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EXCEL - IDEA: XBRL DOCUMENT - FNBH BANCORP INC | Financial_Report.xls |
EX-32.1 - EXHIBIT 32.1 - FNBH BANCORP INC | v305494_ex32-1.htm |
EX-31.2 - EXHIBIT 31.2 - FNBH BANCORP INC | v305494_ex31-2.htm |
EX-31.1 - EXHIBIT 31.1 - FNBH BANCORP INC | v305494_ex31-1.htm |
EX-32.2 - EXHIBIT 32.2 - FNBH BANCORP INC | v305494_ex32-2.htm |
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-Q/A
(Amendment No. 1)
x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 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 0-25752
FNBH BANCORP, INC.
(Exact name of registrant as specified in its charter)
MICHIGAN | 38-2869722 | |
(State or other jurisdiction of incorporation or organization) |
(I.R.S. Employer Identification No.) |
101 East Grand River, Howell, Michigan 48843
(Address of principal executive offices) (Zip Code)
Registrant’s telephone number, including area code: (517) 546-3150
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 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 x 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 ¨ 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 ¨ No x
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date: 453,553 shares of the Corporation’s Common Stock (no par value) were outstanding as of October 31, 2011.
TABLE OF CONTENTS
Page | |||
Number | |||
Disclaimer Regarding Forward-Looking Statements | iii | ||
Explanatory Note | iv | ||
Part I Financial Information (unaudited) | |||
Item 1. | Financial Statements: | ||
Consolidated Balance Sheets as of September 30, 2011 and December 31, 2010 | 1 | ||
Consolidated Statements of Operations for the three and nine months ended September 30, 2011 and 2010 | 2 | ||
Consolidated Statements of Shareholders’ Equity and Comprehensive Income (Loss) for the nine months ended September 30, 2011 and 2010 | 3 | ||
Consolidated Statements of Cash Flows for the nine months ended September 30, 2011 and 2010 | 4 | ||
Notes to Interim Consolidated Financial Statements | 5 | ||
Item 2. | Management’s Discussion and Analysis of Financial Condition and Results of Operations | 21 | |
Item 3. | Quantitative and Qualitative Disclosures about Market Risk | 35 | |
Item 4. | Controls and Procedures | 35 | |
Part II. Other Information | |||
Item 1A | Risk Factors | 36 | |
Item 2. | Unregistered Sales of Equity Securities and Use of Proceeds | 36 | |
Item 6. | Exhibits | 37 | |
Signatures | 38 |
ii |
Discussions and statements in this report that are not statements of historical fact, including, without limitation, statements that include terms such as “will,” “may,” “should,” “believe,” “expect,” “forecast,” “anticipate,” “estimate,” “project,” “intend,” “likely,” “optimistic” and “plan,” and statements about future or projected financial and operating results, plans, projections, objectives, expectations, and intentions and other statements that are not historical facts, are forward-looking statements. Forward-looking statements include, but are not limited to, descriptions of plans and objectives for future operations, products or services; projections of our future revenue, earnings or other measures of economic performance; forecasts of credit losses and other asset quality trends; predictions as to our Bank’s ability to achieve or maintain certain regulatory capital standards; our expectation that we will have or be able to maintain sufficient cash to meet expected obligations during 2011; and descriptions of steps we may take to improve our capital position. These forward-looking statements express our current expectations, forecasts of future events, or long-term goals and, by their nature, are subject to assumptions, risks, and uncertainties. Although we believe that the expectations, forecasts, and goals reflected in these forward-looking statements are reasonable, actual results could differ materially for a variety of reasons, including, among others:
· | our ability to successfully raise new equity capital and/or our ability to implement our capital restoration and recovery plan; |
· | our ability to continue as a going concern in light of the uncertainty regarding the extent and timing of possible future regulatory enforcement action against the Bank; |
· | the failure of assumptions underlying the establishment of and provisions made to our allowance for loan losses; |
· | the timing and pace of an economic recovery in Michigan and the United States in general, including regional and local real estate markets; |
· | the ability of our Bank to attain and maintain certain regulatory capital standards; |
· | limitations on our ability to access and rely on wholesale funding sources; |
· | the continued services of our management team, particularly as we work through our asset quality issues and the implementation of our capital restoration plan; and |
· | implementation of the recently enacted Dodd-Frank Wall Street Reform and Consumer Protection Act or other new legislation, which may have significant effects on us and the financial services industry |
This list provides examples of factors that could affect the results described by forward-looking statements contained in this report, but the list is not intended to be all inclusive. The risk factors disclosed in Part I – Item A of our Annual Report on Form 10-K for the year ended December 31, 2010, as updated by any new or modified risk factors disclosed in Part II – Item 1A of any subsequently filed Quarterly Report on Form 10-Q, include all known risk our management believes could materially affect the results described by forward-looking statements in this report. However, those risks may not be the only risks we face. Our results of operations, cash flows, financial position, and prospects could also be materially and adversely affected by additional factors that are not presently known to us, that we currently consider to be immaterial, or that develop after the date of this report. We cannot assure you that our future results will meet expectations. While we believe the forward-looking statements in this report are reasonable, you should not place undue reliance on any forward-looking statement. In addition, these statements speak only as of the date made. We do not undertake, and expressly disclaim, any obligation to update or alter any statements, whether as a result of new information, future events, or otherwise, except as required by applicable law.
iii |
FNBH Bancorp, Inc.
Quarterly Report on Form 10-Q/A for the period ended September 30, 2011
EXPLANATORY NOTE
FNBH Bancorp, Inc. is filing this Amendment No. 1 (the "Amendment") to its Quarterly Report on Form 10-Q for the period ended September 30, 2011, which Form 10-Q was originally filed with the Securities and Exchange Commission (SEC) on December 2, 2011. This Amendment is being filed to amend and restate the Corporation’s unaudited consolidated financial statements and other information as of and for the three and nine months ended September 30, 2011 to reflect the cumulative effect of adjustments made to the provision and allowance for loan losses and the timing of certain loan charge offs and loan transfers to other real estate owned, which required restatement of the Corporation’s Quarterly Report on Form 10-Q for the period ended June 30, 2011.
In January 2012 and subsequent to the December 2, 2011 filing of the Corporation’s Quarterly Report on Form 10-Q for the period ended September 30, 2011, after consultation with its regulatory examiners, the Corporation’s wholly-owned bank subsidiary, First National Bank in Howell (“the Bank”), determined to restate its June and September 2011 Call Reports to reflect an additional $3.0 million provision expense in the allowance for loan losses, recognize an additional $2.6 million of loan charge offs, and record the transfer of a $0.95 million loan to other real estate owned, effective June 30, 2011, based on findings from an examination initiated in June 2011. The related loan charge offs and transfer to other real estate were originally recognized by the Bank during the quarter ended September 30, 2011. Our previously issued consolidated financial statements included in the Form 10-Q for the quarter ended September 30, 2011, as originally filed with the SEC, should no longer be relied upon.
A detailed summary of the financial statement restatement is provided in Note 12 of the unaudited consolidated financial statements included within this Amendment.
The information in this Amendment not only revises the unaudited consolidated financial statements that were included in the originally filed Form 10-Q for the three and nine months ended September 30, 2011, but also amends other information in that Form 10-Q affected by the revisions described above. Therefore this Amendment should be read together with the originally filed Form 10-Q. Furthermore, except as expressly stated in this Amendment, the information in this Amendment is as of September 30, 2011 and does not reflect events occurring after the filing of the originally filed Form 10-Q or update information or disclosures contained in the originally filed Form 10-Q that were not affected by the revisions described above. Accordingly, this Amendment also should be read in conjunction with the Corporation’s subsequent filings of financial information related to its financial position and results of operations as information in any subsequent filings may update or supersede certain information contained in this Amendment.
The following items of the originally filed Form 10-Q for the three and nine months ended September 30, 2011 have been revised:
Part I – Financial Information
Item 1 – Financial Statements (unaudited)
Item 2 – Management’s Discussion and Analysis of Financial Condition and Results of Operations
Item 4 – Controls and Procedures
In addition, as required by Rule 12b-15 under the Securities and Exchange Act of 1934, as amended, updated certifications by the Corporation’s principal executive officer and principal financial officer are filed herewith as Exhibit 31.1, Exhibit 31.2, Exhibit 32.1 and Exhibit 32.2 to this Amendment.
The Corporation has not amended, and does not intend to amend, any of its other previously filed reports except for its June 30, 2011 Quarterly Report on Form 10-Q originally filed with the SEC on August 16, 2011 (but deemed filed on August 15, 2011 pursuant to Rule 12b-25), as amended by an Amendment No. 1 filed with the SEC on August 26, 2011, to reflect the adjustments described above.
iv |
Part I – Financial Information
Item 1. Financial Statement
FNBH BANCORP INC. AND SUBSIDIARIES
Consolidated Balance Sheets (Unaudited)
September 30, | ||||||||
2011 | December 31, | |||||||
(Restated) | 2010 | |||||||
Assets | ||||||||
Cash and due from banks | $ | 33,665,622 | $ | 40,376,267 | ||||
Short term investments | 196,652 | 196,159 | ||||||
Total cash and cash equivalents | 33,862,274 | 40,572,426 | ||||||
Investment Securities: | ||||||||
Investment securities available for sale, at fair value | 45,132,270 | 27,269,670 | ||||||
FHLBI and FRB stock, at cost | 779,050 | 901,350 | ||||||
Total investment securities | 45,911,320 | 28,171,020 | ||||||
Loans held for investment: | ||||||||
Commercial | 186,285,011 | 203,025,518 | ||||||
Consumer | 15,301,915 | 16,641,544 | ||||||
Real estate mortgage | 15,056,261 | 16,271,284 | ||||||
Total loans held for investment | 216,643,187 | 235,938,346 | ||||||
Less allowance for loan losses | (13,110,063 | ) | (13,970,170 | ) | ||||
Net loans held for investment | 203,533,124 | 221,968,176 | ||||||
Premise and equipment, net | 7,576,255 | 7,692,185 | ||||||
Other real estate owned, held for sale | 3,407,543 | 4,294,212 | ||||||
Accrued interest and other assets | 1,885,866 | 2,642,511 | ||||||
Total assets | $ | 296,176,382 | $ | 305,340,530 | ||||
Liabilities and Shareholders' Equity | ||||||||
Liabilities | ||||||||
Deposits: | ||||||||
Demand (non-interest bearing) | 87,697,326 | 62,294,189 | ||||||
NOW | 29,094,633 | 52,018,941 | ||||||
Savings and money market | 74,213,235 | 75,226,475 | ||||||
Time deposits | 93,025,401 | 100,382,011 | ||||||
Brokered certificates of deposit | 3,371,976 | 3,358,573 | ||||||
Total deposits | 287,402,571 | 293,280,189 | ||||||
Other borrowings | 32,813 | - | ||||||
Accrued interest, taxes, and other liabilities | 1,664,331 | 1,926,543 | ||||||
Total liabilities | 289,099,715 | 295,206,732 | ||||||
Shareholders' Equity | ||||||||
Preferred stock, no par value. Authorized 30,000 shares; no shares issued and outstanding | - | - | ||||||
Common stock, no par value. Authorized 7,000,000 shares at September 30, 2011 and December 31, 2010; 453,553 shares issued and outstanding at September 30, 2011 and 452,675 shares issued and outstanding at December 31, 2010 | 7,075,336 | 6,935,140 | ||||||
Retained earnings (deficit) | (825,903 | ) | 2,747,615 | |||||
Deferred directors' compensation | 577,111 | 708,372 | ||||||
Accumulated other comprehensive income (loss) | 250,123 | (257,329 | ) | |||||
Total shareholders' equity | 7,076,667 | 10,133,798 | ||||||
Total liabilities and shareholders' equity | $ | 296,176,382 | $ | 305,340,530 |
See notes to interim consolidated financial statements (unaudited)
1 |
FNBH BANCORP, INC. AND SUBSIDIARIES
Consolidated Statements of Operations (Unaudited)
Three months ended September 30 | Nine months ended September 30 | |||||||||||||||
2011 | ||||||||||||||||
2011 | 2010 | (Restated) | 2010 | |||||||||||||
Interest and dividend income: | ||||||||||||||||
Interest and fees on loans | $ | 2,766,270 | $ | 3,220,073 | $ | 8,669,858 | $ | 9,956,366 | ||||||||
Interest and dividends on investment securities: | ||||||||||||||||
U.S. Tresaury, agency securities and CMOs | 272,179 | 183,903 | 741,076 | 590,264 | ||||||||||||
Obligations of states and political subdivisions | 60,227 | 68,063 | 191,535 | 211,021 | ||||||||||||
Other securities | 5,166 | 3,555 | 17,492 | 14,364 | ||||||||||||
Interest on short term investments | 245 | 92 | 1,067 | 324 | ||||||||||||
Total interst and dividend income | 3,104,087 | 3,475,686 | 9,621,028 | 10,772,339 | ||||||||||||
Interest expense: | ||||||||||||||||
Interest on deposits | 374,135 | 614,012 | 1,224,692 | 1,981,698 | ||||||||||||
Interest on other borrowings | - | - | - | 1,174 | ||||||||||||
Total interest expense | 374,135 | 614,012 | 1,224,692 | 1,982,872 | ||||||||||||
Net interest income | 2,729,952 | 2,861,674 | 8,396,336 | 8,789,467 | ||||||||||||
Provision for loan losses | 800,000 | 1,200,000 | 5,400,000 | 3,600,000 | ||||||||||||
Net interest income after provision for loan losses | 1,929,952 | 1,661,674 | 2,996,336 | 5,189,467 | ||||||||||||
Noninterest income: | ||||||||||||||||
Service charges and other fee income | 676,418 | 728,172 | 1,975,500 | 2,283,066 | ||||||||||||
Trust income | 50,024 | 57,274 | 153,050 | 186,664 | ||||||||||||
Loss on available for sale securities | (75,608 | ) | - | (75,608 | ) | - | ||||||||||
Other | 40,192 | 2,496 | 72,153 | 2,361 | ||||||||||||
Total noninterest income | 691,026 | 787,942 | 2,125,095 | 2,472,091 | ||||||||||||
Noninterest expense: | ||||||||||||||||
Salaries and employee benefits | 1,231,531 | 1,223,452 | 3,613,957 | 3,929,357 | ||||||||||||
Net occupancy expense | 198,442 | 279,557 | 678,555 | 819,478 | ||||||||||||
Equipment expense | 85,310 | 79,447 | 265,688 | 253,180 | ||||||||||||
Professional and service fees | 421,536 | 454,647 | 1,174,573 | 1,282,352 | ||||||||||||
Loan collection and foreclosed property expenses | 112,878 | 139,120 | 376,724 | 570,500 | ||||||||||||
Computer service fees | 157,485 | 109,301 | 379,368 | 343,066 | ||||||||||||
Computer software amortization expense | 57,226 | 64,422 | 176,532 | 194,750 | ||||||||||||
FDIC assessment fees | 259,442 | 358,099 | 842,928 | 1,074,953 | ||||||||||||
Insurance | 135,855 | 182,743 | 419,171 | 526,765 | ||||||||||||
Printing and supplies | 29,385 | 33,290 | 109,804 | 107,068 | ||||||||||||
Director fees | 17,938 | 15,375 | 57,063 | 48,450 | ||||||||||||
Net loss on sale/writedown of OREO and repossessions | 235,749 | 81,687 | 277,417 | 254,450 | ||||||||||||
Other | 157,032 | 179,594 | 452,021 | 544,570 | ||||||||||||
Total noninterest expense | 3,099,809 | 3,200,734 | 8,823,801 | 9,948,939 | ||||||||||||
Loss before federal income taxes | (478,831 | ) | (751,118 | ) | (3,702,370 | ) | (2,287,381 | ) | ||||||||
Federal income tax benefit | (51,150 | ) | (69,359 | ) | (128,852 | ) | (70,133 | ) | ||||||||
Net loss | $ | (427,681 | ) | $ | (681,759 | ) | $ | (3,573,518 | ) | $ | (2,217,248 | ) | ||||
Per share statistics: | ||||||||||||||||
Basic and diluted EPS | $ | (0.94 | ) | $ | (1.49 | ) | $ | (7.81 | ) | $ | (4.86 | ) | ||||
Basic and diluted average shares outstanding | 457,333 | 456,699 | 457,308 | 456,425 |
See notes to interim consolidated financial statements (unaudited)
2 |
FNBH BANCORP, INC. AND SUBSIDIARIES
Consolidated Statements of Shareholders' Equity and Comprehensive Income (Loss)
For the Nine Months Ended September 30, 2011 and 2010 (Unaudited)
Retained | Deferred | Accumulated Other | ||||||||||||||||||
Common | Earnings (Deficit) | Directors' | Comprehensive | Total | ||||||||||||||||
Stock | (Restated) | Compensation | Income (Loss) | (Restated) | ||||||||||||||||
Balances at January 1, 2010 | $ | 6,738,128 | $ | 6,641,060 | $ | 885,919 | $ | 111,157 | $ | 14,376,264 | ||||||||||
Earned portion of long term incentive plan | 12,324 | 12,324 | ||||||||||||||||||
Issued 1,074 shares to employee stock purchase plan | 3,360 | 3,360 | ||||||||||||||||||
Issued 1,158 shares for deferred directors' fees | 177,548 | (177,548 | ) | - | ||||||||||||||||
Comprehensive loss: | ||||||||||||||||||||
Net loss | (2,217,248 | ) | (2,217,248 | ) | ||||||||||||||||
Change in unrealized gain on investment securities available for sale, net of tax effect | 136,140 | 136,140 | ||||||||||||||||||
Total comprehensive loss | (2,081,108 | ) | ||||||||||||||||||
Balances at September 30, 2010 | $ | 6,931,360 | $ | 4,423,812 | $ | 708,371 | $ | 247,297 | $ | 12,310,840 | ||||||||||
Balances at January 1, 2011 | $ | 6,935,140 | $ | 2,747,615 | $ | 708,372 | $ | (257,329 | ) | $ | 10,133,798 | |||||||||
Earned portion of long term incentive plan | 8,935 | 8,935 | ||||||||||||||||||
Issued 878 shares for deferred directors' fees | 131,261 | (131,261 | ) | - | ||||||||||||||||
Comprehensive loss: | ||||||||||||||||||||
Net loss | (3,573,518 | ) | (3,573,518 | ) | ||||||||||||||||
Change in unrealized gain on investment securities available for sale, net of tax effect | 431,844 | 431,844 | ||||||||||||||||||
Less reclassification adjustment for other-than-temporary impairment charge on securities included in net loss, net of tax effect | 75,608 | 75,608 | ||||||||||||||||||
Total comprehensive loss | (3,066,066 | ) | ||||||||||||||||||
Balances at September 30, 2011 | $ | 7,075,336 | $ | (825,903 | ) | $ | 577,111 | $ | 250,123 | $ | 7,076,667 |
See notes to interim consolidated financial statements (unaudited)
3 |
FNBH BANCORP, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows (Unaudited)
Nine months ended | ||||||||
September 30, | ||||||||
2011 | ||||||||
(Restated) | 2010 | |||||||
Cash flows from operating activities: | ||||||||
Net loss | $ | (3,573,518 | ) | $ | (2,217,248 | ) | ||
Adjustments to reconcile net loss to net cash provided by operating activities: | ||||||||
Provision for loan losses | 5,400,000 | 3,600,000 | ||||||
Depreciation and amortization | 510,606 | 563,912 | ||||||
Deferred income tax benefit | (128,852 | ) | (70,133 | ) | ||||
Net amortization on investment securities | 252,535 | 801 | ||||||
Loss on available for sale securities | 75,608 | - | ||||||
Earned portion of long term incentive plan | 8,935 | 12,324 | ||||||
Loss on disposal of fixed assets | 2,058 | - | ||||||
Net loss on the sale of other real estate owned and repossessions, held for sale | 277,417 | 254,450 | ||||||
Decrease in accrued interest income and other assets | 578,539 | 1,519,180 | ||||||
Decrease in accrued interest, taxes, and other liabilities | (262,212 | ) | (392,793 | ) | ||||
Net cash provided by operating activities | 3,141,116 | 3,270,493 | ||||||
Cash flows from investing activities | ||||||||
Purchases of available for sale securities | (23,635,680 | ) | (4,369,159 | ) | ||||
Proceeds from maturities and calls of available for sale securities | 2,500,000 | 890,000 | ||||||
Proceeds from mortgage-backed securities paydowns - available for sale | 3,581,241 | 3,621,570 | ||||||
Proceeds from repurchase of FHLBI stock | 122,300 | - | ||||||
Net decrease in loans | 11,864,810 | 17,781,058 | ||||||
Proceeds from sale of other real estate owned and repossessions, held for sale | 1,779,494 | 1,674,287 | ||||||
Capital expenditures | (218,628 | ) | (76,340 | ) | ||||
Net cash (used in) provided by investing activities | (4,006,463 | ) | 19,521,416 | |||||
Cash flows from financing activites: | ||||||||
Net decrease in deposits | (5,877,618 | ) | (20,736,854 | ) | ||||
Payments on FHLBI note | - | (413,970 | ) | |||||
Proceeds from borrowings | 32,813 | - | ||||||
Shares issued for employee stock purchase plan | - | 3,360 | ||||||
Net cash used in financing activities | (5,844,805 | ) | (21,147,464 | ) | ||||
Net (decrease) increase in cash and cash equivalents | (6,710,152 | ) | 1,644,445 | |||||
Cash and cash equivalents at beginning of year | 40,572,426 | 37,043,665 | ||||||
Cash and cash equivalents at end of period | $ | 33,862,274 | $ | 38,688,110 | ||||
Supplemental disclosures: | ||||||||
Interest paid | $ | 1,289,025 | $ | 2,077,993 | ||||
Net federal income taxes refunded | - | 1,693,691 | ||||||
Loans transferred to other real estate | 1,170,242 | 5,571,098 | ||||||
Loans charged off | 6,955,979 | 10,332,819 |
See notes to interim consolidated financial statements (unaudited)
4 |
Notes to Consolidated Financial Statements (unaudited)
1. Basis of Presentation
The accompanying unaudited 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 the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, these financial statements do not include all of the information and footnotes required by US GAAP for complete financial statements. In the opinion of management of FNBH Bancorp, Inc. (the Corporation), all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation were included. The results of operations for the three and nine month periods ended September 30, 2011 are not necessarily indicative of the results to be expected for the year ending December 31, 2011. For further information, refer to the consolidated financial statements and footnotes thereto included in the 2010 Annual Report contained in the Corporation’s report on Form 10-K filing. Certain reclassifications have been made to prior period financial statements to conform to the current period presentation.
The consolidated financial statements included in this Form 10-Q have been prepared assuming our wholly-owned subsidiary bank, First National Bank in Howell (the Bank), continues to operate in the normal course of business for the foreseeable future, and do not include any adjustments to recorded assets or liabilities should we be unable to continue as a going concern.
2. Financial Condition and Management’s Plan
In light of the Bank’s continued losses, insufficient capital position at September 30, 2011 and noncompliance with a regulatory capital directive stipulated under a Consent Order (as described in “Management’s Discussion and Analysis of Financial Condition and Results of Operations”), management believes that it is reasonable to anticipate continued and elevated regulatory oversight of the Bank. In addition, any continued weaknesses in the Michigan economy and local real estate market will likely continue to negatively impact the Bank’s near-term performance and profitability. In response to these difficult market conditions and regulatory standing, management has embarked on various initiatives to mitigate the impact of the economic and regulatory challenges facing the Bank. However, even if successful, implementation of all components of management’s plan is not expected to produce profitable results in 2011 and may not be successful in maintaining the Bank or the Corporation as a going concern. Management’s recovery plan is detailed in Note 2 of the consolidated financial statements included in the 2010 Annual Report within the Corporation’s Form 10-K filing.
Integral to management’s plan is the restoration of the Bank’s capital to a level sufficient to comply with the Office of the Comptroller of the Currency’s (“OCC”) capital directive and provide sufficient capital resources and liquidity to meet commitments and business needs. To date, the Bank has not raised the capital necessary to satisfy requirements of the Consent Order. Management and the Board of Directors continue to work to try to raise the additional equity believed necessary to sufficiently recapitalize the Bank. Management and the Board of Directors are committed to pursuing all potential alternatives and sources of capital to restore the Bank’s capital levels. Such alternatives include raising capital from existing shareholders, individuals, institutional capital market investors and private equity funds and the identification of suitors for a sale or merger transaction. See also the “Capital” section within “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included in this Form 10-Q.
While the Company is hopeful that its ongoing efforts to raise additional capital will be successful, there are significant hurdles that remain in order for the Company to raise the amount of capital necessary for the Bank to comply with the requirements of the Consent Order. The Company makes no assurances that its plan or related efforts will improve the Bank’s financial condition and further deterioration of the Bank’s capital position is possible. The current economic environment in southeast Michigan and local real estate market conditions will continue to impose significant challenges on the Bank and are expected to adversely impact financial results. Any further declines in the Bank’s capital levels may likely result in more regulatory oversight or enforcement action by either the OCC or the Federal Deposit Insurance Corporation (the “FDIC”).
3. Investment Securities
Investment securities available for sale consist of the following:
September 30, 2011 | ||||||||||||||||
Unrealized | ||||||||||||||||
Amortized Cost | Gains | Losses | Fair Value | |||||||||||||
Obligations of state and political subdivisions | $ | 5,808,938 | $ | 201,700 | $ | - | $ | 6,010,638 | ||||||||
U.S. agency securities | 3,990,000 | 42,766 | 4,032,766 | |||||||||||||
Mortgage-backed/CMO securities | 34,905,557 | 497,786 | (474,477 | ) | 34,928,866 | |||||||||||
Preferred stock securities(1) | 48,800 | 111,200 | - | 160,000 | ||||||||||||
Total available for sale | $ | 44,753,295 | $ | 853,452 | $ | (474,477 | ) | $ | 45,132,270 |
December 31, 2010 | ||||||||||||||||
Unrealized | ||||||||||||||||
Amortized Cost | Gains | Losses | Fair Value | |||||||||||||
Obligations of state and political subdivisions | $ | 6,309,076 | $ | 94,982 | $ | (117,722 | ) | $ | 6,286,336 | |||||||
Mortgage-backed/CMO securities | 21,169,123 | 206,063 | (439,412 | ) | 20,935,774 | |||||||||||
Preferred stock securities(1) | 48,800 | 9,560 | (10,800 | ) | 47,560 | |||||||||||
Total available for sale | $ | 27,526,999 | $ | 310,605 | $ | (567,934 | ) | $ | 27,269,670 |
(1) Represents preferred stocks issued by Freddie Mac and Fannie Mae
5 |
Investment securities are reviewed quarterly for possible other-than-temporary impairment (OTTI) based on guidance included in ASC Topic 320, Investments – Debt and Equity Instruments. This guidance requires an entity to assess whether it intends to sell, or whether it is more likely than not that it will be required to sell, a security in an unrealized loss position before the recovery of the security’s amortized cost basis. If either of these criteria is met, the entire difference between the amortized cost and fair value is recognized in earnings. For securities that do not meet the aforementioned criteria, the amount of impairment recognized in earnings is limited to the amount related to credit losses, while impairment related to other factors is recognized in other comprehensive income.
Management’s review of the securities portfolio for the existence of OTTI considers various qualitative and quantitative factors regarding each investment category, including if the securities were U.S. Government issued, the credit rating on the securities, credit outlook, payment status and financial condition, the length of time the security has been in a loss position, the size of the loss position and other meaningful information.
The Company makes a quarterly assessment of the other than temporary impairment on its non-agency mortgage backed security primarily based on a quarterly cash flow analysis performed by an independent third-party specialist. The analysis considers attributes of the security and specific loan level collateral underlying the security. The estimated fair value of the security’s cash flow is calculated by the specialist using an INTEX valuation model, subject to certain assumptions regarding expected prepayment rates, default rates, loss severity estimates, and discount rates as key valuation inputs.
At September 30, 2011, the security had a book value of $2,621,000 (89.90% of par); recorded fair value of $2,172,000 (74.50% of par) using an 11.0% discount rate intended to reflect estimated uncertainty and liquidity premiums, after adjustment for estimated credit loss cash flows; and an unrealized loss of $449,000 (15.40% of par).
Certain key attributes of the security or the underlying loans supporting the security include: a super senior tranche position and a weighted average remaining credit score (based on original FICO) for borrowers of 741. The primary location of the underlying loans was: 70% in California; 4% in Florida; and 2% in Arizona. The delinquency status of the underlying loans at September 30, 2011 was: 2.27% past due 30-59 days; 1.32% past due 60-89 days; 10.95% past due 90 days or more; 6.24% in process of foreclosure; and 1.85% held as other real estate owned.
Certain key assumptions used to estimate the fair value of the security at September 30, 2011 include: a forecasted voluntary prepayment rate (CRR) of 9.4%; forecasted default rates on underlying loans of 10.22% for the next 24 months, decreasing to 4.27% by month 37, and decreasing to 0.0% by month 215; and initial loss severity rates of 47.57%, for defaulting loans, decreasing by 2.5% per year beginning in month 13 until reaching a floor of 23.0%. Remaining credit support provided by other collateral pools of underlying loans within the security approximated 5.82% at September 30, 2011.
At September 30, 2011, based on a present value at a prospective yield of future cash flows for the investment as provided by the specialist and after management’s evaluation of the reasonableness of the specialist’s underlying assumptions regarding Level 2 and Level 3 inputs, the Company concluded that the security’s expected cash flows did not support the amortized cost of the security and other-than-temporary impairment of $75,608 had been incurred. Consequently, a realized loss of $75,608 representing credit loss impairment was charged against earnings during the three months ended September 30, 2011, as reported in noninterest income.
The following is a summary of the gross unrealized losses and fair value of securities by length of time that individual securities have been in a continuous loss position:
September 30, 2011 | ||||||||||||||||||||||||
Less than 12 months | 12 months or more | Total | ||||||||||||||||||||||
Unrealized | Unrealized | Unrealized | ||||||||||||||||||||||
losses | Fair Value | losses | Fair Value | losses | Fair Value | |||||||||||||||||||
Mortgage-backed/CMO securities | $ | (25,589 | ) | $ | 6,721,515 | $ | (448,888 | ) | $ | 2,171,794 | $ | (474,477 | ) | $ | 8,893,309 |
December 31, 2010 | ||||||||||||||||||||||||
Less than 12 months | 12 months or more | Total | ||||||||||||||||||||||
Unrealized | Unrealized | Unrealized | ||||||||||||||||||||||
losses | Fair Value | losses | Fair Value | losses | Fair Value | |||||||||||||||||||
Obligations of state and political subdivisions | $ | (117,722 | ) | $ | 2,692,003 | $ | - | $ | - | $ | (117,722 | ) | $ | 2,692,003 | ||||||||||
Mortgage-backed/CMO securities | (59,401 | ) | 6,955,344 | (380,011 | ) | 2,591,514 | (439,412 | ) | 9,546,858 | |||||||||||||||
Preferred stock securities | (10,800 | ) | 22,400 | - | - | (10,800 | ) | 22,400 | ||||||||||||||||
Total available for sale | $ | (187,923 | ) | $ | 9,669,747 | $ | (380,011 | ) | $ | 2,591,514 | $ | (567,934 | ) | $ | 12,261,261 |
The following is a summary of the amortized cost and approximate fair value of investment securities by contractual maturity at September 30, 2011 and December 31, 2010. Expected maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
6 |
September 30, 2011 | December 31, 2010 | |||||||||||||||
Approximate Fair | Approximate Fair | |||||||||||||||
Amortized Cost | Value | Amortized Cost | Value | |||||||||||||
Due in one year or less | $ | - | $ | - | $ | - | $ | - | ||||||||
Due after one year through five years | 3,453,206 | 3,532,886 | 715,954 | 735,290 | ||||||||||||
Due after five years through ten years | 3,653,881 | 3,758,729 | 2,646,610 | 2,701,070 | ||||||||||||
Due after ten years | 2,740,651 | 2,911,789 | 2,995,312 | 2,897,536 | ||||||||||||
$ | 9,847,738 | $ | 10,203,404 | $ | 6,357,876 | $ | 6,333,896 | |||||||||
Mortgage-backed/CMO securities | 34,905,557 | 34,928,866 | 21,169,123 | 20,935,774 | ||||||||||||
Totals | $ | 44,753,295 | $ | 45,132,270 | $ | 27,526,999 | $ | 27,269,670 |
7 |
Investment securities, with an amortized cost of approximately $36,045,000 at September 30, 2011 were pledged to secure public deposits and for other purposes required or permitted by law, including approximately $26,194,000 of securities pledged as collateral at the Federal Home Loan Bank of Indianapolis (FHLBI) to support potential liquidity needs of the Bank. At December 31, 2010, the amortized cost of pledged investment securities totaled $16,847,000 of which $6,557,000 was designated as collateral for borrowings at the FHLBI for contingent liquidity needs of the Bank.
The Bank owns stock in both the Federal Home Loan Bank of Indianapolis (FHLBI) and the Federal Reserve Bank (FRB), both of which are recorded at cost. The Bank is required to hold stock in the FHLBI equal to 5% of the institution’s borrowing capacity with the FHLBI. The Bank’s investment in FHLBI stock amounted to $734,800 at September 30, 2011 and $857,100 at December 31, 2010, respectively. The Bank’s investment in FRB stock, which totaled $44,250 at September 30, 2011 and December 31, 2010, is a requirement for the Bank’s membership in the Federal Reserve System. These investments can only be resold to, or redeemed by, the issuer.
4. Loans
Portfolio loans consist of the following:
September 30, | December 31, | |||||||
2011 | 2010 | |||||||
Commercial | $ | 15,245,277 | $ | 16,195,595 | ||||
Commercial real estate: | ||||||||
Construction, land development, and other land | 14,966,669 | 19,641,905 | ||||||
Owner occupied | 62,330,406 | 63,315,056 | ||||||
Nonowner occupied | 83,859,748 | 91,690,983 | ||||||
Consumer real estate: | ||||||||
Commercial purpose | 9,416,708 | 11,343,509 | ||||||
Mortgage - Residential | 15,507,280 | 16,772,150 | ||||||
Home equity and home equity lines of credit | 10,245,929 | 11,397,448 | ||||||
Consumer and Other | 5,271,660 | 5,783,631 | ||||||
Subtotal | 216,843,677 | 236,140,277 | ||||||
Unearned income | (200,490 | ) | (201,931 | ) | ||||
Total Loans | $ | 216,643,187 | $ | 235,938,346 |
Included in the consumer real estate loans above are residential first mortgages reported as “real estate mortgages” on the consolidated balance sheet. In addition, a portion of these consumer real estate loans include commercial purpose loans where the borrower has pledged a 1-4 family residential property as collateral. Loans also include the reclassification of demand deposit overdrafts, which amounted to $94,000 at September 30, 2011 and $85,000 at December 31, 2010, respectively.
Loans serviced for others, including commercial participations sold, are not reported as assets of the Bank and approximated $4.3 million at September 30, 2011 and $4.2 million at December 31, 2010.
5. Allowance for Loan Losses and Credit Quality of Loans
The Corporation separates its loan portfolio into segments to perform the calculation and analysis of the allowance for loan losses. The four segments analyzed are Commercial, Commercial Real Estate, Consumer Real Estate, and Consumer and Other. The Commercial segment includes loans to finance commercial and industrial businesses that are not secured by real estate. The Commercial Real Estate segment includes: i) construction real estate loans to finance construction and land development and/or loans secured by vacant land and ii) commercial real estate loans secured by non-farm, non-residential real estate which are further classified as either owner occupied or non-owner occupied based on the underlying collateral type. The Consumer Real Estate segment includes (commercial and non-commercial purpose) loans that are secured by 1 – 4 family residential real estate properties, including first mortgages on residential properties and home equity loans and lines of credit that are secured by first or second liens on residential properties. The Consumer and Other segment include all loans not included in any other segment. These are primarily loans to consumers for household, family, and other personal expenditures, such as autos, boats, and recreational vehicles.
Activity in the allowance for loan losses by portfolio segment is a follows:
For the Three Months Ended September 30, 2011 (Restated) | ||||||||||||||||||||
Commercial | Consumer Real | Consumer and | ||||||||||||||||||
Commercial | Real Estate | Estate | Other | Total | ||||||||||||||||
Allowance for loan losses: | ||||||||||||||||||||
Beginning balance | $ | 971,293 | $ | 9,830,476 | $ | 2,108,235 | $ | 144,114 | $ | 13,054,118 | ||||||||||
Charge offs | (2,082 | ) | (649,544 | ) | (227,517 | ) | (23,278 | ) | (902,421 | ) | ||||||||||
Recoveries | 27,014 | 16,734 | 76,133 | 38,485 | 158,366 | |||||||||||||||
Provision | (270,227 | ) | 609,594 | 389,746 | 70,887 | 800,000 | ||||||||||||||
Ending balance | $ | 725,998 | $ | 9,807,260 | $ | 2,346,597 | $ | 230,208 | $ | 13,110,063 |
8 |
For the Three Months Ended September 30, 2010 | ||||||||||||||||||||
Commercial | Consumer Real | Consumer and | ||||||||||||||||||
Commercial | Real Estate | Estate | Other | Total | ||||||||||||||||
Allowance for loan losses: | ||||||||||||||||||||
Beginning balance | $ | 1,251,579 | $ | 10,528,336 | $ | 1,869,229 | $ | 208,187 | $ | 13,857,331 | ||||||||||
Charge offs | (38,853 | ) | (2,083,027 | ) | (245,017 | ) | (36,582 | ) | (2,403,479 | ) | ||||||||||
Recoveries | 33,710 | 286,452 | 6,016 | 35,072 | 361,250 | |||||||||||||||
Provision | (155,071 | ) | 1,222,066 | 184,265 | (51,260 | ) | 1,200,000 | |||||||||||||
Ending balance | $ | 1,091,365 | $ | 9,953,827 | $ | 1,814,493 | $ | 155,417 | $ | 13,015,102 |
For the Nine Months Ended September 30, 2011 (Restated) | ||||||||||||||||||||
Commercial | Consumer Real | Consumer and | ||||||||||||||||||
Commercial | Real Estate | Estate | Other | Total | ||||||||||||||||
Allowance for loan losses: | ||||||||||||||||||||
Beginning balance | $ | 1,049,233 | $ | 10,555,428 | $ | 2,212,618 | $ | 152,891 | $ | 13,970,170 | ||||||||||
Charge offs | (227,011 | ) | (4,870,050 | ) | (1,735,514 | ) | (123,404 | ) | (6,955,979 | ) | ||||||||||
Recoveries | 149,572 | 243,418 | 194,266 | 108,616 | 695,872 | |||||||||||||||
Provision | (245,796 | ) | 3,878,464 | 1,675,227 | 92,105 | 5,400,000 | ||||||||||||||
Ending balance | $ | 725,998 | $ | 9,807,260 | $ | 2,346,597 | $ | 230,208 | $ | 13,110,063 |
For the Nine Months Ended September 30, 2010 | ||||||||||||||||||||
Commercial | Consumer Real | Consumer and | ||||||||||||||||||
Commercial | Real Estate | Estate | Other | Total | ||||||||||||||||
Allowance for loan losses: | ||||||||||||||||||||
Beginning balance | $ | 965,255 | $ | 15,554,706 | $ | 1,915,944 | $ | 229,268 | $ | 18,665,173 | ||||||||||
Charge offs | (452,014 | ) | (8,758,708 | ) | (930,548 | ) | (191,549 | ) | (10,332,819 | ) | ||||||||||
Recoveries | 74,666 | 847,118 | 19,490 | 141,474 | 1,082,748 | |||||||||||||||
Provision | 503,458 | 2,310,711 | 809,607 | (23,776 | ) | 3,600,000 | ||||||||||||||
Ending balance | $ | 1,091,365 | $ | 9,953,827 | $ | 1,814,493 | $ | 155,417 | $ | 13,015,102 |
The following table presents the balance in allowance for loan losses and loan balances by portfolio segment based on impairment method:
September 30, 2011 (Restated) | ||||||||||||||||||||
Commercial | Consumer Real | Consumer and | ||||||||||||||||||
Commercial | Real Estate | Estate | Other | Total | ||||||||||||||||
Allowance for loan losses: | ||||||||||||||||||||
Individually evaluated for impairment | $ | 316,000 | $ | 2,545,000 | $ | 500,000 | $ | - | $ | 3,361,000 | ||||||||||
Collectively evaluated for impairment | 409,998 | 7,262,260 | 1,846,597 | 230,208 | 9,749,063 | |||||||||||||||
Total allowance for loan losses | $ | 725,998 | $ | 9,807,260 | $ | 2,346,597 | $ | 230,208 | $ | 13,110,063 | ||||||||||
Loan balances: | ||||||||||||||||||||
Individually evaluated for impairment | $ | 1,185,201 | $ | 23,632,621 | $ | 2,859,561 | $ | - | $ | 27,677,383 | ||||||||||
Collectively evaluated for impairment | 14,060,076 | 137,524,202 | 32,310,356 | 5,271,660 | 189,166,294 | |||||||||||||||
Total Loans | $ | 15,245,277 | $ | 161,156,823 | $ | 35,169,917 | $ | 5,271,660 | $ | 216,843,677 |
December 31, 2010 | ||||||||||||||||||||
Commercial | Consumer Real | Consumer and | ||||||||||||||||||
Commercial | Real Estate | Estate | Other | Total | ||||||||||||||||
Allowance for loan losses: | ||||||||||||||||||||
Individually evaluated for impairment | $ | 462,000 | $ | 5,776,000 | $ | 297,000 | $ | - | $ | 6,535,000 | ||||||||||
Collectively evaluated for impairment | 587,233 | 4,779,428 | 1,915,618 | 152,891 | 7,435,170 | |||||||||||||||
Total allowance for loan losses | $ | 1,049,233 | $ | 10,555,428 | $ | 2,212,618 | $ | 152,891 | $ | 13,970,170 | ||||||||||
Loan balances: | ||||||||||||||||||||
Individually evaluated for impairment | $ | 1,379,512 | $ | 27,427,229 | $ | 1,396,122 | $ | 403,632 | $ | 30,606,495 | ||||||||||
Collectively evaluated for impairment | 14,816,083 | 147,220,715 | 38,116,985 | 5,379,999 | 205,533,782 | |||||||||||||||
Total Loans | $ | 16,195,595 | $ | 174,647,944 | $ | 39,513,107 | $ | 5,783,631 | $ | 236,140,277 |
Management’s on-going monitoring of the credit quality of the portfolio relies on an extensive credit risk monitoring process that considers several factors including: current economic conditions affecting the Bank’s customers, the payment performance of individual loans and pools of homogenous loans, portfolio seasoning, changes in collateral values, and detailed reviews of specific relationships.
9 |
Our internal loan grading system assigns a risk grade to all commercial loans. This grading system is similar to those employed by banking regulators. Grades 1 through 5 are considered “pass” credits and grade 6 are considered “watch” credits and are subject to greater scrutiny. Those loans graded 7 and higher are considered substandard and are individually evaluated for impairment if reported as nonaccrual and are greater than $100,000 or part of an aggregate relationship exceeding $100,000. All commercial loans are graded at inception and reviewed, and if appropriate, re-graded at various intervals thereafter. Additionally, our commercial loan portfolio and assigned risk grades are periodically subjected to review by external loan reviewers and banking regulators. Certain key factors considered in assigning loan grades include: cash flows, operating performance, financial condition, collateral, industry condition, management, and the strength, liquidity and willingness of guarantors’ support.
A description of the general characteristics of each risk grade follows:
· | RATING 1 (Minimal) - Loans in this category are generally to persons or entities of unquestioned financial strength, a highly liquid financial position, with collateral that is liquid and well margined. These borrowers have performed without question on past obligations, and the Bank expects their performance to continue. Internally generated cash flow covers current maturities on long-term debt by a substantial margin. |
· | RATING 2 (Modest) – These loans generally to persons or entities with strong financial condition and above-average liquidity who have previously satisfactorily handled their obligations with the Bank. Collateral securing the Bank’s debt is margined in accordance with policy guidelines. Internally-generated cash flow covers current maturities on long-term debt more than adequately. |
· | RATING 3 (Average) – These are loans generally with average cash flow and ratios compared to peers. Usually RMA comparisons show where companies fall in the performance spectrum. Companies have consistent performance for 3 or more years. |
· | RATING 4 (Acceptable) – These are loans generally to persons or entities with an average financial condition, adequate collateral margins, adequate cash flow to service long-term debt, and net worth comprised mainly of fixed assets are included in this category. These entities are minimally profitable now, with projections indicating continued profitability into the foreseeable future. Overall, these loans are basically sound. |
· | RATING 5 (Acceptable – Monitor) - These loans are characterized by borrowers who have marginal cash flow, marginal profitability, or have experienced an unprofitable year and a declining financial condition. The borrower has in the past satisfactorily handled debts with the Bank, but in recent months has either been late, delinquent in making payments, or made sporadic payments. While the Bank continues to be adequately secured, margins have decreased or are decreasing, despite the borrower’s continued satisfactory condition. Other characteristics of borrowers in this class include inadequate credit information or weakness of financial statement and repayment capacity, but with collateral that appears to limit exposure. This classification includes loans to established borrowers that are reasonably margined by collateral, but where near term potential for improvement in financial capacity appears limited. |
· | RATING 6 (Special Mention - OAEM) - Loans in this class generally have 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 Bank’s credit position at some future date. These potential weaknesses may result in a deterioration of the repayment of the loan and increase the credit risk. Special mention assets are not adversely classified and do not expose the Bank to sufficient risk to warrant adverse classification. Special mention credits may include a borrower that pays the Bank on a timely basis (occasional 30 day delinquent) and may be experiencing temporary cash flow deficiencies. |
· | RATING 7 (Substandard) - These loans are generally inadequately protected by the current sound worth and paying capacity of the borrower or of the collateral pledged, if any. Loans so classified must have a well-defined weakness, or weaknesses, that jeopardize the liquidation of the debt. They are characterized by the distinct possibility that the Bank will sustain some loss if the deficiencies are not corrected. Loss potential, while existing in the aggregate amount of substandard loans, does not have to exist in individual loans. Substandard credits may include a borrower that pays consistently past due, has significant cash flow shortages and may have a collateral shortfall that requires a specific reserve. |
· | RATING 8 (Doubtful) - This risk rating class has all of the weaknesses inherent in the substandard rating but with the added characteristic that the weaknesses make collection in full or liquidation, on the basis of currently known existing facts, condition, and values, highly questionable and improbable. These are poor quality loans in which neither the collateral, if any, nor the financial condition of the borrower presently ensure collectability in full within a reasonable period of time; in fact, there is permanent impairment in the collateral securing the Bank’s loan. These loans are in a work-out status, must be non-accrual status and have a defined work-out strategy. |
This is a transitional risk rating class while collateral value and other factors are assessed. Loans will remain in this class for the assessment period, but in no event for more than 1 year. If there is no improvement in the Bank’s position during that time, or if collateral value is determined sooner, a charge-off will be taken to best reflect known asset collateral value.
· | RATING 9 (Loss) - Loans in this risk rating have a portion of the loan that is deemed to be uncollectible and of such little value that their continuance as bankable assets is not warranted. This classification means the asset has absolutely no recovery or salvage value. The Bank will take the loss in the period in which the related loan becomes uncollectible. |
The assessment of compensating factors may result in a rating plus or minus one grade from those listed above. These factors include, but are not limited to collateral, guarantors, environmental conditions, history, plan/projection reasonableness, quality of information, and payment delinquency.
The internal loan grading system is applied to the residential real estate portion of our consumer loan portfolio upon certain triggering events (e.g., delinquency, bankruptcy, restructuring, etc.). The primary risk element for the residential real estate portion of consumer loans is the timeliness of borrowers’ scheduled payments. We rely primarily on our internal reporting system to monitor past due loans and have internal policies and procedures to pursue collection and protect our collateral interests in order to mitigate losses.
10 |
Our monitoring of credit quality is further denoted by classification of loans as nonperforming, which reflects loans where the accrual of interest has been discontinued, loans whose terms have been renegotiated to less than market rates due to a serious weakening of the borrower’s financial condition, and loans that are past due 90 days or more and still accruing interest.
The following table summarizes credit risk grades and nonperforming loans by class of loans:
September 30, 2011 (Restated) | ||||||||||||||||||||||||||||||||
Commercial Real Estate | Consumer Real Estate | |||||||||||||||||||||||||||||||
Construction, | Home equity | |||||||||||||||||||||||||||||||
Land | and Home | |||||||||||||||||||||||||||||||
Development, | Owner | Nonowner | Commercial | Mortgage - | equity Lines of | Consumer | ||||||||||||||||||||||||||
Risk Grade | Commercial | Other Land | Occupied | Occupied | Purpose | Residential | Credit | and Other | ||||||||||||||||||||||||
Not Rated | $ | 37,077 | $ | 89,266 | $ | 52,666 | $ | - | $ | - | $ | 12,957,047 | $ | 9,747,516 | $ | 4,317,932 | ||||||||||||||||
1 | 767,837 | - | - | - | - | - | - | - | ||||||||||||||||||||||||
2 | 246,962 | - | 521,860 | - | - | - | - | - | ||||||||||||||||||||||||
3 | 2,512,455 | 171,700 | 3,504,249 | 1,016,141 | 437,561 | - | - | 444,510 | ||||||||||||||||||||||||
4 | 4,519,406 | 1,230,234 | 17,252,533 | 22,747,375 | 1,846,022 | - | - | 132,563 | ||||||||||||||||||||||||
5 | 4,194,083 | 4,961,072 | 27,954,011 | 38,322,215 | 3,218,600 | - | - | 149,168 | ||||||||||||||||||||||||
6 | 866,035 | 257,321 | 4,359,291 | 8,780,071 | 662,547 | - | - | - | ||||||||||||||||||||||||
7 | 2,101,422 | 8,257,076 | 8,685,796 | 12,993,946 | 3,251,978 | 2,550,233 | 498,413 | 227,487 | ||||||||||||||||||||||||
Total | $ | 15,245,277 | $ | 14,966,669 | $ | 62,330,406 | $ | 83,859,748 | $ | 9,416,708 | $ | 15,507,280 | $ | 10,245,929 | $ | 5,271,660 | ||||||||||||||||
Performing | $ | 14,077,524 | $ | 6,473,439 | $ | 56,851,071 | $ | 78,352,909 | $ | 6,612,817 | $ | 14,168,960 | $ | 9,841,010 | $ | 5,224,120 | ||||||||||||||||
Nonperforming | 1,167,753 | 8,493,230 | 5,479,335 | 5,506,839 | 2,803,891 | 1,338,320 | 404,919 | 47,540 | ||||||||||||||||||||||||
Total | $ | 15,245,277 | $ | 14,966,669 | $ | 62,330,406 | $ | 83,859,748 | $ | 9,416,708 | $ | 15,507,280 | $ | 10,245,929 | $ | 5,271,660 |
December 31, 2010 | ||||||||||||||||||||||||||||||||
Commercial Real Estate | Consumer Real Estate | |||||||||||||||||||||||||||||||
Construction, | ||||||||||||||||||||||||||||||||
Land | Home equity and | |||||||||||||||||||||||||||||||
Development, | Nonowner | Commercial | Mortgage - | Home equity Lines of | Consumer and | |||||||||||||||||||||||||||
Risk Grade | Commercial | Other Land | Owner Occupied | Occupied | Purpose | Residential | Credit | Other | ||||||||||||||||||||||||
Not Rated | $ | - | $ | 90,962 | $ | 59,510 | $ | - | $ | - | $ | 13,922,193 | $ | 11,100,433 | $ | 4,429,637 | ||||||||||||||||
1 | 915,371 | - | - | - | - | - | - | - | ||||||||||||||||||||||||
2 | 508,717 | - | - | - | - | - | - | - | ||||||||||||||||||||||||
3 | 2,515,293 | 1,470,334 | 2,135,613 | 843,228 | 353,935 | - | - | 662,640 | ||||||||||||||||||||||||
4 | 3,098,230 | 1,173,686 | 14,786,199 | 22,255,054 | 1,999,213 | - | - | 282,613 | ||||||||||||||||||||||||
5 | 4,627,881 | 5,317,013 | 30,193,755 | 41,308,900 | 3,511,445 | - | - | 161,696 | ||||||||||||||||||||||||
6 | 1,837,269 | 1,865,608 | 6,790,306 | 14,083,914 | 2,284,589 | - | - | - | ||||||||||||||||||||||||
7 | 2,692,834 | 9,724,302 | 9,349,673 | 13,199,887 | 3,194,327 | 2,849,957 | 297,015 | 247,045 | ||||||||||||||||||||||||
Total | $ | 16,195,595 | $ | 19,641,905 | $ | 63,315,056 | $ | 91,690,983 | $ | 11,343,509 | $ | 16,772,150 | $ | 11,397,448 | $ | 5,783,631 | ||||||||||||||||
Performing | $ | 13,897,127 | $ | 10,994,656 | $ | 57,069,363 | $ | 82,662,548 | $ | 8,743,005 | $ | 14,965,365 | $ | 11,209,677 | $ | 5,740,341 | ||||||||||||||||
Nonperforming | 2,298,468 | 8,647,249 | 6,245,693 | 9,028,435 | 2,600,504 | 1,806,785 | 187,771 | 43,290 | ||||||||||||||||||||||||
Total | $ | 16,195,595 | $ | 19,641,905 | $ | 63,315,056 | $ | 91,690,983 | $ | 11,343,509 | $ | 16,772,150 | $ | 11,397,448 | $ | 5,783,631 |
Loans are considered past due when contractually required principal or interest has not been received. The amount classified as past due is the entire principal balance outstanding of the loan, not just the amount of payments that are past due.
11 |
An aging analysis of the recorded investment in past due loans, segregated by class of loans follows:
90+ Days | ||||||||||||||||||||||||||||
30-59 Days | 60-89 Days | 90+ Days | Total Past | Past Due | ||||||||||||||||||||||||
September 30, 2011 | Past Due | Past Due | Past Due | Due | Current | Total | and Accruing | |||||||||||||||||||||
Commercial | $ | 86,618 | $ | - | $ | 75,593 | $ | 162,211 | $ | 15,083,066 | $ | 15,245,277 | $ | - | ||||||||||||||
Commercial real estate: | ||||||||||||||||||||||||||||
Construction, land development, and other land | - | - | 4,993,691 | 4,993,691 | 9,972,978 | 14,966,669 | - | |||||||||||||||||||||
Owner occupied | 109,682 | - | 1,773,642 | 1,883,324 | 60,447,082 | 62,330,406 | - | |||||||||||||||||||||
Nonowner occupied | 165,128 | 3,275 | 703,412 | 871,815 | 82,987,933 | 83,859,748 | - | |||||||||||||||||||||
Consumer real estate: | ||||||||||||||||||||||||||||
Commercial purpose | 169,992 | 79,000 | 393,545 | 642,537 | 8,774,171 | 9,416,708 | - | |||||||||||||||||||||
Mortgage – Residential | 68,364 | 536,675 | 137,962 | 743,001 | 14,764,279 | 15,507,280 | - | |||||||||||||||||||||
Home equity and home equity lines of credit | 231,234 | 217,160 | - | 448,394 | 9,797,535 | 10,245,929 | - | |||||||||||||||||||||
Consumer and Other | 13,560 | 6,729 | 1,895 | 22,184 | 5,249,476 | 5,271,660 | - | |||||||||||||||||||||
Total | $ | 844,578 | $ | 842,839 | $ | 8,079,740 | $ | 9,767,157 | $ | 207,076,520 | $ | 216,843,677 | $ | - |
90+ Days | ||||||||||||||||||||||||||||
30-59 Days | 60-89 Days | 90+ Days | Total Past | Past Due | ||||||||||||||||||||||||
December 31, 2010 | Past Due | Past Due | Past Due | Due | Current | Total | and Accruing | |||||||||||||||||||||
Commercial | $ | 572,949 | $ | - | $ | 530,616 | $ | 1,103,565 | $ | 15,092,030 | $ | 16,195,595 | $ | - | ||||||||||||||
Commercial real estate: | ||||||||||||||||||||||||||||
Construction, land development, and other land | - | - | 6,091,118 | 6,091,118 | 13,550,787 | 19,641,905 | - | |||||||||||||||||||||
Owner occupied | 181,565 | - | 2,672,341 | 2,853,906 | 60,461,150 | 63,315,056 | - | |||||||||||||||||||||
Nonowner occupied | - | - | 2,032,497 | 2,032,497 | 89,658,486 | 91,690,983 | - | |||||||||||||||||||||
Consumer real estate: | ||||||||||||||||||||||||||||
Commercial purpose | - | - | 1,244,601 | 1,244,601 | 10,098,908 | 11,343,509 | - | |||||||||||||||||||||
Mortgage - Residential | - | 179,271 | 533,216 | 712,487 | 16,059,663 | 16,772,150 | - | |||||||||||||||||||||
Home equity and home equity lines of credit | 256,360 | 104,330 | - | 360,690 | 11,036,758 | 11,397,448 | - | |||||||||||||||||||||
Consumer and Other | 41,014 | 13,117 | 1,631 | 55,762 | 5,727,869 | 5,783,631 | - | |||||||||||||||||||||
Total | $ | 1,051,888 | $ | 296,718 | $ | 13,106,020 | $ | 14,454,626 | $ | 221,685,651 | $ | 236,140,277 | $ | - |
Loans are placed on nonaccrual when, in the opinion of management, the collection of additional interest is doubtful. Loans are generally placed on nonaccrual upon becoming ninety days past due. However, loans may be placed on nonaccrual regardless of whether or not they are past due. All cash received on nonaccrual loans is applied to the principal balance. Loans are considered for return to accrual status on an individual basis when all principal and interest amounts contractually due are brought current and future payments are reasonably assured.
The following is a summary of the recorded investment in nonaccrual loans, by class of loan:
September 30, | ||||||||
2011 | December 31, | |||||||
(Restated) | 2010 | |||||||
Commercial | $ | 1,167,753 | $ | 2,298,468 | ||||
Commercial real estate: | ||||||||
Construction, land development, and other land | 7,781,452 | 8,647,249 | ||||||
Owner occupied | 6,191,113 | 6,245,693 | ||||||
Nonowner occupied | 5,506,839 | 9,028,435 | ||||||
Consumer real estate: | ||||||||
Commercial purpose | 2,803,891 | 2,600,504 | ||||||
Mortgage - Residential | 1,338,320 | 1,806,785 | ||||||
Home equity and home equity lines of credit | 404,919 | 187,771 | ||||||
Consumer and Other | 47,540 | 43,290 | ||||||
Total | $ | 25,241,827 | $ | 30,858,195 |
12 |
The following table presents information pertaining to impaired loans and related valuation allowance allocations by class of loan:
September 30, 2011 (Restated) | December 31, 2010 | |||||||||||||||||||||||
Unpaid | Unpaid | |||||||||||||||||||||||
Recorded | Principal | Valuation | Recorded | Principal | Valuation | |||||||||||||||||||
Investment | Balance | Allowance | Investment | Balance | Allowance | |||||||||||||||||||
Impaired loans with a valuation allowance: | ||||||||||||||||||||||||
Commercial | $ | 554,387 | $ | 596,788 | $ | 316,000 | $ | 828,369 | $ | 861,986 | $ | 462,000 | ||||||||||||
Commercial real estate: | ||||||||||||||||||||||||
Construction, land development, and other land | 3,780,992 | 7,087,754 | 741,000 | 6,706,756 | 8,262,532 | 1,085,000 | ||||||||||||||||||
Owner occupied | 3,039,184 | 4,021,870 | 830,000 | 4,606,999 | 5,070,441 | 1,394,000 | ||||||||||||||||||
Nonowner occupied | 5,100,376 | 7,036,895 | 974,000 | 9,737,095 | 10,473,268 | 3,297,000 | ||||||||||||||||||
Consumer real estate: | ||||||||||||||||||||||||
Commercial purpose | 2,328,745 | 3,181,373 | 500,000 | 1,094,917 | 1,100,483 | 297,000 | ||||||||||||||||||
Mortgage - Residential | - | - | - | - | - | - | ||||||||||||||||||
Home equity and home equity lines of credit | - | - | - | - | - | - | ||||||||||||||||||
Consumer and Other | - | - | - | - | - | - | ||||||||||||||||||
Total | 14,803,684 | 21,924,680 | 3,361,000 | 22,974,136 | 25,768,710 | 6,535,000 | ||||||||||||||||||
Impaired loans without a valuation allowance: | ||||||||||||||||||||||||
Commercial | 630,814 | 831,555 | - | 551,143 | 580,023 | - | ||||||||||||||||||
Commercial real estate: | ||||||||||||||||||||||||
Construction, land development, and other land | 3,757,891 | 5,652,486 | - | 1,487,350 | 4,417,929 | - | ||||||||||||||||||
Owner occupied | 4,176,765 | 5,893,831 | - | 3,217,843 | 3,438,668 | - | ||||||||||||||||||
Nonowner occupied | 3,777,413 | 6,952,389 | - | 1,671,186 | 1,698,476 | - | ||||||||||||||||||
Consumer real estate: | ||||||||||||||||||||||||
Commercial purpose | 530,816 | 783,403 | - | 704,837 | 794,233 | - | ||||||||||||||||||
Mortgage - Residential | - | - | - | - | - | - | ||||||||||||||||||
Home equity and home equity lines of credit | - | - | - | - | - | - | ||||||||||||||||||
Consumer and Other | - | - | - | - | - | - | ||||||||||||||||||
Total | 12,873,699 | 20,113,664 | - | 7,632,359 | 10,929,329 | - | ||||||||||||||||||
Total: | ||||||||||||||||||||||||
Commercial | 1,185,201 | 1,428,343 | 316,000 | 1,379,512 | 1,442,009 | 462,000 | ||||||||||||||||||
Commercial real estate: | ||||||||||||||||||||||||
Construction, land development, and other land | 7,538,883 | 12,740,240 | 741,000 | 8,194,106 | 12,680,461 | 1,085,000 | ||||||||||||||||||
Owner occupied | 7,215,949 | 9,915,701 | 830,000 | 7,824,842 | 8,509,109 | 1,394,000 | ||||||||||||||||||
Nonowner occupied | 8,877,789 | 13,989,284 | 974,000 | 11,408,281 | 12,171,744 | 3,297,000 | ||||||||||||||||||
Consumer real estate: | ||||||||||||||||||||||||
Commercial purpose | 2,859,561 | 3,964,776 | 500,000 | 1,799,754 | 1,894,716 | 297,000 | ||||||||||||||||||
Mortgage - Residential | - | - | - | - | - | - | ||||||||||||||||||
Home equity and home equity lines of credit | - | - | - | - | - | - | ||||||||||||||||||
Consumer and Other | - | - | - | - | - | - | ||||||||||||||||||
Total Impaired Loans | $ | 27,677,383 | $ | 42,038,344 | $ | 3,361,000 | $ | 30,606,495 | $ | 36,698,039 | $ | 6,535,000 |
13 |
The following table presents information pertaining to impaired loans for the three and nine months ended September 30, 2011:
Three Months Ended | Nine Months Ended | |||||||||||||||
September 30, 2011 | September 30, 2011 | |||||||||||||||
(Restated) | (Restated) | |||||||||||||||
Average Outstanding Balance | Interest Income Recognized | Average Outstanding Balance | Interest Income Recognized | |||||||||||||
Impaired loans with valuation allowance: | ||||||||||||||||
Commercial | $ | 584,472 | $ | 137 | $ | 724,395 | $ | 196 | ||||||||
Commercial real estate: | ||||||||||||||||
Construction, land development, and other land | 3,852,710 | - | 6,009,207 | - | ||||||||||||
Owner occupied | 3,387,890 | 3,507 | 4,468,993 | 10,527 | ||||||||||||
Nonowner occupied | 5,268,300 | 6,785 | 8,379,598 | 23,438 | ||||||||||||
Consumer real estate: | ||||||||||||||||
Commercial purpose | 2,345,028 | 1,625 | 2,041,093 | 40,092 | ||||||||||||
Mortgage - Residential | - | - | - | - | ||||||||||||
Home equity and home equity lines of credit | - | - | - | - | ||||||||||||
Consumer and Other | - | - | - | - | ||||||||||||
Total | 15,438,400 | 12,054 | 21,623,286 | 74,253 | ||||||||||||
Impaired loans without valuation allowance: | ||||||||||||||||
Commercial | 623,665 | 2,407 | 429,499 | 26,840 | ||||||||||||
Commercial real estate: | ||||||||||||||||
Construction, land development, and other land | 3,781,377 | - | 2,297,303 | - | ||||||||||||
Owner occupied | 3,862,626 | 49,550 | 2,263,065 | 49,550 | ||||||||||||
Nonowner occupied | 3,808,098 | 27,643 | 2,191,437 | 65,064 | ||||||||||||
Consumer real estate: | ||||||||||||||||
Commercial purpose | 599,443 | 1,081 | 610,871 | 2,051 | ||||||||||||
Mortgage - Residential | - | - | - | - | ||||||||||||
Home equity and home equity lines of credit | - | - | - | - | ||||||||||||
Consumer and Other | - | - | - | - | ||||||||||||
Total | 12,675,209 | 80,681 | 7,792,175 | 143,505 | ||||||||||||
Total: | ||||||||||||||||
Commercial | 1,208,137 | 2,544 | 1,153,894 | 27,036 | ||||||||||||
Commercial real estate: | ||||||||||||||||
Construction, land development, and other land | 7,634,087 | - | 8,306,510 | - | ||||||||||||
Owner occupied | 7,250,516 | 53,057 | 6,732,058 | 60,077 | ||||||||||||
Nonowner occupied | 9,076,398 | 34,428 | 10,571,035 | 88,502 | ||||||||||||
Consumer real estate: | ||||||||||||||||
Commercial purpose | 2,944,471 | 2,706 | 2,651,964 | 42,143 | ||||||||||||
Mortgage - Residential | - | - | - | - | ||||||||||||
Home equity and home equity lines of credit | - | - | - | - | ||||||||||||
Consumer and Other | - | - | - | - | ||||||||||||
Total | $ | 28,113,609 | $ | 92,735 | $ | 29,415,461 | $ | 217,758 |
Troubled Debt Restructurings
The Corporation may agree to modify the terms of a loan to improve its ability to collect amounts due. The modified terms are intended to enable customers to mitigate the risk of foreclosure by creating a payment structure that provides for continued loan payment requirements based on their current cash flow ability. Modifications, including renewals that include concessions by the Bank and result from the debtor’s financial difficulties are considered troubled debt restructurings (TDRs).
As a result of adopting the amendments in ASU 2011-02, the Corporation reassessed all loan restructurings that occurred on or after January 1, 2011 for identification as TDRs. The Corporation identified as TDRs certain loans for which the allowance for loan losses had previously been measured under a general allowance methodology. Upon identifying those loans as TDRs, the Corporation identified them as impaired under the guidance in ASC 310-10-35. The amendments in ASU 2011-02 require prospective application of the impairment measurement guidance for those loans newly identified as impaired during the period. At September 30, 2011, the Corporation’s recorded investment in loans for which the allowance for credit losses was previously measured under a general allowance methodology and are now impaired as a result of being identified as TDRs under the new guidance was approximately $1,500,000 million, with a specific valuation allowance of $19,000.
Loan modifications are considered TDRs when the modification includes terms outside of normal lending practices (i.e., concessions) to a borrower who is experiencing financial difficulties.
Typical concessions granted include, but are not limited to:
1. | Agreeing to interest rates below prevailing market rates for debt with similar risk characteristics |
14 |
2. | Extending the amortization period beyond typical lending guidelines for debt with similar risk characteristics |
3. | Forbearance of principal |
4. | Forbearance of accrued interest |
To determine if a borrower is experiencing financial difficulties, the Corporation considers if:
1. | The borrower is currently in default on any other of their debt |
2. | It is likely that the borrower would default on any of their debt if the concession was not granted |
3. | The borrower’s cash flow was sufficient to service all of their debt if the concession was not granted |
4. | The borrower has declared, or is in the process of declaring bankruptcy |
5. | The borrower is a going concern (if the entity is a business) |
The following table summarizes troubled debt restructurings as of September 30, 2011 and December 31, 2010:
September 30, 2011 | December 31, 2010 | |||||||
Outstanding Recorded Investment | Outstanding Recorded Investment | |||||||
Commercial | $ | 1,270,226 | $ | 542,708 | ||||
Commercial real estate: | ||||||||
Construction, land development, and other land | 5,746,440 | 2,210,269 | ||||||
Owner occupied | 4,912,489 | 3,768,230 | ||||||
Nonowner occupied | 5,199,303 | 3,639,478 | ||||||
Consumer real estate: | ||||||||
Commercial purpose | 2,156,367 | 725,574 | ||||||
Mortgage - Residential | 1,169,629 | 1,567,435 | ||||||
Home equity and home equity lines of credit | 19,181 | 33,481 | ||||||
Consumer and Other | 36,277 | 31,873 | ||||||
Total | $ | 20,509,912 | $ | 12,519,048 |
The following table presents information regarding existing loans that were restructured during the three and nine month periods ended September 30, 2011, resulting in the loan being classified as a trouble debt restructuring:
Loans Restructured in the Three Month Period ended September 30, 2011 | Loans Restructured in the Nine Month Period ended September 30, 2011 | |||||||||||||||||||||||
Number of Loans | Pre-Modification Recorded Investment | Post-Modification Recorded Investment | Number of Loans | Pre-Modification Recorded Investment | Post-Modification Recorded Investment | |||||||||||||||||||
Commercial | 4 | $ | 388,887 | $ | 388,887 | 8 | $ | 1,019,504 | $ | 1,019,504 | ||||||||||||||
Commercial real estate: | ||||||||||||||||||||||||
Construction, land development, and other land | 1 | 508,346 | 508,346 | 6 | 1,895,609 | 1,895,609 | ||||||||||||||||||
Owner occupied | 4 | 1,067,682 | 1,067,682 | 13 | 2,972,386 | 2,972,386 | ||||||||||||||||||
Nonowner occupied | 1 | 1,184,105 | 1,184,105 | 4 | 5,220,639 | 4,782,014 | ||||||||||||||||||
Consumer real estate: | ||||||||||||||||||||||||
Commercial purpose | 2 | 127,616 | 127,616 | 8 | 993,481 | 993,481 | ||||||||||||||||||
Mortgage - Residential | - | - | - | 5 | 501,904 | 406,128 | ||||||||||||||||||
Home equity and home equity lines of credit | - | - | - | 1 | 39,721 | 19,721 | ||||||||||||||||||
Consumer and Other | - | - | - | 2 | 37,241 | 37,241 | ||||||||||||||||||
Total | 12 | $ | 3,276,636 | $ | 3,276,636 | 47 | $ | 12,680,485 | $ | 12,126,084 |
During the three months ended September 30, 2011, there were no payment defaults on troubled debt restructurings. For the nine months ended September 30, 2011, the Corporation had one TDR loan with a recorded investment of $447,000 that defaulted within 12 months of its restructuring. A loan is considered to be in payment default generally once it is 90 days contractually past due under the modified terms.
15 |
The following table summarizes the nature of concessions granted by the Corporation to borrowers experiencing financial difficulties in the three and nine month periods ended September 30, 2011:
Loans Restructured in the Three Months Ended September 30, 2011 | ||||||||||||||||||||||||
Non-Market Interest Rate | Extension of Amortization Period | Non-Market Interest Rate and Extension of Amortization Period | ||||||||||||||||||||||
Number of Loans | Pre-Modification Recorded Investment | Number of Loans | Pre-Modification Recorded Investment | Number of Loans | Pre-Modification Recorded Investment | |||||||||||||||||||
Commercial | - | $ | - | - | $ | - | 4 | $ | 388,887 | |||||||||||||||
Commercial real estate: | ||||||||||||||||||||||||
Construction, land development, and other land | - | - | - | - | 1 | 508,346 | ||||||||||||||||||
Owner occupied | - | - | - | - | 4 | 1,067,682 | ||||||||||||||||||
Nonowner occupied | - | - | - | - | 1 | 1,184,105 | ||||||||||||||||||
Consumer real estate: | ||||||||||||||||||||||||
Commercial purpose | 1 | 37,897 | - | - | 1 | 89,719 | ||||||||||||||||||
Mortgage - Residential | - | - | - | - | - | - | ||||||||||||||||||
Home equity and home equity lines of credit | - | - | - | - | - | - | ||||||||||||||||||
Consumer and Other | - | - | - | - | - | - | ||||||||||||||||||
Total | 1 | $ | 37,897 | - | $ | - | 11 | $ | 3,238,739 |
Loans Restructured in the Nine Months Ended September 30, 2011 | ||||||||||||||||||||||||
Non-Market Interest Rate | Extension of Amortization Period | Non-Market Interest Rate and Extension of Amortization Period | ||||||||||||||||||||||
Number of Loans | Pre-Modification Recorded Investment | Number of Loans | Pre-Modification Recorded Investment | Number of Loans | Pre-Modification Recorded Investment | |||||||||||||||||||
Commercial | 1 | $ | 85,907 | 1 | $ | 201,190 | 6 | $ | 732,406 | |||||||||||||||
Commercial real estate: | ||||||||||||||||||||||||
Construction, land development, and other land | - | - | - | - | 6 | 1,895,609 | ||||||||||||||||||
Owner occupied | 1 | 468,840 | 2 | 582,782 | 10 | 1,920,764 | ||||||||||||||||||
Nonowner occupied | 1 | 1,184,105 | 1 | 757,814 | 2 | 3,278,720 | ||||||||||||||||||
Consumer real estate: | ||||||||||||||||||||||||
Commercial purpose | - | - | - | - | 8 | 993,481 | ||||||||||||||||||
Mortgage - Residential | 1 | 141,859 | - | - | 4 | 360,046 | ||||||||||||||||||
Home equity and home equity lines of credit | - | - | - | - | 1 | 39,721 | ||||||||||||||||||
Consumer and Other | - | - | - | - | 2 | 37,241 | ||||||||||||||||||
Total | 4 | $ | 1,880,711 | 4 | $ | 1,541,786 | 39 | $ | 9,257,988 |
During the three and nine month periods ended September 30, 2011, non-market interest rate restructurings included pre-modification recorded investments of $3,068,000 and $8,881,000, respectively, related to performing loans that were renewed at either their existing contractual rates or non-market interest rates. Under new accounting guidance applicable beginning with the third quarter of 2011 (ASU 2011-02), because these performing loans were graded substandard and the modified rates were not market rates for similar loans, these renewals are considered troubled debt restructurings.
6. Fair Value Measurements
The Corporation measures fair values based on ASC Topic 820, Fair Value Measurements and Disclosures. ASC Topic 820 defines fair value and establishes a consistent framework for measuring and expands disclosure requirements for fair value measurements. Fair value represents the estimated price that would be received from selling an asset or paid to transfer a liability, otherwise known as an “exit price”. The three levels of inputs that may be used to measure fair value are as follows:
Level 1: Quoted prices (unadjusted) for identical assets or liabilities in active markets that the entity has the ability to access as of the measurement date.
Level 2: Significant other observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities in active markets; quoted prices for identical or similar assets or liabilities in markets that are not active; or other inputs that are observable or can be derived from or corroborated by observable market data by correlation or other means.
16 |
Level 3: Significant unobservable inputs that reflect a reporting entity’s own assumptions about the assumptions that market participants would use in pricing an asset or liability.
The following is a description of the Corporation’s valuation methodologies used to measure and disclose the fair values of its financial assets and liabilities on a recurring basis:
Securities available for sale. Securities available for sale are recorded at fair value on a recurring basis. Fair value measurement is based on quoted prices, if available. If quoted prices are not available, fair values are measured using independent pricing models. Level 2 securities include U.S. government and agency securities, other U.S. government and agency mortgage-backed securities, municipal bonds and preferred stock securities. Level 3 securities include private collateralized mortgage obligations. Refer to Note 3, Investment Securities, for further information regarding the inputs and assumptions used in estimating the fair value of the Corporation’s non-investment grade CMO security.
Fair value of assets measured on a recurring basis:
Fair Value Measurements at September 30, 2011 | ||||||||||||||||
Quoted Prices in Active Markets for Identical Assets | Significant Other Observable Inputs | Significant Unobservable Inputs | ||||||||||||||
Total | (Level 1) | (Level 2) | (Level 3) | |||||||||||||
Obligations of state and political subdivisions | $ | 6,010,638 | $ | - | $ | 6,010,638 | $ | - | ||||||||
U.S. agency securities | 4,032,766 | - | 4,032,766 | - | ||||||||||||
Mortgage-backed/CMO securities | 34,928,866 | - | 32,757,072 | 2,171,794 | ||||||||||||
Preferred Stock securities | 160,000 | - | 160,000 | - | ||||||||||||
Total investment securities available for sale | $ | 45,132,270 | $ | - | $ | 42,960,476 | $ | 2,171,794 |
Fair Value Measurements at December 31, 2010 | ||||||||||||||||
Quoted Prices in Active Markets for Identical Assets | Significant Other Observable Inputs | Significant Unobservable Inputs | ||||||||||||||
Total | (Level 1) | (Level 2) | (Level 3) | |||||||||||||
Obligations of state and political subdivisions | $ | 6,286,336 | $ | - | $ | 6,286,336 | $ | - | ||||||||
Mortgage-backed/CMO securities | 20,935,774 | - | 18,344,260 | 2,591,514 | ||||||||||||
Preferred Stock securities | 47,560 | - | 47,560 | - | ||||||||||||
Total investment securities available for sale | $ | 27,269,670 | $ | - | $ | 24,678,156 | $ | 2,591,514 |
The reconciliation of the beginning and ending balances of the asset classified by the Corporation within Level 3 of the valuation hierarchy for the nine months ended September 30, 2011 is as follows:
Fair Value Measurements Using Significant Unobservable Inputs | ||||
(Level 3) | ||||
Fair Value of CMO, beginning of period (1) | $ | 2,591,514 | ||
Total gains (losses) realized/unrealized: | ||||
Included in earnings (2) | (75,608 | ) | ||
Included in other comprehensive income (loss) (2) | (68,877 | ) | ||
Purchases, issuances, and other settlements | (275,235 | ) | ||
Transfers into Level 3 (3) | - | |||
Fair Value of CMO, September 30, 2011 | $ | 2,171,794 | ||
Total amount of losses for the period included in earnings attributable to the change in unrealized losses relating to assets still held at September 30, 2011 | $ | 75,608 |
(1) | Non-agency CMO classified as available for sale is valued using internal valuation models and pricing information from third parties. |
(2) | Realized gain (losses), including unrealized losses deemed other-than-temporary, are reported in noninterest income. Unrealized gains (losses) are reported in accumulated other comprehensive income (loss). |
(3) | Transfers in or out are based on the carrying amount of the security at the beginning of the period. |
The following is a description of the Corporation’s valuation methodologies used to measure and disclose the fair values of its financial assets and liabilities on a nonrecurring basis:
17 |
Loans. The Corporation does not record loans at fair value on a recurring basis. However, from time to time, the Corporation records nonrecurring fair value adjustments to impaired loans. These loans are reported in the nonrecurring table below at initial recognition of impairment and on an ongoing basis until recovery or charge off. A loan is considered impaired when it is probable that all of the principal and interest due under the original terms of the loan may not be collected. Impairment is typically measured based on the fair value of the underlying collateral which is determined, where possible, using observable market prices derived from appraisals or broker price opinions, which are considered to be Level 2. When a current appraised value is not available or management determines the fair value of the collateral is further impaired below the appraised value and there is no observable market price, the Corporation records the impaired loan as nonrecurring Level 3. Fair value may also be measured using the present value of expected future cash flows discounted at the loan’s effective interest rate. Since certain assumptions and unobservable inputs are currently used in both techniques, impaired loans are recorded as Level 3 in the fair value hierarchy.
Other real estate owned. Real estate acquired through foreclosure or deed-in-lieu is adjusted to fair value less costs to sell upon transfer of the loan to other real estate owned, usually based on an appraisal of the property. Subsequently, other real estate owned is carried at the lower of carrying value or fair value. A valuation based on a current appraisal or by a broker’s opinion is considered a Level 2 fair value. If management determines the fair value of the property is further impaired below the appraised value and there is no observable market price, the Corporation records the property as nonrecurring Level 3.
Fair value on a nonrecurring basis is as follows (restated):
Fair Value Measurements at September 30, 2011 | ||||||||||||||||
Quoted Prices in Active Markets for Identical Assets | Significant Other Observable Inputs | Significant Unobservable Inputs | ||||||||||||||
Total | (Level 1) | (Level 2) | (Level 3) | |||||||||||||
Impaired loans (1) | $ | 24,316,383 | - | - | 24,316,383 | |||||||||||
Other real estate owned | 3,407,543 | - | - | 3,407,543 |
Fair Value Measurements at December 31, 2010 | ||||||||||||||||
Quoted Prices in Active Markets for Identical Assets | Significant Other Observable Inputs | Significant Unobservable Inputs | ||||||||||||||
Total | (Level 1) | (Level 2) | (Level 3) | |||||||||||||
Impaired loans (1) | $ | 24,071,495 | $ | - | $ | - | $ | 24,071,495 | ||||||||
Other real estate owned | 4,294,212 | - | - | 4,294,212 |
(1) | Represents carrying value and related write-downs and specific reserves on loans for which fair value is measured using either the appraised value of the underlying collateral or the present value of expected future cash flows discounted at the loan’s effective interest rate, and other unobservable inputs. |
7. Fair Value of Financial Instruments
Fair value disclosures require fair-value information about financial instruments for which it is practicable to estimate that value. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. In that regard, the derived fair-value estimates cannot be substantiated by comparison to independent markets and, in many cases, cannot be realized in immediate settlement of the instrument.
Fair-value methods and assumptions for the Corporation’s financial instruments are as follows:
Cash and cash equivalents – The carrying amounts reported in the consolidated balance sheet for cash and short term investments reasonably approximate those assets’ fair values.
Investment securities – Fair values for investment securities are determined as discussed above.
FHLBI and FRB stock – It is not practicable to determine the fair value of the FHLB and FRB stock due to restrictions placed on transferability.
Loans – For variable-rate loans that reprice frequently, fair values are generally based on carrying values, adjusted for credit risk. The fair value of fixed-rate loans is estimated by discounting future cash flows using the current rates at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities.
Accrued interest income – The carrying amount of accrued interest income is a reasonable estimate of fair value.
Deposit liabilities – The fair value of deposits with no stated maturity, such as demand deposit, NOW, savings, and money market accounts, is equal to the amount payable on demand. The fair value of certificates of deposit is estimated using rates currently offered for wholesale funds with similar remaining maturities.
Accrued interest expense – The carrying amount of accrued interest payable is a reasonable estimate of fair value.
Off-balance-sheet instruments – The fair value of commitments to extend credit is estimated using the fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the present creditworthiness of the counterparties. For fixed-rate loan commitments, fair value also considers the difference between current levels of interest rates and the committed rates. The fair value of commitments to extend credit, including letters of credit, is estimated to approximate their aggregate book balance and is not considered material and therefore not included in the following table.
18 |
The estimated fair values of the Corporation’s financial instruments are as follows:
September 30, 2011 | ||||||||||||||||
(Restated) | December 31, 2010 | |||||||||||||||
Carrying Value | Fair Value | Carrying Value | Fair Value | |||||||||||||
Financial assets: | ||||||||||||||||
Cash and cash equivalents | $ | 33,862,000 | $ | 33,862,000 | $ | 40,572,000 | $ | 40,572,000 | ||||||||
Investments and mortgage-backed securities | 45,132,000 | 45,132,000 | 27,270,000 | 27,270,000 | ||||||||||||
FHLBI and FRB stock | 779,000 | N/A | 901,000 | N/A | ||||||||||||
Loans, net | 203,533,000 | 204,490,000 | 221,968,000 | 222,025,000 | ||||||||||||
Accured interest income | 794,000 | 794,000 | 834,000 | 834,000 | ||||||||||||
Financial liabilites: | ||||||||||||||||
Deposits | ||||||||||||||||
Demand | $ | 87,697,000 | $ | 87,697,000 | $ | 62,294,000 | $ | 62,294,000 | ||||||||
NOW | 29,095,000 | 28,979,000 | 52,019,000 | 52,089,000 | ||||||||||||
Savings and money market accounts | 74,213,000 | 74,114,000 | 75,226,000 | 75,276,000 | ||||||||||||
Time deposits | 93,025,000 | 94,094,000 | 100,382,000 | 100,647,000 | ||||||||||||
Brokered certificates | 3,372,000 | 3,475,000 | 3,359,000 | 3,463,000 | ||||||||||||
Other borrowings | 33,000 | 33,000 | - | - | ||||||||||||
Accrued interest expense | 140,000 | 140,000 | 204,000 | 204,000 |
Limitations
Fair-value estimates are made at a specific point in time based on relevant market information and information about the financial instrument. These estimates do not reflect any premium or discounts that could result from offering for sale at one time the Corporation’s entire holdings of a particular financial instrument. Because no market exists for a significant portion of the Corporation’s financial instruments, fair-value estimates are based on judgments regarding future loss experience, current economic conditions, risk characteristics of various financial instruments, and other factors. These estimates are subjective in nature and involve uncertainties and matters of significant judgment, and, therefore, cannot be determined with precision. Changes in assumptions could significantly affect the estimates.
8. Net Income (Loss) per Common Share
During the third quarter of 2011, the Corporation announced a 1-for-7 reverse stock split of the Corporation’s outstanding common stock effective after the close of trading on October 3, 2011. The Corporation’s common stock began trading on a split adjusted basis on the Over-The-Counter Bulletin Board at the opening of trading on October 4, 2011. All common stock and per share amounts in these unaudited interim consolidated financial statements and notes have been adjusted to reflect the reverse split for all periods presented. See also Note 11.
Basic earnings per common share is based on the weighted average number of common shares and participating securities outstanding during the period. Diluted earnings per share are the same as basic earnings per share because any additional potential common shares issuable are included in the basic earnings per share calculation. The Corporation follows guidance included in ASC Topic 260, Earnings Per Share, related to determining whether instruments granted in a share-based payment transaction are participating securities. This guidance requires that unvested stock awards which contain non-forfeitable rights to dividends or dividend equivalents, whether paid or unpaid (referred to as “participating securities”), be included in the number of shares outstanding for both basic and diluted earnings per share calculations. Our unvested restricted stock under the Long-Term Incentive Plan is considered a participating security. In the event of a net loss, the participating securities are excluded from the calculation of both basic and diluted earnings per share, as the impact would be anti-dilutive.
The following table presents basic and diluted earnings per share (1):
Third Quarter | Year-to-Date | |||||||||||||||
(Restated) | ||||||||||||||||
2011 | 2010 | 2011 | 2010 | |||||||||||||
Weighted average common shares outstanding | 457,333 | 456,699 | 457,308 | 456,425 | ||||||||||||
Weighted average unvested restricted stock outstanding | - | - | - | - | ||||||||||||
Weighted average basic and diluted common shares outstanding | 457,333 | 456,699 | 457,308 | 456,425 | ||||||||||||
Net loss available to common shareholders | $ | (427,681 | ) | $ | (681,759 | ) | $ | (3,573,518 | ) | $ | (2,217,248 | ) | ||||
Basic and diluted net loss per share | $ | (0.94 | ) | $ | (1.49 | ) | $ | (7.81 | ) | $ | (4.86 | ) |
(1) | Per share data and as well as number of shares are adjusted to reflect the 1-for-7 reverse stock split effective October 3, 2011. |
9. Long Term Incentive Plan
Under the Long Term Incentive Plan (the “LTIP”), the Corporation had the authority to grant stock options and restricted stock as compensation to key employees. Such authority expired April 22, 2008. The Corporation did not award any stock options under the LTIP. The restricted shares granted under the LTIP have a five-year vesting period. The awards were recorded at fair value on the grant date and are amortized into salary expense over the vesting period.
19 |
A summary of the activity under the LTIP for the nine months ended September 30, 2011 and 2010 is presented below:
2011 | 2010 | |||||||||||||||
Weighted-Average | Weighted-Average | |||||||||||||||
Grant Date | Grant Date | |||||||||||||||
Restricted Stock Awards (1) | Shares | Fair Value | Shares | Fair Value | ||||||||||||
Outstanding at January 1, | 173 | $ | 112.20 | 290 | $ | 122.28 | ||||||||||
Granted | - | - | - | - | ||||||||||||
Vested | (71 | ) | 125.18 | (89 | ) | 138.08 | ||||||||||
Forfeited | - | - | - | - | ||||||||||||
Outstanding at September 30, | 102 | $ | 102.68 | 201 | $ | 115.37 |
(1) | Per share data and as well as number of shares are adjusted to reflect the 1-for-7 reverse stock split effective October 3, 2011. |
The total fair value of the awards vested during the three months ended September 30, 2011 and 2010 was $2,577 and $3,780, respectively. Awards vested during the nine months ended September 30, 2011 and 2010 had a total fair value of $8,935 and $12,324, respectively. As of September 30, 2011, there was $10,473 of total unrecognized compensation cost related to nonvested stock awards under the LTIP. That cost is expected to be recognized over a weighted-average period of 1.20 years.
10. Income Taxes
The provision for income taxes represents federal income tax expense calculated using estimated annualized rates on taxable income or loss generated during the respective periods adjusted, as necessary, to avoid recording tax benefits during loss periods in excess of amounts expected to be realized.
In the third quarter of 2011, the Corporation recorded a federal income tax benefit to reduce its deferred tax valuation allowance established on previously recorded deferred tax assets. The decrease in the recorded valuation allowance resulted from an increase in the deferred tax liability related to appreciation in the available for sale investment portfolio. The Corporation recorded a deferred tax valuation allowance against the tax benefit related to the respective pre-tax losses incurred during the three and nine month periods ended September 2011 and 2010 due to the uncertainty of future taxable income necessary to realize the recorded net deferred tax asset.
11. Subsequent Events
On September 22, 2011, at a Special Shareholder Meeting, the shareholders of FNBH Bancorp, Inc. (the Corporation) approved a 1-for-7 reverse stock split of the Corporation’s outstanding common stock. This reverse stock split became effective as of the close of business on October 3, 2011. The Corporation’s common stock began trading on a spilt adjusted basis on the Over-The-Counter Bulletin Board at the opening of trading on October 4, 2011. All share and per share amounts herein reflect the 1-for-7 reverse stock split. In connection with the reverse stock split, each seven shares of common stock issued and outstanding at the close of trading on the effective date was reclassified into one share of common stock. No fractional shares of common stock were issued as a result of the reverse split; instead, fractional shares were rounded up to the nearest whole share. The reverse stock split reduced the number of shares of outstanding common stock from 3,171,523 to 453,553. There was no change to the number of authorized shares of common stock as a result of the reverse split.
On October 14, 2011, the Corporation adopted a Tax Benefits Preservation Plan (the Plan) designed to protect its ability to utilize its deferred tax assets (such as net operating loss carry forwards) to offset future taxable income and reduce future federal income tax liability. The Corporation’s ability to use these deferred tax assets would be substantially limited if there were an “ownership change” as defined under federal tax rules. The Plan is designed to reduce the likelihood that the Corporation will experience an ownership change by discouraging any person who is not already a 5% shareholder from becoming a 5% shareholder of the Corporation (with certain limited exceptions). As a result of the adoption of the Plan, each shareholder of record on October 14, 2011, received a dividend of one right to purchase certain preferred securities of the Corporation upon the occurrence of certain events for every share of common stock owned by the shareholder.
12. Restatement
Subsequent to filing the Corporation’s September 30, 2011 Quarterly Report on Form 10-Q, management determined that the previously reported unaudited consolidated financial statements for the quarters ended June 30, 2011 and September 30, 2011 required adjustments to the loan loss provision and the allowance for loan losses (“ALLL”) to conform with the Bank’s revised June and September 2011 Call Reports. In assessing the adequacy of the Bank’s allowance for loan losses, management takes into consideration a number of factors, including current economic conditions and prior loan loss experience. This assessment is inherently subjective. Based on input from the Bank’s federal regulators, a reassessment of certain of these factors was performed and the determination was made to increase the ALLL as of June 30, 2011 by increasing the provision for loan losses by an additional $3,000,000.
In addition, based on management’s reassessment of the effects of events and information providing additional evidence about conditions that existed at June 30, 2011 for certain impaired commercial real estate loans, it was determined that portions of such loans were uncollectible and required approximately $2,600,000 of charge offs effective at June 30, 2011. These charge offs were taken primarily against specific reserves that were established prior to June 30, 2011. The restatement also included the transfer of an approximate $950,000 loan to other real estate owned based on management’s determination that the Bank exercised effective control of the underlying collateral at June 30, 2011. Except for the additional $3,000,000 provision expense to increase the ALLL at June 30, 2011, management had previously reported these events (the charge offs and the loan transfer to other real estate) during the quarter ended September 30, 2011. The consolidated financial statements for the three and nine months ended September 30, 2011 are restated to reflect the cumulative effect of the June 30, 2011 adjustments described above. The impact of the restatement is summarized below:
20 |
Effect of Restatement | ||||||||||||||||||||||||
Three Months Ended September 30, 2011 | Nine Months Ended September 30, 2011 | |||||||||||||||||||||||
As Previously Reported | Change | As Restated | As Previously Reported | Change | As Restated | |||||||||||||||||||
Consolidated Statement of Operations | ||||||||||||||||||||||||
Provision for loan losses | $ | 800,000 | $ | - | $ | 800,000 | $ | 2,400,000 | $ | 3,000,000 | $ | 5,400,000 | ||||||||||||
Net income (loss) | (427,681 | ) | - | (427,681 | ) | (573,518 | ) | (3,000,000 | ) | (3,573,518 | ) | |||||||||||||
Earnings (loss) per share: | ||||||||||||||||||||||||
Basic and diluted | (0.94 | ) | - | (0.94 | ) | (1.25 | ) | (6.56 | ) | (7.81 | ) |
As of September 30, 2011 | ||||||||||||
Consolidated Balance Sheet | As Previously Reported | Change | As Restated | |||||||||
Commercial loans | $ | 186,285,011 | $ | - | $ | 186,285,011 | ||||||
Allowance for loan losses | (10,110,063 | ) | (3,000,000 | ) | (13,110,063 | ) | ||||||
Net loans held for investment | 206,533,124 | (3,000,000 | ) | 203,533,124 | ||||||||
Other real estate owned, held for sale | 3,407,543 | - | 3,407,543 | |||||||||
Total assets | 299,176,382 | (3,000,000 | ) | 296,176,382 | ||||||||
Retained earnings (deficit) | 2,174,097 | (3,000,000 | ) | (825,903 | ) | |||||||
Total shareholders’ equity | 10,076,667 | (3,000,000 | ) | 7,076,667 |
Nine Months Ended September 30, 2011 | ||||||||||||
Consolidated Statement of Cash Flows | As Previously Reported | Change | As Restated | |||||||||
Supplemental disclosures: | ||||||||||||
Loans transferred to other real estate | $ | 1,170,242 | $ | - | $ | 1,170,242 | ||||||
Loans charged off | 6,955,979 | - | 6,955,979 |
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The Corporation, a Michigan business corporation, is a one bank holding company which owns all of the outstanding capital stock of First National Bank in Howell (the Bank) and all of the outstanding stock of HB Realty Co., a subsidiary. The following is a discussion of the Corporation’s results of operations for the three and nine months ended September 30, 2011 and 2010, and the Corporation’s financial condition, focusing on its liquidity and capital resources.
Since June 30, 2009 the Bank has been undercapitalized by regulatory standards. Effective September 24, 2009, the Bank has been subject to the terms of a Consent Order agreement with the Office of the Comptroller of the Currency (“OCC”). Pursuant to the Consent Order, the Bank was required to achieve and maintain total capital equal to 11% of risk weighted assets and Tier 1 capital equal to at least 8.5% of adjusted total assets by January 22, 2010. To date, the Bank has failed to meet these required minimum ratios and is currently out of compliance with these required minimum capital ratios as well as other requirements of the Consent Order. In light of the Bank’s noncompliance with the Consent Order, continued losses, deficient capital position and the uncertainty regarding the ability to raise additional equity capital, management believes it is reasonable to anticipate that further regulatory oversight or enforcement action may be taken by the OCC. See also the “Capital” and “Regulatory Enforcement Action” sections of this Management’s Discussion and Analysis for further details.
The success of the Corporation depends to a great extent upon the economic conditions in Livingston County and the surrounding area. The Corporation has in general experienced a slowing economy in Michigan since 2007. In particular, Michigan’s unemployment rate at September 2011, although improved from 2010 levels, remains above the national average and among the worst for all states. Unlike larger banks that are more geographically diversified, we provide banking services to customers primarily in Livingston County. Our loan portfolio, the ability of the borrowers to repay these loans, and the value of the collateral securing these loans is impacted by local economic conditions. The continued economic difficulties in Michigan have had and may continue to have adverse consequences as described below in “Loans and Asset Quality”.
Dramatic declines in commercial real estate values in recent years, with elevated levels of foreclosures and unemployment have resulted in and may continue to result in significant write-downs of asset values by us and other financial institutions. These write-downs have caused many financial institutions to seek additional capital, to merge with larger and stronger institutions and, in some cases, to fail. Additionally, capital and credit markets have continued to experience elevated levels of volatility and disruption in recent years. This market turmoil and tightening of credit have led to a lack of general consumer confidence and reduction in business activity.
21 |
Due to the conditions and events discussed above and elsewhere in this Form 10-Q, there is significant uncertainty regarding the impact of potential future regulatory action against the Bank. The extent of such regulatory action may threaten the Bank’s ability to continue operating as a going concern. Notwithstanding the above, the consolidated financial statements included in this Form 10-Q have been prepared assuming the Bank continues to operate in the normal course of business for the foreseeable future, and do not include any adjustments to recorded assets or liabilities should we be unable to continue as a going concern.
As fully described in Note 2, “Regulatory Matters and Going Concern”, of the consolidated financial statements included in the 2010 Annual Report within the Corporation’s Form 10-K filing, management has undertaken various initiatives identified in its recovery plan to address the current challenges facing the Bank. The successful implementation of the various actions being undertaken by management will be difficult in the current economic environment. Even if such actions are successfully implemented, such strategy may not be sufficient to increase the Bank's capital levels to satisfactory levels, return the Bank to profitability, or otherwise avoid further regulatory oversight or enforcement action. Any further declines in the Bank’s capital levels may result in more severe regulatory oversight or enforcement action by either the OCC or FDIC, including the possibility of regulatory receivership.
It is against this backdrop that we discuss our financial condition and results of operations for the three and nine months ended September 30, 2011 as compared to earlier periods.
(in thousands except per share data) | ||||||||||||||||
Earnings | Third Quarter | Year-to-Date | ||||||||||||||
(Restated) | ||||||||||||||||
2011 | 2010 | 2011 | 2010 | |||||||||||||
Net loss | $ | (428 | ) | $ | (682 | ) | $ | (3,574 | ) | $ | (2,217 | ) | ||||
Basic and diluted net loss per share (1) | $ | (0.94 | ) | $ | (1.49 | ) | $ | (7.81 | ) | $ | (4.86 | ) |
(1) | Per share data is adjusted to reflect the 1-for-7 reverse stock split effective October 3, 2011. |
Net loss for the three months ended September 30, 2011 decreased by $254,000 compared to the same period last year. In the third quarter of 2011, the provision for loan losses decreased by $400,000 and noninterest expense decreased by $101,000. Partially offsetting these favorable variances, noninterest income decreased by $97,000. In addition, federal income tax benefit decreased by $18,000.
Net loss for the nine months ended September 30, 2011, increased $1,357,000 compared to the nine months ended September 30, 2010. Provision for loan losses increased $1,800,000 and noninterest expense decreased $1,125,000. Federal income tax benefit increased by $59,000. Partially offsetting these favorable variances, net interest income and noninterest income decreased by $393,000 and $347,000, respectively.
(in thousands) | ||||||||||||||||
Net Interest Income | Third Quarter | Year-to-Date | ||||||||||||||
2011 | 2010 | 2011 | 2010 | |||||||||||||
Interest and dividend income | $ | 3,104 | $ | 3,476 | $ | 9,621 | $ | 10,772 | ||||||||
Interest expense | 374 | 614 | 1,225 | 1,983 | ||||||||||||
Net Interest Income | $ | 2,730 | $ | 2,862 | $ | 8,396 | $ | 8,789 |
22 |
The following tables show an analysis of net interest margin for the three and nine months ended September 30:
INTEREST YIELDS AND COSTS
(in thousands)
For the three months ended September 30, | ||||||||||||||||||||||||
(Restated) 2011 | 2010 | |||||||||||||||||||||||
Average Balance | Interest | Rate | Average Balance | Interest | Rate | |||||||||||||||||||
Assets: | ||||||||||||||||||||||||
Interest earning assets: | ||||||||||||||||||||||||
Short term investments | $ | 197 | $ | 0.1 | 0.26 | % | $ | 99 | $ | - | 0.12 | % | ||||||||||||
Securites: Taxable | 35,539 | 277.4 | 3.12 | % | 14,024 | 187.5 | 5.35 | % | ||||||||||||||||
Tax-exempt (1) | 5,932 | 89.5 | 6.04 | % | 6,692 | 100.0 | 5.98 | % | ||||||||||||||||
Commercial loans (2)(3) | 187,842 | 2,418.1 | 5.04 | % | 211,195 | 2,780.8 | 5.15 | % | ||||||||||||||||
Consumer loans (2)(3) | 15,343 | 199.9 | 5.17 | % | 17,373 | 245.0 | 5.60 | % | ||||||||||||||||
Real estate loans (2)(3) | 15,196 | 157.2 | 4.14 | % | 17,513 | 204.1 | 4.66 | % | ||||||||||||||||
Total earnings and total interest income | 260,049 | 3,142.2 | 4.75 | % | 266,896 | 3,517.4 | 5.18 | % | ||||||||||||||||
Cash and due from banks | 39,377 | 38,991 | ||||||||||||||||||||||
All other assets | 13,731 | 18,143 | ||||||||||||||||||||||
Allowance for loan losses | (13,108 | ) | (14,047 | ) | ||||||||||||||||||||
Total Assets | $ | 300,049 | $ | 309,983 | ||||||||||||||||||||
Liabilities and Shareholders' Equity: | ||||||||||||||||||||||||
Interest bearing liabilities: | ||||||||||||||||||||||||
NOW | $ | 28,508 | $ | 1.9 | 0.03 | % | $ | 50,311 | $ | 15.0 | 0.12 | % | ||||||||||||
Savings | 42,598 | 10.9 | 0.10 | % | 39,062 | 19.6 | 0.20 | % | ||||||||||||||||
MMDA | 35,259 | 54.6 | 0.61 | % | 32,854 | 51.4 | 0.62 | % | ||||||||||||||||
Time | 97,536 | 306.7 | 1.25 | % | 116,019 | 528.0 | 1.81 | % | ||||||||||||||||
Short term borrowings | 22 | - | - | - | - | - | ||||||||||||||||||
Total interest bearing liabilities and total interest expense | 203,923 | 374.1 | 0.73 | % | 238,246 | 614.0 | 1.02 | % | ||||||||||||||||
Non-interest bearing deposits | 86,618 | 56,632 | ||||||||||||||||||||||
All other liabilities | 1,961 | 2,254 | ||||||||||||||||||||||
Shareholders' Equity | 7,547 | 12,851 | ||||||||||||||||||||||
Total Liabilities and Shareholders' Equity | $ | 300,049 | $ | 309,983 | ||||||||||||||||||||
Interest spread | 4.02 | % | 4.16 | % | ||||||||||||||||||||
Net interest income - FTE | $ | 2,768.1 | $ | 2,903.4 | ||||||||||||||||||||
Net interest margin | 4.18 | % | 4.27 | % |
(1) | Average yields in the above table have been adjusted to a tax-equivalent basis using a 34% tax rate. |
(2) | For purposes of the computation above, average non-accruing loans of $26,956,000 in 2011 and $30,542,000 in 2010 are included in the average daily loan balance. |
(3) | Interest on loans includes origination fees totaling $17,000 in 2011 and $19,000 in 2010. |
23 |
INTEREST YIELDS AND COSTS
(in thousands)
For the nine months ended September 30, | ||||||||||||||||||||||||
(Restated) | ||||||||||||||||||||||||
2011 | 2010 | |||||||||||||||||||||||
Average Balance | Interest | Rate | Average Balance | Interest | Rate | |||||||||||||||||||
Assets: | ||||||||||||||||||||||||
Interest earning assets: | ||||||||||||||||||||||||
Short term investments | $ | 197 | $ | 0.5 | 0.32 | % | $ | 99 | $ | 0.1 | 0.10 | % | ||||||||||||
Securites: Taxable | 32,426 | 758.6 | 3.12 | % | 14,977 | 604.6 | 5.38 | % | ||||||||||||||||
Tax-exempt (1) | 6,097 | 281.1 | 6.15 | % | 6,866 | 309.7 | 6.02 | % | ||||||||||||||||
Commercial loans (2)(3) | 195,715 | 7,570.9 | 5.10 | % | 220,933 | 8,573.4 | 5.12 | % | ||||||||||||||||
Consumer loans (2)(3) | 15,717 | 626.5 | 5.33 | % | 17,775 | 757.3 | 5.70 | % | ||||||||||||||||
Real estate loans (2)(3) | 15,583 | 500.0 | 4.28 | % | 18,293 | 660.6 | 4.82 | % | ||||||||||||||||
Total earnings and total interest income | 265,735 | 9,737.6 | 4.85 | % | 278,943 | 10,905.7 | 5.17 | % | ||||||||||||||||
Cash and due from banks | 32,320 | 31,804 | ||||||||||||||||||||||
All other assets | 13,584 | 17,993 | ||||||||||||||||||||||
Allowance for loan losses | (13,601 | ) | (15,931 | ) | ||||||||||||||||||||
Total Assets | $ | 298,038 | $ | 312,809 | ||||||||||||||||||||
Liabilities and Shareholders' Equity: | ||||||||||||||||||||||||
Interest bearing liabilities: | ||||||||||||||||||||||||
NOW | $ | 28,848 | $ | 6.1 | 0.03 | % | $ | 49,070 | $ | 64.0 | 0.17 | % | ||||||||||||
Savings | 41,624 | 33.6 | 0.11 | % | 39,108 | 57.1 | 0.20 | % | ||||||||||||||||
MMDA | 35,217 | 163.8 | 0.62 | % | 32,471 | 157.7 | 0.65 | % | ||||||||||||||||
Time | 100,282 | 1,021.2 | 1.36 | % | 119,669 | 1,702.9 | 1.90 | % | ||||||||||||||||
Short term borrowings | 7 | - | - | - | - | - | ||||||||||||||||||
FHLBI advances | - | - | - | 21 | 1.2 | 7.29 | % | |||||||||||||||||
Total interest bearing liabilities and total interest expense | 205,978 | 1,224.7 | 0.79 | % | 240,339 | 1,982.9 | 1.10 | % | ||||||||||||||||
Non-interest bearing deposits | 80,664 | 56,475 | ||||||||||||||||||||||
All other liabilities | 2,060 | 2,322 | ||||||||||||||||||||||
Shareholders' Equity | 9,336 | 13,673 | ||||||||||||||||||||||
Total Liabilities and Shareholders' Equity | $ | 298,038 | $ | 312,809 | ||||||||||||||||||||
Interest spread | 4.06 | % | 4.07 | % | ||||||||||||||||||||
Net interest income - FTE | $ | 8,512.9 | $ | 8,922.8 | ||||||||||||||||||||
Net interest margin | 4.23 | % | 4.22 | % |
(1) | Average yields in the above table have been adjusted to a tax-equivalent basis using a 34% tax rate. |
(2) | For purposes of the computation above, average non-accruing loans of $29,417,000 in 2011 and $35,746,000 in 2010 are included in the average daily loan balance. |
(3) | Interest on loans includes origination fees totaling $63,000 in 2011 and $61,000 in 2010. |
Interest Earning Assets/Interest Income (Restated)
On a tax equivalent basis, interest income decreased $375,000 (10.7%) in the third quarter of 2011 compared to the third quarter of 2010. This was due to a decrease in average earning assets of $6,847,000 (2.6%) combined with a decrease in the yield on average earning assets of 43 basis points.
The average balance of securities increased $20,755,000 (100.2%) in the third quarter of 2011 compared to the same period in 2010. This increase was due to $39,974,000 of investment security purchases made from September 2010 through September 2011 as the Bank gradually invested its excess on-balance liquidity into interest earning assets. The yield on average security balances decreased 201 basis points in the third quarter of 2011 compared to 2010. Third quarter 2011 investment yields were impacted by the sales of higher yielding securities in December 2010 and the comparatively lower yields of new securities acquired in the current rate environment.
Loan average balances decreased $27,700,000 (11.3%) in the third quarter of 2011 compared to the same period last year and the average yield decreased 17 basis points. The largest decline in terms of average balances was in commercial loans, the majority of our loan portfolio, which decreased $23,352,000 (11.1%) in the third quarter of 2011 compared to 2010 while the average yield decreased 11 basis points. Commercial loans have continued to decrease due to receipt of scheduled payments, charge offs and decreased loan originations. It is expected that continued efforts to manage the Bank’s regulatory capital levels (i.e., shrinking the Bank’s size) will further decrease both average loan balances and net interest income in future periods. In addition, the renewal of maturing loans in the current lower rate environment will continue to exert downward pressure on average loan portfolio yields.
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Loan yields in 2011 continue to be negatively impacted by the elevated level of nonperforming loans. Management expects the average balance of nonperforming loans to continue to remain high in 2011, adversely impacting net interest income. Moreover, competitive pressures as well as the weakened local economy have had, and are expected to continue to have, a negative impact on commercial loan balances and yields.
For the first nine months of the year, tax equivalent interest income decreased $1,168,000 (10.7%) from 2010. This was due to a decrease in average earning assets of $13,208,000 (4.7%) combined with a decrease in the yield on average earning assets of 32 basis points.
Securities interest income increased $125,000 and resulted from a $16,680,000 (76.4%) increase in average securities balances, partially offset by a 198 basis point decrease in yield attributable to the comparatively lower yields on securities purchased in the current rate environment, as discussed above. Loan interest income decreased $1,294,000 (13.0%) due to lower average balances of $29,987,000 (11.7%) combined with a decrease in the average yield of 8 basis points.
The largest decline in terms of average balances was in commercial loans, which decreased $25,218,000 (11.4%) combined with a decrease in yield of 2 basis points in the first nine months of 2011 compared to 2010. Average balances decreased primarily due to receipt of scheduled payments, charge-offs and decreased loan originations. As noted above, the renewal of maturing loans in the current lower rate environment has exerted downward pressure on average loan portfolio yields.
Interest Bearing Liabilities/Interest Expense
Interest expense on deposits for the third quarter of 2011 decreased $240,000 (39.1%) compared to the third quarter of 2010. This was the result of lower interest rates paid on deposits of 29 basis points combined with lower average deposit balances of $34,345,000 (14.4%).
Interest expense on deposits for the first nine months of 2011 decreased $757,000 (38.2%) compared to 2010. This resulted from a decrease in the average interest rate paid on deposits of 31 basis points and lower average balances of $34,347,000 (14.3%) in 2011 compared to 2010.
Liquidity
Liquidity is managed to ensure stable, reliable and cost-effective sources of funds to satisfy demand for credit, deposit withdrawals and investment opportunities. Liquidity risk is the risk of the Corporation being unable to meet current and future financial obligations in a timely manner. To manage liquidity risk the Corporation relies primarily on a large, stable core deposit base and excess on-balance sheet cash positions. Additionally, the Corporation has access to certain wholesale funding sources (as discussed below) to manage unexpected liquidity needs.
The Corporation identifies, measures and monitors its liquidity profile. The profile is evaluated daily, weekly and monthly by analyzing the composition of all funding sources, reviewing projected liquidity commitments and identifying sources and uses of funds. A contingency funding plan is also prepared that details the potential erosion of funds in the event of systemic financial market crisis or institution-specific stress. In addition, the overall management of the Corporation’s liquidity position is integrated into retail deposit pricing policies to ensure a stable core deposit base.
Asset liquidity for financial institutions typically consists of cash and cash equivalents, certificates of deposit and investment securities available for sale. These categories totaled $79.0 million at September 30, 2011 or about 26.7% of total assets. This compares to $67.8 million or about 22.2% of total assets at year end 2010. Liquidity is important for financial institutions because of the need to meet loan funding commitments and depositor withdrawal requests. Liquidity can vary significantly on a daily basis based on customer activity.
Of the Corporation’s liquid assets at September 30, 2011, investment securities with a fair value of approximately $36,661,000 were pledged to secure borrowing availability on a line of credit from the Federal Home Loan Bank of Indianapolis (“FHLBI”), public deposits and for other purposes as required or permitted by law.
Deposits are the principal source of funds for the Bank. Management monitors rates at other financial institutions in the area to ascertain that its rates are competitive in the market. Management also attempts to offer a wide variety of products to meet the needs of its customers. The makeup of the Bank’s “Large Certificates”, which are generally considered to be more volatile and sensitive to changes in rates, consist principally of local depositors known to the Bank. The Bank had Large Certificates totaling approximately $35,000,000 at September 30, 2011 and December 31, 2010, respectively. The Bank had $3.4 million of brokered deposits at September 30, 2011. Due to the Bank’s capital classification as “undercapitalized” at September 30, 2011, these brokered deposits may not be renewed or additional brokered deposits issued without prior approval of the Federal Deposit Insurance Corporation (“FDIC”). See “Capital” section of this Management’s Discussion and Analysis for further details.
It is Bank management’s intention to handle unexpected liquidity needs through its cash and cash equivalents, FHLBI borrowings, or Federal Reserve discount borrowings. At September 30, 2011, the Bank had a $31,000,000 line of credit available at the FHLBI for which the Bank has pledged investment securities and certain commercial and consumer loans secured by residential real estate as collateral. The Bank also had a $15,000,000 line of credit available at the Federal Reserve for which the Bank has pledged certain commercial loans as collateral. At September 30, 2011, the Bank had no borrowings outstanding against these lines of credit.
Although the Bank has established these lines of credit, because of its undercapitalized status, any borrowing requests are subject to review (i.e., for purpose and repayment ability) and approval by the FHLBI and Federal Reserve, respectively. Consequently, full borrowing availability under these existing lines may be restricted at the respective lender’s discretion and terms may be limited or restricted. However, in the event the Bank would need additional funding and be unable to access either line of credit facility, management could act to remove the pledge of investment securities presently securing a portion of the FHLBI line of credit, thereby allowing such securities to be liquidated to provide further liquidity.
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If necessary, the Bank could also satisfy unexpected liquidity needs through liquidation of unpledged securities and/or repurchase agreements which would allow it to borrow from a broker, pledging investment securities as collateral.
Interest Rate Risk
Interest rate risk is the potential for economic losses due to future rate changes and can be reflected as a loss of future net interest income and/or a loss of current market values. The Corporation’s Asset/Liability Management Committee’s (ALCO) objective is to measure the effect on net interest income and to adjust the balance sheet to minimize the inherent risk while at the same time maximizing income. Tools used by management include the standard GAP report which reflects the repricing schedule for various asset and liability categories and an interest rate shock simulation report. The Bank has no market risk sensitive instruments held for trading purposes. However, the Bank is party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers including commitments to extend credit and letters of credit. A commitment or letter of credit is not recorded as an asset until the instrument is exercised.
The table below shows the scheduled maturity and repricing of the Corporation’s interest sensitive assets and liabilities as of September 30, 2011:
(in thousands) | ||||||||||||||||||||
0-3 | 4-12 | 1-5 | 5+ | |||||||||||||||||
Interest Rate Sensitivity | Months | Months | Months | Months | Total | |||||||||||||||
Assets: | ||||||||||||||||||||
Loans | $ | 87,570 | $ | 50,797 | $ | 77,244 | $ | 1,032 | $ | 216,643 | ||||||||||
Securities | 3,495 | 12,235 | 25,007 | 5,174 | 45,911 | |||||||||||||||
Short term investments | 197 | - | - | - | 197 | |||||||||||||||
Total rate sensitive assets | $ | 91,262 | $ | 63,032 | $ | 102,251 | $ | 6,206 | $ | 262,751 | ||||||||||
Liabilities: | ||||||||||||||||||||
NOW, Savings & MMDA | $ | 31,756 | $ | - | $ | - | $ | 71,552 | $ | 103,308.0 | ||||||||||
Time Deposits | 17,154 | 49,283 | 29,934 | 26 | 96,397 | |||||||||||||||
Total rate sensitive liabilities | $ | 48,910 | $ | 49,283 | $ | 29,934 | $ | 71,578 | $ | 199,705 | ||||||||||
Rate sensitivity GAP and ratios: | ||||||||||||||||||||
GAP for period | $ | 42,352 | $ | 13,749 | $ | 72,317 | $ | (65,372 | ) | |||||||||||
Cumulative GAP | 42,352 | 56,101 | 128,418 | 63,046 | ||||||||||||||||
Cumulative rate sensitive ratio | 1.87 | 1.57 | 2.00 | 1.32 | ||||||||||||||||
December 31, 2010 rate sensitive ratio | 1.55 | 1.50 | 1.83 | 1.14 |
The preceding table sets forth the time periods in which earning assets and interest bearing liabilities will mature or may re-price in accordance with their contractual terms. The entire balance of savings including MMDA and NOW are not categorized as 0-3 months, although they are variable rate products. Some of these balances are core deposits and are not considered rate sensitive. Allocations are made to time periods based on the Bank’s historical experience and management’s analysis of industry trends.
In the GAP table above, the short term (one year and less) cumulative interest rate sensitivity is 157% asset sensitive as of September 30, 2011.
Because of the Bank’s asset sensitive position, if market interest rates increase, this positive GAP position indicates that the interest margin would be positively affected. However, GAP analysis is limited and may not provide an accurate indication of the impact of general interest rate movements on the net interest margin since repricing of various categories of assets and liabilities is subject to the Bank’s needs, competitive pressures, and the needs of the Bank’s customers. In addition, various assets and liabilities indicated as repricing within the same period may in fact reprice at different times within the period and at different rate indices. Due to these inherent limitations in the GAP analysis, the Corporation also utilizes simulation modeling, which measures the impact of upward and downward movements of interest rates on interest margin. This modeling indicates that a 100 basis point gradual decrease in interest rates would decrease net interest income by approximately 1.10% in the first year, while a 200 basis point increase in interest rates would increase net interest income by approximately 4.00% in the first year. This is influenced by the assumptions regarding how quickly and to what extent liabilities will reprice with an increase in interest rates.
Loans
(in thousands) | ||||||||||||||||
Third Quarter | Year-to-Date | |||||||||||||||
(Restated) | ||||||||||||||||
2011 | 2010 | 2011 | 2010 | |||||||||||||
Provision for Loan Losses | $ | 800 | $ | 1,200 | $ | 5,400 | $ | 3,600 |
The year to date 2011 provision for loan loss expense of $5,400,000 exceeds the $3,600,000 expense recognized in the same nine month period of 2010 and primarily reflects continued economic stress in the Bank's market areas as well as relatively elevated levels of historical loan loss experience by the Bank. As a result of management’s reassessment of the allowance for loan losses as of June 30, 2011, it was determined that an additional $3,000,000 of provision expense was required at June 30, 2011 to fund the allowance for loan losses at an adequate level. The provision for loan losses for the third quarter of 2011 was $800,000 compared to $1,200,000 reported in the third quarter of 2010. The reduced current period provision expense correlates with a trending decrease in current and newly identified nonperforming loans, stabilizing real estate values on problem credits and continued shrinkage in the overall loan portfolio relative to conditions faced by the Bank one year ago.
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Year to date 2011 loan charge offs totaled $6,956,000 and included $4,725,000 of charge offs recognized in the quarter ended June 30, 2011 based on management’s reassessment of the effects of events and information that provided additional evidence about conditions that existed at June 30, 2011 related to certain impaired commercial real estate loans. As a result of management’s reassessment and evaluation, it was determined that approximately $2,600,000 of charge offs originally reported in the quarter ended September 30, 2011 required restatement to June 30, 2011. The restated charge offs were taken against previously established specific reserves at June 30, 2011. After giving effect to the June 30, 2011 restatement, current period charge offs for the three months ended September 30, 2011 totaled $902,000 compared to $4,725,000 and $2,404,000 for the quarters ended June 30, 2011 and September 30, 2010, respectively.
A significant portion of the charge offs recognized in 2011 continued to relate to collateral dependent loans resulting from declines in the value of real estate securing our loans and management’s determination of the borrowers’ inability to support future cash flow projections. However, in more recent quarters, the rate of decline in real estate values has slowed and may portend a decrease in future charge offs as the Bank’s higher risk commercial real estate portfolio continues to shrink.
Loans transferred to other real estate during the quarter ended September 30, 2011 totaled $115,000 compared to $1,055,000 and $1,782,000 transferred to ORE during the quarters ended June 30, 2011 and September 30, 2010, respectively.
In recent quarters we have also experienced a decline in the pace of commercial loans migrating to lower loan risk grades, which receive higher allocations in our allowance for loan loss analysis. We have also experienced an improvement in the quality of some credits resulting in improved loan grades and lower reserve allocations. Management considered these factors in conjunction with its quarterly analysis of the loan portfolio to identify and quantify the level of credit risk to estimate losses to determine the recorded provision expense of $5,400,000 for the nine months of 2011 and the level of the allowance for loan losses of $13,110,000 at September 30, 2011.
Loans and Asset Quality
The following table shows the balance and percentage composition of loans as of:
(in thousands) | ||||||||||||||||
September 30, 2011 | December 31, 2010 | |||||||||||||||
Secured by real estate: | Balances | Percent | Balances | Percent | ||||||||||||
Residential first mortgage | $ | 22,436 | 10.4 | % | $ | 24,546 | 10.4 | % | ||||||||
Residential home equity/other junior liens | 12,734 | 5.9 | % | 14,967 | 6.4 | % | ||||||||||
Construction, land development and other land loans | 14,967 | 6.9 | % | 19,641 | 8.3 | % | ||||||||||
Multifamily residential properties | 2,314 | 1.1 | % | 2,364 | 1.0 | % | ||||||||||
Owner-occupied nonfarm, nonresidential properties | 62,330 | 28.7 | % | 63,315 | 26.8 | % | ||||||||||
Other nonfarm, nonresidential properties | 81,545 | 37.6 | % | 89,327 | 37.8 | % | ||||||||||
Commercial | 15,245 | 7.0 | % | 16,196 | 6.9 | % | ||||||||||
Consumer | 4,361 | 2.0 | % | 4,499 | 1.9 | % | ||||||||||
Other | 911 | 0.4 | % | 1,285 | 0.5 | % | ||||||||||
Total gross loans | 216,843 | 100.0 | % | 236,140 | 100.0 | % | ||||||||||
Net unearned fees | (200 | ) | (202 | ) | ||||||||||||
Total loans | $ | 216,643 | $ | 235,938 |
At September 30, 2011, total loans decreased $19,295,000 (8.2%) from December 31, 2010. During the nine months of 2011, construction, land development and other land loans decreased $4,674,000 (23.8%), loans secured by nonresidential properties (owner occupied and nonowner occupied) decreased $8,767,000 (5.7%), commercial loans decreased $951,000 (5.9%), and loans secured by consumer real estate decreased $4,343,000 (11.0%).
In general, the decrease in all portfolio segments was primarily attributable to the receipt of scheduled payments. In addition, charge offs totaling $6,956,000, taken primarily on impaired loans with previously established specific reserves, contributed to the $19,295,000 decrease in loans. These factors, coupled with limited demand for new loans by credit worthy borrowers, have curbed net portfolio growth.
The future size of the loan portfolio is dependent on a number of economic, competitive, and regulatory factors faced by the Bank. In light of the economic and regulatory challenges currently impacting the Bank, we anticipate continued and managed shrinkage of the loan portfolio in the fourth quarter of 2011. Further declines in loans, restrictions on the Bank’s ability to make new loans or competition that leads to lower relative pricing on new loans could adversely impact our operating results.
Nonperforming assets consist of loans accounted for on a nonaccrual basis, loans contractually past due 90 days or more as to interest or principal payments (but not included in nonaccrual loans), and other real estate which has been acquired primarily through foreclosure and is actively managed through the time of disposition to minimize loss. Troubled debt restructured loans (“TDRs”) that are not past due are excluded from nonperforming loan totals.
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The aggregate amount of nonperforming loans and other nonperforming assets are presented below:
(in thousands) | ||||||||||||
September 30, | December 31, | September 30, | ||||||||||
2011 | 2010 | 2010 | ||||||||||
Nonaccrual loans | $ | 25,242 | $ | 30,858 | $ | 28,872 | ||||||
90 days or more past due and still accruing | - | - | 75 | |||||||||
Total nonperforming loans | 25,242 | 30,858 | 28,947 | |||||||||
Other real estate owned | 3,408 | 4,294 | 7,419 | |||||||||
Total nonperforming assets | $ | 28,650 | $ | 35,152 | $ | 36,366 | ||||||
Nonperforming loans as a percent of total loans | 11.65 | % | 13.08 | % | 11.99 | % | ||||||
Allowance for loan losses as a percent of nonperforming loans | 51.94 | % | 45.27 | % | 45.00 | % | ||||||
Nonperforming assets as a percent of total loans and other real estate | 13.02 | % | 14.63 | % | 14.61 | % |
Nonperforming loans at September 30, 2011 decreased $5,616,000 from December 31, 2010 and $3,630,000 from September 30, 2010. The decrease from December 31, 2010 results from the combination of approximately $8,282,000 of charge offs recognized primarily on collateral dependent loans, the upgrade of approximately $4,393,000 of loans now demonstrating both improved cash flows and established payment history following the culmination of successful work-outs and/or restructurings, the transfer of approximately $1,170,000 of loans to other real estate owned, and approximately $3,176,000 of continued payments received from borrowers, which in aggregate, exceeded approximately $11,405,000 of newly identified nonperforming loans which were comprised principally of commercial real estate loans. Management continues to focus on reducing the level of nonperforming assets and making improvements in asset quality.
As of September 30, 2011, approximately $15,626,000 (61.9%) of nonperforming loans are making scheduled payments on their loans. Management closely monitors each of these loans to identify opportunities where workout efforts or restructuring may improve borrowers’ credit risk profiles to facilitate a return to accrual status for credits with sustained repayment histories. All nonperforming loans are reviewed regularly for collectability and uncollectible balances are promptly charged off.
Management regularly evaluates the condition of problem credits and when reduced cash flows coupled with collateral shortfalls are evident, the loans are placed on nonaccrual. In addition, loans are generally placed on nonaccrual when principal or interest is past due ninety days or more. If management believes there is significant risk of not collecting full principal and interest, we may elect to place the loan on nonaccrual even if the borrower is current. Based on the existing level of problem loans, we anticipate that other real estate owned may increase as the Bank manages through the problem loan portfolio and borrowers continue to face financial difficulties and tight credit markets.
At September 30, 2011, impaired loans totaled approximately $27,677,000, of which $14,804,000 were assigned specific reserves of $3,361,000. Impaired loans without specific reserve allocations totaled $12,873,000, indicating that the loans are well collateralized at this time. A loan is considered impaired when it is probable that that all or part of amounts due according to the contractual terms of the loan agreement will not be collected on a timely basis or the loan has been restructured and is classified as a troubled debt restructuring (“TDR”). Impairment is measured by comparing the Bank’s recorded investment in the loan to the present value of expected future cash flows at the loan’s effective interest rate, the fair value of the collateral, or the loan’s observable market price.
Of the impaired loans reported at September 30, 2011, $22,352,000 are on nonaccrual status, based on management’s assessment using criteria discussed above. All cash received on nonaccrual loans is applied to principal balance. Loans are considered for return to accrual status on an individual basis when all principal and interest amounts contractually due are brought current and future payments are reasonable assured. Interest income is recognized on TDRs pursuant to the criteria noted below.
The following table summarizes the troubled debt restructuring component of impaired loans at:
(in thousands) | ||||||||||||||||||||||||
September 30, 2011 | December 31, 2010 | |||||||||||||||||||||||
Accruing Interest | Nonaccrual | Total | Accruing Interest | Nonaccrual | Total | |||||||||||||||||||
Current | $ | 4,902 | $ | 12,104 | $ | 17,006 | $ | 6,660 | $ | 3,365 | $ | 10,025 | ||||||||||||
Past due 30-89 days | - | 286 | 286 | 204 | - | 204 | ||||||||||||||||||
Past due 90 days or more | - | 3,218 | 3,218 | - | 2,290 | 2,290 | ||||||||||||||||||
Total troubled debt restructurings | $ | 4,902 | $ | 15,608 | $ | 20,510 | $ | 6,864 | $ | 5,655 | $ | 12,519 |
Troubled debt restructured loans accrue interest if the borrow complies with the revised terms and conditions and has demonstrated sustained payment performance consistent with the modified terms for a minimum of six consecutive payment cycles after the restructuring date.
Allowance for Loan Losses
The allowance for loan losses at September 30, 2011 was $13,110,000, a decrease of $860,000 from December 31, 2010. The allowance for loan losses represented 6.05% and 5.92% of gross loans at September 30, 2011 and December 31, 2010 and provided a coverage ratio to nonperforming loans of 51.9% and 45.3% at each respective period-end.
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Management estimates the required allowance balance based on past loan loss experience, the nature and volume of the portfolio segments and concentrations, information about specific borrower situations, estimated collateral values, economic conditions and trends, and other factors. Allocations of the allowance are made for specific loans, but the entire allowance is available for any loan that, in management’s judgment, should be charged off. Management continually analyzes portfolio risk to refine the process of effective risk identification and measurement for determination of what it believes is an adequate allowance for loan losses. When all of these factors were considered, management determined that the $5,400,000 provision for the nine months of 2011 and the $13,110,000 allowance as of September 30, 2011 were appropriate.
Given the significant portion of our loans that are secured by real estate, our portfolio continues to be sensitive to the weakened economic conditions in Southeast Michigan and the Bank’s market area, and is especially impacted by depressed real estate values. In response, each quarter our portfolio management practices continue to analyze and quantify risk within all segments of our portfolio to ensure effective problem loan identification procedures. Our practice is to obtain updated appraisals on criticized loans secured by real estate and apply appropriate discounting practices based on perceived declines in market value.
Although updated appraisals received during more recent quarters indicated that property values for collateral on our impaired loans continue to be depressed, the appraisals did not reflect the extent of value erosion relative to that experienced in prior quarters. However, at present, the weak Michigan economy and historically high unemployment levels continue to delay signs of economic recovery in our market area. Consequently, we have continued to allocate reserves for these risks and uncertainties, resulting in reserves above normal levels.
If the economy continues to weaken and/or real estate values decline further, nonperforming loans may increase in subsequent quarters. Due to the uncertainty of future economic conditions and the decline in real estate values, the provision for loan losses for the balance of 2011 may continue to be impacted by the Bank’s concentration in real estate secured loans. While we have considered these factors when determining the level of reserves, it is difficult to accurately predict future economic events, especially in the current environment.
The allowance consists of specific and general components. The specific component relates to loans that are classified as nonaccrual or renegotiated. For such loans that are also classified as impaired, an allowance is established when the discounted cash flows (or collateral value or observable market price) of the impaired loan are lower than the carrying value of that loan. The general component covers non-classified loans and is based on historical loss experience, adjusted for qualitative factors used to reflect changes in the portfolio’s collectability not captured by historical loss data.
The methodology for measuring the appropriate level of allowance and related provision for loan losses relies on several key elements, which include specific allowances for loans considered impaired, general allowances for non-impaired commercial loans based on our internal loan grading system, and general allocations based on historical trends for homogeneous loan groups with similar risk characteristics.
The general allowance allocated to non-impaired commercial loans was based on the internal risk grade of such loans and their assigned portfolio segment, as primarily determined based on underlying collateral; and, if real estate secured, the type of real estate. Each risk grade within a portfolio is assigned a loss allocation factor. The higher a risk grade, the greater the assigned loss allocation percentage. Accordingly, changes in the risk grades of loans affect the amount of the allowance allocation.
Our loss factors are determined based on our actual loss history by loan grade and adjusted for significant qualitative factors that, in management’s judgment, affect the collectability of the portfolio at the analysis date. We use a rolling 24 month charge off history as the base for our computation which is weighted to give emphasis to more recent quarters.
Groups of homogeneous noncommercial loans, such as residential real estate loans, home equity and home equity lines of credit, and consumer loans receive allowance allocations based on loan type, primarily determined based on historical loss experience rather than by risk grade. These allocations are adjusted for consideration of general economic and business conditions, credit quality and delinquency trends, collateral values, and recent loss experience for these similar pools of loans.
Although management evaluates the adequacy of the allowance for loan losses based on information known at a given point in time, as facts and circumstances change, the provision and resulting allowance may also change. While we believe that our allowance for loan loss analysis has identified all probable losses inherent in the portfolio at September 30, 2011, there can be no assurance that all losses have been identified or that the amount of the allowance is sufficient.
(in thousands) | ||||||||||||||||
Third Quarter | Year-to-Date | |||||||||||||||
Noninterest Income | 2011 | 2010 | 2011 | 2010 | ||||||||||||
Total | $ | 691 | $ | 788 | $ | 2,125 | $ | 2,472 |
Noninterest income which includes service charges and other fee income, trust income, gain (loss) on available for sale securities, gain on sale of loans, and other miscellaneous income, decreased by $97,000 (12.3%) in the third quarter of 2011 compared to the same quarter of 2010.
Service charges and other fee income decreased $52,000 (7.1%) in the third quarter of 2011 compared to the third quarter of 2010 primarily due to lower nonsufficient fund fees resulting from the impact of new regulation on overdraft protection effective August 2010, lower commercial loan late fees, lower service charges on business checking accounts, and lower merchant discount fees. These unfavorable variances were partially offset by higher ATM network income and higher check printing fees. In addition, securities loss of $76,000 was recognized during the third quarter of 2011 for the other-than-temporary impairment of a non-government agency CMO security.
29 |
Trust income decreased $7,000 (12.7%) in the third quarter of 2011 compared to the third quarter of 2010. This was due to overall dismal market performance and adverse value fluctuations (as fees are market value based) and fewer customer accounts.
For the nine months ended September 30, 2011, noninterest income decreased $347,000 (14.0%) compared to the same prior year period. The decrease resulted from lower service charges of $308,000 and a decrease in trust income of $34,000, each primarily attributable to the respective factors identified above. In addition, 2011 service charge income was further reduced by lower consumer loan late fees and the lack of mortgage servicing income and mortgage application fees. Noninterest income included an impairment charge of $76,000 incurred on a CMO investment security, as mentioned above. These unfavorable variances were partially offset by gains on sale of SBA loans totaling $71,000 during the nine months ended September 30, 2011.
(in thousands) | ||||||||||||||||
Third Quarter | Year-to-Date | |||||||||||||||
Noninterest Expense | 2011 | 2010 | 2011 | 2010 | ||||||||||||
Total | $ | 3,100 | $ | 3,201 | $ | 8,824 | $ | 9,949 |
Noninterest expense decreased $101,000 (3.2%) in the third quarter of 2011 compared to the same quarter in 2010. For the first nine months of 2011, noninterest expense decreased $1,125,000 (11.3%) compared to 2010. Due to the challenging economic environment, management continues to be focused on initiatives to reduce and contain noninterest expense.
The most significant component of our noninterest expense is salaries and employee benefits. In the third quarter of 2011, salaries and employee benefits increased $8,000 (0.7%) from the third quarter of 2010. This was primarily due to increases in group medical insurance of $19,000 (41.5%) and contract payroll of $10,000 (30.5%). These increases were partially offset by a $17,000 (1.6%) decrease in salary and wage expense. Group medical insurance increased due to greater employee participation in the Bank’s medical insurance plan and an overall increase in medical insurance premium costs in 2011 compared to 2010. Contract payroll expense increased due to the nature and timing of commercial loan workout efforts performed by contract labor during the quarter. Salary and wage expense decreased due to overall leaner staffing levels relative to the same period in 2010.
In the first nine months of 2011, salaries and employee benefits decreased $315,000 (8.0%) from the same period in 2010. This was primarily due to decreases in salaries of $273,000 (8.2%), contract payroll of $75,000 (54.0%) and FICA taxes of $19,000 (8.1%). These decreases were partially offset by an increase of $56,000 (40.2%) in group medical insurance. The decrease in salaries and wages and FICA tax expense resulted from leaner staffing levels in 2011 compared to 2010, primarily related to an upper management position vacant since late July 2010. Contract payroll expense was lower due to reduced loan workout staffing needs and fewer newly identified, higher stress, problem credits relative to the same prior year period. Group medical insurance increased due to reasons identified above.
For the three and nine month periods ended September 30, 2011 occupancy expense decreased $81,000 (29.0%) and $141,000 (17.2%), respectively, compared to the same prior year periods. The decrease related to lower expenses for repairs and maintenance, building services, property taxes, and depreciation. Repairs and maintenance decreased due to fewer and less costly required projects undertaken in 2011 compared to 2010. Building services expense decreased due to a change in the Bank’s janitorial service and lower costs incurred for normal exterior maintenance at the Bank’s facilities. Decreased property taxes reflect decreases in the assessed and taxable values of the Bank’s facilities effective in 2011. Depreciation expense is lower in 2011 compared to expense levels incurred during the same prior year periods due to certain building components becoming fully depreciated.
Equipment expense increased by $6,000 (7.4%) and $13,000 (4.9%) for the three and nine month periods ended September 30, 2011, respectively, compared to 2010. Elevated expense in 2011 resulted from higher rental expense for components of a new phone system installed in 2010 and extensive vehicle maintenance and repairs on the Bank’s courier vehicle, partially offset by lower depreciation expense.
Professional and service fees decreased by $33,000 (7.3%) and $108,000 (8.4%) on both a comparative quarterly and year-to-date basis, respectively, relative to 2010. Legal fees decreased due to fewer newly identified problem credits and foreclosure actions initiated in 2011 relative to the Bank’s experience in the same prior year periods. Audit and accounting fees decreased due to fee adjustments related to financial reform legislation and reduced audit scopes for which fee adjustments were not recognized until late 2010. Other fees decreased in 2011 primarily due to retainer fees paid to an investment banking advisor in 2010 related to the Bank’s recapitalization efforts. Partially offsetting these favorable variances was an increase in network fees.
Computer service fees increased by $48,000 (44.1%) and $36,000 (10.6%) on both a comparative quarterly and year-to-date basis primarily due to one-time expenses incurred in the third quarter of 2011 for the early termination of a software contract and related data conversion fees as the Bank upgrades to an enhanced on-line bill pay application in the fourth quarter of 2011.
FDIC deposit insurance expense declined $99,000 (27.6%) and $232,000 (21.6%) on both a comparative quarterly and year-to-date basis, respectively, relative to 2010, principally resulting from a new rate structure implemented by the FDIC beginning April 1, 2011 and a modest decrease in the Bank’s net asset size.
Insurance expense decreased $47,000 (25.7%) and $108,000 (20.4%) for the three and nine months ended September 30, 2011, respectively, compared to 2010. The decrease resulted from favorable policy renewals and rewrites with new and existing carriers completed in the first quarter of 2011.
Loan collection and foreclosed property expenses decreased $26,000 (18.9%) and $194,000 (34.0%) on both a comparative quarterly and year-to-date basis, respectively, relative to 2010. These expenses include collection costs related to nonperforming and delinquent loans, including costs incurred to protect the Bank’s interest in collateral securing problem loans prior to taking title to the property, appraisal expenses and carrying costs related to other real estate. The decrease primarily resulted from fewer newly identified problem loans and a decrease in the level of other real estate properties owned by the Bank during 2011.
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Net loss on sale/write down of ORE and repossessions primarily represents the loss on sale or additional write downs on these assets subsequent to the transfer of the asset from the loan portfolio. Both the quarterly and year-to-date losses on ORE and repossessions of $236,000 and $277,000, respectively, increased over the same prior year periods. Year-to-date 2011 valuation write downs totaled $308,000, of which $258,000 resulted from third quarter adjustments based on current appraisals, pending offers, and/or interest from potential buyers. Net gain on ORE sales totaled $31,000 for the nine months ended September 30, 2011.
Other expense decreased $23,000 (12.6%) and $93,000 (17.0%) for the three and nine month periods, respectively, compared to 2010. The decrease primarily related to elevated losses incurred on fraudulent checks in June 2010 and lower Michigan use tax expense in 2011. Partially offsetting these decreases, advertising expense and business development expense were elevated in the current quarter and nine month period, respectively.
(in thousands) | ||||||||||||||||
Third Quarter | Year-to-Date | |||||||||||||||
Income Tax Expense (Benefit) | 2011 | 2010 | 2011 | 2010 | ||||||||||||
Total | $ | (51 | ) | $ | (69 | ) | $ | (129 | ) | $ | (70 | ) |
In the third quarter of 2011, the Corporation recorded a federal income tax benefit to reduce its deferred tax valuation allowance established on previously recorded deferred tax assets. The decrease in the recorded valuation allowance resulted from an increase in the deferred tax liability related to appreciation in the available for sale investment portfolio. Due to the uncertainty of generating future taxable income necessary to realize the recorded net deferred tax asset, the Corporation has recorded a deferred tax valuation allowance against the tax benefit related to the respective pre-tax losses incurred during the three and nine month periods ended September 2011 and 2010.
Capital
The Corporation and the Bank are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can result in the initiation of certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct, material effect on the Corporation’s financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Corporation and the Bank must meet specific capital guidelines that involve quantitative measures of assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. The Corporation’s and the Bank’s capital classification are also subject to qualitative judgments by regulators with regard to components, risk weightings, and other factors.
The Federal Deposit Insurance Corporation Improvement Act of 1991 (FDICIA) required that the federal regulatory agencies adopt regulations defining five capital tiers for banks:
Total | Tier 1 | ||||
Risk-Based | Risk-Based | ||||
Capital Ratio | Capital Ratio | Leverage Ratio | |||
Well capitalized | 10% or above | 6% or above | 5% or above | ||
Adequately capitalized | 8% or above | 4% or above | 4% or above | ||
Undercapitalized | Less than 8% | Less than 4% | Less than 4% | ||
Significantly undercapitalized | Less than 6% | Less than 3% | Less than 3% | ||
Critically undercapitalized | - | - | A ratio of tangible equity to total assets of 2% or less |
Quantitative measures established by regulation to ensure capital adequacy require the Corporation and the Bank to maintain minimum amounts and ratios of total and Tier 1 capital (as defined in the regulations) to risk-weighted assets (as defined), and Tier 1 capital (as defined) to average assets (as defined).
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The Corporation’s and the Bank’s actual capital amounts and ratios are presented in the following table:
Minimum for | To be Well Capitalized | |||||||||||||||||||||||
Capital Adequacy | Under Prompt Corrective | |||||||||||||||||||||||
Actual | Purposes | Action Provision | ||||||||||||||||||||||
As of September 30, 2011 (Restated) | Amount | Ratio | Amount | Ratio | Amount | Ratio | ||||||||||||||||||
Total Capital (to risk weighted assets) | ||||||||||||||||||||||||
Bank | $ | 10,015,000 | 4.37 | % | $ | 18,354,000 | 8.00 | % | $ | 22,943,000 | 10.00 | % | ||||||||||||
FNBH Bancorp | 9,888,000 | 4.28 | % | 18,354,000 | 8.00 | % | N/A | N/A | ||||||||||||||||
Tier 1 Capital (to risk weighted assets) | ||||||||||||||||||||||||
Bank | 7,017,000 | 3.06 | % | 9,177,000 | 4.00 | % | 13,766,000 | 6.00 | % | |||||||||||||||
FNBH Bancorp | 6,827,000 | 2.98 | % | 9,177,000 | 4.00 | % | N/A | N/A | ||||||||||||||||
Tier 1 Capital (to average assets) | ||||||||||||||||||||||||
Bank | 7,017,000 | 2.34 | % | 12,002,000 | 4.00 | % | 15,002,000 | 5.00 | % | |||||||||||||||
FNBH Bancorp | 6,827,000 | 2.28 | % | 12,002,000 | 4.00 | % | N/A | N/A |
As of December 31, 2010 | Amount | Ratio | Amount | Ratio | Amount | Ratio | ||||||||||||||||||
Total Capital (to risk weighted assets) | ||||||||||||||||||||||||
Bank | $ | 13,632,000 | 5.58 | % | $ | 19,530,000 | 8.00 | % | $ | 24,412,000 | 10.00 | % | ||||||||||||
FNBH Bancorp | 13,580,000 | 5.56 | % | 19,530,000 | 8.00 | % | N/A | N/A | ||||||||||||||||
Tier 1 Capital (to risk weighted assets) | ||||||||||||||||||||||||
Bank | 10,442,000 | 4.28 | % | 9,765,000 | 4.00 | % | 14,647,000 | 6.00 | % | |||||||||||||||
FNBH Bancorp | 10,390,000 | 4.26 | % | 9,765,000 | 4.00 | % | N/A | N/A | ||||||||||||||||
Tier 1 Capital (to average assets) | ||||||||||||||||||||||||
Bank | 10,442,000 | 3.50 | % | 11,919,000 | 4.00 | % | 14,898,000 | 5.00 | % | |||||||||||||||
FNBH Bancorp | 10,390,000 | 3.49 | % | 11,919,000 | 4.00 | % | N/A | N/A |
The OCC has established the following minimum capital standards for national banks: a leverage requirement consisting of a minimum ratio of Tier 1 capital to total average assets of 3% for the most highly-rated banks, with minimum requirements of 4% to 5% for all others, and a risk-based capital requirement consisting of a minimum ratio of total capital to total risk-weighted assets of 8%, at least one-half of which must be Tier 1 capital. Tier 1 capital consists principally of shareholders’ equity. These capital requirements are minimum requirements. Higher capital levels will be required if warranted by the particular circumstances or risk profiles of individual institutions. Federal law provides the federal banking regulators with broad power to take prompt corrective action to resolve the problems of undercapitalized institutions.
On September 24, 2009, the Bank consented to the issuance of a Consent Order (the “Consent Order”) with the OCC. Pursuant to the Consent Order, the Bank was required to achieve and maintain total capital equal to 11% of risk weighted assets and Tier 1 capital equal to at least 8.5% of adjusted total assets by January 22, 2010. At September 30, 2011 and through the current date, the Bank’s capital ratios are and continue to be significantly below the increased minimum requirements imposed by the OCC. In light of the Bank’s continued losses and capital position at September 30, 2011, it is reasonable to anticipate further regulatory enforcement action by either the OCC or FDIC, particularly if the Corporation is unsuccessful in raising additional capital.
In addition and as a result of noncompliance with certain terms of the Consent Order, the Bank is categorized as “significantly undercapitalized” for Prompt Corrective Action purposes, as described in Note 2 of the 2010 Annual Report contained in the Corporation’s report on Form 10-K filing. The Prompt Corrective Action provisions impose certain restrictions on institutions that are undercapitalized. The restrictions become increasingly more severe as an institution’s capital category declines from undercapitalized to significantly undercapitalized to critically undercapitalized.
Even if we do not become subject to more stringent regulatory requirements or restrictions, our current capital deficiencies and elevated levels of nonperforming assets may make it very difficult to continue as a going concern. Although improved from June 30, 2011, our nonperforming assets exceed the sum of our capital and allowance for loan losses by approximately 43.7%. As described elsewhere in this Form 10-Q, we have established our allowance for loan losses at a level we currently believe, based on the data available to us, is sufficient to absorb expected losses in our loan portfolio. However, this process involves a very significant degree of judgment, is based on numerous different assumptions that are difficult to make and, by its nature, is inherently uncertain. Moreover, the performance of our existing loan portfolio is, in many respects, dependent on external factors such as our borrowers' ability to repay their loan obligations and the value of collateral securing those obligations, which in turn depend on macro and micro economic conditions including the pace of economic recovery in Southeast Michigan. If our loan portfolio performs worse than we currently expect, we may not have sufficient capital to absorb all of the losses, which could render us insolvent.
During 2010 and through the current date, we have worked with financial and legal advisors to pursue various transactions that would provide additional capital to the Bank. We continue to actively pursue these transactions.
However, the Corporation’s alternatives for additional capital are somewhat limited. The ongoing liquidity concerns in the broader market and the loss of confidence in financial institutions will likely serve to increase our cost of funding and further limit our access to capital. We may not be able to raise the necessary capital on favorable terms, or at all. While the Company is hopeful that its ongoing efforts to raise additional capital will be successful, there are significant hurdles that remain in order for the Company to raise the amount of capital necessary for the Bank to comply with the requirements of the Consent Order. An inability to raise capital would likely have a materially adverse effect on our business, financial condition and results of operations. Management’s future plans in response to the Bank’s undercapitalized regulatory classification and the need to raise additional capital pursuant to the Consent Order are described more fully in Note 2 of the 2010 Annual Report contained in the Corporation’s report on Form 10-K filing.
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The Corporation’s ability to pay dividends is subject to various regulatory and state law requirements. Due to the Bank’s financial condition, the Bank cannot pay a dividend to the Corporation without the prior approval of the OCC. The Corporation suspended, indefinitely, the payment of dividends in the third quarter of 2008 due to the Bank’s inability to pay dividends to the holding company and insufficient cash at the holding company to pay the dividends.
Pursuant to the results of recent examinations of the Corporation by the Federal Reserve, the Corporation is considered a troubled institution due to the critically deficient condition of its subsidiary Bank. As such, the Federal Reserve has required the Corporation to take action to support the Bank, which principally involves a capital infusion sufficient to satisfy minimum capital ratios imposed on the Bank. In addition, the Corporation must receive prior approval from the Federal Reserve before the payment of dividends, issuance of debt, or redemption of stock. Additional restrictions imposed on the Corporation by the Federal Reserve relate to changes in the composition of board members, the employment of senior executive officers or changes in the responsibilities of senior executive officers, and limitations on indemnification and severance payments.
As a result of the Bank's current inability to pay dividends to the Corporation, the Corporation has an insufficient level of resources and cash flows to meet operational liquidity needs. The Bank is prohibited from paying expenses on behalf of the Corporation. To resolve the Corporation's illiquidity and the deficient capital levels at the Corporation and the Bank, the Corporation's board of directors has provided certain interim funding to the Corporation. Depending on the extent of the future cash needs of the holding company, the timing and success of any capital raise, and the directors' willingness and ability to continue funding holding company expenses (through loans), the Corporation may be required to attempt to borrow funds from other sources to pay its expenses. Such additional borrowings may be at a price and on terms that are unfavorable to the Corporation. The holding company incurred pre-tax expenses totaling approximately $147,000 through September 30, 2011 and approximately $62,000 for calendar year 2010.
Regulatory Enforcement Action
As discussed above, the Bank is subject to a Consent Order issued by the OCC on September 24, 2009 that requires the Bank to raise capital in order to achieve certain minimum capital ratios. See "Capital" above for more information regarding these capital requirements and the Bank's current failure to meet the capital requirements of the Consent Order.
In addition to the minimum capital ratios, the Consent Order imposes several other requirements on the Bank. The Bank has taken a number of actions to address such other requirements (many of which were underway well before the Consent Order was issued), including:
· | the Board of Directors of the Bank appointed a Compliance Committee to ensure the Bank's compliance with the Consent Order and periodically report on such compliance efforts to the OCC; |
· | the Bank adopted a written strategic plan that included, among other things, the specific requirements set forth in Consent Order, and the Bank has taken ongoing actions to monitor the Bank's performance relative to the strategic plan; |
· | the Bank enhanced its liquidity risk management program via improved procedures for cash flow forecasting, monitoring and reporting, development of a contingency funding plan and increased its borrowing availability under lines of credit secured by certain pledged loans and investments; |
· | the Bank has implemented numerous policies and procedures intended to improve asset quality levels within the loan portfolio, including: identifying, monitoring, and reporting of problem loans via application of a comprehensive risk grade assessment system; development of specific workout strategies on all significant impaired loans; attempted restructuring of certain problem credits to mitigate the extent of potential future loss by the Bank; and, overall improvements to underwriting policies and credit structuring practices; |
· | the Bank engaged an independent third-party loan review specialist to assess the Bank's ability to effectively assign appropriate risk grades and identify problem loans; |
· | the Bank engaged an independent third-party to validate the Bank's allowance for loan loss methodology to ensure it conforms with regulatory guidance and accounting principles generally accepted in the United States of America, including an evaluation of the key assumptions used in the loan loss analysis; |
· | the Bank enhanced its policies and procedures for obtaining appraisals on property securing loans made by the Bank; |
· | the Bank implemented a practice of developing a written action plan for each parcel of other real estate owned; |
· | the Bank has taken ongoing actions in an effort to reduce the Bank's concentration in commercial real estate (CRE) loans and construction and development (C&D) loans; |
· | the Bank has taken ongoing actions to improve many aspects of its credit and loan policies and programs; and |
· | the Bank enhanced its program designed to maintain an adequate allowance for loan and lease losses (ALLL). |
While the Bank believes it has made significant progress in its efforts to comply with all requirements of the Consent Order other than the minimum capital requirements, the OCC continues to cite technical deficiencies and noncompliance with respect to each of the requirements of the Consent Order. As such, additional, ongoing actions by the Bank are required in order to be in full compliance with the Consent Order as ultimately determined by the OCC. While the OCC could take further and immediate regulatory enforcement action against the Bank if the OCC believes the Bank is not in compliance with any requirement of the Consent Order, the Bank currently believes its failure to meet the minimum capital requirements established by the Consent Order is the primary risk factor in determining the likelihood and extent of any further, more severe regulatory enforcement action (such as receivership of the Bank).
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Recent Developments
On September 22, 2011, at a special shareholder meeting, the shareholders of the Company approved a 1-for-7 reverse stock split of the Corporation's outstanding shares of common stock. This reverse stock split was implemented on October 3, 2011. The primary purpose of the reverse stock split was to increase the number of the Corporation’s authorized common stock available for future issuance. Please refer to the proxy statement the Corporation filed with the Securities and Exchange Commission (SEC) on August 10, 2011 for more details regarding the reverse stock split.
The Corporation's efforts to raise capital (as described in "Capital" above) may trigger an ownership change of the Corporation that would negatively affect the Corporation's ability to utilize its net operating loss carry forwards and other deferred tax assets in the future. If such an ownership change were to occur, the Corporation may incur higher than anticipated tax expense, which would reduce future net income. The Corporation is seeking to structure its capital raise in a manner that would avoid any such ownership change. In addition, on October 14, 2011, the Corporation entered into a Tax Benefits Preservation Plan as a further protection against an ownership change that would adversely affect the Corporation's future ability to use its deferred tax assets. The plan adopted by the Corporation is similar to tax benefit preservation plans adopted by other public companies with significant tax attributes that may be subject to limitations under the federal tax laws regarding a change in their ownership. In accordance with the plan, shares held by any person who acquires, without the approval of the Corporation's Board of Directors and excluding certain investors specified in the plan, beneficial ownership of 4.9% or more of the Corporation's outstanding common stock could be subject to significant dilution. There is no guarantee, however, that the plan will prevent the occurrence of an ownership change for purposes of the federal tax laws. Please refer to the Current Report on Form 8-K filed by the Corporation with the SEC on October 18, 2011 and the Registration Statement on Form 8-A filed on October 14, 2011 for more information regarding this plan.
Critical Accounting Policies
The Corporation maintains critical accounting policies for the valuation of investment securities, the allowance for loan losses, and income taxes. Refer to Notes 1c, 1e and 1k of the December 31, 2010 Consolidated Financial Statements as included in Form 10-K for additional information on critical accounting policies.
Contractual Obligations
The Bank had outstanding irrevocable standby letters of credit, which carry a maximum potential commitment of approximately $92,000 at September 30, 2011 and December 31, 2010, respectively. These letters of credit are conditional commitments issued by the Bank to guarantee the performance of a customer to a third party. The majority of these letters of credit are short-term guarantees of one year or less, although some have maturities which extend as long as two years. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loans to customers. The Bank primarily holds real estate as collateral supporting those commitments for which collateral is deemed necessary. The extent of collateral held on those commitments at September 30, 2011 and December 31, 2010, where there is collateral, was in excess of the committed amount. A letter of credit is not recorded on the balance sheet unless a customer fails to perform.
New Accounting Standards
In June 2011, the FASB has issued ASU 2011-05, Comprehensive Income (Topic 220); Presentation of Comprehensive Income. This ASU amends accounting standards to allow an entity the option to present the total of comprehensive income, the components of net income, and the components of other comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements. In both choices, an entity is required to present each component of net income along with total net income, each component of other comprehensive income along with a total for other comprehensive income, and a total amount for comprehensive income. ASU 2011-05 eliminates the option to present the components of other comprehensive income as part of the statement of changes in shareholders’ equity. The amendments in the ASU do not change the items that must be reported in other comprehensive income or when an item of other comprehensive income must be reclassified to net income. ASU 2011-05 should be applied retrospectively effective for fiscal years, and interim periods within those years, beginning after December 15, 2011. The Corporation is currently evaluating both presentation approaches permitted by the ASU for the reporting of comprehensive income.
In April 2011, the FASB issued ASU 2011-02, A Creditor’s Determination of Whether a Restructuring Is a Troubled Debt Restructuring. This ASU provides guidance for creditors when determining whether a creditor has granted a concession and whether a debtor is experiencing financial difficulties for purposes of determining whether a restructuring or loan modification constitutes a troubled debt restructuring. The ASU also provides additional disclosure requirements. This new guidance became effective for the quarter ended September 30, 2011, and applies retrospectively to restructurings occurring since January 1, 2011. Refer to Note 5, Allowance for Loan Losses and Credit Quality of Loans, for disclosures related to this ASU.
In July 2010, FASB issued ASU No. 2010-20, Receivables (Topic 310): Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses. The ASU amends FASB Accounting Standards Codification™ Topic 310, Receivables, to improve the disclosures that an entity provides about the credit quality of its financing receivables and the related allowance for credit losses. As a result of these amendments, an entity is required to disaggregate, by portfolio segment or class of financing receivable, certain existing disclosures and provide certain new disclosures about its financing receivables and related allowance for credit losses. For public entities, the disclosures as of the end of a reporting period were effective for interim and annual reporting periods ending on or after December 15, 2010. The disclosures about activity that occurs during a reporting period were effective for interim and annual reporting periods beginning on or after December 15, 2010 and have been added to Note 5.
In January 2010, the FASB issued ASU 2010-06, Improving Disclosures about Fair Value Measurements. This standard requires new disclosures on the amount and reason for transfers in and out of Level 1 and 2 recurring fair value measurements. The standard also requires disclosure of activities (i.e., on a gross basis), including purchases, sales, issuances, and settlements, in the reconciliation of Level 3 fair value recurring measurements. The standard clarifies existing disclosure requirements on levels of disaggregation and disclosures about inputs and valuation techniques. The new disclosures regarding Level 1 and 2 fair value measurements and clarification of existing disclosures are effective for periods beginning after December 15, 2009. The disclosures about the reconciliation of information in Level 3 recurring fair value measurements are required for periods beginning after December 15, 2010. Adoption of this standard did not have a significant impact on our quarterly disclosures.
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Recent Legislative Developments
In July 2010, the Dodd-Frank Wall Street Reform and Consumer Protection Act was signed into law. Uncertainty remains as to the ultimate impact of the new law, which could have a material adverse impact either on the financial services industry as a whole or on the Corporation’s and Bank’s business, results of operations and financial condition. This new federal law contains a number of provisions that could affect the Corporation and the Bank. For example, the law:
· | Makes national banks (such as the Bank) and their subsidiaries subject to a number of state laws that were previously preempted by federal laws; |
· | Imposes new restrictions on how mortgage brokers and loan originators may be compensated; |
· | Establishes a new federal consumer protection agency that will have broad authority to develop and implement rules regarding most consumer financial products; |
· | Creates new rules affecting corporate governance and executive compensation at all publicly traded companies (such as the Corporation); |
· | Broadens the base for FDIC insurance assessments and makes other changes to federal deposit insurance, including permanently increasing FDIC deposit insurance coverage to $250,000; and |
· | Allows depository institutions to pay interest on business checking accounts |
Many of these provisions are not yet effective and are subject to implementation by various regulatory agencies. As a result, the actual impact this new law will have on the Bank's business is not yet known. However, this law and any other changes to laws applicable to the financial industry may impact the profitability of the Bank's business activities or change certain of its business practices and may expose the Corporation and the Bank to additional costs, including increased compliance costs, and require the investment of significant management attention and resources. As a result, this law may negatively affect the business and future financial performance of the Corporation and the Bank.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
There has been no material change in the market risk faced by the Corporation since December 31, 2010. For information regarding our risk factors, refer to the FNBH Bancorp, Inc. Form 10-K for the year ended December 31, 2010.
Item 4. Controls and Procedures
(a) | Evaluation of Disclosure Controls and Procedures. |
In connection with the restatement of the consolidated financial statements described in this Amendment, a reevaluation of the effectiveness of the Corporation’s disclosure controls and procedures (as defined in Exchange Act Rule 240.13a-15(e)) was performed by management under the supervision and with the participation of the Corporation’s Chief Executive Officer and Chief Financial Officer. Based on that reevaluation, the Chief Executive Officer and the Chief Financial Officer have concluded that the Corporation’s controls and procedures were not effective as of September 30, 2011 due to the estimation of the allowance for loan losses and the timely recognition of loan charge offs and other real estate at that date. The objectives of such evaluation and the Corporation’s disclosure controls and procedures are to ensure that information required to be disclosed by the Corporation in the reports it files or submits under the Securities Exchange Act of 1934 is accumulated and communicated to the Corporation’s management, including its Chief Executive Officer and Chief Financial Officer, to allow timely decisions regarding required disclosures and is recorded, processed, summarized and reported, within the time periods specified in the SEC’s rules and forms.
Although the Bank evaluates the adequacy of the allowance for loan losses based on specific information known to management at a given time, bank regulators, based on the timing of their normal examination process and their independent judgment, may require additions to the allowance for loan losses. In addition, it is extremely difficult to precisely estimate and measure the amount of losses that may be inherent in the loan portfolio at a point in time. Management attempts to accurately quantify the necessary allowance and related provision for loan losses, but there can be no assurance that the modeling process and related assumptions used within the existing allowance for loan loss methodology will successfully identify all losses inherent in the portfolio. Despite these factors and limitations, based on regulatory input and an internal reexamination, management reassessed certain factors and assumptions employed in the allowance for loan losses estimation and determined the need for additional provision expense to increase the allowance for loan losses at June 30, 2011. Management also reassessed the effects of events and information subsequently known to management that provided additional evidence about conditions existing at June 30, 2011 related to the timing and recognition of charge offs on certain loans and the foreclosure on collateral securing an impaired loan. As a result, management determined the need to restate certain charge offs and a loan transfer to other real estate as of June 30, 2011, rather than during the quarter ended September 30, 2011 as previously reported.
Whenever a public company revises previously issued financial statements, the facts and circumstances of such a restatement must also be evaluated in the context of internal control over financial reporting. Generally, a restatement is viewed as a strong indicator of a material weakness in internal control over financial reporting.
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A material weakness in internal control over financial reporting is a deficiency, or combination of deficiencies, in internal control over financial reporting such that there is a reasonable possibility that a material misstatement of a company’s financial statements will not be prevented or detected in a timely basis by the company’s management.
As such, management has determined that the restatement resulted in the identification of a material weakness in internal control at September 30, 2011. The material weakness is currently in the process of being remediated and is expected to be fully remediated in early 2012. Such remediation will entail full incorporation of all regulatory imposed requirements in the computations and internal control processes related to the estimation of the allowance for loan loss and the evaluation and accounting for impaired loans. To address the aforementioned material weakness, management’s remediation plan relies primarily on the recent hiring of an experienced Chief Credit Officer, which filled a position previously vacant for nearly 15 months. The Chief Credit Officer will be responsible for the overall management and implementation of effective processes and procedures designed to ensure: i) the allowance for loan losses methodology and calculation adhere to applicable accounting guidance and regulatory policy; ii) that impaired loans are identified timely and appropriately measured for loss recognition; and iii) revaluations of credit and/or collateral are performed timely.
(b) | Changes in Internal Control Over Financial Reporting. |
During the quarter ended September 30, 2011 there were no changes in the Corporation’s internal control over financial reporting that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
PART II - OTHER INFORMATION
Item 1A. Risk Factors
There have been no material changes to the risk factors disclosed in Item 1A. Risk Factors of the Corporation's Annual Report on Form 10-K for the year ended December 31, 2010.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
There were no sales or repurchases of stock by the Corporation for the three months ended September 30, 2011.
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Item 6. Exhibits
The following exhibits (listed by number corresponding to the Exhibit Table as Item 601 in Regulation S-K) are filed with this report:
31.1 | Certificate of the Chief Executive Officer of FNBH Bancorp, Inc. pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. | |
31.2 | Certificate of the Chief Financial Officer of FNBH Bancorp, Inc. pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. | |
32.1 | Certificate of the Chief Executive Officer of FNBH Bancorp, Inc. pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (18 U.S.C. 1350). | |
32.2 | Certificate of the Chief Financial Officer of FNBH Bancorp, Inc. pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (18 U.S.C. 1350). | |
101.INS | Instance Document | |
101.SCH | XBRL Taxonomy Extension Schema Document | |
101.CAL | XBRL Taxonomy Extension Calculation Linkbase Document | |
101.DEF | XBRL Taxonomy Extension Definition Linkbase Document | |
101.LAB | XBRL Taxonomy Extension Label Linkbase Document | |
101.PRE | XBRL Taxonomy Extension Presentation Linkbase Document |
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this Quarterly Report on Form 10-Q for the quarter ended September 30, 2011 to be signed on its behalf by the undersigned hereunto duly authorized.
FNBH BANCORP, INC. | ||
/s/ Ronald L. Long | ||
Ronald L. Long | ||
President and Chief Executive Officer | ||
/s/ Mark J. Huber | ||
Mark J. Huber | ||
Chief Financial Officer |
Date: March 23, 2012
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