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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C.  20549

 

FORM 10-Q

(Mark one)

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

 

For the quarterly period ended March 31, 2012

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 Numbers: 000-10972

 

First Farmers and Merchants Corporation

(Exact name of registrant as specified in its charter)

 

Tennessee 

62-1148660

(State or other jurisdiction of incorporation or organization)

(I.R.S. Employer Identification No.)

 

 

816 South Garden Street

 

Columbia, Tennessee

38402-1148

(Address of principal executive offices)

(Zip Code)

 

931-388-3145

(Registrant’s telephone number, including area code)

 

 

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

             

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

 

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

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

Large accelerated filer [    ]    

Accelerated filer [ X ]

Non-accelerated filer [    ] (Do not check if a smaller reporting company)      

Smaller reporting company [    ]

 

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

 

As of May 4, 2012, the registrant had 5,330,000 shares of common stock outstanding.

 

 

 

 

 

 

 

 

 

 

 

1


 


 

 

 

 

 

PART I - FINANCIAL INFORMATION

 

 

Item 1. Financial Statements.

 

 

The following unaudited condensed consolidated financial statements of the Registrant and its subsidiaries are included in this Report:

 

Condensed consolidated balance sheets – March 31, 2012 and December 31, 2011.

 

Condensed consolidated statements of income - For the three months ended March 31, 2012 and March 31, 2011.

 

Condensed consolidated statements of comprehensive income

 

Condensed consolidated statements of cash flows - For the three months ended March 31, 2012 and March 31, 2011.

 

Selected notes to condensed consolidated financial statements.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2


 


FIRST FARMERS AND MERCHANTS CORPORATION AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

 

 

March 31,

 

December 31,

 

 

2012

 

2011

 

(Dollars in Thousands, Except Per Share Data)

(Unaudited)

 

 

ASSETS

Cash and due from banks

 $

17,806 

 

 $

17,927 

 

Interest-bearing due from banks

30,196 

 

16,500 

 

Federal funds sold

16,000 

 

38,594 

 

              Total cash and cash equivalents

64,002 

 

73,021 

 

Securities

 

 

 

 

     Available-for-sale (amortized cost $371,187

 

 

 

 

       and $309,374, respectively)

373,799 

 

314,270 

 

     Held-to-maturity (fair market value $35,692

 

 

 

 

       and $37,276, respectively)

33,816 

 

35,214 

 

          Total Securities

407,615 

 

349,484 

 

Loans, net of deferred fees

505,645 

 

517,802 

 

     Allowance for loan  losses

(8,699)

 

(9,200)

 

          Net loans

496,946 

 

508,602 

 

 

 

 

 

 

Bank premises and equipment, net

26,292 

 

25,537 

 

Other real estate owned

7,631 

 

8,827 

 

Bank owned life insurance

23,752 

 

23,621 

 

Goodwill

9,018 

 

9,018 

 

Other assets

19,261 

 

19,339 

 

          TOTAL ASSETS

 $

1,054,517 

 

 $

1,017,449 

 

 

 

 

 

LIABILITIES

Deposits

 

 

 

 

     Noninterest-bearing

 $

152,968 

 

 $

144,003 

 

     Interest- bearing

747,054 

 

712,427 

 

          Total deposits

900,022 

 

856,430 

 

 

 

 

 

 

Securities sold under agreements to repurchase

17,290 

 

16,347 

 

Accounts payable and accrued liabilities

14,885 

 

16,265 

 

Federal Home Loan Bank Advances

10,100 

 

17,100 

 

TOTAL LIABILITIES

942,297 

 

906,142 

 

 

 

 

 

SHAREHOLDERS'

Common stock - $10 par value per share, 8,000,000 shares

 

 

 

EQUITY

        authorized; 5,330,000  shares issued

 

 

 

 

        and outstanding as of  March 31, 2012 and

 

 

 

 

         December 31, 2011

53,300 

 

53,300 

 

Retained earnings

57,219 

 

54,890 

 

Accumulated other comprehensive income

1,606 

 

3,022 

 

        TOTAL SHAREHOLDERS' EQUITY BEFORE NONCONTROLLING INTEREST - PREFERRED STOCK OF SUBSIDIARY

112,125 

 

111,212 

 

Noncontrolling interest - preferred stock of subsidiary

95 

 

95 

 

TOTAL SHAREHOLDERS' EQUITY

112,220 

 

111,307 

 

        TOTAL LIABILITIES AND

 

 

 

 

           SHAREHOLDERS' EQUITY

 $

1,054,517 

 

 $

1,017,449 

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

 

 

 

 

3


 


FIRST FARMERS AND MERCHANTS CORPORATION AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF INCOME

(Unaudited)

 

 

Three months ended March 31,

 

(Dollars in Thousands Except Per Share Data)

2012

2011

INTEREST AND

Interest and fees on loans

 $

6,980 

 $

7,537 

    DIVIDEND INCOME

Income on investment securities

 

 

 

     Taxable interest

1,184 

925 

 

     Exempt from federal income tax

809 

933 

 

     Dividends

48 

48 

 

Other interest income

44 

18 

 

          TOTAL INTEREST INCOME

9,065 

9,461 

INTEREST EXPENSE

Interest on deposits

904 

1,165 

 

Interest on other borrowings

167 

207 

 

          TOTAL INTEREST EXPENSE

1,071 

1,372 

 

               NET INTEREST INCOME

7,994 

8,089 

 

PROVISION FOR LOAN AND LOSSES

600 

725 

 

NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES

7,394 

7,364 

NONINTEREST

 

 

 

     INCOME

Gains on loans sold

119 

173 

 

Trust department income

536 

526 

 

Service fees on deposit accounts

1,648 

1,603 

 

Brokerage fees

42 

 

Earnings on bank owned life insurance

120 

177 

 

Gain on sale of securities

1,212 

60 

 

Loss on foreclosed property

(414)

(220)

 

Other non-interest income

116 

103 

 

          TOTAL NONINTEREST INCOME

3,379 

2,422 

NONINTEREST

Salaries and employee benefits

4,273 

4,134 

    EXPENSE

Net occupancy expense

468 

478 

 

Depreciation expense

328 

306 

 

Data processing expense

475 

464 

 

Legal and professional fees

188 

276 

 

Stationary and office supplies

49 

75 

 

Amortization of intangibles

19 

 

Advertising and promotions

294 

333 

 

FDIC Insurance premium expense

356 

384 

 

Other real estate expense

111 

111 

 

Other noninterest expense

1,212 

1,336 

 

          TOTAL NONINTEREST EXPENSES

7,754 

7,916 

 

INCOME BEFORE PROVISION FOR INCOME TAXES

3,019 

1,870 

 

PROVISION FOR INCOME TAXES

690 

325 

 

Net income before noncontrolling interest - dividends on preferred stock of subsidiary

2,329 

1,545 

 

Noncontrolling interest - dividends on preferred stock of subsidiary

 

      NET INCOME AVAILABLE FOR COMMON SHAREHOLDERS

 $

2,329 

1,545 

PER SHARE

Weighted Average Shares Outstanding

5,330,000 

5,427,650 

 

 Basic earnings per share

 $

0.44 

 $

0.28 

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

 

 

 

4


 


 

 

FIRST FARMERS AND MERCHANTS CORPORATION AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(Unaudited)

 

 

 

(Dollars in thousands)

Three Months Ended

 

March 31,

 

2012

2011

Net Income

 $         2,329

 $         1,545

Comprehensive Income (Loss)

 

 

Unrealized appreciation (depreciation) on available-for-sale securities, net of taxes of $420 and $2 for 2012 and 2011, respectively

             (671)

                   4

Less:  reclassification adjustment for realized gains included in net income, net of taxes of $467 and $23, for 2012 and 2011, respectively

             (745)

               (37)

Net unrealized loss on available-for-sale securities

          (1,416)

               (33)

 

 

 

Comprehensive Income

               913

            1,512

Less:  comprehensive income attributable to the noncontrolling interest

                  -  

                  -  

Total Comprehensive Income

 $           913

 $       1,512

 

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

 

5


 


 

 

 

FIRST FARMERS AND MERCHANTS CORPORATION AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS  

(Unaudited)               

 

(Dollars in Thousands)

Three months Ended March 31,

 

 

2012

2011

OPERATING

Net income available for common shareholders

 $

2,329 

 $

1,545 

ACTIVITIES

   Adjustments to reconcile net income to net cash provided

 

 

 

     by (used in) operating activities

 

 

 

       Provision for loan losses

600 

725 

 

       Provision for depreciation and amortization of

 

 

 

          premises and equipment

329 

306 

 

       Deferred tax expense

59 

346 

 

       Net securities gains

(1,212)

(60)

 

       (Gain) loss from disposition of other real estate

414 

220

 

       Gains on loans sold

(119)

(173)

 

       Proceeds from sale of mortgage loans held for sale

6,888

                    9,417

 

       Funding of mortgage loans held for sale

(5,783)

  (6,586)

 

       Amortization of deposit base intangibles

18 

 

       Amortization of investment security premiums,

 

 

 

          net of accretion of discounts

1,084 

366 

 

       Increase in cash surrender value of life insurance contracts

(131)

(181)

 

       (Increase) decrease in

 

 

 

          Other assets

(936) 

(496) 

 

       Increase (decrease) in

 

 

 

          Other liabilities

590 

(127)

 

               Total adjustments

1,741 

3,775 

 

               Net cash provided by operating activities

4,070 

5,320 

INVESTING

Proceeds from sales of available-for-sale securities

134,018 

14,873 

ACTIVITIES

Proceeds from maturities and calls of available-for-sale securities

19,144 

24,518 

 

Proceeds from maturities and calls of held-to-maturity securities

1,390 

1,404 

 

Purchases of investment securities

 

 

 

      available-for-sale

(214,836)

(69,476)

 

Net decrease in loans

10,915 

5,371 

 

Proceeds from sale of OREO

923 

 

Purchases of premises and equipment

(206)

(406)

 

               Net cash used in investing activities

(48,652)

(23,716)

FINANCING

Net increase in deposits

43,592 

23,017 

ACTIVITIES

Net increase in securities sold under agreements to repurchase

943 

751 

 

Payments to FHLB borrowings

(7,000)

(7,000)

 

Repurchase of common stock

(1,047)

 

Cash dividends paid on common stock

(1,972)

 

Cash dividends paid on preferred stock

 

               Net cash provided by financing activities

35,563 

15,721 

 

Decrease in cash and cash equivalents

(9,019)

(2,675)

 

Cash and cash equivalents at beginning of period

73,021 

32,499 

 

Cash and cash equivalents at end of period

 $

64,002

 $

29,824 

 

Supplemental disclosures of cash flow information

 

 

 

Cash paid during the period for expenses

 

 

 

       Interest on deposits and borrowed funds

 $

1,001 

 $

1,461 

 

       Income Taxes

1,563 

(497)

 

Real estate acquired in settlement of loans

141 

250 

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

 

 

 

6


 


 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

 

NOTE 1 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

 

The accompanying unaudited condensed consolidated financial statements reflect all adjustments that are in the opinion of the First Farmers and Merchants Corporation’s (the Corporation) management, necessary to fairly present the financial position, results of operations and cash flows of the Corporation.  Those adjustments consist only of normal recurring adjustments.

           

The accompanying condensed consolidated financial statements are presented in accordance with the requirements of Form 10-Q and consequently do not include all of the disclosures normally required by accounting principles generally accepted in the United States of America or those normally made in the Registrant’s annual report on Form 10-K.  Accordingly, the reader of the Form 10-Q should refer to the Registrant’s Form 10-K for the year ended December 31, 2011 for further information in this regard.  The condensed consolidated balance sheet of the Corporation as of December 31, 2011 has been derived from the audited consolidated balance sheet of the Corporation as of that date.  The results of operations for the period are not necessarily indicative of the results to be expected for the full year.

Reclassifications

Certain reclassifications have been made to the 2011 condensed consolidated financial statements to conform to the 2012 financial statement presentation.  These reclassifications had no effect on net income.

NOTE 2 – FAIR VALUE MEASUREMENT

 

The fair value of an asset or liability is the price that would be received to sell that asset or paid to transfer that liability in an orderly transaction occurring in the principal market (or most advantageous market in the absence of a principal market) for such asset or liability. Fair value measurement must maximize the use of observable inputs and minimize the use of unobservable inputs.  In estimating fair value, the Corporation utilizes valuation techniques that are consistent with the market approach, the income approach and/or the cost approach. Such valuation techniques are consistently applied. Inputs to valuation techniques include the assumptions that market participants would use in pricing an asset or liability. Financial Accounting Standards Board Accounting Standards Codification (“ASC”) Topic 820, “Fair Value Measurements and Disclosures” establishes a fair value hierarchy for valuation inputs that gives the highest priority to quoted prices in active markets for identical assets or liabilities and the lowest priority to unobservable inputs. The fair value hierarchy is as follows:

 

  • Level 1 Inputs - Unadjusted quoted prices in active markets for identical assets or liabilities.

 

  • Level 2 Inputs - Inputs other than quoted prices included in Level 1 that are observable for the asset or liability, either directly or indirectly. These might include 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, inputs other than quoted prices that are observable for the asset or liability (such as interest rates, volatilities, prepayment speeds, credit risks, etc.) or inputs that are derived principally from or corroborated by market data by correlation or other means.

 

  • Level 3 Inputs - Unobservable inputs for determining the fair values of assets or liabilities that reflect an entity’s own assumptions about the assumptions that market participants would use in pricing the assets or liabilities.

 

Transfers between levels of the fair value hierarchy are recognized on the actual date of the event or circumstances that caused the transfer, which generally coincides with the Corporation’s monthly and/or quarterly valuation process.

 

 

7


 


 

 

Recurring Measurements

 

The following table summarizes financial assets measured at fair value on a recurring basis as of March 31, 2012 and December 31, 2011, and by the level within the fair value hierarchy utilized to measure fair value (dollars in thousands):

 

Assets measured at fair value on a recurring basis as of March 31, 2012

 

 

 

Available-For-Sale Securities

Level 1

Level 2

Level 3

Total

    U.S. Government agencies

 $

 $

86,733 

 $

 $

86,733 

    U.S. government sponsored agency mortgage backed securities

214,576 

214,576 

    States and political subdivisions

53,933 

53,933 

    Corporate bonds

18,557 

18,557 

    Total assets at fair value

 $

 $

373,799 

 $

 $

373,799 

Assets measured at fair value on a recurring basis as of December 31, 2011

 

 

 

Available-For-Sale Securities

Level 1

Level 2

Level 3

Total

    U.S. Government agencies

 $

 $

59,001 

 $

 $

59,001 

    U.S. government sponsored agency mortgage backed securities

176,050 

176,050 

    States and political subdivisions

59,946 

59,946 

    Corporate bonds

23,169 

23,169 

    Total assets at fair value

 $

 $

318,166 

 $

 $

318,166 

 

Following is a description of the valuation methodologies and inputs used for assets measured at fair value on a recurring basis and recognized in the accompanying balance sheets, as well as the general classification of such assets pursuant to the valuation hierarchy.  There have been no significant changes in the valuation techniques during the period ended March 31, 2012. 

 

Available-for-Sale Securities

 

Where quoted market prices are available in an active market, securities are classified within Level 1 of the valuation hierarchy.  If quoted market prices are not available, the Corporation obtains fair value measurements from an independent pricing service, such as Interactive Data, which utilizes pricing models to determine fair value measurement.  The Corporation reviews the pricing quarterly to verify the reasonableness of the pricing.  The fair value measurements consider observable data that may include dealer quotes, market spreads, cash flows, the U.S. Treasury yield curve, live trading levels, trade execution data, market consensus prepayment speeds, credit information and the bond’s terms and conditions, among other factors.  U.S. government agencies, state and political subdivisions, U.S. government sponsored agency mortgage-backed securities, and corporate bonds are classified as Level 2 inputs.

 

Nonrecurring Measurements:

 

The following tables summarize financial assets measured at fair value on a nonrecurring basis as of March 31, 2012 and December 31, 2011, and by the level within the fair value hierarchy utilized to measure fair value (dollars in thousands):

 

Assets measured at fair value on a nonrecurring basis as of March 31, 2012

 

 

 

 

Level 1

Level 2

Level 3

Total

    Impaired loans (collateral dependent)

 $

 $

 $

7,584     

 $

7,584    

    Other real estate owned

832     

832    

Assets measured at fair value on a nonrecurring basis as of December 31, 2011

 

 

 

 

Level 1

Level 2

Level 3

Total

    Impaired loans (collateral dependent)

 $

 $

 $

13,604     

 $

13,604    

    Other real estate owned

8,827     

8,827    

 

8


 


 

Impaired Loans (Collateral Dependent)

 

The estimated fair value of collateral-dependent impaired loans is based on the appraised fair value of the collateral, less estimated cost to sell.  Collateral-dependent impaired loans are classified within Level 3 of the fair value hierarchy.

 

The Corporation considers the appraisal or evaluation as the starting point for determining fair value and then considers other factors and events in the environment that may affect the fair value.  Appraisals of the collateral underlying collateral-dependent loans are obtained when the loan is determined to be collateral-dependent and subsequently as deemed necessary by the Chief Credit Officer.  Appraisals are reviewed for accuracy and consistency by the Chief Credit Officer.  Appraisers are selected from the list of approved appraisers maintained by management.  The appraised values are reduced by discounts to consider lack of marketability and estimated cost to sell if repayment or satisfaction of the loan is dependent on the sale of the collateral.  These discounts and estimates are developed by the Chief Credit Officer by comparison to historical results.  Fair value adjustments for the quarters ended March 31, 2012 and 2011 were approximately $571,000 and $1.0 million, respectively, and $1.2 million for the year ended December 31, 2011.

 

            Loans considered impaired under ASC 310-35, Impairment of a Loan, are loans for which, based on current information and events, it is probably that the creditor will be unable to collect all amounts due according to the contractual terms of the loan agreement.  Impaired loans are subject to nonrecurring fair value adjustments to reflect subsequent (1) partial write-downs that are based on the observable market price or current appraised value of the collateral or (2) the full charge-off of the loan carrying value.

 

Other Real Estate Owned

 

Other real estate owned (OREO) is initially recorded at fair value at the time of acquisition, as determined by independent appraisal or evaluation by the Corporation, less costs to sell when the real estate is acquired in settlement of loans.  Quarterly evaluations of OREO are performed to determine if there has been any subsequent decline in the value of OREO properties.  Estimated fair value of OREO is based on appraisals or evaluations, less costs to sell.  OREO is classified within Level 3 of the fair value hierarchy.  OREO assets are subject to nonrecurring fair value adjustments to reflect subsequent partial write-downs that are based on the observable market price or current appraised value of the collateral.  Fair value adjustments for the quarters ended March 31, 2012 and 2011 were approximately $213,000 and $236,000, respectively, and $385,000 for the year ended December 31, 2011.

 

 

            Appraisals of OREO are obtained when the real estate is acquired and subsequently as deemed necessary by the Chief Credit Officer.  Appraisals are required annually and reviewed for accuracy and consistency by the Chief Credit Officer.  The appraised values are reduced by discounts to consider lack of marketability and estimated cost to sell.  Appraisers are selected from the list of approved appraisers maintained by management.

 

Unobservable (Level 3) Inputs

 

The following table presents quantitative information about unobservable inputs used in nonrecurring Level 3 fair value measurements (dollars in thousands).

 

 

9


 


 

 

 

 

 

 

Quantitative Information about Level 3 Fair Value Measurements

(dollars in thousands)

Fair Value at March 31, 2012

Valuation Technique(s)

Unobservable Input

Range (Weighted Average)

Impaired loans (collateral-dependent)

 $                    7,584

 Market comparable properties

 Marketability discount

 5.0% - 10.0% (7%)

Other real estate/assets owned

 $                       832

 Market comparable properties

 Marketability discount

 5.0% - 10.0% (7%)

 

            ASC Topic 825, “Financial Instruments” (“ASC Topic 825”)  requires disclosure of the fair value of financial assets and liabilities, including those financial assets and liabilities that are not measured and reported at fair value on a recurring basis or non-recurring basis.

 

            The following methods and assumptions were used to estimate the fair value of each class of financial instruments for which it is practicable to estimate that value:

 

Cash and cash equivalents – The carrying amount approximates fair value.

 

Interest bearing deposits in other banks – The carrying amount approximates fair value.

 

Securities held-to-maturity – Fair values are based on quoted market prices, if available.  If a quoted price is not available, fair value is estimated using quoted prices for similar securities.  The fair value estimate is provided to management from a third party using modeling assumptions specific to each type of security that are reviewed and approved by management.  Quarterly sampling of fair values provided by additional third parties supplement the fair value review process.

 

Loans held for sale – The fair value is predetermined at origination based on sale price.

 

Loans (net of the allowance for loan  losses) – The fair value of fixed rate loans and variable rate mortgage loans is estimated by discounting the future cash flows using current rates at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities.  For other variable rate loans, the carrying amount approximates fair value

 

Federal Home Loan Bank stock – The carrying value of Federal Home Loan Bank stock approximates fair value based on the redemption provisions of the Federal Home Loan Bank.

 

Federal Reserve Bank stock – The carrying value of Federal Reserve Bank stock approximates fair value based on the redemption provisions of the Federal Reserve Bank.

 

Accrued interest receivable – The carrying amount approximates fair value.

 

Deposits – The fair value of fixed maturity time deposits is estimated by discounting the future cash flows using the rates currently offered for deposits of similar remaining maturities.  For deposits including demand deposits, savings accounts, NOW accounts, and certain money market accounts, the carrying value approximates fair value.

 

Repurchase agreements – The fair value is estimated by discounting future cash flows using current rates.

 

Advances from Federal Home Loan Bank – The fair value of these fixed-maturity advances is estimated by discounting future cash flows using rates currently offered for advances of similar remaining maturities.

 

Long-term debt – The fair value is estimated by discounting future cash flows using current rates.

 

Accrued interest payable – The carrying amount approximates fair value.

 

 

 

10


 


 

 

 

 

Commitments to originate loans, letters of credit, and lines of credit – The fair value of commitments to originate loans 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 values of letters of credit and lines of credit are based on fees currently charged for similar agreements or on the estimated cost to terminate or otherwise settle the obligations with the counterparties at the reporting date.  The fair values of these commitments are not material.

 

The following table presents estimated fair values of the Corporation’s financial instruments as of March 31, 2012 and indicates the level within the fair value hierarchy of the valuation techniques.

 

(dollars in thousands)

Fair Value Measurements at March 31, 2012 Using

 

Carrying
Amount

Quoted
Prices in
Active
Markets for
Identical
Assets
(Level 1)

Significant Other
Observable Inputs
(Level 2)

Significant
Unobservable Inputs  
(Level 3)

Financial assets

 

 

 

 

      Cash and cash equivalents

 $ 17,806

 $     17,806

 $                      -

 $                   - 

      Interest-bearing deposits in other banks

    30,196

        30,196

      Federal funds sold

    16,000

        16,000

      Federal home loan bank and Federal reserve bank stock

      3,879

                3,879

      Securities available-for-sale

  373,799

            373,799

      Securities held-to-maturity

    33,816

              35,692

      Loans held for sale

      1,518

 

                   1,518

 

      Loans, net

  496,946

         512,515

      Accrued interest receivable

       4,498

                4,498

Financial liabilities

 

 

 

 

      Non-interest bearing deposits

  152,968

      152,968

     Interest bearing deposits

  747,054

            749,421

      Repurchase agreements

    17,290

              17,290

     Advances from Federal Home Loan Bank

    10,100

              10,415

      Accrued interest payable

          808

                    808

Off-balance sheet credit related instruments:

 

 

 

 

      Commitments to extend credit and letters of credit

 

 

 

 

The estimated fair values of financial instruments as of December 31, 2011 were as follows (dollars in thousands):

 

 

December 31, 2011

 

Carrying

Fair

 

Amount

Value

Financial assets

 

 

      Cash and due from banks

 $

17,927 

 $

17,927 

      Interest-bearing deposits in banks

38,594 

38,594 

      Federal funds sold

16,500 

16,500 

      Securities available-for-sale

318,166 

318,166 

      Securities held-to-maturity

35,214 

37,276 

      Loans, net

508,602 

523,847 

      Accrued interest receivable

4,095 

4,095 

Financial liabilities

 

 

      Deposits

856,430 

858,775 

      Federal funds purchased and

 

 

            securities sold under agreements

 

 

            to repurchase

16,347 

16,347 

      Other short term liabilities

      FHLB borrowings

17,100 

17,521 

      Accrued interest payable

878 

878 

Off-balance sheet credit related instruments:

 

 

      Commitments to extend credit

109 

 

11


 


NOTE 3 – SECURITIES

 

            The amortized cost and estimated fair value of securities at March 31, 2012 and December 31, 2011 were as follows (dollars in thousands):

 

 

Amortized

Gross Unrealized

Fair

 

Cost

Gains

Losses

Value

March  31, 2012

 

 

 

 

Available-for-sale securities

 

 

 

 

    U.S. Government agencies

 $     87,386

 $         39

 $     692

 $   86,733

    U.S. Government sponsored agency mortgage backed securities

      214,909

          433

         766

    214,576

    States and political subdivisions

        50,925

       3,008

              -

       53,933

    Corporate bonds

        17,967

          602

           12

       18,557

 

 $  371,187

 $   4,082

 $  1,470

 $ 373,799

Held-to-maturity securities

 

 

 

 

    States and political subdivisions

 $     33,816

 $   1,876

 $           -

 $   35,692

 

 

 

 

 

 

 

 

 

Amortized

Gross Unrealized

Fair

December 31, 2011

Cost

Gains

Losses

Value

Available-for-sale securities

 

 

 

 

    U.S. Government agencies

 $     58,793

 $       214

 $          6

 $   59,001

    U.S. Government sponsored agency mortgage backed securities

      175,352

          843

         145

    176,050

    States and political subdivisions

        56,452

       3,494

              -

       59,946

    Corporate bonds

        18,741

          582

           68

       19,273

 

 $  309,374

 $   5,133

 $     219

 $ 314,270

Held-to-maturity securities

 

 

 

 

    States and political subdivisions

 $     35,214

 $   2,061

 $         -  

 $   37,275

 

           

Certain investments in debt securities are reported in the financial statements at an amount less than their historical cost.  Total fair value of these investments at March 31, 2012 and December 31, 2011, was approximately $199,098 and $$85,009, which is approximately 49% and 24%, respectively, of the Corporation’s available-for-sale and held-to-maturity investment portfolio.  The Corporation evaluates its investment portfolio on a quarterly basis for impairment.  The analysis performed as of March 31, 2012 and December 31, 2011 indicates that all impairment is considered temporary, market driven due primarily to fluctuations in market interest rates, and not credit-related.

 

The following table shows the Corporation’s investments’ gross unrealized losses and fair value of the Corporation’s investments with unrealized losses that are not deemed to be other-than-temporarily impaired, aggregated by investment class and length of time that individual securities have been in a continuous unrealized loss position at March 31, 2012 and December 31, 2011 (dollars in thousands):

 

 

12


 


March 31, 2012

Less than 12 months

12 months or Greater

Total

 

Fair

Unrealized

Fair

Unrealized

Fair

Unrealized

Type of Security

Value

Losses

Value

Losses

Value

Losses

     US Government agencies

 $

74,839 

 $

692 

 $

-

 $

 $

74,839 

 $

692 

     US Government sponsored agency mortgage

         backed securities

123,264 

766 

-

-

123,264 

766 

    Corporate bonds

995 

12 

-

995 

12 

 

 $

199,098 

 $

1,470 

 $

-

 $

 $

199,098 

 $

1,470 

 

 

 

 

 

 

 

 

December 31, 2011

Less than 12 months

12 months or Greater

Total

 

Fair

Unrealized

Fair

Unrealized

Fair

Unrealized

Type of Security

Value

Losses

Value

Losses

Value

Losses

     US Government agencies

 $

15,063

 $

 $

  - 

 $

   - 

 $

15,063 

 $

     US Government sponsored agency mortgage
         backed securities

40,792

145 

 -

 -

40,792 

145 

    Corporate bonds

29,154

67 

 -

 -

29,154 

67 

 

 $

85,009

 $

219 

 $

 $

 $

85,009 

 $

219 

 

The amortized cost and fair value of available-for-sale securities and held-to-maturity securities at March 31, 2012, by contractual maturity, are shown below.  Expected maturities will differ from contractual maturities because issuers may have the right to call or prepay obligations with or without call or prepayment penalties.

 

 

Available for Sale

 

Held to Maturity

March 31, 2011

Amortized

Estimated

 

Amortized

Estimated

 

Cost

Fair Value

 

Cost

Fair Value

Within one year

 $                8,585

 $          8,673

 

 $      2,774

 $      2,801

One to five years

                 30,265

           30,886

 

         7,869

         8,269

Five to ten years

                 84,681

           84,827

 

       10,520

       11,194

After ten years

                 32,748

           34,837

 

       12,653

       13,428

Mortgage-backed securities

               214,908

         214,576

 

                 -

                 -

Total

 $            371,187

 $      373,799

 

 $    33,816

 $    35,692

 

 

 

 

 

 

 

The carrying value of securities pledged as collateral, to secure public deposits and for other purposes, was $209.1 million at March 31, 2012, and $196.1 million at December 31, 2011.

The book value of securities sold under agreements to repurchase amounted to $26.0 million and $22.2 million at March 31, 2012 and December 31, 2011, respectively.

Gross gains of $1.2 million and $60,000 resulting from sales of available-for-sale securities were realized for three month periods ended March 31, 2012 and 2011, respectively.

NOTE 4 – LOANS

 

            The following table presents the Corporation’s loans by class as of March 31, 2012 and December 31, 2011 (dollars in thousands):

 

 

 

13


 


 

 

March 31, 2012

December 31, 2011

Commercial

 

 

Commercial and industrial

 $        57,922

 $          60,448

Non-farm, non-residential real estate

         145,427

           140,147

Construction & development

           24,562

             29,042

Commercial loans secured by real estate

             8,546

               6,161

Other Commercial

           43,285

             45,630

   Commercial total

         279,742

           281,428

Residential

 

 

Consumer loans

           12,183

             14,297

Single Family Residential

         192,917

           196,913

Other retail

           20,803

             25,700

   Retail total

       225,903

         236,910

Total

 $      505,645

 $        518,338

 

Loan Origination/Risk Management. The Corporation has certain lending policies and procedures in place that are designed to maximize loan income within an acceptable level of credit risk. Management reviews and approves these policies and procedures on a regular basis. A reporting system supplements the review process by providing management with frequent reports related to loan production, loan quality, concentrations of credit, loan delinquencies and non-performing and potential problem loans. Diversification in the loan portfolio is a means of managing risk associated with fluctuations in economic conditions.

 

Commercial and industrial loans are underwritten after evaluating and understanding a borrower’s ability to operate profitably and expand its business prudently. Underwriting standards are designed to promote relationship banking rather than transactional banking. Once it is determined that the borrower’s management possesses sound ethics and solid business acumen, the Corporation’s management examines current and projected cash flows to determine the ability of the borrower to repay their obligations as agreed. Commercial and industrial loans are primarily made based on the identified cash flows of the borrower and secondarily on the underlying collateral provided by the borrower. The cash flows of borrowers, however, may not be as expected and the collateral securing these loans may fluctuate in value. Most commercial and industrial loans are secured by the assets being financed or other business assets such as accounts receivable or inventory and may incorporate a personal guarantee; however, some short-term loans may be made on an unsecured basis. In the case of loans secured by accounts receivable, the availability of funds for the repayment of these loans may be substantially dependent on the ability of the borrower to collect amounts due from its customers.

 

Commercial real estate loans are subject to underwriting standards and processes similar to commercial and industrial loans, in addition to those of real estate loans. These loans are viewed primarily as loans secured by real estate. Commercial real estate lending typically involves higher loan principal amounts and the repayment of these loans is generally largely dependent on the successful operation of the property securing the loan or the business conducted on the property securing the loan. Commercial real estate loans may be more adversely affected by conditions in the real estate markets or in the general economy. Management monitors and evaluates commercial real estate loans based on collateral, geography and risk grade criteria. As a general rule, the Corporation avoids financing single-purpose projects unless other underwriting factors are present to help mitigate risk. The Corporation also utilizes third-party experts to provide insight and guidance about economic conditions and trends affecting market areas it serves. In addition, management tracks the level of owner-occupied commercial real estate loans versus non-owner occupied loans. At March 31, 2012, approximately half of the outstanding principal balance of the Corporation’s commercial real estate loans were secured by owner-occupied properties. 

 

With respect to loans to developers and builders (construction and development) that are secured by non-owner occupied properties that the Corporation may originate from time to time, the Corporation generally requires the borrower to have had an existing relationship with the Corporation and have a proven record of success. Construction loans are underwritten utilizing feasibility studies, independent appraisal reviews, sensitivity analysis of absorption and lease rates and financial analysis of the developers and property owners. Construction loans are generally based upon estimates of costs and value associated with the complete project. These estimates may be inaccurate. Construction loans often involve the disbursement of substantial funds with repayment substantially dependent on the success of the ultimate project. Sources of repayment for these types of loans may be pre-committed permanent loans from approved long-term lenders, sales of developed property or an interim loan commitment from the Corporation until permanent financing is obtained. These loans are closely monitored by on-site inspections and are considered to have higher risks than other real estate loans due to their ultimate repayment being sensitive to interest rate changes, governmental regulation of real property, general economic conditions and the availability of long-term financing.

 

14


 


 

 

 

 

The Corporation originates consumer loans utilizing a computer-based credit scoring analysis to supplement the underwriting process. To monitor and manage consumer retail loan risk, policies and procedures are developed and modified, as needed, jointly by line and staff personnel. This activity, coupled with relatively small loan amounts that are spread across many individual borrowers, minimizes risk. Additionally, trend and outlook reports are reviewed by management on a regular basis. Underwriting standards for home equity loans are heavily influenced by statutory requirements, which include, but are not limited to, a maximum loan-to-value percentage of 80%, collection remedies, the number of such loans a borrower can have at one time and documentation requirements.

 

The Corporation contracts with a third party vendor to perform loan reviews.  The Corporation reviews and validates the credit risk program on an annual basis. Results of these reviews are presented to management.  The loan review process complements and reinforces the risk identification and assessment decisions made by lenders and credit personnel, as well as the Corporation’s policies and procedures.

 

The goal of the Corporation is to diversify loans to avoid a concentration of credit in a specific industry, person, entity, product, service, or any area vulnerable to a tax law change or an economic event. A concentration of credit occurs when obligations, direct or indirect, of the same or affiliated interests represent 15 percent or more of the Corporation's capital structure. The Board of Directors recognizes that the Corporation's geographic trade area imposes some limitations regarding loan diversification if the Corporation is to perform the function for which it has been chartered. Specifically, lending to qualified borrowers within the Corporation's trade area will naturally cause concentrations of real estate loans in the primary communities served by the Corporation and loans to employees of major employers in the area.

 

All closed-end commercial loans (excluding loans secured by real estate) are charged off no later than 90 days delinquent.  If a loan is considered uncollectable, it is charged off earlier than 90 days delinquent.  When a commercial loan secured by real estate is past due, a current assessment of the value of the real estate is made.  If the balance of the loan exceeds the fair value of the property, the loan is placed on nonaccrual with a specific reserve equal to the difference between book value and fair value assigned to the credit until such time as the property has been foreclosed.  When the foreclosed property has been legally assigned to the Corporation, a charge-off is taken with the remaining balance, reflecting the fair value less estimated costs to sell, transferred to other real estate owned. 

 

All closed-end consumer loans (excluding conventional 1-4 family residential loans and installment and revolving loans secured by real estate) are charged off no later than 120 days (5 monthly payments) delinquent.  If a loan is considered uncollectable, it is charged off earlier than 120 days delinquent.  For conventional 1-4 family residential loans and installment and revolving loans secured by real estate, when a loan is 90 days past due, a current assessment of the value of the real estate is made.  If the balance of the loan exceeds the fair value of the property, the loan is placed on nonaccrual and foreclosure proceedings are initiated.  When the foreclosed property has been legally assigned to the Corporation, a charge-off is taken with the remaining balance, reflecting the fair value less estimated costs to sell, transferred to other real estate owned.

 

Non-Accrual and Past Due Loans.  Loans are considered past due if the required principal and interest payments have not been received as of the date such payments were due. Loans are placed on non-accrual status when, if (i) principal or interest has been in default for a period of 90 days or more, or (ii) full payment of principal and interest is not expected. Loans may be placed on non-accrual status regardless of whether or not such loans are considered past due. When interest accrual is discontinued, all unpaid accrued interest is reversed. Interest income on non-accrual loans is recognized only to the extent that cash payments are received in excess of principal due. A loan may be returned to accrual status when all the principal and interest amounts contractually due are brought current and future principal and interest amounts contractually due are reasonably assured, which is typically evidenced by a sustained period (three to six months ) of repayment performance by the borrower.  Interest received on these loans during the first quarter of 2012 was approximately $128,000, compared to approximately $255,000 over the same period in 2011.  The Corporation had no loans that were 90 days or more past due that were not included in nonaccrual loans as of March 31, 2012.

 

 

The following table provides details regarding the aging of the Corporation’s loan portfolio as of March 31, 2012 and December 31, 2011 (dollars in thousands):

 

 

 

15


 


 

March 31, 2012

30 - 89 Days
past due

90 Days and
greater Past Due*

Total past dues

Current

Total loans

Retail

 

 

 

 

 

  Consumer loans

 $

53 

 $

70 

 $

123 

 $

12,060 

 $

12,183 

  Single Family Residential

677 

3,516 

4,193 

188,724 

192,917 

  Other retail

379 

382 

20,421 

20,803 

Retail Totals

 $

733 

 $

3,965 

 $

4,698 

 $

221,205 

 $

225,903 

Commercial

 

 

 

 

 

  Commercial & industrial

 $

479 

 $

4,551 

 $

5,030 

 $

52,892 

 $

57,922 

  Non-farm, non-residential real estate

544 

2,406 

2,950 

142,477 

145,427 

  Construction & development

 

24,562 

24,562 

  Commercial loans secured by real estate

8,546 

8,546 

  All other commercial

158 

2,305 

2,463 

40,822 

43,285 

Commercial Totals

 $

1,181 

 $

9,262 

 $

10,443 

 $

269,299 

 $

279,742 

TOTAL

 $

1,914 

 $

13,227 

 $

15,141 

 $

490,504 

 $

505,645 

December 31, 2011

30 - 89   Days
Past Due

90 Days and
greater Past Due*

Total Past Dues

Current

Total Loans

Retail

 

 

 

 

 

  Consumer loans

 $

73 

 $

 $

77 

 $

14,220 

 $

14,297 

  Single Family Residential

5,131 

1,002 

6,133 

190,780 

196,913 

  Other retail

25,699 

25,700 

Retail Totals

 $

5,205 

 $

1,006 

 $

6,211 

 $

230,699 

 $

236,910 

Commercial

 

 

 

 

 

  Commercial & industrial

 $

3,858 

 $

1,419 

 $

5,277 

 $

55,171 

 $

60,448 

  Non-farm, non-residential real estate

2,166 

320 

2,486 

137,661 

140,147 

  Construction & development

44 

44 

28,998 

29,042 

  Commercial loans secured by real estate

6,161

 6,161

  Other commercial

1,441 

159 

1,600 

44,030 

45,630

Commercial Totals

 $

7,509 

 $

1,898 

 $

9,407 

 $

272,021 

 $

281,428 

TOTAL

 $

12,714 

 $

2,904 

 $

15,618 

 $

502,720 

 $

518,338 

*Includes all loans on non-accrual and all bankruptcies.  Loans are automatically placed on non-accrual status once they reach 90 days past due, therefore the Corporation has no loans greater than 90 days past due still accruing interest.

 

The following table summarizes the impaired loans by loan type as of March 31, 2012 and December 31, 2011 (dollars in thousands):

 

March 31, 2012

Unpaid Contractual Principal Balance

Recorded Investment with no allowance

Recorded Investment with allowance

Total Recorded Investment

Related Allowance

Average Recorded Investment

Commercial

 $

13,801 

 $

3,732 

 $

7,418 

 $

11,150 

 $

742 

 $

11,082 

Residential real estate

1,579 

228 

1,081 

1,309 

117 

1,330 

    Total

 $

15,380 

 $

3,960 

 $

8,499 

 $

12,459 

 $

859 

 $

12,412 

December 31, 2011

Unpaid Contractual Principal Balance

Recorded Investment with no allowance

Recorded Investment with allowance

Total Recorded Investment

Related Allowance

Average Recorded Investment

Commercial

 $

14,325 

 $

3,724 

 $

8,663 

 $

12,387 

 $

1,111 

 $

12,769 

Residential real estate

1,388 

142 

1,075 

1,217 

131 

1,269 

    Total

 $

15,713 

 $

3,866 

 $

9,738 

 $

13,604 

 $

1,242 

 $

14,038 

 

16


 


 

 

 

 

Impaired Loans.  Loans are considered impaired when, based on current information and events, it is probable the Corporation will be unable to collect all amounts due in accordance with the original contractual terms of the loan agreement, including scheduled principal and interest payments. Impairment is evaluated in total for smaller-balance loans of a similar nature and on an individual loan basis for other loans. If a loan is impaired, a specific valuation allowance is allocated, if necessary, so that the loan is reported net, at the present value of estimated future cash flows using the loan’s existing rate or at the fair value of collateral if repayment is expected solely from the collateral. Interest payments on impaired loans are typically applied to principal unless collectability of the principal amount is reasonably assured, in which case interest is recognized on a cash basis. Impaired loans, or portions thereof, are charged off when deemed uncollectible.  Interest income recognized on impaired loans (which approximates cash basis interest received on impaired loans) was $128,000 and $255,000 for the three month periods ended March 31, 2012 and 2011, respectively.  The average balance of impaired loans for the three month period ending March 31, 2011 was $9.4 million for commercial loans and $1.1 million for residential real estate loans, totaling $10.5 million.

 

Troubled Debt Restructurings.  Included in certain loan categories of impaired loans are certain loans that have been modified in a troubled debt restructuring, where economic concessions have been granted to borrowers who have experienced financial difficulties.  These concessions typically result from our loss mitigation activities and could include reductions in the interest rate, payment extensions, forgiveness of principal, forbearance or other actions.  Modifications of terms for our loans and their inclusion as troubled debt restructurings are based on individual facts and circumstances.  Loan modifications that are included as troubled debt restructurings may involve either an increase or reduction of the interest rate, extension of the term of the loan, or deferral of principal and/or interest payments, regardless of the period of the modification.  All of the loans identified as troubled debt restructuring were modified due to financial stress of the borrower.  In order to determine if a borrower is experiencing financial difficulty, an evaluation is performed to determine the probability that the borrower will be in payment default on any of its debt in the foreseeable future with the modification.  This evaluation is performed under the Corporation’s internal underwriting policy.

           

When we modify loans in a troubled debt restructuring, we evaluate any possible impairment similar to other impaired loans based on the present value of expected future cash flows, discounted at the contractual interest rate of the original loan or lease agreement, or use the current fair value of the collateral, less selling costs for collateral dependent loans. If we determined that the value of the modified loan is less than the recorded investment in the loan, impairment is recognized through an allowance estimate or a charge-off to the allowance.  In periods subsequent to modification, we evaluate all troubled debt restructuring, including those that have payment defaults, for possible impairment and recognize impairment through the allowance.

 

As of March 31, 2012, the Corporation did not have any commitments to extend additional funds to borrowers with loans modified and included as a troubled debt restructuring.

 

During 2012, certain loans were modified in troubled debt restructurings, where economic concessions were granted to borrowers consisting of reductions in the interest rates, payment extensions, forgiveness of principal, and forbearances.  Presented below, segregated by class of loans, are troubled debt restructurings that occurred during the three months ended March 31, 2012:

 

 

Three Months Ended March 31, 2012

 

 

Post-

 

 

 

Modifications

Net Charge-offs

 

Number of

Outstanding

Resulting from

(dollars in thousands)

Loans

Balance

Modifications

Commercial:

 

 

 

  Commercial and industrial

5

 $                1,068

 

 $                        197

 

  Nonfarm nonresidential

1

                   1,203

 

                           222

 

Total trouble debt restructurings

6

 $                2,271

 

 $                        419

 

 

17


 


 

 

 

 

Loans retain their accrual status at the time of their modification.  As a result, if a loan is on nonaccrual at the time it is modified, it stays as nonaccrual, and if a loan is on accrual at the time of the modification, it generally stays on accrual.  Commercial and consumer loans modified in a troubled debt restructuring are closely monitored for delinquency as an early indicator of possible future default.  If loans modified in a troubled debt restructuring subsequently default, the Corporation evaluates the loan for possible further impairment.  The allowance for loan losses may be increased, adjustments may be made in the allocation of the allowance, or partial charge-offs may be taken to further write-down the carrying value of the loan.  The Corporation considers a loan in default when it is 90 days or more past due or transferred to nonaccrual. 

 

As of March 31, 2012, the Corporation did not have any loans that were modified in troubled debt restructurings that have subsequently defaulted.

 

Credit Quality Indicators. As part of the on-going monitoring of the credit quality of the Corporation’s loan portfolio, management tracks certain credit quality indicators including trends related to (i) the weighted-average risk grade of commercial loans, (ii) the level of classified commercial loans, (iii) net charge-offs, (iv) non-performing loans  and (v) the general economic conditions in the State of Tennessee.

 

The Corporation uses a risk grading matrix to assign a risk grade to each of its commercial loans.  Loans are graded on a scale of 1 through 8.  A description of the general characteristics of the eight risk grades is as follows:

Risk Rating 1        Minimal Risk

 

General Characteristics:

  • Substantially risk free

  • Federal, state, or municipal subdivisions with acceptable investment grade credit rating.

  • Large national, regional, or local entity with proven access to capital markets.

  • Diversity in borrower’s line of business with stable and diversified sales base.

  • Borrower is considered to be an industry leader with many consecutive years of strong profits and exhibits a financial condition, equity position, liquidity, and debt service capacity far exceeding industry norms.

  • Borrower has an abundance of unpledged financeable assets coupled with superior cash generation capabilities.

  • Industry conditions and trends are positive and strong.

  • Borrower has strong management with evidence of management succession.

  • A credit rating by Moody’s, Standard & Poor, or other qualified rating agency that is grade A or higher.

  • A cash secured loan with the cash on deposit in the Corporation or a guaranty from the federal government also warrants this risk rating.

Risk Rating 2             Modest Risk

 

General Characteristics:

 

  • Borrower shows strong profitability, liquidity, and capitalization better than industry norms and a strong market position in the region.

  • Borrower may have limited access to public markets for short-term needs or capital requirements, but has ready access to alternative financing.

  • Loans may be unsecured based on the financial strength of the borrower or secured by collateral that is considered liquid and marketable.

  • Borrower has a proven history of profitability and financial stability.

  • Borrower has a strong market position in its industry and has an abundance of financeable assets available to protect the Corporation’s position.

  • Borrower’s proven and steady management with good management succession.

  • Borrower can withstand major market instabilities of short duration.

  • Credit rating by Moody’s, Standard & Poor, or other qualified rating agency that is grade BAA or higher.

 

 

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Risk Rating 3             Average Risk

 

General Characteristics:

  • Borrower shows a stable earnings history and financial condition in line with industry norms with indications that these trends will continue.

  • The credit extension is considered sound, however elements may be present which suggest the borrower may not be free from temporary impairments in the future.

  • Borrower’s liquidity and leverage is in line with industry norms.

  • Borrower has good management with acceptable management succession.

  • Under most economic and business conditions, borrower has access to alternative financing but limited or no access to capital markets for short-term or capital needs.

  • Borrower may be an individual with a sound financial condition and liquidity with proven historical income to repay the debt as scheduled.

  • Credit extensions are generally secured by acceptable collateral.

Risk Rating 4             Acceptable Risk

 

General Characteristics:

  • Credit is to a borrower with smaller margins of debt service coverage and with some elements of reduced financial strength.

  • Borrower is generally in a lower average market position in its industry.

  • Borrower shows satisfactory asset quality and liquidity, good debt capacity and coverage, and good management in critical positions.

  • Borrower’s management is of unquestioned character but management succession may be questionable.

  • Borrower can obtain similar financing from other financial institutions.

  • Interim losses or moderately declining earnings trends may occur, but the borrower has sufficient strength and financial flexibility to offset these issues.

  • Credit may be to individuals with a moderately leveraged financial condition but with satisfactory liquidity and income to cover debt repayment requirements.

  • Business borrowers may have moderate leverage, but must have historically consistent cash flow to cover debt service and other operating needs.

  • Business borrowers may also have erratic or cyclical operating performances but should demonstrate strong equity positions to support these profitability swings.

  • Asset-based loans that have stabilized and proven performance with the financial capacity to provide for annual clean up may qualify for this rating.

  • Borrower has no access to capital markets but would be financeable by another financial institution or finance company.

  • Credit extensions are generally secured by acceptable collateral.

Risk Rating 5             Pass / Watch 

 

General Characteristics:

 

Loans considered for this risk rating require a heightened level of supervision. 

 

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A) Transitional, Event Driven – This category of risk rated 5 loans captures responses to early warning signals from a relationship and, therefore, signifies a specific, event-driven, transitional credit grade. The event is generally something unplanned or unexpected such as a death, a disaster, the loss of a major client, product line, or key employee; divorce, or health condition of the owner or key management person. This category may be used in transitional upgrades as well as transitional downgrades of credit relationships.  Under these criteria, this category necessitates a plan of action to either upgrade the credit to a “Pass” rating (i.e., Risk Rating 1-4), downgrade the credit to a criticized asset, or exit the relationship within six months.

 

B) Ongoing Supervision Warranted - This category may also be utilized to identify loans having inherent characteristics which warrant more than the normal level of supervision.  Loans meeting these criteria may include larger, more complex loans with unusual structures.  Loans, which, due to structure or nature of the collateral require above average servicing, may also be considered for this risk rating.  Unlike other criteria listed previously for this category, these particular characteristics tend not to be one-time or transitional in nature; therefore, these loans may be expected to remain in this risk rating category longer than six months.  A loan might remain in this risk rating category for its life or until the characteristic warranting the rating can be eliminated or effectively mitigated.

  • Borrower may exhibit declining earnings, strained cash flow, increasing leverage, or weakening market positions that indicate a trend toward an unacceptable risk.

  • Borrower’s liquidity, leverage, and earnings performance is below or trending below industry norms.

  • Interim losses and other adverse trends may occur but not to the level that would impair the Corporation’s position.

  • Borrower may be a newly formed company or in a new line of business or may be an established business with new or unproven management.  Borrower should be adequately capitalized, but may not yet have achieved stabilized cash flow.

  • Borrower generally has a small market position in its industry.

  • Borrower may be engaged in an industry that is experiencing an economic downturn or is particularly susceptible to uncontrollable external factors.

  • Borrower management is of good character although some management weakness may exist, including lack of depth or succession.

  • Borrower generally has limited additional debt capacity and modest coverage, and average or below-average asset quality, margins, and market share.

  • Borrower’s ability to obtain financing from other financial institutions may be impaired.

  • Credit to individuals with marginal financial condition and liquidity but with income still sufficient to service the debt.

Risk Rating 6                 Special Mention

 

A special mention asset has potential weaknesses that deserve management’s close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the asset or in the institution’s credit position at some future date. Special mention assets are not adversely classified and do not expose an institution to sufficient risk to warrant adverse classification.

 

General Characteristics:

 

  • Borrower’s cash flow may not be sufficient to fund anticipated cash needs.

  • Sufficient or modestly sufficient financeable assets are available to protect the Corporation’s position.

  • Adverse trends in borrower’s operations/profits or unbalanced position in borrower’s balance sheet but not to the point where repayment is in jeopardy.

  • Borrower generally shows limited liquidity or high leverage.

  • Borrower’s financial position is in the lower quartile of industry norms.

  • Borrower’s business exhibits a deteriorating market position in the industry.

  • Borrower’s management lacks depth and succession.

  • Business is unable to withstand temporary setbacks without affecting repayment capability.

  • Borrower is not financeable by another Corporation but possibly by a finance company or specialized lender.

Risk Rating 7             Substandard

 

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

 

General Characteristics:

  • The primary source of borrower’s repayment no longer provides satisfactory support and repayment is dependent on secondary sources.

  • A substandard loan is inadequately protected by the current sound worth and paying capacity of the obligor or by the collateral pledged, if any.

  • Normal repayment from the borrower is impaired although no loss of principal is envisioned.

  • A partial loss of interest or principal will occur if the borrower’s deficiencies are not corrected.

  • Borrower’s cash flow is generally not sufficient to fund anticipated cash needs.

  • Borrower’s financeable assets may not be sufficient to protect the Corporation’s position.

  • Adverse trends in borrower’s operations that jeopardized debt repayment may require the borrower to undertake a significant reorganization of financing or the business.

  • Borrower shows poor liquidity and high leverage impairing the repayment of the debt in accordance with agreed upon terms.

  • Borrower’s management lacks depth and succession; may be inexperienced or of questionable character.

  • Borrower’s market position in the industry is deteriorating.

  • Borrower is not financeable by another Corporation or finance company.

Risk Rating 8        Doubtful

 

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

 

General Characteristics:

 

  • Inadequate primary source of repayment.  Assumes a less than satisfactory secondary source of repayment on a most-likely case basis.  There may be adequate secondary source of repayment on a best-case basis.

  • Borrower has the same weaknesses found in Substandard borrowers.

  • Loss probability is extremely high but because of certain important and reasonably specific factors that may work to strengthen the loan, its classification as an estimated loss is deferred until a more exact status may be determined.

  • Pending factors may include proposed merger or acquisition; liquidation procedures; capital injections; perfecting liens on additional collateral; and refinancing plans.

  • Borrower’s cash flow is insufficient to fund cash needs.

  • Borrower’s financeable assets are insufficient to protect the Corporation’s position.

  • Borrower’s source of debt repayment is dependent on liquidation of assets with a probable loss.

  • Borrower may no longer be a going concern, or may not exist as a going concern for the foreseeable future.

  • No alternative financing sources exist for borrower.

 

The following tables present risk grades and classified loans by class of commercial loan in the Corporation’s portfolios as of March 31, 2012 (dollars in thousands):

 

 

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March 31, 2012

Commercial Loan Portfolio: 
Credit risk
profile by
internally assigned grade

Commercial &
Industrial

Non-Farm,
Non-Residential
Real Estate Loans

Construction &
Development

Commercial Loans
Secured
by Real Estate

All Other
Commercial Loans

Commercial
Loan Totals

 

 

 

 

 

 

 

  Pass

 $

48,597 

 $

141,298 

 $

23,185 

 $

7,321 

 $

40,428 

 $

260,829 

  Special Mention

4,319 

798 

503 

415 

6,035 

  Substandard

1,359 

2,128 

874 

810 

1,478 

6,649 

  Doubtful

3,647 

1,203 

1,379 

6,229 

TOTALS

 $

57,922 

 $

145,427 

 $

24,562 

 $

8,546 

 $

43,285 

 $

279,742 

 

Retail Loan Portfolio: 
Credit risk profiles
based on
delinquency status classification

Consumer
Loans

Single-Family
Residential**

All Other
Retail Loans

Retail
Loan Totals

  Performing

 $

12,113 

 $

188,945 

 $

20,424 

 $

221,482 

  Non-performing*

70 

3,972 

379 

4,421 

TOTALS

 $

12,183 

 $

192,917 

 $

20,803 

 $

225,903 

*Loans are classified as non-performing loans and are automatically placed on non-accrual status once they reach 90 days past due.  For the purposes of this calculation, all loans rated at or below Substandard (RR7) are classified as non-performing

**Single-family residential loans include first mortgages, closed-end second mortgages, residential construction loans, and home equity lines of credit (HELOC's).

 

December 31, 2011

 

 

 

 

 

 

Commercial Loan Portfolio:  Credit risk profile by internally assigned grade

Commercial &
Industrial

Non-Farm,
Non-Residential Real Estate Loans

Construction &
Development

Commercial Loans
Secured by
Real Estate

All Other
Commercial Loans

Commercial
Loan Totals

 

 

 

 

 

 

 

  Pass

 $

50,163 

 $

132,291 

 $

27,613 

 $

5,045 

 $

42,771 

 $

257,883 

  Special Mention

4,137 

4,232 

504 

439 

9,312 

  Substandard

1,692 

2,033 

925 

677 

1,480 

6,807 

  Doubtful

4,456 

1,591 

1,379 

7,426 

TOTALS

 $

60,448 

 $

140,147 

 $

29,042 

 $

6,161 

 $

45,630 

 $

281,428 

Retail Loan Portfolio:  Credit risk profiles based on delinquency status classification

Consumer
Loans

Single-Family
 Residential**

All Other
Retail Loans

Retail Loan Totals

 

 

  Performing

 $

14,225 

 $

193,784 

 $

25,368 

 $

233,377 

 

 

  Non-performing*

72 

3,129 

332 

3,533 

 

 

TOTALS

 $

14,297 

 $

196,913 

 $

25,700 

 $

236,910 

 

 

*Loans are classified as non-performing loans and are automatically placed on non-accrual status once they reach 90 days past due.  For the purposes of this calculation, all loans rated at or below Substandard (RR7) are classified as non-performing.

**Single-family residential loans include first mortgages, closed-end second mortgages, residential construction loans, and home equity lines of credit (HELOC's).

 

 

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Allowance for Loan Losses. The allowance for loan losses is a reserve established through a provision for loan losses charged to expense, which represents management’s best estimate of probable losses that have been incurred within the existing portfolio of loans. The allowance, in the judgment of management, is necessary to reserve for estimated loan losses and risks inherent in the loan portfolio. The Corporation’s allowance for loan  loss methodology includes allowance allocations calculated in accordance with ASC Topic 310, “Receivables” (“ASC Topic 310”) and allowance allocations calculated in accordance with ASC Topic 450, “Contingencies” (“ASC Topic 450”) Accordingly, the methodology is based on historical loss experience by type of credit and internal risk grade, specific homogeneous risk pools and specific loss allocations, with adjustments for current events and conditions. The Corporation’s process for determining the appropriate level of the allowance for loan losses is designed to account for credit deterioration as it occurs. The provision for loan  losses reflects loan quality trends, including the levels of and trends related to non-accrual loans, past due loans, potential problem loans, criticized loans and net charge-offs or recoveries, among other factors. The provision for loan  losses also reflects the totality of actions taken on all loans for a particular period.  In other words, the amount of the provision reflects not only the necessary increases in the allowance for loan  losses related to newly identified criticized loans, but it also reflects actions taken related to other loans including, among other things, any necessary increases or decreases in required allowances for specific loans or loan pools. 

 

The level of the allowance reflects management’s continuing evaluation of industry concentrations, specific credit risks, loan loss experience, current loan portfolio quality, present economic, political and regulatory conditions and unidentified losses inherent in the current loan portfolio. Portions of the allowance may be allocated for specific credits; however, the entire allowance is available for any credit that, in management’s judgment, should be charged off. While management utilizes its best judgment and information available, the ultimate adequacy of the allowance is dependent upon a variety of factors beyond the Corporation’s control, including, among other things, the performance of the Corporation’s loan portfolio, the economy, and changes in interest.

 

The Corporation’s allowance for loan  losses consists of three elements: (i) specific valuation allowances determined in accordance with ASC Topic 310 based on probable losses on specific loans; (ii) historical valuation allowances determined in accordance with ASC Topic 450 based on historical loan loss experience for loans with similar characteristics and trends, adjusted, as necessary, to reflect the impact of current conditions; and (iii) general valuation allowances determined in accordance with ASC Topic 450 based on general economic conditions and other qualitative risk factors both internal and external to the Corporation. 

 

The allowances established for probable losses on specific loans are based on a regular analysis and evaluation of problem loans. Loans are classified based on an internal credit risk grading process that evaluates, among other things: (i) the obligor’s ability to repay; (ii) the underlying collateral, if any; and (iii) the economic environment and industry in which the borrower operates. This analysis is performed at the relationship manager level for all commercial loans. When

a loan has a calculated grade of 8 or higher, a special assets officer analyzes the loan to determine whether the loan is impaired and, if impaired, the need to specifically allocate a portion of the allowance for loan  losses to the loan. Specific valuation allowances are determined by analyzing the borrower’s ability to repay amounts owed, collateral deficiencies, the relative risk grade of the loan and economic conditions affecting the borrower’s industry, among other things.

 

Historical valuation allowances are calculated based on the historical loss experience of specific types of loans and the internal risk grade of such loans at the time they were charged-off. The Corporation calculates historical loss ratios for pools of similar loans with similar characteristics based on the proportion of actual charge-offs experienced to the total population of loans in the pool. The historical loss ratios are updated quarterly based on actual charge-off experience.  A historical valuation allowance is established for each pool of similar loans based upon the product of the historical loss ratio and average balance of the loans in the pool. The Corporation’s pools of similar loans include similarly risk-graded groups of commercial and industrial loans, commercial real estate loans, consumer real estate loans and consumer and other loans.