments are the most significant factors driving the value of MSRs. Increases in mortgage loan prepayments reduce estimated future net servicing cash flows because the life of the underlying loan is reduced.  In determining the fair value of the MSRs, mortgage interest rates, which are used to determine prepayment rates and discount rates, are held constant over the estimated life of the portfolio.  Fair values of the MSRs are calculated on a monthly basis.  The values are based upon current market conditions and assumptions, which incorporate the expected life of the loans, estimated costs to service the loans, servicing fees to be received and other factors. MSRs are carried at the lower of the initial capitalized amount, net of accumulated amortization, or fair value.
 
An analysis of changes in mortgage servicing rights assets follows:
 
   
Three Months Ended March 31,
 
   
2011
   
2010
 
   
(In thousands)
 
Balance at beginning of period
 
$
9,030
   
$
8,525
 
Servicing rights originated and capitalized
   
498
     
307
 
Amortization
   
(383
)
   
(502
)
   
$
9,145
   
$
8,330
 
 
Below is an analysis of changes in the mortgage servicing right assets valuation allowance:
 
   
Three Months Ended March 31,
 
   
2011
   
2010
 
   
(In thousands)
 
Balance at beginning of period
 
$
(1,070
)
 
$
(878
)
Aggregate reductions credited to operations
   
80
     
332
 
Aggregate additions charged to operations
   
-
     
(139
)
   
$
(990
)
 
$
(685
)
 
The fair values of the MSRs were $9.4 million and $8.6 million on March 31, 2011 and December 31, 2010, respectively.
 
The primary risk characteristics of the underlying loans used to stratify the servicing assets for the purposes of measuring impairment are interest rate and original term.
 
Our valuation allowance is used to recognize impairments of our MSRs.  An MSR is considered impaired when the market value of the MSR is below the amortized book value of the MSR.  The MSRs are accounted by risk tranche, with the interest rate and term of the underlying loan being the primary strata used in distinguishing the tranches.  Each tranche is evaluated separately for impairment.
 
We have our MSRs analyzed for impairment on a monthly basis.  The underlying loans on all serviced loans are analyzed and, based upon the value of MSRs that are traded on the open market, a current market value for each risk tranche in our portfolio is assigned.  We then compare that market value to the current amortized book value for each tranche.  The change in market value (up to the amortized value of the MSR) is recorded as an adjustment to the MSR valuation allowance, with the offset being recorded as an addition or a reduction to income.
 

 
 
 
 


The impairment is analyzed for other than temporary impairment on a quarterly basis.  The MSRs would be considered other than temporarily impaired if there is likelihood that the impairment would not be recovered before the expected maturity of the asset.  If the underlying mortgage loans have been amortized at a rate greater than the amortization of the MSR, the MSR may be other than temporarily impaired.  As of March 31, 2011, none of the MSRs were considered other than temporarily impaired.
 
The following assumptions were used to calculate the market value of the MSRs as of March 31, 2011 and December 31, 2010:
 
   
March 31, 2011
   
December 31, 2010
 
Prepayment Standard Assumption (PSA) speed
   
210.00
%
   
233.33
%
Discount rate
   
10.75
     
10.75
 
Earnings rate
   
2.47
     
2.17
 

Overview
 
Despite continued weak national economic conditions, compared to historic levels, the Company’s net income increased $1.7 million (378.4%) from $436 thousand in the first quarter of 2010 to $2.1 million in the first quarter of 2011.  Net income available to common shareholders increased $1.6 million (1,760.2%) from a loss of $93 thousand in the first quarter of 2010 to income of $1.5 million in the first quarter of 2011.
 
The national and state economies continue to be depressed relative to historical comparisons.  The Company continues to experience challenges in its loan portfolio, with higher than typically experienced levels of non-performing loans and foreclosed properties.  In response to these challenges, and to proactively position the Company to meet these challenges, we have continued to reduce our concentrations in the commercial real estate and construction real estate portfolios, increased capital by managing growth and restricting dividends and have taken other steps in compliance with the Agreement with the Office of the Comptroller of the Currency (“OCC”) (discussed below).
 
Regulatory Proceedings Against the Bank.  As previously disclosed, the Bank and the OCC entered into a written agreement (the “Agreement”) on January 26, 2010.  The Agreement contains, among other things, directives for the Bank to take specific actions, within time frames specified therein, to address risk management and capital matters that, in the view of the OCC, may impact the Bank’s overall safety and soundness.  Specifically, the Bank is required to, among other things: (i) continue to develop, implement and ensure adherence to written programs designed to reduce the level of credit risk in the Bank’s loan portfolio; (ii) review, revise and ensure adherence to a written capital program; (iii) comply with its approved capital program, which calls for maintaining higher than the regulatory minimum capital ratios; and (iv) obtain prior OCC approval before paying dividends.
 
At March 31, 2011, the Bank believed that it had fully addressed the provisions of the Agreement.  The Bank will continue taking the necessary actions to satisfy all requirements in the Agreement.  A copy of the Agreement was filed as part of the Company’s Current Report on Form 8-K filed on February 1, 2010 with the SEC.  The filing is available on the SEC’s website and the Company’s website.
 

 
 
 
 


 
General. The Company experienced net operating income before provision for income taxes, provision for loan losses and dividends and discount accretion on preferred shares of $4.6 million during the first quarter of 2011, compared to $5.3 million during the same period in 2010.  This represented a decrease of $768 thousand (14.4%).  Net income available to common shareholders for the first quarter of 2011 increased to $1.5 million or $0.24 per share, compared to a net loss available to common shareholders for the same period in 2010 of $93 thousand or a loss of $0.01 per common share for the same period in 2010, an increase of $1.6 million (1,760.2%) in net income available to common shareholders and an increase in earnings per share of $0.25 (2,500.0%).  This increase in net income available to common shareholders was primarily due to a decrease in provision for loan losses of $2.8 million (65.9%) and an increase in non-interest income of $928 thousand (30.4%).  The decrease in provision for loan losses was primarily due to a decrease in net charge-offs in the first quarter of 2011 compared to the first quarter of 2010.  The increase in non-interest income was primarily due to increases in the gain on sale of loans, gain and sale of securities and trust fee income.  Partially offsetting these items was an increase in non-interest expenses of $1.6 million (15.0%).  Non-interest expense increased primarily due to an increase in other expenses of $489 thousand, an increase in salaries and employee benefits of $423 thousand, an increase in supplies expense of $270 thousand and an increase in the loss on sale of other real estate owned of $226 thousand.  The increase in other expenses was due to an increase in expenses associated with the valuation of interest rate contracts (see Item 1, Financial Statements—Note 15, Derivative Financial Instruments in this Form 10-Q for more details).  The increase in salaries and employee benefits was primarily due to an increase in the number of employees, as well as normal wage increases.  Supplies expenses increased primarily due to the purchase of a large volume of small value supplies that were expensed upon purchase rather than tracked in inventory.  The increase in loss on sale of other real estate owned was due to a higher volume of write-downs and sales of other real estate owned during 2011 compared to 2010.  There was also a decrease in net interest income of $51 thousand (0.4%).  Provision for income taxes increased $389 thousand (59.9%) due to higher pre-tax income.
 
The profitability of the Company’s operations depends primarily on its net interest income, which is the difference between total interest earned on interest-earning assets and total interest paid on interest-bearing liabilities.  The Company’s net income is also affected by its provision for loan losses as well as other income and other expenses.  The provision for loan losses reflects the amount management believes to be adequate to cover probable credit losses in the loan portfolio.  Non-interest income or other income consists of mortgage loan servicing fees, trust fees, loan and other fees, service charges on deposits, gain on sale of loans, gain on sale of securities, title insurance premiums and other operating income.  Other expenses include salaries and employee benefits, occupancy expenses, data processing expenses, marketing, amortization and valuation of mortgage servicing rights, amortization and valuation of other intangible assets, supplies expense, loss on other real estate owned, postage, bankcard and ATM network fees, legal, professional and accounting fees, FDIC insurance premiums, collection expenses and other expenses.
 
The amount of net interest income is affected by changes in the volume and mix of interest-earning assets, the level of interest rates earned on those assets, the volume and mix of interest-bearing liabilities, and the level of interest rates paid on those interest-bearing liabilities.  The provision for loan losses is dependent on changes in the loan portfolio and management’s assessment of the collectability of the loan portfolio, as well as economic and market conditions.  Other income and other expenses are impacted by growth of operations and growth in the number of accounts through both acquisitions and core banking business growth.  Growth in operations affects other expenses as a result of additional employees, branch facilities and promotional marketing expenses.  Growth in the number of accounts affects other income including service fees as well as other expenses such as computer services, supplies, postage, telecommunications and other miscellaneous expenses.
 

 

 
 
 
 


Net Interest Income. The following tables present, for the periods indicated, the total dollar amount of interest income from average interest-earning assets and the resultant yields, as well as the interest expense on average interest-bearing liabilities, and the resultant costs, expressed both in dollars and rates:
 
   
Three Months Ended March 31,
 
   
2011
   
2010
 
   
Average Balance
   
Interest
   
Yield/
Rate
   
Average Balance
   
Interest
   
Yield/
Rate
 
   
(Dollars in thousands)
 
Interest-earning Assets:
                               
Loans(1)
 
$
1,191,536
   
$
15,797
     
5.38
%
 
$
1,236,032
   
$
17,272
     
5.67
%
Taxable investment securities
   
134,135
     
463
     
1.40
     
116,315
     
633
     
2.21
 
Investment securities exempt from federal income taxes (2)
   
32,768
     
459
     
5.68
     
37,491
     
482
     
5.21
 
Federal funds sold
   
226
     
-
     
-
     
511
     
-
     
-
 
Other interest-bearing deposits
   
89,958
     
54
     
0.24
     
138,583
     
105
     
0.31
 
Investment in unconsolidated trust subsidiaries
   
1,116
     
22
     
7.99
     
1,116
     
20
     
7.27
 
Total interest-earning assets
   
1,449,739
     
16,795
     
4.70
     
1,530,048
     
18,512
     
4.91
 
Non-interest-earning assets
   
79,184
                     
87,038
                 
Total assets
 
$
1,528,923
                   
$
1,617,086
                 
                                                 
Interest-bearing Liabilities:
                                         
Deposits:
                                               
NOW deposits
 
$
126,929
   
$
49
     
0.16
%
 
$
102,279
   
$
70
     
0.28
%
Money market deposits
   
253,452
     
120
     
0.19
     
211,650
     
137
     
0.26
 
Savings deposits
   
311,193
     
126
     
0.16
     
371,193
     
267
     
0.29
 
Time deposits over $100,000
   
327,966
     
1,274
     
1.58
     
418,953
     
2,358
     
2.28
 
Time deposits under $100,000
   
208,448
     
784
     
1.53
     
215,311
     
1,131
     
2.13
 
Short-term borrowings, including ESOP borrowings under 1 year
   
7,246
     
40
     
2.24
     
18,938
     
216
     
4.63
 
Long-term borrowings, including ESOP borrowings over 1 year
   
25,078
     
214
     
3.46
     
14,549
     
128
     
3.57
 
Long-term capital lease obligations
   
2,211
     
67
     
12.29
     
2,211
     
67
     
12.29
 
Junior subordinated debt owed to unconsolidated trusts
   
37,116
     
723
     
7.90
     
37,116
     
683
     
7.46
 
Total interest-bearing liabilities
   
1,299,639
     
3,397
     
1.06
     
1,392,200
     
5,057
     
1.47
 
Demand deposits--non-interest-bearing
   
53,713
                     
45,800
                 
Other non-interest-bearing liabilities
   
50,806
                     
55,848
                 
Stockholders' equity, including stock owned by ESOP
   
124,765
                     
123,238
                 
Total liabilities and stockholders equity
 
$
1,528,923
                   
$
1,617,086
                 
Net interest income on a fully tax-equivalent basis/interest rate spread(3)
   
$
13,398
     
3.64
%
         
$
13,455
     
3.43
%
Net interest margin on a fully tax-equivalent basis(4)
     
3.75
%
                   
3.57
%
Net interest margin(4)
             
3.70
%
                   
3.52
%

(1)
Average loans include non-accrual loans of $55.1 million and $67.8 million for March 31, 2011 and 2010, respectively. Interest income includes loan origination fees of $407 thousand and $540 thousand for the three months ended March 31, 2011 and 2010, respectively.

(2)
Non-taxable investment income is presented on a fully tax-equivalent basis, adjusting for federal and state exemption of interest income and certain other permanent tax differences.


 
 
 
 


(3)
Interest rate spread represents the difference between the average yield on interest-earning assets and the average cost of interest-bearing liabilities and is presented on a fully tax-equivalent basis.
 
(4)
Net interest margin represents net interest income as a percentage of average interest-earning assets.
 
For the first quarter of 2011, net interest income on a fully tax-equivalent basis decreased $57 thousand (0.4%) compared to the first quarter of 2010, decreasing from $13.5 million in 2010 to $13.4 million in 2011.  The decrease in net interest income on a fully tax-equivalent basis resulted from a decrease in interest income on a fully tax-equivalent basis of $1.7 million (9.3%), which was largely offset by a decrease in interest expense of $1.7 million (32.8%).  Interest income on a fully tax-equivalent basis decreased mainly due to a decrease in the yield on interest-earning assets of 21 basis points, which accounted for a decrease in interest income on a fully tax-equivalent basis of $1.1 million.  There was also a decrease in average interest-earning assets of $80.3 million (5.2%), which accounted for a decrease of $618 thousand in interest income on a fully tax-equivalent basis.  Interest expense decreased primarily due to a decrease in the cost of interest-bearing liabilities of 41 basis points, which accounted for a decrease in interest expense of $1.2 million.  There was also a decrease in average interest-bearing liabilities of $92.6 million (6.6%), which accounted for a decrease of $487 thousand in interest expense.  The net interest margin expressed on a fully tax-equivalent basis increased 18 basis points to 3.75% for the quarter ended March 31, 2011 from 3.57% for the quarter ended March 31, 2010.
 
The following table reconciles net interest income on a fully tax-equivalent basis for the periods presented:
 
   
Three Months Ended March 31,
 
   
2011
   
2010
 
   
(In thousands)
 
Net interest income
 
$
13,220
   
$
13,271
 
Tax-equivalent adjustment to net interest income
   
178
     
184
 
Net interest income, fully tax-equivalent basis
 
$
13,398
   
$
13,455
 

Volume, Mix and Rate Analysis of Net Interest Income. The following tables present the extent to which changes in volume, changes in interest rates, and changes in the interest rates times the changes in volume of interest-earning assets and interest-bearing liabilities have affected the Company’s interest income and interest expense during the periods indicated. Information is provided on changes in each category due to (i) changes attributable to changes in volume (change in volume times the prior period interest rate), (ii) changes attributable to changes in interest rate (changes in rate times the prior period volume) and (iii) changes attributable to changes in rate/volume (changes in interest rate times changes in volume).  Changes attributable to the combined impact of volume and rate have been allocated proportionally to the changes due to volume and the changes due to rate.
 


 
 
 
 



   
Three Months Ended March 31,
 
   
2011 Compared to 2010
 
   
Change Due to Volume
   
Change Due to Rate
   
Total Change
 
   
(In thousands)
 
Interest-earning Assets:
             
 Loans
 
$
(609
)
 
$
(866
)
 
$
(1,475
)
 Taxable investment securities
   
87
     
(257
)
   
(170
)
 Investment securities exempt from federal income taxes(1)
   
(64
)
   
41
     
(23
)
 Federal funds sold
   
-
     
-
     
-
 
 Other interest-bearing deposits
   
(32
)
   
(19
)
   
(51
)
 Investment in unconsolidated trust subsidiaries
   
-
     
2
     
2
 
 Total increase (decrease) in interest income
 
$
(618
)
 
$
(1,099
)
 
$
(1,717
)
Interest-bearing Liabilities:
         
 Now deposits
 
$
15
   
$
(36
)
 
$
(21
)
 Money market deposits
   
24
     
(41
)
   
(17
)
 Savings deposits
   
(38
)
   
(103
)
   
(141
)
 Time deposits over $100,000
   
(447
)
   
(637
)
   
(1,084
)
 Time deposits under $100,000
   
(35
)
   
(312
)
   
(347
)
 Short-term borrowings, including ESOP borrowings under 1 year
   
(96
)
   
(80
)
   
(176
)
 Long-term borrowings, including ESOP borrowings over 1 year
   
90
     
(4
)
   
86
 
 Long-term capital lease obligations
   
-
     
-
     
-
 
 Junior subordinated debt owed to unconsolidated trusts
   
-
     
40
     
40
 
 Total increase (decrease) in interest expense
 
$
(487
)
 
$
(1,173
)
 
$
(1,660
)
 Increase (decrease) in net interest income
 
$
(131
)
 
$
74
   
$
(57
)

____________________
 
(1)
Non-taxable investment income is presented on a fully tax-equivalent basis, adjusting for federal and state exemption of interest income and certain other permanent income tax differences.

Other Income. Changes in other income between the three months ended March 31, 2011 and 2010 were as follows:
 
   
Three Months Ended March 31,
       
   
2011
   
2010
   
Net difference
 
   
(In thousands)
 
 Other income:
                 
 Mortgage loan servicing fees
 
$
667
   
$
646
   
$
21
 
 Trust fees
   
460
     
355
     
105
 
 Loan and other fees
   
752
     
666
     
86
 
 Service charges on deposits
   
383
     
408
     
(25
)
 Gain on sale of loans
   
1,280
     
720
     
560
 
 Gain on sale of securities
   
171
     
47
     
124
 
 Title insurance premiums
   
164
     
188
     
(24
)
 Other operating income
   
107
     
26
     
81
 
   
$
3,984
   
$
3,056
   
$
928
 

 


 
 
 
 


In the first quarter of 2011, other income increased from the first quarter of 2010 by $928 thousand (30.4%) from $3.1 million to $4.0 million.  Gain on sale of loans increased $560 thousand (77.8%) primarily due to an increase in the volume of loans sold from the first quarter of 2010 to the first quarter of 2011.  Gain on sale of securities increased $124 thousand (263.8%) primarily due to an increase in the volume of securities sold from the first quarter of 2010 to the first quarter of 2011.  Trust fees increased $105 thousand (29.6%) primarily due to an increase in trust and investment services accounts and associated fees on those accounts.
 
Other Expenses. Changes in other expenses between the three months ended March 31, 2011 and 2010 were as follows:
 
   
Three Months Ended March 31,
       
   
2011
   
2010
   
Net difference
 
   
(In thousands)
 
 Other expenses:
                 
 Salaries and employee benefits
 
$
5,501
   
$
5,078
   
$
423
 
 Occupancy
   
934
     
977
     
(43
)
 Data processing
   
788
     
724
     
64
 
 Marketing
   
455
     
356
     
99
 
 Amortization and valuation of mortgage servicing rights
   
303
     
309
     
(6
)
 Amortization and valuation of other intangible assets
   
163
     
125
     
38
 
 Supplies
   
361
     
91
     
270
 
 Loss on sale of other real estate owned
   
658
     
432
     
226
 
 Postage
   
177
     
161
     
16
 
 Bankcard and ATM network fees
   
343
     
163
     
180
 
 Legal, professional and accounting fees
   
725
     
753
     
(28
)
 FDIC insurance premiums
   
761
     
898
     
(137
)
 Collection expenses
   
434
     
380
     
54
 
 Other
   
1,027
     
538
     
489
 
   
$
12,630
   
$
10,985
   
$
1,645
 

For the first quarter of 2011, other expenses increased $1.6 million (15.0%) to $12.6 million in 2011 from $11.0 million in the first quarter of 2010.  Other expenses increased $489 thousand (90.9%) primarily due to expenses associated with the valuation of interest rate contracts (see in this Form 10-Q Item 1, Financial Statements—Note 15, Derivative Financial Instruments for more details).  Salaries and employee benefits increased $423 thousand (8.3%) primarily due to an increase in the total number of full-time equivalent employees and normal increases in pay.  Supplies expense increased $270 thousand (296.7%) primarily due to the purchase of a large volume of small value supplies that were expensed upon purchase rather than tracked in inventory.  Loss on sale of other real estate owned increased $226 thousand (52.3%) primarily due to a higher volume of write-downs and sales of other real estate owned during 2011 compared to 2010.
 
Income Taxes. In the first quarter of 2011, provision for income tax expense increased $389 thousand (59.9%) from the first quarter of 2010, from $649 thousand in 2010 to $1.0 million in 2011.  This was due to greater pretax earnings in the first quarter of 2011 compared to the first quarter of 2010.  The effective tax rate decreased from 59.8% to 33.2% between the two periods.  The main reason for this decrease in effective tax rate was due to the permanent tax differences being a larger percentage of the pretax earnings in 2010 than in 2011, as permanent differences were relatively unchanged but pre-tax income was significantly greater in 2011 compared to 2010.
 

 
 
 
 


Financial Condition
 
General. Total assets at March 31, 2011, were $1.5 billion, a decrease of $42.5 million (2.7%) from December 31, 2010.  Total investment securities decreased $28.1 million (15.3%) as securities were sold during the quarter or matured without replacement.  Loans held for sale decreased $19.9 million (79.4%) as the volume of loans originated to be sold was below the sales of such loans during the quarter.  Partially offsetting these decreases was an increase in cash and cash equivalents of $13.6 million (12.8%) as some of the cash generated from the maturities and sales of investment securities and the sales of loans held for sale increased liquid funds.  Much of this decrease in total assets corresponded with a decrease in deposits of $41.9 million (3.1%).  This decrease in total deposits was planned, as there was decreased demand for new loans and the return on cash deposited at other institutions and investments did not warrant maintaining the same levels of cash and investments.  Total liabilities decreased $44.1 million (3.1%) during the first three months of 2011, largely due to this decrease in total deposits.  Stockholders' equity (including stock owned by the Employee Stock Ownership Plan) increased by $1.6 million (1.3%) mainly due to an increase in retained earnings.
 
Investment Securities. The primary purposes of the investment portfolio are to provide a source of earnings for the purpose of managing liquidity, to provide collateral to pledge against public deposits and to manage interest rate risk. In managing the portfolio, the Company seeks to obtain the objectives of safety of principal, liquidity, diversification and maximized return on funds. For an additional discussion with respect to these matters, see “Liquidity and Sources of Capital” below and “Asset Liability Management” under Item 3 of this Form 10-Q.
 
The following tables set forth the amortized cost and fair value of the Company’s securities by accounting classification category and by type of security as indicated:
 
   
At March 31, 2011
   
At December 31, 2010
   
At March 31, 2010
 
   
Amortized Cost
 
Fair Value
 
Amortized Cost
 
Fair Value
 
Amortized Cost
 
Fair Value
 
   
(In thousands)
 
Securities Available for Sale:
 
U.S. Government sponsored agencies
 
$
32,346
   
$
32,494
   
$
42,551
   
$
42,735
   
$
53,354
   
$
53,366
 
States and political subdivisions
   
22,454
     
23,035
     
20,263
     
20,584
     
26,080
     
26,427
 
Residential mortgage-backed securities
   
78,892
     
79,199
     
98,692
     
99,272
     
44,956
     
44,438
 
Total securities available for sale
 
$
133,692
   
$
134,728
   
$
161,506
   
$
162,591
   
$
124,390
   
$
124,231
 
Securities Held to Maturity
 
States and political subdivisions
 
11,026
   
10,786
   
11,107
   
10,951
   
11,353
   
10,792
 
Total securities held to maturity
 
$
11,026
   
$
10,786
   
$
11,107
   
$
10,951
   
$
11,353
   
$
10,792
 
Other securities:
 
Non-marketable equity securities (including FRB and FHLB stock)
 
$
8,102
   
$
8,102
   
$
8,219
   
$
8,219
   
$
8,220
   
$
8,220
 
Investment in unconsolidated trusts
   
1,116
     
1,116
     
1,116
     
1,116
     
1,116
     
1,116
 
Total other securities
 
$
9,218
   
$
9,218
   
$
9,335
   
$
9,335
   
$
9,336
   
$
9,336
 

 
 
 
 


The Company had a total of $79.2 million in Collateralized Mortgage Obligations (“CMOs”) as of March 31, 2011.  All of these CMOs were private label issues or issued by U.S. Government-sponsored agencies and were considered “Investment Grade” (rating of “BBB” or higher).  At the time of purchase, the ratings of these securities ranged from AAA to Aaa.  As of March 31, 2011, the ratings of these securities ranged from AAA to Baa3.  At the time of purchase and on a monthly basis, the Company reviews these securities for impairment on an other-than-temporary basis.  As of March 31, 2011, none of these securities were deemed to have other than temporary impairment. The Company continues to closely monitor the performance and ratings of these securities.
 
Loan Portfolio. The following tables set forth the composition of the loan portfolio:
 
   
At March 31, 2011
   
At December 31, 2010
   
At March 31, 2010
 
   
Amount
   
Percent
   
Amount
   
Percent
   
Amount
   
Percent
 
   
(Dollars in thousands)
 
Commercial
 
$
145,559
     
12.25
%
 
$
149,987
     
12.58
%
 
$
135,081
     
11.04
%
Commercial real estate
   
423,820
     
35.67
     
425,172
     
35.66
     
435,624
     
35.60
 
Residential real estate
   
401,036
     
33.75
     
400,713
     
33.61
     
419,513
     
34.28
 
Construction real estate
   
168,835
     
14.21
     
164,721
     
13.82
     
180,655
     
14.76
 
Installment and other
   
48,922
     
4.12
     
51,632
     
4.33
     
52,862
     
4.32
 
Total loans
   
1,188,172
     
100.00
%
   
1,192,225
     
100.00
%
   
1,223,735
     
100.00
%
Unearned income
   
(2,268
)
           
(2,287
)
           
(2,215
)
       
Gross loans
   
1,185,904
             
1,189,938
             
1,221,520
         
Allowance for loan losses
   
(28,384
)
           
(28,722
)
           
(24,822
)
       
Net loans
 
$
1,157,520
           
$
1,161,216
           
$
1,196,698
         

Total loans decreased $4.1 million (0.3%) from December 31, 2010 to March 31, 2011, remaining at $1.2 billion.  The decrease was primarily in the commercial non-real estate and installment and other loan portfolios, which was partially offset by an increase in the construction real estate portfolio.  Specific risks inherent in the large concentrations of real estate loans are discussed in Item 1A of Part I of the Company’s Form 10-K for the year ending December 31, 2010 filed with the SEC on March 10, 2011.
 
The Bank has been actively reducing its loan concentrations in the commercial real estate and construction real estate categories.  We have adopted as policy certain internal limits on these concentrations, based upon the Bank’s risk profile and the current economic environment.  The Bank began this planned reduction in concentrations in 2009 and has agreed to continue its plan in the Agreement with the OCC.
 
Asset Quality. The following table sets forth the amounts of non-performing loans and non-performing assets at the dates indicated:
 
   
At
March 31, 2011
   
At
December 31, 2010
   
At
March 31, 2010
 
   
(Dollars in thousands)
 
Non-accruing loans
 
$
61,667
   
$
49,968
   
$
64,463
 
Loans 90 days or more past due, still accruing interest
   
-
     
-
     
-
 
Total non-performing loans
   
61,667
     
49,968
     
64,463
 
Other real estate owned
   
21,218
     
21,860
     
20,025
 
Other repossessed assets
   
1,485
     
420
     
403
 
Total non-performing assets
 
$
84,370
   
$
72,248
   
$
84,891
 
Restructured loans, still accruing interest
   
7,081
     
5,588
     
2,990
 
Total non-performing loans to total loans
   
5.19
%
   
4.19
%
   
5.27
%
Allowance for loan losses to non-performing loans
   
46.03
%
   
57.48
%
   
38.51
%
Total non-performing assets to total assets
   
5.54
%
   
4.62
%
   
5.30
%


At March 31, 2011, total non-performing assets increased $12.1 million (16.8%) to $84.4 million from $72.2 million at December 31, 2010, primarily due to an increase in non-accruing loans of $11.7 million (23.4%).  Non-accruing loans increased mainly due to a single large construction loan relationship being placed on non-accrual status.  In addition, other real estate owned decreased $642 thousand (2.9%) and other repossessed assets increased $1.1 million (253.6%).  Loans with specifically identified losses as of March 31, 2011, totaled $7.2 million, with a specific portion of the allowance for loan losses allocated to cover these estimated losses of $802 thousand.  As of March 31, 2011, all collateral-dependent impaired loans have been charged down to value of the collateral, as determined by the Bank.  For further information, please see discussion in “Critical Accounting Policies –Allowance for Loan Losses” and “Results of Operations—Income Statement Analysis” above.
 
Restructured loans are defined as those loans whose terms have been modified, because of a deterioration in the financial condition of the borrower, to provide for a reduction of either interest or principal, regardless of whether such loans are secured or unsecured, regardless of whether such credits are guaranteed by the government or others, and regardless of the effective interest rate on such credits.  Such a loan is considered restructured until paid in full.  However, a loan that is restructured with an interest rate similar to current market interest rates and is in compliance with the modified terms need not be reported as restructured beginning the year after the year in which it was restructured.  Total loans which were considered restructured (including both those considered performing and those considered non-performing) were $8.8 million and $6.5 million as of March 31, 2011 and December 31, 2010, respectively.  Those restructured loans considered performing loans totaled $7.1 million and $5.6 million as of March 31, 2011 and December 31, 2010, respectively.
 
Allowance for Loan Losses. Management believes the allowance for loan losses accounting policy is critical to the portrayal and understanding of the Company’s financial condition and results of operations.  As such, selection and application of this “critical accounting policy” involves judgments, estimates, and uncertainties that are susceptible to change.  In the event that different assumptions or conditions were to prevail, and depending upon the severity of such changes, the possibility of materially different financial condition or results of operations is a reasonable likelihood.  For further information, please see discussion in “Critical Accounting Policies –Allowance for Loan Losses.”
 
The following table presents an analysis of the allowance for loan losses for the periods presented:
 
   
Three Months Ended March 31,
 
   
2011
   
2010
 
   
(Dollars in thousands)
 
Balance at beginning of period
 
$
28,722
   
$
24,504
 
Provision for loan losses
   
1,450
     
4,257
 
Total charge-offs
   
(2,022
)
   
(4,059
)
Total recoveries
   
234
     
120
 
Net charge-offs
   
(1,788
)
   
(3,939
)
Balance at end of period
 
$
28,384
   
$
24,822
 
                 
Gross loans at end of period
 
$
1,185,904
   
$
1,221,520
 
Ratio of allowance to total loans
   
2.39
%
   
2.03
%
Ratio of net charge-offs to average loans(1)
   
0.61
%
   
1.29
%
____________________
 
(1)
Net charge-offs are annualized for the purposes of this calculation.
 


Net charge-offs for the three months ended March 31, 2011, totaled $1.8 million, a decrease of $2.2 million (54.6%), from $3.9 million for the three months ended March 31, 2010.  The majority of the net charge-offs were residential real estate ($928 thousand), installment and other ($279 thousand), commercial non-real estate ($276 thousand) and commercial real estate ($231 thousand).  The decrease in net charge-offs for the first quarter of 2011 compared to the same period in 2010 was primarily due to decreases in net charge-offs in the commercial non-real estate portfolio of $1.0 million and the residential real estate portfolio of $566 thousand.  The provision for loan losses decreased $2.8 million (65.9%) based upon management’s estimate of the adequacy of the reserve for loan losses.  For further information, please see discussion in “Critical Accounting Policies –Allowance for Loan Losses” and “Results of Operations—Income Statement Analysis” above.
 
The following table sets forth the allocation of the allowance for loan losses in each loan category for the periods presented and the percentage of loans in each category to total loans. An allocation for a loan classification is only for internal analysis of the adequacy of the allowance and is not an indication of expected or anticipated losses:
 
   
At March 31, 2011
   
At December 31, 2010
   
At March 31, 2010
 
   
Amount
   
Percent
   
Amount
   
Percent
   
Amount
   
Percent
 
   
(Dollars in thousands)
 
Commercial
 
$
5,609
     
12.25
%
 
$
5,857
     
12.58
%
 
$
6,047
     
11.04
%
Commercial and residential real estate
   
12,125
     
69.42
     
11,102
     
69.27
     
8,790
     
69.88
 
Construction real estate
   
6,727
     
14.21
     
7,322
     
13.82
     
6,695
     
14.76
 
Installment and other
   
4,058
     
4.12
     
4,122
     
4.33
     
3,290
     
4.32
 
Unallocated
   
(135
   
N/A 
     
319
     
N/A 
     
-
     
N/A 
 
Total
 
$
28,384
     
100.00
%
 
$
28,722
     
100.00
%
 
$
24,822
     
100.00
%

The allowance for loan losses increased $3.6 million (14.4%) from March 31, 2010 to March 31, 2011.  This was mainly due to an increase in the allowance allocated to commercial and residential real estate loans.  The allocation for commercial and residential real estate loans increased $3.3 million (37.3%) mainly due to an increase in historical loss experience (based on regression analysis) of $2.6 million.  In addition, the allocation for installment and other loans increased $749 thousand (22.8%) mainly due to an increase in the allocation for historical loss experience (based on regression analysis) of $737 thousand.  The allocation for the commercial non-real estate loan portfolio decreased $466 thousand (7.7%), mainly due to a decrease in the allocation for historical loss experience (based on regression analysis) of $893 thousand.  This was partially offset by an increase in the allocation based on qualitative factors of $433 thousand.  For further information, please see discussion in “Critical Accounting Policies—Allowance for Loan Losses” above.
 
A loan is considered impaired when, based on current information and events, it is probable that the bank will be unable to collect all amounts due according to the original contractual terms of the loan agreement, including both principal and interest.  The impairment amount of the loan is equal to the recorded investment in the loan less the net fair value.  The bank generally uses one of three methods to measure impairment: the fair value of the collateral less disposition costs, the present value of expected future cash flows method, or the observable market price of a loan method.  The impairment amount above collateral value is normally charged to the allowance for loan and lease losses in the quarter it is identified.  Total loans which were deemed to have been impaired as of March 31, 2011 were $68.7 million.  Collateral associated with impaired loans identified as collateral-dependent (less estimated selling costs) exceeded this amount.  Impaired loans identified as cash-flow dependent had a total of $802 thousand in specific loan allocations in the allowance for loan losses to cover estimated losses in these loans.
 


The Bank anticipates the volume of outstanding commercial real estate and construction loans to continue to decline in accordance with the Bank’s established policy.  Overall, management’s outlook for the New Mexico economy after modest growth at the end of 2010 is that the economy will likely add jobs in 2011 and continue a trend of moderate growth thereafter.  For 2011, we expect employment growth of only 0.8%, and less than 1.5% per year in the following two years.  We anticipate that the economy will not recover its 2007 employment level until 2014.  The housing market continued its long decline to its lowest point in a decade.  In March 2011 New Mexico home sales numbers and median prices were down nearly 11% from March 2010; however, on-going changes to qualification criteria for mortgage loans should help potential buyers qualify for mortgages and thus improve sales numbers and median prices.  Given the weak housing market and expiration of ARRA infrastructure spending, construction is unlikely stimulate  rapid economic growth in 2011.
 
Additions to the allowance for loan losses, which are charged to earnings through the provision for loan losses, are determined based on a variety of factors, as indicated above.  Although the Company believes the allowance for loan losses is sufficient to cover probable losses inherent in the loan portfolio, there can be no assurance that the allowance will prove sufficient to cover actual loan losses.
 
Potential Problem Loans. The Company utilizes an internal asset classification system as a means of reporting problem and potential problem assets.  At Board of Directors meetings each quarter, a list of total adversely classified assets is presented showing OREO, other repossessed assets, and all loans listed as “Substandard,” “Doubtful” and “Loss.”  All non-accrual loans are classed either as “Substandard” or “Doubtful” and are thus included in total adversely classified assets.  A separate watch list of loans classified as “Special Mention” is also presented.  An asset is classified Substandard if it is inadequately protected by the current net worth and paying capacity of the obligor or by the collateral pledged, if any. Substandard assets have well-defined weaknesses that jeopardize liquidation of the debt and there is a distinct possibility that the Company will sustain some loss if the deficiencies are not corrected.  Assets classified as Doubtful have all the weaknesses inherent in those classified Substandard, but weaknesses are so pronounced that collection or liquidation is highly questionable and improbable.  Assets classified as Loss are those considered uncollectible and viewed as non-bankable assets worthy of charge-off. Special Mention Assets are those that have potential weaknesses that deserve management’s close attention.  If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the asset or in the Bank’s credit position at some future date.
 
The Company’s determinations as to the classification of its assets and the amount of its valuation allowances are subject to review by the Bank’s primary regulators, which can order the establishment of additional general or specific loss allowances.  The OCC, in conjunction with the other federal banking agencies, has adopted an interagency policy statement on the allowance for loan losses.  The policy statement provides guidance for financial institutions on both the responsibilities of management for the assessment and establishment of adequate allowances and guidance for banking agency examiners to use in determining the adequacy of general valuation guidelines.  Generally, the policy statement recommends that (i) institutions have effective systems and controls to identify, monitor and address asset quality problems; (ii) management analyze all significant factors that affect the collectability of the portfolio in a reasonable manner; and (iii) management establish acceptable allowance evaluation processes that meet the objectives set forth in the policy statement. Management believes it has established an adequate allowance for probable loan losses.  The Company analyzes its process regularly with modifications made as necessary and reports those results quarterly at Board of Directors meetings.  However, there can be no assurance that regulators, in reviewing the Company’s loan portfolio, will not request the Company to materially increase its allowance for loan losses.  Although management believes that adequate specific and general loan loss allowances have been established, actual losses are dependent upon future events and, as such, further additions to the level of specific and general loan loss allowances may become necessary.
 

 

 
 
 
 


The following table shows the amounts of adversely classified assets and special mention loans (not already counted in non-performing loans above) as of the periods indicated:
 
   
At
March 31, 2011
 
At
December 31, 2010
 
At
March 31, 2010
 
   
(In thousands)
 
Performing loans classified as:
 
Substandard
 
$
16,433
   
$
25,667
   
$
28,883
 
Doubtful
   
-
     
-
     
-
 
Total performing adversely classified loans
 
$
16,433
   
$
25,667
   
$
28,883
 
Special mention loans
 
$
1,641
   
$
1,091
   
$
2,744
 

Total performing adversely classified assets decreased $12.5 million (43.1%) from March 31, 2010 to March 31, 2011.  This was primarily due to the foreclosure and subsequent move to other real estate owned of several borrowing relationships in the residential land development, residential construction, and raw land property (all included under “construction real estate” in the preceding table) loan concentrations, as well as upgrading or payoff of several loan relationships in the construction and commercial real estate loan portfolios.  Special mention loans decreased $1.1 million (40.2%) between March 31, 2010 and March 31, 2011, primarily due to due to a combination of downgrades, upgrades and charge-offs of several credits in various loan concentrations and risk ratings over the year.  As of March 31, 2011, the underlying collateral was deemed adequate such that no impairment was required to be recognized.
 
Management carefully monitors the adversely classified assets it has in its portfolio.  Although we do not have direct exposure from subprime mortgages, we have significant concentrations in real estate lending (through construction, residential and commercial loans).  Though the New Mexico real estate environment is currently more favorable than many areas of the nation, real estate values have fallen and there are concerns that such values will stagnate or continue to fall within our market areas.  As a result, we will continue to closely monitor market conditions, our loan portfolio and make any adjustments to our allowance for loan losses deemed necessary to adequately provide for our exposure in these areas.
 
Sources of Funds
 
 
The Company’s cash flows are comprised of three classifications: cash flows from operating activities, cash flows from investing activities and cash flows from financing activities.  Net cash provided by operating activities was $27.3 million and $7.5 million for the three months ended March 31, 2011 and March 31, 2010, respectively, an increase in cash provided of $19.8 million between the two periods.  This increase was primarily due to an increase in cash provided by the sale of loans held for sale of $20.5 million, which was partially offset by a decrease in cash used in the origination of these loans of $1.6 million.  Net cash provided by investing activities was $29.4 million and $22.7 million for the three months ended March 31, 2011 and March 31, 2010, respectively.  The $6.7 million increase in cash provided by investing activities was largely due to an increase in the proceeds from the maturities and paydowns of investment securities of $9.0 million and a decrease in cash used in the purchase of investment securities of $5.0 million.  This was partially offset by a decrease in cash provided by the funding of loans, net of prepayments, of $7.9 million.  Net cash used in financing activities was $43.0 million and $73.2 million for the three months ended March 31, 2011 and March 31, 2010, respectively.  The $30.2 million decrease in cash used in financing activities, between March 31, 2010 and March 31, 2011, was mainly due to an increase in cash provided by net growth of deposits of $29.0 million.
 
The most significant change in deposits from December 31, 2010 to March 31, 2011 occurred in time deposits over $100,000 (decreasing $32.1 million), with decreases also in NOW accounts ($20.4 million) and other time deposits ($4.8 million).  The largest increase in deposits was in savings accounts ($12.0 million), with increases also in MMDA accounts ($3.1 million) and demand deposits ($347 thousand).
 

 
 
 
 


In the event that additional short-term liquidity is needed, we have established relationships with several large regional banks to provide short-term borrowings in the form of federal funds purchases.  We have borrowed at various points of time $50.0 million for a short period (15 to 60 days) from these banks on a collective basis.  Management believes that we will be able to continue to borrow federal funds from our correspondent banks in the future.  Additionally, we are a member of the FHLB and, as of March 31, 2011, we had the ability to borrow from the FHLB up to a total of $252.0 million in additional funds.  We also may borrow through the Federal Reserve Bank’s discount window up to a total of $113.1 million on a short-term basis.  As a contingency plan for significant funding needs, the Asset/Liability Management committee may also consider the sale of investment securities, selling securities under agreement to repurchase, sale of certain loans and/or the temporary curtailment of lending activities.
 
At March 31, 2011, Trinity’s total risk-based capital ratio was 14.95%, the Tier 1 capital to risk-weighted assets ratio was 13.69%, and the Tier 1 capital to adjusted average assets ratio was 10.48%.  At December 31, 2010, Trinity’s total risk-based capital ratio was 14.50%, the Tier 1 capital to risk-weighted assets ratio was 13.23%, and the Tier 1 capital to average assets ratio was 9.82%.
 
At March 31, 2011, the Bank’s total risk-based capital ratio was 14.79%, the Tier 1 capital to risk-weighted assets ratio was 13.53%, and the Tier 1 capital to adjusted average assets ratio was 10.35%.  At December 31, 2010, the Bank’s total risk-based capital ratio was 14.26%, the Tier 1 capital to risk-weighted assets ratio was 12.99%, and the Tier 1 capital to adjusted average assets ratio was 9.64%.  The Bank exceeded the general minimum regulatory requirements to be considered “well-capitalized” under Federal Deposit Insurance Corporation regulations at March 31, 2011 and December 31, 2010.
 
At March 31, 2011 and December 31, 2010, Trinity’s book value per common share was $13.82 and $13.58, respectively.
 
On August 13, 2010, the Company elected to exercise the option to defer the payment of dividends on the preferred stock issued to the U.S. Treasury under the CPP, as provided by the agreements under which the stock was issued, due for the quarterly period ending on August 16, 2010.  On November 8, 2010, the Company again elected to exercise the option to defer the payment of dividends on the Preferred Stock issues, as provided by the agreements under which the stock was issued, due for the quarterly periods ending on November 15, 2010 and February 15, 2011.  The dividend payments would normally be paid in the amount of $444,237.50 for the Company’s Series A Preferred Stock and $39,982.50 for Series B Preferred Stock for each of the quarterly periods.  On April 26, 2011, the Company’s Board of Directors elected to pay these deferred dividends in full, as well as the current dividend payable, on May 16, 2011.
 
 
Asset Liability Management
 
Our net interest income is subject to “interest rate risk” to the extent that it can vary based on changes in the general level of interest rates.  It is our policy to maintain an acceptable level of interest rate risk over a range of possible changes in interest rates while remaining responsive to market demand for loan and deposit products.  The strategy we employ to manage our interest rate risk is to measure our risk using an asset/liability simulation model and adjust the maturity of securities in its investment portfolio to manage that risk.
 
Interest rate risk can also be measured by analyzing the extent to which the repricing of assets and liabilities are mismatched to create an interest sensitivity “gap.”  An asset or liability is considered to be interest rate sensitive within a specific time period if it will mature or reprice within that time period.  The interest rate sensitivity gap is defined as the difference between the amount of interest-earning assets maturing or repricing within a specific time period and the amount of interest-bearing liabilities maturing or repricing within that same time period.  A gap is considered positive when the amount of interest rate sensitive assets exceeds the amount of interest rate sensitive liabilities.  A gap is considered negative when the amount of interest rate sensitive liabilities exceeds the amount of interest rate sensitive assets.  During a period of rising interest rates, therefore, a negative gap would tend to adversely affect net interest income.  Conversely, during a period of falling interest rates, a negative gap position would tend to result in an increase in net interest income. 
 

 
 
 
 


The following tables set forth the amounts of interest-earning assets and interest-bearing liabilities outstanding at March 31, 2011, which we anticipate, based upon certain assumptions, to reprice or mature in each of the future time periods shown.  Except as stated below, the amount of assets and liabilities shown which reprice or mature during a particular period were determined based on the earlier of the term to repricing or the term to repayment of the asset or liability.  These tables are intended to provide an approximation of the projected repricing of assets and liabilities at March 31, 2011 on the basis of contractual maturities and scheduled rate adjustments within a three-month period and subsequent selected time intervals.  The loan amounts in the table reflect principal balances expected to be reinvested and/or repriced as a result of contractual amortization and rate adjustments on adjustable-rate loans.  The contractual maturities and amortization of loans and investment securities reflect modest prepayment assumptions.  While NOW, money market and savings deposit accounts have adjustable rates, it is assumed that the interest rates on these accounts will not adjust immediately to changes in other interest rates.  Therefore, the table is calculated assuming that these accounts will reprice based upon an historical analysis of decay rates of these particular accounts, with repricing assigned to these accounts from 1 to 10 months.
 
   
Time to Maturity or Repricing
 
As of March 31, 2011:
 
0-90 Days
   
91-365 Days
   
1-5 Years
   
Over 5 Years
   
Total
 
   
(Dollars in thousands)
 
Interest-earning Assets:
                             
Loans
 
$
445,184
   
$
428,573
   
$
254,237
   
$
57,910
   
$
1,185,904
 
Loans held for sale
   
5,174
     
-
     
-
     
-
     
5,174
 
Investment securities
   
11,998
     
29,798
     
47,494
     
64,566
     
153,856
 
Securities purchased under agreements to resell
   
393
     
-
     
-
     
-
     
393
 
Interest-bearing deposits with banks
   
101,062
     
-
     
-
     
-
     
101,062
 
Investment in unconsolidated trusts
   
186
     
-
     
-
     
930
     
1,116
 
Total interest-earning assets
 
$
563,997
   
$
458,371
   
$
301,731
   
$
123,406
   
$
1,447,505
 
                                         
Interest-bearing Liabilities:
                                       
NOW deposits
 
$
58,474
   
$
112,092
   
$
-
   
$
-
   
$
170,566
 
Money market deposits
   
85,208
     
125,409
     
-
     
-
     
210,617
 
Savings deposits
   
131,045
     
187,866
     
-
     
-
     
318,911
 
Time deposits over $100,000
   
88,620
     
155,961
     
40,033
     
11,423
     
296,037
 
Time deposits under $100,000
   
53,191
     
126,092
     
25,086
     
1,899
     
206,268
 
Short-term borrowings
   
-
     
10,000
     
-
     
-
     
10,000
 
Long-term borrowings
   
-
     
-
     
20,000
     
2,300
     
22,300
 
Capital lease obligations
   
-
     
-
     
2,211
     
-
     
2,211
 
Junior subordinated debt owed to unconsolidated trusts
   
6,186
     
-
     
-
     
30,930
     
37,116
 
Total interest-bearing liabilities
 
$
422,724
   
$
717,420
   
$
87,330
   
$
46,552
   
$
1,274,026
 
                                         
Rate sensitive assets (RSA)
 
$
563,997
   
$
1,022,368
   
$
1,324,099
   
$
1,447,505
     
1,447,505
 
Rate sensitive liabilities (RSL)
   
422,724
     
1,140,144
     
1,227,474
     
1,274,026
     
1,274,026
 
Cumulative GAP (GAP=RSA-RSL)
   
141,273
     
(117,776
)
   
96,625
     
173,479
     
173,479
 
RSA/Total assets
   
37.03
%
   
67.13
%
   
86.94
%
   
95.05
%
   
95.05
%
RSL/Total assets
   
27.76
%
   
74.86
%
   
80.60
%
   
83.66
%
   
83.66
%
GAP/Total assets
   
9.28
%
   
-7.73
%
   
6.34
%
   
11.39
%
   
11.39
%
GAP/RSA
   
25.05
%
   
-11.52
%
   
7.30
%
   
11.98
%
   
11.98
%


 
 
 
 


Certain shortcomings are inherent in the method of analysis presented in the foregoing table.  For example, although certain assets and liabilities may have similar maturities or periods to repricing, they may react in different degrees to changes in market interest rates.  Also, the interest rates on certain types of assets and liabilities may fluctuate in advance of changes in market interest rates, while interest rates on other types of assets may lag behind changes in market rates.  Additionally, in the event of a change in interest rates, prepayment and early withdrawal levels would likely deviate significantly from those assumed in calculating the table.  Therefore, we do not rely solely on a gap analysis to manage our interest rate risk, but rather we use what we believe to be the more reliable simulation model relating to changes in net interest income.
 
Based on simulation modeling at March 31, 2011 and December 31, 2010, our net interest income would change over a one-year time period due to changes in interest rates as follows:
 
Change in Net Interest Income over One Year Horizon

     
At March 31, 2011
 
At December 31, 2010
 
Changes in Levels of Interest Rates
 
Dollar Change
 
Percent Change
 
Dollar Change
 
Percent Change
 
(Dollars in thousands)
 
 
+2.00
%
 
$
(6,705
)
   
(12.61
)%
 
$
(5,253
)
   
(9.95
)%
 
+1.00
     
(5,456
)
   
(10.26
)
   
(3,363
)
   
(6.37
)
 
(1.00
)
   
(1,675
)
   
(3.15
)
   
(1,711
)
   
(3.24
)
 
(2.00
)
   
(3,446
)
   
(6.48
)
   
(3,426
)
   
(6.49
)

Our simulations used assume the following:
 
1.
Changes in interest rates are immediate.

2.
It is our policy that interest rate exposure due to a 2% interest rate rise or fall be limited to 15% of our annual net interest income, as forecasted by the simulation model.  As demonstrated by the table above, our interest rate risk exposure was within this policy at March 31, 2011.

Changes in net interest income between the periods above reflect changes in the composition of interest-earning assets and interest-bearing liabilities, related interest rates, repricing frequencies, and the fixed or variable characteristics of the interest-earning assets and interest-bearing liabilities.  Projections of income given by the model are not actual predictions, but rather show our relative interest rate risk.  Actual interest income may vary from model projections.  Note that significant declines in interest rates from the current levels are unlikely or impossible as this would result in negative interest rates.
 
 
Evaluation of Disclosure Controls and Procedures
 
We have established disclosure controls and procedures to ensure that material information relating to the Company, including its consolidated subsidiaries, is made known to the officers who certify our financial reports and to other members of senior management and the board of directors and to ensure that information that is required to be disclosed in reports we file with the SEC is properly and timely recorded, processed, summarized and reported.  A review and evaluation was performed by our management, including the Company’s Chief Executive Officer (the “CEO”) and Chief Financial Officer (the “CFO”), of the effectiveness of the design and operation of our disclosure controls and procedures as of March 31, 2011 pursuant to Rule 13a-15(b) under the Securities Exchange Act of 1934.  Based upon and as of the date of that review and evaluation, the CEO and CFO have concluded that our current disclosure controls and procedures were effective as of March 31, 2011.
 
Changes in Internal Control over Financial Reporting.
 
There have been no changes to the Company’s internal control over financial reporting during the last fiscal quarter that have affected, or are reasonably likely to affect, its internal control over financial reporting.
 

 
 
 
 


 
 
Trinity, the Bank, Title Guaranty, Cottonwood, FNM Investment Fund IV, FNM Investor Series IV, TCC Advisors, SWMT and TCC Funds were not involved in any pending legal proceedings, other than routine legal proceedings occurring in the normal course of business, which, in the opinion of management, in the aggregate, would be material to the Company's consolidated financial condition. 
 
 
In addition to the other information in this Quarterly Report on Form 10-Q, shareholders or prospective investors should carefully consider the risk factors disclosed in Item 1A to Part I of Trinity’s Form 10-K for the year ended December 31, 2010, filed with the Securities and Exchange Commission on March 10, 2011.
 
 
During the first quarter of 2011, we made no repurchases of any class of our equity securities.
 
 
None
 
 
 
None
 


 
 
 
 


 




 
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this registration statement to be signed on its behalf by the undersigned thereunto duly authorized.
 
 
TRINITY CAPITAL CORPORATION
   
Date: May 10, 2011
By:
/s/ WILLIAM C. ENLOE
   
William C. Enloe
   
President and Chief Executive Officer
     
Date: May 10, 2011
By:
/s/ DANIEL R. BARTHOLOMEW
   
Daniel R. Bartholomew
   
Chief Financial Officer