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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 September 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.

11,281,625 shares of Common Stock, no par value, were outstanding at October 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      37   

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      38   


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 September 30, 2010 and December 31, 2009

Unaudited Consolidated Statements of Income for the three and nine months ended September 30, 2010 and 2009

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

Unaudited Consolidated Statements of Cash Flows for the nine months ended September 30, 2010 and 2009

Notes to Unaudited Consolidated Financial Statements

 

1

 


Table of Contents

 

PORTER BANCORP, INC. AND SUBSIDIARY

Unaudited Consolidated Balance Sheets

(dollars in thousands except share data)

 

     September 30,
2010
     December 31,
2009
 

Assets

     

Cash and due from financial institutions

   $ 166,077       $ 169,328   

Federal funds sold

     793         2,845   
                 

Cash and cash equivalents

     166,870         172,173   

Securities available for sale

     150,569         168,721   

Mortgage loans held for sale

     484         334   

Loans, net of allowance of $29,392 and $26,392, respectively

     1,298,819         1,386,526   

Premises and equipment

     22,708         23,610   

Other real estate owned

     73,645         14,548   

Goodwill

     23,794         23,794   

Accrued interest receivable and other assets

     43,290         45,384   
                 

Total assets

   $ 1,780,179       $ 1,835,090   
                 

Liabilities and Stockholders’ Equity

     

Deposits

     

Non-interest bearing

   $ 103,424       $ 97,263   

Interest bearing

     1,286,639         1,432,833   
                 

Total deposits

     1,390,063         1,530,096   

Federal funds purchased and repurchase agreements

     34,083         11,517   

Federal Home Loan Bank advances

     110,763         82,980   

Accrued interest payable and other liabilities

     8,922         7,163   

Subordinated capital note

     8,775         9,000   

Junior subordinated debentures

     25,000         25,000   
                 

Total liabilities

     1,577,606         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 September 30, 2010

     34,439         34,307   

Series C – 317,042 issued and outstanding Liquidation preference of $3.6 million at September 30, 2010

     3,283         —     

Common stock, no par, 19,000,000 shares authorized, 11,281,691 and 8,756,440 shares issued and outstanding, respectively

     107,212         83,104   

Additional paid-in capital

     18,468         14,959   

Retained earnings

     33,228         34,811   

Accumulated other comprehensive income

     5,943         2,153   
                 

Total stockholders’ equity

     202,573         169,334   
                 

Total liabilities and stockholders’ equity

   $ 1,780,179       $ 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
September 30,
     Nine Months Ended
September 30,
 
     2010      2009      2010     2009  

Interest income

          

Loans, including fees

   $ 19,293       $ 20,961       $ 58,937      $ 63,333   

Taxable securities

     1,689         2,469         6,023        6,483   

Tax exempt securities

     212         218         643        662   

Fed funds sold and other

     146         154         489        471   
                                  
     21,340         23,802         66,092        70,949   
                                  

Interest expense

          

Deposits

     5,890         8,190         19,816        27,576   

Federal Home Loan Bank advances

     498         858         1,718        2,944   

Subordinated capital note

     83         84         235        284   

Junior subordinated debentures

     170         176         481        636   

Federal funds purchased and other

     123         120         362        355   
                                  
     6,764         9,428         22,612        31,795   
                                  

Net interest income

     14,576         14,374         43,480        39,154   

Provision for loan losses

     5,000         2,000         14,600        5,200   
                                  

Net interest income after provision for loan losses

     9,576         12,374         28,880        33,954   

Non-interest income

          

Service charges on deposit accounts

     757         843         2,270        2,319   

Income from fiduciary activities

     226         227         751        645   

Secondary market brokerage fees

     83         49         273        180   

Title insurance commissions

     38         33         114        97   

Net gain on sales of loans originated for sale

     135         82         410        323   

Net gain on sales of securities

     2,175         321         2,256        322   

Other than temporary impairment on securities

     —           —           (465     —     

Other

     517         481         1,511        1,531   
                                  
     3,931         2,036         7,120        5,417   
                                  

Non-interest expense

          

Salaries and employee benefits

     3,849         3,799         11,727        11,490   

Occupancy and equipment

     1,070         993         3,107        2,972   

Other real estate owned expense

     2,163         353         6,395        706   

FDIC Insurance

     855         626         2,266        1,588   

FDIC special assessment

     —           —           —          781   

State franchise tax

     543         450         1,629        1,350   

Professional fees

     239         175         797        606   

Postage and delivery

     183         193         569        561   

Communications

     179         183         538        568   

Advertising

     104         121         277        404   

Other

     764         691         2,206        2,062   
                                  
     9,949         7,584         29,511        23,088   
                                  

Income before income taxes

     3,558         6,826         6,489        16,283   

Income tax expense

     1,137         2,290         1,943        5,441   
                                  

Net income

     2,421         4,536         4,546        10,842   

Less:

          

Dividends on preferred stock

     498         437         1,373        1,312   

Accretion on Series A preferred stock

     44         44         132        132   

Earnings allocated to participating securities

     88         —           81        —     
                                  

Net income available to common shareholders

   $ 1,791       $ 4,055       $ 2,960      $ 9,398   
                                  

Basic earnings per common share

   $ 0.17       $ 0.46       $ 0.32      $ 1.08   
                                  

Diluted earnings per common share

   $ 0.16       $ 0.46       $ 0.31      $ 1.08   
                                  

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 Nine Months Ended September 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

    1,820,531        —          597,000        365,080        17,429        —          6,182        3,780        3,149        —          —          30,540   

Conversion of Series B preferred to common

    597,000        —          (597,000     —          6,182        —          (6,182     —          —          —          —          —     

Conversion of Series C preferred to common

    48,038        —          —          (48,038     497        —          —          (497     —          —          —          —     

Issuance of unvested stock

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

Forfeited unvested stock

    (9,500     —          —          —          —          —          —          —          —          —          —          —     

Stock-based compensation expense

    —          —          —          —          —          —          —          —          360        —          —          360   

Comprehensive income:

                       

Net income

    —          —          —          —          —          —          —          —          —          4,546        —          4,546   

Changes in accumulated other comprehensive income, net of taxes

    —          —          —          —          —          —          —          —          —          —          3,790        3,790   
                             

Total comprehensive income

    —          —          —          —          —          —          —          —          —          —          —          8,336   
                             

Dividends 5% on Series A preferred stock

    —          —          —          —          —          —          —          —          —          (1,313     —          (1,313

Dividends on Series B & C preferred stock ($0.10 per share)

    —          —          —          —          —          —          —          —          —          (96     —          (96

Amortization of Series A preferred stock discount

    —          —          —          —          —          132        —          —          —          (132     —          —     

Cash dividends declared on common stock ($0.50 per share)

    —          —          —          —          —          —          —          —          —          (4,588     —          (4,588
                                                                                               

Balances, September 30, 2010

    11,281,691        35,000        —          317,042      $ 107,212      $ 34,439      $ —        $ 3,283      $ 18,468      $ 33,228      $ 5,943      $ 202,573   
                                                                                               

See accompanying notes to unaudited consolidated financial statements.

 

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PORTER BANCORP, INC. AND SUBSIDIARY

Unaudited Consolidated Statements of Cash Flows

For Nine Months Ended September 30, 2010 and 2009

(dollars in thousands)

 

     2010     2009  

Cash flows from operating activities

    

Net income

   $ 4,546      $ 10,842   

Adjustments to reconcile net income to net cash from operating activities

    

Depreciation and amortization

     2,289        2,699   

Provision for loan losses

     14,600        5,200   

Net amortization (accretion) on securities

     (161     (198

Stock-based compensation expense

     348        282   

Net gain on loans originated for sale

     (410     (323

Loans originated for sale

     (20,580     (15,615

Proceeds from sales of loans originated for sale

     20,641        15,414   

Net gain on sales of investment securities

     (1,791     (322

Net loss on sales of other real estate owned

     302        73   

Net write-down of other real estate owned

     4,805        350   

Earnings on bank owned life insurance

     (220     (212

Net change in accrued interest receivable and other assets

     2,067        1,318   

Net change in accrued interest payable and other liabilities

     (282     (1,112
                

Net cash from operating activities

     26,154        18,396   
                

Cash flows from investing activities

    

Purchases of available-for-sale securities

     (26,792     (36,957

Sales and calls of available-for-sale securities

     32,914        13,675   

Maturities and prepayments of available-for-sale securities

     19,813        25,316   

Proceeds from sale of other real estate owned

     20,565        9,107   

Improvements to other real estate owned

     (1,792     (108

Loan originations and payments, net

     (10,510     (55,606

Purchases of premises and equipment, net

     (289     (2,428
                

Net cash from investing activities

     33,909        (47,001
                

Cash flows from financing activities

    

Net change in deposits

     (140,033     90,107   

Net change in federal funds purchased and repurchase agreements

     22,566        1,212   

Repayment of Federal Home Loan Bank advances

     (212,217     (212,492

Advances from Federal Home Loan Bank

     240,000        195,000   

Repayment of subordinated capital note

     (225     —     

Issuance of preferred stock and warrants

     11,064        —     

Issuance of common stock and warrants

     19,476        —     

Cash dividends paid on preferred stock

     (1,409     (1,283

Cash dividends paid on common stock

     (4,588     (5,243
                

Net cash from financing activities

     (65,366     67,301   
                

Net change in cash and cash equivalents

     (5,303     38,696   

Beginning cash and cash equivalents

     172,173        52,546   
                

Ending cash and cash equivalents

   $ 166,870      $ 91,242   
                

Supplemental cash flow information:

    

Interest paid

   $ 23,198      $ 25,271   

Income taxes paid

     3,850        6,150   

Supplemental non-cash disclosure:

    

Transfer from loans to other real estate

   $ 82,977      $ 14,724   

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 nine months ended September 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, goodwill and other intangibles, 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 January 2010, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2010-06, “Fair Value Measurements and Disclosures – Improving Disclosures about Fair Value Measurements.” The update requires new disclosures including significant transfers in and out of Level 1 and Level 2 fair value measurements. Also, the ASU provides an update on the reconciliation for fair value measurements using significant unobservable inputs (Level 3). The new guidance is effective for interim and annual periods beginning after December 15, 2009, except for the update on the reconciliation of Level 3 fair value measurements, which is effective for fiscal years beginning after December 15, 2010. The portion that is currently effective did not have an impact on the Company’s consolidated financial statements. The portion that is not yet effective is not expected to have an impact on the Company’s financial statements.

In July 2010, the FASB issued ASU No. 2010-20, “Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses,” which requires significant new disclosures about the allowance for credit losses and the credit quality of financing receivables, which for the Company includes loans and standby letters of credit. The requirements are intended to enhance transparency regarding credit losses and the credit quality of loan and lease receivables. Under this statement, allowance for loan losses is to be disclosed by portfolio segment, while credit quality information, impaired loans and nonaccrual status are to be presented by class. Disclosure of the nature and extent, the financial impact and segment information of troubled debt restructurings will also be required. The disclosures are to be presented at the level of disaggregation that management uses when assessing and monitoring the portfolio’s risk and performance. This ASU is effective for interim and annual reporting periods after December 15, 2010. The adoption of ASU 2010-20 is expected to result in additional quarterly and annual disclosures beginning in the fourth quarter of 2010.

 

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Legislative Developments

The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (the “Act”) was signed into law on July 21, 2010. Generally, the Act is effective the day after it was signed into law, but different effective dates apply to specific sections of the law. Uncertainty remains as to the ultimate impact of the Act, which could have an adverse impact on the financial services industry as a whole and on the Company’s business, results of operations, and financial condition.

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 September 30, 2010, the Company had granted outstanding options to purchase 39,601 shares. The Company also had granted 146,909 unvested shares net of forfeitures and vesting. The Company has 171,924 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 September 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:

 

     Nine Months Ended
September 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

     (15,659     22.62         (552     23.13   

Expired

     (198,997     23.38         —          —     
                     

Outstanding, ending

     82,602      $ 21.76         297,258      $ 22.89   
                     

 

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The following table details stock options outstanding:

 

     September 30,
2010
 

Stock options vested and currently exercisable:

     82,578   

Weighted average exercise price

   $ 21.76   

Aggregate intrinsic value

   $ 0   

Weighted average remaining life (in years)

     1.1   

Total Options Outstanding:

     82,602   

Aggregate intrinsic value

   $ 0   

Weighted average remaining life (in years)

     1.1   

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 September 30, 2010. There were no options exercised during the first nine months of 2010. The Company recorded $2,000 of stock option compensation during the nine months ended September 30, 2010 to salaries and employee benefits. A deferred tax benefit of $1,000 was recognized related to this expense. No options were modified during the period. As of September 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 $346,000 of stock-based compensation during the first nine months of 2010 to salaries and employee benefits. A deferred tax benefit of $121,000 was recognized related to this expense.

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

 

     Nine Months Ended
September 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

     (9,500     13.35         (541     23.13   
                     

Outstanding, ending

     151,553      $ 14.05         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):

 

October 2010 – December 2010

   $ 120   

2011

     488   

2012

     477   

2013

     389   

2014 & thereafter

     448   

 

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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)  

September 30, 2010

          

U.S. Government and federal agency

   $ 10,343       $ 1,023       $ —        $ 11,366   

State and municipal

     24,038         1,851         —          25,889   

Agency mortgage-backed: residential

     90,633         4,792         —          95,425   

Corporate bonds

     14,308         1,431         (5     15,734   

Other debt securities

     704         —           (87     617   
                                  

Total debt securities

     140,026         9,097         (92     149,031   

Equity

     1,400         150         (12     1,538   
                                  

Total

   $ 141,426       $ 9,247       $ (104   $ 150,569   
                                  

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
September 30,
     Nine Months Ended
September 30,
 
     2010     2009      2010     2009  
     (in thousands)  

Proceeds

   $ 24,500      $ 12,913       $ 32,914      $ 13,675   

Gross gains

     2,872        321         3,152        322   

Gross losses

     (697     —           (896     —     

The amortized cost and fair value of the debt 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.

 

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

Maturity

     

Available-for-sale

     

Within one year

   $ 25,592       $ 26,239   

One to five years

     80,000         85,279   

Five to ten years

     32,695         35,746   

Beyond ten years

     1,739         1,767   
                 

Total

   $ 140,026       $ 149,031   
                 

 

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Securities pledged at September 30, 2010 and December 31, 2009 had carrying values of approximately $70.4 million and $67.3 million, respectively, and were pledged to secure public deposits, repurchase agreements, and Federal Home Loan Bank advances.

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 September 30, 2010, the Company held 43 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 July and early August 2010, we determined that we could not 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 September 30, 2010, management does not believe any securities in our portfolio with unrealized losses should be classified as other than temporarily impaired at this time.

Securities with unrealized losses at September 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)  

September 30, 2010

                                       

Corporate bonds

   $ 1,022       $ (5   $ —         $ —        $ 1,022       $ (5

Other debt securities

     —           —          617         (87     617         (87

Equity

     53         (3     316         (9     369         (12
                                                   

Total temporarily impaired

   $ 1,075       $ (8   $ 933       $ (96   $ 2,008       $ (104
                                                   

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:

 

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

Commercial

   $ 81,527      $ 89,903   

Real estate

     1,188,096        1,259,474   

Agriculture

     24,437        25,064   

Consumer

     33,062        36,989   

Other

     1,089        1,488   
                

Subtotal

     1,328,211        1,412,918   

Less: Allowance for loan losses

     (29,392     (26,392
                

Loans, net

   $ 1,298,819      $ 1,386,526   
                

Activity in the allowance for loan losses was as follows:

 

     For the Nine Months Ended  
     September 30,
2010
    September 30,
2009
 
     (in thousands)  

Beginning balance

   $ 26,392      $ 19,652   

Provision for loan losses

     14,600        5,200   

Loans charged-off

     (11,823     (3,112

Loan recoveries

     223        218   
                

Ending balance

   $ 29,392      $ 21,958   
                

Impaired loans were as follows:

 

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

Loans with no allocated allowance for loan losses

   $ 13,449       $ 21,373   

Loans with allocated allowance for loan losses

     35,305         84,766   
                 

Total

   $ 48,754       $ 106,139   
                 

Amount of the allowance for loan losses allocated

   $ 5,526       $ 5,453   

 

     Nine Months
Ended
September 30,
2010
     Year Ended
December 31,
2009
 

Average of impaired loans during the period

   $ 68,527       $ 44,041   

Interest income recognized during impairment

     1,012         1,094   

Cash basis interest income recognized

     87         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.

 

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Nonperforming loans were as follows:

 

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

Loans past due 90 days or more still on accrual

   $ 7,048       $ 5,968   

Non-accrual loans

     38,784         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 September 30, 2010, and December 31, 2009, we had restructured loans totaling $22.0 million and $25.2 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:

 

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

Construction, land development, and land

   $ 57,274       $ 7,526   

Farmland

     1,946         442   

1-4 Family residential

     10,179         4,642   

Multi-family residential

     614         —     

Commercial real estate

     3,632         1,938   
                 

Total

   $ 73,645       $ 14,548   
                 

 

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Net activity relating to other real estate owned during the nine months ended September 30, 2010 is as follows:

 

OREO Activity (in thousands)

      

OREO as of January 1, 2010

   $ 14,548   

Real estate acquired

     82,977   

Valuation adjustments

     (4,805

Improvements

     1,792   

Properties sold

     (20,867
        

OREO as of September 30, 2010

   $ 73,645   
        

Expenses related to other real estate owned include:

 

     Three Months Ended      Nine Months Ended  
     September 30,
2010
     September 30,
2009
     September 30,
2010
     September 30,
2009
 
     (in thousands)  

Net loss on sales

   $ 212       $ 13       $ 302       $ 73   

Impairment write-downs

     926         150         4,805         350   

Operating expenses

     1,025         190         1,288         283   
                                   

Total

   $ 2,163       $ 353       $ 6,395       $ 706   
                                   

Note 6 – Advances from the Federal Home Loan Bank

Advances from the Federal Home Loan Bank were as follows:

 

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

Single maturity advances with fixed rates from 0.15% to 4.82% maturing from 2010 through 2012, averaging 1.66% for 2010

   $ 100,000       $ 70,000   

Monthly amortizing advances with fixed rates from 0.00% to 8.28% and maturities ranging from 2011 through 2035, averaging 3.62% for 2010

     
     10,763         12,980   
                 

Total

   $ 110,763       $ 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 September 30, 2010, the Bank had unused borrowing capacity of $261,000 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.

 

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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.

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

 

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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.

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 September 30, 2010 are summarized below:

 

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

Description

   September 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

   $ 11,366       $ —         $ 11,366       $ —     

State and municipal

     25,889         —           25,889         —     

Agency mortgage-backed

     95,425         —           95,425         —     

Corporate bonds

     15,734         —           15,734         —     

Other debt securities

     617         —           —           617   

Equity securities

     1,538         1,538         —           —     

Total

   $ 150,569       $ 1,538       $ 148,414       $ 617   

 

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

 

Available-for-sale securities

   Nine Months  Ended
September 30, 2010
 

Balance, January 1, 2010

   $ 32,168   

Purchases

     —     

Sales

     (7,769

Net accretion (amortization)

     606   

Principal paydowns

     (3,475

Transfers to Level 2

     (22,878

Net change in unrealized gain/loss

     1,965   

Balance, September 30, 2010

   $ 617   

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

 

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

Description

   September 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

   $ 29,779       $ —         $ —         $ 29,779   

Other real estate owned, net

     73,645         —           —           73,645   

Impaired loans, which are measured for impairment using the fair value of collateral for collateral dependent loans, had a carrying amount of $35.3 million and a valuation allowance of $5.5 million, resulting in an additional provision for loan losses of $3.0 million for the first nine months of 2010. Additional provision for loan losses of $194,000 was recorded during the first nine months 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 $73.6 million. Write-downs of $4.8 million and $350,000 were recorded on other real estate owned during the first nine 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   
                                   

 

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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   

Impaired loans, which are measured for impairment using the fair value of collateral for collateral dependent loans, had a carrying amount of $84.8 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:

 

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

Financial assets

           

Cash and cash equivalents

   $ 166,870       $ 166,870       $ 172,173       $ 172,173   

Securities available for sale

     150,569         150,569         168,721         168,721   

Federal Home Loan Bank stock

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

Loans, net

     1,298,819         1,303,775         1,386,526         1,396,465   

Accrued interest receivable

     8,153         8,153         9,329         9,329   

Financial liabilities

           

Deposits

   $ 1,390,063       $ 1,397,299       $ 1,530,096       $ 1,526,508   

Federal funds purchased and securities sold under agreements to repurchase

     34,083         34,083         11,517         11,517   

Federal Home Loan Bank advances

     110,763         111,046         82,980         83,217   

Subordinated capital notes

     8,775         8,079         9,000         7,323   

Junior subordinated debentures

     25,000         21,722         25,000         18,250   

Accrued interest payable

     2,119         2,119         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 financial institutions, 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

 

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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.

Note 8 – Earnings per Share

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

 

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

Net income

   $ 2,421       $ 4,536       $ 4,546       $ 10,842   

Less:

           

Preferred stock dividends

     498         437         1,373         1,312   

Accretion of Series A preferred stock discount

     44         44         132         132   

Earnings allocated to unvested shares

     27         —           42         —     

Earnings allocated to Series C preferred

     61         —           39         —     
                                   

Net income allocated to common shareholders, basic and diluted

   $ 1,791       $ 4,055       $ 2,960       $ 9,398   
                                   

Basic

           

Weighted average common shares including unvested common shares outstanding

     11,013,063         8,756,289         9,552,646         8,740,314   

Less: Weighted average unvested common shares

     155,865         —           132,685         —     

Less: Weighted average Series C preferred

     360,381         —           122,608         —     
                                   

Weighted average common shares outstanding

     10,496,817         8,756,289         9,297,353         8,740,314   
                                   

Basic earnings per common share

   $ 0.17       $ 0.46       $ 0.32       $ 1.08   
                                   

Diluted

           

Add: Weighted average Series B preferred issued and outstanding

     532,108         —           181,506         —     

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

     —           —           27,427         —     
                                   

Weighted average common shares and potential common shares

     11,028,925         8,756,289         9,506,286         8,740,314   
                                   

Diluted earnings per common share

   $ 0.16       $ 0.46       $ 0.31       $ 1.08   
                                   

Stock options for 82,602 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 September 30, 2010 and 2009 but was not included in the diluted EPS computation as inclusion would have been anti-dilutive. Finally, warrants for the purchase of 1,380,437 shares of non-voting common stock at an exercise price of $11.50 per share were outstanding at September 30, 2010, but were not included in the diluted EPS computation for the three months ended September 30, 2010, 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
September 30,
    Nine Months Ended
September 30,
 
     2010     2009     2010     2009  
     (in thousands)  

Unrealized holding gains on available-for-sale securities

   $ 2,772      $ 4,186      $ 7,622      $ 3,919   

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

     2,175        321        1,791        322   
                                

Net unrealized gains

     597        3,865        5,831        3,597   

Tax effect

     (209     (1,353     (2,041     (1,259
                                

Net-of-tax amount

   $ 388      $ 2,512      $ 3,790      $ 2,338   
                                

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) 1,755,747 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 was automatically convertible 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. We also issued warrants to purchase 1,163,045 shares of non-voting common stock at a price of $11.50 per share.

On July 23, 2010, we completed a $4,255,000 stock offering to another accredited investor 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 transaction, we issued (i) 370,000 shares of Series B preferred stock at $11.50 per share 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 the accredited investor 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 the accredited investor to $5,000,000. The option was exercisable during the five business days following receipt of shareholder approval for purposes of NASDAQ Rule 5635.

The Company held a special meeting of shareholders on September 16, 2010. The shareholders approved the proposal for the issuance of common shares to allow for the conversion or exercise of 597,000 shares of the Series B preferred stock; 365,080 shares of our Series C preferred stock; 1,380,437 shares of non-voting common stock; and an option to purchase 64,784 shares of common stock at $11.50 per share. The shareholders also approved the proposal to authorize the new class of non-voting common stock, which will be issuable upon the exercise of the stock purchase warrants at a purchase price of $11.50 per share.

As a result of the shareholder approval, on September 21, 2010, 597,000 shares of Series B preferred stock were automatically converted into 597,000 shares of common stock. On September 27, 2010, the Company issued an additional 64,784 shares of common stock and granted a warrant to purchase 32,392 shares of non-voting common stock, in connection with the exercise of the option granted in the supplemental private placement transaction. This issuance of the additional shares of common stock resulted in the conversion of 48,038 shares of Series C preferred stock into shares of common stock in accordance with the terms of the Series C preferred stock described below.

 

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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. 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.

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 September 16, 2015. 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.

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%.

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:

 

                 September 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     14.44     12.48     11.93     10.65

Total risk-based capital

     8.0        10.0        16.35        14.39        13.83        12.56   

Tier I leverage ratio

     4.0        5.0        11.71        10.11        9.59        8.57   

 

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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 nine months ended September 30, 2010, respectively, the Company reported net income of $2.4 million and $4.5 million. This compares with net income of $4.5 million and $10.8 million, respectively, for the same periods of 2009. Net income available to common shareholders for the three and nine months ended September 30, 2010 was $1.8 million and $3.0 million, respectively. Fully diluted earnings per common share were $0.16 and $0.31 for the three and nine months ended September 30, 2010, respectively, compared with $0.46 and $1.08 for the same periods of 2009.

 

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Significant developments during the quarter and nine months ended September 30, 2010 consist of the following:

 

   

Net interest margin increased 14 basis points to 3.73% in the third quarter of 2010 compared with 3.59% in the third quarter of 2009. For the first nine months of 2010, net interest margin increased to 3.58% compared with 3.25% for the same period of 2009. The increase in margin since last year benefited from a lower average cost of funds.

 

   

Net interest income increased 1.4% to $14.6 million for the three months ended September 30, 2010, and 11.0% to $43.5 million for the nine months ended September 30, 2010, compared with the same quarter and nine months of 2009, respectively. Net interest income benefited from a lower average cost of funds.

 

   

The Company recorded net income of $2.4 million and $4.5 million for the three and nine months ended September 30, 2010, respectively, compared with net income of $4.5 million and $10.8 million for the same periods of 2009, respectively. The decrease in net income between the comparable periods was due primarily to increased provision for loan losses expense and other real estate owned expense.

 

   

Net loans decreased 4.8% to $1.30 billion compared with $1.37 billion at September 30, 2009.

 

   

Deposits increased 0.8% to $1.39 billion compared with $1.38 billion at September 30, 2009.

 

   

Total assets increased 3.0% to $1.78 billion compared with $1.73 billion at September 30, 2009.

 

   

Efficiency ratio was 60.5% for the first nine months of 2010, compared with 52.2% for the first nine of 2009. Our efficiency ratio increased from 47.1% in the 2009 third quarter to 60.9% in the third quarter of 2010 due primarily to increased other real estate owned expense.

 

   

Non-performing loans decreased $2.9 million, or 5.9%, during the third quarter to $45.8 million at September 30, 2010, compared with $48.7 million at June 30, 2010. The decrease was primarily attributable to non-performing loans moving through the collection, foreclosure and disposition process.

 

   

Non-performing assets increased $2.3 million, or 2.0%, during the third quarter to $119.5 million at September 30, 2010. The increase was primarily attributable to non-performing loans moving through the collection, foreclosure and disposition process.

 

   

Shareholders’ equity rose to $202.6 million at the end of the third quarter and benefited from a stock offering that raised $27 million in gross proceeds at June 30, 2010 and an additional $5 million in gross proceeds during the third quarter. The proceeds from the offering and third quarter net income resulted in improved capital ratios, including 11.71% tier 1 leverage ratio and 14.44% tier 1 risk-based capital ratio as of September 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.

 

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Results of Operations

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

 

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

Gross interest income

   $ 21,340       $ 23,802       $ (2,462     (10.3 )% 

Gross interest expense

     6,764         9,428         (2,664     (28.3

Net interest income

     14,576         14,374         202        1.4   

Provision for credit losses

     5,000         2,000         3,000        150.0   

Non-interest income

     3,931         2,036         1,895        93.1   

Non-interest expense

     9,949         7,584         2,365        31.2   

Net income before taxes

     3,558         6,826         (3,268     (47.9

Income tax expense

     1,137         2,290         (1,153     (50.3

Net income

     2,421         4,536         (2,115     (46.6

Net income of $2,421,000 for the three months ended September 30, 2010 decreased $2.1 million, or 46.6%, from net income of $4,536,000 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 expense. Net interest income benefited from decreased cost of funds to 1.93% in the 2010 third quarter from 2.67% in the prior year third quarter. The increase in non-interest income was due to increased net gains on sales of securities. The increase in non-interest expense was attributable to increased other real estate owned expense, FDIC insurance fees and state franchise tax. Other real estate owned (OREO) expense increased to $2.2 million in the third quarter of 2010 compared with $353,000 in the third quarter of 2009 due to increased losses on sales of OREO, valuation write-downs to account for lower valuations on the underlying real estate collateral, and increased OREO operating costs. FDIC insurance fees increased to $855,000 for the third quarter of 2010 compared with $626,000 in the third quarter of 2009. State franchise tax expense increased to $543,000 in the 2010 third quarter compared with $450,000 in the prior year third quarter.

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

 

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

Gross interest income

   $ 66,092       $ 70,949       $ (4,857     (6.8 )% 

Gross interest expense

     22,612         31,795         (9,183     (28.9

Net interest income

     43,480         39,154         4,326        11.0   

Provision for credit losses

     14,600         5,200         9,400        180.8   

Non-interest income

     7,120         5,417         1,703        31.4   

Non-interest expense

     29,511         23,088         6,423        27.8   

Net income before taxes

     6,489         16,283         (9,794     (60.1

Income tax expense

     1,943         5,441         (3,498     (64.3

Net income

     4,546         10,842         (6,296     (58.1

 

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Net income of $4,546,000 for the nine months ended September 30, 2010 decreased $6.3 million, or 58.1%, from $10,842,000 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 expense. Net interest income benefited from decreased cost of funds to 2.06% in the first nine months of 2010 from 2.98% in the same period of 2009. The increase in non-interest income was due primarily to increased net gains on sales of securities, partially offset by an other than temporary impairment charge on securities of $465,000. Non-interest income also benefited from increased income from fiduciary activities, secondary market brokerage fees, and gains on sales of loans originated for sale. The increase in non-interest expense was due to an increase of $4.5 million in other real estate owned valuation write-downs, a $1.0 million increase in other real estate owned operating costs, increased salary and benefits expense, and franchise tax expense. These increases were partially offset by lower advertising expense and FDIC fees. Total FDIC fees were $2.3 million in the first nine months of 2010 compared with $2.4 million in the first nine months of 2009. The 2009 FDIC fees included a special assessment of $781,000.

Net Interest Income – Our net interest income was $14,576,000 for the three months ended September 30, 2010, an increase of $202,000, or 1.4%, compared with $14,374,000 for the same period in 2009. Net interest spread and margin were 3.51% and 3.73%, respectively, for the third quarter of 2010, compared with 3.26% and 3.59%, respectively, for the third quarter of 2009. Net interest income was $43,480,000 for the nine months ended September 30, 2010, an increase of $4.3 million, or 11.0%, compared with $39,154,000 for the same period of 2009. Net interest spread and margin were 3.37% and 3.58%, respectively, for the first nine months of 2010, compared with 2.88% and 3.25%, respectively, for the first nine months of 2009. Net interest margin for the first nine months of 2010 increased 33 basis points from our margin of 3.25% in the first nine months of 2009 due primarily to increased average earning assets coupled with lower cost of funds.

Our yield on earning assets decreased to 5.44% for the third quarter of 2010 compared to 5.93% for the third quarter of 2009. Our cost of funds also decreased to 1.93% for the third quarter of 2010 compared to 2.67% for the third quarter of 2009. Our yield on earning assets declined 43 basis points from 5.86% during the first nine months of 2009 and our cost of funds decreased 92 basis points from 2.98%.

Our average interest-earning assets were $1.64 billion for the nine months ended September 30, 2010, compared with $1.63 billion for the nine months ended September 30, 2009, a 0.6% increase primarily attributable to growth in loans. Average loans were $1.37 billion for the nine months ended September 30, 2010, compared with $1.36 billion for the nine months ended September 30, 2009, a 0.2% increase. Our total interest income decreased by 6.8% to $66.1 million for the nine months ended September 30, 2010, compared with $70.9 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 2.8%, to $1.47 billion for the nine months ended September 30, 2010, compared with $1.43 billion for the nine months ended September 30, 2009. Our total interest expense decreased by 28.9% to $22.6 million for the nine months ended September 30, 2010, compared with $31.8 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 9.2% to $1.17 billion for the nine months ended September 30, 2010, compared with $1.07 billion for the nine months ended September 30, 2009. The average interest rate paid on certificates of deposits decreased to 2.10% for the nine months ended September 30, 2010, compared with 3.23% for the nine months ended September 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 September 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 September 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)

   $ 1,335,357      $ 19,293         5.73   $ 1,368,970      $ 20,961         6.07

Securities

              

Taxable

     132,624        1,676         5.01        152,231        2,457         6.40   

Tax-exempt (3)

     21,233        212         6.09        21,640        218         6.15   

FHLB stock

     10,072        113         4.45        10,072        125         4.92   

Other equity securities

     1,445        13         3.57        1,901        12         2.50   

Federal funds sold and other

     62,868        33         0.21        45,129        29         0.25   
                                      

Total interest-earning assets

     1,563,599        21,340         5.44     1,599,943        23,802         5.93
                          

Less: Allowance for loan losses

     (27,730          (21,283     

Non-interest earning assets

     168,174             96,043        
                          

Total assets

   $ 1,704,043           $ 1,674,703        
                          

LIABILITIES AND STOCKHOLDERS’ EQUITY

              

Interest-bearing liabilities:

              

Certificates of deposit and other time deposits

   $ 1,095,128      $ 5,381         1.95   $ 1,082,457      $ 7,654         2.81

NOW and money market deposits

     168,910        444         1.04        161,327        461         1.13   

Savings accounts

     35,841        65         0.72        34,250        75         0.87   

Federal funds purchased and repurchase agreements

     12,105        123         4.03        11,332        120         4.20   

FHLB advances

     47,447        498         4.16        78,425        858         4.34   

Junior subordinated debentures

     33,994        253         2.95        34,000        260         3.03   
                                      

Total interest-bearing liabilities

     1,393,425        6,764         1.93     1,401,791        9,428         2.67
                          

Non-interest-bearing liabilities:

              

Non-interest-bearing deposits

     102,963             95,592        

Other liabilities

     6,529             8,759        
                          

Total liabilities

     1,502,917             1,506,142        

Stockholders’ equity

     201,126             168,561        
                          
                    

Total liabilities and stockholders’ equity

   $ 1,704,043           $ 1,674,703        
                          

Net interest income

     $ 14,576           $ 14,374      
                          

Net interest spread

          3.51          3.26
                          

Net interest margin

          3.73          3.59
                          

 

(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 nine month periods ending September 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.

 

     Nine Months Ended September 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)

   $ 1,365,322      $ 58,937         5.77   $ 1,363,150      $ 63,333         6.21

Securities

              

Taxable

     145,961        5,987         5.48        151,550        6,442         5.68   

Tax-exempt (3)

     21,402        643         6.18        21,858        662         6.23   

FHLB stock

     10,072        339         4.50        10,072        351         4.66   

Other equity securities

     1,689        36         2.85        1,901        41         2.88   

Federal funds sold and other

     92,393        150         0.22        78,356        120         0.20   
                                      

Total interest-earning assets

     1,636,839        66,092         5.43     1,626,887        70,949         5.86
                          

Less: Allowance for loan losses

     (27,376          (20,634     

Non-interest earning assets

     148,705             95,714        
                          

Total assets

   $ 1,758,168           $ 1,701,967        
                          

LIABILITIES AND STOCKHOLDERS’ EQUITY

              

Interest-bearing liabilities:

              

Certificates of deposit and other time deposits

   $ 1,167,040      $ 18,329         2.10   $ 1,069,167      $ 25,839         3.23

NOW and money market deposits

     163,157        1,288         1.06        163,674        1,498         1.22   

Savings accounts

     35,587        199         0.75        34,860        239         0.92   

Federal funds purchased and repurchase agreements

     11,769        362         4.11        10,881        355         4.36   

FHLB advances

     54,785        1,718         4.19        114,393        2,944         3.44   

Junior subordinated debentures

     33,998        716         2.82        34,000        920         3.62   
                                      

Total interest-bearing liabilities

     1,466,336        22,612         2.06     1,426,975        31,795         2.98
                          

Non-interest-bearing liabilities:

              

Non-interest-bearing deposits

     101,722             99,523        

Other liabilities

     6,632             8,297        
                          

Total liabilities

     1,574,690             1,534,795        

Stockholders’ equity

     183,478             167,172        
                          

Total liabilities and stockholders’ equity

   $ 1,758,168           $ 1,701,967        
                          

Net interest income

     $ 43,480           $ 39,154      
                          

Net interest spread

          3.37          2.88
                          

Net interest margin

          3.58          3.25
                          

 

(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 September 30,
2010 vs. 2009
    Nine Months Ended September 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

   $ (1,131   $ (537   $ (1,668   $ (4,497   $ 101      $ (4,396

Securities

     (501     (286     (787     (231     (243     (474

FHLB stock

     (12     —          (12     (12     —          (12

Other equity securities

     4        (3     1        —          (5     (5

Federal funds sold and other

     (6     10        4        8        22        30   
                                                

Total decrease in interest income

     (1,646     (816     (2,462     (4,732     (125     (4,857
                                                

Interest-bearing liabilities:

            

Certificates of deposit and other time deposits

     (2,362     89        (2,273     (9,703     2,193        (7,510

NOW and money market accounts

     (42     25        (17     (205     (5     (210

Savings accounts

     (13     3        (10     (45     5        (40

Federal funds purchased and repurchased agreements

     (5     8        3        (21     28        7   

FHLB advances

     (34     (326     (360     544        (1,770     (1,226

Junior subordinated debentures

     (7     —          (7     (204     —          (204
                                                

Total increase (decrease) in interest expense

     (2,463     (201     (2,664     (9,634     451        (9,183
                                                

Increase (decrease) in net interest income

   $ 817      $ (615   $ 202      $ 4,902      $ (576   $ 4,326   
                                                

 

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

 

     Three Months Ended
September 30,
     Nine Months Ended
September 30,
 
     2010      2009      2010     2009  
     (in thousands)  

Service charges on deposit accounts

   $ 757       $ 843       $ 2,270      $ 2,319   

Income from fiduciary activities

     226         227         751        645   

Secondary market brokerage fees

     83         49         273        180   

Title insurance commissions

     38         33         114        97   

Gains on sales of loans originated for sale

     135         82         410        323   

Gains on sales of investment securities, net

     2,175         321         2,256        322   

Other than temporary impairment on securities

     —           —           (465     —     

Other

     517         481         1,511        1,531   
                                  

Total non-interest income

   $ 3,931       $ 2,036       $ 7,120      $ 5,417   
                                  

Non-interest income for the third quarter ended September 30, 2010 increased $1.9 million, or 93.1%, compared with the third quarter of 2009. For the nine months ended September 30, 2010 non-interest income increased by $1.7 million to $7.1 million compared with $5.4 million for same period of 2009. The increase in non-interest income for the third quarter ended September 30, 2010 was primarily due to higher net gains on sales of investment securities and loans originated for sale. These increases were partially offset by decreased income from service charges on deposit accounts. The increase in non-interest income for the nine months ended September 30, 2010 was due to higher net gains on sales of investments, partially offset by an other than temporary impairment charge on securities, and 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 loans originated for sale.

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

 

     Three Months  Ended
September 30,
     Nine Months Ended
September 30,
 
     2010      2009      2010      2009  
     (in thousands)  

Salary and employee benefits

   $ 3,849       $ 3,799       $ 11,727       $ 11,490   

Occupancy and equipment

     1,070         993         3,107         2,972   

Other real estate owned expense

     2,163         353         6,395         706   

FDIC insurance

     855         626         2,266         1,588   

FDIC special insurance assessment

     —           —           —           781   

State franchise tax

     543         450         1,629         1,350   

Professional fees

     239         175         797         606   

Postage and delivery

     183         193         569         561   

Communications

     179         183         538         568   

Office supplies

     113         109         302         327   

Advertising

     104         121         277         404   

Other

     651         582         1,904         1,735   
                                   

Total non-interest expense

   $ 9,949       $ 7,584       $ 29,511       $ 23,088   
                                   

Non-interest expense for the third quarter ended September 30, 2010 increased $2.4 million, or 31.2%, compared with the third quarter of 2009. For the nine months ended September 30, 2010, non-interest expense increased $6.4 million, or 27.8%, to $29.5 million compared with $23.1 million for the first nine months of 2009. The increase in non-interest expense was primarily attributable to increased other real estate owned expense. OREO expense increased $1.8 million over the prior year third quarter, and $5.7 million over the nine

 

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months ended September 30, 2009, due to increased losses on sales of OREO, valuation write-downs to account for lower valuations on the underlying real estate collateral, and increased OREO operating costs. In addition, salary and benefits expense for the 2010 third quarter increased $50,000, or 1.3%, over the prior year third quarter, and increased $237,000, or 2.1%, for the nine months ended September 30, 2010, over the same period of 2009, due to additions to staff. State franchise tax for the 2010 third quarter increased $93,000, or 20.7%, over the prior year third quarter, and increased $279,000, or 20.7%, for the nine months ended September 30, 2010, over the same period of 2009. Professional fees expense for the 2010 third quarter increased $64,000, or 36.6%, over the prior year third quarter, and increased $191,000, or 31.5%, for the nine months ended September 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 $2.3 million in the first nine months of 2010 compared with $2.4 million in the first nine months of 2009. The 2009 FDIC fees included a special assessment of $781,000. Advertising expense for the three months ended September 30, 2010 decreased $17,000, or 14.0%, over the prior year third quarter, and decreased $127,000, or 31.4%, for the nine months ended September 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 expense was $1.1 million, or 32.0% of pre-tax income, for the third quarter ended September 30, 2010, and $1.9 million, or 29.9% of pre-tax income, for the first nine months of 2010, compared with $2.3 million, or 33.5% of pre-tax income, for the third quarter of 2009, and $5.4 million, or 33.4% of pre-tax income, for the first nine 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
September 30,
    Nine Months Ended
September 30,
 
     2010     2009     2010     2009  
     (dollars in thousands)  

Federal statutory rate times financial statement income

   $ 1,245      $ 2,389      $ 2,271      $ 5,699   

Effect of:

        

Tax-exempt income

     (74     (75     (226     (228

Non taxable life insurance income

     (27     (24     (77     (74

Federal tax credits

     (11     (11     (34     (34

Other, net

     4        11        9        78   
                                

Total

   $ 1,137      $ 2,290      $ 1,943      $ 5,441   
                                

Analysis of Financial Condition

Total assets decreased $54.9 million, or 3.0%, to $1.78 billion at September 30, 2010 from $1.84 billion at December 31, 2009. This decrease was primarily attributable to a decrease of $87.7 million in net loans due to efforts to move troubled loans through the collection, foreclosure, and disposition process, which contributed to the increase of $59.1 million in other real estate owned. Total assets at September 30, 2010 increased $51.4 million from $1.7 billion at September 30, 2009, representing a 3.0% increase.

Loans ReceivableLoans receivable decreased $84.7 million, or 6.0%, during the nine months ended September 30, 2010 to $1.3 billion. Our commercial, commercial real estate and real estate construction portfolios decreased by an aggregate of $78.9 million, or 8.5%, during the nine months and comprised 64.1% of the total loan portfolio at September 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 September 30,
2010
    As of December 31,
2009
 
     Amount      Percent     Amount      Percent  
     (dollars in thousands)  

Type of Loan:

          

Real estate:

          

Commercial

   $ 553,576         41.68   $ 535,843         37.93

Construction

     215,946         16.26        304,230         21.53   

Residential

     387,626         29.18        387,017         27.39   

Home equity

     30,948         2.33        32,384         2.29   

Commercial

     81,527         6.14        89,903         6.36   

Consumer

     33,062         2.49        36,989         2.62   

Agriculture

     24,437         1.84        25,064         1.77   

Other

     1.089         0.08        1,488         0.11   
                                  

Total loans

   $ 1,328,211         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 September 30, 2010 and December 31, 2009.

 

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

Loans past due 90 days or more still on accrual

   $ 7,048      $ 5,968   

Non-accrual loans

     38,784        78,888   
                

Total non-performing loans

     45,832        84,856   

Real estate acquired through foreclosure

     73,645        14,548   

Other repossessed assets

     53        80   
                

Total non-performing assets

   $ 119,530      $ 99,484   
                

Non-performing loans to total loans

     3.45     6.00
                

Non-performing assets to total assets

     6.71     5.42
                

Allowance for non-performing loans

   $ 7,311      $ 7,266   
                

Allowance for non-performing loans to non-performing loans

     16.0     8.6
                

Nonperforming loans at September 30, 2010 were $45.8 million, or 3.5% of total loans, compared with $26.3 million, or 1.9% of total loans, at September 30, 2009, and $84.9 million, or 6.0% of total loans at December 31, 2009. The decrease of $39.0 million in non-performing loans from December 31, 2009 to September 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

 

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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.

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 September 30, 2010, we had 31 restructured loans totaling $22.0 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, 20 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 September 30, 2010 were $73.6 million compared with $12.9 million at September 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 the first and second quarters of 2010. 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 $2.2 million and $6.4 million, respectively, for the three and nine months ended September 30, 2010, compared with $353,000 and $706,000, 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 September 30, 2010, increased to 2.21% from 1.58% at September 30, 2009, and 1.87% at December 31, 2009. Provision for loan losses increased by $3.0 million to $5.0 million for the third quarter of 2010 compared with the third quarter of 2009. Provision for loan losses increased by $9.4 million to $14.6 million for the nine months ended September 30, 2010, compared with $5.2 million for the same nine months of 2009. Net loan charge-offs for the third quarter of 2010 were $2.4 million, or 0.18% of average loans, compared with $782,000, or 0.06%, for the third quarter of 2009, and $6.3 million, or 0.46%, for the second quarter of 2010. Net loan charge-offs for the nine months ended September 30, 2010 were $11.6 million, or 0.85% of average loans, compared with $2.9 million or 0.21%, for the first nine months of 2009. Our allowance for loan losses to nonperforming loans increased to 64.13% at September 30, 2010, compared with 31.10% at December 31, 2009, but declined in comparison with 83.60% at September 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 16.0% at September 30, 2010 compared to 7.7% at September 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 nine month periods ended September 30, 2010 and 2009 follows:

 

     Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
     2010     2009     2010     2009  
     (dollars in thousands)  

Balance at beginning of period

   $ 26,836      $ 20,740      $ 26,392      $ 19,652   

Provision for loan losses

     5,000        2,000        14,600        5,200   

Recoveries

     70        47        223        218   

Charge-offs

     (2,514     (829     (11,823     (3,112
                                

Balance at end of period

   $ 29,392      $ 21,958      $ 29,392      $ 21,958   
                                

Allowance for loan losses to period-end loans

     2.21     1.58     2.21     1.58
                                

Net charge-offs to average loans

     0.18     0.06     0.85     0.21
                                

Allowance for loan losses to non-performing loans

     64.13     83.60     64.13     83.60
                                

LiabilitiesTotal liabilities at September 30, 2010 were $1.58 billion compared with $1.67 billion at December 31, 2009, a decrease of $88.2 million, or 5.3%. The decrease was primarily attributable to a decrease in deposits of $140.0 million, or 9.2%, at September 30, 2010 to $1.39 billion from $1.53 billion at December 31, 2009.

 

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Federal Home Loan Bank advances increased $27.8 million, or 33.5%, to $110.8 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.

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 Nine Months
Ended September 30,

2010
    For the Year Ended
December 31,

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

Demand

   $ 101,722         —        $ 99,167         —     

Interest checking

     82,102         0.84     75,602         0.84

Money market

     81,055         1.27        86,619         1.53   

Savings

     35,587         0.75        34,386         0.90   

Certificates of deposit

     1,167,040         2.10        1,089,798         3.01   
                      

Total deposits

   $ 1,467,506         1.81   $ 1,385,572         2.53
                      

The following table sets forth the average daily balances and weighted average rate