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Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

 

FORM 10-Q

(Mark One)

 

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

For the Quarterly Period Ended June 30, 2010

Or

 

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

For the transition period from              to             

Commission file number: 001-33033

PORTER BANCORP, INC.

(Exact name of registrant as specified in its charter)

 

Kentucky   61-1142247

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification No.)

2500 Eastpoint Parkway, Louisville, Kentucky   40223
(Address of principal executive offices)   (Zip Code)

(502) 499-4800

(Registrant’s telephone number, including area code)

 

 

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

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

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

 

Large accelerated filer  ¨    Accelerated filer  ¨
Non-accelerated filer  x    Smaller reporting company  ¨

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

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

10,580,461 shares of Common Stock, no par value, were outstanding at July 31, 2010.

 

 

 


Table of Contents

INDEX

 

         Page
PART I –   FINANCIAL INFORMATION   

ITEM 1.

  FINANCIAL STATEMENTS    1

ITEM 2.

  MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS    21

ITEM 3.

  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK    34

ITEM 4.

  CONTROLS AND PROCEDURES    35
PART II –   OTHER INFORMATION   

ITEM 1.

  LEGAL PROCEEDINGS    36

ITEM 1A.

  RISK FACTORS    36

ITEM 2.

  UNREGISTERED SALES ON EQUITY SECURITIES AND USE OF PROCEEDS    36

ITEM 3.

  DEFAULTS UPON SENIOR SECURITIES    37

ITEM 4.

  SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS    37

ITEM 5.

  OTHER INFORMATION    37

ITEM 6.

  EXHIBITS    37


Table of Contents

PART I – FINANCIAL INFORMATION

Item 1. Financial Statements

The following consolidated financial statements of Porter Bancorp Inc. and Subsidiary, PBI Bank, Inc., are submitted:

Unaudited Consolidated Balance Sheets for June 30, 2010 and December 31, 2009

Unaudited Consolidated Statements of Income for the three and six months ended June 30, 2010 and 2009

Unaudited Consolidated Statement of Changes in Stockholders’ Equity for the six months ended June 30, 2010

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

Notes to Unaudited Consolidated Financial Statements

 

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Table of Contents

PORTER BANCORP, INC. AND SUBSIDIARY

Unaudited Consolidated Balance Sheets

(dollars in thousands except share data)

 

     June 30,
2010
   December 31,
2009

Assets

     

Cash and due from financial institutions

   $ 111,343    $ 169,328

Federal funds sold

     4,059      2,845
             

Cash and cash equivalents

     115,402      172,173

Securities available for sale

     175,738      168,721

Mortgage loans held for sale

     1,377      334

Loans, net of allowance of $26,836 and $26,392, respectively

     1,309,295      1,386,526

Premises and equipment

     22,954      23,610

Other real estate owned

     68,450      14,548

Goodwill

     23,794      23,794

Accrued interest receivable and other assets

     43,647      45,384
             

Total assets

   $ 1,760,657    $ 1,835,090
             

Liabilities and Stockholders’ Equity

     

Deposits

     

Non-interest bearing

   $ 104,384    $ 97,263

Interest bearing

     1,309,942      1,432,833
             

Total deposits

     1,414,326      1,530,096

Federal funds purchased and repurchase agreements

     11,810      11,517

Federal Home Loan Bank advances

     96,695      82,980

Accrued interest payable and other liabilities

     7,601      7,163

Subordinated capital note

     9,000      9,000

Junior subordinated debentures

     25,000      25,000
             

Total liabilities

     1,564,432      1,665,756

Stockholders’ equity

     

Preferred stock, no par, 1,000,000 shares authorized Series A – 35,000 issued and outstanding Liquidation preference of $35 million at June 30, 2010

     34,395      34,307

Series B – 227,000 issued and outstanding Liquidation preference of $2.6 million at June 30, 2010

     2,351      —  

Series C – 365,080 issued and outstanding
Liquidation preference of $4.2 million at June 30, 2010

     3,780      —  

Common stock, no par, 19,000,000 shares authorized, 10,580,494 and 8,756,440 shares issued and outstanding, respectively

     99,824      83,104

Additional paid-in capital

     17,877      14,959

Retained earnings

     32,443      34,811

Accumulated other comprehensive income

     5,555      2,153
             

Total stockholders’ equity

     196,225      169,334
             

Total liabilities and stockholders’ equity

   $ 1,760,657    $ 1,835,090
             

See accompanying notes to unaudited consolidated financial statements.

 

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Table of Contents

PORTER BANCORP, INC. AND SUBSIDIARY

Unaudited Consolidated Statements of Income

(dollars in thousands, except per share data)

 

     Three Months Ended
June 30,
   Six Months Ended
June 30,
     2010     2009    2010     2009

Interest income

         

Loans, including fees

   $ 19,771      $ 21,102    $ 39,644      $ 42,372

Taxable securities

     1,999        2,152      4,334        4,014

Tax exempt securities

     215        223      431        444

Fed funds sold and other

     141        168      343        317
                             
     22,126        23,645      44,752        47,147
                             

Interest expense

         

Deposits

     6,543        9,468      13,926        19,386

Federal Home Loan Bank advances

     500        937      1,220        2,086

Subordinated capital note

     77        98      152        200

Junior subordinated debentures

     159        209      311        460

Federal funds purchased and other

     120        120      239        235
                             
     7,399        10,832      15,848        22,367
                             

Net interest income

     14,727        12,813      28,904        24,780

Provision for loan losses

     6,600        1,600      9,600        3,200
                             

Net interest income after provision for loan losses

     8,127        11,213      19,304        21,580

Non-interest income

         

Service charges on deposit accounts

     793        788      1,513        1,476

Income from fiduciary activities

     273        198      525        418

Secondary market brokerage fees

     130        73      190        131

Title insurance commissions

     39        44      76        64

Net gain on sales of loans originated for sale

     184        241      275        241

Net gain on sales of securities

     24        —        81        1

Other than temporary impairment on securities

     (465     —        (465     —  

Other

     519        551      994        1,050
                             
     1,497        1,895      3,189        3,381
                             

Non-interest expense

         

Salaries and employee benefits

     3,931        3,813      7,878        7,691

Occupancy and equipment

     1,015        981      2,037        1,979

Other real estate owned expense

     3,854        226      4,232        353

FDIC Insurance

     706        503      1,411        962

FDIC special assessment

     —          781      —          781

State franchise tax

     543        450      1,086        900

Professional fees

     292        203      558        431

Postage and delivery

     198        184      386        368

Communications

     173        230      359        385

Advertising

     77        125      173        283

Other

     724        732      1,442        1,371
                             
     11,513        8,228      19,562        15,504
                             

Income (loss) before income taxes

     (1,889     4,880      2,931        9,457

Income tax expense (benefit)

     (758     1,635      806        3,151
                             

Net income (loss)

     (1,131     3,245      2,125        6,306

Less:

         

Dividends on preferred stock

     437        437      875        875

Accretion on Series A preferred stock

     44        44      88        88

Earnings allocated to participating securities

     2        —        83        —  
                             

Net income (loss) available to common shareholders

   $ (1,614   $ 2,764    $ 1,079      $ 5,343
                             

Basic and diluted earnings (loss) per common share

   $ (0.19   $ 0.31    $ 0.13      $ 0.61
                             

See accompanying notes to unaudited consolidated financial statements.

 

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PORTER BANCORP, INC. AND SUBSIDIARY

Unaudited Consolidated Statement of Changes in Stockholders’ Equity

For Six Months Ended June 30, 2010

(dollars in thousands, except share and per share data)

 

     Shares    Amount    Additional          Accumulated
Other
      
     Common     Series A
Preferred
   Series B
Preferred
   Series C
Preferred
   Common    Series A
Preferred
   Series B
Preferred
   Series C
Preferred
   Paid-In
Capital
   Retained
Earnings
    Comprehensive
Income
   Total  

Balances, January 1, 2010

   8,756,440      35,000    —      —      $ 83,104    $ 34,307    $ —      $ —      $ 14,959    $ 34,811      $ 2,153    $ 169,334   

Issuance of stock and warrants in private placement

   1,755,747      —      227,000    365,080      16,720      —        2,351      3,780      2,688      —          —        25,539   

Issuance of unvested stock

   69,182      —      —      —        —        —        —        —        —        —          —        —     

Forfeited unvested stock

   (875   —      —      —        —        —        —        —        —        —          —        —     

Stock-based compensation expense

   —        —      —      —        —        —        —        —        230      —          —        230   

Comprehensive income:

                                 

Net income

   —        —      —      —        —        —        —        —        —        2,125        —        2,125   

Changes in accumulated other comprehensive income, net of taxes

   —        —      —      —        —        —        —        —        —        —          3,402      3,402   
                                       

Total comprehensive income

   —        —      —      —        —        —        —        —        —        —          —        5,527   
                                       

Dividends 5% on Series A preferred stock

   —        —      —      —        —        —        —        —        —        (875     —        (875

Amortization of Series A preferred stock discount

   —        —      —      —        —        88      —        —        —        (88     —        —     

Cash dividends declared on common stock ($0.40 per share)

   —        —      —      —        —        —        —        —        —        (3,530     —        (3,530
                                                                               

Balances, June 30, 2010

   10,580,494      35,000    227,000    365,080    $ 99,824    $ 34,395    $ 2,351    $ 3,780    $ 17,877    $ 32,443      $ 5,555    $ 196,225   
                                                                               

See accompanying notes to unaudited consolidated financial statements.

 

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PORTER BANCORP, INC. AND SUBSIDIARY

Unaudited Consolidated Statements of Cash Flows

For Six Months Ended June 30, 2010 and 2009

(dollars in thousands)

 

     2010     2009  

Cash flows from operating activities

    

Net income

   $ 2,125      $ 6,306   

Adjustments to reconcile net income to net cash from operating activities

    

Depreciation and amortization

     1,617        1,867   

Provision for loan losses

     9,600        3,200   

Net amortization (accretion) on securities

     (222     147   

Stock-based compensation expense

     230        178   

Net gain on loans originated for sale

     (196     (241

Loans originated for sale

     (13,747     (12,128

Proceeds from sales of loans originated for sale

     12,823        12,076   

Net (gain) loss on sales of investment securities

     384        (1

Net (gain) loss on sales of other real estate owned

     90        60   

Net write-down of other real estate owned

     3,880        200   

Earnings on bank owned life insurance

     (144     (142

Net change in accrued interest receivable and other assets

     1,709        738   

Net change in accrued interest payable and other liabilities

     (1,395     (280
                

Net cash from operating activities

     16,754        11,980   
                

Cash flows from investing activities

    

Purchases of available-for-sale securities

     (25,250     (23,272

Sales and calls of available-for-sale securities

     8,415        762   

Maturities and prepayments of available-for-sale securities

     14,891        17,013   

Proceeds from sale of other real estate owned

     15,037        6,737   

Improvements to other real estate owned

     (433     (37

Loan originations and payments, net

     (5,420     (23,550

Purchases of premises and equipment, net

     (137     (1,678
                

Net cash from investing activities

     7,103        (24,025
                

Cash flows from financing activities

    

Net change in deposits

     (115,770     75,643   

Net change in federal funds purchased and repurchase agreements

     293        1,148   

Repayment of Federal Home Loan Bank advances

     (116,285     (66,426

Advances from Federal Home Loan Bank

     130,000        50,000   

Issuance of preferred stock and warrants

     6,809        —     

Issuance of common stock and warrants

     18,730        —     

Cash dividends paid on preferred stock

     (875     (846

Cash dividends paid on common stock

     (3,530     (3,492
                

Net cash from financing activities

     (80,628     56,027   
                

Net change in cash and cash equivalents

     (56,771     43,982   

Beginning cash and cash equivalents

     172,173        52,546   
                

Ending cash and cash equivalents

   $ 115,402      $ 96,528   
                

Supplemental cash flow information:

    

Interest paid

   $ 16,243      $ 15,542   

Income taxes paid

     2,850        3,650   

Supplemental non-cash disclosure:

    

Transfer from loans to other real estate

   $ 72,477      $ 8,877   

Sale and financing of other real estate owned

   $ 3,309        —     

See accompanying notes to unaudited consolidated financial statements.

 

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Table of Contents

PORTER BANCORP, INC. AND SUBSIDIARY

Notes to Unaudited Consolidated Financial Statements

Note 1 – Basis of Presentation and Summary of Significant Accounting Policies

Basis of Presentation – The consolidated financial statements include Porter Bancorp, Inc. (Company or PBI) and its wholly-owned subsidiary, PBI Bank (Bank). All significant inter-company transactions and accounts have been eliminated in consolidation.

The accompanying unaudited consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, the financial statements do not include all of the information and footnotes required by U.S. generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for six months ended June 30, 2010 are not necessarily indicative of the results that may be expected for the entire year. A description of other significant accounting policies is presented in the notes to the Consolidated Financial Statements for the year ended December 31, 2009 included in the Company’s Annual Report on Form 10-K.

Use of Estimates – To prepare financial statements in conformity with U.S. generally accepted accounting principles, management makes estimates and assumptions based on available information. These estimates and assumptions affect the amounts reported in the financial statements and the disclosures provided, and future results could differ. The allowance for loan losses, fair values of financial instruments, and fair values of other real estate owned are particularly subject to change.

Reclassifications – Some items in the prior year financial statements were reclassified to conform to the current presentation.

New Accounting Standards

In June 2009, the FASB issued Statement of Financial Accounting Standards No. 166, Accounting for Transfers of Financial Assets, an Amendment of FASB Statement No. 140 (ASC 810). The new accounting requirement amends previous guidance relating to the transfers of financial assets and eliminates the concept of a qualifying special purpose entity. This Statement must be applied as of the beginning of each reporting entity’s first annual reporting period that begins after November 15, 2009, for interim periods within that first annual reporting period and for interim and annual reporting periods thereafter. This Statement must be applied to transfers occurring on or after the effective date. Additionally, on and after the effective date, the concept of a qualifying special-purpose entity is no longer relevant for accounting purposes. Therefore, formerly qualifying special-purpose entities should be evaluated for consolidation by reporting entities on and after the effective date in accordance with the applicable consolidation guidance. Additionally, the disclosure provisions of this Statement were also amended and apply to transfers that occurred both before and after the effective date of this Statement. The impact of adoption was not material.

The FASB issued Statement of Financial Accounting Standards No. 167, Amendments to FASB Interpretation No. 46(R) (ASC 810-65-2), which amended guidance for consolidation of variable interest entities by replacing the quantitative-based risks and rewards calculation for determining which enterprise, if any, has a controlling financial interest in a variable interest entity with an approach focused on identifying which enterprise has the power to direct the activities of a variable interest entity that most significantly impact the entity’s economic performance and (1) the obligation to absorb losses of the entity or (2) the right to receive benefits from the entity. This Statement also requires additional disclosures about an enterprise’s involvement in variable interest entities. This Statement is effective as of the beginning of each reporting entity’s first annual reporting period that begins after November 15, 2009, for interim periods within that first annual reporting period, and for interim and annual reporting periods thereafter. Early adoption is prohibited. The impact of adoption was not material.

 

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Note 2 – Stock Plans and Stock Based Compensation

On February 23, 2006, the Company adopted the Porter Bancorp, Inc. 2006 Stock Incentive Plan. The 2006 Plan permits the issuance of up to 400,000 shares of the Company’s common stock upon the exercise of stock options or upon the grant of stock awards. As of June 30, 2010, the Company had granted outstanding options to purchase 50,628 shares. The Company also had granted 155,534 unvested shares net of forfeitures and vesting. The Company has 152,272 shares remaining available for issue under the plan. All shares issued under the above mentioned plans came from authorized and unissued shares.

On May 15, 2006, the board of directors approved the Porter Bancorp, Inc. 2006 Non-Employee Directors Stock Ownership Incentive Plan, which was approved by holders of the Company’s voting common stock on June 8, 2006. On May 22, 2008, shareholders voted to amend the plan to change the form of incentive award from stock options to unvested shares. Under the terms of the plan, 100,000 shares are reserved for issuance to non-employee directors upon the exercise of stock options or upon the grant of unvested stock awards granted under the plan. Prior to the amendment, options were granted automatically under the plan at fair market value on the date of grant. The options vest over a three-year period and have a five year term. Unvested shares are granted automatically under the plan at fair market value on the date of grant and vest semi-annually on the anniversary date of the grant over three years. To date, the Company has granted options to purchase 43,001 shares and issued 4,644 unvested shares to non-employee directors. At June 30, 2010, 49,812 shares remain available for issue under this plan.

All stock options have an exercise price that is equal to or greater than the fair market value of the Company’s stock on the date the options were granted. Options granted generally become fully exercisable at the end of three years of continued employment. Options have a life of five years.

The following table summarizes stock option activity:

 

     Six Months Ended
June 30, 2010
   Twelve Months Ended
December 31, 2009
     Options     Weighted
Average
Exercise
Price
   Options     Weighted
Average
Exercise
Price

Outstanding, beginning

   297,258      $ 22.89    297,810      $ 22.89

Forfeited

   (4,632     21.43    (552     23.13

Expired

   (198,997     23.38    —          —  
                 

Outstanding, ending

   93,629      $ 21.92    297,258      $ 22.89
                 

The following table details stock options outstanding:

 

     June 30,
2010

Stock options vested and currently exercisable:

     93,604

Weighted average exercise price

   $ 21.92

Aggregate intrinsic value

   $ 0

Weighted average remaining life (in years)

     1.6

Total Options Outstanding:

     93,629

Aggregate intrinsic value

   $ 0

Weighted average remaining life (in years)

     1.6

 

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The intrinsic value of stock options is calculated based on the exercise price of the underlying awards and the market price of our common stock as of the reporting date. The intrinsic value of the vested and expected to vest stock options is $0 at June 30, 2010. There were no options exercised during the first six months of 2010. The Company recorded $1,000 of stock option compensation during the six months ended June 30, 2010 to salaries and employee benefits. No options were modified during the period. As of June 30, 2010, no stock options issued by the Company have been exercised.

From time-to-time the Company issues unvested shares to employees and non-employee directors. The shares vest either semi-annually or annually over three to ten years on the anniversary date of the issuance date provided the employee or director continues in such capacity at the vesting date. The fair value of the 2010 unvested shares issued to certain employees was $11.60 per share. The fair value of shares issued to non-employee directors was $13.45 per share. The Company recorded $229,000 of stock-based compensation during the first six months of 2010 to salaries and employee benefits. A deferred tax benefit of $80,000 was recognized related to this expense.

The following table summarizes unvested share activity as of and for the periods indicated:

 

     Six Months Ended
June 30, 2010
   Twelve Months Ended
December 31, 2009
     Shares     Weighted
Average
Grant
Price
   Shares     Weighted
Average
Grant
Price

Outstanding, beginning

   113,817      $ 15.66    72,441      $ 19.83

Granted

   69,182        11.66    54,268        10.97

Vested

   (21,946     15.15    (12,351     19.19

Forfeited

   (875     20.59    (541     23.13
                 

Outstanding, ending

   160,178      $ 13.98    113,817      $ 15.66
                 

Unrecognized stock based compensation expense related to stock options and unvested shares for the remainder of 2010 and beyond is estimated as follows (in thousands):

 

July 2010 – December 2010

   $ 261

2011

     511

2012

     499

2013

     409

2014 & thereafter

     466

 

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Note 3 – Securities

The fair value of available for sale securities and the related gross unrealized gains and losses recognized in accumulated other comprehensive income (loss) were as follows:

 

     Amortized
Cost
   Gross
Unrealized
Gains
   Gross
Unrealized
Losses
    Fair
Value
     (in thousands)

June 30, 2010

          

U.S. Government and federal agency

   $ 10,377    $ 515    $ —        $ 10,892

State and municipal

     24,277      1,273      (23     25,527

Agency mortgage-backed: residential

     94,753      4,629      (10     99,372

Private label mortgage-backed: residential

     22,935      2,133      (839     24,229

Corporate bonds

     12,745      952      (12     13,685

Other debt securities

     704      —        (98     606
                            

Total debt securities

     165,791      9,502      (982     174,311

Equity

     1,400      32      (5     1,427
                            

Total

   $ 167,191    $ 9,534    $ (987   $ 175,738
                            

December 31, 2009

          

U.S. Government and federal agency

   $ 586    $ 33    $ —        $ 619

State and municipal

     24,537      955      (37     25,455

Agency mortgage-backed: residential

     91,127      4,028      —          95,155

Private label mortgage-backed: residential

     33,516      279      (2,156     31,639

Corporate bonds

     13,054      760      (49     13,765

Other

     704      —        (175     529
                            

Total debt securities

     163,524      6,055      (2,417     167,162

Equity

     1,885      75      (401     1,559
                            

Total

   $ 165,409    $ 6,130    $ (2,818   $ 168,721
                            

Sales and calls of available for sale securities were as follows:

 

     Three Months Ended
June 30,
   Six Months Ended
June 30,
     2010    2009    2010     2009
     (in thousands)

Proceeds

   $ 252    $ 261    $ 8,415      $ 762

Gross gains

     24      —        280        1

Gross losses

     —        —        (199     —  

The amortized cost and fair value of the investment securities portfolio are shown by expected maturity. Expected maturities may differ from contractual maturities if issuers have the right to call or prepay obligations with or without call or prepayment penalties.

 

     June 30, 2010
     Amortized
Cost
   Fair
Value
     (in thousands)

Maturity

     

Available-for-sale

     

Within one year

   $ 39,176    $ 39,797

One to five years

     81,758      85,879

Five to ten years

     34,120      36,238

Beyond ten years

     10,737      12,397
             

Total

   $ 165,791    $ 174,311
             

 

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Securities pledged at June 30, 2010 and December 31, 2009 had carrying values of approximately $66.0 million and $67.3 million, respectively, and were pledged to secure public deposits, repurchase agreements, and Federal Home Loan Bank advances.

The Company’s mortgage-backed securities portfolio includes non-agency collateralized mortgage obligations with a market value of $24.2 million which had net unrealized gains of approximately $1.3 million at June 30, 2010. These non-agency mortgage-backed securities were rated AAA at purchase and remain rated AAA at June 30, 2010. The Company monitors its securities portfolio to insure it has adequate credit support and as of June 30, 2010, the Company believes there is no other-than-temporary impairment (OTTI).

The Company evaluates securities for OTTI at least on a quarterly basis, and more frequently when economic or market concerns warrant such evaluation. Consideration is given to the length of time and the extent to which the fair value has been less than cost, the financial condition and near-term prospects of the issuer, underlying credit quality of the issuer, and the intent and ability of the Company to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value. In analyzing an issuer’s financial condition, the Company may consider whether the securities are issued by the federal government or its agencies, whether downgrades by bond rating agencies have occurred, the sector or industry trends and cycles affecting the issuer, and the results of reviews of the issuer’s financial condition. Management currently intends to hold all securities with unrealized losses until recovery, which for fixed income securities may be at maturity.

At June 30, 2010, the Company held 42 equity securities. Management monitors the underlying financial condition of the issuers and current market pricing for these equity securities monthly. Based upon the relevant market information and stock price trends in June, July and early August 2010, we have determined that we cannot objectively assert that our basis in 21 equity securities that have been in an unrealized loss position for more than 12 months is recoverable in the near term. As such during the second quarter, we recorded an other than temporary impairment charge totaling $465,000 for equity securities held in our portfolio with an original cost of $1.6 million. The market prices of the stocks had been below our initial investment for more than twelve months and after consideration of the issuers’ financial conditions and the likelihood the market value would recover to our cost basis in the reasonable period of time, the investment was written down to fair value. As of June 30, 2010, management does not believe any of the remaining securities in our portfolio with unrealized losses should be classified as other than temporarily impaired at this time.

Securities with unrealized losses at June 30, 2010 and December 31, 2009, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, are as follows:

 

     Less than 12 Months     12 Months or More     Total  

Description of Securities

   Fair
Value
   Unrealized
Loss
    Fair
Value
   Unrealized
Loss
    Fair
Value
   Unrealized
Loss
 
     (in thousands)  

June 30, 2010

                                 

U.S. Government and federal agency

   $ —      $ —        $ —      $ —        $ —      $ —     

State and municipal

     488      (3     1,044      (20     1,532      (23

Agency mortgage-backed

     2,642      (10     —        —          2,642      (10

Private label mortgage-backed

     1,666      (7     5,643      (832     7,309      (839

Corporate bonds

     988      (12     —        —          988      (12

Other debt securities

     —        —          606      (98     606      (98

Equity

     64      (5     —        —          64      (5
                                             

Total temporarily impaired

   $ 5,848    $ (37   $ 7,293    $ (950   $ 13,141    $ (987
                                             

December 31, 2009

                                 

State and municipal

   $ 867    $ (5   $ 1,033    $ (32   $ 1,900    $ (37

Agency mortgage-backed: residential

     8      —          —        —          8      —     

Private label mortgage-backed: residential

     23,731      (1,977     4,091      (179     27,822      (2,156

Corporate bonds

     —        —          1,997      (49     1,997      (49

Other

     529      (175     —        —          529      (175

Equity

     46      (12     701      (389     747      (401
                                             

Total temporarily impaired

   $ 25,181    $ (2,169   $ 7,822    $ (649   $ 33,003    $ (2,818
                                             

 

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Note 4 – Loans

Loans were as follows:

 

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

Commercial

   $ 86,925      $ 89,903   

Real estate

     1,189,122        1,259,474   

Agriculture

     24,086        25,064   

Consumer

     34,588        36,989   

Other

     1,410        1,488   
                

Subtotal

     1,336,131        1,412,918   

Less: Allowance for loan losses

     (26,836     (26,392
                

Loans, net

   $ 1,309,295      $ 1,386,526   
                

Activity in the allowance for loan losses was as follows:

 

     June 30,
2010
    June 30,
2009
 
     (in thousands)  

Beginning balance

   $ 26,392      $ 19,652   

Provision for loan losses

     9,600        3,200   

Loans charged-off

     (9,309     (2,283

Loan recoveries

     153        171   
                

Ending balance

   $ 26,836      $ 20,740   
                

Impaired loans were as follows:

 

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

Loans with no allocated allowance for loan losses

   $ 11,099    $ 21,373

Loans with allocated allowance for loan losses

     41,380      84,766
             

Total

   $ 52,479    $ 106,139
             

Amount of the allowance for loan losses allocated

   $ 5,080    $ 5,453

 

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     Six Months
Ended
June 30,
2010
   Year Ended
December 31,
2009

Average of impaired loans during the period

   $ 75,118    $ 44,041

Interest income recognized during impairment

     764      1,094

Cash basis interest income recognized

     57      987

Impaired loans include restructured loans and commercial, construction, agriculture, and commercial real estate loans on non-accrual or classified as doubtful, whereby collection of the total amount is improbable, or loss, whereby all or a portion of the loan has been written off or a specific allowance for loss had been provided.

Nonperforming loans were as follows:

 

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

Loans past due 90 days or more still on accrual

   $ 10,497    $ 5,968

Non-accrual loans

     38,199      78,888

Nonperforming loans include impaired loans and smaller balance homogeneous loans, such as residential mortgage and consumer loans, that are collectively evaluated for impairment. At June 30, 2010, and December 31, 2009, we had restructured loans totaling $23.7 million and $23.4 million, respectively, with borrowers who experienced deterioration in financial condition. These loans are secured by 1-4 residential properties, commercial real estate properties, equipment or inventory. Management believes these loans are well secured and the borrowers have the ability to repay the loans in accordance with the renegotiated terms. These restructured loans were on accrual status at each period end as payments were being made according to the restructured loan terms.

Note 5 – Other Real Estate Owned

Other real estate owned (OREO) is real estate acquired as a result of foreclosure or by deed in lieu of foreclosure. It is classified as real estate owned until such time as it is sold. When property is acquired as a result of foreclosure or by deed in lieu of foreclosure, it is recorded at its fair market value less cost to sell. Any write-down of the property at the time of acquisition is charged to the allowance for loan losses. Subsequent reductions in fair value are recorded as non-interest expense. To determine the fair value of OREO for smaller dollar single family homes, we consult with internal real estate sales staff and external realtors, investors, and appraisers. If the internally evaluated market price is below our underlying investment in the property, appropriate write-downs are taken. For larger dollar commercial real estate properties, we obtain a new appraisal of the subject property in connection with the transfer to other real estate owned. In some of these circumstances, an appraisal is in process at quarter end and we must make our best estimate of the fair value of the underlying collateral based on our internal evaluation of the property, review of the most recent appraisal, and discussions with the currently engaged appraiser. We do not obtain updated appraisals on a quarterly basis after the receipt of the initial appraisal. Rather, we internally review the fair value of the other real estate owned in our portfolio on a quarterly basis to determine if a new appraisal is warranted based on the specific circumstances of each property. The following table presents the major categories of OREO:

 

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

Construction, land development, and land

   $ 54,366    $ 7,526

Farmland

     807      442

1-4 Family residential

     10,467      4,642

Multi-family residential

     609      —  

Commercial real estate

     2,201      1,938
             

Total

   $ 68,450    $ 14,548
             

 

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Expenses related to other real estate owned include:

 

     Three Months Ended    Six Months Ended
     June 30,
2010
   June 30,
2009
   June 30,
2010
   June 30,
2009
     (in thousands)

Net loss on sales

   $ 91    $ 54    $ 90    $ 60

Impairment write-downs

     3,640      125      3,880      200

Operating expenses

     123      47      262      93
                           

Total

     3,854      226      4,232      353
                           

Note 6 – Advances from the Federal Home Loan Bank

Advances from the Federal Home Loan Bank were as follows:

 

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

Single maturity advances with fixed rates from 0.11% to 4.82%maturing from 2010 through 2012, averaging 1.91% for 2010

   $ 85,000    $ 70,000

Monthly amortizing advances with fixed rates from 0.00% to 8.28%and maturities ranging from 2011 through 2035, averaging 3.64% for 2010

     11,695      12,980
             

Total

   $ 96,695    $ 82,980
             

Each advance is payable per terms on agreement, with a prepayment penalty. The advances were collateralized by first mortgage residential loans, under a blanket lien arrangement. At June 30, 2010, the Bank had unused borrowing capacity of $56.7 million with the FHLB.

Note 7 – Fair Values Measurement

The FASB issued guidance that defines fair value, establishes a framework for measuring fair value, and expands disclosures about fair value measurements. The guidance also establishes a fair value hierarchy about the assumptions used to measure fair value and describes three levels of inputs that may be used to measure fair value:

Level 1: Quoted prices (unadjusted) for identical assets or liabilities in active markets that an entity has the ability to access as of the measurement date, or observable inputs.

Level 2: Significant other observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities, quoted prices in markets that are not active, and other inputs that are observable or can be corroborated by observable market data.

Level 3: Significant unobservable inputs that reflect an entity’s own assumptions about the assumptions that market participants would use in pricing an asset or liability.

 

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In certain cases, the inputs used to measure fair value may fall into different levels of the fair value hierarchy. When that occurs, we classify the fair value hierarchy on the lowest level of input that is significant to the fair value measurement. We used the following methods and significant assumptions to estimate fair value.

Securities: The fair values of securities available for sale are determined by obtaining quoted prices on nationally recognized securities exchanges, if available. This valuation method is classified as Level 1 in the fair value hierarchy. For securities where quoted prices are not available, fair values are calculated on market prices of similar securities, or matrix pricing, which is a mathematical technique used widely in the industry to value debt securities without relying exclusively on quoted prices for the specific securities but rather by relying on the securities’ relationship to other benchmark quoted securities. Matrix pricing relies on the securities’ relationship to similarly traded securities, benchmark curves, and the benchmarking of like securities. Matrix pricing utilizes observable market inputs such as benchmark yields, reported trades, broker/dealer quotes, issuer spreads, two-sided markets, benchmark securities, bids, offers, reference data, and industry and economic events. In instances where broker quotes are used, these quotes are obtained from market makers or broker-dealers recognized to be market participants. This valuation method is classified as Level 2 in the fair value hierarchy. For securities where quoted prices or market prices of similar securities are not available, fair values are calculated using discounted cash flows or other market indicators. These calculations utilize appropriate market variable inputs that include estimates and assumptions such as discount rates, prepayment speeds, default rates, and loss severities on a security by security basis. This valuation method is classified as Level 3 in the fair value hierarchy.

Impaired Loans: An impaired loan is evaluated at the time the loan is identified as impaired and is recorded at the lower of cost or fair value. Fair value is measured based on the value of the collateral securing the loan and is classified as Level 3 in the fair value hierarchy. Fair value is determined using several methods. Generally, the fair value of real estate is determined based on appraisals by qualified licensed appraisers. These appraisals may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach.

Adjustments are routinely made in the appraisal process by the appraisers to adjust for differences between the comparable sales and income data available. These routine adjustments are made to adjust the value of a specific property relative to comparable properties for variations in qualities such as location, size, and income production capacity relative to the subject property of the appraisal. Such adjustments are typically significant and result in a Level 3 classification of the inputs for determining fair value.

We routinely apply an internal discount to the value of appraisals used in the fair value evaluation of our impaired loans. The deductions to the appraisal take into account changing business factors and market conditions, as well as potential value impairment in cases where our appraisal date predates a likely change in market conditions. These deductions range from 10% for routine real estate collateral to 25% for real estate that is determined (1) to have a thin trading market or (2) to be specialized collateral. This is in addition to estimated discounts for cost to sell of six percent.

Impaired loans are evaluated quarterly for additional impairment. We obtain updated appraisals on properties securing our loans when circumstances are warranted such as at the time of renewal or when market conditions have significantly changed. This determination is made on a property-by-property basis in light of circumstances in the broader economic climate and our assessment of deterioration of real estate values in the market in which the property is located. The first stage of our assessment involves management’s inspection of the property in question. Management also engages in conversations with local real estate professionals, investors, and market makers to determine the likely marketing time and value range for the property. The second stage involves an assessment of current trends in the regional market. After thorough consideration of these factors, management will either internally evaluate fair value or order a new appraisal.

 

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Other Real Estate Owned: OREO is evaluated at the time of acquisition and recorded at fair value as determined by independent appraisal or internal market evaluation less cost to sell. Our quarterly evaluations of OREO for impairment are driven by property type. For smaller dollar single family homes, we consult with internal real estate sales staff and external realtors, investors, and appraisers. Based on these consultations, we determine asking prices for OREO properties we are marketing for sale. If the internally evaluated fair value is below our underlying investment in the property, appropriate write-downs are taken.

For larger dollar commercial real estate properties, we obtain a new appraisal of the subject property in connection with the transfer to other real estate owned. In some of these circumstances, an appraisal is in process at quarter end, and we must make our best estimate of the fair value of the underlying collateral based on our internal evaluation of the property, review of the most recent appraisal, and discussions with the currently engaged appraiser. We do not obtain updated appraisals on a quarterly basis after the receipt of the initial appraisal. Rather, we internally review the fair value of the other real estate owned in our portfolio on a quarterly basis to determine if a new appraisal is warranted based on the specific circumstances of each property.

Financial assets measured at fair value on a recurring basis at June 30, 2010 are summarized below:

 

           Fair Value Measurements at June 30, 2010 Using
          (in thousands)

Description

   June 30,
2010
   Quoted Prices In
Active Markets for
Identical Assets
(Level 1)
   Significant Other
Observable Inputs
(Level 2)
   Significant
Unobservable
Inputs

(Level 3)

Available-for-sale securities

           

U.S. Government and federal agency

   $ 10,892    $ —      $ 10,892    $ —  

State and municipal

     25,527      —        25,527      —  

Agency mortgage-backed

     99,372      —        99,372      —  

Private label mortgage-backed

     24,229      —        24,229      —  

Corporate bonds

     13,685      —        13,685      —  

Other debt securities

     606      —        —        606

Equity securities

     1,427      1,427      —        —  
                           

Total

   $ 175,738    $ 1,427    $ 173,705    $ 606
                           

Roll-forward of activity for our Significant Unobservable Inputs (Level 3) follows:

 

Available-for-sale securities

   Six Months Ended
June 30, 2010
 

Balance, January 1, 2010

   $ 32,168   

Purchases

     —     

Sales

     (7,712

Net accretion (amortization)

     606   

Principal paydowns

     (3,475

Transfers to Level 2

     (25,165

Net change in unrealized gain

     4,184   
        

Balance, June 30, 2010

   $ 606   
        

 

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Financial assets measured at fair value on a non-recurring basis at June 30, 2010 are summarized below:

 

          Fair Value Measurements at June 30, 2010 Using
          (in thousands)

Description

   June 30,
2010
   Quoted Prices In
Active Markets for
Identical Assets
(Level 1)
   Significant Other
Observable Inputs
(Level 2)
   Significant
Unobservable
Inputs

(Level 3)

Impaired loans

   $ 36,300    $ —      $ —      $ 36,300

Other real estate owned, net

     68,450      —        —        68,450

Impaired loans, which are measured for impairment using the fair value of collateral for collateral dependent loans, had a carrying amount of $41.4 million and a valuation allowance of $5.1 million, resulting in an additional provision for loan losses of $2.4 million for the first six months of 2010. Additional provision for loan losses of $103,000 was recorded during the first six month of 2009 related to impaired loans.

Other real estate owned which is measured at the lower of carrying or fair value less costs to sell, had a net carrying amount of $68.5 million. Write-downs of $3.9 million and $200,000 were recorded on other real estate owned during the first six months of 2010 and 2009, respectively.

Financial assets measured at fair value on a recurring basis at December 31, 2009 are summarized below:

 

          Fair Value Measurements at December 31, 2009 Using
          (in thousands)

Description

   December
31, 2009
   Quoted Prices In
Active  Markets for
Identical Assets
(Level 1)
   Significant Other
Observable Inputs
(Level 2)
   Significant
Unobservable
Inputs

(Level 3)

Available-for-sale securities

           

U.S. Government and federal agency

   $ 619    $ —      $ 619    $ —  

State and municipal

     25,455      —        25,455      —  

Agency mortgage-backed

     95,155      —        95,155      —  

Private label mortgage-backed

     31,639      —        —        31,639

Corporate bonds

     13,765      —        13,765      —  

Other debt securities

     529      —        —        529

Equity securities

     1,559      1,559      —        —  
                           

Total

   $ 168,721    $ 1,559    $ 134,994    $ 32,168
                           

Financial assets measured at fair value on a non-recurring basis at December 31, 2009 are summarized below:

 

          Fair Value Measurements at December 31, 2009 Using
          (in thousands)

Description

   December 31,
2009
   Quoted Prices In
Active Markets for
Identical Assets
(Level 1)
   Significant Other
Observable Inputs
(Level 2)
   Significant
Unobservable
Inputs

(Level 3)

Impaired loans

   $ 79,313    $ —      $ —      $ 79,313

Other real estate owned

     14,548      —        —        14,548

 

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Table of Contents

Impaired loans, which are measured for impairment using the fair value of collateral for collateral dependent loans, had a carrying amount of $84.4 million and a valuation allowance of $5.5 million.

Other real estate owned which is measured at the lower of carrying or fair value less costs to sell, had a net carrying amount of $14.5 million.

Carrying amount and estimated fair values of financial instruments were as follows for the periods indicated:

 

     June 30, 2010    December 31, 2009
     Carrying
Amount
   Fair
Value
   Carrying
Amount
   Fair
Value
     (in thousands)

Financial assets

           

Cash and cash equivalents

   $ 115,402    $ 115,402    $ 172,173    $ 172,173

Securities available for sale

     175,738      175,738      168,721      168,721

Federal Home Loan Bank stock

     10,072      N/A      10,072      N/A

Loans, net

     1,309,295      1,315,336      1,386,526      1,396,465

Accrued interest receivable

     8,383      8,383      9,329      9,329

Financial liabilities

           

Deposits

   $ 1,414,326    $ 1,417,327    $ 1,530,096    $ 1,526,508

Federal funds purchased and securities sold under agreements to repurchase

     11,810      11,810      11,517      11,517

Federal Home Loan Bank advances

     96,695      97,200      82,980      83,217

Subordinated capital notes

     9,000      8,260      9,000      7,323

Junior subordinated debentures

     25,000      21,422      25,000      18,250

Accrued interest payable

     2,310      2,310      2,705      2,705

The methods and assumptions used to estimate fair value are described as follows:

Carrying amount is the estimated fair value for cash and cash equivalents, interest-bearing deposits with banks, repurchase agreements, accrued interest receivable and payable, demand deposits, short-term borrowings, and variable rate loans or deposits that reprice frequently and fully. The fair value of loans is estimated in accordance with paragraph 55-3 of ASC 825, “Disclosures about Fair Value of Financial Instruments,” by discounting expected future cash flows using market rates on like maturity. For fixed rate loans or deposits and for variable rate loans or deposits with infrequent repricing or repricing limits, fair value is based on discounted cash flows using current market rates applied to the estimated life and credit risk. Fair value of subordinated capital notes and junior subordinated debentures are based on current rates for similar types of financing. The carrying amount is the estimated fair value for variable and subordinated debentures that reprice frequently. The fair value of off-balance-sheet items is based on the current fees or cost that would be charged to enter into or terminate such arrangements, which is not material.

 

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Note 8 – Earnings per Share

The factors used in the basic and diluted earnings per share computations follow:

 

     Three Months Ended
June 30,
   Six Months Ended
June 30,
     2010     2009    2010    2009
     (in thousands, except share and per share data)

Net income (loss)

   $ (1,131   $ 3,245    $ 2,125    $ 6,306

Less:

          

Preferred stock dividends

     437        437      875      875

Accretion of Series A preferred stock discount

     44        44      88      88

Earnings allocated to unvested shares

     3        —        83      —  

Earnings allocated to Series C preferred

     (1     —        —        —  
                            

Net income (loss) allocated to common shareholders, basic and diluted

   $ (1,614   $ 2,764    $ 1,079    $ 5,343
                            

Basic

          

Weighted average common shares including unvested common shares outstanding

     8,846,862        8,754,908      8,810,326      8,732,195

Less: Weighted average unvested common shares

     180,933        125,020      155,985      102,306

Less: Weighted average Series C preferred

     4,012        —        2,017      —  
                            

Weighted average common shares outstanding

     8,661,917        8,629,888      8,652,324      8,629,889
                            

Basic earnings (loss) per common share

   $ (0.19   $ 0.31    $ 0.13    $ 0.61
                            

Diluted

          

Add: Weighted average Series B preferred issued and outstanding

     2,495        —        1,254      —  

Add: Dilutive effects of assumed exercises of common and Preferred Series B & C stock warrants

     —          —        120      —  
                            

Weighted average common shares and potential common shares

     8,664,412        8,629,888      8,653,698      8,629,889
                            

Diluted earnings (loss) per common share

   $ (0.19   $ 0.31    $ 0.13    $ 0.61
                            

Stock options for 93,629 shares of common stock for 2010 and 297,258 shares of common stock for 2009 were not considered in computing diluted earnings per common share because they were anti-dilutive. Additionally, a warrant for the purchase of 314,821 shares of the Company’s common stock at an exercise price of $16.68 was outstanding at June 30, 2010 and 2009 but was not included in the diluted EPS computation as inclusion would have been anti-dilutive.

 

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Note 9 – Other Comprehensive Income (Loss)

Other comprehensive income components and related tax effects were as follows:

 

     Three Months Ended
June 30,
    Six Months Ended
June 30,
 
     2010     2009     2010     2009  
     (in thousands)  

Unrealized holding gains (losses) on available-for-sale securities

   $ 1,325      $ (362   $ 4,850      $ (267

Less: Reclassification adjustment for net gains and other temporary impairment realized in income

     (441     —          (384     1   
                                

Net unrealized gains (losses)

     1,766        (362     5,234        (268

Tax effect

     (618     127        (1,832     94   
                                

Net-of-tax amount

   $ 1,148      $ (235   $ 3,402      $ (174
                                

Note 10 – Capital

On June 30, 2010, we completed a $27.0 million stock offering to a group of accredited investors in a private placement transaction exempt from the registration requirements of the federal and state securities laws. In connection with the private placement transaction, we issued (i) 1,755,745 shares of common stock at a price of $11.50 per share; (ii) 227,000 shares of Series B preferred stock at a price of $11.50 per share, which will automatically convert into an aggregate of 227,000 shares of common stock upon receipt of shareholder approval, as discussed below; and (iii) 365,080 shares of Series C preferred stock at price of $11.50 per share.

Each share of Series B preferred stock is automatically convertible into one share of common stock on the third business day after the date of receipt of shareholder approval. Each share of Series B preferred stock provides for cumulative dividends of ten percent (10%) for the six month period ending December 31, 2010, and (ii) fifteen percent (15%) for each six-month period thereafter. If the shareholder approval described below occurs within the first six-month period, no dividends will be owed or paid on the Series B preferred stock.

The Series C preferred stock is a non-voting class of stock substantially similar in priority to the common stock, except for a liquidation preference over shares of our common stock. After receipt of shareholder approval, as discussed below, the Series C preferred stock will automatically convert into common stock on a one share for one share basis at such time as, after giving effect to the automatic conversion, the holder of such Series C preferred stock (and its affiliates or any other persons with which it is acting in concert or whose holdings would otherwise be required to be aggregated for purposes of federal banking law) beneficially holds, directly or indirectly, less than 9.9% of the number of shares of common stock then issued and outstanding.

We also issued warrants to purchase 1,163,045 shares of non-voting common stock at a price of $11.50 per share. The non-voting common stock is a non-voting class of stock substantially similar in rights and priority to our common stock, except that the non-voting common stock has no voting rights. The warrants become exercisable upon receipt of shareholder approval and expire on the fifth anniversary of that date. To the extent issued upon exercise of the warrants, the non-voting common stock will automatically convert into common stock on a one share for one share basis at such time as, after giving effect to the automatic conversion, the holder of such non-voting common stock (and its affiliates or any other persons with which it is acting in concert or whose holdings would otherwise be required to be aggregated for purposes of federal banking law) holds, directly or indirectly, beneficially less than 9.9% of the number of shares of common stock then issued and outstanding. In estimating the fair value of the warrants, we utilized the Black-Scholes model which includes assumptions regarding the Company’s common stock prices, stock price volatility (38.9%), dividend yield (3.88%), the risk free interest rate (1.79%) and the estimated life (5 years) of the warrants. As a result, the Company estimated the fair value of the warrants to be $2.29 per warrant.

NASDAQ Rule 5635 requires shareholder approval when the total number of shares of common stock sold in a private placement at a price less than the greater of book or market value would exceed 20% of a company’s outstanding common stock. We must obtain shareholder approval to enable the exercise of the option described

 

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in Note 11 and the conversion into common stock of the Series B preferred stock, Series C preferred stock and new non-voting common stock. The shareholders must also approve the new non-voting common stock issuable upon exercise of the warrants. We expect to submit these proposals for shareholder approval during the third quarter of 2010.

Each of the federal bank regulatory agencies has established minimum leverage capital requirements for banking organizations. Banking organizations must maintain a minimum ratio of Tier 1 capital to adjusted average quarterly assets equal to 3% to 5% subject to federal bank regulatory evaluation of an organization’s overall safety and soundness. PBI Bank has agreed with its primary regulators to maintain a ratio of total capital to total risk-weighted assets of at least 12.0% and a ratio of Tier 1 capital to total risk-weighted assets of 9.0% by June 30, 2010.

The following table shows the ratios of Tier 1 capital and total capital to risk-adjusted assets and the leverage ratios for Porter Bancorp, Inc. and PBI Bank at the dates indicated:

 

                 June 30, 2010     December 31, 2009  
     Regulatory
Minimums
    Well-Capitalized
Minimums
    Porter
Bancorp
    PBI
Bank
    Porter
Bancorp
    PBI
Bank
 

Tier I capital

   4.0   6.0   14.00   12.28   11.93   10.65

Total risk-based capital

   8.0      10.0      15.93      14.21      13.83      12.56   

Tier I leverage ratio

   4.0      5.0      11.11      9.73      9.59      8.57   

Note 11 – Subsequent Event

On July 23, 2010, we completed a $4,255,000 stock offering to SBAV LP in a supplemental private placement transaction exempt from the registration requirements of the federal and state securities laws. In connection with the supplemental private placement, we entered into a letter agreement with SBAV LP, which incorporated by reference the terms and conditions of the June 30 private placement. Pursuant to the terms of the letter agreement, we issued to SBAV LP (i) 370,000 shares of Series B preferred stock at $11.50 per share, which will automatically convert into an aggregate of 370,000 shares of common stock upon receipt of shareholder approval and (ii) a warrant to purchase 185,000 shares of non-voting common stock at a purchase price of $11.50 per share.

We also granted SBAV LP an option to purchase 64,784 shares of common stock and a warrant to purchase 32,392 shares of non-voting common stock at a purchase price of $11.50 per share. The option exercise price is $745,016, increasing the total potential gross proceeds to be received from SBAV LP to $5,000,000. The option is exercisable during the five business days following receipt of shareholder approval for purposes of NASDAQ Rule 5635.

 

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

and Results of Operations

This item analyzes our financial condition, change in financial condition and results of operations. It should be read in conjunction with the unaudited condensed consolidated financial statements and accompanying notes presented in Part I, Item 1 of this report.

Cautionary Note Regarding Forward-Looking Statements

This report contains statements about the future expectations, activities and events that constitute forward-looking statements under the Private Securities Litigation Reform Act. Forward-looking statements are based on our beliefs, assumptions and expectations of our future financial and operating performance and growth plans, taking into account information currently available to us. These statements are not statements of historical fact. The words “believe,” “may,” “should,” “anticipate,” “estimate,” “expect,” “intend,” “objective,” “seek,” “plan,” “strive” or similar words, or the negatives of these words, identify forward-looking statements.

Forward-looking statements involve risks and uncertainties that may cause our actual results to differ materially from the expectations of future results we expressed or implied in any forward-looking statements. These risks and uncertainties can be difficult to predict and may be out of our control. Factors that could contribute to differences in our results include, but are not limited to the factors listed in Part 2, Item 1A – Risk Factors in this report and the more detailed risks identified, and the cautionary statements included in our December 31, 2009 Annual Report on Form 10-K.

Forward-looking statements are not guarantees of performance or results. A forward-looking statement may include a statement of the assumptions or bases underlying the forward-looking statement. The Company believes it has chosen these assumptions or bases in good faith and that they are reasonable. We caution you however, that assumptions or bases almost always vary from actual results, and the differences between assumptions or bases and actual results can be material. The forward-looking statements included in this report speak only as of the date of the report. We have no duty, and do not intend to, update these statements unless applicable laws require us to do so.

Overview

Porter Bancorp, Inc. (NASDAQ: PBIB) is a Louisville, Kentucky-based bank holding company which operates 18 full-service banking offices in twelve counties through its wholly-owned subsidiary, PBI Bank. Our markets include metropolitan Louisville in Jefferson County and the surrounding counties of Henry and Bullitt, and extend south along the Interstate 65 corridor to Tennessee. We serve south central Kentucky and southern Kentucky from banking offices in Butler, Green, Hart, Edmonson, Barren, Warren, Ohio and Daviess Counties. We also have an office in Lexington Kentucky, the second largest city in Kentucky. The Bank is both a traditional community bank with a wide range of commercial and personal banking products, including wealth management and trust services, and an innovative online bank which delivers competitive deposit products and services through an online banking division operating under the name of Ascencia.

For the three and six months ended June 30, 2010, respectively, the Company reported net loss of $1.1 million and net income of $2.1 million. This compares with net income of $3.2 million and $6.3 million, respectively, for the same periods of 2009. Net loss available to common shareholders for the three months ended June 30, 2010 was $1.6 million. Net income available to common shareholders for the six months ended June 30, 2010 was $1.2 million. Basic and diluted earnings (loss) per common share were ($0.19) and $0.13 for the three and six months ended June 30, 2010, respectively, compared with $0.31 and $0.61 for the same periods of 2009.

 

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Significant developments during the quarter and six months ended June 30, 2010 consist of the following:

 

   

Net interest margin increased 58 basis points to 3.71% in the second quarter of 2010 compared with 3.13% in the second quarter of 2009. For the first six months of 2010, net interest margin increased to 3.51% compared with 3.08% for the same period of 2009. The increase in margin since last year benefited from a lower average cost of funds. Net interest margin was also up from the first quarter of 2010 by 39 basis points primarily due to lower average cost of funds.

 

   

Net interest income increased 14.9% to $14.7 million for the three months ended June 30, 2010, and 16.6% to $28.9 million for the six months ended June 30, 2010, compared with the same quarter and six months of 2009, respectively. Net interest income benefited from a lower average cost of funds.

 

   

The Company recorded a net loss of $1.1 million for the three months ended June 30, 2010, and net income of $2.1 million for the six months ended June 30, 2010, compared with net income of $3.2 million and $6.3 million for the same periods of 2009, respectively. The loss for the 2010 second quarter was due primarily to a $5.0 million increase in the provision for loan losses to $6.6 million compared with $1.6 million in the second quarter of 2009 and a write-down of $3.4 million of other real estate owned.

 

   

Net loans decreased 2.3% to $1.31 billion compared with $1.34 billion at June 30, 2009.

 

   

Deposits increased 3.7% to $1.41 billion compared with $1.36 billion at June 30, 2009.

 

   

Total assets increased 3.0% to $1.76 billion compared with $1.71 billion at June 30, 2009.

 

   

Efficiency ratio was 60.2% for the first six months of 2010, compared with 55.1% for the first six of 2009. Our efficiency ratio increased from 49.8% to 60.2% as a result of $3.4 million in other real estate owned write-downs.

 

   

Non-performing loans decreased $11.8 million, or 19.5%, during the second quarter to $48.7 million at June 30, 2010, compared with $60.5 million at March 31, 2010. The decrease was primarily attributable to non-performing loans moving through the collection, foreclosure and disposition process.

 

   

Non-performing assets decreased $3.0 million, or 2.5%, during the second quarter to $117.2 million at June 30, 2010. The decrease was primarily due to sales of other real estate owned.

 

   

Shareholders’ equity rose to $196.2 million at the end of the second quarter and benefited from a stock offering that raised $27.0 million in gross proceeds that closed June 30, 2010. The proceeds resulted in improved capital ratios, including 11.11% tier 1 leverage ratio and 14.00% tier 1 risk-based capital ratio as of June 30, 2010.

The banking industry continues to experience very difficult times. Porter Bancorp is not immune from these difficulties. Real estate lending remains a core business for the Company, and we expect continued weakening in that sector in 2010. We have set up a real estate department with a dedicated real estate sales expert that has been successful in selling OREO properties and assisting in the sale of properties securing non-performing loans.

The following discussion and analysis covers the primary factors affecting our performance and financial condition.

Results of Operations

The following table summarizes components of income and expense and the change in those components for the three months ended June 30, 2010 compared with the same period of 2009:

 

     For the Three Months
Ended June 30,
   Change from
Prior Period
 
     2010     2009    Amount     Percent  
     (dollars in thousands)  

Gross interest income

   $ 22,126      $ 23,645    $ (1,519   (6.4 )% 

Gross interest expense

     7,399        10,832      (3,433   (31.7

Net interest income

     14,727        12,813      1,914      14.9   

Provision for credit losses

     6,600        1,600      5,000      312.5   

Non-interest income

     1,497        1,895      (398   (21.0

Non-interest expense

     11,513        8,228      3,285      39.9   

Net income before taxes

     (1,889     4,880      (6,769   (138.7

Income tax expense (benefit)

     (758     1,635      (2,393   (146.4

Net income (loss)

     (1,131     3,245      (4,376   (134.9

 

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Net loss of $1,131,000 for the three months ended June 30, 2010 decreased $4.4 million, or 134.9%, from net income of $3,245,000 for the comparable period of 2009. This decrease in earnings was primarily attributable to increased provision for loan losses expense, and other real estate owned write-downs of $3.4 million to account for lower valuations. Net interest income benefited from decreased cost of funds to 2.05% in the 2010 second quarter from 2.98% in the prior year second quarter. The decrease in non-interest income was due to an other than temporary impairment charge on securities of $465,000, and lower gains on sales of loans originated for sale. These decreases were partially offset by increased income from service charges, fiduciary activities, and net gains on sales of securities. The increase in non-interest expense was due to the $3.4 million of other real estate owned write-downs, and increased salary and benefits expense and franchise tax expense. These increases were partially off-set by lower FDIC fees. Total FDIC fees were $706,000 in the second quarter of 2010 compared with $1.3 million in the second quarter of 2009. The 2009 FDIC fees included a special assessment of $781,000.

The following table summarizes components of income and expense and the change in those components for the six months ended June 30, 2010 compared with the same period of 2009:

 

     For the Six Months
Ended June 30,
   Change from
Prior Period
 
     2010    2009    Amount     Percent  
     (dollars in thousands)  

Gross interest income

   $ 44,752    $ 47,147    $ (2,395   (5.1 )% 

Gross interest expense

     15,848      22,367      (6,519   (29.1

Net interest income

     28,904      24,780      4,124      16.6   

Provision for credit losses

     9,600      3,200      6,400      200.0   

Non-interest income

     3,189      3,381      (192   (5.7

Non-interest expense

     19,562      15,504      4,058      26.2   

Net income before taxes

     2,931      9,457      (6,526   (69.0

Income tax expense

     806      3,151      (2,345   (74.4

Net income

     2,125      6,306      (4,181   (66.3

Net income of $2,125,000 for the six months ended June 30, 2010 decreased $4.2 million, or 66.3%, from $6,306,000 for the comparable period of 2009. This decrease in earnings was primarily attributable to increased provision for loan losses expense, and other real estate owned write-downs of $3.4 million to account for lower valuations on the underlying real estate collateral. Net interest income benefited from decreased cost of funds to 2.13% in the first six months of 2010 from 3.13% in the same period of 2009. The decrease in non-interest income was due to an other than temporary impairment charge on securities of $465,000, partially offset by increased income from service charges, fiduciary activities, net gains on sales of securities, and gains on sales of loans originated for sale. The increase in non-interest expense was due to the $3.4 million of other real estate owned write-downs, and increased salary and benefits expense and franchise tax expense. These increases were partially off-set by lower FDIC fees. Total FDIC fees were $1.4 million in the first half of 2010 compared with $1.7 million in the second half of 2009. The 2009 FDIC fees included a special assessment of $781,000.

Net Interest Income – Our net interest income was $14,727,000 for the three months ended June 30, 2010, an increase of $1.9 million, or 14.9%, compared with $12,813,000 for the same period in 2009. Net interest spread and margin were 3.51% and 3.71%, respectively, for the second quarter of 2010, compared with 2.76% and 3.13%, respectively, for the second quarter of 2009. Net interest income was $28,904,000 for the six months

 

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ended June 30, 2010, an increase of $4.1 million, or 16.6%, compared with $24,780,000 for the same period of 2009. Net interest spread and margin were 3.29% and 3.51%, respectively, for the first six months of 2010, compared with 2.69% and 3.08%, respectively, for the first six months of 2009. Net interest margin for the three months ended June 30, 2010, increased 39 basis points from our margin of 3.32% in the 2010 first quarter due primarily to lower cost of funds. Net interest margin for the first six months of 2010 increased 43 basis points from our margin of 3.08% in the first half of 2009 due primarily to increased average earning assets coupled with lower cost of funds.

Our yield on earning assets decreased to 5.56% for the second quarter of 2010 compared to 5.74% for the second quarter of 2009. Our cost of funds also decreased to 2.05% for the second quarter of 2010 compared to 2.98% for the second quarter of 2009. Our yield on earning assets declined 40 basis points from 5.82% during the first six months of 2010 and our cost of funds decreased 100 basis points from 3.13%.

Our average interest-earning assets were $1.67 billion for the six months ended June 30, 2010, compared with $1.64 billion for the six months ended June 30, 2009, a 2.0% increase primarily attributable to growth in loans. Average loans were $1.38 billion for the six months ended June 30, 2010, compared with $1.36 billion for the six months ended June 30, 2009, a 1.5% increase. Our total interest income decreased by 5.1% to $44.8 million for the six months ended June 30, 2010, compared with $47.1 million for the same period in 2009. The change was due to lower yield on interest earning assets resulting from increased non-accrual loans.

Our average interest-bearing liabilities also increased by 4.4%, to $1.50 billion for the six months ended June 30, 2010, compared with $1.44 billion for the six months ended June 30, 2009. Our total interest expense decreased by 29.1% to $15.8 million for the six months ended June 30, 2010, compared with $22.4 million during the same period in 2009, primarily due to continued repricing of certificates of deposit at maturity at lower interest rates. Our average volume of certificates of deposit increased by 13.3% to $1.2 billion for the six months ended June 30, 2010, compared with $1.1 billion for the six months ended June 30, 2009. The average interest rate paid on certificates of deposits decreased to 2.17% for the six months ended June 30, 2010, compared with 3.45% for the six months ended June 30, 2009. The certificate of deposit volume increase reflected organic growth from promotional efforts throughout the period.

 

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Average Balance Sheets

The following table presents the average balance sheets for the three month periods ending June 30, 2010 and 2009, along with the related calculations of tax-equivalent net interest income, net interest margin and net interest spread for the related periods.

 

     Three Months Ended June 30,  
     2010     2009  
     Average
Balance
    Interest
Earned/Paid
   Average
Yield/Cost
    Average
Balance
    Interest
Earned/Paid
   Average
Yield/Cost
 
     (dollars in thousands)  

ASSETS

              

Interest-earning assets:

              

Loan receivables (1)(2)

   $ 1,356,883      $ 19,771    5.84   $ 1,360,191      $ 21,102    6.22

Securities

              

Taxable

     148,968        1,988    5.35        152,416        2,141    5.63   

Tax-exempt (3)

     21,431        215    6.19        21,909        223    6.28   

FHLB stock

     10,072        112    4.46        10,072        112    4.46   

Other equity securities

     1,742        11    2.53        1,901        11    2.32   

Federal funds sold and other

     66,291        29    0.18        112,900        56    0.20   
                                  

Total interest-earning assets

     1,605,387        22,126    5.56     1,659,389        23,645    5.74
                      

Less: Allowance for loan losses

     (27,064          (20,581     

Non-interest earning assets

     159,362             96,058        
                          

Total assets

   $ 1,737,685           $ 1,734,866        
                          

LIABILITIES AND STOCKHOLDERS’ EQUITY

              

Interest-bearing liabilities:

              

Certificates of deposit and other time deposits

   $ 1,158,976      $ 6,084    2.11   $ 1,086,698      $ 8,869    3.27

NOW and money market deposits

     156,992        393    1.00        166,469        517    1.25   

Savings accounts

     36,428        66    0.73        35,599        82    0.92   

Federal funds purchased and repurchase

     11,590        120    4.15        10,624        120    4.53   

FHLB advances

     50,809        500    3.95        123,388        937    3.05   

Junior subordinated debentures

     34,000        236    2.78        34,000        307    3.62   
                                  

Total interest-bearing liabilities

     1,448,795        7,399    2.05     1,456,778        10,832    2.98
                      

Non-interest-bearing liabilities:

              

Non-interest-bearing deposits

     103,379             103,102        

Other liabilities

     6,306             7,818        
                          

Total liabilities

     1,558,480             1,567,698        

Stockholders’ equity

     179,205             167,168        
                          

Total liabilities and stockholders’ equity

   $ 1,737,685           $ 1,734,866        
                          

Net interest income

     $ 14,727        $ 12,813   
                      

Net interest spread

        3.51        2.76
                      

Net interest margin

        3.71        3.13
                      

 

(1) Includes loan fees in both interest income and the calculation of yield on loans.
(2) Calculations include non-accruing loans in average loan amounts outstanding.
(3) Taxable equivalent yields are calculated assuming a 35% federal income tax rate.

 

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Average Balance Sheets

The following table presents the average balance sheets for the six month periods ending June 30, 2010 and 2009, along with the related calculations of tax-equivalent net interest income, net interest margin and net interest spread for the related periods.

 

     Six Months Ended June 30,  
     2010     2009  
     Average
Balance
    Interest
Earned/Paid
   Average
Yield/Cost
    Average
Balance
    Interest
Earned/Paid
   Average
Yield/Cost
 
     (dollars in thousands)  

ASSETS

              

Interest-earning assets:

              

Loan receivables (1)(2)

   $ 1,380,553      $ 39,644    5.79   $ 1,360,192      $ 42,372    6.28

Securities

              

Taxable

     152,740        4,311    5.69        151,204        3,985    5.31   

Tax-exempt (3)

     21,488        431    6.22        21,969        444    6.27   

FHLB stock

     10,072        226    4.52        10,072        226    4.52   

Other equity securities

     1,813        23    2.56        1,901        29    3.08   

Federal funds sold and other

     107,400        117    0.22        95,245        91    0.19   
                                  

Total interest-earning assets

     1,674,066        44,752    5.42     1,640,583        47,147    5.82
                      

Less: Allowance for loan losses

     (27,196          (20,304     

Non-interest earning assets

     138,809             95,547        
                          

Total assets

   $ 1,785,679           $ 1,715,826        
                          

LIABILITIES AND STOCKHOLDERS’ EQUITY

              

Interest-bearing liabilities:

              

Certificates of deposit and other time deposits

   $ 1,203,592      $ 12,948    2.17   $ 1,062,412      $ 18,185    3.45

NOW and money market deposits

     160,233        844    1.06        164,867        1,037    1.27   

Savings accounts

     35,458        134    0.76        35,170        164    0.94   

Federal funds purchased and repurchase

     11,598        239    4.16        10,652        235    4.45   

FHLB advances

     58,515        1,220    4.20        132,675        2,086    3.17   

Junior subordinated debentures

     34,000        463    2.75        34,000        660    3.91   
                                  

Total interest-bearing liabilities

     1,503,396        15,848    2.13     1,439,776        22,367    3.13
                      

Non-interest-bearing liabilities:

              

Non-interest-bearing deposits

     101,091             101,521        

Other liabilities

     6,684             8,063        
                          

Total liabilities

     1,611,171             1,549,360        

Stockholders’ equity

     174,508             166,466        
                          

Total liabilities and stockholders’ equity

   $ 1,785,679           $ 1,715,826        
                          

Net interest income

     $ 28,904        $ 24,780   
                      

Net interest spread

        3.29        2.69
                      

Net interest margin

        3.51        3.08
                      

 

(1) Includes loan fees in both interest income and the calculation of yield on loans.
(2) Calculations include non-accruing loans in average loan amounts outstanding.
(3) Taxable equivalent yields are calculated assuming a 35% federal income tax rate.

 

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Rate/Volume Analysis

The table below sets forth certain information regarding changes in interest income and interest expense for the periods indicated. For each category of interest-earning assets and interest-bearing liabilities, information is provided on changes attributable to (1) changes in rate (changes in rate multiplied by old volume); (2) changes in volume (changes in volume multiplied by old rate); and (3) changes in rate-volume (change in rate multiplied by change in volume). Changes in rate-volume are proportionately allocated between rate and volume variance.

 

     Three Months Ended June 30,
2010 vs. 2009
    Six Months Ended June 30,
2010 vs. 2009
 
     Increase (decrease)
due to change in
    Net
Change
    Increase (decrease)
due to change in
    Net
Change
 
     Rate     Volume       Rate     Volume    
     (in thousands)  

Interest-earning assets:

            

Loan receivables

   $ (1,280   $ (51   $ (1,331   $ (3,354   $ 626      $ (2,728

Securities

     (109     (52     (161     286        27        313   

Other equity securities

     1        (1     —          (5     (1     (6

Federal funds sold and other

     (8     (19     (27     14        12        26   
                                                

Total increase (decrease) in interest income

     (1,396     (123     (1,519     (3,059     664        (2,395
                                                

Interest-bearing liabilities:

            

Certificates of deposit and other time deposits

     (3,342     557        (2,785     (7,417     2,180        (5,237

NOW and money market accounts

     (96     (28     (124     (165     (28     (193

Savings accounts

     (18     2        (16     (31     1        (30

Federal funds purchased and repurchased agreements

     (10     10        —          (16     20        4   

FHLB advances

     222        (659     (437     540        (1,406     (866

Junior subordinated debentures

     (71     —          (71     (197     —          (197
                                                

Total increase (decrease) in interest expense

     (3,315     (118     (3,433     (7,286     767        (6,519
                                                

Increase (decrease) in net interest income

   $ 1,919      $ (5   $ 1,914      $ 4,227      $ (103   $ 4,124   
                                                

 

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Non-Interest Income – The following table presents the major categories of non-interest income for the three and six months ended June 30, 2010 and 2009:

 

     Three Months Ended
June 30,
   Six Months Ended
June 30,
     2010     2009    2010     2009
     (in thousands)

Service charges on deposit accounts

   $ 793      $ 788    $ 1,513      $ 1,476

Income from fiduciary activities

     273        198      525        418

Secondary market brokerage fees

     130        73      190        131

Title insurance commissions

     39        44      76        64

Gains on sales of loans originated for sale

     184        241      275        241

Gains on sales of investment securities, net

     24        —        81        1

Other than temporary impairment on securities

     (465     —        (465     —  

Other

     519        551      994        1,050
                             

Total non-interest income

   $ 1,497      $ 1,895    $ 3,189      $ 3,381
                             

Non-interest income for the second quarter ended June 30, 2010 decreased $398,000, or 21.0%, compared with the second quarter of 2009. For the six months ended June 30, 2010 non-interest income decreased by $192,000 to $3.2 million compared with $3.4 million for same period of 2009. The decrease in non-interest income for the second quarter ended June 30, 2010 was primarily due to an other than temporary impairment charge on securities, and lower net gains on sales of loans originated for sale. These decreases were partially offset by increased income from fiduciary activities from new business development, and secondary market brokerage fees from increased volume of secondary market loan originations. The decrease in non-interest income for the six months ended June 30, 2010 was primarily due to an other than temporary impairment charge on securities. This charge was partially offset by increased income from fiduciary activities from new business development, secondary market brokerage fees from increased volume of secondary market loan originations, and net gains on sales of investment securities.

Non-interest ExpenseThe following table presents the major categories of non-interest expense for the three and six months ended June 30, 2010 and 2009:

 

     Three Months Ended
June 30,
   Six Months Ended
June 30,
     2010    2009    2010    2009
     (in thousands)

Salary and employee benefits

   $ 3,931    $ 3,813    $ 7,878    $ 7,691

Occupancy and equipment

     1,015      981      2,037      1,979

Other real estate owned expense

     3,854      226      4,232      353

FDIC insurance

     706      503      1,411      962

FDIC special insurance assessment

     —        781      —        781

State franchise tax

     543      450      1,086      900

Professional fees

     292      203      558      431

Postage and delivery

     198      184      386      368

Communications

     173      230      359      385

Office supplies

     92      114      189      218

Advertising

     77      125      173      283

Other

     632      618      1,253      1,153
                           

Total non-interest expense

   $ 11,513    $ 8,228    $ 19,562    $ 15,504
                           

Non-interest expense for the second quarter ended June 30, 2010 increased $3.3 million, or 39.9%, compared with the second quarter of 2009. For the six months ended June 30, 2010, non-interest expense increased $4.1 million, or 26.2%, to $19.6 million compared with $15.5 million for the first six months of 2009. The increase in non-interest expense was primarily attributable to write-downs of $3.4 million on other real estate owned to

 

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account for lower valuations. In addition, salary and benefits expense for the 2010 second quarter increased $118,000, or 3.1%, over the prior year second quarter, and increased $187,000, or 2.43%, for the six months ended June 30, 2010, over the same period of 2009, due to additions to staff. State franchise tax for the 2010 second quarter increased $93,000, or 20.7%, over the prior year second quarter, and increased $186,000, or 20.7%, for the six months ended June 30, 2010, over the same period of 2009. Professional fees expense for the 2010 second quarter increased $89,000, or 43.8%, over the prior year second quarter, and increased $127,000, or 29.5%, for the six months ended June 30, 2010, over the same period of 2009, due to higher legal and accounting services fees. These increases were partially offset by lower FDIC fees and advertising costs. FDIC fees were $1.4 million in the first six months of 2010 compared with $1.7 million in the first half of 2009. The 2009 FDIC fees included a special assessment of $781,000. Advertising expense for the three months ended June 30, 2010 decreased $48,000, or 38.4%, over the prior year second quarter, and decreased $110,000, or 38.9%, for the six months ended June 30, 2010, over the same period of 2009, due to the decision to replace certain media advertising with customer relationship focused marketing.

Income Tax ExpenseIncome tax benefit was $758,000, or 40.1% of pre-tax loss, for the second quarter ended June 30, 2010, and income tax expense of $806,000, or 27.5% of pre-tax income, for the first six months of 2010, compared with $1.6 million, or 33.5% of pre-tax income, for the second quarter of 2009, and $3.2 million, or 33.3% or pre-tax income, for the first six months of 2009.

Effective tax rates differ from the federal statutory rate of 35% applied to income before income taxes due to the following:

 

     Three Months Ended
June 30,
    Six Months Ended
June 30,
 
     2010     2009     2010     2009  
     (dollars in thousands)  

Federal statutory rate times financial statement income

   $ (661   $ 1,708      $ 1,026      $ 3,310   

Effect of:

        

Tax-exempt income

     (76     (76     (152     (153

Non taxable life insurance income

     (26     (25     (50     (50

Federal tax credits

     (11     (11     (23     (23

Other, net

     16        39        5        67   
                                

Total

   $ (758   $ 1,635      $ 806      $ 3,151   
                                

Analysis of Financial Condition

Total assets decreased $74.4 million, or 4.1%, to $1.76 billion at June 30, 2010 from $1.84 billion at December 31, 2009. This decrease was primarily attributable to a decrease of $77.2 million in net loans due to efforts to move troubled loans through the collection, foreclosure, and disposition process, which contributed to the increase of $53.9 million in other real estate owned. Total assets at June 30, 2010 increased $50.8 million from $1.7 billion at June 30, 2009, representing a 3.0% increase.

Loans ReceivableLoans receivable decreased $76.8 million, or 5.4%, during the six months ended June 30, 2010 to $1.3 billion. Our commercial, commercial real estate and real estate construction portfolios decreased by an aggregate of $73.4 million, or 7.9%, during the six months and comprised 64.1% of the total loan portfolio at June 30, 2010.

Loan Portfolio CompositionThe following table presents a summary of the loan portfolio at the dates indicated, net of deferred loan fees, by type. There are no foreign loans in our portfolio. Except for commercial real estate, construction real estate and residential real estate, there is no concentration of loans in any industry exceeding 10% of total loans.

 

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     As of June 30,
2010
    As of December 31,
2009
 
     Amount    Percent     Amount    Percent  
     (dollars in thousands)  

Type of Loan:

          

Real estate:

          

Commercial

   $ 546,456    40.90    $ 535,843    37.93

Construction

     223,149    16.70        304,230    21.53   

Residential

     388,226    29.06        387,017    27.39   

Home equity

     31,291    2.33        32,384    2.29   

Commercial

     86,925    6.51        89,903    6.36   

Consumer

     34,588    2.59        36,989    2.62   

Agriculture

     24,086    1.80        25,064    1.77   

Other

     1,410    0.11        1,488    0.11   
                          

Total loans

   $ 1,336,131    100.00    $ 1,412,918    100.00
                          

Non-Performing AssetsNon-performing assets consist of loans past due 90 days or more still on accrual, loans on which interest is no longer accrued, real estate acquired through foreclosure and repossessed assets.

The following table sets forth information with respect to non-performing assets as of June 30, 2010 and December 31, 2009.

 

     June 30,
2010
    December 31,
2009
 
     (dollars in thousands)  

Loans past due 90 days or more still on accrual

   $ 10,497      $ 5,968   

Non-accrual loans

     38,199        78,888   
                

Total non-performing loans

     48,696        84,856   

Real estate acquired through foreclosure

     68,450        14,548   

Other repossessed assets

     51        80   
                

Total non-performing assets

   $ 117,197      $ 99,484   
                

Non-performing loans to total loans

     3.64     6.00
                

Non-performing assets to total assets

     6.66     5.42
                

Allowance for non-performing loans

   $ 7,204      $ 7,266   
                

Non-performing loans to allowance for non-performing loans

     14.8     8.6
                

Nonperforming loans at June 30, 2010 were $48.7 million, or 3.6% of total loans, compared with $19.3 million, or 1.4% of total loans, at June 30, 2009, and $84.9 million, or 6.0% of total loans at December 31, 2008. The decrease of $36.2 million in non-performing loans from December 31, 2009 to June 30, 2010 is primarily attributable to efforts to move troubled loans through collection, foreclosure, and disposition process.

We do not have a formal loan modification program. Rather, we work with individual customers on a case-by-case basis to facilitate the orderly collection of our principal and interest before a loan becomes a non-performing loan. If a customer is unable to make contractual payments, we review the particular circumstances of that customer’s situation and negotiate a revised payment stream. In other words, we identify performing customers experiencing financial difficulties, and through negotiations, we lower their interest rate, most typically on a short-term basis for three to six months. Our goal when restructuring a credit is to afford the customer a reasonable period of time to remedy the issue causing cash flow constraints within their business so that they can return to performing status over time.

 

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Our loan modifications have taken the form of reduction in interest rate and/or curtailment of scheduled principal payments for a short-term period, usually three to six months, but in some cases until maturity of the loan. Our restructured loans are all collateral secured loans. If a customer fails to perform under the modified terms, we place the loan on non-accrual status and begin the process of working with the customer to liquidate the underlying collateral to satisfy the debt.

At June 30, 2010, we had 22 restructured loans totaling $23.7 million with borrowers who experienced deterioration in financial condition compared with 21 loans totaling $25.2 million at December 31, 2009. All of these loans were granted interest rate reductions to provide cash flow relief to customers experiencing cash flow difficulties. Of these loans, 9 loans totaling approximately $6.7 million were also granted principal payment deferrals until maturity. There were no concessions made to forgive principal relative to these loans. These loans are secured by first liens on 1-4 residential or commercial real estate properties. We do not hold a second or junior lien position on these restructured loans. Management believes these loans are well secured and the borrowers have the ability to repay the loans in accordance with the renegotiated terms. As such, these restructured loans were on accrual status at the balance sheet date as payments were being made according to the restructured loan terms. These loans have not had a partial charge-off. In accordance with ASC 310-50-2, we continue to report restructured loans as restructured until such time as the loan has developed a reasonable repayment history, the borrower displays the financial capacity to repay, and the loan terms return to the terms in place prior to the restructure. If the customer fails to perform, we place the loan on non-accrual status and seek to liquidate the underlying collateral for these loans. Our non-accrual policy for restructured loans is identical to our non-accrual policy for all loans. Our policy calls for a loan to be reported as non-accrual if it is maintained on a cash basis because of deterioration in the financial condition of the borrower, payment in full of principal and interest is not expected, or principal or interest has been in default for a period of 90 days or more unless the assets are both well secured and in the process of collection. Changes in value for impairment, including the amount attributed to the passage of time, are recorded entirely within the provision for loan losses.

We consider any loan that is restructured for a borrower experiencing financial difficulties due to a borrower’s potential inability to pay in accordance with contractual terms of the loan a troubled debt restructure. Specifically, we consider a concession involving a modification of the loan terms, such as (i) a reduction of the stated interest rate, (ii) reduction or deferral of principal, or (iii) reduction or deferral of accrued interest at a stated interest rate lower than the current market rate for new debt with similar risk all to be troubled debt restructurings. When a modification of terms is made for a competitive reason, we do not consider that to be a troubled debt restructuring. The primary example of a competitive modification would be an interest rate reduction for a performing customer to a market rate as the result of a market decline in rates.

Foreclosed properties at June 30, 2010 were $68.5 million compared with $9.6 million at June 30, 2009 and $14.5 million at December 31, 2009. See Footnote 5, “Other Real Estate Owned”, to the financial statements. The majority of the increase was due to loans on two multi-unit residential condominiums and patio home developments that were valued at approximately $41.7 million. The bank acquired deeds in lieu of foreclosure on these properties. In addition, the increase in foreclosed properties from year-end 2009 reflects the normal progression of troubled loans through workout, collateral repossession and ultimate disposition. We value foreclosed properties at fair value less costs to sell when acquired and expect to liquidate these properties to recover our investment in the due course of business. Net loss on sales, write-downs, and operating expenses for other real estate owned totaled $3.9 million and $4.2 million, respectively, for the three and six months ended June 30, 2010, compared with $226,000 and $353,000, respectively, for the same periods of 2009.

Allowance for Loan LossesThe allowance for loan losses is based on management’s continuing review and risk evaluation of individual loans, loss experience, current economic conditions, risk characteristics of various categories of loans and such other factors that, in management’s judgment, require current recognition in estimating loan losses.

 

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Management has established loan grading procedures that result in specific allowance allocations for any estimated inherent risk of loss. For loans not individually graded, a general allowance allocation is computed using factors developed over time based on actual loss experience. The specific and general allocations plus consideration of qualitative factors represent management’s best estimate of probable losses contained in the loan portfolio at the evaluation date. Although the allowance for loan losses is comprised of specific and general allocations, the entire allowance is available to absorb any credit losses.

Our loan loss reserve, as a percentage of total loans at June 30, 2010, increased to 2.01% from 1.52% at June 30, 2009, and 1.87% at December 31, 2009. Provision for loan losses increased $5.0 million to $6.6 million for the second quarter of 2010 compared with the second quarter of 2009. Provision for loan losses increased $6.4 million to $9.6 million for the six months ended June 30, 2010, compared with $3.2 million for the same six months of 2009. Net loan charge-offs for the second quarter of 2010 were $6.3 million, or 0.46% of average loans, compared with $1.2 million, or 0.09%, for the second quarter of 2009, and $2.8 million, or 0.20%, for the first quarter of 2010. Net loan charge-offs for the six months ended June 30, 2010 were $9.2 million, or 0.66% of average loans, compared with $2.1 million, or 0.16%, for the first six months of 2009. Our allowance for loan losses to nonperforming loans increased to 55.11% at June 30, 2010, compared with 31.10% at December 31, 2009, but declined in comparison with 107.59% at June 30, 2009. The change in this metric between periods is attributable to the fluctuation in non-accrual loans. We have assessed these loans for collectability and considered, among other things, the borrower’s ability to repay, the value of the underlying collateral, and other market conditions to ensure the allowance for loan losses is adequate to absorb probable incurred losses.

The majority of our nonperforming loans are secured by real estate collateral. While our nonperforming loans have trended upward since 2008, the underlying collateral coverage for nonperforming loans supports the likelihood of collection of our principal, and therefore, we do not estimate a proportionate upward trending in losses. Our allowance for non-performing loan to non-performing loans was 14.8% at June 30, 2010 compared to 8.9% at June 30, 2009, and 8.6% at December 31, 2009.

An analysis of changes in allowance for loan losses and selected ratios for the three and six month periods ended June 30, 2010 and 2009 follows:

 

     Three Months Ended
June 30,
    Six Months Ended
June 30,
 
     2010     2009     2010     2009  
           (dollars in thousands)        

Balance at beginning of period

   $ 26,543      $ 20,371      $ 26,392      $ 19,652   

Provision for loan losses

     6,600        1,600        9,600        3,200   

Recoveries

     96        69        153        171   

Charge-offs

     (6,403     (1,300     (9,309     (2,283
                                

Balance at end of period

   $ 26,836      $ 20,740      $ 26,836      $ 20,740   
                                

Allowance for loan losses to period-end loans

     2.01     1.52     2.01     1.52
                                

Net charge-offs to average loans

     0.46     0.09     0.66     0.16
                                

Allowance for loan losses to non-performing loans

     55.11     107.59     55.11     107.59
                                

LiabilitiesTotal liabilities at June 30, 2010 were $1.56 billion compared with $1.67 billion at December 31, 2009, a decrease of $101.3 million, or 6.1%. The decrease was primarily attributable to a decrease in deposits of $115.8 million, or 7.6%, at June 30, 2010 to $1.41 billion from $1.53 billion at December 31, 2009. The decrease in deposits was primarily due to planned reduction in brokered deposits and internet division deposits.

Federal Home Loan Bank advances increased $13.7 million, or 16.5%, to $96.7 million from $83.0 million at December 31, 2009. These advances are used from time to time to fund asset growth and manage interest rate risk in accordance with our asset/liability management strategies.

 

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Deposits are our primary source of funds. The following table sets forth the average daily balances and weighted average rates paid for our deposits for the periods indicated:

 

     For the Six Months
Ended June 30,

2010
    For the Year Ended
December 31,

2009
 
     Average
Balance
   Average
Rate
    Average
Balance
   Average
Rate
 
     (dollars in thousands)  

Demand

   $ 101,091    —        $ 99,167    —     

Interest checking

     80,541    0.80     75,602    0.84

Money market

     79,692    1.32        86,619    1.53   

Savings

     35,458    0.76        34,386    0.90   

Certificates of deposit

     1,203,592    2.17        1,089,798    3.01   
                  

Total deposits

   $ 1,500,374    1.87   $ 1,385,572    2.53
                  

The following table sets forth the average daily balances and weighted average rates paid for our certificates of deposit for the periods indicated:

 

     For the Six Months
Ended June 30,

2010
    For the Year
Ended December 31,
2009
 
     Average
Balance
   Average
Rate
    Average
Balance
   Average
Rate
 
     (dollars in thousands)  

Less than $100,000

   $ 605,464    2.16   $ 611,011    3.03

$100,000 or more

     598,128    2.18     478,787    2.98
                  

Total

   $ 1,203,592    2.17   $ 1,089,798    3.01
                  

The following table shows at June 30, 2010 and December 31, 2009 the amount of our time deposits of $100,000 or more by time remaining until maturity:

 

Maturity Period

   As of
June 30,
2010
   As of
December 31,
2009
     (in thousands)

Three months or less

   $ 115,416    $ 154,365

Three months through six months

     101,584      162,828

Six months through twelve months

     116,041      131,861

Over twelve months

     219,333      167,236
             

Total

   $ 552,374    $ 616,290
             

Liquidity

Liquidity risk arises from the possibility we may not be able to satisfy current or future financial commitments, or may become unduly reliant on alternative funding sources. The objective of liquidity risk management is to ensure that the cash flow requirements of depositors and borrowers, as well as our operating cash needs, are met,

 

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taking into account all on- and off-balance sheet funding demands. Liquidity risk management also includes ensuring cash flow needs are met at a reasonable cost. We maintain an investment and funds management policy, which identifies the primary sources of liquidity, establishes procedures for monitoring and measuring liquidity and establishes minimum liquidity requirements in compliance with regulatory guidance. The liquidity position is continually monitored and reviewed by our Asset Liability Committee.

Funds are available from a number of sources, including the sale of securities in the available-for-sale portion of the investment portfolio, principal pay-downs on loans and mortgage-backed securities, brokered deposits and other wholesale funding. During 2009 and the first six months of 2010, PBI Bank utilized brokered and wholesale deposits to supplement its funding strategy. At June 30, 2010, these deposits totaled $85.5 million compared with $114.6 million at December 31, 2009. PBI Bank also secured federal funds borrowing lines from major correspondent banks totaling $44.0 million on an unsecured basis and an additional $25 million on a secured basis.

Traditionally, PBI Bank has utilized borrowings from the FHLB to supplement our funding requirements. At June 30, 2010, the Bank had an unused borrowing capacity with the FHLB of $56.7 million. Management believes our sources of liquidity are adequate to meet expected cash needs for the foreseeable future.

We use cash to pay dividends on common stock, if and when declared by the board of directors, and to service debt. The main sources of funding include dividends paid by PBI Bank, management fees received from PBI Bank and affiliated banks and financing obtained in the capital markets. PBI Bank must obtain the prior written consent of its primary regulators prior to declaring or paying any future dividends.

Capital

Stockholders’ equity increased $26.9 million to $196.2 million at June 30, 2010 compared with $169.3 million at December 31, 2009. The increase was due to the completion of a stock offering during the 2010 second quarter that raised $27.0 million in gross proceeds, net income earned during the first six months of 2010 reduced by dividends declared on common stock and dividends paid on 5% cumulative preferred stock, and increased unrealized net gains on available-for-sale securities. Both the Company and PBI Bank qualified as well capitalized under regulatory guidelines at June 30, 2010.

See Footnote 10 “Capital” for detailed regulatory capital ratios.

Item 3. Quantitative and Qualitative Disclosures about Market Risk

The Company’s interest sensitivity profile was asset sensitive at June 30, 2010, and December 31, 2009. Given an instantaneous 100 basis point decrease in rates that was sustained for 12 months, base net interest income would decrease by an estimated 4.8% at June 30, 2010 compared with a decrease of 4.5% at December 31, 2009. Given a 100 basis point increase in interest rates, base net interest income would increase by an estimated 4.3% at June 30, 2010, compared with an increase of 4.9% at December 31, 2009 and is within the risk tolerance parameters of our risk management policy.

The following table indicates the estimated impact on net interest income under various interest rate scenarios for the twelve months following June 30, 2010, as calculated using the static shock model approach:

 

     Change in Future
Net Interest Income
 
     Dollar Change    Percentage Change  
     (dollars in thousands)  

+ 200 basis points

   $ 5,502    8.88

+ 100 basis points

     2,664    4.30   

 

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We did not run a model simulation for declining interest rates as of June 30, 2010, because the Federal Reserve effectively lowered the federal funds target rate between 0.00% to 0.25% in December 2008. Therefore, no further short-term rate reductions can occur. As we implement strategies to mitigate the risk of rising interest rates in the future, these strategies will lessen our forecasted “base case” net interest income in the event of no interest rate changes.

Item 4. Controls and Procedures

As of the end of the period covered by this Quarterly Report on Form 10-Q for the quarter ended June 30, 2010, we carried out an evaluation, under the supervision and with the participation of our management, including our chief executive officer and chief financial officer, of the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934). Based on this evaluation, our chief executive officer and chief financial officer concluded that, as of the end of the fiscal quarter covered by this report, these disclosure controls and procedures are effective to ensure that information required to be disclosed by us in the reports we file or submit under the Exchange Act is: (a) recorded, processed, summarized and reported within the time periods specified in the rules and forms of the Securities and Exchange Commission, and (b) accumulated and communicated to our management, including our chief executive officer and chief financial officer, as appropriate to allow timely decisions regarding required disclosure. Additionally, there was no change in our internal control over financial reporting during the fiscal quarter covered by this report that has materially affected, or is reasonably likely to materially affect, the internal control over financial reporting.

 

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PART II – OTHER INFORMATION

 

Item 1. Legal Proceedings

In the normal course of operations, we are defendants in various legal proceedings. In the opinion of management, there is no proceeding pending or, to the knowledge of our management, threatened litigation in which an adverse decision could result in a material adverse change in our business or consolidated financial position.

 

Item 1A. Risk Factors

Information regarding risk factors appears in the Company’s Annual Report on Form 10-K for the year ended December 31, 2009 under Item 1A – Risk Factors. There have been no material changes from the risk factors previously discussed in our Form 10-K.

 

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

Sale of Equity Securities

On June 30, 2010, the Company completed a $27.0 million stock offering in a private placement to select accredited investors in which the Company issued:

 

   

1,755,747 shares of common stock for $11.50 per share,

 

   

227,000 shares of Cumulative Mandatory Convertible Perpetual Preferred Stock, Series B (“Series B Preferred Stock”) for $11.50 per share;

 

   

365,080 shares of Non-Voting Mandatory Convertible Preferred Stock, Series C (“Series C Preferred Stock”) for $11.50 per share; and

 

   

warrants to purchase 1,163,045 shares of convertible non-voting common stock (“Non-Voting Common Stock”) at a purchase price of $11.50 per share (“Warrants”).

On July 23, 2010, the Company completed a supplemental private placement to one additional accredited investor on comparable terms as the June 30, 2010 private placement. The Company received aggregate gross proceeds of $4,255,000 from the new investor in exchange for the sale and issuance of:

 

   

370,000 shares of Series B Preferred Stock for $11.50 per share, and

 

   

a Warrant to purchase 185,000 shares of Non-Voting Common Stock at a purchase price of $11.50 per share.

The Company also granted the new investor an option to purchase both 64,784 shares of common stock and a Warrant to purchase 32,392 shares of Non-Voting Common Stock at a purchase price of $11.50 per share. The option exercise price is $745,016, increasing the total potential gross proceeds to be received from the new investor to $5,000,016. The option will become exercisable during the five business days following shareholder approval at the special meeting.

The Company must obtain shareholder approval to (1) issue common stock upon the conversion of Series B Preferred Stock, Series C Preferred Stock and Non-Voting Common Stock and the exercise of the option to purchase common stock in accordance with NASDAQ Rule 5635; and (2) authorize the new class of Non-Voting Common Stock issuable upon the exercise of the Warrants. The Company expects to submit these proposals for shareholder approval at a special shareholder meeting during the third quarter of 2010.

 

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Both the June 30, 2010 and July 23, 2010 private placements were exempt from registration pursuant to section 4(2) of the Securities Act of 1933.

Purchases of Equity Securities by Issuer

In December 2006, the Company’s Board of Directors approved the repurchase of shares of Porter Bancorp’s common stock in an amount not to exceed $3 million, exclusive of any fees or commissions. As of June 30, 2010, Porter Bancorp had approximately $2.5 million remaining to purchase shares under the current stock repurchase program. The shares may be repurchased from time to time in open market transactions or privately negotiated transactions at its discretion, subject to market conditions and other factors. The Company did not repurchase any shares in the second quarter of 2010. The terms of the $35 million senior preferred stock transaction with the U.S. Treasury limit our ability to repurchase shares of common stock until after November 21, 2011, unless the preferred shares sold to the U.S. Treasury have been redeemed in whole or transferred to an unaffiliated third party.

 

Item 3. Default Upon Senior Securities

Not applicable.

 

Item 4. (Reserved)

 

Item 5. Other Information

Not applicable.

 

Item 6. Exhibits

(a) Exhibits

The following exhibits are filed or furnished as part of this report:

 

Exhibit
Number

  

Description of Exhibit

31.1    Certification of Principal Executive Officer, pursuant to Rule 13a – 14(a).
31.2    Certification of Principal Financial Officer, pursuant to Rule 13a – 14(a).
32.1    Certification of Principal Executive Officer, pursuant to 18 U.S.C Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2    Certification of Principal Financial Officer, pursuant to 18 U.S.C Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

 

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act if 1934, the Registrant had duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

        PORTER BANCORP, INC.
    (Registrant)
August 16, 2010     By:  

  /s/ Maria L. Bouvette

        Maria L. Bouvette
        President & Chief Executive Officer
August 16, 2010     By:  

  /s/ David B. Pierce

        David B. Pierce
        Chief Financial Officer and Chief Accounting Officer

 

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