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EX-32 - ACCESS NATIONAL CORPv222691_ex32.htm
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EX-31.2 - ACCESS NATIONAL CORPv222691_ex31-2.htm
 
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 March 31, 2011

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: 000-49929

ACCESS NATIONAL CORPORATION
(Exact name of registrant as specified in its charter)

Virginia
(State or other jurisdiction of
incorporation or organization)
82-0545425
(I.R.S. Employer
Identification No.)

1800 Robert Fulton Drive, Suite 300, Reston, Virginia  20191
  (Address of principal executive offices) (Zip Code)

(703) 871-2100
(Registrant's telephone number, including area code)
N/A

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

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 such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes x No ¨

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 ¨ (Do not check if a smaller reporting company)
 
Smaller reporting company x
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes o No x

The number of shares outstanding of Access National Corporation’s common stock, par value $0.835, as of May 11, 2011 was 10,329,331 shares.

 
 

 

Table of Contents
ACCESS NATIONAL CORPORATION
FORM 10-Q

INDEX

PART I
FINANCIAL INFORMATION
 
Item 1.
Financial Statements (Unaudited)
Page 2
 
Consolidated Balance Sheets, March 31, 2011 and December 31, 2010 (Audited)
Page 2
 
Consolidated Statements of Income, three months ended March 31, 2011 and 2010
Page 3
 
Consolidated Statements of Changes in Shareholders' Equity, three months ended March 31, 2011 and 2010
Page 4
 
Consolidated Statements of Cash Flows, three months ended March 31, 2011 and 2010
Page 5
 
Notes to Consolidated Financial Statements (Unaudited)
Page 6
Item 2.
Management's Discussion and Analysis of Financial Condition and Results of Operations
Page 25
Item 3.
Quantitative and Qualitative Disclosures About Market Risk
Page 37
Item 4.
Controls and Procedures
Page 38
 
PART II
OTHER INFORMATION
 
     
Item 1.
Legal Proceedings
Page 39
Item1A.
Risk Factors
Page 39
Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds
Page 39
Item 3.
Defaults Upon Senior Securities
Page 39
Item 4.
(Removed and Reserved)
Page 40
Item 5.
Other Information
Page 40
Item 6.
Exhibits
Page 40
 
Signatures
Page 41
 
 
- 1 -

 

PART I - FINANCIAL INFORMATION

Item 1.  Financial Statements

ACCESS NATIONAL CORPORATION
Consolidated Balance Sheets
(In Thousands, Except for Share Data)

   
March 31,
   
December 31,
 
 
 
2011
   
2010
 
   
(Unaudited)
       
ASSETS
               
                 
Cash and due from banks
  $ 9,308     $ 9,198  
Interest-bearing deposits in other banks and federal funds sold
    32,693       102,709  
Securities available for sale, at fair value
    124,983       124,307  
Restricted stock
    4,438       4,438  
Loans held for sale, at fair value
    33,689       82,244  
Loans
    497,469       491,529  
Allowance for loan losses
    (10,722 )     (10,527 )
Net loans
    486,747       481,002  
Premises and equipment
    8,876       8,934  
Accrued interest receivable
    2,396       2,380  
Other real estate owned
    1,859       1,859  
Other assets
    12,209       14,753  
Total assets
  $ 717,198     $ 831,824  
                 
LIABILITIES AND SHAREHOLDERS' EQUITY
               
Deposits
               
Noninterest-bearing deposits
  $ 87,597     $ 83,972  
Savings and interest-bearing deposits
    148,485       158,352  
Time deposits
    260,077       385,524  
Total deposits
    496,159       627,848  
Other liabilities
               
Short-term borrowings
    127,053       80,348  
Long-term borrowings
    6,482       37,034  
Subordinated debentures
    6,186       6,186  
Other liabilities and accrued expenses
    6,846       8,215  
Total liabilities
  $ 642,726     $ 759,631  
                 
SHAREHOLDERS' EQUITY
               
Common stock, par value, $0.835; authorized, 60,000,000 shares; issued and outstanding, 10,330,508 shares at March 31, 2011 and 10,376,169 shares at December 31, 2010
  $ 8,626     $ 8,664  
Additional paid in capital
    17,572       17,794  
Retained earnings
    49,595       47,530  
Accumulated other comprehensive income (loss), net
    (1,321 )     (1,795 )
Total shareholders' equity
    74,472       72,193  
Total liabilities and shareholders' equity
  $ 717,198     $ 831,824  

See accompanying notes to consolidated financial statements (Unaudited).

 
- 2 -

 

ACCESS NATIONAL CORPORATION
Consolidated Statements of Income
(In Thousands, Except for Share Data)
(Unaudited)

   
Three Months Ended March 31,
 
   
2011
   
2010
 
Interest and Dividend Income
           
Interest and fees on loans
  $ 7,882     $ 7,872  
Interest on deposits in other banks
    55       37  
Interest and dividends on securities
    633       350  
Total interest and dividend income
    8,570       8,259  
                 
Interest Expense
               
Interest on deposits
    1,511       1,968  
Interest on short-term borrowings
    377       265  
Interest on long-term borrowings
    62       389  
Interest on subordinated debentures
    53       52  
Total interest expense
    2,003       2,674  
                 
Net interest income
    6,567       5,585  
Provision for loan losses
    223       198  
Net interest income after provision for loan losses
    6,344       5,387  
                 
Noninterest Income
               
Service fees on deposit accounts
    173       160  
Gain on sale of loans
    5,516       5,240  
Mortgage broker fee income
    336       338  
Other income
    (186 )     285  
Total noninterest income
    5,839       6,023  
                 
Noninterest Expense
               
Salaries and employee benefits
    5,393       5,252  
Occupancy and equipment
    665       684  
Other operating expenses
    2,573       3,567  
Total noninterest expense
    8,631       9,503  
                 
Income before income taxes
    3,552       1,907  
                 
Income tax expense
    1,265       691  
NET INCOME
  $ 2,287     $ 1,216  
                 
Earnings per common share:
               
Basic
  $ 0.22     $ 0.12  
Diluted
  $ 0.22     $ 0.11  
                 
Average outstanding shares:
               
Basic
    10,359,386       10,572,017  
Diluted
    10,404,677       10,589,506  

See accompanying notes to consolidated financial statements (Unaudited).

 
- 3 -

 

ACCESS NATIONAL CORPORATION
Consolidated Statements of Changes in Shareholders' Equity
(In Thousands, Except for Share Data)
(Unaudited)

                      
Accumulated
       
                     
Other
       
         
Additional
         
Compre-
       
   
Common
   
Paid in
   
Retained
   
hensive
       
   
Stock
   
Capital
   
Earnings
   
Income (Loss)
   
Total
 
Balance, December 31, 2010
  $ 8,664     $ 17,794     $ 47,530     $ (1,795 )   $ 72,193  
Comprehensive income:
                                       
Net income
    -       -       2,287       -       2,287  
Other comprehensive income, unrealized holding gains arising during the period (net of tax, $244)
    -       -       -       474       474  
Total comprehensive income
                                    2,761  
Stock option exercises (0 shares)
    -       -       -       -       -  
Dividend reinvestment plan (0 shares)
    -       -       -       -       -  
Repurchased under share repurchase program (45,661 shares)
    (38 )     (282 )     -       -       (320 )
Cash dividends
    -       -       (222 )     -       (222 )
Stock-based compensation expense recognized in earnings
    -       60       -       -       60  
                                         
Balance, March 31, 2011
  $ 8,626     $ 17,572     $ 49,595     $ (1,321 )   $ 74,472  
                                         
Balance, December 31, 2009
  $ 8,799     $ 18,552     $ 40,377     $ 50     $ 67,778  
Comprehensive income:
                                       
Net income
    -       -       1,216       -       1,216  
Other comprehensive income, unrealized holdings losses arising during the period (net of tax, $59)
    -       -       -       (115 )     (115 )
Total comprehensive income
                                    1,101  
Stock option exercises (15,000 shares)
    13       39       -       -       52  
Dividend reinvestment plan (74,721 shares)
    62       355       -       -       417  
Repurchased under share repurchase program (11,836 shares)
    (10 )     (61 )     -       -       (71 )
Cash dividends
    -       -       (106 )     -       (106 )
Stock-based compensation expense recognized in earnings
    -       46       -       -       46  
                                         
Balance, March 31, 2010
  $ 8,864     $ 18,931     $ 41,487     $ (65 )   $ 69,217  

See accompanying notes to consolidated financial statements (Unaudited).

 
- 4 -

 

ACCESS NATIONAL CORPORATION
Consolidated Statements of Cash Flows
(In Thousands)
(Unaudited)

   
Three Months Ended March 31,
 
   
2011
   
2010
 
Cash Flows from Operating Activities
           
Net income
  $ 2,287     $ 1,216  
Adjustments to reconcile net income to net cash provided by (used in) operating activities:
               
Provision for loan losses
    223       198  
Provision for losses on mortgage loans sold
    126       500  
Net gains/losses on sales and write-down of other real estate owned
    -       352  
Deferred tax benefit
    (4 )     (132 )
Stock-based compensation
    60       46  
Valuation allowance on derivatives
    (43 )     (261 )
Amortization of premiums on securities, net
    12       9  
Depreciation and amortization
    115       116  
Changes in assets and liabilities:
               
(Decrease) increase in valuation of loans held for sale carried at fair value
    (109 )     893  
Decrease in loans held for sale
    48,664       25,633  
Decrease in other assets
    2,326       3,186  
Decrease in other liabilities
    (1,494 )     (7,696 )
Net cash provided by operating activities
    52,163       24,060  
Cash Flows from Investing Activities
               
Proceeds from maturities and calls of securities available for sale
    5,030       14,969  
Purchases of securities available for sale
    (5,000 )     (45,000 )
Net (increase) decrease in loans
    (5,968 )     16,768  
Proceeds from sales of other real estate owned
    -       490  
Purchases of premises and equipment
    (52 )     (63 )
Net cash used in investing activities
    (5,990 )     (12,836 )
Cash Flows from Financing Activities
               
Net (decrease) increase in demand, interest-bearing demand and savings deposits
    (6,242 )     13,375  
Net decrease in time deposits
    (125,447 )     (19,820 )
Decrease in securities sold under agreement to repurchase
    (4,160 )     (3,237 )
Net increase (decrease) in other short-term borrowings
    20,866       (8,089 )
Net decrease in long-term borrowings
    (554 )     (5,970 )
Proceeds from issuance of common stock
    -       469  
Repurchase of common stock
    (320 )     (70 )
Dividends paid
    (222 )     (106 )
Net cash used in financing activities
    (116,079 )     (23,448 )
                 
Decrease in cash and cash equivalents
    (69,906 )     (12,224 )
Cash and Cash Equivalents
               
Beginning
    111,907       31,221  
Ending
  $ 42,001     $ 18,997  
Supplemental Disclosures of Cash Flow Information
               
Cash payments for interest
  $ 2,278     $ 3,056  
Cash payments for income taxes
  $ 655     $ 2,264  
Supplemental Disclosures of Noncash Investing Activities
               
Unrealized gain (loss) on securities available for sale
  $ 718     $ (174 )

See accompanying notes to consolidated financial statements (Unaudited).

 
- 5 -

 

Notes to Consolidated Financial Statements (Unaudited)

NOTE 1 – BASIS OF PRESENTATION

Access National Corporation (the “Corporation”) is a bank holding company incorporated under the laws of the Commonwealth of Virginia.  The Corporation has two wholly-owned subsidiaries, Access National Bank (the “Bank”), which is an independent commercial bank chartered under federal laws as a national banking association, and Access National Capital Trust II, which was formed for the purpose of issuing redeemable capital securities.  The Bank has three active subsidiaries, Access National Mortgage Corporation (the “Mortgage Corporation”), Access Real Estate LLC (“Access Real Estate”), and Access Capital Management Holding LLC (“ACM”).

The accompanying unaudited interim consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) for interim financial information and with rules and regulations of the Securities and Exchange Commission (“SEC”). The statements do not include all of the information and footnotes required by GAAP for complete financial statements. All adjustments have been made which, in the opinion of management, are necessary for a fair presentation of the results for the interim periods presented. Such adjustments are all of a normal and recurring nature. All significant inter-company accounts and transactions have been eliminated in consolidation. Certain prior period amounts have been reclassified to conform to the current period presentation. The results of operations for the three months ended March 31, 2011 are not necessarily indicative of the results that may be expected for the entire year ending December 31, 2011. These consolidated financial statements should be read in conjunction with the Corporation’s audited financial statements and the notes thereto as of December 31, 2010, included in the Corporation’s Annual Report on Form 10-K for the fiscal year ended December 31, 2010.

NOTE 2 – STOCK-BASED COMPENSATION PLANS

During the first three months of 2011, the Corporation granted 95,100 stock options to officers, directors, and employees under the 2009 Stock Option Plan (the “Plan”). Options granted under the Plan have an exercise price equal to the fair market value as of the grant date. Options granted have a vesting period of two and one half years and expire three and one half years after the issue date.  Stock–based compensation expense recognized in other operating expense during the first three months of 2011 and 2010 was approximately $60 thousand and $46 thousand, respectively. The fair value of options is estimated on the date of grant using a Black Scholes option-pricing model with the assumptions noted below.

The total unrecognized compensation cost related to non-vested share based compensation arrangements granted under the Plan as of March 31, 2011 was $327,253.  The cost is expected to be recognized over a weighted average period of 1.92 years.
 
 
- 6 -

 

NOTE 2 – STOCK-BASED COMPENSATION PLANS (continued)

A summary of stock option activity under the Plan for the three months ended March 31, 2011 and March 31, 2010 is presented as follows:

    
Three Months Ended
                   
   
March 31, 2011
                   
                         
Expected life of options granted, in years
    3.32                    
Risk-free interest rate
    1.19 %                  
Expected volatility of stock
    49 %                  
Annual expected dividend yield
    1 %                  
                           
Fair value of granted options
  $ 225,698                    
Non-vested options
    286,200                    
                           
                           
                 
Weighted Avg.
       
   
Number of
   
Weighted Avg.
   
Remaining
   
Aggregate Intrinsic
 
   
Options
   
Exercise Price
   
Contractual Term, in years
   
Value
 
                           
Outstanding at beginning of year
    418,525     $ 5.98       1.34     $ 290,583  
Granted
    95,100     $ 6.68       3.32     $ -  
Exercised
    -     $ -       -     $ -  
Lapsed or Canceled
    (84,100 )   $ 7.35       0.21     $ -  
                                 
Outstanding at March 31, 2011
    429,525     $ 5.87       1.79     $ 530,978  
                                 
Exercisable at March 31, 2011
    143,325     $ 6.43       0.66     $ 96,611  
                                 
   
Three Months Ended
                         
   
March 31, 2010
                         
                                 
Expected life of options granted, in years
    3.40                          
Risk-free interest rate
    1.39 %                        
Expected volatility of stock
    48 %                        
Annual expected dividend yield
    1 %                        
                                 
Fair value of granted options
  $ 212,268                          
Non-vested options
    278,575                          
                                 
                               
                   
Weighted Avg.
         
   
Number of
   
Weighted Avg.
   
Remaining
   
Aggregate Intrinsic
 
   
Options
   
Exercise Price
   
Contractual Term, in years
   
Value
 
                                 
Outstanding at beginning of year
    439,079     $ 6.44       1.53     $ 216,870  
Granted
    102,500     $ 5.97       3.40     $ -  
Exercised
    (15,000 )   $ 3.45       -     $ -  
Lapsed or canceled
    (34,370 )   $ 6.46       0.45     $ -  
                                 
Outstanding at March 31, 2010
    492,209     $ 6.43       1.86     $ 222,398  
                                 
Exercisable at March 31, 2010
    213,634     $ 7.80       2.56     $ -  

NOTE 3 – SECURITIES
 
The following table provides the amortized cost and fair value for the categories of available for sale securities. Available for sale securities are carried at fair value with net unrealized gains or losses reported on an after tax basis as a component of cumulative other comprehensive income in shareholders’ equity. The fair value of securities is impacted by interest rates, credit spreads, market volatility, and liquidity.

 
- 7 -

 

NOTE 3 – SECURITIES (continued)
 
The following table provides the amortized costs and fair values of securities available for sale as of March 31, 2011 and December 31, 2010.

   
March 31, 2011
 
   
Amortized Cost
   
Gross
Unrealized
Gains
   
Gross
Unrealized
(Losses)
   
Estimated
Fair Value
 
         
(In Thousands)
       
U.S. Government agencies
  $ 124,376     $ 65     $ (2,051 )   $ 122,390  
Mortgage backed securities
    640       4       -       644  
Municipals - taxable
    470       -       -       470  
CRA mutual fund
    1,500       -       (21 )     1,479  
    $ 126,986     $ 69     $ (2,072 )   $ 124,983  

   
December 31, 2010
 
   
Amortized Cost
   
Gross
Unrealized
Gains
   
Gross
Unrealized
(Losses)
   
Estimated
Fair Value
 
         
(In Thousands)
       
U.S. Government agencies
  $ 124,388     $ 62     $ (2,738 )   $ 121,712  
Mortgage backed securities
    670       -       (40 )     630  
Municipals - taxable
    470       2       -       472  
CRA mutual fund
    1,500       -       (7 )     1,493  
    $ 127,028     $ 64     $ (2,785 )   $ 124,307  
 
 
- 8 -

 

NOTE 3 – SECURITIES (continued)

The amortized cost and estimated fair value of securities available for sale as of March 31, 2011 and December 31, 2010 by contractual maturity are shown below. Actual maturities may differ from contractual maturities because some of the securities may be called or prepaid without any penalties.

   
March 31, 2011
   
December 31, 2010
 
         
Estimated
         
Estimated
 
   
Amortized
   
Fair
   
Amortized
   
Fair
 
   
Cost
   
Value
   
Cost
   
Value
 
   
(In Thousands)
 
U.S. Government agencies:
                       
Due in one year or less
  $ 5,000     $ 5,013     $ 5,000     $ 5,022  
Due after one through five years
    45,005       44,886       50,026       49,751  
Due after five through ten years
    29,981       29,278       29,978       29,181  
Due after ten through fifteen years
    44,390       43,213       39,384       37,758  
Municipals - taxable:
                               
Due after one through five years
    470       470       470       472  
Mortgage backed securities:
                               
Due after fifteen years
    640       644       670       630  
CRA Mutual Fund
    1,500       1,479       1,500       1,493  
Total
  $ 126,986     $ 124,983     $ 127,028     $ 124,307  

The estimated fair value of securities pledged to secure public funds, securities sold under agreements to repurchase, and for other purposes amounted to $61.1 million at March 31, 2011 and $60.9 million at December 31, 2010.

 
- 9 -

 

NOTE 3 – SECURITIES (continued)

Securities available for sale that have an unrealized loss position at March 31, 2011 and December 31, 2010 are as follows:

    
Securities in a loss
   
Securities in a loss
             
   
Position for less than
   
Position for 12 Months
             
   
12 Months
   
or Longer
   
Total
 
 
 
Estimated
         
Estimated
         
Estimated
       
   
Fair
   
Unrealized
   
Fair
   
Unrealized
   
Fair
   
Unrealized
 
March 31, 2011  
Value
   
Losses
   
Value
   
Losses
   
Value
   
Losses
 
   
(In Thousands)
 
Investment securities available for sale:
                                   
                                     
U.S. Government agencies
  $ 82,319     $ (2,051 )   $ -     $ -     $ 82,319     $ (2,051 )
CRA Mutual fund
    1,479       (21 )   $ -     $ -       1,479       (21 )
Total
  $ 83,798     $ (2,072 )   $ -     $ -     $ 83,798     $ (2,072 )

    
Securities in a loss
   
Securities in a loss
             
   
Position for less than
   
Position for 12 Months
             
   
12 Months
   
or Longer
   
Total
 
 
 
Estimated
         
Estimated
         
Estimated
       
   
Fair
   
Unrealized
   
Fair
   
Unrealized
   
Fair
   
Unrealized
 
December 31, 2010  
Value
   
Losses
   
Value
   
Losses
   
Value
   
Losses
 
   
(In Thousands)
 
Investment securities available for sale:
                                   
                                     
Mortgage backed securities
  $ 630     $ (40 )   $ -     $ -     $ 630     $ (40 )
U.S. Government agencies
    96,623       (2,738 )     -       -       96,623       (2,738 )
CRA Mutual fund
    1,493       (7 )     -       -       1,493       (7 )
Total
  $ 98,746     $ (2,785 )   $ -     $ -     $ 98,746     $ (2,785 )

Management does not believe that any individual unrealized loss as of March 31, 2011 and December 31, 2010 is other than a temporary impairment.  These unrealized losses are primarily attributable to changes in interest rates and not due to credit deterioration or losses.  The Corporation has the ability to hold these securities for a time necessary to recover the amortized cost or until maturity when full repayment would be received.

The Corporation’s restricted stock consists of Federal Home Loan Bank of Atlanta (“FHLB”) stock and Federal Reserve Bank (“FRB”) stock.  The amortized costs of the restricted stock as of March 31, 2011 and December 31, 2010 are as follows:
   
March 31, 2011
   
December 31, 2010
 
   
(In Thousands)
 
Restricted Stock:
           
                 
Federal Reserve Bank stock
  $ 999     $ 999  
                 
FHLB stock
    3,439       3,439  
    $ 4,438     $ 4,438  
 
 
- 10 -

 

NOTE 4 – LOANS AND THE ALLOWANCE FOR LOAN LOSSES

The following table presents the composition of the loans held for investment portfolio at March 31, 2011 and December 31, 2010:
   
Composition of Loan Portfolio
 
   
(Dollars In Thousands)
 
   
March 31, 2011
   
December 31, 2010
 
   
Amount
   
Percentage of
Total
   
Amount
   
Percentage of 
Total
 
                         
Commercial real estate
  $ 216,148       43.45 %   $ 217,999       44.35 %
Residential real estate
    133,302       26.80       137,752       28.03  
Commercial
    109,042       21.92       94,798       19.28  
Real estate construction
    36,303       7.30       38,093       7.75  
Consumer
    2,674       0.53       2,887       0.59  
Total loans
  $ 497,469       100.00 %   $ 491,529       100.00 %
Less allowance for loan losses
    10,722               10,527          
Net loans
  $ 486,747             $ 481,002          

Allowance for Loan Losses

The allowance for loan losses totaled approximately $10.7 million at March 31, 2011 compared to $10.5 million at year end December 31, 2010. The allowance for loan losses was equivalent to approximately 2.16% of total loans held for investment at March 31, 2011 and 2.14% at December 31, 2010. Adequacy of the allowance is assessed and the allowance is increased by provisions for loan losses charged to expense no less than quarterly.  Charge-offs are taken when a loan is identified as uncollectible.

The methodology by which we systematically determine the amount of our allowance is set forth by the Board of Directors in our Loan Policy and implemented by management.  The results of the analysis are documented, reviewed, and approved by the Board of Directors no less than quarterly.

The level of the allowance for loan losses is determined by management through an ongoing, detailed analysis of historical loss rates and risk characteristics. During each quarter, management evaluates the collectability of all loans in the portfolio and ensures an accurate risk rating is assigned to each loan. The risk rating scale and definitions commonly adopted by the Federal Banking Agencies is contained within the framework prescribed by the bank’s Loan Policy. Any loan that is deemed to have potential or well defined weaknesses that may jeopardize collection in full is then analyzed to ascertain its level of weakness. If appropriate, the loan may be charged-off or a specific reserve may be assigned if the loan is deemed to be impaired.

During the risk rating verification process, each loan identified as inadequately protected by the current sound worth and paying capacity of the obligor or of the collateral pledged is considered impaired and is placed on non-accrual status. On these loans, management analyzes the potential impairment of the individual loan and may set aside a specific reserve. Any amounts deemed uncollectible during that analysis are charged-off.
 
For the remaining loans in each segment, the bank calculates the probability of loss as a group using the risk rating for each of the following loan types:  Commercial Real Estate, Residential Real Estate, Commercial, Real Estate Construction, and Consumer.  Management calculates the historical loss rate in each group by risk rating using a period of at least three years. This historical loss rate may then be adjusted based on management’s assessment of internal and external environmental factors. This adjustment is meant to account for changes between the historical economic environment and current conditions, and for changes in the ongoing management of the portfolio which affects the loans’ potential losses.

 
- 11 -

 

NOTE 4 – LOANS AND THE ALLOWANCE FOR LOAN LOSSES (continued)

Once complete, management compares the condition of the portfolio using several different characteristics, as well as its experience, to the experience of other banks in its peer group in order to determine if it is directionally consistent with others’ experience in our area and line of business. Based on that analysis, management aggregates the probabilities of loss of the remaining portfolio based on the specific and general allowances and may provide additional amounts to the allowance for loan losses as needed. Since this process involves estimates, the allowance for loan losses may also contain an amount that is non material which is not allocated to a specific loan or to a group of loans but is deemed necessary to absorb additional losses in the portfolio.

Management and the Board of Directors subject the reserve adequacy and methodology to a review on a regular basis by internal auditors, external auditors and bank regulators, and such reviews have not resulted in any material adjustment to the reserve.

 
- 12 -

 

NOTE 4 – LOANS AND THE ALLOWANCE FOR LOAN LOSSES (continued)

The following tables provide detailed information about the allowance for loan losses as of and for the periods indicated.

    
Allowance for Loan Losses and Recorded Investment in Loans
 
For the Quarter Ended March 31, 2011
 
Commercial
Real Estate
   
Residential
Real Estate
   
Commercial
   
Real Estate
Construction
   
Consumer
   
Total
 
   
(In Thousands)
 
                                     
Allowance for loan losses:
                                   
Beginning Balance
  $ 5,316     $ 2,925     $ 1,506     $ 757     $ 23     $ 10,527  
Charge-offs
    (161 )     (2 )     (21 )     -       -       (184 )
Recoveries
    74       10       72       -       -       156  
Provisions
    (28 )     (30 )     352       (75 )     4       223  
Ending Balance
  $ 5,201     $ 2,903     $ 1,909     $ 682     $ 27     $ 10,722  
                                                 
Ending balance: individually evaluated for impairment
  $ 818     $ 414     $ -     $ -     $ -     $ 1,232  
Ending balance: collectively evaluated for impairment
  $ 4,383     $ 2,489     $ 1,909     $ 682     $ 27     $ 9,490  
Ending balance: loans acquired with deteriorated credit quality
  $ -     $ -     $ -     $ -     $ -     $ -  
                                                 
Loans
                                               
Ending balance
  $ 216,148     $ 133,302     $ 109,042     $ 36,303     $ 2,674     $ 497,469  
Ending balance: individually evaluated for impairment
  $ 6,450     $ 1,839     $ 874     $ -     $ -     $ 9,163  
Ending balance: collectively evaluated for impairment
  $ 209,698     $ 131,463     $ 108,168     $ 36,303     $ 2,674     $ 488,306  
Ending balance: loans acquired with deteriorated credit quality
  $ -     $ -     $ -     $ -     $ -     $ -  

For the Year Ended December 31, 2010
 
Commercial
Real Estate
   
Residential
Real Estate
   
Commercial
   
Real Estate
Construction
   
Consumer
   
Total
 
   
(In Thousands)
 
                                     
Allowance for loan losses:
                                   
Beginning Balance
  $ 4,407     $ 2,606     $ 1,562     $ 539     $ 13     $ 9,127  
Charge-offs
    (624 )     (875 )     (501 )     (48 )     -       (2,048 )
Recoveries
    109       38       385       99       1       632  
Provisions
    1,424       1,156       60       167       9       2,816  
Ending Balance
  $ 5,316     $ 2,925     $ 1,506     $ 757     $ 23     $ 10,527  
                                                 
Ending balance: individually evaluated for impairment
  $ 960     $ 283     $ -     $ -     $ -     $ 1,243  
Ending balance: collectively evaluated for impairment
  $ 4,356     $ 2,642     $ 1,506     $ 757     $ 23     $ 9,284  
Ending balance: loans acquired with deteriorated credit quality
  $ -     $ -     $ -     $ -     $ -     $ -  
                                                 
Loans
                                               
Ending balance
  $ 217,999     $ 137,752     $ 94,798     $ 38,093     $ 2,887     $ 491,529  
Ending balance: individually evaluated for impairment
  $ 6,712     $ 949     $ 900     $ -     $ -     $ 8,561  
Ending balance: collectively evaluated for impairment
  $ 211,287     $ 136,803     $ 93,898     $ 38,093     $ 2,887     $ 482,968  
Ending balance: loans acquired with deteriorated credit quality
  $ -     $ -     $ -     $ -     $ -     $ -  
 
 
- 13 -

 

NOTE 4 – LOANS AND THE ALLOWANCE FOR LOAN LOSSES (continued)

Identifying and Classifying Portfolio Risks by Risk Rating

Management evaluates the collectability of all loans in the portfolio and assigns a proprietary risk rating. Ratings range from the highest to lowest quality based on factors including measurements of ability to pay, collateral type and value, borrower stability, management experience, and credit enhancements.  These ratings are consistent with the bank regulatory rating system.

A loan may have portions of its balance in one rating and other portions in a different rating. The Bank may use these “split ratings” when factors cause loan loss risk to exist for part but not all of the principal balance. Split ratings may also be used where cash collateral or a government agency has provided a guaranty that partially covers a loan.

For clarity of presentation, the Corporation’s loan portfolio is profiled below in accordance with the risk rating framework that has been commonly adopted by the federal banking agencies.  The definitions of the various risk rating categories are as follows:

Pass - The condition of the borrower and the performance of the loan is satisfactory or better.
 
Special mention - A special mention asset has one or more potential weaknesses that deserve management’s close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the asset or in the institution’s credit position at some future date.

Substandard - A substandard asset is inadequately protected by the current sound worth and paying capacity of the obligor or of the collateral pledged, if any. Assets so classified must have a well-defined weakness, or weaknesses, that jeopardize the liquidation of the debt. They are characterized by the distinct possibility that the bank will sustain some loss if the deficiencies are not corrected.

Doubtful - An asset classified doubtful has all the weaknesses inherent in one classified substandard with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions, and values, highly questionable and improbable.

Loss - Assets classified loss are considered uncollectible and their continuance as bankable assets is not warranted. This classification does not mean that the asset has absolutely no recovery or salvage value and partial recovery may be effected in the future.

The Bank did not have any loans classified as loss at March 31, 2011 or December 31, 2010.  It is the Bank’s policy to charge-off any loan once the risk rating is classified as loss.


 
- 14 -

 

NOTE 4 – LOANS AND THE ALLOWANCE FOR LOAN LOSSES (continued)

The profile of the portfolio, as indicated by risk rating, as of March 31, 2011 and December 31, 2010 is shown below.

    
Credit Quality Indicators
 
   
As of March 31, 2011 and December 31, 2010
 
Credit Risk Profile by Regulatory Risk Rating
                                                       
                                     
   
Commercial Real
Estate
   
Residential Real Estate
   
Commercial
   
Real Estate
Construction
   
Consumer
   
Totals
 
   
3/31/11
   
12/31/10
   
3/31/11
   
12/31/10
   
3/31/11
   
12/31/10
   
3/31/11
   
12/31/10
   
3/31/11
   
12/31/10
   
3/31/11
   
12/31/10
 
   
(In Thousands)
 
Pass
  $ 173,712     $ 173,101     $ 123,427     $ 125,808     $ 102,020     $ 87,883     $ 35,490     $ 36,343     $ 2,674     $ 2,887     $ 437,323     $ 426,022  
Special mention
    23,796       26,016       3,566       4,828       4,157       4,827       937       1,585       -       -       32,456       37,256  
Substandard
    19,412       19,613       6,394       7,218       3,350       2,498       -       310       -       -       29,156       29,639  
Doubtful
    -       143       -       -       -       -       -       -       -       -       -       143  
Loss
    -       -       -       -       -       -       -       -       -       -       -       -  
Unearned income
    (772 )     (874 )     (85 )     (102 )     (485 )     (410 )     (124 )     (145 )     -       -       (1,466 )     (1,531 )
Total
  $ 216,148     $ 217,999     $ 133,302     $ 137,752     $ 109,042     $ 94,798     $ 36,303     $ 38,093     $ 2,674     $ 2,887     $ 497,469     $ 491,529  

Loans listed as non-performing are also placed on non-accrual status. The accrual of interest is discontinued at the time a loan is 90 days delinquent or when the credit deteriorates and there is doubt that the credit will be paid as agreed, unless the credit is well-secured and in process of collection. Once the loan is on non-accrual status, all accrued but unpaid interest is also charged-off, and all payments are used to reduce the principal balance.  Once the principal balance is repaid in full, additional payments are taken into income.  A loan may be returned to accrual status if the borrower shows renewed willingness and ability to repay under the term of the loan agreement.  The risk profile based upon payment activity is shown below.

    
Credit Quality Indicators
 
   
As of March 31, 2011 and December 31, 2010
 
Credit Risk Profile Based on Payment Activity
                                                       
                                     
   
Commercial Real
Estate
   
Residential Real Estate
   
Commercial
   
Real Estate
Construction
   
Consumer
   
Totals
 
   
3/31/11
   
12/31/10
   
3/31/11
   
12/31/10
   
3/31/11
   
12/31/10
   
3/31/11
   
12/31/10
   
3/31/11
   
12/31/10
   
3/31/11
   
12/31/10
 
   
(In Thousands)
 
Performing
  $ 209,698     $ 211,287     $ 131,463     $ 136,803     $ 108,168     $ 93,898     $ 36,303     $ 38,093     $ 2,674     $ 2,887     $ 488,306     $ 482,968  
Non-performing
    6,450       6,712       1,839       949       874       900       -       -       -       -       9,163       8,561  
Total
  $ 216,148     $ 217,999     $ 133,302     $ 137,752     $ 109,042     $ 94,798     $ 36,303     $ 38,093     $ 2,674     $ 2,887     $ 497,469     $ 491,529  
 
 
- 15 -

 

NOTE 4 – LOANS AND THE ALLOWANCE FOR LOAN LOSSES (continued)

Loans are considered past due if a contractual payment is not made by the calendar day after the payment is due. However, for reporting purposes loans past due 1 to 29 days are excluded from loans past due and are included in the total for current loans in the table below. The delinquency status of the loans in the portfolio is shown below as of March 31, 2011 and December 31, 2010.  Loans that were on non-accrual status are not included in any past due amounts.

    
Age Analysis of Past Due Loans
 
   
As of March 31, 2011
 
   
30-59 Days
Past Due
   
60-89 Days
Past Due
   
Greater than
90 Days Past
Due
   
Total Past
Due
   
Non-accrual
Loans
   
Current
Loans
   
Total
Loans
 
   
(In Thousands)
 
Commercial real estate
  $ 682     $ -     $ -     $ 682     $ 6,450     $ 209,016     $ 216,148  
Residential real estate
    1,325       -       -       1,325       1,839       130,138       133,302  
Commercial
    92       -       -       92       874       108,076       109,042  
Real estate construction
    -       -       -       -       -       36,303       36,303  
Consumer
    -       -       -       -