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UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

(Mark One)

☑ Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the quarterly period ended June 30, 2015

 

Or

 

☐ Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

Commission File Number: 000-30973

 

MBT FINANCIAL CORP.

(Exact name of registrant as specified in its charter)

 

Michigan		38-3516922
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)

102 E. Front Street

Monroe, Michigan 48161

(Address of principal executive offices)

(Zip Code)

 

(734) 241-3431

(Registrant’s telephone number, including area code)

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☑ No ☐

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ☑ No ☐

 

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

 

Large accelerated filer ☐        Accelerated Filer ☑      

Non-accelerated filer ☐          Smaller reporting company ☐

 

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

 

As of August 10, 2015, there were 22,750,173 shares of the Company’s Common Stock outstanding.

 

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Part I Financial Information

Item 1. Financial Statements

 

MBT FINANCIAL CORP.

CONSOLIDATED BALANCE SHEETS

 

		June 30, 2015
Dollars in thousands		(Unaudited)				December 31, 2014
ASSETS
Cash and Cash Equivalents
Cash and due from banks
Non-interest bearing		$	14,398			$	15,957
Interest bearing			9,175				36,165
Total cash and cash equivalents			23,573				52,122
Securities - Held to Maturity			35,277				32,613
Securities - Available for Sale			503,703				473,176
Federal Home Loan Bank stock - at cost			4,148				7,537
Loans held for sale			1,602				548
Loans			623,570				610,332
Allowance for Loan Losses			(13,079	)			(13,208	)
Loans - Net			610,491				597,124
Accrued interest receivable and other assets			28,189				29,465
Other Real Estate Owned			4,233				5,615
Bank Owned Life Insurance			52,373				51,825
Premises and Equipment - Net			28,515				28,632
Total assets		$	1,292,104			$	1,278,657
LIABILITIES
Deposits:
Non-interest bearing		$	238,164			$	218,221
Interest-bearing			883,116				893,590
Total deposits			1,121,280				1,111,811
Repurchase agreements			15,000				15,000
Interest payable and other liabilities			16,960				17,310
Total liabilities			1,153,240				1,144,121
STOCKHOLDERS' EQUITY
Common stock (no par value; 50,000,000 shares authorized, 22,741,898 and 22,718,077 shares issued and outstanding)			23,270				23,037
Retained earnings			119,194				114,132
Unearned compensation			(30	)			-
Accumulated other comprehensive loss			(3,570	)			(2,633	)
Total stockholders' equity			138,864				134,536
Total liabilities and stockholders' equity		$	1,292,104			$	1,278,657

 

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

 

 

MBT FINANCIAL CORP.

CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME - UNAUDITED

 

		Three Months Ended June 30,								Six Months Ended June 30,
Dollars in thousands, except per share data		2015				2014				2015				2014
Interest Income
Interest and fees on loans		$	7,154			$	7,021			$	14,586			$	14,100
Interest on investment securities-
Tax-exempt			273				297				548				604
Taxable			2,436				2,200				4,864				4,318
Interest on balances due from banks			14				22				40				54
Total interest income			9,877				9,540				20,038				19,076
Interest Expense
Interest on deposits			619				801				1,264				1,656
Interest on borrowed funds			177				187				351				373
Total interest expense			796				988				1,615				2,029
Net Interest Income			9,081				8,552				18,423				17,047
Provision For (Recovery Of) Loan Losses			-				100				(800	)			200
Net Interest Income After
Provision For Loan Losses			9,081				8,452				19,223				16,847
Other Income
Income from wealth management services			1,191				1,168				2,413				2,302
Service charges and other fees			1,030				968				1,924				1,900
Debit card income			591				542				1,155				1,031
Net gain on sales of securities available for sale			22				219				258				276
Net loss on sales of Other Real Estate Owned			(21	)			(342	)			(284	)			(330	)
Origination fees on mortgage loans sold			137				88				266				150
Bank owned life insurance income			362				351				633				705
Rent income on Other Real Estate Owned			103				130				137				265
Other			390				460				928				949
Total other income			3,805				3,584				7,430				7,248
Other Expenses
Salaries and employee benefits			5,750				5,804				11,624				11,532
Occupancy expense			606				670				1,426				1,414
Equipment expense			790				662				1,524				1,279
Marketing expense			308				212				554				415
Professional fees			550				521				1,126				939
Other Real Estate Owned expenses			179				361				305				700
FDIC Deposit Insurance Assessment			429				620				843				1,260
Bonding and other insurance expense			227				255				457				519
Telephone expense			109				104				204				247
Other			782				582				1,486				1,185
Total other expenses			9,730				9,791				19,549				19,490
Income Before Income Taxes			3,156				2,245				7,104				4,605
Income Tax Expense			871				558				2,042				1,151
Net Income		$	2,285			$	1,687			$	5,062			$	3,454
Other Comprehensive Income (Loss) - Net of Tax
Unrealized gains (losses) on securities			(3,760	)			3,443				(819	)			7,002
Reclassification adjustment for losses included in net income			(15	)			(144	)			(171	)			(182	)
Postretirement benefit liability			26				27				53				(266	)
Total Other Comprehensive Income (Loss) - Net of Tax			(3,749	)			3,326				(937	)			6,554
Comprehensive Income (Loss)		$	(1,464	)		$	5,013			$	4,125			$	10,008
Basic Earnings Per Common Share		$	0.10			$	0.08			$	0.22			$	0.16
Diluted Earnings Per Common Share		$	0.10			$	0.08			$	0.22			$	0.16
Common Stock Dividends Declared Per Share		$	-			$	-			$	-			$	-

 

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

 

 

MBT FINANCIAL CORP.

CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY - UNAUDITED

 

														Accumulated
														Other
		Common				Retained				Unearned				Comprehensive
Dollars in thousands		Stock				Earnings				Compensation				Income (Loss)				Total
Balance - January 1, 2015		$	23,037			$	114,132			$	-			$	(2,633	)		$	134,536
Issuance of Common Stock
SOSARs exercised (8,301 shares)			-				-				-				-				-
Restricted stock awards (6,000 shares)			35				-				(35	)			-				-
Other stock issued (9,520 shares)			53				-				-				-				53
Equity Compensation			145				-				5				-				150
Net income			-				5,062				-				-				5,062
Other comprehensive loss - net of tax			-				-				-				(937	)			(937	)
Balance - June 30, 2015		$	23,270			$	119,194			$	(30	)		$	(3,570	)		$	138,864

 

														Accumulated
														Other
		Common				Retained				Unearned				Comprehensive
Dollars in thousands		Stock				Earnings				Compensation				Income (Loss)				Total
Balance - January 1, 2014		$	14,671			$	106,817			$	(7	)		$	(10,873	)		$	110,608
Issuance of Common Stock
SOSARs exercised (7,287 shares)			1				-				-				-				1
Restricted stock awards (6,000 shares)			29				-				(29	)			-				-
Other stock issued (2,071,362 shares)			8,814				-				-				-				8,814
Stock Offering Expense			(754	)			-				-				-				(754	)
Equity Compensation			98				-				19				-				117
Net income			-				3,454				-				-				3,454
Other comprehensive income - net of tax			-				-				-				6,554				6,554
Balance - June 30, 2014		$	22,859			$	110,271			$	(17	)		$	(4,319	)		$	128,794

 

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

 

 

MBT FINANCIAL CORP.

CONSOLIDATED STATEMENTS OF CASH FLOWS - UNAUDITED

 

		Six Months Ended June 30,
Dollars in thousands		2015				2014
Cash Flows from Operating Activities
Net Income		$	5,062			$	3,454
Adjustments to reconcile net income to net cash from operating activities
Provision for (recovery of) loan losses			(800	)			200
Depreciation			792				827
Decrease in net deferred federal income tax asset			1,711				1,102
Net amortization of investment premium and discount			651				483
Writedowns of Other Real Estate Owned			369				163
Net increase (decrease) in interest payable and other liabilities			(270	)			489
Net increase in interest receivable and other assets			(324	)			(741	)
Equity based compensation expense			150				118
Net gain on sale/settlement of securities			(258	)			(276	)
Increase in cash surrender value of life insurance			(548	)			(621	)
Net cash provided by operating activities		$	6,535			$	5,198
Cash Flows from Investing Activities
Proceeds from maturities and redemptions of investment securities held to maturity		$	6,005			$	6,058
Proceeds from maturities and redemptions of investment securities available for sale			84,584				10,407
Proceeds from sales of investment securities available for sale			16,672				55,998
Net increase in loans			(13,715	)			(5,300	)
Proceeds from sales of other real estate owned			1,412				3,696
Proceeds from sales of other assets			75				25
Purchase of investment securities held to maturity			(8,707	)			(4,590	)
Purchase of investment securities available for sale			(130,248	)			(97,323	)
Purchase of bank premises and equipment			(684	)			(1,382	)
Net cash used for investing activities		$	(44,606	)		$	(32,411	)
Cash Flows from Financing Activities
Net increase (decrease) in deposits		$	9,469			$	(19,929	)
Repayment of Federal Home Loan Bank borrowings			-				(12,000	)
Proceeds from issuance of common stock			53				8,060
Net cash provided by (used for) financing activities		$	9,522			$	(23,869	)
Net Decrease in Cash and Cash Equivalents		$	(28,549	)		$	(51,082	)
Cash and Cash Equivalents at Beginning of Period			52,122				77,798
Cash and Cash Equivalents at End of Period		$	23,573			$	26,716
Supplemental Cash Flow Information
Cash paid for interest		$	1,629			$	2,046
Cash paid for federal income taxes		$	331			$	49
Supplemental Schedule of Non Cash Investing Activities
Transfer of loans to other real estate owned		$	40			$	2,305
Transfer of loans to other assets		$	54			$	42

  

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

 

 

MBT FINANCIAL CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

 

1. BASIS OF PRESENTATION AND ACCOUNTING POLICIES

The unaudited consolidated financial statements include the accounts of MBT Financial Corp. (the “Company”) and its subsidiary, Monroe Bank & Trust (the “Bank”). The Bank includes the accounts of its wholly owned subsidiary, MB&T Financial Services, Inc. The Bank operates seventeen branches in Monroe County, Michigan, seven branches in Wayne County, Michigan, and a loan and wealth management office in Lenawee County. The Bank’s primary source of revenue is from providing loans to customers, who are predominantly small and middle-market businesses and middle-income individuals. The Company’s sole business segment is community banking.

 

The accounting and reporting policies of the Bank conform to practice within the banking industry and are in accordance with accounting principles generally accepted in the United States. Preparation of financial statements in conformity with generally accepted accounting principles requires Management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Material estimates that are particularly susceptible to significant changes in the near term are the determination of the allowance for loan losses, the valuation of other real estate owned, and the fair value of investment securities.

 

The accompanying unaudited consolidated financial statements of the Company have been prepared in accordance with the instructions to Form 10-Q. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. However, such information reflects all adjustments (consisting of normal recurring adjustments), which are, in the opinion of Management, necessary for fair statement of results for the interim periods.

 

The significant accounting policies are as follows:

 

PRINCIPLES OF CONSOLIDATION

The consolidated financial statements include the accounts of the Company and its subsidiary. All material intercompany transactions and balances have been eliminated.

 

COMPREHENSIVE INCOME

Accounting principles generally require that revenue, expenses, gains, and losses be included in net income. Certain changes in assets and liabilities, however, such as unrealized gains and losses on securities available for sale and amounts recognized related to postretirement benefit plans (gains and losses, prior service costs, and transition assets or obligations), are reported as a direct adjustment to the equity section of the balance sheet. Such items, along with net income, are components of comprehensive income.

 

BUSINESS SEGMENTS

While the Company's chief decision makers monitor the revenue streams of various products and services, operations are managed and financial performance is evaluated on a company wide basis. Accordingly, all of the Company’s operations are considered by management to be aggregated in one reportable segment.

  

 

FAIR VALUE

The Company measures or monitors many of its assets and liabilities on a fair value basis. Fair value is used on a recurring basis for assets and liabilities that are elected to be accounted for under The Fair Value Option as well as for certain assets and liabilities in which fair value is the primary basis of accounting. Examples of these include derivative instruments and available for sale securities. Additionally, fair value is used on a non-recurring basis to evaluate assets or liabilities for impairment or for disclosure purposes. Examples of these non-recurring uses of fair value include certain loans held for sale accounted for on a lower of cost or market basis. Fair value is defined 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. Depending on the nature of the asset or liability, the Company uses various valuation techniques and assumptions when estimating fair value.

 

When determining the fair value measurements for assets and liabilities required or permitted to be recorded at and/or marked to fair value, the Company considers the principal or most advantageous market in which it would transact and considers assumptions that market participants would use when pricing the asset or liability. When possible, the Company looks to active and observable markets to price identical assets or liabilities. When identical assets and liabilities are not traded in active markets, the Company looks to market observable data for similar assets or liabilities. Nevertheless, certain assets and liabilities are not actively traded in observable markets and the Company must use alternative valuation techniques to derive a fair value measurement.

 

ACCOUNTING PRONOUNCEMENTS

The Financial Accounting Standards Board (FASB) issued Accounting Standards Update 2014-09 (ASU 2014-09), “Revenue from Contracts with Customers (Topic 606)”. ASU 2014-09 adopts a standardized approach for revenue recognition and was a joint effort with the International Accounting Standards Board (IASB). The new revenue recognition standard is based on a core principle of recognizing revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. ASU 2014-09 does not apply to financial instruments. ASU 2014-09 is effective for public entities for reporting periods beginning after December 15, 2016 (therefore, for the year ending December 31, 2017 for the Corporation). Early implementation is not allowed for public companies. Management is currently assessing the impact to the Corporation’s consolidated financial statements.

 

  

2. EARNINGS PER SHARE

 

The calculations of earnings per common share are as follows:

 

		For the three months ended June 30,								For the six months ended June 30,
		2015				2014				2015				2014
Basic
Net income		$	2,285,000			$	1,687,000			$	5,062,000			$	3,454,000
Average common shares outstanding			22,733,739				22,205,086				22,727,825				21,515,737
Earnings per common share - basic		$	0.10			$	0.08			$	0.22			$	0.16
Diluted
Net income		$	2,285,000			$	1,687,000			$	5,062,000			$	3,454,000
Average common shares outstanding			22,733,739				22,205,086				22,727,825				21,515,737
Equity compensation			197,805				293,150				190,172				289,428
Average common shares outstanding - diluted			22,931,544				22,498,236				22,917,997				21,805,165
Earnings per common share - diluted		$	0.10			$	0.08			$	0.22			$	0.16

  

  

3. STOCK BASED COMPENSATION

Stock Options - The following table summarizes the options that had been granted to certain key executives in accordance with the Long-Term Incentive Compensation Plan that was approved by shareholders at the Annual Meeting of Shareholders on April 6, 2000.

 

						Weighted Average
		Shares				Exercise Price
Options Outstanding, January 1, 2015			205,400			$	19.08
Granted			-				-
Exercised			-				-
Forfeited			5,500				15.83
Expired			89,500				23.40
Options Outstanding, June 30, 2015			110,400			$	15.74
Options Exercisable, June 30, 2015			110,400			$	15.74

 

Stock Only Stock Appreciation Rights (SOSARs) - On January 21, 2015, 72,500 Stock Only Stock Appreciation Rights (SOSARs) were awarded to certain executives in accordance with the MBT 2008 Stock Incentive Plan that was approved by shareholders on May 1, 2008. The SOSARs have a term of ten years and vest in three equal annual installments beginning on December 31, 2015. The fair value of $2.85 for the SOSARs was estimated at the date of the grant, using the Black-Scholes option pricing model, with the following assumptions: expected option lives of 7 years, expected volatility of 57.07%, a risk free interest rate of 1.70% and dividend yield of 0.00%. The fair value of the Company’s common stock was $4.94 on the grant date.

 

On May 28, 2015, 55,500 Stock Only Stock Appreciation Rights (SOSARs) were awarded to certain executives in accordance with the MBT 2008 Stock Incentive Plan that was approved by shareholders on May 1, 2008 and amended by shareholders on May 7, 2015. The SOSARs have a term of ten years and vest in three equal annual installments beginning on December 31, 2015. The fair value of $2.44 for the SOSARs was estimated at the date of the grant, using the Black-Scholes option pricing model, with the following assumptions: expected option lives of 7 years, expected volatility of 55.57%, a risk free interest rate of 1.90% and dividend yield of 3.00%. The fair value of the Company’s common stock was $5.79 on the grant date.

 

SOSARs granted under the plan are structured as fixed grants with the exercise price equal to the market value of the underlying stock on the date of the grant. 

 

The following table summarizes the SOSARs that have been granted:

 

						Weighted Average
		SOSARs				Base Price
SOSARs Outstanding, January 1, 2015			557,439			$	3.58
Granted			128,000				5.31
Exercised			22,666				2.36
Forfeited			11,502				5.46
Expired			-				-
SOSARs Outstanding, June 30, 2015			651,271			$	3.93
SOSARs Exercisable, June 30, 2015			422,224			$	3.46

 

The exercise of a SOSAR results in the issuance of a number of shares of common stock of the Company based on the appreciation of the market price of the stock over the exercise price of the SOSAR. The market value of the Company’s common stock on June 30, 2015 was $5.74. The value of the exercisable SOSARs that are in-the-money as of June 30, 2015 was $1,144,000, and exercise of those SOSARs on that date would have resulted in the issuance of 199,380 shares of common stock.

  

 

Restricted Stock Unit Awards – On January 21, 2015, 25,000 performance restricted stock units were awarded to certain key executive officers in accordance with the MBT 2008 Stock Incentive Plan that was approved by shareholders on May 1, 2008 and amended by shareholders on May 7, 2015. Each Restricted Stock Unit (RSU) is equivalent to one share of MBT Financial Corp. common stock. Stock will be issued to the participants following a two year performance period that ends on December 31, 2016. Earned RSUs vest on December 31, 2017 and as of June 30, 2015 none of the RSUs were vested.

 

Restricted Stock Awards – On May 28, 2015, 6,000 restricted shares were awarded to certain non-executive members of the board of directors in accordance with the MBT 2008 Stock Incentive Plan that was approved by shareholders on May 1, 2008 and amended by shareholders on May 7, 2015. The restricted shares vest on December 31, 2015. The expense for the restricted stock is based on the grant date value of $5.79 and is recognized over the vesting period. The unrecognized cost related to the non-vested restricted stock awards was $30,000 as of June 30, 2015.

 

The total expense for equity based compensation was $94,000 in the second quarter of 2015 and $79,000 in the second quarter of 2014. The total expense for equity based compensation was $177,000 in the first six months of 2015 and $146,000 in the first six months of 2014.

 

 

4. LOANS

The Bank makes commercial, consumer, and mortgage loans primarily to customers in Monroe County, Michigan, southern and western Wayne County, Michigan, Lenawee County, Michigan, and surrounding areas. Although the Bank has a diversified loan portfolio, a substantial portion of its debtors’ ability to honor their contracts is dependent on the automotive, manufacturing, and real estate development economic sectors.

 

Loans consist of the following (000s omitted):

 

		June 30,				December 31,
		2015				2014
Residential real estate loans		$	217,538			$	223,701
Commercial and Construction real estate loans			263,168				262,395
Agriculture and agricultural real estate loans			18,976				16,700
Commercial and industrial loans			83,625				62,761
Loans to individuals for household, family, and other personal expenditures			40,263				44,775
Total loans, gross		$	623,570			$	610,332
Less: Allowance for loan losses			13,079				13,208
Net Loans		$	610,491			$	597,124

 

Loans are placed in a nonaccrual status when, in the opinion of Management, the collection of additional interest is doubtful. All loan relationships over $250,000 that are classified by Management as nonperforming as well as selected performing accounts and all renegotiated loans are reviewed for impairment each quarter. Allowances for loans determined to be impaired are included in the allowance for loan losses. All cash received on nonaccrual loans is applied to the principal balance. Nonperforming assets consist of nonaccrual loans, loans 90 days or more past due, restructured loans, nonaccrual investment securities, other real estate owned, and other repossessed assets. Other real estate owned includes real estate that has been acquired in full or partial satisfaction of loan obligations or upon foreclosure and real estate that the bank has purchased but no longer intends to use for bank premises.

 

 

The following table summarizes nonperforming assets (000’s omitted):

 

		June 30,				December 31,
		2015				2014
Nonaccrual loans		$	11,135			$	13,040
Loans 90 days past due and accruing			-				10
Restructured loans			22,812				22,896
Total nonperforming loans		$	33,947			$	35,946
Other real estate owned			4,233				5,615
Other assets			4				18
Nonperforming investment securities			-				-
Total nonperforming assets		$	38,184			$	41,579
Nonperforming assets to total assets			2.95	%			3.25	%
Allowance for loan losses to nonperforming loans			38.53	%			36.74	%

 

 

5. ALLOWANCE FOR LOAN LOSSES

The Company separates its loan portfolio into segments to perform the calculation and analysis of the allowance for loan losses. The six segments analyzed are Agriculture and Agricultural Real Estate, Commercial, Commercial Real Estate, Construction Real Estate, Residential Real Estate, and Consumer and Other. The Agriculture and Agricultural Real Estate segment includes all loans to finance agricultural production and all loans secured by agricultural real estate. This segment does not include loans to finance agriculture that are secured by residential real estate, which are included in the Residential Real Estate segment. The Commercial segment includes loans to finance commercial and industrial businesses that are not secured by real estate. The Commercial Real Estate segment includes loans secured by non-farm, non-residential real estate. The Construction Real Estate segment includes loans to finance construction and land development. This includes residential and commercial construction and land development. The Residential Real Estate segment includes all loans, other than construction loans, that are secured by single family and multi family residential real estate properties. The Consumer and Other segment includes all loans not included in any other segment. These are primarily loans to consumers for household, family, and other personal expenditures, such as autos, boats, and recreational vehicles.

  

 

Activity in the allowance for loan losses during the three and six months ended June 30, 2015 was as follows (000s omitted):

 

 

		Agriculture and Agricultural Real Estate				Commercial				Commercial Real Estate				Construction Real Estate				Residential Real Estate				Consumer and Other				Total
Allowance for loan losses: For the three months ended June 30, 2015
Beginning Balance		$	255			$	1,380			$	5,678			$	810			$	3,073			$	1,995			$	13,191
Charge-offs			(75	)			(58	)			(120	)			-				(57	)			(97	)			(407	)
Recoveries			3				97				21				12				133				29				295
Provision			242				62				(142	)			(199	)			(79	)			116				-
Ending balance		$	425			$	1,481			$	5,437			$	623			$	3,070			$	2,043			$	13,079
Allowance for loan losses: For the six months ended June 30, 2015
Beginning Balance		$	216			$	1,361			$	6,179			$	803			$	3,226			$	1,423			$	13,208
Charge-offs			(75	)			(164	)			(120	)			-				(253	)			(117	)			(729	)
Recoveries			10				171				182				621				356				60				1,400
Provision			274				113				(804	)			(801	)			(259	)			677				(800	)
Ending balance		$	425			$	1,481			$	5,437			$	623			$	3,070			$	2,043			$	13,079
Allowance for loan losses as of June 30, 2015
Ending balance individually evaluated for impairment		$	80			$	473			$	913			$	478			$	630			$	208			$	2,782
Ending balance collectively evaluated for impairment			345				1,008				4,524				145				2,440				1,835				10,297
Ending balance		$	425			$	1,481			$	5,437			$	623			$	3,070			$	2,043			$	13,079
Loans as of June 30, 2015
Ending balance individually evaluated for impairment		$	892			$	1,276			$	16,827			$	1,819			$	12,117			$	514			$	33,445
Ending balance collectively evaluated for impairment			18,084				82,349				233,178				11,344				205,421				39,749				590,125
Ending balance		$	18,976			$	83,625			$	250,005			$	13,163			$	217,538			$	40,263			$	623,570

  

 

Activity in the allowance for loan losses during the three and six months ended June 30, 2014 was as follows (000s omitted):

 

		Agriculture and Agricultural Real Estate				Commercial				Commercial Real Estate				Construction Real Estate				Residential Real Estate				Consumer and Other				Total
Allowance for loan losses: For the three months ended June 30, 2014
Beginning Balance		$	205			$	1,780			$	7,460			$	1,430			$	4,478			$	805			$	16,158
Charge-offs			-				(440	)			(1,103	)			-				(79	)			(40	)			(1,662	)
Recoveries			5				56				211				20				73				40				405
Provision			4				(108	)			967				(303	)			(192	)			(268	)			100
Ending balance		$	214			$	1,288			$	7,535			$	1,147			$	4,280			$	537			$	15,001
Allowance for loan losses: For the six months ended June 30, 2014
Beginning Balance		$	171			$	1,989			$	7,030			$	1,397			$	4,606			$	1,016			$	16,209
Charge-offs			-				(626	)			(1,211	)			(210	)			(211	)			(78	)			(2,336	)
Recoveries			5				89				276				254				238				66				928
Provision			38				(164	)			1,440				(294	)			(353	)			(467	)			200
Ending balance		$	214			$	1,288			$	7,535			$	1,147			$	4,280			$	537			$	15,001
Allowance for loan losses as of June 30, 2014
Ending balance individually evaluated for impairment		$	36			$	511			$	2,234			$	900			$	1,713			$	243			$	5,637
Ending balance collectively evaluated for impairment			178				777				5,301				247				2,567				294				9,364
Ending balance		$	214			$	1,288			$	7,535			$	1,147			$	4,280			$	537			$	15,001
Loans as of June 30, 2014
Ending balance individually evaluated for impairment		$	947			$	1,870			$	27,281			$	3,221			$	14,438			$	556			$	48,313
Ending balance collectively evaluated for impairment			16,260				61,093				238,694				11,628				208,011				14,585				550,271
Ending balance		$	17,207			$	62,963			$	265,975			$	14,849			$	222,449			$	15,141			$	598,584

 

Each period the provision for loan losses in the income statement results from the combination of an estimate by Management of loan losses that occurred during the current period and the ongoing adjustment of prior estimates of losses occurring in prior periods.

 

The provision for loan losses increases the allowance for loan losses, a valuation account which appears on the consolidated balance sheets. As the specific customer and amount of a loan loss is confirmed by gathering additional information, taking collateral in full or partial settlement of the loan, bankruptcy of the borrower, etc., the loan is charged off, reducing the allowance for loan losses. If, subsequent to a charge off, the Bank is able to collect additional amounts from the customer or sell collateral worth more than earlier estimated, a recovery is recorded.

 

To serve as a basis for making this provision, the Bank maintains an extensive credit risk monitoring process that considers several factors including: current economic conditions affecting the Bank’s customers, the payment performance of individual loans and pools of homogeneous loans, portfolio seasoning, changes in collateral values, and detailed reviews of specific loan relationships.

  

 

The Company utilizes an internal loan grading system to assign a risk grade to all commercial loans, all renegotiated loans, and each commercial credit relationship. Grades 1 through 4 are considered “pass” credits and grades 5 and 6 are considered “watch” credits and are subject to greater scrutiny. Loans with grades 7, 8, and 9 and considered “doubtful” or “loss” and have generally been charged off. A description of the general characteristics of each grade is as follows:

•

Grade 1 – Excellent – Loans secured by marketable collateral, with adequate margin, or supported by strong financial statements, including substantial levels of tangible net worth. Probability of serious financial deterioration is unlikely. Possess a sound repayment source and a secondary source. This classification will also include individual loans backed by liquid personal assets, established history and unquestionable character. High liquidity, minimum risk, strong ratios, and low handling costs are common to these loans.

•

Grade 2 – Above Average – Loans that exhibit less than average risk and clearly demonstrate debt service coverage that is consistently above average as well as a strong capital base. These loans may have some deficiency or vulnerability, but with offsetting features and are considered to be fully collectable.

•

Grade 3 – Satisfactory – Loans that have an acceptable amount of risk but may exhibit vulnerability to deterioration if adverse circumstances are encountered. These loans should demonstrate adequate debt service coverage and adequate levels of capital support but warrant periodic monitoring to ensure that weaknesses do not materialize or advance.

•

Grade 4 – Pass – Loans that are considered “pass credits” and typically demonstrate adequate debt service coverage. The level of risk is considered acceptable but these loans warrant ongoing monitoring to ensure that adverse trends or other credit deficiencies have not materialized or advanced. The level of risk is considered acceptable so long as the loan is given adequate and ongoing management supervision.

•	Grade 5 – Watch – Loans that possess some credit deficiency or potential weakness that deserves close attention. The primary source of loan repayment is sufficient but may be considered inadequate by the Bank’s standards.

•

Grade 6 – Substandard – Loans that exhibit one or more of the following characteristics: (1) a defined credit weakness, financial deterioration is underway, and uncertainty about the likelihood that the loan will be paid from the primary source of repayment; (2) inadequately protected by the current net worth and paying capacity of the obligor; (3) reliance on secondary source of repayment such as collateral liquidation or guarantees; (4) distinct possibility the Bank will sustain loss if deficiencies are not corrected; (5) unusual courses of action are needed to maintain a high probability of repayment; (6) insufficient cash flow to repay principal but continuing to pay interest; (7) the Bank is subordinated or unsecured due to flaws in documentation; (8) loans are restructured or are on nonaccrual status due to concessions to the borrower when compared to normal loan terms; (9) the Bank is contemplating foreclosure or legal action due to the apparent deterioration in the loan; or (10) there is deterioration in the market conditions and the borrower is highly vulnerable to these conditions.

•

Grade 7 – Doubtful – Loans that exhibit one or more of the following characteristics: (1) loans with all the weaknesses of Substandard loans and collection or liquidation is not probable to result in payment in full; (2) the primary source of repayment is gone and there is considerable doubt as to the quality of the secondary source of repayment; or (3) the possibility of loss is high, but certain important pending factors may strengthen the loan and loss classification is deferred.

•	Grades 8 & 9 - Loss – Loans are considered uncollectible and of such little value that continuing to carry them on the Bank’s financial statements is not feasible.

 

The assessment of compensating factors may result in a rating plus or minus one grade from those listed above. These factors include, but are not limited to collateral, guarantors, environmental conditions, history, plan/projection reasonableness, quality of information, and payment delinquency.

  

 

The portfolio segments in each credit risk grade as of June 30, 2015 are as follows (000s omitted):

 

Credit Quality Indicators as of June 30, 2015

Credit Risk by Internally Assigned Grade

 

			Agriculture and Agricultural Real Estate				Commercial				Commercial Real Estate				Construction Real Estate				Residential Real Estate				Consumer and Other				Total
Not Rated			$	113			$	4,936			$	338			$	5,410			$	137,651			$	36,305			$	184,753
1				-				2,500				-				-				-				-				2,500
2				173				284				572				-				-				366				1,395
3				400				14,785				9,043				-				213				-				24,441
4				15,039				54,369				182,901				4,767				57,611				3,259				317,946
5				2,075				4,064				33,221				2,522				8,620				82				50,584
6				1,176				2,687				23,930				464				13,443				251				41,951
7				-				-				-				-				-				-				-
8				-				-				-				-				-				-				-
9				-				-				-				-				-				-				-
Total			$	18,976			$	83,625			$	250,005			$	13,163			$	217,538			$	40,263			$	623,570
Performing			$	17,865			$	82,258			$	233,612			$	11,299			$	204,953			$	39,636			$	589,623
Nonperforming				1,111				1,367				16,393				1,864				12,585				627				33,947
Total			$	18,976			$	83,625			$	250,005			$	13,163			$	217,538			$	40,263			$	623,570

 

 

The portfolio segments in each credit risk grade as of December 31, 2014 are as follows (000s omitted):

 

Credit Quality Indicators as of December 31, 2014

Credit Risk by Internally Assigned Grade

 

			Agriculture and Agricultural Real Estate				Commercial				Commercial Real Estate				Construction Real Estate				Residential Real Estate				Consumer and Other				Total
Not Rated			$	122			$	2,700			$	-			$	5,402			$	138,355			$	40,371			$	186,950
1				-				3,060				-				-				-				369				3,429
2				330				287				830				-				132				-				1,579
3				491				7,084				9,923				-				464				-				17,962
4				13,458				41,441				176,685				4,357				58,902				3,260				298,103
5				1,261				4,903				34,385				2,471				10,112				199				53,331
6				1,038				3,286				27,646				696				15,736				576				48,978
7				-				-				-				-				-				-				-
8				-				-				-				-				-				-				-
9				-				-				-				-				-				-				-
Total			$	16,700			$	62,761			$	249,469			$	12,926			$	223,701			$	44,775			$	610,332
Performing			$	15,702			$	61,287			$	231,461			$	10,740			$	211,143			$	44,053			$	574,386
Nonperforming				998				1,474				18,008				2,186				12,558				722				35,946
Total			$	16,700			$	62,761			$	249,469			$	12,926			$	223,701			$	44,775			$	610,332

  

 

Loans are considered past due when contractually required payment of interest or principal has not been received. The amount classified as past due is the entire principal balance outstanding of the loan, not just the amount of payments that are past due. The following is a summary of past due loans as of June 30, 2015 and December 31, 2014 (000s omitted):

 

June 30, 2015		30-59 Days Past Due				60-89 Days Past Due				>90 Days Past Due				Total Past Due				Current				Total Loans				Recorded Investment >90 Days Past Due and Accruing
Agriculture and Agricultural Real Estate		$	283			$	-			$	219			$	502			$	18,474			$	18,976			$	-
Commercial			77				27				91				195				83,430				83,625				-
Commercial Real Estate			3,003				1,166				914				5,083				244,922				250,005				-
Construction Real Estate			-				-				-				-				13,163				13,163				-
Residential Real Estate			1,621				355				1,005				2,981				214,557				217,538				-
Consumer and Other			33				-				7				40				40,223				40,263				-
Total		$	5,017			$	1,548			$	2,236			$	8,801			$	614,769			$	623,570			$	-

 

December 31, 2014		30-59 Days Past Due				60-89 Days Past Due				>90 Days Past Due				Total Past Due				Current				Total Loans				Recorded Investment >90 Days Past Due and Accruing
Agriculture and Agricultural Real Estate		$	449			$	-			$	80			$	529			$	16,171			$	16,700			$	-
Commercial			142				44				60				246				62,515				62,761				10
Commercial Real Estate			2,127				1,118				2,287				5,532				243,937				249,469				-
Construction Real Estate			334				-				-				334				12,592				12,926				-
Residential Real Estate			2,946				741				777				4,464				219,237				223,701				-
Consumer and Other			124				15				61				200				44,575				44,775				-
Total		$	6,122			$	1,918			$	3,265			$	11,305			$	599,027			$	610,332			$	10

  

Loans are placed on non-accrual status when, in the opinion of Management, the collection of additional interest is doubtful. Loans are automatically placed on non-accrual status upon becoming ninety days past due, however, loans may be placed on non-accrual status regardless of whether or not they are past due. All cash received on non-accrual loans is applied to the principal balance. Loans are considered for return to accrual status on an individual basis when all principal and interest amounts contractually due are brought current and future payments are reasonably assured.

  

The following is a summary of non-accrual loans as of June 30, 2015 and December 31, 2014 (000s omitted):

 

		June 30, 2015				December 31, 2014
Agriculture and Agricultural Real Estate		$	218			$	80
Commercial			272				315
Commercial Real Estate			5,397				6,287
Construction Real Estate			76				409
Residential Real Estate			5,058				5,760
Consumer and Other			114				189
Total		$	11,135			$	13,040

 

For loans deemed to be impaired due to an expectation that all contractual payments will probably not be received, impairment is measured by comparing the Bank’s recorded investment in the loan to the present value of expected cash flows discounted at the loan’s effective interest rate, the fair value of the collateral, or the loan’s observable market price.

  

 

The following is a summary of impaired loans as of June 30, 2015 and 2014 (000s omitted):

 

June 30, 2015		Recorded Investment				Unpaid Principal Balance				Related Allowance				Average Recorded Investment for the Three Months Ended				Interest Income Recognized in the Three Months Ended				Average Recorded Investment for the Six Months Ended				Interest Income Recognized in the Six Months Ended
With no related allowance recorded:
Agriculture and Agricultural Real Estate		$	-			$	-			$	-			$	-			$	-			$	-			$	-
Commercial			156				166				-				170				3				174				6
Commercial Real Estate			8,010				8,705				-				8,380				83				8,430				175
Construction Real Estate			17				199				-				211				1				247				3
Residential Real Estate			7,308				8,100				-				7,782				93				7,830				187
Consumer and Other			34				34				-				35				1				36				1
With an allowance recorded:
Agriculture and Agricultural Real Estate			892				891				80				904				12				911				24
Commercial			1,120				1,167				473				1,199				15				1,227				28
Commercial Real Estate			8,817				10,390				913				10,843				105				10,900				207
Construction Real Estate			1,802				1,833				478				1,823				21				1,828				42
Residential Real Estate			4,809				5,214				630				4,985				45				4,988				97
Consumer and Other			480				479				208				483				5				487				11
Total:
Agriculture and Agricultural Real Estate		$	892			$	891			$	80			$	904			$	12			$	911			$	24
Commercial			1,276				1,333				473				1,369				18				1,401				34
Commercial Real Estate			16,827				19,095				913				19,223				188				19,330				382
Construction Real Estate			1,819				2,032				478				2,034				22				2,075				45
Residential Real Estate			12,117				13,314				630				12,767				138				12,818				284
Consumer and Other			514				513				208				518				6				523				12

 

 

		Recorded Investment as of December 31, 2014				Unpaid Principal Balance as of December 31, 2014				Related Allowance as of December 31, 2014				Average Recorded Investment for the Three Months Ended June 30, 2014				Interest Income Recognized in the Three Months Ended June 30, 2014				Average Recorded Investment for the Six Months Ended June 30, 2014				Interest Income Recognized in the Six Months Ended June 30, 2014
With no related allowance recorded:
Agriculture and Agricultural Real Estate		$	256			$	256			$	-			$	259			$	2			$	259			$	3
Commercial			363				412				-				873				17				921				26
Commercial Real Estate			8,084				8,882				-				13,717				230				14,807				388
Construction Real Estate			297				954				-				925				13				972				18
Residential Real Estate			6,424				7,200				-				7,350				84				7,426				168
Consumer and Other			3				3				-				55				1				57				2
With an allowance recorded:
Agriculture and Agricultural Real Estate			661				661				34				701				9				707				19
Commercial			1,051				1,062				554				1,162				16				1,176				31
Commercial Real Estate			10,929				12,758				1,502				14,712				163				14,749				323
Construction Real Estate			1,820				1,851				671				2,775				29				2,865				60
Residential Real Estate			5,251				5,658				672				7,801				87				7,648				158
Consumer and Other			531				529				222				503				5				507				11
Total:
Agriculture and Agricultural Real Estate		$	917			$	917			$	34			$	960			$	11			$	966			$	22
Commercial			1,414				1,474				554				2,035				33				2,097				57
Commercial Real Estate			19,013				21,640				1,502				28,429				393				29,556				711
Construction Real Estate			2,117				2,805				671				3,700				42				3,837				78
Residential Real Estate			11,675				12,858				672				15,151				171				15,074				326
Consumer and Other			534				532				222				558				6				564				13

 

The Bank may agree to modify the terms of a loan in order to improve the Bank’s ability to collect amounts due. These modifications may include reduction of the interest rate, extension of the loan term, or in some cases, reduction of the principal balance. Modifications that are performed due to the debtor’s financial difficulties are considered Troubled Debt Restructurings (“TDRs”).

  

 

Loans that have been classified as TDRs during the three and six month periods ended June 30, 2015 and June 30, 2014 are as follows (000s omitted from dollar amounts):

 

		Three months ended												Six months ended
		June 30, 2015												June 30, 2015
		Number of Contracts				Pre-Modification Recorded Principal Balance				Post-Modification Recorded Principal Balance				Number of Contracts				Pre-Modification Recorded Principal Balance				Post-Modification Recorded Principal Balance
Agriculture and Agricultural Real Estate			-			$	-			$	-				-			$	-			$	-
Commercial			1				66				64				1				66				64
Commercial Real Estate			2				352				304				3				684				636
Construction Real Estate			-				-				-				-				-				-
Residential Real Estate			7				581				533				7				581				533
Consumer and Other			-				-				-				-				-				-
Total			10			$	999			$	901				11			$	1,331			$	1,233

 

 

		Three months ended												Six months ended
		June 30, 2014												June 30, 2014
		Number of Contracts				Pre-Modification Recorded Principal Balance				Post-Modification Recorded Principal Balance				Number of Contracts				Pre-Modification Recorded Principal Balance				Post-Modification Recorded Principal Balance
Agriculture and Agricultural Real Estate			-			$	-			$	-				1			$	314			$	314
Commercial			4				295				91				4				295				91
Commercial Real Estate			2				301				140				4				1,247				1,059
Construction Real Estate			-				-				-				-				-				-
Residential Real Estate			7				579				556				10				844				779
Consumer and Other			-				-				-				-				-				-
Total			13			$	1,175			$	787				19			$	2,700			$	2,243

 

The Bank considers TDRs that become past due under the modified terms as defaulted. There were no loans that became TDRs during the three and six month periods ended June 30, 2015 and June 30, 2014 that subsequently defaulted during the three month periods ended June 30, 2015 and June 30, 2014, respectively.

 

The Company has allocated $2,650,000 of specific reserves to customers whose loan terms have been modified in troubled debt restructurings at June 30, 2015. In addition, there were no commitments to lend additional amounts to borrowers that are classified as troubled debt restructurings as of June 30, 2015 and June 30, 2014.

  

 

6. INVESTMENT SECURITIES 

 

The following is a summary of the Bank’s investment securities portfolio as of June 30, 2015 and December 31, 2014 (000’s omitted):

 

		Held to Maturity
		June 30, 2015
						Gross				Gross				Estimated
		Amortized				Unrealized				Unrealized				Market
		Cost				Gains				Losses				Value
Obligations of States and Political Subdivisions		$	34,777			$	1,086			$	(290	)		$	35,573
Corporate Debt Securities			500				-				-				500
		$	35,277			$	1,086			$	(290	)		$	36,073

  

  

		Available for Sale
		June 30, 2015
						Gross				Gross				Estimated
		Amortized				Unrealized				Unrealized				Market
		Cost				Gains				Losses				Value
Obligations of U.S. Government Agencies		$	363,481			$	1,057			$	(3,799	)		$	360,739
Mortgage Backed Securities issued by U.S. Government Agencies			116,943				216				(1,038	)			116,121
Obligations of States and Political Subdivisions			17,467				318				(76	)			17,709
Corporate Debt Securities			6,990				11				-				7,001
Equity Securities			2,044				89				-				2,133
		$	506,925			$	1,691			$	(4,913	)		$	503,703

 

 

		Held to Maturity
		December 31, 2014
						Gross				Gross				Estimated
		Amortized				Unrealized				Unrealized				Market
		Cost				Gains				Losses				Value
Obligations of States and Political Subdivisions		$	32,113			$	1,287			$	(69	)		$	33,331
Corporate Debt Securities			500				-				-				500
		$	32,613			$	1,287			$	(69	)		$	33,831

 

 

		Available for Sale
		December 31, 2014
						Gross				Gross				Estimated
		Amortized				Unrealized				Unrealized				Market
		Cost				Gains				Losses				Value
Obligations of U.S. Government Agencies		$	343,703			$	1,372			$	(3,027	)		$	342,048
Mortgage Backed Securities issued by U.S. Government Agencies			105,890				406				(890	)			105,406
Obligations of States and Political Subdivisions			19,286				377				(82	)			19,581
Corporate Debt Securities			3,975				27				-				4,002
Equity Securities			2,044				95				-				2,139
		$	474,898			$	2,277			$	(3,999	)		$	473,176

  

 

The amortized cost and estimated market values of securities by contractual maturity as of June 30, 2015 are shown below. 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.

  

		Held to Maturity								Available for Sale
						Estimated								Estimated
		Amortized				Market				Amortized				Market
		Cost				Value				Cost				Value
Contractual maturity in
1 year or less		$	4,383			$	4,426			$	4,756			$	4,771
After 1 year through five years			17,818				18,024				129,538				129,078
After 5 years through 10 years			10,186				10,606				236,228				234,397
After 10 years			2,890				3,017				17,416				17,203
Total			35,277				36,073				387,938				385,449
Mortgage Backed Securities			-				-				116,943				116,121
Securities with no stated maturity			-				-				2,044				2,133
Total		$	35,277			$	36,073			$	506,925			$	503,703

 

The investment securities portfolio is evaluated for impairment throughout the year. Impairment is recorded against individual securities, unless the decrease in fair value is attributable to interest rates or the lack of an active market, and Management determines that the Company does not intend to sell the investments and it is not more likely than not that the Company will be required to sell the investments before a recovery of their amortized costs bases, which may be maturity. The following table shows the gross unrealized losses and fair value of the Company’s investments with unrealized losses (in thousands), aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position at June 30, 2015 and December 31, 2014.

  

		June 30, 2015
		Less than 12 months								12 months or longer								Total
		Aggregate Fair Value				Gross Unrealized Losses				Aggregate Fair Value				Gross Unrealized Losses				Aggregate Fair Value				Gross Unrealized Losses
Obligations of United States Government Agencies		$	134,877			$	1,760			$	119,424			$	2,039			$	254,301			$	3,799
Mortgage Backed Securities issued by U.S. Government Agencies			62,638				433				31,842				605				94,480				1,038
Obligations of States and Political Subdivisions			14,109				241				5,230				125				19,339				366
		$	211,624			$	2,434			$	156,496			$	2,769			$	368,120			$	5,203

  

 

		December 31, 2014
		Less than 12 months								12 months or longer								Total
		Aggregate Fair Value				Gross Unrealized Losses				Aggregate Fair Value				Gross Unrealized Losses				Aggregate Fair Value				Gross Unrealized Losses
Obligations of United States Government Agencies		$	47,695			$	144			$	159,650			$	2,883			$	207,345			$	3,027
Mortgage Backed Securities issued by U.S. Government Agencies			32,756				175				40,556				715				73,312				890
Obligations of States and Political Subdivisions			9,341				52				4,276				99				13,617				151
		$	89,792			$	371			$	204,482			$	3,697			$	294,274			$	4,068

 

The amount of investment securities issued by government agencies, states, and political subdivisions with unrealized losses and the amount of unrealized losses on those investment securities are primarily the result of market interest rates and not the result of the credit quality of the issuers of the securities. Because the Company does not intend to sell the investments and it is not more likely than not that the Company will be required to sell the investments before recovery of their amortized cost bases, which may be maturity, the Company does not consider those investments to be other than temporarily impaired at June 30, 2015. As of June 30, 2015 and December 31, 2014, there were 168 and 116 securities in an unrealized loss position, respectively.

  

  

7. FAIR VALUE OF FINANCIAL INSTRUMENTS

 

Fair value, as defined in ASC Topic 820, is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. A fair value measurement assumes that the transaction to sell the asset or transfer the liability occurs in the principal market for the asset or liability or, in the absence of a principal market, the most advantageous market for the asset or liability. The price in the principal (or most advantageous) market used to measure the fair value of the asset or liability is not adjusted for transaction costs. An orderly transaction is a transaction that assumes exposure to the market for a period prior to the measurement date to allow for market activities that are usual and customary for transactions involving such assets or liabilities; it is not a forced transaction. Market participants are buyers and sellers in the principal market that are (i) independent, (ii) knowledgeable, (iii) able to transact and (iv) willing to transact.

 

The Company utilizes fair value measurements to record fair value adjustments to certain assets and to determine fair value disclosures. Fair value is used on a recurring basis for Available for Sale Securities. Additionally, fair value is used on a non-recurring basis to evaluate assets or liabilities for impairment or for disclosure purposes. Examples of these non-recurring uses of fair value include certain loans held for sale accounted for on a lower of cost or market basis. Depending on the nature of the asset or liability, the Company uses various valuation techniques and assumptions when estimating fair value.

 

The Company applied the following fair value hierarchy:

 

Level 1 – Inputs to the valuation methodology are quoted prices (unadjusted) for identical assets or liabilities in active markets. The Company’s mutual fund investments where quoted prices are available in an active market generally are classified within Level 1 of the fair value hierarchy.

 

Level 2 – Inputs to the valuation methodology include quoted prices for similar assets and liabilities in active markets and inputs that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the financial instrument. The Company’s borrowed funds and investments in U.S. government agency securities, government sponsored mortgage backed securities, corporate debt securities, and obligations of states and political subdivisions are generally classified in Level 2 of the fair value hierarchy. Fair values for these instruments are estimated using pricing models, quoted prices of securities with similar characteristics, or discounted cash flows.

 

Level 3 – Inputs to the valuation methodology are unobservable and significant to the fair value measurement. Private equity investments and trust preferred collateralized debt obligations are classified within Level 3 of the fair value hierarchy. Fair values are initially valued based on transaction price and are adjusted to reflect exit values.

  

 

The following tables present information about the Company’s financial assets and liabilities measured at fair value on a recurring basis at June 30, 2015 and December 31, 2014, and the valuation techniques used by the Company to determine those fair values.

 

																		Total
		Carrying																Estimated
June 30, 2015		Value				Level 1				Level 2				Level 3				Fair Value
Financial Assets:
Cash and due from banks		$	23,573			$	23,573			$	-			$	-			$	23,573
Securities - Held to Maturity
Obligations of States and Political Subdivisions			34,777				-				35,573				-				35,573
Corporate Debt Securities			500				-				500				-				500
Securities - Available for Sale
Obligations of U.S. Government Agencies			360,739				-				360,739				-				360,739
MBS issued by U.S. Government Agencies			116,121				-				116,121				-				116,121
Obligations of States and Political Subdivisions			17,709				-				17,709				-				17,709
Corporate Debt Securities			7,001				-				7,001				-				7,001
Other Securities			2,133				2,133				-				-				2,133
Federal Home Loan Bank Stock			4,148				-				4,148				-				4,148
Loans Held for Sale			1,602				-				-				1,638				1,638
Loans, net			610,491				-				-				620,207				620,207
Accrued Interest Receivable			4,006				-				-				4,006				4,006
Financial Liabilities:
Noninterest Bearing Deposits			238,164				238,164				-				-				238,164
Interest Bearings Deposits			883,116				-				884,991				-				884,991
Repurchase Agreements			15,000				-				15,568				-				15,568
Accrued Interest Payable			123				-				-				123				123

 

 

																		Total
		Carrying																Estimated
December 31, 2014		Value				Level 1				Level 2				Level 3				Fair Value
Financial Assets:
Cash and due from banks		$	52,122			$	52,122			$	-			$	-			$	52,122
Securities - Held to Maturity
Obligations of States and Political Subdivisions			32,113				-				33,331				-				33,331
Corporate Debt Securities			500				-				500				-				500
Securities - Available for Sale
Obligations of U.S. Government Agencies			342,048				-				342,048				-				342,048
MBS issued by U.S. Government Agencies			105,406				-				105,406				-				105,406
Obligations of States and Political Subdivisions			19,581				-				19,581				-				19,581
Corporate Debt Securities			4,002				-				4,002				-				4,002
Other Securities			2,139				2,139				-				-				2,139
Federal Home Loan Bank Stock			7,537				-				7,537				-				7,537
Loans Held for Sale			548				-				-				560				560
Loans, net			597,124				-				-				608,109				608,109
Accrued Interest Receivable			3,943				-				-				3,943				3,943
Financial Liabilities:
Noninterest Bearing Deposits			218,221				218,221				-				-				218,221
Interest Bearings Deposits			893,590				-				895,522				-				895,522
Repurchase Agreements			15,000				-				15,828				-				15,828
Accrued Interest Payable			137				-				-				137				137

  

  

In instances where inputs used to measure fair value fall into different levels in the above fair value hierarchy, fair value measurements in their entirety are categorized based on the lowest level input that is significant to the valuation. The Company’s assessment of the significance of particular inputs to these fair value measurements requires judgment and considers factors specific to each asset.

 

The changes in Level 3 assets measured at fair value on a recurring basis were (000’s omitted):

 

Investment Securities - Available for Sale		2015				2014
Balance at January 1		$	-			$	5,751
Total realized and unrealized losses included in income			-				(21	)
Total unrealized gains included in other comprehensive income			-				362
Net purchases, sales, calls and maturities			-				(125	)
Net transfers in/out of Level 3			-				-
Balance at June 30		$	-			$	5,967

 

The Company did not have any sales or purchases of Level 3 available for sale securities during the period. The Company sold all of its Level 3 Available for Sale securities in the second and third quarters of 2014.

 

Both observable and unobservable inputs may be used to determine the fair value of positions classified as Level 3 assets. As a result, the unrealized gains and losses for these assets presented in the tables above may include changes in fair value that were attributable to both observable and unobservable inputs.

 

The Company also has assets that under certain conditions are subject to measurement at fair value on a nonrecurring basis. These assets include loans and Other Real Estate Owned. The Company estimated the fair values of these assets using Level 3 inputs, specifically discounted cash flow projections.

 

Assets measured at fair value on a nonrecurring basis are as follows (000’s omitted):

  

		Balance at June 30, 2015				Quoted Prices in Active Markets for Identical Assets (Level 1)				Significant Other Observable Inputs (Level 2)				Significant Unobservable Inputs (Level 3)
Impaired loans		$	33,445			$	-			$	-			$	30,663
Other Real Estate Owned		$	4,233			$	-			$	-			$	4,233

 

 

		Balance at December 31, 2014				Quoted Prices in Active Markets for Identical Assets (Level 1)				Significant Other Observable Inputs (Level 2)				Significant Unobservable Inputs (Level 3)
Impaired loans		$	35,670			$	-			$	-			$	32,015
Other Real Estate Owned		$	5,615			$	-			$	-			$	5,615

  

Impaired loans categorized as Level 3 assets consist of non-homogenous loans that are considered impaired. The Company estimates the fair value of the loans based on the present value of expected future cash flows using management’s best estimate of key assumptions. These assumptions include future payment ability, timing of payment streams, and estimated realizable values of available collateral (typically based on outside appraisals). Other Real Estate Owned (OREO) consists of property received in full or partial satisfaction of a receivable. The Company utilizes independent appraisals to estimate the fair value of OREO properties.

  

 

8. FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK

 

The Bank is a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit and standby letters of credit. Those instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the consolidated statements of condition.

 

The Bank’s exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit and standby letters of credit is represented by the contractual amount of those instruments. The Bank uses the same credit policies in making commitments and conditional obligations as it does for its other lending activities.

 

Financial instruments whose contractual amounts represent off-balance sheet credit risk were as follows (000s omitted):

 

 

		Contractual Amount
		June 30, 2015				December 31, 2014
Commitments to extend credit:
Unused portion of commercial lines of credit		$	65,825			$	66,319
Unused portion of credit card lines of credit			3,996				3,630
Unused portion of home equity lines of credit			20,972				19,544
Standby letters of credit and financial guarantees written			3,136				3,178
All other off-balance sheet commitments			-				-

 

Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Most commercial lines of credit are secured by real estate mortgages or other collateral, and generally have fixed expiration dates or other termination clauses. Since the lines of credit may expire without being drawn upon, the total committed amounts do not necessarily represent future cash requirements. Credit card lines of credit have various established expiration dates, but are fundable on demand. Home equity lines of credit are secured by real estate mortgages, a majority of which have ten year expiration dates, but are fundable on demand. The Bank evaluates each customer’s creditworthiness on a case-by-case basis. The amount of the collateral obtained, if deemed necessary by the Bank upon extension of credit, is based on Management’s credit evaluation of the counterparty.

 

Standby letters of credit written are conditional commitments issued by the Bank to guarantee the performance of a customer to a third party. Those guarantees are primarily issued to support public and private borrowing arrangements and other business transactions.

 

 

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

 

Introduction

MBT Financial Corp. (the “Company”) is a bank holding company with one commercial bank subsidiary, Monroe Bank & Trust (“the Bank”). The Bank operates 17 branch offices in Monroe County, Michigan and 7 branch offices in Wayne County, Michigan, and a loan and wealth management office in Lenawee County, Michigan. The Bank’s primary source of income is interest income on its loans and investments and its primary expense is interest expense on its deposits and borrowings. The discussion and analysis should be read in conjunction with the accompanying consolidated statements and footnotes.

 

 

Executive Overview

The Bank is operated as a community bank, primarily providing loan, deposit, and wealth management products and services to the people, businesses, and communities in its market area. In addition to our commitment to our mission of serving the needs of our local communities, we are focused on improving asset quality, increasing net interest income, and improving non-interest income and expenses.

 

The net profit of $2,285,000 for the quarter ended June 30, 2015 was an increase of $598,000 or 35.4% compared to the second quarter of 2014. The increase was the result of improvement in net interest income, non interest income, non interest expense, and a lower provision for loan losses. These improvements resulted in increases in income before taxes and in federal income tax expense. This quarter marked the sixteenth consecutive quarterly profit following significant losses caused by the severe economic downturn that impacted the regional and national economies beginning in 2006.

 

The national economic recovery is continuing, and the recovery in southeast Michigan is strong. Local unemployment rates continued to improve, and total employment is also growing. Commercial and residential development property values continue to improve, with some values reaching or exceeding their pre-recession levels. Our total classified assets, which include internal watch list loans, other real estate owned, and non-performing and watch list investment securities, improved significantly during 2014 and this trend of improvement is continuing through the first half of 2015. Classified assets went down $5.4 million, or 10.4% during the second quarter of 2015, and decreased $34.8 million or 43.0% compared to a year ago. Loan recoveries decreased in the second quarter of 2015, but net charge offs for the quarter remained low at 0.07% of loans, annualized. Due to the low charge offs and improving loan quality metrics, we did not need to record a provision expense to maintain an appropriate Allowance for Loan and Lease Losses (ALLL). The loan portfolio held for investment increased slightly during the quarter, and the ALLL as a percent of loans decreased from 2.13% to 2.09%. We will continue to assess the adequacy of our ALLL each quarter, and adjust it as necessary by debiting or crediting the provision expense.

 

Net Interest Income increased $529,000, or 6.2% compared to the second quarter of 2014 even though the net interest margin decreased from 3.15% to 3.12% as the average earning assets increased $76.7 million. The net interest margin decreased because the yield on earnings assets decreased more than the cost of interest bearing liabilities as interest rates remain at historically low levels. The provision for loan losses decreased $100,000 compared to the second quarter of 2014 as we were able to maintain an adequate ALLL without recording a provision expense this quarter. Non-interest income for the quarter increased $221,000, primarily due to a decrease in the losses on Other Real Estate Owned. Non-interest expenses decreased $61,000, as salaries and employee benefits, occupancy, OREO expense, FDIC deposit insurance assessments, and insurance expenses decreased. These decreases were partially offset by increases in equipment and marketing expenses that were related to some product changes and enhancements. We expect non-interest expenses to remain near the current level throughout the second half of 2015.

  

  

Critical Accounting Policies

The Company’s Allowance for Loan Losses, Fair Value of Investment Securities, and Other Real Estate Owned are “critical accounting estimates” because they are estimates that are based on assumptions that are highly uncertain, and if different assumptions were used or if any of the assumptions used were to change, there could be a material impact on the presentation of the Company’s financial condition. These assumptions include, but are not limited to, collateral values, the effect of economic conditions on the financial condition of the borrowers, the Company, and the issuers of investment securities, market interest rates, and projected earnings for the Company.

 

To determine the Allowance for Loan Losses, the Company estimates losses on all loans that are not classified as non accrual or renegotiated by applying historical loss rates, adjusted for current conditions, to those loans. In addition, all non accrual loan relationships over $250,000 that are classified by Management as nonperforming as well as selected performing accounts and all renegotiated loans are individually tested for impairment. Any amount of monetary impairment is included in the Allowance for Loan Losses.

 

To determine the fair value of investment securities, the Company utilizes quoted prices in active markets for identical assets, quoted prices for similar assets in active markets, or discounted cash flow calculations for investments where there is little, if any, market activity for the asset.

 

To determine the fair value of Other Real Estate Owned, the Company utilizes independent appraisals to estimate the fair value of the property.

 

Financial Condition

The pace of the regional economic recovery has increased over the last year, with local unemployment and property values steadily improving throughout 2014 and the first half of 2015. Management efforts are focused on improving asset quality, increasing net interest income, and improving non-interest income and expenses.

 

With respect to asset quality, our nonperforming assets (“NPAs”) decreased 4.6% during the quarter, from $40.0 million to $38.2 million, and total classified assets decreased 10.4% from $51.6 million to $46.2 million. Loan delinquencies increased from 1.3% to 1.4% during the quarter, but remain below the 1.9% total at the end of 2014 and the 2.0% total reported one year ago. Over the last twelve months, NPAs decreased $21.9 million, or 36.4%, with nonperforming loans decreasing 30.3% from $48.7 million to $33.9 million, and Other Real Estate Owned (“OREO”) decreasing 46.6% from $7.9 million to $4.2 million. Total classified assets, which include internally classified watch list loans, other real estate, and watch list investment securities, decreased $34.8 million, or 43.0%. The Company’s Allowance for Loan and Lease Losses (“ALLL”) decreased $1.9 million over the last four quarters in spite of growth in the loan portfolio because of the improvement in the quality of the assets in the loan portfolio and a decrease in the historical loss rates. The ALLL is now 2.09% of loans, down from 2.50% at June 30, 2014. The ALLL is 38.53% of nonperforming loans (“NPLs”), compared to 36.74% at year end and 30.80% at June 30, 2014. In light of current economic conditions, we believe that this level of ALLL adequately estimates the potential losses in the loan portfolio.

  

 

Since December 31, 2014, total loans held for investment increased 2.2% as new loan activity in the first half of 2015 was strong enough to cover payments received and other reductions in the period. Our pipeline of loans in process remains steady, and we expect new loan production to continue to exceed run off, resulting in an increase in loans outstanding, in the next few quarters.

 

Since December 31, 2014, deposits increased $9.5 million, other liabilities decreased $0.4 million and capital increased $4.3 million, and as a result our total assets increased $13.4 million, or 1.1%. The Company expects minimal deposit funding growth for the remainder of the year as expected growth in local deposits will be offset by the maturity of $5.1 million in brokered certificates of deposit early in the third quarter. The composition of deposits continues to change as customers move funds from maturing interest accounts to non interest bearing demand deposit accounts due to the low interest rate environment. The expected loan growth will be funded by reductions in our cash and investments. The increase in total capital during the first half of 2015 was due to the profit of $5.1 million, reduced by the $0.9 million decrease in the accumulated other comprehensive income (AOCI). AOCI decreased mainly due to a decrease in the value of our securities available for sale. Capital increased at a higher rate than assets, causing the capital to assets ratio to increase from 10.52% at December 31, 2014 to 10.75% at June 30, 2015.

 

Results of Operations – Second Quarter 2015 vs. Second Quarter 2014

Net Interest Income - A comparison of the income statements for the three months ended June 30, 2015 and 2014 shows an increase of $529,000, or 6.2%, in Net Interest Income. Interest income on loans increased $133,000 or 1.9% even though the average yield on loans decreased from 4.71% to 4.62% as the average loans outstanding increased $22.6 million. The loan yield decreased this quarter due to the continued low interest rates while loans outstanding increased due to improving economic conditions and increased purchases of loan participations. The interest income on investments, fed funds sold, and interest bearing balances due from banks increased $204,000 even though the yield decreased from 1.99% to 1.94% because the average amount of investments, fed funds sold, and interest bearing balances due from banks increased $54.1 million. The Company continues to maintain a very high liquidity position by keeping a large amount of funds in low yielding short term investments and deposits in the Federal Reserve Bank. The interest expense on deposits decreased $182,000 or 22.7% even though the average deposits increased $62.8 million because the average cost of deposits decreased from 0.30% to 0.22%. The average cost of deposits decreased because maturing time deposits are either resetting at lower rates or customers are moving the funds to non interest bearing demand deposit accounts due to the low interest rate environment. The cost of borrowed funds decreased $10,000 as the average amount of borrowed funds decreased $10.2 million.

 

Provision for Loan Losses - The Provision for Loan Losses decreased $100,000 compared to the second quarter of 2014 as no provision expense was recorded in the second quarter of 2015. We charged off $407,000 of principal while recovering $295,000 of previously charged off loans in the second quarter of 2015, for a net charge off total of $112,000. Each quarter, the Company conducts a review and analysis of its ALLL to determine its adequacy. This analysis involves specific allocations for impaired credits and a general allocation for losses expected based on historical experience adjusted for current conditions. Due to an improvement in portfolio risk indicators and a decrease in the historical loss percentages, the amount of ALLL required at the end of the second quarter of 2015 decreased from $13.2 million at December 31, 2014 to approximately $13.1 million. This allowed us to recognize the net charge offs without recording a provision expense. The ALLL is 2.09% of loans as of June 30, 2015, and, in light of current economic conditions, we believe that at this level the ALLL adequately estimates the potential losses in our loan portfolio.

  

 

Other Income – Non interest income increased $221,000, or 6.2% compared to the second quarter of 2014. Excluding gains and losses on securities and other real estate owned activity, non-interest income increased $97,000, or 2.6%. Wealth management income increased $23,000 or 2.0% as the market value of assets managed increased due to new assets brought in and market value appreciation. Service charges and other fees on deposit accounts increased $62,000, or 6.4% as we added new features and benefits to our primary checking account product and instituted a monthly service fee. Debit card income increased $49,000, or 9.0% and origination fees on mortgage loans sold increased $49,000, or 55.7%, both due to increased activity. Gains on securities transactions decreased $197,000 due to gains in the second quarter of 2014. Income from other real estate activity improved $321,000, due to losses and write downs of the carrying values properties in the second quarter of 2014.

 

Other Expenses – Total non-interest expenses decreased $61,000, or 0.6% compared to the second quarter of 2014. Salaries and Employee Benefits decreased $54,000, or 0.9%, even though the officer incentive compensation accrual increased $80,000 because the decrease in the number of full time equivalent employees from 367 in the second quarter of 2014 to 350 in the second quarter of 2015 resulted in lower salaries and benefits expenses. Improving operational efficiency is one of Management’s key objectives this year, and further reductions in staffing are expected in the second half of 2015. Occupancy expense decreased $64,000, or 9.6% due to lower depreciation, utilities, and maintenance and repairs costs. Equipment expense went up $128,000, or 19.3% primarily due to higher computer expenses. Other real estate owned expense went down $182,000, or 50.4% due to a decrease in the number of properties owned. FDIC insurance assessments decreased $191,000 as the termination of our consent order in the second quarter of 2014 resulted in a decrease in the assessment rate. Other expense increased $200,000, or 34.4% due to higher ATM expenses, directors’ fees, and training and education expenses.

 

As a result of the above activity, the Profit Before Income Taxes in the second quarter of 2015 was $3,156,000, an increase of $911,000 compared to the pre-tax profit of $2,245,000 in the second quarter of 2014. The Company recorded a federal income tax expense of $871,000 in the second quarter of 2015, reflecting an effective tax rate of 27.6%, compared to the tax expense of $558,000 in the second quarter of 2014, which reflected an effective rate of 24.9%. The increase in the effective tax rate was the result of the decrease in the percentage of operating income that was from municipal investments and bank owned life insurance. The Net profit for the second quarter of 2015 was $2,285,000, an increase of 35.4% compared to the net profit of $1,687,000 in the second quarter of 2014.

 

Results of Operations – Six Months Ended June 30, 2015 vs. Six Months Ended June 30, 2014

Net Interest Income - A comparison of the income statements for the six months ended June 30, 2015 and 2014 shows an increase of $1,376,000, or 8.1%, in Net Interest Income. Interest income on loans increased $486,000 or 3.4% as the average yield on loans was unchanged at 4.76% and the average loans outstanding increased $20.9 million. The loan yield was unchanged this year even though market rates are lower due to the recovery of interest on a charged off loan in the first quarter of 2015. The interest income on investments, fed funds sold, and interest bearing balances due from banks increased $476,000 even though the yield decreased from 1.98% to 1.96% because the average amount of investments, fed funds sold, and interest bearing balances due from banks increased $55.3 million. The Company continues to maintain a very high liquidity position by keeping a large amount of funds in low yielding short term investments and deposits in the Federal Reserve Bank. The interest expense on deposits decreased $392,000 or 23.7% even though the average deposits increased $60.7 million because the average cost of deposits decreased from 0.31% to 0.23%. The cost of borrowed funds decreased $22,000 as the average amount of borrowed funds decreased $11.1 million.

  

 

Provision for Loan Losses - The Provision for Loan Losses decreased $1,000,000 compared to the first six months of 2014 as a small provision of $200,000 was recorded in 2014 and a negative provision expense of $800,000 was recorded in 2015 due to the recovery of a previously charged off loan that occurred in the first half of 2015. Each quarter, the Company conducts a review and analysis of its ALLL to determine its adequacy. This analysis involves specific allocations for impaired credits and a general allocation for losses expected based on historical experience adjusted for current conditions. Due to an improvement in portfolio risk indicators and a decrease in the historical loss percentages, the amount of ALLL required at June 30, 2015 decreased to $13.1 million from the $15.0 million required at June 30, 2014. The ALLL is 2.09% of loans as of June 30, 2015, compared to 2.50% at June 30, 2014, and in light of current economic conditions, we believe that the ALLL adequately estimates the potential losses in our loan portfolio.

 

Other Income – Non interest income increased $182,000, or 2.5% compared to the first six months of 2014. Excluding gains and losses on securities and other real estate owned activity, non-interest income increased $154,000, or 2.1%. Wealth management income increased $111,000 or 4.8% as the market value of assets managed increased due to new assets brought in and market value appreciation. Debit card income increased $124,000, or 12.0% and origination fees on mortgage loans sold increased $116,000, or 77.3%, both due to increased activity.

 

Other Expenses – Total non-interest expenses increased $59,000, or 0.3% compared to the first six months of 2014. Salaries and Employee Benefits increased $92,000, or 0.8%, as the officer incentive compensation accrual increased $160,000. This increase was mitigated by decreases in salaries and benefits expenses that were the result of the decrease in the number of full time equivalent employees from 367 in 2014 to 350 in 2015. Improving operational efficiency is one of Management’s key objectives this year, and further reductions in staffing are expected in the second half of 2015. Equipment expense went up $245,000, or 19.2% due to higher computer expenses and one-time costs related to the conversion of the system used for our bill payment service in 2015. Marketing expense increased $139,000, or 33.5% due to increased advertising and expenses related to enhancing our main checking account product. Professional fees increased $187,000, or 19.9% due to higher legal, accounting, and consulting fees. Other real estate owned expense went down $395,000, or 56.4% due to the sale of some of our high maintenance cost properties in the second half of 2014. FDIC insurance assessments decreased $417,000 as the termination of our consent order in the second quarter of 2014 resulted in a decrease in the assessment rate. Other expense increased $301,000, or 25.4% due to higher ATM expenses, directors’ fees, and training and education expenses.

 

As a result of the above activity, the Profit Before Income Taxes in the first half of 2015 was $7,104,000, an increase of $2,499,000 compared to the pre-tax profit of $4,605,000 in the first six months of 2014. The Company recorded a federal income tax expense of $2,042,000 in the first six months of 2015, reflecting an effective tax rate of 28.7%, compared to the tax expense of $1,151,000 in the first six months of 2014, which reflected an effective rate of 25.0%. The increase in the effective tax rate was the result of the decrease in the percentage of operating income that was from municipal investments and bank owned life insurance. The Net profit for the first six months of 2015 was $5,062,000, an increase of 46.6% compared to the net profit of $3,454,000 in the first half of 2014.

  

 

Cash Flows

Cash flows provided by operating activities increased $1,337,000 compared to the first six months of 2014 due to the increase of $1,608,000 in net income. Cash flows used for investing activities increased by $12.2 million from $32.4 million in the first six months of 2014 to $44.6 million in the first six months of 2015 as the additional cash from operations and financing activities was invested in loans and investment securities. Loan growth used $8.4 million more cash in the first six months of 2015 than it did in the first six months of 2014 as loan portfolio growth accelerated this year due to improving economic conditions and increased use of loan participations. The amount of cash used to purchase investment securities exceeded the cash provided by investment sales, redemptions, and maturities in both periods. In the first six months of 2014, the cash used for investment purchases was the result of the Company’s effort to improve its interest income by investing its excess cash. In the first six months of 2015, the cash used for investment purchases was also provided by deposit growth. The amount of cash provided by financing activities in the first six months of 2015 was $9.5 million as the deposit funding increased by that amount. In the first six months of 2014, $23.9 million of cash was used for financing activities due to the decrease of $19.9 million in deposits and the repayment of $12.0 million in advances from the Federal Home Loan Bank of Indianapolis, partially offset by $8.1 million of cash provided by the issuance of nearly 2.1 million shares of common stock. In the first six months of 2015, the use of cash for investing activities exceeded the cash provided by operations and financing activities by $28.5 million, resulting in a decrease of that amount in cash and cash equivalents during the six months. In the first six months of 2014, the use of cash for investing and financing activities exceeded the small amount provided by operations, and the amount of cash and cash equivalents decreased by $51.1 million during the period.

 

Liquidity and Capital

The Company believes it has sufficient liquidity to fund its lending activity and allow for fluctuations in deposit levels. Internal sources of liquidity include the maturities of loans and securities in the ordinary course of business as well as our available for sale securities portfolio. External sources of liquidity include a line of credit with the Federal Home Loan Bank of Indianapolis, the Federal funds line that has been established with our correspondent bank, and Repurchase Agreements with money center banks that allow us to pledge securities as collateral for borrowings. As of June 30, 2015, the Bank was not utilizing any of its authorized limit of $255 million with the Federal Home Loan Bank of Indianapolis, or its $20 million overdraft line of credit with the Federal Home Loan Bank of Indianapolis, or its $25 million federal funds line with a correspondent bank. The Company periodically draws on its overdraft and fed funds lines to ensure that funding will be available if needed.

 

The Company’s Funds Management Policy includes guidelines for desired amounts of liquidity and capital. The Funds Management Policy also includes contingency plans for liquidity and capital that specify actions to take if liquidity and capital ratios fall below the levels contained in the policy. Throughout the first six months of 2015 the Company was in compliance with its Funds Management Policy regarding liquidity and capital.

 

Total stockholders’ equity of the Company was $138.9 million at June 30, 2015 and $134.5 million at December 31, 2014. Common stock increased $233,000 due to the issuance of stock under compensation programs and for our Employee Stock Purchase Plan, retained earnings increased $5.1 million due to the year to date profit, and the Accumulated Other Comprehensive Loss (AOCL) increased $0.9 million due to a decrease in the value of our securities that are classified as Available For Sale. Total equity increased $4.3 million and total assets increased $13.4 million, so the ratio of equity to assets increased from 10.52% at December 31, 2014 to 10.75% at June 30, 2015.

 

Federal bank regulatory agencies have set capital adequacy standards for Total Risk Based Capital, Tier 1 Risk Based Capital, and Leverage Capital. These standards require banks to maintain Leverage and Tier 1 ratios of at least 4% and a Total Capital ratio of at least 8% to be adequately capitalized. The regulatory agencies consider a bank to be well capitalized if its Total Risk Based Capital is at least 10% of Risk Weighted Assets, Tier 1 Capital is at least 8% of Risk Weighted Assets, and the Leverage Capital Ratio is at least 5%. The Basel III capital requirements that are being phased in beginning in the first quarter of 2015 increased the well capitalized requirement for the Tier 1 Capital as a percent of Risk Weighted Assets from 6% to 8%. Basel III also implemented the new Common Equity Tier 1 Capital to Risk Weighted Assets ratio, with a minimum of 6.5% required to be considered well capitalized.

  

 

The following table summarizes the capital ratios of the Company and the Bank:

 

 

		Actual								Minimum to Qualify as Well Capitalized
		Amount				Ratio				Amount				Ratio
As of June 30, 2015:
Total Capital to Risk-Weighted Assets
Consolidated		$	145,813				18.55	%		$	78,597				10.0	%
Monroe Bank & Trust			144,165				18.35	%			78,552				10.0	%
Tier 1 Capital to Risk-Weighted Assets
Consolidated			135,855				17.29	%			62,878				8.0	%
Monroe Bank & Trust			134,216				17.09	%			62,842				8.0	%
Common Equity Tier 1 Capital to
Risk-Weighted Assets
Consolidated			135,855				17.29	%			51,088				6.5	%
Monroe Bank & Trust			134,216				17.09	%			51,059				6.5	%
Tier 1 Capital to Average Assets
Consolidated			135,855				10.56	%			64,343				5.0	%
Monroe Bank & Trust			134,216				10.43	%			64,323				5.0	%

 

 

		Actual								Minimum to Qualify as Well Capitalized
		Amount				Ratio				Amount				Ratio
As of December 31, 2014:
Total Capital to Risk-Weighted Assets
Consolidated		$	129,032				17.22	%		$	74,917				10.0	%
Monroe Bank & Trust			127,400				17.01	%			74,895				10.0	%
Tier 1 Capital to Risk-Weighted Assets
Consolidated			119,573				15.96	%			44,950				6.0	%
Monroe Bank & Trust			117,944				15.75	%			44,937				6.0	%
Tier 1 Capital to Average Assets
Consolidated			119,573				9.68	%			61,731				5.0	%
Monroe Bank & Trust			117,944				9.55	%			61,721				5.0	%

  

The Bank had entered into a Consent Order with its state and federal regulators on July 12, 2010. Following the termination of the Consent Order on June 30, 2014, the Bank became subject to certain informal regulatory requirements and restrictions, including, among other things, requirements to maintain a Tier 1 leverage ratio of at least 9%, continue to reduce classified and delinquent assets, continually monitor its progress, and submit quarterly progress reports to the regulators. The informal agreement also required the Bank to request prior approval from its state and federal regulators before paying dividends to the Company. This informal agreement was terminated in the second quarter of 2015. However, the Company currently remains subject to a requirement to request prior approval from the Federal Reserve System in connection with any payment of dividends by it to its shareholders.

  

 

Market risk for the Bank, as is typical for most banks, consists mainly of interest rate risk and market price risk. The Bank’s earnings and the economic value of its equity are exposed to interest rate risk and market price risk, and monitoring this risk is the responsibility of the Asset/Liability Management Committee (ALCO) of the Bank. The Bank’s market risk is monitored quarterly and it has not changed significantly since year-end 2014.

 

Internal Revenue Service Audit

Since the fourth quarter of 2010, the Internal Revenue Service (IRS) has been conducting an audit of our tax returns for the 2004, 2005, 2007, 2008, 2009, and 2010 tax years. The Company recorded a tax liability in the second quarter of 2012 to reflect the amount of a settlement offer that the Company proposed to the IRS in an attempt to resolve the audit. Based on current knowledge, the Company believes that the accrued tax liability is adequate to absorb the effect relating to the ultimate resolution of the uncertain tax positions challenged by the IRS.

 

Although the timing of the resolution and/or closure of the audit remains highly uncertain, the Company and the IRS have recently made progress toward resolution and the Company believes it is reasonably possible that the IRS will conclude this audit within the current year. Management will re-evaluate the estimated potential federal income tax payable noted above each quarter based on current, relevant facts.

 

Forward-Looking Statements

Certain statements contained herein are not based on historical facts and are "forward-looking statements" within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Forward-looking statements which are based on various assumptions (some of which are beyond the Company's control), may be identified by reference to a future period or periods, or by the use of forward-looking terminology, such as "may," "will," "believe," "expect," "estimate," "anticipate," "continue," or similar terms or variations on those terms, or the negative of these terms. Actual results could differ materially from those set forth in forward-looking statements, due to a variety of factors, including, but not limited to, those related to the economic environment, particularly in the market areas in which the Company operates, competitive products and pricing, fiscal and monetary policies of the U.S. Government, changes in government regulations affecting financial institutions, including regulatory fees and capital requirements, changes in prevailing interest rates, acquisitions and the integration of acquired businesses, credit risk management, asset/liability management, changes in the financial and securities markets, including changes with respect to the market value of our financial assets, the availability of and costs associated with sources of liquidity, and the ability of the Company to resolve or dispose of problem loans.

 

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

 

 

Item 3. Quantitative and Qualitative Disclosures about Market Risk

 

The Bank faces market risk to the extent that the fair values of its financial instruments are affected by changes in interest rates. The Bank does not face market risk due to changes in foreign currency exchange rates, commodity prices, or equity prices. The asset and liability management process of the Bank seeks to monitor and manage the amount of interest rate risk. This is accomplished by analyzing the differences in repricing opportunities for assets and liabilities, by simulating operating results under varying interest rate scenarios, and by estimating the change in the net present value of the Bank’s assets and liabilities due to interest rate changes.

 

 

Each quarter, the Asset and Liability Committee (ALCO), which includes the senior management of the Bank and a non executive member of the board of directors, estimates the effect of interest rate changes on the projected net interest income of the Bank. The sensitivity of the Bank’s net interest income to changes in interest rates is measured by using a computer based simulation model to estimate the impact on earnings of both gradual and sudden increases of 100, 200, 300, and 400 basis points and decreases of 100 and 200 basis points in the interest rates. The net interest income projections are compared to a base case projection, which assumes no changes in interest rates.

 

The Bank’s ALCO has established limits in the acceptable amount of interest rate risk, as measured by the change in the Bank’s projected net interest income, in its policy. Throughout the first two quarters of 2015, the Bank’s interest rate risk has remained within its policy limits.

 

The ALCO also monitors interest rate risk by estimating the effect of changes in interest rates on the economic value of the Bank’s equity each quarter. The economic value of the Bank’s equity is first determined by subtracting the fair value of the Bank’s liabilities from the fair value of the Bank’s assets. The Bank estimates the interest rate risk by calculating the effect of market interest rate changes on that economic value of its equity. For this analysis, the Bank assumes immediate parallel shifts of plus 100, 200, 300, and 400 basis points and minus 100 and 200 basis points in interest rates. The discount rates used to determine the present values of the loans and deposits, as well as the prepayment rates for the loans, are based on Management’s expectations of the effect of the rate changes on the market for loans and deposits. In addition, each quarter, the Bank conducts additional analyses that utilize other rate scenarios, such as larger shifts in rates and changes in the shape of the yield curve, to assess the Bank’s exposure to interest rate risk in stress scenarios.

 

The Bank’s interest rate risk, as measured by the net interest income and economic value of equity simulations, has not changed significantly from December 31, 2014.

 

Item 4. Controls and Procedures

The Company carried out an evaluation, under the supervision and with the participation of the Company's management, including the Company's Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Company's disclosure controls and procedures as of June 30, 2015, pursuant to Exchange Act Rule 13a-15. Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the Company's disclosure controls and procedures were effective as of June 30, 2015, in alerting them in a timely manner to material information relating to the Company (including its consolidated subsidiaries) required to be included in the Company's periodic SEC filings.

 

There was no change in the Company’s internal control over financial reporting that occurred during the Company’s fiscal quarter ended June 30, 2015, that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

 

 

Part II Other Information

  

Item 1. Legal Proceedings

MBT Financial Corp. and its subsidiaries are not a party to, nor is any of their property the subject of any material legal proceedings other than ordinary routine litigation incidental to their respective businesses, nor are any such proceedings known to be contemplated by governmental authorities.

  

 

Item 1A. Risk Factors

Due to an increase in cyber security events affecting the financial services industry globally, the Company has identified an additional risk factor to those risk factors disclosed by the Company in its Report on Form 10-K for the fiscal year ended December 31, 2014.

 

We face the risk of cyber-attack to our computer systems.

Our computer systems, software and networks have been and will continue to be vulnerable to unauthorized access, loss or destruction of data (including confidential client information), account takeovers, unavailability of service, computer viruses or other malicious code, cyber-attacks and other events. These threats may derive from human error, fraud or malice on the part of employees or third parties, or may result from accidental technological failure. If one or more of these events occurs, it could result in the disclosure of confidential client information, damage to our reputation with our clients and the market, additional costs to us (such as repairing systems or adding new personnel or protection technologies), regulatory penalties and financial losses, to both us and our clients and customers. Such events could also cause interruptions or malfunctions in our operations (such as the lack of availability of our online banking system), as well as the operations of our clients, customers or other third parties. Although we maintain safeguards to protect against these risks, there can be no assurance that we will not suffer losses in the future that may be material in amount.

 

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

None.

 

Item 3. Defaults Upon Senior Securities

None.

 

Item 4. Mine Safety Disclosures

None.

 

Item 5. Other Information

No matters to be reported.

  

 

Item 6. Exhibits

3.1

Articles of Incorporation of MBT Financial Corp. Previously filed as Exhibit 3.1 to MBT Financial Corp.’s Form 10-Q for its quarter ended June 30, 2011.

 

3.2

Amended and Restated Bylaws of MBT Financial Corp. Previously filed as Exhibit 3.2 to MBT Financial Corp.’s Form 10-Q for its quarter ended March 31, 2008.

 

10.1

MBT Financial Corp. 2008 Stock Incentive Plan, as amended effective May 28, 2015. Previously filed as Exhibit 10 to MBT Financial Corp.’s Form 8-K filed with the Commission on June 1, 2015.

 

31.1

Certification by Chief Executive Officer required by Securities and Exchange Commission Rule 13a-14.

 

31.2

Certification by Chief Financial Officer required by Securities and Exchange Commission Rule 13a-14.

 

32.1

Certification by Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as enacted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

 

32.2

Certification by Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as enacted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

 

101.INS     XBRL Instance Document

 

101.SCH     XBRL Taxonomy Extension Schema Document

 

101.CAL     XBRL Taxonomy Extension Calculation Linkbase Document

 

101.DEF     XBRL Taxonomy Extension Definition Linkbase Document

 

101.LAB     XBRL Taxonomy Extension Label Linkbase Document

 

101.PRE     XBRL Taxonomy Extension Presentation Linkbase Document

  

 

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.

 

		MBT Financial Corp.
		(Registrant)
August 10, 2015			By	/s/ H. Douglas Chaffin
Date		H. Douglas Chaffin
		President
		Chief Executive Officer
August 10, 2015			By	/s/ John L. Skibski
Date			John L. Skibski
			Executive Vice President and
			Chief Financial Officer

 

 

 

Exhibit Index

 

 

Exhibit Number	Description of Exhibits
31.1	Certification by Chief Executive Officer required by Securities and Exchange Commission Rule 13a-14.
31.2	Certification by Chief Financial Officer required by Securities and Exchange Commission Rule 13a-14.
32.1	Certification by Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as enacted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2	Certification by Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as enacted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
101.INS	XBRL Instance Document
101.SCH	XBRL Taxonomy Extension Schema Document
101.CAL	XBRL Taxonomy Extension Calculation Linkbase Document
101.DEF	XBRL Taxonomy Extension Definition Linkbase Document
101.LAB	XBRL Taxonomy Extension Label Linkbase Document
101.PRE	XBRL Taxonomy Extension Presentation Linkbase Document