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EX-32 - SECTION 906 CERTIFICATION - TECHE HOLDING COex_32.htm
EX-31.1 - SECTION 302 CERTIFICATION - TECHE HOLDING COex_31-1.htm
EX-31.2 - SECTION 302 CERTIFICATION - TECHE HOLDING COex_31-2.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 1-13712


TECHE HOLDING COMPANY
(Exact name of registrant as specified in its charter)

Louisiana
 
72-128746
(State or other jurisdiction of
incorporation or organization)
 
(I.R.S. Employer Identification No.)

1120 Jefferson Terrace Boulevard New Iberia, Louisiana
   
70560
 
(Address of principal executive offices)
   
(Zip Code)
 

Registrant’s telephone number, including area code    (337) 365-0366

N/A
Former name, former address and former fiscal year, if changed since last report.

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 (Section 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 a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer o
Accelerated filer o
Non-accelerated filer o
(Do not check if a smaller reporting company)
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 o   No x
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: May 4, 2011.

Class
 
2,084,448
$.01 par value common stock
 
Outstanding Shares


 
1

 
TECHE HOLDING COMPANY

QUARTERLY REPORT ON FORM 10-Q

INDEX


   
Page
       
PART I.
FINANCIAL INFORMATION
     
       
Item 1.
Financial Statements
     
       
Unaudited Consolidated Balance Sheets as of March 31, 2011 and September 30, 2010
 
3
 
Unaudited Consolidated Statements of Income for the three and six months ended March 31, 2011 and 2010
 
4
 
Unaudited Consolidated Statements of Cash Flows for the six months ended March 31, 2011 and 2010
 
5
 
Notes to Unaudited Consolidated Financial Statements
 
6
 
         
Item 2.
 
Management’s Discussion and Analysis of Financial Condition and Results of Operations
 
26
 
         
Item 3.
Quantitative and Qualitative Disclosure About Market Risk
 
32
 
         
Item 4
Controls and Procedures
 
32
 
         
PART II.
OTHER INFORMATION
 
32
 
         
Item 1.
Legal Proceedings
 
32
 
         
Item 1A.
Risk Factors
 
32
 
         
Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds
 
32
 
         
Item 3.
Defaults Upon Senior Securities
 
32
 
         
Item 4.
[Reserved]
 
32
 
         
Item 5.
Other Information
 
32
 
         
Item 6.
Exhibits
 
33
 
         
Signatures
       




 
2

 

TECHE HOLDING COMPANY
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)


   
March 31,
2011
 
September 30,
2010*
 
ASSETS
    (unaudited)        
               
Cash and due from banks
 
$
15,127
 
$
15,420
 
Interest-bearing deposits
   
49,394
   
25,235
 
Securities available-for-sale at fair value
   
21,854
   
14,996
 
Securities held-to-maturity—at amortized cost (estimated fair value of $60,022 and $61,711)
   
58,090
   
59,566
 
Loans receivable—net of allowance for loan losses of $10,452 and $9,256
   
577,701
   
586,635
 
Accrued interest receivable
   
2,409
   
2,480
 
Investment in Federal Home Loan Bank stock, at cost
   
4,280
   
5,402
 
Real estate owned, net
   
2,039
   
1,181
 
Prepaid expenses and other assets
   
7,775
   
6,898
 
Goodwill
   
3,647
   
3,647
 
Life insurance contracts
   
13,606
   
13,310
 
Premises and equipment, net
   
26,230
   
26,754
 
               
TOTAL ASSETS
 
$
782,152
 
$
761,524
 
               
LIABILITIES AND STOCKHOLDERS’ EQUITY
             
               
Deposits
 
$
610,892
 
$
579,355
 
Advances from Federal Home Loan Bank
   
83,585
   
100,017
 
Advance payments by borrowers for taxes and insurance
   
1,929
   
2,463
 
Accrued interest payable
   
355
   
429
 
Accounts payable and other liabilities
   
7,813
   
3,747
 
               
TOTAL LIABILITIES
   
704,574
   
686,011
 
               
COMMITMENTS AND CONTINGENCIES
   
-
   
-
 
               
STOCKHOLDERS’ EQUITY:
             
Preferred stock, 5,000,000 shares authorized, none issued
   
-
   
-
 
Common stock, $.01 par value, 10,000,000 shares authorized; 4,682,143 and 4,672,567 shares issued
   
47
   
47
 
Additional paid-in capital
   
52,968
   
52,685
 
Retained earnings
   
75,798
   
73,942
 
Unearned ESOP shares
   
(195
)
 
(326
)
Treasury stock, 2,597,983 and 2,591,081 shares - at cost
   
(51,088
)
 
(50,862
)
Accumulated other comprehensive loss on held-to-maturity securities
   
(428
)
 
(428
)
Accumulated other comprehensive income on available for sale securities
   
476
   
455
 
               
TOTAL STOCKHOLDERS’ EQUITY
   
77,578
   
75,513
 
               
TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY
 
$
782,152
 
$
761,524
 

See Notes to Unaudited Consolidated Financial Statements.

*  derived from audited financial statements

 
3

 

TECHE HOLDING COMPANY
UNAUDITED CONSOLIDATED STATEMENTS OF INCOME
(IN THOUSANDS, EXCEPT PER SHARE DATA)


 
Three Months Ended
   
Six Months Ended
 
 
March 31,
   
March 31,
 
 
2011
 
2010
   
2011
 
2010
 
     
INTEREST INCOME:
                         
Interest and fees on loans
$
9,103
 
$
9,603
   
$
18,467
 
$
19,333
 
Interest and dividends on investments
 
475
   
717
     
971
   
1,413
 
Other interest income
 
158
   
54
     
301
   
129
 
TOTAL INTEREST INCOME
 
9,736
   
10,374
     
19,739
   
20,875
 
INTEREST EXPENSE:
                         
Deposits
 
1,394
   
1,820
     
2,857
   
3,751
 
Advances from Federal Home Loan Bank
 
969
   
1,120
     
2,048
   
2,256
 
TOTAL INTEREST EXPENSE
 
2,363
   
2,940
     
4,905
   
6,007
 
NET INTEREST INCOME
 
7,373
   
7,434
     
14,834
   
14,868
 
                           
PROVISION FOR LOAN LOSSES
 
1,000
   
900
     
2,150
   
2,096
 
                           
NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES
 
6,373
   
6,534
     
12,684
   
12,772
 
                           
NON-INTEREST INCOME:
                         
Total other-than temporary impairment losses
 
--
   
(8)
     
--
   
(374)
 
Portion of impairment losses recognized in other comprehensive income
 
--
   
--
     
--
   
262
 
Net impairment losses recognized in earnings
 
--
   
(8)
     
--
   
(112)
 
Service charges and other
 
3,584
   
3,698
     
7,263
   
7,515
 
Gain on sale of premises and equipment
 
--
   
--
     
103
   
--
 
Gain on sale of loans
 
10
   
--
     
19
   
--
 
Gain on securities
 
8
   
--
     
8
   
67
 
Other income
 
248
   
258
     
438
   
455
 
TOTAL NON-INTEREST INCOME
 
3,850
   
3,948
     
7,831
   
7,925
 
                           
NON-INTEREST EXPENSE:
                         
Compensation and employee benefits
 
4,196
   
4,273
     
8,193
   
8,270
 
Occupancy expense
 
1,538
   
1,570
     
2,918
   
3,093
 
Marketing and professional
 
794
   
756
     
1,534
   
1,417
 
FDIC premiums and assessments
 
225
   
241
     
448
   
635
 
Other operating expenses
 
1,165
   
1,140
     
2,407
   
2,206
 
TOTAL NON-INTEREST EXPENSE
 
7,918
   
7,980
     
15,500
   
15,621
 
                           
INCOME BEFORE INCOME TAXES
 
2,305
   
2,502
     
5,015
   
5,076
 
INCOME TAXES
 
792
   
802
     
1,678
   
1,643
 
NET INCOME
$
1,513
 
$
1,700
   
$
3,337
 
$
3,433
 
BASIC EARNINGS PER COMMON SHARE
$
0.73
 
$
0.81
   
$
1.61
 
$
1.64
 
DILUTED EARNINGS PER COMMON SHARE
$
0.72
 
$
0.80
   
$
1.59
 
$
1.62
 

See Notes to Unaudited Consolidated Financial Statements.


 
4

 

TECHE HOLDING COMPANY
UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)

   
For the Six Months
 
   
Ended March 31,
 
   
2011
   
2010
 
CASH FLOWS FROM OPERATING ACTIVITIES
               
Net income
 
$
3,337
   
$
3,433
 
Adjustments to reconcile net income to net cash provided by operating activities:
               
Accretion of discount and amortization of premium on investments and mortgage-backed securities
   
(200
)
   
(92
)
Provision for loan losses
   
2,150
     
2,096
 
Provision for real estate owned
   
-
     
20
 
Impairment of securities
   
-
     
112
 
Gain on sale of land
   
(103
)
   
-
 
Gain on sale of OREO
   
(37
)
   
(2
)
Gain on sale of loans
   
(19
)
   
-
 
Gain on sale of equity securities
   
(8
)
   
(67
)
Depreciation
   
715
     
788
 
Excess tax benefits from share-based payment arrangements
   
(31
)
   
(36
)
Stock-based compensation
   
289
     
196
 
Change in accounts payable and other liabilities
   
4,066
     
(1,145
)
Change in life insurance contracts
   
(296
)
   
(293
)
Change in prepaid expenses and other assets
   
(877
)
   
(3,759
)
Change in accrued interest payable
   
(74
)
   
(295
)
Other – net
   
88
     
(244
)
Net cash provided by operating activities
   
9,000
     
712
 
                 
CASH FLOWS FROM INVESTING ACTIVITIES:
               
Purchase of mortgage-backed securities available for sale and equity securities
   
(9,024
)
   
(36
)
Purchase of securities held to maturity
   
(10,470
)
   
-
 
Principal repayments and proceeds from sale of mortgage-backed securities available for sale
   
1,971
     
3,065
 
Proceeds from sale of equity securities
   
58
     
384
 
Principal repayments of securities held to maturity
   
12,291
     
16,201
 
Net loan originations
   
4,271
     
(6,004
)
Purchase of loans
   
-
     
(1,127
)
Proceeds from sale of loan participations
   
869
     
1,142
 
Redemption (Purchase) of FHLB Stock
   
1,122
     
(329
)
Proceeds from sale of land
   
499
     
-
 
Proceeds from sale of OREO
   
840
     
762
 
Purchase of premises and equipment
   
(587
)
   
(873
)
Net cash provided by investing activities
   
1,840
     
13,185
 
                 
CASH FLOWS FROM FINANCING ACTIVITIES:
               
Repayment of ESOP loan
   
131
     
130
 
Net increase in deposits
   
31,537
     
1,274
 
Net decrease in FHLB advances
   
(16,432
)
   
(2,771
)
Net decrease in advance payments by borrowers for taxes and insurance
   
(534
)
   
(565
)
Dividends paid
   
(1,481
)
   
(1,473
)
Excess tax benefits from share-based payment arrangements
   
31
     
36
 
Proceeds from exercise of stock options
   
-
     
20
 
Purchase of common stock for treasury
   
(226
)
   
-
 
Net cash provided (used) by financing activities
   
13,026
     
(3,349
)
                 
NET INCREASE IN CASH
   
23,866
     
10,548
 
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD
   
40,655
     
23,675
 
CASH AND CASH EQUIVALENTS, END OF PERIOD
 
$
64,521
   
$
34,223
 
                 
Supplemental schedule of noncash investing activities:
               
Transfer from loans to real estate owned
 
$
1,730
   
$
1,463
 
Loans originated to finance/sell real estate owned
   
67
     
1,311
 

See Notes to Unaudited Consolidated Financial Statements.

 
5

 

TECHE HOLDING COMPANY
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1 - PRINCIPLES OF CONSOLIDATION

The consolidated financial statements as of March 31, 2011 and September 30, 2010 and for the three and six months ended March 31, 2011 and 2010, include the accounts of Teche Holding Company (the “Company”) and its subsidiary, Teche Federal Bank (the “Bank”). The Company’s business is conducted principally through the Bank. All significant inter-company accounts and transactions have been eliminated in consolidation.

NOTE 2 - BASIS OF PRESENTATION

The accompanying unaudited consolidated financial statements were prepared in accordance with instructions for Form 10-Q and, therefore, do not include all information necessary for a complete presentation of consolidated financial condition, results of operations, and cash flows in conformity with accounting principles generally accepted in the United States of America. However, all adjustments, consisting of normal recurring accruals, which, in the opinion of management, are necessary for a fair presentation of the consolidated financial statements have been included. The results of operations for the three and six months ended March 31, 2011 are not necessarily indicative of the results that may be expected for the entire fiscal year or any other period. These financial statements should be read in conjunction with the audited consolidated financial statements and the accompanying notes thereto included in the Company’s Annual Report on Form 10-K for the year ended September 30, 2010.

NOTE 3 - INCOME PER SHARE

Basic and diluted net income per share is computed based on the weighted average number of shares outstanding during each period. Diluted net income per share reflects the potential dilution that could occur if stock options were exercised, resulting in the issuance of common stock that then shared in the net income of the Company.

Following is a summary of the information used in the computation of basic and diluted income per common share for the three and six months ended March 31, 2011 and 2010 (in thousands).

 
Three Months Ended
 
Six Months Ended
 
March 31,
 
March 31,
 
2011
 
2010
 
2011
 
2010
Weighted average number of common shares outstanding - used in computation of basic income per common share
 
2,081
   
2,100
   
2,070
   
2,099
Effect of dilutive securities:
                     
Common stock equivalents
 
17
   
18
   
23
   
18
Weighted average number of common shares outstanding plus effect of dilutive securities - used in computation of diluted net income per common share
 
2,098
   
2,118
   
2,093
   
2,117



 
6

 

For the three and six months ended March 31, 2011 and 2010, net income for determining diluted earnings per share was equivalent to net income. Options to purchase shares that have been excluded from the determination of diluted earnings per share because they are antidilutive (the exercise price is higher than the current market price) amount to approximately 104,000 and 192,000 for the three and six months ended March 31, 2011 and 2010, respectively.

NOTE 4 - COMPREHENSIVE INCOME

Comprehensive income includes net income and other comprehensive income which includes unrealized gains and losses on securities.  Following is a summary of the Company’s comprehensive income for the three and six months ended March 31, 2011 and 2010 (in thousands).


   
For Three Months
   
For Six Months
 
   
Ended March 31,
   
Ended March 31,
 
   
2011
   
2010
   
2011
   
2010
 
                                 
Net income
 
$
1,513
   
$
1,700
   
$
3,337
   
$
3,433
 
Reclassification of realized losses (gains), net of  tax
   
(5
)
   
 -
     
(5
)
   
(45
)
Noncredit portion of OTTI losses on held-to-maturity securities, net of tax
   
-
     
-
     
-
     
(173
)
Unrealized gains (losses), net of tax
   
57
     
38
     
26
     
(22
)
Total comprehensive income
 
$
1,565
   
$
1,738
   
$
3,358
   
$
3,193
 


NOTE 5 - NEW ACCOUNTING PRONOUNCEMENTS

 
ASC (860) Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities, will require more information about transfers of financial assets, including securitization transactions, and where companies have continuing exposure to the risks related to transferred financial assets. This guidance also eliminates the concept of a qualifying special-purpose entity, and changes the requirements for derecognizing financial assets and requires additional disclosures.
 
ASC (860) was adopted by the Company on October 1, 2010.  Earlier application was prohibited. The recognition and measurement provisions are being applied to transfers that occur on or after the effective date.  The adoption of this standard did not have a material impact on the consolidated financial statements.
 
ASU-Accounting Standards Update (2010-06) Fair Value Measurements and Disclosures (Topic 820): Improving Disclosures about Fair Value Measurements (Jan 2010).   This update provides amendments to Topic 820 that will provide more robust disclosures about (1) the different classes of assets and liabilities measured at fair value, (2) the valuation techniques and inputs used, (3) the activity in Level 3 fair value measurements, and (4) the transfers between Levels 1, 2, and 3. The update is effective for interim and annual reporting periods beginning after December 15, 2009 except for the disclosures about purchases, sales, issuances, and settlements in the roll forward of activity in Level 3 fair value measurements.  Those disclosures are effective for fiscal years beginning after December 15, 2010, and for interim periods within those fiscal years. The Company adopted the fair value disclosures guidance on January 1, 2010, except for the gross presentation of the Level 3 rollforward information which is not
 
 
7

 
 
required to be adopted by the Company until October 1, 2011.  The adoption requires additional disclosure.

ASU - Accounting Standards Update (2010-20), Receivables (Topic 310): Disclosure about the Credit Quality of Financing Receivables and the Allowance for Credit Losses. The objective of this ASU is for an entity to provide disclosures that facilitate financial statement users’ evaluation of the following: (1) the nature of credit risk inherent in the entity’s portfolio of financing receivables; (2) how that risk is analyzed and assessed in arriving at the allowance for credit losses; and (3) the changes and reasons for those changes in the allowance for credit losses.

To achieve these objectives, an entity should provide disclosures on a disaggregated basis on two defined levels: (1) portfolio segment; and (2) class of financing receivable. The ASU makes changes to existing disclosure requirements and includes additional disclosure requirements about financing receivables, including:  (1) credit quality indicators of financing receivables at the end of the reporting period by class of financing receivables; (2) the aging of past due financing receivables at the end of the reporting period by class of financing receivables; and (3) the nature and extent of troubled debt restructurings that occurred during the period by class of financing receivables and their effect on the allowance for credit losses.

ASU – Accounting Standards Update (2011-01), Receivables (Topic 310), Deferral of the Effective Date of Disclosures about Troubled Debt Restructurings in Update No. 2010-20: Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit losses, delays the effective date of the disclosures to be concurrent with the effective date of the guidance for determining what constitutes a troubled debt restructuring, as presented in proposed ASU Receivables (Topic 310): Clarifications to Accounting for Troubled Debt Restructurings by Creditors.

ASU – Accounting Standards Update (2011-02), Receivables (Topic 310), A Creditor’s Determination of Whether a Restructuring Is a Troubled Debt Restructuring, provides additional guidance to assist creditors in determining whether a restructuring of a receivable meets the criteria to be considered a troubled debt restructuring. This standard should be applied to the first period beginning after June 15, 2011 and should be applied retrospectively to the beginning of the annual period in the year of adoption.  The Company does not anticipate the standard having a material impact on the consolidated financial statements.
 

 
8

 

NOTE 6 – FAIR VALUE MEASUREMENTS
 
The Company utilizes fair value measurements to record fair value adjustments to certain assets and liabilities and to determine fair value disclosures. Available for sale securities are recorded at fair value on a recurring basis. Additionally, from time to time, the Company may be required to record at fair value other assets on a nonrecurring basis, such as securities held-to-maturity, loans held for sale, loans held for investment and certain other assets. These nonrecurring fair value adjustments typically involve application of lower of cost or market accounting, other than temporary impairment accounting or impairments of individual assets.
 
This is a three-tier fair value hierarchy which prioritizes the inputs used in measuring fair value as follows:
 
Level 1     - Observable inputs such as quoted prices in active markets;
 
Level 2     - Inputs, other than the quoted prices in active markets, that are observable either directly or indirectly; and
 
Level 3     - Unobservable inputs in which there is little or no market data, which require the reporting entity to develop its own assumptions.
 
Following is a description of valuation methodologies used for assets recorded at fair value.
 
Investment Securities
 
Securities available for sale are valued at quoted market prices where available. If quoted market prices are not available, fair values are based on quoted market prices of comparable securities. Level 1 securities include those traded on an active exchange, such as the New York Stock Exchange, U.S. Treasury securities that are traded by dealers or brokers in active over-the-counter markets and money market funds. Level 2 securities include mortgage-backed securities issued by government sponsored entities, municipal bonds. Securities classified as Level 3 include asset-backed securities in less liquid markets. Securities held to maturity are valued using discounted cash flow models that use assumptions about prepayment speeds, coupon default rates, discount rates and timing and other assumptions that may affect the amounts of cash flows.
 
Loans
 
The Company does not record loans at fair value on a recurring basis. However, from time to time, a loan is considered impaired and an allowance for loan losses is established. Loans for which it is probable that payment of interest and principal will not be made in accordance with the contractual terms of the loan agreement are considered impaired. Once a loan is identified as individually impaired, management measures impairment in accordance with ASC (310), “Accounting by Creditors for Impairment of a Loan.” 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 impaired loans were evaluated based on the fair value of the collateral less estimated costs to sell.  Impaired loans where an allowance is established based on the fair value of collateral require classification in the fair value hierarchy.  When the fair value of the collateral is based on an observable market price or a current appraised value, the Company records the impaired loan as nonrecurring Level 2. When an appraised value is not available or management determines the fair value of the collateral is
 
 
9

 
 
further impaired below the appraised value and there is no observable market price, the Company records the impaired loan as nonrecurring Level 3.
 
Other Real Estate Owned
 
OREO, consisting of properties obtained through foreclosure or in satisfaction of loans, is reported at the lower of cost or fair value, determined on the basis of current appraisals, comparable sales, and other estimates of value obtained principally from independent sources, adjusted for estimated selling costs (Level 2). At the time of foreclosure, any excess of the loan balance over the fair value of the real estate held as collateral is treated as a charge against the allowance for loan losses. Gains or losses on sale and generally any subsequent adjustments to the value are recorded as a component of OREO expense.
 

 
10

 
 
   
Fair Value
 
Fair Value Hierarchy
   
At March 31, 2011
 
Level 1
 
Level 2
 
Level 3
 
(In thousands)
                         
Assets valued on a recurring basis:
                         
Mortgage-backed securities:
                         
Government National Mortgage Assoc.
 
$
1,971
 
$
-
 
$
1,971
 
$
-
 
Federal Home Loan Mortgage Corp.
   
4,201
   
-
   
4,201
   
-
 
Federal National Mortgage Assoc.
   
12,652
   
-
   
12,652
   
-
 
     
18,824
   
-
   
18,824
   
-
 
                           
CMOs:
                         
Government National Mortgage Assoc.
   
2,341
   
-
   
2,341
   
-
 
Other equity securities
   
689
   
689
   
-
   
-
 
Total AFS securities
 
$
21,854
 
$
689
 
$
21,165
 
$
-
 
 
Assets valued on a non-recurring basis:
                         
Impaired loans
   
7,083
   
-
   
7,083
   
-
 
Total non-recurring
 
$
7,083
 
$
-
 
$
7,083
 
$
-
 


   
Fair Value At September
 
Fair Value Hierarchy
   
30, 2010
 
Level 1
 
Level 2
 
Level 3
 
(In thousands)
                         
Assets valued on a recurring basis:
                         
Mortgage-backed securities:
                         
Government National Mortgage Assoc.
 
$
2,098
 
$
-
 
$
2,098
 
$
-
 
Federal Home Loan Mortgage Corp.
   
5,109
   
-
   
5,109
   
-
 
Federal National Mortgage Assoc.
   
4,669
   
-
   
4,669
   
-
 
     
11,876
   
-
   
11,876
   
-
 
                           
CMOs:
                         
Government National Mortgage Assoc.
   
2,652
   
-
   
2,652
   
-
 
Marketable equity securities
   
468
   
468
   
-
   
-
 
Total recurring
 
$
14,996
 
$
468
 
$
14,528
 
$
-
 
                           
Assets valued on a non-recurring basis:
                         
CMOs:  Private label
 
$
110
 
$
-
 
$
110
 
$
-
 
Impaired loans
   
 6,484
   
-
   
6,484
   
-
 
Other real estate owned
   
760
   
-
   
760
   
-
 
Total non-recurring
 
$
7,354
 
$
-
 
$
7,354
 
$
-
 

The fair value of a financial instrument is the current amount that would be exchanged between willing parties, other than in a forced liquidation.  Fair value is best determined based upon quoted market prices.  However, in many instances, there are no quoted market prices for the Company’s various financial
 
 
11

 
 
instruments.  In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques.  Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows.  Accordingly, the fair value estimates may not be realized in an immediate settlement of the instrument.  ASC 825 excludes certain financial instruments and all non-financial instruments from its disclosure requirements.  Accordingly, the aggregate fair value amounts presented may not necessarily represent the underlying fair value of the Company.

The following methods and assumptions were used by the Company in estimating fair value disclosures for financial instruments:

Cash - For those short-term instruments, the carrying amount is a reasonable estimate of fair value.

Investment Securities – See discussion in the beginning of Note 6 on the valuation of fair value of investment securities.  Investment securities’ fair value equals quoted market price, if available. If a quoted market price is not available, fair value is estimated using quoted market prices for similar securities.

Loans - See discussion in the beginning of Note 6 on the valuation of fair value of impaired loans.  The fair value of loans is estimated by discounting the future cash flows using the current rates at which similar loans would be made to borrowers for the same remaining maturities.  No adjustment has been made for illiquidity in the market for loans as there is no active market for many of the Company’s loans on which to reasonably base this estimate.

Federal Home Loan Bank Stock - Federal Home Loan Bank (FHLB) stock is recorded at cost and is periodically reviewed for impairment. No ready market exists for the FHLB stock.  It has no quoted market value and is carried at cost.  Cost approximates fair market value based upon the redemption requirements of the FHLB, and this investment is not considered impaired at March 31, 2011.  The FHLB of Dallas is still redeeming stock.

Bank Owned Life Insurance- The carrying amounts of bank owned life insurance contracts approximate fair value.

Accrued Interest - The carrying amounts of accrued interest receivable and payable approximate fair value.

Deposits - The fair value of demand deposits, savings accounts, and certain money market deposits is the amount payable on demand at the reporting date. The fair value of fixed-maturities certificates of deposit is estimated using the rates currently offered for deposits of similar remaining maturities.

Advances from Federal Home Loan Bank - The fair value of advances is estimated using rates currently available for advances of similar remaining maturities.

Commitments - The fair value of commitments to extend credit was not significant.


 
12

 

The estimated fair values of the Company’s financial instruments are as follows at March 31, 2011 and September 30, 2010:
 
   
March 31, 2011
 
September 30, 2010
   
Carrying
 
Estimated
 
Carrying
 
Estimated
   
Amount
 
Fair Value
 
Amount
 
Fair Value
(In thousands)
                       
Financial assets:
                       
Cash and cash equivalents
 
$
64,521
 
$
64,521
 
$
40,655
 
$
40,655
Investment securities
   
79,944
   
81,876
   
74,562
   
76,707
FHLB stock
   
4,280
   
4,280
   
5,402
   
5,402
Accrued interest receivable
   
2,409
   
2,409
   
2,480
   
2,480
Life Insurance contracts
   
13,606
   
13,606
   
13,310
   
13,310
Loans receivable, net
   
577,701
   
608,628
   
586,635
   
621,556
                         
Financial liabilities:
                       
Deposits
   
610,892
   
616,895
   
579,355
   
588,399
Advance from Federal Home Loan Bank
   
83,585
   
90,527
   
100,017
   
111,619
Accrued interest payable
   
355
   
355
   
429
   
429


NOTE 7 – SECURITIES

The amortized cost and estimated fair values of securities available-for-sale are as follows:

   
March 31, 2011
       
Gross
 
Gross
 
Estimated
 
   
Amortized Cost
 
Unrealized Gains
 
Unrealized Losses
 
Fair
Value
 
(In thousands)
                         
Mortgage-backed securities:
                         
Government National Mortgage Assoc.
 
$
1,913
 
$
58
 
$
-
 
$
1,971
 
Federal Home Loan Mortgage Corp.
   
4,089
   
112
   
-
   
4,201
 
Federal National Mortgage Assoc.
   
12,510
   
190
   
(48
)
 
12,652
 
     
18,512
   
360
   
(48
)
 
18,824
 
                           
CMOs:
                         
Government National Mortgage Assoc.
   
2,199
   
142
   
-
   
2,341
 
Other equity securities
   
422
   
269
   
(2
)
 
689
 
Total
 
$
21,133
 
$
771
 
$
(50
)
$
21,854
 

 
 
13

 
 
 
   
September 30, 2010
       
Gross
 
Gross
 
Estimated
 
   
Amortized Cost
 
Unrealized Gains
 
Unrealized Losses
 
Fair
Value
 
(In thousands)
                         
Mortgage-backed securities:
                         
Government National Mortgage Assoc.
 
$
2,039
 
$
59
 
$
-
 
$
2,098
 
Federal Home Loan Mortgage Corp.
   
4,974
   
135
   
-
   
5,109
 
Federal National Mortgage Assoc.
   
4,448
   
221
   
-
   
4,669
 
     
11,461
   
415
   
-
   
11,876
 
                           
CMOs:
                         
Government National Mortgage Assoc.
   
2,474
   
178
   
-
   
2,652
 
Other equity securities
   
372
   
96
   
-
   
468
 
Total
 
$
14,307
 
$
689
 
$
-
 
$
14,996
 

The amortized cost and estimated fair values of securities held-to-maturity are as follows:

   
March 31, 2011
       
Gross
 
Gross
 
Estimated
 
   
Amortized Cost
 
Unrealized Gains
 
Unrealized Losses
 
Fair
Value
 
(In thousands)
                         
Investment securities:
                         
Time deposits other banks
 
$
33,629
 
$
-
 
$
-
 
$
33,629
 
Mortgage-backed securities:
                         
Federal National Mortgage Assoc.
   
14,009
   
835
   
-
   
14,844
 
Federal Home Loan Mortgage Corp.
   
6,513
   
496
   
-
   
7,009
 
Private Label
   
1,671
   
351
   
(198
)
 
1,824
 
CMOs:
                         
Federal Home Loan Mortgage Corp.
   
149
   
-
   
(4
)
 
145
 
Federal National Mortgage Assoc.
   
1,179
   
32
   
(1
)
 
1,210
 
Private Label
   
940
   
425
   
(4
)
 
1,361
 
Total
 
$
58,090
 
$
2,139
 
$
(207
)
$
60,022
 


 
14

 
 
   
September 30, 2010
   
Amortized Cost
 
Gross Unrealized Gains
 
Gross Unrealized Losses
 
Estimated Fair
Value
 
(In thousands)
                         
Investment securities:
                         
Federal Home Loan Bank
 
$
5,000
 
$
3
 
$
--
 
$
5,003
 
Time deposits other banks
   
24,219
   
--
   
--
   
24,219
 
Mortgage-backed securities:
                         
Federal National Mortgage Assoc.
   
17,873
   
1,069
   
--
   
18,942
 
Federal Home Loan Mortgage Corp.
   
7,918
   
577
   
--
   
8,495
 
Private Label
   
1,841
   
291
   
(217
)
 
1,915
 
CMOs:
                         
Federal Home Loan Mortgage Corp.
   
197
   
2
   
--
   
199
 
Federal National Mortgage Assoc.
   
1,343
   
67
   
--
   
1,410
 
Private Label
   
1,175
   
361
   
(8
)
 
1,528
 
Total
 
$
59,566
 
$
2,370
 
$
(225
)
$
61,711
 

Details concerning available-for-sale securities with unrealized losses as of March 31, 2011 are as follows:

   
Securities with losses under 12 months
 
Securities with losses over 12 months
 
Total
 
(In thousands)
 
Fair value
 
Unrealized
 
Fair    value
 
Unrealized
 
Fair   value
 
Unrealized
 
Available-for-sale
                                     
                                       
Marketable equity securities
 
$
4
 
$
(2
)
$
-
 
$
-
 
$
4
 
$
(2
)
Mortgage-backed securities:
                                     
Federal National Mortgage Assoc.
   
3,884
   
(48
)
 
-
   
-
   
3,884
   
(48
)
   
$
3,888
 
$
(50
)
$
-
 
$
-
 
$
3,888
 
$
(50
)
                                       

Details concerning held-to-maturity securities with unrealized losses as of March 31, 2011 are as follows:

   
Securities with losses under 12 months
 
Securities with losses over 12 months
 
Total
 
(In thousands)
 
Fair value
 
Unrealized
 
Fair value
 
Unrealized
 
Fair value
 
Unrealized
 
Held-to-maturity
                                     
                                       
Investment  securities:
                                     
Mortgage-backed securities:
                                     
Private Label
 
$
46
 
$
(6
)
$
682
 
$
(192
)
$
728
 
$
(198
)
CMOs:
                                     
Federal Home Loan Mortgage Corp.
   
145
   
(4
)
 
-
   
-
   
145
   
(4
)
Federal National Mortgage Assoc.
   
187
   
(1
)
 
-
   
-
   
187
   
(1
)
Private Label
   
549
   
(4
)
 
7
   
-
   
556
   
(4
)
   
$
927
 
$
(15
)
$
689
 
$
(192
)
$
1,616
 
$
(207
)

There were no available-for-sale securities with unrealized losses as of September 30, 2010.

 
15

 

Details concerning held-to-maturity securities with unrealized losses as of September 30, 2010 are as follows:
 
   
Securities with losses under 12 months
 
Securities with losses over 12 months
 
Total
 
(In thousands)
 
Fair value
 
Unrealized
 
Fair value
 
Unrealized
 
Fair value
 
Unrealized
 
Held-to-maturity
                                     
                                       
Investment securities:
                                     
Private Label
 
$
53
 
$
(18
)
$
809
 
$
(199
)
$
862
 
$
(217
)
CMOs:
                                     
Private Label
   
368
   
(6
)
 
8
   
(2
)
 
376
   
(8
)
   
$
421
 
$
(24
)
$
817
 
$
(201
)
$
1,238
 
$
(225
)

The Bank had a total of 34 securities classified as held-to-maturity in an unrealized loss position; with total gross unrealized losses of $207,000 as of March 31, 2011.

Management of the Company has asserted that they have no intent to sell impaired securities and it is more likely than not that impaired securities will not be required to be sold. These unrealized losses generally result from changes in market interest rates and as a result of the disruption in the existing mortgage securities market due to illiquidity in certain sectors of that market.  The unrealized losses associated with investment securities issued by government sponsored enterprises (GSE) are caused by changes in interest rates and are not considered credit related since the contractual cash flows of these investments are guaranteed by these agencies.  GSE’s have access to additional capital and liquidity resources from the U.S. Treasury, which indicates that they will be able to honor their guarantees, related to the contractual cash flows of the MBS that they have issued.  In the case of securities issued by the Government National Mortgage Association, the securities are fully guaranteed by the U.S. Government.

The private label mortgage backed securities and CMOs are not backed by the full faith and credit of the U.S. Government.  For each private label security, duration of the impairment, credit support and cash flows were assessed to determine whether the security was temporarily or other than temporarily impaired.  Management evaluates the actual mortgage delinquencies, foreclosures, and real estate owned for each security, as well as future expected losses in the underlying mortgage collateral to determine if there is a high probability for expected losses and contractual shortfalls of interest or principal, which could warrant further recognition of impairment.  Based upon such evaluation, it was determined that some securities have been other-than-temporarily impaired and a corresponding charge to earnings for credit related impairment was recognized with the non-credit related impairment recognized in other comprehensive income.  There were no realized credit losses in the private label securities portfolio for the six months ended March 31, 2011.  In the performance of cash flow analysis on private label securities, management determined that none of the impaired securities had non-credit losses that were required to be recognized in other comprehensive income for the six months ended March 31, 2011.  All private label securities that have not been written down have been determined to have sufficient credit support and cash flows to recover the amortized cost of the related securities.


 
16

 

The amortized cost and estimated fair value of available-for-sale securities by contractual maturity at March 31, 2011, are shown below.  Expected maturities may differ from contractual maturities because issuers may have the right to call or prepay obligations with or without call or prepayment penalties.

(In thousands)
 
Amortized
Cost
 
Fair
Value
 
Due within one year
 
$
-
 
$
-
 
Due after one year but within five years
   
-
   
-
 
Due after five years within ten years
   
-
   
-
 
Due after ten years
   
-
   
-
 
Total
   
-
   
-
 
               
Mortgage-backed securities
   
20,711
   
21,165
 
Equity securities
   
422
   
689
 
Total
 
$
21,133
 
$
21,854
 

The amortized cost and estimated fair value of held-to-maturity securities by contractual maturity at March 31, 2011, are shown below.  Expected maturities may differ from contractual maturities because issuers may have the right to call or prepay obligations with or without call or prepayment penalties.

(In thousands)
 
Amortized
Cost
 
Fair
Value
 
Due within one year
 
$
19,729
 
$
19,729
 
Due after one year but within five years
   
13,900
   
13,900
 
Due after five years within ten years
   
-
   
-
 
Due after ten years
   
-
   
-
 
Total
   
33,629
   
33,629
 
               
Mortgage-backed securities
   
24,461
   
26,393
 
Total
 
$
58,090
 
$
60,022
 

There were no impairment losses in the equity securities portfolio for the three and six months ended March 31, 2011.  Management will continue to monitor the equity securities and make an impairment adjustment if deemed necessary based upon the prospects for recovery and the duration and severity of the unrealized losses.

The following table presents a roll-forward of the amount of credit losses on the Bank’s investment securities recognized in earnings for the six months ended March 31, 2011 (in thousands).

Beginning balance of credit losses
 
$
1,442
 
Other-than-temporary impairment credit losses
   
-
 
Reduction for realized losses
   
(133
)
Ending balance of cumulative credit losses recognized in earnings
 
$
1,309
 

The assumptions used to estimate credit related losses are based on estimates obtained from third parties and cash flow projections.  The assumptions used to determine the cash flows were based on estimates of loss severity, credit default, and prepayment speeds developed from third party servicers’ reports.


 
17

 

NOTE 8-LOANS

Loans Receivable

Loans receivable are summarized as follows:

     Mar ‘11     %Total     Sept ‘10     %Total  
                         
Commercial real estate loans
  $ 114,726       19.5 %   $ 118,858       19.9 %
Commercial non-real estate loans
    24,813       4.2 %     30,929       5.2 %
Commercial-construction loans
    6,556       1.1 %     5,526       0.9 %
Commercial-land
    18,865       3.2 %     19,004       3.2 %
Residential-construction loans
    4,457       0.8 %     4,320       0.7 %
Residential-real estate loans
    341,650       57.9 %     337,885       56.6 %
Consumer-Mobile home loans
    38,924       6.6 %     40,094       6.7 %
Consumer-other
    39,731       6.7 %     40,807       6.8 %
Total Loans
    589,722       100.0 %     597,423       100.0 %
Less:
                               
Allowance for loan losses
    10,452             $ 9,256          
Deferred loan fees
    1,569               1,532          
Total Net Loans
  $ 577,701             $ 586,635          

Commercial non-real estate loans declined $6.1 million mainly due to loan payoffs from one customer relationship totaling $4.1 million.  Residential real estate loans increased $3.8 million mainly due to originations of 15 year term conforming one-to-four family mortgage loans.  At March 31, 2011 approximately $263 million of loans receivable were pledged as collateral securing advances from the FHLB. 

CREDIT QUALITY OF LOANS AND ALLOWANCE FOR LOAN LOSSES

Changes in the allowance for loan losses are as follows:

   
Six Months Ended March 31,
 
(in 000’s)
 
2011
   
2010
 
Beginning ALLL
  $ 9,256     $ 6,806  
Provision for Loan Losses
    2,150       2,096  
Recoveries
    41       10  
Charge-offs
    (995 )     (659 )
Ending ALLL
  $ 10,452     $ 8,253  


The amount of nonaccrual loans at March 31, 2011 and September 30, 2010 was approximately $14.2 million and $14.1 million, respectively.  The Company had total impaired loans of approximately $12.8 million and $10.5 million at March 31, 2011 and September 30, 2010, respectively.  Specific reserves allocated to impaired loans totaled approximately $2.9 million and $2.1 million as of March 31, 2011 and September 30, 2010, respectively.  Impaired loans totaling approximately $2.8 million and $2.0 million had no specific reserves allocated as of March 31, 2011 and September 30, 2010, respectively.  Interest
 
 
18

 
 
recognized on impaired loans totaled $15,000 for the six months ended March 31, 2011, which included $3,000 recognized on the $7.1 million of impaired loans net of allowance for loan loss, which represents the portion of impaired loans with an allowance recorded at March 31, 2011.  Interest recognized on impaired loans consists of accrued but uncollected interest on loans that are performing at this time.  Two commercial loans totaling $1.5 million were classified as troubled debt restructurings due to a modification of terms allowing the customer to make interest only payments for an amount of time.  One large commercial loan totaling $1.7 million was classified as a troubled debt restructuring due to an extension of maturity date and amount borrowed.  One customer relationship with three residential real estate loans totaling $358,000 was modified by an extension of term, and reduction in interest rate to obtain a lower payment for the customer.  The effect on net interest income of troubled debt restructurings is insignificant for the six months ended March 31, 2011.

Allowance for Loan Losses and Recorded Investment in Loans for the six months ended March 31, 2011

The allowance for possible loan losses is a reserve established through a provision for possible loan losses charged to expense, which represents management’s best estimate of probable losses that have been incurred within the existing portfolio of loans.  The allowance, in the judgment of management, is necessary to reserve for estimated loan losses and risks inherent in the loan portfolio.  The methodology is based on historical loss experience by type of credit and internal risk grade, specific homogeneous risk pools and specific loss allocations, with adjustments for current events and conditions.  The Company’s process for determining the appropriate level of the allowance for possible loan losses is designed to account for credit deterioration as it occurs.  The provision for possible loan losses reflects loan quality trends, potential problem loans, and criticized loans and net charge-offs, among other factors.  The provision for possible loan losses also reflects the totality of actions taken on all loans for a particular period.  In other words, the amount of the provision reflects not only the necessary increases in the allowance for possible loan losses related to newly identified criticized loans, but it also reflects actions taken related to other loans including, among other things, any necessary increases or decreases in required allowances for specific loans or loan pools.

The table below provides an allocation of the quarter-end allowance for possible loan losses by loan type; however, allocation of a portion of the allowance to one category of loans does not preclude its availability to absorb losses in other categories:

 
19

 

                 
   
Real Estate
                         
(in thousands)
 
Commercial-real estate
   
Commercial-construction
   
Commercial-Land
   
Residential-construction
   
Residential-real estate
   
Commercial-non real estate
   
Consumer-Mobile Homes
   
Consumer-Other
   
Total
 
Allowance for loan losses:
                                                     
                                                       
Beginning Balance
    2,402       68       1,076       61       4,173       327       640       509       9,256  
Charge-offs
    229       -       -       -       520       133       98       15       995  
Recoveries
    -       -       -       -       33       -       2       6       41  
Provision
    910       60       494       8       504       32       75       67       2,150  
Ending balance
    3,083       128       1,570       69       4,190       226       619       567       10,452  
                                                                         
Ending balance allocation:
                                                                       
Individually evaluated for impairment
    1,216       51       1,382       -       290       -       -       -       2,939  
                                                                         
Collectively evaluated for impairment
  $ 1,867     $ 77     $ 188     $ 69     $ 3,900     $ 226     $ 619     $ 567     $ 7,513  
                                                                         
Loan:
Ending Balance
Collectively evaluated for impairment
    110,340       5,484       12,517       4,457       340,897       24,545       38,924       39,731       576,895  
                                                                         
Ending Balance individually evaluated for impairment
    4,386       1,072       6,348       -       753       268       -       -       12,827  


Credit Quality Indicators
As of March 31, 2011

Commercial Credit Exposure
Credit Risk Profile by Internally Assigned Grade

Prime – Credits secured by cash (accounts held in the Bank), stocks, bonds (companies with debt ratings of (“A” or better), U.S. Government securities with advance rates within bank policy and cash value of insurance policies (with sound AM Best rating).

Excellent – Demonstrates exceptional credit fundamentals, including stable and predictable profit margins and cash flows, strong liquidity and conservative balance sheet. Significant historical cash flow coverage of existing and pro-forma debt service coverage. Credits rated Excellent will have a strong primary source of repayment usually consisting of strong historical cash flows along with strong secondary and tertiary repayment sources.  Subsequent repayment sources could consist of financially strong guarantors, low loan to value ratios on collateral with a strong secondary market or resale source. Companies fitting the profile of minimal risk will have low leverage, a defined management succession plan and a broad product mix.

 
20

 
 
Average – Borrowers that fit this classification would most likely be a typical middle market business or high net worth individual.  Loans would typically be secured and may have some reliance on inventory. Cash flow is adequate to service debt but may be susceptible to some deterioration due to cyclical, seasonal or economic events.  Management is experienced but is concentrated in a few key people. Credits fitting this classification would typically have at least one very strong repayment source  and a good secondary repayment source. Company product mix may lack diversity. The majority of loans fall within this classification. Annual financial statements on the borrower and guarantor(s) should be obtained.

Satisfactory – Displays an acceptable degree of risk in the short-term. Unfavorable characteristics may exist, however, these are offset by the positive trends. Some unpredictability in earnings and cash flow may exist. Leverage may be higher than typical in the industry and liquidity less than desirable. Management, while competent, may not be experienced and lack depth. Secondary and tertiary sources of repayment may be limited. Companies in a start-up situation typically fit this classification. Other characteristics of this classification would be companies with volatility in earning and/or increasing leverage.

Special Mention – A Special Mention asset has 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.  Special Mention assets are not adversely classified and do not expose the Bank to sufficient risk to warrant adverse classification.

Substandard - Assets classified Substandard have a well-defined weakness or weaknesses. A Substandard asset is inadequately protected by the current net worth or paying capacity of the obligor or pledged collateral, if any. It is characterized by the distinct possibility that the Bank will sustain some loss if the deficiencies are not corrected. Weaknesses are to be based upon objective evidence.

Doubtful - Assets classified Doubtful have all of the weaknesses inherent in those classified Substandard. In addition, these weaknesses make collection or liquidation in full highly questionable and improbable, on the basis of the currently existing facts, conditions and values.

Loss - Assets classified as Loss are considered uncollectible, or of such little value that the continuance of the loan or Other Asset on the books of the Bank is not warranted.  Some recovery of funds could be possible in the future, but the amount and probability of this recovery are not determinable, thus leaving little justification for the assets to remain on the books.

A Loss classification does not mean that an asset has no recovery or salvage value, but simply that it is not practical or desirable to defer writing off or reserving all or a portion of a basically worthless asset, even though partial recovery may be effected in the future.

Commercial Loans

Our underwriting philosophy is centered primarily around the borrower’s ability to generate adequate cash flow to service the debt in accordance with the terms and conditions of the loan agreement.  Understanding the borrower’s businesses along with their level of experience and the background of the principals is also a part of our lending philosophy.  Generally, our loans are secured by collateral and we assess the market value of the collateral and the strength it brings to the loan.  We generally require personal guarantees of the principals assessing the financial strength and liquidity of each guarantor as part of our process.

 
21

 
 
Common risks to each class of commercial loans include risks that are not specific to the individual transactions such as general economic conditions within our markets.  There are risks associated with each individual transaction such as a change in marital status, disability or death of the borrower and the loss of value of our collateral due to market conditions.

In addition to these common risks, additional risks are inherent in certain types of commercial loans.

Commercial Construction and Land Development:
Commercial construction and land development loans are dependent upon the supply and demand for commercial real estate in the markets we serve as well as the demand for newly constructed residential homes and lots.  A continuing decrease in demand could result in significant decreases in the underlying collateral values and make repayment of the outstanding loans more difficult for our borrowers.

Commercial Mortgage and C&I Loans:
The repayment of commercial mortgage and C&I loans is primarily dependent upon the ability of our borrowers to produce cash flow consistent with original projections analyzed during the credit underwriting process.  While our loans are generally secured by collateral with limitations on maximum loan to value, there is the risk that liquidation of the collateral will not fully satisfy the loan balance.

Non-owner occupied nonresidential and multifamily properties:
Loans secured by non-residential properties such as office buildings, and loans secured by multifamily housing are dependent upon the ability of the property to produce enough cash flow sufficient to service the debt.  These types of properties are generally susceptible to high unemployment or generally weak economic conditions which can result in high vacancy rates.

Non-commercial loans

Most of our non-commercial loans are centrally underwritten.  When assessing credit risk, we analyze certain factors relating to credit performance such as payment history, credit utilization, length of credit history.  Since most of our non-commercial loans are secured, we evaluate the likely market value of the collateral.  Common risks that are not specific to individual loan transactions include economic conditions within or markets, particularly unemployment and potential declines in real estate values.  Personal events such as disability or death and a change in marital status also add risk to non-commercial loans.

In addition to these common risks, additional risks are inherent in certain types of non-commercial loans.

Revolving Mortgages:

Revolving loans such as HELOCs may be secured by first and junior liens on residential real estate making such loans susceptible to deterioration in residential real estate values.  Additional risks include lien perfection deficiencies.  Further, open end lines of credit have the inherent risk that the borrower may draw on the lines in excess of their collateral value particularly in a deteriorating real estate market.

Consumer Loans:

Consumer loans include loans secured by personal property such as automobiles, mobile homes, and other title recreational vehicles such as boats, RV’s and motorcycles.  Consumer loans also may include unsecured loans.  The value of the underlying collateral within this group of loans is especially volatile due to the potential rapid depreciation in values.
 
 
22

 

 
Residential Construction and Permanent Mortgages:
Residential mortgages are typically secured by 1-4 family residential property and residential lots.  Declines in market value can result in residential mortgages in excess of the property securing the loan. Residential construction loans can experience delays in construction and cost overruns that can exceed the borrower’s financial ability to complete the home leading to unmarketable collateral.
 
Commercial Credit Exposure
Credit Risk Profile by Internally Assigned Grade

   
Commercial-Land
 
Commercial- Construction
 
Commercial-Non-Real Estate
 
Commercial-Real-Estate
 
Total
 
% Total
 
                           
Prime
 
$
-
 
$
-
 
$
2,828
 
$
-
 
$
2,828
 
1.7
%
Excellent
   
-
   
-
   
92
   
44
   
136
 
0.1
 
Average
   
7,398
   
5,040
   
18,102
   
78,134
   
108,674
 
65.9
 
Satisfactory
   
4,335
   
68
   
1,649
   
28,980
   
35,032
 
21.2
 
Special Mention
   
783
   
376
   
2,038
   
3,182
   
6,379
 
3.9
 
Substandard
   
4,967
   
1,021
   
99
   
3,170
   
9,257
 
5.6
 
Doubtful
   
-
   
-
   
-
   
-
   
-
 
0.0
 
Loss
   
1,382
   
51
   
5
   
1,216
   
2,654
 
1.6
 
   
$
18,865
 
$
6,556
 
$
24,813
 
$
114,726
 
$
164,960
 
100.0
%

Consumer Credit Exposure Credit Risk Profile
By Creditworthiness Category

 (in thousands)
 
Residential-Real-Estate Construction
 
Residential-Prime
 
Total
             
Grade:
                 
Pass
 
$
4,457
 
$
337,630
 
$
342,087
Special Mention
   
-
   
229
   
229
Substandard
   
-
   
3,448
   
3,448
Loss
   
-
   
343
   
343
   
$
4,457
 
$
341,650
 
$
346,107

Consumer Credit Exposure
Credit Risk Profile Based on Payment Activity

 (in thousands)
 
Consumer-Mobile Homes
 
Consumer-Other Loans
 
Total
             
Performing
 
$
38,454
 
$
39,498
 
$
77,952
Nonperforming
   
470
   
233
   
703
   
$