Form 10-Q
Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-Q

 

 

(Mark One)

x Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934.

For the quarterly period ended June 30, 2010

 

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

For the transition period                      to                     

Commission File Number: 0-26486

 

 

Auburn National Bancorporation, Inc.

(Exact Name of Registrant as Specified in Its Charter)

 

 

 

Delaware   63-0885779

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification No.)

100 N. Gay Street

Auburn, Alabama 36830

(334) 821-9200

(Address and telephone number of principal executive offices)

 

(Former Name, Former Address and Former Fiscal Year, if Changed Since Last Report)

 

 

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

Yes  x             No  ¨

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

Yes  ¨             No  ¨

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

 

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

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

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

 

Class

 

Outstanding at July 30, 2010

Common Stock, $0.01 par value per share   3,642,693 shares

 

 

 


Table of Contents

AUBURN NATIONAL BANCORPORATION, INC. AND SUBSIDIARIES

INDEX

 

PART I. FINANCIAL INFORMATION

   PAGE

Item 1

   Financial Statements   
  

Condensed Consolidated Balance Sheets (Unaudited) as of June 30, 2010 and December 31, 2009

   3
  

Condensed Consolidated Statements of Earnings (Unaudited) for the quarter and six months ended June 30, 2010 and 2009

   4
  

Condensed Consolidated Statements of Stockholders’ Equity and Comprehensive Income (Unaudited) for the six months ended June 30, 2010 and 2009

   5
  

Condensed Consolidated Statements of Cash Flows (Unaudited) for the six months ended June 30, 2010 and 2009

   6
  

Notes to Condensed Consolidated Financial Statements

   7

Item 2

   Management’s Discussion and Analysis of Financial Condition and Results of Operations    23
  

Table 1 – Explanation of Non-GAAP Financial Measures

   40
  

Table 2 – Selected Quarterly Financial Data

   41
  

Table 3 – Selected Financial Data

   42
  

Table 4 – Average Balances and Net Interest Income Analysis – for the quarters ended June 30, 2010 and 2009

   43
  

Table 5 – Average Balances and Net Interest Income Analysis – for the six months ended June 30, 2010 and 2009

   44
  

Table 6 – Loan Portfolio Composition

   45
  

Table 7 – Allowance for Loan Losses and Nonperforming Assets

   46
  

Table 8 – Allocation of Allowance for Loan Losses

   47
  

Table 9 – CDs and Other Time Deposits of $100,000 or more

   48
Item 3    Quantitative and Qualitative Disclosures About Market Risk    49
Item 4    Controls and Procedures    49
PART II. OTHER INFORMATION   
Item 1    Legal Proceedings    50

Item 1A

   Risk Factors    50
Item 2    Unregistered Sales of Equity Securities and Use of Proceeds    50
Item 3    Defaults Upon Senior Securities    51
Item 4    Removed and Reserved    51
Item 5    Other Information    51
Item 6    Exhibits    51

 

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Table of Contents

PART 1. FINANCIAL INFORMATION

 

ITEM 1. FINANCIAL STATEMENTS

AUBURN NATIONAL BANCORPORATION, INC. AND SUBSIDIARIES

Condensed Consolidated Balance Sheets

(Unaudited)

 

(Dollars in thousands, except share data)   

June 30,

2010

    December 31,
2009
 
   

Assets:

    

Cash and due from banks

   $ 13,934      $ 11,567   

Federal funds sold

     10,365        —     

Interest bearing bank deposits

     1,009        828   
   

Cash and cash equivalents

     25,308        12,395   
   

Securities available-for-sale

     333,107        334,762   

Loans held for sale

     4,269        4,881   

Loans, net of unearned income

     376,624        376,103   

Allowance for loan losses

     (6,580     (6,495
   

Loans, net

     370,044        369,608   
   

Premises and equipment, net

     8,197        8,282   

Bank-owned life insurance

     15,951        15,719   

Other real estate

     6,341        7,292   

Other assets

     20,907        20,443   
   

Total assets

   $ 784,124      $ 773,382   
   
    

Liabilities:

    

Deposits:

    

Noninterest-bearing

   $ 86,509      $ 76,497   

Interest-bearing

     519,246        502,912   
   

Total deposits

     605,755        579,409   

Federal funds purchased and securities sold under agreements to repurchase

     2,151        15,960   

Long-term debt

     113,340        118,349   

Accrued expenses and other liabilities

     3,836        3,481   
   

Total liabilities

     725,082        717,199   
   
    

Stockholders’ equity:

    

Preferred stock of $.01 par value; authorized 200,000 shares; no issued shares

     —          —     

Common stock of $.01 par value; authorized 8,500,000 shares; issued 3,957,135 shares

     39        39   

Additional paid-in capital

     3,752        3,751   

Retained earnings

     60,720        58,917   

Accumulated other comprehensive income, net

     1,174        111   

Less treasury stock, at cost - 314,442 shares and 314,018 shares for June 30, 2010 and December 31, 2009, respectively

     (6,643     (6,635
   

Total stockholders’ equity

     59,042        56,183   
   

Total liabilities and stockholders’ equity

   $     784,124      $ 773,382   
   

See accompanying notes to condensed consolidated financial statements

 

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AUBURN NATIONAL BANCORPORATION, INC. AND SUBSIDIARIES

Condensed Consolidated Statements of Earnings

(Unaudited)

 

     Quarter ended June 30     Six months ended June 30  
(Dollars in thousands, except share and per share data)    2010     2009     2010     2009  
   

Interest income:

        

Loans, including fees

   $ 5,492      $ 5,430      $ 10,925      $ 10,776   

Securities

     2,959        3,809        6,178        7,733   

Federal funds sold and interest bearing bank deposits

     10        9        17        15   
   

Total interest income

     8,461        9,248        17,120        18,524   
   

Interest expense:

        

Deposits

     2,615        3,505        5,255        7,029   

Short-term borrowings

     3        15        14        31   

Long-term debt

     1,155        1,209        2,332        2,420   
   

Total interest expense

     3,773        4,729        7,601        9,480   
   

Net interest income

     4,688        4,519        9,519        9,044   

Provision for loan losses

     750        700        2,200        1,250   
   

Net interest income after provision for loan losses

     3,938        3,819        7,319        7,794   
   

Noninterest income:

        

Service charges on deposit accounts

     334        302        648        605   

Mortgage lending

     625        1,310        1,107        2,640   

Bank-owned life insurance

     106        110        232        208   

Other

     296        299        620        602   

Securities gains (losses), net:

        

Realized gains, net

     1,431        1,024        2,531        1,904   

Total other-than-temporary impairments

     (20     (1,287     (260     (6,420

Non-credit portion of other-than temporary impairments recognized in (transferred from) other comprehensive income

     20        (495     210        1,635   
   

  Total securities gains (losses), net

     1,431        (758     2,481        (2,881
   

Total noninterest income

     2,792        1,263        5,088        1,174   
   

Noninterest expense:

        

Salaries and benefits

     1,939        1,974        3,844        4,023   

Net occupancy and equipment

     364        395        748        739   

Professional fees

     191        174        367        335   

FDIC and other regulatory assessments

     286        578        562        775   

Other real estate owned, net

     911        28        972        8   

Prepayment penalty on long-term debt

     298        —          298        —     

Other

     820        775        1,654        1,597   
   

Total noninterest expense

     4,809        3,924        8,445        7,477   
   

Earnings before income taxes

     1,921        1,158        3,962        1,491   

Income tax expense

     314        226        738        313   
   

Net earnings

   $ 1,607      $ 932      $ 3,224      $ 1,178   
   

Net earnings per share:

        

Basic and diluted

   $ 0.44      $ 0.25      $ 0.88      $ 0.32   
   

Weighted average shares outstanding:

        

Basic and diluted

     3,642,877        3,644,491        3,642,996        3,645,652   
   

See accompanying notes to condensed consolidated financial statements

 

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AUBURN NATIONAL BANCORPORATION, INC. AND SUBSIDIARIES

Condensed Consolidated Statements of Stockholders’ Equity and Comprehensive Income

(Unaudited)

 

              

Additional

paid-in

capital

  

Retained

earnings

   

Accumulated
other

comprehensive

income (loss)

   

Treasury

stock

   

Total

 
     Common Stock            
(Dollars in thousands, except share and per share data)    Shares    Amount            
   

Balance, December 31, 2008

   3,957,135    $ 39    $ 3,749    $     59,283      $ 603      $     (6,546   $     57,128   

Comprehensive income:

                 

Net earnings

   —        —        —        1,178        —          —          1,178   

Other comprehensive loss due to change in other-than-temporary impairment losses related to factors other than credit on available-for-sale, net

   —        —        —        —          (1,031     —          (1,031

Other comprehensive loss due to change in all other unrealized gains (losses) on securities available-for- sale, net

   —        —        —        —          (2,877     —          (2,877
   

Total comprehensive loss

   —        —        —        1,178        (3,908     —          (2,730

Cash dividends paid ($0.38 per share)

   —        —        —        (1,386     —          —          (1,386

Stock repurchases (2,955 shares)

   —        —        —        —          —          (67     (67

Sale of treasury stock (105 shares)

   —        —        2      —          —          1       3   
   

Balance, June 30, 2009

   3,957,135    $ 39    $ 3,751    $ 59,075      $ (3,305   $ (6,612   $ 52,948   
   

Balance, December 31, 2009

   3,957,135    $ 39    $ 3,751    $ 58,917      $ 111      $ (6,635   $ 56,183   

Comprehensive income:

                 

Net earnings

   —        —        —        3,224        —          —          3,224   

Other comprehensive loss due to change in other-than-temporary impairment losses related to factors other than credit on available-for-sale, net

   —        —        —        —          (133     —          (133

Other comprehensive income due to change in all other unrealized gains (losses) on securities available-for- sale, net

   —        —        —        —          1,196        —          1,196   
   

Total comprehensive income

   —        —        —        3,224        1,063        —          4,287   

Cash dividends paid ($0.39 per share)

   —        —        —        (1,421     —          —          (1,421

Stock repurchases (484 shares)

   —        —        —        —          —          (8     (8

Sale of treasury stock (60 shares)

   —        —        1      —          —          —          1  
   

Balance, June 30, 2010

   3,957,135    $ 39    $ 3,752    $ 60,720      $ 1,174      $ (6,643   $ 59,042   
   

See accompanying notes to condensed consolidated financial statements

 

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AUBURN NATIONAL BANCORPORATION, INC. AND SUBSIDIARIES

Condensed Consolidated Statements of Cash Flows

(Unaudited)

 

     Six months ended June 30  
(In thousands)    2010     2009  
   

Cash flows from operating activities:

    

Net earnings

   $ 3,224      $ 1,178   

Adjustments to reconcile net earnings to net cash provided by operating activities:

    

Provision for loan losses

     2,200        1,250   

Depreciation and amortization

     387        327   

Premium amortization and discount accretion, net

     916        764   

Net (gain) loss on securities

     (2,481     2,881   

Net gain on sale of loans held for sale

     (927     (2,474

Net loss (gain) on other real estate

     857        (33

Loss on prepayment of long-term debt

     298        —     

Loans originated for sale

     (38,702     (106,894

Proceeds from sale of loans

     40,130        106,353   

Increase in cash surrender value of bank owned life insurance

     (232     (208

Net increase in other assets

     (1,201     (1,049

Net increase (decrease) in accrued expenses and other liabilities

     355        (100
   

Net cash provided by operating activities

     4,824        1,995   
   

Cash flows from investing activities:

    

Proceeds from sales of securities available-for-sale

     120,083        89,703   

Proceeds from maturities of securities available-for-sale

     71,029        75,754   

Purchase of securities available-for-sale

     (186,208     (220,133

Net increase in loans

     (3,113     (10,110

Net purchases of premises and equipment

     (75     (813

Proceeds from sale of other real estate

     571        258   
   

Net cash provided by (used in) investing activities

     2,287        (65,341
   

Cash flows from financing activities:

    

Net increase in noninterest-bearing deposits

     10,012        5,195   

Net increase in interest-bearing deposits

     16,334        60,404   

Net decrease in federal funds purchased and securities sold under agreements to repurchase

     (13,809     (1,369

Repayments or retirement of long-term debt

     (5,307     (5,010

Proceeds from sale of treasury stock

     1       3   

Stock repurchases

     (8     (67

Dividends paid

     (1,421     (1,386
   

Net cash provided by financing activities

     5,802        57,770   
   

Net change in cash and cash equivalents

     12,913        (5,576

Cash and cash equivalents at beginning of period

     12,395        36,433   
   

Cash and cash equivalents at end of period

   $ 25,308      $ 30,857   
   
   

Supplemental disclosures of cash flow information:

    

Cash paid during the period for:

    

Interest

   $ 7,770      $ 9,413   

Income taxes

     843        1,308   

Supplemental disclosure of non-cash transactions:

    

Real estate acquired through foreclosure

     477        5,049   
   

See accompanying notes to condensed consolidated financial statements

 

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AUBURN NATIONAL BANCORPORATION, INC. AND SUBSIDIARIES

Notes to the Condensed Consolidated Financial Statements

NOTE 1: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

General

Auburn National Bancorporation, Inc. (the “Company”) provides a full range of banking services to individual and corporate customers in Lee County, Alabama and surrounding counties through its subsidiary, AuburnBank (the “Bank”). The Company does not have any segments other than banking that are considered material.

Basis of Presentation and Use of Estimates

The unaudited condensed consolidated financial statements in this report have been prepared in accordance with U.S. generally accepted accounting principles for interim financial information. Accordingly, these financial statements do not include all of the information and footnotes required by U.S. generally accepted accounting principles for complete financial statements. The unaudited condensed consolidated financial statements include, in the opinion of management, all adjustments necessary to present a fair statement of the financial position and the results of operations for all periods presented. All such adjustments are of a normal recurring nature. The results of operations as of and for the six months ended June 30, 2010, are not necessarily indicative of the results of operations that the Company and its subsidiaries may achieve for future interim periods or the entire year. For further information, refer to the consolidated financial statements and footnotes included in the Company’s annual report on Form 10-K for the year ended December 31, 2009.

Reclassifications

Certain amounts reported in prior periods have been reclassified to conform to the current-period presentation. These reclassifications had no effect on the Company’s previously reported net earnings or total stockholders’ equity.

Subsequent Events

The Company has evaluated the effects of events or transactions through the date of this filing that have occurred subsequent to period end June 30, 2010. The Company does not believe there are any material subsequent events that would require further recognition or disclosure.

Accounting Developments

In the first quarter of 2010, the Company adopted new guidance related to the following Codification topics:

 

   

Accounting Standards Update (“ASU”) 2009-16, Accounting for Transfers of Financial Assets (Statement of Financial Accounting Standards (“SFAS”) No. 166, Accounting for Transfers of Financial Assets – an amendment of FASB Statement No. 140); and

 

   

ASU 2009-17, Improvements to Financial Reporting by Enterprises Involved with Variable Interest Entities (SFAS No. 167, Amendments to FASB Interpretation No. 46(R)); and

 

   

ASU 2010-6, Improving Disclosures about Fair Value Measurements.

 

   

ASU 2010-10, Consolidation: Amendments for Certain Investment Funds

Information about these pronouncements is described in more detail below.

ASU 2009-16, Accounting for Transfers of Financial Assets (SFAS No. 166, Accounting for Transfers of Financial Assets — an amendment of FASB Statement No. 140), modifies certain guidance contained in FASB Accounting Standards Codification (“ASC”) 860, Transfers and Servicing. This standard eliminates the concept of qualifying special purpose entities (QSPEs) and provides additional criteria transferors must use to evaluate transfers of financial assets. To determine if a transfer is to be accounted for as a sale, the transferor must assess whether it and all of the entities included in its consolidated financial statements have surrendered control of the assets. A transferor must consider all arrangements or agreements made or contemplated at the time of transfer before reaching a conclusion on whether control has been relinquished. SFAS No. 166 addresses situations in which a portion of a financial asset is transferred. In such instances the

 

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transfer can only be accounted for as a sale when the transferred portion is considered to be a participating interest. SFAS No. 166 also requires that any assets or liabilities retained from a transfer accounted for as a sale be initially recognized at fair value. This standard is effective for the Company as of January 1, 2010, with adoption applied prospectively for transfers that occur on and after the effective date. Adoption of this standard did not have a significant impact on the consolidated financial statements of the Company.

ASU 2009-17, Improvements to Financial Reporting by Enterprises Involved with Variable Interest Entities (SFAS No. 167, Amendments to FASB Interpretation No. 46(R)), amends several key consolidation provisions related to variable interest entities (“VIEs”), which are included in FASB ASC 810, Consolidation. First, the scope of SFAS No. 167 includes entities that are currently designated as QSPEs. Second, SFAS No. 167 changes the approach companies use to identify the VIEs for which they are deemed to be the primary beneficiary and are required to consolidate. Under existing rules, the primary beneficiary is the entity that absorbs the majority of a VIE’s losses and receives the majority of the VIE’s returns. The guidance in SFAS No. 167 identifies a VIE’s primary beneficiary as the entity that has the power to direct the VIE’s significant activities, and has an obligation to absorb losses or the right to receive benefits that could be potentially significant to the VIE. Third, SFAS No. 167 requires companies to continually reassess whether they are the primary beneficiary of a VIE. Existing rules only require companies to reconsider primary beneficiary conclusions when certain triggering events have occurred. SFAS No. 167 was effective for the Company as of January 1, 2010, and applies to all current QSPEs and VIEs, and VIEs created after the effective date. Adoption of this standard did not have a significant impact on the consolidated financial statements of the Company.

ASU 2010-6, Improving Disclosures about Fair Value Measurements, amends AS 820, Fair Value Measurements and Disclosures. ASU 2010-6 requires expanded disclosures related to fair value measurements including (i) the amounts of significant transfers of assets or liabilities between Levels 1 and 2 of the fair value hierarchy and the reasons for the transfers, (ii) the reasons for transfers of assets or liabilities in or out of Level 3 of the fair value hierarchy, with significant transfers disclosed separately, (iii) the policy for determining when transfers between levels of the fair value hierarchy are recognized and (iv) for recurring fair value measurements of assets and liabilities in Level 3 of the fair value hierarchy, a gross presentation of information about purchases, sales, issuances and settlements. ASU 2010-6 further clarifies that (i) fair value measurement disclosures should be provided for each class of assets and liabilities (rather than major category), which would generally be a subset of assets or liabilities within a line item in the statement of financial position and (ii) companies should provide disclosures about the valuation techniques and inputs used to measure fair value for both recurring and nonrecurring fair value measurements for each class of assets and liabilities included in Levels 2 and 3 of the fair value hierarchy. The disclosures related to the gross presentation of purchases, sales, issuances and settlements of assets and liabilities included in Level 3 of the fair value hierarchy will be required for the Company beginning January 1, 2011. The remaining disclosure requirements and clarifications in ASU 2010-06 became effective for the Company on January 1, 2010. Adoption did not affect the Company’s consolidated financial results, since it amended only the disclosure requirements for fair value measurements. See Note 7 of the Condensed Consolidated Financial Statements.

ASU 2010-10, Consolidation: Amendments for Certain Investment Funds, which defers, for certain investment funds, the consolidation requirements resulting from the issuance of ASU 2009-17. Specifically, the deferral is applicable for a reporting entity’s interest in an entity (1) that has all the attributes of an investment company or (2) for which it is industry practice to apply measurement principles for financial reporting purposes that are consistent with those followed by investment companies. ASU 2010-10 was effective for periods beginning after November 15, 2009. Adoption of this standard did not have a significant impact on the consolidated financial statements of the Company.

 

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NOTE 2: BASIC AND DILUTED EARNINGS PER SHARE

Basic net earnings per share is computed by dividing net earnings by the weighted average common shares outstanding for the quarter and six months ended June 30, 2010 and 2009, respectively. Diluted net earnings per share reflect the potential dilution that could occur if the Company’s potential common stock was issued. At June 30, 2010 and 2009, respectively, the Company had no options issued or outstanding.

A reconciliation of the numerator and denominator of the basic earnings per share computation to the diluted earnings per share computation for the quarter and six months ended June 30, 2010 and 2009 is presented below.

 

     Quarter ended June 30    Six months ended June 30
(Dollars in thousands, except share and per share data)    2010    2009    2010    2009

Basic:

           

Net earnings

   $ 1,607    $ 932    $ 3,224    $ 1,178

Average common shares outstanding

     3,642,877      3,644,491      3,642,996      3,645,652
 

Earnings per share

   $ 0.44    $ 0.25    $ 0.88    $ 0.32
 

Diluted:

           

Net earnings

   $ 1,607    $ 932    $ 3,224    $ 1,178

Average common shares outstanding

     3,642,877      3,644,491      3,642,996      3,645,652

Dilutive effect of options issued

     —        —        —        —  
 

Average diluted shares outstanding

     3,642,877      3,644,491      3,642,996      3,645,652
 

Earnings per share

   $ 0.44    $ 0.25    $ 0.88    $ 0.32
 

NOTE 3: COMPREHENSIVE INCOME

Comprehensive income is defined as the change in equity from all transactions other than those with shareholders, and it includes net earnings and other comprehensive income (loss). Comprehensive income (loss) for the quarter and six months ended June 30, 2010 and 2009 is presented below.

 

     Quarter ended June 30     Six months ended June 30  
(In thousands)    2010     2009     2010     2009  

Comprehensive income:

        

Net earnings

   $ 1,607      $ 932      $ 3,224      $ 1,178   

Other comprehensive income (loss):

        

Due to change in other-than-temporary impairment losses related to factors other than credit on securities available-for-sale, net

     (13     (1,031     (133     (1,031

Due to change in all other unrealized gains (losses) on securities available-for-sale, net

     387        (1,419     1,196        (2,877
   

Total comprehensive income (loss)

   $ 1,981      $ (1,518   $ 4,287      $ (2,730
   

NOTE 4: VARIABLE INTEREST ENTITIES

The Company is involved in various entities that are considered to be variable interest entities (“VIEs”), as defined by authoritative accounting literature. Generally, a VIE is a corporation, partnership, trust or other legal structure that does not have equity investors with substantive voting rights or has equity investors that do not provide sufficient financial resources for the entity to support its activities.

At June 30, 2010, the Company did not have any consolidated variable interest entities to disclose but did have several nonconsolidated VIEs, discussed below.

Nonconsolidated Variable Interest Entities

The Company owns the common stock of subsidiary business trusts, which have issued mandatorily redeemable preferred capital securities (“trust preferred securities”) in the aggregate of approximately $7.2 million at the time of issuance. These trusts meet the definition of a VIE of which the Company is not the primary beneficiary; the trusts’ only assets are junior

 

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subordinated debentures issued by the Company, which were acquired by the trusts using the proceeds from the issuance of the trust preferred securities and common stock. The junior subordinated debentures are included in long-term debt and the Company’s equity interests in the business trusts are included in other assets. Interest expense on the junior subordinated debentures is reported in interest expense on long-term debt. For regulatory reporting and capital adequacy purposes, the Federal Reserve Board has indicated that such trust preferred securities will continue to constitute Tier 1 Capital until further notice.

Periodically, the Company may invest in various limited partnerships that sponsor affordable housing projects in its primary markets and surrounding areas as a means of supporting local communities. These investments are designed to generate a return primarily through the realization of federal tax credits. These projects are funded through a combination of debt and equity and the partnerships meet the definition of a VIE. While the Company’s investment in a single entity may at times exceed 50% of the outstanding equity interests, the Company does not consolidate the partnerships due to the nature of the management activities of the general partner and the performance guaranties provided by the project sponsors giving them the majority of the variability. The Company typically provides financing during the construction and development of the properties; however, permanent financing is generally obtained from independent parties upon completion of a project. As of June 30, 2010 and December 31, 2009, the Company had investments of $1.7 million and $0.3 million, respectively, related to these projects, which are included in other assets on the Consolidated Balance Sheets. As of June 30, 2010 and December 31, 2009, the Company had no unfunded commitments related to affordable housing investments included in other liabilities. Additionally, the Company had outstanding loan commitments with certain of the partnerships totaling $11.4 million at June 30, 2010 and December 31, 2010, respectively. The funded portion of these loans was approximately $1.7 million at June 30, 2010. There was no funded portion for any of the outstanding loan commitments with certain of the partnerships at December 31, 2009. The funded portions of these loans are included in loans, net of unearned income on the Consolidated Balance Sheets.

The following table summarizes VIE’s that are not consolidated by the Company as of June 30, 2010.

 

(Dollars in thousands)    Maximum
Loss
Exposure
   Liability
Recognized
   Classification

Type:

        

Low income housing partnerships (a)

   $ 6,086    $ —      Other assets

Trust preferred issuances

     N/A      7,217    Long-term debt

 

(a) Maximum loss exposure represents $1.7 million of current investments and $4.4 million of contractual funding commitments. Only the current investment amount is included in Other Assets.

NOTE 5: SECURITIES

At June 30, 2010 and December 31, 2009, all securities within the scope of FASB ASC 320, Investments – Debt and Equity Securities were classified as available-for-sale. The fair value and amortized cost for securities available-for-sale at June 30, 2010 and December 31, 2009, by contractual maturity are presented below.

 

     June 30, 2010
     1 year    1 to 5    5 to 10    After 10    Fair    Gross Unrealized    Amortized
(Dollars in thousands)    or less    years    years    years    Value    Gains    Losses    Cost

Available-for-sale:

                       

Agency obligations (a)

   $     —      27,284    61,177    67,632    156,093    977    7    155,123

Agency RMBS (a)

         —      —      7,268    81,481    88,749    2,696    —      86,053

State and political subdivisions

         —      468    14,298    68,768    83,534    1,150    506    82,890

Trust preferred securities:

                       

Pooled

         —      —      —      20    20    —      210    230

Individual issuer

         —      —      —      1,580    1,580    —      1,870    3,450

Corporate debt

         —      2,296    835    —      3,131    —      369    3,500
 

Total available-for-sale

   $     —      30,048    83,578    219,481    333,107    4,823    2,962    331,246
 

 

(a) Includes securities issued by U.S. government agencies or government sponsored entities.

 

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     December 31, 2009
(Dollars in thousands)    1 year    1 to 5    5 to 10    After 10    Fair    Gross Unrealized    Amortized
   or less    years    years    years    Value    Gains    Losses    Cost

Available-for-sale:

                       

Agency obligations (a)

   $     —      —      42,626    47,594    90,220    363    630    90,487

Agency RMBS (a)

     —      —      5,261    153,381    158,642    3,264    380    155,758

State and political subdivisions

     —      382    16,073    65,107    81,562    1,031    578    81,109

Trust preferred securities:

                       

Pooled

     —      —      —      23    23    —      257    280

Individual issuer

     —      —      —      1,440    1,440    —      2,010    3,450

Corporate debt

     —      2,142    733    —      2,875    —      626    3,501
 

Total available-for-sale

   $     —      2,524    64,693    267,545    334,762    4,658    4,481    334,585
 

 

(a) Includes securities issued by U.S. government agencies or government sponsored entities.

Securities with aggregate fair values of $213.9 million and $203.4 million at June 30, 2010 and December 31, 2009, respectively, were pledged to secure public deposits, securities sold under agreements to repurchase, Federal Home Loan Bank (“FHLB”) advances, and for other purposes required or permitted by law.

Included in other assets are cost-method investments. The carrying amounts of cost-method investments were $6.0 million at June 30, 2010 and December 31, 2009, respectively. Cost-method investments primarily include FHLB of Atlanta stock and Federal Reserve Bank stock.

Gross Unrealized Losses and Fair Value

The fair values and gross unrealized losses on securities at June 30, 2010 and December 31, 2009, respectively, segregated by those securities that have been in an unrealized loss position for less than twelve months and twelve months or more are presented below.

 

     Less than 12 months    12 months or longer    Total
(Dollars in thousands)   

Fair

Value

   Unrealized
Losses
   Fair
Value
   Unrealized
Losses
   Fair
Value
   Unrealized
Losses

June 30, 2010:

                 

Agency obligations

   $ 13,993    7    —      —      13,993    7

State and political subdivisions

     21,674    342    2,899    164    24,573    506

Trust preferred securities:

                 

Pooled

     —      —      20    210    20    210

Individual issuer

     —      —      1,580    1,870    1,580    1,870

Corporate debt

     —      —      3,131    369    3,131    369
 

Total

   $     35,667    349    7,630    2,613    43,297    2,962
 

December 31, 2009:

                 

Agency obligations

   $ 46,219    630    —      —      46,219    630

Agency RMBS

     48,343    380    —      —      48,343    380

State and political subdivisions

     18,868    351    2,837    227    21,705    578

Trust preferred securities:

                 

Pooled

     13    37    10    220    23    257

Individual issuer

     —      —      1,440    2,010    1,440    2,010

Corporate debt

     —      —      2,876    626    2,876    626
 

Total

   $     113,443    1,398    7,163    3,083    120,606    4,481
 

The applicable date for determining when securities are in an unrealized loss position is June 30, 2010. As such, it is possible that a security had a market value that exceeded its amortized cost on other days during the past twelve-month period.

For the securities in the previous table, the Company does not have the intent to sell and has determined it is not more likely than not that the Company will be required to sell the security before recovery of the amortized cost basis, which may be

 

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maturity. The Company has assessed each security for credit impairment. For debt securities, the Company evaluates, where necessary, whether credit impairment exists by comparing the present value of the expected cash flows to the securities’ amortized cost basis. For cost-method investments, the Company evaluates whether an event or change in circumstances has occurred during the reporting period that may have a significant adverse effect on the fair value of the investment.

In determining whether a loss is temporary, the Company considers all relevant information including:

 

 

the length of time and the extent to which the fair value has been less than the amortized cost basis;

 

 

adverse conditions specifically related to the security, an industry, or a geographic area (for example, changes in the financial condition of the issuer of the security, or in the case of an asset-backed debt security, in the financial condition of the underlying loan obligors, including changes in technology or the discontinuance of a segment of the business that may affect the future earnings potential of the issuer or underlying loan obligors of the security or changes in the quality of the credit enhancement);

 

 

the historical and implied volatility of the fair value of the security;

 

 

the payment structure of the debt security and the likelihood of the issuer being able to make payments that increase in the future;

 

 

failure of the issuer of the security to make scheduled interest or principal payments;

 

 

any changes to the rating of the security by a rating agency; and

 

 

recoveries or additional declines in fair value subsequent to the balance sheet date.

To the extent the Company estimates future expected cash flows, the Company considered all available information in developing those expected cash flows. For asset-backed securities such as pooled trust preferred securities, such information generally included:

 

 

remaining payment terms of the security (including as applicable, terms that require underlying obligor payments to increase in the future);

 

 

current delinquencies and nonperforming assets of underlying collateral;

 

 

expected future default rates;

 

 

subordination levels or other credit enhancements.

Agency obligations

The unrealized losses associated with agency obligations are primarily driven by changes in interest rates and not due to the credit quality of the securities. These securities are issued by U.S. government agencies or government-sponsored entities and do not have any credit losses given the explicit or implicit government guarantee.

Agency residential mortgage-backed securities (“RMBS”)

The unrealized losses associated with Agency RMBS are primarily driven by changes in interest rates and not due to the credit quality of the securities. These securities are issued by U.S. government agencies or government-sponsored entities and do not have any credit losses given the explicit or implicit government guarantee.

Securities of U.S. states and political subdivisions

The unrealized losses associated with securities of U.S. states and political subdivisions are primarily driven by changes in interest rates and are not due to the credit quality of the securities. These securities will continue to be monitored as part of the Company’s quarterly impairment analysis, but are expected to perform even if the rating agencies reduce the credit rating of the bond insurers. As a result, the Company expects to recover the entire amortized cost basis of these securities.

Pooled trust preferred securities

The unrealized losses associated with pooled trust preferred securities are primarily driven by higher projected collateral losses and wider credit spreads. Pooled trust preferred securities primarily consist of securities issued by community banks and thrifts. The Company assesses impairment for these securities using a cash flow model. The key assumptions include default probabilities of the underlying collateral and recoveries on collateral defaults. Based upon the Company’s assessment of the expected credit losses for these securities, and given the performance of the underlying collateral compared to the Company’s credit enhancement, the Company expects to recover the remaining amortized cost basis of these securities.

 

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Individual issuer trust preferred securities

The unrealized losses associated with individual issuer trust preferred securities are primarily related to securities backed by individual issuer community banks. For individual issuers, management evaluates the financial performance of the issuer on a quarterly basis to determine if it is probable that the issuer can make all contractual principal and interest payments. Based upon its evaluation, the Company expects to recover the entire amortized cost basis of these securities.

Corporate debt securities

The unrealized losses associated with corporate debt securities are primarily related to securities backed by an individual issuer community bank. The Company evaluates the financial performance of the issuer on a quarterly basis to determine if it is probable that the issuer can make all contractual principal and interest payments. Based upon its evaluation, the Company expects to recover the entire amortized cost basis of these securities.

Cost-method investments

At June 30, 2010, cost-method investments with an aggregate cost of $6.0 million were not evaluated for impairment because the Company did not identify any events or changes in circumstances that may have a significant adverse effect on the fair value of these cost-method investments.

The carrying values of the Company’s investment securities could decline in the future if the underlying performance of the collateral for pooled trust preferred securities, the financial condition of individual issuers of trust preferred securities, or the credit quality of other securities deteriorate and the Company determines it is probable that it will not recover the entire amortized cost basis for the security. As a result, there is a risk that significant other-than-temporary impairment charges may occur in the future given the current economic environment.

The following tables show the applicable credit ratings, fair values, gross unrealized losses, and life-to-date impairment charges for pooled and individual issuer trust preferred securities at June 30, 2010 and December 31, 2009, respectively, segregated by those securities that have been in an unrealized loss position for less than twelve months and twelve months or more.

Trust Preferred Securities as of June 30, 2010

 

     Credit Rating    Fair Value    Unrealized losses   

Life-to-date

Impairment

Charges

          

Less than

12 months

  

12 months

or longer

   Total   
(Dollars in thousands)    Moody’s    Fitch               

Pooled:

                    

ALESCO Preferred Funding XVII, Ltd. (a)

   Ca    CC    $ 20    $ —      210    210    $ 1,770

Individual issuer (b):

                    

Carolina Financial Capital Trust I

   n/a    n/a      135      —      315    315      —  

Main Street Bank Statutory Trust I (c)

   n/a    n/a      300      —      200    200      —  

MNB Capital Trust I

   n/a    n/a      100      —      400    400      —  

PrimeSouth Capital Trust I

   n/a    n/a      125      —      375    375      —  

TCB Trust

   n/a    n/a      250      —      250    250      —  

United Community Capital Trust

   n/a    n/a      670      —      330    330      —  
 

Total individual issuer

           1,580      —      1,870    1,870      —  
 

Total trust preferred securities

         $ 1,600    $ —      2,080    2,080    $ 1,770
 

n/a - not applicable, securities not rated.

 

(a) Class B Deferrable Third Priority Secured Floating Rate Notes. The underlying collateral is primarily composed of community banks and thrifts.

 

(b) 144A Floating Rate Capital Securities. Underlying issuer is a community bank holding company. Securities have no excess subordination or overcollateralization.

 

(c) Issuer acquired by BB&T Corporation.

 

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Trust Preferred Securities as of December 31, 2009

 

     Credit Rating    Fair Value    Unrealized losses   

Life-to-date

Impairment

Charges

          

Less than

12 months

  

12 months

or longer

   Total   
(Dollars in thousands)    Moody’s    Fitch               

Pooled:

                    

ALESCO Preferred Funding XVII, Ltd. (a)

   Ca    B    $ 10    $ —      220    220    $ 1,770

U.S. Capital Funding IV, Ltd. (b)

   Ca    CC      13      37    —      37      2,450

Total pooled

           23      37    220    257      4,220

Individual issuer (c):

                    

Carolina Financial Capital Trust I

   n/a    n/a      90      —      360    360      —  

Main Street Bank Statutory Trust I (d)

   n/a    n/a      275      —      225    225      —  

MNB Capital Trust I

   n/a    n/a      125      —      375    375      —  

PrimeSouth Capital Trust I

   n/a    n/a      125      —      375    375      —  

TCB Trust

   n/a    n/a      325      —      175    175      —  

United Community Capital Trust

   n/a    n/a      500      —      500    500      —  
 

Total individual issuer

           1,440      —      2,010    2,010      —  
 

Total trust preferred securities

         $ 1,463    $ 37    2,230    2,267    $ 4,220
 

n/a - not applicable, securities not rated.

 

(a) Class B Deferrable Third Priority Secured Floating Rate Notes. The underlying collateral is primarily composed of community banks and thrifts.

 

(b) Class B-2 Fixed/Floating Rate Senior Surbordinate Notes. The underlying collateral is primarily composed of community banks and thrifts.

 

(c) 144A Floating Rate Capital Securities. Underlying issuer is a community bank holding company. Securities have no excess subordination or overcollateralization.

 

(d) Issuer acquired by BB&T Corporation.

For pooled trust preferred securities, the Company estimated expected future cash flows of the security by estimating the expected future cash flows of the underlying collateral and applying those collateral cash flows, together with any credit enhancements such as subordination interests owned by third parties, to the security. The expected future cash flows of the underlying collateral are determined using the remaining contractual cash flows adjusted for future expected credit losses (which consider default probabilities derived from issuer credit ratings for the underlying collateral). The probability-weighted expected future cash flows of the security are then discounted at the interest rate used to recognize income on the security to arrive at a present value amount.

Excess subordination is defined as the amount of performing collateral that is in excess of what is needed to payoff a specified class of securities and all classes senior to the specified class. Performing collateral is defined as total collateral minus all collateral that is currently deferring or currently in default. This definition assumes that all collateral that is currently deferring will default with a zero recovery rate. The underlying issuers can cure, or the bonds could recover a higher percentage upon default than zero. Excess subordination, as defined previously, does not consider any excess interest spread that is built into the structure of the security, which provides another source of repayment for the bonds.

At June 30, 2010 and December 31, 2009, respectively, there was no excess subordination for the Class B notes of ALESCO Preferred Funding XVII, Ltd or the B-2 notes of U.S. Capital Funding IV, Ltd.

 

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Other-Than-Temporarily Impaired Securities

On a quarterly basis, management makes an assessment to determine whether there have been events or economic circumstances to indicate that a security on which there is an unrealized loss is other-than-temporarily impaired. For equity securities with an unrealized loss, the Company considers many factors including the severity and duration of the impairment; the intent and ability of the Company to hold the security for a period of time sufficient for a recovery in value; and recent events specific to the issuer or industry. Equity securities on which there is an unrealized loss that is deemed to be other-than-temporary are written down to fair value with the write-down recorded as a realized loss in securities gains (losses).

For debt securities with an unrealized loss, an other-than-temporary impairment write-down is triggered when (1) the Company has the intent to sell a debt security, (2) it is more likely than not that the entity will be required to sell the debt security before recovery of its amortized cost basis, or (3) the entity does not expect to recover the entire amortized cost basis of the debt security. If the Company has the intent to sell a debt security or if it is more-likely-than-not that it will be required to sell the debt security before recovery, the other-than-temporary write-down is equal to the entire difference between the debt security’s amortized cost and its fair value. If the Company does not intend to sell the security or it is not more likely than not that it will be required to sell the security before recovery, the other-than-temporary impairment write-down is separated into the amount that is credit related (credit loss component) and the amount due to all other factors. The credit loss component is recognized in earnings, as a realized loss in securities gains (losses), and is the difference between the security’s amortized cost basis and the present value of its expected future cash flows. The remaining difference between the security’s fair value and the present value of future expected cash flows is due to factors that are not credit related and is recognized in other comprehensive income, net of applicable taxes.

The following table presents a roll-forward of the credit loss component of the amortized cost of debt securities that the Company has written down for other-than-temporary impairment and the credit component of the loss is recognized in earnings (referred to as “credit-impaired” debt securities). Other-than-temporary impairments recognized in earnings for the quarter and six months ended June 30, 2010 and 2009 for credit-impaired debt securities are presented as additions in two components based upon whether the current period is the first time the debt security was credit-impaired (initial credit impairment) or is not the first time the debt security was credit-impaired (subsequent credit impairments). The credit loss component is reduced if the Company sells, intends to sell or believes it will be required to sell previously credit-impaired debt securities. Additionally, the credit loss component is reduced if the Company receives cash flows in excess of what it expected to receive over the remaining life of the credit-impaired debt security or the security matures. Changes in the credit loss component of credit-impaired debt securities were:

 

     Quarter ended June 30    Six months ended June 30
(Dollars in thousands)    2010    2009    2010    2009

Balance, beginning of period

   $ 4,620    $ 1,688    $ 4,570    $ —  

Additions:

           

Initial credit impairments

     —        975      —        2,663

Subsequent credit impairments

     —        142      50      142

Reductions:

           

Securities sold

     —        —        —        —  

Due to change in intent to sell or requirement to sell

     —        —        —        —  

Increases in expected cash flows

     —        —        —        —  
 

Balance, end of period

   $ 4,620    $ 2,805    $ 4,620    $ 2,805
 

 

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Other-Than-Temporary Impairment

The following table presents details of other-than-temporary impairment related to securities, including equity securities carried at cost, for the quarter and six months ended June 30, 2010 and 2009.

 

     Quarter ended June 30     Six months ended June 30
(Dollars in thousands)    2010    2009     2010    2009

Other-than-temporary impairment charges (included in earnings):

          

Debt securities:

          

Pooled trust preferred securities

   $ —      $ 975      $ 50    $ 975

Individual issuer trust preferred securities

     —        142        —        1,830
 

Total debt securities

     —        1,117        50      2,805

Cost-method investments

     —        665        —        1,980
 

Total other-than-temporary impairment charges

   $ —      $ 1,782      $ 50    $ 4,785
 

Other-than-temporary impairment on debt securities:

          

Recorded as part of gross realized losses:

          

Credit-related

   $ —      $ 1,117      $ 50    $ 2,805

Securities with intent to sell

     —        —          —        —  

Recorded directly to (transferred from) other comprehensive income for non-credit related impairment

     20      (495     210      1,635
 

Total other-than-temporary impairment on debt securities

   $ 20    $ 622      $ 260    $ 4,440
 

Realized Gains and Losses

The following table presents the gross realized gains and losses on securities, including cost-method investments. Realized losses include other-than-temporary impairment charges.

 

     Quarter ended June 30     Six months ended June 30  
(Dollars in thousands)    2010    2009     2010     2009  

Gross realized gains

   $ 1,431    $ 1,057      $ 2,570      $ 1,937   

Gross realized losses

     —        (1,815     (89     (4,818
   

Net realized gains (losses)

   $ 1,431    $ (758   $ 2,481      $ (2,881
   

NOTE 6: MORTGAGE SERVICING RIGHTS, NET

Mortgage servicing right (“MSRs”) are recognized based on the fair value of the servicing right on the date the corresponding mortgage loan is sold. An estimate of the Company’s MSRs is determined using assumptions that market participants would use in estimating future net servicing income, including estimates of prepayment speeds, discount rate, default rates, cost to service, escrow account earnings, contractual servicing fee income, ancillary income, and late fees. Subsequent to the date of transfer, the Company has elected to measure its MSRs under the amortization method. Under the amortization method, MSRs are amortized in proportion to, and over the period of, estimated net servicing income.

The Company has recorded MSRs related to loans sold without recourse to Fannie Mae. The Company generally sells conforming, fixed-rate, closed-end, residential mortgages to Fannie Mae. Prior to January 1, 2009, the volume of loans sold servicing retained was not significant; therefore no servicing rights were capitalized. MSRs are included in Other assets on the accompanying Consolidated Balance Sheets

 

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The change in amortized MSRs and the related valuation allowance for the quarter and six months ended June 30, 2010 and 2009 are presented below.

 

     Quarter ended June 30     Six months ended June 30  
(Dollars in thousands)    2010     2009     2010     2009  

Beginning Balance

   $ 851      $ 266      $ 834      $ —     

Additions

     62        442        111        708   

Amortization expense

     (36     (22     (68     (22

Change in valuation allowance

     —          —          —          —     
   

Ending Balance

   $ 877      $ 686      $ 877      $ 686   
   

Fair value of amortized MSRs:

        

Beginning of period

     1,030        295        978        —     

End of period

     1,023        768        1,023        768   
   

The Company periodically evaluates mortgage servicing rights for impairment. Impairment is determined by stratifying MSRs into groupings based on predominant risk characteristics, such as interest rate and loan type. If, by individual stratum, the carrying amount of the MSRs exceeds fair value, a valuation reserve is established. The valuation reserve is adjusted as the fair value changes. At June 30, 2010 and 2009, respectively, there was no valuation allowance recorded for amortized MSRs.

NOTE 7: FAIR VALUE DISCLOSURES

“Fair value” is defined by FASB ASC 820, Fair Value Measurements and Disclosures, 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. FASB ASC 820 establishes a hierarchy for inputs used in measuring fair value that maximizes the use of observable inputs and minimizes the use of unobservable inputs by requiring that most observable inputs be used when available. Observable inputs are inputs that market participants would use in pricing the asset or liability developed based on market data obtained from sources independent of the Company. Unobservable inputs are inputs that reflect the Company’s assumptions about the inputs market participants would use in pricing the asset or liability developed based on the best information available in the circumstances. The hierarchy is broken down into three levels based on the reliability of inputs as follows:

Level 1—inputs to the valuation methodology are quoted prices (unadjusted) for identical assets or liabilities in active markets.

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.

Level 3—inputs to the valuation methodology are unobservable and significant to the fair value measurement.

The Company’s assets and liabilities recorded at fair value have been categorized based upon a fair value hierarchy in accordance with FASB ASC 820.

Securities – Securities available-for-sale are recorded at fair value on a recurring basis. Where quoted prices are available in an active market, securities are classified within Level 1 of the valuation hierarchy. Level 1 securities would include highly-liquid government securities such as U.S. Treasuries and exchange-traded equity securities.

When instruments are traded in secondary markets and quoted market prices are not available, the Company generally relies on prices obtained from independent vendors. Vendors compile prices from various sources and often apply matrix pricing for similar securities when no price is observable. Securities measured with these valuation techniques are generally classified within Level 2 of the valuation hierarchy and often involve using quoted market prices for similar securities, pricing models or discounted cash flow analyses using inputs observable in the market where available. Examples include U.S. government agency securities and residential mortgage-backed securities.

Security fair value measurements using significant inputs that are unobservable in the market due to limited activity or a less liquid market are classified within Level 3 of the valuation hierarchy. Such measurements include securities valued using models or a combination of valuation techniques such as weighting of models and vendor or broker pricing, where the unobservable inputs are significant to the overall fair value measurement. Securities classified as Level 3 include pooled and individual issuer trust preferred securities.

 

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Loans held for sale – Loans held for sale are carried at the lower of cost or estimated fair value and are subjected to nonrecurring fair value adjustments. Estimated fair value is determined on the basis of the current market value of similar loans. All of the Company’s loans held for sale are classified within Level 2 of the valuation hierarchy.

Loans, net – Loans considered impaired under FASB ASC 310-10-35, Receivables, are loans for which, based on current information and events, it is probable that the Company will be unable to collect all amounts due according to the contractual terms of the loan agreement. Impaired loans are subject to nonrecurring fair value adjustments to reflect (1) partial write-downs that are based on the observable market price or current appraised value of the collateral, or (2) the full charge-off of the loan carrying value. All of the Company’s impaired loans are classified within Level 3 of the valuation hierarchy.

Other real estate – Other real estate, consisting of properties obtained through foreclosure or in satisfaction of loans, are adjusted to fair value less costs to sell upon transfer of the loans to other real estate. Subsequently, other real estate is carried at the lower of carrying value or fair value less costs to sell. Fair value is generally determined on the basis of current appraisals, comparable sales, and other estimates of value obtained principally from independent sources, adjusted for estimated selling costs. All of the Company’s other real estate is classified within Level 3 of the valuation hierarchy.

Other assets – The Company has certain financial assets carried at fair value on a recurring basis, including interest rate swap agreements. The carrying amount of interest rate swap agreements is based on information obtained from a third party bank. The Company classified these derivative assets within Level 2 of the valuation hierarchy. These swaps qualify as derivatives, but are not designated as hedging instruments. The Company had no derivative contracts to assist in managing interest rate sensitivity at June 30, 2010 or December 31, 2009.

Mortgage servicing rights, net, included in other assets on the accompanying consolidated balance sheets, are carried at the lower of cost or estimated fair value and are subjected to nonrecurring fair value adjustments. MSRs do not trade in an active market with readily observable prices. To determine the fair value of MSRs, the Company engages an independent third party. The independent third party’s valuation model calculates the present value of estimated future net servicing income using assumptions that market participants would use in estimating future net servicing income, including estimates of prepayment speeds, discount rate, default rates, cost to service, escrow account earnings, contractual servicing fee income, ancillary income, and late fees. Because the valuation of MSRs requires the use of significant unobservable inputs, all of the Company’s MSRs are classified within Level 3 of the valuation hierarchy.

Other liabilities – The Company has certain financial liabilities carried at fair value on a recurring basis, including interest rate swap agreements. The carrying amount of interest rate swap agreements is based on information obtained from a third party bank. The Company classified these derivative liabilities within Level 2 of the valuation hierarchy. These swaps qualify as derivatives, but are not designated as hedging instruments. The Company had no derivative contracts to assist in managing interest rate sensitivity at June 30, 2010 or December 31, 2009.

 

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Assets and liabilities measured at fair value on a recurring basis

The following table presents the balances of the assets and liabilities measured at fair value on a recurring basis as of June 30, 2010 and December 31, 2009, respectively, by caption, on the consolidated balance sheets by FASB ASC 820 valuation hierarchy (as described above).

 

(Dollars in thousands)    Amount   

Quoted Prices in
Active Markets

for

Identical Assets
(Level 1)

   Significant
Other
Observable
Inputs
(Level 2)
  

Significant
Unobservable
Inputs

(Level 3)

 June 30, 2010:

           

 Securities available-for-sale:

           

Agency obligations

   $ 156,093    —      156,093    —  

Agency RMBS

     88,749    —      88,749    —  

States and political subdivisions

     83,534    —      83,534    —  

Trust preferred securities:

           

Pooled

     20    —      —      20

Individual issuer

     1,580    —      —      1,580

Corporate debt

     3,131    —      3,131    —  
 

 Total securities available-for-sale

     333,107    —      331,507    1,600

 Other assets (1)

     1,244    —      1,244    —  
 

Total assets at fair value

   $ 334,351    —      332,751    1,600
 
           

 Other liabilities (1)

   $ 1,244    —      1,244    —  
 

Total liabilities at fair value

   $ 1,244    —      1,244    —  
 

 December 31, 2009:

           

 Securities available-for-sale:

           

Agency obligations

   $ 90,220    —      90,220    —  

Agency RMBS

     158,642    —      158,642    —  

States and political subdivisions

     81,562    —      81,562    —  

Trust preferred securities:

           

Pooled

     23    —      —      23

Individual issuer

     1,440    —      —      1,440

Corporate debt

     2,875    —      2,875    —  
 

 Total securities available-for-sale

     334,762    —      333,299    1,463

 Other assets (1)

     931    —      931    —  
 

Total assets at fair value

   $     335,693    —      334,230    1,463
 
           

 Other liabilities (1)

   $ 931    —      931    —  
 

Total liabilities at fair value

   $ 931    —      931    —  
 
(1)

Includes fair value of interest rate swap agreements.

Level changes in fair value measurements

Transfers between levels of the fair value hierarchy are recognized on the actual date of the event or circumstances that caused the transfer, which generally coincides with the Corporation’s monthly and/or quarterly valuation process. The Company monitors the valuation techniques utilized for each category of financial assets and liabilities to ascertain when transfers between levels have been affected. The nature of the Company’s financial assets and liabilities generally is such that transfers in and out of any level are expected to be rare. For the six months ended June 30, 2010, there were no transfers between levels.

 

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The following is a reconciliation of the beginning and ending balances of recurring fair value measurements for financial assets recognized in the accompanying condensed consolidated balance sheets using Level 3 inputs:

 

     Six months ended June 30  
(Dollars in thousands)    2010     2009  

Beginning balance

   $ 1,463      $ 8,705   

Total realized and unrealized gains and (losses):

    

Included in net earnings

     (50     (3,328

Included in other comprehensive income

     187        (1,082

Purchases, issuances and settlements

     —          —     

Transfers in and/or (out) of Level 3

     —          (2,613
   

Ending balance

   $         1,600      $         1,682   
   

The transfer from Level 3 to Level 2 during the six months ended June 30, 2009 primarily related to corporate debt securities. Due to an increase in trading activity and observable inputs for the Company’s corporate debt securities during the quarter ended March 31, 2009, the fair value measurements for these securities were recognized using Level 2 inputs as of March 31, 2009.

Assets and liabilities measured at fair value on a nonrecurring basis

The following table presents the balances of the assets and liabilities measured at fair value on a nonrecurring basis as of June 30, 2010 and December 31, 2009, respectively, by caption, on the consolidated balance sheets and by FASB ASC 820 valuation hierarchy (as described above):

 

(Dollars in thousands)    Amount   

Active Markets
for

Identical
Assets

(Level 1)

   Other
Observable
Inputs
(Level 2)
  

Significant
Unobservable
Inputs

(Level 3)

 June 30, 2010:

           

 Loans held for sale

   $ 4,269    —      4,269    —  

 Loans, net (1)

     8,240    —      —      8,240

 Other real estate owned

     6,341    —      —      6,341

 Other assets (2)

     877    —      —      877
 

Total assets at fair value

   $ 19,727    —      4,269    15,458
 
           

 December 31, 2009:

           

 Loans held for sale

   $ 4,881    —      4,881    —  

 Loans, net (1)

     8,430    —      —      8,430

 Other real estate owned

     7,292    —      —      7,292

 Other assets (2)

     834    —      —      834
 

Total assets at fair value

   $     21,437    —      4,881    16,556
 
(1)

Loans considered impaired under FASB ASC 310-10-35, Receivables.

(2)

Mortgage servicing rights, net included in this category.

NOTE 8: FAIR VALUE OF FINANCIAL INSTRUMENTS

FASB ASC 825, Financial Instruments, requires disclosure of fair value information about financial instruments, whether or not recognized on the face of the balance sheet, for which it is practicable to estimate that value. The assumptions used in the estimation of the fair value of the Company’s financial instruments are explained below. Where quoted market prices are not available, fair values are based on estimates using discounted cash flow and other valuation techniques. Discounted cash flows can be significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. The following fair value estimates cannot be substantiated by comparison to independent markets and should not be considered representative of the liquidation value of the Company’s financial instruments, but rather a good–faith estimate of the fair value of financial instruments held by the Company. FASB ASC 825 excludes certain financial instruments and all nonfinancial instruments from its disclosure requirements.

 

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

Cash and cash equivalents

Due to their short-term nature, the carrying amounts reported in the balance sheet are assumed to approximate fair value for these assets. For purposes of disclosure, cash equivalents include federal funds sold and other short-term investments.

Securities

Fair value measurement is based upon quoted prices if available. If quoted market prices are not available, estimated fair values are based on quoted market prices of comparable instruments. See Note 5 for additional disclosure related to fair value measurements for securities.

Loans held for sale

Loans held for sale are carried at the lower of cost or estimated fair value and are subjected to nonrecurring fair value adjustments. Estimated fair value is determined on the basis of the current market value of similar loans.

Loans, net

The fair value of loans is calculated using discounted cash flows. The discount rates used to determine the present value of the loan portfolio are estimated market discount rates that reflect the credit and interest rate risk inherent in the loan portfolio. This method of estimating fair value does not incorporate the exit-price concept of fair value prescribed by FASB ASC 820 and generally produces a higher value than an exit-price approach. The estimated maturities are based on the Company’s historical experience with repayments adjusted to estimate the effect of current market conditions. The carrying amount of accrued interest approximates its fair value.

Deposits

Under FASB ASC 825, the fair value of deposits with no stated maturity, such as noninterest bearing demand deposits, interest bearing demand deposits and savings and certain types of money market accounts, is equal to the amount payable on demand at the reporting date (i.e., their carrying amount). The carrying amounts of variable-rate, fixed-term money market accounts and certificates of deposit approximate their fair values at the reporting date. Fair values for fixed-rate certificates of deposit are estimated using discounted cash flows. The discount rates used are based on estimated market rates for deposits of similar remaining maturities.

Short-term borrowings

The fair value of federal funds purchased, securities sold under agreements to repurchase, and other short–term borrowings approximate their carrying value.

Long-term debt

The fair value of the Company’s fixed rate long-term debt is estimated using discounted cash flows based on estimated current market rates for similar types of borrowing arrangements. The carrying amount of the Company’s variable rate long-term debt approximates its fair value.

Derivative Instruments

From time to time, the Company enters into interest rate swaps to meet the financing, interest rate and equity risk management needs of its customers. The carrying amounts of these derivative instruments represent their fair value. Generally, the fair value of these instruments is based on an observable market price.

Off-balance sheet Instruments

The fair values of the Company’s off-balance-sheet financial instruments are based on fees charged to enter into similar agreements. However, commitments to extend credit do not represent a significant value to the Company until such commitments are funded. The Company has determined that the estimated fair value of commitments to extend credit approximates the carrying amount and is immaterial to the financial statements.

 

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The carrying value and related estimated fair value of the Company’s financial instruments at June 30, 2010 and December 31, 2009 are presented below.

 

     June 30, 2010    December 31, 2009
(Dollars in thousands)    Carrying
amount
   Estimated
fair value
   Carrying
amount
   Estimated
fair value

Financial Assets:

           

Cash and cash equivalents

   $ 25,308    $ 25,308    $ 12,395    $ 12,395

Securities

     333,107      333,107      334,762      334,762

Loans held for sale

     4,269      4,269      4,881      4,881

Loans, net

     370,044      375,612      369,608      373,940

Derivative assets

     1,244      1,244      931      931

Financial Liabilities:

           

Deposits

   $     605,755    $     612,949    $     579,409    $     585,597

Short-term borrowings

     2,151      2,151      15,960      15,960

Long-term debt

     113,340      121,090      118,349      124,004

Derivative liabilities

     1,244      1,244      931      931

NOTE 9: DERIVATIVE INSTRUMENTS

Financial derivatives are reported at fair value in other assets or other liabilities. The accounting for changes in the fair value of a derivative depends on whether it has been designated and qualifies as part of a hedging relationship. For derivatives not designated as hedges, the gain or loss is recognized in current earnings. From time to time, the Company may enter into interest rate swaps (“swaps”) to facilitate customer transactions and meet their financing needs. Upon entering into these instruments to meet customer needs, the Company enters into offsetting positions in order to minimize the risk to the Company. These swaps qualify as derivatives, but are not designated as hedging instruments. At June 30, 2010, the Company had no derivative contracts to assist in managing interest rate sensitivity.

Interest rate swap contracts involve the risk of dealing with counterparties and their ability to meet contractual terms. When the fair value of a derivative instrument contract is positive, this generally indicates that the counter party or customer owes the Company, and results in credit risk to the Company. When the fair value of a derivative instrument contract is negative, the Company owes the customer or counterparty and therefore, has no credit risk.

A summary of the Company’s interest rate swaps as of and for the six months ended June 30, 2010 is presented below.

 

          Other
Assets
   Other
Liabilities
   Other
noninterest
income
 
(Dollars in thousands)    Notional    Estimated
Fair Value
   Estimated
Fair Value
   Gains
(Losses)
 

Interest rate swap agreements:

           

Pay fixed / receive variable

   $ 6,242    $ —      $ 1,244    $ (313

Pay variable / receive fixed

     6,242      1,244      —        313   
   

Total interest rate swap agreements

   $     12,484    $     1,244    $     1,244    $     —     
   

 

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

The following discussion and analysis is designed to provide a better understanding of various factors related to the results of operations and financial condition of the Auburn National Bancorporation, Inc. (the “Company”) and its wholly-owned subsidiary, AuburnBank (the “Bank”). This discussion is intended to supplement and highlight information contained in the accompanying unaudited condensed consolidated financial statements and related notes for the quarter and six months ended June 30, 2010 and 2009, as well as the information contained in our annual report on Form 10-K for the year ended December 31, 2009 and our quarterly report on Form 10-Q for the quarter ended March 31, 2010.

Certain of the statements made herein under the caption “MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS,” and elsewhere, including information incorporated herein by reference to other documents, are “forward-looking statements” within the meaning of, and subject to, the protections of Section 27A of the Securities Act of 1933, as amended, (the “Securities Act”) and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”).

Forward-looking statements include statements with respect to our beliefs, plans, objectives, goals, expectations, anticipations, assumptions, estimates, intentions, and future performance, and involve known and unknown risks, uncertainties and other factors, which may be beyond our control, and which may cause our actual results, performance or achievements to be materially different from future results, performance or achievements expressed or implied by such forward-looking statements.

All statements other than statements of historical fact are statements that could be forward-looking statements. You can identify these forward-looking statements through our use of words such as “may,” “will,” “anticipate,” “assume,” “should,” “desired,” “indicate,” “would,” “believe,” “contemplate,” “expect,” “seek,” “estimate,” “evaluate,” “continue,” “plan,” “point to,” “project,” “predict,” “could,” “intend,” “target,” “potential,” and other similar words and expressions of the future. These forward-looking statements may not be realized due to a variety of factors, including, without limitation:

 

   

the effects of future economic, business and market conditions and changes, domestic and foreign, including seasonality;

 

   

the impact of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Financial Reform Act) on our business, business practices and cost of operations;

 

   

governmental monetary and fiscal policies;

 

   

legislative and regulatory changes, including changes in banking, securities and tax laws, regulations and rules and their application by our regulators, and changes in the scope and cost of FDIC insurance and other coverage;

 

   

changes in accounting policies, rules and practices;

 

   

the risks of changes in interest rates on the levels, composition and costs of deposits, loan demand, and the values and liquidity of loan collateral, securities, and interest sensitive assets and liabilities;

 

   

changes in borrower credit risks and payment behaviors;

 

   

changes in the availability and cost of credit and capital in the financial markets;

 

   

changes in the prices, values and sales volumes of residential and commercial real estate;

 

   

the effects of competition from a wide variety of local, regional, national and other providers of financial, investment and insurance services;

 

   

the failure of assumptions and estimates underlying the establishment of reserves for possible loan losses and other estimates;

 

   

the risks of mergers, acquisitions and divestitures, including, without limitation, the related time and costs of implementing such transactions, integrating operations as part of these transactions and possible failures to achieve expected gains, revenue growth and/or expense savings from such transactions;

 

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changes in technology or products that may be more difficult, costly, or less effective than anticipated;

 

   

the effects of war or other conflicts, acts of terrorism or other catastrophic events, such as the recent oil spill in the Gulf of Mexico, that may affect general economic conditions;

 

   

the failure of assumptions and estimates, as well as differences in, and changes to, economic, market and credit conditions, including changes in borrowers’ credit risks and payment behaviors from those used in our loan portfolio stress test;

 

   

the risks that our deferred tax assets could be reduced if estimates of future taxable income from our operations and tax planning strategies are less than currently estimated, and sales of our capital stock could trigger a reduction in the amount of net operating loss carry-forwards that we may be able to utilize for income tax purposes; and

 

   

other factors and information in this report and other filings that we make with the SEC under the Exchange Act, including our annual report on Form 10-K for the year ended December 31, 2009 and subsequent quarterly and current reports. See Part II, Item 1A, “RISK FACTORS.”

All written or oral forward-looking statements that are made by or attributable to us are expressly qualified in their entirety by this cautionary notice. We have no obligation and do not undertake to update, revise or correct any of the forward-looking statements after the date of this report, or after the respective dates on which such statements otherwise are made.

Business

The Company is a one-bank holding company established in 1984 and incorporated under the laws of the State of Delaware. The Bank, the Company’s principal subsidiary, is an Alabama state-chartered bank that is a member of the Federal Reserve System and has operated continuously since 1907. Both the Company and the Bank are headquartered in Auburn, Alabama. The Bank conducts its business in East Alabama, including Lee County and surrounding areas. The Bank operates full-service branches in Auburn, Opelika, Hurtsboro and Notasulga, Alabama. In-store branches are located in the Auburn and Opelika Kroger stores, as well as Wal-Mart SuperCenter stores in Auburn, Opelika and Phenix City, Alabama. Mortgage loan offices are located in Phenix City, Valley, and Mountain Brook, Alabama.

Summary of Results of Operations

 

     Quarter ended June 30    Six months ended June 30
(Dollars in thousands, except per share amounts)    2010    2009    2010    2009

Net interest income (a)

   $ 5,126    $ 4,923    $ 10,394    $ 9,807

Less: tax-equivalent adjustment

     438      404      875      763
 

Net interest income (GAAP)

     4,688      4,519      9,519      9,044

Noninterest income

     2,792      1,263      5,088      1,174
 

Total revenue

     7,480      5,782      14,607      10,218

Provision for loan losses

     750      700      2,200      1,250

Noninterest expense

     4,809      3,924      8,445      7,477

Income tax expense

     314      226      738      313
 

Net earnings

   $ 1,607    $ 932    $ 3,224    $ 1,178
 

Basic and diluted earnings per share

   $ 0.44    $ 0.25    $ 0.88    $ 0.32
 

 

(a) Tax-equivalent. See “Table 1 - Explanation of Non-GAAP Financial Measures.”

Financial Summary

The Company’s net earnings were $3.2 million for the first six months of 2010 compared to $1.2 million for the first six months of 2009. Basic and diluted earnings per share were $0.88 per share for the first six months of 2010 compared to $0.32 per share for the first six months of 2009.

Net interest income (tax-equivalent) was $10.4 million for the first six months of 2010, an increase of approximately 6% from the first six months of 2009. Average loans were $378.8 million in the first six months of 2010, an increase of $5.2 million, or 1%, from the first six months of 2009. Average deposits were $602.6 million in the first six months of 2010, an increase of $6.4 million, or 1%, from the first six months of 2009.

 

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The provision for loan losses during the first six months of 2010 was $2.2 million, compared to $1.3 million in the first six months of 2009. The Company’s annualized net charge-off ratio was 1.12% in the first six months of 2010, compared to 0.54% in the first six months of 2009. Excluding a $1.3 million charge-off related to one construction and land development loan, the Company’s annualized net charge-off ratio was 0.43% in the first six months of 2010.

Noninterest income was $5.1 million for the first six months of 2010, compared to noninterest income of $1.2 million in the first six months of 2009. The increase in noninterest income is primarily due to a decrease in other-than-temporary impairment charges reflected within net securities gains (losses). Net securities gains (losses) included $0.1 million of other-than-temporary impairment charges in the first six months of 2010, compared to $4.8 million of other-than-temporary impairment charges in the first six months of 2009. Other-than-temporary impairment charges recognized in earnings during the first six months of 2009 primarily related to the Company’s investments in pooled trust preferred securities and the common stock and trust preferred securities of Silverton Financial Services, Inc.

Noninterest expense was $8.4 million during the first six months of 2010, compared to noninterest expense of $7.5 million during the first six months of 2009. The increase in noninterest expense was primarily due to an increase in other real estate owned expense of $1.0 million during the first six months of 2010 when compared to the first six months of 2009. The increase in other real estate owned expense primarily related to write-downs of the carrying value of certain foreclosed (other real estate owned) properties due to deterioration in real estate values.

In the first six months of 2010, the Company paid cash dividends of $1.4 million, or $0.39 per share. The Company’s balance sheet remains strong and well capitalized under regulatory guidelines with a total risk-based capital ratio of 15.49% and a tier 1 leverage ratio of 8.27% at June 30, 2010.

In the second quarter of 2010, net earnings were $1.6 million, or $0.44 per share, compared to $0.9 million, or $0.25 per share, for the second quarter of 2009. Total revenue was $7.5 million for the second quarter of 2010, compared to $5.8 million in the second quarter of 2009. The provision for loan losses during the second quarter of 2010 was $750,000, compared to $700,000 in the second quarter of 2009. The Company’s annualized net charge-off ratio was 0.76% in the second quarter of 2010, compared to 0.63% in the second quarter of 2009. Noninterest expense was $4.8 million for the second quarter of 2010, compared to $3.9 million in the second quarter of 2009.

CRITICAL ACCOUNTING POLICIES

The accounting and financial reporting policies of the Company conform with U.S. generally accepted accounting principles and with general practices within the banking industry. In connection with the application of those principles, we have made judgments and estimates which, in the case of the determination of our allowance for loan losses, our assessment of other-than-temporary impairment, recurring and non-recurring fair value measurements, and the valuation of deferred tax assets, were critical to the determination of our financial position and results of operations. Other policies also require subjective judgment and assumptions and may accordingly impact our financial position and results of operations.

Allowance for Loan Losses

The Company assesses the adequacy of the allowance prior to the end of each calendar quarter. The level of the allowance is based upon management’s evaluation of the loan portfolios, past loan loss experience, current asset quality trends, known and inherent risks in the portfolio, adverse situations that may affect the borrower’s ability to repay (including the timing of future payment), the estimated value of any underlying collateral, composition of the loan portfolio, economic conditions, industry and peer bank loan quality indications and other pertinent factors, including regulatory recommendations. This evaluation is inherently subjective as it requires material estimates including the amounts and timing of future cash flows expected to be received on impaired loans that may be susceptible to significant change. Loan losses are charged off when management believes that the full collectability of the loan is unlikely. A loan may be partially charged-off after a “confirming event” has occurred which validates that full repayment pursuant to the terms of the loan is unlikely. Allocation of the allowance may be made for specific loans, but the entire allowance is available for any loan that, in management’s judgment, is deemed to be uncollectible.

The Company deems loans impaired when, based on current information and events, it is probable that the Company will be unable to collect all amounts due according to the contractual terms of the loan agreement. Collection of all amounts due according to the contractual terms means that both the interest and principal payments of a loan will be collected as scheduled in the loan agreement.

An impairment allowance is recognized if the fair value of the loan is less than the recorded investment in the loan (recorded investment in the loan is the principal balance plus any accrued interest, net of deferred loan fees or costs and

 

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unamortized premium or discount). The impairment is recognized through the allowance. Loans that are impaired are recorded at the present value of expected future cash flows discounted at the loan’s effective interest rate, or if the loan is collateral dependent, impairment measurement is based on the fair value of the collateral, less estimated disposal costs. The Company believes it follows appropriate accounting and regulatory guidance in determining impairment and accrual status of impaired loans.

The level of allowance maintained is believed by management to be adequate to absorb probable losses inherent in the portfolio at the balance sheet date. The allowance is increased by provisions charged to expense and decreased by charge-offs, net of recoveries of amounts previously charged-off.

In assessing the adequacy of the allowance, the Company also considers the results of its ongoing independent loan review process. The Company’s loan review process assists in determining whether there are loans in the portfolio whose credit quality has weakened over time and evaluating the risk characteristics of the loan portfolio. The Company’s loan review process includes the judgment of management, the input from independent loan reviewers and, if applicable, reviews by bank regulatory agencies conducted as part of their examination process. The Company incorporates loan review results in the determination of whether or not it is probable that we will be able to collect all amounts due according to the contractual terms of a loan.

As part of the Company’s quarterly assessment of the allowance, management divides the loan portfolio into five segments: commercial loans (including financial and agricultural loans), construction and land development loans, mortgage loans secured by commercial real estate, mortgage loans secured by residential real estate, and consumer loans. The Company analyzes each segment and estimates an allowance allocation for each loan segment.

The allocation of the allowance for loan losses begins with a process of estimating the probable losses inherent for each loan segment. The estimates for the loans are established by category and based on the Company’s internal system of credit risk ratings and historical loss data. The estimated loan loss allocation rate for the Company’s internal system of credit risk grades is based on its experience with similarly graded loans. For loan segments where the Company believes it does not have sufficient historical loss data, the Company may make adjustments based, in part, on loss rates of peer bank groups.

The estimated loan loss allocation for all five loan portfolio segments is then adjusted for management’s estimate of probable losses for several “qualitative and environmental” factors. The allocation for qualitative and environmental factors is subjective and does not lend itself to exact mathematical calculation. This amount represents estimated probable inherent credit losses which exist, but have not yet been identified, as of the balance sheet date, and are based upon quarterly trend assessments in delinquent and nonaccrual loans, credit concentration changes, prevailing economic conditions, changes in lending personnel experience, changes in lending policies or procedures and other influencing factors. These qualitative and environmental factors are considered for each of the five loan segments and the allowance allocation, as determined by the processes noted above, is increased or decreased based on the incremental assessment of these factors.

The Company maintains an unallocated amount for inherent factors that cannot be practically assigned to individual loan segments or categories. An example is the imprecision in the overall measurement process, in particular the volatility of the national and local economy.

Assessment for Other-Than-Temporary Impairment of Securities

On a quarterly basis, management makes an assessment to determine whether there have been events or economic circumstances to indicate that a security on which there is an unrealized loss is other-than-temporarily impaired. For equity securities with an unrealized loss, the Company considers many factors including the severity and duration of the impairment; the intent and ability of the Company to hold the security for a period of time sufficient for a recovery in value; and recent events specific to the issuer or industry. Equity securities for which there is an unrealized loss that is deemed to be other-than-temporary are written down to fair value with the write-down recorded as a realized loss in securities gains (losses).

For debt securities with an unrealized loss, an other-than-temporary impairment write-down is triggered when (1) the Company has the intent to sell a debt security, (2) it is more likely than not that the entity will be required to sell the debt security before recovery of its amortized cost basis, or (3) the entity does not expect to recover the entire amortized cost basis of the debt security. If the Company has the intent to sell a debt security or if it is more likely than not that it will be required to sell the debt security before recovery, the other-than-temporary write-down is equal to the entire difference between the debt security’s amortized cost and its fair value. If the Company does not intend to sell the security or it is not more likely than not that it will be required to sell the security before recovery, the other-than-temporary impairment write-down is separated into the amount that is credit related (credit loss component) and the amount due to all other factors. The credit loss component is recognized in earnings, as a realized loss in securities gains (losses), and is the difference between

 

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the security’s amortized cost basis and the present value of its expected future cash flows. The remaining difference between the security’s fair value and the present value of future expected cash flows is due to factors that are not credit related and is recognized in other comprehensive income, net of applicable taxes.

The Company assesses impairment for pooled trust preferred securities using a cash flow model. The key assumptions include default probabilities of the underlying collateral and recoveries on collateral defaults. These assumptions may have a significant effect on the determination of the present value of expected future cash flows and the resulting amount of other-than-temporary impairment. As such, the use of different models and assumptions, as well as changes in market conditions, could result in materially different net earnings and retained earnings results.

Fair Value Determination

GAAP requires management to value and present at fair value certain of the Company’s assets and liabilities, including investments classified as available-for-sale and derivatives. FASB ASC 820, Fair Value Measurements and Disclosures, which defines fair value, establishes a framework for measuring fair value in accordance with U.S. generally accepted accounting principles and expands disclosures about fair value measurements. For more information regarding fair value measurements and disclosures, please refer to Note 7 of the Condensed Consolidated Financial Statements.

Fair values are based on market prices when available. However, some of the Company’s transactions lack an available trading market characterized by frequent transactions between willing buyers and sellers. In these cases, fair value is estimated using pricing models that use discounted cash flows and other pricing techniques. Pricing models and their underlying assumptions are based upon management’s best estimates for appropriate discount rates, default rates, prepayments, market volatility and other factors, taking into account current observable market data and experience.

These assumptions may have a significant effect on the reported fair values of assets and liabilities and the related income and expense. As such, the use of different models and assumptions, as well as changes in market conditions, could result in materially different net earnings and retained earnings results.

Other Real Estate Owned

Other real estate owned (“OREO”), consists of properties obtained through foreclosure or in satisfaction of loans and is reported at the lower of cost or fair value, less estimated costs to sell at the date acquired with any loss recognized as a charge-off through the allowance for loan losses. Additional OREO losses for subsequent valuation adjustments are determined on a specific property basis and are included as a component of other noninterest expense along with holding costs. Any gains or losses on disposal realized at the time of disposal are also reflected in noninterest expense. Significant judgments and complex estimates are required in estimating the fair value of OREO, and the period of time within which such estimates can be considered current is significantly shortened during periods of market volatility, as experienced during 2009 and 2010. As a result, the net proceeds realized from sales transactions could differ significantly from appraisals, comparable sales, and other estimates used to determine the fair value of other OREO.

Deferred Tax Asset Valuation

A valuation allowance is recognized for a deferred tax asset if, based on the weight of available evidence, it is more-likely-than-not that some portion or the entire deferred tax asset will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. Management considers the scheduled reversal of deferred tax liabilities, projected future taxable income and tax planning strategies in making this assessment. Based upon the level of taxable income over the last three years and projections for future taxable income over the periods in which the deferred tax assets are deductible, management believes it is more-likely-than-not that the Company will realize the benefits of these deductible differences at June 30, 2010. The amount of the deferred tax assets considered realizable, however, could be reduced in the near term if estimates of future taxable income during future periods are reduced.

 

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RESULTS OF OPERATIONS

Average Balance Sheet and Interest Rates

 

     Six months ended June 30
     2010    2009

(Dollars in thousands)

   Average
Balance
   Yield/
Rate
   Average
Balance
   Yield/
Rate

Loans and loans held for sale

   $     381,694    5.77%    $     378,365    5.74%

Securities - taxable

     248,210    3.64%      275,937    4.57%

Securities - tax-exempt

     80,603    6.44%      69,906    6.47%
                         

Total securities

     328,813    4.33%      345,843    4.95%

Federal funds sold

     16,195    0.21%      12,607    0.22%

Interest bearing bank deposits

     829    0.00%      1,423    0.14%
                         

Total interest-earning assets

     727,531    4.99%      738,238    5.27%
                         

Deposits:

           

NOW

     93,174    0.74%      89,290    1.02%

Savings and money market

     109,012    1.15%      92,121    1.21%

Certificates of deposits less than $100,000

     113,595    2.56%      109,974    3.62%

Certificates of deposits and other time deposits of $100,000 or more

     202,835    2.83%      227,587    3.59%
                         

Total interest-bearing deposits

     518,616    2.04%      518,972    2.73%

Short-term borrowings

     4,230    0.67%      12,277    0.51%

Long-term debt

     116,604    4.03%      122,174    3.99%
                         

Total interest-bearing liabilities

     639,450    2.40%      653,423    2.93%
                         

Net interest income and margin

   $ 10,394    2.88%    $ 9,807    2.68%
                         

Net Interest Income and Margin

Net interest income (tax-equivalent) increased 6% in the first six months of 2010 from the first six months of 2009 due to net interest margin improvement. Net interest margin (tax-equivalent) was 2.88% for the first six months of 2010, compared to 2.68% for the first six months of 2009.

The tax-equivalent yield on total interest earning assets decreased 28 basis points in the first six months of 2010 from the first quarter of 2009 to 4.99%. This decrease was primarily driven by a 62 basis point decrease in the tax-equivalent yield on total securities to 4.33%.

The cost of total interest-bearing liabilities decreased 53 basis points in the first six months of 2010 from the first six months of 2009, to 2.40%. This decrease was primarily driven by a 69 basis point decrease in the cost of total interest-bearing deposits to 2.04%.

Provision for Loan Losses

The provision for loan losses represents a charge to earnings necessary to provide an allowance for loan losses that, in management’s evaluation, should be adequate to provide coverage for the probable losses on outstanding loans. The provision for loan losses amounted to $2.2 million and $1.3 million for the six months ended June 30, 2010 and 2009, respectively.

The increase in the provision for loan losses reflects increases in the overall level of risk within the loan portfolio, past due and nonperforming loans, and increases in net-charge offs during the first six months of 2010 when compared to the first six months of 2009. The impact of continuing economic distress, specifically its impact on our construction and land development loan portfolio, contributed to the significant increase in the provision for loan losses in the first six months of 2010 when compared to the first six months of 2009. The construction and land development loan portfolio has experienced some weakness due to continued decreased real estate sales which has led to falling appraisal values of the collateral which secures the Company’s construction and land development loan portfolio. The Company’s collateral for construction and land development loans is generally the primary source of repayment. As the value of the collateral deteriorates, ultimate repayment by the borrower becomes increasingly difficult. As a result, the Company has increased its allowance for loan losses which has led to increased provision for loan losses in the first six months of 2010 when compared to the first six months of 2009.

 

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Based upon its assessment of the loan portfolio, management adjusts the allowance for loan losses to an amount it believes should be appropriate to adequately cover probable losses in the loan portfolio. The Company’s allowance for loan losses as a percentage of total loans was 1.75% at June 30, 2010, compared to 1.73% at December 31, 2009. Based upon our evaluation of the loan portfolio, management believes the allowance for loan losses to be adequate to absorb our estimate of probable losses existing in the loan portfolio at June 30, 2010. While our policies and procedures used to estimate the allowance for loan losses, as well as the resultant provision for loan losses charged to operations, are considered adequate by management and are reviewed from time to time by our regulators, they are necessarily approximate and imprecise. Factors beyond our control, such as conditions in the local and national economy, local real estate market, or industry conditions which may have a material adverse effect on our asset quality and the adequacy of our allowance for loan losses and, thus, the resulting provision for loan losses.

Noninterest Income

 

     Quarter ended June 30    Six months ended June 30
(Dollars in thousands)    2010    2009    2010    2009

Service charges on deposit accounts

   $ 334    $ 302    $ 648    $ 605

Mortgage lending income

     625      1,310      1,107      2,640

Bank-owned life insurance

     106      110      232      208

Securities gains (losses), net

     1,431      (758)      2,481      (2,881)

Other

     296      299      620      602
 

Total noninterest income

   $ 2,792    $ 1,263    $ 5,088    $ 1,174
 

The Company’s income from mortgage lending is primarily attributable to the (1) origination and sale of new mortgage loans and (2) servicing mortgage loans. The Company’s normal practice is to originate mortgage loans for sale in the secondary market and to either release or retain the associated mortgage servicing rights (“MSRs”) when the loan is sold. Prior to January 1, 2009, the volume of loans sold with servicing retained was not significant; therefore no servicing rights were capitalized. MSRs are recognized based on the fair value of the servicing right on the date the corresponding mortgage loan is sold. Subsequent to the date of transfer, the Company has elected to measure its MSRs under the amortization method. Servicing fee income is reported net of any related amortization expense.

The following table presents a breakdown of the Company’s mortgage lending income.

 

     Quarter ended June 30    Six months ended June 30
(Dollars in thousands)    2010    2009    2010    2009

Origination income

   $ 535    $ 1,226    $ 927    $ 2,474

Servicing fees, net

     90      84      180      166
 

Total mortgage lending income

   $ 625    $ 1,310    $ 1,107    $ 2,640
 

Mortgage lending income was $1.1 million in the first six months of 2010, compared to $2.6 million in the first six months of 2009. A significant decrease in the level of mortgage refinance activity during the first six months of 2010 when compared to the record levels experienced in the first six months of 2009 contributed to the decrease in mortgage lending income during the first six months of 2010.

Mortgage lending decreased in the second quarter of 2010 when compared to the second quarter of 2009 due to the same factors described above.

The Company recorded net securities gains of $2.5 million in the first six months of 2010, compared to net securities losses of $2.9 million in the first six months of 2009. The change in net securities gains (losses) is primarily due to a significant decline in other-than-temporary impairment charges in the first six months of 2010 when compared to the first six months of 2009. Other-than-temporary impairment charges recognized in earnings were approximately $0.1 million in the first six months of 2010, compared to approximately $4.8 million in the first six months of 2009. Other-than-temporary impairment charges recognized in earnings for the first six months of 2009 were primarily related to pooled trust preferred securities and investments in the common stock and trust preferred securities of Silverton Financial Services, Inc.

Securities gains (losses), net improved in the second quarter of 2010 when compared to the second quarter of 2009 due to the same factors described above.

 

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Noninterest Expense

 

     Quarter ended June 30    Six months ended June 30
(Dollars in thousands)    2010    2009    2010    2009

Salaries and benefits

   $ 1,939    $ 1,974    $ 3,844    $ 4,023

Net occupancy and equipment

     364      395      748      739

Professional fees

     191      174      367      335

FDIC and other regulatory assessments

     286      578      562      775

Other real estate owned, net

     911      28      972      8

Prepayment penalty on long-term debt

     298      —        298      —  

Other

     820      775      1,654      1,597
 

Total noninterest expense

   $ 4,809    $ 3,924    $ 8,445    $ 7,477
 

Salaries and benefits expense was $3.8 million in the first six months of 2010, compared to $4.0 million in the first six months of 2009. The decrease primarily related to decreases in commissions paid to our mortgage originators as a result of decreased origination volume.

FDIC and other regulatory assessments expense was $0.6 million in 2010, compared to $0.8 million in 2009. Although the cost of annual FDIC insurance premiums increased in the first six months of 2010 when compared to the first six months of 2009, the first six months of 2009 included a one-time special assessment charge from the FDIC of approximately $0.4 million.

FDIC and other regulatory assessments decreased in the second quarter of 2010 when compared to the second quarter of 2009 due to the same factors described above.

Other real estate owned expense was approximately $1.0 million in the first six months of 2010. The increase in other real estate owned expense during the first six months of 2010 related to write-downs of the carrying value of certain foreclosed (OREO) properties due to deterioration in real estate values. The write-downs related to the Company’s two largest OREO properties with a carrying value of $5.6 million at June 30, 2010.

Other real estate owned expense increased in the second quarter of 2010 when compared to the second quarter of 2009 due to the same factors described above.

Noninterest expense for the quarter and six months ended June 30, 2010 includes a $0.3 million prepayment penalty on long-term debt. The Company prepaid $5.0 million of securities sold under agreements to repurchase included in long-term debt on the Consolidated Balance Sheets during the second quarter of 2010 as part of its strategy to reduce wholesale funding sources.

Income Tax Expense

Income tax expense was $0.7 million in the first six months of 2010, compared to $0.3 million in the first six months of 2009. This change was primarily due to an increase in the level of earnings before taxes in the first six months of 2010 when compared to the first six months of 2009. The annualized effective tax rate for the first six months of 2010 was 18.63%, compared to an annualized effective income tax rate of 20.99% for the first six months of 2009. The decrease in the Company’s annualized effective tax rate in the first six months of 2010 when compared to the first six months of 2009 was primarily due to the recognition of a valuation allowance against deferred tax assets related to nondeductible capital losses during the first six months of 2009.

Income tax expense was $0.3 million in the second quarter of 2010, compared to $0.2 million in the second quarter of 2009. The annualized effective tax rate for the second quarter of 2010 was 16.35%, compared to an annualized effective income tax rate of 19.52% for the second quarter of 2009. The change in income tax expense and the annualized effective tax rate for the second quarter of 2010 when compared to the second quarter of 2009 are due to the same factors described above.

BALANCE SHEET ANALYSIS

Securities

Securities available-for-sale were $333.1 million and $334.8 million as of June 30, 2010 and December 31, 2009, respectively. The net unrealized gain on securities available-for-sale was $1.9 million at June 30, 2010 compared to a net unrealized gain of $0.2 million at December 31, 2009. Increases in the fair value of securities available-for-sale during the second quarter of 2010 were primarily driven by changes in interest rates and the narrowing of credit spreads.

 

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The average yields earned on total securities were 4.33% in the first six months of 2010 and 4.95% in the first six months of 2009.

Loans

 

     2010    2009
(In thousands)    Second
Quarter
   First
Quarter
   Fourth
Quarter
   Third
Quarter
   Second
Quarter

Commercial, financial and agricultural

   $ 56,168     52,918     53,884     54,350     52,397 

Construction and land development

     48,758     57,945     56,820     56,956     53,304 

Real estate - mortgage:

              

Commercial

     159,367     158,781     156,928     156,356     147,843 

Residential

     100,451     99,660     97,407     106,932     108,576 

Consumer installment

     12,037     11,475     11,236     11,065     11,330 
 

Total loans

     376,781     380,779     376,275     385,659     373,450 

Less: unearned income

     (157)    (160)     (172)    (211)    (229)
 

Loans, net of unearned income

   $     376,624     380,619     376,103     385,448     373,221 
 

Total loans, net of unearned income, were $376.6 million as of June 30, 2010, an increase of $0.5 million from $376.1 million at December 31, 2009. Four loan categories represented the majority of the loan portfolio as of June 30, 2010. Commercial real estate mortgage loans represented 42%, residential real estate mortgage loans represented 27%, construction and land development loans represented 13% and commercial, financial and agricultural loans represented 15% of the Company’s total loans at June 30, 2010. Approximately 50% of the Company’s commercial real estate mortgage loans were owner-occupied at June 30, 2010.

Within the residential real estate mortgage portfolio, the Company had junior lien mortgages of approximately $25.1 million, or 7% of total loans, net of unearned income at both June 30, 2010 and December 31, 2009. For residential real estate mortgage loans with a consumer purpose, approximately $4.5 million and $5.8 million required interest only payments at June 30, 2010 and December 31, 2009, respectively. The Company’s residential real estate mortgage portfolio does not include any option ARM loans, subprime loans, or any material amount of other high risk consumer mortgage products.

Purchased loan participations included in the Company’s loan portfolio were approximately $7.3 million and $9.4 million as of June 30, 2010 and December 31, 2009, respectively. All purchased loan participations are underwritten by the Company and independent of the selling bank. In addition, all loans, including purchased participations, are evaluated for collectability during the course of the Company’s normal loan review procedures. If the Company deems a participation loan impaired, it applies the same accounting policies and procedures described under “CRITICAL ACCOUNTING POLICIES – Allowance for Loan Losses”.

The specific economic and credit risks associated with our loan portfolio include, but are not limited to, the impact of recessionary economic conditions on our borrowers’ cash flows, real estate market sales volumes and valuations, real estate industry concentrations, deterioration in certain credits, interest rate fluctuations, reduced collateral values or non-existent collateral, title defects, inaccurate appraisals, financial deterioration of borrowers, fraud, and any violation of laws and regulations.

We attempt to reduce these economic and credit risks by adhering to loan to value guidelines for collateralized loans, investigating the creditworthiness of borrowers and monitoring borrowers’ financial position. Also, we establish and periodically review our lending policies and procedures. Banking regulations limit our credit exposure by prohibiting loan relationships that exceed 10% of the capital accounts of the bank, if such loans are not secured; or 20% of the capital accounts if loans in excess of 10% are fully secured, approximately $13.3 million. Furthermore, we have an internal limit for aggregate credit exposure (loans outstanding plus unfunded commitments) to a single borrower of $12.0 million. Our loan policy requires that the Loan Committee of the Bank’s Board of Directors approve any loan relationships that exceed this internal limit. At June 30, 2010 and December 31, 2009, the Company had no loan relationships exceeding these limits.

 

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We periodically analyze our commercial loan portfolio to determine if a concentration of credit risk exists in any one or more industries. We use broadly accepted industry classification systems in order to classify borrowers into various industry classifications. Loan concentrations to borrowers in the following industries exceeded 25% of the Bank’s total risk-based capital at June 30, 2010 (and related balances at December 31, 2009).

 

(In thousands)    June 30,
2010
   December 31,
2009

Lessors of 1 to 4 family residential properties

   $ 36,705    $ 34,961

Office buildings:

     

Owner occupied

   $ 21,282    $ 15,740

Non-owner occupied

     2,906      5,382
 

Total office buildings

   $     24,188    $     21,122

At June 30, 2010 the Company’s geographic loan distribution was concentrated primarily in Lee County, Alabama and surrounding areas. Although not a significant concentration, the Company has some exposure to geographic areas that could be affected by the oil spill in the Gulf of Mexico. In addition to the Gulf of Mexico being a popular vacation destination for borrowers located in our primary trade area, the Company also operated a loan production office in the Gulf Shores/Orange Beach, Alabama area from 2004 to 2008. Separately, the Company previously purchased participations in two construction and land development loans related to projects along the Florida Gulf Coast. Management will continue to monitor the Company’s exposure and prospective provisions for loan losses will incorporate any deterioration in affected loan segments as necessary.

The following table summarizes the Company’s total exposure to loans secured by real estate and other real estate owned in geographic areas that could be affected by the oil spill.

 

(In thousands)   

June 30,

2010

   December 31,
2009

Construction & land development

   $ 2,583       $ 4,926   

Residential real estate

     6,845         7,094   
 

Total loans

     9,428         12,020   

Other real estate owned

     3,810         4,329   
 

Total exposure

   $     13,238       $     16,349   
 

as a % of total assets

     1.69%      2.11%

At June 30, 2010, the Company had approximately $6.8 million of loans secured by residential real estate in coastal counties along the Gulf of Mexico that could be affected by the oil spill. These locations include Baldwin County, Alabama, and Bay, Escambia, Okaloosa and Walton County, Florida.

At June 30, 2010, the carrying value related to one of the Company’s purchased participations was $2.6 million. At June 30, 2010, this loan was classified as a troubled-debt restructuring (“TDR”) and nonaccrual loan. The other purchased participation loan defaulted and was foreclosed upon previously. At June 30, 2010, the carrying value of the Company’s interest in the property was approximately $3.8 million and is included in other real estate owned.

The average yield earned on loans and loans held for sale was 5.77% in the first six months of 2010 and 5.74% in the first six months of 2009.

Allowance for Loan Losses

The Company maintains the allowance for loan losses at a level that management deems appropriate to adequately cover the Company’s estimate of probable losses in the loan portfolio. At June 30, 2010 and December 31, 2009, the allowance for loan losses was $6.6 million and $6.5 million, respectively, which management deemed to be adequate at each of the respective dates. The judgments and estimates associated with the determination of the allowance for loan losses are described under “CRITICAL ACCOUNTING POLICIES.”

 

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A summary of the changes in the allowance for loan losses and certain asset quality ratios for the second quarter of 2010 and the previous four quarters is presented below.

 

     2010    2009
(Dollars in thousands)    Second
Quarter
   First
Quarter
   Fourth
Quarter
   Third
Quarter
   Second
Quarter

Balance at beginning of period

   $     6,546        6,495     5,458     4,646     4,532 

Charge-offs:

              

Commercial, financial and agricultural

     (326)       (68)     (91)    (128)    —   

Construction & land development

     (169)       (1,293)    (1,629)    —       (459)

Residential real estate - mortgage

     (262)       (46)    (202)    (204)    (144)

Consumer installment

     (83)       (5)    (17)    (10)    (23)
 

Total charge-offs

     (840)       (1,412)    (1,939)    (342)    (626)

Recoveries

     124        13     76     54     40 
 

Net charge-offs

     (716)       (1,399)    (1,863)    (288)    (586)

Provision for loan losses

     750        1,450     2,900     1,100     700 
 

Ending balance

   $ 6,580        6,546     6,495     5,458     4,646 
 

as a % of loans

     1.75 %    1.72     1.73     1.42     1.24 

as a % of nonperforming loans

     72 %    60     69     64     720 

Net charge-offs as a % of average loans

     0.76 %    1.48     1.95     0.31     0.63 
 

As described under “CRITICAL ACCOUNTING POLICIES,” management assesses the adequacy of the allowance prior to the end of each calendar quarter. The level of the allowance is based upon management’s evaluation of the loan portfolios, past loan loss experience, known and inherent risks in the portfolio, adverse situations that may affect the borrower’s ability to repay (including the timing of future payment), the estimated value of any underlying collateral, composition of the loan portfolio, economic conditions, industry and peer bank loan quality indications and other pertinent factors. This evaluation is inherently subjective as it requires various material estimates and judgments including the amounts and timing of future cash flows expected to be received on impaired loans that may be susceptible to significant change. The ratio of our allowance for loan losses to total loans outstanding was 1.75% at June 30, 2010, compared to 1.73% at December 31, 2009. In the future, the allowance to total loans outstanding ratio will increase or decrease to the extent the factors that influence our quarterly allowance assessment in their entirety either improve or weaken.

Approximately $1.3 million in net charge-offs during the first six months of 2010 primarily related to one construction and land development loan. The charge-off related to this loan, which was recognized during the first quarter of 2010, was equal to its corresponding valuation allowance (included in the allowance for loan losses) of $1.3 million at December 31, 2009.

At June 30, 2010, the ratio of our allowance for loan losses as a percentage of nonperforming loans was 72%, compared to 69% at December 31, 2009. The increase in this ratio was primarily due to a decrease in nonperforming loans.

At June 30, 2010, the Company’s recorded investment in loans considered impaired was $8.9 million, with a corresponding valuation allowance (included in the allowance for loan losses) of $0.7 million. At December 31, 2009, the Company’s recorded investment in loans considered impaired was $9.7 million, with a corresponding valuation allowance (included in the allowance for loan losses) of $1.3 million.

In addition, our regulators, as an integral part of their examination process, will periodically review the Company’s allowance for loan losses, and may require the Company to make additional provisions to the allowance for loan losses based on their judgment about information available to them at the time of their examinations.

Nonperforming Assets

At June 30, 2010, the Company had $15.5 million in nonperforming assets compared to $16.6 million at December 31, 2009. Included in nonperforming assets were nonperforming loans of $9.2 million and $9.4 million at June 30, 2010 and December 31, 2009, respectively. The majority of the balance in nonperforming assets at June 30, 2010 related to deterioration in the construction and land development loan portfolio. The decrease in nonperforming assets from December 31, 2009 was primarily due to principal payments made by borrowers on nonperforming construction and land development loans and write-downs on certain properties included in other real estate owned.

 

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The table below provides information concerning total nonperforming assets and certain asset quality ratios for the second quarter of 2010 and the previous four quarters.

 

     2010    2009
(In thousands)    Second
Quarter
    First
Quarter
   Fourth
Quarter
   Third
Quarter
   Second
Quarter

Nonperforming assets:

             

Nonaccrual loans

   $ 9,151       10,934    9,352    8,490    645

Other nonperforming assets (primarily other real estate owned)

     6,341       7,081    7,292    5,279    5,149
 

Total nonperforming assets

   $     15,492       18,015    16,644    13,769    5,794
 

as a % of loans and foreclosed properties

     4.05    4.65    4.34    3.52    1.53

as a % of total assets

     1.98    2.28    2.15    1.75    0.72

Nonperforming loans as a % of total loans

     2.43    2.87    2.49    2.20    0.17

Accruing loans 90 days or more past due

   $ 243       374    5    122    28
 

The Lee County Association of Realtors (“LCAR”) of Alabama reported that the average median selling price for residential homes during the quarter ended June 30, 2010 was $166,013, a decrease of 2.0% from the same quarter a year earlier. LCAR also reported that residential inventory at June 30, 2010 was 1,519 homes, an increase of 13.1% from a year earlier and the average number of days on the market for residential homes sold during the quarter ended June 30, 2010 was 163 days. Although stable median home prices are positive signs for this market, the supply of housing and the average number of days on the market for homes sold remain elevated. Continued weakness in the real estate market and the overall economy could adversely affect the Company’s volume of nonperforming assets. For additional discussion of risk factors, see Part I “Item 1A. Risk Factors” on page 17 in our annual report on Form 10-K for the year ended December 31, 2009.

The table below provides information concerning the composition of nonaccrual loans for the second quarter of 2010 and the previous four quarters.

 

     2010    2009
(In thousands)    Second
Quarter
   First
Quarter
   Fourth
Quarter
   Third
Quarter
   Second
Quarter

Nonaccrual loans:

              

Construction and land development

   $     4,686    $ 6,500    $ 7,542    $ 6,652    $ 97

Real estate - mortgage:

              

Commercial

     2,326      1,730      961      856      —  

Residential

     2,137      2,687      842      972      538

Consumer installment

     2      17      7      10      10
 

Total nonaccrual loans / nonperfoming loans

   $ 9,151    $     10,934    $     9,352    $     8,490    $     645
 

The Company discontinues the accrual of interest income when (1) there is a significant deterioration in the financial condition of the borrower and full repayment of principal and interest is not expected or (2) the principal or interest is more than 90 days past due, unless the loan is both well-secured and in the process of collection. At June 30, 2010, the Company had $9.2 million in loans on nonaccrual, compared to $9.4 million at December 31, 2009. Approximately $4.5 million of total nonaccrual loans at June 30, 2010 related to two construction and land development loans. One loan is secured by a completed residential condominium project located in the Company’s primary markets. The other loan is a purchased participation secured by partially developed land located near the Florida Gulf Coast.

Due to the weakening credit status of a borrower, the Company may elect to formally restructure certain loans to facilitate a repayment plan that minimizes the potential losses that we might incur. Restructured loans are classified as impaired loans, and if the loans are on nonaccrual status as of the date of restructuring, the loans are included in the nonaccrual loan balances noted above. The Company had $4.5 million and $0.2 million, respectively, in restructured loans included within nonaccrual loan balances at June 30, 2010 and December 31, 2009.

Nonaccrual loan balances do not include loans that have been restructured that were performing as of the restructure date. At June 30, 2010 and December 31, 2009, respectively, the Company had no accruing restructured loans.

The Company had approximately $243,000 and $5,000 thousand in loans 90 days past due and still accruing interest at June 30, 2010 and December 31, 2009, respectively.

 

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The table below provides information concerning the composition of other real estate owned for the first quarter of 2010 and the previous four quarters.

 

     2010    2009
(In thousands)    Second
Quarter
   First
Quarter
   Fourth
Quarter
   Third
Quarter
   Second
Quarter

Other real estate owned:

              

Residential condo development

   $ 3,810    $ 4,329    $ 4,329    $ 4,329    $ 4,329

New home construction

     253      253      490      650      574

Developed lots

     136      136      136      169      96

Undeveloped land

     1,746      2,210      2,210      —        —  

Other

     396      153      127      131      150
 

Total other real estate owned

   $     6,341    $     7,081    $     7,292    $     5,279    $     5,149
 

The Company owned $6.3 million in other real estate, which we had acquired from borrowers at June 30, 2010, compared to $7.3 million at December 31, 2009. At June 30, 2010, other real estate owned included two properties with a total carrying value of $5.6 million. The first property is undeveloped land located near the Company’s primary markets. The second property is a completed condominium project on the Florida Gulf Coast. The Company had previously purchased a participation interest in the first lien mortgage loan on this property from Silverton Bank. Subsequently, this loan defaulted and was foreclosed upon and the Company’s interest in the property is currently included in other real estate owned. Following Silverton Bank’s failure on May 1, 2009, the FDIC has held this property as the receiver of Silverton Bank. CB Richard Ellis, a national real estate firm, has been managing this property and selling condominiums in the project as an FDIC contractor. The Company depends upon the FDIC and CB Richard Ellis for information regarding this property and its performance. Based upon the latest information available to us, including appraisals, current unit sales, and comparable sales, we believe that the fair value of the Company’s interest in these properties, less selling costs, exceeds the Company’s recorded investment.

Potential Problem Loans

Potential problem loans represent those loans with a well-defined weakness and where information about possible credit problems of borrowers has caused management to have serious doubts about the borrower’s ability to comply with present repayment terms. Potential problem loans, which are not included in nonperforming assets, amounted to $13.8 million, or 3.7% of total loans outstanding, net of unearned income at June 30, 2010, compared to $16.8 million, or 4.5% of total loans outstanding, net of unearned income at December 31, 2009. The decrease in potential problem loans from December 31, 2009 primarily related to decreases in the commercial real estate and residential real estate mortgage loan categories. Continued weakness in the real estate market and the overall economy has adversely affected the Company’s volume of potential problem loans, and these economic conditions are expected to persist for the foreseeable future.

The table below provides information concerning the composition of potential problem loans for the second quarter of 2010 and the previous four quarters.

 

     2010    2009
(In thousands)    Second
Quarter
   First
Quarter
   Fourth
Quarter
   Third
Quarter
   Second
Quarter

Potential problem loans:

              

Commercial, financial, and agricultural

   $ 1,295    $ 1,430    $ 1,771    $ 1,560    $ 718

Construction and land development

     1,667      1,636      1,682      6,070      3,196

Real estate - mortgage:

              

Commercial

     4,695      5,313      5,659      1,504      —  

Residential

     6,059      5,981      7,502      6,872      7,964

Consumer installment

     80      149      198      217      59
 

Total potential problem loans

   $     13,796    $     14,509    $     16,812    $     16,223    $     11,937
 

At June 30, 2010, approximately $1.7 million or 12.0% of total potential problem loans were past due at least 30 days but less than 90 days.

 

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The following table is a summary of the Company’s performing loans that were past due at least 30 days but less than 90 days for the second quarter of 2010 and the previous four quarters.

 

     2010    2009
(In thousands)    Second
Quarter
   First
Quarter
   Fourth
Quarter
   Third
Quarter
   Second
Quarter

Performing loans past due 30 to 90 days:

              

Commercial, financial, and agricultural

   $ 463    $ 206    $ 339    $ 398    $ 280

Construction and land development

     246      20      137      518      47

Real estate - mortgage:

              

Commercial

     1,026      1,658      1,048      890      —  

Residential

     445      3,357      1,626      736      161

Consumer installment

     87      3      46      82      72
 

Total performing loans past due 30 to 90 days

   $     2,267    $     5,244    $     3,196    $     2,624    $     560
 

Deposits

Total deposits were $605.8 million and $579.4 million at June 30, 2010, and December 31, 2009, respectively. The increase of $26.4 million in total deposits from December 31, 2009 was largely due to increases of $10.0 million, $7.9 million, and $8.8 million, respectively, in noninterest bearing demand deposits, interest bearing demand deposits (or “NOW accounts”), and money market accounts. The increase in noninterest bearing deposits is primarily due to an increase in the number of new accounts and an increase in the balances of existing customer accounts; the increase in NOW accounts primarily relates to seasonal increases in public depositor account balances; and the increase in money market accounts reflects decreases in interest rates and related shifts as customers sought more yield in a low interest rate environment.

The average rate paid on total interest-bearing deposits was 2.04% in the first six months of 2010 and 2.73% in the first six months of 2009.

Noninterest bearing deposits were 14% and 13% of total deposits as of June 30, 2010 and December 31, 2009, respectively.

Other Borrowings

Other borrowings consist of short-term borrowings and long-term debt. Short-term borrowings consist of federal funds purchased, securities sold under agreements to repurchase, and other short-term borrowings. The Bank had available federal funds lines totaling $34.0 million with none outstanding at June 30, 2010, compared to $34.0 million with $12.5 million outstanding at December 31, 2009. Securities sold under agreements to repurchase totaled $2.2 million at June 30, 2010, compared to $3.5 million at December 31, 2009.

The average rate paid on short-term borrowings was 0.67% in the first six months of 2010 and 0.51% in the first six months of 2009.

Long-term debt includes FHLB advances with an original maturity greater than one year, securities sold under agreements to repurchase with an original maturity greater than one year, and subordinated debentures related to trust preferred securities. At June 30, 2010 and December 31, 2009, the Bank had $20.0 million and $25.0 million, respectively, in securities sold under agreements to repurchase with an original maturity greater than one year. The Bank had $86.1 million in long-term FHLB advances and the Company had $7.2 million in junior subordinated debentures related to trust preferred securities outstanding at both June 30, 2010 and December 31, 2009.

The average rate paid on long-term debt was 4.03% in the first six months of 2010 and 3.99% in the first six months of 2009.

CAPITAL ADEQUACY

The Company’s consolidated stockholders’ equity balances were $59.0 million and $56.2 million as of June 30, 2010 and December 31, 2009, respectively. The increase from December 31, 2009 is primarily driven by net earnings of $3.2 million and other comprehensive income due to the change in unrealized gains (losses) on securities available-for-sale of $1.1 million, which was offset by cash dividends paid of approximately $1.4 million.

The Company’s tier 1 leverage ratio was 8.27%, tier 1 risk-based capital ratio was 14.25% and total risk-based capital ratio was 15.49% at June 30, 2010. These ratios exceed the minimum regulatory capital percentages of 5.0% for tier 1 leverage ratio, 6.0% for tier 1 risk-based capital ratio and 10.0% for total risk-based capital ratio to be considered “well-capitalized.” Based on current regulatory standards, the Company is classified as “well capitalized.”

 

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MARKET AND LIQUIDITY RISK MANAGEMENT

Management’s objective is to manage assets and liabilities to provide a satisfactory, consistent level of profitability within the framework of established liquidity, loan, investment, borrowing, and capital policies. The Bank’s Asset Liability Management Committee (“ALCO”) is charged with the responsibility of monitoring these policies, which are designed to ensure acceptable composition of asset/liability mix. Two critical areas of focus for ALCO are interest rate sensitivity and liquidity risk management.

Interest Rate Sensitivity Management

In the normal course of business, the Company is exposed to market risk arising from fluctuations in interest rates. ALCO measures and evaluates interest rate risk so that the Bank can meet customer demands for various types of loans and deposits. Measurements used to help manage interest rate sensitivity include an earnings simulation model and an economic value of equity model.

Management believes that interest rate risk is best estimated by our earnings simulation modeling. Forecasted levels of earning assets, interest-bearing liabilities, and off-balance sheet financial instruments are combined with ALCO forecasts of market interest rates for the next 12 months and are combined with other factors in order to produce various earnings simulations and estimates. To limit interest rate risk, we have guidelines for earnings at risk which seek to limit the variance of net interest income to less than a 10 percent decline for a 200 basis point change up or down in rates from management’s flat interest rate forecast over the next twelve months. The results of our current simulation model would indicate that we are in compliance with our current guidelines at June 30, 2010.

Economic value of equity measures the extent that estimated economic values of our assets, liabilities and off-balance sheet items will change as a result of interest rate changes. Economic values are estimated by discounting expected cash flows from assets, liabilities and off-balance sheet items, which establishes a base case economic value of equity. To help limit interest rate risk, we have a guideline stating that for a 200 basis point instantaneous change in interest rates up or down, the economic value of equity should not decrease by more than 30 percent. The results of our current economic value of equity model would indicate that we are in compliance with our guidelines at June 30, 2010.

Each of the above analyses may not, on its own, be an accurate indicator of how our net interest income will be affected by changes in interest rates. Income associated with interest-earning assets and costs associated with interest-bearing liabilities may not be affected uniformly by changes in interest rates. In addition, the magnitude and duration of changes in interest rates may have a significant impact on net interest income. For example, although certain assets and liabilities may have similar maturities or periods of repricing, they may react in different degrees to changes in market interest rates, and other economic and market factors. Interest rates on certain types of assets and liabilities fluctuate in advance of changes in general market rates, while interest rates on other types may lag behind changes in general market rates. In addition, certain assets, such as adjustable rate mortgage loans, have features (generally referred to as “interest rate caps and floors”) which limit changes in interest rates. Prepayment and early withdrawal levels also could deviate significantly from those assumed in calculating the maturity of certain instruments. The ability of many borrowers to service their debts also may decrease during periods of rising interest rates or economic stress, which may differ across industries and economic sectors. ALCO reviews each of the above interest rate sensitivity analyses along with several different interest rate scenarios in seeking satisfactory, consistent levels of profitability within the framework of the Company’s established liquidity, loan, investment, borrowing, and capital policies.

The Company may also use derivative financial instruments to improve the balance between interest-sensitive assets and interest-sensitive liabilities and as one tool to manage interest rate sensitivity while continuing to meet the credit and deposit needs of our customers. From time to time, the Company may enter into interest rate swaps (“swaps”) to facilitate customer transactions and meet their financing needs. These swaps qualify as derivatives, but are not designated as hedging instruments. At June 30, 2010 and December 31, 2009, the Company had no derivative contracts to assist in managing interest rate sensitivity.

Liquidity Risk Management

Liquidity is the Company’s ability to convert assets into cash equivalents in order to meet daily cash flow requirements, primarily for deposit withdrawals, loan demand and maturing obligations. Without proper management of its liquidity, the Company could experience higher costs of obtaining funds due to insufficient liquidity, while excessive liquidity can lead to a decline in earnings due to the cost of foregoing alternative higher-yielding investment opportunities.

 

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Liquidity is managed at two levels. The first is the liquidity of the Company. The second is the liquidity of the Bank. The management of liquidity at both levels is essential, because the Company and the Bank have different funding needs and sources, and each are subject to regulatory guidelines and requirements.

The primary source of funding and the primary source of liquidity for the Company include dividends received from the Bank, and secondarily proceeds from the possible issuance of common stock or other securities. Primary uses of funds for the Company include dividends paid to shareholders, stock repurchases, and interest payments on junior subordinated debentures issued by the Company in connection with trust preferred securities. The junior subordinated debentures are presented as long-term debt in the Consolidated Balance Sheets and the related trust preferred securities are includible in Tier 1 Capital for regulatory capital purposes.

Primary sources of funding for the Bank include customer deposits, other borrowings, repayment and maturity of securities, sales of securities, and sale and repayment of loans. The Bank has access to federal funds lines from various banks and borrowings from the Federal Reserve discount window. In addition to these sources, the Bank has participated in the FHLB’s advance program to obtain funding for its growth. Advances include both fixed and variable terms and are taken out with varying maturities. At June 30, 2010, the Bank had an available line of credit with the FHLB totaling $234.4 million with $86.1 million outstanding. At June 30, 2010, the Bank also had $34.0 million of federal funds lines with none outstanding. Primary uses of funds include repayment of maturing obligations and growing the loan portfolio.

Management believes that the Company and the Bank have adequate sources of liquidity to meet all known contractual obligations and unfunded commitments, including loan commitments and reasonable borrower, depositor, and creditor requirements over the next twelve months.

Off-Balance Sheet Arrangements

At June 30, 2010, the Bank had outstanding standby letters of credit of $7.8 million and unfunded loan commitments outstanding of $46.8 million. Because these commitments generally have fixed expiration dates and many will expire without being drawn upon, the total commitment level does not necessarily represent future cash requirements. If needed to fund these outstanding commitments, the Bank has the ability to liquidate federal funds sold or securities available-for-sale, or draw on its available credit facilities.

The Company also has commitments to fund certain affordable housing investments. The Company invests in various limited partnerships that sponsor affordable housing projects in its primary markets and surrounding areas as a means of supporting local communities. These investments are designed to generate a return primarily through the realization of federal tax credits. The Company typically provides financing during the construction and development of the properties; however, permanent financing is generally obtained from independent parties upon completion of a project. As of June 30, 2010, the Company had investments of $1.7 million, related to these projects, which are included in other assets on the Consolidated Balance Sheets. Total unfunded commitments outstanding for affordable housing investments were $4.4 million at June 30, 2010. When commitments to fund affordable housing investments are contingent upon a future event, a liability must be recognized when that contingent event becomes probable. As of June 30, 2010, the Company had no unfunded commitments related to affordable housing investments included in other liabilities. Additionally, the Company had outstanding loan commitments with certain of the partnerships totaling $11.4 million at June 30, 2010. The funded portion of these loans was approximately $1.7 million at June 30, 2010. The funded portions of these loans are included in loans, net of unearned income on the Consolidated Balance Sheets.

Effects of Inflation and Changing Prices

The Condensed Consolidated Financial Statements and related consolidated financial data presented herein have been prepared in accordance with U.S. generally accepted accounting principles and practices within the banking industry which require the measurement of financial position and operating results in terms of historical dollars without considering the changes in the relative purchasing power of money over time due to inflation. Unlike most industrial companies, virtually all the assets and liabilities of a financial institution are monetary in nature. As a result, interest rates have a more significant impact on a financial institution’s performance than the effects of general levels of inflation.

 

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Table of Contents

CURRENT ACCOUNTING DEVELOPMENTS

The following accounting pronouncements have been issued by the FASB, but are not yet effective:

 

 

ASU 2010-11, Derivatives and Hedging: Scope Exception Related to Embedded Credit Derivatives; and

 

 

ASU 2010-20, Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses.

Information about these pronouncements is described in more detail below.

ASU 2010-11 amends and clarifies the accounting for credit derivatives embedded in interests in securitized financial assets. This guidance is effective for the Company beginning in third quarter 2010. The adoption of ASU 2010-11 is not expected to have a material impact to the consolidated financial statements.

ASU 2010-20 requires enhanced disclosures for the allowance for credit losses and financing receivables, which include certain loans and long-term accounts receivable. Companies will be required to disaggregate credit quality information, including receivables on nonaccrual status, aging of past due receivables, and the roll forward of the allowance for credit losses, by portfolio segment or class of financing receivable. Portfolio segment is the level at which an entity evaluates credit risk and determines its allowance for credit losses, and class of financing receivable is generally a lower level of portfolio segment. Companies must also provide more granular information on the nature and extent of TDRs and their effect on the allowance for credit losses. This guidance is effective for the Company beginning in fourth quarter 2010 with prospective application. The adoption of ASU 2010-20 will not affect the Company’s consolidated financial results since it amends only the disclosure requirements for financing receivables and the allowance for credit losses.

 

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Table of Contents

Table 1 - Explanation of Non-GAAP Financial Measures

In addition to results presented in accordance with U.S. generally accepted accounting principles (GAAP), this quarterly report on Form 10-Q includes certain designated net interest income amounts presented on a tax-equivalent basis, a non-GAAP financial measure, including the calculation of the efficiency ratio.

The Company believes the presentation of net interest income on a tax-equivalent basis provides comparability of net interest income from both taxable and tax-exempt sources and facilitates comparability within the industry. Although the Company believes these non-GAAP financial measures enhance investors’ understanding of its business and performance, these non-GAAP financial measures should not be considered an alternative to GAAP. The reconciliation of these non-GAAP financial measures from GAAP to non-GAAP is presented below.

 

     2010    2009
(in thousands)    Second
Quarter
   First
Quarter
   Fourth
Quarter
   Third
Quarter
   Second
Quarter

Net interest income (GAAP)

   $ 4,688    4,831    5,109    4,662    4,519

Tax-equivalent adjustment

     438    437    438    432    404
 

Net interest income (Tax-equivalent)

   $     5,126    5,268    5,547    5,094    4,923
 

 

     Six months ended
June 30
(In thousands)    2010    2009

Net interest income (GAAP)

   $ 9,519    9,044

Tax-equivalent adjustment

     875    763
 

Net interest income (Tax-equivalent)

   $     10,394    9,807
 

 

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Table 2 - Selected Quarterly Financial Data

 

     2010    2009
(Dollars in thousands, except per share amounts)    Second
Quarter
    First
Quarter
   Fourth
Quarter
    Third
Quarter
   Second
Quarter

Results of Operations

            

Net interest income (a)

   $ 5,126      5,268    5,547      5,094    4,923

Less: tax-equivalent adjustment

     438      437    438      432    404
 

Net interest income (GAAP)

     4,688      4,831    5,109      4,662    4,519

Noninterest income (loss)

     2,792      2,296    799      1,159    1,263
 

Total revenue

     7,480      7,127    5,908      5,821    5,782

Provision for loan losses

     750      1,450    2,900      1,100    700

Noninterest expense

     4,809      3,636    3,735      3,421    3,924

Income tax expense

     314      424    (930   277    226
 

Net earnings

   $ 1,607      1,617    203      1,023    932
 

Per share data:

            

Basic and diluted net earnings

   $ 0.44      0.44    0.06      0.28    0.25

Cash dividends declared

     0.195      0.195    0.190      0.190    0.190

Weighted average shares outstanding:

            

Basic and diluted

     3,642,877      3,643,116    3,643,395      3,644,097    3,644,491

Shares outstanding, at period end

     3,642,693      3,643,112    3,643,117      3,644,097    3,644,097

Book value

   $ 16.21      15.86    15.42      16.03    14.53

Common stock price

            

High

   $ 21.00      21.95    25.98      29.99    30.00

Low

     16.86      17.61    18.93      22.50    21.75

Period end:

     18.80      20.65    19.69      24.40    28.50

To earnings ratio

     15.41   x    19.86    29.39      28.05    25.22

To book value

     116   %    130    128      152    196

Performance ratios:

            

Return on average equity

     10.96   %    11.31    1.37      7.64    6.63

Return on average assets

     0.82   %    0.82    0.10      0.52    0.46

Dividend payout ratio

     44.32   %    44.32    316.67      67.86    73.08

Asset Quality:

            

Allowance for loan losses as a % of:

            

Loans

     1.75   %    1.72    1.73      1.42    1.24

Nonperforming loans

     72   %    60    69      64    720

Nonperforming assets as a % of:

            

Loans and foreclosed properties

     4.05   %    4.65    4.34      3.52    1.53

Total assets

     1.98   %    2.28    2.15      1.75    0.72

Nonperforming loans as a % of total loans

     2.43   %    2.87    2.49      2.20    0.17

Net charge-offs as a % of average loans

     0.76   %    1.48    1.95      0.31    0.63

Capital Adequacy:

            

Tier 1 risk-based capital ratio

     14.25   %    13.76    13.73      13.70    13.81

Total risk-based capital ratio

     15.49   %    15.01    14.98      14.88    14.82

Tier 1 Leverage Ratio

     8.27   %    8.17    8.13      8.05    7.89

Other financial data:

            

Net interest margin (a)

     2.82   %    2.94    3.02      2.74    2.64

Effective income tax rate

     16.35   %    20.77    NM      21.31    19.52

Efficiency ratio (b)

     60.74   %    48.07    58.86      54.71    63.43

Selected average balances:

            

Securities

   $ 326,553      331,098    338,261      346,353    353,168

Loans, net of unearned income

     378,491      379,092    381,112      377,170    374,465

Total assets

     785,286      784,183    777,363      790,885    803,903

Total deposits

     606,041      599,021    589,452      604,005    611,224

Long-term debt

     114,880      118,347    118,351      118,355    120,997

Total stockholders’ equity

     58,648      57,208    59,349      53,584    56,265

Selected period end balances:

            

Securities

   $ 333,107      333,660    334,762      338,924    349,472

Loans, net of unearned income

     376,624      380,619    376,103      385,448    373,221

Allowance for loan losses

     6,580      6,546    6,495      5,458    4,646

Total assets

     784,124      791,324    773,382      786,042    800,910

Total deposits

     605,755      608,588    579,409      597,591    616,442

Long-term debt

     113,340      118,345    118,349      118,355    118,358

Total stockholders’ equity

     59,042      57,778    56,183      58,405    52,948
 

 

(a) Tax-equivalent. See “Table 1 - Explanation of Non-GAAP Financial Measures.”
(b) Efficiency ratio is the result of noninterest expense divided by the sum of noninterest income and tax-equivalent net interest income.

NM - not meaningful

 

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Table 3 - Selected Financial Data

 

     Six months ended June 30,
(Dollars in thousands, except per share amounts)    2010     2009

Results of Operations

    

Net interest income (a)

   $ 10,394      9,807

Less: tax-equivalent adjustment

     875      763
 

Net interest income (GAAP)

     9,519      9,044

Noninterest income (loss)

     5,088      1,174
 

Total revenue

     14,607      10,218

Provision for loan losses

     2,200      1,250

Noninterest expense

     8,445      7,477

Income tax expense

     738      313
 

Net earnings

   $ 3,224      1,178
 

Per share data:

    

Basic and diluted net earnings

   $ 0.88      0.32

Cash dividends declared

     0.39      0.96

Weighted average shares outstanding:

    

Basic and diluted

     3,642,996      3,645,652

Shares outstanding, at period end

     3,642,693      3,644,097

Book value

   $ 16.21      14.53

Common stock price

    

High

   $ 21.95      30.00

Low

     16.86      18.07

Period end:

     18.80      28.50

To earnings ratio

     15.41   x    25.22

To book value

     116   %    196

Performance ratios:

    

Return on average equity

     11.13   %    4.12

Return on average assets

     0.82   %    0.30

Dividend payout ratio

     44.32   %    118.75

Asset Quality:

    

Allowance for loan losses as a % of:

    

Loans

     1.75   %    1.24

Nonperforming loans

     72   %    720

Nonperforming assets as a % of:

    

Loans and foreclosed properties

     4.05   %    1.53

Total assets

     1.98   %    0.72

Nonperforming loans as a % of total loans

     2.43   %    0.17

Net charge-offs as a % of average loans

     1.12   %    0.54

Capital Adequacy:

    

Tier 1 risk-based capital ratio

     14.25   %    13.81

Total risk-based capital ratio

     15.49   %    14.82

Tier 1 Leverage Ratio

     8.27   %    7.89

Other financial data:

    

Net interest margin (a)

     2.88   %    2.68

Effective income tax rate

     18.63   %    20.99

Efficiency ratio (b)

     54.55   %    68.09

Selected average balances:

    

Securities

   $ 328,813      345,843

Loans, net of unearned income

     378,790      373,588

Total assets

     784,737      791,667

Total deposits

     602,550      596,158

Long-term debt

     116,604      122,174

Total stockholders’ equity

     57,932      57,150

Selected period end balances:

    

Securities

   $ 333,107      349,472

Loans, net of unearned income

     376,624      373,221

Allowance for loan losses

     6,580      4,646

Total assets

     784,124      800,910

Total deposits

     605,755      616,442

Long-term debt

     113,340      118,358

Total stockholders’ equity

     59,042      52,948
 

 

(a) Tax-equivalent. See “Table 1 - Explanation of Non-GAAP Financial Measures.”
(b) Efficiency ratio is the result of noninterest expense divided by the sum of noninterest income and tax-equivalent net interest income.

 

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Table 4 - Average Balances and Net Interest Income Analysis

 

     Quarter ended June 30
     2010    2009
(Dollars in thousands)    Average
Balance
   Interest
Income/
Expense
   Yield/
Rate
   Average
Balance
   Interest
Income/
Expense
   Yield/
Rate
               

Interest-earning assets:

                 

Loans and loans held for sale (1)

   $ 381,605    $ 5,492    5.77%    $ 379,162    $ 5,430    5.74%

Securities - taxable

     246,157      2,110    3.44%      279,464      3,025    4.34%

Securities - tax-exempt (2)

     80,396      1,287    6.42%      73,704      1,188    6.47%
               

Total securities

     326,553      3,397    4.17%      353,168      4,213    4.78%

Federal funds sold

     19,520      10    0.21%      13,944      8    0.23%

Interest bearing bank deposits

     585      —      0.00%      1,923      1    0.10%
               

Total interest-earning assets

     728,263    $ 8,899    4.90%      748,197    $ 9,652    5.17%

Cash and due from banks

     11,746            16,618      

Other assets

     45,277            39,088      
                           

Total assets

   $ 785,286          $ 803,903      
                           

Interest-bearing liabilities:

                 

Deposits:

                 

NOW

   $ 93,002    $ 167    0.72%    $ 92,131    $ 244    1.06%

Savings and money market

     113,639      337    1.19%      95,247      283    1.19%

Certificates of deposits less than $100,000

     113,492      703    2.48%      112,771      979    3.48%

Certificates of deposits and other time deposits of $100,000 or more

     201,510      1,408    2.80%      231,089      1,999    3.47%
               

Total interest-bearing deposits

     521,643      2,615    2.01%      531,238      3,505    2.65%

Short-term borrowings

     2,227      3    0.54%      11,760      15    0.51%

Long-term debt

     114,880      1,155    4.03%      120,997      1,209    4.01%
               

Total interest-bearing liabilities

     638,750    $ 3,773    2.37%      663,995    $ 4,729    2.86%

Noninterest-bearing deposits

     84,398            79,986      

Other liabilities

     3,490            3,657      

Stockholders’ equity

     58,648            56,265      
                           

Total liabilities and stockholders’ equity

   $     785,286          $     803,903      
                           

Net interest income and margin

      $     5,126    2.82%       $     4,923    2.64%
                     

 

(1) Average loan balances are shown net of unearned income and loans on nonaccrual status have been included in the computation of average balances.
(2) Yields on tax-exempt securities have been computed on a tax-equivalent basis using an income tax rate of 34%.

 

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Table 5 - Average Balances and Net Interest Income Analysis

 

     Six months ended June 30
     2010    2009
(Dollars in thousands)    Average
Balance
   Interest
Income/
Expense
   Yield/
Rate
   Average
Balance
   Interest
Income/
Expense
   Yield/
Rate
               

Interest-earning assets:

                 

Loans and loans held for sale (1)

   $     381,694    $     10,925    5.77%    $     378,365    $     10,776    5.74%

Securities - taxable

     248,210      4,477    3.64%      275,937      6,252    4.57%

Securities - tax-exempt (2)

     80,603      2,576    6.44%      69,906      2,244    6.47%
               

Total securities

     328,813      7,053    4.33%      345,843      8,496    4.95%

Federal funds sold

     16,195      17    0.21%      12,607      14    0.22%

Interest bearing bank deposits

     829      —      0.00%      1,423      1    0.14%
               

Total interest-earning assets

     727,531    $ 17,995    4.99%      738,238    $ 19,287    5.27%

Cash and due from banks

     12,384            16,756      

Other assets

     44,822            36,673      
                           

Total assets

   $ 784,737          $ 791,667      
                           

Interest-bearing liabilities:

                 

Deposits:

                 

NOW

   $ 93,174    $ 343    0.74%    $ 89,290    $ 453    1.02%

Savings and money market

     109,012      624    1.15%      92,121      555    1.21%

Certificates of deposits less than $100,000

     113,595      1,442    2.56%      109,974      1,972    3.62%

Certificates of deposits and other time deposits of $100,000 or more

     202,835      2,846    2.83%      227,587      4,049    3.59%
               

Total interest-bearing deposits

     518,616      5,255    2.04%      518,972      7,029    2.73%

Short-term borrowings

     4,230      14    0.67%      12,277      31    0.51%

Long-term debt

     116,604      2,332    4.03%      122,174      2,420    3.99%
               

Total interest-bearing liabilities

     639,450    $ 7,601    2.40%      653,423    $ 9,480    2.93%

Noninterest-bearing deposits

     83,934            77,186      

Other liabilities

     3,421            3,908      

Stockholders’ equity

     57,932            57,150      
                           

Total liabilities and stockholders’ equity

   $ 784,737          $ 791,667      
                           

Net interest income and margin

      $ 10,394    2.88%       $ 9,807    2.68%
                     

 

(1) Average loan balances are shown net of unearned income and loans on nonaccrual status have been included in the computation of average balances.
(2) Yields on tax-exempt securities have been computed on a tax-equivalent basis using an income tax rate of 34%.

 

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Table 6 - Loan Portfolio Composition

 

     2010    2009
(In thousands)    Second
Quarter
   First
Quarter
   Fourth
Quarter
   Third
Quarter
   Second
Quarter

Commercial, financial and agricultural

   $ 56,168     52,918     53,884     54,350     52,397 

Construction & land development

     48,758     57,945     56,820     56,956     53,304 

Real estate - mortgage:

              

Commercial

     159,367     158,781     156,928     156,356     147,843 

Residential

     100,451     99,660     97,407     106,932     108,576 

Consumer installment

     12,037     11,475     11,236     11,065     11,330 
 

Total loans

     376,781     380,779     376,275     385,659     373,450 

Less: unearned income

     (157)    (160)    (172)    (211)    (229)
 

Loans, net of unearned income

     376,624     380,619     376,103     385,448     373,221 

Less: allowance for loan losses

     (6,580)    (6,546)    (6,495)    (5,