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

[X] Quarterly Report Pursuant to Section 13 or 15(d)
of the Securities Exchange Act of 1934

For the quarterly period ended March 31, 2011

[   ] Transition Report Pursuant to Section 13 or 15(d)
of the Securities Exchange Act of 1934

For the transition period from ____________ to _____________

Commission File Number:  0-27622

HIGHLANDS BANKSHARES, INC.
(Exact name of registrant as specified in its charter)


Virginia
(State or other jurisdiction of
incorporation or organization)
54-1796693
(I.R.S. Employer
Identification No.)
 
P.O. Box 1128
Abingdon, Virginia
(Address of principal executive offices)
 
 
24212-1128
(Zip Code)

276-628-9181
(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 Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).   Yes [   ]        No [    ]

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or smaller reporting company (See definition of “large accelerated filer, accelerated filer and smaller reporting company” in Rule 12b-2 of the Act). Large Accelerated Filer  [  ]   Accelerated Filer  [  ]    Non-Accelerated Filer [  ]  Smaller Reporting Company  [X]
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes [  ] No [X ]

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.
 
5,011,152 shares of common stock, par value $0.625 per share,
outstanding as of May 11, 2011
 



 
 
 

 
Highlands Bankshares, Inc.

FORM 10-Q
For the Quarter Ended March 31, 2011

INDEX
   
PART I. FINANCIAL INFORMATION
PAGE
   
Item 1.  Financial Statements
 
   
Consolidated Balance Sheets
  at March 31, 2011 (Unaudited) and December 31, 2010
 
3
 
 
Consolidated Statements of Income (Unaudited)
  for the Three Months Ended March 31, 2011 and 2010
4
   
Consolidated Statements of Cash Flows (Unaudited)
  for the Three Months Ended March 31, 2011 and 2010
5
   
Consolidated Statements of Changes in
  Stockholders’ Equity (Unaudited) for the Three Months
  Ended March 31, 2011 and 2010
6
   
Notes to Consolidated Financial Statements (Unaudited)
6-30
   
Item 2. Management’s Discussion and Analysis of
              Financial Condition and Results of Operations
31-37
   
Item 3. Quantitative and Qualitative Disclosures About Market Risk
37
   
Item 4.  Controls and Procedures
37
 
 
PART II.  OTHER INFORMATION
 
   
Item 1.  Legal Proceedings
38
   
Item 1A. Risk Factors
38
   
Item 2.  Unregistered Sales of Equity Securities and Use of Proceeds
38
   
Item 3.  Defaults Upon Senior Securities
38
   
Item 4.  Removed and Reserved
38
   
Item 5.  Other Information
38
   
Item 6.  Exhibits
38
   
SIGNATURES AND CERTIFICATIONS
39-46


 
2

 

PART I.
FINANCIAL INFORMATION
ITEM 1.  Financial Statements

Consolidated Balance Sheets
(Amounts in thousands)
 
 
ASSETS
 
(Unaudited)
March 31, 2011
   
(Note 1)
December 31, 2010
 
             
Cash and due from banks
  $ 16,515     $ 15,693  
Federal funds sold
    61,741       66,459  
                 
   Total Cash and Cash Equivalents
    78,256       82,152  
                 
Investment securities available for sale  (amortized cost $64,188 at  
    March 31, 2011, $62,093 at December 31, 2010)
    58,579       56,096  
Other investments, at cost
    6,026       6,026  
Loans, net of allowance for loan losses of $12,215 at March 31, 2011,
    $10,320 at December 31, 2010
    425,657       440,274  
Premises and equipment, net
    23,230       23,509  
Deferred tax assets
    12,955       11,887  
Interest receivable
    2,721       2,544  
Bank owned life Insurance
    12,889       12,777  
Other real estate owned
    16,006       15,316  
Other assets
    4,738       4,927  
                 
    Total Assets
  $ 641,057     $ 655,508  
                 
LIABILITIES AND STOCKHOLDERS’ EQUITY
               
                 
LIABILITIES
               
                 
Deposits:
               
  Non-interest bearing
  $ 90,067     $ 85,923  
  Interest bearing
    442,433       450,849  
                 
    Total Deposits
    532,500       536,772  
                 
Interest, taxes and other liabilities
    1,585       1,786  
Other short-term borrowings
    57,959       65,952  
Long-term debt
    14,850       14,968  
Capital securities
    3,150       3,150  
                 
    Total Other Liabilities
    77,544       85,856  
                 
    Total Liabilities
    610,044       622,628  
                 
STOCKHOLDERS’ EQUITY
               
                 
Common stock (5,011 shares issued and outstanding)
    3,132       3,132  
Additional paid-in capital
    7,783       7,783  
Retained earnings
    23,800       25,923  
Accumulated other comprehensive income (loss)
    (3,702 )     (3,958 )
                 
  Total Stockholders’ Equity
    31,013       32,880  
                 
    Total Liabilities and Stockholders’ Equity
  $ 641,057     $ 655,508  
                 
 
See accompanying Notes to Consolidated Financial Statements

 
3

 

Consolidated Statements of Income
(Amounts in thousands, except per share data)
(Unaudited)
 
   
Three Months Ended  
March 31, 2011
   
Three Months Ended
  March 31, 2010
 
INTEREST INCOME
           
Loans receivable and fees on loans
  $ 6,427     $ 7,219  
Securities available for sale:
               
  Taxable
    284       208  
  Exempt from taxable income
    225       545  
Other investment income
    17       21  
Federal funds sold
    36       5  
                 
    Total Interest Income
    6,989       7,998  
                 
INTEREST EXPENSE
               
Deposits
    1,798       2,322  
Federal funds purchased
    -       1  
Other borrowed funds
    907       897  
                 
    Total Interest Expense
    2,705       3,220  
                 
    Net Interest Income
    4,284       4,778  
                 
Provision for Loan Losses
    3,603       1,212  
                 
    Net Interest Income after Provision for Loan Losses
    681       3,566  
                 
NON-INTEREST INCOME
               
Securities gains (losses), net
    29       (1 )
Service charges on deposit accounts
    494       457  
Other service charges, commissions and fees
    396       338  
Other  operating income, rents
    166       156  
Other than temporary impairment charge
    (114 )     --  
 
               
    Total Non-Interest Income
    971       950  
                 
NON-INTEREST EXPENSE
               
Salaries and employee benefits
    2,528       2,636  
Occupancy expense of bank premises
    260       302  
Furniture and equipment expense
    338       400  
Other operating expense
    1,337       1,170  
Foreclosed Assets – Loss on Sale / Write-down
    253       189  
Foreclosed Assets – Operating Expenses
    312       74  
                 
    Total Non-Interest Expense
    5,028       4,771  
                 
    Income (Loss) Before Income Taxes
    (3,376 )     (255 )
                 
Income Tax Expense (Benefit) (Note 3)
    (1,253 )     (299 )
                 
    Net Income (Loss)
  $ (2,123 )   $ 44  
                 
Basic Earnings (Loss)  Per Common Share (Note 6)
  $ (0.43 )   $ 0.01  
                 
Earnings (Loss) Per Common Share – Assuming Dilution
  $ (0.43 )   $ 0.01  
                 
Dividends Per Share
  $ -     $ -  

See accompanying Notes to Consolidated Financial Statements


 
4

 


Consolidated Statements of Cash Flows
(Amounts in thousands)
(Unaudited)
 
   
Three Months Ended
   
Three Months Ended
 
   
March 31, 2011
   
March 31, 2010
 
CASH FLOWS FROM OPERATING  ACTIVITIES:
           
Net income (loss)
  $ (2,123 )   $ 44  
Adjustments to reconcile net income  (loss) to net cash provided by operating activities
               
Provision for loan losses
    3,603       1,212  
Depreciation and amortization
    288       326  
Net realized (gains) losses on available for sale securities
    (29 )     1  
Net amortization on securities
    135       42  
             Other than temporary impairment charge
            -  
Amortization of Capital issue costs
    2       1  
            (Increase) decrease in interest receivable
    (177 )     (113 )
Valuation adjustment of other real estate owned
    195       83  
(Increase) decrease in other assets
    (1,128 )     (1,500 )
Increase (decrease) in interest, taxes and other liabilities
    (201 )     636  
                 
Net cash provided by operating activities
     681       732  
                 
CASH FLOWS FROM INVESTING ACTIVITIES:
               
Securities available for sale:
               
       Proceeds from sale of securities
    2,332       1,090  
Proceeds from maturities of debt and equity securities
    1,726       2,776  
Purchase of debt and equity securities
    (6,374 )     (256 )
Net (increase) decrease in loans
    9,568       (9,570 )
Proceeds from sales of other real estate owned
    558       445  
Premises and equipment expenditures
    (4 )     (2 )
                 
Net cash provided by (used in) investing activities
    7,806       (5,517 )
                 
CASH FLOWS FROM FINANCING ACTIVITIES:
               
Net increase (decrease) in time deposits
    (12,494 )     1,408  
Net increase in demand, savings and other deposits
    8,222       3,147  
Decrease in short-term borrowings
    (7,993 )     (3,110 )
Decrease in long-term debt
    (118 )     (531 )
                 
Net cash provided by (used in) financing activities
    (12,383 )     914  
                 
Net decrease in cash and cash equivalents
    (3,896 )     (3,871 )
CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR
    82,152       29,337  
                 
CASH AND CASH EQUIVALENTS AT END OF PERIOD
  $ 78,256     $ 25,466  
                 
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
               
Cash paid during the year for:
               
Interest
  $ 2,980     $ 3,220  
Income taxes
  $ -     $ 250  
                 
     SUPPLEMENTAL DISCLOSURE OF NONCASH TRANSACTIONS
               
Transfer of loans to other real estate owned
  $ 1,446     $ 690  

See accompanying Notes to Consolidated Financial Statements

 
5

 

Consolidated Statements of Changes in Stockholders’ Equity
(Amounts in thousands)
(Unaudited)
                           
Accumulated
       
               
Additional
         
Other
   
Total
 
   
Common Stock
   
Paid-in
   
Retained
   
Comprehensive
   
Stockholders’
 
   
Shares
   
Par Value
   
Capital
   
Earnings
   
Income
   
Equity
 
                                     
Balance, December 31, 2009
    5,011     $ 3,132     $ 7,783     $ 28,063     $ (3,550 )   $ 35,428  
                                                 
Comprehensive income:
                                               
Net income
    -       -       -       44       -       44  
Change in unrealized loss on securities available for sale, net of deferred income tax expense of $46
    -       -       -       -       88       88  
    Total comprehensive income
    -       -       -       -       -       132  
                                                 
Balance, March 31, 2010
    5,011     $ 3,132     $ 7,783     $ 28,107     $ (3,462 )   $ 35,560  
                                                 
                                                 
Balance, December 31, 2010
    5,011     $ 3,132     $ 7,783     $ 25,923     $ (3,958 )   $ 32,880  
                                                 
Comprehensive income:
                                               
Net income / (loss)
    -       -       -       (2,123 )     -       (2,123 )
Change in unrealized loss on securities available for sale, net of deferred income tax expense of  $141
    -       -       -       -       274       274  
Less: reclassification adjustment
  net of deferred tax expense of $10
    -       -       -       -       (18 )     (18 )
    Total comprehensive income
    -       -       -       -       -       (1,867 )
                                                 
                                                 
Balance, March 31, 2011
    5,011     $ 3,132     $ 7,783     $ 23,800     $ (3,702 )   $ 31,013  
                                                 

See accompanying Notes to Consolidated Financial Statements


Notes to Consolidated Financial Statements
(Unaudited)
(in thousands, except share, per share and percentage data)
 
 
Note 1  -  General

The consolidated financial statements of Highlands Bankshares, Inc. (the “Company”) conform to United States generally accepted accounting principles and to banking industry practices. The accompanying consolidated interim financial statements are unaudited. In the opinion of management, all adjustments necessary for a fair presentation of the consolidated financial statements have been included. All such adjustments are of a normal and recurring nature. The consolidated balance sheet as of December 31, 2010 has been extracted from the audited financial statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2010 (the “2010 Form 10-K”). The notes included herein should be read in conjunction with the notes to consolidated financial statements included in the 2010 Form 10-K. The results of operations for the three-month period ended March 31, 2011 are not necessarily indicative of the results to be expected for the full year.

The preparation of financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

 
6

 

Notes to Consolidated Financial Statements
(Unaudited)
(in thousands, except share, per share and percentage data)

Note 2  -  Loans and Allowance for Loan Losses  (amounts in thousands)

A summary of transactions in the consolidated allowance for loan losses for the three months ended March 31 is as follows:


   
2011
   
2010
 
             
Allowance for loan losses at  beginning of year
  $ 10,320     $ 11,681  
 
Loans charged off:
               
  Residential 1-4 Family
    84       9  
  Multifamily
    -       175  
  Construction and Land Loans
    785       117  
  Commercial, Owner Occupied
    90       -  
  Commercial, Non-owner occupied
    -       -  
  Second Mortgages
    222       -  
  Equity Lines of Credit
    10       -  
  Farmland
    143       -  
                 
  Secured (other ) and unsecured
               
   Personal
    38       147  
  Commercial
    313       396  
  Agricultural
    28       24  
 
  Overdrafts
    53       41  
          Total
    1,766       909  
 
Recoveries of loans previously
  charged off:
               
                 
  Residential 1-4 Family
    1       -  
  Multifamily
    -       -  
  Construction and Land Loans
    30       -  
  Commercial, Owner Occupied
    -       -  
  Commercial, Non-owner occupied
    -       -  
  Second Mortgages
    -       -  
  Equity Lines of Credit
    -       -  
  Farmland
    -       -  
                 
  Secured (other ) and unsecured
               
  Personal
    21       19  
 Commercial
    6       1  
 Agricultural
    -       -  
 Overdrafts
    -       4  
                 
            Total
    58       24  
 
               
Net loans charged off
    1,708       885  
Provision for loan losses
    3,603       1,212  
 
Allowance for loan losses end of year
  $ 12,215     $ 12,008  


 
7

 


Notes to Consolidated Financial Statements
(Unaudited)
(in thousands, except share, per share and percentage data)


The composition of net loans is as follows:

   
March 31,
2011
   
December 31, 2010
 
Real Estate Secured:
           
Residential 1-4 family
  $ 175,551     $ 175,522  
Multifamily
    15,570       15,593  
Construction and Land Loans
    28,556       30,901  
Commercial, Owner Occupied
    77,138       78,279  
Commercial, Non-owner occupied
    38,161       43,652  
Second mortgages
    13,289       14,132  
Equity lines of credit
    10,138       10,016  
Farmland
    12,933       12,790  
      371,336       380,885  
                 
Secured (other) and unsecured
               
Personal
    25,711       26,773  
Commercial
    38,222       40,471  
Agricultural
    2,909       2,848  
      66,842       70,092  
                 
Overdrafts
    276       214  
                 
      438,454       451,191  
Less:
               
  Allowance for loan losses
    12,215       10,320  
  Net deferred fees
    582       597  
      12,797       10,017  
                 
Loans, net
  $ 425,657     $ 440,274  


 
8

 

Notes to Consolidated Financial Statements
(Unaudited)
(in thousands, except share, per share and percentage data)

The following table is an analysis of past due loans as of March 31, 2011:

   
30-59 Days Past Due
   
60-89 Days Past Due
   
Greater Than 90 Days
   
Total Past Due
   
Current
   
Total Financing Receivables
   
Recorded Investment > 90 Days and Accruing
 
                                           
Real Estate Secured
                                         
Residential 1-4 family
  $ 3,998     $ 285     $ 5,635     $ 9,918     $ 165,633     $ 175,551     $ 490  
Equity lines of credit
    119       -       -       119       10,019       10,138       -  
Multifamily
    -       -       -       -       15,570       15,570       -  
Farmland
    130       -       631       761       12,172       12,933       -  
Construction, Land Development, Other Land Loans
    142       48       2,588       2,778       25,778       28,556       -  
Commercial Real Estate- Owner Occupied
    614       -       6,582       7,196       69,942       77,138       -  
Commercial Real Estate- Non Owner Occupied
    298       -       1,442       1,740       36,421       38,161       -  
Second Mortgages
    114       5       322       441       12,848       13,289       -  
Non Real Estate Secured
                                                       
Personal
    313       118       87       518       25,469       25,987       43  
Business
    469       196       1,159       1,824       36,398       38,222       46  
Agricultural
    -       -       -       -       2,909       2,909       -  
                                                         
          Total
  $ 6,197     $ 652     $ 18,446     $ 25,295     $ 413,159     $ 438,454     $ 579  
                                                         


The following table is an analysis of past due loans as of  December 31, 2010:

 
   
30-59 Days Past Due
   
60-89 Days Past Due
   
Greater Than 90 Days
   
Total Past Due
   
Current
   
Total Financing Receivables
   
Recorded Investment > 90 Days and Accruing
 
                                           
Real Estate Secured
                                         
Residential 1-4 family
  $ 3,780     $ 1,245     $ 4,937     $ 9,962     $ 165,560     $ 175,522     $ 1,726  
Equity lines of credit
    -       99       -       99       9,917       10,016       -  
Multifamily
    -       -       40       40       15,553       15,593       -  
Farmland
    348       -       774       1,122       11,668       12,790       -  
Construction, Land Development, Other Land Loans
    825       152       3,153       4,130       26,771       30,901       53  
Commercial Real Estate- Owner Occupied
    1,612       105       6,301       8,018       70,260       78,278       1,776  
Commercial Real Estate- Non Owner Occupied
    -       165       1,520       1,685       41,967       43,652       602  
Second Mortgages
    234       -       529       763       13,369       14,132       -  
Non Real Estate Secured
                                                       
Personal
    303       101       74       478       26,510       26,988       14  
Business
    190       406       1,456       2,052       38,419       40,471       289  
Agricultural
    7       -       96       103       2,745       2,848       68  
                                                         
          Total
  $ 7,299     $ 2,273     $ 18,880     $ 28,452     $ 422,739     $ 451,191     $ 4,528  
                                                         



 
9

 


Notes to Consolidated Financial Statements
(Unaudited)
(in thousands, except share, per share and percentage data)

The accrual of interest on loans is discontinued at the time the loan is 90 days delinquent unless the credit is well-secured and in process of collection.  Credit card loans and other personal loans are typically charged off no later than 180 days past due.   In all cases, loans are placed on non-accrual or charged-off at an earlier date if collection of principal or interest is considered doubtful. The March 31, 2011 total includes approximately $6,827 of loans that are current and paying under the terms of their existing loan agreement but are categorized as non accrual due to regulatory guidelines.

The following is a summary of non-accrual loans at March 31, 2011 and December 31, 2010:
 
   
March 31, 2011
   
December 31, 2010
 
Real Estate Secured
           
Residential 1-4 Family
  $ 5,635     $ 3,211  
Multifamily
    1,673       40  
Construction and Land Loans
    3,789       3,100  
Commercial-Owner Occupied
    6,582       4,525  
Commercial- Non Owner Occupied
    5,808       918  
Second Mortgages
    322       529  
Equity Lines of Credit
    -       -  
Farmland
    631       774  
Secured (other) and Unsecured
               
Personal
    86       60  
Commercial
    1,159       1,167  
Agricultural
    -       29  
                 
Total
  $ 25,685     $ 14,353  

 
10

 
Notes to Consolidated Financial Statements
(Unaudited)
(in thousands, except share, per share and percentage data)

The following tables represent a summary of credit quality indicators of the Bank’s loan portfolio at March 31, 2011 and December 31, 2010: The grades are assigned and / or modified by the Company’s credit review and credit analysis departments based on the creditworthiness of the borrower and the overall strength of the loan.

Credit Risk Profile by Internally Assigned Grade as of March 31, 2011
Grade (1)
 
Residential 1-4 Family
   
Multifamily
   
Farmland
   
Construction,
Land Loans
   
Commercial Real Estate-
Owner
Occupied
   
Commercial
Real Estate
Non-Owner
Occupied
 
                                     
Quality
    38,614       1,892       931       4,311       7,161       2,782  
Satisfactory
    79,467       9,270       4,335       6,808       24,807       15,273  
Acceptable
    37,449       1,796       4,637       6,306       23,215       9,823  
Special Mention
    4,825       -       307       770       8,284       302  
Substandard
    14,825       2,612       2,723       10,734       13,671       9,982  
Doubtful
    370       -       -       -       -       -  
                                                 
     Total
  $ 175,550     $ 15,570     $ 12,933     $ 28,929     $ 77,138     $ 38,162  



Credit Risk Profile by Internally Assigned Grade as of December 31, 2010
Grade (1)
 
Residential 1-4 Family
   
Multifamily
   
Farmland
   
Construction,
Land Loans
   
Commercial Real Estate- Owner Occupied
   
Commercial Real Estate Non-Owner Occupied
 
                                     
Quality
    40,371       1,911       977       4,298       7,102       3,604  
Satisfactory
    80,759       9,258       4,399       7,355       26,055       16,729  
Acceptable
    36,411       1,806       4,285       5,585       27,878       13,013  
Special Mention
    4,778       946       178       2,346       5,430       304  
Substandard
    12,832       1,672       2,951       11,317       11,390       10,002  
Doubtful
    371       -       -       -       424       -  
                                                 
     Total
  $ 175,522     $ 15,593     $ 12,790     $ 30,901     $ 78,279     $ 43,652  
 
(1)  Quality--This grade is reserved for the Bank’s top quality loans. These loans have excellent sources of repayment, with no significant identifiable risk of collection.  Generally, loans assigned this rating will demonstrate the following characteristics:
 
 
·  
Conformity in all respects with Bank policy, guidelines, underwriting standards, and Federal and State regulations (no exceptions of any kind).
 
 
·  
Documented historical cash flow that meets or exceeds required minimum Bank guidelines, or that can be supplemented with verifiable cash flow from other sources.
 
 
·  
Adequate secondary sources to liquidate the debt, including combinations of liquidity, liquidation of collateral, or liquidation value to the net worth of the borrower or guarantor.
 
 
For existing loans, all of the requirements above apply plus all payments have been made as agreed, current financial information on all borrowers and guarantors has been obtained and analyzed, and overall business operating trends are either stable or improving.
 
 
   Satisfactory-This grade is given to performing loans. These loans have adequate sources of repayment, with little identifiable risk of collection. Loans assigned this rating will demonstrate the following characteristics:
 
 
·  
General conformity to the Bank's policy requirements, product guidelines and underwriting standards.  Any exceptions that are identified during the underwriting and approval process have been adequately mitigated by other factors.
 
 
·  
Documented historical cash flow that meets or exceeds required minimum Bank guidelines, or that can be supplemented with verifiable cash flow from other sources.  
 
 
11

 


Notes to Consolidated Financial Statements
(Unaudited)
(in thousands, except share, per share and percentage data)
 
·  
Adequate secondary sources to liquidate the debt, including combinations of liquidity, liquidation of collateral, or liquidation value to the net worth of the borrower or guarantor
 
 
For existing loans, all of the requirements outlined above will apply, plus all payments have been made as agreed, current financial information on all borrowers and guarantors has been obtained and analyzed, and overall business operating trends are stable with any declines considered minor and temporary.
 
 
Acceptable-This grade is given to loans that show signs of weakness in either adequate sources of repayment or collateral, but have demonstrated mitigating factors that minimize the risk of delinquency or loss.  Loans assigned this rating may demonstrate some or all of the following characteristics:
 
 
·  
Additional exceptions to the Bank's policy requirements, product guidelines or underwriting standards that present a higher degree of risk to the Bank.  Although the combination and/or severity of identified exceptions is greater, all exceptions have been properly mitigated by other factors.
 
 
·  
Unproved, insufficient or marginal primary sources of repayment that appear sufficient to service the debt at this time.  Repayment weaknesses may be due to minor operational issues, financial trends, or reliance on projected (not historic) performance.
 
 
·  
Marginal or unproven secondary sources to liquidate the debt, including combinations of liquidation of collateral and liquidation value to the net worth of the borrower or guarantor.
 
 
For existing loans, payments have generally been made as agreed with only minor and isolated delinquencies.
 
 
Special Mention -This grade is given to Watch List loans that include the following characteristics:
 
 
·  
Loans with underwriting guideline tolerances and/or exceptions with no identifiable mitigating factors.
 
 
·  
Extending loans that are currently performing satisfactorily but with potential weaknesses that may, if not corrected, weaken the asset or inadequately protect the Bank's position at some future date. Potential weaknesses are the result of deviations from prudent lending practices.
 
 
·  
Loans where adverse economic conditions that develop subsequent to the loan origination do not jeopardize liquidation of the debt, but do substantially increase the level of risk may also warrant this rating.
 
 
  Substandard-Loans in this category are characterized by deterioration in quality exhibited by any number of well-defined weaknesses requiring corrective action. A substandard loan is inadequately protected by the current sound net worth and paying capacity of the obligor or of the collateral pledged, if any. Loans classified as substandard must have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt; they are characterized by the distinct possibility that the institution will sustain some loss if the deficiencies are not corrected.
 
 
 The weaknesses may include, but are not limited to:
 
 
·  
High debt to worth ratios and or declining or negative earnings trends
 
 
·  
Declining or inadequate liquidity
 
 
·  
Improper loan structure  or questionable repayment sources
 
 
·  
Lack of well-defined secondary repayment source, and
 
 
·  
Unfavorable competitive comparisons.
 
 
Such loans are no longer considered to be adequately protected due to the borrower's declining net worth, lack of earnings capacity, declining collateral margins and/or unperfected collateral positions. A possibility of loss of a portion of the loan balance cannot be ruled out. The repayment ability of the borrower is marginal or weak and the loan may have exhibited excessive overdue status or extensions and/or renewals.
 

 
12

 

Notes to Consolidated Financial Statements
(Unaudited)
(in thousands, except share, per share and percentage data)
 

 
Doubtful -Loans classified Doubtful have all the weaknesses inherent in loans classified Substandard, plus the added characteristic that the weaknesses make collection or liquidation in full on the basis of currently existing facts, conditions, and values highly questionable and improbable. The ability of the borrower to service the debt is extremely weak, overdue status is constant, the debt has been placed on non-accrual status, and no definite repayment schedule exists.
 
However, these loans are not yet rated as loss because certain events may occur which would salvage the debt. Among these events are:
 
 
·  
Injection of capital
 
 
·  
Alternative financing
 
 
·  
Liquidation of assets or the pledging of additional collateral.
 
Credit Risk Profile based on payment activity as of  March 31, 2011:
   
Consumer -
Non Real Estate
   
Equity Line of Credit / Second Mortgages
   
Commercial -
Non Real Estate
   
Agricultural - Non Real Estate
 
                         
Performing
  $ 25,624     $ 23,105     $ 37,063     $ 2,909  
Nonperforming (>90 days past due)
    363       322       1,159       -  
                                 
     Total
  $ 25,987     $ 23,427     $ 38,222     $ 2,909  
                                 

Credit Risk Profile based on payment activity as of December 31, 2010:
   
Consumer - Non Real Estate
   
Equity Line of Credit / Second Mortgages
   
Commercial - Non Real Estate
   
Agricultural - Non Real Estate
 
                         
Performing
  $ 26,699     $ 23,619     $ 39,015     $ 2,751  
Nonperforming (>90 days past due)
    74       529       1,456       97  
                                 
     Total
  $ 26,773     $ 24,148     $ 40,471     $ 2,848  
                                 

 
13

 

Notes to Consolidated Financial Statements
(Unaudited)
(in thousands, except share, per share and percentage data)

The following tables reflect the Bank’s impaired loans at March 31, 2011:


   
Recorded Investment
   
Unpaid Principal Balance
   
Related Allowance
   
Average Recorded Investment
   
Interest Income Recognized
 
With No Related Allowance
                             
Real Estate Secured
                             
Residential 1-4 family
  $ 8,854     $ 9,252     $ -     $ 8,152     $ 77  
Equity lines of credit
    -       -       -       -       -  
Multifamily
    980       980       -       510       15  
Farmland
    631       1,300       -       703       -  
Construction, Land Development, Other Land Loans
    5,778       6,493       -       4,815       58  
Commercial Real Estate- Owner Occupied
    8,641       8,641       -       7,069       48  
Commercial Real Estate- Non Owner Occupied
    4,059       4,059       -       3,783       62  
Second Mortgages
    509       509       -       604       5  
Non Real Estate Secured
                                       
Personal /Consumer
    20       20       -       21       2  
Business Commercial
    1,279       1,382       -       1,273       15  
Agricultural
    -       -       -       -       -  
Credit Cards
    -       -       -       -       -  
                                         
          Total
  $ 30,751     $ 32,636     $ -     $ 26,930     $ 282  

 
   
Recorded Investment
   
Unpaid Principal Balance
   
Related Allowance
   
Average Recorded Investment
   
Interest Income Recognized
 
With an Allowance Recorded
                             
Real Estate Secured
                             
Residential 1-4 family
  $ 5,039     $ 5,178     $ 748     $ 4,777     $ 41  
Equity lines of credit
    -       -       -       -       -  
Multifamily
    1,632       1,652       282       1,632       13  
Farmland
    311       311       41       312       5  
Construction, Land Development, Other Land Loans
    4,790       4,940       1,040       5,912       33  
Commercial Real Estate- Owner Occupied
    3,697       3,697       1,300       3,987       26  
Commercial Real Estate- Non Owner Occupied
    4,788       4,788       882       4,911       69  
Second Mortgages
    424       424       112       254       2  
Non Real Estate Secured
                                       
Personal /Consumer
    74       74       14       62       1  
Business Commercial
    1962       1,962       978       2047       18  
Agricultural
    -       -       -       14       -  
Credit Cards
    -       -       -       -       -  
                                         
          Total
  $ 22,717     $ 23,026     $ 5,397     $ 23,908     $ 208  

 
14

 

Notes to Consolidated Financial Statements
(Unaudited)
(in thousands, except share, per share and percentage data)

The following tables reflect the Bank’s impaired loans at December 31, 2010:
 
   
Recorded Investment
   
Unpaid Principal Balance
   
Related Allowance
   
Average Recorded Investment
   
Interest Income Recognized
 
With No Related Allowance
                             
Real Estate Secured
                             
Residential 1-4 family
  $ 7,451     $ 7,772     $ -     $ 6,857     $ 191  
Equity lines of credit
    -       -       -       -       -  
Multifamily
    40       40       -       1,314       1  
Farmland
    774       1,300       -       924       -  
Construction, Land Development, Other Land Loans
    3,853       3,853       -       5,768       141  
Commercial Real Estate- Owner Occupied
    5,498       5,498       -       3,318       260  
Commercial Real Estate- Non Owner Occupied
    3,506       3,506       -       2,215       77  
Second Mortgages
    700       700       -       516       25  
Non Real Estate Secured
                                       
Personal /Consumer
    21       21       -       11       2  
Business Commercial
    1,266       1,266       -       1,162       55  
Agricultural
    -       -       -       -       -  
Credit Cards
    -       -       -       -       -  
                                         
          Total
  $ 23,109     $ 23,956     $ -     $ 22,085     $ 752  

 
   
Recorded Investment
   
Unpaid Principal Balance
   
Related Allowance
   
Average Recorded Investment
   
Interest Income Recognized
 
With an Allowance Recorded
                             
Real Estate Secured
                             
Residential 1-4 family
  $ 4,515     $ 4,515     $ 644