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EX-32 - EX-32 - Independence Bancshares, Inc.d29430_ex32.htm
EX-31.1 - EX-31.1 - Independence Bancshares, Inc.d29430_ex31-1.htm

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, 2012


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 No. 000-51907


Independence Bancshares, Inc.

(Exact name of registrant as specified in its charter)



South Carolina

20-1734180

(State or other jurisdiction of incorporation)

(I.R.S. Employer Identification No.)

 

 

500 East Washington Street

Greenville, South Carolina 29601

(Address of principal executive offices)


(864) 672-1776

(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 [ X ]  No [   ]


Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of "accelerated filer and large accelerated filer" in Rule 12b-2 of the Exchange Act).


Large accelerated filer [   ]    Accelerated filer [   ]    Non-accelerated [   ]    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: 2,085,010 shares of common stock, $.01 par value per share, were issued and outstanding as of May 4, 2012.




Independence Bancshares, Inc.


Part I - Financial Information


Item 1. Financial Statements


Consolidated Balance Sheets

 

 

 

 

 

 

March 31, 2012

 

December 31, 2011

 

 

 

 

(unaudited)

 

(audited)

Assets

 

 

 

 

Cash and due from banks

$       8,356,675

 

$       5,651,491

 

Federal funds sold

11,710,000

 

9,550,000

 

Investment securities available for sale

12,264,977

 

12,621,404

 

Non-marketable equity securities

898,600

 

918,350

 

Loans, net of allowance for loan losses of $1,958,235 and $2,110,523, respectively


71,314,445

 


74,778,838

 

Accrued interest receivable

318,696

 

296,679

 

Property and equipment, net

2,297,951

 

2,341,739

 

Other real estate owned and repossessed assets

5,446,020

 

5,389,501

 

Other assets

821,443

 

757,151

 

 

 

 

 

 

 

 

         Total assets

$   113,428,807

 

$   112,305,153

 

 

 

 

 

 

 

 

 

 

 

Liabilities

 

 

 

  

Deposits:

 

 

 

 

Noninterest bearing

$       7,762,729

 

$       7,003,423

 

Interest bearing

89,722,527

 

89,564,721

 

   Total deposits

97,485,256

 

96,568,144

 

 

 

 

 

  

Borrowings

7,000,000

 

7,000,000

     

Securities sold under agreements to repurchase

22,509

 

107,777

 

Accrued interest payable

52,943

 

56,986

 

Accounts payable and accrued expenses

204,028

 

143,573

 

 

 

 

 

 

 

 

 

 

Total liabilities

  104,764,736

 

103,876,480

 

 

 

 

 

 

 

Commitments and contingencies

 

 

 

 

 

 

 

 

 

 

Shareholders’ equity

 

 

 

 

Preferred stock, par value $.01 per share; 10,000,000 shares

 

 

 

 

 

authorized; no shares issued

 

  -

 

  -

 

Common stock, par value $.01 per share; 100,000,000 shares

 

 

 

 

    

authorized; 2,085,010 shares issued and outstanding

20,850

 

20,850

 

Additional paid-in capital

21,102,085

 

21,102,085

 

Accumulated other comprehensive income

130,825

 

84,450

 

Accumulated deficit

(12,589,689)

 

(12,778,712)

 

 

 

 

 

 

 

 

 

 

Total shareholders’ equity

8,664,071

 

8,428,673

 

 

 

 

 

 

 

 

 

 

Total liabilities and shareholders’ equity

$   113,428,807

 

$   112,305,153



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



2



Independence Bancshares, Inc.



Consolidated Statements of Operations and Comprehensive Income (Loss)

(unaudited)


 

Three Months Ended

March 31,

 

2012

 

2011

Interest income

 

 

 

  Loans

$  1,006,529 

 

$  1,115,729 

  Investment securities

87,260 

 

75,737 

  Federal funds sold and other

12,174 

 

12,226 

          Total interest income

1,105,963 

 

1,203,692 

 

 

 

 

Interest expense

 

 

 

  Deposits

228,815 

 

387,278 

  Borrowings

52,737 

 

52,146 

          Total interest expense

281,552 

 

439,424 

 

 

 

 

          Net interest income

824,411 

 

764,268 

 

 

 

 

Provision for loan losses

 

870,000 

 

                    

 

 

          Net interest income (expense) after  provision  

             for loan losses

824,411 

 

(105,732)

 

 

 

 

Noninterest income

62,682 

 

54,734 

 

 

 

 

Noninterest expenses

 

 

 

  Compensation and benefits

$    448,800 

 

$     413,973 

  Real estate owned activity

(337,466)

 

527,933 

  Occupancy and equipment

142,114 

 

147,720 

  Insurance

116,789 

 

125,662 

  Data processing and related costs

79,563 

 

76,316 

  Professional fees

175,845 

 

72,815 

  Other

72,425 

 

65,885 

          Total noninterest expenses

698,070 

 

1,430,304 

 

 

 

 

          Income (loss) before income tax expense

189,023 

 

(1,481,302)

 

          

 

          

Income tax expense  

 

 

                   

 

                   

          Net income (loss)

$     189,023 

 

$  (1,481,302)

 

 

 

 

Other comprehensive income (loss), net of tax

 

 

 

Unrealized gain on investment securities available

      for sale, net of tax

$      56,928 

 

$            395 

Reclassification adjustment included in net income,

       net of tax

(10,553)

 

Other comprehensive income

46,375 

 

395 

 

 

 

 

Total comprehensive income (loss)

$     235,398 

 

$  (1,480,907)

 

 

 

 

Income (loss) per common share – basic and diluted

$           0.09 

 

$           (0.71)

 

 

 

 

Weighted average common shares outstanding – basic and diluted

2,085,010 

 

2,085,010 




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




3




Independence Bancshares, Inc.


Consolidated Statements of Changes in Shareholders’ Equity

 (unaudited)

 

 
 
Common stock

Additional
paid-in capital

Accumulated
other
comprehensive
income

Accumulated
deficit

Total

Shares

Amount

 

 

 

 

 

 

December 31, 2010

2,085,010

 

$  20,850

 

$  21,095,485

 

$   34,725

 

$  (10,699,716)

 

$   10,451,344

Compensation expense related to stock options granted

-

 

-

 

3,300

 

-

 

 

3,300

Net loss

-

 

-

 

-

 

-

 

(1,481,302)

 

(1,481,302)

Unrealized gain on investment securities available for sale, net of tax

-

 

 -

 

-

 

395

 

-

 

 395

March 31, 2011

2,085,010

 

$  20,850

 

$  21,098,785

 

$  35,120

 

$  (12,181,018)

 

$    8,973,737

 

 

 

 

 

 

 

 

 

 

 

 

December 31, 2011

2,085,010

 

$  20,850

 

$  21,102,085

 

$  84,450

 

$  (12,778,712)

 

$    8,428,673

Net income

-

 

-

 

-

 

-

 

189,023 

 

189,023

Unrealized gain on investment securities available for sale, net of tax

-

 

-

 

-

 

46,375

 

 

46,375

March 31, 2012

2,085,010

 

$  20,850

 

$  21,102,085

 

$  130,825

 

$  (12,589,689)

 

$    8,664,071



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



4



Independence Bancshares, Inc.


Consolidated Statements of Cash Flows

(unaudited)

 

Three Months Ended

March 31,

 

2012

 

2011

Operating activities

 

 

 

  Net income (loss)

$       189,023 

 

$  (1,481,302)

  Adjustments to reconcile net income (loss) to cash used in operating activities

 

 

 

     Provision for loan losses

 

870,000 

     Depreciation

46,719 

 

49,267 

     Amortization of investment securities premiums, net

17,246 

 

6,550 

     Compensation expense related to stock options granted

 

3,300 

     Gain on sale of investment securities

(15,990)

 

     (Gain) loss on sale and write-downs of REO and repossessed assets, net

(411,433)

 

445,795 

     Increase  in other assets, net

(86,309)

 

(134,460)

     Increase (decrease) in other liabilities, net

32,522

 

(46,883)

          Net cash used in operating activities

(228,222)

 

(287,733)

 

 

 

 

Investing activities

 

 

 

  Repayments of loans, net

2,085,363 

 

2,516,656 

  Purchase of investment securities available for sale

(2,592,228)

 

(822,191)

  Maturities and  sales of investment securities available for sale

2,602,460 

 

1,000,000 

  Repayments of investment securities available for sale

415,204 

 

291,297 

  Redemption of non-marketable equity securities, net

19,750 

 

103,900 

  Purchase of property and equipment, net

(2,931)

 

(1,403)

  Sale of other real estate owned and repossessed assets

1,733,944 

 

544,247 

         Net cash provided by investing activities

4,261,562 

 

3,632,506 

 

 

 

 

Financing activities

 

 

 

  Increase in deposits, net

917,112 

 

377,331 

  Decrease in borrowings

(85,268)

 

(28,558)

        Net cash provided by financing activities

831,844 

 

348,773 

 

 

 

 

Net increase in cash and cash equivalents

4,865,184 

 

3,693,546 

 

 

 

 

Cash and cash equivalents at beginning of the period

15,201,491 

 

10,693,102 

 

 

 

 

Cash and cash equivalents at end of the period

$  20,066,675 

 

$  14,386,648 

 

 

 

 

Supplemental information:

 

 

 

     Cash paid for

 

 

 

          Interest

$       285,595 

 

$      444,220 

     Schedule of non-cash transactions

 

 

 

Change in unrealized gain on securities, net of tax

$         46,375 

 

$             395 

Transfers between loans and other real estate owned

$    1,379,030 

 

$      709,500 



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



5





Notes to Unaudited Consolidated Financial Statements


NOTE 1 – NATURE OF BUSINESS AND BASIS OF PRESENTATION


Independence Bancshares, Inc. (the “Company”) is a South Carolina corporation organized to operate as a bank holding company pursuant to the federal Bank Holding Company Act of 1956 and the South Carolina Bank Holding Company Act, and to own and control all of the capital stock of Independence National Bank (the “Bank”). The Bank is a national association organized under the laws of the United States to conduct general banking business in Greenville, South Carolina.


Basis of Presentation


The accompanying unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and with the instructions to Form 10-Q. Accordingly, they do not include all information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements. However, in the opinion of management, all adjustments (consisting of normal recurring adjustments) considered necessary for a fair presentation have been included. Operating results for the three month period ended March 31, 2012 are not necessarily indicative of the results that may be expected for the year ending December 31, 2012. For further information, refer to the financial statements and footnotes thereto included in our Annual Report on Form 10-K for 2011 as filed with the Securities and Exchange Commission.


Subsequent Events


Subsequent events are events or transactions that occur after the balance sheet date but before financial statements are issued. Recognized subsequent events are events or transactions that provide additional evidence about conditions that existed at the date of the balance sheet, including the estimates inherent in the process of preparing financial statements. Non-recognized subsequent events are events that provide evidence about conditions that did not exist at the date of the balance sheet but arose after that date. Management performed an evaluation to determine whether or not there have been any subsequent events since the balance sheet date, and concluded that no subsequent events had occurred requiring accrual or disclosure through the date of this filing.


Recent Regulatory Developments


On November 14, 2011, the Bank entered into a Consent Order (the “Consent Order”) with its primary regulator, the Office of the Comptroller of the Currency (the “OCC”), which, among other things, contains a requirement that the Bank maintain minimum capital levels that exceed the minimum regulatory capital ratios for “well-capitalized” banks. The minimum capital ratios for a bank are generally 8% for total capital, 4% for Tier 1 capital and 4% for leverage. To be eligible to be classified as “well-capitalized,” a bank must generally maintain a total capital ratio of 10% or more, a Tier 1 capital ratio of 6% or more, and a leverage ratio of 5% or more. The Consent Order requires the Bank to achieve Tier 1 capital at least equal to 9% of adjusted total assets, Tier 1 risk based capital at least equal to 10%, and total risk based capital at least equal to 12% of risk-weighted assets by March 31, 2012. As a result of the Consent Order, the Bank is no longer deemed “well-capitalized” regardless of its capital levels.  The Bank did not achieve these capital requirements by March 31, 2012; therefore, the OCC has the authority to subject us to further enforcement actions. For additional information on the Consent Order, including actions the Bank has taken in response to the Consent Order, see “Management’s Discussion and Analysis – Recent Regulatory Developments” and “Management’s Discussion and Analysis – Results of Operations – Capital Resources.”


NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES


A summary of significant accounting policies is included in our Annual Report on Form 10-K filed with the Securities and Exchange Commission for the year ended December 31, 2011.  For further information, refer to the consolidated financial statements and footnotes thereto included in our Annual Report on Form 10-K for 2011 as filed with the Securities and Exchange Commission. 



6





Cash and Cash Equivalents - For purposes of reporting cash flows, cash and cash equivalents include cash, amounts due from banks and federal funds sold. Generally, federal funds are sold for one-day periods. Due to the short term nature of cash and cash equivalents, the carrying amount of these instruments is deemed to be a reasonable estimate of fair value.


Income (Loss) per Share - Basic income (loss) per share represents net income (loss) divided by the weighted average number of common shares outstanding during the period. Diluted income (loss) per share reflects additional common shares that would have been outstanding if dilutive potential common shares had been issued.  Potential common shares that may be issued by the Company relate to outstanding stock options and warrants, and are determined using the treasury stock method. For the three month period ended March 31, 2012, all of the potential common shares were considered anti-dilutive due to the average trading price of the Company’s common stock which was well below the exercise price of all outstanding options and warrants. For the three month period ended March 31,2011, as a result of the Company’s net loss, all of the potential common shares were considered anti-dilutive.


Fair Value Measurements - The Company determines the fair market values of its financial instruments based on the fair value hierarchy established in FASB ASC Topic 820, “Fair Value Measurements and Disclosures” (“ASC Topic 820”), which provides a framework for measuring and disclosing fair value under generally accepted accounting principles.  ASC Topic 820 requires disclosures about the fair value of assets and liabilities recognized in the balance sheet in periods subsequent to initial recognition, whether the measurements are made on a recurring basis (for example, available-for-sale investment securities) or on a nonrecurring basis (for example, impaired loans).


ASC Topic 820 defines fair value as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date.  ASC Topic 820 also establishes a fair value hierarchy which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value.  The standard describes three levels of inputs that may be used to measure fair value: 


Level 1 – Valuations are based on quoted prices in active markets for identical assets or liabilities.


Level 2 – Valuations are based on observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities, quoted prices in markets that are not active, or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.


Level 3 – Valuations include unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.


Income Taxes - The Company accounts for income taxes in accordance with FASB ASC Topic 740, “Income Taxes". Deferred tax assets and liabilities are recognized for the expected future tax consequences of events that have been recognized in the consolidated financial statements or tax returns.  Deferred tax assets and liabilities are measured using the enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be realized or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. Valuation allowances are established to reduce deferred tax assets if it is determined to be “more likely than not” that all or some portion of the potential deferred tax asset will not be realized. For further information, refer to the consolidated financial statements and footnotes thereto included in our Annual Report on Form 10-K for 2011 as filed with the Securities and Exchange Commission. 


We did not recognize any income tax benefit or expense for the three month periods ended March 31, 2012 and 2011 due to the Company’s large cumulative net operating loss carry-forward position, as well as the 100% valuation allowance on our deferred tax assets. Accounting literature states that a deferred tax asset should be reduced by a valuation allowance if, based on the weight of all available evidence, it is more likely than not (a likelihood of more than 50%) that some portion or the entire deferred tax asset will not be realized. The determination of whether a deferred tax asset is realizable is based on weighting all available evidence, including both positive and negative evidence. In making such judgments, significant weight is given to evidence that can be objectively verified. During our September 30, 2010 quarterly analysis of the valuation allowance recorded against our deferred tax assets, we determined that it was not more likely than not that our deferred tax assets will be recognized in future years due to the continued decline in credit quality and the resulting impact on net interest margin, increased net losses, and negative impact on capital as a result of provision for loan losses and write-downs on other real estate owned, and we recorded a 100% valuation allowance against the deferred tax asset. We will continue to analyze our deferred tax assets and related valuation allowance each quarter taking into account performance compared to forecast and current economic or internal information that would impact forecasted earnings.


7



The Company believes that its income tax filing positions taken or expected to be taken in its tax returns will more likely than not be sustained upon audit by the taxing authorities, and does not anticipate any adjustments that will result in a material adverse impact on the Company’s financial condition, results of operations, or cash flows. Therefore, no reserves for uncertain income tax positions have been recorded pursuant to ASC 740, “Income Taxes”.


Recently Issued Accounting Pronouncements - The following is a summary of recent authoritative pronouncements that may affect our accounting, reporting, and disclosure of financial information:


In July 2010, the Receivables topic of the Accounting Standards Codification (“ASC”) was amended by Accounting Standards Update (“ASU”) 2010-20 to require expanded disclosures related to a company’s allowance for credit losses and the credit quality of its financing receivables. The amendments require the allowance disclosures to be provided on a disaggregated basis. The Company is required to include these disclosures in its interim and annual financial statements. See Note 4, Loans, for applicable disclosures.


Disclosures about Troubled Debt Restructurings (“TDRs”) required by ASU 2010-20 were deferred by the Financial Accounting Standards Board (“FASB”) in ASU 2011-01 issued in January 2011. In April 2011, the FASB issued ASU 2011-02 to assist creditors with their determination of when a restructuring is a TDR.   The determination is based on whether the restructuring constitutes a concession and whether the debtor is experiencing financial difficulties as both events must be present.  Disclosures related to TDRs under ASU 2010-20 were required beginning with the quarter ended March 31, 2012. See Note 4, Loans, for applicable disclosures.


In April 2011, the criteria used to determine effective control of transferred assets in the Transfers and Servicing topic of the ASC was amended by ASU 2011-03. The requirement for the transferor to have the ability to repurchase or redeem the financial assets on substantially the agreed terms and the collateral maintenance implementation guidance related to that criterion were removed from the assessment of effective control. The other criteria to assess effective control were not changed. The amendments were effective for the Company beginning January 1, 2012 and did not have a material effect on the financial statements.


ASU 2011-04 was issued in May 2011 to amend the Fair Value Measurement topic of the ASC by clarifying the application of existing fair value measurement and disclosure requirements and by changing particular principles or requirements for measuring fair value or for disclosing information about fair value measurements. The amendments were effective for the Company beginning January 1, 2012 and did not have a material effect on the financial statements.


The Comprehensive Income topic of the ASC was amended in June 2011. The amendment eliminates the option to present other comprehensive income as a part of the statement of changes in stockholders’ equity and requires consecutive presentation of the statement of net income and other comprehensive income. The amendments were applicable to the Company on January 1, 2012 and have been applied retrospectively. In December 2011, the topic was further amended to defer the effective date of presenting reclassification adjustments from other comprehensive income to net income on the face of the financial statements. Companies should continue to report reclassifications out of accumulated other comprehensive income consistent with the presentation requirements in effect prior to the amendments while FASB redeliberates future requirements.


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





8






NOTE 3 – INVESTMENT SECURITIES


Investment securities classified as “Available for Sale” are carried at fair value with unrealized gains and losses excluded from earnings and reported as a separate component of shareholders’ equity (net of estimated tax effects). Realized gains or losses on the sale of investments are based on the specific identification method. The amortized costs and fair values of investment securities available for sale are as follows:


 

 

 

March 31, 2012

 

 

 

Amortized
Cost

 

Gross Unrealized

 

Fair
Value

Gains

 

Losses

Government-sponsored enterprises

$    1,000,000

 

$                  -

 

$       (517)

   

$        999,483

Mortgage-backed securities

        7,664,194

       

148,581

 

(9,150)

    

7,803,625

Municipals, taxable

3,402,564

 

75,098

 

(15,793)

 

3,461,869

 

 

Total investment securities

$12,066,758

 

$    223,679

 

$(25,460)

 

$12,264,977

 

 

 

 


 

 

 

December 31, 2011

 

 

 

Amortized
Cost

 

Gross Unrealized

 

Fair
Value

Gains

 

Losses

Government-sponsored enterprises

$    2,000,000

 

$             879

 

$              - 

   

$     2,000,879

Mortgage-backed securities

       7,086,422

       

151,018

 

    

7,237,440

Municipals, taxable

3,407,028

 

28,588

 

(52,531)

 

3,383,085

 

 

Total investment securities

$12,493,450

 

$    180,485

 

$(52,531)

 

$12,621,404


At March 31, 2012, investment securities with a fair value of $3.1 million and unrealized losses of $25,460 had been in a continuous loss position for less than twelve months. At March 31, 2012, all remaining investment securities were in an unrealized gain position. The Company believes, based on industry analyst reports and credit ratings that the deterioration in the fair value of these investment securities available for sale is attributed to changes in market interest rates and not in the credit quality of the issuer and therefore, these losses are not considered other-than-temporary. The Company has the ability and intent to hold these securities until such time as the values recover or the securities mature. At December 31, 2011, investment securities with a fair value of $2.2 million and unrealized losses of $52,531 had been in a continuous loss position for less than twelve months and all remaining investment securities were in an unrealized gain position.


NOTE 4 – LOANS


At March 31, 2012, our gross loan portfolio consisted primarily of $47.4 million of commercial real estate loans, $10.5 million of commercial business loans, and $15.5 million of consumer and home equity loans. Our current loan portfolio composition is not materially different than the loan portfolio composition disclosed in the footnotes to the consolidated financial statements included in our Annual Report on Form 10-K for 2011 as filed with the SEC.


Certain credit quality statistics related to our loan portfolio have improved over the past several quarters, including reductions of in-migration of nonaccrual loans and reductions in the aggregate level of nonperforming assets. To the extent such improvement continues, we may continue to reduce our allowance for loan losses in future periods based on our assessment of the inherent risk in the loan portfolio at those future reporting dates. A reduction in the allowance for loan losses would result in a lower provision for loans losses being recorded in future periods. Conversely, there can be no assurance that loan losses in future periods will not exceed the current allowance for loan losses amount or that future increases in the allowance for loan losses will not be required. Additionally, no assurance can be given that our ongoing evaluation of the loan portfolio, in light of changing economic conditions and other relevant factors, will not require significant future additions to the allowance for loan losses, thus adversely impacting our business, financial condition, results of operations, and cash flows.





9






Loan Performance and Asset Quality


Generally, a loan will be placed on nonaccrual status when it becomes 90 days past due as to principal or interest (unless the loan is well-collateralized and in the process of collection), or when management believes, after considering economic and business conditions and collection efforts, that the borrower’s financial condition is such that collection of the loan is doubtful. When a loan is placed in nonaccrual status, interest accruals are discontinued and income earned but not collected is reversed.  Cash receipts on nonaccrual loans are not recorded as interest income, but are used to reduce principal. Loans are removed from nonaccrual status when they become current as to both principal and interest and when concern no longer exists as to the collectibility of principal or interest based on current available information or as evidenced by sufficient payment history, generally six monhts.


The following table summarizes delinquencies and nonaccruals, by portfolio class, as of March 31, 2012 and December 31, 2011.

 

Single and
multifamily
residential
real estate

 

Construction
and
development

 

Commercial
real estate -
other

 

Commercial
business

 

Consumer

 

Total

March 31, 2012

 

 

 

 

 

 

 

 

 

 

 

30-59 days past due

$      301,505

 

$       101,896

 

$         59,114

 

$         20,718

 

$         4,965

 

$       488,198

60-89 days past due

-

 

-

 

-

 

-

 

-

 

-

>90 days past due and still accruing

-

 

1,092,794

 

-

 

-

 

-

 

1,092,794

Nonaccrual

459,584

 

4,215,721

 

364,572

 

-

 

-

 

 5,039,877

Total past due and nonaccrual

761,089

 

5,410,411

 

423,686

 

20,718

 

4,965

 

6,620,869

Current

20,227,563

 

8,392,288

 

26,392,166

 

10,445,598

 

1,291,749

 

66,749,364

   Total loans (gross of deferred fees)

$  20,988,652

 

$  13,802,699

 

$  26,815,852

 

$  10,466,316

 

$  1,296,714

 

$  73,370,233


 

 

Single and
multifamily
residential
real estate

 

Construction
and
development

 

Commercial
real estate -
other

 

Commercial
business

 

Consumer

 

Total

December 31, 2011

 

 

 

 

 

 

 

 

 

 

 

30-59 days past due

$     760,086

 

$       516,483

 

$                   -

 

$         66,500

 

$                 -

 

$    1,343,069

60-89 days past due

-

 

-

 

-

 

-

 

14,358

 

14,358

Nonaccrual

1,558,914

 

3,128,943

 

354,990

 

-

 

-

 

5,042,847

Total past due and nonaccrual

2,319,000

 

3,645,426

 

354,990

 

66,500

 

14,358

 

6,400,274

Current

21,041,151

 

9,428,473

 

27,253,948

 

 11,279,861

 

1,560,507

 

70,563,940

   Total loans (gross of deferred fees)

$  23,360,151

 

$  13,073,899

 

$  27,608,938

 

$  11,346,361

 

$  1,574,865

 

$  76,964,214

 

 

 

 

 

 

 

 

 

 

 

 

At both March 31, 2012 and December 31, 2011, there were nonaccrual loans of $5.0 million. Foregone interest income related to nonaccrual loans equaled $89,076 and $170,457 for the three months ended March 31, 2012 and 2011, respectively. No interest income was recognized on nonaccrual loans during the three months ended March 31, 2012 and 2011. At March 31, 2012 there was one accruing loan which was contractually past due more than 90 days. This loan is well-secured and in the process of collection through normal means, and we believe no doubt exists as to collectibility of principal and interest.  This relationship will be brought current as to principal and interest in May based on scheduled lot sales. At December 31, 2011, there were no accruing loans which were contractually past due 90 days or more as to principal or interest payments.


As part of the loan review process, loans are given individual credit grades, representing the risk the Company believes is associated with the loan balance. Credit grades are assigned based on factors that impact the collectability of the loan, the strength of the borrower, the type of collateral, and loan performance. Commercial loans are individually graded at origination and credit grades are reviewed on a regular basis in accordance with our loan policy. Consumer loans are assigned a “pass” credit rating unless something within the loan warrants a specific classification grade.




10






The following table summarizes management’s internal credit risk grades, by portfolio class, as of March 31, 2012 and December 31, 2011.


March 31, 2012

Single and
multifamily
residential
real estate

 

Construction
and
development

 

Commercial
real estate -
other

 

Commercial
business

 

Consumer

 

Total

Pass Loans

$  13,124,121

 

$       509,310

 

$          27,468

 

$                  -

 

$  1,296,714

 

$  14,957,613

Grade 1 - Prime

-

 

-

 

-

 

308,750

 

-

 

308,750

Grade 2 - Good

-

 

-

 

1,289,562

 

128,244

 

-

 

1,417,806

Grade 3 - Acceptable

1,621,770

 

382,359

 

10,054,293

 

4,905,719

 

-

 

16,964,141

Grade 4 – Acceptable w/ Care

4,511,318

 

6,358,407

 

13,610,384

 

5,060,428

 

-

 

29,540,537

Grade 5 – Special Mention

1,111,291

 

101,896

 

143,674

 

63,175

 

-

 

1,420,036

Grade 6 - Substandard

620,152

 

6,450,727

 

1,690,471

 

-

 

-

 

8,761,350

Grade 7 - Doubtful

-

 

-

 

-

 

-

 

-

 

-

   Total loans (gross of deferred fees)

$  20,988,652

 

$  13,802,699

 

$  26,815,852

 

$  10,466,316

 

$  1,296,714

 

$  73,370,233



December 31, 2011

Single and
multifamily
residential
real estate

 

Construction
and
development

 

Commercial
real estate -
other

 

Commercial
business

 

Consumer

 

Total

Pass Loans

$  13,448,213

 

$       668,187

 

$         38,122

 

$                   -

 

$  1,499,204

 

$  15,653,726

Grade 1 - Prime

-

 

-

 

-

 

308,750

 

-

 

308,750

Grade 2 - Good

 

 

-

 

1,303,456

 

131,153

 

-

 

1,434,609

Grade 3 - Acceptable

1,982,863

 

393,526

 

11,335,186

 

4,927,092

 

-

 

18,638,667

Grade 4 – Acceptable w/ Care

5,214,948

 

5,094,973

 

12,431,878

 

5,912,866

 

-

 

28,654,665

Grade 5 – Special Mention

1,108,603

 

103,036

 

317,477

 

66,500

 

-

 

1,595,616

Grade 6 - Substandard

1,605,524

 

6,814,177

 

2,182,819

 

-

 

75,661

 

10,678,181

Grade 7 - Doubtful

-

 

-

 

-

 

-

 

-

 

-

   Total loans (gross of deferred fees)

$  23,360,151

 

$  13,073,899

 

$  27,608,938

 

$  11,346,361

 

$  1,574,865

 

$  76,964,214


Loans graded one through four are considered “pass” credits. At March 31, 2012, approximately 86% of the loan portfolio had a credit grade of “pass” compared to 84% at December 31, 2011.  For loans to qualify for this grade, they must be performing relatively close to expectations, with no significant departures from the intended source and timing of repayment. Consumer loans are assigned a “pass” credit rating unless something within the loan warrants a specific classification grade. As of March 31, 2012, we had loans totaling $1.4 million classified as special mention.  This classification is utilized when an initial concern is identified about the financial health of a borrower.  Loans are designated as such in order to be monitored more closely than other credits in the loan portfolio. At March 31, 2012, substandard loans totaled $8.8 million, with all loans being collateralized by real estate. Substandard credits are evaluated for impairment on a quarterly basis.


The Company identifies impaired loans through its normal internal loan review process. A loan is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement.  Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due.  Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record, and the amount of the shortfall in relation to the principal and interest owed. Loans on the Company's problem loan watch list are considered potentially impaired loans. Generally, once loans are considered impaired, they are moved to nonaccrual status and recognition of interest income is discontinued. Impairment is measured on a loan-by-loan basis based on the determination of the most probable source of repayment which is usually liquidation of the underlying collateral, but may also include discounted future cash flows, or in rare cases, the market value of the loan itself.   



11



Large groups of smaller balance homogeneous loans are collectively evaluated for impairment. Accordingly, the Company does not separately identify individual consumer and residential loans for impairment disclosures, unless such loans are the subject of a restructuring agreement.


At March 31, 2012, impaired loans totaled $8.6 million, all of which were valued on a nonrecurring basis at the lower of cost or market value of the underlying collateral. Market values were obtained using independent appraisals, updated in accordance with our reappraisal policy, or other market data such as recent offers to the borrower. As of March 31, 2012, we had loans totaling approximately $1.5 million that were classified in accordance with our loan rating policies but were not considered impaired. The following table summarizes information relative to impaired loans, by portfolio class, at March 31, 2012 and December 31, 2011.


 

Unpaid
principal
balance

 

Recorded
investment

 

Related
allowance

 

Average
impaired
investment

 

Year to date
interest
income

March 31, 2012

 

 

 

 

 

 

 

 

 

With no related allowance recorded:

 

 

 

 

 

 

 

 

 

   Single and multifamily residential real estate

$91,195

 

$        91,195

 

$              -

 

$         91,195

 

$         884

   Construction and development

2,189,102

 

2,189,102

 

-

 

2,202,168

 

33,831

   Commercial real estate - other

1,425,411

 

1,375,899

 

-

 

865,445

 

-

With related allowance recorded:

 

 

 

 

 

 

 

 

 

   Single and multifamily residential real estate

500,949

 

415,000

 

86,500

 

964,665

 

-

   Construction and development

5,476,212

 

4,215,721

 

348,421

 

4,407,332

 

25,039

   Commercial real estate - other

314,572

 

314,572

 

8,572

 

157,286

 

-

   Consumer

-

 

-

 

-

 

37,830

 

-

Total:

 

 

 

 

 

 

 

 

 

   Single and multifamily residential real estate

592,144

 

506,195

 

86,500

 

1,055,860

 

884

   Construction and development

7,665,314

 

6,404,823

 

348,421

 

6,609,500

 

58,870

   Commercial real estate - other

1,739,983

 

1,690,471

 

8,572

 

1,022,731

 

-

   Consumer

-

 

-

 

-

 

37,830

 

-

 

$   9,997,441

 

$   8,601,489

 

$  443,493

 

$   8,725,921

 

$    59,754

December 31, 2011

 

 

 

 

 

 

 

 

 

With no related allowance recorded:

 

 

 

 

 

 

 

 

 

   Single and multifamily residential real estate

$91,195

 

$91,195

 

$              -

 

$      106,348

 

$             -

   Construction and development

2,215,234

 

2,215,234

 

-

 

1,910,774

 

75,449

   Commercial real estate - other

404,502

 

354,990

 

-

 

780,124

 

-

   Commercial business

-

 

-

 

-

 

18,453

 

-

With related allowance recorded:

 

 

 

 

 

 

 

 

 

   Single and multifamily residential real estate

1,600,279

 

1,514,330

 

141,830

 

2,001,323

 

-

   Construction and development

6,038,519

 

4,598,943

 

383,421

 

6,078,709

 

100,694

   Commercial real estate - other

-

 

-

 

-

 

404,916

 

9,907

   Commercial business

-

 

-

 

-

 

18,453

 

-

   Consumer

75,661

 

75,661

 

38,424

 

15,132

 

-

Total:

 

 

 

 

 

 

 

 

 

   Single and multifamily residential real estate

1,691,474

 

1,605,525

 

141,830

 

2,107,671

 

-

   Construction and development

8,253,753

 

6,814,177

 

383,421

 

7,989,483

 

176,143

   Commercial real estate - other

404,502

 

354,990

 

-

 

1,185,040

 

9,907

   Commercial business

-

 

-

 

-

 

36,906

 

-

   Consumer

75,661

 

75,661

 

38,424

 

15,132

 

-

 

$  10,425,390

 

$  8,850,353

 

$  563,675

 

$  11,334,232

 

$  186,050

 

 

 

 

 

 

 

 

 

 



12



TDRs are loans which have been restructured from their original contractual terms and include concessions that would not otherwise have been granted outside of the financial difficulty of the borrower. Concessions can relate to the contractual interest rate, maturity date, or payment structure of the note. As part of our workout plan for individual loan relationships, we may restructure loan terms to assist borrowers facing challenges in the current economic environment. The purpose of a TDR is to facilitate ultimate repayment of the loan.


The carrying balance of troubled debt restructurings as of March 31, 2012 was $1.3 million and consisted of two performing loans within one relationship. The carrying balance of troubled debt restructurings as of December 31, 2011 was $1.3 million which consisted of two non-performing loans in one relationship, and the collateral securing these loans was subsequently transferred to real estate owned during the quarter ended March 31, 2012.

  

There were two commercial real estate loans that were modified during the three months ended March 31, 2012 totaling $1.3 million (pre-modification investment equaling post-modification investment). These loans were modified with a term concession.


There were no loans modified as troubled debt restructurings within the previous 12-month period for which there was a payment default during the three months ended March 31, 2012.


Provision and Allowance for Loan Losses


An allowance for loan losses is maintained at a level deemed appropriate by management to adequately provide for known and inherent losses in the loan portfolio. The allowance for loan losses is established as losses are estimated to have occurred through a provision for loan losses charged to earnings. Loan losses are charged against the allowance when management believes the uncollectability of a loan balance is confirmed. Subsequent recoveries, if any, are credited to the allowance.


The allowance for loan losses is evaluated on a regular basis by management and is based upon management’s periodic review of the collectability of the loans in light of historical experience, the nature and volume of the loan portfolio, adverse situations that may affect the borrower’s ability to repay, estimated value of any underlying collateral and prevailing economic conditions. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available.


The allowance consists of both a specific and a general component. The specific component relates to loans that are impaired loans as defined in FASB ASC Topic 310, “Receivables”. For such loans, an allowance is established when either the discounted cash flows or collateral value or observable market price of the impaired loan is lower than the carrying value of that loan. The general component covers non-impaired loans and is based on historical loss experience adjusted for qualitative factors.




13




The following table summarizes activity related to our allowance for loan losses for the three months ended March 31, 2012 and 2011, by portfolio segment.


 

Single and
multifamily
residential
real estate

 

Construction
and
development

 

Commercial
real estate -
other

 

Commercial
business

 

Consumer

 

Total

March 31, 2012

 

 

 

 

 

 

 

 

 

 

 

Allowance for loan losses:

 

 

 

 

 

 

 

 

 

 

 

Balance, beginning of period

$       576,669 

 

$       688,847 

 

$        347,061 

 

$        412,808 

 

$      85,138 

 

$    2,110,523 

Provision for loan losses

74,413 

 

586,064 

 

(305,038)

 

(363,173)

 

7,734 

 

Loan charge-offs

(55,330)

 

(6,939)

 

 

 

(90,019)

 

(152,288)

Loan recoveries

 

 

 

 

 

 - 

     Net loans charged-off

(55,330)

 

(6,939)

 

 

 

(90,019)

 

(152,288)

Balance, end of period

$       595,752 

 

$    1,267,972 

 

$         42,023 

 

$         49,635 

 

$        2,853 

 

$    1,958,235 

 

 

 

 

 

 

 

 

 

 

 

 

Individually reviewed for impairment

$         86,500 

 

$       348,421 

 

$           8,572 

 

 

$               - 

 

$       443,493 

Collectively reviewed for impairment

509,252 

 

919,551 

 

33,451 

 

49,635 

 

2,853

 

1,514,742 

Total allowance for loan losses

$       595,752 

 

$    1,267,972 

 

$         42,023 

 

$         49,635 

 

$        2,853 

 

$    1,958,235 

 

 

 

 

 

 

 

 

 

 

 

 

Gross loans, end of period:

 

 

 

 

 

 

 

 

 

 

 

Individually reviewed for impairment

$       506,195 

 

$    6,404,823 

 

$    1,690,471 

 

$                  - 

 

$                - 

 

$    8,601,489 

Collectively reviewed for impairment

20,482,457 

 

7,397,876 

 

25,125,381 

 

10,466,316 

 

1,296,714 

 

64,768,744 

Total loans (gross of deferred fees)

$  20,988,652 

 

$  13,802,699 

 

$  26,815,852 

 

$  10,466,316 

 

$  1,296,714 

 

$  73,370,233 

 

 

 

 

 

 

 

 

 

 

 

 

March 31, 2011

 

 

 

 

 

 

 

 

 

 

 

Allowance for loan losses:

 

 

 

 

 

 

 

 

 

 

 

Balance, beginning of year

$       859,255 

 

$    1,365,914 

 

$       473,504 

 

$       306,791 

 

$      57,028 

 

$    3,062,492 

Provision for loan losses

135,359 

 

740,328 

 

35,240 

 

(37,345)

 

(3,582)

 

870,000 

Loan charge-offs

(360,696)

 

(636,432)

 

(25,706)

 

 

 

(1,022,834)

Loan recoveries

 

 

 

214,114 

 

 

214,114 

     Net loans charged-off

(360,696)

 

(636,432)

 

(25,706)

 

214,114 

 

 

(808,720)

Balance, end of year

$       633,918 

 

$    1,469,810 

 

$       483,038 

 

$       483,560 

 

$      53,446 

 

$    3,123.772 

 

 

 

 

 

 

 

 

 

 

 

 

Individually reviewed for impairment

$       196,154 

 

$       879,993 

 

$       152,000 

 

$                  - 

 

$               - 

 

$    1,228,147 

Collectively reviewed for impairment

437,764 

 

589,817 

 

331,038 

 

483,560 

 

53,446 

 

1,895,625 

Total allowance for loan losses

$       633,918 

 

$    1,469,810 

 

$       483,038 

 

$       483,560 

 

$      53,446 

 

$    3,123.772 

 

 

 

 

 

 

 

 

 

 

 

 

Gross loans, end of period:

 

 

 

 

 

 

 

 

 

 

 

Individually reviewed for impairment

$    2,017,236 

 

$    9,845,911 

 

$    1,430,870 

 

$                  - 

 

$                - 

 

$  13,294,017 

Collectively reviewed for impairment

23,751,524 

 

7,145,117 

 

32,196,165 

 

12,638,943 

 

1,495,898 

 

77,227,647 

Total loans (gross of deferred fees)

$  25,768,760 

 

$  16,991,028 

 

$  33,627,035 

 

$  12,638,943 

 

$  1,495,898 

 

$  90,521,664 

 

 

 

 

 

 

 

 

 

 

 

 

Portions of the allowance for loan losses may be allocated for specific loans or portfolio segments. However, the entire allowance for loan losses is available for any loan that, in management’s judgment, should be charged-off. Beginning first quarter 2012, we began using the average of the last eight quarters of our charge-off history versus the prior three years with a heavier weight on the most recent year, both adjusted for portfolio and economic factors. As a result, there were decreases in the commercial real estate and commercial business segments which were offset by increases in the other real estate segments.  While management utilizes the best judgment and information available to it, the ultimate adequacy of the allowance for loan losses depends on a variety of factors beyond our control, including the performance of our loan portfolio, the economy, changes in interest rates, and the view of the regulatory authorities toward loan classifications. If delinquencies and defaults increase, we may be required to increase our provision for loan losses, which would adversely affect our results of operations and financial condition. There can be no assurance that charge-offs of loans in future periods will not exceed the allowance for loan losses as estimated at any point in time or that provisions for loan losses will not be significant to a particular accounting period.


14






NOTE 5 – FAIR VALUE


Assets and Liabilities Measured at Fair Value


Fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. The Company determines the fair values of its financial instruments based on the fair value hierarchy, which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The three levels of inputs that may be used to measure fair value are detailed in Note 1.


Available-for-sale investment securities ($12,264,977 at March 31, 2012) are carried at fair value and measured on a recurring basis using Level 2 inputs (other observable inputs). Fair values are estimated by using bid prices and quoted prices of pools or tranches of securities with similar characteristics.


We do not record loans at fair value on a recurring basis. However, from time to time, a loan is considered impaired and a specific reserve within the allowance for loan losses is established or the loan is charged down to the fair value less costs to sell. At March 31, 2012, all impaired loans were evaluated on a nonrecurring basis based on the market value of the underlying collateral. Market values are generally obtained using independent appraisals or other market data, which the Company considers to be Level 2 inputs (other observable inputs). The aggregate carrying amount, net of specific reserves, of impaired loans carried at fair value at March 31, 2012 was $4,501,800.    


Other real estate owned and repossessed assets, generally consisting of properties or other collateral obtained through foreclosure or in satisfaction of loans, are carried at fair value and measured on a non-recurring basis. Market values are generally obtained using independent appraisals or other current market information, including but not limited to offers received on a property, which the Company considers to be level 2 inputs (other observable inputs). The carrying amount of other real estate owned and repossessed assets carried at fair value at March 31, 2012 was $5,446,020.


The Company has no assets whose fair values are measured using Level 1 or Level 3 inputs. The Company also has no liabilities carried at fair value or measured at fair value. 


Disclosures about Fair Value of Financial Instruments


FASB ASC Topic 825, “Financial Instruments” requires disclosure of fair value information, whether or not recognized in the consolidated balance sheets, when it is practical to estimate the fair value. FASB ASC Topic 825 defines a financial instrument as cash, evidence of an ownership interest in an entity or contractual obligations which require the exchange of cash or other financial instruments. Certain items are specifically excluded from the disclosure requirements, including the Company’s common stock, property and equipment and other assets and liabilities.


Fair value approximates carrying value for the following financial instruments due to the short-term nature of the instrument: cash and due from banks, federal funds sold, and securities sold under agreements to repurchase. Investment securities are valued using quoted market prices. No ready market exists for non-marketable equity securities, and they have no quoted market value. However, redemption of these stocks has historically been at par value. Accordingly, the carrying amounts are deemed to be a reasonable estimate of fair value. Fair value of loans is based on the discounted present value of the estimated future cash flows. Discount rates used in these computations approximate the rates currently offered for similar loans of comparable terms and credit quality.


Fair value for demand deposit accounts and interest bearing accounts with no fixed maturity date is equal to the carrying value. Fair value of certificate of deposit accounts are estimated by discounting cash flows from expected maturities using current interest rates on similar instruments. Fair value for FHLB advances is based on discounted cash flows using the Company’s current incremental borrowing rate.


The Company has used management’s best estimate of fair value based on the above assumptions. Thus, the fair values presented may not be the amounts that could be realized in an immediate sale or settlement of the instrument. In addition, any income taxes or other expenses, which would be incurred in an actual sale or settlement, are not taken into consideration in the fair value presented.


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The estimated fair values of the Company’s financial instruments at March 31, 2012 and December 31, 2011 are as follows:


 

 

March 31, 2012

 

December 31, 2011

 

 

Carrying
Amount

 

Fair
Value

 

Carrying
Amount

 

Fair
Value

Financial Assets:

 

 

 

 

 

 

 

 

Cash and due from banks

$  8,356,675

 

$  8,356,675

 

$  5,651,491

 

$  5,651,491

 

Federal funds sold

11,710,000

 

11,710,000

 

9,550,000

 

   9,550,000

 

Investment securities available for sale

12,264,977

 

12,264,977

 

12,621,404

 

12,621,404

 

Non-marketable equity securities

898,600

 

898,600

 

918,350

 

918,350

 

Loans, net

71,314,445

 

70,464,482

 

74,778,838

 

73,856,166

 

 

 

 

 

 

 

 

 

Financial Liabilities:

 

 

 

 

 

 

 

 

Deposits

97,485,256

 

97,685,602

 

96,568,144

 

96,772,145

 

Federal Home Loan Bank advances

7,000,000

 

7,250,384

 

7,000,000

 

7,281,360

    Securities sold under agreements to repurchase

22,509

 

22,509

 

107,777

 

107,777


 
 


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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations


The following discussion reviews our results of operations and assesses our financial condition. You should read the following discussion and analysis in conjunction with the accompanying consolidated financial statements. The commentary should be read in conjunction with the discussion of forward-looking statements, the financial statements, and the related notes and the other statistical information included in this report.


DISCUSSION OF FORWARD-LOOKING STATEMENTS


This report contains statements which constitute forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Forward-looking statements may relate to our financial condition, results of operation, plans, objectives, or future performance. These statements are based on many assumptions and estimates and are not guarantees of future performance. Our actual results may differ materially from those anticipated in any forward-looking statements, as they will depend on many factors about which we are unsure, including many factors which are beyond our control. The words “may,” “would,” “could,” “should,” “will,” “expect,” “anticipate,” “predict,” “project,” “potential,” “believe,” “continue,” “assume,” “intend,” “plan,” and “estimate,” as well as similar expressions, are meant to identify such forward-looking statements. Potential risks and uncertainties that could cause our actual results to differ from those anticipated in our forward-looking statements include, but are not limited, to the following:


·

our ability to comply with our Consent Order, including the capital directive therein, and potential regulatory actions if we fail to comply;

·

general economic conditions, either nationally or regionally and especially in our primary service area, being less favorable than expected, resulting in, among other things, a deterioration in credit quality;

·

greater than expected losses due to higher credit losses generally and specifically because losses in the sectors of our loan portfolio secured by real estate are greater than expected due to economic factors, including, but not limited to, declining real estate values, increasing interest rates, increasing unemployment, or changes in payment behavior or other factors;

·

greater than expected losses due to higher credit losses because our loans are concentrated by loan type, industry segment, borrower type, or location of the borrower or collateral;

·

the amount of our loan portfolio collateralized by real estate and weakness in the real estate market;

·

the rate of delinquencies and amount of loans charged-off;

·

the adequacy of the level of our allowance for loan losses and the amount of loan loss provisions required in future periods;

·

the rate of loan growth in recent years and the lack of seasoning of our loan portfolio;

·

our ability to attract and retain key personnel;

·

our ability to retain our existing customers, including our deposit relationships;

·

significant increases in competitive pressure in the banking and financial services industries;

·

adverse changes in asset quality and resulting credit risk related losses and expenses;

·

changes in the interest rate environment which could reduce anticipated or actual margins;

·

changes in political conditions or the legislative or regulatory environment, including but not limited to the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”) and regulations adopted thereunder, changes in federal and/or state tax laws or interpretations thereof by taxing authorities and other governmental initiatives affecting the banking and financial services industries;

·

changes occurring in business conditions and inflation;

·

increased funding costs due to market illiquidity, increased competition for funding, and/or increased regulatory requirements with regard to funding;

·

changes in deposit flows;

·

changes in technology;

·

changes in monetary and tax policies;

·

changes in accounting policies and practices, as may be adopted by the regulatory agencies, as well as the Public Company Accounting Oversight Board and the Financial Accounting Standards Board;

·

loss of consumer confidence and economic disruptions resulting from terrorist activities or other military actions; and

·

other risks and uncertainties detailed our Annual Report on Form 10-K for the year ended December 31, 2011 and from time to time in our filings with the Securities and Exchange Commission.



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These risks are exacerbated by the developments over the last three plus years in local, national and international financial markets, and we are unable to predict what effect these uncertain market conditions will continue to have on our Company. Beginning in 2008 and continuing through 2011, the capital and credit markets experienced unprecedented levels of extended volatility and disruption. During the first quarter of 2012, economic conditions, while slow by historical standards, have shown signs of stabilization. However, as a result of U.S. government fiscal challenges, continued volatility in European sovereign and bank debt, slow improvement in domestic employment conditions, and the economic and monetary policy statements by the Board of Governors of the Federal Reserve System (the “Federal Reserve”), it is difficult to predict if this stabilization is indicative of a lasting trend. Current economic reports are mixed and the outlook for the remainder of 2012 is unclear and does not yet indicate expectations of a sustained recovery. There can be no assurance that the current level of economic activity will not continue to materially and adversely impact the U.S. economy in general, the banking industry, and our business, financial condition and results of operations, as well as our ability to maintain sufficient capital or other funding for liquidity and business purposes.


All forward-looking statements in this report are based on information available to us as of the date of this report. Although we believe that the expectations reflected in our forward-looking statements are reasonable, we cannot guarantee you that these expectations will be achieved. We undertake no obligation to publicly update or otherwise revise any forward-looking statements, whether as a result of new information, future events, or otherwise.


Critical Accounting Policies


We have adopted various accounting policies that govern the application of accounting principles generally accepted in the United States of America and with general practices within the banking industry in the preparation of our financial statements. Our significant accounting policies are described in the footnotes to our audited consolidated financial statements as of December 31, 2011, as filed in our Annual Report on Form 10-K.


Certain accounting policies involve significant judgments and assumptions by us that have a material impact on the carrying value of certain assets and liabilities. We consider these accounting policies to be critical accounting policies. The judgment and assumptions we use are based on historical experience and other factors, which we believe to be reasonable under the circumstances. Because of the nature of the judgment and assumptions we make, actual results could differ from these judgments and estimates that could have a material impact on the carrying values of our assets and liabilities and our results of operations.


Allowance for Loan Losses


We believe the allowance for loan losses is the critical accounting policy that requires the most significant judgments and estimates used in preparation of our consolidated financial statements. Some of the more critical judgments supporting the amount of our allowance for loan losses include judgments about the credit worthiness of borrowers, the estimated value of the underlying collateral, the assumptions about cash flow, determination of loss factors for estimating credit losses, the impact of current events and conditions, and other factors impacting the level of probable inherent losses. Under different conditions or using different assumptions, the actual amount of credit losses incurred by us may be different from management’s estimates provided in our consolidated financial statements. Refer to the portion of this discussion that addresses our allowance for loan losses for a more complete discussion of our processes and methodology for determining our allowance for loan losses.


Other Real Estate Owned and Repossessed Assets

 

Real estate and other property acquired in settlement of loans is recorded at the lower of cost or fair value less estimated selling costs, establishing a new cost basis when acquired. Fair value of such property is reviewed regularly and write-downs are recorded when it is determined that the carrying value of the property exceeds the fair value less estimated costs to sell. Recoveries of value are recorded only to the extent of previous write-downs on the property in accordance with FASB ASC Topic 360 “Property, Plant, and Equipment”. Write-downs or recoveries of value resulting from the periodic reevaluation of such properties, costs related to holding such properties, and gains and losses on the sale of foreclosed properties are charged against income. Costs relating to the development and improvement of such properties are capitalized.



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Income Taxes


We use assumptions and estimates in determining income taxes payable or refundable for the current year, deferred income tax liabilities and assets for events recognized differently in our consolidated financial statements and income tax returns, and income tax benefit or expense. Determining these amounts requires analysis of certain transactions and interpretation of tax laws and regulations. Management exercises judgment in evaluating the amount and timing of recognition of resulting tax liabilities and assets.  These judgments and estimates are reevaluated on a continual basis as regulatory and business factors change. Valuation allowances are established to reduce deferred tax assets if it is determined to be “more likely than not” that all or some portion of the potential deferred tax asset will not be realized. No assurance can be given that either the tax returns submitted by us or the income tax reported on the financial statements will not be adjusted by either adverse rulings by the United States Tax Court, changes in the tax code, or assessments made by the Internal Revenue Service. We are subject to potential adverse adjustments, including, but not limited to, an increase in the statutory federal or state income tax rates, the permanent non-deductibility of amounts currently considered deductible either now or in future periods, and the dependency on the generation of future taxable income, including capital gains, in order to ultimately realize deferred income tax assets.


Overview


The following discussion describes our results of operations for the three month periods ended March 31, 2012 and 2011 and also analyzes our financial condition as of March 31, 2012.


Like most community banks, we derive the majority of our income from interest we receive on our loans and investments.  Our primary source of funds for making these loans and investments is our deposits, on which we pay interest. Consequently, one of the key measures of our success is our amount of net interest income, or the difference between the income on our interest-earning assets, such as loans and investments, and the expense on our interest-bearing liabilities, such as deposits and borrowings. Another key measure is the spread between the yield we earn on these interest-earning assets and the rate we pay on our interest-bearing liabilities.


There are risks inherent in all loans, so we maintain an allowance for loan losses to absorb probable losses on existing loans that may become uncollectible. We establish and maintain this allowance by charging a provision for loan losses against our operating earnings. In the following section we have included a detailed discussion of this process.


In addition to earning interest on our loans and investments, we earn income through fees and other expenses we charge to our customers. We describe the various components of this noninterest income, as well as our noninterest expenses, in the following discussion.


Markets in the United States and elsewhere have experienced extreme volatility and disruption over the past three plus years. These circumstances have exerted significant downward pressure on prices of equity securities and virtually all other asset classes, and have resulted in substantially increased market volatility, severely constrained credit and capital markets, particularly for financial institutions, and an overall loss of investor confidence. Loan portfolio performances have deteriorated at many institutions resulting from, among other factors, a weak economy and a decline in the value of the collateral supporting their loans. Dramatic slowdowns in the housing industry, due in part to falling home prices and increasing foreclosures and unemployment, have created strains on financial institutions. Many borrowers are now unable to repay their loans, and the collateral securing these loans has, in some cases, declined below the loan balance. In response to the challenges facing the financial services sector, beginning in 2008 a multitude of new regulatory and governmental actions have been announced including the Emergency Economic Stabilization Act, approved by Congress and signed by President Bush on October 3, 2008, and the American Recovery and Reinvestment Act on February 17, 2009, among others. Some of the more recent actions include:


·

On July 21, 2010, the U.S. President signed into law the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (the “Dodd-Frank Act”), a comprehensive regulatory framework that will likely result in dramatic changes across the financial regulatory system, some of which became effective immediately and some of which will not become effective until various future dates.  Implementation of the Dodd-Frank Act will require many new rules to be made by various federal regulatory agencies over the next several years.  Uncertainty remains as to the ultimate impact of the Dodd-Frank Act until final rulemaking is complete, which could have a material adverse impact either on the financial services industry as a whole or on our business, financial condition, results of operations, and cash flows.  Provisions in the legislation that affect consumer financial protection regulations, deposit insurance assessments, payment of interest on demand deposits, and interchange fees could increase the costs associated with deposits and place limitations on certain revenues those deposits may generate.  The Dodd-Frank Act includes provisions that, among other things, will:



19



o

Centralize responsibility for consumer financial protection by creating a new agency, the Bureau of Consumer Financial Protection, responsible for implementing, examining, and enforcing compliance with federal consumer financial laws;


o

Create the Financial Stability Oversight Council that will recommend to the Federal Reserve increasingly strict rules for capital, leverage, liquidity, risk management and other requirements as  companies grow in size and complexity;


o

Provide mortgage reform provisions regarding a customer’s ability to repay, restricting variable-rate lending by requiring that the ability to repay variable-rate loans be determined by using the maximum rate that will apply during the first five years of a variable-rate loan term, and making more loans subject to provisions for higher cost loans, new disclosures, and certain other revisions;


o

Change the assessment base for federal deposit insurance from the amount of insured deposits to consolidated assets less tangible capital, eliminate the ceiling on the size of the Deposit Insurance Fund (“DIF”), and increase the floor on the size of the DIF, which generally will require an increase in the level of assessments for institutions with assets in excess of $10 billion;


o

Make permanent the $250,000 limit for federal deposit insurance and provide unlimited federal deposit insurance until December 31, 2012 for noninterest-bearing demand transaction accounts at all insured depository institutions;


o

Implement corporate governance revisions, including with regard to executive compensation and proxy access by shareholders, which apply to all public companies, not just financial institutions;


o

Repeal the federal prohibitions on the payment of interest on demand deposits, thereby permitting depository institutions to pay interest on business transactions and other accounts;


o

Amend the Electronic Fund Transfer Act (“EFTA”) to, among other things, give the Federal Reserve the authority to establish rules regarding interchange fees charged for electronic debit transactions by payment card issuers having assets over $10 billion and to enforce a new statutory requirement that such fees be reasonable and proportional to the actual cost of a transaction to the issuer;


o

Eliminate the Office of Thrift Supervision (“OTS”) on July 21, 2011. The Office of the Comptroller of the Currency (“OCC”), which is the primary federal regulator for national banks, now has become the primary federal regulator for federal thrifts.  In addition, the Federal Reserve now supervises and regulates all savings and loan holding companies that were formerly regulated by the OTS.


·

On September 27, 2010, the U.S. President signed into law the Small Business Jobs Act of 2010 (the “Act”). The Small Business Lending Fund (the “SBLF”), which was enacted as part of the Act, is a $30 billion fund that encourages lending to small businesses by providing Tier 1 capital to qualified community banks with assets of less than $10 billion. On December 21, 2010, the U.S. Treasury published the application form, term sheet and other guidance for participation in the SBLF. Under the terms of the SBLF, the Treasury will purchase shares of senior preferred stock from banks, bank holding companies, and other financial institutions that will qualify as Tier 1 capital for regulatory purposes and rank senior to a participating institution’s common stock. The application deadline for participating in the SBLF was May 16, 2011. We did not participate in the SBLF.


·

Internationally, both the Basel Committee on Banking Supervision (the “Basel Committee”) and the Financial Stability Board (established in April 2009 by the Group of Twenty (“G-20”) Finance Ministers and Central Bank Governors to take action to strengthen regulation and supervision of the financial system with greater international consistency, cooperation, and transparency) have committed to raise capital standards and


20



 

liquidity buffers within the banking system (“Basel III”). On September 12, 2010, the Group of Governors and Heads of Supervision agreed to the calibration and phase-in of the Basel III minimum capital requirements (raising the minimum Tier 1 common equity ratio to 4.5% and minimum Tier 1 equity ratio to 6.0%, with full implementation by January 2015) and introducing a capital conservation buffer of common equity of an additional 2.5% with full implementation by January 2019. The U.S. federal banking agencies support this agreement. In December 2010, the Basel Committee issued the Basel III rules text, outlining the details and time-lines of global regulatory standards on bank capital adequacy and liquidity. According to the Basel Committee, the framework sets out higher and better-quality capital, better risk coverage, the introduction of a leverage ratio as a backstop to the risk-based requirement, measures to promote the build-up of capital that can be drawn down in periods of stress, and the introduction of two global liquidity standards.


·

In November 2010, the Federal Reserve's monetary policymaking committee, the Federal Open Market Committee (“FOMC”), decided that further support to the economy was needed. With short-term interest rates already nearing 0%, the FOMC agreed to deliver that support by committing to purchase additional longer-term Treasury securities, as it had in 2008 and 2009. The FOMC announced that it intended to purchase an additional $600 billion of longer-term U.S. Treasury securities by the end of the second quarter of 2011, at a pace of about $75 billion per month. In addition, the FOMC stated that it would maintain its existing policy of reinvesting principal payments from its securities holdings.  


·

In November 2010, the FDIC approved two proposals that amend the deposit insurance assessment regulations. The first proposal implements a provision in the Dodd-Frank Act that changes the assessment base from one based on domestic deposits (as it has been since 1935) to one based on assets. The assessment base changes from adjusted domestic deposits to average consolidated total assets minus average tangible equity. The second proposal changes the deposit insurance assessment system for large institutions in conjunction with the guidance given in the Dodd-Frank Act. In February 2011, the FDIC approved the final rules that change the assessment base from domestic deposits to average assets minus average tangible equity, adopt a new scorecard-based assessment system for financial institutions with more than $10 billion in assets, and finalize the designated reserve ratio target size at 2.0% of insured deposits. We elected to voluntarily participate in the unlimited deposit insurance component of the Treasury’s Transaction Account Guarantee Program (“TAGP”) through December 31, 2010. Coverage under the program was in addition to and separate from the basic coverage available under the FDIC’s general deposit insurance rules. As a result of the Dodd-Frank Act that was signed into law on July 21, 2010, the program ended on December 31, 2010, and all institutions are now required to provide full deposit insurance on noninterest-bearing transaction accounts until December 31, 2012. There will not be a separate assessment for this as there was for institutions participating in the deposit insurance component of the TAGP.


·

In June 2011, the Federal Reserve approved a final debit card interchange rule in accordance with the Dodd-Frank Act. The final rule caps an issuer’s base fee at $0.21 per transaction and allows an additional 5 basis point charge per transaction to help cover fraud losses. Though the rule technically does not apply to institutions with less than $10 billion in assets, such as the Bank, there is concern that the price controls may harm community banks, which could be pressured by the marketplace to lower their own interchange rates. The Federal Reserve also adopted requirements for issuers to include two unaffiliated networks for debit card transactions – one signature-based and one PIN-based.  The effective date for the final rules on the pricing and routing restrictions was October 1, 2011. The results of these final rules may impact our interchange income from debit card transactions in the future. Thus far, the Bank has not experienced a material impact on its interchange fees.


·

On September 21, 2011, the FOMC announced that, in order to support a stronger economic recovery and to help ensure that inflation, over time, is at levels consistent with its statutory mandate, it had decided to extend the average maturity of its holdings of securities. In addition, the FOMC announced that it intended to purchase, by the end of June 2012, $400 billion of Treasury securities with remaining maturities of 3 years or less in order to put downward pressure on longer-term interest rates and help make broader financial conditions more accommodative. Further, to help support conditions in mortgage markets, the FOMC intends to now reinvest in agency mortgage-backed securities the principal payments from its holdings of agency debt and agency mortgage-backed securities.


·

On April 5, 2012, President Obama signed the Jumpstart Our Business Startup Act (the “JOBS Act”), which is intended to stimulate economic growth by helping smaller and emerging growth companies access the U.S. capital markets. The JOBS Act amends various provisions of, and adds new sections to, the Securities Act of


21



 

1933 and the Securities Exchange Act of 1934, as well as provisions of the Sarbanes-Oxley Act of 2002. In addition, under the JOBS Act, a bank or bank holding company is permitted to have 2,000 shareholders before being subject to public company requirements and to deregister from the SEC when its shareholder count falls below 1,200. The SEC has been directed to issue rules implementing these amendments by April 5, 2013. We are currently evaluating the effects that these amendments, as well as the full JOBS Act, will have on the Company.


Although it is likely that further regulatory actions will arise as the Federal government attempts to address the economic situation, we cannot predict the effect that fiscal or monetary policies, economic control, or new federal or state legislation may have on our business and earnings in the future.


Recent Regulatory Developments


On November 14, 2011, the Bank entered into a Consent Order (the “Consent Order”) with its primary regulator, the Office of the Comptroller of the Currency (the “OCC”), which, among other things, contains a requirement that the Bank maintain minimum capital levels that exceed the minimum regulatory capital ratios for “well-capitalized” banks. The minimum capital ratios for a bank are generally 8% for total capital, 4% for Tier 1 capital and 4% for leverage. To be eligible to be classified as “well-capitalized,” a bank must generally maintain a total capital ratio of 10% or more, a Tier 1 capital ratio of 6% or more, and a leverage ratio of 5% or more. The Consent Order requires the Bank to achieve Tier 1 capital at least equal to 9% of adjusted total assets, Tier 1 risk based capital at least equal to 10%, and total risk based capital at least equal to 12% of risk-weighted assets by March 31, 2012. As a result of the Consent Order, the Bank is no longer deemed “well-capitalized” regardless of its capital levels.  The Bank did not achieve these capital requirements by March 31, 2012; therefore, the OCC has the authority to subject us to further enforcement actions.


In addition, the Consent Order includes several specific requirements for the Bank which are designed to strengthen the Bank’s financial condition. The Board of Directors and management of the Bank have been aggressively working, and will continue to diligently work, to comply with all the requirements of the Consent Order.  A summary of the requirements of the Consent Order and the Bank’s status on complying with the Consent Order is as follows:


Requirements of the Consent Order

Bank’s Compliance Status

The Compliance Committee, which was established by the Board of Directors pursuant to the Formal Agreement, shall continue to be responsible for monitoring and coordinating the Bank's adherence to the provisions of the Consent Order. The Compliance Committee is required to meet at least monthly to review progress and status of actions needed to achieve full compliance with each article of the Consent Order and report this information to the Board.

The Compliance Committee meets monthly to review written progress reports provided by management and then reports to the Board the status of actions needed to achieve full compliance with each article of the Consent Order. These reports are forwarded to the OCC on a monthly basis.

Review and revise, within 60 days of the effective date of the Consent Order, the assessment of Board supervision being provided to the Bank, which was previously required and provided to the OCC under the Formal Agreement.

 

The Compliance Committee completed this review and assessment, including obtaining Board approval of the findings and recommendations, in January 2012, and submitted its report to the OCC immediately thereafter.

Update, within 60 days of the effective date of the Consent Order, the written assessment of the capabilities of the Bank’s current management to perform present and anticipated duties and who have sufficient experience to address problem bank situations.


The Compliance Committee completed this assessment, including obtaining Board approval of the findings and recommendations, in January 2012, and submitted its report to the OCC immediately thereafter.


 

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Complete, within 90 days of the effective date of the Consent Order, a written analysis on the Board’s decision whether to sell, merge or liquidate the Bank or remain an independent national bank. In the event the Board decides the Bank is to remain independent, and the OCC has advised the Bank in writing that there is no supervisory objection to the Bank’s written analysis as outlined in the Consent Order, the Board must, within thirty (30) days thereafter, review and revise as necessary, and adopt, implement, and thereafter ensure Bank adherence to an updated written Strategic Plan for the Bank covering at least a three-year period.

The Board completed this written analysis and submitted it to the OCC on February 24, 2012.   

Achieve Tier 1 capital at least equal to 9% of adjusted total assets, Tier 1 risk based capital at least equal to 10%, and total risk based capital at least equal to 12% of risk-weighted assets by March 31, 2012.

The Bank did not achieve these capital requirements as of March 31, 2012; however, the Board is taking aggressive action to stabilize the Bank’s balance sheet and pursue conservative operating initiatives to enhance profitability, while simultaneously pursuing other strategic initiatives to improve the Bank’s capital position, including raising additional capital, continuing to limit the Bank’s growth, and/or selling assets.

Review and revise, within 90 days of the effective date of the Consent Order, the Bank’s Capital Plan to achieve and maintain compliance with stated minimum capital ratios. If the Bank fails to submit an acceptable Capital Plan, fails to implement or adhere to an approved Capital Plan, or fails to achieve and maintain the minimum capital ratios, and if directed so by the Assistant Deputy Controller (“ADC”), develop and submit, within 30 days of the ADC’s notice, a Disposition Plan detailing the Board’s plan to sell or merge the Bank or to implement a voluntary liquidation.

The OCC granted an extension to February 28, 2012, for compliance with this Article. The Board submitted its Capital Plan to the OCC on February 24, 2012.

Revise and revise as necessary, adopt, and implement, within 90 days of the effective date of the Consent Order, and thereafter ensure Bank adherence to a written Profit Plan to improve and sustain the earnings of the Bank.

The OCC granted an extension to February 28, 2012, for compliance with this Article. The Board submitted its Profit Plan to the OCC on February 24, 2012.

Review and revise as necessary, within 60 days of the effective date of the Consent Order, and thereafter maintain a comprehensive liquidity risk management program which assesses, on an ongoing basis, the Bank's current and projected funding needs, and ensures that sufficient funds or access to funds exist to meet those needs.

The OCC granted an extension to February 28, 2012, for compliance with this Article. The Board submitted its revised comprehensive liquidity risk management program, including example monitoring reports and revised policies, to the OCC on February 24, 2012.





23





Develop and implement, within 90 days of the effective date of the Consent Order, and thereafter ensure Bank adherence to a written program to reduce the high level of credit risk in the Bank. The program shall include, but not be limited to procedures which strengthen credit underwriting; management of credit operations and the maintenance of an adequate, qualified staff in all loan functional areas; and loan collections. At least quarterly, the Board shall prepare a written assessment of the Bank's credit risk, which shall evaluate the Bank's progress under the aforementioned program.

The Bank is continuing to utilize a criticized assets report covering the entire credit relationship with respect to such assets. Ongoing monthly monitoring is being performed by management and the Board of Directors and forwarded to the OCC.

Extend credit, directly or indirectly, including renewals, modifications or extensions, to a borrower whose loans or other extensions of credit exceed $300,000 and are criticized by the OCC or any other bank examiner, only after the Board or designated committee finds that the extension of additional credit is necessary to promote the best interests of the Bank, the Bank has performed an appropriate written credit and collateral analysis, and the Board’s formal plan to collect or strengthen the criticized asset will not be compromised by the extension of additional credit.

As of May 4, 2012, we are not aware of any violations of this provision of the Consent Order. All extensions of credit or modifications related to a criticized borrower have been properly approved by the Board.

Continue to ensure adherence to the Bank’s comprehensive policy for determining the adequacy of the Bank’s allowance for loan losses in accordance with Generally Accepted Accounting Principles (“GAAP”).

The Bank’s Allowance for Loan Losses methodology and model is reviewed and approved by the Board on a quarterly basis and forwarded to the OCC.

Review and revise as necessary, adopt, and implement, within 60 days of the effective date of the Consent Order, and thereafter ensure adherence to a written program to improve the Bank's loan portfolio management.

The OCC granted an extension to February 28, 2012, for compliance with this Article. The Board submitted its revised comprehensive loan portfolio management program, including example monitoring reports and revised policies, to the OCC on February 24, 2012.

Review and revise as necessary, adopt, and implement, within 60 days of the effective date of the Consent Order, and thereafter ensure adherence to a written concentration management program to improve the Bank's policies and procedures to control and monitor concentrations of credit.



The OCC granted an extension to February 28, 2012, for compliance with this Article. The Board submitted its revised comprehensive concentration management program, including example monitoring reports and revised policies, to the OCC on February 24, 2012.

Obtain, within 60 days of the effective date of the Consent Order (and thereafter, within 60 days from the receipt of any Report of Examination or other applicable correspondence from the OCC or any internal or external loan review), current and complete credit information on all loans lacking such information, including those criticized by the OCC or any other bank examiner.

As of May 4, 2012, we are not aware of any violations of this provision of the Consent Order.


 


24





Ensure, within 60 days of the effective date of the Consent Order (and thereafter, within 60 days from the receipt of any Report of Examination or other applicable correspondence from the OCC or any internal or external loan review), that proper collateral documentation is maintained on all loans and correct each collateral exception listed by the OCC or any other bank examiner.

As of May 4, 2012, we are not aware of any violations of this provision of the Consent Order.

Effective immediately, the Bank may grant, extend, renew, alter or restructure any loan or other extension of credit only after: (1) documenting the specific reason or purpose for the extension of credit; (2) identifying the expected source of repayment in writing; (3) structuring the repayment terms to coincide with the expected source of repayment; (4) obtaining and analyzing current and satisfactory credit information, including cash flow analysis, where loans are to be repaid from operations; and (5) documenting, with adequate supporting material, the value of collateral and properly perfecting the Bank's lien on it where applicable.

As of May 4, 2012, we are not aware of any violations of this provision of the Consent Order.

 

We intend to take all actions necessary to enable the Bank to comply with the requirements of the Consent Order, and as of the date hereof we believe we have submitted all documentation required to the OCC. However, we were unable to increase our capital ratios to the requirements in the Consent Order by March 31, 2012. There can be no assurance that the Bank will be able to comply fully with the remaining provisions of the Consent Order, and the determination of our compliance will be made by the OCC. However, we have taken significant steps as noted above in an effort to comply with the provisions of the Consent Order and are continuing to work toward full compliance. We anticipate that we will also need additional capital in order to continue to absorb the potential write-downs needed to remove the majority of nonperforming assets from our balance sheet, given the particularly challenging real estate market.  In addition, we have recently performed a thorough review of our loan portfolio including both nonperforming loans and performing loans.  We have stress tested our borrowers’ abilities to repay their loans and believe that we have identified substantially all of the loans that could become problem assets in the near future.  We have projected our estimate of the future possible losses associated with these potential problem assets, which will also require additional capital if these potential losses are realized.   As a result of the recent downturn in the financial markets, the availability of many sources of capital has become significantly restricted or has become increasingly costly as compared to the prevailing market rates prior to the volatility.  We cannot predict when or if the capital markets will return to more favorable conditions.  We are actively evaluating a number of capital sources and balance sheet management strategies to ensure that our projected level of regulatory capital can support our balance sheet and meet or exceed the minimum requirements set forth in the Consent Order.


Currently, the Company also has to obtain the prior written approval of the Federal Reserve Bank of Richmond before (1) declaring or paying any dividends, (2) directly or indirectly accepting dividends or any other form of payment representing a reduction in capital from the Bank, (3) making any distributions of interest, principal or other sums on subordinated debentures or trust preferred securities, (4) directly or indirectly, incurring, increasing or guaranteeing any debt, and (5) directly or indirectly, purchasing or redeeming any shares of its stock.  Pursuant to our plans to preserve capital, the Company has no plans to undertake any of the foregoing activities.


Results of Operations


Three months ended March 31, 2012 and 2011


We recorded net income of $189,023, or $0.09 per diluted share, for the quarter ended March 31, 2012, an increase of $1.7 million, or 113%, compared to a net loss of $1.5 million, or $0.71 per diluted share, for the quarter ended March 31, 2011. This change from a net loss to a net income position between comparable quarters was primarily driven by a gain on the sale of a bank-owned property, zero provision for loan losses and reduced net changes in fair value and losses on other real estate owned. Each of these components is discussed in greater detail below.





25






The following table sets forth information related to our average balance sheet, average yields on assets, and average costs of liabilities for the three months ended March 31, 2012 and 2011. We derived these yields by dividing annualized income or expense by the average balance of the corresponding assets or liabilities. We derived average balances from the daily balances throughout the periods indicated. The net amount of capitalized loan fees are amortized into interest income on loans.


     

For the Three Months Ended March 31,

 

2012

 

2011

 

 

 

 

 

 

 

 

 

 

 

 

 

Average
Balance

 

Income/
Expense

 

Yield/
Rate

 

Average
Balance

 

Income/
Expense

 

Yield/
Rate

 


 


 








  Federal funds sold and other

 $  10,343,010

 

$       12,174

 

 0.47%

 

 $     8,585,734

 

$       12,226

 

 0.58%

  Investment securities (1)

 12,839,033

 

87,260

 

 2.73  

 

 10,515,426

 

75,737

 

 2.92  

  Loans (2)

 76,242,072

 

1,006,529

 

 5.30  

 

 92,937,199

 

1,115,729

 

 4.87  

Total interest-earning assets

 $  99,424,115

 

$  1,105,963

 

 4.46%

 

$ 112,038,359

 

$  1,203,692

 

 4.36 %

 

 

 

 

 

 

 

 

 

 

 

 

  NOW accounts

 $    5,773,544

 

$         5,562

 

 0.39%

 

 $     6,144,809

 

$       10,659

 

 0.70%

  Savings & money market

 36,989,970

 

68,954

 

 0.75  

 

 33,983,710

 

100,850

 

 1.20  

  Time deposits (excluding brokered
      time deposits)

 37,947,543

 

104,237

 

 1.10  

 

 32,933,151

 

136,486

 

 1.68  

  Brokered time deposits

 8,436,534

 

50,062

 

 2.38  

 

 24,681,697

 

139,283

 

 2.29  

Total interest-bearing deposits

 89,147,591

 

228,815

 

 1.03  

 

 97,743,367

 

387,278

 

 1.61  

  Borrowings

 7,154,685

 

52,737

 

 2.96  

 

 7,085,742

 

52,146

 

 2.98  

       Total interest-bearing liabilities

 $  96,302,276

 

$     281,552

 

 1.17%

 

 $ 104,829,109

 

$    439,424

 

 1.70 %

 

 

 

 

 

 

 

 

 

 

 

 

Net interest spread

 

 

 

 

 3.29%

 

 

 

 

 

 2.66%

Net interest income/ margin

 

 

 $     824,411

 

 3.33%

 

 

 

$    764,268

 

 2.77 %


(1)

The average balances for investment securities exclude the unrealized gain recorded for available for sale securities.

(2)

Nonaccrual loans are included in average balances for yield computations.


For the three months ended March 31, 2012, we recognized $1.1 million in interest income and $281,552 in interest expense, resulting in net interest income of $824,411, an increase of $60,143, or 8%, over the same period in 2011. Average earning assets decreased to $99.4 million for the three months ended March 31, 2012 from $112.0 million for the three months ended March 31, 2011, a decrease of $12.6 million, or 11%. This decrease in earning assets was primarily due to a $16.7 million decrease in average loans between periods offset by a $2.3 million increase in investment securities and a $1.8 million increase in federal funds sold. Average interest bearing liabilities decreased to $96.3 million for the three months ended March 31, 2012 from $104.8 million for the three months ended March 31, 2011, a decrease of $8.5 million, or 8%. During 2009, we adopted measures to promote the long term stability of the Bank. These measures included restructuring the balance sheet to focus on credit quality and management of our funding sources to increase liquidity and the net interest margin. As a result, average loans have decreased between periods, with funds from net loan payoffs being used to repay FHLB advances and brokered time deposits as well as to strengthen our liquidity position through cash and the investment securities portfolio. Net interest margin, calculated as annualized net interest income divided by average earning assets, increased from 2.77% for the quarter ended March 31, 2011 to 3.33% for the quarter ended March 31, 2012, primarily due to a decrease in cost of funds from 1.70% to 1.17% between periods, as well as an increase in yield on earning assets from 4.36% to 4.46% between periods, due to the mix of liabilities and the timing of their repricing.  




26




We did not recognize any provision for loan losses for the quarter ended March 31, 2012, representing a decrease of $870,000, or 100%, compared to the expense of $870,000 for the quarter ended March 31, 2011. The allowance as a percentage of gross loans decreased to 2.67% as of March 31, 2012 compared to 2.74% at December 31, 2011.  Specific reserves were approximately $443,000 on impaired loans of $8.6 million as of March 31, 2012 compared to specific reserves of approximately $564,000 on impaired loans of $8.9 million as of December 31, 2011. As of March 31, 2012, the general reserve allocation was 2.34% of gross loans not impaired compared to 2.27% as of December 31, 2011. The sharp decrease in provision for loan losses for the current quarter is due to the significant decrease in loan balances between the comparable periods and a decrease in net charge-off levels combined with a lack of new required specific reserves. As discussed above, we reallocated our reserves between loan types due to a shift to an eight quarter charge-off history, adjusted for portfolio and economic factors, as a basis for our loss factors in our allowance model. For the quarter ended March 31, 2011, the large provision expense was a result of higher impaired and nonaccrual loans, and their related specific reserves, in addition to an increase in the general allowance allocation due to declining economic conditions and increased charge-off levels. Though we continue to have elevated levels of non-performing loans, we did experience a decrease in non-performing loans and net charge-offs during the quarter ended March 31, 2012 compared to the quarter ended March 31, 2011.  The provision for loan losses is discussed further below under “Provision and Allowance for Loan Losses.”


For the three months ended March 31, 2012, noninterest income was $62,682 compared to $54,734 for the three months ended March 31, 2011, an increase of $7,948, or 15%, between comparable periods. Other noninterest income for the three months ended March 31, 2012 and 2011 was derived from service charges on deposits, customer service fees, gains on investment securities sales, and mortgage origination income. In addition, we recognized a gain of $15,990 on the sale of investment securities available for sale.


During the current quarter, we incurred noninterest expenses of $698,070, compared to noninterest expenses of $1.4 million for the quarter ended March 31, 2011, a decrease of $732,234, or 51%. This decrease in noninterest expenses for the three month period ended March 31, 2012 primarily resulted from a decrease of $865,399, or 164%, in real estate owned activity which includes expenses to carry other real estate, gains and losses on sales of other real estate, as well as write-downs on real estate owned. Included in real estate owned activity is a $522,000 gain on the sale of a piece of property originally purchased by the Bank to be used as a future headquarters but was transferred to other real estate owned upon entering into a contract to sell the property. In addition, the decrease in expense was attributable to a property which incurred a large write-down during the quarter ended March 31, 2011 based on an appraisal received in that year. Write-downs or recoveries and gains or losses are charged against income, if necessary, as a result of our regular review of the fair value of repossessed property. Offsetting this large decrease was an increase in compensation and benefits of $34,827 due to vacant positions in the March 31, 2011 quarter which were filled prior to the quarter ended March 31, 2012. In addition, professional fees increased $103,030 due to consulting and legal expenses related to compliance with our Consent Order as well as strategic initiatives to increase capital.


We did not recognize any income tax benefit or expense for the three months ended March 31, 2012 and 2011. Accounting literature states that a deferred tax asset should be reduced by a valuation allowance if, based on the weight of all available evidence, it is more likely than not (a likelihood of more than 50%) that some portion or the entire deferred tax asset will not be realized. The determination of whether a deferred tax asset is realizable is based on weighting all available evidence, including both positive and negative evidence. In making such judgments, significant weight is given to evidence that can be objectively verified. During our September 30, 2010 quarterly analysis of the valuation allowance recorded against our deferred tax assets, we determined that it was not more likely than not that our deferred tax assets will be recognized in future years due to the continued decline in credit quality and the resulting impact on net interest margin, increased net losses, and negative impact on capital as a result of provision for loan losses and write-downs on other real estate owned, and booked a 100% valuation allowance against the deferred tax asset. We will continue to analyze our deferred tax assets and related valuation allowance each quarter taking into account performance compared to forecast and current economic or internal information that would impact forecasted earnings. No expense was recognized on net income for the quarter ended March 31, 2012 due to the Company’s large cumulative net operating loss carry-forward position as well as the 100% valuation allowance on our deferred tax assets. The net income for the quarter ended March 31, 2012 does not represent a trend toward sustained profitability.

 



27




Assets and Liabilities


General


Total assets as of March 31, 2012 were $113.4 million, representing an increase of $1.1 million, or 1%, compared to December 31, 2011. The increase in assets is due to an increase in deposits of approximately $917,000 which contributed to the increase in our cash and cash equivalents.  Loans decreased $3.5 million, which was the result of $2.1 million of net loan payoffs and $1.4 million in transfers between loans and other real estate owned. Other real estate owned remained relatively flat due to the repossession of four properties offset by the sale of two properties as well as net write-downs taken during the three months ended March 31, 2012. Investment securities decreased due to mortgage-backed securities repayments of approximately $415,000. These decreases were offset by an increase in cash and cash equivalents of $4.9 million. At March 31, 2012, our total assets consisted principally of $20.1 million in cash and due from banks, $12.3 million in investment securities, $71.3 million in net loans, $2.3 million in property and equipment and $5.4 million in other real estate owned and repossessed assets. Our management closely monitors and seeks to maintain appropriate levels of interest-earning assets and interest-bearing liabilities so that maturities of assets are such that adequate funds are provided to meet customer withdrawals and demand.


Liabilities at March 31, 2012 totaled $104.8 million, representing an increase of approximately $888,000, or 9%, compared to December 31, 2011, and consisted principally of $97.5 million in deposits and $7.0 million in borrowings. Our borrowings consisted of FHLB advances and customer repurchase agreements. At March 31, 2012, shareholders’ equity was $8.7 million compared to $8.4 million at December 31, 2011. The increase in shareholders’ equity was due to net income of $189,023 for the three months ended March 31, 2012 as well as an increase in unrealized gains on investment securities.


Loans


Since loans typically provide higher interest yields than other types of interest-earning assets, we invest a substantial percentage of our earning assets in our loan portfolio. At March 31, 2012, our gross loan portfolio consisted primarily of $47.4 million of commercial real estate loans, $10.5 million of commercial business loans, and $15.5 million of consumer and home equity loans. Our current loan portfolio composition is not materially different than the loan portfolio composition disclosed in the footnotes to the consolidated financial statements included in our Annual Report on Form 10-K for 2011 as filed with the SEC. We experienced net payoffs of $2.1 million during the three months ended March 31, 2012 due to low market demand, careful consideration of liquidity needs and credit risk management.


Loan Performance and Asset Quality


The downturn in general economic conditions over the past three years has resulted in increased loan delinquencies, defaults and foreclosures within our loan portfolio. The declining real estate market has had a significant impact on the performance of our loans secured by real estate. In some cases, this downturn has resulted in a significant impairment to the value of our collateral and our ability to sell the collateral upon foreclosure. Although the real estate collateral provides an alternate source of repayment in the event of default by the borrower, in our current market the value of the collateral has deteriorated during the time the credit is extended.  There is a risk that this trend will continue, which could result in additional loss of earnings, increases in our provision for loan losses and loan charge-offs.


Past due payments are often one of the first indicators of a problem loan. We perform a continuous review of our past due report in order to identify trends that can be resolved quickly before a loan becomes significantly past due. We determine past due and delinquency status based on the contractual terms of the note. When a borrower fails to make a scheduled loan payment, we attempt to cure the default through several methods including, but not limited to, collection contact and assessment of late fees.  Generally, a loan will be placed on nonaccrual status when it becomes 90 days past due as to principal or interest (unless the loan is well-collateralized and in the process of collection), or when management believes, after considering economic and business conditions and collection efforts, that the borrower’s financial condition is such that collection of the loan is doubtful.  When a loan is placed in nonaccrual status, interest accruals are discontinued and income earned but not collected is reversed. Cash receipts on nonaccrual loans are not recorded as interest income, but are used to reduce principal.





28




Refer to Note 4, Loans, for a table summarizing delinquencies and nonaccruals, by portfolio class, as of March 31, 2012 and December 31, 2011.  Total delinquent and nonaccrual loans increased slightly from $6.4 million at December 31, 2011 to $6.6 million at March 31, 2012, an increase of $220,595 or 3%. This increase was a result of movement in several categories. Nonaccrual loans remained flat during the quarter due to the repossession of single and multifamily residential real estate and construction and development properties in satisfaction of loans offset by one construction and development loan moving to nonaccrual status. At March 31, 2012, nonaccrual loans represented 6.7% of gross loans compared to 6.6% of gross loans as of December 31, 2011. Loans past due 30-89 days are considered potential problem loans and amounted to $488,198 at March 31, 2012 compared to $1,357,427 at December 31, 2011. The decrease in this category is primarily due to two loans which returned to current status. During the quarter ended March 31, 2012, one loan became >90 days past due but is still accruing interest as the loan is well-secured and in the process of collection through normal means. Management does not believe there is doubt as to the full colletability of principal and interest on this loan.   This relationship will be brought current as to principal and interest in May based on scheduled lot sales.


Another method used to monitor the loan portfolio is credit grading. As part of the loan review process, loans are given individual credit grades, representing the risk we believe is associated with the loan balance. Credit grades are assigned based on factors that impact the collectability of the loan, the strength of the borrower, the type of collateral, and loan performance. Commercial loans are individually graded at origination and credit grades are reviewed on a regular basis in accordance with our loan policy. Consumer loans are assigned a “pass” credit rating unless something within the loan warrants a specific classification grade. Refer to Note 4, Loans, for a table summarizing management’s internal credit risk grades, by portfolio class, as of March 31, 2012 and December 31, 2011.

 

Loans graded one through four are considered “pass” credits. At March 31, 2012, approximately 86% of the loan portfolio had a credit grade of “pass” compared to 84% at December 31, 2011.  For loans to qualify for this grade, they must be performing relatively close to expectations, with no significant departures from the intended source and timing of repayment. Consumer loans are assigned a “pass” credit rating unless something within the loan warrants a specific classification grade.


Loans with a credit grade of five are not considered classified; however they are categorized as a special mention or watch list credit, and are considered potential problem loans. This classification is utilized by us when we have an initial concern about the financial health of a borrower.  These loans are designated as such in order to be monitored more closely than other credits in our portfolio. We then gather current financial information about the borrower and evaluate our current risk in the credit.  We will then either reclassify the loan as “substandard” or back to its original risk rating after a review of the information.  There are times when we may leave the loan on the watch list, if, in management’s opinion, there are risks that cannot be fully evaluated without the passage of time, and we determine to review the loan on a more regular basis.  Loans on the watch list are not considered problem loans until they are determined by management to be classified as substandard. As of March 31, 2012, we had loans totaling $1.4 million on the watch list compared to $1.6 million as of December 31, 2011, a decrease of approximately $176,000 million or 11%. This decrease in watch list loans was due to the full payoff of one loan within this category. No loans were added to the watch list during the quarter ended March 31, 2012 nor were any loans downgraded during the quarter.


Loans graded six or greater are considered classified credits. At March 31, 2012 and December 31, 2011, classified loans totaled $8.8 million and $10.7 million, respectively. The decrease in this category of $1.9 million, or 18%, during the three months ended March 31, 2012 is due to the repossession of four properties totaling $1.4 million, charge-offs of approximately $152,000, and the upgrade of one relationship in the amount of $507,000 to “pass” based on the strength of the borrower which changed due to an acquisition of a related entity. Classified credits are evaluated for impairment on a quarterly basis.


A loan is considered impaired when, based on current information and events, it is probable that we will be unable to collect the scheduled payments of principal or interest when due, according to the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Impairment is measured on a loan-by-loan basis by calculating either the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s obtainable market price, or the fair value of the collateral if the loan is collateral dependent.  The resultant shortfall is charged to provision for loan losses and is classified as a specific reserve. When an impaired loan is ultimately charged-off, the charge-off is taken against the specific reserve.


At March 31, 2012, impaired loans totaled $8.6 million, all of which were valued on a nonrecurring basis at the lower of cost or market value of the underlying collateral.  Market values were obtained using independent appraisals, updated in accordance with our reappraisal policy, or other market data such as recent offers to the borrower. As of March


29





31, 2012, we had loans totaling approximately $160,000 that were classified in accordance with our loan rating policies but were not considered impaired. Refer to Note 4, Loans, for a table summarizing information relative to impaired loans, by portfolio class, at March 31, 2012 and December 31, 2011.


TDRs are loans which have been restructured from their original contractual terms and include concessions that would not otherwise have been granted outside of the financial difficulty of the borrower. Concessions can relate to the contractual interest rate, maturity date, or payment structure of the note. As part of our workout plan for individual loan relationships, we may restructure loan terms to assist borrowers facing challenges in the current economic environment. The purpose of a TDR is to facilitate ultimate repayment of the loan.


The carrying balance of troubled debt restructurings as of March 31, 2012 was $1.3 million and consisted of two performing loans within one relationship. The carrying balance of troubled debt restructurings as of December 31, 2011 was $1.3 million which consisted of two non-performing loans in one relationship, and the collateral securing these loans was subsequently transferred to real estate owned during the quarter ended March 31, 2012.

  

There were two commercial real estate loans that were modified during the three months ended March 31, 2012 totaling $1.3 million (pre-modification investment equaling post-modification investment). These loans were modified with a term concession.


There were no loans modified as troubled debt restructurings within the previous 12-month period for which there was a payment default during the three months ended March 31, 2012.


Provision and Allowance for Loan Losses


We have established an allowance for loan losses through a provision for loan losses charged to expense on our consolidated statement of operations. At March 31, 2012, the allowance for loan losses was $2.0 million, or 2.67% of gross loans, compared to $2.1 million at December 31, 2011, or 2.74% of gross loans. This decrease in the allowance for loan losses is due to charge-offs taken against specific reserves, as well as payoffs in our residentitial and commercial real estate portfolios, which carry higher historical loss ratios and, consequently, higher reserve factors within our allowance model.


The allowance for loan losses represents an amount which we believe will be adequate to absorb probable losses on existing loans that may become uncollectible. We strive to follow a comprehensive, well-documented, and consistently applied analysis of our loan portfolio in determining an appropriate level for the allowance for loan losses. Our judgment as to the adequacy of the allowance for loan losses is based on a number of assumptions about future events, which we believe to be reasonable, but which may or may not prove to be accurate. Our determination of the allowance for loan losses is based on what we believe are all significant factors that impact the collectability of loans, including consideration of factors such as the balance of impaired loans, the quality, mix, and size of our overall loan portfolio, economic conditions that may affect the borrower’s ability to repay, the amount and quality of collateral securing the loans, our historical loan loss experience, and a review of specific problem loans. We also consider subjective issues such as changes in lending policies and procedures, changes in the local/national economy, changes in volume or type of credits, changes in volume/severity of problem loans, quality of loan review and Board of Director oversight, concentrations of credit, and peer group comparisons.


Our allowance for loan losses consists of both specific and general reserve components. The specific reserve component relates to loans that are impaired loans as defined in FASB ASC Topic 310, “Receivables”. Loans determined to be impaired are excluded from the general reserve calculation described below and evaluated individually for impairment. Impaired loans totaled $8.6 million at March 31, 2012, with an associated specific reserve of $443,493. See Note 4, Loans, as well as the above discussion under “Loan Performance and Credit Quality” for additional information related to impaired loans.


The general reserve component covers non-impaired loans and is calculated by applying historical loss factors to each sector of the loan portfolio and adjusting for qualitative environmental factors. Qualitative adjustments are used to adjust the historical average for changes to loss indicators within the economy, our market, and specifically our portfolio. The general reserve component is then combined with the specific reserve to determine the total allowance for loan losses.




30





Refer to Note 4, Loans, for a table summarizing activity related to our allowance for loan losses for the three months ended March 31, 2012 and 2011, by portfolio segment. As of March 31, 2012, the allowance for loan losses was $2.0 million, or 2.67% of gross loans, compared to $2.1 million, or 2.74% of gross loans, as of December 31, 2011 and $3.1 million, or 3.45% of gross loans, as of March 31, 2011. We recognized zero provision for loan losses for the three months ended March 31, 2012, a decrease of $870,000, or 100%, compared to the expense of $870,000 for the three months ended March 31, 2011. Net loan charge-offs decreased significantly during the quarter ended March 31, 2012, from $808,720 for the three months ended March 31, 2011 to $152,288 for the three months ended March 31, 2012, a decrease of $656,432 or 81%. This decrease in net charge-offs is due to elevated levels of net charge-offs in 2011 due to the impact of the extended duration of this economic deterioration on our borrowers as well as poor asset quality trends in our loan portfolio.  Charge-offs thus far in 2012 relate to unsecured consumer loans and write-downs of collateral to fair value, against specific reserves, at the time of repossession. The charge-offs during the three months ended March 31, 2011 were partial charge-offs taken on certain collateral-dependent loans within our real estate portfolio segments. Partial charge-offs were based on recent appraisals and evaluations on commercial real estate loans in the process of foreclosure. Loans with partial charge-offs are typically considered impaired loans and remain on nonaccrual status.  As new appraisals have been obtained late in 2011 and early in 2012 in accordance with our re-appraisal policy, deteriorations in collateral values have slowed resulting in fewer partial charge-offs.


Other Real Estate Owned and Repossessed Assets


As of March 31, 2012 and December 31, 2011, we had $5.4 million in other real estate owned and $39,457 in repossessed assets. During the three months ended March 31, 2012, four pieces of collateral were obtained from three loan relationships that went through the foreclosure process. We also completed the sale of two repossessed properties. The following table summarizes changes in other real estate owned and repossessed assets for the three months ended March 31, 2012:


 

 

 

 

2012

Balance at beginning of period

$    5,389,501 

Repossessed property acquired in settlement of loans

1,379,030 

Sales of repossessed property

(1,733,944)

Gain on sale and write-downs of repossessed property, net

411,433 

Balance at end of period

$    5,446,020 


As of March 31, 2012, other real estate owned consisted of residential land lots valued at $1.2 million, 1-4 family residential dwellings valued at $1.7 million, commercial land valued at $1.9 million and commercial office space valued at $581,212. Repossessed assets consisted of equipment valued at $39,457. These assets are being actively marketed with the primary objective of liquidating the collateral at a level which most accurately approximates fair value and allows recovery of as much of the unpaid principal loan balance as possible upon the sale of the asset within a reasonable period of time. Based on currently available valuation information, the carrying value of these assets is believed to be representative of their fair value less estimated costs to sell, although there can be no assurance that the ultimate proceeds from the sale of these assets will be equal to or greater than their carrying values, particularly in the current real estate environment and the continued downward trend in third party appraised values.

 

Deposits


Our primary source of funds for loans and investments is our deposits. At March 31, 2012, we had $97.5 million in deposits, representing an increase of $917,112, or 1%, compared to December 31, 2011. Deposits at March 31, 2012 consisted primarily of $15.4 million in demand deposit accounts, $38.0 million in money market accounts and $43.6 million in time deposits. During the fourth quarter of 2006, we began obtaining deposits outside of our local market area in the form of brokered time deposits. Due to the interest rate environment in our market, as well as strong competition from other banking and financial services companies in gathering deposits, brokered time deposits allowed us to obtain funding in order to support loan growth. However, due to regulatory constraints, including as a result of our Consent Order, we can no longer accept brokered time deposits without prior approval from the FDIC. At March 31, 2012, we had $5.5 million in brokered time deposits, a decrease of $4.0 million compared to December 31, 2011 balances of $9.5 million.   Our strong customer deposit growth during 2011 and thus far in 2012, along with the decrease in our loan portfolio, enabled us to maintain a strong liquidity position while decreasing our reliance on brokered deposits, thereby lowering our cost of interest-bearing liabilities. We will continue to reduce our reliance on brokered time deposits and other noncore funding sources, while focusing our efforts to gather core deposits in our local market. Our loan-to-deposit ratio was 75.2% and 79.6% at March 31, 2012 and December 31, 2011, respectively.



31




Since January 20, 2010, we have had to obtain written approval from the OCC to accept, renew or rollover brokered time deposits, and as a result of the Consent Order we are no longer permitted to renew or rollover brokered time deposits without the permission of the FDIC. During the next six months of 2012, we have $3.9 million of brokered deposits maturing. We believe we have adequate funding sources available to pay off brokered deposits as they mature. See additional discussion below under “Liquidity.”


Borrowings


We use borrowings to fund growth of earning assets in excess of deposit growth. Borrowings totaled $7.0 million at March 31, 2012, compared to $7.1 million at December 31, 2011. FHLB advances accounted for $7.0 million of total borrowings as of March 31, 2012 and December 31, 2011. These advances are secured with approximately $50.0 million of first and second mortgage loans and $646,800 of stock in the FHLB.  The remaining balance in borrowings represents customer repurchase agreements.


Liquidity


Liquidity represents the ability of a company to convert assets into cash or cash equivalents without significant loss, and the ability to raise additional funds by increasing liabilities. Liquidity management involves monitoring our sources and uses of funds in order to meet our day-to-day cash flow requirements while maximizing profits. Liquidity management is made more complicated because different balance sheet components are subject to varying degrees of management control. For example, the timing of maturities of our investment portfolio is fairly predictable and subject to a high degree of control at the time investment decisions are made. However, net deposit inflows and outflows are far less predictable and are not subject to the same degree of control.


Our ability to maintain and expand our deposit base and borrowing capabilities serves as our primary source of liquidity.  We plan to meet our future cash needs through the liquidation of temporary investments and the generation of deposits within our market. In addition, we will receive cash upon the maturity and sale of loans and the maturity of investment securities. Our investment securities available for sale at March 31, 2012 amounted to $12.3 million, or 10.8% of total assets. Investment securities traditionally provide a secondary source of liquidity since they can be converted into cash in a timely manner.  At March 31, 2012, $4.7 million of our investment portfolio was pledged against outstanding debt. Therefore, the related debt would need to be repaid prior to the securities being sold and converted to cash.


We plan to continue reducing brokered time deposits during 2012, and have set aside liquid assets to pay the $3.9 million in brokered deposits that are scheduled to mature by September 30, 2012.   As brokered deposits and advances have matured in 2011 and 2012, we have not replaced these funds with wholesale funding as we have sought to reduce our reliance on brokered time deposits and other noncore funding sources. Since January 20, 2010, we have had to obtain written approval from the OCC to accept, renew or rollover brokered time deposits, and under the terms of the Consent Order we are no longer permitted to renew or rollover brokered time deposits without the permission of the FDIC. We believe we have adequate funding sources available to pay off brokered deposits as they mature.


We are a member of the FHLB, from which applications for borrowings can be made for leverage purposes. The FHLB requires that securities, qualifying mortgage loans, and stock of the FHLB owned by the Bank be pledged to secure any advances from the FHLB. At March 31, 2012, we had collateral that would support approximately $5.6 million in additional borrowings. Like all banks, we are subject to the FHLB’s credit risk rating policy which assigns member institutions a rating which is reviewed quarterly.  The rating system utilizes key factors such as loan quality, capital, liquidity, profitability, etc.  During the fourth quarter of 2010, the FHLB downgraded our credit risk rating, which resulted in decreased borrowing availability (total line reduced to 15% of total assets from 20% of total assets) and increased collateral requirements (moved to 125% of borrowings from 115%). Our ability to access our available borrowing capacity from the FHLB in the future is subject to our rating and any subsequent changes based on our financial performance as compared to factors considered by the FHLB in their assignment of our credit risk rating each quarter.    


We also pledge collateral to the Federal Reserve Bank’s Borrower-in-Custody of Collateral program, and our available credit under this program was approximately $8.3 million as of March 31, 2012. During the second quarter of 2011, we were informed by the Federal Reserve Bank that our available credit under the Borrower-in-Custody of Collateral program had been moved from Primary Credit to Secondary Credit, meaning borrowing requests have to be reviewed and approved in advance, and advances are to be short term in nature. This change also resulted in an increase in our collateral requirements and a corresponding decrease in our borrowing capacity with the Federal Reserve Bank.

  

We have a $2.0 million federal funds purchased line of credit through a correspondent bank that is secured by investment securities, but has not been utilized.



32




We believe our liquidity sources are adequate to meet our operating needs. However, we continue to carefully focus on liquidity management during 2012. Comprehensive weekly and monthly liquidity analyses serve management as vital decision-making tools by providing summaries of anticipated changes in loans, investments, core deposits, and wholesale funds. These internal funding reports provide management with the details critical to anticipate immediate and long-term cash requirements, such as expected deposit runoff, loan paydowns and amount and cost of available borrowing sources, including secured overnight federal funds lines with our various correspondent banks. 

 

The level of liquidity is measured by the cash, cash equivalents, and investment securities available for sale to total assets ratio, which was at 28.5% at March 31, 2012 compared to 24.8% as of December 31, 2011. The increase in liquidity is due to net loan payoffs of $2.1 million and an increase in deposits of $917,112 during the three months ended March 31, 2012.


Impact of Off-Balance Sheet Instruments


Through the operations of our Bank, we have made contractual commitments to extend credit in the ordinary course of our business activities.  These commitments are legally binding agreements to lend money to our customers at predetermined interest rates for a specified period of time. At March 31, 2012, we had issued commitments to extend credit of $9.8 million through various types of lending arrangements. We evaluate each customer’s credit worthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by us upon extension of credit, is based on our credit evaluation of the borrower. Collateral varies but may include accounts receivable, inventory, property, plant and equipment, and commercial and residential real estate. We manage the credit risk on these commitments by subjecting them to normal underwriting and risk management processes.


Commitments and Contingencies


As of March 31, 2012, there were no significant firm commitments outstanding for capital expenditures.


Capital Resources


Total shareholders' equity increased to $8.7 million at March 31, 2012 from $8.4 million at December 31, 2011, due to net income of $189,023 for the three months ended March 31, 2012 as well as an increase in unrealized gains on investment securities. We believe that our capital is sufficient to fund the activities of our Bank’s operations; however, the rate of net losses has deteriorated our capital base below our established individual minimum capital ratios as discussed in greater detail below. We have not been immune to the unprecedented levels of extended volatility and disruption in the capital and credit markets and can give no assurances with respect to our capital levels.  


Our Bank and Company are subject to various regulatory capital requirements administered by the federal banking agencies. However, the Federal Reserve guidelines contain an exemption from the capital requirements for “small bank holding companies,” which in 2006 were amended to cover most bank holding companies with less than $500 million in total assets that do not have a material amount of debt or equity securities outstanding registered with the SEC. Although our class of common stock is registered under Section 12 of the Securities Exchange Act, we believe that because our stock is not listed on any exchange or otherwise actively traded, the Federal Reserve Board will interpret its new guidelines to mean that we qualify as a small bank holding company. Nevertheless, our Bank remains subject to these capital requirements. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Bank's financial statements.  Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of the Bank's assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices. The Bank's capital amounts and classifications are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors.





33






Quantitative measures established by regulation to ensure capital adequacy require the Bank to maintain minimum ratios of Tier 1 and total capital as a percentage of assets and off-balance-sheet exposures, adjusted for risk weights ranging from  0% to 100%. Tier 1 capital of the Bank consists of common shareholders' equity, excluding the unrealized gain or  loss on securities available for sale, less certain intangible assets. The Bank's Tier 2 capital consists of the allowance for loan losses subject to certain limitations.  Total capital for purposes of computing the capital ratios consists of the sum of Tier 1 and Tier 2 capital. The regulatory minimum requirements are 4% for Tier 1 capital and 8% for total risk-based capital.


The Bank is also required to maintain capital at a minimum level based on quarterly average assets, which is known as the leverage ratio. Only the strongest banks are allowed to maintain capital at the minimum requirement of 3%.  All others are subject to maintaining ratios 1% to 2% above the minimum.


On November 14, 2011, the Bank entered into a Consent Order with its primary regulator, the OCC, which contains a requirement that the Bank maintain minimum capital requirements that exceed the minimum regulatory capital ratios for “well-capitalized” banks. The Consent Order requires the Bank to achieve Tier 1 capital at least equal to 9% of adjusted total assets, Tier 1 risk based capital at least equal to 10%, and total risk based capital at least equal to 12% of risk-weighted assets by March 31, 2012. As a result of the Consent Order, the Bank is no longer deemed “well-capitalized” regardless of its capital levels.  The Bank did not achieve these capital requirements by March 31, 2012; therefore, the OCC has the authority to subject us to further enforcement actions. See additional discussion above under “Recent Regulatory Developments.”


The following table summarizes the capital amounts and ratios of the Bank and the regulatory minimum requirements at March 31, 2012 and December 31, 2011.

 

(Dollars in thousands)

 

 

 

 

Per capital directive
of the Consent Order

 

For capital
adequacy purposes

 

To be well capitalized
under prompt
corrective
action provisions

 

 

Actual

 

Minimum

 

Minimum

 

Minimum

 

 

Amount

 

   Ratio

 

Amount

 

Ratio

 

Amount

 

Ratio

 

Amount

 

Ratio

 

 

 

 

 

 

 

 

 

 

   

 

 

 

 

As of March 31, 2012

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total Capital (to risk weighted assets)

$ 9,575,000

 

11.2%

 

$10,237,000

 

12.0%

 

$ 6,824,000

 

8.0%

 

$8,531,000

 

10.0%

 

Tier 1 Capital (to risk weighted assets)

8,497,000

 

10.0  

 

8,531,000

 

10.0  

 

3,412,000

 

 4.0  

 

5,118,000

 

6.0  

 

Tier 1 Capital (to average assets)

8,497,000

 

7.6  

 

10,055,000

 

9.0  

 

4,469,000

 

 4.0  

 

5,586,000

 

5.0  

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

As of December 31, 2011

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total Capital (to risk weighted assets)

$ 9,420,000

 

10.7%

 

$10,550,000

 

12.0%

 

$ 7,033,000

 

8.0%

 

$8,792,000

 

10.0%

 

Tier 1 Capital (to risk weighted assets)

8,308,000

 

9.5  

 

8,792,000

 

10.0  

 

3,517,000

 

 4.0  

 

5,275,000

 

6.0  

 

Tier 1 Capital (to average assets)

8,308,000

 

7.3  

 

10,266,000

 

9.0  

 

4,563,000

 

 4.0  

 

5,703,000

 

5.0  

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 


34





Item 3. Quantitative and Qualitative Disclosures About Market Risk


Not applicable


Item 4. Controls and Procedures


As of the end of the period covered by this report, we carried out an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer and acting Principal Financial and Accounting Officer, of the effectiveness of our disclosure controls and procedures as defined in Exchange Act Rule 13a-15(e). Based upon that evaluation, our Chief Executive Officer and acting Principal Financial and Accounting Officer have concluded that our current disclosure controls and procedures are effective as of March 31, 2012. There have been no significant changes in our internal controls over financial reporting during the fiscal quarter ended March 31, 2012 that have materially affected, or are reasonably likely to materially affect, our internal controls over financial reporting.


The design of any system of controls and procedures is based in part upon certain assumptions about the likelihood of future events. There can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions, regardless of how remote.

 


Part II - Other Information


Item 1. Legal Proceedings


There are no material pending legal proceedings to which we are a party or of which any of our properties are the subject.


Item 1A. Risk Factors


Not applicable


Item 2. Unregistered Sales of Equity Securities and Use of Proceeds


Not applicable


Item 3. Default Upon Senior Securities


Not applicable


Item 4.  Mine Safety Disclosures


Not applicable


Item 5. Other Information


As previously disclosed in our report on Form 8-K filed on April 4, 2012, Kimberly D. Barrs resigned as Executive Vice President and Acting Chief Financial Offer of the company and the Bank effective as of April 30, 2012. Lawrence R. Miller, the Chief Executive officer of the Company and the Bank, is serving as the acting Principal Financial and Accounting Officer as of January 1, 2012.






35






Item 6. Exhibits



31.1

Rule 13a-14(a) Certification of the Principal Executive Officer and acting Principal Financial and Accounting Officer.


32

Section 1350 Certifications.


101

The following materials from the Company’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2012, formatted in eXtensible Business Reporting Language (XBRL); (i) Consolidated Balance Sheets at March 31, 2012 and December 31, 2011, (ii) Consolidated Statements of Operations and Comprehensive Income (Loss) for the three months ended March 31, 2012 and 2011, (iii) Consolidated Statements of Changes in Shareholders’ Equity for the three months ended March 31, 2012 and 2011, (iv) Consolidated Statements of Cash Flows for the three months ended March 31, 2012 and 2011, and (v) Notes to Consolidated Financial Statements*.

* Pursuant to Rule 406T of Regulation S-T, the Interactive Data Files on Exhibit 101 hereto are deemed not filed or part of a registration statement or prospectus for purposes of Sections 11 or 12 of the Securities Act of 1933, as amended, are deemed not filed for purposes of Section 18 of the Securities and Exchange Act of 1934, as amended, and otherwise are not subject to liability under those sections.  








36







SIGNATURES


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





Date: May 4, 2012

By:  /s/ Lawrence R. Miller                      

Lawrence R. Miller

Chief Executive Officer and acting Principal Financial

and Accounting Officer







37






EXHIBIT INDEX


Exhibit

Number

Description



31.1

Rule 13a-14(a) Certification of the Principal Executive Officer and acting Principal Financial and Accounting Officer.


32

Section 1350 Certifications.


101

The following materials from the Company’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2012, formatted in eXtensible Business Reporting Language (XBRL); (i) Consolidated Balance Sheets at March 31, 2012 and December 31, 2011, (ii) Consolidated Statements of Operations and Comprehensive Income (Loss) for the three months ended March 31, 2012 and 2011, (iii) Consolidated Statements of Changes in Shareholders’ Equity for the three months ended March 31, 2012 and 2011, (iv) Consolidated Statements of Cash Flows for the three months ended March 31, 2012 and 2011, and (v) Notes to Consolidated Financial Statements*.

* Pursuant to Rule 406T of Regulation S-T, the Interactive Data Files on Exhibit 101 hereto are deemed not filed or part of a registration statement or prospectus for purposes of Sections 11 or 12 of the Securities Act of 1933, as amended, are deemed not filed for purposes of Section 18 of the Securities and Exchange Act of 1934, as amended, and otherwise are not subject to liability under those sections.