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, 2013

 

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:  7,914,730 shares of common stock outstanding as of April 30, 2013.

 

 

 



Table of Contents

 

Oak Valley Bancorp

March 31, 2013

 

Table of Contents

 

 

 

Page

PART I — FINANCIAL INFORMATION

2

 

 

 

Item 1.

Consolidated Financial Statements

2

 

 

 

Condensed Consolidated Balance Sheets at March 31, 2013 (Unaudited), and December 31, 2012

2

 

 

Condensed Consolidated Statements of Income (Unaudited) for the Three Month Periods Ended March 31, 2013 and March 31, 2012

3

 

 

Condensed Consolidated Statements of Comprehensive Income (Unaudited) for the Three Month Periods Ended March 31, 2013 and March 31, 2012

4

 

 

Condensed Consolidated Statements of Changes of Shareholders’ Equity for the Three-Month Period Ended March 31, 2013 (Unaudited) and the Year Ended December 31, 2012

5

 

 

Condensed Consolidated Statements of Cash Flows (Unaudited) for the Three-Month Periods Ended March 31, 2013 and March 31, 2012

6

 

 

Notes to Condensed Consolidated Financial Statements

7

 

 

 

Item 2.

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

25

 

 

 

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

38

 

 

 

Item 4.

Controls and Procedures

38

 

 

 

PART II — OTHER INFORMATION

39

 

 

 

Item 1.

Legal Proceedings

39

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

39

Item 3.

Defaults Upon Senior Securities

39

Item 4.

Mine Safety Disclosures

39

Item 5.

Other Information

39

Item 6.

Exhibits

40

 



Table of Contents

 

PART I — FINANCIAL STATEMENTS

 

Item 1. Consolidated Financial Statements (Unaudited)

 

OAK VALLEY BANCORP

CONDENSED CONSOLIDATED BALANCE SHEETS

AT MARCH 31, 2013 (UNAUDITED) AND DECEMBER 31, 2012 (AUDITED)

 

 

 

March 31,

 

December 31,

 

 

 

2013

 

2012

 

ASSETS

 

 

 

 

 

 

 

 

 

 

 

Cash and due from banks

 

$

96,098,169

 

$

130,799,998

 

Federal funds sold

 

21,770,000

 

10,535,000

 

Cash and cash equivalents

 

117,868,169

 

141,334,998

 

 

 

 

 

 

 

Securities available for sale

 

114,578,829

 

103,865,881

 

Loans, net of allowance for loan losses of $7,743,439 and $7,974,975 at March 31, 2013 and December 31, 2012, respectively

 

381,631,757

 

382,411,361

 

Bank premises and equipment, net

 

12,917,443

 

13,182,451

 

Other real estate owned

 

970,632

 

0

 

Interest receivable and other assets

 

20,451,484

 

19,786,065

 

 

 

 

 

 

 

 

 

$

648,418,314

 

$

660,580,756

 

 

 

 

 

 

 

LIABILITIES AND SHAREHOLDERS’ EQUITY

 

 

 

 

 

 

 

 

 

 

 

Deposits

 

$

580,214,881

 

$

586,992,650

 

Interest payable and other liabilities

 

4,105,189

 

3,619,382

 

Total liabilities

 

584,320,070

 

590,612,032

 

 

 

 

 

 

 

Commitments and contingencies

 

 

 

 

 

 

 

 

 

 

 

Shareholders’ equity

 

 

 

 

 

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

 

0

 

6,750,000

 

Common stock, no par value; 50,000,000 shares authorized, 7,914,730 and 7,907,780 shares issued and outstanding at March 31, 2013 and December 31, 2012, respectively

 

23,758,210

 

23,673,210

 

Additional paid-in capital

 

2,378,110

 

2,341,814

 

Retained earnings

 

35,190,668

 

33,958,737

 

Accumulated other comprehensive income, net of tax

 

2,771,256

 

3,244,963

 

 

 

 

 

 

 

Total shareholders’ equity

 

64,098,244

 

69,968,724

 

 

 

 

 

 

 

 

 

$

648,418,314

 

$

660,580,756

 

 

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

 

2



Table of Contents

 

OAK VALLEY BANCORP

CONDENSED CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)

FOR THE THREE MONTH PERIODS ENDED MARCH 31, 2013 AND MARCH 31, 2012

 

 

 

THREE MONTHS ENDED MARCH 31,

 

 

 

2013

 

2012

 

INTEREST INCOME

 

 

 

 

 

Interest and fees on loans

 

$

5,232,140

 

$

5,715,043

 

Interest on securities available for sale

 

786,775

 

833,685

 

Interest on federal funds sold

 

6,756

 

5,067

 

Interest on deposits with banks

 

57,374

 

29,806

 

Total interest income

 

6,083,045

 

6,583,601

 

 

 

 

 

 

 

INTEREST EXPENSE

 

 

 

 

 

Deposits

 

233,813

 

315,217

 

FHLB advances

 

 

4,707

 

Total interest expense

 

233,813

 

319,924

 

 

 

 

 

 

 

Net interest income

 

5,849,232

 

6,263,677

 

PROVISION FOR LOAN LOSSES

 

100,000

 

300,000

 

 

 

 

 

 

 

Net interest income after provision for loan losses

 

5,749,232

 

5,963,677

 

 

 

 

 

 

 

OTHER INCOME

 

 

 

 

 

Service charges on deposits

 

286,718

 

281,078

 

Earnings on cash surrender value of life insurance

 

100,547

 

105,000

 

Mortgage commissions

 

50,514

 

47,409

 

Gains on called securities

 

18,352

 

21,547

 

Other

 

328,503

 

376,192

 

Total non-interest income

 

784,634

 

831,226

 

 

 

 

 

 

 

OTHER EXPENSES

 

 

 

 

 

Salaries and employee benefits

 

2,543,919

 

2,575,563

 

Occupancy expenses

 

740,007

 

750,874

 

Data processing fees

 

304,518

 

277,861

 

OREO expenses

 

 

20,074

 

Regulatory assessments (FDIC & DFI)

 

120,000

 

117,000

 

Other operating expenses

 

930,641

 

855,392

 

Total non-interest expense

 

4,639,085

 

4,596,764

 

 

 

 

 

 

 

Net income before provision for income taxes

 

1,894,781

 

2,198,139

 

 

 

 

 

 

 

PROVISION FOR INCOME TAXES

 

595,350

 

737,234

 

NET INCOME

 

$

1,299,431

 

$

1,460,905

 

 

 

 

 

 

 

Preferred stock dividends

 

67,500

 

168,750

 

NET INCOME AVAILABLE TO COMMON SHAREHOLDERS

 

$

1,231,931

 

$

1,292,155

 

 

 

 

 

 

 

NET INCOME PER COMMON SHARE

 

$

0.16

 

$

0.17

 

 

 

 

 

 

 

NET INCOME PER DILUTED COMMON SHARE

 

$

0.16

 

$

0.17

 

 

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

 

3



Table of Contents

 

OAK VALLEY BANCORP

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (UNAUDITED)

FOR THE THREE MONTH PERIODS ENDED MARCH 31, 2013 AND MARCH 31, 2012

 

 

 

THREE MONTHS ENDED MARCH 31,

 

 

 

2013

 

2012

 

 

 

 

 

 

 

Net income

 

$

1,299,431

 

$

1,460,905

 

Available for sale securities:

 

 

 

 

 

Gross unrealized loss arising during the year

 

(786,588

)

(434,031

)

Reclassification adjustment for gains realized in net income (net of income tax of $7,552 and $8,867 for the 2013 and 2012 periods, respectively)

 

(10,800

)

(12,680

)

Income tax benefit related to unrealized losses

 

323,681

 

178,604

 

Other comprehensive loss

 

(473,707

)

(268,107

)

Comprehensive income

 

$

825,724

 

$

1,192,798

 

 

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

 

4



Table of Contents

 

OAK VALLEY BANCORP

CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY

FOR THE YEAR ENDED DECEMBER 31, 2012 AND THE THREE-MONTH PERIOD ENDED MARCH 31, 2013 (UNAUDITED)

 

 

 

YEAR ENDED DECEMBER 31, 2012 AND THREE MONTHS ENDED MARCH 31, 2013

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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

 

7,718,469

 

$

23,453,443

 

13,500

 

$

13,500,000

 

$

2,128,700

 

$

28,629,757

 

$

2,690,106

 

$

70,402,006

 

Stock options exercised

 

54,436

 

219,767

 

 

 

 

 

 

 

 

 

 

 

219,767

 

Tax benefit on stock options exercised

 

 

 

 

 

 

 

 

 

37,218

 

 

 

 

 

37,218

 

Restricted stock issued

 

134,875

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Repurchase of Series B preferred stock

 

 

 

 

 

(6,750

)

$

(6,750,000

)

 

 

 

 

 

 

(6,750,000

)

Preferred stock dividend payments

 

 

 

 

 

 

 

 

 

 

 

(451,875

)

 

 

(451,875

)

Stock based compensation

 

 

 

 

 

 

 

 

 

175,896

 

 

 

 

 

175,896

 

Other comprehensive income

 

 

 

 

 

 

 

 

 

 

 

 

 

554,857

 

554,857

 

Net income

 

 

 

 

 

 

 

 

 

 

 

5,780,855

 

 

 

5,780,855

 

Balances, December 31, 2012

 

7,907,780

 

$

23,673,210

 

6,750

 

$

6,750,000

 

$

2,341,814

 

$

33,958,737

 

$

3,244,963

 

$

69,968,724

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Stock options exercised

 

11,250

 

85,000

 

 

 

 

 

 

 

 

 

 

 

85,000

 

Restricted stock cancelled

 

(4,300

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Repurchase of Series B preferred stock

 

 

 

 

 

(6,750

)

$

(6,750,000

)

 

 

 

 

 

 

(6,750,000

)

Preferred stock dividend payments

 

 

 

 

 

 

 

 

 

 

 

(67,500

)

 

 

(67,500

)

Stock based compensation

 

 

 

 

 

 

 

 

 

36,296

 

 

 

 

 

36,296

 

Other comprehensive loss

 

 

 

 

 

 

 

 

 

 

 

 

 

(473,707

)

(473,707

)

Net income

 

 

 

 

 

 

 

 

 

 

 

1,299,431

 

 

 

1,299,431

 

Balances, March 31, 2013

 

7,914,730

 

$

23,758,210

 

0

 

$

0

 

$

2,378,110

 

$

35,190,668

 

$

2,771,256

 

$

64,098,244

 

 

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

 

5



Table of Contents

 

OAK VALLEY BANCORP

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)

FOR THE THREE MONTH PERIODS ENDED MARCH 31, 2013 AND MARCH 31, 2012

 

 

 

THREE MONTHS ENDED MARCH 31,

 

 

 

2013

 

2012

 

 

 

 

 

 

 

CASH FLOWS FROM OPERATING ACTIVITIES:

 

 

 

 

 

Net income

 

$

1,299,431

 

$

1,460,905

 

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

 

 

 

 

 

Provision for loan losses

 

100,000

 

300,000

 

Increase (decrease) in deferred fees/costs, net

 

16,891

 

(61,865

)

Depreciation

 

289,782

 

281,490

 

Amortization of investment securities, net

 

74,766

 

38,817

 

Stock based compensation

 

36,296

 

24,569

 

Excess tax benefits from stock-based payment arrangements

 

0

 

(32,842

)

Gain on sale of premises and equipment

 

0

 

(21,875

)

OREO write downs and (gain)/losses on sale

 

0

 

(3,548

)

Gain on called available for sale securities

 

(18,352

)

(21,547

)

Earnings on cash surrender value of life insurance

 

(100,547

)

(105,000

)

Increase in interest payable and other liabilities

 

485,807

 

627,473

 

Increase in interest receivable

 

(94,962

)

(115,485

)

Increase in other assets

 

(138,677

)

(470,831

)

Net cash from operating activities

 

1,950,435

 

1,900,261

 

 

 

 

 

 

 

CASH FLOWS FROM INVESTING ACTIVITIES:

 

 

 

 

 

Purchases of available for sale securities

 

(18,690,316

)

(21,970,982

)

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

 

7,116,014

 

6,108,382

 

Net (increase) decrease in loans

 

(307,919

)

2,501,095

 

Purchase of FRB Stock

 

0

 

(1,450

)

Redemption of FHLB stock

 

0

 

135,300

 

Proceeds from sale of OREO

 

0

 

247,923

 

Proceeds from sales of premises and equipment

 

0

 

21,875

 

Net purchases of premises and equipment

 

(24,774

)

(75,317

)

Net cash (used in) investing activities

 

(11,906,995

)

(13,033,174

)

 

 

 

 

 

 

CASH FLOWS FROM FINANCING ACTIVITIES:

 

 

 

 

 

FHLB payments

 

0

 

(3,000,000

)

Preferred stock dividend payment

 

(67,500

)

(168,750

)

Repurchase of Series B preferred stock

 

(6,750,000

)

0

 

Net decrease in demand deposits and savings accounts

 

(6,323,636

)

(17,538,864

)

Net (decrease) increase in time deposits

 

(454,133

)

62,152

 

Excess tax benefits from stock-based payment arrangements

 

0

 

32,842

 

Proceeds from sale of common stock and exercise of stock options

 

85,000

 

108,753

 

Net cash used in financing activities

 

(13,510,269

)

(20,503,867

)

 

 

 

 

 

 

NET DECREASE IN CASH AND CASH EQUIVALENTS

 

(23,466,829

)

(31,636,780

)

 

 

 

 

 

 

CASH AND CASH EQUIVALENTS, beginning of period

 

141,334,998

 

101,084,775

 

 

 

 

 

 

 

CASH AND CASH EQUIVALENTS, end of period

 

$

117,868,169

 

$

69,447,995

 

 

 

 

 

 

 

SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:

 

 

 

 

 

Cash paid during the period for:

 

 

 

 

 

Interest

 

$

234,626

 

$

339,172

 

Income taxes

 

$

40,000

 

$

0

 

 

 

 

 

 

 

NON-CASH INVESTING ACTIVITIES:

 

 

 

 

 

Real estate acquired through foreclosure

 

$

970,632

 

$

0

 

Change in unrealized gain on available-for-sale securities

 

$

(804,940

)

$

(455,578

)

 

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

 

6



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, 2013 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, 2012.

 

NOTE 2 — RECENT ACCOUNTING PRONOUNCEMENTS

 

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.

 

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 and did not have a material impact on the Company’s consolidated financial statements.

 

In January 2013, the FASB issued ASU No. 2013-01, Clarifying the Scope of Disclosures about Offsetting Assets and Liabilities. The Update clarifies that ASU. 2011-11 applies only to derivatives, including bifurcated embedded derivatives, repurchase agreements and reverse repurchase agreements, and securities borrowing and securities lending transactions that are either offset or subject to an enforceable master netting arrangement or similar agreement. Entities with other types of financial assets and financial liabilities subject to a master netting arrangement or similar agreement are no longer subject to the disclosure requirements in ASU. 2011-11.  The amendments are effective for annual and interim reporting periods beginning on or after January 1, 2013 and did not have a material impact on the Company’s consolidated financial statements.

 

7



Table of Contents

 

In February 2013, the FASB issued ASU No. 2013-02, Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income. The Update requires an entity to provide information about the amounts reclassified out of accumulated other comprehensive income by component and to present either on the face of the statement where net income is presented, or in the notes, significant amounts reclassified out of accumulated other comprehensive income by the respective line items of net income, but only if the amount reclassified is required to be reclassified to net income in its entirety in the same reporting period. The amendments are effective for annual and interim reporting periods beginning on or after December 15, 2012 and did not 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

 

In May 2012, the Company repurchased from the U.S. Treasury 6,750 shares of Series B Preferred Stock for aggregate consideration of $6.75 million.  In March 2013, the Company repurchased the remaining 6,750 shares of Series B Preferred Stock for aggregate consideration of $6.75 million plus $67,500 for accrued interest.  As of March 31, 2013, there are no outstanding shares of Series B Preferred Stock.

 

NOTE 4 — SECURITIES

 

The amortized cost and estimated fair values of debt securities as of March 31, 2013 are as follows:

 

 

 

Amortized
Cost

 

Gross
Unrealized
Gains

 

Gross
Unrealized
Losses

 

Fair Market
Value

 

Available-for-sale securities:

 

 

 

 

 

 

 

 

 

U.S. agencies

 

$

53,984,164

 

$

2,737,470

 

$

(50,104

)

$

56,671,530

 

Collateralized mortgage obligations

 

11,293,930

 

823,268

 

 

12,117,198

 

Municipalities

 

32,936,971

 

1,489,595

 

(319,122

)

34,107,444

 

SBA Pools

 

1,163,656

 

 

(814

)

1,162,842

 

Corporate debt

 

4,676,385

 

59,012

 

(1,671

)

4,733,726

 

Asset Backed Securities

 

2,914,298

 

 

(549

)

2,913,749

 

Mutual Fund

 

2,899,936

 

 

(27,596

)

2,872,340

 

 

 

$

109,869,340

 

$

5,109,345

 

$

(399,856

)

$

114,578,829

 

 

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, 2013.

 

 

 

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

 

$

6,387,199

 

$

(50,104

)

$

 

$

 

$

6,387,199

 

$

(50,104

)

Collateralized mortgage obligations

 

 

 

 

 

 

 

Municipalities

 

8,918,631

 

(270,144

)

1,106,673

 

(48,978

)

10,025,304

 

(319,122

)

SBA Pools

 

867,039

 

(612

)

290,932

 

(202

)

1,157,971

 

(814

)

Corporate debt

 

748,329

 

(1,671

)

 

 

748,329

 

(1,671

)

Asset Backed Securities

 

2,913,750

 

(549

)

 

 

2,913,750

 

(549

)

Mutual Fund

 

2,872,340

 

(27,596

)

 

 

2,872,340

 

(27,596

)

Total temporarily impaired securities

 

$

22,707,288

 

$

(350,676

)

$

1,397,605

 

$

(49,180

)

$

24,104,893

 

$

(399,856

)

 

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Table of Contents

 

At March 31, 2013, there were two municipalities and one SBA pool that comprised the total securities in an unrealized loss position for greater than 12 months and three agencies, thirteen municipalities, two corporate bonds and four SBA pools that make up the total securities in a loss position for less 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.  This evaluation encompasses various factors including, the nature of the investment, the cause of the impairment, the severity and duration of the impairment, credit ratings and other credit related factors such as third party guarantees and volatility of the security’s fair value.  Management has determined that no investment security is other than temporarily impaired. The unrealized losses are due primarily to interest rate changes and the Bank 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, 2013, 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

 

$

12,754,411

 

$

12,724,159

 

Due after one year through five years

 

18,085,561

 

19,451,869

 

Due after five years through ten years

 

35,010,887

 

36,438,105

 

Due after ten years

 

44,018,481

 

45,964,696

 

 

 

$

109,869,340

 

$

114,578,829

 

 

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

 

 

 

Amortized
Cost

 

Gross
Unrealized
Gains

 

Gross
Unrealized
Losses

 

Fair Market
Value

 

Available-for-sale securities:

 

 

 

 

 

 

 

 

 

U.S. agencies

 

$

52,607,537

 

$

2,949,355

 

$

(39,833

)

$

55,517,059

 

Collateralized mortgage obligations

 

11,698,399

 

905,985

 

 

12,604,384

 

Municipalities

 

25,323,157

 

1,727,206

 

(58,075

)

26,992,288

 

SBA Pools

 

1,178,242

 

86

 

(20

)

1,178,308

 

Corporate debt

 

4,669,390

 

37,048

 

(836

)

4,705,602

 

Mutual Fund

 

2,874,727

 

 

(6,487

)

2,868,240

 

 

 

$

98,351,452

 

$

5,619,680

 

$

(105,251

)

$

103,865,881

 

 

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, 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

 

$

1,954,005

 

$

(39,833

)

$

 

$

 

$

1,954,005

 

$

(39,833

)

Collateralized mortgage obligations

 

 

 

 

 

 

 

Municipalities

 

3,088,970

 

(58,075

)

 

 

3,088,970

 

(58,075

)

SBA Pools

 

 

 

294,889

 

(20

)

294,889

 

(20

)

Corporate debt

 

749,164

 

(836

)

 

 

749,164

 

(836

)

Mutual Fund

 

2,493,512

 

(6,487

)

 

 

2,493,512

 

(6,487

)

Total temporarily impaired securities

 

$

8,285,651

 

$

(105,231

)

$

294,889

 

$

(20

)

$

8,580,540

 

$

(105,251

)

 

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Table of Contents

 

We recognized a gain of $18,000 for the three month period ended March 31, 2013, on certain available-for-sale securities that were partially called, which compares to $22,000 in the same period of 2012.  There were no sales of available-for-sale securities during the first three months of 2012 and 2011.

 

Securities carried at $55,252,000 and $56,484,000 at March 31, 2013 and December 31, 2012, respectively, were pledged to secure deposits of public funds.

 

NOTE 5 — LOANS

 

Our customers are primarily located in Stanislaus, San Joaquin, Tuolumne, Inyo, and Mono Counties. As of March 31, 2013, approximately 82% of the Bank’s loans are commercial real estate loans which include construction loans. Approximately 9% of the Bank’s loans are for general commercial uses including professional, retail, and small business. Additionally, 7% 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, 2013

 

December 31, 2012

 

Commercial real estate:

 

 

 

 

 

Commercial real estate- construction

 

$

4,682,262

 

$

6,581,854

 

Commercial real estate- mortgages

 

281,706,834

 

278,766,279

 

Land

 

13,430,380

 

14,269,477

 

Farmland

 

19,906,336

 

16,456,921

 

Commercial and industrial

 

34,922,105

 

36,528,505

 

Consumer

 

924,782

 

1,095,801

 

Consumer residential

 

24,589,781

 

25,659,090

 

Agriculture

 

9,829,458

 

11,628,260

 

Total loans

 

389,991,938

 

390,986,187

 

 

 

 

 

 

 

Less:

 

 

 

 

 

Deferred loan fees and costs, net

 

(616,742

)

(599,851

)

Allowance for loan losses

 

(7,743,439

)

(7,974,975

)

Net loans

 

$

381,631,757

 

$

382,411,361

 

 

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, concentration 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, our 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

 

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Table of Contents

 

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 Bank avoids financing single-purpose projects unless other underwriting factors are present to help mitigate risk. The Bank 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, 2013, commercial real estate loans equal to approximately 35.8% of the outstanding principal balance of our 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 Bank may originate from time to time, the Bank generally requires the borrower to have had an existing relationship with the Bank 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 Bank 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 Bank 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 Bank’s policies and procedures.

 

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, 2013

 

December 31, 2012

 

Commercial real estate:

 

 

 

 

 

Commercial real estate- construction

 

$

142,595

 

$

126,427

 

Commercial real estate- mortgages

 

2,033,156

 

3,345,098

 

Land

 

2,360,579

 

2,419,223

 

Farmland

 

0

 

0

 

Commercial and industrial

 

20,691

 

21,311

 

Consumer

 

0

 

0

 

Consumer residential

 

910,998

 

1,010,998

 

Agriculture

 

0

 

0

 

Total non-accrual loans

 

$

5,468,019

 

$

6,923,057

 

 

Had non-accrual loans performed in accordance with their original contract terms, we would have recognized additional interest income of approximately $176,000 in three month period ended March 31, 2013, as compared to $154,000 in the same period of 2012.

 

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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 March 31, 2013:

 

March 31, 2013

 

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

 

Commercial real estate:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Commercial R.E. - construction

 

$

0

 

$

0

 

$

142,595

 

$

142,595

 

$

4,539,667

 

$

4,682,262

 

$

0

 

Commercial R.E. - mortgages

 

1,385,035

 

0

 

1,628,146

 

3,013,181

 

278,693,653

 

281,706,834

 

0

 

Land

 

2,767,713

 

0

 

1,820,703

 

4,588,416

 

8,841,964

 

13,430,380

 

0

 

Farmland

 

102,511

 

0

 

0

 

102,511

 

19,803,825

 

19,906,336

 

0

 

Commercial and industrial

 

378,024

 

0

 

0

 

378,024

 

34,544,081

 

34,922,105

 

0

 

Consumer

 

0

 

0

 

0

 

0

 

924,782

 

924,782

 

0

 

Consumer residential

 

0

 

0

 

910,998

 

910,998

 

23,678,783

 

24,589,781

 

0

 

Agriculture

 

0

 

0

 

0

 

0

 

9,829,458

 

9,829,458

 

0

 

Total

 

$

4,633,283

 

$

0

 

$

4,502,442

 

$

9,135,725

 

$

380,856,213

 

$

389,991,938

 

$

0

 

 

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, 2012:

 

December 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

 

Commercial real estate:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Commercial R.E. - construction

 

$

0

 

$

0

 

$

126,427

 

$

126,427

 

$

6,455,427

 

$

6,581,854

 

$

0

 

Commercial R.E. - mortgages

 

55,089

 

623,118

 

2,386,688

 

3,064,895

 

275,701,384

 

278,766,279

 

0

 

Land

 

0

 

54,427

 

2,364,797

 

2,419,224

 

11,850,253

 

14,269,477

 

0

 

Farmland

 

0

 

0

 

0

 

0

 

16,456,921

 

16,456,921

 

0

 

Commercial and industrial

 

16,138

 

0

 

0

 

16,138

 

36,512,367

 

36,528,505

 

0

 

Consumer

 

0

 

0

 

0

 

0

 

1,095,801

 

1,095,801

 

0

 

Consumer residential

 

0

 

0

 

1,010,998

 

1,010,998

 

24,648,092

 

25,659,090

 

0

 

Agriculture

 

0

 

0

 

0

 

0

 

11,628,260

 

11,628,260

 

0

 

Total

 

$

71,227

 

$

677,545

 

$

5,888,910

 

$

6,637,682

 

$

384,348,505

 

$

390,986,187

 

$

0

 

 

Impaired Loans. Loans are considered impaired when, based on current information and events, it is probable the Bank 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, 2013 and 2012. Average recorded investment in impaired loans was $6,566,000 for the three months ended March 31, 2013, as compared to $6,944,000 for the same period of 2012.  Impaired loans, or portions thereof, are charged off when deemed uncollectible.

 

12



Table of Contents

 

Impaired loans as of March 31, 2013 and December 31, 2012 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, 2013

 

 

 

 

 

 

 

 

 

 

 

 

 

Commercial real estate:

 

 

 

 

 

 

 

 

 

 

 

 

 

Commercial R.E. - construction

 

$

209,195

 

$

0

 

$

142,595

 

$

142,595

 

$

3,635

 

$

134,511

 

Commercial R.E. - mortgages

 

4,098,518

 

1,085,317

 

947,839

 

2,033,156

 

22,377

 

3,059,126

 

Land

 

6,779,176

 

0

 

2,360,579

 

2,360,579

 

492,292

 

2,389,901

 

Farmland

 

0

 

0

 

0

 

0

 

0

 

0

 

Commercial and Industrial

 

27,690

 

20,691

 

0

 

20,691

 

0

 

21,001

 

Consumer

 

0

 

0

 

0

 

0

 

0

 

0

 

Consumer residential

 

1,109,187

 

846,416

 

64,583

 

910,998

 

74,303

 

960,998

 

Agriculture

 

0

 

0

 

0

 

0

 

0

 

0

 

Total

 

$

12,223,766

 

$

1,952,424

 

$

3,515,596

 

$

5,468,019

 

$

592,607

 

$

6,565,537

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

December 31, 2012

 

 

 

 

 

 

 

 

 

 

 

 

 

Commercial real estate:

 

 

 

 

 

 

 

 

 

 

 

 

 

Commercial R.E. - construction

 

$

193,027

 

$

0

 

$

126,427

 

$

126,427

 

$

2,872

 

$

222,757

 

Commercial R.E. - mortgages

 

5,728,716

 

1,875,320

 

1,469,777

 

3,345,097

 

136,015

 

3,093,523

 

Land

 

6,866,869

 

663,232

 

1,755,991

 

2,419,223

 

409,656

 

2,833,250

 

Farmland

 

0

 

0

 

0

 

0

 

0

 

0

 

Commercial and Industrial

 

27,812

 

21,311

 

0

 

21,311

 

0

 

52,822

 

Consumer

 

0

 

0

 

0

 

0

 

0

 

0

 

Consumer residential

 

1,034,884

 

1,010,999

 

0

 

1,010,999

 

0

 

534,578

 

Agriculture

 

0

 

0

 

0

 

0

 

0

 

0

 

Total

 

$

13,851,308

 

$

3,570,862

 

$

3,352,195

 

$

6,923,057

 

$

548,543

 

$

6,736,930

 

 

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 Bank’s internal underwriting policy.

 

At March 31, 2013, there were 5 loans and leases that were considered to be troubled debt restructurings, all of which are considered non-accrual totaling $2,524,000.  At December 31, 2012, there were 6 loans and leases that were considered to be troubled debt restructurings, all of which are considered non-accrual totaling $2,567,000.  The decrease of one TDR loan during the first three months of 2013 is due to a foreclosure on a loan totaling $54,000 and is included in OREO as of March 31, 2013.  At March 31, 2013 and December 31, 2012 there were unfunded commitments of $1,749,000 and $1,697,000, 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 Bank will receive proceeds to pay down the principal as the residential properties sell.  We have allocated $496,000 and $413,000 of specific reserves to loans whose terms have been modified in troubled debt restructurings as of March 31, 2013 and December 31, 2012, respectively.

 

During the three month period ended March 31, 2013, the terms of one loan were modified as troubled debt restructurings. 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.

 

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Table of Contents

 

The following table presents loans by class modified as troubled debt restructurings that occurred during the three month period ended March 31, 2013 and 2012:

 

 

 

Three Months Ended

 

Three Months Ended

 

 

 

March 31, 2013

 

March 31, 2012

 

 

 

Number
of
Loans

 

Pre-
Modification
Outstanding
Recorded
Investment

 

Post-
Modification
Outstanding
Recorded
Investment

 

Number
of
Loans

 

Pre-
Modification
Outstanding
Recorded
Investment

 

Post-
Modification
Outstanding
Recorded
Investment

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Commercial real estate:

 

 

 

 

 

 

 

 

 

 

 

 

 

Commercial R.E. - construction

 

0

 

$

0

 

$

0

 

0

 

$

0

 

$

0

 

Commercial R.E. - mortgages

 

0

 

0

 

0

 

0

 

0

 

0

 

Land

 

1

 

541,594

 

541,594

 

0

 

0

 

0

 

Farmland

 

0

 

0

 

0

 

0

 

0

 

0

 

Commercial and Industrial

 

0

 

0

 

0

 

0

 

0

 

0

 

Consumer

 

0

 

0

 

0

 

0

 

0

 

0

 

Consumer residential

 

0

 

0

 

0

 

0

 

0

 

0

 

Agriculture

 

0

 

0

 

0

 

0

 

0

 

0

 

Total

 

1

 

$

541,594

 

$

541,594

 

0

 

$

0

 

$

0

 

 

The troubled debt restructuring during the three months ended March 31, 2013 did not increase the allowance for loan losses as a result of loan modifications because the loans are evaluated as an impaired loan and a specific valuation allowance would have already been allocated, if necessary, prior to the loan modification.  There were no charge-offs as a result of loan modifications, as the contractual balances outstanding were determined to be collectible.

 

The following table presents loans by class modified as troubled debt restructurings within the previous twelve months and for which there was a payment default during the three month periods ended March 31, 2013 and 2012.

 

 

 

Three Months Ended

 

Three Months Ended

 

 

 

March 31, 2013

 

March 31, 2012

 

 

 

Number
of Loans

 

Recorded
Investment

 

Number
of Loans

 

Recorded
Investment

 

Commercial real estate:

 

 

 

 

 

 

 

 

 

Commercial R.E. - construction

 

0

 

0

 

0

 

$

0

 

Commercial R.E. - mortgages

 

0

 

0

 

0

 

0

 

Land

 

0

 

0

 

1

 

571,594

 

Farmland

 

0

 

0

 

0

 

0

 

Commercial and Industrial

 

0

 

0

 

0

 

0

 

Consumer

 

0

 

0

 

0

 

0

 

Consumer residential

 

0

 

0

 

0

 

0

 

Agriculture

 

0

 

0

 

0

 

0

 

Total

 

0

 

$

0

 

1

 

$

571,594

 

 

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

 

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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.

·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.

 

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Table of Contents

 

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 Bank 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 Bank 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 Bank. 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.

 

As of March 31, 2013, there are no loans that are classified with a risk grade of 8- Loss.

 

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Table of Contents

 

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

 

 

 

March 31, 2013

 

December 31, 2012

 

 

 

Weighted Average
Risk Grade

 

Weighted Average
Risk Grade

 

Commercial real estate:

 

 

 

 

 

Commercial real estate - construction

 

3.35

 

3.23

 

Commercial real estate - mortgages

 

3.19

 

3.22

 

Land

 

4.62

 

4.56

 

Farmland

 

3.03

 

3.04

 

Commercial and Industrial

 

3.10

 

3.09

 

Consumer

 

2.39

 

2.55

 

Consumer residential

 

3.16

 

3.17

 

Agriculture

 

3.59

 

3.50

 

Total gross loans

 

3.23

 

3.25

 

 

The following table presents risk grade totals by class of loans as of March 31, 2013 and December 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, 2013

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Pass

 

$

4,539,667

 

$

269,196,191

 

$

8,302,088

 

$

19,906,336

 

$

33,849,455

 

$

908,027

 

$

23,289,371

 

$

8,517,739

 

$

368,508,874

 

Special mention

 

 

7,738,719

 

 

 

273,652

 

 

 

1,311,719

 

9,324,090

 

Substandard

 

142,595

 

4,771,924

 

5,128,292

 

 

798,998

 

16,755

 

1,300,410

 

 

12,158,974

 

Doubtful

 

 

 

 

 

 

 

 

 

 

Total loans

 

$

4,682,262

 

$

281,706,834

 

$

13,430,380

 

$

19,906,336

 

$

34,922,105

 

$

924,782

 

$

24,589,781

 

$

9,829,458

 

$

389,991,938

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

December 31, 2012

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Pass

 

$

6,455,427

 

$

263,567,665

 

$

8,974,864

 

$

16,456,921

 

$

35,435,491

 

$

1,079,583

 

$

24,257,465

 

$

10,291,678

 

$

366,519,094

 

Special mention

 

 

7,832,840

 

 

 

280,631

 

 

 

1,336,582

 

9,450,053

 

Substandard

 

126,427

 

7,365,774

 

5,294,613

 

 

812,383

 

16,218

 

1,401,625

 

 

15,017,040

 

Doubtful

 

 

 

 

 

 

 

 

 

 

Total loans

 

$

6,581,854

 

$

278,766,279

 

$

14,269,477

 

$

16,456,921

 

$

36,528,505

 

$

1,095,801

 

$

25,659,090

 

$

11,628,260

 

$

390,986,187

 

 

Allowance for Loan Losses. The allowance for loan losses is a reserve established by the Bank 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 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 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.

 

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 Bank’s control, including, among other things,

 

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Table of Contents

 

the performance of the Bank’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 Bank and 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 Bank and the Company. In general, such valuation allowances are determined by evaluating, among other things: (i) the experience, ability and effectiveness of the Bank’s lending management and staff; (ii) the effectiveness of the Bank’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.

 

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Table of Contents

 

The following table details activity in the allowance for loan losses by portfolio segment for the three months ended March 31, 2013 and 2012. 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, 2013 and 2012

 

 

 

Commercial

 

Commercial

 

 

 

Consumer

 

 

 

 

 

 

 

 

 

Real Estate

 

and Industrial

 

Consumer

 

Residential

 

Agriculture

 

Unallocated

 

Total

 

Three Months Ended March 31, 2013

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Beginning balance

 

$

6,571,290

 

$

473,727

 

$

50,062

 

$

383,653

 

$

285,734

 

$

210,509

 

$

7,974,975

 

Charge-offs

 

(236,114

)

0

 

(4,343

)

(100,000

)

0

 

0

 

(340,457

)

Recoveries

 

6,096

 

0