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Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

 

 

Form 10-Q

 

 

 

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

 

¨ 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 0-22961

 

 

ANNAPOLIS BANCORP, INC.

(Exact name of registrant as specified in its charter)

 

 

 

Maryland   52-1595772

(State or other Jurisdiction of

Incorporation or Organization)

 

(I.R.S. Employer

Identification No.)

1000 Bestgate Road, Annapolis, Maryland 21401

(Address of principal executive offices)

(410) 224-4455

(Registrants telephone number, including area code)

 

 

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

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for a 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

At April 30, 2012, the Registrant had 3,975,075 shares of common stock outstanding.

 

 

 


Table of Contents

TABLE OF CONTENTS

 

PART I - FINANCIAL INFORMATION

     PAGE   

Item 1 – Financial Statements

  

Consolidated Balance Sheets as of March 31, 2012 (unaudited) and December 31, 2011

     1   

Consolidated Statements of Operations for the Three Month Periods Ended
March  31, 2012 and 2011 (unaudited)

     2   

Consolidated Statements of Comprehensive Income for the Three Month Periods Ended
March  31, 2012 and 2011 (unaudited)

     3   

Consolidated Statements of Cash Flows for the Three Month Periods Ended
March  31, 2012 and 2011 (unaudited)

     4-5   

Notes to Consolidated Financial Statements (unaudited)

     6-29   

Item  2 – Management’s Discussion and Analysis of Financial Condition and Results of Operations

     29-38   

Item 3 – Quantitative and Qualitative Disclosures About Market Risk

     38   

Item 4 – Controls and Procedures

     39   

PART II - OTHER INFORMATION

        

Item 1 – Legal Proceedings

     39   

Item 1A – Risk Factors

     39   

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

     39   

Item 3 – Defaults Upon Senior Securities

     39   

Item 4 – Mine Safety Disclosures

     39   

Item 5 – Other Information

     39   

Item 6 – Exhibits

     40   

SIGNATURES

     41   

CERTIFICATIONS

     42-47   

This Quarterly Report on Form 10-Q contains statements which constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These statements appear in a number of places in this Report and include all statements regarding the intent, belief or current expectations of Annapolis Bancorp, Inc. (the “Company”), its directors or its officers with respect to, among other things: (i) the Company’s financing plans; (ii) trends affecting the Company’s financial condition, results of operations; plans and objectives (iii) the Company’s growth strategy; (iv) the Company’s future performance and business, including, but not limited to statements with respect to the adequacy of the allowance for credit losses, delinquency trends, market risk and the impact of interest rate changes, capital markets conditions, capital adequacy and liquidity, and the effect of legal proceedings and new accounting standards on the Company’s financial condition and results of operations; and (v) the declaration and payment of dividends. All statements contained herein that are not clearly historical in nature are forward-looking, and the words “anticipate,” “believe,” “continues,” “expect,” “estimate,” “intend,” “project” and similar expressions and future or conditional verbs such as “will,” “would,” “should,” “could,” “might,” “can,” “may,” or similar expressions are generally intended to identify forward-looking statements. Investors are cautioned that any such forward-looking statements are not guarantees of future performance and involve certain risks and uncertainties which could cause actual results to differ materially from those expressed in forward-looking statements. Factors that might cause such a difference may, include, but are not limited to: (i) the rate of declining growth in the economy and employment levels, as well as general business and economic conditions; (ii) changes in interest rates, as well as the magnitude of such changes; (iii) the fiscal and monetary policies of the federal government and its agencies; (iv) changes in federal bank regulatory and supervisory policies, including required levels of capital; (v) the relative strength or weakness of the consumer and commercial credit sectors and of the real estate market; (vi) the performance of the stock and bond markets; (vii) competition in the financial services industry, (viii) possible legislative, tax or regulatory changes, and such other risks and uncertainties as set forth in the Company’s filings with the Securities and Exchange Commission. All forward-looking statements included in this quarterly report on Form 10-Q are based upon information available to the Company as of the date of this report, and other than to the extent required by applicable law, including the requirements of applicable securities laws, the Company undertakes no obligation to publicly release the results of any revisions that may be made to any forward-looking statements to reflect events or circumstances after the date of such statements or to reflect the occurrence of anticipated or unanticipated events.


Table of Contents

PART I - FINANCIAL INFORMATION

Item 1 - Financial Statements

Annapolis Bancorp, Inc. and Subsidiaries

Consolidated Balance Sheets

as of March 31, 2012 and December 31, 2011

(in thousands)

 

     (Unaudited)
March 31, 2012
     (Audited)
December 31, 2011
 

Assets

     

Cash and due from banks

   $ 1,954       $ 2,026   

Interest bearing balances with banks

     37,306         18,288   

Federal funds sold and other overnight investments

     3         26,583   

Investment securities available for sale, at fair value

     82,783         87,549   

Federal Reserve and Federal Home Loan Bank stock

     2,992         2,992   

Loans, less allowance for credit losses of $6,765 and $7,182

     294,098         283,284   

Premises and equipment, net

     8,593         8,418   

Accrued interest receivable

     1,294         1,279   

Deferred income taxes

     2,550         2,617   

Investment in bank owned life insurance

     5,679         5,624   

Prepaid FDIC Insurance

     1,116         1,198   

Real estate owned

     1,510         1,222   

Other assets

     678         490   
  

 

 

    

 

 

 

Total Assets

   $ 440,556       $ 441,570   
  

 

 

    

 

 

 

Liabilities and Stockholders’ Equity

     

Deposits

     

Noninterest bearing

   $ 54,959       $ 56,664   

Interest bearing

     291,693         293,717   

Securities sold under agreements to repurchase

     12,912         11,344   

Long-term borrowings

     35,000         35,000   

Guaranteed preferred beneficial interests in junior subordinated debentures

     5,000         5,000   

Accrued interest and dividends payable

     214         219   

Other liabilities

     2,764         2,258   
  

 

 

    

 

 

 

Total liabilities

     402,542         404,202   
  

 

 

    

 

 

 

Stockholders’ Equity

     

Preferred stock, par value $0.01 per share; authorized 5,000,000 shares; Series A, $1,000 per share liquidation preference, shares issued and outstanding 8,152 shares at March 31, 2012 and at December 31, 2011, net of discount of zero and $6

     8,152         8,146   

Common stock, par value $0.01 per share; authorized 10,000,000 shares; issued and outstanding 3,974,991 shares at March 31, 2012 and 3,958,293 shares at December 31, 2011

     40         39   

Warrants

     234         234   

Paid in capital

     11,796         11,779   

Retained earnings

     16,895         16,179   

Accumulated other comprehensive income

     897         991   
  

 

 

    

 

 

 

Total stockholders’ equity

     38,014         37,368   
  

 

 

    

 

 

 

Total liabilities and stockholders’ equity

   $ 440,556       $ 441,570   
  

 

 

    

 

 

 

The accompanying notes are an integral part of these financial statements.

 

1


Table of Contents

Annapolis Bancorp, Inc. and Subsidiaries

Consolidated Statements of Operations

for the Three Month Periods Ended March 31, 2012 and 2011

(unaudited)

(in thousands, except Shares and Per Share data)

 

     For the Three Months
Ended March 31,
 
     2012      2011  

Interest and dividend income

     

Loans, including fees

   $ 4,232       $ 4,191   

Interest bearing balances with banks

     7         4   

Federal funds sold and other overnight investments

     12         7   

Mortgage-backed securities

     304         348   

U. S. Treasury securities and obligations of other U. S. Government agencies

     215         329   

State and municipal securities

     11         11   

Equity securities

     27         20   
  

 

 

    

 

 

 

Total interest and dividend income

     4,808         4,910   
  

 

 

    

 

 

 

Interest expense

     

Certificates of deposit, $100,000 or more

     142         135   

Other deposits

     293         459   

Securities sold under agreements to repurchase

     11         17   

Interest on long-term borrowings

     328         321   
  

 

 

    

 

 

 

Total interest expense

     774         932   
  

 

 

    

 

 

 

Net interest income

     4,034         3,978   

Provision for credit losses

     167         557   
  

 

 

    

 

 

 

Net interest income after provision for credit losses

     3,867         3,421   
  

 

 

    

 

 

 

Noninterest income

     

Service charges and fees on deposits

     284         300   

Mortgage banking fees

     46         2   

Other fee income

     87         29   

Gain on sale of loans

     0         68   

Gain on sale of real estate owned and repossessed assets

     20         0   

Loss on disposal of fixed assets

     0         (31
  

 

 

    

 

 

 

Total noninterest income

     437         368   
  

 

 

    

 

 

 

Noninterest expense

     

Personnel

     1,689         1,761   

Occupancy and equipment

     378         421   

Data processing

     212         208   

Legal and professional fees

     131         79   

Marketing and advertising

     118         109   

FDIC Insurance

     82         146   

Other operating expenses

     384         319   
  

 

 

    

 

 

 

Total noninterest expense

     2,994         3,043   
  

 

 

    

 

 

 

Income before income taxes

     1,310         746   

Income tax expense

     486         237   
  

 

 

    

 

 

 

Net income

     824         509   

Preferred stock dividend and discount accretion

     108         122   
  

 

 

    

 

 

 

Net income available to common shareholders

   $ 716       $ 387   
  

 

 

    

 

 

 

Basic earnings per common share

   $ 0.18       $ 0.10   
  

 

 

    

 

 

 

Basic weighted average shares

     3,968,820         3,938,070   
  

 

 

    

 

 

 

Diluted earnings per common share

   $ 0.18       $ 0.10   
  

 

 

    

 

 

 

Diluted weighted average shares

     4,009,056         3,950,427   
  

 

 

    

 

 

 

The accompanying notes are an integral part of these financial statements.

 

2


Table of Contents

Annapolis Bancorp, Inc. and Subsidiaries

Consolidated Statements of Comprehensive Income

for the Three Month Periods Ended March 31, 2012 and 2011

(unaudited)

(dollars in thousands)

 

     For the Three Months Ended
March 31,
 
     2012     2011  

Net income available to common shareholders

   $ 716      $ 387   

Unrealized net holding losses, on Available-for-sale portfolios, net of tax benefit of ($62) and ($149), respectively

     (94     (228
  

 

 

   

 

 

 

Comprehensive income

   $ 622      $ 159   
  

 

 

   

 

 

 

The accompanying notes are an integral part of these financial statements.

 

3


Table of Contents

Annapolis Bancorp, Inc. and Subsidiaries

Consolidated Statements of Cash Flows

for the Three Month Periods Ended March 31, 2012 and 2011

(unaudited)

(in thousands)

 

     For the Three Months  Ended
March 31,
 
     2012     2011  

Cash flows from operating activities

    

Net income

   $ 824      $ 509   

Adjustments to reconcile net income to net cash provided by operating activities

    

Depreciation and amortization

     124        145   

Amortization of premiums and accretions of discounts, net

     66        85   

Provision for credit losses

     167        557   

Origination of loans held for sale

     0        (5,215

Proceeds from sale of loans held for sale

     0        6,198   

Stock based compensation

     16        38   

Deferred income taxes

     129        (51

Earnings on life insurance policies

     (55     (41

Gain on sale of loans held for sale

     0        (68

Gain on sale of real estate owned and repossessed assets

     (20     0   

Loss on disposal of fixed assets

     0        31   

Decrease (increase) in:

    

Accrued interest receivable

     (15     117   

Prepaid FDIC insurance

     82        132   

Other assets

     (113     255   

Increase (decrease) in:

    

Accrued interest payable

     (5     (3

Accrued income taxes, net of taxes refundable

     483        103   

Deferred loan origination fees

     52        (43

Other liabilities

     23        217   
  

 

 

   

 

 

 

Net cash provided by operating activities

     1,758        2,966   
  

 

 

   

 

 

 

Cash flows from investing activities

    

Proceeds from sales and maturities of securities available for sale

     17,104        9,781   

Purchase of securities available for sale

     (12,560     (3,008

Net decrease (increase) in federal funds sold

     26,580        (5,421

Net (increase) decrease in interest bearing certificates of deposit

     (19,018     3,244   

Net increase in loans receivable, net

     (11,411     (6,546

Purchase of premises and equipment, net of disposals

     (310     (108

Proceeds from sales of repossessed assets

     46        0   
  

 

 

   

 

 

 

Net cash provided by (used in) investing activities

     431        (2,058
  

 

 

   

 

 

 

 

4


Table of Contents

Annapolis Bancorp, Inc. and Subsidiaries

Consolidated Statements of Cash Flows (continued)

for the Three Month Periods Ended March 31, 2012 and 2011

(unaudited)

(in thousands)

(continued)

 

     For the Three Months  Ended
March 31,
 
     2012     2011  

Cash flows from financing activities

    

Net increase (decrease) in:

    

Time deposits

     (5,348     170   

Other deposits

     1,619        (4,911

Securities sold under agreements to repurchase

     1,568        (1,841

Proceeds from stock options exercised

     0        14   

Proceeds from issuance of common stock

     2        2   

Payment of preferred stock dividend

     (102     (102
  

 

 

   

 

 

 

Net cash used in financing activities

     (2,261     (6,668
  

 

 

   

 

 

 

Net decrease in cash

     (72     (5,760

Cash and cash equivalents, beginning of period

     2,026        7,854   
  

 

 

   

 

 

 

Cash and cash equivalents, end of period

   $ 1,954      $ 2,094   
  

 

 

   

 

 

 

Supplemental cash flow information

    

Interest paid, including interest credited to accounts

   $ 1,016      $ 1,037   

Income taxes paid

   $ 310      $ 225   

Non-cash investing activities

    

Transfers from loans to real estate owned

   $ 288      $ 0   

Transfers from loans to other assets

   $ 90      $ 0   

The accompanying notes are an integral part of these financial statements.

 

5


Table of Contents

Annapolis Bancorp, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

for the Three Month Periods Ended March 31, 2012 and 2011

(unaudited)

Note A – Basis of Presentation

 

The accompanying unaudited consolidated financial statements of Annapolis Bancorp, Inc. (the “Company”) 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. Accordingly, they do not include all the information and footnotes required for complete financial statements. In the opinion of management, all adjustments and reclassifications that are normal and recurring in nature and are considered necessary for fair presentation have been included. Operating results for the three month period ended March 31, 2012 are not necessarily indicative of the results that may be expected for the year ended December 31, 2012 or any other period. These unaudited consolidated financial statements should be read in conjunction with the Company’s Form 10-K for the year ended December 31, 2011, which includes the consolidated financial statements and footnotes. Certain reclassifications have been made to amounts previously reported to conform to the classifications made in 2012.

Note B – Business

 

The Company was incorporated on May 26, 1988, under the laws of the State of Maryland, to serve as a bank holding company for BankAnnapolis (the “Bank”). Annapolis Bancorp, Inc. as a bank holding company and the Bank are subject to governmental supervision, regulation, and control.

The Bank currently conducts a general commercial and retail banking business in its market area, emphasizing the banking needs of small businesses, professional concerns and individuals from its headquarters in Annapolis, its five other branches located in Anne Arundel County, Maryland and one branch located on Kent Island in Queen Anne’s County, Maryland. The Bank closed its Market House branch on May 27, 2011 and moved the corresponding deposits to its Bestgate location. On April 19, 2012, the Bank announced plans to open a new branch in Waugh Chapel Towne Centre in late 2012.

The Bank has built its reputation on exemplary customer service and outreach to the communities surrounding each of the Bank’s locations. The Bank is committed to offering products and services that focus on relationship banking and provide an alternative to the large multi-regional financial institutions that are so pervasive in the markets the Bank serves. The Bank attracts most of its customer deposits from Anne Arundel County, Maryland, and to a lesser extent, Queen Anne’s County, Maryland. The Bank’s lending operations are centered in Anne Arundel County, but extend throughout Central and Southern Maryland.

 

6


Table of Contents

Note C – Stock Based Compensation

 

Stock based-compensation expense for the three month periods ended March 31, 2012 and 2011 was $16,000 and $38,000, respectively. Stock-based compensation expense recognized in the consolidated statements of income for the first quarter of 2012 and 2011 reflects estimated forfeitures.

During the first quarter of 2012 and 2011, there were no options granted to employees or directors of the Company or Bank.

Stock option activity for the three months ended March 31, 2012 and 2011 was as follows:

 

     Shares     Weighted Average
Exercise Price
     Weighted Average
Remaining
Contractual Term
     Aggregate
Intrinsic Value
(in thousands)
 

Outstanding at December 31, 2011

     92,302      $ 7.22         

Grants

     0        0.00         

Exercised

     0        0.00         

Forfeitures

     0        0.00         

Expired

     0        0.00         
  

 

 

         

Outstanding as of March 31, 2012

     92,302      $ 7.22         
  

 

 

         

Exercisable at March 31, 2012

     91,460      $ 7.21         2.4       $ 38   
  

 

 

         

Outstanding at December 31, 2010

     124,270      $ 6.06         

Grants

     0        0.00         

Exercised

     (5,333     2.64         

Forfeitures

     0        0.00         

Expired

     (22,374     2.64         
  

 

 

         

Outstanding as of March 31, 2011

     96,563      $ 7.05         
  

 

 

         

Exercisable at March 31, 2011

     94,204      $ 6.99         2.8       $ 13   
  

 

 

         

The aggregate intrinsic value in the table above represents the total pre-tax value of the exercisable in-the-money options (that is, the difference between the closing stock price on the last trading day in the first three months of 2012 and 2011, and the exercise price of the options multiplied by the number of shares) on March 31, 2012 and March 31, 2011. This amount changes based on the fair market value of the Company’s stock. The total intrinsic value of options exercisable at March 31, 2012 and March 31, 2011 was $37,530 and $13,349, respectively. No options vested during the three month periods ending March 31, 2012 and 2011. As of March 31, 2012, $772 of total unrecognized costs related to options is expected to be recognized over a weighted average period of 0.25 years. As of March 31, 2011, $4,798 of total unrecognized costs related to options was expected to be recognized over a weighted average period of 0.8 years.

There were no restricted shares granted to employees during the first quarter of 2012.

During the first quarter of 2011, an employee of the Bank was awarded 5,000 restricted shares at a market value of $4.45 per share. One-half of the restricted shares vest on each of the employee’s first two anniversaries of employment with the Bank, with the shares being fully vested on February 28, 2013.

 

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During the first quarter of 2012, non-employee directors of the Bank were awarded a total of 16,268 shares of restricted stock at a market value of $4.30 per share in lieu of an annual retainer. These shares vest on January 25, 2013. During the first quarter of 2011, non-employee directors of the Bank were awarded a total of 12,782 shares of restricted stock at a market value of $4.30 per share in lieu of an annual retainer. These shares vested on January 27, 2012. A net reversal of $2,106 in compensation related expense was recognized for the three month-period ended March 31, 2012 and $22,671 in expense was recognized for the three-month period ended March 31, 2011 relating to shares issued to employees including the effect of forfeitures. Non-compensation expense of $17,500 and $13,750 of expense was recognized for the three month periods ended March 31, 2012 and 2011, respectively, relating to the shares issued to non-employee directors. The reversal of expense for the three-month period ended March 31, 2012 reflects the impact of forfeitures of deferred share units previously granted and expensed.

As of March 31, 2012, 10,000 restricted share units of the 44,768 restricted shares and restricted share units outstanding have vested; the remaining 34,768 shares will vest over a weighted average period of 0.94 years.

Restricted stock activity for the three months ended March 31, 2012 and 2011 was as follows:

 

     Shares     Weighted Average
Grant Price
 

Outstanding at December 31, 2011

     57,282      $ 3.86   

Grants

     16,268        4.30   

Issued

     (16,282     4.29   

Forfeitures

     (12,500     4.08   
  

 

 

   

Outstanding as of March 31, 2012

     44,768      $ 3.85   
  

 

 

   

Outstanding at December 31, 2010

     68,384      $ 3.66   

Grants

     17,782        4.34   

Issued

     (18,884     3.77   

Forfeitures

     0        0.00   
  

 

 

   

Outstanding as of March 31, 2011

     67,282      $ 3.84   
  

 

 

   

As of March 31, 2012, $122,000 of total unrecognized costs related to unvested restricted shares and restricted share units is expected to be recognized over a weighted average period of 0.94 years. As of March 31, 2011, $170,000 of total unrecognized costs related to unvested restricted shares and restricted share units was expected to be recognized over a weighted average period of 2.3 years.

 

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Note D – Earnings Per Share

 

Information regarding earnings per share is summarized as follows:

Computation of Earnings Per Share

(in thousands, except Earnings Per Share)

 

     For the Three  Months
Ended

March 31,
 
     2012      2011  

Net income available to common shareholders

   $ 716       $ 387   

Weighted average common shares outstanding

     3,969         3,938   

Basic earnings per common share

   $ 0.18       $ 0.10   

Net income available to common shareholders

   $ 716       $ 387   

Weighted average common shares outstanding

     3,969         3,938   

Effect of potential dilutive common shares

     40         12   

Total weighted average diluted common shares outstanding

     4,009         3,950   

Diluted earnings per common share

   $ 0.18       $ 0.10   

Basic earnings per common share are calculated using the weighted-average number of shares of common stock outstanding during the period. Diluted earnings per common share are calculated using the weighted-average number of shares of common stock plus dilutive potential shares of common stock outstanding during the period. Potential common shares consist of stock options and restricted stock, restricted share units and warrants. For both the three months ended March 31, 2012 and 2011, 58,969 shares of common stock, respectively, attributable to outstanding stock options, restricted stock and restricted share units were excluded from the calculations of diluted earnings per share because their effect was anti-dilutive.

 

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Table of Contents

Note E – Investment Securities

 

Investment securities are summarized as follows:

 

(dollars in thousands)    Amortized
Cost
     Unrealized
Gains
     Unrealized
Losses
     Estimated Fair
Value
 

March 31, 2012

           

Available for sale

           

U.S. Government agency

   $ 40,657       $ 260       $ 57       $ 40,860   

State and municipal

     1,077         64         0         1,141   

Residential mortgage-backed securities

     38,941         1,293         116         40,118   

Other equity securities

     627         37         0         664   
  

 

 

    

 

 

    

 

 

    

 

 

 
   $ 81,302       $ 1,654       $ 173       $ 82,783   
  

 

 

    

 

 

    

 

 

    

 

 

 
     Amortized
Cost
     Unrealized
Gains
     Unrealized
Losses
     Estimated Fair
Value
 

December 31, 2011

           

Available for sale

           

U.S. Government agency

   $ 47,782       $ 306       $ 56       $ 48,032   

State and municipal

     1,077         59         0         1,136   

Residential mortgage-backed securities

     36,435         1,372         82         37,725   

Other equity securities

     618         38         0         656   
  

 

 

    

 

 

    

 

 

    

 

 

 
   $ 85,912       $ 1,775       $ 138       $ 87,549   
  

 

 

    

 

 

    

 

 

    

 

 

 

The amortized cost and estimated fair value of securities by contractual maturities at March 31, 2012 are shown below. Actual maturities of these securities may differ from contractual maturities because borrowers may have the right to prepay obligations with or without call or prepayment penalties.

 

     March 31, 2012  
     Available for Sale  
     Amortized
Cost
     Estimated
Fair Value
 
(dollars in thousands)              

Due within one year

   $ 115       $ 116   

Due after one through five years

     23,468         23,562   

Due after five through ten years

     14,274         14,428   

Due after ten years

     42,818         44,013   

Equity securities

     627         664   
  

 

 

    

 

 

 
   $ 81,302       $ 82,783   
  

 

 

    

 

 

 

The following table shows the level of the Company’s gross unrealized losses and the fair value of the associated securities by type and maturity for securities available for sale at March 31, 2012 and December 31, 2011.

 

     Less than 12 months      12 months or more      Total  
March 31, 2012    Estimated
Fair Value
     Unrealized
Losses
     Estimated
Fair Value
     Unrealized
Losses
     Estimated
Fair Value
     Unrealized
Losses
 
(dollars in thousands)                                          

U. S. Government agency

   $ 10,943       $ 57       $ 0       $ 0       $ 10,943       $ 57   

Residential mortgage-backed securities

     5,397         59         1,796         57         7,193         116   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
   $ 16,340       $ 116       $ 1,796       $ 57       $ 18,136       $ 173   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

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Table of Contents
     Less than 12 months      12 months or more      Total  
December 31, 2011    Estimated
Fair Value
     Unrealized
Losses
     Estimated
Fair Value
     Unrealized
Losses
     Estimated
Fair Value
     Unrealized
Losses
 
(dollars in thousands)                                          

U. S. Government Agency

   $ 16,044       $ 56       $ 0       $ 0       $ 16,044       $ 56   

Residential mortgage-backed securities

     0         0         1,854         82         1,854         82   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
   $ 16,044       $ 56       $ 1,854       $ 82       $ 17,898       $ 138   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

The unrealized losses that exist are the result of market changes in interest rates since the original purchase. Because the Company does not intend to sell the investments and it is not more likely than not that the Company will be required to sell the investments before recovery of their amortized cost basis, the Company does not consider those investments to be other-than-temporarily impaired at March 31, 2012. The Company has used a variety of tools to analyze the contents of its security portfolio and at this time does not believe that the unrealized losses in the portfolio shown in the table above are other than temporary. At March 31, 2012 mortgaged-backed securities with a fair market value of $1.8 million carried bond ratings below investment grade. These securities were evaluated by an independent third-party consulting firm using an expected cash flow model that includes assumptions related to prepayment rates, default trends, and loss severity, and were deemed by management not to be other-than-temporarily impaired at March 31, 2012. At March 31, 2012, both securities were current on both principal and interest payments.

Note F – Loans, Allowance For Credit Losses And Credit Quality

 

Major classifications of loans are as follows:

 

     March 31,
2012
    December 31,
2011
 

Commercial

   $ 49,123      $ 47,683   

Real estate

    

Commercial

     120,630        114,883   

Construction

     40,006        35,026   

One to four-family

     47,238        48,314   

Home equity

     35,702        36,005   

Consumer

     8,531        8,870   
  

 

 

   

 

 

 
     301,230        290,781   
  

 

 

   

 

 

 

Deferred loan fees, net

     (367     (315

Allowance for credit losses

     (6,765     (7,182
  

 

 

   

 

 

 
     (7,132     (7,497
  

 

 

   

 

 

 

Loans, net

   $ 294,098      $ 283,284   
  

 

 

   

 

 

 

The maturity and rate repricing distribution of the loan portfolio is as follows:

 

Repricing or maturing within one year

   $ 105,092       $ 100,804   

Maturing over one to five years

     129,604         132,637   

Maturing over five years

     66,534         57,340   
  

 

 

    

 

 

 
   $ 301,230       $ 290,781   
  

 

 

    

 

 

 

The Company’s goal is to mitigate risks inherent in the loan portfolio. Commercial loans and loans secured by real estate make up the majority of the loan portfolio, accounting for 97% of the portfolio as of March 31, 2012 and as of December 31, 2011. To mitigate risk, commercial loans are generally secured by receivables, inventories, equipment and other assets of the business. Personal guarantees of the borrowers are generally required.

 

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Loans secured by commercial real estate properties generally involve larger principal amounts and a greater degree of risk than one- to four-family residential mortgage loans. Because payments on loans secured by commercial real estate properties are often dependent on the successful operation or management of the properties, repayment of such loans may be subject to adverse conditions in the real estate market or the economy. The Bank seeks to minimize these risks through its underwriting standards, which require such loans to be qualified on the basis of the property’s value, debt service coverage ratio, and, under certain circumstances, additional collateral. The Bank generally also requires personal guarantees on its commercial real estate loans.

Construction loans are generally considered to involve a higher degree of credit risk than long-term financing of improved, owner-occupied real estate. Risk of loss on a construction loan is dependent largely upon the accuracy of the initial estimate of the security property’s value upon completion of construction as compared to the estimated costs of construction, including interest. Also, the Bank assumes certain risks associated with the borrowers’ ability to complete construction in a timely and workmanlike manner. If the estimate of value proves to be inaccurate, or if construction is not performed timely or accurately, the Bank may be faced with a project which, when completed, has a value that is insufficient to assure full repayment.

The Bank currently originates one- to four-family residential mortgage loans in amounts typically up to 80% (or higher with private mortgage insurance) of the lower of the appraised value or the selling price of the property securing the loan. The origination of adjustable-rate residential mortgage loans, as opposed to fixed-rate residential mortgage loans, helps to reduce the Bank’s exposure to increases in interest rates. However, adjustable-rate loans generally pose credit risks not inherent in fixed-rate loans, primarily because as interest rates rise, the underlying payments of the borrower rise, thereby increasing the potential for default. Periodic and lifetime caps on interest rate increases help to reduce the risks associated with the Bank’s adjustable-rate loans, but also limit the interest rate sensitivity of its adjustable-rate mortgage loans.

Specific loan reserves are established based upon credit and/or collateral risks on an individual loan basis. A risk rating system is employed to proactively estimate loss exposure and provide a measuring system for setting general and specific reserve allocations.

 

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Table of Contents

The following table shows the allowance for credit losses and recorded investment in loans receivable for the three month periods ended March 31, 2012 and 2011:

Allowance for Credit Losses and Recorded Investment in Loans Receivable

for the Three Months Ended March 31, 2012

 

(Dollars in thousands)    Commercial     Commercial
Real Estate
    Residential      Consumer      Unallocated      Total  

Allowance for credit losses

               

Beginning balance, December 31, 2011

   $ 1,387      $ 3,972      $ 1,422       $ 401       $ 0       $ 7,182   

Charge-offs

     32        0        340         231         0         603   

Recoveries

     10        0        1         8         0         19   

Provision

     (317     (140     519         105         0         167   
  

 

 

   

 

 

   

 

 

    

 

 

    

 

 

    

 

 

 

Ending balance, March 31, 2012

   $ 1,048      $ 3,832      $ 1,602       $ 283       $ 0       $ 6,765   
  

 

 

   

 

 

   

 

 

    

 

 

    

 

 

    

 

 

 

Allowance for credit losses:

               

Period ending amount: Individually evaluated for impairment

   $ 293      $ 1,321      $ 951       $ 69       $ 0       $ 2,634   
  

 

 

   

 

 

   

 

 

    

 

 

    

 

 

    

 

 

 

Period ending amount: Collectively evaluated for impairment

   $ 755      $ 2,511      $ 651       $ 214       $ 0       $ 4,131   
  

 

 

   

 

 

   

 

 

    

 

 

    

 

 

    

 

 

 

Loans:

               

Period ending amount: Loans acquired with deteriorating credit quality

   $ 0      $ 0      $ 0       $ 0       $ 0       $ 0   
  

 

 

   

 

 

   

 

 

    

 

 

    

 

 

    

 

 

 

Loans individually evaluated for impairment

   $ 1,077      $ 6,514      $ 2,337       $ 139       $ 0       $ 10,067   
  

 

 

   

 

 

   

 

 

    

 

 

    

 

 

    

 

 

 

Loans collectively evaluated for impairment

   $ 48,046      $ 154,122      $ 80,603       $ 8,392       $ 0       $ 291,163   
  

 

 

   

 

 

   

 

 

    

 

 

    

 

 

    

 

 

 

for the Three Months Ended March 31, 2011

 

(Dollars in thousands)    Commercial      Commercial
Real Estate
    Residential      Consumer      Unallocated      Total  

Allowance for credit losses

                

Beginning balance, December 31, 2010

   $ 1,868       $ 3,205      $ 1,257       $ 523       $ 0       $ 6,853   

Charge-offs

     471         0        0         55         0         526   

Recoveries

     5         0        0         3         0         8   

Provision

     484         (151     177         47         0         557   
  

 

 

    

 

 

   

 

 

    

 

 

    

 

 

    

 

 

 

Ending balance, March 31, 2011

   $ 1,886       $ 3,054      $ 1,434       $ 518       $ 0       $ 6,892   
  

 

 

    

 

 

   

 

 

    

 

 

    

 

 

    

 

 

 

Allowance for credit losses:

                

Period ending amount: Individually evaluated for impairment

   $ 346       $ 351      $ 523       $ 185       $ 0       $ 1,405   
  

 

 

    

 

 

   

 

 

    

 

 

    

 

 

    

 

 

 

Period ending amount: Collectively evaluated for impairment

   $ 1,540       $ 2,703      $ 911       $ 333       $ 0       $ 5,487   
  

 

 

    

 

 

   

 

 

    

 

 

    

 

 

    

 

 

 

Loans:

                

Period ending amount: Loans acquired with deteriorating credit quality

   $ 0       $ 0      $ 0       $ 0       $ 0       $ 0   
  

 

 

    

 

 

   

 

 

    

 

 

    

 

 

    

 

 

 

Loans individually evaluated for impairment

   $ 1,625       $ 1,644      $ 3,016       $ 436       $ 0       $ 6,721   
  

 

 

    

 

 

   

 

 

    

 

 

    

 

 

    

 

 

 

Loans collectively evaluated for impairment

   $ 50,589       $ 130,398      $ 87,333       $ 9,772       $ 0       $ 278,092   
  

 

 

    

 

 

   

 

 

    

 

 

    

 

 

    

 

 

 

 

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Table of Contents

Nonaccrual loans totaled approximately $5.8 million and $6.2 million at March 31, 2012 and December 31, 2011, respectively. At March 31, 2012 there was one loan for $234,000 that was past due greater than 90 days and still accruing while there were none at December 31, 2011. As of March 31, 2012, $2.6 million of loan loss allowances were allocated to all loans classified as impaired with $1.6 million of loan loss allowances allocated to all loans classified as impaired at December 31, 2011.

As part of the on-going monitoring of the credit quality of the Company’s loan portfolio, management assigns a Risk Assessment Rating (‘Risk Rating”) to extensions of credit based upon the degree of risk, the likelihood of repayment and the effect on the Bank’s safety and soundness. The Risk Rating, applied consistently, enables lending personnel and bank management to monitor the loan portfolio. The Risk Rating is an integral part of the bank’s loan loss provision formulation process and, properly maintained, the Risk Rating assessment can provide an early warning signal of deterioration in a credit.

The Company uses a risk rating matrix to assign a risk grade to each loan. The Risk Ratings are divided into five general categories:

 

  1. Risk Ratings 1 - 6 are assigned to “Pass” credits.

 

  2. Risk Rating 7 is assigned to “Pass” credits that are also considered “Watch” credits.

 

  3. Risk Rating 8 is assigned to “Criticized” credits.

 

  4. Risk Ratings 9 and 10 are assigned to “Classified” credits.

 

  5. Risk Rating 11 is assigned to “Loss” credits.

A general description of the characteristics of the risk ratings are described below:

 

   

Risk ratings 1, 2 and 3 – these ratings have the highest degree of probability of repayment. Borrowers in this category are established entities, well-positioned within their industry with a proven track record of solid financial performance. These ratings are usually reserved for the strongest customers of the Bank, who have strong capital, stable earnings and alternative sources of financing.

 

   

Risk ratings 4 and 5 – these ratings have a below and average degree of risk. The customers have, generally strong to adequate net worth, stable earnings trends and strong to moderate liquidity.

 

   

Risk rating 6 – this category represents an above average degree of risk as to repayment with minimal loss potential. Borrowers in this category generally exhibit adequate operating trends, satisfactory balance sheet trends, moderate leverage and adequate liquidity; however, there is minimal excess operating cushion.

 

   

Risk rating 7 – this rating includes loans on management’s “Watch” list. Borrowers in this category generally exhibit characteristics of an acceptable/adequate credit, but may be experiencing income volatility, negative operating trends, and a more highly leveraged balance sheet.

 

   

Risk rating 8 – this rating is for “Other Assets Especially Mentioned” in accordance with regulatory guidelines. This rating generally includes loans to borrowers with currently protected, but potentially weak assets that deserve management’s close attention.

 

   

Risk rating 9 – this rating is for loans considered “Substandard” in accordance with regulatory guidelines. This rating represents assets inadequately protected by the current sound worth and paying capacity of the borrower or of the collateral pledged. These assets have a well-defined weakness, or weaknesses, that jeopardize liquidation of the debt and are characterized by the distinct possibility that the Bank will sustain some loss if deficiencies are not corrected.

 

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Table of Contents
   

Risk rating 10 – this rating is for loans considered “Doubtful” in accordance with regulatory guidelines. Borrowers in this category have all the weaknesses inherent in a “Substandard” credit with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions, and values, highly improbable.

 

   

Risk rating 11 – this rating is for loans considered “Loss” in accordance with regulatory guidelines. This category represents loans that are considered uncollectible and of such little value that their continuance as a bankable asset is not warranted. This classification does not mean that the asset has absolutely no recovery or salvage value, but simply it is neither practical nor desirable to defer writing off all or some portion of the credit, even though partial recovery may be effected in the future.

The following table presents credit quality indicators:

Credit Quality Indicators

as of March 31, 2012

(Dollars in thousands)

 

            Commercial Real Estate  
     Commercial      Construction      Other  
     2012      2012      2012  

Risk Rating:

        

Other Assets Especially Mentioned

   $ 2,922       $ 2,423       $ 12,812   

Substandard

     1,956         1,886         1,337   

Doubtful

     192         1,152         1,250   

Loss

     0         0         0   
  

 

 

    

 

 

    

 

 

 
   $ 5,070       $ 5,461       $ 15,399   
  

 

 

    

 

 

    

 

 

 

 

     Residential      Consumer
Installment
 
     2012      2012  

Risk Rating:

     

Other Assets Especially Mentioned

   $ 1,716       $ 292   

Substandard

     2,847         164   

Doubtful

     938         69   

Loss

     0         0   
  

 

 

    

 

 

 
   $ 5,501       $ 525   
  

 

 

    

 

 

 

Credit Quality Indicators

as of December 31, 2011

(Dollars in thousands)

 

            Commercial Real Estate  
     Commercial      Construction      Other  
     2011      2011      2011  

Risk Rating:

        

Other Assets Especially Mentioned

   $ 2,181       $ 2,432       $ 7,944   

Substandard

     3,571         1,986         3,194   

Doubtful

     32         1,152         1,250   

Loss

     0         0         0   
  

 

 

    

 

 

    

 

 

 
   $ 5,784       $ 5,570       $ 12,388   
  

 

 

    

 

 

    

 

 

 

 

15


Table of Contents
     Residential      Consumer
Installment
 
     2011      2011  

Risk Rating:

     

Other Assets Especially Mentioned

   $ 1,867       $ 290   

Substandard

     2,632         348   

Doubtful

     1,418         215   

Loss

     0         0   
  

 

 

    

 

 

 
   $ 5,917       $ 853   
  

 

 

    

 

 

 

The following table presents an age analysis of past due loans receivable:

Age Analysis of Past Due Loans Receivable

As of March 31, 2012

(Dollars in thousands)

 

     30-59
Days

Past Due
     60-89
Days Past

Due
     Greater
than 90
Days
     Total Past
Due
     Current      Total
Loans
     Recorded
Investment
90 Days
and
Accruing
 

2012

                    

Commercial

   $ 196       $ 0       $ 0       $ 196       $ 48,927       $ 49,123       $ 0   

Commercial Real Estate

                    

Construction

     0         0         1,152         1,152         38,854         40,006         0   

Other

     366         0         488         854         119,776         120,630         234   

Residential

     529         184         1,386         2,099         80,841         82,940         0   

Consumer

     10         0         21         31         8,500         8,531         0   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
   $ 1,101       $ 184       $ 3,047       $ 4,332       $ 296,898       $ 301,230       $ 234   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Age Analysis of Past Due Loans Receivable

As of December 31, 2011

(Dollars in thousands)

 

     30-59
Days

Past Due
     60-89
Days Past
Due
     Greater
than 90
Days
     Total Past
Due
     Current      Total
Loans
     Recorded
Investment
90 Days
and
Accruing
 

2011

                    

Commercial

   $ 0       $ 32       $ 178       $ 210       $ 47,473       $ 47,683       $ 0   

Commercial Real Estate

                    

Construction

     229         0         1,152         1,381         33,645         35,026         0   

Other

     482         0         0         482         114,401         114,883         0   

Residential

     687         0         1,972         2,659         81,660         84,319         0   

Consumer

     23         0         342         365         8,505         8,870         0   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
   $ 1,421       $ 32       $ 3,644       $ 5,097       $ 285,684       $ 290,781       $ 0   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total past due loans at March 31, 2012 decreased $765,000 to $4.3 million from $5.1 million as of December 31, 2011 primarily due to payments received including payoffs and pay-downs totaling approximately $182,000, movements to other assets of $378,000, charge-offs of loans deemed uncollectable of approximately $452,000, and the return of loans to performing of $1.4 million. Additions to past due as of March 31, 2012 compared to December 31, 2011 totaled approximately $1.6 million.

 

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Table of Contents

Loans are considered impaired when, based on current information it is probable that the Bank will not collect all principal and interest payments according to contractual terms. Generally, loans are considered impaired once principal and interest payments are past due and they are placed on non-accrual. When a loan is placed on nonaccrual status, the Bank shall debit all accrued and unpaid income outstanding on the account. Management also considers the financial condition of the borrower, cash flows of the loan and the value of the related collateral. Impaired loans do not include large groups of smaller balance homogeneous credits such as residential real estate and consumer installment loans, which are evaluated collectively for impairment. Loans specifically reviewed for impairment are not considered impaired during periods of “minimal delay” in payment (usually ninety days or less) provided eventual collection of all amounts due is expected. Impaired loans are measured based on the present value of expected future cash flows discounted at the loan’s effective interest rate, except that as a practical expedient, the Bank may measure impairment based on a loan’s observable market price or the fair value of the collateral, if the loan is collateral dependent. Interest payments on impaired loans are typically applied to principal unless collectability is reasonably assured, in which case interest is recognized on a cash basis. Impaired loans or portions thereof, are charged-off when deemed uncollectible.

The Company’s policy states that when the probability for full repayment of a loan is unlikely, the Bank will initiate a full charge-off or a partial write-down of the asset based upon the status of the loan.

Consumer loans less than $25,000 for which payments of principal and/or interest are past due ninety (90) days are charged-off and referred for collection. Consumer loans of $25,000 or more are evaluated for charge-off or partial write-down at the discretion of Bank management.

Any other loan over 120 days past due is evaluated for charge-off or partial write-down at the discretion of Bank management.

Generally, real estate secured loans are charged-off on a deficiency basis after liquidation of the collateral. Bank management may determine that when the full loan balance is clearly uncollectible and some loss is anticipated a charge-off or write-down is appropriate prior to liquidation of the collateral. An updated evaluation or appraisal of the property may be required to determine the appropriate level of charge-off or write-down.

 

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Table of Contents

The following tables presents a summary of impaired loans as of and for the three months ended March 31, 2012 and as of December 31, 2011 and for the year then ended:

Impaired Loans

as of and for the Three Month Period Ended March 31, 2012

 

(Dollars in thousands)    Recorded
Investment
     Unpaid
Principal
Balance
     Related
Allowance
     Average
Recorded
Investment
     Interest Income
Recognized
 

With no related allowance recorded

              

Commercial

   $ 199       $ 199       $ 0       $ 169       $ 4   

Commercial real estate

     488         488         0         166         0   

Residential real estate

     476         476         0         869         2   

Consumer

     17         17         0         150         1   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
     1,180         1,180         0         1,354         7   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

With an allowance recorded

              

Commercial

     1,029         1,029         293         1,101         16   

Commercial real estate

     6,260         6,260         1,321         3,744         213   

Residential real estate

     2,337         2,337         951         2,100         46   

Consumer

     139         139         69         175         4   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
     9,765         9,765         2,634         7,120         279   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

              

Commercial

     1,228         1,228         293         1,270         20   

Commercial real estate

     6,748         6,748         1,321         3,910         213   

Residential real estate

     2,813         2,813         951         2.969         48   

Consumer

     156         156         69         325         5   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
   $ 10,945       $ 10,945       $ 2,634       $ 8,474       $ 286   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Impaired Loans

as of and for the Year Ended December 31, 2011

 

(Dollars in thousands)    Recorded
Investment
     Unpaid
Principal
Balance
     Related
Allowance
     Average
Recorded
Investment
     Interest Income
Recognized
 

With no related allowance recorded

              

Commercial

   $ 242       $ 242       $ 0       $ 950       $ 9   

Commercial real estate

     0         0         0         595         0   

Residential real estate

     1,074         1,074         0         1,472         47   

Consumer

     195         195         0         188         11   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
     1,511         1,511         0         3,205         67   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

With an allowance recorded

              

Commercial

   $ 1,156       $ 1,156       $ 195       $ 700       $ 4   

Commercial real estate

     2,444         2,444         731         3,597         196   

Residential real estate

     1,981         1,981         475         1,681         63   

Consumer

     289         289         161         243         20   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
     5,870         5,870         1,562         6,221         283   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

              

Commercial

   $ 1,398       $ 1,398       $ 195       $ 1,650       $ 13   

Commercial real estate

     2,444         2,444         731         4,192         196   

Residential real estate

     3,055         3,055         475         3,153         110   

Consumer

     484         484         161         431         31   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
   $ 7,381       $ 7,381       $ 1,562       $ 9,426       $ 350   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

The Company considers a loan to be a troubled debt restructuring when for economic or legal reasons related to a borrower’s financial difficulties, the Company grants a concession to the borrower that it would not otherwise consider. The Company may consider granting a concession in an attempt to protect as much of its investment as possible.

 

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Table of Contents

The restructuring of a loan may include, but is not necessarily limited to: (1) the transfer from the borrower to the Bank of real estate, receivables from third parties, other assets, or an equity interest in the borrower in full or partial satisfaction of the loan (2) the issuance or other granting of an equity interest to the Company by the borrower to satisfy fully or partially a debt unless the equity interest is granted pursuant to existing terms for converting the debt in to an equity interest (3) a modification of the loan terms, such as a reduction of the stated interest rate, principal, or accrued interest or an extension of the maturity date at a stated interest rate lower than the current market rate for new debt with similar risk, or (4) a reduction of the face amount or maturity amount of the debt as stated in the instrument or other agreement and (5) a reduction of accrued interest. The current outstanding balance of troubled debt restructurings as of March 31, 2012 included $854,000 of loans in accrual status and $1.7 million of loans classified as nonaccrual. During the three months ended March 31, 2012 no new loans were added to those considered to be troubled debt restructurings. The following table is a summary of loans determined to be troubled debt restructurings for the twelve months ended December 31, 2011.

 

     Modifications made during the year
ended
December 31, 2011
 
     Number
of
Contracts
     Pre-
Modification
Outstanding
Recorded
Investment
     Post-
Modification
Outstanding
Recorded
Investment
 

Troubled Debt Restructurings

        

Commercial

     3       $ 840       $ 840   

Commercial Real Estate

     2         1,863         1,298   

Residential Real Estate

     3         453         453   

Consumer

     1         46         46   
  

 

 

    

 

 

    

 

 

 
     9       $ 3,202       $ 2,637   
  

 

 

    

 

 

    

 

 

 

 

     Number
of
Contracts
     Recorded
Investment
 

Troubled Debt Restructurings that Subsequently Defaulted

     

Troubled Debt Restructurings

     

Commercial

     0       $ 0   

Commercial Real Estate

     0         0   

Residential Real Estate

     0         0   

Consumer

     0         0   
  

 

 

    

 

 

 
     0       $ 0   
  

 

 

    

 

 

 

Note G – Fair Value Measurements

 

Fair Value Hierarchy

The Company follows FASB’s guidance on “Fair Value Measurements.” The guidance defines fair value, establishes a framework for measuring fair value in GAAP and expands disclosures about fair value measurements. The guidance applies whenever other

 

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Table of Contents

standards require (or permit) assets or liabilities to be measured at fair value but does not expand the use of fair value in any new circumstances. In this standard, the FASB clarifies the principle that fair value should be based on the assumptions market participants would use when pricing the asset or liability. In support of this principle, the guidance establishes a fair value hierarchy that prioritizes the information used to develop those assumptions.

The Company utilizes fair value measurements to record fair value adjustments to certain assets and to determine fair value disclosures. Securities available for sale are recorded at fair value on a recurring basis. Additionally, from time to time, the Company may be required to record at fair value all other assets on a nonrecurring basis, such as loans held for sale, loans held for investment and certain other assets. These nonrecurring fair value adjustments typically involve application of lower of cost or market accounting or write-downs of individual assets.

The guidance establishes a fair value hierarchy that prioritizes the information used to develop those assumptions. The fair value hierarchy is as follows:

Level 1 inputs – Unadjusted quoted prices in active markets for identical assets or liabilities that the entity has the ability to access at the measurement date.

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 and liabilities in active markets, and inputs other than quoted prices that are observable for the asset or liability, such as interest rates and yield curves that are observable at commonly quoted intervals.

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. Fair values are measured using independent pricing models or other model-based valuation techniques such as present value of future cash flows, adjusted for the assets credit rating, prepayment assumptions and other factors such as credit loss assumptions

An asset or liability’s categorization within the fair value hierarchy is based upon the lowest level of input that is significant to the fair value measurement. Management reviews and updates the fair value hierarchy classifications of the Company’s assets and liabilities on a quarterly basis. During the three months ended March 31, 2012, there were no transfers made between Level 1, 2, and 3 inputs.

Assets and Liabilities Measured at Fair Value on a Recurring Basis

The following table presents information about the Company’s assets measured at fair value on a recurring basis as of March 31, 2012 and December 31, 2011, and indicates the fair value hierarchy of the valuation techniques utilized by the Company to determine such fair value.

 

20


Table of Contents
(dollars in thousands)           Fair Value Measurements of Assets
at March 31, 2012 Using
        

Description

   Fair Value
March 31,
2012
     Quoted
Prices in
Active
Markets for
Identical
Assets
(Level 1)
     Other
Observable
Inputs
(Level 2)
     Significant
Unobservable
Inputs

(Level 3)
     Total
Changes in
Fair Values
Included in
Period
Earnings
 

Investment Securities Available for Sale

              

Debt securities

              

Issued by the U.S. Treasury and other U. S. Government agencies

   $ 40,860       $ 0       $ 40,860       $ 0       $ 0   

Issued by State and municipal

     1,141         0         1,141         0         0   

Mortgage-backed securities issued by Government agencies

     38,379         0         38,379         0         0   

Private label mortgage-backed securities

     1,739         0         0         1,739         0   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total Debt Securities

     82,119         0         80,380         1,739         0   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Equity securities

              

Mutual funds

     664         0         664         0         0   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total Equity Securities

     664         0         664         0         0   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total Investment Securities Available for Sale

   $ 82,783       $ 0       $ 81,044       $ 1,739       $ 0   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Fair Value Measurements Using Significant Unobservable Inputs (Level 3) – Roll Forward

at March 31, 2012

 

Investment Securities Available for Sale – Debt Securities

  

Beginning Balance at December 31, 2011

   $ 1,855   

Transfers in to Level 3

     0   

Transfers out of Level 3

     0   

Unrealized gains

     14   

Repayments

     (130
  

 

 

 

Ending Balance at March 31, 2012

   $ 1,739   
  

 

 

 

 

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Table of Contents
(dollars in thousands)           Fair Value Measurements of Assets
at December 31, 2011 Using
        

Description

   Fair Value
December 31,
2011
     Quoted
Prices in
Active
Markets for
Identical
Assets
(Level 1)
     Other
Observable
Inputs
(Level 2)
     Significant
Unobservable
Inputs

(Level 3)
     Total
Changes in
Fair Values
Included in
Period
Earnings
 

Investment Securities Available for Sale

              

Debt securities

              

Issued by the U.S. Treasury and Government agencies

   $ 48,032       $ 0       $ 48,032       $ 0       $ 0   

Issued by State and municipal

     1,136         0         1,136         0         0   

Mortgage-backed securities issued by Government agencies

     35,870         0         35,870         0         0   

Private label mortgage-backed securities

     1,855         0         0         1,855         0   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total Debt Securities

     86,893         0         85,038         1,855         0   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Equity Securities

              

Mutual funds

     656         0         656         0         0   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total Equity Securities

     656         0         656         0         0   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total Investment Securities Available for Sale

   $ 87,549       $ 0       $ 85,694       $ 1,855       $ 0   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Fair Value Measurements Using Significant Unobservable Inputs (Level 3) – Roll Forward

at December 31, 2011

 

Investment Securities Available for Sale – Debt Securities

  

Beginning Balance at December 31, 2010

   $ 2,401   

Transfers in to Level 3

     0   

Transfers out of Level 3

     0   

Unrealized gains

     100   

Repayments

     (646
  

 

 

 

Ending Balance at December 31, 2011

   $ 1,855   
  

 

 

 

Level 1 securities include those traded on an active exchange such as the New York Stock Exchange, Treasury securities that are traded by dealers or brokers in active over-the-counter markets and money market funds. Level 2 securities include mortgage backed securities issued by government sponsored entities, municipal bonds and corporate debt securities. Securities classified as Level 3 include securities below investment grade and asset-backed securities in illiquid markets. Level 3 securities include two private-label residential one to-four family mortgage backed securities. These 2005 senior tranches in a securitization trust were rated “Aa1 and Aaa” by Moody’s when purchased in 2005 and are currently rated “Ca” and “B3”, respectively. The Company engages the service of independent third party valuation professionals to estimate the fair value of these securities. The valuation is meant to be “Level 3” pursuant to FASB ASC Topic 820 – Fair Value Measurements and Disclosures. The valuation uses an expected cash flow model that includes assumptions related to prepayment rates, default trends, and loss severity. At March 31, 2012, both securities were current on both principal and interest payments, and had a fixed weighted average coupon of 5.50%. One security had a weighted average remaining life of 1.46 years and the other had a weighted average remaining life of 0.53 years.

 

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Table of Contents

The following table details the Level 3 securities:

 

               Remaining      Current Rating

(in thousands)

   Class    Coupon    Par Value      Moody’s    Fitch

CWHL 2005-21

   A13    5.5% Fixed    $ 228       B3    CC

WFMBS 2005-14

   IA7    5.5% Fixed      1,567       Ca    A

We calculated fair value for the two securities by using a present value of future cash flows model, which incorporated assumptions as follows as of March 31, 2012 and December 31, 2011:

March 31, 2012

 

     3 Month
Cumulative
Default (1)
    Weighted
Average
Life (2)
   Modified
Duration (3)
   Yield (4)  

CWHL 2005-21

     2.85   0.53 years    0.48 years      8.00

WFMBS 2005-14

     1.86   1.46 years    1.29 years      8.00

 

(1) The anticipated level of total defaults from the issuer within the pool of performing collateral as of March 31, 2012.
(2) The average number of years that each dollar of principal remains outstanding.
(3) The weighted average of present values for a series of cash flows which accurately indicates the average time until the cash flows are received.
(4) The discount rate obtained from taking a sequence of cash flows and an estimated price.

December 31, 2011

 

     3 Month
Cumulative
Default (1)
    Weighted
Average
Life (2)
   Modified
Duration (3)
   Yield
(4)
 

CWHL 2005-21

     3.04   0.65 years    0.59 years      8.00

WFMBS 2005-14

     3.84   2.10 years    1.80 years      8.00

 

(5) The anticipated level of total defaults from the issuer within the pool of performing collateral as of December 31, 2011.
(6) The average number of years that each dollar of principal remains outstanding.
(7) The weighted average of present values for a series of cash flows which accurately indicates the average time until the cash flows are received.
(8) The discount rate obtained from taking a sequence of cash flows and an estimated price.

The fair value of the Level 3 securities is assessed on a quarterly basis by obtaining an independent third party review of the securities so designated. In addition to using an expected cash-flow model the analysis includes an evaluation of the characteristics and performance of the underlying collateral of each of the securities. Management reviews and compares the results on a quarterly basis to available market information.

The significant unobservable inputs used in the fair value measurement of these private label mortgage-backed securities include prepayment rates, probability of default and loss severity in the event of default. Significant increases or decreases in any of these may result in a lower or higher fair value measurement. A significant increase in default rates could result in a higher level of losses and slower prepayment rates, conversely a lower level of default rates could result in lower levels of losses and increased prepayment rates.

 

23


Table of Contents
(in thousands)          

Fair Value Measurements

at March 31, 2012 Using

               

Description

   Fair Value
December 31,
2011
     Quoted Prices
in Active
Markets for
Identical
Assets

(Level 1)
     Other
Observable
Inputs
(Level 2)
     Significant
Unobservable
Inputs

(Level 3)
     Trading
Gains and
(Losses)
     Total
Changes
in Fair
Values
Included
in Period
Earnings
 

Impaired loans

                 

Commercial

     935         0         935       $ 0       $ 0       $ 0   

Commercial real estate

     4,813         0         4,813         0         0         0   

Residential real estate

     1,862         0         1,862         0         0         0   

Construction

     614         0         614         0         0         0   

Consumer

     87         0         87         0         0         0   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total impaired loans

     8,311         0         8,311         0         0         0   

Real estate owned

     1,510         0         1,510         0         0         0   

Other assets (repossessed assets)

     116         0         116         0         0         0   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total Assets Measured at Fair Value on a Non Recurring Basis

   $ 9,937       $ 0       $ 9,937       $ 0       $ 0       $ 0   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

(in thousands)           Fair Value Measurements
at December 31, 2011 Using
               

Description

   Fair Value
December 31,
2011
     Quoted Prices
in Active
Markets for
Identical
Assets

(Level 1)
     Other
Observable
Inputs
(Level 2)
     Significant
Unobservable
Inputs

(Level 3)
     Trading
Gains and
(Losses)
     Total
Changes
in Fair
Values
Included
in Period
Earnings
 

Impaired loans

                 

Commercial

   $ 1,202       $ 0       $ 1,202       $ 0       $ 0       $ 0   

Commercial real estate

     995         0         995         0         0         0   

Residential real estate

     2,580         0         2,580         0         0         0   

Construction

     719         0         719         0         0         0   

Consumer

     323         0         323         0         0         0   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total impaired loans

     5,819         0         5,819         0         0         0   

Real estate owned

     1,222         0         1,222         0         0         0   

Other assets (repossessed assets)

     52         0         52         0         0         0   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total Assets Measured at Fair Value on a Non Recurring Basis

   $ 7,093       $ 0       $ 7,093       $ 0       $ 0       $ 0   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

The Company may be required from time to time, to measure certain assets at fair value on a non-recurring basis in accordance with GAAP. These include assets that are measured at the lower of cost or market that were recognized at fair value below cost at the end of the period.

Loans for which it is probable that the Company will not collect all of principal and interest due according to contractual terms are measured for impairment in accordance with FASB guidance on Accounting by Creditors for Impairment of a Loan. Allowable methods for estimating fair value include using the fair value of the collateral for collateral dependent loans or, where a loan is determined not to be collateral dependent, using the discounted cash flow method. In our determination of fair value, we have categorized both methods of valuation as estimates based on Level 2 inputs.

 

24


Table of Contents

If the impaired loan is identified as collateral dependent, then the fair value method of measuring the amount of impairment is utilized. This method requires obtaining a current independent appraisal or utilizing some other method of valuation for the collateral and applying a discount factor to the value based on our loan review policy and procedures.

If the impaired loan is determined not to be collateral dependent, then the discounted cash flow method is used. This method requires the impaired loan to be recorded at the present value of expected future cash flow’s discounted at the loan’s effective interest rate. The effective interest rate of a loan is the contractual interest rate adjusted for any net deferred loan fees or costs, premiums, or discounts existing at origination or acquisition of the loan.

Management establishes a specific reserve for loans that have an estimated fair value below the carrying value. Impaired loans had a carrying value of $10.9 million as of March 31, 2012. Of the $10.9 million of impaired loans, $9.8 million had specific reserves of $2.6 million.

When there is little prospect of collecting principal or interest, loans, or portions of loans, may be charged-off to the allowance for credit losses. Losses are recognized in the period an obligation becomes uncollectible. The recognition of a loss does not mean that the loan has absolutely no recovery or salvage value, but rather that it is not practical or desirable to defer writing off the loan even though a partial recovery may occur in the future. During the three months ended March 31, 2012 the Company charged-off $603,000 of impaired loans to the allowance for credit losses.

Property acquired by the Company as a result of foreclosure on a mortgage loan will be classified as “real estate owned.” Personal property acquired through repossession will be classified as “repossessed assets.” Property acquired will be recorded at the lower of the unpaid principal balance or fair value at the date of acquisition and subsequently carried at the lower of cost or net realizable value. Any required write-down of the loan to its net realizable value will be charged against the allowance for credit losses. As of March 31, 2012 the Company held $1.5 million in real estate owned as a result of foreclosure. Of the $1.5 million in real estate owned, $1.2 million is undeveloped lots, while $288,000 is a single family home. Real estate owned carried at appraised value is considered to be using Level 2 inputs. The Company held $1.2 million in real estate owned as a result of foreclosure as of December 31, 2011. The $1.2 million in real estate owned consisted of a number of undeveloped lots.

The Company records repossessed assets such as boats, automobiles or equipment at the lower of cost or estimated fair value on the acquisition date and at the lower of such initial amount or estimated fair value less selling costs thereafter. Estimated fair value is generally based upon independent values of the collateral obtained through valuation or listing services specifically used for the type of asset repossessed. We consider these collateral values to be estimated using Level 2 inputs. Repossessed assets at March 31, 2012 totaled $116,000 and $52,000 at December 31, 2011.

The fair value of the Company’s time deposits was estimated using discounted cash flow analyses. The discount rates used were based on rates currently offered for deposits with similar remaining maturities. The fair value of the Company’s time deposit liabilities do not take into consideration the value of the Company’s long-term relationships with depositors, which may have significant value.

 

25


Table of Contents

The carrying amount for customer repurchase agreements and variable rate borrowings approximate the fair values at the reporting date. The fair value of fixed rate Federal Home Loan Bank advances is estimated by computing the discounted value of contractual cash flows payable at current interest rates for obligations with similar remaining terms. The fair value of variable rate Federal Home Loan Bank advances is estimated to be carrying value since these liabilities are based on a spread to a current pricing index

The estimated fair values of the Company’s financial instruments are summarized below. The fair values of a significant portion of these financial instruments are estimates derived using present value techniques and may not be indicative of the net realizable or liquidation values. Also, the calculation of estimated fair values is based on market conditions at a specific point in time and may not reflect current or future fair values.

The following tables present information about the Company’s financial assets and financial liabilities measured at fair value as of March 31, 2012 and December 31, 2011, and indicates the fair value hierarchy of the valuation techniques utilized by the Company to determine such fair value.

 

     March 31, 2012      December 31, 2011  
(dollars in thousands)    Carrying
Amount
     Estimated Fair
Value
     Carrying
Amount
     Estimated Fair
Value
 

Financial assets

           

Level 2 inputs:

           

Cash and due from banks

   $ 1,954       $ 1,954       $ 2,026       $ 2,026   

Interest bearing balances with banks

     37,306         37,306         18,288         18,288   

Federal funds sold

     3         3         26,583         26,583   

Investment securities, available for sale

     81,044         81,044         85,694         85,694   

Federal Reserve and Federal Home Loan Bank stock

     2,992         2,992         2,992         2,992   

Loans and loans held for sale, net

     294,098         294,447         283,284         283,667   

Accrued interest receivable

     1,294         1,294         1,279         1,279   

Bank owned life insurance

     5,679         5,679         5,624         5,624   

Real estate owned

     1,510         1,510         1,222         1,222   

Level 3 inputs:

           

Other debt securities

     1,739         1,739         1,855         1,855   

Financial liabilities

           

Level 2 inputs:

           

Noninterest bearing deposits

   $ 54,959       $ 54,959       $ 56,664       $ 56,664   

Interest bearing deposits

     291,693         292,997         293,717         298,788   

Securities sold under agreements to repurchase

     12,912         12,912         11,344         11,344   

Long-term borrowings

     35,000         31,542         35,000         31,357   

Junior subordinated debt

     5,000         5,000         5,000         5,000   

Accrued interest and dividends payable

     214         214         167         167   

The carrying amount of cash and due from banks, federal funds sold and interest bearing balances with banks approximates fair value.

The fair values of U.S. Treasury and Government agency securities and mortgage backed securities are determined using market quotations.

The carrying amount of Federal Reserve stock and Federal Home Loan Bank stock approximates fair value.

 

26


Table of Contents

The fair value of fixed-rate loans is estimated to be the present value of scheduled payments discounted using interest rates currently in effect. The fair value of variable-rate loans, including loans with a demand feature, is estimated to equal the carrying amount. The valuation of loans is adjusted for possible credit losses. The fair value of loans held for sale are at the carrying value (lower of cost or market) since such loans are typically committed to be sold (servicing released) at a profit.

The carrying amount of accrued interest receivable approximates fair value.

The fair value of bank owned life insurance is the current cash surrender value which is the carrying value.

The carrying value of real estate owned approximates fair value at the reporting date.

The fair value of noninterest bearing deposits is the amount payable on demand at the reporting date, since generally accepted accounting standards does not permit an assumption of core deposit value.

The fair value of interest bearing transaction, savings, and money market deposits with no defined maturity is the amount payable on demand at the reporting date, since generally accepted accounting standards does not permit an assumption of core deposit value.

The fair value of certificates of deposit is estimated by discounting the future cash flows using the current rates at which similar deposits would be accepted.

The carrying amount for customer repurchase agreements and variable rate borrowings approximate the fair values at the reporting date. The fair value of fixed rate Federal Home Loan Bank advances is estimated by computing the discounted value of contractual cash flows payable at current interest rates for obligations with similar remaining terms. The fair value of variable rate Federal Home Loan Bank advances is estimated to be carrying value since these liabilities are based on a spread to a current pricing index.

The carrying amount of junior subordinated debentures approximate the fair values at the reporting date.

The carrying amount of accrued interest payable approximates fair value.

Management has reviewed the unfunded portion of commitments to extend credit, as well as standby and other letters of credit, and has determined that the fair value of such instruments is equal to the fee, if any, collected and unamortized for the commitment made.

Note H – Preferred Stock

 

The Company is authorized to issue up to 5,000,000 shares of preferred stock with a par value of $.01 per share. On January 30, 2009 the Company completed a transaction to participate in the Government sponsored Troubled Asset Relief Program which resulted in the Treasury purchasing 8,152 shares of Fixed Rate Cumulative Perpetual Preferred Stock, Series A (the “Series A Preferred Stock”) at a value of $8.2 million and a warrant to purchase 299,706 shares of the Company’s common stock. The Series A Preferred Stock qualifies as Tier 1 Capital. The Series A Preferred Stock pays a dividend of 5% per annum; payable quarterly for five years then pays a dividend of 9% per annum thereafter. Dividends declared for each of the three months ended March 31, 2012 and 2011 was $101,900.

 

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The warrant is exercisable at $4.08 per share at any time on or before January 30, 2019. The number of shares of common stock issuable upon exercise of the warrant and the exercise price per share will be adjusted if specific events occur.

On April 18, 2012, Annapolis Bancorp, Inc. (the “Company”) announced that it had redeemed 4,076 shares of its Series A Preferred Stock for $4,076,000. Following the redemption, 4,076 shares of Series A Preferred Stock remain outstanding totaling $4,076,000.

 

Note I – New Accounting Pronouncements

 

All pending but not yet effective Accounting Standards Updates (“ASU”) were evaluated and only those listed below could have a material impact on the Company’s financial condition or results of operation.

In April, 2011, the FASB issued ASU No. 2011-03, “Reconsideration of Effective Control for Repurchase Agreements.” ASU No. 2011-03 affects all entities that enter into agreements to transfer financial assets that both entitle and obligate the transferor to repurchase or redeem the financial assets before their maturity. The amendments in ASU No. 2011-03 remove from the assessment of effective control the criterion relating to the transferor’s ability to repurchase or redeem financial assets on substantially the agreed terms, even in the event of default by the transferee. ASU No. 2011-03 also eliminates the requirement to demonstrate that the transferor possesses adequate collateral to fund substantially all the cost of purchasing replacement financial assets. The guidance is effective for the Company’s reporting period ended March 31, 2012. The guidance was applied prospectively to transactions or modifications of existing transactions that occurred on or after January 1, 2012.

In May, 2011, FASB issued ASU No. 2011-04, “Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs.” The amendments in this ASU generally represent clarifications of Topic 820, but also include some instances where a particular principle or requirement for measuring fair value or disclosing information about fair value measurements has changed. This ASU results in common principles and requirements for measuring fair value and for disclosing information about fair value measurements in accordance with U.S. GAAP and IFRSs. The amendments in this ASU are to be applied prospectively. For public entities, the amendments are effective during interim and annual periods beginning after December 15, 2011. Early application by public entities is not permitted. The Company has adopted the methodologies prescribed by this ASU by the date required. The ASU did not have a material impact on its financial condition or results of operations.

In June, 2011, FASB issued ASU No. 2011-05, “Amendments to Topic 220, Comprehensive Income.” Under the amendments in this ASU an entity has 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

 

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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. This ASU eliminates the option to present the components of other comprehensive income as part of the statement of changes in stockholders’ equity. The amendments in this 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.

The amendments in ASU 2011-05 should be applied retrospectively. For public entities, the amendments are effective for fiscal years, and interim periods within those years, beginning after December 15, 2011. The provisions of ASU 2011-05 are effective for the Company’s first reporting period beginning on January 1, 2012, with early adoption permitted. The Company has adopted ASU 2011-05 and it did not have a material impact on the Company’s financial statements.

In December, 2011 FASB issued ASU 2011-11, “Balance Sheet (Topic 210) - “Disclosures about Offsetting Assets and Liabilities.” ASU 2011-11 amends Topic 210, “Balance Sheet,” to require an entity to disclose both gross and net information about financial instruments, such as sales and repurchase agreements and reverse sale and repurchase agreements and securities borrowing/lending arrangements, and derivative instruments that are eligible for offset in the statement of financial position and/or subject to a master netting arrangement or similar agreement. ASU 2011-11 is effective for annual and interim periods beginning on January 1, 2013, and is not expected to have a significant impact on the Company’s financial statements.

In December, 2011 FASB issued ASU 2011-12, “Comprehensive Income (Topic 220) - Deferral of the Effective Date for Amendments to the Presentation of Reclassifications of Items Out of Accumulated Other Comprehensive Income in Accounting Standards Update No. 2011-05.” ASU 2011-12 defers changes in ASU No. 2011-05 that relate to the presentation of reclassification adjustments to allow the FASB time to redeliberate whether to require presentation of such adjustments on the face of the financial statements to show the effects of reclassifications out of accumulated other comprehensive income on the components of net income and other comprehensive income. ASU 2011-12 allows entities to continue to report reclassifications out of accumulated other comprehensive income consistent with the presentation requirements in effect before ASU No. 2011-05. All other requirements in ASU No. 2011-05 are not affected by ASU No. 2011-12. ASU 2011-12 is effective for annual and interim periods beginning after December 15, 2011. The Company has adopted ASU 2011-12 and it did not have a material impact on the Company’s financial statements.

Item 2 – Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

Critical Accounting Policies

 

The Company’s consolidated financial statements are prepared in accordance with GAAP and follow general practices within the banking industry. Application of these principles requires management to make estimates, assumptions, and judgments that affect the amounts reported in the financial statements and accompanying notes. These estimates,

 

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assumptions, and judgments are based on information available as of the date of the financial statements; accordingly, as this information changes, the financial statements could reflect different estimates, assumptions, and judgments. Certain policies inherently have a greater reliance on the use of estimates, assumptions, and judgments and as such have a greater possibility of producing results that could be materially different than originally reported. Estimates, assumptions, and judgments are necessary when assets and liabilities are required to be recorded at fair value, when a decline in the value of an asset not carried on the financial statements at fair value warrants an impairment write-down or valuation reserve to be established, or when an asset or liability needs to be recorded contingent upon a future event. Carrying assets and liabilities at fair value inherently results in more financial statement volatility. The fair values and the information used to record valuation adjustments for certain assets and liabilities are based either on quoted market prices or are provided by other third-party sources, when available.

Significant accounting policies followed by the Company are presented in Note 1 to the Company’s 2011 consolidated financial statements which can be found in the Company’s Form 10-K and recent accounting provisions adopted have been presented herein in Note I. These policies, along with the disclosures presented in the other financial statement notes and in this financial review, provide information on how significant assets and liabilities are valued in the financial statements and how those values are determined. Based on the valuation techniques used and the sensitivity of financial statement amounts to the methods, assumptions, and estimates underlying those amounts management has identified the determination of the allowance for credit losses to be the accounting area that requires the most subjective or complex judgments, and as such could be most subject to revision as new information becomes available.

The allowance for credit losses represents management’s estimate of probable credit losses inherent in the loan portfolio. Determining the amount of the allowance for credit losses is considered a critical accounting estimate because it requires significant judgment and the use of estimates related to the amount and timing of expected future cash flows on impaired loans, estimated losses on pools of homogeneous loans based on historical loss experience, and consideration of current economic trends and conditions, all of which may be susceptible to significant change. The loan portfolio also represents the largest asset type on the consolidated balance sheet.

Allowance for Credit Losses Methodology

 

The Bank’s allowance for credit losses is established through a provision for loan losses based on management’s evaluation of the risks inherent in its loan portfolio and the general economy. The allowance for credit losses is maintained at an amount management considers adequate to cover estimated losses in loans receivable which are deemed probable and estimable based on information currently known to management. The overall allowance consists of both ASC 310 specific reserves for individual loans and ASC 450 general reserves for loan portfolios by specific categories and types. The Bank estimates an acceptable allowance for credit loss with the objective of quantifying portfolio risk into a dollar figure of inherent losses, thereby translating the subjective risk value into an objective number. Emphasis is placed on independent external loan reviews and regular internal reviews. The determination of the allowance for loan losses is based on the Bank’s historical loss experience and ten (10) qualitative factors for specific categories and types of loans. The combination of the loss experience factor and the total qualitative factors (“Total

 

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ALLL Factor”) is expressed as a percentage of the portfolio for specific categories and types of loans to create the inherent loss index for each loan portfolio. Individual loans deemed impaired are separated from the respective loan portfolios and a specific reserve allocation is assigned based upon Bank management’s best estimate as to the loss exposure for each loan. Each Total ALLL Factor is assigned a percentage weight and that total weight is applied to each loan category. The Total ALLL Factor is different for each loan type and for each risk assessment category within each loan type.

 

   

The Bank’s historical loss experience is calculated by aggregating the actual loan losses by category for the previous eight quarters and converting that total into a percentage for each loan category.

Previously (in 2011), due to the Bank’s limited historical loss experience, the loss experience factor was the greater of either the Bank’s historical loss experience or the peer group average historical loss experience.

 

   

Qualitative factors include: levels and trends in delinquencies and non-accruals; trends in volumes and terms of loans; effects of any changes in lending policies; the experience, ability and depth of management; national and local economic trends and conditions (including Peer Group loss experience); concentrations of credit; quality of the bank’s loan review system; and, external factors, such as competition, legal and regulatory requirements.

The total allowance for credit losses changes as the percentage weight assigned to each Total ALLL Factor is increased or decreased due to its particular circumstance, as the various types and categories of loans change as a percentage of total loans and as the aggregate of specific allowances is adjusted due to an increase or decrease in impaired loans.

Management believes this approach effectively measures the risk associated with any particular loan or group of loans. The Bank’s Board of Directors engages an independent loan review consultant to evaluate the adequacy of the Bank’s allowance for credit losses. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Bank’s allowance for credit losses. Such agencies may require the Bank to make additional provisions for estimated credit losses based upon judgments different from those of management. The Bank recorded a total provision for credit losses of $167,000 for the three month period ended March 31, 2012 and $557,000 for the same period in 2011. The aggregate provision was based upon the results of quarterly evaluations using a combination of factors including the level of nonperforming loans, the Bank’s growth in total gross loans and the Bank’s net credit loss experience. Total gross loans, increased by $10.4 million for the three months ended March 31, 2012. For the same period, the Bank recorded charge-offs of $603,000 and recovered $19,000 on previously charged-off loans. As of March 31, 2012, the Bank’s allowance for credit losses was $6.8 million or 2.25% of total loans and 97.94% of nonperforming loans as compared to $7.2 million, or 2.47% of total loans and 102.3% of nonperforming loans as of December 31, 2011.

The Bank continues to monitor and modify its allowance for credit losses as conditions dictate. While management believes that, based on information currently available, the Bank’s allowance for credit losses is sufficient to cover losses inherent in its loan portfolio at this time, no assurances can be given that the Bank’s level of allowance for credit losses will be sufficient to cover future loan losses incurred by the Bank or that future

 

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adjustments to the allowance for credit losses will not be necessary if economic and other conditions differ substantially from economic and other conditions at the time management determined the current level of the allowance for credit losses. Management may in the future increase the level of the allowance as its loan portfolio increases or as circumstances dictate.

Activity in the allowance for credit losses for the three months ended March 31, 2012 and 2011 is shown below:

 

(dollars in thousands)    For the Three Months
Ended March 31,
 
     2012     2011  

Total loans outstanding - at March 31,

   $ 300,863      $ 285,072   

Average loans outstanding year-to-date

     296,497        282,037   

Allowance for credit losses at beginning of period

   $ 7,182      $ 6,853   
  

 

 

   

 

 

 

Provision charged to expense

     167        557   
  

 

 

   

 

 

 

Chargeoffs:

  

Commercial loans

     32        471   

Real estate and construction loans

     340        0   

Consumer and other loans

     231        55   
  

 

 

   

 

 

 

Total

     603        526   
  

 

 

   

 

 

 

Recoveries:

  

Commercial loans

     9        5   

Real estate and construction loans

     2        0   

Consumer and other loans

     8        3   
  

 

 

   

 

 

 

Total

     19        8   
  

 

 

   

 

 

 

Net chargeoffs

     584        518   
  

 

 

   

 

 

 

Allowance for credit losses at end of period

   $ 6,765      $ 6,892   
  

 

 

   

 

 

 

Allowance for credit losses as a percent of total loans

     2.25     2.42

Net chargeoffs (recoveries) as a percent of average loans

     0.20     0.18

The Bank’s nonperforming assets, which are comprised of loans delinquent 90 days or more, non-accrual loans, loans that are categorized as being a troubled debt restructuring, loans with repossessed collateral and repossessed assets totaled $8.5 million at March 31, 2012, compared to $8.3 million at December 31, 2011, an increase in nonperforming assets of $221,000 or 2.7% The percentage of nonperforming assets to total assets was 1.94% at March 31, 2012, compared to 1.88% at December 31, 2011. The increase in nonperforming assets was principally attributable to the addition of a $671,000 in nonaccrual loans and a $234,000 matured loan under consideration for renewal past due more than 90 days and still accruing. Offsetting the additions to nonperforming were charge-offs of $452,000 and payments and payoffs totaling $232,000.

The $8.5 million in nonperforming assets at March 31, 2012 included $5.8 million in nonaccrual loans, $234,000 in loans past due more than 90 days, $854,000 in accruing troubled debt restructuring and $1.6 million in other assets. Of the $5.8 million in nonaccrual loans at March 31, 2012, $5.2 million were secured by real estate, $414,000 were commercial loans and $156,000 were consumer and other loans. At December 31, 2011, assets classified as nonperforming totaled $8.3 million and consisted of $6.2 million in nonaccrual loans and $856,000 in accruing troubled debt restructuring and $1.3 million in other assets. Included in the $6.2 million of nonaccrual loans was $5.3 million of loans secured by real estate, $390,000 of commercial and $484,000 of consumer and other loans.

 

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Comparison of Financial Condition at March 31, 2012 and December 31, 2011

 

Total assets of $440.6 million at March 31, 2012 decreased 0.23% or $1.0 million compared to $441.6 million at December 31, 2011. Loan demand improved in the first three months of 2012, with $301.2 million of gross loans as of March 31, 2012, an increase of $10.4 million from $290.8 million at December 31, 2011. The increase resulted primarily from the origination, net of payments of approximately $9.6 million in real estate secured loans and $1.4 million in commercial loans offset by charge-offs of $603,000. Interest bearing balances with banks increased $19.0 million as cash previously maintained in federal funds sold was transferred to other interest bearing balances with banks. Investment securities decreased $4.8 million or 5.4% to $82.8 million from $87.5 million at December 31, 2011 balance.

Deposits of $346.7 million at March 31, 2012 decreased $3.7 million or 1.1% from December 31, 2011 deposits of $350.4 million. Money market balances increased $3.0 million in total while demand deposit balances decreased $1.7 million. The primary increase in money market balances was due to a related party transaction whereby funds were deposited to purchase and payoff $2.5 million of notes relating to loans outstanding to one borrower. Certificate of deposit balances decreased $5.4 million. Certificates totaling $3.0 million invested in the CDARS program matured and were not renewed.

Comparison of Operating Results for the Three Months Ended March 31, 2012 and 2011.

 

General. The Company recorded net income of $824,000 for the three months ended March 31, 2012; an increase of $315,000, compared to net income of $509,000 for the three months ended March 31, 2011. Net income available to common shareholders for the three months ended March 31, 2012 was $716,000 or $0.18 per basic and diluted common shares compared to net income available to common shareholders of $387,000 or $0.10 per basic and diluted shares for the three months ended March 31, 2011. Net interest income increased by $56,000 or 1.4% for the three months ended March 31, 2012 compared to the same period in 2011. The provision for credit losses decreased $390,000 to $167,000 for the three months ended March 31, 2012 compared to $557,000 for the three month period ended March 31, 2011.

Interest Income. Total interest and dividend income decreased $102,000 or 2.1% for the three months ended March 31, 2012 compared to the same period in 2011 as a result of lower yields on investments. Interest income on investments decreased $151,000. The yield on the investment securities portfolio decreased to 2.57% from 3.01% on balances $8.0 million lower on average over the same period in 2011. Income on the loan portfolio increased $41,000 or 1.0% for the three months ended March 31, 2012. The improvement in interest income on the loan portfolio was due to an increase in average loan balances of $14.5 million. Income of approximately $180,000 on a loan previously categorized as nonaccrual was recognized during the three month period ended March 31, 2011. The yield on the loan portfolio decreased to 5.74% for the three months ended March 31, 2012 from 6.03% for the three months ended March 31, 2011.

 

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Interest Expense. Total interest expense decreased by $158,000 or 17.0% for the three months ended March 31, 2012 compared to the three months ended March 31, 2011. The decrease was due to reducing the yields on the Company’s deposit products including the Company’s “Superior Savings” account. The Company’s savings accounts had an average balance of $134.5 million for the three months ended March 31, 2012 and a yield of 0.36% compared to an average balance of $139.7 million and a yield of 0.73% for the three months ended March 31, 2011. Contributing to the decrease in interest expense were lower yields on all other deposit products, primarily money market accounts and certificates of deposit and lower yields on repurchase agreements. The average rate of interest paid on all interest bearing liabilities was 0.90% for the three months ended March 31, 2012 compared to 1.09% for the three months ended March 31, 2011. Interest expense on long-term borrowings and junior subordinated debentures was $328,000 for the three months ended March 31, 2012 compared to $321,000 for the three months ended March 31, 2011, an increase of $7,000.

Net Interest Income. Net interest income increased by $56,000 or 1.4% for the three months ended March 31, 2012 compared to the three months ended March 31, 2011. The increase was primarily the result of the lower overall cost of deposits. The Company’s cost of funds decreased to 0.78% for the three months ended March 31, 2012 compared to 0.97% for the three months ended March 31, 2011.

For the three months ended March 31, 2012, the net interest margin decreased to 3.87% compared to 4.00% for the three months ended March 31, 2011. The decrease in net interest margin was primarily the result of the decrease in the yield on new loans and investments. The yield on earning assets decreased to 4.61% for the three months ended March 31, 2012 from 4.93% for the same period in 2011.

Provision for Credit Losses. The Bank recorded a provision for credit losses of $167,000 for the three months ended March 31, 2012 compared to $557,000 for the same period in 2011. The provision was based on the composition and credit quality of the loan portfolio as of March 31, 2012 and reflected the qualitative factors used to calculate the allowance for credit losses relating to historical delinquencies and losses and to factors relating to local economic conditions. Total gross loans increased by $10.4 million for the three month period ended March 31, 2012 compared to December 31, 2011. The Bank recorded net charge-offs on loans deemed uncollectible of $584,000 for the three months ended March 31, 2012 compared to $518,000 for the same period in 2011.

Noninterest Income. Total noninterest income increased by $69,000 or 18.8% to $437,000 for the three months ended March 31, 2012. Noninterest income was $368,000 for the same period in 2011. The increase in noninterest income was due to higher mortgage banking fees of $44,000 and gains on the sale of repossessed assets of $20,000 compared to a loss of $31,000 on the disposal of fixed assets recorded for the three months ended March 31, 2011.

Noninterest Expense. Total noninterest expense decreased by $49,000 or 1.6% for the three months ended March 31, 2012 compared to the same period in 2011. The decrease in total noninterest expense during the first three months of 2012 compared with the same period in 2011 was the result of lower personnel expense, lower occupancy and equipment expense and lower FDIC expense offset by higher legal expenses. Personnel expense decreased $72,000 over the same period in 2011 due to open staff positions and to the reversal of expense resulting from the forfeiture of stock grants. Occupancy and equipment expense decreased $43,000 compared to the three months ended March 31, 2011 as 2011 expense included accelerated depreciation on assets from the Bank’s Market House branch

 

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that was closed in 2011. FDIC insurance expense decreased $64,000 compared to the same period in the prior year as a result of the FDIC’s revised assessment methodology. An increase in legal expense of $50,000 was the result of increased collection costs in 2012 as the first quarter of 2011 included recoupment of $44,000 of legal expenses from the payoff of a nonaccrual loan.

Income Tax Expense. The Company recorded income tax expense for the three-month period ended March 31, 2012 of $486,000 compared to $237,000 for the three months ended March 31, 2011. The Company’s combined effective federal and state income tax rate was approximately 37.1% for the three months ended March 31, 2012 versus 35.8% for the three months ended March 31, 2011.

The table below sets forth certain information regarding changes in interest income and interest expense attributable to (1) changes in volume (change in volume multiplied by the old rate); (2) changes in rates (change in rate multiplied by the old volume); and (3) changes in rate/volume (change in rate multiplied by change in volume).

Rate/Volume Analysis

 

(dollars in thousands)    Three Months Ended March 31, 2012 vs. 2011  
     Increase or
(Decrease)
    Due to Change in  
       Volume     Rate     Rate/
Volume
 

Interest income on:

        

Loans

   $ 41      $ 217        ($212   $ 36   

Investment securities

     (151     (60     (108     17   

Interest bearing deposits in other banks

     3        0        3        0   

Federal funds sold and other overnight Investments

     5        5        0        0   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total interest income

     (102     162        (317     53   

Interest expense on:

        

NOW accounts

     (3     0        (3     0   

Money market accounts

     (12     13        (20     (5

Savings accounts

     (128     (9     (126     7   

Certificates of deposit

     (16     (15     (4     3   

Repurchase agreements

     (6     (1     (5     (0

Long-term borrowing

     3        0        0        3   

Junior subordinated debt

     4        0        4        0   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total interest expense

     (158     (12     (154     8   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net interest income

   $ 56      $ 174        ($163   $ 45   
  

 

 

   

 

 

   

 

 

   

 

 

 

 

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Consolidated Average Balances, Yields and Rates

(dollars in thousands)

 

      Three Month Periods Ended  
     March 31, 2012     March 31, 2011  
     Average
Balance
     Interest
(1)
     Yield/
Rate
    Average
Balance
     Interest
(1)
     Yield/
Rate
 

Assets

                

Interest earning assets

                

Federal funds sold and other overnight investments

   $ 20,449       $ 12         0.24   $ 11,870       $ 7         0.24

Interest bearing balances with banks

     15,478         7         0.18     14,482         4         0.11

Investment securities (1)

     87,303         557         2.57     95,278         708         3.01

Loans (2)

     296,497         4,232         5.74     282,037         4,191         6.03
  

 

 

    

 

 

      

 

 

    

 

 

    

Total interest earning assets

     419,727         4,808         4.61     403,667         4,910         4.93

Noninterest earning assets

                

Cash and due from banks

     7,362              7,874         

Other assets

     13,836              15,744         
  

 

 

         

 

 

       

Total Assets

   $ 440,925            $ 427,285         
  

 

 

         

 

 

       

Liabilities and Stockholders’ Equity

                

Interest bearing deposits

                

NOW accounts

   $ 31,872       $ 8         0.10   $ 32,811       $ 11         0.14

Money market accounts

     51,887         39         0.30     41,568         51         0.50

Savings accounts

     134,536         122         0.36     139,661         250         0.73

Certificates of deposit

     73,816         266         1.45     77,879         282         1.47

Repurchase agreements

     12,425         11         0.36     13,559         17         0.51

Long-term borrowings

     35,000         281         3.23     35,000         278         3.22

Junior subordinated debt

     5,000         47         3.78     5,000         43         3.49
  

 

 

    

 

 

      

 

 

    

 

 

    

Total interest bearing liabilities

     344,536         774         0.90     345,478         932         1.09
     

 

 

         

 

 

    

Noninterest bearing Liabilities

                

Demand deposit accounts

     56,044              44,974         

Other liabilities

     2,534              1,945         

Stockholders’ Equity

     37,811              34,888         
  

 

 

         

 

 

       

Total Liabilities and Stockholders’ Equity

   $ 440,925            $ 427,285         
  

 

 

         

 

 

       

Interest rate spread

           3.70           3.84

Ratio of interest earning assets to interest bearing liabilities

           121.82           116.84

Net interest income and net interest margin

      $ 4,034         3.87      $ 3,978         4.00
     

 

 

         

 

 

    
(1) No tax-equivalent adjustments are made, as the effect would not be material.
(2) Includes nonaccrual loans

Liquidity

 

Liquidity is the capacity to change the nominal level and mix of assets or liabilities, for any purpose, quickly and economically. Poor or inadequate liquidity risk management could result in a critical situation in which the Bank would be unable to meet deposit withdrawal or loan funding requests from its customers. Either situation could potentially harm both the profits and reputation of the Bank.

The Company’s major source of liquidity is its deposit base. At March 31, 2012, total deposits were $346.7 million. Core deposits, considered to be stable funding sources and defined as all deposits except time deposits totaled $273.7 million or 79.0% of total deposits. Liquidity is also provided through the Company’s overnight investment in federal funds sold, interest bearing deposits with banks as well as securities available-for-sale and investment securities with maturities less than one year. At March 31, 2012, interest bearing deposits with banks, federal funds sold and other overnight investments totaled $37.3 million while investment securities available-for-sale totaled $82.8 million.

 

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In addition, the Bank has external sources of funds, which can be used as needed. The FHLB is the primary source of this external liquidity. The FHLB has established credit availability for banks up to 40% of the bank’s total assets. The Bank currently has an approved line of credit with the FHLB of 25% of total assets with the ability to request an increase in the line if necessary. Total assets are based on the most recent quarterly financial information submitted by the Bank to the appropriate regulatory agency. The ability to borrow funds is subject to the Bank’s continued creditworthiness, compliance with the terms and conditions of the FHLB’s Advance Applications and the pledging of sufficient eligible collateral to secure advances. At March 31, 2012, the Bank had a $110.1 million credit limit with the FHLB with advances outstanding of $35.0 million. The Bank had loans currently pledged as collateral sufficient to borrow up to $8.6 million of the remaining $75.1 million availability from the FHLB. The Bank also has the ability to borrow from the Federal Reserve Bank’s discount window. Additional collateral including cash, investment securities and home-equity loans are available for pledging purposes in the event the Bank would need to draw on the unused portion of the line of credit. Additionally, at March 31, 2012, the Bank had available credit with its correspondent banks of $19.2 million.

Capital Resources

 

Total stockholders’ equity was $38.0 million at March 31, 2012, representing an increase of $646,000 or 1.7% from December 31, 2011. The growth of stockholders’ equity in the first three months of 2012 was attributable to income of $824,000, stock based compensation of $16,000 and stock purchases through the Company’s Employee Stock Purchase Plan of $2,000. Offsetting these increases was a decrease in stockholder’s equity from the declaration of $102,000 in preferred stock dividends and a decrease of $94,000 in accumulated other comprehensive income resulting from lower market values of securities available-for-sale.

During the first quarter of 2009 the Company received an infusion of capital under TARP. Under TARP, the U. S. Treasury created the CPP, pursuant to which it provides access to capital that will serve as Tier 1 capital to financial institutions through a standardized program to acquire preferred stock (accompanied by warrants) from eligible financial institutions. On January 30, 2009, the Company sold 8,152 shares of the Company’s Fixed Rate Cumulative Preferred Stock, Series A (the “Series A Preferred Stock”), having a liquidation amount per share equal to $1,000, and a warrant to purchase 299,706 shares of the Company’s common stock, at an exercise price of $4.08 per share, to the Treasury under the CPP for a total purchase price of $8,152,000.

On April 18, 2012, Annapolis Bancorp, Inc. (the “Company”) announced that it had redeemed 4,076 shares of its Series A Preferred Stock for $4,076,000. Following the redemption, 4,076 shares of Series A Preferred Stock remain outstanding for a total of $4,076,000 in Series A Preferred Stock.

The Company currently has $5.0 million of junior subordinated debt issued in the form of trust preferred securities. Trust preferred securities are considered regulatory capital for purposes of determining the Company’s Tier 1 capital ratios. Regulatory guidance was issued by the Board of Governors of the Federal Reserve System ruled that banks could continue to include trust preferred securities in regulatory capital.

 

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The following table summarizes the Company’s risk-based capital ratios:

Annapolis Bancorp, Inc.

 

 

     March 31, 2012     December 31,
2011
    Minimum
Regulatory
Requirements
    Well-Capitalized
Regulatory
Requirements
 

Risk Based Capital Ratios:

        

Tier 1 Capital

     12.7     12.8     4.0     6.0

Total Capital

     14.0     14.0     8.0     10.0

Tier 1 Leverage Ratio

     9.6     9.4     4.0     5.0

As of March 31, 2012 and after the April 18, 2012 redemption of 50% of the Series A Preferred Stock, both the Company and the Bank met the criteria for classification as a “well-capitalized” institution. Designation as a well-capitalized institution under these regulations is not a recommendation or endorsement of the Company or the Bank by federal bank regulators.

Risk Management

 

The Board of Directors is the foundation for effective corporate governance and risk management. The Board demands accountability of management, keeps stockholders’ and other constituencies’ interests in focus, advocates the upholding of the Company’s code of ethics, and fosters a strong internal control environment. Through its Audit Committee, the Board actively reviews critical risk positions, including market, credit, liquidity, and operational risk. The Company’s goal in managing risk is to reduce earnings volatility, control exposure to unnecessary risk, and ensure appropriate returns for risk assumed. Senior management manages risk at the business line level, supplemented with corporate-level oversight through the Asset Liability Committee, internal audit and quality control functions.

Dodd-Frank Wall Street Reform and Consumer Protection Act

 

As a result of the enactment of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”) banks are no longer prohibited from paying interest on demand deposit accounts, including those from businesses, effective July 21, 2011. It is not clear what effect the elimination of this prohibition will have on the Bank’s interest expense, allocation of deposits, deposit pricing, loan pricing, net interest margin, ability to compete, ability to establish and maintain customer relationships, or profitability. The Dodd-Frank Act also includes a regulation to limit debit card interchange fees charged by issuing banks. The impact this regulation will have on the Bank’s noninterest income is not yet known.

Management continues to monitor the implementation of the Dodd-Frank Act which includes many provisions that went into effect on July 21, 2011 and many other provisions which will be phased-in over the next several months and years.

Item 3. Quantitative and Qualitative Disclosures about Market Risk

 

Not applicable.

 

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Item 4. Controls and Procedures

 

As of the end of the period covered by this report, based on an evaluation of the Company’s disclosure controls and procedures (as defined in Rules 13a-15(e) and 15(d)-15(e) under the Exchange Act), each of the chief executive officer and the chief financial officer of the Company has concluded that the Company’s disclosure controls and procedures are effective to ensure that information required to be disclosed by the Company in its Exchange Act reports is recorded, processed, summarized and reported within the applicable time periods specified by the Securities and Exchange Commission’s rules and forms.

There were no changes in the Company’s internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) that occurred during the Company’s last fiscal quarter that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

PART II – OTHER INFORMATION

 

Item 1 – Legal Proceedings

 

Neither the Company nor the Bank is involved in any pending legal proceedings other than routine legal proceedings occurring in the ordinary course of business which involve amounts in the aggregate believed by management to be immaterial to the financial condition of the Company and the Bank.

Item 1A – Risk Factors

 

Not applicable.

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

 

None.

Item 3 – Defaults Upon Senior Securities

 

None.

Item 4 – Mine Safety Disclosures

 

None

Item 5 – Other Information

 

None.

 

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Item 6 – Exhibits

The following exhibits are filed as part of this report.

 

 

    3.1    Articles of Incorporation of Annapolis Bancorp, Inc.*
    3.2    Amended and Restated Bylaws of Annapolis Bancorp, Inc.**
    3.3    Articles of Incorporation of BankAnnapolis***
    3.4    Bylaws of BankAnnapolis***
    4.0    Stock Certificate of Annapolis National Bancorp, Inc.*
    4.1    Form of Stock Certificate for the Fixed Rate Cumulative Preferred Stock, Series A. *******
    4.2    Warrant To Purchase 299,706 Shares of Common Stock Of Annapolis Bancorp, Inc. *******
  10.1    Annapolis National Bancorp, Inc. Employee Stock Option Plan*+
  10.2    Annapolis National Bancorp, Inc. 2000 Employee Stock Option Plan****
  10.3    Annapolis Bancorp, Inc. 2006 Stock Incentive Plan*****
  10.4    Form of Stock Option Award Agreement*****
  10.5    Form of Restricted Share Award Agreement*****
  10.6    Form of Deferral Election Agreement for Deferred Share Units*****
  10.7    Annapolis Bancorp, Inc. 2007 Employee Stock Purchase Plan ******
  10.8    Securities Purchase Agreement by and between the United States Department of the Treasury and Annapolis Bancorp, Inc. dated January 30, 2009*******
  31.1    Certification Pursuant to Rules 13a-14(a) or 15d-14(a) under the Securities Exchange Act of 1934, as amended (filed herewith)
  31.2    Certification Pursuant to Rules 13a-14(a) or 15d-14(a) under the Securities Exchange Act of 1934, as amended (filed herewith)
  32.1    Certification Pursuant to 18 U.S.C. Section 1350 (filed herewith)
  32.2    Certification Pursuant to 18 U.S.C. Section 1350 (filed herewith)
101.INS    XBRL Instance Document
101.SCH    XBRL Taxonomy Extension Schema
101.CAL    XBRL Taxonomy Extension Calculation Linkbase
101.DEF    Taxonomy Extension Definition Linkbase
101.LAB    XBRL Taxonomy Extension Label Linkbase
101.PRE    XBRL Taxonomy Extension Presentation Linkbase

 

+ Management contract or compensatory plan or arrangement.
* Incorporated herein by reference to the Company’s Registration Statement on Form SB-2, as amended, Commission File Number 333-29841, filed with the Securities and Exchange Commission on June 23, 1997.
** Incorporated herein by reference to the Company’s Report on Form 8-K, filed with the Securities and Exchange Commission on October 23, 2007.
*** Incorporated herein by reference to the Company’s Annual Report on Form 10-KSB for the fiscal year ended December 31, 2000, filed with the Securities and Exchange Commission on March 28, 2001.
**** Incorporated herein by reference to the Company’s Definitive Proxy Statement for the 2000 annual meeting, filed with the Securities and Exchange Commission on April 5, 2000.
***** Incorporated herein by reference to the Company’s Registration Statement on Form S-8, Commission File Number 333-136382, filed with the Securities and Exchange Commission on August 8, 2006.
****** Incorporated herein by reference to the Company’s Definitive Proxy Statement for the 2007 annual meeting, filed with the Securities and Exchange Commission on April 13, 2007.
******* Incorporated herein by reference to the Company’s Current Report on Form 8-K, filed with the Securities and Exchange Commission on February 2, 2009.

 

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SIGNATURES

 

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

 

   

ANNAPOLIS BANCORP, INC.

(Registrant)

Date: May 11, 2012       /s/    RICHARD M. LERNER        
      Richard M. Lerner
      Chief Executive Officer
Date: May 11, 2012       /s/    EDWARD J. SCHNEIDER        
      Edward J. Schneider
      Chief Financial Officer

 

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