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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

 

 

FORM 10-Q

 

 

(Mark One)

x	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2014

OR

 

¨	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE EXCHANGE ACT

For the transition period from                      to                     

Commission File Number: 0-18392

 

 

AMERIANA BANCORP

(Exact name of registrant as specified in its charter)

 

 

 

Indiana		35-1782688
(State or Other Jurisdiction of Incorporation or Organization)		(I.R.S. Employer Identification No.)
2118 Bundy Avenue, New Castle, Indiana		47362-1048
(Address of Principal Executive Offices)		(Zip Code)

Registrant’s telephone number, including area code: (765) 529-2230

Not Applicable

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

 

 

Indicate by check mark whether the registrant (l) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  ¨

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

 

Large accelerated filer		¨		Accelerated filer		¨
Non-accelerated filer		¨  (Do not check if a smaller reporting company)		Smaller reporting company		x

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x

At November 10, 2014, the registrant had 3,006,952 shares of its common stock outstanding.

 

 

 

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AMERIANA BANCORP

Table of Contents

 

						Page No.
Part I. Financial Information
		Item 1.		Financial Statements (Unaudited)			3
				Consolidated Condensed Balance Sheets at September 30, 2014 and December 31, 2013			3
				Consolidated Condensed Statements of Income for the Three and Nine Months Ended September  30, 2014 and 2013			4
				Consolidated Condensed Statements of Comprehensive Income for the Three and Nine Months Ended September 30, 2014 and 2013			6
				Consolidated Condensed Statement of Shareholders’ Equity for the Nine Months Ended September  30, 2014			7
				Consolidated Condensed Statements of Cash Flows for the Nine Months Ended September 30, 2014 and 2013			8
				Notes to Consolidated Condensed Financial Statements			9
		Item 2.		Management’s Discussion and Analysis of Financial Condition and Results of Operations			32
		Item 3.		Quantitative and Qualitative Disclosure about Market Risk			47
		Item 4.		Controls and Procedures			47
Part II. Other Information
		Item 1.		Legal Proceedings			47
		Item 1A.		Risk Factors			47
		Item 2.		Unregistered Sales of Equity Securities and Use of Proceeds			47
		Item 3.		Defaults upon Senior Securities			47
		Item 4.		Mine Safety Disclosures			47
		Item 5.		Other Information			47
		Item 6.		Exhibits			48
Signatures							49

 

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PART I - FINANCIAL INFORMATION

ITEM I - FINANCIAL STATEMENTS

Ameriana Bancorp

Consolidated Condensed Balance Sheets

(In thousands, except share data)

 

		September 30,				December 31,
		2014				2013
		(Unaudited)
Assets
Cash on hand and in other institutions		$	6,163			$	5,049
Interest-bearing demand deposits			22,665				35,818
Cash and cash equivalents			28,828				40,867
Interest-bearing time deposits			4,908				2,974
Investment securities available for sale, at fair value			49,762				37,803
Investment securities held to maturity, at amortized cost			7,168				2,347
Loans held for sale			90				—
Loans, net of allowance for loan losses of $4,014 and $3,993			320,997				312,035
Premises and equipment, net			14,834				14,686
Stock in Federal Home Loan Bank, at cost			4,472				4,472
Goodwill			656				656
Cash value of life insurance			28,269				27,731
Other real estate owned			5,402				5,171
Other assets			9,008				9,862
Total assets		$	474,394			$	458,604
Liabilities and Shareholders’ Equity
Liabilities
Deposits
Noninterest-bearing		$	60,879			$	52,747
Interest-bearing			315,242				309,954
Total deposits			376,121				362,701
Borrowings			50,810				50,810
Drafts payable			1,014				1,503
Other liabilities			6,546				5,877
Total liabilities			434,491				420,891
Commitments and contingencies
Shareholders’ equity
Preferred stock - 5,000,000 shares authorized and unissued			—				—
Common stock, $1.00 par value
Authorized 15,000,000 shares
Issued – 3,222,652 and 3,215,752 shares			3,223				3,216
Outstanding – 2,997,652 and 2,990,752 shares
Additional paid-in capital			1,315				1,176
Retained earnings			38,313				36,659
Accumulated other comprehensive income (loss)			50				(340	)
Treasury stock at cost – 225,000 shares			(2,998	)			(2,998	)
Total shareholders’ equity			39,903				37,713
Total liabilities and shareholders’ equity		$	474,394			$	458,604

See notes to consolidated condensed financial statements

 

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Ameriana Bancorp

Consolidated Condensed Statements of Income

(In thousands, except per share data)

(Unaudited)

 

		Three Months Ended September 30,								Nine Months Ended September 30,
		2014				2013				2014				2013
Interest Income
Interest and fees on loans		$	3,859			$	3,950			$	11,981			$	11,985
Interest on mortgage-backed securities			268				128				747				438
Interest on investment securities			44				44				131				131
Other interest and dividend income			74				62				245				182
Total interest income			4,245				4,184				13,104				12,736
Interest Expense
Interest on deposits			416				411				1,250				1,258
Interest on borrowings			344				335				1,023				997
Total interest expense			760				746				2,273				2,255
Net Interest Income			3,485				3,438				10,831				10,481
Provision for loan losses			22				210				322				675
Net Interest Income After Provision for Loan Losses			3,463				3,228				10,509				9,806
Other Income
Other fees and service charges			700				650				1,986				1,831
Brokerage and insurance commissions			400				385				1,202				1,221
Net realized and recognized gains on available-for-sale investment securities (includes $75 for the three months ended September 30, 2013, and $167 for the nine months ended September 30, 2013 related to accumulated other comprehensive income reclassifications)			—				75				—				167
Gains on sales of loans and servicing rights			41				130				82				450
Net gain (loss) from sales and write-downs of other real estate owned			(4	)			80				3				78
Other real estate owned income			65				60				209				175
Increase in cash value of life insurance			181				164				538				532
Other			38				31				148				102
Total other income			1,421				1,575				4,168				4,556
Other Expense
Salaries and employee benefits			2,403				2,305				6,974				6,724
Net occupancy expense			357				386				1,116				1,148
Furniture and equipment expense			202				191				575				634
Legal and professional fees			154				102				482				427
FDIC deposit insurance premiums and assessments			103				116				283				411
Data processing expense			262				222				746				662
Printing and office supplies			66				54				192				196
Marketing expense			134				106				352				266
Other real estate owned expense			73				80				179				263
Other			463				458				1,272				1,323
Total other expense			4,217				4,020				12,171				12,054
Income Before Income Taxes			667				783				2,506				2,308
Income tax (includes $26 for the three months ended September 30, 2013, and $57 for the nine months ended September 30, 2013 related to income tax expense from reclassification items)			166				222				673				602
Net Income		$	501			$	561			$	1,833			$	1,706

See notes to consolidated condensed financial statements

 

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Ameriana Bancorp

Consolidated Condensed Statements of Income

(In thousands, except per share data)

(Unaudited)

 

		Three Months Ended September 30,								Nine Months Ended September 30,
		2014				2013				2014				2013
Basic Earnings Per Share		$	0.17			$	0.19			$	0.61			$	0.57
Diluted Earnings Per Share		$	0.17			$	0.19			$	0.61			$	0.57
Dividends Declared Per Share		$	0.02			$	0.01			$	0.06			$	0.03

See notes to consolidated condensed financial statements

 

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Ameriana Bancorp

Consolidated Condensed Statements of Comprehensive Income

(In thousands, except per share data)

(Unaudited)

 

		Three Months Ended September 30,								Nine Months Ended September 30,
		2014				2013				2014				2013
Net Income		$	501			$	561			$	1,833			$	1,706
Unrealized appreciation (depreciation) on available-for-sale securities, net of tax benefit of $89 and tax expense of $8 for the three months ended September 30, 2014 and September 30, 2013, respectively, and net of tax expense of $204 and tax benefit of $313 for the nine months ended September 30, 2014 and September 30, 2013, respectively			(173	)			16				390				(615	)
Less: reclassification adjustment for realized gains included in net income, net of tax expense of $26 for the three months ended September 30, 2013, and net of tax expense of $57 for the nine months ended September 30, 2013			—				49				—				110
Other comprehensive (loss) income			(173	)			(33	)			390				(725	)
Comprehensive Income		$	328			$	528			$	2,223			$	981

See notes to consolidated condensed financial statements

 

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Ameriana Bancorp

Consolidated Condensed Statement of Shareholders’ Equity

For the Nine Months Ended September 30, 2014

(In thousands, except per share data)

(Unaudited)

 

		Common Stock				Additional Paid-in Capital				Retained Earnings				Accumulated Other Comprehensive Income (Loss)				Treasury Stock				Total
Balance at December 31, 2013		$	3,216			$	1,176			$	36,659			$	(340	)		$	(2,998	)		$	37,713
Net Income			—				—				1,833				—				—				1,833
Other comprehensive income			—				—				—				390				—				390
Share-based compensation			—				57				—				—				—				57
Exercise of stock options			7				78				—				—				—				85
Tax benefit realized from exercise of stock options			—				4				—				—				—				4
Dividends declared ($0.06 per share)			—				—				(179	)			—				—				(179	)
Balance at September 30, 2014		$	3,223			$	1,315			$	38,313			$	50			$	(2,998	)		$	39,903

See notes to consolidated condensed financial statements.

 

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Ameriana Bancorp

Consolidated Condensed Statements of Cash Flows

(In thousands)

(Unaudited)

 

		Nine Months Ended September 30,
		2014				2013
Operating Activities
Net income		$	1,833			$	1,706
Items not requiring (providing) cash
Provision for losses on loans			322				675
Depreciation and amortization			940				1,125
Increase in cash value of life insurance			(538	)			(532	)
Gain from sale of available-for-sale securities			—				(167	)
Net gain from sales and write-downs of other real estate owned			(3	)			(78	)
Share-based compensation			57				—
Mortgage loans originated for sale			(2,233	)			(12,579	)
Proceeds from sales of mortgage loans originated for sale			2,196				13,478
Gains on sales of mortgage loans and servicing rights			(82	)			(450	)
Increase in accrued interest and dividends payable			323				297
Other adjustments			341				1,978
Net cash provided by operating activities			3,156				5,453
Investing Activities
Purchase of available for sale securities			(16,252	)			(10,144	)
Purchase of held to maturity securities			(4,822	)			—
Proceeds/principal from the sale of securities			—				10,184
Net change in interest-bearing time deposits			(1,934	)			3,722
Principal collected on mortgage-backed securities			4,706				6,440
Net change in loans			(10,051	)			(6,565	)
Proceeds from sales of other real estate owned			532				634
Net purchases and construction of premises and equipment			(864	)			(1,045	)
Net cash (used in) provided by investing activities			(28,685	)			3,226
Financing Activities
Net change in demand and savings deposits			19,851				599
Net change in certificates of deposit			(6,431	)			(7,730	)
Decrease in drafts payable			(489	)			(282	)
Net change in advances by borrowers for taxes and insurance			620				513
Proceeds from exercise of stock options			89				—
Cash dividends paid			(150	)			(90	)
Net cash provided by (used in) financing activities			13,490				(6,990	)
Change in Cash and Cash Equivalents			(12,039	)			1,689
Cash and Cash Equivalents at Beginning of Year			40,867				20,853
Cash and Cash Equivalents at End of Quarter		$	28,828			$	22,542
Supplemental information:
Interest paid on deposits		$	956			$	960
Interest paid on borrowings		$	1,024			$	999
Income tax paid		$	190			$	232
Non-cash supplemental information:
Transfers from loans to other real estate owned		$	767			$	266

See notes to consolidated condensed financial statements.

 

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AMERIANA BANCORP AND SUBSIDIARIES

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS (unaudited)

NOTE A — BASIS OF PRESENTATION

The consolidated condensed financial statements include the accounts of Ameriana Bancorp (the “Company”) and its wholly-owned subsidiary Ameriana Bank (the “Bank”). The Bank has two wholly-owned subsidiaries, Ameriana Insurance Agency and Ameriana Financial Services, Inc. All significant intercompany accounts and transactions have been eliminated in consolidation.

The unaudited interim consolidated condensed financial statements have been prepared in accordance with the instructions to Form 10-Q and, therefore, do not include all information and disclosures required by generally accepted accounting principles (“GAAP”) for complete financial statements. In the opinion of management, the financial statements reflect all adjustments (comprised only of normal recurring adjustments and accruals) necessary to present fairly the Company’s financial position and results of operations and cash flows. The consolidated condensed balance sheet of the Company as of December 31, 2013 has been derived from the audited consolidated balance sheet of the Company as of that date. The results of operations for the three and nine months ended September 30, 2014 are not necessarily indicative of the results to be expected in the full year or for any other period. These statements should be read in conjunction with the consolidated financial statements and related notes which are included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2013.

NOTE B — SHAREHOLDERS’ EQUITY

On August 25, 2014, the Board of Directors declared a quarterly cash dividend of $0.02 per share. This dividend, totaling approximately $60,000, was accrued for payment to shareholders of record on September 19, 2014 and was paid on October 10, 2014.

Cash received from options exercised under all share-based compensation arrangements for the third quarter of 2014 was $39,000, with a tax benefit realized of $3,000. No stock options were granted during the third quarter of 2014.

NOTE C — EARNINGS PER SHARE

Earnings per share were computed as follows:

 

		(In thousands, except share data)
		Three Months Ended September 30,
		2014												2013
		Net Income				Weighted Average Shares				Per Share Amount				Net Income				Weighted Average Shares				Per Share Amount
Basic Earnings Per Share: Income available to common shareholders		$	501				2,997,200			$	0.17			$	561				2,988,952			$	0.19
Effect of dilutive stock options			—				5,653								—				325
Diluted Earnings Per Share: Income available to common shareholders and assumed conversions		$	501				3,002,853			$	0.17			$	561				2,989,277			$	0.19

 

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		(In thousands, except share data)
		Nine Months Ended September 30,
		2014												2013
		Net Income				Weighted Average Shares				Per Share Amount				Net Income				Weighted Average Shares				Per Share Amount
Basic Earnings Per Share: Income available to common shareholders		$	1,833				2,993,386			$	0.61			$	1,706				2,988,952			$	0.57
Effect of dilutive stock options			—				5,008								—				102
Diluted Earnings Per Share: Income available to common shareholders and assumed conversions		$	1,833				2,998,394			$	0.61			$	1,706				2,989,054			$	0.57

Options to purchase 15,232 shares of common stock at exercise prices of $15.35 to $15.56 per share and 95,232 shares of common stock at exercise prices of $13.01 to $15.56 per share that were outstanding at September 30, 2014 and 2013, respectively, were not included in the computation of diluted earnings per share because the options were anti-dilutive, in that the exercise prices of the options exceeded the market value of the Company’s stock for the periods presented.

NOTE D — INVESTMENT SECURITIES

The following tables provide the composition of investment securities at September 30, 2014 and December 31, 2013 (dollars in thousands):

 

		Amortized Cost				Gross Unrealized Gains				Gross Unrealized Losses				Fair Value
Available for sale at September 30, 2014
Ginnie Mae and GSE mortgage-backed pass-through securities		$	45,760			$	281			$	213			$	45,828
Ginnie Mae collateralized mortgage obligations			2,131				—				37				2,094
Mutual fund			1,815				25				—				1,840
		$	49,706			$	306			$	250			$	49,762

 

		Amortized Cost				Gross Unrealized Gains				Gross Unrealized Losses				Fair Value
Held to maturity at September 30, 2014
GSE mortgage-backed pass-through securities		$	4,822			$	—			$	32			$	4,790
Municipal securities			2,346				8				—				2,354
		$	7,168			$	8			$	32			$	7,144

 

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		Amortized Cost				Gross Unrealized Gains				Gross Unrealized Losses				Fair Value
Available for sale at December 31, 2013
Ginnie Mae and GSE mortgage-backed pass-through securities		$	34,205			$	100			$	499			$	33,806
Ginnie Mae collateralized mortgage obligations			2,349				—				135				2,214
Mutual fund			1,787				—				4				1,783
		$	38,341			$	100			$	638			$	37,803

 

		Amortized Cost				Gross Unrealized Gains				Gross Unrealized Losses				Fair Value
Held to maturity at December 31, 2013
Municipal securities		$	2,347			$	—			$	—			$	2,347

The amortized cost and fair value of securities at September 30, 2014 by contractual maturity are shown below (dollars in thousands). Expected maturities will differ from contractual maturities because issuers may have the right to call or prepay obligations with or without call or prepayment penalties.

 

		Available for Sale
		Amortized Cost				Fair Value
Within one year		$	—			$	—
One to five years			—				—
Five to ten years			—				—
After ten years			—				—
			—				—
Ginnie Mae and GSE mortgage-backed pass-through securities			45,760				45,828
Ginnie Mae collateralized mortgage obligations			2,131				2,094
Mutual fund			1,815				1,840
		$	49,706			$	49,762

 

		Held to Maturity
		Amortized Cost				Fair Value
Within one year		$	50			$	50
One to five years			260				261
Five to ten years			535				537
After ten years			1,501				1,506
Municipal securities			2,346				2,354
GSE mortgage-backed pass-through securities			4,822				4,790
		$	7,168			$	7,144

 

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Mortgage-backed pass-through securities: The contractual cash flows of these investments are guaranteed by either Ginnie Mae, a U.S. Government agency, or by Fannie Mae and Freddie Mac, U.S. Government-sponsored entities, institutions which the U.S. Government has affirmed its commitment to support. Accordingly, it is expected that the securities would not be settled at a price less than the amortized cost of the Company’s investment.

Collateralized mortgage obligations: The contractual cash flows of these investments are guaranteed by Ginnie Mae, a U.S. Government agency. Accordingly, it is expected that the securities would not be settled at a price less than the amortized cost of the Company’s investment.

Municipal Securities: The municipal securities consisted of non-rated local issue tax increment revenue bonds.

Mutual fund: The mutual fund balance consisted of an investment in the CRA Qualified Investment mutual fund, whose portfolio composition is primarily in debt securities with an average credit quality rating of AAA.

Certain investment securities are reported in the financial statements at an amount less than their historical cost. Total fair value of these investments at September 30, 2014 and December 31, 2013 was $31,458,000 and $32,002,000, respectively, which was approximately 55.3% and 79.6%, respectively, of the Company’s investment portfolio at these dates.

Should the impairment of any of these securities become other than temporary, the cost basis of the investment will be reduced and the resulting loss recognized in net income in the period the other-than-temporary impairment is identified.

The following table shows the Company’s investments’ gross unrealized losses and fair value, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position at September 30, 2014 and December 31, 2013 (dollars in thousands):

 

		Less Than 12 Months								12 Months or Longer								Total
		Fair Value				Unrealized Losses				Fair Value				Unrealized Losses				Fair Value				Unrealized Losses
Available for sale at September 30, 2014
Ginnie Mae and GSE mortgage-backed pass-through securities		$	16,667			$	64			$	7,907			$	149			$	24,574			$	213
Ginnie Mae collateralized mortgage obligations			—				—				2,094				37				2,094				37
		$	16,667			$	64			$	10,001			$	186			$	26,668			$	250

 

		Less Than 12 Months								12 Months or Longer								Total
		Fair Value				Unrealized Losses				Fair Value				Unrealized Losses				Fair Value				Unrealized Losses
Held to maturity at September 30, 2014
GSE mortgage-backed pass-through securities		$	4,790			$	32			$	—			$	—			$	4,790			$	32

 

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		Less Than 12 Months								12 Months or Longer								Total
		Fair Value				Unrealized Losses				Fair Value				Unrealized Losses				Fair Value				Unrealized  Losses
Available for sale at December 31, 2013
Ginnie Mae and GSE mortgage-backed pass-through securities		$	27,963			$	498			$	42			$	1			$	28,005			$	499
Ginnie Mae collateralized mortgage obligations			2,214				135				—				—				2,214				135
Mutual fund			1,783				4				—				—				1,783				4
		$	31,960			$	637			$	42			$	1			$	32,002			$	638

Investment securities with a total market value of $8,694,000 and $8,914,000 were pledged at September 30, 2014 and December 31, 2013, respectively, to secure a repurchase agreement.

There were no sales of available for sale securities during the three-month period ended September 30, 2014, compared to a gross gain of $75,000 resulting from sales of $2,595,000 of available for sale securities that was realized in the three-month period ended September 30, 2013.

There were no sales of available for sale securities during the nine-month period ended September 30, 2014, compared to a gross gain of $178,000 and a gross loss of $11,000 resulting from sales of $10,184,000 of available for sale securities that were realized in the nine-month period ended September 30, 2013, with a tax expense of $57,000.

NOTE E — LOANS AND ALLOWANCE FOR LOAN AND LEASE LOSSES

(Dollars in Thousands)

 

		At September 30,				At December 31,
		2014				2013
Real estate loans:
Commercial		$	111,093			$	104,766
Residential			168,388				168,529
Construction			14,834				11,382
Commercial loans and leases			29,044				29,254
Municipal loans			785				997
Consumer loans			2,067				2,032
Total loans			326,211				316,960
Less:
Undisbursed loan proceeds			467				248
Deferred loan fees, net			733				684
Allowance for loan losses			4,014				3,993
			5,214				4,925
Total loans - net		$	320,997			$	312,035

 

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The risk characteristics of each loan portfolio segment are as follows:

Commercial Real Estate: These loans are viewed primarily as cash flow loans and secondarily as loans secured by real estate. Commercial real estate lending typically involves higher loan principal amounts and the repayment of these loans is generally dependent on the successful operation of the property securing the loan or the business conducted on the property securing the loan. Commercial real estate loans may be more adversely affected by conditions in the real estate markets or in the general economy. The properties securing the Bank’s commercial real estate portfolio are diverse in terms of type and geographic location. Management monitors and evaluates commercial real estate loans based on collateral and risk grade criteria. As a general rule, the Bank avoids financing single purpose projects unless other underwriting factors are present to help mitigate risk. In addition, management tracks the level of owner-occupied commercial real estate loans versus non-owner occupied loans.

Construction Real Estate: Construction loans are underwritten utilizing feasibility studies, independent appraisal reviews, sensitivity analysis of absorption and lease rates and financial analysis of the developers and property owners. Construction loans are generally based on estimates of costs and value associated with the completed project. These estimates may be inaccurate. Construction loans often involve the disbursement of substantial funds with repayment substantially dependent on the success of the ultimate project. Sources of repayment for these types of loans may be pre-committed permanent loans from approved long-term lenders, sales of developed property or an interim loan commitment from the Bank until permanent financing is obtained. These loans are closely monitored by on-site inspections and are considered to have higher risks than other real estate loans due to their ultimate repayment being sensitive to interest rate changes, timely completion and sale of the property, sale of the property at a price commensurate with the initial estimate, governmental regulation of real property, general economic conditions and the availability of long-term financing.

Commercial Loans and Leases: Commercial loans and leases are primarily based on the identified cash flows of the borrower and secondarily on the underlying collateral provided by the borrower. The cash flows of borrowers, however, may not be as expected and the collateral securing these loans may fluctuate in value. Most commercial loans are secured by the assets being financed or other business assets such as accounts receivable or inventory and may incorporate a personal guarantee; however, some short-term loans may be made on an unsecured basis. In the case of loans secured by accounts receivable, the availability of funds for the repayment of these loans may be substantially dependent on the ability of the borrower to collect amounts due from its customers.

Residential and Consumer: With respect to residential loans that are secured by one-to four-family residences and are generally owner occupied, the Bank generally establishes a maximum loan-to-value ratio and requires private mortgage insurance if that ratio is exceeded. Home equity loans are typically secured by a subordinate interest in one-to four-family residences, and consumer loans are secured by consumer assets such as automobiles or recreational vehicles. Some consumer loans are unsecured such as small installment loans and certain lines of credit. Repayment of these loans is primarily dependent on the personal income of the borrowers, which can be impacted by economic conditions in their market areas such as unemployment levels. Repayment can also be impacted by changes in property values on residential properties. Risk is mitigated by the fact that the loans are of smaller individual amounts and spread over a large number of borrowers.

Municipal: Municipal loans are primarily based on the identified cash flows of the borrower and secondarily on the underlying collateral provided by the borrower. Most municipal loans are secured by the full faith and credit of the municipality. The availability of funds for the repayment of these loans may be substantially dependent on the ability of the municipality to collect taxes or other revenue.

Allowance for Loan and Lease Losses Methodology:

Bank policy is designed to ensure that an adequate allowance for loan and lease losses (“ALLL”) will be maintained. Primary responsibility for ensuring that the Bank has processes in place to consistently assess the adequacy of the ALLL rests with the Board. The Board has charged the Chief Credit Officer with responsibility for establishing the methodology to be used and to assess the adequacy of the ALLL quarterly. The methodology will be reviewed and affirmed by the Loan Review Officer. Quarterly, the Board will review recommendations from the Chief Credit Officer to adjust the allowance as appropriate.

 

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The methodology employed by the Bank for each portfolio segment will at a minimum contain the following:

 

1)

Loans will be segmented by type of loan.

 

2)

Loans will be further segmented by risk grades.

 

3)

The required ALLL for types of performing homogeneous loans which do not have a specific reserve will be determined by applying a factor based on historical losses averaged over the twelve quarters prior to the most recent quarter. In those instances where the Bank’s historical experience is not available, management will develop factors based on industry experience and best practices.

 

4)

All criticized and classified loans will be tested for impairment by applying one of three methodologies:

a. Present value of future cash flows;

b. Fair value of collateral less cost to sell; or

c. The loan’s observable market price.

 

5)

All troubled debt restructurings (“TDR”) are considered impaired loans.

 

6)

Loans tested for impairment will be removed from other pools to prevent layering (double-counting).

 

7)

The required ALLL for each group of loans will be added together to determine the total required ALLL for the Bank. The required ALLL will be compared to the current ALLL to determine the required provision to increase the ALLL or credit to decrease the ALLL.

The historical loss experience is determined by portfolio segment and is based on the actual loss history experienced by the Bank over the twelve quarters prior to the most recent quarter. Management believes the historical loss experience methodology is appropriate in the current economic environment, as it captures loss rates that are comparable to the current period being analyzed.

Management also factors in the following qualitative considerations:

 

1)

Changes in policies and procedures;

 

2)

Changes in national, regional and local economic and business conditions;

 

3)

Changes in the composition and size of the portfolio and in the terms of loans;

 

4)

Changes in the experience, ability and depth of lending management and other relevant staff;

 

5)

Changes in the volume and severity of past due loans, the volume of non-accrual loans, and the volume and severity of adversely classified or graded loans;

 

6)

Changes in the quality of the Bank’s loan review system;

 

7)

Changes in the value of underlying collateral for collateral-dependent loans;

 

8)

The existence and effect of any concentration of credit, and changes in the level of such concentrations; and

 

9)

The effect of other external factors such as competition and legal and regulatory requirements on the level of estimated credit losses in the existing portfolio.

The following table presents the balance and activity in allowance for loan losses as of September 30, 2014 (dollars in thousands):

Allowance for Loan Losses

For Three Months Ended September 30, 2014

 

		Commercial Real Estate Loans				Residential Real Estate Loans				Construction Real Estate Loans				Commercial Loans and Leases				Municipal Loans				Consumer Loans				Total
Balance at beginning of quarter		$	1,248			$	1,683			$	392			$	558			$	—			$	123			$	4,004
Provision (credit) for losses			61				78				(139	)			—				—				22				22
Charge-offs (1)			(5	)			(8	)			—				—				—				(29	)			(42	)
Recoveries			—				3				1				15				—				11				30
Balance at end of quarter		$	1,304			$	1,756			$	254			$	573			$	—			$	127			$	4,014

 

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The following table presents the balance and activity in allowance for loan losses and the recorded investment in loans and impairment methods as of September 30, 2014 (dollars in thousands):

Allowance for Loan Losses and Recorded Investment in Loans

For Nine Months Ended September 30, 2014

 

		Commercial Real Estate Loans				Residential Real Estate Loans				Construction Real Estate Loans				Commercial Loans and Leases				Municipal Loans				Consumer Loans				Total
Balance at beginning of year		$	1,165			$	1,743			$	356			$	623			$	—			$	106			$	3,993
Provision (credit) for losses			242				92				(59	)			(17	)			—				64				322
Charge-offs (1)			(106	)			(88	)			(46	)			(59	)			—				(63	)			(362	)
Recoveries			3				9				3				26				—				20				61
Balance at end of period		$	1,304			$	1,756			$	254			$	573			$	—			$	127			$	4,014
Ending allowance balance:
Individually evaluated for impairment		$	—			$	425			$	230			$	98			$	—			$	8			$	761
Collectively evaluated for impairment			1,304				1,331				24				475				—				119				3,253
Total		$	1,304			$	1,756			$	254			$	573			$	—			$	127			$	4,014
Ending loan balance:
Individually evaluated for impairment		$	4,325			$	4,747			$	3,716			$	207			$	—			$	84			$	13,079
Collectively evaluated for impairment			106,768				163,641				11,118				28,837				785				1,983				313,132
Total		$	111,093			$	168,388			$	14,834			$	29,044			$	785			$	2,067			$	326,211

The following tables present the balance and activity in allowance for loan losses as of September 30, 2013 (dollars in thousands):

Allowance for Loan Losses

For Three Months Ended September 30, 2013

 

		Commercial Real Estate Loans				Residential Real Estate Loans				Construction Real Estate Loans				Commercial Loans and Leases				Municipal Loans				Consumer Loans				Total
Balance at beginning of quarter		$	459			$	1,631			$	769			$	1,014			$	—			$	81			$	3,954
Provision (credit) for losses			(78	)			257				(40	)			53				—				18				210
Charge-offs (1)			—				(237	)			—				(4	)			—				(15	)			(256	)
Recoveries			—				3				1				18				—				9				31
Balance at end of quarter		$	381			$	1,654			$	730			$	1,081			$	—			$	93			$	3,939

 

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Allowance for Loan Losses

For Nine Months Ended September 30, 2013

 

		Commercial Real Estate Loans				Residential Real Estate Loans				Construction Real Estate Loans				Commercial Loans and Leases				Municipal Loans				Consumer Loans				Total
Balance at beginning of year		$	789			$	1,504			$	785			$	1,080			$	—			$	81			$	4,239
Provision (credit) for losses			71				540				(73	)			109				—				28				675
Charge-offs (1)			(479	)			(429	)			(2	)			(135	)			—				(45	)			(1,090	)
Recoveries			—				39				20				27				—				29				115
Balance at end of period		$	381			$	1,654			$	730			$	1,081			$	—			$	93			$	3,939

The following table presents the balance in allowance for loan losses and the recorded investment in loans and impairment methods as of December 31, 2013 (dollars in thousands):

Allowance for Loan Losses and Recorded Investment in Loans

For Year Ended December 31, 2013

 

		Commercial Real Estate Loans				Residential Real Estate Loans				Construction Real Estate Loans				Commercial Loans and Leases				Municipal Loans				Consumer Loans				Total
Ending allowance balance:
Individually evaluated for impairment		$	96			$	495			$	285			$	148			$	—			$	8			$	1,032
Collectively evaluated for impairment			1,069				1,248				71				475				—				98				2,961
Total		$	1,165			$	1,743			$	356			$	623			$	—			$	106			$	3,993
Ending loan balance:
Individually evaluated for impairment		$	4,836			$	6,266			$	4,113			$	732			$	—			$	69			$	16,016
Collectively evaluated for impairment			99,930				162,263				7,269				28,522				997				1,963				300,944
Total		$	104,766			$	168,529			$	11,382			$	29,254			$	997			$	2,032			$	316,960

(1) Policy for Charging Off Loans:

A loan should be charged off at any point in time when it no longer can be considered a bankable asset, meaning collectable within the parameters of policy. The Bank shall not renew any loan, or put a loan on a demand basis, only to defer a problem, nor is it appropriate to attempt long-term recoveries while reporting loans as assets.

An unsecured loan generally should be charged off no later than when it is 120 days past due as to principal or interest. For loans in the legal process of foreclosure against collateral of real and/or liquid value, the 120-day rule does not apply. Such charge-offs can be deferred until the foreclosure process progresses to the point where the Bank can adequately determine whether or not any ultimate loss will result. In similar instances where other legal actions will cause extraordinary delays, such as the settlement of an estate, if the loan is well collateralized, the 120-day period may be extended. On loans where the Bank is unsecured or not fully collateralized, the loan should be charged off or written down to the documented collateral value rather than merely being placed on non-accrual status.

 

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All charge-offs and forgiveness of debt equal to or greater than $100,000 must be approved by the Loan Committee upon recommendation by the Chief Credit Officer. The Loan Committee consists of the Bank’s Chief Executive Officer, Chief Credit Officer, Chief Banking Officer and Loan Review Officer. Charge-offs less than $100,000 and greater than $10,000 and decisions to defer the charge-off of a loan must be approved by the Chief Credit Officer.

Narrative Description of Borrower Rating:

Grade 1 — Highest Quality (Pass)

This loan represents a credit extension of the highest quality. The borrower’s historic (at least five years) cash flows manifest extremely large and stable margins of coverage. Balance sheets are conservative, well capitalized, and liquid. After considering debt service for proposed and existing debt, projected cash flows continue to be strong and provide ample coverage. The borrower typically reflects broad geographic and product diversification and has broad access to alternative financial markets. Also included in this category may be loans secured by U.S. government securities, U.S. government agencies, highly rated municipal bonds, insured savings accounts, and insured certificates of deposit drawn on high quality banks.

Grade 2 — Excellent Quality (Pass)

This loan has a sound primary and secondary source of repayment. The borrower has proven access to alternative sources of financing. This loan carries a low level of risk, with minimal loss exposure. The borrower has the ability to perform according to the terms of the credit facility. The margins of cash flow coverage are strong. This category also includes loans secured by high quality traded stocks and lower grade municipal bonds (must still be investment grade).

Grade 3 — Good Quality (Pass)

This loan has a sound primary source of repayment. The borrower may have access to alternative sources of financing, but sources are not as widely available as they are to a higher graded borrower. This loan carries a normal level of risk, with minimal loss exposure. The borrower has the ability to perform according to the terms of the credit facility. The margins of cash flow coverage are satisfactory but vulnerable to more rapid deterioration than the higher quality loans. Real estate loans in this category display advance rates below the suggested maximum, debt coverage well in excess of the suggested level, or are leased beyond the loan term by a “credit” tenant.

Grade 4 — Acceptable Quality (Pass)

The borrower is a reasonable credit risk and demonstrates the ability to repay the debt from normal business operations. Risk factors may include reliability of margins and cash flows, liquidity, dependence on a single product or industry, cyclical trends, depth of management, or limited access to alternative financing sources. Historic financial information may indicate erratic performance, but current trends are positive. Quality of financial information is adequate, but is not as detailed and sophisticated as information found on higher graded loans. If adverse circumstances arise, the impact on the borrower may be significant. All small business loans extended based upon credit scoring should be classified in this category unless deterioration occurs, in which case they should bear one of the below mentioned grades.

Grade 5 — Marginal Quality (Pass)

The borrower is an acceptable credit risk and while it can demonstrate it has the ability to repay the debt from normal business operations, the coverage is not as strong as an Acceptable Quality loan. Weakness in one or more areas are defined. Risk factors would typically include a higher leverage position than desirable, low liquidity, weak or sporadic cash flow, the lack of reasonably current and complete financial information, and/or overall financial trends are erratic.

Grade 6 — Elevated Risk, Management Attention (Watch)

While the borrower at origination was not considered a high risk potential, there are characteristics related to the financial condition, and/or a level of concern regarding either or both the primary and secondary source of repayment, that may preclude this from being a pass credit. These credit facilities are considered “pass” credits but exhibit the potential of developing a more serious weakness in their operation going forward. Usually, a credit in this category will be upgraded or downgraded on further analysis within a short period of time.

Grade 7 — Special Mention

These credit facilities have developing weaknesses that deserve extra attention from the loan officer and other management personnel. If the developing weakness is not corrected or mitigated, there may be deterioration in the ability of the borrower to repay the Bank’s debt in the future. This grade should not be assigned to loans which bear certain peculiar risks normally associated with the type of financing involved, unless circumstances have caused the risk to increase to a level higher than would have been acceptable when the credit was originally approved. Loans where actual, not potential, weaknesses or problems are clearly evident and significant should generally be graded in one of the grade categories below.

 

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Grade 8 — Substandard

Loans and other credit extensions bearing this grade are considered to be inadequately protected by the current sound worth and debt service capacity of the borrower or of any pledged collateral. These obligations, even if apparently protected by collateral value, have well-defined weaknesses related to adverse financial, managerial, economic, market, or political conditions which have clearly jeopardized repayment of principal and interest as originally intended. Furthermore, there is the possibility that some future loss will be sustained by the Bank if such weaknesses are not corrected. Clear loss potential, however, does not have to exist in any individual assets classified as substandard.

Grade 9 — Doubtful

Loans and other credit extensions graded “9” have all the weaknesses inherent in those graded “8,” with the added characteristic that the severity of the weaknesses make collection or liquidation in full highly questionable or improbable based upon currently existing facts, conditions, and values. The probability of some loss is extremely high, but because of certain important and reasonably specific factors, the amount of loss cannot be determined. Such pending factors could include merger or liquidation, additional capital injection, refinancing plans, or perfection of liens on additional collateral. Loans in this classification should be placed in nonaccrual status, with collections applied to principal on the Bank’s books.

Grade 10 — Loss

Loans in this classification are considered uncollectible and cannot be justified as a viable asset of the Bank. This classification does not mean the loan has absolutely no recovery value, but that it is neither practical nor desirable to defer writing off this loan even though partial recovery may be obtained in the future.

The following tables present the credit risk profile of the Company’s loan portfolio based on rating category and payment activity as of September 30, 2014 and December 31, 2013 (dollars in thousands):

Loan Portfolio Quality Indicators

At September 30, 2014

 

		Commercial Real Estate Loans				Residential Real Estate Loans				Construction Real Estate Loans				Commercial Loans and Leases				Municipal Loans				Consumer Loans				Total
Rating:
Pass (Grades 1-5)		$	103,601			$	161,597			$	12,253			$	28,686			$	785			$	1,983			$	308,905
Watch (Grade 6)			3,169				—				—				151				—				—				3,320
Special Mention (Grade 7)			—				3,381				—				—				—				—				3,381
Substandard (Grade 8)			3,511				1,414				230				—				—				—				5,155
Doubtful (Grade 9)			812				1,996				2,351				207				—				84				5,450
Loss (Grade 10)			—				—				—				—				—				—				—
Total		$	111,093			$	168,388			$	14,834			$	29,044			$	785			$	2,067			$	326,211

 

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Loan Portfolio Quality Indicators

At December 31, 2013

 

		Commercial Real Estate Loans				Residential Real Estate Loans				Construction Real Estate Loans				Commercial Loans and Leases				Municipal Loans				Consumer Loans				Total
Rating:
Pass (Grades 1-5)		$	100,086			$	160,390			$	8,541			$	28,453			$	997			$	1,963			$	300,430
Watch (Grade 6)			1,137				—				—				56				—				—				1,193
Special Mention (Grade 7)			2,250				3,488				—				13				—				—				5,751
Substandard (Grade 8)			942				1,884				1,634				—				—				—				4,460
Doubtful (Grade 9)			351				2,767				1,207				732				—				69				5,126
Loss (Grade 10)			—				—				—				—				—				—				—
Total		$	104,766			$	168,529			$	11,382			$	29,254			$	997			$	2,032			$	316,960

For all loan classes, the entire balance of a loan is considered delinquent if the minimum payment contractually required to be made is not received by the specified due date.

The following tables present the Company’s loan portfolio aging analysis as of September 30, 2014 and December 31, 2013 (dollars in thousands):

Loan Portfolio Aging Analysis

At September 30, 2014

 

		30-59 Days Past Due (A)				60-89 Days Past Due				90 Days and Greater				Total Past Due				Current				Total Loans Receivable				Total Loans > 90 days and Accruing
Real estate loans:
Commercial		$	3,511			$	—			$	812			$	4,323			$	106,770			$	111,093			$	—
Residential			963				285				1,606				2,854				165,534				168,388				—
Construction			—				—				2,351				2,351				12,483				14,834				—
Commercial loans and leases			91				—				117				208				28,836				29,044				—
Municipal loans			—				—				—				—				785				785				—
Consumer loans			10				27				3				40				2,027				2,067				3
Total		$	4,575			$	312			$	4,889			$	9,776			$	316,435			$	326,211			$	3

 

(A)	Includes $298,000 in loans classified as nonaccrual that are less than 30 days past due, and all are residential real estate loans.

Loan Portfolio Aging Analysis

At December 31, 2013

 

		30-59 Days Past Due (A)				60-89 Days Past Due				Greater than 90 Days				Total Past Due				Current				Total Loans Receivable				Total Loans > 90 days and Accruing
Real estate loans:
Commercial		$	—			$	—			$	351			$	351			$	104,415			$	104,766			$	—
Residential			1,598				612				2,257				4,467				164,062				168,529				9
Construction			1,018				—				188				1,206				10,176				11,382				—
Commercial loans and leases			169				—				564				733				28,521				29,254				—
Municipal loans			—				—				—				—				997				997				—
Consumer loans			36				—				—				36				1,996				2,032				—
Total		$	2,821			$	612			$	3,360			$	6,793			$	310,167			$	316,960			$	9

 

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(A)	Includes $507,000 in loans classified as nonaccrual that are less than 30 days past due, of which $338,000 are residential real estate loans and $169,000 are commercial loans.

Impaired Loans: For all loan classes, a loan is designated as impaired when, based on current information or events, it is probable that the Bank will be unable to collect all amounts due (principal and interest) according to the contractual terms of the loan agreement. Payments with insignificant delays not exceeding 90 days outstanding are not considered impaired. Certain non-accrual and substantially delinquent loans may be considered to be impaired. Generally, loans are placed on non-accrual status at 90 days past due and accrued interest is reversed against earnings, unless the loan is well-secured and in the process of collection. The accrual of interest on impaired and non-accrual loans is discontinued when, in management’s opinion, the borrower may be unable to meet payments as they become due.

For all loan classes, when interest accrual is discontinued all unpaid accrued interest is reversed when considered uncollectible. When a loan is in a non-accrual status, all cash payments of interest are applied to loan principal. Should the loan be reinstated to accrual status, all cash payments of interest received while in non-accrual status will be taken into income over the remaining life of the loan using the level yield accounting method.

The following table presents impaired loans as of September 30, 2014 (dollars in thousands):

Impaired Loans

At September 30, 2014

 

														Three Months Ended September 30, 2014								Nine Months Ended September 30, 2014
		Recorded Balance				Unpaid Principal Balance				Specific Allowance				Average Investment in Impaired Loans (1)				Interest Income Recognized (2)				Average Investment in Impaired Loans (1)				Interest Income Recognized (2)
Loans without a specific valuation allowance:
Real estate loans:
Commercial		$	4,325			$	4,804				N/A			$	4,332			$	44			$	4,576			$	154
Residential			3,344				3,570				N/A				3,591				31				4,001				66
Construction			2,201				2,201				N/A				2,946				21				3,097				57
Commercial loans and leases			70				98				N/A				71				—				317				—
Municipal loans			—				—				N/A				—				—				—				—
Consumer loans			—				—				N/A				—				—				—				—
Total		$	9,940			$	10,673				N/A			$	10,940			$	96			$	11,991			$	277
Loans with a specific valuation allowance:
Real estate loans:
Commercial		$	—			$	—			$	—			$	—			$	—			$	—			$	—
Residential			1,403				1,478				425				1,405				5				1,412				47
Construction			1,515				2,350				230				1,515				—				1,432				51
Commercial loans and leases			137				183				98				142				—				153				—
Municipal loans			—				—				—				—				—				—				—
Consumer loans			84				84				8				89				—				79				—
Total		$	3,139			$	4,095			$	761			$	3,151			$	5			$	3,076			$	98
All Impaired Loans		$	13,079			$	14,768			$	761			$	14,091			$	101			$	15,067			$	375

 

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(1)	Includes all loans that were classified as impaired at any time during the three-month and nine-month periods (not just impaired loans at September 30, 2014), and their average balance for only the period during which they were classified as impaired.

(2)	Interest recorded in income during only the period the loans were classified as impaired, for all loans that were classified as impaired at any time during the three months and nine months ended September 30, 2014.

For all loan classes, interest income on loans individually classified as impaired is recognized on a cash basis after all past due and current principal payments have been made.

The following table presents impaired loans as of September 30, 2013 (dollars in thousands):

Impaired Loans

At September 30, 2013

 

														Three Months Ended September 30, 2013								Nine Months Ended September 30, 2013
		Recorded Balance				Unpaid Principal Balance				Specific Allowance				Average Investment in Impaired Loans (1)				Interest Income Recognized (2)				Average Investment in Impaired Loans (1)				Interest Income Recognized (2)
Loans without a specific valuation allowance:
Real estate loans:
Commercial		$	3,571			$	4,050				N/A			$	3,611			$	46			$	3,720			$	140
Residential			2,699				3,009				N/A				2,855				25				3,294				71
Construction			236				236				N/A				237				3				251				10
Commercial loans and leases			472				608				N/A				480				—				574				1
Municipal loans			—				—				N/A				—				—				—				—
Consumer loans			—				—				N/A				—				—				—				—
Total		$	6,978			$	7,903				N/A			$	7,183			$	74			$	7,839			$	222
Loans with a specific valuation allowance:
Real estate loans:
Commercial		$	1,310			$	1,310			$	116			$	1,318			$	16			$	1,332			$	48
Residential			3,451				3,474				495				3,453				19				3,450				57
Construction			3,694				4,086				300				3,725				26				3,807				77
Commercial loans and leases			277				312				161				285				—				300				—
Municipal loans			—				—				—				—				—				—				—
Consumer loans			76				76				8				64				—				57				—
Total		$	8,808			$	9,258			$	1,080			$	8,845			$	61			$	8,946			$	182
All Impaired Loans		$	15,786			$	17,161			$	1,080			$	16,028			$	135			$	16,785			$	404

 

(1)	Includes all loans that were classified as impaired at any time during the three-month and nine-month periods (not just impaired loans at September 30, 2013), and their average balance for only the period during which they were classified as impaired.

 

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(2)	Interest recorded in income during only the period the loans were classified as impaired, for all loans that were classified as impaired at any time during the three months and nine months ended September 30, 2013.

For all loan classes, interest income on loans individually classified as impaired is recognized on a cash basis after all past due and current principal payments have been made.

The following table presents impaired loans as of December 31, 2013 (dollars in thousands):

Impaired Loans

At December 31, 2013

 

														Year Ended December 31, 2013
		Recorded Balance				Unpaid Principal Balance				Specific Allowance				Average Investment in Impaired Loans (1)				Interest Income Recognized (2)
Loans without a specific valuation allowance:
Real estate loans:
Commercial		$	3,542			$	3,542				N/A			$	3,679			$	184
Residential			3,158				3,405				N/A				3,650				112
Construction			1,272				1,272				N/A				1,178				13
Commercial loans and leases			472				608				N/A				581				1
Municipal loans			—				—				N/A				—				—
Consumer loans			—				—				N/A				2				—
Total		$	8,444			$	8,827				N/A			$	9,090			$	310
Loans with a specific valuation allowance:
Real estate loans:
Commercial		$	1,294			$	1,294			$	96			$	1,324			$	63
Residential			3,108				3,151				495				3,023				59
Construction			2,841				3,016				285				2,871				102
Commercial loans and leases			260				299				148				293				—
Municipal loans			—				—				—				—				—
Consumer loans			69				69				8				54				—
Total		$	7,572			$	7,829			$	1,032			$	7,565			$	224
All Impaired Loans		$	16,016			$	16,656			$	1,032			$	16,655			$	534

 

(1)	Includes all loans that were classified as impaired at any time during 2013 (not just impaired loans at December 31, 2013), and their average balance for only the period during which they were classified as impaired.

(2)	Interest recorded in income during only the period the loans were classified as impaired, for all loans that were classified as impaired at any time during 2013.

For all loan classes, interest income on loans individually classified as impaired is recognized on a cash basis after all past due and current principal payments have been made.

 

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Non-Accrual Loans: Any loan which becomes 90 days delinquent, the full collection of principal and interest is in doubt, or a portion of principal has been charged off, should be placed on non-accrual status. The loan does not have to be placed on non-accrual if the charge-off is part of a Chapter 13 reaffirmation. At the time a loan is placed on non-accrual, all accrued but unpaid interest will be reversed from interest income. Placing the loan on non-accrual does not relieve the borrower of the obligation to repay interest.

For all loan classes, when a loan is on non-accrual status all payments are applied to loan principal.

A loan placed on non-accrual may be restored to accrual status when all delinquent principal and interest has been brought current, and the Bank expects full payment of the remaining contractual principal and interest including any previous charge-offs. Should the loan be reinstated to accrual status, all payments of interest received while in non-accrual status will be taken into income over the remaining life of the loan using the level yield accounting method. Restoring a non-accrual loan to accrual status requires the approval of the CCO. All loans placed on non-accrual status require the approval of the CCO and must be documented on the loan system and in the file.

The following table presents the Company’s non-accrual loans at September 30, 2014 and December 31, 2013 (dollars in thousands):

Loans Accounted for on a Non-Accrual Basis

 

		At September 30, 2014				At December 31, 2013
Real estate loans:
Commercial		$	812			$	351
Residential			1,996				2,767
Construction			2,351				1,207
Commercial loans and leases			207				733
Municipal loans			—				—
Consumer loans			—				—
Total		$	5,366			$	5,058

Total non-accrual loans at September 30, 2014 and December 31, 2013 included $2,449,000 and $1,781,000 of TDRs, respectively.

Troubled Debt Restructurings: Our loan and lease portfolio includes certain loans that have been modified as a TDR, where concessions have been granted to borrowers who have experienced financial difficulties. These concessions typically result from loss mitigation efforts and could include reductions in the interest rate, payment extensions, forgiveness of principal, forbearance or other actions. Certain TDRs are classified as nonperforming at the time of restructuring and typically are returned to performing status after considering the borrower’s sustained repayment performance for a reasonable period of at least six consecutive months.

When we modify loans and leases as a TDR, we evaluate any possible impairment similar to other impaired loans based on the present value of expected future cash flows, discounted at the contractual interest rate of the original loan or lease agreement, or use the current fair value of the collateral, less selling costs for collateral dependent loans. If we determine that the value of the modified loan is less than the recorded balance of the loan (net of previous charge-offs, deferred loan fees or costs and unamortized premium or discount), impairment is recognized through a specific allowance or charge-off to the allowance. In periods subsequent to modification, we evaluate all TDRs, including those that have payment defaults, for possible impairment and recognize impairment through the allowance.

 

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There were no loans classified as a TDR during either the three-month period or the nine-month period ended September 30, 2014.

There were no loans classified as a TDR during the three-month period ended September 30, 2013, and one loan was classified as a TDR during the nine-month period ended September 30, 2013, and it is shown in the table below identified by class (dollars in thousands). The modification was an interest rate concession.

 

		Three Months Ended September 30, 2013												Nine Months Ended September 30, 2013
		Modifications												Modifications
		Number				Recorded Balance Before				Recorded Balance After				Number				Recorded Balance Before				Recorded Balance After
Real estate loans:
Commercial			—			$	—			$	—				—			$	—			$	—
Residential			—				—				—				1				230				230
Construction			—				—				—				—				—				—
Commercial loans and leases			—				—				—				—				—				—
Municipal loans			—				—				—				—				—				—
Consumer loans			—				—				—				—				—				—
Total			—			$	—			$	—				1			$	230			$	230

There were no TDRs that had payment defaults during the three-month and nine-month periods ended September 30, 2014 and September 30, 2013, respectively. Default occurs when a loan or lease is 90 days or more past due or transferred to nonaccrual and is within 12 months of restructuring.

NOTE F — ACCOUNTING DEVELOPMENTS

 

•

Financial Accounting Standards Board (“FASB”)

In January 2014, the FASB issued ASU 2014-01, “Accounting for Investments in Qualified Affordable Housing Projects,” to permit entities to make an accounting policy election to account for their investments in qualified affordable housing projects using the proportional amortization method if certain conditions are met. The ASU modifies the conditions that an entity must meet to be eligible to use a method other than the equity or cost methods to account for qualified affordable housing project investments. The ASU is effective for fiscal years, and interim periods within those years, beginning after December 15, 2014. The Company will adopt the methodologies prescribed by this ASU by the date required, and does not anticipate that the ASU will have a material effect on its financial position or results of operations.

In January 2014, the FASB issued Accounting Standards Update (“ASU”) 2014-04, “Reclassification of Residential Real Estate Collateralized Consumer Mortgage Loans upon Foreclosure,” to reduce diversity by clarifying when a creditor should be considered to have received physical possession of residential real estate property collateralizing a consumer mortgage loan such that the loan receivable should be derecognized and the real estate property recognized. The ASU is effective for fiscal years, and interim periods within those years, beginning after December 15, 2014. The Company will adopt the methodologies prescribed by this ASU by the date required, and does not anticipate that the ASU will have a material effect on its financial position or results of operations.

In April 2014, the FASB issued ASU 2014-08, “Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity.” This update seeks to better define the groups of assets which qualify for discontinued operations, in order to ease the burden and cost for prepares and stakeholders. This issue changed “the criteria for reporting discontinued operations” and related reporting requirements, including the provision for disclosures about the “disposal of and individually significant component of an entity that does not qualify for

 

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discontinued operations presentation.” The amendments in this Update are effective for fiscal years beginning after December 15, 2014. Early adoption is permitted only for disposals or classifications as held for sale. The Company will adopt the methodologies prescribed by this ASU by the date required, and does not anticipate that the ASU will have a material effect on its financial position or results of operations.

In May 2014, the FASB, in joint cooperation with IASB, issued ASU 2014-09, “Revenue from Contracts with Customers.” The topic of Revenue Recognition had become broad, with several other regulatory agencies issuing standards which lacked cohesion. The new guidance establishes a “common framework” and “reduces the number of requirements to which an entity must consider in recognizing revenue” and yet provides improved disclosures to assist stakeholders reviewing financial statements. The amendments in this Update are effective for annual reporting periods beginning after December 15, 2016. Early adoption is not permitted. The Company will adopt the methodologies prescribed by this ASU by the date required, and does not anticipate that the ASU will have a material effect on its financial position or results of operations.

In June 2014, the FASB issued ASU 2014-11, “Transfers and Servicing.” This update addresses the concerns of stakeholders’ by changing the accounting practices surrounding repurchase agreements. The new guidance changes the “accounting for repurchase-to-maturity transactions and linked repurchase financings to secured borrowing accounting, which is consistent with the accounting for other repurchase agreements.” The amendments in this Update are effective for annual reporting periods beginning after December 15, 2015. Early adoption is prohibited. The Company will adopt the methodologies prescribed by this ASU by the date required, and does not anticipate that the ASU will have a material effect on its financial position or results of operations.

In June 2014, the FASB issued ASU 2014-12, “Compensation – Stock Compensation.” This update defines the accounting treatment for share-based payments and “resolves the diverse accounting treatment of those awards in practice.” The new requirement mandates that “a performance target that affects vesting and that could be achieved after the requisite service period be treated as a performance condition.” Compensation cost will now be recognized in the period in which it becomes likely that the performance target will be met. The amendments in this Update are effective for annual reporting periods beginning after December 15, 2015. Early adoption is permitted. The Company will adopt the methodologies prescribed by this ASU by the date required, and does not anticipate that the ASU will have a material effect on its financial position or results of operations.

In August 2014, FASB, issued ASU 2014-14, “Classification of Certain Government-Guaranteed Mortgage Loans upon Foreclosure.” The objective of this update is to reduce diversity in practice by addressing the classification of foreclosed mortgage loans that are fully or partially guaranteed under government programs. Currently, some creditors reclassify those loans to real estate as with other foreclosed loans that do not have guarantees; others reclassify the loans to other receivables. The amendments affect creditors that hold government-guaranteed mortgage loans, including those guaranteed by the FHA and the VA. The amendments in this update are effective for annual reporting periods ending after December 15, 2015, and interim periods beginning after December 15, 2015. An entity should adopt the amendments in this update using either a prospective transition method or a modified retrospective transition method. For prospective transition, an entity should apply the amendments in this update to foreclosures that occur after the date of adoption. For the modified retrospective transition, an entity should apply the amendments in the update by means of a cumulative-effect adjustment (through a reclassification to a separate other receivable) as of the beginning of the annual period of adoption. Prior periods should not be adjusted. However, a reporting entity must apply the same method of transition as elected under ASU No. 2014-04. Early adoption, including adoption in an interim period, is permitted if the entity already has adopted update 2014-04. The Company will adopt the methodologies prescribed by this ASU by the date required, and does not anticipate that the ASU will have a material effect on its financial position or results of operations.

In August 2014, FASB, issued ASU 2014-15, “Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern.” The update provides U.S. GAAP guidance on management’s responsibility in evaluating whether there is substantial doubt about a company’s ability to continue as a going concern and about related footnote disclosures. For each reporting period, management will be required to evaluate whether there are conditions or events that raise substantial doubt about a company’s ability to continue as a going concern within one year from the date the financial statements are issued. The amendments in this update are effective for annual reporting periods ending after December 15, 2016, and for annual and interim periods thereafter. Early adoption is permitted. The Company will adopt the methodologies prescribed by this ASU by the date required, and does not anticipate that the ASU will have a material effect on its financial position or results of operations.

 

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NOTE G — RETIREMENT PLAN

The Company entered into separate agreements with certain officers and directors that provide retirement benefits. The Company records an expense equal to the projected present value of the payment due at the full eligibility date. The liability for the plan at September 30, 2014 and December 31, 2013 was $2,080,000 and $2,012,000, respectively. The expense for the plan was $55,000 for the three-month periods ended September 30, 2014 and September 30, 2013. The expense for the plan was $164,000 for the nine-month periods ended September 30, 2014 and September 30, 2013.

NOTE H — DISCLOSURES ABOUT FAIR VALUE OF ASSETS AND LIABILITIES

ASC Topic 820, Fair Value Measurements, defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. A fair value hierarchy has been established that requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The standard describes three levels of inputs that may be used to measure fair value:

Level 1 Quoted prices in active markets for identical assets or liabilities.

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

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

Following is a description of the valuation methodologies used for instruments measured at fair value on a recurring basis and recognized in the accompanying balance sheet, as well as the general classification of such instruments pursuant to the valuation hierarchy.

Recurring Measurements: Available-for-sale Securities

Where quoted market prices are available in an active market, securities are classified within Level 1 of the valuation hierarchy. The security valued in Level 1 is a mutual fund.

Level 2 securities include U.S. Government agency and U.S. Government-sponsored enterprise pass-through mortgage-backed securities and collateralized mortgage obligations. Level 2 securities are valued by a third party pricing service commonly used in the banking industry utilizing observable inputs, and the values are reviewed by the Bank’s management. The pricing provider utilizes evaluated pricing models that vary based on asset class. These models incorporate available market information including quoted prices of securities with similar characteristics and, because many fixed-income securities do not trade on a daily basis, apply available information through processes such as benchmark curves, benchmarking of like securities, sector grouping and matrix pricing. In addition, model processes, such as an option adjusted spread model is used to develop prepayment and interest rate scenarios for securities with prepayment features. The Company has reviewed the methodologies used by the third party and has determined that the securities are properly classified as Level 2.

The Company held no Level 3 securities in its available-for-sale portfolio on either September 30, 2014 or December 31, 2013.

 

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The following table presents the fair value measurements of assets recognized in the accompanying consolidated condensed balance sheet measured at fair value on a recurring basis and the level within the fair value hierarchy in which the fair value measurements fall at September 30, 2014 and December 31, 2013 (dollars in thousands):

 

						Fair Value Measurements Using
Available-for-sale securities:		Fair Value				Quoted Prices in Active Markets for Identical Assets (Level 1)				Significant Other Observable Inputs (Level 2)				Significant Unobservable Inputs (Level 3)
At September 30, 2014:
Ginnie Mae and GSE mortgage-backed pass-through securities		$	45,828			$	—			$	45,828			$	—
Ginnie Mae collateralized mortgage obligations			2,094				—				2,094				—
Mutual fund			1,840				1,840				—				—
		$	49,762			$	1,840			$	47,922			$	—
At December 31, 2013:
Ginnie Mae and GSE mortgage-backed pass-through securities		$	33,806			$	—			$	33,806			$	—
Ginnie Mae collateralized mortgage obligations			2,214				—				2,214				—
Mutual fund			1,783				1,783				—				—
		$	37,803			$	1,783			$	36,020			$	—

Transfers between Levels

Transfers between levels did not occur during the three months and nine months ended September 30, 2014.

Level 3 Reconciliation

There is no reconciliation for the three-month and nine-month periods ended September 30, 2014 and September 30, 2013, respectively, as there were no fair value measurements using significant unobservable (Level 3) inputs for the available-for-sale portfolio during those periods.

Nonrecurring Measurements

Following is a description of valuation methodologies used for instruments measured at fair value on a non-recurring basis and recognized in the accompanying consolidated condensed balance sheet, as well as the general classification of such instruments pursuant to the valuation hierarchy:

Collateral-Dependent Impaired Loans

The estimated fair value of collateral-dependent impaired loans is based on the appraised fair value of the collateral, less estimated cost to sell. Collateral-dependent impaired loans are classified within Level 3 of the fair value hierarchy.

The Company considers the appraisal or evaluation as the starting point for determining fair value and then considers other factors and events in the environment that may affect the fair value. Appraisals of the collateral underlying collateral-dependent loans are obtained when the loan is determined to be collateral-dependent and subsequently as deemed necessary by management. Appraisals are reviewed for accuracy and consistency by management. Appraisers are selected from the list of approved appraisers maintained by management. The appraised values are reduced by discounts to consider lack of marketability and estimated cost to sell if repayment or satisfaction of the loan is dependent on the sale of the collateral. These discounts and estimates are developed by management by comparison to historical results.

 

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Other Real Estate Owned

Other real estate owned (“OREO”) is carried at the lower of fair value at acquisition date or current estimated fair value, less estimated cost to sell when the real estate is acquired. Estimated fair value of OREO is based on appraisals or evaluations. OREO is classified within Level 3 of the fair value hierarchy.

Appraisals of OREO are obtained when the real estate is acquired and subsequently as deemed necessary by management. Appraisals are reviewed for accuracy and consistency by management. Appraisers are selected from the list of approved appraisers maintained by management.

The following table presents the fair value measurements of assets recognized in the accompanying balance sheet measured at fair value on a nonrecurring basis and the level within the ASC 820 fair value hierarchy in which the fair value measurements fall at September 30, 2014 and December 31, 2013:

 

						Fair Value Measurements Using
		Fair Value				Quoted Prices in Active Markets for Identical Assets (Level 1)				Significant Other Observable Inputs (Level 2)				Significant Unobservable Inputs (Level 3)
At September 30, 2014:
Impaired loans		$	3,375			$	—			$	—			$	3,375
Other real estate owned			—				—				—				—
At December 31, 2013:
Impaired loans		$	6,353			$	—			$	—			$	6,353
Other real estate owned			2,401				—				—				2,401

Unobservable (Level 3) Inputs:

The following table presents quantitative information about unobservable inputs used in recurring and nonrecurring Level 3 fair value measurements at September 30, 2014 (dollars in thousands):

 

Fair Value

Valuation Technique

Unobservable Inputs

Rate/Rate Range

Impaired loans

$

3,375

Third party valuations

Discount to reflect realizable value

0.0% - 67.7

%

The following table presents quantitative information about unobservable inputs used in recurring and nonrecurring Level 3 fair value measurements at December 31, 2013 (dollars in thousands):

 

		Fair Value				Valuation Technique		Unobservable Inputs		Rate/Rate Range
Impaired loans		$	6,353			Third party valuations		Discount to reflect realizable value			0.0% - 77.9	%
Other real estate owned			2,401			Third party valuations		Discount to reflect realizable value			6.0% - 20.7	%

 

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Fair Value of Financial Instruments

Fair values are based on estimates using present value and other valuation techniques in instances where quoted market prices are not available. These techniques are significantly affected by the assumptions used, including discount rates and estimates of future cash flows. As such, the derived fair value estimates may not be realized upon an immediate settlement of the instruments. Accordingly, the aggregate fair value amounts presented do not represent, and should not be construed to represent, the underlying value of the Company.

The following table presents the estimates of fair value of financial instruments and the level within the fair value hierarchy in which the fair value measurements fall (dollars in thousands) at September 30, 2014:

 

Fair Value Measurements Using
		Carrying Value				Fair Value				Quoted Prices in Active Markets for Identical Assets (Level 1)				Significant Other Observable Inputs (Level 2)				Significant Unobservable Inputs (Level 3)
Assets
Cash and cash equivalents		$	28,828			$	28,828			$	28,828			$	—			$	—
Interest-bearing time deposits			4,908				4,911				4,911				—				—
Investment securities held to maturity			7,168				7,144				—				4,790				2,354
Loans			320,997				326,708				—				313,629				13,079
Stock in FHLB			4,472				4,472				—				4,472				—
Mortgage servicing rights			532				532				—				—				532
Interest and dividends receivable			1,115				1,115				—				1,115				—
Liabilities
Deposits			376,121				376,516				236,967				139,549				—
Borrowings			50,810				47,239				—				41,105				6,134
Drafts payable			1,014				1,014				—				1,014				—
Interest and dividends payable			401				401				—				401				—

The following table presents the estimates of fair value of financial instruments and the level within the fair value hierarchy in which the fair value measurements fall (dollars in thousands) at December 31, 2013:

 

Fair Value Measurements Using
		Carrying Value				Fair Value				Quoted Prices in Active Markets for Identical Assets (Level 1)				Significant Other Observable Inputs (Level 2)				Significant Unobservable Inputs (Level 3)
Assets
Cash and cash equivalents		$	40,867			$	40,867			$	40,867			$	—			$	—
Interest-bearing time deposits			2,974				2,983				2,983				—				—
Investment securities held to maturity			2,347				2,347				—				—				2,347
Loans			312,035				319,232				—				303,216				16,016
Stock in FHLB			4,472				4,472				—				4,472				—
Mortgage servicing rights			582				582				—				—				582
Interest and dividends receivable			818				818				—				818				—
Liabilities
Deposits			362,701				363,536				217,115				146,421				—
Borrowings			50,810				46,897				—				41,330				5,567
Drafts payable			1,503				1,503				—				1,503				—
Interest and dividends payable			78				78				—				78				—

 

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The following methods and assumptions were used to estimate the fair value of each class of financial instrument:

Cash and Cash Equivalents and Stock in FHLB: The carrying amounts reported in the condensed consolidated balance sheets approximate those assets’ fair values.

Interest-bearing time deposits: The carrying amounts reported in the condensed consolidated balance sheets approximate those assets’ fair values.

Held to maturity securities: The carrying amount for September 30, 2014 and December 31, 2013 represents the amortized cost balance as of that date.

Loans: The fair values for loans are estimated using a discounted cash flow calculation that applies external interest rates used to price new similar loans to a schedule of aggregated expected monthly maturities on loans.

Mortgage Servicing Rights: The initial amount recorded is an estimate of the fair value of the streams of net servicing revenues that will occur over the estimated life of the servicing arrangement, and the initial amount recorded is then amortized over the estimated life. Annually, a valuation of the servicing rights is performed by an independent third party and reviewed by the Bank’s management, with impairment, if any, recognized through a valuation allowance. The valuation is based on the discounted cash flow method utilizing Bloomberg’s Median Forecasted Prepayment Speeds for mortgage-backed securities assumed to possess enough similarities to the Bank’s servicing portfolio to facilitate a comparison.

Interest and Dividends Receivable/Payable: The fair value of accrued interest and dividends receivable/payable approximates carrying values.

Deposits: The fair values of non-maturity demand, savings, and money market accounts are equal to the amount payable on demand at the balance sheet date. Fair values for certificates of deposit are estimated using a discounted cash flow calculation that applies interest rates currently being offered on deposits to a schedule of aggregated expected monthly maturities on deposits.

Borrowings: The fair value of borrowings is estimated using a discounted cash flow calculation, based on borrowing rates for periods comparable to the remaining terms to maturity of the borrowings.

Drafts Payable: The fair value approximates carrying value.

NOTE I — COLLATERAL FOR LETTERS OF CREDIT

As of September 30, 2014, there were two outstanding letters of credit from the Federal Home Loan Bank of Indianapolis totaling $5,030,000 that the Company had collateralized with residential mortgage loans.

 

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ITEM 2 – MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Management’s Discussion and Analysis of Financial Condition and Results of Operations (the “MD&A”) is designed to provide a narrative on our financial condition, results of operations, liquidity, critical accounting policies, off-balance sheet arrangements and the future impact of accounting standards. It is useful to read our MD&A in conjunction with the consolidated financial statements contained in Part I in this Quarterly Report on Form 10-Q (this “Form 10-Q”), our Annual Report on Form 10-K for the fiscal year ended December 31, 2013 (the “Form 10-K”), and our other reports on Forms 10-Q and current reports on Forms 8-K and other publicly available information.

FORWARD-LOOKING STATEMENTS

This Form 10-Q may contain certain “forward-looking statements” within the meaning of the federal securities laws. These statements are not historical facts, rather statements based on Ameriana Bancorp’s (the “Company”) current expectations regarding its business strategies, intended results and future performance. Forward-looking statements are generally preceded by terms such as “expects,” “believes,” “anticipates,” “intends” and similar expressions. Such statements are subject to certain risks and uncertainties including changes in economic conditions in the Company’s market area, changes in policies by regulatory agencies, fluctuations in interest rates and real estate property values in our market area, demand for loans and deposits in the Company’s market area, changes in the quality or composition of our loan portfolio, changes in accounting principles, laws and regulations, and competition that could cause actual results to differ materially from historical earnings and those presently anticipated or projected. Additional factors that may affect our results are discussed in the Form 10-K under Part I, Item 1A- “Risk Factors” and in other reports filed with the Securities and Exchange Commission. The Company cautions readers not to place undue reliance on any such forward-looking statements, which speak only as of the date made. The factors listed above could affect the Company’s financial performance and could cause the Company’s actual results for future periods to differ materially from any opinions or statements expressed with respect to future periods in any current statements.

The Company does not undertake, and specifically disclaims any obligation, to publicly release the result of any revisions that may be made to any forward-looking statements to reflect events or circumstances after the date of such statements or to reflect the occurrence of anticipated or unanticipated events.

Who We Are

Ameriana Bancorp is an Indiana chartered bank holding company subject to regulation and supervision by the Board of Governors of the Federal Reserve System (the “Federal Reserve Board”) under the Bank Holding Company Act of 1956, as amended. The Company became the holding company for Ameriana Bank, an Indiana chartered commercial bank headquartered in New Castle, Indiana (the “Bank”), in 1990. The Company also holds a minority interest in a limited partnership organized to acquire and manage real estate investments, which qualify for federal tax credits.

The Bank began operations in 1890. Since 1935, the Bank has been a member of the Federal Home Loan Bank (the “FHLB”) System. Its deposits are insured to applicable limits by the Deposit Insurance Fund, administered by the Federal Deposit Insurance Corporation (the “FDIC”). The Bank conducts business through its main office at 2118 Bundy Avenue, New Castle, Indiana and through thirteen branch offices located throughout Central Indiana. Our primary markets are found in Hamilton, Hancock, Hendricks, Henry, Madison, Marion and Shelby counties.

The Bank has two wholly-owned subsidiaries, Ameriana Insurance Agency (“AIA”) and Ameriana Financial Services, Inc. (“AFS”). AIA provides insurance sales from offices in New Castle, Greenfield and Avon, Indiana. AFS operates a brokerage facility in conjunction with LPL Financial that provides non-bank investment product alternatives to its customers and the general public.

 

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What We Do

The Bank is a community-oriented financial institution. Our principal business consists of attracting deposits from the general public and investing those funds, along with borrowed funds, primarily in mortgage loans on single-family residences, multi-family loans, construction loans, commercial real estate loans, and commercial and industrial loans, and, to a lesser extent, consumer loans, leases and loans to municipalities. We have from time to time purchased loans and loan participations in the secondary market. We also invest in various federal and government agency obligations and other investment securities permitted by applicable laws and regulations, including mortgage-backed, municipal and equity securities. We offer customers in our market area time deposits with terms ranging from three months to seven years, interest-bearing and noninterest-bearing checking accounts, savings accounts and money market accounts. Our primary source of borrowings is FHLB advances. Through our subsidiaries, we engage in insurance, investment and brokerage activities.

Our primary source of income is net interest income, which is the difference between the interest income earned on our loan and investment portfolios and the interest expense incurred on our deposits and borrowings. Our loan portfolio typically earns more interest than the investment portfolio, and our deposits typically have a lower average rate than FHLB advances and other borrowings. Several factors affect our net interest income. These factors include loan, investment, deposit, and borrowing portfolio balances, their composition, the length of their maturities, re-pricing characteristics, liquidity, credit, and interest rate risk, as well as market and competitive conditions and the current interest rate environment.

Executive Overview of the Third Quarter of 2014

The Company recorded net income of $501,000, or $0.17 per diluted share, for the three-month period ended September 30, 2014, increasing year-to-date earnings to $1.8 million, which was a $127,000, or 7.4%, improvement over the first nine months of 2013.

 

•

The Company declared a quarterly dividend of $0.02 per share, which represented a $0.01 per share increase over the same quarter a year earlier.

 

•

At September 30, 2014, the Bank’s tier 1 leverage ratio was 9.41%, the tier 1 risk-based capital ratio was 14.25%, and the total risk-based capital ratio was 15.50%. All three ratios were considerably above the levels required under regulatory guidelines to be considered “well capitalized.”

 

•

Net interest income on a fully tax-equivalent basis for the third quarter of 2014 represented an increase of $48,000, or 1.4%, from the same quarter of 2013, primarily due to a $34.5 million, or 9.0%, increase in average interest-earning assets.

 

•

Net interest margin of 3.33% on a fully tax-equivalent basis for the third quarter of 2014 was twenty-five basis points lower than the same period in 2013.

 

•

The Bank recorded a $22,000 provision for loan losses in the third quarter of 2014, which reflected a $188,000 reduction from the same quarter a year earlier, primarily as a result of improved credit quality.

 

•

Other income of $1.4 million for the third quarter of 2014 represented a decrease of $154,000, or 9.8%, from the year earlier quarter that resulted primarily from the following changes:

 

•

An $89,000, decrease in gains on sales of loans and servicing rights compared to the same quarter a year earlier that resulted from both a weaker real estate market resulting in lower originations and from a decision to retain most of the new residential mortgage loan production in the Bank’s portfolio;

 

•

No sales of investment securities, compared with $75,000 in gains realized form sales in the same quarter a year earlier; and

 

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$4,000 in net losses from sales and write-downs of OREO, compared with $80,000 in net gains for the same quarter a year earlier; partly offset by

 

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A $50,000, or 7.7%, increase in other fees and service charges on deposit accounts due primarily to an increase in the number of checking accounts that resulted from the Bank’s continuing focus on growing core deposit relationships.

 

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•

$4.2 million in other expense for the third quarter of 2014 was $197,000, or 4.9%, higher than the same quarter in 2013 and resulted primarily from the following changes:

 

•

A $98,000, or 4.3%, increase in salaries and employee benefits that was due primarily to a $59,000 increase related to our frozen defined benefit retirement plan, and $47,000 of compensation and benefits related to personnel hired for two new banking centers;

 

•

A $52,000 increase in legal and professional fees, due primarily to a $41,000 increase in recruiting fees; and

 

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A $40,000 increase in data processing expense that related primarily to our cost to support greater use of new technology by our customers.

 

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Income before income taxes was $667,000 for the third quarter of 2014 and income tax expense was $166,000, which resulted in an effective rate of 24.9% that was lower than the statutory rate due primarily to a significant amount of tax-exempt income from bank-owned life insurance.

For the third quarter of 2014, total assets declined slightly by $46,000 to $474.4 million from June 30, 2014:

 

•

Investments in interest-bearing demand deposits decreased $12.5 million to $22.7 million at September 30, 2014, of which $22.0 million was invested at the Federal Reserve Bank of Chicago.

 

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The $49.8 million total for investment securities available-for-sale represented a $2.3 million decrease from June 30, 2014, and resulted primarily from mortgage-backed securities principal payments during the quarter. The portfolio consists primarily of mortgage-backed securities insured by either Ginnie Mae, Fannie Mae or Freddie Mac.

 

•

The investment securities held-to-maturity portfolio increased $4.8 million during the third quarter as the result of a purchase of a Freddie Mac pass-through mortgage-backed security.

 

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Net loans receivable increased $8.1 million during the quarter to $321.0 million at September 30, 2014, with $7.8 million growth occurring in the commercial real estate loan portfolio. The Bank had a strong loan pipeline at the end of the third quarter.

 

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Total non-performing loans of $5.4 million, or 1.7% of total net loans, at September 30, 2014, represented a decrease of $2.1 million from September 30, 2013.

 

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The allowance for loan losses of $4.0 million at September 30, 2014 was 1.24% of total loans and 74.8% of non-performing loans, compared to 1.22% and 53.1%, respectively, at September 30, 2013.

 

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OREO of $5.4 million at September 30, 2014 represented a $264,000 decrease from June 30, 2014 that was primarily the net result of the addition of two properties totaling $204,000 and sale of two properties with a total book value of $462,000.

 

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During the third quarter of 2014, total deposits decreased by $1.1 million, or 0.3%, to $376.1 million, which related primarily to approximately $2.6 million in withdrawals from one business money market account relationship with the funds withdrawn for other business purposes.

 

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There was no change in the total amount or weighted average cost of borrowed money at September 30, 2014 from June 30, 2014.

 

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Total shareholders’ equity of $39.9 million at September 30, 2014 represented an increase of $327,000 over June 30, 2014, as $501,000 of net income, $42,000 from an exercise of stock options and $17,000 of

 

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share-based compensation related to the granting of stock options, was partly offset by a $173,000 decline to a $50,000 unrealized gain net of income tax related to the Company’s available-for-sale investment securities portfolio and by $60,000 in shareholder dividends declared during the quarter.

Strategic Issues

To diversify the balance sheet and provide new avenues for loan and deposit growth, the Bank further expanded into the greater Indianapolis area, adding three full-service offices in 2008 and 2009 in the suburban markets of Carmel, Fishers and Westfield. As a result, more than half of our banking centers are located in the Indianapolis metropolitan area. These banking centers are focused on generating new deposit and lending relationships, where significant opportunities exist to win market share from smaller institutions lacking the depth of financial products and services, and large institutions that have concentrated on large business customers. Although the expansion strategy initially negatively affected earnings, the Bank’s expansion into new markets is critical for its long-term sustainable growth.

In 2012, the Bank closed its McCordsville Banking Center. The Fishers Banking Center, which is in close proximity to the McCordsville and Geist communities, allowed Ameriana to serve the financial needs of its McCordsville customers from a consolidated and still convenient location. In 2013, the Bank purchased two vacant banking centers in Hamilton County. The Noblesville Banking Center opened in September 2014, and the Bank expects to open the Fishers Crossing Banking Center in the fourth quarter of 2014. With the addition of these two offices, Ameriana has five locations in Hamilton County. A Broad Ripple Banking Center, the Bank’s first brick and mortar location in Marion County, is scheduled for Spring 2015. The Bank is in the process of determining the appropriate time to construct a banking center building on its Plainfield property, based on its long-term expansion strategy. Ameriana is committed to developing a branch network that meets the changing needs of customers while maximizing profitability for its shareholders.

Earnings pressure is expected to continue as the uncertain economy maintains stress on efforts to grow the loan portfolio, and also due to the current interest rate environment that has proven to be difficult for the financial institution industry. Deposit acquisition remains competitive; however, the Bank’s disciplined pricing has resulted in further reduction of its cost of deposits. The Bank’s pricing strategies, along with an increase in mortgage-backed securities, have mitigated the negative effect of the low interest rate environment resulting in net interest income growth. Managing noninterest expense has been a priority of the Bank, and management has utilized aggressive cost control measures including job restructuring and eliminating certain discretionary expenditures, to limit growth in noninterest expense as new banking centers are added.

With the Bank’s mantra of “Soundness. Profitability. Growth – in that order, no exceptions,” the priorities, culture and risk strategy of the Bank are focused on asset quality and credit risk management. Despite the current economic pressures, as well as the industry’s challenges related to compliance and regulatory requirements, tightened credit standards, and capital preservation, management remains cautiously optimistic that business conditions will continue to improve over the longer term and is steadfast in the belief that the Company is well positioned to grow and enhance shareholder value as this recovery occurs.

With a community banking history stretching over 124 years, the Bank has built its strong reputation with community outreach programs and being a workplace of choice. By combining its rich tradition with its ability to provide its customers with financial advice and solutions, the Bank will accomplish its mission by:

 

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being our customer’s first choice for financial advice and solutions;

 

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informing and educating customers on the basics of money management; and

 

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understanding and meeting customer’s financial needs throughout their life cycle.

Serving customers requires the commitment of all Ameriana Bank associates to provide exceptional service and sound financial advice. We believe these qualities will differentiate us from our competitors and increase profitability and shareholder value.

 

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CRITICAL ACCOUNTING POLICIES

The accounting and reporting policies of the Company are maintained in accordance with accounting principles generally accepted in the United States and conform to general practices within the banking industry. The Company’s significant accounting policies are described in detail in the Notes to the Company’s Consolidated Financial Statements contained in the Company’s annual report on Form 10-K. The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions. The financial position and results of operations of the Company can be affected by these estimates and assumptions, and such estimates and assumptions are integral to the understanding of reported results. Critical accounting policies are those policies that management believes are the most important to the portrayal of the Company’s financial condition and results, and they require management to make estimates that are difficult, subjective or complex, and subject to change if actual circumstances differ from those that were assumed. The following are the Company’s critical accounting policies:

Allowance for Loan Losses. The allowance for loan losses provides coverage for probable losses in the Company’s loan portfolio. Management evaluates the adequacy of the allowance for loan losses each quarter based on changes, if any, in underwriting activities, the loan portfolio composition (including product mix and geographic, industry or customer-specific concentrations), trends in loan performance, including the level of non-performing, delinquent and classified loans, regulatory guidance and economic factors. This evaluation is inherently subjective, as it requires the use of significant management estimates. Many factors can affect management’s estimates of specific and expected losses, including volatility of default probabilities, rating migrations, loss severity and economic and political conditions. The allowance is increased through provisions charged to earnings and reduced by net charge-offs.

The Company determines the amount of the allowance based on relative risk characteristics of the loan portfolio. The allowance recorded for commercial loans is based on reviews of individual credit relationships and an analysis of the migration of commercial loans and actual loss experience. The allowance recorded for noncommercial loans is based on an analysis of loan mix, risk characteristics of the portfolio, fraud loss and bankruptcy experiences and historical losses, adjusted for current trends, for each loan category or group of loans. The allowance for loan losses relating to impaired loans is based on the loan’s observable market price, the collateral for certain collateral-dependent loans, or the discounted cash flows using the loan’s effective interest rate.

Regardless of the extent of the Company’s analysis of customer performance, portfolio trends or risk management processes, certain inherent but undetected losses are probable within the loan portfolio. This is due to several factors, including inherent delays in obtaining information regarding a customer’s financial condition or changes in their unique business conditions, the subjective nature of individual loan evaluations, collateral assessments and the interpretation of economic trends. Volatility of economic or customer-specific conditions affecting the identification and estimation of losses for larger, non-homogeneous credits and the sensitivity of assumptions utilized to establish allowances for homogenous groups of loans are among other factors. The Company estimates a range of inherent losses related to the existence of these exposures. The estimates are based upon the Company’s evaluation of risk associated with the commercial and consumer allowance levels and the estimated impact of the current economic environment. Future adjustments to the allowance for loan losses may be necessary if conditions differ substantially from the assumptions used in making the evaluations. In addition, various regulatory agencies periodically review the Company’s allowance for loan losses. Such agencies may require the Company to recognize adjustments to the allowance based on their judgments at the time of their examination.

Mortgage Servicing Rights. Mortgage servicing rights (“MSRs”) associated with loans originated and sold, where servicing is retained, are capitalized and included in other assets in the consolidated balance sheet. The value of the capitalized servicing rights represents the present value of the future servicing fees arising from the right to service loans in the portfolio. Critical accounting policies for MSRs relate to the initial valuation and subsequent impairment tests. The methodology used to determine the valuation of MSRs requires the development and use of a number of estimates, including anticipated principal amortization and prepayments of that principal balance. Events that may significantly affect the estimates used are changes in interest rates, mortgage loan prepayment speeds and the payment performance of the underlying loans. The carrying value of the MSRs is periodically reviewed for impairment based on a determination of fair value. Impairment, if any, is recognized through a valuation allowance and is recorded as amortization of intangible assets.

 

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Valuation Measurements. Valuation methodologies often involve a significant degree of judgment, particularly when there are no observable active markets for the items being valued. Investment securities and residential mortgage loans held for sale are carried at fair value, as defined by FASB fair value guidance, which requires key judgments affecting how fair value for such assets and liabilities is determined. In addition, the outcomes of valuations have a direct bearing on the carrying amounts for goodwill and intangible assets. To determine the values of these assets and liabilities, as well as the extent to which related assets may be impaired, management makes assumptions and estimates related to discount rates, asset returns, prepayment rates and other factors. The use of different discount rates or other valuation assumptions could produce significantly different results, which could affect the Company’s results of operations.

Income Tax Accounting. We file a consolidated federal income tax return. The provision for income taxes is based upon income in our consolidated financial statements. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect of a change in tax rates on our deferred tax assets and liabilities is recognized as income or expense in the period that includes the enactment date.

Under U.S. GAAP, a valuation allowance is required to be recognized if it is “more likely than not” that a deferred tax asset will not be realized. The determination of the realizability of the deferred tax asset is highly subjective and dependent upon judgment concerning our evaluation of both positive and negative evidence, our forecasts of future income, applicable tax planning strategies, and assessments of current and future economic and business conditions. Positive evidence includes the existence of taxes paid in available carry-back years as well as the probability that taxable income will be generated in future periods, while negative evidence includes any cumulative losses in the current year and prior two years and general business and economic trends. At September 30, 2014 and December 31, 2013, we determined that our existing valuation allowance was adequate, largely based on available tax planning strategies and our projections of future taxable income. Any reduction in estimated future taxable income may require us to increase the valuation allowance against our deferred tax assets. Any required increase to the valuation allowance would result in additional income tax expense in the period and could have a significant impact on our future earnings.

Positions taken in our tax returns may be subject to challenge by the taxing authorities upon examination. The benefit of an uncertain tax position is initially recognized in the financial statements only when it is more likely than not the position will be sustained upon examination by the tax authorities. Such tax positions are both initially and subsequently measured as the largest amount of tax benefit that is more likely than not of being realized upon settlement with the tax authority, assuming full knowledge of the position and all relevant facts. Differences between our position and the position of tax authorities could result in a reduction of a tax benefit or an increase to a tax liability, which could adversely affect our future income tax expense.

We believe our tax policies and practices are critical accounting policies because the determination of our tax provision and current and deferred tax assets and liabilities have a material impact on our net income and the carrying value of our assets. We believe our tax liabilities and assets are adequate and are properly recorded in the condensed consolidated financial statements at September 30, 2014.

FINANCIAL CONDITION

Total assets of $474.4 million at September 30, 2014 represented an increase of $15.8 million, or 3.4%, from $458.6 million at December 31, 2013. The increase in total assets for the nine-month period resulted primarily from a $16.8 million increase in investment securities and a $9.0 million increase in net loans receivable that was funded by $13.4 million, or 3.7%, growth in the Bank’s deposit accounts and a $13.2 million reduction in interest-bearing demand deposits.

Cash and cash equivalents decreased $12.0 million to $28.8 million at September 30, 2014 from $40.8 million at December 31, 2013. Included in the total at September 30, 2014 was $22.0 million of interest-bearing demand deposits at the Federal Reserve Bank of Chicago. Cash and cash equivalents represent an immediate source of liquidity to fund loans or meet deposit outflows. The decrease for the first nine months of 2014 resulted primarily from the growth in the loan portfolio and the investment securities portfolio exceeding the growth in deposit accounts.

 

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At September 30, 2014, the Bank held $4.9 million in FDIC insured bank certificates of deposit, which had a weighted-average rate of 1.12% and a weighted-average remaining life of 1.9 years. There was one $249,000 maturity and nine new certificates totaling $2.2 million added during the first nine months of 2014.

Investment securities available-for-sale increased by $12.0 million to $49.8 million at September 30, 2014 from $37.8 million at December 31, 2013. The increase resulted primarily from seven purchases of mortgage-backed securities totaling $16.2 million and a $594,000 increase in the market value of the portfolio that resulted from a decrease in market interest rates, partly offset by $4.7 million in principal repayments on mortgage-backed pass-through and collateralized mortgage obligation securities. All purchases consisted of Ginnie Mae and Fannie Mae mortgage-backed securities with final maturities of less than fifteen years, as the Company is focused on limiting interest rate risk and credit risk in its portfolio.

Investment securities held-to-maturity increased by $4.8 million to $7.2 million at September 30, 2014 from $2.4 million at December 31, 2013, as a result of the purchase of a $4.8 million Freddie Mac mortgage-backed pass through security. The other securities in the held-to-maturity portfolio are tax-exempt local municipal bonds.

All mortgage-backed pass-through and collateralized mortgage obligation securities in the available-for-sale and held-to-maturity portfolios, with a total fair value of $52.7 million at September 30, 2014, are insured by either Ginnie Mae, a U.S. Government agency, or by Fannie Mae or Freddie Mac, each a U.S. Government sponsored enterprise.

Net loans receivable increased by $9.0 million to $321.0 million at September 30, 2014 from $312.0 million at December 31, 2013, as commercial real estate loans increased $6.3 million to $111.1 million and construction loans increased $3.5 million to $14.8 million. Sales of new production residential mortgage loans into the secondary market totaled only $2.2 million, as most originations during the first nine months of 2014 were retained in the portfolio to offset repayments, and as a result total residential real estate loans declined only $141,000 to $168.4 million at September 30, 2014 from $168.5 million at December 31, 2013. The Bank’s mortgage-banking strategy is reviewed regularly to ensure that it remains consistent with the Bank’s overall balance sheet management objectives. Commercial loans and leases declined $210,000 to $29.0 million, municipal loans decreased $212,000 to $785,000 and consumer loans totaling $2.1 million at September 30, 2014 were relatively unchanged for the nine-month period.

Premises and equipment of $14.8 million at September 30, 2014 represented a $148,000 increase from $14.7 million at December 31, 2013. The net increase resulted from capital expenditures totaling $864,000 that were related primarily to two new banking centers, partly offset by $716,000 of depreciation during the period.

Goodwill was $656,000 at September 30, 2014, unchanged from December 31, 2013. Goodwill of $457,000 relates to deposits associated with a banking center acquired in 1998, and $199,000 is the result of three separate insurance business acquisitions. The Bank’s impairment tests reflected no impairment of the goodwill as of September 30, 2014.

We have investments in life insurance on employees and directors, which had a balance or cash surrender value of $28.3 million and $27.7 million at September 30, 2014 and December 31, 2013, respectively. The non-taxable increase in cash surrender value of this life insurance was $538,000 for the first nine months of 2014, compared to $532,000 for the same period a year earlier.

OREO totaled $5.4 million at September 30, 2014, a $231,000 increase from $5.2 million at December 31, 2013. There were eight transfers to OREO with book values totaling $767,000, and four sales of properties with book values totaling $528,000 during the nine-month period ended September 30, 2014.

Other assets of $9.0 million at September 30, 2014 represented a $854,000 reduction from December 31, 2013. This decrease resulted primarily from a $681,000 reduction in deferred tax assets related primarily to taxable income for the nine-month period and a $509,000 reduction in total prepaid expense, partly offset by a $297,000 increase in accrued interest and dividends receivable.

Total liabilities increased $13.6 million, or 3.2%, from $420.9 million at December 31, 2013 to $434.5 million at September 30, 2014, primarily due to the increase in deposits.

 

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Total deposits of $376.1 million at September 30, 2014 represented an increase of $13.4 million, or 3.7%, from $362.7 million at December 31, 2013. The Bank has maintained a strong focus on nurturing existing and attracting new core deposit relationships, while limiting its efforts related to highly rate-sensitive deposits. During the first nine months of 2014, money market, savings and checking balances, exclusive of public funds checking, increased $8.8 million, as customers continued to choose the more liquid deposit products, due primarily to the ongoing economic uncertainty and related low interest rate environment. Public funds checking balances increased $11.1 million, due primarily to a balance of approximately $8.1 million from a $10.5 million deposit near the end of the second quarter that represented construction funds that are projected to be withdrawn over an eighteen-month period that began in June 2014. Total certificates of deposit balances declined $6.5 million, due mostly to the Bank’s decision not to accept the renewal of a $7.5 million State of Indiana six-month certificate because there was not a current need for these funds. The Bank has concentrated on strategies designed to grow total balances in multi-product deposit relationships, and continues to utilize pricing strategies designed to produce growth with an acceptable marginal cost for both existing and new deposits.

Total borrowed money of $50.8 million at September 30, 2014 was unchanged from December 31, 2013. Wholesale funding options and strategies are continuously analyzed to ensure that the Bank retains sufficient sources of credit to fund all of the its needs, and to control funding costs by using this alternative to organic deposit account funding when appropriate.

Drafts payable of $1.0 million at September 30, 2014 decreased $489,000 from $1.5 million at December 31, 2013. This difference will vary and is a function of the dollar amount of checks issued near period end and the time required for those checks to clear.

Total shareholders’ equity of $39.9 million at September 30, 2014 represented a $2.2 million increase over the total of $37.7 million at December 31, 2013. The increase resulted from net income of $1.8 million, a $390,000 improvement to a $50,000 unrealized gain net of income tax related to the Company’s available-for-sale investment securities portfolio, $89,000 from exercises of stock options and $57,000 in share-based compensation related to stock options, partly offset by $179,000 in dividends declared during the nine-month period ended September 30, 2014. The Company’s and the Bank’s regulatory capital ratios were all considerably above the levels required under regulatory guidelines to be considered “well capitalized.”

RESULTS OF OPERATIONS

Third Quarter of 2014 compared to the Third Quarter of 2013

The Company recorded net income of $501,000, or $0.17 per diluted share, for the third quarter of 2014, compared to net income of $561,000, or $0.19 per diluted share, for the third quarter of 2013.

The earnings decline of $60,000, or 10.7%, for the third quarter of 2014 compared to the same quarter a year earlier was related primarily to a decrease in mortgage banking revenue, decreases in gains from sales of OREO and investment securities, and expense related to two new banking centers, partly offset by a reduction in the provision for loan losses that resulted from improved credit quality.

Net Interest Income

Net interest income on a fully tax-equivalent basis of $3.5 million for the third quarter of 2014 represented an increase of $48,000, or 1.4%, compared to the same period of 2013, primarily due to a $34.5 million, or 9.0%, increase in average interest-earning assets to $416.7 million. Net interest margin on a fully tax-equivalent basis for the third quarter of 2014 of 3.33% was twenty-five basis points lower than the year earlier period.

Tax-exempt interest was $35,000 for the third quarter of 2014 compared to $36,000 for the same period of 2013, and resulted from municipal securities and municipal loans. Tax-equivalent adjustments were $15,000 for the third quarter of 2014 and 2013.

“Net interest income on a fully tax-equivalent basis” is calculated by increasing net interest income by an amount that represents the additional taxable interest income that would be needed to produce the same amount of after-tax income as the tax-exempt interest income included in net interest income for the period.

 

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“Net interest margin on fully tax-equivalent basis” is calculated by dividing annualized “net interest income on a fully tax-equivalent basis” by average interest-earning assets for the period.

Our “fully tax-equivalent basis” calculations are based on a federal income tax rate of 34%.

Provision for Loan Losses

The following table sets forth an analysis of the Bank’s allowance for loan losses for the periods indicated:

 

		(Dollars in thousands)
		Three Months Ended September 30,
		2014				2013
Balance at beginning of quarter		$	4,004			$	3,954
Provision for loan losses			22				210
Charge-offs			(42	)			(256	)
Recoveries			30				31
Net charge-offs			(12	)			(225	)
Balance at end of period		$	4,014			$	3,939
Allowance to total loans			1.24	%			1.22	%
Allowance to non-performing loans			74.76	%			53.09	%

We recorded a provision for loan losses of $22,000 for the third quarter of 2014, a $188,000 reduction from the year earlier quarter that was reflective of the declining pressure of economic conditions on credit quality, including a decrease in non-performing loans and charge-offs. Net charge-offs decreased from $225,000 for the third quarter of 2013 to $12,000 for the third quarter of 2014. Total charge-offs of $42,000 for the third quarter of 2014 included no loans with specific reserves at June 30, 2014.

The following table summarizes the Company’s non-performing loans:

 

		(Dollars in thousands)
		September 30,
		2014				2013
Loans accounted for on a non-accrual basis		$	5,366			$	6,096
Accruing loans contractually past due 90 days or more			3				1,323
Total of non-accrual and 90 days or more past due loans (1)		$	5,369			$	7,419
Percentage of total net loans			1.67	%			2.33	%
Other non-performing assets (2)		$	5,402			$	5,991
Total non-performing assets		$	10,771			$	13,410
Percentage of total assets			2.27	%			3.05	%
Troubled debt restructurings in total of nonaccrual and 90 days or more past due loans (1)		$	2,449			$	2,681
Total troubled debt restructurings		$	9,909			$	11,167

 

(1)	Total non-accrual loans and accruing loans 90 days or more past due at September 30, 2014 included $2.4 million of TDRs, which consisted of a $1.5 million residential construction loan, three residential non-construction loans totaling $727,000, and three commercial loans totaling $207,000.

(2)	Other non-performing assets represent property acquired through foreclosure or repossession. This property is carried at the lower of its fair market value or its carrying value.

 

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The allowance for loan losses of $4.0 million at September 30, 2014 was $75,000 higher than a year earlier, and the allowance for loan losses to non-performing loans ratio increased from 53.09% at September 30, 2013 to 74.76% at September 30, 2014, due primarily to a lower total of non-performing loans. Non-performing loans of $5.4 million at September 30, 2014 represented a $2.0 million decrease from the total of $7.4 million at September 30, 2013, but a $797,000 increase from the end of the prior quarter with a corresponding $1.2 million decrease in total loans past due 30 to 90 days from the prior quarter. It is management’s opinion that the allowance for loan losses at September 30, 2014 is adequate based on measurements of the credit risk in the entire portfolio as of that date.

At September 30, 2014, the Bank had $9.9 million in loans categorized as TDRs, with seven loans totaling $2.4 million also included in the table above in the total for loans accounted for on a non-accrual basis. The total of $9.9 million included $3.7 million related to a hotel in northern Indiana, a $1.5 million construction loan on a residential condominium project, twenty-one loans on other residential properties totaling $3.5 million, a $965,000 loan for developed commercial land, three commercial loans totaling $207,000, and a commercial real estate loan for $2,000.

Other Income

The Company recorded other income of $1.4 million for the third quarter of 2014, a decrease of $154,000, or 9.8%, from the same period a year earlier that resulted primarily from the following changes:

 

•

An $89,000, or 68.5%, decrease in gains on sales of loans and servicing rights to $41,000 from $130,000 for the third quarter of 2013 that resulted from both a weaker real estate market resulting in lower originations and from a decision to put most of the new production in the Bank’s portfolio; partly offset by

 

•

No sales of investment securities, compared with $75,000 in gains from $2.6 million in sales for the same quarter a year earlier; and

 

•

$4,000 in net losses from sales and write-downs of OREO, compared with $80,000 in net gains for the same quarter a year earlier; partly offset by

 

•

A $50,000, or 7.7%, increase in other fees and service charges on deposit accounts to $700,000 for the third quarter of 2014 from $650,000 for the year earlier quarter, that was due primarily to a 5.3% increase in the number of checking accounts since the end of the third quarter of 2013 that resulted from the Bank’s continuing focus on growing core deposit relationships.

Other Expense

Total other expense of $4.2 million for the third quarter of 2014 was $197,000, or 4.9%, higher than the third quarter of 2013, with the following major differences:

 

•

A $98,000, or 4.3%, increase in salaries and employee benefits to $2.4 million that was due primarily to a $59,000 increase in retirement benefits expense related to our frozen defined benefit plan, and $47,000 of compensation and benefits related to personnel hired for two new banking centers;

 

•

A $52,000 increase in legal and professional fees, due primarily to a $41,000 increase in recruiting fees;

 

•

A $40,000 increase in data processing expense that related primarily to our cost to support greater use of new technology by our customers; and

 

•

A $28,000 increase in marketing expense that related primarily to media advertising to build brand awareness in the greater Indianapolis metropolitan area; partly offset by

 

•

A $29,000 decrease in net occupancy expense that related mostly to reduced real estate taxes from successful appeals of assessments; and

 

•

A $13,000 decrease in FDIC deposit insurance premiums that resulted from a reduction in the Bank’s assessment rate.

 

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Income Tax Expense

The Company recorded income tax expense of $166,000 on pre-tax income of $667,000 for the three-month period ended September 30, 2014, compared to income tax expense of $222,000 on pre-tax income of $783,000 for the same period a year earlier. Both quarters had a significant amount of tax-exempt income, primarily from bank-owned life insurance.

We have a deferred state tax asset that is primarily the result of operating losses sustained since 2003. We started recording a valuation allowance against our current period state income tax benefit in 2005 due to our concern that we may not be able to use more than the tax asset already recorded on the books without modifying the use of Ameriana Investment Management, Inc. (“AIMI”), our investment subsidiary, which was liquidated effective December 31, 2009. Operating income from AIMI was not subject to state income taxes under state law, and as a result was also a major factor in the growth of the deferred state tax asset.

The Company also has a deferred federal tax asset that is composed of tax benefit from a net operating loss carry-forward and purchased tax credits. The federal loss carry-forward expires in 2026, and the tax credits begin to expire in 2023. The tax credits include alternative minimum tax credits, which have no expiration date. Management believes that the Company will be able to utilize the benefits recorded for loss carry-forwards and credits within the allotted time periods.

In addition to the liquidation of AIMI, the Bank has initiated several strategies designed to expedite the use of both the deferred state tax asset and the deferred federal tax asset. Through sales of $34.5 million of municipal securities and only one purchase since December 31, 2006, that segment of the investment securities portfolio has been reduced to $2.3 million. The proceeds from these sales have been reinvested in taxable financial instruments. The Bank has periodically evaluated a sale/leaseback transaction that could result in a taxable gain on its office properties, and also allow the Bank to convert nonearning assets to assets that will produce taxable income. Additionally, the Bank is exploring options related to reducing its current investment in tax-exempt bank owned life insurance policies that involve the reinvestment of the proceeds in taxable financial instruments with a similar or greater risk-adjusted after-tax yield. Sales of banking centers not important to long-term growth objectives that would result in taxable gains and reduced operating expenses could be considered by the Bank.

Nine Months Ended September 30, 2014 compared to the Nine Months Ended September 30, 2013

The Company recorded net income of $1.8 million, or $0.61 per diluted share, for the first nine months of 2014, an increase of $127,000, or 7.43%, from net income of $1.7 million, or $0.57 per diluted share, for the first nine months of 2013.

The earnings improvement for the period was related primarily to revenue enhancement and expense reduction from improved credit quality, including a decrease in the provision for loan losses, an increase in interest on mortgage-backed securities, an increase in loan prepayment penalties and an increase in fees and service charges on deposit accounts, partly offset by a reduction in mortgage banking revenue and gains from investment securities sales, and a reduction in net gains from sales of OREO.

Net Interest Income

Net interest income on a fully tax-equivalent basis of $10.9 million for the first nine months of 2014 represented an increase of $349,000, or 3.3%, compared to the same period of 2013, and was primarily due to a $25.7 million, or 6.7%, increase in average interest-earning assets to $411.4 million, a $93,000 increase in loan prepayment penalties and the recognition of $173,000 of interest income as a result of the repurchase of a non-performing loan by the servicer. The Company’s net interest margin on a fully tax-equivalent basis for the first nine months of 2014 of 3.53% was eleven basis points lower than the year earlier period.

Tax-exempt interest was $107,000 for the first nine months of 2014 compared to $109,000 for the same period of 2013. Our tax exempt interest results from holdings of bank-qualified municipal securities and municipal loans. The tax-equivalent adjustments were $45,000 and $46,000 for the first nine months of 2014 and 2013, respectively.

 

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Provision for Loan Losses

The following table sets forth an analysis of the Bank’s allowance for loan losses for the periods indicated:

 

		(Dollars in thousands)
		Nine Months Ended September 30,
		2014				2013
Balance at beginning of year		$	3,993			$	4,239
Provision for loan losses			322				675
Charge-offs			(362	)			(1,090	)
Recoveries			61				115
Net charge-offs			(301	)			(975	)
Balance at end of period		$	4,014			$	3,939

We recorded a provision for loan losses of $322,000 for the first nine months of 2014, compared with $675,000 for the same period in 2013. The 2014 provision represents a $353,000, or 52.3%, decrease from the nine-month period a year earlier. The lower provision is also reflective of the effect of slowly improving economic conditions on credit quality, including a reduced amount of non-performing loans and charge-offs. Charge offs of $362,000 for the nine-month period ended September 30, 2014 included $101,000 for two commercial real estate loans, $80,000 for four residential real estate loans, $59,000 for two commercial loans, and $46,000 for two construction loans. Charge-offs of $1.1 million for the nine-month period a year earlier included a charge-off of $479,000 related to a hotel in northern Indiana, which was fully-reserved at December 31, 2012. The allowance to total loans was 1.24% at September 30, 2014, compared with 1.22% at September 30, 2013.

Other Income

The Company recorded other income of $4.2 million for the first nine months of 2014, a decrease of $388,000, or 8.58%, from the same period a year earlier that resulted primarily from the following changes:

 

•

No sales of investment securities, compared to $167,000 in net gains from $10.2 million in sales of investment securities for the same period a year earlier;

 

•

A $368,000, or 81.8%, decrease in gains on sales of loans and servicing rights to $82,000 from $450,000 for the first nine months of 2013 that resulted from both a reduction in refinance volume and from a decision to put most of the new 2014 production in the Bank’s portfolio; and

 

•

A $75,000 decrease in net gains from sales and write-downs of OREO to $3,000 for the first nine months of 2014 from $78,000 for the same period a year earlier; partly offset by

 

•

A $155,000, or 8.5%, increase in other fees and service charges on deposit accounts to $2.0 million for the first nine months of 2014 from $1.8 million for the year earlier period, that was due primarily to a 5.3% increase in the number of checking accounts since the end of the third quarter of 2013 that resulted from the Bank’s continuing focus on growing core deposit relationships;

 

•

A $34,000 increase in other real estate owned income to $209,000, that resulted primarily from the January 2014 collection of $26,000 in delinquent rent from a tenant of a commercial strip center; and

 

•

A $46,000 increase in other that related primarily to $36,000 in claim proceeds received in excess of the planned replacement cost for landscaping damage at a banking center.

 

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Other Expense

The net increase of $117,000, or 1.0%, in other expense to $12.2 million for the first nine months of 2014 compared with the same period of 2013 resulted primarily from the net of the following differences:

 

•

A $250,000, or 3.7%, increase in salaries and employee benefits to $7.0 million that was due primarily to a $161,000 increase in retirement benefits expense related to our frozen defined benefit plan, a $54,000 net increase in compensation that resulted primarily from the addition of commercial lenders and personnel for two new banking centers, and a $35,000 increase in employee health insurance expense related mostly to the offering of a high deductible plan with the initial funding of health savings accounts;

 

•

An $84,000 increase in data processing expense to $746,000 that related primarily to our cost to support greater use of new technology by our customers;

 

•

An $86,000 increase in marketing expense that related primarily to media advertising to build brand awareness in the greater Indianapolis metropolitan area; and

 

•

A $55,000 increase in legal and professional fees, due primarily to a $35,000 increase in legal fees and a $26,000 increase in recruiting fees; partly offset by:

 

•

A $128,000 decrease in FDIC deposit insurance premiums that resulted from a reduction in the Bank’s assessment rate;

 

•

A $32,000 decrease in net occupancy expense that related mostly to reduced real estate taxes from successful appeals of assessments;

 

•

A $59,000 decrease in furniture and equipment expense that related mostly to reduced ATM maintenance expense and lower depreciation;

 

•

An $84,000 decrease in OREO expense to $179,000 that related primarily to real estate tax refunds from successful appeals of assessments that resulted in a $50,000 expense reduction; and

 

•

A $51,000 reduction in other expense that resulted primarily from the reversal of $62,000 of loan expense as a result of the repurchase of a non-performing loan by the servicer.

Income Tax Expense

The Company had income before income taxes of $2.5 million for the first nine months of 2014, and recorded income tax expense of $673,000, an effective tax rate of 26.9% that resulted from a large amount of tax-exempt income. The Company had income before income taxes of $2.3 million for the same period of 2013, and recorded income tax expense of $602,000, an effective rate of 26.1% that was also a result of a large amount of tax-exempt income. For both nine-month periods, the Bank had a significant amount of tax-exempt income from BOLI, in addition to tax-exempt income from municipal loans and municipal securities.

OFF-BALANCE SHEET ARRANGEMENTS

In the normal course of operations, we engage in a variety of financial transactions that, in accordance with GAAP, are not recorded in our financial statements. These transactions involve, to varying degrees, elements of credit, interest rate and liquidity risk. Such transactions are used primarily to manage customers’ requests for funding and take the form of loan commitments and lines of credit.

We do not have any off-balance-sheet arrangements that have or are reasonably likely to have a current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that is material to investors.

LIQUIDITY AND CAPITAL RESOURCES

Liquidity is the ability to meet current and future obligations of a short-term nature. Historically, funds provided by operations, loan repayments and new deposits have been our principal sources of liquid funds. In addition, we have the ability to obtain funds through the sale of investment securities and mortgage loans, through borrowings from the FHLB system, and through the brokered certificates market. We regularly adjust the investments in liquid assets based upon our assessment of (1) expected loan demand, (2) expected deposit flows, (3) yields available on interest-earning deposits and securities and (4) the objectives of our asset/liability program.

 

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The Company is a separate entity and apart from the Bank and must provide for its own liquidity. In addition to its operating expenses, the Company is responsible for the payment of dividends declared for its shareholders and the payment of interest on its subordinated debentures. At times, the Company has repurchased its stock. Substantially all of the Company’s operating cash is obtained from subsidiary dividends. Payment of such dividends to the Company by the Bank is limited under Indiana law.

At September 30, 2014, we had $33.6 million in loan commitments outstanding and $59.3 million of additional commitments for line of credit receivables. Certificates of deposit due within one year of September 30, 2014 totaled $69.3 million, or 18.4% of total deposits. If these maturing certificates of deposit do not remain with us, other sources of funds must be used, including other certificates of deposit, brokered CDs, and borrowings. Depending on market conditions, we may be required to pay higher rates on such deposits or other borrowings than currently paid on the certificates of deposit due on or before September 30, 2015. However, based on past experiences we believe that a significant portion of the certificates of deposit will remain. We have the ability to attract and retain deposits by adjusting the interest rates offered. We held no brokered CDs at September 30, 2014 or at December 31, 2013.

Our primary investing activity, the origination and purchase of loans, is offset by the sale of loans and principal repayments. In the first nine months of 2014, net loans receivable increased by $9.0 million, or 2.9%.

Financing activities consist primarily of activity in deposit accounts and FHLB advances. Deposit flows are affected by the overall level of interest rates, the interest rates and products we offer, and our local competitors and other factors. Total deposits increased by $13.4 million, or 3.7%, and total FHLB advances were unchanged during the first nine months of 2014.

The Bank is subject to various regulatory capital requirements set by the FDIC, including a risk-based capital measure. The Company is also subject to similar capital requirements set by the Federal Reserve Board. The risk-based capital guidelines include both a definition of capital and a framework for calculating risk-weighted assets by assigning balance sheet assets and off-balance sheet items to broad risk categories.

There are five capital categories defined in the regulations, ranging from well capitalized to critically under-capitalized. Classification in any of the undercapitalized categories can result in actions by regulators that could have a material effect on a bank’s operations. At September 30, 2014 and December 31, 2013, the Bank was categorized as “well capitalized” and met all subject capital adequacy requirements. There are no conditions or events since September 30, 2014 that management believes have changed this classification.

Actual, required, and well capitalized amounts and ratios for the Bank are as follows:

 

September 30, 2014
		Actual Capital								Required For Adequate Capital								To Be Well Capitalized
		Amount				Ratio				Amount				Ratio				Amount				Ratio
Total risk-based capital ratio (risk based capital to risk-weighted assets)		$	48,205				15.50	%		$	24,875				8.00	%		$	31,093				10.00	%
Tier 1 risk-based capital ratio (tier 1 capital to risk-weighted assets)		$	44,304				14.25	%		$	12,437				4.00	%		$	18,656				6.00	%
Tier 1 leverage ratio (tier 1 capital to adjusted average total assets)		$	44,304				9.41	%		$	14,126				3.00	%		$	23,544				5.00	%

 

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December 31, 2013
		Actual Capital								Required For Adequate Capital								To Be Well Capitalized
		Amount				Ratio				Amount				Ratio				Amount				Ratio
Total risk-based capital ratio (risk based capital to risk-weighted assets)		$	45,897				15.16	%		$	24,219				8.00	%		$	30,274				10.00	%
Tier 1 risk-based capital ratio (tier 1 capital to risk-weighted assets)		$	42,110				13.91	%		$	12,109				4.00	%		$	18,164				6.00	%
Tier 1 leverage ratio (tier 1 capital to adjusted average total assets)		$	42,110				9.47	%		$	13,334				3.00	%		$	22,223				5.00	%

Actual, required, and well capitalized amounts and ratios for the Company are as follows:

 

September 30, 2014
		Actual Capital								Required For Adequate Capital								To Be Well Capitalized
		Amount				Ratio				Amount				Ratio				Amount				Ratio
Total risk-based capital ratio (risk based capital to risk-weighted assets)		$	49,086				15.60	%		$	25,170				8.00	%		$	31,463				10.00	%
Tier 1 risk-based capital ratio (tier 1 capital to risk-weighted assets)		$	45,185				14.36	%		$	12,585				4.00	%		$	18,878				6.00	%
Tier 1 leverage ratio (tier 1 capital to adjusted average total assets)		$	45,185				9.59	%		$	14,137				3.00	%		$	23,562				5.00	%

 

December 31, 2013
		Actual Capital								Required For Adequate Capital								To Be Well Capitalized
		Amount				Ratio				Amount				Ratio				Amount				Ratio
Total risk-based capital ratio (risk based capital to risk-weighted assets)		$	46,477				15.17	%		$	24,503				8.00	%		$	30,628				10.00	%
Tier 1 risk-based capital ratio (tier 1 capital to risk-weighted assets)		$	42,690				13.94	%		$	12,251				4.00	%		$	18,377				6.00	%
Tier 1 leverage ratio (tier 1 capital to adjusted average total assets)		$	42,690				9.60	%		$	13,343				3.00	%		$	22,238				5.00	%

AVAILABLE INFORMATION

Our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and any amendments to such reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended, are made available free of charge on our website, www.ameriana.com, as soon as reasonably practicable after such reports are electronically filed with, or furnished to, the Securities and Exchange Commission. Information on our website should not be considered a part of this Form 10-Q.

 

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ITEM 3 – QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK

Not applicable as issuer is a smaller reporting company.

ITEM 4 – CONTROLS AND PROCEDURES

As of the end of the period covered by this report, we carried out an evaluation, under the supervision and with the participation of our principal executive officer and principal financial officer, of the effectiveness of our disclosure controls and procedures. Based on this evaluation, our principal executive officer and principal financial officer concluded that our disclosure controls and procedures are effective in ensuring that information required to be disclosed by us in reports that we file or submit under the Securities Exchange Act of 1934, as amended, (1) is recorded, processed, summarized and reported, within the time periods specified in the SEC’s rules and forms and (2) is accumulated and communicated to our management, including our principal executive and principal financial officers as appropriate to allow timely discussions regarding required disclosures. It should be noted that the design of our disclosure controls and procedures is based in part upon certain reasonable assumptions about the likelihood of future events, and there can be no assurance that any design of disclosure controls and procedures will succeed in achieving its stated goals under all potential future conditions, but our principal executive and principal financial officers have concluded that our disclosure controls and procedures are, in fact, effective at a reasonable assurance level.

There were no changes in the Company’s internal control over financial reporting during the three months ended September 30, 2014 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

PART II - OTHER INFORMATION

ITEM 1 – LEGAL PROCEEDINGS

Neither the Company nor the Bank is involved in any pending legal proceedings other than routine legal proceedings occurring in the ordinary course of business. Such routine legal proceedings, in the aggregate, are believed by management to be immaterial to the financial condition and results of operations of the Company.

ITEM 1A – RISK FACTORS

In addition to the other information set forth in this report, you should carefully consider the factors discussed in Part I, “Item 1A. Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2013, which could materially affect our business, financial condition or future results. The risks described in our Annual Report on Form 10-K are not the only risks that we face. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial also may materially adversely affect our business, financial condition and/or operating results.

ITEM 2 – UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

The Company did not repurchase any of its common stock during the quarter ended September 30, 2014, and at September 30, 2014 had no approved repurchase plans or programs.

ITEM 3 – DEFAULTS UPON SENIOR SECURITIES

Not Applicable

ITEM 4 – MINE SAFETY DISCLOSURES

Not Applicable

ITEM 5 – OTHER INFORMATION

Not Applicable

 

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ITEM 6 – EXHIBITS

 

No.		Description
31		Rule 13a-14(a)/15d-14(a) Certifications
32		Section 1350 Certifications
101		The following materials from Ameriana Bancorp’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2014 formatted in Extensible Business Reporting Language (XBRL): (i) the Consolidated Condensed Balance Sheets, (ii) the Consolidated Condensed Statements of Income, (iii) the Consolidated Condensed Statements of Comprehensive Income, (iv) the Consolidated Condensed Statement of Shareholders’ Equity, (v) the Consolidated Condensed Statements of Cash Flows and (vi) related Notes.

 

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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 thereunto duly authorized.

 

						AMERIANA BANCORP
DATE:		November 10, 2014				/s/ Jerome J. Gassen
						Jerome J. Gassen
						President and Chief Executive Officer
						(Duly Authorized Representative)
DATE:		November 10, 2014				/s/ John J. Letter
						John J. Letter
						Executive Vice President-Treasurer and Chief Financial Officer
						(Principal Financial Officer and Accounting Officer)

 

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