The Company uses interest rate swaps to reduce interest rate risks and to manage net interest income. The Company entered into an interest rate swap agreement on July 1, 2010 to manage the interest rate exposure on its Floating Rate Junior Subordinated Deferrable Interest Debentures due 2036. By entering into this agreement, the Company converts a floating rate liability into a fixed rate liability through 2020. Under the terms of the agreement, the Company receives interest quarterly at the rate equivalent to three month LIBOR plus 1.70% repricing every three months on the same date as the Company’s Floating Rate Junior Subordinated Deferrable Interest Debentures due 2036 and pays interest expense monthly at the fixed rate of 4.91%. The interest expense on the interest rate swap was $27,359 for quarter ended March 31, 2012.
The Company also entered into two swap agreements dated August 15, 2011 to manage the interest rate risk related to two commercial loans. The agreements allow the Company to convert fixed rate assets to floating rate assets through 2021. The Company receives interest monthly at the rate equivalent to one-month LIBOR plus 3.55% repricing on the same date as the loans and pays interest at the fixed rate of 5.875%. The interest income on the interest rate swaps was a reduction $22,670 for quarter ended March 31, 2012.
Interest differentials paid or received under the swap agreements are reflected as adjustments to interest income. These interest rate swap agreements are considered cash flow hedge derivative instruments that qualify for hedge accounting. The notional amounts of the interest rate swaps are not exchanged and do not represent exposure to credit loss. In the event of default by a counter party, the risk in these transactions is the cost of replacing the agreements at current market rates.
The effects of derivative instruments on the Consolidated Financial Statements for March 31, 2012 and December 31, 2011 are as follows:
|
(In thousands except as noted)
|
|
March 31, 2012 |
|
|
Derivatives designated as hedging instruments
|
|
Notional/
Contract
Amount
|
|
|
Estimated Net
Fair Value
|
|
Fair Value
Balance Sheet
Location
|
|
Expiration
Date
|
|
|
Interest rate swap-10 year cash flow
|
|
$ |
4,000 |
|
|
$ |
(385 |
) |
Other Liabilities
|
|
9/15/2020
|
|
|
Interest rate swap-10 year cash flow
|
|
|
2,111 |
|
|
|
(62 |
) |
Other Liabilities
|
|
8/15/2021
|
|
|
Interest rate swap-10 year cash flow
|
|
|
2,235 |
|
|
|
(64 |
) |
Other Liabilities
|
|
8/15/2021
|
|
| |
|
March 31, 2012 |
|
|
Derivatives in cash flow hedging relationships
|
|
Amount of Gain (Loss)
Recognized in OCI on
Derivatives, net of tax
(Effective Portion)
|
|
Location of Gain or
(Loss) Recognized in
Income on Derivative
(Ineffective Portion)
|
|
Amount of Gain (Loss)
Recognized in Income
on Derivative
(Ineffective Portion)
|
|
|
Interest rate swap-10 year cash flow
|
|
$ |
(255 |
) |
Not applicable
|
|
$ |
- |
|
|
Interest rate swap-10 year cash flow
|
|
|
(41 |
) |
Not applicable
|
|
|
- |
|
|
Interest rate swap-10 year cash flow
|
|
|
(42 |
) |
Not applicable
|
|
|
- |
|
| |
|
$ |
(338 |
) |
|
|
$ |
- |
|
| |
|
December 31, 2011
|
|
|
Derivatives designated as hedging instruments
|
|
Notional/
Contract Amount
|
|
|
Estimated Net
Fair Value
|
|
Fair Value
Balance Sheet
Location
|
|
Expiration
Date
|
|
|
Interest rate swap-10 year cash flow
|
|
$ |
4,000 |
|
|
|
(452 |
) |
Other Liabilities
|
|
9/15/2020
|
|
|
Interest rate swap-10 year cash flow
|
|
|
2,117 |
|
|
|
88 |
|
Other Assets
|
|
8/15/2021
|
|
|
Interest rate swap-10 year cash flow
|
|
|
2,245 |
|
|
|
91 |
|
Other Assets
|
|
8/15/2021
|
|
| |
|
December 31, 2011 |
|
|
Derivatives in cash flow hedging relationships
|
|
Amount of Gain (Loss)
Recognized in OCI on
Derivatives, net of tax
(Effective Portion)
|
|
Location of Gain or
(Loss) Recognized in
Income on Derivative
(Ineffective Portion)
|
|
Amount of Gain (Loss)
Recognized in Income
on Derivative
(Ineffective Portion)
|
|
|
Interest rate swap-10 year cash flow
|
|
$ |
(298 |
) |
Not applicable
|
|
$ |
- |
|
|
Interest rate swap-10 year cash flow
|
|
|
58 |
|
Not applicable
|
|
|
- |
|
|
Interest rate swap-10 year cash flow
|
|
|
60 |
|
Not applicable
|
|
|
- |
|
| |
|
$ |
(180 |
) |
|
|
$ |
- |
|
|
Note 6.
|
Earnings Per Share
|
The following table shows the weighted average number of shares used in computing earnings per share and the effect on weighted average number of shares of dilutive potential common stock.
| |
|
Three Months Ended
|
|
|
Three Months Ended
|
|
| |
|
March 31, 2012
|
|
|
March 31, 2011
|
|
| |
|
Shares
|
|
|
Per Share Amount
|
|
|
Shares
|
|
|
Per Share Amount
|
|
|
Basic earnings per share
|
|
|
3,680,230 |
|
|
$ |
0.26 |
|
|
|
3,655,354 |
|
|
$ |
0.25 |
|
|
Effect of dilutive securities, stock-based awards
|
|
|
11,614 |
|
|
|
|
|
|
|
14,175 |
|
|
|
|
|
| |
|
|
3,691,844 |
|
|
$ |
0.26 |
|
|
|
3,669,529 |
|
|
$ |
0.25 |
|
At March 31, 2012, there were no options outstanding.
|
Note 7.
|
Stock Based Compensation
|
Stock Incentive Plan
On May 19, 2009, the shareholders of the Company approved the Company’s Stock Incentive Plan (the “Plan”), which superseded and replaced the Omnibus Stock Ownership and Long Term Incentive Plan.
Under the Plan, stock options, stock appreciation rights, non-vested and/or restricted shares, and long-term performance unit awards may be granted to directors and certain employees for purchase of the Company’s common stock. The effective date of the Plan is March 19, 2009, the date the Company’s Board approved the Plan, and it has a termination date of December 31, 2019. The Company’s Board may terminate, suspend or modify the Plan within certain restrictions. The Plan authorizes for issuance 350,000 shares of the Company’s common stock. The Plan requires that options be granted at an exercise price equal to at least 100% of the fair market value of the common stock on the date of the grant. Such options are generally not exercisable until three years from the date of issuance and generally require continuous employment during the period prior to exercise. The options will expire in no more than ten years after the date of grant. The stock options, stock appreciation rights, restricted shares, and long-term performance unit awards for certain employees are generally subject to vesting requirements and are subject to forfeiture if vesting and other contractual provision requirements are not met.
The Company previously issued stock options to non-employee directors under its Non-employee Director Stock Option Plan, which expired in 1999. Under that plan, each non-employee director of the Company or its subsidiary received an option grant covering 2,240 shares of Company common stock on April 1 of each year during the five-year term of the plan. The first grant under the plan was made on May 1, 1995. The exercise price of awards was fixed at the fair market value of the shares on the date the option was granted. During the term of the plan, options for a total of 120,960 shares of common stock were granted. Effective January 1, 2000, the Omnibus Stock Ownership and Long-Term Incentive Plan for employees was amended and restated to include non-employee directors. The Company did not grant stock options during the three months ended March 31, 2012 or March 31, 2011. At March 31, 2012, there were no options outstanding.
Restricted Shares
The restricted shares are accounted for using the fair market value of the Company’s common stock on the date the restricted shares were awarded. The restricted shares issued to certain officers are subject to a vesting period, whereby, the restrictions on the shares lapse on the third year anniversary of the date the restricted shares were awarded. Compensation expense for these shares is accrued over the three year period.
The Company has granted awards of non-vested shares to certain officers and vested shares (effective March 31, 2010) to non-employee directors under the above-described incentive plans:11,925 shares, 9,714 shares and 9,784 shares of unvested restricted stock to executive officers and 5,632 shares, 4,752 shares and 5,553 shares of vested restricted stock to non-employee directors on February 16, 2012, February 17, 2011 and March 5, 2010, respectively. Compensation expense for these non-vested shares amounted to $ 34,468 and $35,279, net of forfeiture, for the three months ended March 31, 2012 and 2011, respectively. The restricted shares issued to non-employee directors are no longer subject to a vesting period. Beginning in 2011, compensation expense for the non-employee director shares is recognized at the date the shares are granted. During the quarter ended March 31, 2012, compensation expense for non-employee director shares was $68,035.
The Company granted performance-based stock rights relating to 11,925, 9,714 and 9,784 shares to certain officers on February 16, 2012, February 17, 2011 and March 5, 2010, respectively, under the Plan.
The performance-based stock rights are accounted for using the fair market value of the Company’s common stock on the date the restricted shares were awarded, and adjusted as the market value of the stock changes. The performance-based stock rights shares issued to executive officers are subject to a vesting period, whereby the restrictions on the shares lapse on the third year anniversary of the date the restricted shares were awarded. The award for 2010 is subject to the Company reaching a predetermined return on average equity ratio for the final year of the vesting period. The award for 2012 and 2011 is subject to the Company reaching a predetermined three year performance average on the return on average equity ratio as compared to a predetermined peer group of banks. Compensation expense for performance-based stock rights amounted to $48,000 in both the quarters ended March 31, 2012, and 2011, respectively.
A summary of the status of options granted under the Plans is presented below:
| |
|
Three Months Ended March 31, 2012
|
|
| |
|
Number of Shares
|
|
|
Weighted Average
Exercise Price
|
|
|
|
Average Intrinsic Value (1)
|
|
| |
|
|
|
|
|
|
|
|
|
|
|
Outstanding at January 1, 2012
|
|
|
23,732 |
|
|
$ |
13.00 |
|
|
|
|
|
|
Granted
|
|
|
- |
|
|
|
|
|
|
|
|
|
|
Exercised
|
|
|
- |
|
|
|
|
|
|
|
|
|
|
Forfeited
|
|
|
(23,732 |
) |
|
|
13.00 |
|
|
|
|
|
|
Outstanding at March 31, 2012
|
|
|
- |
|
|
|
|
|
|
|
|
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
Exercisable at end of quarter
|
|
|
- |
|
|
|
|
|
|
|
|
|
|
Weighted-average fair value per option of options granted during the year
|
|
|
|
|
|
|
|
|
|
|
|
|
(1) The aggregate intrinsic value of stock options in the table above reflects the pre-tax intrinsic value (the amount by which the March 31, 2012 market value of the underlying stock option exceeded the exercise price of the option) that would have been received by the option holders had all option holders exercised their options on March 31, 2012. This amount changes based on the changes in the market value of the Company’s common stock.
No options were exercised during the three month period ended March 31, 2012. The total intrinsic value of options exercised during the three months ended March 31, 2011 was $97,303.
A summary of the status of the Company’s non-vested restricted shares granted under the above-described plans is presented below:
| |
|
Three Months Ended March 31, 2012
|
|
| |
|
Shares
|
|
|
Weighted Average
Fair Value
|
|
| |
|
|
|
|
|
|
|
Nonvested at January 1, 2012
|
|
|
32,572 |
|
|
$ |
12.44 |
|
| |
|
|
|
|
|
|
|
|
|
Granted
|
|
|
11,925 |
|
|
|
12.08 |
|
|
Vested
|
|
|
(13,074 |
) |
|
|
10.06 |
|
|
Forfeited
|
|
|
- |
|
|
|
|
|
|
Nonvested at March 31, 2012
|
|
|
31,423 |
|
|
|
13.30 |
|
As of March 31, 2012, there was $262,137 of total unrecognized compensation cost related to non-vested share-based compensation arrangements granted under the plans. This type of deferred compensation cost is recognized over a period of three years.
A summary of the status of the Company’s non-vested performance-based stock rights is presented below:
| |
|
Three Months Ended March 31, 2012
|
|
| |
|
Performance
Based Stock
Rights
|
|
|
Weighted Average
Fair Value
|
|
|
Nonvested at January 1, 2012
|
|
|
32,572 |
|
|
$ |
12.44 |
|
| |
|
|
|
|
|
|
|
|
|
Granted
|
|
|
11,925 |
|
|
|
12.08 |
|
|
Vested
|
|
|
(13,074 |
) |
|
|
10.06 |
|
|
Forfeited
|
|
|
|
|
|
|
|
|
|
Nonvested at March 31, 2012
|
|
|
31,423 |
|
|
|
13.30 |
|
|
Note 8.
|
Employee Benefit Plans
|
On December 20, 2007, the Company’s Board of Directors approved the termination of the defined benefit pension plan effective on December 31, 2009, and effective January 1, 2010 replaced the defined benefit pension plan with an enhanced 401(k) plan. On August 16, 2010, the Company received a favorable determination letter dated August 12, 2010 from the Internal Revenue Service for the December 31, 2011 termination date. Between January 1, 2010 and December 10, 2010, the Company distributed $7,203,754 of pension benefits, of which $7,086,067 was distributed between November 30, 2010 and December 10, 2010, and represented the final distribution upon the plan’s termination. On February 1, 2011, the Company filed a Post-Distribution Certification for Standard Termination with the Pension Benefit Guaranty Corporation.
The Company has a defined contribution retirement plan under Internal Revenue Code (“Code”) Section 401(k) covering employees who have completed 3 months of service and who are at least 18 years of age. Under the plan, a participant may contribute an amount up to 100% of their covered compensation for the year, not to exceed the dollar limit set by law (Code Section 402(g)). The Company will make an annual matching contribution equal to 100% on the first 1% of compensation deferred and 50% on the next 5% of compensation deferred, for a maximum match of 3.5% of compensation. Beginning in 2010, the Company began making an additional safe harbor contribution equal to 6% of compensation to all eligible participants. The Company’s 401(k) expenses for the quarters ended March 31, 2012 and 2011 were $171,464 and $163,530, respectively.
The Company also maintains a Director Deferred Compensation Plan (“Deferred Compensation Plan"). This plan provides that any non-employee director of the Company or the Bank may elect to defer receipt of all or any portion of his or her compensation as a director. A participating director may elect to have amounts deferred under the Deferred Compensation Plan held in a deferred cash account, which is credited on a quarterly basis with interest equal to the highest rate offered by the Bank at the end of the preceding quarter. Alternatively, a participant may elect to have a deferred stock account in which deferred amounts are treated as if invested in the Company’s common stock at the fair market value on the date of deferral. The value of a stock account will increase and decrease based upon the fair market value of an equivalent number of shares of common stock. In addition, the deferred amounts deemed invested in common stock will be credited with dividends on an equivalent number of shares. Amounts considered invested in the Company’s common stock are paid, at the election of the director, either in cash or in whole shares of the common stock and cash in lieu of fractional shares. Directors may elect to receive amounts contributed to their respective accounts in one or up to five installments.
The Company has a nonqualified deferred compensation plan for a former key employee’s retirement, in which the contribution expense is solely funded by the Company. The retirement benefit to be provided is variable based upon the performance of underlying life insurance policy assets. Deferred compensation expense amounted to $8,322 and $711 for the quarters ended March 31, 2012 and 2011, respectively.
Concurrent with the establishment of the Deferred Compensation Plan, the Company purchased life insurance policies on this employee with the Company named as owner and beneficiary. These life insurance policies are intended to be utilized as a source of funding the Deferred Compensation Plan. The Company has recorded in other assets of $1,154,356 and $1,145,876 representing cash surrender value of these policies at March 31, 2012 and December 31, 2011, respectively.
|
Note 9.
|
Fair Value Measurement
|
The Company adopted ASC 820 “Fair Value Measurement and Disclosures” (previously Statement of Financial Accounting Standards (“SFAS”) No. 157, “Fair Value Measurements”) on January 1, 2008 to record fair value adjustments to certain assets and liabilities and to determine fair value disclosures. ASC 820 clarifies that fair value of certain assets and liabilities is an exit price, representing the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants.
ASC 820 specifies a hierarchy of valuation techniques based on whether the inputs to those valuation techniques are observable or unobservable. Observable inputs reflect market data obtained from independent sources, while unobservable inputs reflect the Company’s market assumptions. The three levels of the fair value hierarchy under ASC 820 based on these two types of inputs are as follows:
| |
Level 1 –
|
Valuation is based on quoted prices in active markets for identical assets and liabilities.
|
| |
Level 2 –
|
Valuation is based on observable inputs including quoted prices in active markets for similar assets and liabilities, quoted prices for identical or similar assets and liabilities in less active markets, and model-based valuation techniques for which significant assumptions can be derived primarily from or corroborated by observable data in the market.
|
| |
Level 3 –
|
Valuation is based on model-based techniques that use one or more significant inputs or assumptions that are unobservable in the market.
|
The following describes the valuation techniques used by the Company to measure certain financial assets and liabilities recorded at fair value on a recurring basis in the financial statements:
Securities available for sale: Securities available for sale are recorded at fair value on a recurring basis. Fair value measurement is based upon quoted market prices, when available (Level 1). If quoted market prices are not available, fair values are measured utilizing independent valuation techniques of identical or similar securities for which significant assumptions are derived primarily from or corroborated by observable market data. Third party vendors compile prices from various sources and may determine the fair value of identical or similar securities by using pricing models that considers observable market data (Level 2). If the inputs used to provide the evaluation for certain securities are unobservable and/or there is little, if any market activity then the security would fall to the lowest level of the hierarchy (Level 3). The carrying value of restricted Federal Reserve Bank and FHLB stock approximates fair value based on the redemption provisions of each and is therefore excluded from the following table.
Interest rate swaps: Interest rate swaps are recorded at fair value on a recurring basis. The Company utilities interest rate swap agreement as part of the management of interest rate risk to modify the repricing characteristics of certain portions of the Company's interest-bearing assets and liabilities. The Company determine the fair value of its interest rate swap using externally developed pricing models based on market observable inputs and therefore classifies such valuation as Level 2. The Company has considered counterparty credit risk in the valuation of its interest rate swap assets and has considered its own credit risk in the valuation of its interest rate swap liabilities.
The following table presents the balances of financial assets and liabilities measured at fair value on a recurring basis as of March 31, 2012 and December 31, 2011 by levels within the valuation hierarchy:
| |
|
Fair Value Measurements Using |
|
|
(In thousands)
|
|
Balance
|
|
|
Quoted Prices in Active Markets for Identical Assets (Level 1) |
|
|
Significant Other
Observable Inputs
(Level 2)
|
|
|
Signicant
Unobservable
Inputs (Level 3)
|
|
|
Assets at March 31, 2012
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Available-for-sale securities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Obligations of U.S. Government corporations and agencies
|
|
$ |
48,538 |
|
|
$ |
- |
|
|
$ |
48,538 |
|
|
$ |
- |
|
|
Obligations of states and political subdivisions
|
|
|
7,347 |
|
|
|
- |
|
|
|
7,347 |
|
|
|
- |
|
|
Corporate bonds
|
|
|
276 |
|
|
|
- |
|
|
|
- |
|
|
|
276 |
|
|
Mutual funds
|
|
|
351 |
|
|
|
351 |
|
|
|
- |
|
|
|
- |
|
|
Total assets at fair value
|
|
$ |
56,512 |
|
|
$ |
351 |
|
|
$ |
55,885 |
|
|
$ |
276 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Liabilities at March 31, 2012
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest rate swap
|
|
|
511 |
|
|
|
- |
|
|
|
511 |
|
|
|
- |
|
|
Total liabilities at fair value
|
|
$ |
511 |
|
|
$ |
- |
|
|
$ |
511 |
|
|
$ |
- |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Assets at December 31, 2011
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Available-for-sale securities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Obligations of U.S. Government corporations and agencies
|
|
$ |
39,572 |
|
|
$ |
- |
|
|
$ |
39,572 |
|
|
$ |
- |
|
Obligations of states and political subdivisions
|
|
|
7,394 |
|
|
|
- |
|
|
|
7,394 |
|
|
|
- |
|
|
Corporate bonds
|
|
|
335 |
|
|
|
- |
|
|
|
- |
|
|
|
335 |
|
|
Mutual funds
|
|
|
349 |
|
|
|
349 |
|
|
|
- |
|
|
|
|
|
|
Total available-for sale securities
|
|
|
47,650 |
|
|
|
349 |
|
|
|
46,966 |
|
|
|
335 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest rate swap
|
|
|
179 |
|
|
|
- |
|
|
|
179 |
|
|
|
- |
|
|
Total assets at fair value
|
|
$ |
47,829 |
|
|
$ |
349 |
|
|
$ |
47,145 |
|
|
$ |
335 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Liabilities at December 31, 2011
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest rate swap
|
|
|
452 |
|
|
|
- |
|
|
|
452 |
|
|
|
- |
|
|
Total liabilities at fair value
|
|
$ |
452 |
|
|
$ |
- |
|
|
$ |
452 |
|
|
$ |
- |
|
Change in Level 3 Fair Value
The changes in Level 3 assets measured at estimated fair value on a recurring basis during the three months ended March 31, 2012 and year ended December 31, 2011 were as follows:
| |
|
Total Gains (Losses) Realized/Unrealized
|
|
|
(In thousands)
|
|
Balance
January 1,
2012
|
|
|
Included in
earnings
|
|
|
Included in Other
Comprehensive
Income
|
|
|
Transfers in
and/or out of
Level 3 and 2
|
|
|
Balance
March 31,
2012
|
|
|
Available-for-sale securities
|
|
$ |
335 |
|
|
$ |
- |
|
|
$ |
(59 |
) |
|
$ |
- |
|
|
$ |
276 |
|
| |
|
Total Gains (Losses) Realized/Unrealized
|
|
|
(In thousands)
|
|
Balance
January 1,
2011
|
|
|
Included in
earnings
|
|
|
Included in Other
Comprehensive
Income
|
|
|
Transfers in
and/or out of
Level 3 and 2
|
|
|
Balance
December 31,
2011
|
|
|
Available-for-sale securities
|
|
$ |
552 |
|
|
$ |
(189 |
) |
|
$ |
(28 |
) |
|
$ |
- |
|
|
$ |
335 |
|
Certain assets are measured at fair value on a nonrecurring basis in accordance with accounting principles generally accepted in the United States. Adjustments to the fair value of these assets usually result from the application of lower-of-cost-or-market accounting or write-downs of individual assets.
The following describes the valuation techniques used by the Company to measure certain financial assets recorded at fair value on a nonrecurring basis in the financial statements:
Impaired Loans: Loans are designated as impaired when, in the judgment of management based on current information and events, it is probable that all amounts due according to the contractual terms of the loan agreement will not be collected. The measurement of loss associated with impaired loans can be based on either the observable market price of the loan or the fair value of the collateral securing the loans. Collateral may be in the form of real estate or business assets including equipment, inventory, and accounts receivable. The vast majority of the Company's collateral is in real estate. The value of real estate collateral is determined utilizing an income or market valuation approach based on an appraisal conducted by an independent, licensed appraiser outside of the Company using observable market data (Level 2). However, if the collateral is a house or building in the process of construction or if an appraisal of the real estate property is over two years old, then the fair value is considered Level 3. The value of business equipment is based upon an outside appraisal if deemed significant, or the net book value on the applicable business’ financial statements if not considered significant using observable market data. Likewise, values for inventory and accounts receivables collateral are based on financial statement balances or aging reports (Level 3). Impaired loans allocated to the Allowance for Loan Losses are measured at fair value on a nonrecurring basis. Any fair value adjustments are recorded in the period incurred as provision for loan losses on the Consolidated Statements of Income. At March 31, 2012, the Company's Level 3 loans consisted of one loan secured by residential real estate of $702,000 with a reserve of $83,000 and four loans totalling $591,000 secured with business assets and a reserve of $440,000.
Other Real Estate Owned (“OREO”): Foreclosed assets are adjusted to fair value upon transfer of the loans to OREO. Subsequently, OREO is carried at the lower of carrying value or fair market value less selling costs. Fair value is based upon independent market prices, appraised values of the collateral, or management’s estimation of the value of the collateral. When the fair value of the collateral is based on an observable market price or a current appraised value, the Company considers the OREO as nonrecurring Level 2. When a current appraised value is not available or management determines the fair value of the collateral is further impaired below the appraised value and there is no observable market price, the Company considers records the OREO as nonrecurring Level 3.
Management believes that the fair value component in its valuation follows the provisions of ASC 820.
The following table summarizes the Company’s financial assets that were measured at fair value on a nonrecurring basis during the period.
| |
|
Carrying Value at March 31, 2012 |
|
|
(In thousands)
|
|
Balance as of
March 31, 2012
|
|
|
Quoted Prices in
Active Markets for
Identical Assets
(Level 1)
|
|
Significant Other
Observable Inputs
(Level 2)
|
|
|
Significant Other
Observable Inputs
(Level 3)
|
|
|
Assets:
|
|
|
|
|
|
|
|
|
|
|
|
|
Impaired loans, net
|
|
$ |
1,657 |
|
$ |
- |
|
$ |
887 |
|
|
$ |
770 |
|
|
Other real estate owned, net
|
|
|
1,776 |
|
|
- |
|
|
1,776 |
|
|
|
- |
|
| |
|
Carrying Value at December 31, 2011 |
|
|
(In thousands)
|
|
Balance as of
December 31, 2011
|
|
|
Quoted Prices in
Active Markets for
Identical Assets
(Level 1)
|
|
Significant Other
Observable Inputs
(Level 2)
|
|
|
Significant Other
Observable Inputs
(Level 3)
|
|
|
Assets:
|
|
|
|
|
|
|
|
|
|
|
|
|
Impaired loans, net
|
|
$ |
1,855 |
|
$ |
- |
|
$ |
971 |
|
|
$ |
884 |
|
|
Other real estate owned, net
|
|
|
1,776 |
|
|
- |
|
|
1,776 |
|
|
|
- |
|
The changes in Level 3 assets measured at estimated fair value on a nonrecurring basis during the three month period ended March 31, 2012 were as follows:
| |
Fair Value Measurements
|
|
|
(In thousands)
|
|
Impaired
Loans
|
|
|
Other Real
Estate
Owned
|
|
|
Balance January 1, 2012
|
|
$ |
884 |
|
|
$ |
1,776 |
|
|
Total gains (losses) realized /unrealized:
|
|
|
|
|
|
|
|
|
|
Included in earnings
|
|
|
- |
|
|
|
- |
|
|
Included in other comprehensive income
|
|
|
- |
|
|
|
- |
|
|
Purchases
|
|
|
- |
|
|
|
- |
|
|
Issuances
|
|
|
- |
|
|
|
- |
|
|
Sales
|
|
|
- |
|
|
|
- |
|
|
Settlements
|
|
|
- |
|
|
|
- |
|
|
Transfers into Level 3
|
|
|
- |
|
|
|
- |
|
|
Transfers out of Level 3
|
|
|
114 |
|
|
|
- |
|
|
Balance March 31, 2012
|
|
$ |
770 |
|
|
$ |
1,776 |
|
| |
|
|
|
|
|
|
|
|
|
Change in unrealized gains (losses) included in earnings for the period, attributable to assets and liabilities still held at March 31, 2012
|
|
$ |
- |
|
|
$ |
- |
|
| |
Quantitative Information about Level 3 Fair Value Measurements
|
|
(In thousands)
|
Fair Value
Level
|
|
Valuation Technique(s)
|
|
Unobservable Input
|
|
Range-
(Weighted average)*
|
|
Securities available-for-sale
|
3
|
|
Discounted cash flow
|
|
Constant prepayment rate
|
|
1%
|
| |
|
|
|
|
Probability of default
|
|
0%-100% Average 28%
|
| |
|
|
|
|
Loss severity
|
|
100%
|
| |
|
|
|
|
|
|
|
|
Impaired Loans
|
3
|
|
Discounted appraised value
|
|
Selling cost
|
|
4%
|
| |
|
|
|
|
Discount for lack of marketability
and age of appraisal
|
|
25%-100%, Average 69%
|
| |
|
|
|
|
Probablility of default
|
|
>50% |
| |
|
|
|
|
|
|
|
|
Other Real Estate Owned
|
3
|
|
Discounted appraised value
|
|
Selling cost
|
|
8%
|
| |
|
|
|
|
Discount for lack of marketability
and age of appraisal
|
|
12%
|
____________________________________
*Range and weighted average are not shown where there is only a single instance reported.
The fair value of a financial instrument is the current amount that would be exchanged between willing parties, other than in a forced liquidation. Fair value is best determined based upon quoted market prices. However, in many instances, there are no quoted market prices for the Company’s various financial instruments. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. Accordingly, the fair value estimates may not be realized in an immediate settlement of the instruments. ASC 820 (previously SFAS No. 107 “Disclosures about Fair Value of Financial Instruments”) excludes certain financial instruments and all non-financial instruments from its disclosure requirements. Accordingly, the aggregate fair value amounts presented may not necessarily represent the underlying fair value of the Company.
The following methods and assumptions were used to estimate the fair value of each class of financial instruments for which it is practicable to estimate that value:
Cash and cash equivalents
The carrying amounts of cash and short-term instruments with a maturity of three months or less approximate fair value. Instruments with maturities of greater than three months are estimated using a discounted cash flow calculation that applies interest rates currently being offered on similar instruments.
Securities
For securities and marketable equity securities held for investment purposes, fair values are based on quoted market prices or dealer quotes. For other securities held as investments, fair value equals quoted market price, if available. If a quoted market price is not available, fair values are based on quoted market prices for similar securities. See Note 2 “Securities” of the Notes to Consolidated Financial Statements for further discussion on determining fair value for pooled trust preferred securities.
Loans Receivable
For variable-rate loans that reprice frequently and with no significant change in credit risk, fair values are based on carrying values. Fair values for certain mortgage loans (e.g., one-to-four family residential), credit card loans, and other consumer loans are based on quoted market prices of similar loans sold in conjunction with securitization transactions, adjusted for differences in loan characteristics. Fair values for other loans (i.e., commercial real estate and investment property mortgage loans, commercial and industrial loans) are estimated using discounted cash flow analyses, using interest rates currently being offered for loans with similar terms to borrowers of similar credit quality. Fair values for nonperforming loans are estimated using discounted cash flow analyses or underlying collateral values, where applicable.
Accrued Interest
The carrying amounts of accrued interest approximate fair value.
Life Insurance
The carrying amount of life insurance contracts is assumed to be a reasonable fair value. Life insurance contracts are carried on the balance sheet at their redemption value. This redemption value is based on existing market conditions and therefore represents the fair value of the contract.
Interest Rate Swaps
The fair values are based on quoted market prices or mathematical models using current and historical data.
Deposit Liabilities
The fair values disclosed for demand deposits (i.e., interest and non-interest bearing checking, statement savings and money market accounts) are, by definition, equal to the amount payable at the reporting date (that is, their carrying amounts). Fair values of fixed rate certificates of deposit are estimated using a discounted cash flow calculation that applies interest rates currently being offered to a schedule of aggregated expected monthly maturities on time deposits.
Federal Funds Purchased
The carrying amounts of the Company’s federal funds purchased are approximate fair value.
Borrowed Funds
The fair values of the Company’s FHLB advances and other borrowings are estimated using discounted cash flow analyses based on the Company’s current incremental borrowing rates for similar types of borrowing arrangements.
Off-Balance-Sheet Financial Instruments
The fair value of commitments to extend credit is estimated using the fees currently charged to enter similar agreements, taking into account the remaining terms of the agreements and the present creditworthiness of the counterparties. For fixed-rate loan commitments, fair value also considers the difference between current levels of interest rates and the committed rates.
The fair value of standby letters of credit is based on fees currently charged for similar agreements or on the estimated cost to terminate them or otherwise settle the obligations with the counterparties at the reporting date.
At March 31, 2012 and December 31, 2011, the fair value of loan commitments and standby letters of credit were deemed immaterial.
The estimated fair values of the Company's financial instruments are as follows:
| |
|
Fair Value Measurements at March 31, 2012
|
|
|
(In thousands )
|
|
Balance as of
March 31, 2012
|
|
|
Quoted Prices in Active Markets for Identical Assets (Level 1)
|
|
|
Significant Other Observable Inputs (Level 2)
|
|
|
Significant Other Observable Inputs (Level 3)
|
|
|
Assets
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash and short-term investments
|
|
$ |
44,675 |
|
|
$ |
42,186 |
|
|
$ |
2,489 |
|
|
$ |
- |
|
|
Securities available for sale
|
|
|
56,512 |
|
|
|
351 |
|
|
|
55,885 |
|
|
|
276 |
|
|
Restricted investments
|
|
|
2,557 |
|
|
|
- |
|
|
|
2,557 |
|
|
|
- |
|
|
Net Loans
|
|
|
459,442 |
|
|
|
- |
|
|
|
458,672 |
|
|
|
770 |
|
|
Accrued interest receivable
|
|
|
1,464 |
|
|
|
1,464 |
|
|
|
- |
|
|
|
- |
|
|
BOLI
|
|
|
11,725 |
|
|
|
- |
|
|
|
11,725 |
|
|
|
- |
|
|
Total Financial Assets
|
|
$ |
576,375 |
|
|
$ |
44,001 |
|
|
$ |
531,328 |
|
|
$ |
1,046 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Liabilities
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Deposits
|
|
$ |
515,736 |
|
|
$ |
360,128 |
|
|
$ |
155,608 |
|
|
$ |
- |
|
|
Borrowings
|
|
|
25,934 |
|
|
|
- |
|
|
|
25,934 |
|
|
|
- |
|
|
Company obligated mandatorily
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
redeemable capital securities
|
|
|
5,249 |
|
|
|
- |
|
|
|
5,249 |
|
|
|
- |
|
|
Accrued interest payable
|
|
|
408 |
|
|
|
408 |
|
|
|
- |
|
|
|
- |
|
|
Interest rate swaps
|
|
|
511 |
|
|
|
- |
|
|
|
511 |
|
|
|
- |
|
|
Total Financial Liabilities
|
|
$ |
547,838 |
|
|
$ |
360,536 |
|
|
$ |
187,302 |
|
|
$ |
- |
|
| |
|
Fair Value Measurements at December 31, 2011
|
|
| |
|
Balance as of
December 31, 2011
|
|
|
Quoted Prices in Active Markets for Identical Assets (Level 1)
|
|
|
Significant Other Observable Inputs (Level 2)
|
|
|
Significant Other Observable Inputs (Level 3)
|
|
|
Assets
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash and short-term investments
|
|
$ |
72,207 |
|
|
$ |
69,660 |
|
|
$ |
2,547 |
|
|
$ |
- |
|
|
Securities available for sale
|
|
|
47,649 |
|
|
|
349 |
|
|
|
46,965 |
|
|
|
335 |
|
|
Restricted investments
|
|
|
2,543 |
|
|
|
- |
|
|
|
2,543 |
|
|
|
- |
|
|
Net Loans
|
|
|
463,449 |
|
|
|
- |
|
|
|
462,565 |
|
|
|
884 |
|
|
Accrued interest receivable
|
|
|
1,534 |
|
|
|
1,534 |
|
|
|
- |
|
|
|
- |
|
| Interest rate swap |
|
|
179 |
|
|
|
- |
|
|
|
179 |
|
|
|
- |
|
|
BOLI
|
|
|
11,621 |
|
|
|
- |
|
|
|
11,621 |
|
|
|
- |
|
| Total Financial Assets |
|
$ |
599,182 |
|
|
$ |
71,543 |
|
|
$ |
526,420 |
|
|
$ |
1,219 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Liabilities
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Deposits
|
|
$ |
535,567 |
|
|
$ |
366,699 |
|
|
$ |
168,868 |
|
|
$ |
- |
|
|
Borrowings
|
|
|
26,023 |
|
|
|
- |
|
|
|
26,023 |
|
|
|
- |
|
|
Company obligated mandatorily
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
redeemable capital securities
|
|
|
4,982 |
|
|
|
- |
|
|
|
4,982 |
|
|
|
- |
|
|
Accrued interest payable
|
|
|
401 |
|
|
|
401 |
|
|
|
- |
|
|
|
- |
|
|
Interest rate swaps
|
|
|
452 |
|
|
|
- |
|
|
|
452 |
|
|
|
- |
|
|
Total Financial Liabilities
|
|
$ |
567,425 |
|
|
$ |
367,100 |
|
|
$ |
200,325 |
|
|
$ |
- |
|
The Company assumes interest rate risk (the risk that general interest rate levels will change) as a result of its normal operations. As a result, the fair values of the Company’s financial instruments will change when interest rate levels change and that change may be either favorable or unfavorable to the Company. Management attempts to match maturities of assets and liabilities to the extent believed necessary to minimize interest rate risk. However, borrowers with fixed rate obligations are less likely to prepay in a rising rate environment. Conversely, depositors who are receiving fixed rates are more likely to withdraw funds before maturity in a rising rate environment and less likely to do so in a falling rate environment. Management monitors rates and maturities of assets and liabilities and attempts to minimize interest rate risk by adjusting terms of new loans and deposits and by investing in securities with terms that mitigate the Company’s overall interest rate risk.
|
Note 10.
|
Subsequent Events
|
In accordance with ASC 855-10/SFAS 165, the Company evaluates subsequent events that have occurred after the balance sheet date, but before the financial statements are issued. There are two types of subsequent events: (1) recognized, or those that provide additional evidence about conditions that existed at the date of the balance sheet, including the estimates inherent in the process of preparing financial statements, and (2) non-recognized, or those that provide evidence about conditions that did not exist at the date of the balance sheet but arose after that date.
Based on the evaluation, the Company did not identify any recognized or non-recognized subsequent events that would have required adjustment to, or disclosure in, the financial statements.
CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS
In addition to the historical information contained herein, this report contains forward-looking statements. Forward-looking statements are based on certain assumptions and describe future plans, strategies, and expectations of Fauquier Bankshares, Inc. (“the Company”) the and are generally identifiable by use of the words “believe,” “expect,” “intend,” “anticipate,” “estimate,” “project” “may,” “will” or similar expressions. Although we believe our plans, intentions and expectations reflected in these forward-looking statements are reasonable, we can give no assurance that these plans, intentions, or expectations will be achieved. Our ability to predict results or the actual effect of future plans or strategies is inherently uncertain, and actual results could differ materially from those contemplated. Factors that could have a material adverse effect on our operations and future prospects include, but are not limited to, changes in: interest rates, general economic conditions, the legislative/regulatory climate, monetary and fiscal policies of the U.S. Government, including policies of the U.S. Treasury and the Board of Governors of the Federal Reserve System, the quality or composition of the Bank’s loan or investment portfolios, demand for loan products, deposit flows, competition, demand for financial services in our market area, our plans to expand our branch network and increase our market share, and accounting principles, policies and guidelines. These risks and uncertainties should be considered in evaluating forward-looking statements in this report and you should not place undue reliance on such statements, which reflect our position as of the date of this report.
GENERAL
The Company was incorporated under the laws of the Commonwealth of Virginia on January 13, 1984. The Company is a registered bank holding company and owns all of the voting shares of The Fauquier Bank (“the Bank”). The Company engages in its business through the Bank, a Virginia state-chartered bank that commenced operations in 1902. The Company has no significant operations other than owning the stock of the Bank. The Company had issued and outstanding 3,695,160 shares of common stock, par value $3.13 per share, held by approximately 408 holders of record on March 31, 2012. The Bank has ten full service branch offices located in the Virginia communities of Old Town-Warrenton, Warrenton, Catlett, The Plains, Sudley Road-Manassas, Old Town-Manassas, New Baltimore, Bealeton, Bristow and Haymarket. An eleventh branch office is currently projected to open in Gainesville, Virginia during 2013. The executive offices of the Company and the main office of the Bank are located at 10 Courthouse Square, Warrenton, Virginia 20186.
The Bank’s general market area principally includes Fauquier County, western Prince William County, and neighboring communities and is located approximately fifty (50) miles southwest of Washington, D.C.
The Bank provides a range of consumer and commercial banking services to individuals, businesses and industries. The deposits of the Bank are insured up to applicable limits by the Deposit Insurance Fund of the Federal Deposit Insurance Corporation (“FDIC”). The basic services offered by the Bank include: non-interest-bearing and interest bearing demand deposit accounts, money market deposit accounts, NOW accounts, time deposits, safe deposit services, credit cards, cash management, direct deposits, notary services, night depository, prepaid debit cards, cashier’s checks, domestic collections, savings bonds, automated teller services, drive-in tellers, internet banking, telephone banking, and banking by mail. In addition, the Bank makes secured and unsecured commercial and real estate loans, issues stand-by letters of credit and grants available credit for installment, unsecured and secured personal loans, residential mortgages and home equity loans, as well as automobile and other types of consumer financing. The Bank provides automated teller machine (“ATM”) cards, as a part of the Maestro, Accel-Exchange and Plus ATM networks, thereby permitting customers to utilize the convenience of larger ATM networks. The Bank also is a member of the Certificate of Deposit Account Registry Service (“CDARS”) and Insured Cash Sweep Service (“IND”), to provide customers multi-million dollar FDIC insurance on CD investments and deposit sweeps through the transfer and/or exchange with other FDIC insured institutions. CDARS and IND are registered service marks of Promontory Interfinancial Network, LLC.
The Bank operates a Wealth Management Services (“WMS” or “Wealth Management”) division that began with the granting of trust powers to the Bank in 1919. The WMS division provides personalized services that include investment management, trust, estate settlement, retirement, insurance, and brokerage services.
The Bank, through its subsidiary Fauquier Bank Services, Inc., has equity ownership interests in Bankers Insurance, LLC, a Virginia independent insurance company, Bankers Title Shenandoah, LLC, a title insurance company, and Infinex Investments, Inc., a full service broker/dealer. Bankers Insurance and Bankers Title Shenandoah are owned by a consortium of Virginia community banks, and Infinex is owned by banks and banking associations in various states.
The revenues of the Bank are primarily derived from interest on, and fees received in connection with, real estate and other loans, and from interest and dividends from investment and mortgage-backed securities, and short-term investments. The principal sources of funds for the Bank’s lending activities are its deposits, repayment of loans, the sale and maturity of investment securities, and borrowings from the Federal Home Loan Bank (“FHLB”) of Atlanta. Additional revenues are derived from fees for deposit-related and WMS-related services. The Bank’s principal expenses are the interest paid on deposits and operating and general administrative expenses.
As is the case with banking institutions generally, the Bank’s operations are materially and significantly influenced by general economic conditions and by related monetary and fiscal policies of financial institution regulatory agencies, including the Board of Governors of the Federal Reserve System (“Federal Reserve”). As a Virginia-chartered bank and a member of the Federal Reserve, the Bank is supervised and examined by the Federal Reserve and the Virginia State Corporation Commission. Interest rates on competing investments and general market rates of interest influence deposit flows and costs of funds. Lending activities are affected by the demand for financing of real estate and other types of loans, which in turn is affected by the interest rates at which such financing may be offered and other factors affecting local demand and availability of funds. The Bank faces strong competition in the attraction of deposits (its primary source of lendable funds) and in the origination of loans.
As of March 31, 2012, the Company had total consolidated assets of $594.2 million, total loans net of allowance for loan losses of $450.3 million, total consolidated deposits of $511.2 million, and total consolidated shareholders’ equity of $48.1 million.
CRITICAL ACCOUNTING POLICIES
GENERAL. The Company’s financial statements are prepared in accordance with accounting principles generally accepted in the United States (“GAAP”). The financial information contained within our statements is, to a significant extent, based on measures of the financial effects of transactions and events that have already occurred. A variety of factors could affect the ultimate value that is obtained either when earning income, recognizing an expense, recovering an asset or relieving a liability. We use historical loss factors as one factor in determining the inherent loss that may be present in our loan portfolio. Actual losses could differ significantly from the historical factors that we use in our estimates. In addition, GAAP itself may change from one previously acceptable accounting method to another method. Although the economics of the Company’s transactions would be the same, the timing of events that would impact the Company’s transactions could change.
ALLOWANCE FOR LOAN LOSSES. The allowance for loan losses is an estimate of the losses that may be sustained in our loan portfolio. The allowance is based on three basic principles of accounting: (i) Accounting Standards Codification (“ASC”) 450 “Contingencies” (previously Statement of Financial Accounting Standards (“SFAS”) No. 5, "Accounting for Contingencies") which requires that losses be accrued when they are probable of occurring and estimable, (ii) ASC 310 “Receivables” (previously SFAS No. 114, "Accounting by Creditors for Impairment of a Loan") which requires that losses be accrued based on the differences between the value of collateral, present value of future cash flows or values that are observable in the secondary market and the loan balance and (iii) Securities and Exchange Commission (“SEC”) Staff Accounting Bulletin No. 102, “Selected Loan Loss Allowance Methodology and Documentation Issues,” which requires adequate documentation to support the allowance for loan losses estimate.
The Company’s allowance for loan losses has two basic components: the specific allowance and the general allowance. Each of these components is determined based upon estimates that can and do change when the actual events occur. The specific allowance is used to individually allocate an allowance for larger balance, non-homogeneous loans identified as impaired. The specific allowance uses various techniques to arrive at an estimate of loss. Analysis of the borrower’s overall financial condition, resources and payment record, the prospects for support from financial guarantors, and the fair market value of collateral are used to estimate the probability and severity of inherent losses. The general allowance is used for estimating the loss on pools of smaller-balance, homogeneous loans; including 1-4 family mortgage loans, installment loans, other consumer loans, and outstanding loan commitments. Also, the general allowance is used for the remaining pool of larger balance, non-homogeneous loans which were not identified as impaired. The general allowance begins with estimates of probable losses inherent in the homogeneous portfolio based upon various statistical analyses. These include analysis of historical delinquency and credit loss experience, together with analyses that reflect current trends and conditions. The Company also considers trends and changes in the volume and term of loans, changes in the credit process and/or lending policies and procedures, and an evaluation of overall credit quality. The general allowance uses a historical loss view as an indicator of future losses. As a result, even though this history is regularly updated with the most recent loss information, it could differ from the loss incurred in the future. The general allowance also captures losses that are attributable to various economic events, industry or geographic sectors whose impact on the portfolio have occurred but have yet to be recognized.
Specifically, the Company uses both external and internal qualitative factors when determining the non-loan-specific allowances. The external factors utilized include: unemployment in the Company’s defined market area of Fauquier County, Prince William County, and the City of Manassas (“market area”), as well as state and national unemployment trends; new residential construction permits for the market area; bankruptcy statistics for the Virginia Eastern District and trends for the United States; and foreclosure statistics for the market area and the state. Quarterly, these external qualitative factors as well as relevant anecdotal information are evaluated from data compiled from local periodicals such as The Washington Post, The Fauquier Times Democrat, and The Bull Run Observer, which cover the Company’s market area. Additionally, data is gathered from the Federal Reserve Beige Book for the Richmond Federal Reserve District, Global Insight’s monthly economic review, the George Mason School of Public Policy Center for Regional Analysis, and daily economic updates from various other sources. Internal Bank data utilized includes: loans past due aging statistics, nonperforming loan trends, trends in collateral values, loan concentrations, loan review status downgrade trends, and lender turnover and experience trends. Both external and internal data is analyzed on a rolling eight quarter basis to determine risk profiles for each qualitative factor. Ratings are assigned through a defined matrix to calculate the allowance consistent with authoritative accounting literature. A narrative summary of the reserve allowance is produced quarterly and reported directly to the Company’s Board of Directors. The Company’s application of these qualitative factors to the allowance for loan losses has been consistent over the reporting period.
The Company employs an independent outsourced loan review function, which annually substantiates and/or adjusts internally generated risk ratings. This independent review is reported directly to the Company’s Board of Directors’ audit committee, and the results of this review are factored into the calculation of the allowance for loan losses.
EXECUTIVE OVERVIEW
This discussion is intended to focus on certain financial information regarding the Company and the Bank and may not contain all the information that is important to the reader. The purpose of this discussion is to provide the reader with a more thorough understanding of our financial statements. As such, this discussion should be read carefully in conjunction with the consolidated financial statements and accompanying notes contained elsewhere in this report.
The Bank is the primary independent community bank in its immediate market area as measured by deposit market share. It seeks to be the primary financial service provider for its market area by providing the right mix of consistently high quality customer service, efficient technological support, value-added products, and a strong commitment to the community. The Company and the Bank’s primary operating businesses are in commercial and retail lending, deposit accounts and core deposits, and assets under WMS management.
Net income of $954,000 for the first quarter of 2012 was a 3.6% increase from the net income for the first quarter of 2011 of $921,000. Loans, net of reserve, totaling $450.3 million at March 31, 2012, decreased 0.4% when compared with December 31, 2011, and decreased 1.0% when compared with March 31, 2011. Deposits, totaling $511.2 million at March 31, 2012, decreased 3.7% compared with year-end 2011, and decreased 0.6% when compared with March 31, 2011. Assets under WMS management, totaling $307.1 million in market value at March 31, 2012, decreased 5.8% from March 31, 2011.
Net interest income is the largest component of net income, and equals the difference between income generated on interest-earning assets and interest expense incurred on interest-bearing liabilities. Future trends regarding net interest income are dependent on the absolute level of market interest rates, the shape of the yield curve, the amount of lost income from non-performing assets, the amount of prepaying loans, the mix and amount of various deposit types, competition for loans and deposits, and many other factors, as well as the overall volume of interest-earning assets. These factors are individually difficult to predict, and when taken together, the uncertainty of future trends compounds. Based on management’s current projections, net interest income may increase as average interest-earning assets increase, but this may be offset in part or in whole by a possible contraction in the Bank’s net interest margin resulting from competitive market conditions and/or a flat or inverted yield curve. A steeper yield curve is projected to result in an increase in net interest income, while a flatter or inverted yield curve is projected to result in a decrease in net interest income. The current absolute level of historically low market interest rates, as well as the current slowness of new loan production, is also projected to result in a decrease in net interest income.
The Bank’s non-performing assets totaled $6.9 million or 1.16% of total assets at March 31, 2012, as compared with $6.7 million or 1.10% of total assets at December 31, 2011, and $5.3 million or 0.89% of total assets at March 31, 2011. Nonaccrual loans totaled $4.8 million or 1.06% of total loans at March 31, 2012 compared with $4.6 million or 1.01% of total loans at December 31, 2011, and $1.7 million or 0.37% of total loans at March 31, 2011. The provision for loan losses was $500,000 for the first three months of 2012 compared with $463,000 for the first three months of 2011. Loan charge-offs, net of recoveries, totaled $351,000 or 0.08% of total average loans for the first three months of 2012, compared with $96,000 or 0.02% of total average loans for the first three months of 2011. Total allowance for loan losses was $6.9 million or 1.50% of total loans at March 31, 2012 compared with $6.7 million or 1.47% of loans at December 31, 2011 and $6.7 million or 1.45% of loans at March 31, 2011.
COMPARISON OF OPERATING RESULTS FOR THE THREE MONTHS ENDED MARCH 31, 2012 and MARCH 31, 2011
NET INCOME
Net income of $954,000 for the first quarter of 2012 was a 3.6% increase from the net income for the first quarter of 2011 of $921,000. Earnings per share on a fully diluted basis were $0.26 for the first quarter of 2012 compared to $0.25 for the first quarter of 2011. Profitability as measured by return on average assets increased from 0.63% in the first quarter of 2011 to 0.64% for the same period in 2012. Profitability as measured by return on average equity decreased from 8.37% to 7.97% over the same respective quarters in 2011 and 2012. The increase in net income was primarily due to a $189,000 decrease in other-than-temporary impairment losses on securities. This was partially offset by a $143,000 decrease in net interest income in the first quarter of 2012 compared with the first quarter of 2011.
NET INTEREST INCOME AND EXPENSE
Net interest income decreased $143,000 or 2.6% to $5.40 million for the quarter ended March 31, 2012 from $5.54 million for the quarter ended March 31, 2011. The decrease in net interest income was due primarily to the decline in loan balances and reduced yields on earning assets. These were partially offset by reduced rates on deposits and wholesale funding over the same period. The Company’s net interest margin decreased from 4.12% in the first quarter of 2011 to 3.89% in the first quarter of 2012.
Total interest income decreased $332,000 or 4.8% to $6.51 million for the first quarter of 2012 from $6.84 million for the first quarter of 2011. This decrease was primarily due to a 38 basis point decline in the yield on earning assets and reduced loan balances from first quarter 2011 to first quarter 2012. This was partially offset by an increase in balances of investment securities and deposits in other banks.
The average yield on loans was 5.42% for the first quarter of 2012, down from 5.77% in the first quarter of 2011. Average loan balances decreased $6.6 million or 1.4% from $463.2 million during the first quarter of 2011 to $456.6 million during the first quarter of 2012. The decrease in loans outstanding and yield resulted in a $385,000 or 5.9% decline in interest and fee income from loans for the first quarter of 2012 compared with the same period in 2011.
Average investment security balances increased $4.6 million from $51.4 million in the first quarter of 2011 to $56.0 million in the first quarter of 2012. The tax-equivalent average yield on investments increased from 2.64% for the first quarter of 2011 to 2.72% for the first quarter of 2012. Interest and dividend income on security investments increased $40,000 or 13.1%, from $309,000 for the first quarter of 2011 to $349,000 for the first quarter of 2012. Interest income on deposits in other banks increased $12,000 from first quarter 2011 to first quarter 2012 resulting from higher earning balances at the Federal Reserve.
Total interest expense decreased $189,000 or 14.5% from $1.30 million for the first quarter of 2011 to $1.11 million for the first quarter of 2012, primarily due to the decline in interest paid on money market accounts and time deposits.
Interest paid on deposits decreased $192,000 or 19.1% from $1.01 million for the first quarter of 2011 to $815,000 for the first quarter of 2012. Average balances on time deposits declined $16.7 million or 9.7% from $173.3 million to $156.6 million while the average rate decreased from 1.70% to 1.60% in the first quarter of 2011 to the first quarter of 2012, resulting in $102,000 less of interest expense. Average money market accounts decreased $35.0 million or 43.1% from the first quarter of 2011 to the first quarter of 2012, while the rate declined from 0.45% to 0.23%, resulting in $64,000 less in interest expense. Average savings account balances increased $9.0 million from first quarter 2011 to first quarter 2012, while their average rate decreased from 0.26% to 0.16% over the same period, resulting in a decrease of $10,000 of interest expense for the first quarter of 2012. Average NOW deposit balances increased $39.5 million from the first quarter of 2011 to the first quarter of 2012, while the average rate decreased from 0.46% to 0.31%, resulting in a decrease of $15,000 in NOW interest expense for the first quarter of 2012. The decrease in money market accounts and majority of the increase in NOW accounts was due to the elimination of the “sweep” money market account and transfer, for the most part, into the business NOW account.
Interest expense on capital securities increased $1,000 from the first quarter of 2011 to the first quarter of 2012. From the first quarter of 2011 to the first quarter of 2012, interest expense on FHLB of Atlanta advances increased $3,000. The average rate on total interest-bearing liabilities decreased from 1.10% in the first quarter of 2011 to 0.95% for the first quarter of 2012.
The following table sets forth information relating to the Company’s average balance sheet and reflects the average yield on assets and average cost of liabilities for the periods indicated and the average yields and rates paid for the periods indicated. These yields and costs are derived by dividing income or expense by the average daily balances of assets and liabilities, respectively, for the periods presented.
Average Balances, Income and Expense, and Average Yields and Rates
| |
|
Three Months Ended March 31, 2012 |
|
|
Three Months Ended March 31, 2011 |
|
|
(In thousands except as noted)
|
|
Average
|
|
|
Income/
|
|
|
Average
|
|
|
Average
|
|
|
Income/
|
|
|
Average
|
|
|
Assets
|
|
Balances
|
|
|
Expense
|
|
|
Rate
|
|
|
Balances
|
|
|
Expense
|
|
|
Rate
|
|
|
Loans
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Taxable
|
|
$ |
442,503 |
|
|
$ |
6,024 |
|
|
|
5.46 |
% |
|
$ |
445,456 |
|
|
$ |
6,328 |
|
|
|
5.76 |
% |
|
Tax-exempt (1)
|
|
|
9,099 |
|
|
|
146 |
|
|
|
6.44 |
% |
|
|
15,851 |
|
|
|
268 |
|
|
|
6.85 |
% |
|
Nonaccrual (2)
|
|
|
5,046 |
|
|
|
- |
|
|
|
|
|
|
|
1,938 |
|
|
|
- |
|
|
|
|
|
|
Total Loans
|
|
|
456,648 |
|
|
|
6,170 |
|
|
|
5.42 |
% |
|
|
463,245 |
|
|
|
6,596 |
|
|
|
5.77 |
% |
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Securities
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Taxable
|
|
|
49,090 |
|
|
|
288 |
|
|
|
2.34 |
% |
|
|
45,531 |
|
|
|
251 |
|
|
|
2.20 |
% |
|
Tax-exempt (1)
|
|
|
6,896 |
|
|
|
93 |
|
|
|
5.41 |
% |
|
|
5,843 |
|
|
|
88 |
|
|
|
6.00 |
% |
|
Total securities
|
|
|
55,986 |
|
|
|
381 |
|
|
|
2.72 |
% |
|
|
51,374 |
|
|
|
339 |
|
|
|
2.64 |
% |
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Deposits in banks
|
|
|
51,354 |
|
|
|
37 |
|
|
|
0.29 |
% |
|
|
41,737 |
|
|
|
25 |
|
|
|
0.24 |
% |
|
Federal funds sold
|
|
|
8 |
|
|
|
- |
|
|
|
0.22 |
% |
|
|
11 |
|
|
|
- |
|
|
|
0.29 |
% |
|
Total earning assets
|
|
|
563,996 |
|
|
$ |
6,588 |
|
|
|
4.69 |
% |
|
|
556,367 |
|
|
$ |
6,960 |
|
|
|
5.07 |
% |
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Less: Reserve for loan losses
|
|
|
(6,891 |
) |
|
|
|
|
|
|
|
|
|
|
(6,434 |
) |
|
|
|
|
|
|
|
|
|
Cash and due from banks
|
|
|
4,958 |
|
|
|
|
|
|
|
|
|
|
|
5,273 |
|
|
|
|
|
|
|
|
|
|
Bank premises and equipment, net
|
|
|
14,991 |
|
|
|
|
|
|
|
|
|
|
|
14,140 |
|
|
|
|
|
|
|
|
|
|
Other real estate owned
|
|
|
1,776 |
|
|
|
|
|
|
|
|
|
|
|
3,110 |
|
|
|
|
|
|
|
|
|
|
Other assets
|
|
|
23,530 |
|
|
|
|
|
|
|
|
|
|
|
23,467 |
|
|
|
|
|
|
|
|
|
|
Total Assets
|
|
$ |
602,360 |
|
|
|
|
|
|
|
|
|
|
$ |
595,923 |
|
|
|
|
|
|
|
|
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Liabilities and Shareholders' Equity
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Deposits
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Demand deposits
|
|
$ |
75,625 |
|
|
|
|
|
|
|
|
|
|
$ |
71,194 |
|
|
|
|
|
|
|
|
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest-bearing deposits
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
NOW accounts
|
|
|
175,315 |
|
|
$ |
137 |
|
|
|
0.31 |
% |
|
|
135,822 |
|
|
$ |
153 |
|
|
|
0.46 |
% |
|
Money market accounts
|
|
|
46,275 |
|
|
|
26 |
|
|
|
0.23 |
% |
|
|
81,258 |
|
|
|
90 |
|
|
|
0.45 |
% |
|
Savings accounts
|
|
|
64,517 |
|
|
|
25 |
|
|
|
0.16 |
% |
|
|
55,528 |
|
|
|
36 |
|
|
|
0.26 |
% |
|
Time deposits
|
|
|
156,561 |
|
|
|
626 |
|
|
|
1.60 |
% |
|
|
173,304 |
|
|
|
728 |
|
|
|
1.70 |
% |
|
Total interest-bearing deposits
|
|
|
442,668 |
|
|
|
814 |
|
|
|
0.74 |
% |
|
|
445,912 |
|
|
|
1,007 |
|
|
|
0.92 |
% |
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Federal funds purchased
|
|
|
8 |
|
|
|
- |
|
|
|
0.76 |
% |
|
|
8 |
|
|
|
- |
|
|
|
0.67 |
% |
|
Federal Home Loan Bank advances
|
|
|
25,000 |
|
|
|
247 |
|
|
|
3.96 |
% |
|
|
25,000 |
|
|
|
245 |
|
|
|
3.91 |
% |
|
Capital securities of subsidiary trust
|
|
|
4,124 |
|
|
|
50 |
|
|
|
4.86 |
% |
|
|
4,124 |
|
|
|
49 |
|
|
|
4.76 |
% |
|
Total interest-bearing liabilities
|
|
|
471,800 |
|
|
|
1,111 |
|
|
|
0.95 |
% |
|
|
475,044 |
|
|
|
1,301 |
|
|
|
1.10 |
% |
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other liabilities
|
|
|
6,903 |
|
|
|
|
|
|
|
|
|
|
|
5,077 |
|
|
|
|
|
|
|
|
|
|
Shareholders' equity
|
|
|
48,032 |
|
|
|
|
|
|
|
|
|
|
|
44,608 |
|
|
|
|
|
|
|
|
|
|
Total Liabilities & Shareholders' Equity
|
|
$ |
602,360 |
|
|
|
|
|
|
|
|
|
|
$ |
595,923 |
|
|
|
|
|
|
|
|
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net interest spread
|
|
|
|
|
|
$ |
5,477 |
|
|
|
3.74 |
% |
|
|
|
|
|
$ |
5,659 |
|
|
|
3.96 |
% |
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest expense as a percent of average earning assets
|
|
|
|
|
|
|
|
|
|
|
0.80 |
% |
|
|
|
|
|
|
|
|
|
|
0.95 |
% |
|
Net interest margin
|
|
|
|
|
|
|
|
|
|
|
3.89 |
% |
|
|
|
|
|
|
|
|
|
|
4.12 |
% |
(1) Income and rates on non-taxable assets are computed on a tax equivalent basis using a federal tax rate of 34%.
(2) Nonaccrual loans are included in the average balance of total loans and total earning assets.
RATE/VOLUME ANALYSIS
The following table sets forth certain information regarding changes in interest income and interest expense of the Company for the periods indicated. For each category of interest-earning asset and interest-bearing liability, information is provided on changes attributable to changes in volume (change in volume multiplied by old rate); and changes in rates (change in rate multiplied by old volume). Changes in rate-volume, which cannot be separately identified, are allocated proportionately between changes in rate and changes in volume.
| |
|
Three Months Ended March 31, 2012 Compared to Three Months Ended March 31, 2011
|
|
| |
|
|
|
|
Due to
|
|
|
Due to
|
|
|
(In thousands)
|
|
Change
|
|
|
Volume
|
|
|
Rate
|
|
|
Interest Income
|
|
|
|
|
|
|
|
|
|
|
Loans; taxable
|
|
$ |
(304 |
) |
|
$ |
(42 |
) |
|
$ |
(262 |
) |
|
Loans; tax-exempt (1)
|
|
|
(122 |
) |
|
|
(114 |
) |
|
|
(8 |
) |
|
Securities; taxable
|
|
|
37 |
|
|
|
20 |
|
|
|
17 |
|
|
Securities; tax-exempt (1)
|
|
|
5 |
|
|
|
16 |
|
|
|
(11 |
) |
|
Deposits in banks
|
|
|
12 |
|
|
|
6 |
|
|
|
6 |
|
|
Federal funds sold
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
Total Interest Income
|
|
|
(372 |
) |
|
|
(114 |
) |
|
|
(258 |
) |
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest Expense
|
|
|
|
|
|
|
|
|
|
|
|
|
|
NOW accounts
|
|
|
(16 |
) |
|
|
44 |
|
|
|
(60 |
) |
|
Money market accounts
|
|
|
(64 |
) |
|
|
(39 |
) |
|
|
(25 |
) |
|
Savings accounts
|
|
|
(11 |
) |
|
|
6 |
|
|
|
(17 |
) |
|
Time deposits
|
|
|
(102 |
) |
|
|
(70 |
) |
|
|
(32 |
) |
|
Federal funds purchased and securities sold under agreements to repurchase
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
Federal Home Loan Bank advances
|
|
|
2 |
|
|
|
- |
|
|
|
2 |
|
|
Capital securities of subsidiary trust
|
|
|
1 |
|
|
|
- |
|
|
|
1 |
|
|
Total Interest Expense
|
|
|
(190 |
) |
|
|
(59 |
) |
|
|
(131 |
) |
|
Net Interest Income
|
|
$ |
(182 |
) |
|
$ |
(55 |
) |
|
$ |
(127 |
) |
(1) Income and rates on non-taxable assets are computed on a tax equivalent basis using a federal tax rate of 34%.
PROVISION FOR LOAN LOSSES, ALLOWANCE FOR LOAN LOSSES, AND ASSET QUALITY
The provision for loan losses was $500,000 for the first quarter of 2012 compared with $463,000 for the first quarter of 2011. The amount of the provision for loan loss was based upon management’s continual evaluation of the adequacy of the allowance for loan losses, which encompasses the overall risk characteristics of the loan portfolio, trends in the Bank’s delinquent and non-performing loans, estimated values of collateral, and the impact of economic conditions on borrowers. Greater weight is given to the loss history by loan category, prolonged changes in portfolio delinquency trends by loan category, and changes in economic trends. There can be no assurances, however, that future losses will not exceed estimated amounts, or that increased amounts of provisions for loan losses will not be required in future periods.
OTHER INCOME
Total other income increased by $235,000 from $1.25 million for the first quarter of 2011 to $1.48 million in the first quarter of 2012. Non-interest income is derived primarily from recurring non-interest fee income, which consists primarily of fiduciary trust and other Wealth Management fees, brokerage fees, service charges on deposit accounts, debit card interchange income and other fee income. The increase was primarily due to an $189,000 decrease in other-than-temporary impairment losses on securities during the first quarter of 2012 compared with the first quarter of 2011.
Trust and estate income increased $40,000 or 13.1% from the first quarter of 2011 to the first quarter of 2012 primarily due to an increase in estate settlement revenue.
Brokerage service revenues decreased $30,000 or 26.9% from the first quarter of 2011 to the first quarter of 2012 due to better than expected annuity sales in 2011 that did not reoccur in 2012.
Service charges on deposit accounts increased $19,000 or 2.9% to $692,000 for the first quarter of 2012 compared to one year earlier. The change is primarily due to an increase in numbers of transaction deposit customers generating increased deposit activity.
Other service charges, commissions and fees increased $17,000 or 4.8% from $349,000 in first quarter of 2011 to $366,000 in the first quarter of 2012. Included in other service charges, commissions, and income is debit card interchange income which totaled $244,000 and $219,000 for the first quarters of 2012 and 2011, respectively. Also included is Bank Owned Life Insurance (“BOLI”) income, which was $104,000 during the first quarter of 2012, compared with $103,000 one year earlier. Total BOLI was $11.7 million in cash value at March 31, 2012, compared with $11.3 million one year earlier.
OTHER EXPENSE
Total other expense decreased $20,000 or 0.4% during the first quarter of 2012 compared with the first quarter of 2011, primarily due to the reduction in FDIC expense.
Salaries and employees’ benefits decreased $5,000 or 0.2%. Active full-time equivalent personnel totaled 157.5 employees at March 31, 2012 compared with 158.5 employees as at March 31, 2011. The Bank expects personnel costs, consisting primarily of salary and benefits, to continue to be its largest expense. As such, the most important factor with regard to potential changes in other expenses is the expansion of staff. For the remainder of 2012, the Company plans no additional growth in full-time equivalent personnel.
Occupancy expense decreased $5,000 or 1.0%, while furniture and equipment expense decreased $42,000 or 13.3%, from first quarter 2011 to first quarter 2012. The decrease in furniture and equipment expense was due primarily to decreases in technology hardware and software depreciation and maintenance.
Marketing expense increased from $138,000 for the first quarter of 2011 to $165,000 for the first quarter of 2012 due to an increase in direct mail marketing. The majority of marketing expense is related to the direct mail program for transaction deposit accounts.
Legal, accounting and consulting expense decreased $12,000 or 4.5% in the first quarter of 2012 compared with the first quarter of 2011.
FDIC deposit insurance expense decreased 40.8% from $198,000 for the first quarter of 2011 to $117,000 for the first quarter of 2012. The decline was due to a change in the FDIC assessment base from average deposits to average assets less tangible equity as required by the Dodd-Frank Wall Street Reform and Consumer Protection Act. This new lower rate is assumed to be in effect in the near-term, however, future FDIC assessment expense is difficult to project, as it is largely dependent on the relative health of the U.S. banking industry and any resulting changes in regulation.
Data processing expense increased $16,000 or 5.5% for the first quarter of 2012 compared with the same time period in 2011 due to the growth in customer accounts and transactions processed. The Bank outsources much of its data processing to third-party vendors.
Other operating expenses increased $76,000 or 10.5% in the first quarter of 2012 compared with the first quarter of 2011. The increase was primarily due to higher external fraud on customer's accounts and deposit account-related charge-offs.
INCOME TAXES
Income tax expense was $313,000 for the quarter ended March 31, 2012 compared with $271,000 for the quarter ended March 31, 2011. The effective tax rates were 24.7% and 22.8% for the first quarter of 2012 and 2011, respectively. The effective tax rate differed from the statutory federal income tax rate of 34% due to the Bank’s investment in tax-exempt loans and securities, income from the BOLI purchases, and community development tax credits.
COMPARISON OF FINANCIAL CONDITION AT MARCH 31, 2012 and DECEMBER 31, 2011
Total assets were $594.2 million at March 31, 2012 compared with $614.2 million at December 31, 2011, a decrease of 3.3% or $20.0 million. Balance sheet categories reflecting significant changes included interest-bearing deposits in other banks, securities, and deposits. Each of these categories is discussed below.
INTEREST-BEARING DEPOSITS IN OTHER BANKS. Interest-bearing deposits in other banks were $40.1 million at March 31, 2012, reflecting a decrease of $26.5 million from December 31, 2011. The decrease in interest-bearing deposits in other banks was primarily due to the reduction in excess liquidity caused by the increase in investment securities as well as the reduction in the Bank’s deposits.
INVESTMENT SECURITIES. Total investment securities were $56.5 million at March 31, 2012, reflecting an increase of $8.9 million from $47.6 million at December 31, 2011. The increase is due to purchases of government backed mortgage pools that are used to collateralize public deposits in excess of FDIC deposit insurance.
DEPOSITS. For the three months ended March 31, 2012, total deposits decreased by $19.4 million or 3.7% when compared with total deposits at December 31, 2011. Non-interest-bearing deposits increased by $8.1 million and interest-bearing deposits decreased by $27.5 million. Included in interest-bearing deposits at March 31, 2012 and December 31, 2011 were $35.6 million and $42.4 million, respectively, of brokered deposits as defined by the Federal Reserve. Of the $35.6 million in brokered deposits, $31.3 million represent deposits of Bank customers, exchanged through the CDARS’ network. With the CDARS’ program, funds are placed into certificate of deposits issued by other banks in the network, in increments of less than $250,000, to ensure both principal and interest are eligible for complete FDIC coverage. These deposits are exchanged with other member banks on a dollar-for-dollar basis, bringing the full amount of our customers deposits back to the Bank and making these funds fully available for lending in our community. The increase in the Bank’s non-interest-bearing deposits and the decrease in interest-bearing deposits during the first three months of 2012 were the result of many factors difficult to segregate and quantify, and equally difficult to use as factors for future projections. The economy, local competition, retail customer preferences, changes in seasonal cash flows by both commercial and retail customers, changes in business cash management practices by Bank customers, the relative pricing from wholesale funding sources, the in-and-outflow of local government tax receipts, and the Bank’s funding needs all contributed to the change in deposit balances. The Bank projects to increase its transaction accounts and other deposits during the remainder of 2012 and beyond through the expansion of its branch network, as well as by offering value-added NOW and demand deposit products, and selective rate premiums on its interest-bearing deposits.
ASSET QUALITY
Non-performing assets, in most cases, consist of loans that are 90 days or more past due and for which the accrual of interest has been discontinued. Management evaluates all loans that are 90 days or more past due, as well as borrowers that have suffered financial distress, to determine if they should be placed on non-accrual status. Factors considered by management include the net realizable value of collateral, if any, and other resources of the borrower that may be available to satisfy the delinquency.
Loans are placed on non-accrual status when principal or interest is delinquent for 90 days or more, unless the loans are well secured and in the process of collection. Any unpaid interest previously accrued on such loans is reversed from income. Interest income generally is not recognized on specific impaired loans unless the likelihood of further loss is remote. Interest payments received on such loans are applied as a reduction of the loan principal balance. Interest income on other non-accrual loans is recognized only to the extent of interest payments received.
Non-performing assets totaled $6.9 million or 1.16% of total assets at March 31, 2012, compared with $6.7 million or 1.10% of total assets at December 31, 2011, and $5.3 million, or 0.89% of total assets at March 31, 2011. Included in non-performing assets at March 31, 2012 were $276,000 of non-performing pooled trust preferred bonds at market value, $1.8 million of other real estate owned and $4.8 million of non-accrual loans. Non-accrual loans as a percentage of total loans were 1.06% at March 31, 2012, as compared with 1.01% and 0.37% at December 31, 2011 and March 31, 2011, respectfully.
There was one loan totaling $86,000 that was past due 90 days or more and still accruing interest at March 31, 2012, compared with $101,000 on December 31, 2011 and none at March 31, 2011. For additional information regarding non-performing assets and potential loan problems, see “Loans and Allowance for Loan Losses” in Note 3 of the Notes to Consolidated Financial Statements contained herein.
At March 31, 2012, no concentration of loans to commercial borrowers engaged in similar activities exceeded 10% of total loans. The largest industry concentration at March 31, 2012 was approximately 5.4% of loans to the hospitality industry (hotels, motels, inns, etc.).
Based on regulatory guidelines, the Bank is required to monitor the commercial investment real estate loan portfolio for: (a) concentrations above 100% of Tier 1 capital and loan loss reserve for construction and land loans and (b) 300% for permanent investor real estate loans. As of March 31, 2012, construction and land loans were $34.0 million or 59.3% of the concentration limit. Commercial investor real estate loans, including construction and land loans, were $121.6 million or 212.2% of the concentration level.
CONTRACTUAL OBLIGATIONS
As of March 31, 2012, there have been no other material changes outside the ordinary course of business to the contractual obligations disclosed in “Management’s Discussion and Analysis and Results of Operations” in the Company’s Annual Report on Form 10-K for the year ended December 31, 2011.
OFF-BALANCE SHEET ARRANGEMENTS
As of March 31, 2012, there have been no material changes to the off-balance sheet arrangements disclosed in “Management’s Discussion and Analysis and Results of Operations” in the Company’s Annual Report on Form 10-K for the year ended December 31, 2011.
CAPITAL
The Company and the Bank are subject to various regulatory capital requirements administered by banking agencies. Failure to meet minimum capital requirements can trigger certain mandatory and discretionary actions by regulators that could have a direct material effect on the Company’s financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company and the Bank must meet specific capital guidelines that involve quantitative measures of their assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. The Company’s and the Bank’s capital amounts and classifications are also subject to qualitative judgments by the regulators about components, risk weightings and other factors. Quantitative measures established by regulation to ensure capital adequacy require the Company and the Bank to maintain minimum amounts and ratios (set forth in the table below) of Total and Tier 1 Capital (as defined in the regulations) to risk-weighted assets (as defined in the regulations), and of Tier 1 Capital to average assets (as defined in the regulations). Management believes, as of March 31, 2012, that the Company and the Bank more than satisfy all capital adequacy requirements to which they are subject.
At March 31, 2012 and December 31, 2011, the Company exceeded its regulatory capital ratios, as set forth in the following table:
Risk Based Capital Ratios
| |
|
March 31, 2012
|
|
|
December 31, 2011
|
|
|
(In thousands except where noted)
|
|
|
|
|
|
|
|
Tier 1 Capital:
|
|
|
|
|
|
|
|
Shareholders' Equity
|
|
$ |
48,055 |
|
|
$ |
47,571 |
|
| |
|
|
|
|
|
|
|
|
|
Plus: Unrealized loss on securities available for sale/FAS 158, net
|
|
|
1,432 |
|
|
|
1,328 |
|
|
Less: Unrealized loss on equity securities, net
|
|
|
- |
|
|
|
- |
|
|
Less: Acumulated net gain (loss) on cash flow hedge and retirement obligations
|
|
|
(99 |
) |
|
|
- |
|
|
Plus: Company-obligated madatorily redeemable capital securities
|
|
|
4,000 |
|
|
|
4,000 |
|
|
Less: Disallowed deferred tax assets
|
|
|
- |
|
|
|
- |
|
|
Total Tier 1 Capital
|
|
|
53,586 |
|
|
|
52,899 |
|
| |
|
|
|
|
|
|
|
|
|
Tier 2 Capital:
|
|
|
|
|
|
|
|
|
|
Allowable Allowance for Loan Losses
|
|
|
5,553 |
|
|
|
5,501 |
|
| |
|
|
|
|
|
|
|
|
|
Total Capital:
|
|
|
59,139 |
|
|
|
58,400 |
|
| |
|
|
|
|
|
|
|
|
|
Risk Weighted Assets:
|
|
$ |
442,950 |
|
|
$ |
438,830 |
|
| |
|
|
|
|
|
|
|
|
|
Regulatory Capital Ratios:
|
|
|
|
|
|
|
|
|
|
Leverage Ratio
|
|
|
8.90 |
% |
|
|
8.70 |
% |
|
Tier 1 to Risk Weighted Assets
|
|
12.10 |
% |
|
|
12.05 |
% |
|
Total Capital to Risk Weighted Assets
|
|
13.35 |
% |
|
|
13.31 |
% |
CAPITAL RESOURCES AND LIQUIDITY
Shareholders’ equity totaled $48.1 million at March 31, 2012 compared with $47.6 million at December 31, 2011 and $45.0 million at March 31, 2011. The amount of equity reflects management’s desire to increase shareholders’ return on equity while maintaining a strong capital base. On January 19, 2012, the Company’s Board of Directors authorized the Company to repurchase up to 110,093 shares (3% of common stock outstanding on January 1, 2012) beginning January 1, 2012 and continuing until the next Board reset. No shares were repurchased during the three month period ended March 31, 2012.
Accumulated other comprehensive income/loss increased to an unrealized loss net of tax benefit of $1.5 million at March 31, 2012 compared with $1.3 million at December 31, 2011.
As discussed in “Company-Obligated Mandatorily Redeemable Capital Securities” in Note 4 of the Notes to Consolidated Financial Statements contained herein, during 2006, the Company established a subsidiary trust that issued $4.0 million of capital securities as part of a separate pooled trust preferred security offering with other financial institutions. Under applicable regulatory guidelines, the capital securities are treated as Tier 1 capital for purposes of the Federal Reserve’s capital guidelines for bank holding companies, as long as the capital securities and all other cumulative preferred securities of the Company together do not exceed 25% of Tier 1 capital. As discussed above under “Capital,” banking regulations have established minimum capital requirements for financial institutions, including risk-based capital ratios and leverage ratios. As of March 31, 2012, the appropriate regulatory authorities have categorized the Company and the Bank as “well capitalized.”
The primary sources of funds are deposits, repayment of loans, maturities of investments, funds provided from operations, federal funds lines of credit with the Federal Reserve and other banks, and advances from the FHLB of Atlanta. While scheduled repayments of loans and maturities of investment securities are predictable sources of funds, deposit flows and loan repayments are greatly influenced by the general level of interest rates, economic conditions and competition. The Bank uses its sources of funds to fund existing and future loan commitments, to fund maturing certificates of deposit and demand deposit withdrawals, to invest in other interest-earning assets, to maintain liquidity, and to meet operating expenses. Management monitors projected liquidity needs and determines the desirable funding level based in part on the Bank’s commitments to make loans and management’s assessment of the Bank’s ability to generate funds. Management is not aware of any market or institutional trends, events or uncertainties that are expected to have a material effect on the liquidity, capital resources or operations of the Company or the Bank. Nor is management aware of any current recommendations by regulatory authorities that would have a material effect on liquidity, capital resources or operations. The Bank’s internal sources of such liquidity are deposits, loan and investment repayments, and securities available for sale. The Bank’s primary external sources of liquidity are federal funds lines of credit with the Federal Reserve Bank and other banks and advances from the FHLB of Atlanta.
Cash and amounts due from depository institutions, interest-bearing deposits in other banks, and federal funds sold totaled $44.7 million at March 31, 2012 compared with $72.2 million at December 31, 2011. These assets provide a primary source of liquidity for the Bank. In addition, management has designated the entire investment portfolio as available of sale, of which approximately $14.9 million was unpledged and readily salable at March 31, 2012. Furthermore, the Bank has an available line of credit with the FHLB of Atlanta with a borrowing limit of approximately $110.2 million at March 31, 2012 to provide additional sources of liquidity, as well as available federal funds purchased lines of credit with the Federal Reserve and various other commercial banks totaling approximately $57.7 million. At March 31, 2012, $25 million of the FHLB of Atlanta line of credit and no federal funds purchased lines of credit were in use.
The following table sets forth information relating to the Company’s sources of liquidity and the outstanding commitments for use of liquidity at March 31, 2012 and December 31, 2011. The liquidity coverage ratio is derived by dividing the total sources of liquidity by the outstanding commitments for use of liquidity.
Liquidity Sources and Uses
| |
|
March 31, 2012
|
|
|
December 31, 2011
|
|
|
(In thousands except as noted)
|
|
Total
|
|
|
In Use
|
|
|
Available
|
|
|
Total
|
|
|
In Use
|
|
|
Available
|
|
|
Sources:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Federal funds borrowing lines of credit
|
|
$ |
57,716 |
|
|
$ |
- |
|
|
$ |
57,716 |
|
|
$ |
58,144 |
|
|
$ |
- |
|
|
$ |
58,144 |
|
|
Federal Home Loan Bank advances
|
|
|
119,574 |
|
|
|
25,000 |
|
|
|
94,574 |
|
|
|
110,706 |
|
|
|
25,000 |
|
|
|
85,706 |
|
|
Federal funds sold and interest-bearing deposits in other banks, excluding requirements
|
|
|
|
|
|
|
|
|
|
|
21,311 |
|
|
|
|
|
|
|
|
|
|
|
46,633 |
|
|
Securities, available for sale and unpledged at fair value
|
|
|
|
|
|
|
|
|
|
|
14,930 |
|
|
|
|
|
|
|
|
|
|
|
9,671 |
|
|
Total short-term funding sources
|
|
|
|
|
|
|
|
|
|
$ |
188,531 |
|
|
|
|
|
|
|
|
|
|
$ |
200,154 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Uses:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Unfunded loan commitments and lending lines of credit
|
|
|
|
|
|
|
|
|
|
$ |
66,747 |
|
|
|
|
|
|
|
|
|
|
$ |
70,737 |
|
|
Letters of credit
|
|
|
|
|
|
|
|
|
|
|
4,416 |
|
|
|
|
|
|
|
|
|
|
|
3,992 |
|
|
Total potential short-term funding uses
|
|
|
|
|
|
|
|
|
|
$ |
71,163 |
|
|
|
|
|
|
|
|
|
|
$ |
74,729 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Ratio of short-term funding sources to potential short-term funding uses
|
|
|
|
|
|
|
|
|
|
|
264.9 |
% |
|
|
|
|
|
|
|
|
|
|
267.8 |
% |
IMPACT OF INFLATION AND CHANGING PRICES
The consolidated financial statements and the accompanying notes presented elsewhere in this document have been prepared in accordance with U.S. GAAP, which require the measurement of financial position and operating results in terms of historical dollars without considering the change in the relative purchasing power of money over time and due to inflation. Unlike most industrial companies, virtually all the assets and liabilities of the Company and the Bank are monetary in nature. The impact of inflation is reflected in the increased cost of operations. As a result, interest rates have a greater impact on our performance than inflation does. Interest rates do not necessarily move in the same direction or to the same extent as the prices of goods and services.
CHANGES IN ACCOUNTING PRINCIPLES
For information regarding recent accounting pronouncements and their effect on the Company, see “Recent Accounting Pronouncements” in Note 1 of the Notes to Consolidated Financial Statements contained herein.
An important component of both earnings performance and liquidity is management of interest rate sensitivity. Interest rate sensitivity reflects the potential effect on net interest income and economic value of equity from a change in market interest rates. The Bank is subject to interest rate sensitivity to the degree that its interest-earning assets mature or reprice at different time intervals than its interest-bearing liabilities. However, the Bank is not subject to the other major categories of market risk such as foreign currency exchange rate risk or commodity price risk. The Bank uses a number of tools to manage its interest rate risk, including simulating net interest income under various scenarios, monitoring the present value change in equity under the same scenarios, and monitoring the difference or gap between rate sensitive assets and rate sensitive liabilities over various time periods. Management believes that rate risk is best measured by simulation modeling.
There have been no material changes to the quantitative and qualitative disclosures made in the Company’s Annual Report on Form 10-K for the year ended December 31, 2011.
Disclosure Controls and Procedures
The Company maintains disclosure controls and procedures that are designed to provide assurance that the information required to be disclosed in the reports filed or submitted under the Securities Exchange Act of 1934 is recorded, processed, summarized, and reported within the time periods required by the Securities and Exchange Commission. An evaluation of the effectiveness of the design and operations of the Company’s disclosure controls and procedures at the end of the period covered by this report was carried out under the supervision and with the participation of the management of Fauquier Bankshares, Inc., including the Chief Executive Officer and the Chief Financial Officer. Based on such an evaluation, the Chief Executive Officer and the Chief Financial Officer concluded the Company’s disclosure controls and procedures were effective as of the end of such period.
The Company regularly assesses the adequacy of its internal control over financial reporting and enhances its controls in response to internal control assessments and internal and external audit and regulatory recommendations. There have not been any significant changes in the Company’s internal control over financial reporting or in other factors that have materially affected or are reasonably likely to materially affect, such controls during the quarter ended March 31, 2012.
PART II. OTHER INFORMATION
There is no pending or threatened legal proceedings to which the Company or the Bank is a party or to which the property of either the Company or the Bank is subject to that, in the opinion of management, may materially impact the financial condition of either the Company or the Bank.
There have been no material changes to the risk factors faced by the Company from those disclosed in Company’s Annual Report on Form 10-K for the year ended December 31, 2011.
On January 19, 2012, the Company’s Board of Directors authorized the Company to repurchase up to 110,093 shares (3% of common stock outstanding on January 1, 2012) beginning January 1, 2012 and continuing until the next Board reset. No shares were repurchased during the three month period ended March 31, 2012.
None
Not applicable
None
| Exhibit |
Exhibit |
| Number |
Description |
| |
|
|
3.1
|
Articles of Incorporation of Fauquier Bankshares, Inc., as amended, incorporated by reference to Exhibit 3.1 to Form 10-K filed March 15, 2010.
|
| |
|
|
3.2
|
By-laws of Fauquier Bankshares, Inc., as amended and restated, incorporated by reference to Exhibit 3.2 to Form 10-Q filed August 9, 2010.
|
| |
|
|
|
Certification of CEO pursuant to Rule 13a-14(a).
|
| |
|
|
|
Certification of CFO pursuant to Rule 13a-14(a).
|
| |
|
|
|
Certification of CEO pursuant to 18 U.S.C. Section 1350.
|
| |
|
|
|
Certification of CFO pursuant to 18 U.S.C. Section 1350.
|
| |
|
|
101.INS
|
XBRL Instance Document
|
| |
|
|
101.SCH
|
XBRL Taxonomy Extension Schema Document
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101.CAL
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XBRL Taxonomy Extension Calculation Linkbase Document
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101.DEF
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XBRL Taxonomy Extension Definition Linkbase Document
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101.LAB
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XBRL Taxonomy Extension Label Linkbase Document
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101.PRE
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XBRL Taxonomy Extension Presentation Linkbase Document
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Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
FAUQUIER BANKSHARES, INC.
(Registrant)
/s/ Randy K. Ferrell
Randy K. Ferrell
President & Chief Executive Officer
Dated: May 11, 2012
/s/ Eric P. Graap
Eric P. Graap
Executive Vice President & Chief Financial Officer
Dated: May 11, 2012