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SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES

EXCHANGE ACT OF 1934

 

FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2012

 

Commission file number: 000-33063

 

Sierra Bancorp

(Exact name of Registrant as specified in its charter)

 

California 33-0937517
(State of Incorporation) (IRS Employer Identification No)

 

86 North Main Street, Porterville, California 93257

(Address of principal executive offices)                  (Zip Code)

 

(559) 782-4900

(Registrant’s telephone number, including area code)

 

Not Applicable

(Former name, former address and former fiscal year, if changed since last report)

 

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days.

Yes  R                    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 during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

Yes  R                    No  £

 

Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.

Large accelerated filer £ Accelerated filer R
Non-accelerated filer £ (Do not check if a smaller reporting company) Smaller Reporting Company £

 

Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes  £                    No  R

 

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

 

Common stock, no par value, 14,103,209 shares outstanding as of April 30, 2012

 

 
 

FORM 10-Q

 

Table of Contents

  Page
Part I - Financial Information 1
Item 1. Financial Statements (Unaudited) 1
Consolidated Balance Sheets 1
Consolidated Statements of Income 2
Consolidated Statements of Income 3
Consolidated Statements of Cash Flows 4
Notes to Unaudited Consolidated Financial Statements 5
   
Item 2. Management’s Discussion & Analysis of Financial Condition & Results of Operations 26
Forward-Looking Statements 26
Critical Accounting Policies 26
Overview of the Results of Operations and Financial Condition 27
Earnings Performance 28
Net Interest Income and Net Interest Margin 28
Provision for Loan and Lease Losses 31
Non-interest Revenue and Operating Expense 32
Provision for Income Taxes 35
Balance Sheet Analysis 35
Earning Assets 35
Investments 35
Loan Portfolio 36
Nonperforming Assets 38
Allowance for Loan and Lease Losses 39
Off-Balance Sheet Arrangements 41
Other Assets 41
Deposits and Interest-Bearing Liabilities 42
Deposits 42
Other Interest-Bearing Liabilities 43
Non-Interest Bearing Liabilities 44
Liquidity and Market Risk Management 45
Capital Resources 47
   
Item 3. Qualitative & Quantitative Disclosures about Market Risk 49
   
Item 4. Controls and Procedures 49
   
Part II - Other Information 50
Item 1. - Legal Proceedings 50
Item 1A. - Risk Factors 50
Item 2. - Unregistered Sales of Equity Securities and Use of Proceeds 50
Item 3. - Defaults upon Senior Securities 50
Item 4. - (Removed and Reserved) 50
Item 5. - Other Information 50
Item 6. - Exhibits 51
   
Signatures 52

 

 
 

PART I - FINANCIAL INFORMATION

Item 1 – Financial Statements

 

 

SIERRA BANCORP

CONSOLIDATED BALANCE SHEETS

(dollars in thousands)

 

 

   March 31, 2012   December 31, 2011 
ASSETS  (unaudited)   (audited) 
Cash and due from banks  $40,672   $42,805 
Interest-bearing deposits in banks   31,070    20,231 
Total Cash & Cash Equivalents   71,742    63,036 
Investment securities available for sale   416,866    406,471 
Loans held for sale   763    1,354 
Loans and leases:          
Gross loans and leases   751,469    757,591 
Allowance for loan and lease losses   (17,408)   (17,283)
Deferred loan and lease fees, net   690    621 
Net Loans and Leases   734,751    740,929 
Premises and equipment, net   20,791    20,721 
Operating leases, net   345    384 
Foreclosed assets   15,679    15,364 
Goodwill   5,544    5,544 
Other assets   81,690    81,602 
TOTAL ASSETS  $1,348,171   $1,335,405 
           
LIABILITIES AND SHAREHOLDERS' EQUITY          
LIABILITIES          
Deposits:          
Non-interest bearing  $312,050   $300,045 
Interest bearing   810,828    786,223 
Total Deposits   1,122,878    1,086,268 
Federal funds purchased and repurchase agreements   5,845    3,037 
Short-term borrowings   -    17,120 
Long-term borrowings   5,000    15,000 
Junior subordinated debentures   30,928    30,928 
Other liabilities   13,275    14,488 
TOTAL LIABILITIES   1,177,926    1,166,841 
SHAREHOLDERS' EQUITY          
Common stock, no par value; 24,000,000 shares          
authorized; 14,103,209 and 14,101,609 shares issued          
and outstanding at March 31, 2012 and          
December 31, 2011, respectively   64,338    64,321 
Additional paid in capital   2,249    2,221 
Retained earnings   99,207    98,174 
Accumulated other comprehensive income   4,451    3,848 
TOTAL SHAREHOLDERS' EQUITY   170,245    168,564 
           
TOTAL LIABILITIES AND          
SHAREHOLDERS' EQUITY  $1,348,171   $1,335,405 

  

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

1
 

 

SIERRA BANCORP

CONSOLIDATED STATEMENTS OF INCOME

(dollars in thousands, except per share data, unaudited)

 

   For the Quarter   For the Quarter 
Interest income:  Ended March 31, 2012   Ended March 31, 2011 
Interest and fees on loans  $11,144   $11,782 
Interest on investment securities:          
Taxable   1,884    1,916 
Tax-exempt   666    716 
Interest on federal funds sold and interest-bearing deposits   14    8 
Total interest income   13,708    14,422 
           
Interest expense:          
Interest on deposits   885    1,091 
Interest on short-term borrowings   5    34 
Interest on long-term borrowings   131    140 
Interest on mandatorily redeemable trust preferred securities   199    181 
Total interest expense   1,220    1,446 
           
Net Interest Income   12,488    12,976 
           
Provision for loan losses   2,750    3,600 
           
Net Interest Income after Provision for Loan Losses   9,738    9,376 
           
Non-interest revenue:          
Service charges on deposit accounts   2,287    2,255 
Gains on investment securities available-for-sale   70    - 
Other income, net   1,688    1,321 
Total other operating income   4,045    3,576 
           
Other operating expense:          
Salaries and employee benefits   5,665    5,710 
Occupancy expense   1,489    1,575 
Other   4,829    4,417 
Total other operating expenses   11,983    11,702 
           
Income before income taxes   1,800    1,250 
           
Provision for income taxes   (79)   (279)
           
Net Income  $1,879   $1,529 
           
PER SHARE DATA          
Book value  $12.07   $11.55 
Cash dividends  $0.06   $0.06 
Earnings per share basic  $0.13   $0.11 
Earnings per share diluted  $0.13   $0.11 
Average shares outstanding, basic   14,101,879    13,981,780 
Average shares outstanding, diluted   14,107,551    14,060,661 
           
Total shareholder Equity (in thousands)  $170,245   $161,523 
Shares outstanding   14,103,209    13,985,761 
Dividends Paid (in thousands)  $846   $839 

 

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

2
 

 

SIERRA BANCORP

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(dollars in thousands, unaudited)

 

   For the Quarter   For the Quarter 
   Ended March 31, 2012   Ended March 31, 2011 
           
Net Income  $1,879   $1,529 
Other comprehensive income, before tax:          
Unrealized gains on securities:          
Unrealized holding gains arising during period   1,119    1,839 
Less: reclassification adjustment for gains included in net income   (70)   - 
Other comprehensive income, before tax   1,049    1,839 
Income tax expense related to items of other          
comprehensive income, net of tax   (446)   (773)
Other comprehensive income   603    1,066 
           
Comprehensive income  $2,482   $2,595 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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

3
 

 

SIERRA BANCORP

CONSOLIDATED STATEMENTS OF CASH FLOWS

(dollars in thousands, unaudited)

 

   Quarter Ended March 31, 
   2012   2011 
Cash flows from operating activities:          
Net income  $1,879   $1,529 
Adjustments to reconcile net income to net cash provided by operating activities:          
Gain on investment of securities   (70)   - 
Gain on sales of loans   (50)   (43)
Loss on disposal of fixed assets   -    53 
Loss (Gain) on sale on foreclosed assets   126    (18)
Writedowns on foreclosed assets   851    458 
Share-based compensation expense   67    64 
Provision for loan losses   2,750    3,600 
Depreciation and amortization   585    644 
Net amortization on securities premiums and discounts   1,920    1,259 
Increase in unearned net loan fees   (69)   (76)
Increase in cash surrender value of life insurance policies   (669)   (419)
Proceeds from sales of loans portfolio   2,224    1,154 
Net (Increase) Decrease in loans held-for-sale   (1,583)   870 
(Increase) Decrease in interest receivable and other assets   (218)   716 
Decrease in other liabilities   (1,213)   (363)
Net Decrease in FHLB Stock   319    316 
Deferred Income Tax Benefit   (1)   (3)
Excess tax benefit from equity based compensation   (36)   (1)
Net cash provided by operating activities   6,812    9,740 
           
Cash flows from investing activities:          
Maturities of securities available for sale   135    - 
Proceeds from sales/calls of securities available for sale   3,837    1,275 
Purchases of securities available for sale   (38,308)   (62,148)
Principal pay downs on securities available for sale   23,139    18,156 
Net Decrease in loans receivable, net   193    22,327 
Purchases of premises and equipment, net   (616)   (988)
Proceeds from sales of foreclosed assets   2,012    2,463 
Net cash used in investing activities   (9,608)   (18,915)
           
Cash flows from financing activities:          
Increase in deposits   36,610    39,431 
Decrease in borrowed funds   (27,120)   (14,650)
Increase in repurchase agreements   2,808    - 
Increase in Fed funds purchased   -    35 
Cash dividends paid   (846)   (839)
Stock options exercised   14    74 
Excess tax benefit from equity based compensation   36    1 
Net cash provided by financing activities   11,502    24,052 
           
Increase in cash and due from banks   8,706    14,877 
           
Cash and Cash Equivalents          
Beginning of period   63,036    42,645 
    End of period  $71,742   $57,522 

 

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

4
 

Sierra Bancorp

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

March 31, 2012

 

Note 1 – The Business of Sierra Bancorp

 

Sierra Bancorp (the “Company”), headquartered in Porterville, California, is a California corporation registered as a bank holding company under the Bank Holding Company Act of 1956, as amended. The Company was incorporated in November 2000 and acquired all of the outstanding shares of Bank of the Sierra (the “Bank”) in August 2001. The Company’s principal subsidiary is the Bank, and the Company exists primarily for the purpose of holding the stock of the Bank and of such other subsidiaries it may acquire or establish. At the present time, the Company’s only other direct subsidiaries are Sierra Statutory Trust II and Sierra Capital Trust III, which were formed in March 2004 and June 2006, respectively, solely to facilitate the issuance of capital trust pass-through securities. Pursuant to the Financial Accounting Standards Board’s (FASB’s) standard on the consolidation of variable interest entities, these trusts are not reflected on a consolidated basis in the financial statements of the Company. References herein to the “Company” include Sierra Bancorp and its consolidated subsidiary, the Bank, unless the context indicates otherwise.

 

The Bank is a California state-chartered bank headquartered in Porterville, California, that offers a full range of retail and commercial banking services to communities in the central and southern sections of the San Joaquin Valley. Our branch footprint stretches from Fresno on the north to Bakersfield on the south, and on the southern end extends east through the Tehachapi plateau and into the northwestern tip of the Mojave Desert. The Bank was incorporated in September 1977 and opened for business in January 1978, and in the ensuing years has grown to be the largest independent bank headquartered in the South San Joaquin Valley. Our growth has primarily been organic, but includes the acquisition of Sierra National Bank in 2000. We currently operate 25 full service branch offices throughout our geographic footprint, as well as an internet branch which provides the ability to open deposit accounts online. The Bank’s newest brick and mortar branch opened for business in the city of Selma in February 2011. In addition to our full-service branches, the Bank has an agricultural credit division and an SBA lending unit with staff located at our corporate headquarters, and offsite ATM’s at six different non-branch locations. The Bank’s deposit accounts are insured by the Federal Deposit Insurance Corporation (FDIC) up to maximum insurable amounts.

 

Note 2 – Basis of Presentation

 

The accompanying unaudited consolidated financial statements have been prepared in a condensed format, and therefore do not include all of the information and footnotes required by U.S. generally accepted accounting principles (GAAP) for complete financial statements. The information furnished in these interim statements reflects all adjustments that are, in the opinion of management, necessary for a fair statement of the results for such period. Such adjustments are of a normal recurring nature, unless otherwise disclosed in this Form 10-Q. In preparing the accompanying consolidated financial statements, management has taken subsequent events into consideration and recognized them where appropriate. The results of operations in the interim statements are not necessarily indicative of the results that may be expected for any other quarter, or for the full year. Certain amounts reported for 2011 have been reclassified to be consistent with the reporting for 2012. The interim financial information should be read in conjunction with the Company’s Annual Report on Form 10-K for the year ended December 31, 2011, as filed with the Securities and Exchange Commission.

 

Note 3 – Current Accounting Developments

 

In September 2011, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2011-08, Intangibles—Goodwill and Other (Topic 350) - Testing Goodwill for Impairment. The objective of ASU 2011-08 is to simplify how entities test goodwill for impairment. Topic 350 requires an entity to test goodwill for impairment on at least an annual basis, by comparing the fair value of a reporting unit with its carrying amount, including goodwill (step one). If the fair value of a reporting unit is less than its carrying amount, then the second step of the test must be performed to measure the amount of the impairment loss, if any. Pursuant to ASU 2011-08, an entity will not be required to calculate the fair value of a reporting unit and perform step one unless, after assessing qualitative factors, the entity determines that it is more likely than not that its fair value is less than its carrying amount. The more-likely-than-not threshold is defined as having a likelihood of more than 50 percent. This update is effective for annual and interim goodwill impairment tests performed for fiscal years beginning after December 15, 2011. The adoption of ASU 2011-08 did not have an impact on the Company’s financial statements, as the Company has not been required to perform the second step of the goodwill impairment test since the first step has, to date, determined that the fair value of the reporting unit, Bank of the Sierra, is greater than its carrying amount.

5
 

In June 2011, the Financial FASB issued ASU 2011-05, Comprehensive Income (Topic 220) - Presentation of Comprehensive Income. Current U.S. generally accepted accounting principles allow reporting entities several alternatives for displaying other comprehensive income and its components in financial statements, and ASU 2011-05 is intended to improve the consistency of this reporting issue. The amendments in this ASU require all non-owner changes in stockholders’ equity to be presented either in a single continuous statement of comprehensive income, or in two separate but consecutive statements. In a single continuous statement, the entity is required to present the components of net income and total net income, the components of other comprehensive income and a total for other comprehensive income, along with the total of comprehensive income in that statement. In the two-statement approach, an entity is required to present components of net income and total net income in the statement of net income. The statement of other comprehensive income should immediately follow the statement of net income and include the components of other comprehensive income and a total for other comprehensive income, along with a total for comprehensive income. Furthermore, the entity is required to present, on the face of the financial statements, adjustments for items that are reclassified from other comprehensive income to net income in the statements, where the components of net income and the components of other comprehensive income are presented. The amendments in the ASU do not change the following: 1) items that must be reported in other comprehensive income; 2) when an item of other comprehensive income must be reclassified to net income; 3) the option to present components of other comprehensive income either net of related tax effects or before related tax effects; or, 4) how earnings per share is calculated or presented. The amendments in ASU 2011-05 should be applied retrospectively. For public entities, such as the Company, the amendments are effective for fiscal years, and interim periods within those years, beginning after December 15, 2011. The Company’s adoption of this ASU impacted our presentation of comprehensive income, but not the calculation of such.

 

In May 2011, the FASB issued ASU No. 2011-04, Fair Value Measurement (Topic 820): Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs, to substantially converge the fair value measurement and disclosure guidance in U.S. GAAP with International Financial Reporting Standards (“IFRS”). The amended guidance changes several aspects of current fair value measurement guidance, including the following provisions: 1) the application of the concepts of “highest and best use” and “valuation premise”; 2) the introduction of an option to measure groups of offsetting assets and liabilities on a net basis; 3) the incorporation of certain premiums and discounts in fair value measurements; and, 4) the measurement of the fair value of certain instruments classified in shareholders’ equity. In addition, the amended guidance includes several new fair value disclosure requirements, including, among other things, information about valuation techniques and unobservable inputs used in Level 3 fair value measurements and a narrative description of Level 3 measurements’ sensitivity to changes in unobservable inputs. For public entities such as the Company, the provisions of ASU 2011-04 are effective for interim and annual periods beginning after December 15, 2011, and are to be applied prospectively. The implementation of ASU 2011-04 did not change fair value measurements for any of the Company’s assets or liabilities carried at fair value, and thus did not impact the Company’s statements of income and condition.

 

Note 4 – Supplemental Disclosure of Cash Flow Information

 

During the three months ended March 31, 2012 and 2011, cash paid for interest due on interest-bearing liabilities was $995,000 and $1.291 million, respectively. There was no cash paid for income taxes during the three months ended March 31, 2012 of 2011. Assets totaling $3.283 million and $1.881 million were acquired in settlement of loans for the three months ended March 31, 2012 and March 31, 2011, respectively, and we received $2.012 million in cash from the sale of foreclosed assets during the first three months of 2012 relative to $2.442 million during the first three months of 2011. The Company extended $425,000 in loans to finance the sale of foreclosed assets during the three months ended March 31, 2012, and $1.381 million during the first three months of 2011.

 

Note 5 – Share Based Compensation

 

The 2007 Stock Incentive Plan (the “2007 Plan”) was adopted by the Company in 2007. Our 1998 Stock Option Plan (the “1998 Plan”) was concurrently terminated, although options to purchase 187,250 shares that were granted prior to the termination of the 1998 Plan were still outstanding as of March 31, 2012 and remain unaffected by the termination. The 2007 Plan provides for the issuance of both “incentive” and “nonqualified” stock options to officers and employees, and of “nonqualified” stock options to non-employee directors of the Company. The 2007 Plan also provides for the potential issuance of restricted stock awards to these same classes of eligible participants, on such terms and conditions as are established at the discretion of the Board of Directors or the Compensation Committee. The total number of shares of the Company’s authorized but unissued stock reserved for issuance pursuant to awards under the 2007 Plan was initially 1,500,000 shares, although options have been granted since the inception of the plan and the number remaining available for grant as of March 31, 2012 was 880,060. The dilutive impact of stock options outstanding is discussed below in Note 6, Earnings per Share. No restricted stock awards have been issued by the Company.

6
 

Pursuant to FASB’s standards on stock compensation, share-based compensation expense is reflected in our income statement for each option granted over the vesting period of such option. The Company is utilizing the Black-Scholes model to value stock options, and the “multiple option” approach is used to allocate the resulting valuation to actual expense. Under the multiple option approach, an employee’s options for each vesting period are separately valued and amortized. This appears to be the preferred method for option grants with multiple vesting periods, which is the case for most options granted by the Company. A pre-tax charge of $67,000 was reflected in the Company’s income statement during the first quarter of 2012 and $65,000 was charged during the first quarter of 2011, as compensation expense related to outstanding and unvested stock options.

 

Note 6 – Earnings per Share

 

The computation of earnings per share, as presented in the Consolidated Statements of Income, is based on the weighted average number of shares outstanding during each period. There were 14,101,879 weighted average shares outstanding during the first quarter of 2012, and 13,981,780 during the first quarter of 2011.

 

Diluted earnings per share include the effect of the potential issuance of common shares, which for the Company is limited to “in-the-money” shares that would be issued on the exercise of outstanding stock options. The dilutive effect of options outstanding was calculated using the treasury stock method, excluding anti-dilutive shares and adjusting for unamortized expense and windfall tax benefits. For the first quarter of 2012, the dilutive effect of options outstanding calculated under the treasury stock method totaled 5,672 shares, which were added to basic weighted average shares outstanding for purposes of calculating diluted earnings per share. Likewise, for the first quarter of 2011 shares totaling 78,881 were added to basic weighted average shares outstanding in order to calculate diluted earnings per share.

 

Note 7 – Comprehensive Income

 

Comprehensive income, as presented in the Consolidated Statements of Comprehensive Income, includes net income and other comprehensive income. The Company’s only source of other comprehensive income is unrealized gains and losses on available-for-sale investment securities. Reclassification adjustments, resulting from gains or losses on investment securities that were realized and included in net income of the current period that also had been included in other comprehensive income as unrealized holding gains or losses in the period in which they arose, are excluded from comprehensive income of the current period.

 

Note 8 – Financial Instruments with Off-Balance-Sheet Risk

 

The Company is a party to financial instruments with off-balance-sheet risk in the normal course of business, in order to meet the financing needs of its customers. These financial instruments consist of commitments to extend credit, and standby letters of credit. They involve, to varying degrees, elements of risk in excess of the amount recognized in the balance sheet. The Company’s exposure to credit loss in the event of nonperformance by counterparties for commitments to extend credit and letters of credit is represented by the contractual amount of those instruments. The Company uses the same credit policies in making commitments and issuing letters of credit as it does for making loans included on the balance sheet. The following financial instruments represent off-balance-sheet credit risk (dollars in thousands):

 

7
 

 

   March 31, 2012   December 31, 2011 
Commitments to extend credit  $153,924   $154,323 
Standby letters of credit  $11,103   $11,113 
Commercial letters of credit  $8,988   $8,991 

 

Commitments to extend credit consist primarily of unfunded home equity lines of credit, commercial real estate construction loans, commercial revolving lines of credit, and mortgage warehouse lines of credit. Construction loans are established under standard underwriting guidelines and policies and are secured by deeds of trust, with disbursements made over the course of construction. Commercial revolving lines of credit have a high degree of industry diversification. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. Standby letters of credit are generally unsecured and are issued by the Company to guarantee the performance of a customer to a third party, while commercial letters of credit represent the Company’s commitment to pay a third party on behalf of a customer upon fulfillment of contractual requirements. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loans to customers.

 

Note 9 – Fair Value Disclosures and Reporting, the Fair Value Option and Fair Value Measurements

 

FASB’s standards on financial instruments, and on fair value measurements and disclosures, require all entities to disclose the estimated fair value of all financial instruments for which it is practicable to estimate fair values. In addition to those footnote disclosure requirements, FASB’s standard on investments requires that our debt securities, which are classified as available for sale, and our equity securities that have readily determinable fair values, be measured and reported at fair value in our statement of financial position. Certain impaired loans are also reported at fair value, as explained in greater detail below, and foreclosed assets are carried at the lower of cost or fair value. While the fair value option outlined under FASB’s standard on financial instruments permits companies to report certain other financial assets and liabilities at fair value, we have not elected the fair value option for any additional financial assets or liabilities.

 

Fair value measurements and disclosure standards also establish a framework for measuring 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. Further, they establish a fair value hierarchy that requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The standards describe three levels of inputs that may be used to measure fair value:

 

·Level 1: Quoted prices (unadjusted) for identical assets or liabilities in active markets that the entity has the ability to access as of the measurement date.

 

·Level 2: Significant observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities, quoted prices in markets that are not active, and other inputs that are observable or can be corroborated by observable market data.

 

·Level 3: Significant unobservable inputs that reflect a company’s own assumptions about the factors that market participants would likely consider in pricing an asset or liability.

 

Fair value estimates are made at a specific point in time based on relevant market data and information about the financial instruments. These estimates do not reflect any premium or discount that could result from offering the Company’s entire holdings of a particular financial instrument for sale at one time, nor do they attempt to estimate the value of anticipated future business related to the instruments. In addition, the tax ramifications related to the realization of gains and losses can have a significant effect on fair value estimates and have not been considered in any estimates. Because no market exists for a significant portion of the Company’s financial instruments, fair value disclosures are based on judgments regarding current economic conditions, risk characteristics of various financial instruments and other factors. These estimates are subjective in nature and involve uncertainties and matters of significant judgment and therefore cannot be determined with precision. Changes in assumptions could significantly affect the fair values presented. The following methods and assumptions were used by the Company to estimate the fair value of its financial instruments disclosed at March 31, 2012 and December 31, 2011:

8
 

 

·Cash and cash equivalents and short-term borrowings: For cash and cash equivalents and short-term borrowings, the carrying amount is estimated to be fair value.

 

·Investment securities: The fair values of investment securities are determined by obtaining quoted prices on nationally recognized securities exchanges or by matrix pricing, which is a mathematical technique used widely in the industry to value debt securities by relying on the securities’ relationship to other benchmark quoted securities when quoted prices for the specific securities are not readily available.

 

·Loans and leases: For variable-rate loans and leases that re-price frequently with no significant change in credit risk or interest rate spread, fair values are based on carrying values. Fair values for other loans and leases are estimated by discounting projected cash flows at interest rates being offered at each reporting date for loans and leases with similar terms, to borrowers of comparable creditworthiness. Fair values of loans held for sale are estimated using quoted market prices for similar loans or the amount that has been committed to purchase the loan. The carrying amount of accrued interest receivable approximates its fair value.

 

·Cash surrender value of life insurance policies: The fair values are based on cash surrender values at each reporting date.

 

·Investments in, and capital commitments to, limited partnerships: The fair values of our investments in WNC Institutional Tax Credit Fund Limited Partnerships and any other limited partnerships are estimated using quarterly indications of value provided by the general partner. The fair values of undisbursed capital commitments are assumed to be the same as their book values.

 

·Other investments: Included in other assets are certain long-term investments carried at cost, which approximates their estimated fair value.

 

·Deposits: Fair values for demand deposits and other non-maturity deposits are equal to the amount payable on demand at the reporting date, which is the carrying amount. Fair values for fixed-rate certificates of deposit are estimated using a cash flow analysis, discounted at interest rates being offered at each reporting date by the Bank for certificates with similar remaining maturities. The carrying amount of accrued interest payable approximates its fair value.

 

·Short-term borrowings: The carrying amounts approximate fair values for federal funds purchased, overnight FHLB advances, borrowings under repurchase agreements, and other short-term borrowings maturing within ninety days of the reporting dates. Fair values of other short-term borrowings are estimated by discounting projected cash flows at the Company’s current incremental borrowing rates for similar types of borrowing arrangements.

 

·Long-term borrowings: The fair values of the Company’s long-term borrowings are estimated using projected cash flows discounted at the Company’s current incremental borrowing rates for similar types of borrowing arrangements.

 

·Subordinated debentures: The fair values of subordinated debentures are determined based on the current market value for like instruments of a similar maturity and structure.

 

·Commitments to extend credit and letters of credit: Commitments to extend credit are primarily for adjustable rate loans. Commitments to fund fixed rate loans and letters of credit, where such exist, are also at rates which approximate market rates at each reporting date. Thus, if funded, the carrying amounts would approximate fair values for the newly created financial assets at the funding date. However, because of the high degree of uncertainty with regard to whether or not these commitments will ultimately be funded, fair values for loan commitments and letters of credit in their current undisbursed state cannot reasonably be estimated, and only notional values are disclosed in the table below.

 

 

9
 

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

 

Fair Value of Financial Instruments        
(dollars in thousands, unaudited)  March 31, 2012   December 31, 2011 
   Carrying Value   Fair Value   Carrying Value   Fair Value 
Financial Assets:                    
Cash and cash equivalents  $71,742   $71,742   $63,036   $63,036 
Investment securities available for sale  $416,866   $416,866   $406,471   $406,471 
Loans and leases, net  $735,514   $773,396   $742,283   $783,847 
Cash surrender value of life insurance policies  $38,326   $38,326   $37,657   $37,657 
Other Investments  $6,721   $6,721   $7,040   $7,040 
Investment in Limited Partnership  $9,654   $9,654   $9,927   $9,927 
Accrued Int Receivable  $5,189   $5,189   $5,368   $5,368 
                     
Financial Liabilities:                    
Deposits  $1,122,878   $1,040,423   $1,086,268   $1,002,315 
Fed Funds Purchased and Repurchase Agreements  $5,845   $5,845   $3,037   $3,037 
Short-term borrowings  $-   $-   $17,120   $17,120 
Long-term borrowoings  $5,000   $5,174   $15,000   $15,287 
Subordinated debentures  $30,928   $12,179   $30,928   $12,262 
Limited partnership capital commitment  $203   $203   $353   $353 
Accrued Interest Payable  $288   $288   $514   $514 
                     
   Notional Amount        Notional Amount      
Off-balance-sheet financial instruments:                    
Commitments to extend credit  $153,924        $154,323      
Standby letters of credit  $11,103        $11,113      
Commercial lines of credit  $8,988        $8,991      

 

 

For each financial asset category that was actually reported at fair value at March 31, 2012, the Company used the following methods and significant assumptions:

 

·Investment Securities: The fair values of trading securities and securities available for sale are determined by obtaining quoted prices on nationally recognized securities exchanges or by matrix pricing, which is a mathematical technique used widely in the industry to value debt securities by relying on the their relationship to other benchmark quoted securities.

 

·Loans held for sale: Since loans designated by the Company as available-for-sale are typically sold shortly after making the decision to sell them, realized gains or losses are usually recognized within the same period and fluctuations in fair values are thus not relevant for reporting purposes. If available-for-sale loans stay on our books for an extended period of time, the fair value of those loans is determined using quoted secondary-market prices.

 

·Impaired loans: Impaired loans carried at fair value are those for which it is probable that the bank will be unable to collect all amounts due (including both interest and principal) according to the original contractual terms of the loan agreement, and for which the carrying value has been written down to the fair value of the loan. The carrying value is equivalent to the fair value of the collateral, net of expected disposition costs, for collateral-dependent loans, or the present value of anticipated future cash flows for other loans.

 

·Foreclosed assets: Repossessed real estate (OREO) and other assets are carried at the lower of cost or fair value. Fair value is appraised value less expected selling costs for OREO and some other assets such as mobile homes, and estimated sales proceeds as determined by using reasonably available sources for all other assets. Foreclosed assets for which appraisals can be feasibly obtained are periodically measured for impairment using updated appraisals. Other foreclosed assets are periodically re-evaluated by adjusting expected cash flows and timing of resolution, again using reasonably available sources. If impairment is determined to exist, the book value of a foreclosed asset is immediately written down to its estimated impaired value through the income statement, thus the carrying amount is equal to the fair value and there is no valuation allowance.

 

10
 

Assets reported at fair value on a recurring basis are summarized below:

 

Fair Value Measurements - Recurring                
(dollars in thousands, unaudited)                
   Fair Value Measurements at March 31, 2012, Using 
                 
   Level 1   Level 2   Level 3   Total 
Investment Securities                    
U.S. Government agencies  $-   $2,015   $-   $2,015 
Obligations of states and                    
political subdivisions   -    74,039    -    74,039 
U.S. Government agencies                    
collateralized by mortgage                    
obligations   -    339,023    -    339,023 
Other Securities   1,789    -    -    1,789 
                     
Total availabe-for-sale securities   1,789    415,077    -    416,866 
                     
Loans Held for Sale   763    -    -    763 
                     
Total  $2,552   $415,077   $-   $417,629 

 

 

   Fair Value Measurements at December 31, 2011, Using 
                 
   Level 1   Level 2   Level 3   Total 
Investment Securities                    
U.S. Government agencies  $-   $2,026   $-   $2,026 
Obligations of states and                  - 
political subdivisions   -    71,340    -    71,340 
U.S. Government agencies                    
collateralized by mortgage                    
obligations   -    331,758    -    331,758 
Other Securities   1,347    -    -    1,347 
                     
Total availabe-for-sale securities   1,347    405,124    -    406,471 
                     
Loans Held for Sale   1,354    -    -    1,354 
                     
Total  $2,701   $405,124   $-   $407,825 

 

11
 

Assets reported at fair value on a nonrecurring basis are summarized below:

 

Fair Value Measurements - Nonrecurring

(dollars in thousands, unaudited)

 

   Fair Value Measurements at March 31, 2012, Using 
                 
   Level 1   Level 2   Level 3   Total 
Impaired Loans  $-   $36,060   $16,182   $52,242 
Foreclosed Assets  $-   $15,679   $-   $15,679 

 

   Fair Value Measurements at December 31, 2011, Using 
                 
   Level 1   Level 2   Level 3   Total 
Impaired Loans  $-   $29,942   $24,334   $54,276 
Foreclosed Assets  $-   $13,497   $1,867   $15,364 

 

The table above only includes impaired loan balances for which a specific reserve has been established or on which a write-down has been taken. Information on the Company’s total impaired loan balances, and specific loss reserves associated with those balances, is included in Note 11 below, and in Management’s Discussion and Analysis of Financial Condition and Results of Operation in the “Nonperforming Assets” and “Allowance for Loan and Lease Losses” sections.

 

The table below presents additional valuation information for impaired loan balances which are measured within Level 3 of the fair value hierarchy, as of March 31, 2012:

 

Quantitative Information about Level 3 Fair Value measurements

(dollars in thousands, unaudited)

 

Asset   Fair Value
Amount
  Valuation
Technique
  Unobservable
Input
  Range
(Wtd Ave.)
                 
Unsecured loans    $       3,086   Historical Loss Rates   Historical Losses (1)   0.53% - 53.62% (15.91%)
            Qualitative Factors (2)   50.00% - 250.00% (117.13%)
Unsecured loans - TDRs    $       3,509   Discounted Cash Flow   Discount Rate (3)   4.25% - 12.99% (7.04%)
Real Estate Secured loans    $       4,690   Adjusted Appraised Value   Selling Costs (4)   5.00% - 25.00% (16.85%)
Real Estate Secured loans - TDRs    $       4,897   Discounted Cash Flow   Discount Rate (3)   4.25% - 10.50% (6.62%)

 

(1) Represents the range of historical losses incurred over the twelve months ending 12/31/2011 for similar loan types.

(2) Represents the range of qualitative adjustments applied to historical loss factors in determining fair market value.

(3) Represents the range of original interest rates on loans at the time of restructure.

(4) Represents the range of estimated selling and closing costs that might be incurred through escrow at the time of sale.

 

The unobservable inputs are based on management’s best estimates of appropriate discounts in arriving at fair market value. Significant increases or decreases in any of those inputs could result in a significantly lower or higher fair value measurement. For example, a change in either direction of actual loss rates would have a directionally opposite change in the calculation of the fair value of unsecured impaired loans.

 

 

12
 

Note 10 – Investments

 

Although the Company currently has the intent and the ability to hold the securities in its investment portfolio to maturity, the securities are all marketable and are classified as “available for sale” to allow maximum flexibility with regard to interest rate risk and liquidity management. Pursuant to FASB’s guidance on accounting for debt and equity securities, available for sale securities are carried on the Company’s financial statements at their estimated fair market values, with monthly tax-effected “mark-to-market” adjustments made vis-à-vis accumulated other comprehensive income in shareholders’ equity. The Company’s available-for-sale investment securities totaled $417 million at March 31, 2012, and $406 million at December 31, 2011.

 

Amortized Cost And Estimated Fair Value

 

The amortized cost and estimated fair value of investment securities available-for-sale are as follows

(Dollars in thousands):

 

   March 31, 2012 
   Amortized Cost   Gross
Unrealized
Gains
   Gross
Unrealized
Losses
   Estimated
Fair Value
 
                 
U.S. Government agencies  $2,004   $11   $-   $2,015 
Obligations of state and                    
 political subdivisions   70,694    3,562    (217)   74,039 
U.S. Government agencies                    
 collateralized by mortgage                    
 obligations   335,259    4,469    (705)   339,023 
Equity Securities   1,336    453    -    1,789 
   $409,293   $8,495   $(922)  $416,866 

 

 

   December 31, 2011 
   Amortized Cost   Gross
Unrealized
Gains
   Gross
Unrealized
Losses
   Estimated
Fair Value
 
                 
U.S. Government agencies  $2,008   $18   $-   $2,026 
Obligations of state and                    
 political subdivisions   67,851    3,634    (145)   71,340 
U.S. Government agencies                    
 collateralized by mortgage                    
 obligations   328,751    4,467    (1,460)   331,758 
Equity Securities   1,336    11    -    1,347 
   $399,946   $8,130   $(1,605)  $406,471 

 

At March 31, 2012 and December 31, 2011, the Company had 65 securities and 80 securities, respectively, with unrealized losses. Management has evaluated these securities as of the respective dates, and does not believe that any of the associated unrealized losses are other than temporary. Information pertaining to these investment securities, aggregated by investment category and length of time that individual securities have been in a continuous loss position, is disclosed in the table below.

 

13
 

 

 

Investment Portfolio - Unrealized Losses

(dollars in thousands, unaudited)

   March 31, 2012 
   Less than 12 Months   Over 12 Months 
   Fair Value   Gross
Unrealized
Losses
   Fair Value   Gross
Unrealized
Losses
 
                 
US Treasuries  $-   $-   $-   $- 
US Government Agencies   -    -    -    - 
Obligations of State and Political Subdivisions   5,266    (145)   1,222    (72)
Agency-Issued Mortgage-Backed Securities (MBS)   100,774    (701)   -    - 
Private-Label MBS   -    -    669    (3)
Other Securities   -    -    -    - 
   TOTAL  $106,040   $(846)  $1,891   $(75)

 

 

   December 31, 2011 
   Less than 12 Months   Over 12 Months 
   Fair Value   Gross
Unrealized
Losses
   Fair Value   Gross
Unrealized
Losses
 
                 
US Treasuries  $-   $-   $-   $- 
US Government Agencies   -    -    -    - 
Obligations of State and Political Subdivisions   1,735    (26)   1,978    (119)
Agency-Issued Mortgage-Backed Securities (MBS)   144,953    (1,433)   -    - 
Private-Label MBS   -    -    949    (28)
Other Securities   -    -    -    - 
   TOTAL  $146,688   $(1,459)  $2,927   $(147)

 

 

 

Note 11 – Credit Quality and Nonperforming Assets

 

Credit Quality Classifications

 

The Company monitors the credit quality of loans on a continuous basis using the regulatory and accounting classifications of pass, special mention, substandard and impaired to characterize the associated credit risk. Balances classified as “loss” are immediately charged-off. The Company uses the following definitions of risk classifications:

 

·Pass: Loans listed as pass include larger non-homogeneous loans not meeting the risk rating definitions below and smaller, homogeneous loans that are not assessed on an individual basis.

 

·Special Mention: Loans classified as special mention have potential issues that deserve the close attention of management. If left uncorrected, these potential weaknesses could eventually diminish the prospects for full repayment of principal and interest according to the contractual terms of the loan agreement, or could result in deterioration of the Company’s credit position at some future date.

 

·Substandard: Loans classified as substandard are loans with at least one clear and well-defined weakness such as a highly leveraged position, unfavorable financial operating results and/or trends, uncertain repayment sources or poor financial condition, which could jeopardize the ultimate recoverability of the debt.

 

·Impaired: A loan is considered impaired, when, based on current information and events, it is probable that the Company will be unable to collect all amounts due according to the contractual terms of the loan agreement. Impaired loans include all nonperforming loans, loans classified as restructured troubled debt, and certain other loans that are still being maintained on accrual status. If the Bank grants a concession to a borrower in financial difficulty, the loan falls into the category of a troubled debt restructuring (TDR). TDR’s may be classified as either nonperforming or performing loans depending on their accrual status.
14
 

Credit quality classifications for the Company’s loan balances were as follows, as of the dates indicated:

 

Credit Quality Classifications

(dollars in thousands, unaudited)

 

   March 31, 2012 
   Pass   Special Mention   Substandard   Impaired   Total 
Real Estate:                         
1-4 Family residential construction  $3,098   $2,316   $-   $1,974   $7,388 
Other construction/Land   19,566    8,179    1,018    11,610    40,373 
1-4 Family - closed end   74,949    8,941    1,174    18,310    103,374 
Equity Lines   61,129    394    2,074    1,543    65,140 
Multi-family residential   4,575    616    -    2,941    8,132 
Commercial real estate - owner occupied   141,895    23,420    9,276    9,091    183,682 
Commercial real estate - non-owner occupied   64,800    7,815    3,580    28,787    104,982 
Farmland   49,148    1,870    3,602    6,655    61,275 
Total Real Estate   419,160    53,551    20,724    80,911    574,346 
                          
Agricultural   14,220    1,558    26    -    15,804 
Commercial and Industrial   88,524    5,877    2,676    3,962    101,039 
Small Business Administration   14,453    2,034    332    4,283    21,102 
Direct finance leases   5,327    48    5    324    5,704 
Consumer loans   27,844    878    477    4,275    33,474 
Total Gross Loans and Leases  $569,528   $63,946   $24,240   $93,755   $751,469 

 

   December 31, 2011 
   Pass   Special Mention   Substandard   Impaired   Total 
             
Real Estate:                         
1-4 Family residential construction  $4,240   $2,004   $-   $2,244   $8,488 
Other construction/Land   18,185    8,873    1,015    11,987    40,060 
1-4 Family - closed end   75,765    7,574    1,354    20,260    104,953 
Equity Lines   62,867    456    1,795    1,379    66,497 
Multi-family residential   4,620    618    -    2,941    8,179 
Commercial real estate - owner occupied   141,245    23,289    8,878    9,658    183,070 
Commercial real estate - non-owner occupied   64,746    7,463    4,514    29,120    105,843 
Farmland   47,719    1,878    3,626    6,919    60,142 
Total Real Estate   419,387    52,155    21,182    84,508    577,232 
                          
Agricultural   15,477    1,574    27    -    17,078 
Commercial and Industrial   83,780    7,529    3,078    5,021    99,408 
Small Business Administration   16,251    -    852    3,903    21,006 
Direct finance leases   6,089    63    -    591    6,743 
Consumer loans   30,004    1,006    808    4,306    36,124 
Total Gross Loans and Leases  $570,988   $62,327   $25,947   $98,329   $757,591 

 

15
 

Past Due and Nonperforming Assets

 

Nonperforming assets are comprised of loans for which the Company is no longer accruing interest, and foreclosed assets, including mobile homes and other real estate owned (“OREO”). OREO consists of properties acquired by foreclosure or similar means, which the Company is offering or will offer for sale. Nonperforming loans and leases result when reasonable doubt exists with regard to the ability of the Company to collect all principal and interest on a loan or lease. At that point, we stop accruing interest on the loan or lease in question, and reverse any previously-recognized interest to the extent that it is uncollected or associated with interest-reserve loans. Any asset for which principal or interest has been in default for a period of 90 days or more is also placed on non-accrual status, even if interest is still being received, unless the asset is both well secured and in the process of collection. An aging of the Company’s loan balances, by number of days past due as of the indicated dates, is presented in the following tables:

16
 

Loan Portfolio Aging

(dollars in thousands, unaudited)

 

   March 31, 2012 
   30-59 Days Past Due   60-89 Days Past Due   90 Days Or More Past
Due(2)
   Total Past Due   Current   Total Financing Receivables   Non-Accrual Loans(1) 
Real Estate:                                   
1-4 Family residential construction  $178   $352   $-   $530   $6,858   $7,388   $1,974 
Other construction/Land   451    2,135    1,076    3,662    36,711    40,373    3,669 
1-4 Family - closed end   1,237    941    1,392    3,570    99,804    103,374    5,578 
Equity Lines   285    493    903    1,681    63,459    65,140    1,472 
Multi-family residential   -    -    2,941    2,941    5,191    8,132    2,941 
Commercial real estate - owner occupied   931    1,933    4,399    7,263    176,419    183,682    5,440 
Commercial real estate - non-owner occupied   4,313    586    7,610    12,509    92,473    104,982    13,779 
Farmland   29    -    6,376    6,405    54,870    61,275    6,655 
Total Real Estate   7,424    6,440    24,697    38,561    535,785    574,346    41,508 
                                    
Agricultural   99    -    -    99    15,705    15,804    - 
Commercial and Industrial   955    347    2,261    3,563    97,476    101,039    2,942 
Small Business Administration   1,399    346    2,604    4,349    16,753    21,102    3,366 
Direct finance leases   48    -    330    378    5,326    5,704    324 
Consumer loans   234    323    1,115    1,672    31,802    33,474    1,831 
Total Gross Loans and Leases  $10,159   $7,456   $31,007   $48,622   $702,847   $751,469   $49,971 

 

(1) Included in Total Financing Receivables

(2) Includes commercial and consumer loans over 90 days past due and still accruing in the amount of $320,000.

 

   December 31, 2011 
   30-59 Days Past Due   60-89 Days Past Due   90 Days Or More Past
Due(2)
   Total Past Due   Current   Total Financing Receivables   Non-Accrual Loans(1) 
Real Estate:                                   
1-4 Family residential construction  $-   $-   $-   $-   $8,488   $8,488   $2,244 
Other construction/Land   1,354    -    1,417    2,771    37,289    40,060    4,083 
1-4 Family - closed end   1,777    1,835    1,661    5,273    99,680    104,953    7,605 
Equity Lines   253    511    640    1,404    65,093    66,497    1,309 
Multi-family residential   -    -    2,941    2,941    5,238    8,179    2,941 
Commercial real estate - owner occupied   3,070    1,038    5,581    9,689    173,381    183,070    7,086 
Commercial real estate - non-owner occupied   1,031    577    7,128    8,736    97,107    105,843    13,958 
Farmland   6,436    -    188    6,624    53,518    60,142    6,919 
Total Real Estate   13,921    3,961    19,556    37,438    539,794    577,232    46,145 
                                    
Agricultural   -    -    -    -    17,078    17,078    - 
Commercial and Industrial   701    386    3,160    4,247    95,161    99,408    3,778 
Small Business Administration   828    917    2,715    4,460    16,546    21,006    3,452 
Direct finance leases   63    -    591    654    6,089    6,743    591 
Consumer loans   520    619    838    1,977    34,147    36,124    2,144 
Total Gross Loans and Leases  $16,033   $5,883   $26,860   $48,776   $708,815   $757,591   $56,110 

 

(1) Included in Total Financing Receivables

(2) Includes Small Business Administration loans over 90 days past due and still accruing in the amount of $48,000.

 

Troubled Debt Restructurings

 

A loan that is modified for a borrower who is experiencing financial difficulty is classified as a troubled debt restructuring (“TDR”), if the modification constitutes a concession. At March 31, 2012, the Company had a total of $61.7 million in TDR’s, including $24.0 million in TDR’s that were on non-accrual status. Generally, a non-accrual loan that has been modified as a TDR remains on non-accrual status for a period of at least six months to demonstrate the borrower’s ability to comply with the modified terms. However, performance prior to the modification, or significant events that coincide with the modification, could result in a loan’s return to accrual status after a shorter performance period or even at the time of loan modification. TDR’s may have the TDR designation removed in the calendar year following the restructuring, if the loan is in compliance with all modified terms and is yielding a market rate of interest. Regardless of the period of time that has elapsed, if the borrower’s ability to meet the revised payment schedule is uncertain then the loan will be kept on non-accrual status. Moreover, a TDR is generally considered to be in default when it appears that the customer will not likely be able to repay all principal and interest pursuant to the terms of the restructured agreement.

17
 

The Company may agree to different types of concessions when modifying a loan or lease. The table below summarizes TDR’s which were modified during the noted period, by type of concession:

 

Troubled Debt Restructurings, by Type of Loan Modification

(dollars in thousands, unaudited)

 

   For the Quarter Ended March 31, 2012 
     
   Rate Modification   Term Modification   Interest Only Modification   Rate & Term Modification   Rate & Interest Only Modification   Term & Interest Only Modification   Rate, Term & Interest Only Modification   Total 
Trouble Debt Restructurings                                        
Real Estate:                                        
    Other construction/Land  $-   $-   $-   $53   $-   $-   $-   $53 
    1-4 family - closed-end   -    110    -    -    -    -    -    110 
    Equity Lines   -    -    -    -    -    -    -    - 
    Commercial RE - owner occupied   -    779    -    318    -    -    -    1,097 
    Commercial RE - non owner occupied   -    74    -    -    -    -    -    74 
           Total Real Estate Loans   -    963    -    371    -    -    -    1,334 
 Agricultural Products   -    -    -    -    -    -    -    - 
 Commercial and Industrial   -    25    -    -    -    -    -    25 
 Consumer loans   -    109    -    118    -    -    -    227 
 Small Business Administration Loans   -    -    -    475    -    -    -    475 
   $-   $1,097   $-   $964   $-   $-   $-   $2,061 

 

The following table presents, by class, additional details related to loans classified as TDR’s during the three months ended March 31, 2012, including the recorded investment in the loan both before and after modification and balances that were modified during the period:

 

18
 

 

Troubled Debt Restructurings

(dollars in thousands, unaudited)

 

   For the Quarter Ended March 31, 2012
   Number of Loans  Pre-Modification
Outstanding Recorded Investment
   Post-Modification
Outstanding Recorded Investment
   Reserve Difference(1)   Reserve 
Real Estate:                       
     Other Construction/Land  1  $53   $53   $-   $- 
     1-4 family - closed-end  2   110    110    6    8 
     Equity Lines  -   -    -    -    - 
     Commercial RE- owner occupied  2   747    1,097    (71)   - 
     Commercial RE- non-owner occupied  1   74    74    6    6 
           Total Real Estate Loans      984    1,334    (59)   14 
                        
Agricultural products  -   -    -    -    - 
Commercial and Industrial  2   25    25    (11)   2 
Small Business Administration Loans  1   468    475    2    118 
Consumer loans  4   228    227    (14)   12 
      $1,705   $2,061   $(82)  $146 

 

(1) This represents the change in the ALL reserve for these credits measured as the difference between the specific post-modification impairment reserve and the pre-modification reserve calculated under our general allowance for loan loss methodology.

 

The table below summarizes TDR’s that defaulted during the period noted, and any charge-offs on those TDR’s resulting from such default.

 

Troubled Debt Restructurings

(dollars in thousands, unaudited)

 

   12 Months Ended March 31, 2012
   Subsequent Default    
   Number of Loans  Recorded Investment   Charge-Offs 
         
Real Estate:             
     1-4 family - closed-end  1  $93   $- 
     Equity Lines  1   213    - 
     Commercial RE- owner occupied  2   1,773    - 
           Total Real Estate Loans      2,079    - 
              
Consumer loans  3   488    - 
      $2,567   $- 

 

 

19
 

Note 12 – Allowance for Loan and Lease Losses

 

The allowance for loan and lease losses, a contra-asset, is established through a provision for loan and lease losses based on management’s evaluation of probable loan losses on certain specifically identified loans, as well as probable incurred losses inherent in the remaining loan portfolio. It is maintained at a level that is considered adequate to absorb remaining probable loan losses, after factoring in charge-offs taken against the allowance and recoveries credited back to the allowance. Specifically identifiable and quantifiable losses are immediately charged off against the allowance; recoveries are generally recorded only when cash payments are received subsequent to the charge off. We employ a systematic methodology, consistent with FASB guidelines on loss contingencies and impaired loans, for determining the appropriate level of the allowance for loan and lease losses and adjusting it on at least a quarterly basis. Pursuant to that methodology, impaired loans and leases are individually analyzed and a criticized asset action plan is completed specifying the financial status of the borrower and, if applicable, the characteristics and condition of collateral and any associated liquidation plan. A specific loss allowance is created for each impaired loan, if necessary. The following tables disclose the unpaid principal balance, recorded investment (including accrued interest), average recorded investment, and interest income recognized for impaired loans on our books as of the dates indicated. Balances are shown by loan type, and are further broken out by those that required an allowance and those that did not, with the associated allowance disclosed for those that required such.

20
 

 

Impaired Loans  March 31, 2012 
(dollars in thousands, unaudited)  Unpaid Principal Balance(1)   Recorded Investment(2)   Related Allowance   Average Recorded Investment   Interest Income Recognized(3) 
With an Allowance Recorded                         
Real Estate:                         
1-4 family residential construction  $352   $352   $97   $352   $- 
Other Construction/Land   3,061    2,725    743    2,730    33 
1-4 Family - closed-end   8,903    8,874    1,049    9,254    76 
Equity Lines   1,236    1,236    554    1,237    - 
Multifamily residential   2,941    2,941    1,048    2,941    - 
Commercial RE- owner occupied   4,979    4,979    1,331    5,112    27 
Commercial RE- non-owner occupied   16,916    16,916    2,280    16,923    50 
Farmland   6,975    6,376    201    6,387    - 
Total Real Estate   45,363    44,399    7,303    44,936    186 
Agriculture   -    -    -    -    - 
Commercial and Industrial   3,469    3,440    1,383    3,480    17 
Small Business Administration   4,283    4,283    1,296    4,283    11 
Direct finance leases   325    324    160    325    - 
Consumer loans   4,033    3,995    754    4,051    36 
    57,473    56,441    10,896    57,075    250 
With no Related Allowance Recorded                            
Real Estate:                         
1-4 family residential construction  $4,350   $1,622   $-   $1,685   $- 
Other Construction/Land   11,578    8,885    -    8,887    82 
1-4 Family - closed-end   9,710    9,436    -    9,449    28 
Equity Lines   306    307    -    307    - 
Multifamily residential   -    -    -    -    - 
Commercial RE- owner occupied   4,135    4,112    -    4,121    11 
Commercial RE- non-owner occupied   12,022    11,871    -    12,058    170 
Farmland   279    279    -    280    - 
Total Real Estate   42,380    36,512    -    36,787    291 
Agriculture   -    -    -    -    - 
Commercial and Industrial   522    522    -    557    - 
Small Business Administration   -    -    -    -    - 
Direct finance leases   -    -    -    -    - 
Consumer loans   280    280    -    285    4 
    43,182    37,314    -    37,629    295 
Total  $100,655   $93,755   $10,896   $94,704   $545 

 

(1)Contractual principal balance due from customer

(2)Principal balance on Company's books, less any direct charge offs.

(3)Interest income is recognized on performing balances on a regular accrual basis

 

21
 

 

Impaired Loans  December 31, 2011 
(dollars in thousands, unaudited)  Unpaid Principal Balance(1)   Recorded Investment(2)   Related Allowance   Average Recorded Investment   Interest Income Recognized(3) 
With an Allowance Recorded                         
Real Estate:                         
   1-4 family residential construction  $188   $188   $13   $188   $- 
   Other Construction/Land   3,477    2,906    735    2,925    89 
   1-4 Family - closed-end   8,086    8,057    821    8,071    222 
   Equity Lines   1,072    1,072    243    1,069    - 
   Multifamily residential   2,941    2,941    850    2,950    - 
   Commercial RE- owner occupied   3,628    3,628    834    3,645    24 
   Commercial RE- non-owner occupied   17,454    17,454    1,733    17,842    274 
   Farmland   -    -    -    -    - 
       Total Real Estate   36,846    36,246    5,229    36,690    609 
Agriculture   -    -    -    -    - 
Commercial and Industrial   4,135    4,106    1,481    4,197    24 
Small Business Administration   3,902    3,903    1,212    3,903    2 
Direct finance leases   591    591    291    591    - 
Consumer loans   3,896    3,858    541    3,920    56 
    49,370    48,704    8,754    49,301    691 
With no Related Allowance Recorded                            
Real Estate:                         
   1-4 family residential construction  $4,784   $2,056   $-   $2,069   $- 
   Other Construction/Land   11,740    9,081    -    9,326    193 
   1-4 Family - closed-end   12,467    12,203    -    12,250    101 
   Equity Lines   307    307    -    318    - 
   Multifamily residential   -    -    -    -    - 
   Commercial RE- owner occupied   6,049    6,030    -    6,136    17 
   Commercial RE- non-owner occupied   11,818    11,666    -    12,033    190 
   Farmland   7,468    6,919    -    6,956    - 
       Total Real Estate   54,633    48,262    -    49,088    501 
Agriculture   -    -    -    -    - 
Commercial and Industrial   916    915    -    965    11 
Small Business Administration   -    -    -    -    - 
Direct finance leases   -    -    -    -    - 
Consumer loans   448    448    -    462    11 
    55,997    49,625    -    50,515    523 
    Total  $105,367   $98,329   $8,754   $99,816   $1,214 

 

(1)Contractual principal balance due from customer

(2)Principal balance on Company's books, less any direct charge offs.

(3)Interest income is recognized on performing balances on a regular accrual basis

 

22
 

Similar but condensed information as of the dates noted is provided in the following table:

 

 

Impaired Loans        
(dollars in thousands, unaudited)        
   March 31, 2012   December 31, 2011 
           
Impaired loans without a valuation allowance  $37,314   $49,625 
Impaired loans with a valuation allowance   56,441    48,704 
Total impaired loans (1)  $93,755   $98,329 
Valuation allowance related to impaired loans  $10,896   $8,754 
Total non-accrual loans  $49,971   $56,110 
Total loans past-due ninety days or more and still accruing  $320   $48 

 

(1) Principal balance on Company's books less any direct charge-off

  

The specific loss allowance for an impaired loan represents the difference between the face value of the loan and either its current appraised value less estimated disposition costs, or its net present value as determined by a discounted cash flow analysis. The discounted cash flow approach is used to measure impairment on loans for which it is anticipated that repayment will be provided from cash flows other than those generated solely by the disposition of underlying collateral. Any change in impairment attributable to the passage of time is adjusted for by means of adjustments to the loan loss provision. If a distressed borrower displays the desire and ability to continue paying on the loan, but is unable to do so except on a modified basis, an amended repayment plan may be negotiated. For these TDR’s, the act of modification in and of itself suggests that the Company believes the source of repayment will likely be from borrower-generated cash flows, thus they are also typically evaluated for impairment by discounting projected cash flows. Included in the valuation allowance for impaired loans shown in the table above are specific reserves allocated to TDR’s, totaling $4.886 million at March 31, 2012, and $3.653 million at December 31, 2011.

 

For loans where repayment is expected to be provided solely by the underlying collateral, impairment is measured using the fair value of the collateral. If the collateral value, net of the expected costs of disposition, is less than the loan balance, then a specific loss reserve is established for the shortfall in collateral coverage. If the discounted collateral value is greater than or equal to the loan balance, no specific loss reserve is established. At the time a collateral-dependent loan is designated as nonperforming, a new appraisal is ordered and typically received within 30 to 60 days if a recent appraisal was not already available. We generally use external appraisals to determine the fair value of the underlying collateral for nonperforming real estate loans, although the Company’s licensed staff appraisers may update older appraisals based on current market conditions and property value trends. Until an updated appraisal is received, the Company uses the existing appraisal to determine the amount of the specific loss allowance that may be required, and adjusts the specific loss allowance, as necessary, once a new appraisal is received. Updated appraisals are generally ordered at least annually for collateral-dependent loans that remain impaired. Current appraisals were available for 74% of the Company’s impaired real estate loan balances at March 31, 2012. Furthermore, the Company analyzes collateral-dependent loans on at least a quarterly basis, to determine if any portion of the recorded investment in such loans can be identified as uncollectible and would therefore constitute a confirmed loss. All amounts deemed to be uncollectible are promptly charged off against the Company’s allowance for loan and lease losses, with the loan then carried at the fair value of the collateral, as appraised, less estimated costs of disposition if such costs were not reflected in appraised values. Once a charge-off or write-down is recorded, it will not be restored to the loan balance on the Company’s accounting books.

 

Our methodology also provides that a “general” allowance be established for probable incurred losses inherent in loans and leases that are not impaired. These unimpaired loan balances are segregated by credit quality, and are then evaluated in pools with common characteristics. At the present time, pools are based on the same segmentation of loan types presented in our regulatory filings. While this methodology utilizes historical loss data and other measurable information, the classification of loans and the establishment of the allowance for loan and lease losses are both to some extent based on management’s judgment and experience. Our methodology incorporates a variety of risk considerations, both quantitative and qualitative, in establishing an allowance for loan and lease losses that management believes is appropriate at each reporting date. Quantitative information includes our historical loss experience, delinquency and charge-off trends, current collateral values, and the anticipated timing of collection of principal for nonperforming loans. Qualitative factors include the general economic environment in our markets and, in particular, the state of the agricultural industry and other key industries in the Central San Joaquin Valley. Lending policies and procedures (including underwriting standards), the experience and abilities of lending staff, the quality of loan review, credit concentrations (by geography, loan type, industry and collateral type), the rate of loan portfolio growth, and changes in legal or regulatory requirements are additional factors that are considered. The total general reserve established for probable incurred losses on unimpaired loans was $6.5 million at March 31, 2012.

23
 

During the quarter ended March 31, 2012 we adjusted certain qualitative factors used in determining our allowance for loan and lease losses pursuant to our assessment that default risk in non-impaired loans is declining, but there were no material changes made to the methodology used to determine our allowance for loan and lease losses. As we add new products and expand our geographic coverage, and as the economic environment changes, we expect to continue to enhance our methodology to keep pace with the size and complexity of the loan and lease portfolio and respond to pressures created by external forces. We engage outside firms on a regular basis to assess our methodology and perform independent credit reviews of our loan and lease portfolio. In addition, the Company’s external auditors, the FDIC, and the California DFI review the allowance for loan and lease losses as an integral part of their audit and examination processes. Management believes that the current methodology is appropriate given our size and level of complexity. The tables that follow detail the activity in the allowance for loan and lease losses for the periods noted:

 

24
 

 

Allowance for Credit Losses and Recorded Investment in Financing Receivables

(dollars in thousands, unaudited)

 

   For the Quarter Ended March 31, 2012 
   Real Estate   Agricultural Products   Commercial and Industrial   Small Business Administration   Direct Finance Leases   Consumer   Total 
                             
Allowance for credit losses:                                   
Beginning Balance  $8,260   $19   $4,638   $1,447   $311   $2,608   $17,283 
         Charge-offs   954    -    1,091    86    198    625    2,954 
         Recoveries   131    -    125    -    -    73    329 
         Provision   2,463    (1)   31    36    61    160    2,750 
                                    
Ending Balance  $9,900   $18   $3,703   $1,397   $174   $2,216   $17,408 
                                    
Reserves:                                   
         Specific  $7,303   $-   $1,383   $1,296   $160   $754   $10,896 
         General   2,597    18    2,320    101    14    1,462    6,512 
                                    
   $9,900   $18   $3,703   $1,397   $174   $2,216   $17,408 
                                    
Loans evaluated for impairment:                                   
         Individually  $80,911   $-   $3,962   $4,283   $324   $4,275   $93,755 
         Collectively   493,435    15,804    97,077    16,819    5,380    29,199    657,714 
                                    
Ending Balance  $574,346   $15,804   $101,039   $21,102   $5,704   $33,474   $751,469 

 

   For the Year Ended December 31, 2011 
   Real Estate   Agricultural Products   Commercial and Industrial   Small Business Administration   Direct Finance Leases     Consumer      Total  
                                    
Allowance for credit losses:                                   
Beginning Balance  $10,143   $62   $6,379   $1,274   $284   $2,996   $21,138 
         Charge-offs   (10,596)   -    (3,407)   (148)   (82)   (2,754)   (16,987)
         Recoveries   418    -    323    71    57    263    1,132 
         Provision   8,295    (43)   1,343    250    52    2,103    12,000 
                                    
Ending Balance  $8,260   $19   $4,638   $1,447   $311   $2,608   $17,283 
                                    
Reserves:                                   
         Specific  $5,229   $-   $1,481   $1,212   $291   $541   $8,754 
         General   3,031    19    3,157    235    20    2,067    8,529 
                                    
   $8,260   $19   $4,638   $1,447   $311   $2,608   $17,283 
                                    
Loans evaluated for impairment:                                   
         Individually  $84,508   $-   $5,021   $3,903   $591   $4,306   $98,329 
        Collectively   492,724    17,078    94,387    17,103    6,152    31,818    659,262 
                                    
Ending Balance  $577,232   $17,078   $99,408   $21,006   $6,743   $36,124   $757,591 

 

25
 

 

PART I - FINANCIAL INFORMATION

 

ITEM 2

 

MANAGEMENT’S DISCUSSION AND

ANALYSIS OF FINANCIAL CONDITION

AND RESULTS OF OPERATIONS

  

FORWARD-LOOKING STATEMENTS

 

This Form 10-Q includes forward-looking statements that involve inherent risks and uncertainties. Words such as “expects”, “anticipates”, “believes”, “projects”, and “estimates” or variations of such words and similar expressions are intended to identify forward-looking statements. These statements are not guarantees of future performance and involve certain risks, uncertainties and assumptions that are difficult to predict. Therefore, actual outcomes and results may differ materially from what is expressed, forecast in, or implied by such forward-looking statements.

 

A variety of factors could have a material adverse impact on the Company’s financial condition or results of operations, and should be considered when evaluating the potential future financial performance of the Company. These include, but are not limited to, further deterioration in economic conditions in the Company’s service areas; risks associated with fluctuations in interest rates; liquidity risks; increases in nonperforming assets and net credit losses that could occur, particularly in times of weak economic conditions or rising interest rates; the Company’s ability to secure buyers for foreclosed properties; the loss in market value of available-for-sale securities that could result if interest rates change substantially or an issuer has real or perceived financial difficulties; the Company’s ability to attract and retain skilled employees; the Company’s ability to successfully deploy new technology; the success of branch expansion; and risks associated with the multitude of current and prospective laws and regulations to which the Company is and will be subject.

  

CRITICAL ACCOUNTING POLICIES

 

The Company’s financial statements are prepared in accordance with accounting principles generally accepted in the United States. The financial information and disclosures contained within those statements are significantly impacted by Management’s estimates and judgments, which are based on historical experience and various other assumptions that are believed to be reasonable under current circumstances. Actual results may differ from those estimates under divergent conditions.

 

Critical accounting policies are those that involve the most complex and subjective decisions and assessments, and have the greatest potential impact on the Company’s stated results of operations. In Management’s opinion, the Company’s critical accounting policies deal with the following areas: the establishment of the Company’s allowance for loan and lease losses, as explained in detail in Note 12 to the consolidated financial statements and the “Provision for Loan and Lease Losses” and “Allowance for Loan and Lease Losses” sections of this discussion and analysis; the valuation of impaired loans and foreclosed assets, which is discussed in Note 11 to the consolidated financial statements and in the “Nonperforming Assets” and “Allowance for Loan and Lease Losses” sections of this discussion and analysis; income taxes, especially with regard to the ability of the Company to recover deferred tax assets, as discussed in the “Provision for Income Taxes” and “Other Assets” sections of this discussion and analysis; goodwill, which is evaluated annually for impairment based on the fair value of the Company as discussed in the “Other Assets” section of this discussion and analysis; and equity-based compensation, which is discussed in greater detail in Note 5 to the consolidated financial statements. Critical accounting areas are evaluated on an ongoing basis to ensure that the Company’s financial statements incorporate the most recent expectations with regard to those areas.

 

 

26
 

OVERVIEW OF THE RESULTS OF OPERATIONS

AND FINANCIAL CONDITION

 

results of operations Summary

 

First Quarter 2012 compared to First Quarter 2011

 

Net income for the quarter ended March 31, 2012 was $1.879 million, representing an increase of $350,000, or 23%, relative to net income of $1.529 million for the quarter ended March 31, 2011. Basic and diluted earnings per share for the first quarter of 2012 were $0.13, compared to $0.11 basic and diluted earnings per share for the first quarter of 2011. The Company’s annualized return on average equity was 4.44% and annualized return on average assets was 0.57% for the quarter ended March 31, 2012, compared to a return on equity of 3.86% and return on assets of 0.48% for the quarter ended March 31, 2011. The primary drivers behind the variance in net income are as follows:

 

·Net interest income was down $488,000, or 4%, due to a 37 basis point drop in the Company’s net interest margin, partially offset by a $39 million increase in average interest-earning assets. Negative factors impacting the Company’s net interest margin include a shift from average loan balances into lower-yielding investment balances, and lower loan yields resulting from increased competition for quality loans. However, these negatives were partially offset by a reduced reliance on interest-bearing liabilities stemming from increases in the average balances of non-interest bearing demand deposits and equity, a shift in average interest-bearing deposit balances from higher-cost time deposits into lower-cost non-maturity deposits, and net interest recoveries in 2012 versus net interest reversals in 2011.

 

·The Company’s loan loss provision was reduced by $850,000, or 24%. This reduction was due in part to a drop of $649,000, or 20%, in net loans charged off for the quarter over quarter comparison.

 

·Total non-interest revenue increased by $469,000, or 13%, due primarily to a sizeable increase in gains on bank-owned life insurance (BOLI) associated with deferred compensation plans, and favorable variances in various other non-interest income categories including debit card interchange fees and tax-credit investment costs (which are accounted for as a reduction in non-interest income).

 

·Total operating expense increased by $281,000, or 2%. The largest unfavorable variances in operating expense include an increase in expenses associated with OREO, an increase in deferred compensation expense accruals (related to the increase in BOLI income discussed above), and the variance created by $181,000 in non-recurring vendor credits received in the first quarter of 2011 for prior-year overcharges. The largest favorable variances in non-interest expense include a drop in occupancy expense, due in part to lower costs resulting from the purchase of our headquarters office building in the fourth quarter of 2011, and a lower FDIC assessment accrual.

 

·The Company had a negative provision for income taxes in the first quarters of both 2012 and 2011. This tax benefit is the result of a high level of tax credits relative to our pre-credit tax liability, as calculated for book purposes. Tax credits include those related to investments in low-income housing tax credit funds, as well as hiring tax credits.

 

Financial Condition Summary

 

March 31, 2012 relative to December 31, 2011

 

The most significant characteristics of, and changes in, the Company’s balance sheet during the first three months of 2012 are outlined below:

 

·The Company’s assets totaled $1.348 billion at March 31, 2012, an increase of $13 million, or 1%, relative to total assets of $1.335 billion at December 31, 2011. Total assets increased due to growth in investment securities and an increase in cash and balances due from banks, less loan runoff. Gross loan and lease balances declined $7 million, or 1%, including a drop of over $6 million in nonperforming loans.

 

27
 
·Total nonperforming assets fell to $66 million at March 31, 2012 from $71 million at December 31, 2011, a decline of 8%. In addition to nonperforming assets, the Company had $38 million in performing restructured troubled debt (TDR’s) as of March 31, 2012, an increase of $2 million, or 4%, relative to year-end 2011.

 

·Our allowance for loan and lease losses was $17.4 million as of March 31, 2012, which represents a slight increase relative to the balance at year-end 2011. The allowance also increased slightly as a percentage of total loans, to 2.32% at March 31, 2012 from 2.28% at December 31, 2011.

 

·Total deposits increased by $37 million, or 3%. Core non-maturity deposits actually increased by $44 million, or 6%, which includes sizeable increases in non-interest bearing demand deposits, interest-bearing transaction accounts, and savings deposits. Customer time deposits, including reciprocal deposits obtained via the Certificate of Deposit Account Registry Service (CDARS), declined by $7 million, or 2%, due to the non-renewal of time deposits managed by our Treasury Department. Because of the strong growth in deposits and a $3 million increase in customer repos, we were able to eliminate short-term borrowings from the Federal Home Loan Bank, which totaled $17 million at year-end 2011, and reduce longer-term FHLB advances by $10 million, or 67%.

 

·Total capital increased by $2 million, or 1%, to $170 million at March 31, 2012. Because capital increased and risk-adjusted assets declined, our consolidated total risk-based capital ratio increased to 21.95% at March 31, 2012 from 21.72% at year-end 2011. Further, our tier one risk-based capital ratio was 20.69% and our tier one leverage ratio was 14.09% at March 31, 2012.

  

EARNINGS PERFORMANCE

 

The Company earns income from two primary sources. The first is net interest income, which is interest income generated by earning assets less interest expense on interest-bearing liabilities. The second is non-interest income, which consists mainly of customer service charges and fees but also comes from non-customer sources such as bank-owned life insurance. The majority of the Company’s non-interest expenses are operating costs that relate to providing a full range of banking services to our customers.

 

Net interest income AND NET INTEREST MARGIN

 

For the first quarter of 2012 relative to the first quarter of 2011 net interest income declined by $488,000, or 4%. The level of net interest income depends on several factors in combination, including growth in earning assets, yields on earning assets, the cost of interest-bearing liabilities, the relative volume of earning assets and interest-bearing liabilities, and the mix of products which comprise the Company’s earning assets, deposits, and other interest-bearing liabilities. Net interest income can also be impacted by the reversal of interest for loans placed on non-accrual status during the reporting period, and by the recovery of interest on loans that have been on non-accrual and are either sold or returned to accrual status.

 

The following table shows the average balance of each significant balance sheet category, and the amount of interest income or interest expense associated with that category, for the noted periods. The table also shows the calculated yields on each major component of the Company’s investment and loan portfolio, the average rates paid on each key segment of the Company’s interest-bearing liabilities, and our net interest margin for those periods.

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Average Balances and Rates  For the Quarter   For the Quarter 
(dollars in thousands, except per share data)  Ended March 31, 2012   Ended March 31, 2011 
   Average Balance (1)   Income/ Expense   Average Rate/Yield (2)(3)   Average Balance (1)   Income/ Expense   Average Rate/Yield (2)(3) 
Assets                              
Investments:                              
Federal funds sold/Due from time  $23,783   $14    0.23%  $10,326   $8    0.31%
Taxable   338,721    1,881    2.20%   276,740    1,916    2.77%
Non-taxable   73,267    666    5.45%   71,814    716    6.04%
Equity   1,478    3    0.80%   1,549    -    0.00%
         Total Investments   437,249    2,564    2.63%   360,429    2,640    3.34%
                               
Loans and Leases:(4) (5)                              
Agricultural   14,182    145    4.11%   12,088    152    5.10%
Commercial   109,872    1,556    5.70%   102,185    1,522    6.04%
Real Estate   530,965    8,576    6.50%   569,672    9,049    6.44%
Consumer   33,270    802    9.70%   44,082    944    8.68%
Direct Financing Leases   4,890    65    5.35%   7,948    115    5.87%
Other   55,150    -    0.00%   49,730    -    0.00%
         Total Loans and Leases   748,329    11,144    5.99%   785,705    11,782    6.08%
Total Interest Earning Assets (5)   1,185,578    13,708    4.77%   1,146,134    14,422    5.23%
Other Earning Assets   6,995              8,347           
Non-Earning Assets   139,513              138,694           
  Total Assets  $1,332,086             $1,293,175           
                               
Liabilities and Shareholders' Equity                              
Interest Bearing Deposits:                              
Demand Deposits  $64,525   $67    0.42%  $-   $-    0.00%
NOW   192,260    194    0.41%   177,104    215    0.49%
Savings Accounts   98,841    57    0.23%   78,182    46    0.24%
Money Market   80,463    33    0.16%   156,491    190    0.49%
CDAR's   18,229    15    0.33%   32,762    54    0.67%
Certificates of Deposit<$100,000   103,625    172    0.67%   161,388    274    0.69%
Certificates of Deposit>$100,000   220,536    297    0.54%   191,285    287    0.61%
Brokered Deposits   15,000    50    1.34%   6,833    25    1.48%
         Total Interest Bearing Deposits   793,479    885    0.45%   804,045    1,091    0.55%
Borrowed Funds:                              
Federal Funds Purchased   -    -    0.00%   3    -    0.00%
Repurchase Agreements   2,954    5    0.68%   -    -    0.00%
Short Term Borrowings   1,796    -    0.00%   5,103    34    2.70%
Long Term Borrowings   12,912    131    4.08%   15,000    140    3.79%
TRUPS   30,928    199    2.59%   30,928    181    2.37%
         Total Borrowed Funds   48,590    335    2.77%   51,034    355    2.82%
         Total Interest Bearing Liabilities   842,069    1,220    0.58%   855,079    1,446    0.69%
Demand Deposits   300,408              261,801           
Other Liabilities   19,305              15,489           
Shareholders' Equity   170,304              160,806           
  Total Liabilities and Shareholders' Equity  $1,332,086             $1,293,175           
                               
Interest Income/Interest Earning Assets             4.77%             5.23%
Interest Expense/Interest Earning Assets             0.41%             0.51%
  Net Interest Income and Margin(6)       $12,488    4.36%       $12,976    4.72%

 

(1) Average balances are obtained from the best available daily or monthly data and are net of deferred fees and related direct costs.

(2) Yields and net interest margin have been computed on a tax equivalent basis utilizing a 34% effective tax rate.

(3) Annualized

(4) Loan costs have been included in the calculation of interest income. Loan costs were approximately $239 thousand and $193 thousand for the quarters ended March 31, 2012 and 2011. Loans are gross of the allowance for possible loan losses.

(5) Non-accrual loans have been included in total loans for purposes of total earning assets.

(6) Net interest margin represents net interest income as a percentage of average interest-earning assets (tax-equivalent).

 

29
 

 

The Volume and Rate Variances table below sets forth the dollar difference in interest earned or paid for each major category of interest-earning assets and interest-bearing liabilities for the noted periods, and the amount of such change attributable to changes in average balances (volume) or changes in average interest rates. Volume variances are equal to the increase or decrease in average balance multiplied by prior period rates, and rate variances are equal to the increase or decrease in rate times prior period average balances. Variances attributable to both rate and volume changes are calculated by multiplying the change in rate by the change in average balance, and have been allocated to the rate variance.

 

 

Volume & Rate Variances  Quarter Ended March 31, 
(dollars in thousands)      2012 over 2011     
   Increase(decrease) due to 
Assets:  Volume   Rate   Net 
Investments:            
Federal funds sold / Due from time  $10   $(4)  $6 
Taxable   429    (464)   (35)
Non-taxable(1)   14    (64)   (50)
Equity   -    3    3 
         Total Investments   453    (529)   (76)
Loans and Leases:               
Agricultural   26    (33)   (7)
Commercial   114    (80)   34 
Real Estate   (615)   142    (473)
Consumer   (232)   90    (142)
Direct Financing Leases   (44)   (6)   (50)
Other   -    -    - 
         Total Loans and Leases   (751)   113    (638)
         Total Interest Earning Assets  $(298)  $(416)  $(714)
Liabilities               
Interest Bearing Deposits:               
Demand Deposits  $-   $67   $67 
NOW   18    (39)   (21)
Savings Accounts   12    (1)   11 
Money Market   (92)   (65)   (157)
CDAR's   (24)   (15)   (39)
Certificates of Deposit < $100,000   (98)   (4)   (102)
Certificates of Deposit > $100,000   44    (34)   10 
Brokered Deposits   30    (5)   25 
          Total Interest Bearing Deposits   (110)   (96)   (206)
Borrowed Funds:               
Federal Funds Purchased   -    -    - 
Repurchase Agreements   -    5    5 
Short Term Borrowings   (22)   (12)   (34)
Long Term Borrowings   (19)   10    (9)
TRUPS   -    18    18 
          Total Borrowed Funds   (41)   21    (20)
          Total Interest Bearing Liabilities   (151)   (75)   (226)
          Net Interest Margin/Income  $(147)  $(341)  $(488)

 

(1) Yields on tax exempt income have not been computed on a tax equivalent basis.

 

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As shown above, the volume variance for the first quarter of 2012 relative to the first quarter of 2011 was negative $147,000, despite the fact that average interest-earning assets were $39 million higher. The negative volume variance was primarily the result of an unfavorable shift in average earning asset balances. We experienced a $37 million drop in average loans due to declining balances of relatively high-yielding real estate and consumer loans, while there was an increase of $77 million in the average balance of investments, including a $13 million increase in overnight fed funds sold and short-term interest-earning deposits in other banks, which have yields that are significantly lower than average loan yields. The average balance of nonperforming loans was also $5 million higher in the first quarter of 2012 than in the first quarter of 2011. Unfavorable changes in average asset balances were partially countered by positive swings in average liability and equity balances. We experienced movement out of aggregate time deposits and wholesale borrowings into lower-cost non-maturity deposits for the comparative quarters, including a $39 million increase in the average balance of non-interest bearing demand deposits. A $9 million increase in average equity also helped reduced our reliance on interest-bearing liabilities and thus helped limit the magnitude of the negative volume variance.

 

The impact of interest rate changes on net interest income was also negative for the quarterly comparison, with a $341,000 unfavorable rate variance. There hasn’t been a significant change in market interest rates during the past year, but our weighted average yield on interest-earning assets was 47 basis points lower due in large part to the addition of investment securities in a relatively low-rate environment. The unfavorable change in our yield on earning assets was exacerbated by lower commercial and agricultural loan yields, which declined 34 basis points and 99 basis points, respectively, due to increased competition for quality loans. By comparison, our weighted average cost of interest-bearing liabilities was just 10 basis points lower, due primarily to the general lack of competitive pressures on deposit rates and an improving deposit mix. The negative rate variance is exacerbated by our sizeable net interest position, which is the difference between interest-earning assets and interest-bearing liabilities. Our average net interest position for the first quarter of 2011, which is the base period for the rate variance calculation, was $291 million, meaning that the yield decrease for interest-earning assets was applied to a much higher balance than the rate decrease for interest-bearing liabilities and had a greater impact on net interest income. Helping offset the negative factors impacting the Company’s rate variance was a $13 million reduction in average interest-bearing liabilities facilitated by increases in average demand deposits and average equity. Also impacting the rate variance were interest reversals on loans placed on non-accrual, and interest recoveries on loans that were removed from non-accrual status. The impact was favorable for the quarter over quarter comparison, since net interest recoveries totaled $143,000 in the first quarter of 2012 as opposed to net interest reversals of $27,000 in the first quarter of 2011.

 

The Company’s net interest margin, which is tax-equivalent net interest income as a percentage of average interest-earning assets, is affected by the same factors discussed above relative to rate and volume variances. Our net interest margin was 4.35% in the first quarter of 2012, a decline of 37 basis points relative to the first quarter of 2011. The principle negative factor impacting our net interest margin in 2012 was the shift from average loan balances into lower-yielding investment balances. Having a favorable impact on our net interest margin were a shift in average balances from higher-cost liabilities into lower-cost non-maturity deposits, a reduced reliance on interest-bearing liabilities, and net interest recoveries.

 

Provision for loan and LEASE losses

 

Credit risk is inherent in the business of making loans. The Company sets aside an allowance for loan and lease losses, a contra-asset account, through periodic charges to earnings which are reflected in the income statement as the provision for loan and lease losses. These charges are in amounts sufficient to achieve an allowance for loan and lease losses that, in management’s judgment, is adequate to absorb probable loan losses related to specifically-identified impaired loans, as well as probable incurred losses in the remaining loan portfolio. Specifically identifiable and quantifiable loan losses are immediately charged off against the allowance. The loan loss provision is also impacted by the level of loan charge-offs, since charge-offs affect historical loss factors used in determining general reserves for non-impaired loans and could necessitate reserve replenishment. Net loans charged off in the first quarter of 2012 totaled $2.625 million, relative to $3.274 million in the first quarter of 2011. The Company’s policies for monitoring the adequacy of the allowance and determining loan amounts that should be charged off, and other detailed information with regard to changes in the allowance, are discussed in note 12 to the consolidated financial statements, and below under “Allowance for Loan and Lease Losses.” The process utilized to establish an appropriate allowance for loan and lease losses can result in a high degree of variability in the Company’s loan loss provision, and consequently in our net earnings.

 

31
 

Consistent with the lower level of net charge-offs, the Company’s loan loss provision was reduced by $850,000, or 24%, in the first quarter of 2012 relative to the first quarter of 2011. Our loan loss provision in recent periods has been utilized for specific reserves on impaired loans and to replenish reserves subsequent to loan charge-offs, and the provision in 2011 was additionally utilized to build general reserves for performing loans due to higher historical loss factors. The severity of economic challenges has contributed to much higher provisions for the past several years than recorded in prior periods of strong economic growth, due to the negative impact of recessionary conditions on many of our borrowers and the resulting credit challenges in our loan portfolio.

 

 

NON-INTEREST INCOME and OPERATING expense

 

The following table provides details on the Company’s non-interest income and operating expense for the first quarter of 2012 and the first quarter of 2011:

 

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Non Interest Income/Expense                
(dollars in thousands, unaudited)  For the Quarter 
   Ended March 31, 
OTHER OPERATING INCOME:  2012   % of Tota1    2011   % of Total  
Service charges on deposit accounts  $2,287    56.54%  $2,255    63.06%
Other service charges, commissions & fees   1,122    27.74%   906    25.33%
Gains on sales of loans   50    1.24%   43    1.20%
Gains on securities   70    1.73%   -    0.00%
Loan servicing income   5    0.12%   6    0.17%
Bank owned life insurance   586    14.48%   374    10.46%
Other   (75)   -1.85%   (8)   -0.22%
     Total non-interest income  $4,045    100.00%  $3,576    100.00%
     As a % of average interest-earning assets (1)        1.37%        1.27%
                     
OTHER OPERATING EXPENSES:                    
Salaries and employee benefits  $5,665    47.28%  $5,710    48.80%
Occupancy costs                    
  Furniture & equipment   483    4.03%   521    4.45%
  Premises   1,006    8.40%   1,054    9.01%
Advertising and marketing costs   471    3.93%   422    3.61%
Data processing costs   418    3.49%   273    2.33%
Deposit services costs   579    4.83%   637    5.44%
Loan services costs                    
  Loan processing   268    2.24%   226    1.93%
  Foreclosed assets   1,071    8.94%   624    5.33%
Other operating costs                    
  Telephone & data communications   347    2.90%   295    2.52%
   Postage & mail   180    1.51%   141    1.21%
  Other   189    1.58%   230    1.97%
Professional services costs                    
  Legal & accounting   362    3.02%   382    3.26%
  Other professional service   651    5.43%   933    7.97%
Stationery & supply costs   207    1.73%   172    1.47%
Sundry & tellers   86    0.69%   82    0.70%
    Total non-interest Expense  $11,983    100.00%  $11,702    100.00%
     As a % of average interest-earning assets (1)        4.07%        4.14%
Efficiency Ratio (2)   69.63%        68.24%     

 

(1) Annualized

(2) Tax Equivalent

 

The Company’s results reflect an increase in total non-interest income of $469,000, or 13%, for the first quarter of 2012 relative to the first quarter of 2011. As discussed in greater detail below, the increase in 2012 is due primarily to a higher level of income recognized on bank-owned life insurance (BOLI) associated with deferred compensation plans and favorable variances in various other non-interest income categories, partially offset by lower income on operating leases and a loss on the sale of OREO in the first quarter of 2012 relative to a gain in the first quarter of 2011. Total other operating income was an annualized 1.37% of average interest-earning assets in the first quarter of 2012 relative to 1.27% in the first quarter of 2011.

 

Service charge income on deposits increased by $32,000, or 1%, for the quarterly comparison, due to fees for higher risk deposit accounts which were instituted in the fourth quarter of 2011 and which totaled $150,000 in the first quarter of 2012. Those fees were partially offset by a drop of $82,000, or 6%, in returned item and overdraft charges. Other service charges, commissions, and fees increased by $216,000, or 24%, for the quarter, due to increases in debit card point-of-sale interchange fees, ATM fees charged for non-customer transactions, and merchant fees, as well as a $93,000 drop in pass-through operating costs associated with our investment in low-income housing tax credit funds. Rental income on operating leases, which is also included in other service charges, commissions, and fees, reflects a decline of $37,000 for the quarter, however, because of leases that have matured or paid off.

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The Company realized $70,000 in gains on securities in the first quarter of 2012, due to the “clean-up” sale of a large number of odd-lot mortgage-backed securities with relatively small remaining balances totaling $3.1 million. There were no gains on securities in the first quarter of 2011. Loan sale and servicing income remained at minimal levels in both periods.

 

Bank-owned life insurance income increased by $212,000, or 57%, in the first quarter of 2012 relative to the first quarter of 2011. The increase is mainly due to fluctuations in income on BOLI associated with deferred compensation plans, which is classified as “separate account” BOLI. The Company owns and derives income from two basic types of BOLI: “general account,” and “separate account.” At March 31, 2012 the Company had $35.2 million invested in single-premium general account BOLI, which includes a $5.0 million BOLI purchase consummated at the end of the third quarter of 2011. Income from our general account BOLI is used to fund expenses associated with executive salary continuation plans, director retirement plans and other employee benefits, and is typically fairly consistent with interest credit rates that do not change frequently. The BOLI purchase during 2011 contributed approximately $40,000 to the increase in BOLI income in the first quarter of 2012 relative to the first quarter of 2011. In addition to general account BOLI, the Company had $3.1 million invested in separate account BOLI at March 31, 2012, the earnings on which help offset deferred compensation accruals for certain directors and senior officers. These deferred compensation BOLI accounts have returns pegged to participant-directed investment allocations which can include equity, bond, or real estate indices, and are thus subject to gains or losses which often contribute to significant fluctuations in income from period to period. There was a gain on separate account BOLI totaling $310,000 in the first quarter of 2012 relative to a gain of $123,000 in the first quarter of 2011, for an increase of $187,000 in deferred compensation BOLI income for the quarter. As noted, gains and losses on separate account BOLI are related to participant gains and losses on deferred compensation balances. Participant gains are accounted for as expense accruals which, combined with their associated tax effect, effectively offset income on separate account BOLI, while participant losses result in expense accrual reversals that effectively offset losses on separate account BOLI.

 

The “Other” category under non-interest income includes gains and losses on the disposition of real properties and other assets, and rental income generated by the Company’s alliance with Investment Centers of America (ICA). Other non-interest income declined by $67,000, or 838%, in the first quarter of 2012 in comparison to the first quarter of 2011. The relatively steep percentage decline is primarily due to net losses on the sale of OREO totaling $126,000 in the first quarter of 2012, relative to a net gain of $18,000 in the first quarter of 2011. Partially offsetting the increase in OREO losses was the fact that we had $25,000 in gains on the disposition of leased equipment subsequent to the termination or maturity of leases in the quarter ended March 31, 2012, relative to $52,000 in losses for the like period in 2011.

 

Total operating expense (non-interest expense) was $11.983 million for the quarter ended March 31, 2012, an increase of $281,000, or 2%, relative to total operating expense for the first quarter of 2011. As detailed below, the principle factors in this increase were larger OREO write-downs, higher deferred compensation expense accruals, and the variance created by $181,000 in non-recurring vendor credits received in the first quarter of 2011 for prior-year overcharges. Those increases were partially offset by a lower FDIC assessment and a drop in occupancy expense. Despite the increase in expenses, non-interest expense fell to an annualized 4.07% of average interest-earning assets for the first quarter of 2012 from 4.14% in the first quarter of 2011, due to a higher average balance of interest-earning assets.

 

The largest component of non-interest expense, salaries and employee benefits, declined by $45,000, or 1%, for the quarter. The decline in salaries is due to lower accruals for incentive pay and bonuses, and an increase in the level of salaries that are directly related to successful loan originations and are thus deferred and amortized over the life of the related loans. Those variances were partially offset by a $72,000 increase in deferred compensation expense (related to the increase in BOLI income discussed above), and an increase in regular salaries. Salaries and benefits declined to 47.28% of total non-interest expense for the first quarter of 2012 from 48.8% in the first quarter of 2011.

 

Total occupancy expense declined by $86,000, or 5%, for the first quarter of 2012 relative to the first quarter of 2011, due to a drop in depreciation expense on furniture and equipment, lower costs resulting from the purchase of our headquarters office building in the fourth quarter of 2011, and lower property taxes stemming from updated valuations on Bank-owned branch buildings. Marketing costs increased for the quarter, although the increase was primarily due to the timing of payments and does not represent a permanent increase. Data processing costs were also higher for the comparative quarters, rising by $145,000, or 53%, due to $181,000 in non-recurring vendor credits received in the first quarter of 2011, as noted above. Deposit services costs reflect a drop of $58,000, or 9%, due primarily to lower costs associated with debit card processing and ATM servicing.

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Loan processing costs increased $42,000, or 19%, due primarily to a $37,000 addition to our reserve for unfunded commitments. Foreclosed asset costs increased by $447,000, or 72%, comprised of a $393,000 increase in OREO write-downs and a $54,000 increase in OREO operating expense.

 

Telecommunications costs reflect an increase of $52,000, or 18%, due to costs associated with the addition and enhancement of data circuits. Postage and mail costs increased by $39,000, or 28%, due in large part to costs associated with a direct-mail marketing campaign targeting commercial loans. The drop in the “other” category under other operating costs is from lower depreciation expense on operating leases where the Bank is the lessor, due to the maturity of leases.

 

Under professional services costs, legal and accounting costs declined by $20,000, or 5%, due in large part to consulting costs incurred in 2011 with regard to numerous changes in regulatory expectations and the associated promulgation of new guidance on overdrafts. The cost of other professional services declined by $282,000, or 30%, due to lower FDIC assessment accruals and lower legal costs associated with collections, partially offset by an increase of $115,000 in accruals for directors deferred compensation plans resulting from larger gains on those plans in the first quarter of 2012. Our accruals for FDIC assessments declined to $285,000 for the first quarter of 2012 relative to $627,000 in the first quarter of 2011 due to lower overall assessment rates, the Company’s reduced risk profile, and an excess accrual in the first quarter of 2011. The cost of supplies increased $35,000 due to the timing of payments, while sundry losses did not experience a material change for the comparative quarters.

 

Because non-interest expense increased by a relatively greater amount than net interest income plus non-interest income, the Company’s tax-equivalent overhead efficiency ratio increased slightly to 69.63% in the first quarter of 2012 from 68.24% in the first quarter of 2011. The overhead efficiency ratio represents total operating expense divided by the sum of fully tax-equivalent net interest and non-interest income, with the provision for loan losses, investment gains/losses, and other extraordinary gains/losses excluded from the equation.

 

PROVISION FOR INCOME TAXES

 

The Company sets aside a provision for income taxes on a monthly basis. The amount of the tax provision is determined by applying the Company’s statutory income tax rates to pre-tax book income, adjusted for permanent differences between pre-tax book income and actual taxable income. Such permanent differences include but are not limited to tax-exempt interest income, increases in the cash surrender value of BOLI, California Enterprise Zone deductions, certain expenses that are not allowed as tax deductions, and tax credits. Our tax credits consist primarily of those generated by a $9.2 million investment in low-income housing tax credit funds, and California state employment tax credits. Because of the relatively high portion of the Company’s pretax income that consists of tax-exempt interest income and BOLI income, and the level of tax credits available in relation to our pre-credit tax liability, as calculated for book purposes, our tax accrual rate is currently very sensitive to changes in pretax income. The referenced factors actually resulted in a negative provision for income taxes, or tax benefit, in the first quarters of both 2012 and 2011. The tax benefit was $79,000, or -4% of pre-tax income in the first quarter of 2012, relative to a tax benefit of $279,000 which was -22% of pre-tax income in the first quarter of 2011.

 

 

balance sheet analysis

 

EARNING ASSETS

 

INVESTMENTS

 

The major components of the Company’s earning assets are its investments and loans, and the detailed composition and growth characteristics of both are significant determinants of the financial condition of the Company. The Company’s investments are analyzed in this section, while the loan and lease portfolio is discussed in a later section of this Form 10-Q.

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The Company’s investments consist of debt and marketable equity securities (together, the “investment portfolio”), investments in the time deposits of other banks, surplus interest-earning balances in our Federal Reserve Bank account, and overnight fed funds sold. Surplus Federal Reserve Bank balances and fed funds sold to correspondent banks represent the investment of temporary excess liquidity. The Company’s investments serve several purposes: 1) they provide liquidity to even out cash flows from the loan and deposit activities of customers; 2) they provide a source of pledged assets for securing public deposits, bankruptcy deposits and certain borrowed funds which require collateral; 3) they constitute a large base of assets with maturity and interest rate characteristics that can be changed more readily than the loan portfolio, to better match changes in the deposit base and other funding sources of the Company; 4) they are an alternative interest-earning use of funds when loan demand is light; and 5) they can provide partially tax exempt income. Aggregate investments were 33% of total assets at March 31, 2012, compared to 32% at December 31, 2011.

 

We had no fed funds sold at March 31, 2012 or December 31, 2011. Our balance of interest-bearing balances at other banks was $31 million at March 31, 2012, however, up from $20 million at the end of 2011, primarily because excess balance sheet liquidity was placed in our Federal Reserve Bank account at higher yields than could be realized by selling fed funds. Surplus liquidity, which was generated during the quarter from growth in deposits and loan runoff, was also deployed into longer-term, higher-yielding agency-issued mortgage-backed securities and municipal bonds, hence the book balance of the Company’s investment portfolio increased by $10 million, or 3%, during the first quarter of 2012. The book balance of our investment securities was $417 million at March 31, 2012. Although the Company currently has the intent and the ability to hold the securities in its investment portfolio to maturity, the securities are all marketable and are classified as “available for sale” to allow maximum flexibility with regard to interest rate risk and liquidity management.

 

The following table sets forth the Company’s investment portfolio by investment type as of the dates noted:

 

Investment Portfolio

(dollars in thousands, unaudited)

 

   March 31, 2012   December 31, 2011 
         
   Amortized   Fair Market   Amortized   Fair Market 
   Cost   Value   Cost   Value 
Available for Sale                    
    US Government Agencies & Corporations  $2,004   $2,015   $2,008   $2,026 
    Mortgage-backed securities   335,259    339,023    328,751    331,758 
    State & political subdivisions   70,694    74,039    67,851    71,340 
    Equity securities   1,336    1,789    1,336    1,347 
Total Investment Securities  $409,293   $416,866   $399,946   $406,471 

 

Mortgage-backed securities increased by $7 million, or 2%, during the first quarter of 2012, net of prepayments and the “clean-up” sale of a large number of odd-lot mortgage-backed securities totaling $3.1 million in book value. The sale had virtually no impact on the yield or duration of our investment portfolio. The balance of municipal bonds increased by $3 million, or 4%, as the Company has also taken advantage of relative value in that sector. It should be noted that all newly purchased municipal bonds have strong underlying ratings. No equity securities were bought or sold during the first quarter of 2012, although the market value of those securities increased by $442,000, or 33%. Investment portfolio securities that were pledged as collateral for FHLB borrowings, repurchase agreements, public deposits and for other purposes as required or permitted by law totaled $201 million at March 31, 2012 and $208 million at December 31, 2011, leaving $214 million in unpledged debt securities at March 31, 2012 and $197 million at December 31, 2011. Securities pledged in excess of actual pledging needs, and thus available for liquidity purposes if necessary, totaled $97 million at March 31, 2012 and $94 million at December 31, 2011.

 

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Loan Portfolio

 

The Company’s loans and leases, gross of the associated allowance for losses and deferred fees and origination costs, totaled $752 million at March 31, 2012, a drop of $7 million, or 1%, since December 31, 2011. Loan balances have been declining due to reductions associated with the resolution of impaired loans, and runoff in the normal course of business. Our ability to offset this contraction with organic loan growth has been hindered by weak demand from creditworthy borrowers, tightened credit criteria for real estate loans, and heightened competition. To address these issues, management has made selective personnel changes and established branch objectives weighted toward high-quality loan growth, with a particular focus on commercial loans and agricultural loans. Furthermore, there is anecdotal evidence that the local economy is beginning to improve, which could also benefit loan growth. We have seen a recent increase in lending activity, but no assurance can be provided that this will be sustained and that loan growth will improve, especially in the near term. A comparative schedule of the distribution of the Company’s loans at March 31, 2012 and December 31, 2011, by outstanding balance as well as by percentage of total loans, is presented in the following Loan and Lease Distribution table. The balances shown for each loan type are before deferred or unamortized loan origination, extension, or commitment fees, and deferred origination costs.

 

 

Loan and Lease Distribution

(dollars in thousands, unaudited)

   March 31, 2012   December 31, 2011 
Real Estate:          
     1-4 family residential construction  $7,388   $8,488 
     Other Construction/Land   40,373    40,060 
     1-4 family - closed-end   104,137    106,307 
     Equity Lines   65,140    66,497 
     Multi-family residential   8,132    8,179 
     Commercial RE- owner occupied   183,682    183,070 
     Commercial RE- non-owner occupied   104,982    105,843 
     Farmland   61,275