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 June 30, 2012

 

FNB BANCORP

(Exact name of registrant as specified in its charter)

 

California

(State or other jurisdiction of incorporation)

 

000-49693		92-2115369
(Commission File Number)		(IRS Employer Identification No.)

 

975 El Camino Real, South San Francisco, California		94080
(Address of principal executive offices)		(Zip Code)

 

Registrant’s telephone number, including area code:          (650) 588-6800

 

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 S No £

 

Indicate by check mark whether the registrant has submitted electronically and posted on its Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

Yes S No £

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

	Large accelerated filer £		Accelerated filer £
	Non-accelerated filer S		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 S

 

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date: Common Stock as of August 3, 2012: 3,514,745 shares.

 

 

FNB BANCORP

QUARTERLY REPORT ON FORM 10-Q

TABLE OF CONTENTS

 

PART I. FINANCIAL INFORMATION
		Page No
Item 1.	Consolidated Financial Statements (unaudited):
	Consolidated Balance Sheets	3
	Consolidated Statement of Earnings	4
	Consolidated Statement of Comprehensive Earnings	5
	Consolidated Statements of Cash Flows	6
	Notes to Consolidated Financial Statements	7
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	26
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	41
Item 4T.	Controls and Procedures	41
PART II.	OTHER INFORMATION	41
Item 1.	Legal Proceedings	41
Item 1A.	Risk Factors	42
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	42
Item 4.	Mining Safety Disclosures	42
Item 6.	Exhibits	42
SIGNATURES		43

 

 

PART I—FINANCIAL INFORMATION

 

Item 1. Financial Statements.

 

FNB BANCORP AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
(UNAUDITED)

 

		June 30,				December 31,
(Dollar amounts in thousands)		2012				2011
ASSETS
Cash and due from banks		$	44,856			$	38,474
Securities available-for-sale, at fair value			203,548				187,664
Loans, net of deferred loan fees and allowance for loan losses of $8,458 and $9,897 on June 30, 2012 and December 31, 2011			453,300				443,721
Bank premises, equipment, and leasehold improvements, net			12,916				13,227
Bank owned life insurance			11,594				9,521
Other equity securities			4,603				4,608
Accrued interest receivable			3,621				3,614
Other real estate owned, net			1,923				2,747
Goodwill			1,841				1,841
Prepaid expenses			1,609				2,107
Other assets			8,939				8,117
Total assets		$	748,750			$	715,641
Liabilities & Stockholders’ Equity
Deposits
Demand, noninterest bearing		$	159,370			$	139,382
Demand, interest bearing			63,971				63,308
Savings and money market			323,372				310,237
Time			105,130				108,851
Total deposits			651,843				621,778
Accrued expenses and other liabilities			7,586				6,667
Total liabilities			659,429				628,445
Stockholders’ equity
Preferred stock - series C - no par value, authorized and outstanding 12,600 shares (liquidation preference of $1,000 per share)			12,600				12,600
Common stock, no par value, authorized 10,000,000 shares; issued and outstanding  3,514,745 shares at June 30, 2012 and 3,506,405 shares at December 31, 2011			49,097				48,895
Retained earnings			24,179				22,427
Accumulated other comprehensive earnings , net of tax			3,445				3,274
Total stockholders’ equity			89,321				87,196
Total liabilities and stockholders’ equity		$	748,750			$	715,641

 

 See accompanying notes to consolidated financial statements.

 

 

FNB BANCORP AND SUBSIDIARY

CONSOLIDATED STATEMENT OF EARNINGS

(UNAUDITED)

(Dollar amounts and average shares are in thousands, except earnings per share amounts)

 

		Three months ended								Six months ended
		June 30,								June 30,
		2012				2011				2012				2011
Interest income:
Interest and fees on loans		$	6,758			$	7,407			$	13,513			$	14,845
Interest on taxable securities			617				462				1,230				866
Interest on tax-exempt securities			503				401				1,017				778
Total interest income			7,878				8,270				15,760				16,489
Interest expense:
Deposits			653				857				1,337				1,741
Total interest expense			653				857				1,337				1,741
Net interest income			7,225				7,413				14,423				14,748
Provision for loan losses			400				400				800				850
Net interest income after provision for loan losses			6,825				7,013				13,623				13,898
Noninterest income:
Service charges			744				811				1,496				1,508
Credit card fees			155				178				308				328
Net gain on sale of available-for-sale securities			325				128				809				150
Bank owned life insurance earnings			111				84				578				165
Other income			80				188				144				251
Total noninterest income			1,415				1,389				3,335				2,402
Noninterest expense:
Salaries and employee benefits			3,645				3,423				7,419				6,909
Occupancy expense			598				585				1,198				1,141
Equipment expense			432				417				878				825
Professional fees			383				393				971				757
FDIC assessment			156				300				336				675
Telephone, postage and supplies			271				298				549				611
Operating (recoveries) losses			(56	)			10				52				234
Bankcard expenses			157				165				313				301
Data processing expense			138				154				276				286
Low income housing expense			70				69				139				139
(Gain) loss on sale of other real estate owned			(9	)			25				(4	)			(66	)
Loss on impairment of other real estate owned			—				230				—				230
Other real estate owned expense			15				73				51				261
Other expense			698				630				1,373				1,217
Total noninterest expense			6,498				6,772				13,551				13,520
Earnings before provision for income tax expense			1,742				1,630				3,407				2,780
Provision for income tax expense			514				450				891				797
Net earnings			1,228				1,180				2,516				1,983
Dividends and discount accretion on preferred stock			157				214				343				428
Net earnings available to common stockholders		$	1,071			$	966			$	2,173			$	1,555
Earnings per share data:
Basic		$	0.30			$	0.28			$	0.62			$	0.44
Diluted		$	0.30			$	0.27			$	0.61			$	0.44
Weighted average shares outstanding:
Basic			3,514				3,509				3,512				3,509
Diluted			3,576				3,535				3,563				3,528

 

See accompanying notes to consolidated financial statements.

 

 

FNB BANCORP AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF COMPREHENSIVE EARNINGS

(UNAUDITED)

 

(Dollar amounts in thousands)		Three months ended								Six months ended
		June 30,								June 30,
		2012				2011				2012				2011
Net earnings		$	1,228			$	1,180			$	2,516			$	1,983
Unrealized holding gain on available-for-sale securities, net of tax			631				1,147				648				1,444
Reclassification adjustment for gains recognized on available-for-sale securities sold, net of tax			(192	)			(76	)			(477	)			(89	)
Total comprehensive earnings		$	1,667			$	2,251			$	2,687			$	3,338

 

See accompanying notes to consolidated financial statements. 

 

 

FNB BANCORP AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF CASH FLOWS

(UNAUDITED)

 

(Dollar amounts in thousands)		Six months ended
		June 30
		2012				2011
Cash flow from operating activities:
Net earnings		$	2,516			$	1,983
Adjustments to reconcile net earnings to net cash provided by operating activities:
Net gain on sale of securities available-for-sale			(809	)			(150	)
Depreciation, amortization and accretion			1,680				1,332
Loss (gain) on sale of other real estate owned			5				(66	)
Stock-based compensation expense			121				154
Provision for loan losses			800				850
(Increase) decrease in accrued interest receivable			(7	)			691
Decrease in prepaid expense			498				877
Increase in bank-owned life insurance			(2,073	)			(166	)
(Increase) decrease in other assets			(801	)			25
Valuation allowance on other real estate owned			—				230
Increase (decrease) in accrued expenses and other liabilities			800				(205	)
Net cash provided by operating activities			2,730				5,555
Cash flows from investing activities:
Purchase of securities available-for-sale			(43,995	)			(29,786	)
Proceeds from matured/called/sold securities available-for-sale			28,269				14,655
Investment, net of redemption, in other equity securities			5				317
Proceeds from sale of other real estate owned			832				4,078
Net investment in other real estate owned			(13	)			—
Net (increase) decrease in loans			(10,379	)			14,222
Purchases of bank premises, equipment, leasehold improvements			(427	)			(842	)
Net cash (used in) provided by investing activities			(25,708	)			2,644
Cash flows from financing activities:
Net increase in demand and savings deposits			33,786				11,854
Net decrease in time deposits			(3,721	)			(11,786	)
Dividends paid on common stock			(421	)			(167	)
Exercise of stock options			59				7
Dividends paid on preferred stock series A and B			—				(327	)
Dividends on preferred stock series C			(343	)			—
Net cash (used in) provided by financing activities			29,360				(419	)
NET INCREASE IN CASH AND CASH EQUIVALENTS			6,382				7,780
Cash and cash equivalents at beginning of period			38,474				60,874
Cash and cash equivalents at end of period		$	44,856			$	68,654
Additional cash flow information:
Interest paid		$	1,338			$	1,728
Income taxes paid			930				1,090
Non-cash investing and financing activities:
Change in unrealized gain in available for-sale securities, net of tax			648				1,444
Loans transferred to other real estate owned			—				—
Deemed dividends on preferred stock			—				101

 

See accompanying notes to consolidated financial statements.

 

 

FNB BANCORP AND SUBSIDIARY

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

JUNE 30, 2012

 

(UNAUDITED)

 

NOTE A – BASIS OF PRESENTATION

 

FNB Bancorp (the “Company”) is a bank holding company registered under the Bank Holding Company Act of 1956, as amended. The Company was incorporated under the laws of the State of California on February 28, 2001. The consolidated financial statements include the accounts of FNB Bancorp and its wholly owned subsidiary, First National Bank of Northern California (the “Bank”). The Bank provides traditional banking services in San Mateo and San Francisco counties.

 

All intercompany transactions and balances have been eliminated in consolidation. The financial statements include all adjustments of a normal and recurring nature, which are, in the opinion of management, necessary for a fair presentation of the financial position and of operationsresults for the interim periods presented, as required by Regulation S-X, Rule 10-01.

 

The accompanying unaudited financial statements have been prepared in accordance with the instructions to Form 10-Q and, therefore, do not include all information and footnotes normally included in financial statements prepared in conformity with accounting principles generally accepted in the United States of America. Accordingly, these financial statements should be read in conjunction with the audited financial statements and notes thereto for the year ended December 31, 2011.

 

Results of operations for interim periods are not necessarily indicative of results for the full year.

 

NOTE B – STOCK OPTION PLANS

 

Stock option expense is recorded based on the fair value of option contracts issued. The fair value is determined by the expected contract term, the risk free interest rate, the volatility of the Company’s stock price and the level of dividends the Company is expected to pay.

 

The expected term of options granted is derived from historical plan behavior and represents the period of time that options granted are expected to be outstanding. The risk-free rate for periods within the contractual life of the option is based on the U. S. Treasury yield curve in effect at the time of the grant.

 

The amount of compensation expense for options recorded in the quarters ended June 30, 2012 and June 30, 2011 was $59,000 and $81,000, respectively. There was an income tax benefit of $22,000 recognized in the statements of earnings for these amounts for the quarter ended June 30, 2012, but no tax benefit recognized for the same quarter ended in 2011. The amount of compensation expense for options recorded in the six months ended June 30, 2012 and 2011 was $121,000 and $154,000, respectively. There was an income tax benefit of $22,000 recognized in the statements of earnings for these amounts for the six months ended June 30, 2012, but no tax benefit recognized for the six months ended June 30, 2011.

 

 

The intrinsic value for options exercised during the quarter ended June 30, 2012 was $58,000.The intrinsic value for options exercised during the six month period ended June 30, 2012 was $61,000. The intrinsic value of options exercisable as of June 30, 2012 was $620,000. The intrinsic value for options exercised during the quarter and six months ended June 30, 2011 was $6,000.

 

The amount of total unrecognized compensation expense related to non-vested options at June 30, 2012 was $472,000, and the weighted average period over which it will be amortized is 3.1 years.

 

NOTE C – EARNINGS PER SHARE CALCULATION

 

Earnings per common share (EPS) is computed based on the weighted average number of common shares outstanding during the period. Basic EPS excludes dilution and is computed by dividing net earnings available to common stockholders (after deducting dividends and related accretion on preferred stock) by the weighted average of common shares outstanding. Diluted EPS reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock. All common stock equivalents are anti-dilutive when a net loss occurs.

 

Earnings per share have been computed based on the following :

 

(Dollar amounts in thousands)		Three months ended								Six months ended
		June 30,								June 30,
		2012				2011				2012				2011
Net earnings		$	1,228			$	1,180			$	2,516			$	1,983
Dividends and discount accretion on preferred stock			157				214				343				428
Net earnings available to common stockholders		$	1,071			$	966			$	2,173			$	1,555
Average number of shares outstanding			3,514,000				3,509,000				3,512,000				3,509,000
Effect of dilutive options			62,000				26,000				51,000				19,000
Average number of shares outstanding used to calculate diluted earnings per share			3,576,000				3,535,000				3,563,000				3,528,000

 

Antidilutive options that were excluded from the calculation for the quarter and year to date totaled 277,032 and 299,194 in 2012, and 334,997 and 322,797 in 2011, respectively.

 

 

NOTE D – SECURITIES AVAILABLE FOR SALE

 

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

 

(Dollar amounts in thousands)		Amortized				Unrealized				Unrealized				Carrying
		cost				gains				losses				value
June 30, 2012
U. S. Treasury securities		$	8,212			$	172			$	—			$	8,384
Obligations of U.S. Government agencies			62,995				1,102				—				64,097
Mortgage backed securities			36,162				1,260				—				37,422
Obligations of states and political subdivisions			73,885				3,290				(39	)			77,136
Corporate debt			16,455				190				(136	)			16,509
Totals		$	197,709			$	6,014			$	(175	)		$	203,548

 

(Dollar amounts in thousands)		Amortized				Unrealized				Unrealized				Carrying
		cost				gains				losses				value
December 31, 2011:
U.S. Treasury securities		$	12,371			$	263			$	—			$	12,634
Obligations of U.S. government agencies			53,150				964				(12	)			54,102
Mortgage-backed securities			32,606				838				(9	)			33,435
Obligations of states and political subdivisions			73,674				3,592				(15	)			77,251
Corporate debt			10,314				102				(174	)			10,242
Totals		$	182,115			$	5,759			$	(210	)		$	187,664

 

An analysis of gross unrealized losses within the available-for-sale investment securities portfolio as of June 30, 2012 and December 31, 2011 follows.

 

		Total				< 12 Months				Total				12 Months or >				Total				Total
June 30, 2012		Fair				Unrealized				Fair				Unrealized				Fair				Unrealized
(Dollar amounts in thousands)		Value				Losses				Value				Losses				Value				Losses
Obligations of states and political subdivisions		$	4,753			$	(39	)		$	—			$	—			$	4,753			$	(39	)
Corporate debt			5,176				(45	)			1,369				(91	)			6,545				(136	)
Total		$	9,929			$	(84	)		$	1,369			$	(91	)		$	11,298			$	(175	)

 

		Total				< 12 Months				Total				12 Months or >				Total			Total
December 31, 2011:		Fair				Unrealized				Fair				Unrealized				Fair			Unrealized
(Dollar amounts in thousands)		Value				Losses				Value				Losses				Value			Losses
Obligations of U.S. government agencies		$	6,293			$	(12	)		$				$	—			$	6,293		$	(12)
Mortgage-backed securities			6,466				(9	)			—				—				6,466			(9)
Obligations of states and political subdivisions			2,744				(15	)			—				—				2,744			(15)
Corporate debt			5,554				(173	)			500				(1	)			6,054			(174)
Total		$	21,057			$	(209	)		$	500			$	(1	)		$	21,557		$	(210)

 

 

 

At June 30, 2012, there were two securities in an unrealized loss position for greater than 12 consecutive months. At December 31, 2011, there was one security in an unrealized loss position for greater than 12 consecutive months. Management periodically evaluates each security in an unrealized loss position to determine if the impairment is temporary or other-than-temporary. The unrealized losses are due solely to interest rate changes and the Company does not intend to sell nor expects it will be required to sell investment securities identified with impairments prior to the earliest of forecasted recovery or the maturity of the underlying investment security. Management has determined that no investment security is other-than-temporarily impaired at June 30, 2012.

 

The amortized cost and carrying value of available-for-sale debt securities as of June 30, 2012 by contractual maturity, are shown below. Expected maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.

 

At June 30, 2012:
(Dollar amounts in thousands)		Amortized				Carrying
		Cost				Value
Available-for-sale:
Due in one year or less		$	12,359			$	12,462
Due after one through five years			84,506				86,243
Due after five years through ten years			61,512				63,750
Due after ten years			39,332				41,093
		$	197,709			$	203,548

 

For the six months ended June 30, 2012, gross realized gains amounted to $817,000 on the sale of $22,717,000 in securities. For the six months ended June 30, 2011, gross realized gains amounted to $150,000 on the sale of $10,185,000 in securities. For the six months ended June 30, 2012 and June 30, 2011, gross unrealized losses were $8,000 and $2,000, respectively.

 

At June 30, 2012, securities with an amortized cost of $68,349,000 and fair value of $70,592,000 were pledged as collateral for public deposits and for other purposes required by law.

 

At June 30, 2012 and December 31, 2011, the Bank had investments in Federal Reserve Bank stock of $1,062,000 classified as other equity securities in the accompanying balance sheet. These investments in Federal Reserve Bank stock are carried at cost, and evaluated periodically for impairment. At June 30, 2012 and December 31, 2011, the Bank had investments in Federal Home Loan Bank stock classified as other equity securities in the accompanying balance sheet of $3,293,000 and $3,300,000, respectively. These investments in Federal Home Loan Bank stock are carried at cost, and evaluated periodically for impairment.

 

 

NOTE E – LOANS

 

Loans are summarized as follows at June 30, 2012 and December 31, 2011:

 

		June 30				December 31
(Dollar amounts in thousands)		2012				2011
Commercial real estate		$	244,753			$	257,413
Real estate construction			25,644				28,229
Real estate multi-family			39,960				36,369
Real estate 1 to 4 family			95,886				86,322
Commercial & industrial			53,562				43,074
Consumer loans			2,037				2,335
Gross loans			461,842				453,742
Net deferred loan fees			(84	)			(124	)
Allowance for loan losses			(8,458	)			(9,897	)
Net loans		$	453,300			$	443,721

 

A summary of impaired loans, the related allowance for loan losses, average investment and income recognized on impaired loans follows.

 

			Impaired Loans At June 30, 2012
(Dollar amounts in thousands)			Recorded Investment				Unpaid Principal Balance				Related Allowance
With no related allowance recorded
Commercial & industrial		$	1,751			$	2,327			$	─
Commercial real estate construction			6,186				6,186				─
Commercial real estate			2,886				3,452				─
Residential - 1 to 4 family			1,527				1,675				─
Total			12,350				13,640				─
With an allowance recorded
Commercial & industrial		$	3,105			$	3,421			$	505
Commercial real estate construction			1,052				1,052				75
Real estate multi-family			3,242				3,369				42
Commercial real estate			8,811				9,987				477
Residential- 1 to 4 family			4,916				4,916				157
Consumer			10				10				1
Total			21,136				22,755				1,257
Total
Commercial & industrial		$	4,856			$	5,748			$	505
Commercial real estate construction			7,238				7,238				75
Real estate multi-family			3,242				3,369				42
Commercial real estate			11,697				13,439				477
Residential - 1 to 4 family			6,443				6,591				157
Consumer			10				10				1
Grand total		$	33,486			$	36,395			$	1,257

 

 

		Impaired Loans
		3 months ended June 30, 2012								6 months ended June 30, 2012
		Average								Average
(Dollar amounts in thousands)		Recorded				Income				Recorded				Income
		Investment				Recognized				Investment				Recognized
With no related allow ance recorded
Commercial & industrial		$	1,840			$	29			$	1,888			$	45
Commercial real estate construction			6,197				85				6,209				109
Commercial real estate			2,886				16				2,886				36
Residential - 1 to 4 family			1,539				15				1,542				32
Total			12,462				145				12,525				222
With an allow ance recorded
Commercial & industrial		$	3,328			$	39			$	3,358			$	60
Commercial real estate construction			1,054				14				1,056				29
Commercial real estate			8,827				59				10,033				130
Real estate multi-family			3,252				—				3,263				—
Residential- 1 to 4 family			4,916				18				4,916				40
Consumer			10				—				10				—
Total			21,387				130				22,636				259
Total
Commercial & industrial		$	5,168				68			$	5,246			$	105
Commercial real estate construction			7,251				99				7,265				138
Commercial real estate			11,713				75				12,919				166
Real estate multi-family			3,252				—				3,263				—
Residential - 1 to 4 family			6,455				33				6,458				72
Consumer			10				—				10				—
Grand total		$	33,848			$	275			$	35,161			$	481

 

		Impaired Loans
		For the Year Ended December 31, 2011
						Unpaid
(Dollar amounts in thousands)		Recorded				Principal				Related
		Investment				Balance				Allowance
With no related allowance recorded
Commercial & industrial		$	2,926			$	3,560			$	—
Commercial real estate construction			6,232				6,232				—
Commercial real estate			3,269				3,835				—
Residential- 1 to 4 family			1,059				1,145				—
Total			13,486				14,772				—
With an allowance recorded
Commercial & industrial		$	5,881				5,896			$	428
Commercial real estate construction			1,586				1,686				214
Commercial real estate			11,767				11,767				727
Residential- 1 to 4 family			2,254				2,262				200
Total			21,488				21,611				1,569
Total
Commercial & industrial		$	8,807			$	9,456			$	428
Commercial real estate construction			7,818				7,918				214
Commercial real estate			15,036				15,602				727
Residential - 1 to 4 family			3,313				3,407				200
Grand total		$	34,974			$	36,383			$	1,569

 

 

		Impaired Loans
		3 months ended								6 months ended
		June 30, 2011								June 30, 2011
		Average								Average
(Dollar amounts in thousands)		Recorded				Income				Recorded				Income
			Investment				Recognized				Investment				Recognized
With no related allowance recorded
Commercial & industrial		$	5,566			$	41			$	4,962			$	45
Commercial real estate			1,933				30				1,934				27
Residential - 1 to 4 family			1,069				11				1,082				12
Total			8,568				82				7,978				84
With an allowance recorded
Commercial		$	4,102			$	8			$	4,125			$	8
Commercial real estate construction			8,400				37				8,402				65
Commercial real estate			6,710				11				6,746				9
Residential- 1 to 4 family			2,256				18				2,256				20
Total			21,467				74				21,529				102
Total
Commercial & industrial		$	9,668				49			$	9,087			$	53
Commercial real estate construction			8,400				37				8,402				65
Commercial real estate			8,643				41				8,680				36
Residential - 1 to 4 family			3,325				29				3,338				32
Grand total		$	30,035			$	156			$	29,507			$	186

 

Nonaccrual loans totaled $19,030,000 and $19,098,000 as of June 30, 2012 and December 31, 2011. The difference between impaired loans and nonaccrual loans represents loans that are restructured, are performing under modified agreements, and accruing interest.

 

The following aggregate information is provided at June 30, 2012 and December 31, 2011, about the contractual balances of nonaccrual loans:

 

		Loans on Nonaccrual Status as of
(Dollar amounts in thousands)		June 30,				December 31,
		2012				2011
Commercial & industrial		$	5,805			$	7,019
Real estate - construction			115				642
Commercial real estate			5,102				6,826
Real estate multi-family			3,242				3,283
Real estate 1 to 4 family			4,756				1,328
Consumer			10				—
Total		$	19,030			$	19,098

 

Interest income on impaired loans of $275,000 and $481,000 was recognized for the three and six months ended June 30, 2012, and $1,143,000 was recognized from cash payments received during the year ended December 31, 2011. The amount of interest on impaired loans not collected for the three and six months ended June 30, 2012 was $355,000 and $768,000, and the year ended December 31, 2011 was $1,137,000. The cumulative amount of unpaid interest on impaired loans was $250,000 and $513,000 for the three and six months ended June 30, 2012, and $1,967,000 for the year ended December 31, 2011.

 

 

Troubled Debt Restructurings

The Company offers a variety of modifications to borrowers. The modification categories offered can generally be described in the following categories.

 

Rate Modification – A modification in which the interest rate is changed.

 

Term modification – A modification in which the maturity date, timing of payments, or frequency of payments is changed.

 

Interest Only Modification – A modification in which the loan is converted to interest only payments for a period of time.

 

Payment Modification – A modification in which the dollar amount of the payment is changed, other than an interest only modification described above.

 

As of June 30, 2012 and 2011, respectively, there were no available commitments for troubled debt restructurings.

 

A summary of the number, principal amounts outstanding for troubled debt restructurings were as follows as of June 30, 2012 and December 31, 2011.

 

		Modifications
		As of June 30, 2012
						Pre-				Post-
						Modification				Modification
						Outstanding				Outstanding
		Number of				Recorded				Recorded
		Contracts				Investment				Investment
(Dollar amounts in thousands)
Commercial & industrial			6			$	3,584			$	3,584
Real estate 1 to 4 family			3				1,481				1,481
Commercial real estate			4				5,299				5,299
Real estate multi family			1				3,242				3,242
Total			14				13,606				13,606

 

 

		Modifications
		As of March 31, 2012
						Pre-				Post-
						Modification				Modification
						Outstanding				Outstanding
		Number of				Recorded				Recorded
		Contracts				Investment				Investment
Troubled Debt Restructurings:
Commercial & industrial			5			$	2,925			$	2,925
Real estate 1 to 4 family			2				994				994
Commercial real estate			5				6,021				6,021
Real estate multi family			1				3,262				3,262
Total			13			$	13,202			$	13,202

 

None of these loans defaulted within twelve months following the date of restructure. All restructurings were a modification of interest rate and/or impairment. There were no principal reductions granted.

 

	Modifications
	As of December 31, 2011
						Pre-				Post-
						Modification				Modification
						Outstanding				Outstanding
		Number of				Recorded				Recorded
		Contracts				Investment				Investment
(Amounts in thousands)
Commercial & industrial			5			$	2,987	$			2,987
Real estate 1 to 4 family			2				1,004				1,004
Commercial real estate			6				9,173				9,173
Real estate multi family			1				3,283				3,283
Total			14				16,447				16,447

 

 

Risk rating system

 

Loans to borrowers graded as pass or pooled loans represent loans to borrowers of acceptable or better credit quality. They demonstrate sound financial positions, repayment capacity and credit history. They have an identifiable and stable source of repayment.

 

Special mention loans have potential weaknesses that deserve management’s attention. If left uncorrected these potential weaknesses may result in a deterioration of the repayment prospects for the asset or in the Bank’s credit position at some future date. These assets are not adversely classified and do not expose the Bank to sufficient risk to warrant adverse classification.

 

Substandard loans are inadequately protected by current sound net worth, paying capacity of the borrower, or pledged collateral. Loans are normally classified as Substandard when there are unsatisfactory characteristics causing more than acceptable levels of risk. A substandard loan normally has one or more well-defined weakness that could jeopardize the repayment of the debt. For example, a) cash flow deficiency, which may jeopardize future payments; b) sale of non-collateral assets has become primary source of repayment; c) the borrower is bankrupt; or d) for any other reason, future repayment is dependent on court action.

 

Doubtful loans represent credits with weakness inherent in the Substandard classification and where collection or liquidation in full is highly questionable. To be classified Doubtful, there must be specific pending factors which prevent the Loan Review Officer from determining the amount of loss contained in the credit. When the amount of loss can be reasonably estimated, that amount is classified as “loss” and the remainder is classified as Substandard.

 

Commercial Real Estate Loans

 

Our commercial real estate loans are made primarily to investors or small businesses where our primary source of repayment is from cash flows generated by the properties, either through rent collection or business profits. The borrower’s promissory notes are secured with recorded liens on the underlying property. The borrowers would normally also be required to personally guarantee repayment of the loan. The Bank uses conservative underwriting standards in reviewing applications for credit. Generally, our borrowers have multiple sources of income, so if cash flow generated from the property declines, at least in the short term, the borrowers can normally cover these short term cash flow deficiencies from their available cash reserves. Risk of loss to the Bank is increased when there are cash flow decreases sufficiently large and for such a prolonged period of time that loan payments can no longer be made by the borrowers.

 

Our real estate construction loans are generally made to borrowers who are rehabilitating a building, converting a building use from one type of use to another, or developing land and building residential or commercial structures for sale or lease. The borrower’s promissory notes are secured with recorded liens on the underlying property. The borrowers would normally also be required to personally guarantee repayment of the loan. The Bank uses conservative underwriting standards in reviewing applications for credit. Generally, our borrowers have sufficient resources to make the required construction loan payments during the construction and absorption or lease-up period. After construction is complete, the loans are normally paid off from proceeds from the sale of the building or through a refinance to a commercial real estate loan. Risk of loss to the Bank is increased when there are material construction cost overruns, significant delays in the time to complete the project and/or there has been a material drop in the value of the projects in the marketplace since the inception of the loan.

 

Commercial and Industrial Loans

 

Our commercial and industrial loans are generally made to small businesses to provide them with at least some of the working capital necessary to fund their daily business operations. These loans are generally either unsecured or secured by fixed assets, accounts receivable and/or inventory. The borrowers would normally also be required to personally guarantee repayment of the loan. The Bank uses conservative underwriting standards in reviewing applications for credit. Risk of loss to the Bank is increased when our small business customers experience a significant business downturn, incur significant financial losses, or file for relief from creditors through bankruptcy proceedings.

 

 

Residential Real Estate Loans

 

Our residential real estate loans are generally made to borrowers who are buying or refinancing their primary personal residence or a rental property of 1-4 single family residential units. The Bank uses conservative underwriting standards in reviewing applications for credit. Risk of loss to the Bank is increased when borrowers lose their primary source of income and/or property values decline significantly.

 

Consumer and installment Loans

 

Our consumer and installment loans generally consist of personal loans, credit card loans, automobile loans or other loans secured by personal property. The Bank uses conservative underwriting standards in reviewing applications for credit. Risk of loss to the Bank is increased when borrowers lose their primary source of income, or file for relief from creditors through bankruptcy proceedings.

 

 

		Age Analysis of Past Due Loans As of June 30, 2012
(Dollar amounts in thousands)
		30-59				60-89				Greater																Recorded
		Days				Days				Than				Total												Investment >
		Past				Past				90				Past								Total				90 Days and
		Due				Due				Days				Due				Current				Loans				Accruing
Commercial & industrial		$	483			$	38			$	3,645			$	4,166			$	49,396			$	53,562			$	—
Commercial real estate			500				—				5,102				5,602				239,151				244,753				—
Commercial real estate -construction			—				—				—				—				25,644				25,644				—
Real estate multi-family			—								3,242				3,242				36,718				39,960				—
Residential			—				69				3,775				3,844				92,042				95,886				—
Consumer			—				—				—				—				2,037				2,037				—
Total		$	983			$	107			$	15,764			$	16,854			$	444,988			$	461,842			$	—

 

		Age Analysis of Past Due Loans As of December 31, 2011
(Dollar amounts in thousands)
		30-59 Days				60-89 Days				Over				Total												Recorded Investment >
		Past				Past				90				Past								Total				90 Days and
		Due				Due				Days				Due				Current				Loans				Accruing
Commercial & industrial		$	247			$	712			$	232			$	1,191			$	41,883			$	43,074		$	—
Commercial real estate			1,618				—				10,109				11,727				245,686				257,413
Commercial real estate -construction			549				—				527				1,076				27,153				28,229			—
Real estate multi-family			—				—				—				—				36,369				36,369			—
Real estate 1 to 4 family			71				2,629				257				2,957				83,365				86,322			—
Consumer			—				—				—				—				2,335				2,335			—
Total		$	2,485			$	3,341			$	11,125			$	16,951			$	436,791			$	453,742		$	—

 

 

$19,030,000 and $19,098,000 in nonaccrual loans included past due loans of $16,854,000 and $16,951,000 at June 30, 2012 and December 31, 2011.

 

		Credit Quality Indicators As of June 30, 2012
(Dollar amounts in thousands)
						Special				Sub-								Total
		Pass				mention				standard				Doubtful				loans
Commercial & industrial		$	50,525			$	—			$	2,705			$	332			$	53,562
Real estate construction			23,929				—				1,715				—				25,644
Commercial real estate			233,798				3,377				7,578				—				244,753
Real estate multi-family			36,718				—				3,242				—				39,960
Real estate 1 to 4 family			91,086				—				4,444				356				95,886
Consumer loans			2,027				—				10				—				2,037
Totals		$	438,083			$	3,377			$	19,694			$	688			$	461,842

 

 

		Credit Quality Indicators
		As of December 31, 2011
(Dollar amounts in thousands)
						Special				Sub-								Total
		Pass				mention				standard				Doubtful				loans
Commercial & industrial		$	35,089			$	—			$	7,720			$	265			$	43,074
Real estate construction			25,987				—				2,242				—				28,229
Commercial real estate			247,253				—				10,160				—				257,413
Real estate multi-family			33,085				—				3,284				—				36,369
Real estate 1 to 4 family			82,014				—				3,862				446				86,322
Consumer loans			2,335				—				—				—				2,335
Totals		$	425,763			$	—			$	27,268			$	711			$	453,742

 

 

Allowance for Credit Losses
For the Three Months Ended June 30, 2012

 

(Dollar amounts in thousands)
						Real Estate
		Commercial												Multi				1 to
		& industrial				Commercial				Construction				family				4 family				Consumer				Total
Allowance for credit losses
Beginning balance		$	1,628			$	3,592			$	1,055			$	151			$	1,798			$	63			$	8,287
Charge-offs			(312)				—				(54	)			—				—				(1)				(367	)
Recoveries			—				(2	)			—				—				139				1				138
Provision			418				162				(167	)			(102	)			89				0				400
Ending balance		$	1,734			$	3,752			$	834			$	49			$	2,026			$	63			$	8,458
Ending balance: individually evaluated for impairment		$	505			$	477			$	75			$	42			$	157			$	1			$	1,257
Ending balance: collectively evaluated for impairment		$	1,229			$	3,275			$	759			$	7			$	1,869			$	62			$	7,201

 

Allowance for Credit Losses
For the Six Months Ended June 30, 2012

 

(Dollar amounts in thousands)
										Real Estate
		Commercial												Multi				1 to
		& industrial				Commercial				Construction				family				4 family				Consumer				Total
Allowance for credit losses
Beginning balance		$	1,618			$	4,745			$	1,171			$	671			$	1,592			$	100			$	9,897
Charge-offs			(1,487	)			(738	)			(54	)			—				(109	)			(4)				(2,392	)
Recoveries			1				3				3				—				148				4				153
Provision			1,602				(255	)			(283	)			(622	)			395				(37	)			800
Ending balance		$	1,734			$	3,752			$	834			$	49			$	2,026			$	63			$	8,458
Ending balance: individually evaluated for impairment		$	505			$	477			$	75			$	42			$	157			$	1			$	1,257
Ending balance: collectively evaluated for impairment		$	1,229			$	3,275			$	759			$	7			$	1,869			$	62			$	7,201

 

 

Recorded Investment in Loans at June 30, 2012

 

(Dollar amounts in thousands)

 

		Commercial												Multi				1 to
		& industrial				Commercial				Construction				family				4 family				Consumer				Total
Loans:
Ending balance		$	53,562			$	244,753			$	25,644			$	39,960			$	95,886			$	2,037			$	461,842
Ending balance: individually evaluated for impairment		$	7,082			$	9,471			$	7,238			$	3,242			$	6,443			$	10			$	33,486
Ending balance: collectively evaluated for impairment		$	46,480			$	235,282			$	18,406			$	36,718			$	89,443			$	2,027			$	428,356

 

Allowance for Credit Losses
For the Three Months Ended June 30, 2011

 

(Dollar amounts in thousands)

 

		Commercial				Commercial				Real estate				Real estate
		& industrial				real estate				construction				1 to 4 family				Consumer				Total
Allowance for credit losses
Beginning balance		$	1,605			$	4,360			$	2,105			$	1,605			$	109			$	9,784
Charge-offs			100				(525	)			—				—				(50	)			(475	)
Recoveries			1				—				9				—				—				10
Provision			583				530				(578	)			(145	)			10				400
Ending balance		$	2,289			$	4,365			$	1,536			$	1,460			$	69			$	9,719
Ending balance: individually evaluated for impairment		$	1,223			$	858			$	143			$	176			$	—			$	2,400
Ending balance: collectively evaluated for impairment		$	1,066			$	3,507			$	1,393			$	1,284			$	69			$	7,319

 

 

Allowance for Credit Losses
For the Six Months Ended June 30, 2011

(Dollar amounts in thousands)

 

		Commercial				Commercial				Real Estate				1 to
		& industrial				Real Estate				Construction				4 family				Consumer				Total
Allowance for credit losses
Beginning balance		$	2,102			$	4,103			$	1,999				1,233			$	87			$	9,524
Charge-offs			(100	)			(525	)			—				—				(53	)			(678	)
Recoveries			5				—				18				—				—				23
Provision			282				787				(481	)			227				35				850
Ending balance		$	2,289			$	4,365			$	1,536				1,460			$	69			$	9,719
Ending balance: individually evaluated for impairment		$	1,223			$	858			$	143			$	176			$	—			$	2,400
Ending balance: collectively evaluated for impairment		$	1,066			$	3,507			$	1,393	$			1,284			$	69			$	7,319

 

Recorded Investment in Loans at June 30, 2011

(Dollar amounts in thousands)

		Commercial				Commercial				Real estate				Real estate
		& industrial				real estate				construction				1 to 4 family				Consumer				Total
Loans:
Ending balance		$	43,623			$	315,806			$	29,938			$	77,992			$	2,321			$	469,680
Ending balance: individually evaluated for impairment		$	6,328			$	9,017			$	8,696			$	3,636			$	—			$	27,677
Ending balance: collectively evaluated for impairment		$	37,295			$	306,789			$	21,242			$	74,356			$	2,321			$	442,003

 

NOTE F – FAIR VALUE MEASUREMENT

 

The following tables present information about the Company’s assets and liabilities measured at fair value as of June 30, 2012 and December 31, 2011, and indicate the fair value techniques used by the Company to determine such fair value. In general, fair values determined by Level 1 inputs utilize quoted prices (unadjusted) in active markets for identical assets or liabilities that the Company has the ability to access. Level 2 inputs include quoted prices for similar assets and liabilities in active markets, and inputs other than quoted prices that are observable for the asset or liability, such as interest rates and yield curves that are observable at commonly quoted intervals. Level 3 inputs are unobservable inputs for the asset or liability, and include situations where there is little, if any, market activity for the asset or liability. In certain cases, the inputs used to measure fair value may fall into different levels of the fair value hierarchy. In such cases, the level in the fair value hierarchy within which the fair value measurement in its entirety falls has been determined based on the lowest level input that is significant to the fair value measurement in its entirety. The Company’s assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment, and considers factors specific to the asset or liability.

 

The following tables present the recorded amounts of assets measured at fair value on a recurring basis:

 

						Fair Value Measurements
(Dollar amounts in thousands)						at June 30, 2012, Using
						Quoted Prices
						in Active
						Markets				Other				Significant
						for Identical				Observable				Unobservable
		Fair Value				Assets				Inputs				Inputs
Description		6/30/2012				(Level 1)				(Level 2)				(Level 3)
U. S. Treasury securities		$	8,384			$	8,384			$	—			$	—
Obligations of U.S.
Government agencies			64,097				—				64,097				—
Mortgage-backed securities			37,422				—				37,422				—
Obligations of states and political subdivisions			77,136				—				77,136				—
Corporate debt			16,509				—				16,509				—
Total assets measured at fair value		$	203,548			$	8,384			$	195,164			$	—

 

						Fair Value Measurements
(Dollar amounts in thousands)						at December 31, 2011, Using
						Quoted Prices
						in Active
						Markets				Other				Significant
						for Identical				Observable				Unobservable
		Fair Value				Assets				Inputs				Inputs
Description		12/31/2011				(Level 1)				(Level 2)				(Level 3)
U. S. Treasury securities		$	12,634			$	12,634			$	—			$	—
Obligations of U.S.
Government agencies			54,102				—				54,102				—
Mortgage-backed securities			33,435				—				33,435				—
Obligations of states and political subdivisions			77,251				—				77,251				—
Corporate debt			10,242				—				10,242				—
Total assets measured at fair value		$	187,664			$	12,634			$	175,030			$	—

 

The following tables present the recorded amount of assets measured at fair value on a non-recurring basis:

 

(Dollar amounts in thousands)						Fair Value Measurements at June 30, 2012, Using
						Quoted Prices											Losses				Losses
						in Active											for three				for three
						Markets			Other				Significant				months				months
						for Identical			Observable				Unobservable				ended				ended
		Fair Value				Assets			Inputs				Inputs				June 30,				June 30,
Description		6/30/2012				(Level 1)			(Level 2)				(Level 3)				2012				2011
Impaired loans		$	12,384			$	—		$	—			$	12,384			$	225				894
Total impaired assets measured at fair value		$	12,384			$	—		$	—			$	12,384			$	225			$	894

 

						Fair Value Measurements
(Dollar amounts in thousands)						at December 31, 2011, Using
						Quoted Prices in
						Active Markets				Other				Significant
						for Identical				Observable				Unobservable
		Fair Value				Assets				Inputs				Inputs
Description		12/31/11				(Level 1)				(Level 2)				(Level 3)
Impaired loans		$	8,383			$	—			$	—			$	8,383
Other real estate owned			2,747				—				—				2,747
Total impaired assets measured at fair value		$	11,130			$	—			$	—			$	11,130

 

 

The Bank does not record loans at fair value. However, from time to time, if a loan is considered impaired, a specific allocation within the allowance for loan losses may be required. Loans for which it is probable that payment of interest and principal will not be made in accordance with the contractual terms of the loan agreement are considered impaired. The fair value of impaired loans is estimated using one of several methods, including collateral value, market value of similar debt, enterprise value, liquidation value and cash flows. Those impaired loans not requiring an allowance represent loans for which the value of the expected repayments or collateral exceed the recorded investments in such loans. Impaired loans where an allowance is established based on the fair value of collateral or when the impaired loan has been written down to fair value require classification in the fair value hierarchy. If the fair value of the collateral is based on an observable market price or a current appraised value, the Bank records the impaired loans as nonrecurring Level 3. When an appraised value is not available, or management determines the fair value of the collateral is further impaired below the appraised value and there is no observable market price, the Bank also records the impaired loans as nonrecurring Level 3.

 

Other real estate owned is carried at the lower of historical cost or fair market value. An appraisal (a Level 3 valuation) is obtained at the time the Company acquires property through the foreclosure process. Any loan balance outstanding that exceeds the appraised value of the property is charged off against the allowance for loan loss at the time the property is acquired. Subsequent to acquisition, the Bank updates the property’s appraised value on at least an annual basis. If the value of the property has declined during the year, a loss due to valuation impairment charge is recorded along with a corresponding reduction in the book carrying value of the property.

 

Fair Values of Financial Instruments.

 

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

 

Cash and Cash Equivalents.

 

The carrying amounts reported in the balance sheet for cash and short-term instruments are a reasonable estimate of fair value, which will approximate their historical cost.

 

Securities Available-for-Sale.

 

Fair values for investment securities are based on quoted market prices, where available. If quoted market prices are not available, fair values are based on quoted market prices of comparable instruments.

 

Loans Receivable.

 

For variable-rate loans that reprice frequently and with no significant change in credit risk, fair values are based on carrying values and credit risk factors. For fixed rate loans, fair values are based on discounted cash flows, credit risk factors, and liquidity factors.

 

Deposit liabilities.

 

The fair values disclosed for demand deposits (e.g., interest and non-interest checking, savings, and money market accounts) are, by definition, equal to the amount payable on demand at the reporting date (i.e., their carrying amounts). The fair values for fixed-rate certificates of deposit are based on discounted cash flows.

 

Federal Home Loan Bank Advances.

 

The fair values of Federal Home Loan Bank Advances are based on discounted cash flows. The discount rate is equal to the market rate currently offered by similar products.

 

Interest Receivable and Payable

 

The interesrt receivable and payable balances approximate their fair value due to the short-term nature of their settlement dates.

 

Undisbursed loan commitments, lines of credit, Mastercard line and standby letters of credit.

 

The fair value of these off-balance sheet items are based on discounted cash flows of expected fundings.

 

The Bank has excluded non-financial assets and non-financial liabilities, such as Bank premises and equipment, deferred taxes and other liabilities.

 

The following table provides summary information on the estimated fair value of financial instruments at June 30, 2012:

 

(Dollar amounts in thousands)		Carrying				Fair				Fair value measurements
		amount				value				Level 1				Level 2				Level 3
Financial assets:
Cash and cash equivalents		$	44,856			$	44,856			$	44,856
Securities available for sale			203,548				203,548				8,384			$	195,164
Loans			461,842				467,931								455,547			$	12,384
Accrued interest receivable			3,621				3,621								3,621
Financial liabilities:
Accrued interest payable			297				297								297
Deposits			651,843				652,293				546,713				105,580
Off-balance-sheet liabilities:
Undisbursed loan commitments, lines of credit, standby letters of credit and Mastercard lines of credit			—				847											847

 

 

 

The carrying amount of loans include $19,030,000 of nonaccrual loans (loans that are not accruing interest) as of June 30, 2012. The fair value of nonaccrual loans is based on the collateral values that secure the loans or the cash flows expected to be received.

 

The following table provides summary information on the estimated fair value of financial instruments at December 31, 2011:

 

(Dollar amounts in thousands)		Carrying				Fair				Fair value measurements
		amount				value				Level 1				Level 2				Level 3
Financial assets:
Cash and cash equivalents		$	38,474			$	38,474			$	38,474
Securities available for sale			187,664				187,664				12,634			$	175,030
Loans, net			453,742				454,342								445,959			$	8,383
Accrued interest receivable			3,614				3,614								3,614
Financial liabilities:
Accrued interest payable			299				299								299
Deposits			621,778				622,291				512,927				109,364
Off-balance-sheet liabilities:
Undisbursed loan commitments, lines of credit, standby letters of credit and Mastercard lines of credit			—				945											945

 

The carrying amount of loans include $19,098,000 of nonaccrual loans (loans that are not accruing interest) as of December 31, 2011. The fair value of nonaccrual loans is based on the collateral values that secure the loans or the cash flows expected to be received.

 

NOTE G – PREFERRED STOCK

 

On September 15, 2011, Preferred Stock was issued to the U. S. Treasury as part of the Treasury’s Small Business Lending Fund (“SBLF”), as Preferred Stock – Series C – Non-Cumulative. The initial dividend rate is 5%. Depending on the volume of our small business lending, the dividend rate can be reduced to as low as one percent. If lending does not increase in the first two years, the dividend rate will increase to seven percent. After 4.5 years, the dividend rate will increase to nine percent if the Company has not repaid the SBLF funding.

 

This program does not contain any of the various restrictions (including restrictions related to the payment of dividends to Common Stockholders) that the Treasury’s Capital Purchase Program (“TARP”) required. The Series A and B Preferred Stock, which contained a blended yield of 6.83% to the expected repayment date, were paid off in full and canceled with the proceeds received from the U. S. Treasury’s SBLF investment.

 

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

 

Forward-Looking Information and Uncertainties Regarding Future Financial Performance.

 

This report, including management’s discussion below, concerning earnings and financial condition, contains “forward-looking statements.” Forward-looking statements are estimates of or statements about expectations or beliefs regarding the Company’s future financial performance or anticipated future financial condition that are based on current information and that are subject to a number of risks and uncertainties that could cause actual operating results in the future to differ significantly from those expected at the current time. Those risks and uncertainties include, although they are not limited to, the following:

 

Increased Competition. Increased competition from other banks and financial service businesses, mutual funds and securities brokerage and investment banking firms that offer competitive loan and investment products and competitive market pricing, which could require us to reduce interest rates and loan fees to attract new loans or to increase interest rates that we offer on time deposits, either or both of which could, in turn, reduce interest income and net interest margins. These factors could reduce our ability to attract new deposits and loans and leases.

 

Liquidity Risk. The stability of funding sources and continued availability of borrowings; our ability to raise capital or incur debt on reasonable terms.

 

Possible Adverse Changes in Economic Conditions. Adverse changes in national or local economic conditions could (i) reduce loan demand which could, in turn, reduce interest income and net interest margins; (ii) adversely affect the financial capability of borrowers to meet their loan obligations, which, in turn, could result in increases in loan losses and require increases in provisions for loan losses, thereby adversely affecting operating results; and (iii) lead to reductions in real property values that, due to the Company’s reliance on real property to secure many of its loans, could make it more difficult to prevent losses from being incurred on non-performing loans through the sale of such real properties.

 

Possible Adverse Changes in National Economic Conditions and Federal Reserve Board Monetary Policies. Changes in national economic policies, such as increases in inflation or declines in economic output often prompt changes in Federal Open Market Committee (“FOMC”) monetary policies that could reduce interest income or increase the cost of funds to the Company, either of which could result in reduced earnings. In addition, deterioration in economic conditions that could result in increased loan and lease losses.

 

Changes in Regulatory Policies. Changes in federal and national bank regulatory policies, such as increases in capital requirements or in loan loss reserve or asset/liability ratio requirements, liquidity requirements, and the risks associated with concentration in real estate related loans could adversely affect earnings by reducing yields on earning assets or increasing operating costs.

 

Due to these and other possible uncertainties and risks, readers are cautioned not to place undue reliance on the forward-looking statements contained in this report, which speak only as of the date of this report, or to make predictions based solely on historical financial performance. The Company also disclaims any obligation to update forward-looking statements contained in this report.

 

Critical Accounting Policies And Estimates

 

Management’s discussion and analysis of its financial condition and results of operations are based upon the Company’s financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires the Company to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On an on-going basis, the Company evaluates its estimates, including those related to its loans and allowance for loan losses. The Company bases its estimates on current market conditions, historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. All adjustments that, in the opinion of management, are necessary for a fair presentation for the periods presented have been reflected as required by Regulation S-X, Rule 10-01. The Company believes the following critical accounting policy requires significant judgments and estimates used in the preparation of the consolidated financial statements.

 

Allowance for Loan Losses

 

The allowance for loan losses is periodically evaluated for adequacy by management. Factors considered include the Company’s historical loan loss experience, known and inherent risks in the portfolio, current economic conditions, known adverse situations that may affect the borrower’s ability to repay, regulatory policies, and the estimated value of underlying collateral. The evaluation of the adequacy of the allowance is based on the above factors along with prevailing and anticipated economic conditions that may impact borrowers’ ability to repay their loans. Determination of the allowance is based upon objective and subjective judgments by management based on the information currently available. Adverse changes in information could result in higher than expected charge-offs and loan loss provisions.

 

Goodwill

 

Goodwill arises from the Company’s purchase price exceeding the fair value of the net assets of an acquired business. Goodwill represents the value attributable to intangible elements acquired. The value of goodwill is supported ultimately by profit from the acquired business. A decline in earnings could lead to impairment, which would be recorded as a write-down in the Company’s consolidated statements of income. Events that may indicate goodwill impairment include significant or adverse changes in results of operations of the acquired business or asset, economic or political climate; an adverse action or assessment by a regulator; unanticipated competition; and a more-likely-than-not expectation that a reporting unit will be sold or disposed of at a loss.

 

Other Than Temporary Impairment

 

Other than temporary impairment (“OTTI”) is triggered if the Company has the intent to sell the security, it is likely that it will be required to sell the security before recovery, or if the Company does not expect to recover the entire amortized cost basis of the security. If the Company intends to sell the security or it is likely it will be required to sell the security before recovering its cost basis, the entire impairment loss would be recognized in earnings as an OTTI. If the Company does not intend to sell the security and it is not likely that the Company will be required to sell the security but the Company does not expect to recover the entire amortized cost basis of the security, only the portion of the impairment loss representing credit losses would be recognized in earnings as an OTTI. The credit loss is measured as the difference between the amortized cost basis and the present value of the cash flows expected to be collected of a security. Projected cash flows are discounted by the original or current effective interest rate depending on the nature of the security being measured for potential OTTI. The remaining impairment loss related to all other factors, the difference between the present value of the cash flows expected to be collected and fair value, would be recognized as a charge to other comprehensive income (“OCI”). Impairment losses related to all other factors are to be presented as a separate category within OCI.

 

For investment securities held to maturity, this amount is accreted over the remaining life of the debt security prospectively based on the amount and timing of future estimated cash flows. The accretion of the OTTI amount recorded in OCI will increase the carrying value of the investment, and would not affect earnings. If there is an indication of additional credit losses the security is re-evaluated accordingly based on the procedures described above.

 

Provision for and Deferred Income Taxes

 

The Company is subject to income tax laws of the United States, its states, and the municipalities in which it operates. The Company considers its income tax provision methodology to be critical, as the determination of current and deferred taxes is based on complex analyses of many factors including interpretation of federal and state laws, the difference between tax and financial reporting bases of assets and liabilities (temporary differences), estimates of amounts due or owed, the timing of reversals of temporary differences and current financial standards. Actual results could differ significantly from the estimates due to tax law interpretations used in determining the current and deferred income tax liabilities. Additionally, there can be no assurances that estimates and interpretations used in determining income tax liabilities may not be challenged by federal and state taxing authorities.

 

Recent Accounting Pronouncements

 

In May, 2011, the FASB issued ASU No. 2011-04, “Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRS.” The amendments in this Update result in common fair value measurement and disclosure requirements in U.S. GAAP and IFRS. Consequently, the amendments change the wording used to describe many of the requirements in U.S. GAAP for measuring fair value and for disclosing information about fair value measurements. For many of the requirements, the Board does not intend for the amendments in this Update to result in a change in the application of the requirements in Topic 820.

 

Some of the amendments clarify the Board’s intent about the application of existing fair value measurements. Other amendments change a particular principle or requirement for measuring fair value or for disclosing information about fair value measurements. As this ASU is disclosure-related only, the adoption of this ASU did not impact the Bank’s financial condition or results of operations.

 

Regardless of whether an entity chooses to present comprehensive income in a single continuous statement or in two separate but consecutive statements, the entity is required to present on the face of the financial statements reclassification adjustments for items that are reclassified from other comprehensive income to net income in the statement(s) where the components of net income and the components of other comprehensive income are presented.

 

The amendments in this Update do not change the items that must be reported in other comprehensive income or when an item of other comprehensive income must be reclassified to net income. The amendments do not change the option for an entity to present components of other comprehensive income either net of related tax effects or before related tax effects, with one amount shown for the aggregate income tax expense or benefit related to the total of other comprehensive income items. In both cases, the tax effect for each component must be disclosed in the notes to the financial statements or presented in the statement in which other comprehensive income is presented. The amendments do not affect how earnings per share is calculated or presented. This ASU had no material impact on the Bank when adopted.

 

 

In December, 2011, the FASB issued ASU 2011-12, “Comprehensive Income” – (Topic 220). “Deferral of the Effective Date for Amendments to the Presentation of Reclassifications of Items Out of Accumulated Other Comprehensive Income in Accounting Standards Update No. 2011-05.” In order to defer only those changes in Update 2011-05 that relate to the presentation of reclassification adjustments, the paragraphs in this Update supersede certain pending paragraphs in Update 2011-05. The amendments are being made to allow the Board time to redeliberate whether to present on the face of the financial statements the effects of reclassifications out of accumulated other comprehensive income on the components of net income and other comprehensive income for all periods presented. While the Board is considering the operational concerns about the presentation requirements for reclassification adjustments and the needs of financial statement users for additional information about reclassification adjustments, entities should continue to report reclassifications out of accumulated other comprehensive income consistent with the presentation requirements in effect before Update 2011-05.

 

All other requirements in Update 2011-05 are not affected by this Update, including the requirement to report comprehensive income either in a single continuous financial statement or in two separate but consecutive financial statements.

 

In July, 2012, the FASB issued ASU 2012-02 “Intangibles-Goodwill and Other” – (Topic 350) “Testing Indefinite-Lived Intangible Assets for Impairment.” In accordance with the amendments in this Update, an entity has the option first to assess qualitative factors to determine whether the existence of events and circumstances indicates that it is more likely than not that the indefinite-lived intangible asset is impaired. If, after assessing the totality of events and circumstances, an entity concludes that it is not more likely than not that the indefinite-lived intangible asset is impaired, then the entity is not required to take further action.

 

Earnings Analysis

 

Net earnings for the quarter ended June 30, 2012 were $1,228,000, compared to net earnings of $1,180,000 for the quarter ended June 30, 2011, an increase of $48,000, or 4%. Cash dividend payments on the preferred shares outstanding were made as scheduled during the six months ended June 30, 2012 and 2011, respectively. Net earnings for the six months ended June 30, 2012 were $2,516,000 compared to net earnings of $1,983,000 for the six months ended June 30, 2011, an improvement of $533,000. Net earnings before income tax expense for the quarter ended June 30, 2012 were $1,742,000, compared to net earnings before income tax expense of $1,630,000 for the quarter ended June 30, 2011, an increase of $112,000. Net earnings available to common stockholders for the quarter ended June 30, 2012, were $1,071,000, compared to net earnings available to common stockholders of $966,000 for the quarter ended June 30, 2011. Earnings before income tax expense were $3,407,000 for the six months ended June 30, 2012 compared to net earnings before income tax expense of $2,780,000 for the six months ended June 30, 2011, an improvement of $627,000. The principal items contributing to this change were an increase in gain on sales of available-for-sale securities of $659,000, and an increase in bank-owned life insurance, which was $413,000, offset by a decrease in net interest income of $325,000. Net earnings available to common stockholders were $2,173,000 for the six months ended June 30, 2012, compared to net earnings available to common stockholders of $1,555,000 for the six months ended June 30, 2011.

 

Net interest income for the quarter ended June 30, 2012 was $7,225,000, compared to $7,413,000 for the quarter ended June 30, 2011, a decrease of $188,000, or 2.5%. Net interest income for the six months ended June 30, 2012 was $14,423,000 compared to $14,748,000 for the six months ended June 30, 2011, a decrease of $325,000, or 2.2%.

 

Basic and diluted earnings per share were $0.30 for the second quarter of 2012 compared to basic and diluted earnings of $0.28 and $0.27, respectively, for the second quarter of 2011. Basic earnings per share were $0.62 and diluted earnings per share were $0.61 for the six months ended June 30, 2012, compared to basic and diluted earnings per share of $0.44 for the six months ended June 30, 2011.

 

The following table presents an analysis of net interest income and average earning assets and liabilities for the three-and six-month periods ended June 30, 2012 compared to the three-and six-month periods ended June 30, 2011.

 

TABLE 1		NET INTEREST INCOME AND AVERAGE BALANCES FNB BANCORP AND SUBSIDIARY
		Three months ended June 30,
		2012												2011
(Dollar amounts in thousands)										Annualized												Annualized
		Average								Average				Average								Average
		Balance				Interest				Yield				Balance				Interest				Yield
INTEREST EARNING ASSETS
Loans, gross (1) (2)		$	459,778			$	6,758				5.90	%		$	470,490			$	7,407				6.31	%
Taxable securities			132,987				617				1.86	%			90,094				462				2.06	%
Nontaxable securities (3)			71,416				670				3.76	%			46,934				537				4.59	%
Fed funds sold			—				—				n/a				29				—				n/a
Total interest earning assets			664,181				8,045				4.86	%			607,547				8,406				5.55	%
NONINTEREST EARNING ASSETS:
Cash and due from banks			43,722												62,897
Premises			12,970												13,601
Other assets			29,478												29,071
Total noninterest earning assets			86,170												105,569
TOTAL ASSETS		$	750,351											$	713,116
INTEREST BEARING LIABILITIES:
Demand, int bearing		$	62,809				22				0.14	%		$	62,201				36				0.23	%
Money market			276,251				411				0.60	%			263,796				538				0.82	%
Savings			51,403				26				0.20	%			46,110				29				0.25	%
Time deposits			105,828				194				0.74	%			113,695				254				0.90	%
Total interest bearing liabilities			496,291				653				0.53	%			485,802				857				0.71	%
NONINTEREST BEARING LIABILITIES:
Demand deposits			155,329												136,831
Other liabilities			10,255												7,845
Total noninterest bearing liabilities			165,584												144,676
TOTAL LIABILITIES			661,875												630,478
Stockholders’ equity			88,476												82,638
TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY		$	750,351											$	713,116
NET INTEREST INCOME AND MARGIN ON TOTAL EARNING ASSETS (4)						$	7,392				4.46	%						$	7,549				4.98	%

 

 

(1) Interest on non-accrual loans is recognized into income on a cash received basis if the loan has demonstrated performance and full collection is considered probable.

(2) Amounts of interest earned include loan fees of $277,000 and $273,000 for the quarters ended June 30, 2012 and 2011, respectively.

(3) Tax equivalent adjustments recorded at the statutory rate of 34% that are included in the nontaxable securities portfolio are $167,000 and $136,000 for the quarters ended June 30, 2012 and 2011, respectively. Tax equivalent adjustments included in the nontaxable securities portfolio were derived from nontaxable municipal interest income.

(4) The annualized net interest margin is computed by dividing net interest income by total average interest earning assets and multiplied by an annualization factor.

 

 

TABLE 2		NET INTEREST INCOME AND AVERAGE BALANCES FNB BANCORP AND SUBSIDIARY
		Six months ended June 30,
		2012												2011
(Dollar amounts in thousands)										Annualized												Annualized
		Average								Average				Average								Average
		Balance				Interest				Yield				Balance				Interest				Yield
INTEREST EARNING ASSETS
Loans, gross (1) (2)		$	456,159			$	13,513				5.97	%		$	476,279			$	14,845				6.29	%
Taxable securities			128,225				1,230				1.93	%			87,750				866				1.99	%
Nontaxable securities (3)			71,818				1,354				3.80	%			45,272				1,035				4.61	%
Fed funds sold			—				—				n/a				14				—				n/a
Tot interest earning assets			656,202				16,097				4.95	%			609,315				16,746				5.54	%
NONINTEREST EARNING ASSETS:
Cash and due from banks			45,479												59,140
Premises			13,038												13,546
Other assets			28,176												29,993
Tot noninterest earning assets			86,693												102,679
TOTAL ASSETS		$	742,895											$	711,994
Demand, int bearing		$	62,710				50				0.16	%		$	61,449				70				0.23	%
Money market			273,499				828				0.61	%			260,875				1,081				0.84	%
Savings			50,383				50				0.20	%			45,991				57				0.25	%
Time deposits			107,323				409				0.77	%			115,883				533				0.93	%
Tot interest bearing liabilities			493,915				1,337				0.55	%			484,198				1,741				0.73	%
NONINTEREST BEARING LIABILITIES:
Demand deposits			150,436												138,226
Other liabilities			10,367												7,563
Tot noninterest bearing liabilities			160,803												145,789
TOTAL LIABILITIES			654,718												629,987
Stockholders’ equity			88,177												82,007
TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY		$	742,895											$	711,994
NET INTEREST INCOME AND MARGIN ON TOTAL EARNING ASSETS (4)						$	14,760				4.54	%						$	15,005				4.97	%

 

(1) Interest on non-accrual loans is recognized into income on a cash received basis if the loan has demonstrated performance and full collection is considered probable.

(2) Amounts of interest earned included loan fees of $567,000 and $519,000 for the six months ended June 30, 2012 and 2011, respectively.

(3) Tax equivalent adjustments recorded at the statutory rate of 34% that are included in the nontaxable securities portfolio are $337,000 and $257,000 for the six months ended June 30, 2012 and 2011, respectively. Tax equivalent adjustments included in the nontaxable securities portfolio were derived from nontaxable municipal interest income.

(4) The annualized net interest margin is computed by dividing net interest income by total average interest earning assets and multiplied by an annualization factor.

 

Tables 1 and 2, above, show the various components that contributed to changes in net interest income for the three and six months ended June 30, 2012 and 2011. The principal interest earning assets are loans, from a volume as well as from a rate or yield perspective. For the quarter ended June 30, 2012, average loans outstanding represented 69.2% of average earning assets. For the quarter ended June 30, 2011, they represented 77.4% of average earning assets. For the six months ended June 30, 2012 and 2011, average loans outstanding represented 69.5% and 78.2%, respectively, of average earning assets.

 

The taxable equivalent yield on average interest earning assets for the quarter ended June 30, 2012 compared to the quarter ended June 30, 2011 decreased from 5.55% to 4.86%, or 69 basis points. Average loans decreased by $10,712,000, quarter to quarter, while their yield decreased from 6.31% to 5.90%, or 41 basis points. Interest income on total interest earning assets for the quarter decreased $361,000 or 4.3% on a fully-taxable equivalent basis.

 

For the three months ended June 30, 2012 compared to the three months ended June 30, 2011, the cost on total interest bearing liabilities decreased from 0.71% to 0.53%, a decrease of 18 basis points. Time deposit interest cost decreased from 0.90% to 0.74%. Their average balance outstanding decreased by $7,867,000, or 6.9%, while their expense decreased $60,000. Money market deposits average volume increased $12,455,000, or 4.7%, while their cost decreased 22 basis points, or 26.8%.

 

For the six months ended June 30, 2012 compared to the six months ended June 30, 2011, interest income on interest earning assets decreased $649,000 or 3.9% on a fully-taxable equivalent basis, but average earning assets increased $46,887,000, or 7.7%. Average loans decreased by $20,120,000, or 4.2%. Interest on loans decreased $1,332,000 or 9.0%, while the yield decreased 32 basis points, or 5.1%. The cost on total interest bearing liabilities decreased from 0.73% to 0.55%. Time deposit averages decreased $8,560,000 or 7.4%. Their yield decreased 16 basis points, or 17.2%. Money market deposit average balances increased $12,624,000, or 4.8%, and their cost decreased $253,000, or 23.4%.

 

For the three and six month periods ended June 30, 2012 and June 30, 2011, respectively, the following tables show the dollar amount of change in interest income and expense and the dollar amounts attributable to: (a) changes in volume (changes in volume at the current year rate), and b) changes in rate (changes in rate times the prior year’s volume). In this table, the dollar change in rate/volume is prorated to volume and rate proportionately.

 

Table 3		FNB BANCORP AND SUBSIDIARY
		RATE/VOLUME VARIANCE ANALYSIS
		Three Months Ended June 30,
(Dollar amounts in thousands)		2012 Compared to 2011
						Variance
		Interest				Attributable to
		Income/Expense				Rate				Volume
INTEREST EARNING ASSETS
Loans		$	(649	)		$	(492	)		$	(157	)
Taxable securities			155				(44	)			199
Nontaxable securities (1)			133				(96	)			229
Total		$	(361	)		$	(632	)		$	271
INTEREST BEARING LIABILITIES
Demand deposits		$	14			$	14			$	0
Money market			127				146				(19	)
Savings deposits			3				6				(3	)
Time deposits			60				42				18
Total		$	204			$	208			$	(4	)
NET INTEREST INCOME		$	(157	)		$	(424	)		$	267

 

(1)

Includes tax equivalent adjustment of $167,000 and $136,000 in the three months ended June 30, 2012 and June 30, 2011, respectively.

 

		RATE/VOLUME VARIANCE ANALYSIS
		Six Months Ended June 30,
(Dollar amounts in thousands)		2012 Compared to 2011
						Variance
		Interest				Attributable to
		Income/Expense				Rate				Volume
INTEREST EARNING ASSETS
Loans		$	(1,332	)		$	(705	)		$	(627	)
Taxable securities			364				(35	)			399
Nontaxable securities (1)			319				(182	)			501
Total		$	(649	)		$	(922	)		$	273
INTEREST BEARING LIABILITIES
Demand deposits		$	20			$	21			$	(1	)
Money market			253				305				(52	)
Savings deposits			7				11				(4	)
Time deposits			124				85				39
Total		$	404			$	422			$	(18	)
NET INTEREST INCOME		$	(245	)		$	(500	)		$	255

 

(1)

Includes tax equivalent adjustment of $337,000 and $257,000 in the six months ended June 30, 2012 and June 30, 2011, respectively.

 

Noninterest income

 

The following table shows the principal components of noninterest income for the periods indicated.

 

Table 5		NONINTEREST INCOME
		Three months
		ended Jun 30,								Variance
(Dollar amounts in thousands)		2012				2011				Amount				Percent
Service charges		$	744			$	811			$	(67	)			-8.3	%
Credit card fees			155				178				(23	)			-12.9	%
Net gain on available-for-sale of securities			325				128				197				153.9	%
Bank owned life insurance policy earnings			111				84				27				32.1	%
Other income			80				188				(108	)			-57.4	%
Total noninterest income		$	1,415			$	1,389			$	26				1.9	%

 

		Six months
		ended June 30,								Variance
(Dollars in thousands)		2012				2011				Amount				Percent
Service charges		$	1,496			$	1,508			$	(12	)			-0.8	%
Credit card fees			308				328				(20	)			-6.1	%
Net gain on sale of available-for-securities			809				150				659				439.3	%
Bank owned life insurance policy earnings			578				165				413				250.3	%
Other income			144				251				(107	)			-42.6	%
Total noninterest income		$	3,335			$	2,402			$	933				38.8	%

 

Noninterest income consists mainly of service charges on deposits, credit card fees and several other types of miscellaneous income. The increase in gain on sale of available-for-sale securities for the quarter and six months as a result of re-positioning our portfolio in anticipation of the acquisition of Oceanic Bank. The other significant item was the increase in bank-owned life insurance policy earnings. During the first quarter of 2012, the bank recorded a one-time gain on life insurance due to the passing of Mr. Mike Wyman, the former Chairman of the Board and CEO of the Company.

 

Noninterest expense

 

The following table shows the principal components of noninterest expense for the periods indicated.

 

Table 6		NONINTEREST EXPENSE
		Three months
		ended June 30,								Variance
(Dollar amounts in thousands)		2012				2011				Amount				Percent
Salaries and employee benefits		$	3,645			$	3,423			$	222				6.5	%
Occupancy expense			598				585				13				2.2	%
Equipment expense			432				417				15				3.6	%
Professional fees			383				393				(10	)			-2.5	%
FDIC assessment			156				300				(144	)			-48.0	%
Telephone, postage & supplies			271				298				(27	)			-9.1	%
Operating losses			(56	)			10				(66	)			-660.0	%
Bankcard expenses			157				165				(8	)			-4.8	%
Data processing expense			138				154				(16	)			-10.4	%
Low income housing expense			70				69				1				1.4	%
Other real estate owned expense			15				73				(58	)			-79.5	%
(Gain) loss on sale of other real estate owned			(9	)			25				(34	)			-136.0	%
Loss on impairment of other real estate owned			—				230				(230	)			-100.0	%
Other expense			698				630				68				10.8	%
Total noninterest expense		$	6,498			$	6,772			$	(274	)			-4.0	%

 

		Six months
		ended June 30,								Variance
(Dollars in thousands)		2012				2011				Amount				Percent
Salaries and employee benefits		$	7,419			$	6,909			$	510				7.4	%
Occupancy expense			1,198				1,141				57				5.0	%
Equipment expense			878				825				53				6.4	%
Professional fees			971				757				214				28.3	%
FDIC assessment			336				675				(339	)			-50.2	%
Telephone, postage & supplies			549				611				(62	)			-10.1	%
Operating losses			52				234				(182	)			-77.8	%
Bankcard expenses			313				301				12				4.0	%
Data processing expense			276				286				(10	)			-3.5	%
Low income housing expense			139				139				0				0.0	%
Other real estate owned expense			51				261				(210	)			-80.5	%
Gain on sale of other real estate owned			(4	)			(66	)			62				-93.9	%
Loss on impairment of other real estate owned			—				230				(230	)			-100.0	%
Other expense			1,373				1,217				156				12.8	%
Total noninterest expense		$	13,551			$	13,520			$	31				0.2	%

 

Noninterest expense consists mainly of salaries and employee benefits. For the three months ended June 30, 2012 compared to three months ended June 30, 2011, it represented 56.1% and 50.5% of total noninterest expenses. For the six months ended June 30, 2012 and 2011, it was 54.7% and 51.1%, respectively, of total noninterest expenses. During the second quarter of 2012, an additional loan officer was added to our Sunnyvale loan production office. The FDIC assessment rate was reduced in 2012 compared to 2011, by $144,000 and $339,000 for the quarter and six months ended June 30, 2012 compared to the same periods of 2011. During the first quarter of 2011, the Bank experienced an operational loss of approximately $200,000 related to an unauthorized foreign wire transfer. The operational loss was increased by another $300,000 during the third quarter of 2011 when our insurance company denied coverage of our insurance reimbursement claim that had been filed. The Company disagrees with our insurance carrier’s decision to not cover the claim and has filed suit against the insurance carrier asking the courts to force the insurance company to pay our claim. Any recoveries that may be recovered as a result of our legal remedy efforts would be recorded as other income if and when any recovery actually occurs. Declines in our other real estate owned expenses in both the quarter and year-to-date period ending June 30, 2012 compared to the same periods in 2011 are directly related to the number of properties managed by the Bank.

 

Provision for Loan Losses.

 

There was a provision for loan losses of $800,000 and $850,000 for the six months ended June 30, 2012 and 2011, respectively. There was a provision of $400,000 for the three months ended June 30, 2012 and 2011, respectively. The allowance for loan losses was $8,458,000 or 1.83% of total gross loans at June 30, 2012, compared to $9,897,000 or 2.18% of total gross loans at December 31, 2011. The allowance for loan losses is maintained at a level considered adequate for management to provide for probable loan losses inherent in the loan portfolio. Charge-offs that have occurred in 2012 were related to loans with significant allowance allocations prior to the charge-off date, and is the primary reason the allowance for loan loss has declined without the need for a significant increase in the provision for loan losses.

 

Income Taxes

 

The effective tax rate for the quarter ended June 30, 2012 was a 29.5% tax expense compared to a 27.6% tax expense for the quarter ended June 30, 2011. The effective tax rate for the six months ended June 30, 2012 and June 30, 2011, respectively was a tax expense of 26.2% compared to a tax expense of 28.7%. Tax preference items which usually affect our effective tax rate are changing amounts invested in tax-advantaged securities, available Low Income Housing Credits, and amounts of interest income on qualifying loans in Enterprise Zones. During the first quarter of 2012, the Company recognized a tax free gain on proceeds of life insurance of approximately $370,000 due to the passing of the Company’s former Chairman and CEO, Mike Wyman. During the second quarter of 2012, the effective tax rate rose due to increased earnings that were fully taxable, primarily as a result of the level of gain on sale of available-for-sale securities.

 

Asset and Liability Management

 

Ongoing management of the Company’s interest rate sensitivity limits interest rate risk through monitoring the mix and maturity of loans, investments and deposits. Management regularly reviews the Company’s position and evaluates alternative sources and uses of funds as well as changes in external factors. Various methods are used to achieve and maintain the desired rate sensitivity position including the sale or purchase of assets and product pricing.

 

In order to ensure that sufficient funds are available for loan growth and deposit withdrawals, as well as to provide for general needs, the Company must maintain an adequate level of liquidity. Asset liquidity comes from the Company’s ability to convert short-term investments into cash and from the maturity and repayment of loans and investment securities. Liability liquidity comes from Company’s customer base, which provides core deposit growth. The overall liquidity position of the Company is closely monitored and evaluated regularly. Management believes the Company’s liquidity sources at June 30, 2012 are adequate to meet its operating needs in 2012 and our liquidity positions are sufficient to meet our liquidity needs in the near term.

 

Financial Condition

 

Assets. Total assets increased to $748,750,000 at June 30, 2012 from $715,641,000 at December 31, 2011, an increase of $33,109,000. The principal source of this increase was $15,884,000 in securities available-for-sale, $6,382,000 in cash and due from banks, and $9,579,000 in net loans.

Loans. Gross loans before loan fees at June 30, 2012 were $461,842,000, an increase of $8,100,000 or 1.8% from December 31, 2011. Commercial real estate loans decreased $12,660,000, construction loans decreased $2,585,000, real estate multi family increased $3,591,000, real estate one to four family increased $9,564,000, commercial loans increased $10,488,000, and consumer loans decreased by a modest $298,000. The portfolio breakdown was as follows:

 

TABLE 7		LOAN PORTFOLIO
		June 30				Percent				December 31				Percent
(Dollar amounts in thousands)			2012								2011
Commercial real estate		$	244,753				53	%		$	257,413				57	%
Real estate construction			25,644				5	%			28,229				6	%
Real estate multi family			39,960				9	%			36,369				8	%
Real estate 1 to 4 family			95,886				21	%			86,322				19	%
Commercial & industrial			53,562				12	%			43,074				9	%
Consumer loans			2,037				0	%			2,335				1	%
Gross loans			461,842				100	%			453,742				100	%
Net deferred loan fees			(84	)			0	%			(124	)			0	%
Total		$	461,758				100	%		$	453,618				100	%

 

Allowance for loan losses. Management of the Company is responsible for assessing the overall risks within the Bank’s loan portfolio, assessing the specific loss expectancy, and determining the adequacy of the allowance for loan losses. The level of the allowance is determined by internally generating credit quality ratings, historical loss experience, a review of economic conditions in the Company’s market area, and a variety of general economic factors that could affect the amount of expected losses within the Bank’s portfolio. The Company’s management considers changes in national and local economic conditions, as well as the condition of various market segments. It also reviews any changes in the nature and volume of the portfolio. Management watches for the existence and effect of any concentrations of credit, and changes in the level of such concentrations. It also reviews the effect of external factors, such as competition and legal and regulatory requirements. Finally, the Company is committed to maintaining an adequate allowance, identifying credit weaknesses by consistent review of loans, and maintaining the ratings and changing those ratings in a timely manner as circumstances change.

 

A summary of activity in the allowance for loan losses for the six months ended June 30, 2012 and the six months ended June 30, 2011 is as follows.

 

TABLE 8		ALLOWANCE FOR LOAN LOSSES
		Six months ended
(Dollar amounts in thousands)		June 30, 2012				June 30, 2011
Balance, beginning of period		$	9,897			$	9,524
Provision for loan losses			800				850
Recoveries			153				23
Amounts charged off			(2,392	)			(678	)
Balance, end of period		$	8,458			$	9,719

 

During the six months ended June 30, 2012, there was a provision for loan losses of $800,000, compared to $850,000 for the same period in 2011. The decrease in the provision was considered necessary given the existing risk levels within the Bank’s loan portfolio. Loan charge-off levels have increased year over year, yet overall financial risk in the loan portfolio has declined.

 

In management’s judgment, the allowance was adequate to absorb losses currently inherent in the loan portfolio at June 30, 2012. However, changes in prevailing economic conditions in the Company’s markets or in the financial condition of its customers could result in changes in the level of nonperforming assets and charge-offs in the future and, accordingly, changes in the allowance.

 

The allowance is affected by a number of factors, and does not necessarily move in tandem with the level of gross loans outstanding. Management continues to monitor the factors that affect the allowance, and is prepared to make adjustments as they become necessary.

 

Nonperforming assets. Nonperforming assets consist of nonaccrual loans, loans that are 90 days or more past due but are still accruing interest and other real estate owned. At June 30, 2012, there was $20,953,000 in nonperforming assets, compared to $21,845,000 at December 31, 2011. Nonaccrual loans were $19,030,000 at June 30, 2012, compared to $19,098,000 at December 31, 2011. There were no loans past due 90 days and still accruing at either date.

 

There was $1,923,000 in Other Real Estate Owned at June 30, 2012 which consisted of two separate properties and $2,747,000 at December 31, 2011. During the first six months of 2012, the Bank sold one property and did not foreclose on any new loans. Management intends to aggressively market the two remaining properties. While management believes these properties will sell, there can be no assurance that these properties will sell quickly given the current real estate market, nor can the expected sales price be accurately predicted.

 

Deposits. Total deposits at June 30, 2012 were $651,843,000 compared to $621,778,000 on December 31, 2011. Of these totals, noninterest-bearing demand deposits were $159,370,000 or 24.4% of the total on June 30, 2012 and $139,382,000 or 22.4% on December 31, 2011. Time deposits were $105,130,000 on June 30, 2012 and $108,851,000 on December 31, 2011.

 

The following table sets forth the maturity schedule of the time certificates of deposit on June 30, 2012:

 

TABLE 9
(Dollar amounts in thousands)		Under				$100,000
Maturities		$100,000				or more				Total
Three months or less		$	11,146			$	26,227			$	37,373
Over three through six months			8,235				13,399				21,634
Over six through twelve months			11,711				12,072				23,783
Over twelve months			8,712				13,628				22,340
Total		$	39,804			$	65,326			$	105,130

 

Regulatory Capital. The following table shows the regulatory capital ratios and leverage ratios at June 30, 2012 and December 31, 2011 for the Bank:

 

 

TABLE 10											Minimum “Well
		June 30,				December 31,					Capitalized”
Regulatory Capital Ratios		2012				2011					Requirements
Total Regulatory Capital Ratio			16.19	%			16.44	%	≥			10.00	%
Tier 1 Capital			14.94	%			15.18	%	≥			6.00	%
Leverage Ratios			11.09	%			11.15	%	≥			5.00	%

 

Liquidity. Liquidity is a measure of the Company’s ability to convert assets into cash with minimal loss. As of June 30, 2012, liquid assets (cash, cash equivalents and securities available for sale) were $248,404,000, or 33.2% of total assets. As of December 31, 2011, liquid assets were $226,138,000, or 31.6% of total assets. Liquidity consists of cash and due from banks, federal funds sold, and securities available-for-sale. The Company’s primary uses of funds are loans, and the primary sources of funds are deposits. The relationship between total net loans and total deposits is a useful additional measure of liquidity. The Company also has federal funds borrowing facilities totaling $45,000,000, a Federal Home Loan Bank line up to 30% of total assets, and a Federal Reserve Bank borrowing facility.

 

The relationship between total net loans and total deposits is a useful additional measure of liquidity. A higher loan to deposit ratio may lead to a loss of liquid assets in the future. This must be balanced against the fact that loans represent the highest interest earning assets. A lower loan to deposit ratio means lower potential income. On June 30, 2012, net loans were at 69.5% of deposits. On December 31, 2011, net loans were at 71.4% of deposits.

 

Off-Balance Sheet Items

 

The Company has certain ongoing commitments under operating leases. These commitments do not significantly impact operating results. As of June 30, 2012 and December 31, 2011, commitments to extend credit and letters of credit were the only financial instruments with off-balance sheet risk. The Company has not entered into any contracts for financial derivative instruments such as futures, swaps, options or similar instruments. Loan commitments and letters of credit were $84,734,000 and $92,690,000 at June 30, 2012 and December 31, 2011, respectively. As a percentage of net loans, these off-balance sheet items represent 18.7% and 20.9% respectively.

 

Item 3. Quantitative and Qualitative Disclosures About Market Risk.

 

Market risk is the risk of loss to future earnings, to fair values of assets or to future cash flows that may result from changes in the price or value of a financial instrument. The value of a financial instrument may change as a result of changes in interest rates and other market conditions. Market risk is attributed to all market risk sensitive financial instruments, including loans, investment securities, deposits and borrowings. The Company does not engage in trading activities or participate in foreign currency transactions for its own account. Accordingly, exposure to market risk is primarily a function of asset and liability management activities and of changes in market rates of interest. Changes in rates can cause or require increases in the rates paid on deposits that may take effect more rapidly or may be greater than the increases in the interest rates that the Company is able to charge on loans and the yields that it can realize on its investments. The extent of that market risk depends on a number of variables including the sensitivity to changes in market interest rates and the maturities of the Company’s interest earning assets and deposits.

 

Item 4T. Controls and Procedures.

 

(a) Disclosure Controls and Procedures: An evaluation of the Company’s disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) was carried out under the supervision and with the participation of the Company’s Chief Executive Officer, Chief Financial Officer and other members of the Company’s senior management as of June 30, 2012. The Company’s Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures as currently in effect are effective in ensuring that the information required to be disclosed by the Company in the reports it files or submits under the Act is (i) accumulated and communicated to the Company’s management (including the Chief Executive Officer and Chief Financial Officer) to allow timely decisions regarding required disclosure, and (ii) recorded, processed, summarized and reported within the time periods specified in the Commission’s rules and forms.

 

(b) Internal Control Over Financial Reporting: An evaluation of any changes in the Company’s internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)), that occurred during the Company’s six months ended June 30, 2012, was carried out under the supervision and with the participation of the Company’s Chief Executive Officer, Chief Financial Officer and other members of the Company’s senior management. The Company’s Chief Executive Officer and Chief Financial Officer concluded that no change identified in connection with such evaluation has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

 

PART II—OTHER INFORMATION

 

Item 1. Legal Proceedings

 

There are no material legal proceedings adverse to the Company or First National Bank to which any director, officer, affiliate of the Company, or 5% shareholder of the Company, or any associate of any such director, officer, affiliate or 5% shareholder of the Company are a party, and none of the foregoing persons has a material interest adverse to the Company or First National Bank.

 

From time to time, the Company and/or First National Bank are a party to claims and legal proceedings arising in the ordinary course of business. The Company’s management is not aware of any material pending legal proceedings to which either it or First National Bank may be a party or has recently been a party, which will have a material adverse effect on the financial condition or results of operations of the Company and First National Bank, taken as a whole.

 

Item 1A. Risk Factors

 

During the course of normal operations, the Bank and the Company manage a variety of risks including, but not limited to, credit risk, operational risk, interest rate risk and regulatory compliance risk. For a more complete discussion of the risk factors facing the Bank and the Company, please refer to the section entitled “Item 1A – Risk Factors” in the Company’s December 31, 2011 Form 10K.

 

On July 21, 2010, the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Act”) was signed into law. The purpose of this legislation was to bring about regulatory changes and oversight that would help stop past abuses from recurring in the future. This legislation gives new powers to the FDIC and the Federal Reserve Bank that they may use in the execution of their duties as regulators and overseers of the banking industry. It also created a new federal consumer protection agency named the Consumer Financial Protection Bureau (“CFPB”). All existing consumer laws and regulations will be transferred to the CFPB. This Act is expected to enable regulators to issue numerous new banking regulations and requirements that have not yet been fully developed or promulgated. The ultimate effect the Act has on the Company’s operations will ultimately be determined by the significance of the new banking regulations that are issued as a result of the Act.

 

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

 

 

c) ISSUER PURCHASES OF EQUITY SECURITIES

 

On August 24, 2007, the Board of Directors of the Company authorized a stock repurchase program which calls for the repurchase of up to five percent (5%) of the Company’s then outstanding 2,863,635 shares of Common Stock, or 143,182 shares. There were no repurchases during the quarter ended June 30, 2012. There were 10,457 shares remaining that may be purchased under this Plan as of June 30, 2012.

 

Item 4. Mining Safety Disclosures

 

Not applicable.

 

Item 6. Exhibits

 

Exhibits

 

	31: Rule 13a-14(a)/15d-14(a) Certifications
	32: Section 1350 Certifications

 

SIGNATURES

 

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

 

		FNB BANCORP
		(Registrant)
Dated:
August 14, 2012		By:	/s/ Thomas C. McGraw
			Thomas C. McGraw
			Chief Executive Officer
			(Authorized Officer)
		By:	/s/ David A. Curtis
			David A. Curtis
			Senior Vice President
			Chief Financial Officer
			(Principal Financial Officer)

 

43

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