Table of Contents

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

Form 10-Q

 

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

 

For the quarterly period ended March 31, 2012

 

OR

 

o         TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

Commission file number 001-34142

 

OAK VALLEY BANCORP

(Exact name of registrant as specified in its charter)

 

California

 

26-2326676

State or other jurisdiction of

 

I.R.S. Employer

incorporation or organization

 

Identification No.

 

125 N. Third Ave., Oakdale, CA  95361

(Address of principal executive offices)

 

(209) 848-2265

Issuer’s telephone number

 

Not applicable

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

 

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

 

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

 

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

 

Large accelerated filer o

 

Accelerated filer o

 

 

 

Non-accelerated filer o

 

Smaller reporting company x

(Do not check if a smaller reporting company)

 

 

 

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

 

APPLICABLE ONLY TO CORPORATE ISSUERS

 

State the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date:  7,880,780 shares of common stock outstanding as of April 30, 2012.

 

 

 



Table of Contents

 

Oak Valley Bancorp

March 31, 2012

 

Table of Contents

 

 

 

 

 

Page

PART I – FINANCIAL INFORMATION

 

3

 

 

 

Item 1.

 

Consolidated Financial Statements

 

3

 

 

 

 

 

 

Condensed Consolidated Balance Sheets at March 31, 2012 (Unaudited), and December 31, 2011

 

3

 

 

 

 

 

Condensed Consolidated Statements of Income (Unaudited) for the Three Month Period Ended March 31, 2012 and March 31, 2011

 

4

 

 

 

 

 

Condensed Consolidated Statements of Comprehensive Income (Unaudited) for the Three Month Periods Ended March 31, 2012 and March 31, 2011

 

5

 

 

 

 

 

Condensed Consolidated Statements of Changes of Shareholders’ Equity for the Three-Month Period Ended March 31, 2012 (Unaudited) and the Year Ended December 31, 2011

 

6

 

 

 

 

 

Condensed Consolidated Statements of Cash Flows (Unaudited) for the Three-Month Periods Ended March 31, 2012 and March 31, 2011

 

7

 

 

 

 

 

Notes to Condensed Consolidated Financial Statements

 

8

 

 

 

 

 

Item 2.

 

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

 

27

 

 

 

 

 

Item 3.

 

Quantitative and Qualitative Disclosures About Market Risk

 

41

 

 

 

 

 

Item 4.

 

Controls and Procedures

 

41

 

 

 

 

 

PART II – OTHER INFORMATION

 

42

 

 

 

 

 

Item 1.

 

Legal Proceedings

 

42

Item 2.

 

Unregistered Sales of Equity Securities and Use of Proceeds

 

42

Item 3.

 

Defaults Upon Senior Securities

 

42

Item 4.

 

Mine Safety Disclosures

 

42

Item 5.

 

Other Information

 

42

Item 6.

 

Exhibits

 

42

 

2



Table of Contents

 

PART I — FINANCIAL STATEMENTS

 

Item 1. Consolidated Financial Statements (Unaudited)

 

OAK VALLEY BANCORP

CONDENSED CONSOLIDATED BALANCE SHEETS

AT MARCH 31, 2012 (UNAUDITED) AND DECEMBER 31, 2011 (AUDITED)

 

 

 

 

 

 

 

 

 

 

 

March 31,

 

December 31,

 

 

 

2012

 

2011

 

ASSETS

 

 

 

 

 

Cash and due from banks

 

$

65,337,995

 

$

73,189,775

 

Federal funds sold

 

4,110,000

 

27,895,000

 

Cash and cash equivalents

 

69,447,995

 

101,084,775

 

 

 

 

 

 

 

Securities available for sale

 

105,084,610

 

89,694,859

 

Loans, net of allowance for loan loss of $7,792,147 and $8,609,174 at March 31, 2012 and December 31, 2011, respectively

 

384,218,846

 

386,958,076

 

Bank premises and equipment, net

 

13,293,112

 

13,499,285

 

Other real estate owned

 

0

 

244,375

 

Interest receivable and other assets

 

21,468,068

 

20,690,288

 

 

 

 

 

 

 

 

 

$

593,512,631

 

$

612,171,658

 

 

 

 

 

 

 

LIABILITIES AND SHAREHOLDERS’ EQUITY

 

 

 

 

 

 

 

 

 

 

 

Deposits

 

$

518,727,291

 

$

536,204,003

 

Interest payable and other liabilities

 

3,193,122

 

2,565,649

 

Federal Home Loan Bank advances

 

0

 

3,000,000

 

 

 

 

 

 

 

Total liabilities

 

521,920,413

 

541,769,652

 

 

 

 

 

 

 

Commitments and contingencies

 

 

 

 

 

 

 

 

 

 

 

Shareholders’ equity

 

 

 

 

 

Series B Preferred stock, no par value; $1,000 per share liquidation preference, 10,000,000 shares authorized and 13,500 issued and outstanding at March 31, 2012 and December 31, 2011

 

13,500,000

 

13,500,000

 

Common stock, no par value; 50,000,000 shares authorized, 7,883,780 and 7,718,469 shares issued and outstanding at March 31, 2012 and December 31, 2011, respectively

 

23,562,196

 

23,453,443

 

Additional paid-in capital

 

2,186,111

 

2,128,700

 

Retained earnings

 

29,921,912

 

28,629,757

 

Accumulated other comprehensive income, net of tax

 

2,421,999

 

2,690,106

 

 

 

 

 

 

 

Total shareholders’ equity

 

71,592,218

 

70,402,006

 

 

 

 

 

 

 

 

 

$

593,512,631

 

$

612,171,658

 

 

 

 

 

 

 

 

 

 

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

 

3



Table of Contents

 

OAK VALLEY BANCORP

CONDENSED CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)

FOR THE THREE MONTH PERIODS ENDED MARCH 31, 2012 AND MARCH 31, 2011

 

 

 

THREE MONTHS ENDED MARCH 31,

 

 

 

2012

 

2011

 

 

 

 

 

 

 

INTEREST INCOME

 

 

 

 

 

Interest and fees on loans

 

$

5,715,043

 

$

5,941,678

 

Interest on securities available for sale

 

833,685

 

694,075

 

Interest on federal funds sold

 

5,067

 

15,218

 

Interest on deposits with banks

 

29,806

 

16,671

 

Total interest income

 

6,583,601

 

6,667,642

 

 

 

 

 

 

 

INTEREST EXPENSE

 

 

 

 

 

Deposits

 

315,217

 

440,520

 

FHLB advances

 

4,707

 

21,674

 

Total interest expense

 

319,924

 

462,194

 

 

 

 

 

 

 

Net interest income

 

6,263,677

 

6,205,448

 

PROVISION FOR LOAN LOSSES

 

300,000

 

600,000

 

 

 

 

 

 

 

Net interest income after provision for loan losses

 

5,963,677

 

5,605,448

 

 

 

 

 

 

 

OTHER INCOME

 

 

 

 

 

Service charges on deposits

 

281,078

 

258,095

 

Earnings on cash surrender value of life insurance

 

105,000

 

128,298

 

Mortgage commissions

 

47,409

 

9,873

 

Other

 

397,739

 

274,975

 

Total non-interest income

 

831,226

 

671,241

 

 

 

 

 

 

 

OTHER EXPENSES

 

 

 

 

 

Salaries and employee benefits

 

2,575,563

 

2,333,990

 

Occupancy expenses

 

750,874

 

656,530

 

Data processing fees

 

277,861

 

258,635

 

OREO expenses

 

20,074

 

248,778

 

Regulatory assessments (FDIC & DFI)

 

117,000

 

198,000

 

Other operating expenses

 

855,392

 

829,904

 

Total non-interest expense

 

4,596,764

 

4,525,837

 

 

 

 

 

 

 

Net income before provision for income taxes

 

2,198,139

 

1,750,852

 

 

 

 

 

 

 

PROVISION FOR INCOME TAXES

 

737,234

 

585,376

 

NET INCOME

 

$

1,460,905

 

$

1,165,476

 

 

 

 

 

 

 

Preferred stock dividends and accretion

 

168,750

 

210,411

 

NET INCOME AVAILABLE TO COMMON SHAREHOLDERS

 

$

1,292,155

 

$

955,065

 

 

 

 

 

 

 

NET INCOME PER COMMON SHARE

 

$

0.17

 

$

0.12

 

 

 

 

 

 

 

NET EARNINGS PER DILUTED COMMON SHARE

 

$

0.17

 

$

0.12

 

 

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

 

4



Table of Contents

 

OAK VALLEY BANCORP

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (UNAUDITED)

FOR THE THREE MONTH PERIODS ENDED MARCH 31, 2012 AND MARCH 31, 2011

 

 

 

 

 

 

 

 

 

 

 

THREE MONTHS ENDED MARCH 31,

 

 

 

2012

 

2011

 

 

 

 

 

 

 

Net income

 

$

1,460,905

 

$

1,165,476

 

Available for sale securities:

 

 

 

 

 

Gross unrealized (loss) gain arising during the year

 

(434,031

)

201,009

 

Reclassification adjustment for gains realized in net income

 

(21,547

)

(25,884

)

Income tax benefit (expense)

 

187,471

 

(72,063

)

Other comprehensive (loss) income

 

(268,107

)

103,062

 

Comprehensive income

 

$

1,192,798

 

$

1,268,538

 

 

 

 

 

 

 

 

 

 

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

 

5



Table of Contents

 

OAK VALLEY BANCORP

CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY

FOR THE YEAR ENDED DECEMBER 31, 2011 AND THE THREE-MONTH PERIOD ENDED MARCH 31, 2012 (UNAUDITED)

 

 

 

YEAR ENDED DECEMBER 31, 2011 AND THREE MONTHS ENDED MARCH 31, 2012

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Accumulated

 

 

 

 

 

 

 

 

 

 

 

 

 

Additional

 

 

 

Other

 

Total

 

 

 

Common Stock

 

Preferred Stock

 

Paid-in

 

Retained

 

Comprehensive

 

Shareholders’

 

 

 

Shares

 

Amount

 

Shares

 

Amount

 

Capital

 

Earnings

 

Income

 

Equity

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balances, January 1, 2012

 

7,702,127

 

$

24,003,549

 

13,500

 

$

13,013,945

 

$

2,080,218

 

$

24,016,466

 

$

1,543,554

 

$

64,657,732

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Stock options exercised

 

3,037

 

$

9,894

 

 

 

 

 

 

 

 

 

 

 

$

9,894

 

Restricted stock issued

 

13,305

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Repurchase of Series A preferred stock

 

 

 

 

 

(13,500

)

$

(13,500,000

)

 

 

 

 

 

 

(13,500,000

)

Series B preferred stock issued

 

 

 

 

 

13,500

 

13,500,000

 

 

 

 

 

 

 

13,500,000

 

Preferred stock accretion

 

 

 

 

 

 

 

486,055

 

 

 

$

(486,055

)

 

 

0

 

Preferred stock dividend payments

 

 

 

 

 

 

 

 

 

 

 

(761,249

)

 

 

(761,249

)

Payment to repurchase U.S. Treasury Warrant

 

 

 

(560,000

)

 

 

 

 

 

 

 

 

 

 

(560,000

)

Stock based compensation

 

 

 

 

 

 

 

 

 

48,482

 

 

 

 

 

48,482

 

Other comprehensive income

 

 

 

 

 

 

 

 

 

 

 

 

 

1,146,552

 

1,146,552

 

Net income

 

 

 

 

 

 

 

 

 

 

 

5,860,595

 

 

 

5,860,595

 

Balances, December 31, 2011

 

7,718,469

 

$

23,453,443

 

13,500

 

$

13,500,000

 

$

2,128,700

 

$

28,629,757

 

$

2,690,106

 

$

70,402,006

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Stock options exercised

 

27,436

 

$

108,753

 

 

 

 

 

 

 

 

 

 

 

$

108,753

 

Tax benefit on stock options exercised

 

 

 

 

 

 

 

 

 

32,842

 

 

 

 

 

32,842

 

Restricted stock issued

 

137,875

 

 

 

 

 

 

 

 

 

 

 

 

 

0

 

Preferred stock dividend payments

 

 

 

 

 

 

 

 

 

 

 

(168,750

)

 

 

(168,750

)

Stock based compensation

 

 

 

 

 

 

 

 

 

24,569

 

 

 

 

 

24,569

 

Other comprehensive loss

 

 

 

 

 

 

 

 

 

 

 

 

 

(268,107

)

(268,107

)

Net income

 

 

 

 

 

 

 

 

 

 

 

1,460,905

 

 

 

1,460,905

 

Balances, March 31, 2012

 

7,883,780

 

$

23,562,196

 

13,500

 

$

13,500,000

 

$

2,186,111

 

$

29,921,912

 

$

2,421,999

 

$

71,592,218

 

 

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

 

6



Table of Contents

 

OAK VALLEY BANCORP

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)

FOR THE THREE MONTH PERIODS ENDED MARCH 31, 2012 AND MARCH 31, 2011

 

 

 

THREE MONTHS ENDED MARCH 31,

 

 

 

2012

 

2011

 

 

 

 

 

 

 

CASH FLOWS FROM OPERATING ACTIVITIES:

 

 

 

 

 

Net income

 

$

1,460,905

 

$

1,165,476

 

Adjustments to reconcile net earnings to net cash from operating activities:

 

 

 

 

 

Provision for loan losses

 

300,000

 

600,000

 

Decrease in deferred fees/costs, net

 

(61,865

)

(18,995

)

Depreciation

 

281,490

 

225,471

 

Amortization of investment securities, net

 

38,817

 

532

 

Stock based compensation

 

24,569

 

12,000

 

Excess tax benefits from stock-based payment arrangements

 

(32,842

)

0

 

Gain on sale of premises and equipment

 

(21,875

)

0

 

OREO write downs and losses/(gain) on sale

 

(3,548

)

219,166

 

Gain on called available for sale securities

 

(21,547

)

(25,884

)

Earnings on cash surrender value of life insurance

 

(105,000

)

(128,298

)

Increase in interest payable and other liabilities

 

627,473

 

349,490

 

Increase in interest receivable

 

(115,485

)

(84,647

)

Increase in other assets

 

(470,831

)

(7,249

)

Net cash from operating activities

 

1,900,261

 

2,307,062

 

 

 

 

 

 

 

CASH FLOWS FROM INVESTING ACTIVITIES:

 

 

 

 

 

Purchases of available for sale securities

 

(21,970,982

)

(22,085,657

)

Proceeds from maturities, calls, and principal paydowns of securities available for sale

 

6,108,382

 

1,881,943

 

Net decrease in loans

 

2,501,095

 

8,842,258

 

Purchase of FRB Stock

 

(1,450

)

0

 

Redemption of FHLB stock

 

135,300

 

134,000

 

Proceeds from sale of OREO

 

247,923

 

0

 

Proceeds from sales of premises and equipment

 

21,875

 

0

 

Net purchases of premises and equipment

 

(75,317

)

(78,384

)

Net cash used in investing activities

 

(13,033,174

)

(11,305,840

)

 

 

 

 

 

 

CASH FLOWS FROM FINANCING ACTIVITIES:

 

 

 

 

 

FHLB payments

 

(3,000,000

)

0

 

Preferred stock dividend payment

 

(168,750

)

(168,750

)

Net (decrease) increase in demand deposits and savings accounts

 

(17,538,864

)

16,102,250

 

Net increase (decrease) in time deposits

 

62,152

 

(7,200,472

)

Excess tax benefits from stock-based payment arrangements

 

32,842

 

0

 

Proceeds from sale of common stock and exercise of stock options

 

108,753

 

9,894

 

Net cash (used in) from financing activities

 

(20,503,867

)

8,742,922

 

 

 

 

 

 

 

NET DECREASE IN CASH AND CASH EQUIVALENTS

 

(31,636,780

)

(255,856

)

 

 

 

 

 

 

CASH AND CASH EQUIVALENTS, beginning of period

 

101,084,775

 

68,936,916

 

 

 

 

 

 

 

CASH AND CASH EQUIVALENTS, end of period

 

$

69,447,995

 

$

68,681,060

 

 

 

 

 

 

 

SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:

 

 

 

 

 

Cash paid during the period for:

 

 

 

 

 

Interest

 

$

339,172

 

$

477,548

 

Income taxes

 

$

0

 

$

221,119

 

 

 

 

 

 

 

NON-CASH INVESTING ACTIVITIES:

 

 

 

 

 

Change in unrealized (loss) gain on available-for-sale securities

 

$

(455,578

)

$

175,125

 

 

 

 

 

 

 

NON-CASH FINANCING ACTIVITIES:

 

 

 

 

 

Accretion of preferred stock

 

$

0

 

$

41,662

 

 

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

 

7



Table of Contents

 

OAK VALLEY BANCORP

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

NOTE 1 — BASIS OF PRESENTATION

 

On July 3, 2008 (the “Effective Date”), a bank holding company reorganization was completed whereby Oak Valley Bancorp (the “Company”) became the parent holding company for Oak Valley Community Bank ( the “Bank”).  On the Effective Date, each outstanding share of the Bank was converted into one share of Oak Valley Bancorp and the Bank became a wholly-owned subsidiary of the holding company.

 

The accounting principles followed by the Company and the methods of applying these principles conform with accounting principles generally accepted in the United States of America (GAAP) and with general practices within the banking industry. In preparing financial statements in conformity with GAAP, management is required to make estimates and assumptions that affect the reported amounts in the financial statements. Actual results could differ significantly from those estimates. Material estimates common to the banking industry that are particularly susceptible to significant change in the near term include, but are not limited to, the determination of the allowance for loan losses, the estimation of compensation expense related to stock options granted to employees and directors, and valuation allowances associated with deferred tax assets, the recognition of which are based on future taxable income.

 

The interim consolidated financial statements included in this report are unaudited but reflect all adjustments which, in the opinion of management, are necessary for a fair presentation of the financial position and results of operations for the interim periods presented. All such adjustments are of a normal recurring nature. The results of operations for the three month period ended March 31, 2012 are not necessarily indicative of the results of a full year’s operations.  Certain prior year amounts have been reclassified to conform to the current year presentation. There was no effect on net income or shareholders’ equity.  For further information, refer to the audited consolidated financial statements and footnotes included in the Company’s Form 10-K for the year ended December 31, 2011.

 

NOTE 2 — RECENT ACCOUNTING PRONOUNCEMENTS

 

In May 2011, the FASB issued Accounting Standards Update (“ASU”) No. 2011-04 Fair Value Measurement (Topic 820) Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs. The ASU improves the comparability of fair value measurements presented and disclosed in accordance with U.S. generally accepted accounting principles (GAAP) and International Financial Reporting Standards (IFRSs) by changing the wording used to describe many of the requirements in U.S GAAP for measuring fair value and disclosure of information. The amendments to this ASU provide explanation on how to measure fair value but do not require any additional fair value measurements and does not establish valuation standards or affect valuation practices outside of financial reporting. The amendments clarify existing fair value measurements and disclosure requirements to include application of the highest and best use and valuation premises concepts; measuring fair value of an instrument classified in a reporting entity’s shareholders’ equity; and disclosures requirements regarding quantitative information about unobservable inputs categorized within Level 3 of the fair value hierarchy. In addition, clarification is provided for measuring the fair value of financial instruments that are managed in a portfolio and the application of premiums and discounts in a fair value measurement. For public entities, ASU 2011-04 is effective during interim and annual periods beginning after December 15, 2011. There was no significant impact on the Company’s financial position or results of operations as a result of adopting this ASU.

 

In June 2011, the FASB issued ASU No. 2011-05 Comprehensive Income (Topic 220) Presentation of Comprehensive Income. The ASU improves the comparability, consistency, and transparency of financial reporting and increases the prominence of items reported in other comprehensive income. The amendments to Topic 220, Comprehensive Income, require entities to present the total of comprehensive income, the components of net income, and the components of other comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements. Entities are no longer permitted to present components of other comprehensive income as part of the statement of changes in stockholders’ equity. Any adjustments for items are that reclassified from other comprehensive income to net income are to be presented on the face of the entities financial statement regardless the method of presentation for comprehensive income.  The amendments do not change items to be reported in comprehensive income or when an item of other comprehensive income must be reclassified to net income, nor do the amendments change the option to present the components of other comprehensive income either net of related tax effects or before related tax effects. ASU 2011-05 is effective for fiscal years, and interim periods beginning on or after December 15, 2011.   In December 2011, the FASB issued ASU No. 2011-12, Deferral of the Effective Date for Amendments to the Presentation of Reclassifications of Items Out of Accumulated Other Comprehensive Income in Accounting Standards Update No. 2011-05. The ASU defers indefinitely the requirement to present reclassification adjustments and the effect of those reclassification adjustments on the face of the financial statements where net income is presented, by component of net income, and on the face of the financial statements where other comprehensive income is presented, by component of other comprehensive income. The adoption of the ASUs did not have a material impact on the Company’s consolidated financial statements.

 

8



Table of Contents

 

In December 2011, the FASB issued ASU No. 2011-11, Disclosures about Offsetting Assets and Liabilities. The update requires an entity to offset, and present as a single net amount, a recognized eligible asset and a recognized eligible liability when it has an unconditional and legally enforceable right of setoff and intends either to settle the asset and liability on a net basis or to realize the asset and settle the liability simultaneously. The ASU requires an entity to disclose information about offsetting and related arrangements to enable users of its financial statements to understand the effect of those arrangements on its financial position. The amendments are effective for annual and interim reporting periods beginning on or after January 1, 2013. The Company is currently in the process of evaluating the ASU but does not expect it will have a material impact on the Company’s consolidated financial statements.

 

NOTE 3 — PREFERRED STOCK REPURCHASE AND WARRANT REDEMPTION

 

In August 2011, The Company repurchased the $13,500,000 of Series A Preferred Stock originally issued to the U.S. Treasury in December 2008 in connection with the Company’s participation in the Capital Purchase Program (“CPP”).  The Company simultaneously issued $13,500,000 in Series B Preferred Stock to the U.S. Treasury under the Small Business Lending Funding (“SBLF”) program.  Subsequently, the Company fully redeemed a warrant to purchase 350,346 shares of its Common Stock, at the exercise price of $5.78 per share that the Company had granted to the U.S. Treasury pursuant to the CPP, for a purchase price of $560,000, which settled in September 2011.  So long as the preferred stock remains outstanding under SBLF, it will pay quarterly cumulative dividends at a variable rate between 1% and 5% per year for the first 2.5 years depending on growth of our small business loan portfolio.  If there is no loan growth after 2.5 years, the dividend rate could increase to 7% and if the preferred stock remains outstanding after 4.5 years, the rate increases to 9%, regardless of loan growth.

 

NOTE 4 — SECURITIES

 

The amortized cost and estimated fair values of debt securities as of March 31, 2012 are as follows:

 

 

 

Amortized Cost

 

Gross
Unrealized
Gains

 

Gross
Unrealized
Losses

 

Fair Market
Value

 

Available-for-sale securities:

 

 

 

 

 

 

 

 

 

U.S. agencies

 

$

59,906,876

 

2,481,613

 

$

(125,112

)

$

62,263,377

 

Collateralized mortgage obligations

 

10,970,471

 

636,179

 

 

11,606,650

 

Municipalities

 

22,180,784

 

1,370,987

 

(184,564

)

23,367,207

 

SBA Pools

 

1,221,868

 

 

(599

)

1,221,269

 

Corporate debt

 

3,898,994

 

 

(68,917

)

3,830,077

 

Mutual Fund

 

2,789,598

 

15,625

 

(9,193

)

2,796,030

 

 

 

$

100,968,591

 

$

4,504,404

 

$

(388,385

)

$

105,084,610

 

 

9



Table of Contents

 

The following tables detail the gross unrealized losses and fair values aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position at March 31, 2012.

 

 

 

Less than 12 months

 

12 months or more

 

Total

 

Description of Securities

 

Fair Value

 

Unrealized
Loss

 

Fair
Value

 

Unrealized
Loss

 

Fair Value

 

Unrealized
Loss

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

U.S. agencies

 

$

15,172,301

 

$

(125,112

)

$

 

 

$

15,172,301

 

$

(125,112

)

Collateralized mortgage obligations

 

 

 

 

 

 

 

Municipalities

 

7,823,553

 

(184,564

)

 

 

7,823,553

 

(184,564

)

SBA Pools

 

1,216,426

 

(599

)

 

 

1,216,426

 

(599

)

Corporate debt

 

3,830,077

 

(68,917

)

 

 

3,830,077

 

(68,917

)

Mutual Fund

 

990,807

 

(9,193

)

 

 

990,807

 

(9,193

)

Total temporarily impaired securities

 

$

29,033,164

 

$

(388,385

)

$

 

$

 

$

29,033,164

 

$

(388,385

)

 

At March 31, 2012, there were no securities in an unrealized loss position for greater than 12 months.  Management periodically evaluates each available-for-sale investment security in an unrealized loss position to determine if the impairment is temporary or other than temporary.  Management has determined that no investment security is other than temporarily impaired. The unrealized losses are due solely to interest rate changes and the Company does not intend to sell the securities and it is not likely that we will be required to sell the securities before the earlier of the forecasted recovery or the maturity of the underlying investment security.

 

The amortized cost and estimated fair value of debt securities at March 31, 2012, by contractual maturity or call date, are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.

 

 

 

Amortized

 

Fair

 

 

 

Cost

 

Value

 

Available-for-sale securities:

 

 

 

 

 

Due in one year or less

 

$

11,497,415

 

$

11,473,757

 

Due after one year through five years

 

12,210,183

 

13,317,075

 

Due after five years through ten years

 

29,938,511

 

31,102,342

 

Due after ten years

 

47,322,482

 

49,191,436

 

 

 

$

100,968,591

 

$

105,084,610

 

 

The amortized cost and estimated fair values of debt securities as of December 31, 2011, are as follows:

 

 

 

Amortized
Cost

 

Gross
Unrealized
Gains

 

Gross
Unrealized
Losses

 

Fair Market
Value

 

Available-for-sale securities:

 

 

 

 

 

 

 

 

 

U.S. agencies

 

$

52,101,177

 

2,722,817

 

$

(14,686

)

$

54,809,308

 

Collateralized mortgage obligations

 

11,366,368

 

728,104

 

 

12,094,472

 

Municipalities

 

15,660,035

 

1,312,377

 

(370

)

16,972,042

 

SBA Pools

 

1,236,366

 

55

 

 

1,236,421

 

Corporate debt

 

2,000,000

 

0

 

(185,716

)

1,814,284

 

Mutual Fund

 

2,759,316

 

17,188

 

(8,172

)

2,768,332

 

 

 

$

85,123,262

 

$

4,780,541

 

$

(208,944

)

$

89,694,859

 

 

10



Table of Contents

 

The following tables detail the gross unrealized losses and fair values aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position at December 31, 2011.

 

 

 

Less than 12 months

 

12 months or more

 

Total

 

Description of Securities

 

Fair
Value

 

Unrealized
Loss

 

Fair
Value

 

Unrealized
Loss

 

Fair
Value

 

Unrealized
Loss

 

U.S. agencies

 

$

2,985,314

 

$

(14,686

)

$

 

 

$

2,985,314

 

$

(14,686

)

Collateralized mortgage obligations

 

 

 

 

 

 

 

Municipalities

 

561,580

 

(370

)

 

 

561,580

 

(370

)

SBA Pools

 

 

 

 

 

 

 

Corporate debt

 

1,814,284

 

(185,716

)

 

 

1,814,284

 

(185,716

)

Mutual Fund

 

991,828

 

(8,172

)

 

 

991,828

 

(8,172

)

Total temporarily impaired securities

 

$

6,353,006

 

$

(208,944

)

$

 

$

 

$

6,353,006

 

$

(208,944

)

 

At December 31, 2011, there were no securities in an unrealized loss position for greater than 12 months. Management periodically evaluates each available-for-sale investment security in an unrealized loss position to determine if the impairment is temporary or other than temporary. Management has determined that no investment security is other than temporarily impaired. The unrealized losses are due solely to interest rate changes and the Company does not intend to sell the securities and it is not likely that we will be required to sell the securities before the earlier of the forecasted recovery or the maturity of the underlying investment security.

 

The Company recognized a gain of $21,547 for the three month period ended March 31, 2012, on certain available-for-sale securities that were partially called, which compares to $25,884 in the same period of 2011.  There were no sales of available-for-sale securities during the first three months of 2012 and 2011.

 

Securities carried at $53,745,429 and $53,419,019 at March 31, 2012 and December 31, 2011, respectively, were pledged to secure deposits of public funds.

 

NOTE 5 — LOANS

 

The Company’s customers are primarily located in Stanislaus, San Joaquin, Tuolumne, Inyo, and Mono Counties. As of March 31, 2012, approximately 84% of the Company’s loans are commercial real estate loans which includes construction loans. Approximately 8% of the Company’s loans are for general commercial uses including professional, retail, and small business. Additionally, 6% of the Company’s loans are for residential real estate and other consumer loans. The remaining 2% are agriculture loans.

 

Loan totals were as follows:

 

 

 

March 31, 2012

 

December 31, 2011

 

Commercial real estate:

 

 

 

 

 

Commercial real estate- construction

 

$

14,156,962

 

$

14,595,324

 

Commercial real estate- mortgages

 

284,397,096

 

284,263,685

 

Land

 

10,195,637

 

10,635,954

 

Farmland

 

21,017,090

 

20,549,849

 

Commercial and industrial

 

32,329,830

 

32,017,744

 

Consumer

 

1,045,006

 

1,212,986

 

Consumer residential

 

22,853,820

 

23,870,519

 

Agriculture

 

6,588,121

 

9,055,622

 

Total loans

 

392,583,562

 

396,201,683

 

 

 

 

 

 

 

Less:

 

 

 

 

 

Deferred loan fees and costs, net

 

(572,568

)

(634,433

)

Allowance for loan losses

 

(7,792,148

)

(8,609,174

)

Net loans

 

$

384,218,846

 

$

386,958,076

 

 

11


 


Table of Contents

 

Loan Origination/Risk Management. The Company has certain lending policies and procedures in place that are designed to maximize loan income within an acceptable level of risk. Management reviews and approves these policies and procedures on a regular basis. A reporting system supplements the review process by providing management with frequent reports related to loan production, loan quality, concentrations of credit, loan delinquencies and non-performing and potential problem loans. Diversification in the loan portfolio is a means of managing risk associated with fluctuations in economic conditions.

 

Commercial and industrial loans are underwritten after evaluating and understanding the borrower’s ability to operate profitably and prudently expand its business. Underwriting standards are designed to promote relationship banking rather than transactional banking. Once it is determined that the borrower’s management possesses sound ethics and solid business acumen, the Company’s management examines current and projected cash flows to determine the ability of the borrower to repay their obligations as agreed. Commercial and industrial loans are primarily made based on the identified cash flows of the borrower and secondarily on the underlying collateral provided by the borrower. The cash flows of borrowers, however, may not be as expected and the collateral securing these loans may fluctuate in value. Most commercial and industrial loans are secured by the assets being financed or other business assets such as accounts receivable or inventory and may incorporate a personal guarantee; however, some short-term loans may be made on an unsecured basis. In the case of loans secured by accounts receivable, the availability of funds for the repayment of these loans may be substantially dependent on the ability of the borrower to collect amounts due from its customers.

 

Commercial real estate loans are subject to underwriting standards and processes similar to commercial and industrial loans, in addition to those of real estate loans. These loans are viewed primarily as cash flow loans and secondarily as loans secured by real estate. Commercial real estate lending typically involves higher loan principal amounts and the repayment of these loans is generally largely dependent on the successful operation of the property securing the loan or the business conducted on the property securing the loan. Commercial real estate loans may be more adversely affected by conditions in the real estate markets or in the general economy. The properties securing the Company’s commercial real estate portfolio are diverse in terms of type and geographic location. This diversity helps reduce the Company’s exposure to adverse economic events that affect any single market or industry. Management monitors and evaluates commercial real estate loans based on collateral, geography and risk grade criteria. As a general rule, the Company avoids financing single-purpose projects unless other underwriting factors are present to help mitigate risk. The Company also utilizes third-party experts to provide insight and guidance about economic conditions and trends affecting market areas it serves. In addition, management tracks the level of owner-occupied commercial real estate loans versus non-owner occupied loans. At March 31, 2012, approximately 37.1% of the outstanding principal balance of the Company’s commercial real estate loans were secured by owner-occupied properties.

 

With respect to loans to developers and builders that are secured by non-owner occupied properties that the Company may originate from time to time, the Company generally requires the borrower to have had an existing relationship with the Company and have a proven record of success. Construction loans are underwritten utilizing feasibility studies, independent appraisal reviews, sensitivity analysis of absorption and lease rates and financial analysis of the developers and property owners. Construction loans are generally based upon estimates of costs and value associated with the complete project. These estimates may be inaccurate. Construction loans often involve the disbursement of substantial funds with repayment substantially dependent on the success of the ultimate project. Sources of repayment for these types of loans may be pre-committed permanent loans from approved long-term lenders, sales of developed property or an interim loan commitment from the Company until permanent financing is obtained. These loans are closely monitored by on-site inspections and are considered to have higher risks than other real estate loans due to their ultimate repayment being sensitive to interest rate changes, governmental regulation of real property, general economic conditions and the availability of long-term financing.

 

The Company originates consumer loans utilizing a computer-based credit scoring analysis to supplement the underwriting process. To monitor and manage consumer loan risk, policies and procedures are developed and modified, as needed, jointly by line and staff personnel. This activity, coupled with relatively small loan amounts that are spread across many individual borrowers, minimizes risk. Additionally, trend and outlook reports are reviewed by management on a regular basis. Underwriting standards for home equity loans follow bank policy, which include, but are not limited to, a maximum loan-to-value percentage of 80%, a maximum housing and total debt ratio of 36% and 42%, respectively and other specified credit and documentation requirements.

 

The Company maintains an independent loan review department that reviews and validates the credit risk program on a periodic basis. Results of these reviews are presented to management. The loan review process complements and reinforces the risk identification and assessment decisions made by lenders and credit personnel, as well as the Company’s policies and procedures.

 

12



Table of Contents

 

Non-Accrual and Past Due Loans. Loans are considered past due if the required principal and interest payments have not been received as of the date such payments were due. Loans are placed on non-accrual status when, in management’s opinion, the borrower may be unable to meet payment obligations as they become due, as well as when required by regulatory provisions. Loans may be placed on non-accrual status regardless of whether or not such loans are considered past due. When interest accrual is discontinued, all unpaid accrued interest is reversed. Interest income is subsequently recognized only to the extent cash payments are received in excess of principal due. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured.

 

Non-accrual loans, segregated by class of loans, were as follows:

 

 

 

March 31, 2012

 

December 31, 2011

 

Commercial real estate:

 

 

 

 

 

Commercial real estate- construction

 

$

290,867

 

$

179,262

 

Commercial real estate- mortgages

 

2,994,798

 

3,671,693

 

Land

 

3,266,962

 

3,277,463

 

Farmland

 

0

 

0

 

Commercial and industrial

 

103,170

 

104,481

 

Consumer

 

0

 

0

 

Consumer residential

 

0

 

0

 

Agriculture

 

0

 

0

 

Total non-accrual loans

 

$

6,655,797

 

$

7,232,899

 

 

Had non-accrual loans performed in accordance with their original contract terms, the Company would have recognized additional interest income of approximately $154,000 in three month period ended March 31, 2012, as compared to $181,000 in the same period of 2011.

 

The following table analyzes past due loans including the non-accrual loans in the above table, segregated by class of loans, as of March 31, 2012:

 

 

 

30-59 
Days Past
Due

 

60-89
Days Past
Due

 

Greater
Than 90
Days Past
Due

 

Total Past
Due

 

Current

 

Total

 

Greater
Than 90
Days Past
Due and
Still
Accruing

 

March 31, 2012

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Commercial real estate:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Commercial R.E. - construction

 

$

58,261

 

$

0

 

$

290,867

 

$

349,128

 

$

13,807,834

 

$

14,156,962

 

$

0

 

Commercial R.E. - mortgages

 

666,851

 

0

 

2,577,216

 

3,244,067

 

281,153,029

 

284,397,096

 

0

 

Land

 

1,067,726

 

1,864,502

 

2,580,230

 

5,512,458

 

4,683,179

 

10,195,637

 

0

 

Farmland

 

0

 

0

 

0

 

0

 

21,017,090

 

21,017,090

 

0

 

Commercial and industrial

 

0

 

351,192

 

79,059

 

430,251

 

31,899,579

 

32,329,830

 

0

 

Consumer

 

0

 

0

 

0

 

0

 

1,045,006

 

1,045,006

 

0

 

Consumer residential

 

0

 

0

 

0

 

0

 

22,853,820

 

22,853,820

 

0

 

Agriculture

 

0

 

0

 

0

 

0

 

6,588,121

 

6,588,121

 

0

 

Total

 

$

1,792,838

 

$

2,215,694

 

$

5,527,372

 

$

9,535,904

 

$

383,047,658

 

$

392,583,562

 

$

0

 

 

13



Table of Contents

 

The following table analyzes past due loans including the non-accrual loans in the above table, segregated by class of loans, as of December 31, 2011:

 

 

 

30-59
Days Past
Due

 

60-89
Days
Past Due

 

Greater
Than 90
Days Past
Due

 

Total Past
Due

 

Current

 

Total

 

Greater
Than 90
Days Past
Due and
Still
Accruing

 

December 31, 2011

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Commercial real estate:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Commercial R.E. - construction

 

$

0

 

$

0

 

$

179,263

 

$

179,263

 

$

14,416,061

 

$

14,595,324

 

$

0

 

Commercial R.E. - mortgages

 

424,683

 

0

 

3,671,693

 

4,096,376

 

280,167,309

 

284,263,685

 

0

 

Land

 

0

 

0

 

2,580,231

 

2,580,231

 

8,055,723

 

10,635,954

 

0

 

Farmland

 

0

 

0

 

0

 

0

 

20,549,849

 

20,549,849

 

0

 

Commercial and industrial

 

0

 

79,059

 

0

 

79,059

 

31,938,685

 

32,017,744

 

0

 

Consumer

 

16,419

 

0

 

0

 

16,419

 

1,196,567

 

1,212,986

 

0

 

Consumer residential

 

0

 

0

 

0

 

0

 

23,870,519

 

23,870,519

 

0

 

Agriculture

 

0

 

0

 

0

 

0

 

9,055,622

 

9,055,622

 

0

 

Total

 

$

441,102

 

$

79,059

 

$

6,431,187

 

$

6,951,348

 

$

389,250,335

 

$

396,201,683

 

$

0

 

 

Impaired Loans. Loans are considered impaired when, based on current information and events, it is probable the Company will be unable to collect all amounts due in accordance with the original contractual terms of the loan agreement, including scheduled principal and interest payments. Impairment is evaluated in total for smaller-balance loans of a similar nature and on an individual loan basis for other loans. If a loan is impaired, a specific valuation allowance is allocated, if necessary, so that the loan is reported net, at the present value of estimated future cash flows using the loan’s existing rate or at the fair value of collateral if repayment is expected solely from the collateral. Interest payments on impaired loans are typically applied to principal unless collectability of the principal amount is reasonably assured, in which case interest is recognized on a cash basis. There was no interest income realized on impaired loans for the three months ended March 31, 2012 and 2011. Average recorded investment in impaired loans was $6,944,000 for the three months ended March 31, 2012 as compared to $11,391,000 for the same period of 2011. Impaired loans, or portions thereof, are charged off when deemed uncollectible.

 

14



Table of Contents

 

Impaired loans as of March 31, 2012 and December 31, 2011 are set forth in the following table. No interest income was recognized on impaired loans subsequent to their classification as impaired.

 

 

 

Unpaid
Contractual
Principal
Balance

 

Recorded
Investment
With No
Allowance

 

Recorded
Investment
With
Allowance

 

Total
Recorded
Investment

 

Related
Allowance

 

Average
Recorded
Investment

 

March 31, 2012

 

 

 

 

 

 

 

 

 

 

 

 

 

Commercial real estate:

 

 

 

 

 

 

 

 

 

 

 

 

 

Commercial R.E. - construction

 

$

357,467

 

$

0

 

$

290,867

 

$

290,867

 

$

1,656

 

$

235,064

 

Commercial R.E. - mortgages

 

4,887,323

 

2,577,217

 

417,581

 

2,994,798

 

83,721

 

3,333,246

 

Land

 

7,659,989

 

686,732

 

2,580,230

 

3,266,962

 

266,761

 

3,272,213

 

Farmland

 

0

 

0

 

0

 

0

 

0

 

0

 

Commercial and Industrial

 

116,299

 

103,170

 

0

 

103,170

 

0

 

103,826

 

Consumer

 

0

 

0

 

0

 

0

 

0

 

0

 

Consumer residential

 

0

 

0

 

0

 

0

 

0

 

0

 

Agriculture

 

0

 

0

 

0

 

0

 

0

 

0

 

Total

 

$

13,021,078

 

$

3,367,119

 

$

3,288,678

 

$

6,655,797

 

$

352,138

 

$

6,944,349

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

December 31, 2011

 

 

 

 

 

 

 

 

 

 

 

 

 

Commercial real estate:

 

 

 

 

 

 

 

 

 

 

 

 

 

Commercial R.E. - construction

 

$

245,862

 

$

0

 

$

179,262

 

$

179,262

 

$

5,984

 

$

1,177,407

 

Commercial R.E. - mortgages

 

4,469,681

 

3,671,693

 

0

 

3,671,693

 

0

 

4,111,549

 

Land

 

7,659,990

 

697,232

 

2,580,231

 

3,277,463

 

544,630

 

3,329,784

 

Farmland

 

0

 

0

 

0

 

0

 

0

 

0

 

Commercial and Industrial

 

116,867

 

104,481

 

0

 

104,481

 

0

 

36,655

 

Consumer

 

0

 

0

 

0

 

0

 

0

 

0

 

Consumer residential

 

0

 

0

 

0

 

0

 

0

 

0

 

Agriculture

 

0

 

0

 

0

 

0

 

0

 

0

 

Total

 

$

12,492,400

 

$

4,473,406

 

$

2,759,493

 

$

7,232,899

 

$

550,614

 

$

8,655,395

 

 

Troubled Debt Restructurings — In order to determine whether a borrower is experiencing financial difficulty, an evaluation is performed of the probability that the borrower will be in payment default on any of its debt in the foreseeable future without the modification. This evaluation is performed under the Company’s internal underwriting policy.

 

At March 31, 2012, there were 5 loans and leases that were considered to be troubled debt restructurings, all of which are considered nonaccrual totaling $3,582,000. At March 31, 2012 and December 31, 2011 there were unfunded commitments of $1,497,000 and $1,644,000, respectively, on one loan classified as a troubled debt restructure because of an agreement with a borrower to continue advancing funds and covering overhead costs on a residential development project. The Company will receive proceeds to pay down the principal as the residential properties sell.

 

The Company has allocated $268,000 and $551,000 of specific reserves to loans whose terms have been modified in troubled debt restructurings as of March 31, 2012 and December 31, 2011, respectively. The Company had commitments to lend an additional $1,497,000 and $1,644,000 to one of these borrowers as of March 31, 2012 and December 31, 2011, respectively, as described above.

 

During the three-month period ended March 31, 2012, there were no loans modified as troubled debt restructurings. If a loan modification is granted, the modification of the terms of such loans typically includes one or a combination of the following: a reduction of the stated interest rate of the loan; an extension of the maturity date; or a temporary payment modification in which the payment amount allocated towards principal was reduced. In some cases, a permanent reduction of the accrued interest on the loan is conceded.

 

Since there was no troubled debt restructurings during the three-month period ended March 31, 2012, there was no increase in the allowance for loan losses as a result of loan modifications and there were no charge offs as a result of loan modifications.

 

15


 


Table of Contents

 

The following table presents loans by class modified as troubled debt restructurings for which there was a payment default within twelve months following the modification during the three month period ended March 31, 2012.

 

 

 

Three Months Ended

 

 

 

March 31, 2012

 

 

 

Number of
Loans

 

Recorded
Investment

 

Commercial real estate:

 

 

 

 

 

Commercial R.E. - construction

 

0

 

$

0

 

Commercial R.E. - mortgages

 

0

 

0

 

Land

 

1

 

571,594

 

Farmland

 

0

 

0

 

Commercial and Industrial

 

0

 

0

 

Consumer

 

0

 

0

 

Consumer residential

 

0

 

0

 

Agriculture

 

0

 

0

 

Total

 

1

 

$

571,594

 

 

A loan is considered to be in payment default once it is ninety days contractually past due under the modified terms.

 

Quality ratings (Risk Grades) are assigned to all commitments and stand-alone notes. Risk grades define the basic characteristics of commitments or stand-alone note in relation to their risk. All loans are graded using a system that maximizes the loan quality information contained in loan review grades, while ensuring that the system is compatible with the grades used by bank examiners.

 

We grade loans using the following letter system:

 

1 Exceptional Loan

2 Quality Loan

3A Better Than Acceptable Loan

3B Acceptable Loan

3C Marginally Acceptable Loan

4 (W) Watch Acceptable Loan

5 Other Loans Especially Mentioned

6 Substandard Loan

7 Doubtful Loan

8 Loss

 

1. Exceptional Loan - Loans with A+ credits that contain very little, if any, risk. Grade 1 loans are considered Pass.  To qualify for this rating, the following characteristics must be present:

 

·A high level of liquidity and whose debt-servicing capacity exceeds expected obligations by a substantial margin.

·Where leverage is below average for the industry and earnings are consistent or growing without severe vulnerability to economic cycles.

·Also included in this rating (but not mandatory unless one or more of the preceding characteristics are missing) are loans that are fully secured and properly margined by our own time instruments or U.S. blue chip securities. To be properly margined cash collateral must be equal to, or greater than, 110% of the loan amount.

 

2. Quality Loan - Loans with excellent sources of repayment that conform in all respects to bank policy and regulatory requirements. These are also loans for which little repayment risk has been identified. No credit or collateral exceptions. Grade 2 loans are considered Pass.  Other factors include:

 

·Unquestionable debt-servicing capacity to cover all obligations in the ordinary course of business from well-defined primary and secondary sources.

·Consistent strong earnings.

·A solid equity base.

 

3A. Better than Acceptable Loan - In the interest of better delineating the loan portfolio’s true credit risk for reserve allocation, further granularity has been sought by splitting the grade 3 category into three classifications. The distinction between the three are bank-defined guidelines and represent a further refinement of the regulatory definition of a pass, or grade 3 loan. Grade 3A is the stronger third of the pass category, but is not strong enough to be a grade 2 and is characterized by:

 

·Strong earnings with no loss in last three years and ample cash flow to service all debt well above policy guidelines.

·Long term experienced management with depth and defined management succession.

 

16



Table of Contents

 

·The loan has no exceptions to policy.

·Loan-to-value on real estate secured transactions is 10% to 20% less than policy guidelines.

·Very liquid balance sheet that may have cash available to pay off our loan completely.

·Little to no debt on balance sheet.

 

3B. Acceptable Loan - 3B loans are simply defined as all loans that are less qualified than 3A loans and are stronger than 3C loans. These loans are characterized by acceptable sources of repayment that conform to bank policy and regulatory requirements. Repayment risks are acceptable for these loans. Credit or collateral exceptions are minimal, are in the process of correction, and do not represent repayment risk. These loans:

 

·Are those where the borrower has average financial strengths, a history of profitable operations and experienced management.

·Are those where the borrower can be expected to handle normal credit needs in a satisfactory manner.

 

3C. Marginally Acceptable - 3C loans have similar characteristics as that of 3Bs with the following additional characteristics: Requires collateral. A credit facility where the borrower has average financial strengths, but usually lacks reliable secondary sources of repayment other than the subject collateral.  Other common characteristics can include some or all of the following: minimal background experience of management, lacking continuity of management, a start-up operation, erratic historical profitability (acceptable reasons-well identified), lack of or marginal sponsorship of guarantor, and government guaranteed loans.

 

4W Watch Acceptable - Watch grade will be assigned to any credit that is adequately secured and performing but monitored for a number of indicators. These characteristics may include any unexpected short-term adverse financial performance from budgeted projections or prior period’s results (i.e., declining profits, sales, margins, cash flow, or increased reliance on leverage, including adverse balance sheet ratios, trade debt issues, etc.). Additionally, any managerial or personal problems of company management, decline in the entire industry or local economic conditions failure to provide financial information or other documentation as requested; issues regarding delinquency, overdrafts, or renewals; and any other issues that cause concern for the company. Loans to individuals or loans supported by guarantors with marginal net worth and/or marginal collateral. Weakness identified in a Watch credit is short-term in nature.  Loans in this category are usually accounts the Company would want to retain providing a positive turnaround can be expected within a reasonable time frame.  Grade 4 loans are considered Pass.

 

5 Other Loans Especially Mentioned (Special Mention) - A special mention extension of credit is defined as having potential weaknesses that deserve management’s close attention. If left uncorrected, these potential weaknesses may, at some future date result in the deterioration of the repayment prospects for the credit or the institution’s credit position. Extensions of credit that might be detailed in this category include the following:

 

·The lending officer may be unable to properly supervise the credit because of an inadequate loan or credit agreement.

·Questions exist regarding the condition of and/or control over collateral.

·Economic or market conditions may unfavorably affect the obligor in the future.

·A declining trend in the obligor’s operations or an imbalanced position in the balance sheet exists, but not to the point that repayment is jeopardized.

 

6 Substandard Loan - A “substandard” extension of credit is inadequately protected by the current sound worth and paying capacity of the obligor or of the collateral pledged, if any. Extensions of credit so classified must have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. They are characterized by the distinct possibility that the Company will sustain some loss if the deficiencies are not corrected. Loss potential, while existing in the aggregate amount of substandard credits, does not have to exist in individual extensions of credit classified substandard.

 

7 Doubtful Loan - An extension of credit classified “doubtful” has all the weaknesses inherent in one classified substandard, with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions, and values, highly questionable and improbable. The possibility of loss is extremely high but because of certain important and reasonably specific pending factors that may work to the advantage of and strengthen the credit, its classification as an estimated loss is deferred until its more exact status may be determined. Pending factors may include a proposed merger or acquisition, liquidation proceedings, capital injection, perfecting liens on additional collateral or refinancing plans. The entire loan need not be classified doubtful when collection of a specific portion appears highly probable. An example of proper use of the doubtful category is the case of a company being liquidated, with the trustee-in-bankruptcy indicating a minimum disbursement of 40 percent and a maximum of 65 percent to unsecured creditors, including the Company. In this situation, estimates are based on liquidation value appraisals with actual values yet to be realized. By definition, the only portion of the credit that is doubtful is the 25 percent difference between 40 and 65 percent. A proper classification of such a credit would show 40 percent substandard, 25 percent doubtful, and 35 percent loss. A credit classified as doubtful should be resolved within a ‘reasonable’ period of time. Reasonable is generally defined as the period between examinations. In other words, a credit classified doubtful at an examination should be cleared up before the next exam. However, there may be situations that warrant continuation of the doubtful classification a while longer.

 

8. Loss - Extensions of credit classified “loss” are considered uncollectible and of such little value that their continuance as bankable assets is not warranted. This classification does not mean that the credit has absolutely no recovery or salvage value, but rather that it is not practical or desirable to defer writing off, even though partial recovery may be affected in the future. It should not be the Company’s practice to attempt long-term recoveries while the credit remains on the books. Losses should be taken in the period in which they surface as uncollectible.

 

17



Table of Contents

 

The following table presents weighted average risk grades of our loan portfolio:

 

 

 

March 31, 2012

 

December 31, 2011

 

 

 

Weighted Average
Risk Grade

 

Weighted Average
Risk Grade

 

Commercial real estate:

 

 

 

 

 

Commercial real estate - construction

 

3.56

 

3.52

 

Commercial real estate - mortgages

 

3.24

 

3.26

 

Land

 

4.82

 

4.75

 

Farmland

 

3.38

 

3.40

 

Commercial and Industrial

 

3.14

 

3.21

 

Consumer

 

2.64

 

2.76

 

Consumer residential

 

3.11

 

3.10

 

Agriculture

 

3.31

 

3.23

 

Total gross loans

 

3.28

 

3.30

 

 

The following table presents risk grade totals by class of loans as of March 31, 2012.  Risk grades 1 through 4 have been aggregated in the “Pass” line.

 

Dollars in thousands

 

Commercial R.E.
Construction

 

Commercial R.E.
Mortgages

 

Land

 

Farmland

 

Commercial and
Industrial

 

Consumer

 

Consumer
Residential

 

Agriculture

 

Total

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

March 31, 2012

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Pass

 

$

13,866,095

 

$

267,048,227

 

$

3,996,447

 

$

19,680,236

 

$

31,263,756

 

$

1,027,870

 

$

22,459,853

 

$

5,905,546

 

$

365,248,030

 

Special mention

 

 

7,848,738

 

 

 

142,525

 

 

 

 

7,991,263

 

Substandard

 

290,867

 

9,500,131

 

6,199,190

 

1,336,854

 

923,549

 

17,136

 

393,967

 

682,575

 

19,344,269

 

Doubtful

 

 

 

 

 

 

 

 

 

 

Total loans

 

$

14,156,962

 

$

284,397,096

 

$

10,195,637

 

$

21,017,090

 

$

32,329,830

 

$

1,045,006

 

$

22,853,820

 

$

6,588,121

 

$

392,583,562

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

December 31, 2011

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Pass

 

$

14,416,062

 

$

264,913,517

 

$

4,419,659

 

$

19,188,322

 

$

31,000,530

 

$

1,179,624

 

$

23,475,447

 

$

8,357,801

 

$

366,950,962

 

Special mention

 

 

8,684,736

 

 

 

78,011

 

 

 

 

8,762,747

 

Substandard

 

179,262

 

10,665,432

 

6,216,295

 

1,361,527

 

939,203

 

16,943

 

395,072

 

697,821

 

20,471,555

 

Doubtful

 

 

 

 

 

 

16,419

 

 

 

16,419

 

Total loans

 

$

14,595,324

 

$

284,263,685

 

$

10,635,954

 

$

20,549,849

 

$

32,017,744

 

$

1,212,986

 

$

23,870,519

 

$

9,055,622

 

$

396,201,683

 

 

Allowance for Loan Losses. The allowance for loan losses is a reserve established through a provision for loan losses charged to expense, which represents management’s best estimate of probable losses that have been incurred within the existing portfolio of loans. The allowance, in the judgment of management, is necessary to reserve for estimated loan losses and risks inherent in the loan portfolio. The Company’s allowance for loan loss methodology includes allowance allocations calculated in accordance with ASC Topic 310, “Receivables” and allowance allocations calculated in accordance with ASC Topic 450, “Contingencies.” Accordingly, the methodology is based on historical loss experience by type of credit and internal risk grade, specific homogeneous risk pools and specific loss allocations, with adjustments for current events and conditions. The Company’s process for determining the appropriate level of the allowance for loan losses is designed to account for credit deterioration as it occurs. The provision for loan losses reflects loan quality trends, including the levels of and trends related to non-accrual loans, past due loans, potential problem loans, criticized loans and net charge-offs or recoveries, among other factors. The provision for loan losses also reflects the totality of actions taken on all loans for a particular period.  In other words, the amount of the provision reflects not only the necessary increases in the allowance for loan losses related to newly identified criticized loans, but it also reflects actions taken related to other loans including, among other things, any necessary increases or decreases in required allowances for specific loans or loan pools.

 

18



Table of Contents

 

The level of the allowance reflects management’s continuing evaluation of industry concentrations, specific credit risks, loan loss experience, current loan portfolio quality, present economic, political and regulatory conditions and unidentified losses inherent in the current loan portfolio. Portions of the allowance may be allocated for specific credits; however, the entire allowance is available for any credit that, in management’s judgment, should be charged off. While management utilizes its best judgment and information available, the ultimate adequacy of the allowance is dependent upon a variety of factors beyond the Company’s control, including, among other things, the performance of the Company’s loan portfolio, the economy, changes in interest rates and the view of the regulatory authorities toward loan classifications.

 

The Company’s allowance for loan losses consists of three elements: (i) specific valuation allowances determined in accordance with ASC Topic 310 based on probable losses on specific loans; (ii) historical valuation allowances determined in accordance with ASC Topic 450 based on historical loan loss experience for similar loans with similar characteristics and trends, adjusted, as necessary, to reflect the impact of current conditions; and (iii) general valuation allowances determined in accordance with ASC Topic 450 based on general economic conditions and other qualitative risk factors both internal and external to the Company.

 

The allowances established for probable losses on specific loans are based on a regular analysis and evaluation of problem loans. Loans are classified based on an internal credit risk grading process that evaluates, among other things: (i) the obligor’s ability to repay; (ii) the underlying collateral, if any; and (iii) the economic environment and industry in which the borrower operates. This analysis is performed at the relationship manager level for all commercial loans. When a loan has a calculated grade of 5 or higher, a special assets officer analyzes the loan to determine whether the loan is impaired and, if impaired, the need to specifically allocate a portion of the allowance for loan losses to the loan. Specific valuation allowances are determined by analyzing the borrower’s ability to repay amounts owed, collateral deficiencies, the relative risk grade of the loan and economic conditions affecting the borrower’s industry, among other things.

 

Historical valuation allowances are calculated based on the historical loss experience of specific types of loans and the internal risk grade of such loans at the time they were charged-off. The Company calculates historical loss ratios for pools of similar loans with similar characteristics based on the proportion of actual charge-offs experienced to the total population of loans in the pool. The historical loss ratios are periodically updated based on actual charge-off experience. A historical valuation allowance is established for each pool of similar loans based upon the product of the historical loss ratio and the total dollar amount of the loans in the pool. The Company’s pools of similar loans include similarly risk-graded groups of commercial and industrial loans, commercial real estate loans, consumer real estate loans and consumer and other loans.

 

General valuation allowances are based on general economic conditions and other qualitative risk factors both internal and external to the Company. In general, such valuation allowances are determined by evaluating, among other things: (i) the experience, ability and effectiveness of the Company’s lending management and staff; (ii) the effectiveness of the Company’s loan policies, procedures and internal controls; (iii) changes in asset quality; (iv) changes in loan portfolio volume; (v) the composition and concentrations of credit; (vi) the impact of competition on loan structuring and pricing; (vii) the effectiveness of the internal loan review function; (viii) the impact of environmental risks on portfolio risks; and (ix) the impact of rising interest rates on portfolio risk. Management evaluates the degree of risk that each one of these components has on the quality of the loan portfolio on a quarterly basis. Each component is determined to have either a high, moderate or low degree of risk. The results are then input into a “general allocation matrix” to determine an appropriate general valuation allowance.

 

Included in the general valuation allowances are allocations for groups of similar loans with risk characteristics that exceed certain concentration limits established by management. Concentration risk limits have been established, among other things, for certain industry concentrations, large balance and highly leveraged credit relationships that exceed specified risk grades, and loans originated with policy exceptions that exceed specified risk grades.

 

Loans identified as losses by management, internal loan review and/or bank examiners are charged-off. Furthermore, consumer loan accounts are charged-off automatically based on regulatory requirements.

 

19


 


Table of Contents

 

The following table details activity in the allowance for loan losses by portfolio segment for the three months ended March 31, 2012 and 2011. Allocation of a portion of the allowance to one category of loans does not preclude its availability to absorb losses in other categories.

 

Allowance for Loan Losses

For the Three Months Ended March 31, 2012 and 2011

 

 

 

Commercial

 

Commercial

 

 

 

Consumer

 

 

 

 

 

 

 

 

 

Real Estate

 

and industrial

 

Consumer

 

Residential

 

Agriculture

 

Unallocated

 

Total

 

Three Months Ended March 31, 2012

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Beginning balance

 

$

6,969,004

 

$

606,307

 

$

65,060

 

$

347,905

 

$

363,174

 

$

257,724

 

$

8,609,174

 

Charge-offs

 

(1,106,790

)

0

 

(18,642

)

0

 

0

 

0

 

(1,125,432

)

Recoveries

 

4,707

 

0

 

1,835

 

1,864