UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20552

 

 

FORM 10-Q

 

 

QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE

SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended March 31, 2012

For the quarterly period ended March 31, 2012

Commission File Number 000-32561

 

 

 

Middlefield Banc Corp.

(Exact name of registrant as specified in its charter)

 

 

 

Ohio		34-1585111
(State or other jurisdiction of incorporation or organization)		(IRS Employer Identification No.)

15985 East High Street, Middlefield, Ohio 44062-9263

(Address of principal executive offices)

(440) 632-1666

(Registrant’s telephone number, including area code)

 

 

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for 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 website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (Section 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    YES  x    NO  ¨

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

 

Large accelerated filer		¨		Accelerated filer		¨
Non-accelerated filer		¨		Small 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

State the number of shares outstanding of each of the issuer’s classes of common equity as of the latest practicle date:

Class: Common Stock, without par value

Outstanding at May 15, 2012: 1,970,044

 

 

 

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MIDDLEFIELD BANC CORP.

INDEX

 

		Page
		Number
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements (unaudited)
Consolidated Balance Sheet as of March 31, 2012 and December 31, 2011			3
Consolidated Statement of Income for the Three Months ended March 31, 2012 and 2011			4
Consolidated Statement of Comprehensive Income for the Three Months ended March 31, 2012 and 2011			5
Consolidated Statement of Changes in Stockholders’ Equity for the Three Months ended March  31, 2012			6
Consolidated Statement of Cash Flows for the Three Months ended March 31, 2012 and 2011			7
Notes to Consolidated Financial Statements			8
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations			28
Item 3. Quantitative and Qualitative Disclosures About Market Risk			38
Item 4. Controls and Procedures			39
PART II - OTHER INFORMATION
Item 1. Legal Proceedings			40
Item 1A. Risk Factors			40
Item 2. Unregistered sales of equity securities and use of proceeds			40
Item 3. Default Upon Senior Securities			40
Item 4. Mine Safety Disclosures			40
Item 5. Other Information			40
Item 6. Exhibits and Reports on Form 8 – K			40
SIGNATURES			47
Exhibit 31.1
Exhibit 31.2
Exhibit 32

 

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MIDDLEFIELD BANC CORP.

CONSOLIDATED BALANCE SHEET

(Dollar amounts in thousands)

(Unaudited)

 

		March 31,				December 31,
		2012				2011
ASSETS
Cash and due from banks		$	22,022			$	15,730
Federal funds sold			23,587				18,660
Cash and cash equivalents			45,609				34,390
Investment securities available for sale			183,770				193,977
Loans			404,269				401,880
Less allowance for loan losses			7,267				6,819
Net loans			397,002				395,061
Premises and equipment			8,368				8,264
Goodwill			4,559				4,559
Bank-owned life insurance			8,326				8,257
Accrued interest and other assets			10,315				10,043
TOTAL ASSETS		$	657,949			$	654,551
LIABILITIES
Deposits:
Noninterest-bearing demand		$	64,517			$	63,348
Interest-bearing demand			63,509				55,853
Money market			71,047				75,621
Savings			172,236				167,207
Time			212,633				218,933
Total deposits			583,942				580,962
Short-term borrowings			7,365				7,392
Other borrowings			16,561				16,831
Accrued interest and other liabilities			1,622				2,113
TOTAL LIABILITIES			609,490				607,298
STOCKHOLDERS’ EQUITY
Common stock, no par value; 10,000,000 shares authorized, 1,961,217 and 1,951,868 shares issued			31,420				31,240
Retained earnings			19,272				18,206
Accumulated other comprehensive income			4,501				4,541
Treasury stock, at cost; 189,530 shares			(6,734	)			(6,734	)
TOTAL STOCKHOLDERS’ EQUITY			48,459				47,253
TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY		$	657,949			$	654,551

See accompanying notes to the unaudited consolidated financial statements.

 

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MIDDLEFIELD BANC CORP.

CONSOLIDATED STATEMENT OF INCOME

(Dollar amounts in thousands, except per share data)

(Unaudited)

 

		Three Months Ended March 31,
		2012				2011
INTEREST INCOME
Interest and fees on loans		$	5,537			$	5,301
Interest-bearing deposits in other institutions			4				2
Federal funds sold			3				9
Investment securities:
Taxable interest			915				1,323
Tax-exempt interest			747				698
Dividends on stock			26				26
Total interest income			7,232				7,359
INTEREST EXPENSE
Deposits			1,497				2,037
Short term borrowings			59				59
Other borrowings			84				109
Trust preferred debt			46				136
Total interest expense			1,686				2,341
NET INTEREST INCOME			5,546				5,018
Provision for loan losses			600				865
NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES			4,946				4,153
NONINTEREST INCOME
Service charges on deposit accounts			431				428
Investment securities gains, net			—				15
Earnings on bank-owned life insurance			68				73
Other income			295				183
Total noninterest income			794				699
NONINTEREST EXPENSE
Salaries and employee benefits			1,750				1,690
Occupancy expense			248				272
Equipment expense			170				158
Data processing costs			199				180
Ohio state franchise tax			129				128
Federal deposit insurance expense			243				225
Professional fees			214				211
Loss (gain) on sale of other real estate owned			18				(20	)
Other expense			811				861
Total noninterest expense			3,782				3,705
Income before income taxes			1,958				1,147
Income taxes			435				145
NET INCOME		$	1,523			$	1,002
EARNINGS PER SHARE
Basic		$	0.86			$	0.62
Diluted			0.86				0.62
DIVIDENDS DECLARED PER SHARE		$	0.26			$	0.26

See accompanying notes to the unaudited consolidated financial statements.

 

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MIDDLEFIELD BANC CORP.

CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME

(Dollar amounts in thousands)

(Unaudited)

 

		Three Months Ended March 31,
		2012				2011
Net income		$	1,523			$	1,002
Other comprehensive loss:
Net unrealized holding loss on available for sale securities			(60	)			(246	)
Tax effect			20				82
Reclassification adjustment for gains included in net income			—				(15	)
Tax effect			—				5
Total other comprehensive loss			(40	)			(174	)
Comprehensive income		$	1,483			$	828

See accompanying notes to the unaudited consolidated financial statements.

 

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MIDDLEFIELD BANC CORP.

CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS’ EQUITY

(Dollar amounts in thousands, except dividend per share amount)

(Unaudited)

 

										Accumulated
										Other								Total
		Common				Retained				Comprehensive				Treasury				Stockholders’
		Stock				Earnings				Income				Stock				Equity
Balance, December 31, 2011		$	31,240			$	18,206			$	4,541			$	(6,734	)		$	47,253
Net income							1,523												1,523
Comprehensive loss											(40	)							(40	)
Dividend reinvestment and purchase plan (9,349 shares)			180																180
Cash dividends ($0.26 per share)							(457	)											(457	)
Balance, March 31, 2012		$	31,420			$	19,272			$	4,501			$	(6,734	)		$	48,459

See accompanying notes to the unaudited consolidated financial statements.

 

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MIDDLEFIELD BANC CORP.

CONSOLIDATED STATEMENT OF CASH FLOWS

(Dollar amounts in thousands)

(Unaudited)

 

		Three Months Ended March 31,
		2012				2011
OPERATING ACTIVITIES
Net income		$	1,523			$	1,002
Adjustments to reconcile net income to net cash provided by operating activities:
Provision for loan losses			600				865
Investment securities gains, net			—				(15	)
Depreciation and amortization			221				211
Amortization of premium and discount on investment securities			224				116
Amortization of deferred loan fees, net			(55	)			(40	)
Earnings on bank-owned life insurance			(68	)			(73	)
Deferred income taxes			(28	)			(384	)
Loss (gain) on sale of other real estate owned			18				(20	)
Gain on sale of loans			(85	)			—
Increase in accrued interest receivable			(442	)			(487	)
Decrease in accrued interest payable			(104	)			(31	)
Decrease in prepaid federal deposit insurance			211				225
Other, net			(438	)			(338	)
Net cash provided by operating activities			1,577				1,031
INVESTING ACTIVITIES
Investment securities available for sale:
Proceeds from repayments and maturities			18,533				10,135
Proceeds from sale of securities			—				14,879
Purchases			(8,611	)			(13,247	)
Increase in loans, net			(2,643	)			(4,487	)
Proceeds from the sale of other real estate owned			210				170
Purchase of premises and equipment			(253	)			(26	)
Net cash provided by investing activities			7,236				7,423
FINANCING ACTIVITIES
Net increase in deposits			2,980				3,353
Decrease in short-term borrowings, net			(27	)			(331	)
Repayment of other borrowings			(270	)			(365	)
Common stock issuance			—				666
Proceeds from dividend reinvestment & purchase plan			180				148
Cash dividends			(457	)			(424	)
Net cash provided by financing activities			2,406				3,047
Increase in cash and cash equivalents			11,219				11,501
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD			34,390				30,635
CASH AND CASH EQUIVALENTS AT END OF PERIOD		$	45,609			$	42,136
SUPPLEMENTAL INFORMATION
Cash paid during the year for:
Interest on deposits and borrowings		$	1,790			$	2,372
Income taxes			200				850
Non-cash investing transactions:
Transfers from loans to other real estate owned		$	157			$	96

See accompanying notes to the unaudited consolidated financial statements.

 

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MIDDLEFIELD BANC CORP.

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1—BASIS OF PRESENTATION

The consolidated financial statements of Middlefield Banc Corp. (“Company”) include its two bank subsidiaries The Middlefield Banking Company (“MB”) and Emerald Bank (“EB”) and a non-bank asset resolution subsidiary EMORECO, Inc. All significant inter-company items have been eliminated.

The accompanying financial statements have been prepared in accordance with U.S. generally accepted accounting principles and the instructions for Form 10-Q and Article 10 of Regulation S-X. In management’s opinion, the financial statements include all adjustments, consisting of normal recurring adjustments, that the Company considers necessary to fairly state the Company’s financial position and the results of operations and cash flows. The consolidated balance sheet at December 31, 2011, has been derived from the audited financial statements at that date but does not include all of the necessary informational disclosures and footnotes as required by U. S. generally accepted accounting principles. The accompanying financial statements should be read in conjunction with the financial statements and notes thereto included with Middlefield’s Form 10-K for the year ended December 31, 2011 (File No. 000-32561). The results of Middlefield’s operations for any interim period are not necessarily indicative of the results of Middlefield’s operations for any other interim period or for a full fiscal year.

Recent Accounting Pronouncements

In April 2011, the Financial Accounting Standards Board (“FASB”) issued ASU 2011-03, Transfers and Services (Topic 860): Reconsideration of Effective Control for Repurchase Agreements. The main objective in developing this Update is to improve the accounting for repurchase agreements (repos) and other agreements that both entitle and obligate a transferor to repurchase or redeem financial assets before their maturity. The amendments in this Update remove from the assessment of effective control (1) the criterion requiring the transferor to have the ability to repurchase or redeem the financial assets on substantially the agreed terms, even in the event of default by the transferee, and (2) the collateral maintenance implementation guidance related to that criterion. The amendments in this Update apply to all entities, both public and nonpublic. The amendments affect 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 guidance in this Update is effective for the first interim or annual period beginning on or after December 15, 2011 and should be applied prospectively to transactions or modifications of existing transactions that occur on or after the effective date. Early adoption is not permitted. This ASU is not expected to have a significant impact on the Company’s financial statements.

 

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In May 2011, the FASB issued ASU 2011-04, Fair Value Measurement (Topic 820): Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs. The amendments in this Update result in common fair value measurement and disclosure requirements in U.S. GAAP and IFRSs. Consequently, the amendments change the wording used to describe many of the requirements in U.S. GAAP for measuring fair value and for disclosing information about fair value measurements. The amendments in this Update are to be applied prospectively. For public entities, the amendments are effective during interim and annual periods beginning after December 15, 2011. For nonpublic entities, the amendments are effective for annual periods beginning after December 15, 2011. Early application by public entities is not permitted. The Company has provided the necessary disclosures in Note 4.

In June 2011, the FASB issued ASU 2011-05, Comprehensive Income (Topic 220): Presentation of Comprehensive Income. The amendments in this Update improve the comparability, clarity, consistency, and transparency of financial reporting and increase the prominence of items reported in other comprehensive income. To increase the prominence of items reported in other comprehensive income and to facilitate convergence of U.S. GAAP and IFRS, the option to present components of other comprehensive income as part of the statement of changes in stockholders’ equity was eliminated. The amendments require that all non-owner changes in stockholders’ equity be presented either in a single continuous statement of comprehensive income or in two separate but consecutive statements. In the two-statement approach, the first statement should present total net income and its components followed consecutively by a second statement that should present total other comprehensive income, the components of other comprehensive income, and the total of comprehensive income. All entities that report items of comprehensive income, in any period presented, will be affected by the changes in this Update. For public entities, the amendments are effective for fiscal years, and interim periods within those years, beginning after December 15, 2011. For nonpublic entities, the amendments are effective for fiscal years ending after December 15, 2012, and interim and annual periods thereafter. The amendments in this Update should be applied retrospectively, and early adoption is permitted. The Company has provided the necessary disclosure in the Consolidated Statement of Comprehensive Income.

In September 2011, the FASB issued ASU 2011-08, Intangibles – Goodwill and Other Topics (Topic 350), Testing Goodwill for Impairment. The objective of this Update is to simplify how entities, both public and nonpublic, test goodwill for impairment. The amendments in the Update permit an entity to first assess qualitative factors to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount as a basis for determining whether it is necessary to perform the two-step goodwill impairment test described in Topic 350. The more-likely-than-not threshold is defined as having a likelihood of more than 50 percent. Under the amendments in this Update, an entity is not required to calculate the fair value of a reporting unit unless the entity determines that it is more likely than not that its fair value is less than its carrying amount. The amendments in this Update apply to all entities, both public and nonpublic, that have goodwill reported in their financial statements and are effective for interim and annual goodwill impairment tests performed for fiscal years beginning after December 15, 2011. Early adoption is permitted, including for annual and interim goodwill impairment tests performed as of a date before September 15, 2011, if an entity’s financial statements for the most recent annual or interim period have not yet been issued or, for nonpublic entities, have not yet been made available for issuance. This ASU did not have a significant impact on the Company’s financial statements.

In December 2011, the FASB issued ASU 2011-11, Balance Sheet (Topic 210): Disclosures about Offsetting Assets and Liabilities. The amendments in this Update affect all entities that have financial instruments and derivative instruments that are either (1) offset in accordance with either Section 210-20-45 or Section 815-10-45 or (2) subject to an enforceable master netting arrangement or similar agreement. The requirements amend the disclosure requirements on offsetting in Section 210-20-50. This information will enable users of an entity’s financial statements to evaluate the effect or potential effect of netting arrangements on an entity’s financial position, including the effect or potential effect of rights of setoff associated with certain financial instruments and derivative instruments in the scope of this Update. An entity is required to apply the amendments for annual reporting periods beginning on or after January 1, 2013, and interim periods within those annual periods. An entity should provide the disclosures required by those amendments retrospectively for all comparative periods presented. This ASU is not expected to have a significant impact on the Company’s financial statements.

 

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In December 2011, the 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. In order to defer only those changes in Update 2011-05 that relate to the presentation of reclassification adjustments, the paragraphs in this Update supersede certain pending paragraphs in Update 2011-05. Entities should continue to report reclassifications out of accumulated other comprehensive income consistent with the presentation requirements in effect before Update 2011-05. All other requirements in Update 2011-05 are not affected by this Update, including the requirement to report comprehensive income either in a single continuous financial statement or in two separate but consecutive financial statements. Public entities should apply these requirements for fiscal years, and interim periods within those years, beginning after December 15, 2011. Nonpublic entities should begin applying these requirements for fiscal years ending after December 15, 2012, and interim and annual periods thereafter. This ASU is not expected to have a significant impact on the Company’s financial statements.

NOTE 2—STOCK-BASED COMPENSATION

The Company has 9,000 unvested stock options outstanding but no unrecognized stock-based compensation costs outstanding as of March 31, 2012. The unvested options are scheduled to vest on May 9, 2012.

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

 

						Weighted-								Weighted-
						average								average
						Exercise								Exercise
		2012				Price				2011				Price
Outstanding, January 1			88,774			$	26.81				89,077			$	27.87
Granted			—				—				—				—
Exercised			—				—				—				—
Forfeited			—				—				(7,549	)			29.22
Outstanding, March 31			88,774			$	26.81				81,528			$	27.75

 

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NOTE 3—EARNINGS PER SHARE

The Company provides dual presentation of Basic and Diluted earnings per share. Basic earnings per share uses net income as reported as the numerator and the actual average shares outstanding as the denominator. Diluted earnings per share includes any dilutive effects of options, warrants, and convertible securities.

There are no convertible securities that would affect the denominator in calculating basic and diluted earnings per share. The following tables set forth the composition of the weighted-average common shares (denominator) used in the basic and diluted earnings per share computation.

 

		For the Three Months Ended March 31,
		2012				2011
Weighted average common shares outstanding			1,953,512				1,811,419
Average treasury stock shares			(189,530	)			(189,530	)
Weighted average common shares and common stock equivalents used to calculate basic earnings per share			1,763,982				1,621,889
Additional common stock equivalents (stock options) used to calculate diluted earnings per share			603				—
Weighted average common shares and common stock equivalents used to calculate diluted earnings per share			1,764,585				1,621,889

Options to purchase 88,774 shares of common stock, at prices ranging from $17.55 to $40.24, were outstanding during the three months ended March 31, 2012. Of those options, 9,000 were considered dilutive based on the strike price exceeding the grant price. The remaining 79,774 options had no dilutive effect on the earnings per share.

Options to purchase 81,528 shares of common stock at prices ranging from $22.33 to $40.24 were outstanding during the three months ended March 31, 2011 but were not included in the computation of diluted earnings per share as they were anti-dilutive due to the strike price being greater than the market price as of March 31, 2011.

 

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NOTE 4—FAIR VALUE MEASUREMENTS

Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in the principal or most advantageous market for an asset or liability in an orderly transaction between market participants at the measurement date. GAAP established a fair value hierarchy that prioritizes the use of inputs used in valuation methodologies into the following three levels:

 

Level I:

Quoted prices are available in active markets for identical assets or liabilities as of the reported date.

 

Level II:

Pricing inputs are other than the quoted prices in active markets, which are either directly or indirectly observable as of the reported date. The nature of these assets and liabilities includes items for which quoted prices are available but traded less frequently and items that are fair-valued using other financial instruments, the parameters of which can be directly observed.

 

Level III:

Assets and liabilities that have little to no pricing observability as of the reported date. These items do not have two-way markets and are measured using management’s best estimate of fair value, where the inputs into the determination of fair value require significant management judgment or estimation.

The following tables present the assets measured on a recurring basis on the Consolidated Balance Sheet at their fair value as of March 31, 2012 and December 31, 2011 by level within the fair value hierarchy. Financial assets and liabilities are classified in their entirety based on the lowest level of input that is significant to the fair value measurement.

 

						March 31, 2012
(Dollar amounts in thousands)		Level I				Level II				Level III				Total
Assets measured on a recurring basis:
U.S. government agency securities		$	—			$	20,543			$	—			$	20,543
Obligations of states and political subdivisions			—				87,620				—				87,620
Mortgage-backed securities in government-sponsored entities							68,060								68,060
Private-label mortgage-backed securities			—				6,796				—				6,796
Total debt securities			—				183,019				—				183,019
Equity securities in financial institutions			5				746				—				751
Total		$	5			$	183,765			$	—			$	183,770

 

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						December 31, 2011
		Level I				Level II				Level III				Total
Assets measured on a recurring basis:
U.S. government agency securities		$	—			$	31,933			$	—			$	31,933
Obligations of states and political subdivisions			—				88,400				—				88,400
Mortgage-backed securities in government- sponsored entities							65,573								65,573
Private-label mortgage-backed securities			—				7,321				—				7,321
Total debt securities			—				193,227				—				193,227
Equity securities in financial institutions			5				745				—				750
Total		$	5			$	193,972			$	—			$	193,977

The Company obtains fair values from an independent pricing service which represent either quoted market prices for the identical securities (Level 1 inputs) or fair values determined by pricing models using a market approach that considers observable market data, such as interest rate volatilities, LIBOR yield curve, credit spreads and prices from market makers and live trading systems (Level 2).

Financial instruments are considered Level III when their values are determined using pricing models, discounted cash flow methodologies or similar techniques and at least one significant model assumption or input is unobservable. In addition to these unobservable inputs, the valuation models for Level III financial instruments typically also rely on a number of inputs that are readily observable either directly or indirectly. Level III financial instruments also include those for which the determination of fair value requires significant management judgment or estimation. The Company has no securities considered to be Level III as of March 31, 2012.

The Company uses prices compiled by third party vendors due to the recent stabilization in the markets along with improvements in third party pricing methodology that have narrowed the variances between third party vendor prices and actual market prices.

The following tables present the assets measured on a nonrecurring basis on the Consolidated Balance Sheet at their fair value as of March 31, 2012 and December 31, 2011, by level within the fair value hierarchy. Impaired loans that are collateral dependent are written down to fair value through the establishment of specific reserves. Techniques used to value the collateral that secure the impaired loan include: quoted market prices for identical assets classified as Level I inputs; observable inputs, employed by certified appraisers, for similar assets classified as Level II inputs. In cases where valuation techniques included inputs that are unobservable and are based on estimates and assumptions developed by management based on the best information available under each circumstance, the asset valuation is classified as Level III inputs.

 

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						March 31, 2012
(Dollar amounts in thousands)		Level I				Level II				Level III				Total
Assets measured on a recurring basis:
Impaired loans		$	—			$	—			$	5,798			$	5,798
Other real estate owned			—				—				2,125				2,125
						December 31, 2011
		Level I				Level II				Level III				Total
Assets measured on a recurring basis:
Impaired loans		$	—			$	—			$	13,581			$	13,581
Other real estate owned			—				—				2,196				2,196

The following table presents additional quantitative information about assets measured at fair value on a non-recurring basis and for which the Company uses Level III inputs to determine fair value:

 

		Quantitative Information about Level III Fair Value  Measurements
(unaudited, in thousands) March 31, 2012		Estimate				Valuation Techniquest		Unobservable Input		Range (Weighted Average)
Impaired loans		$	5,798			Appraisal of collateral (1)		Appraisal adjustments (2)		0% to -50.0% (-36.1%)
								Liquidation expenses (2)		0% to 42.7% (-3.3%)
Other real estate owned		$	2,125			Appraisal of collateral (1), (3)

 

(1)	Fair value is generally determined through independent appraisals of the underlying collateral, which generally include various level 3 inputs which are not identifiable.

(2)	Appraisals may be adjusted by management for qualitative factors such as economic conditions and estimated liquidation expenses. The range and weighted average of liquidation expenses and other appraisal adjustments are presented as a percent of the appraisal.

(3)	Includes qualitative adjustments by management and estimated liquidation expenses.

 

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The estimated fair value of the Company’s financial instruments is as follows:

 

		March 31, 2012
		Carrying																Total
		Value				Level I				Level II				Level III				Fair Value
		(in thousands)
Financial assets:
Cash and cash equivalents		$	45,609			$	45,609			$	—			$	—			$	45,609
Investment securities
Available for sale			183,770				5				183,765				—				183,770
Net loans			397,002				—				—				384,755				384,755
Bank-owned life insurance			8,326				8,326								—				8,326
Federal Home Loan Bank stock			1,887				1,887								—				1,887
Accrued interest receivable			2,676				2,676				—				—				2,676
Financial liabilities:
Deposits		$	583,942			$	371,308			$	—			$	218,353			$	589,661
Short-term borrowings			7,365				7,365				—				—				7,365
Other borrowings			16,561				—				—				16,999				16,999
Accrued interest payable			541				541				—				—				541

 

		March 31, 2012								December 31, 2011
		Carrying				Fair				Carrying				Fair
		Value				Value				Value				Value
		(in thousands)
Financial assets:
Cash and cash equivalents		$	45,609			$	45,609			$	34,390			$	34,390
Investment securities
Available for sale			183,770				183,770				193,977				193,977
Net loans			397,002				384,755				395,061				382,542
Bank-owned life insurance			8,326				8,326				8,257				8,257
Federal Home Loan Bank stock			1,887				1,887				1,887				1,887
Accrued interest receivable			2,676				2,676				2,234				2,234
Financial liabilities:
Deposits		$	583,942			$	589,661			$	580,962			$	587,178
Short-term borrowings			7,365				7,365				7,392				7,392
Other borrowings			16,561				16,999				16,831				17,327
Accrued interest payable			541				541				645				645

Financial instruments are defined as cash, evidence of ownership interest in an entity, or a contract which creates an obligation or right to receive or deliver cash or another financial instrument from/to a second entity on potentially favorable or unfavorable terms.

Fair value is defined as the amount at which a financial instrument could be exchanged in a current transaction between willing parties other than in a forced liquidation sale. If a quoted market price is available for a financial instrument, the estimated fair value would be calculated based upon the market price per trading unit of the instrument.

 

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If no readily available market exists, the fair value estimates for financial instruments should be based upon management’s judgment regarding current economic conditions, interest rate risk, expected cash flows, future estimated losses, and other factors as determined through various option pricing formulas or simulation modeling. Since many of these assumptions result from judgments made by management based upon estimates which are inherently uncertain, the resulting estimated fair values may not be indicative of the amount realizable in the sale of a particular financial instrument. In addition, changes in assumptions on which the estimated fair values are based may have a significant impact on the resulting estimated fair values.

As certain assets such as deferred tax assets and premises and equipment are not considered financial instruments, the estimated fair value of financial instruments would not represent the full value of the Company.

The Company employed simulation modeling in determining the estimated fair value of financial instruments for which quoted market prices were not available based upon the following assumptions:

Cash and Cash Equivalents, Federal Home Loan Bank Stock, Accrued Interest Receivable, Accrued Interest Payable, and Short-Term Borrowings

The fair value is equal to the current carrying value.

Bank-Owned Life Insurance

The fair value is equal to the cash surrender value of the life insurance policies.

Investment Securities Available for Sale

The fair value of investment securities is equal to the available quoted market price. If no quoted market price is available, fair value is estimated using the quoted market price for similar securities. Fair value for certain private-label collateralized mortgage obligations were determined utilizing discounted cash flow models, due to the absence of a current market to provide reliable market quotes for the instruments.

Loans

The fair value is estimated by discounting future cash flows using current market inputs at which loans with similar terms and qualities would be made to borrowers of similar credit quality. Where quoted market prices were available, primarily for certain residential mortgage loans, such market rates were used as estimates for fair value.

Deposits and Other Borrowed Funds

The fair values of certificates of deposit and other borrowed funds are based on the discounted value of contractual cash flows. The discount rates are estimated using rates currently offered for similar instruments with similar remaining maturities. Demand, savings, and money market deposits are valued at the amount payable on demand as of year-end.

Commitments to Extend Credit

These financial instruments are generally not subject to sale, and estimated fair values are not readily available. The carrying value, represented by the net deferred fee arising from the unrecognized commitment or letter of credit, and the fair value, determined by discounting the remaining contractual fee over the term of the commitment using fees currently charged to enter into similar agreements with similar credit risk, are not considered material for disclosure.

 

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NOTE 5—INVESTMENT SECURITIES AVAILABLE FOR SALE

The amortized cost and fair values of securities available for sale are as follows:

 

		March 31, 2012
						Gross				Gross
		Amortized				Unrealized				Unrealized				Fair
(Dollar amounts in thousands)		Cost				Gains				Losses				Value
U.S. government agency securities		$	20,162			$	399			$	(18	)		$	20,543
Obligations of states and political subdivisions:
Taxable			8,204				646				—				8,850
Tax-exempt			75,123				3,691				(44	)			78,770
Mortgage-backed securities in government-sponsored entities			66,350				1,761				(51	)			68,060
Private-label mortgage backed securities			6,361				467				(32	)			6,796
Total debt securities			176,200				6,964				(145	)			183,019
Equity securities in financial institutions			750				1				—				751
Total		$	176,950			$	6,965			$	(145	)		$	183,770

 

		December 31, 2011
						Gross				Gross
		Amortized				Unrealized				Unrealized				Fair
		Cost				Gains				Losses				Value
U.S. government agency securities		$	31,520			$	427			$	(14	)		$	31,933
Obligations of states and political subdivisions:
Taxable			8,207				766				—				8,973
Tax-exempt			75,807				3,681				(61	)			79,427
Mortgage-backed securities in government-sponsored entities			63,808				1,819				(54	)			65,573
Private-label mortgage-backed securities			7,005				411				(95	)			7,321
Total debt securities			186,347				7,104				(224	)			193,227
Equity securities in financial institutions			750				—				—				750
Total		$	187,097			$	7,104			$	(224	)		$	193,977

 

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

 

		Amortized				Fair
(Dollar amounts in thousands)		Cost				Value
Due in one year or less		$	2,303			$	2,353
Due after one year through five years			4,769				5,065
Due after five years through ten years			17,911				18,745
Due after ten years			151,217				156,856
Total		$	176,200			$	183,019

There were no sales of investment securities available for sale during the three-months ended March 31, 2012. Proceeds from the sales of investment securities available for sale were $14.9 million during the three-months ended March 31, 2011. Gross gains realized were $15,000 during the three-months ended March 31, 2011.

Investment securities with an approximate carrying value of $52,126,000 and $47,187,000 at March 31, 2012 and 2011, respectively, were pledged to secure deposits and other purposes as required by law.

The following tables show the Company’s gross unrealized losses and fair value, aggregated by investment category and length of time that the individual securities have been in a continuous unrealized loss position.

 

		March 31, 2012
		Less than Twelve Months								Twelve Months or Greater								Total
						Gross								Gross								Gross
		Fair				Unrealized				Fair				Unrealized				Fair				Unrealized
(Dollar amounts in thousands)		Value				Losses				Value				Losses				Value				Losses
U.S. government agency securities		$	980			$	(18	)		$	—			$	—			$	980			$	(18	)
Obligations of states and political subdivisions			1,091				(19	)			532				(25	)			1,623				(44	)
Mortgage-backed securities in government-sponsored entities			9,407				(51	)			—				—				9,407				(51	)
Private-label mortgage-backed securities			—				—				396				(32	)			396				(32	)
Total		$	11,478			$	(88	)		$	928			$	(57	)		$	12,406			$	(145	)

 

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		December 31, 2011
		Less than Twelve Months								Twelve Months or Greater								Total
						Gross								Gross								Gross
		Fair				Unrealized				Fair				Unrealized				Fair				Unrealized
		Value				Losses				Value				Losses				Value				Losses
U.S. government agency securities		$	1,986			$	(14	)		$	—			$	—			$	1,986			$	(14	)
Obligations of states and political subdivisions			2,707				(40	)			919				(21	)			3,626				(61	)
Mortgage-backed securities in government-sponsored entities			8,992				(54	)			—				—				8,992				(54	)
Private-label mortgage-backed securities			1,628				(42	)			398				(53	)			2,026				(95	)
Total		$	15,313			$	(150	)		$	1,317			$	(74	)		$	16,630			$	(224	)

On a quarterly basis, the Company performs an assessment to determine whether there have been any events or economic circumstances indicating that a security with an unrealized loss has suffered other-than-temporary impairment (“OTTI”) pursuant to FASB ASC Topic 320 Investments — Debt and Equity Securities. A debt security is considered impaired if the fair value is less than its amortized cost basis at the reporting date. The accounting literature requires the Company to assess whether the unrealized loss is other-than-temporary. Prior to the adoption of FSP FAS 115-2, which was subsequently incorporated into FASB ASC Topic 320 Investments — Debt and Equity Securities, unrealized losses that were determined to be temporary were recorded, net of tax, in other comprehensive income for available for sale securities, whereas unrealized losses related to held-to-maturity securities determined to be temporary were not recognized. Regardless of whether the security was classified as available for sale or held to maturity, unrealized losses that were determined to be other than temporary were recorded to earnings. An unrealized loss was considered other than temporary if (i) it was probable that the holder would not collect all amounts due according to the contractual terms of the debt security, or (ii) the fair value was below the amortized cost of the debt security for a prolonged period of time and the Company did not have the positive intent and ability to hold the security until recovery or maturity.

OTTI losses are recognized in earnings when the Company has the intent to sell the debt security or it is more likely than not that it will be required to sell the debt security before recovery of its amortized cost basis. However, even if the Company does not expect to sell a debt security, it must evaluate expected cash flows to be received and determine if a credit loss has occurred.

Under this ASC, an unrealized loss is generally deemed to be other than temporary and a credit loss is deemed to exist if the present value of the expected future cash flows is less than the amortized cost basis of the debt security. As a result the credit loss component of an OTTI is recorded as a component of investment securities gains (losses) in the accompanying Consolidated Statement of Income, while the remaining portion of the impairment loss is recognized in other comprehensive income, provided the Company does not intend to sell the underlying debt security and it is “more likely than not” that the Company will not have to sell the debt security prior to recovery.

Debt securities issued by U.S. government agencies, U.S. government-sponsored enterprises, and state and political subdivisions accounted for more than 96% of the total available-for-sale portfolio as of March 31, 2012 and no credit losses are expected, given the explicit and implicit guarantees provided by the U.S. federal government and the lack of significant unrealized loss positions within the obligations of state and political subdivisions security portfolio. The Company’s assessment was concentrated mainly on private-label collateralized mortgage obligations of approximately $6.8 million for which the Company evaluates credit losses on a quarterly basis. The gross unrealized gain position related to these private-label collateralized mortgage obligations amounted to $467,000 and the gross unrealized loss position was $32,000 on March 31, 2012. The Company considered the following factors in determining whether a credit loss exists and the period over which the debt security is expected to recover:

 

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•

The length of time and the extent to which the fair value has been less than the amortized cost basis.

 

•

Changes in the near term prospects of the underlying collateral of a security such as changes in default rates, loss severity given default and significant changes in prepayment assumptions;

 

•

The level of cash flows generated from the underlying collateral supporting the principal and interest payments of the debt securities; and

 

•

Any adverse change to the credit conditions and liquidity of the issuer, taking into consideration the latest information available about the overall financial condition of the issuer, credit ratings, recent legislation and government actions affecting the issuer’s industry and actions taken by the issuer to deal with the present economic climate.

For the three months ended March 31, 2012, there were no available-for-sale debt securities with an unrealized loss that suffered OTTI.

NOTE 6—LOANS AND RELATED ALLOWANCE FOR LOAN LOSSES

Major classifications of loans are summarized as follows (in thousands):

 

		March 31,				December 31,
		2012				2011
Commercial and industrial		$	60,924			$	59,185
Real estate—construction			21,444				21,545
Real estate—mortgage:
Residential			207,735				208,139
Commercial			109,941				108,502
Consumer installment			4,225				4,509
			404,269				401,880
Less allowance for loan losses			7,267				6,819
Net loans		$	397,002			$	395,061

The Company’s primary business activity is with customers located within its local trade area, eastern Geauga County, and contiguous counties to the north, east, and south. The Company also serves the central Ohio market with offices in Dublin and Westerville, Ohio. Commercial, residential, consumer, and agricultural loans are granted. Although the Company has a diversified loan portfolio, loans outstanding to individuals and businesses are dependent upon the local economic conditions in the Company’s immediate trade area.

 

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The following tables summarize the primary segments of the loan portfolio and allowance for loan losses (in thousands):

 

										Real Estate- Mortgage
March 31, 2012		Commercial and industrial				Real estate- construction				Residential				Commercial				Consumer installment				Total
Total loans		$	60,924			$	21,444			$	207,735			$	109,941			$	4,225			$	404,269
Individually evaluated for impairment		$	4,020			$	700			$	4,743			$	7,119			$	—			$	16,582
Collectively evaluated for impairment			56,904				20,744				202,992				102,822				4,225				387,687

 

										Real estate- Mortgage
December 31, 2011		Commercial and industrial				Real estate- construction				Residential				Commercial				Consumer installment				Total
Total loans		$	59,185			$	21,545			$	208,139			$	108,502			$	4,509			$	401,880
Individually evaluated for impairment		$	4,492			$	867			$	4,882			$	6,491			$	—			$	16,732
Collectively evaluated for impairment			54,693				20,678				203,257				102,011				4,509				385,148

 

										Real Estate- Mortgage
March 31, 2012		Commercial and industrial				Real estate- construction				Residential				Commercial				Consumer installment				Total
Allowance for loan losses:
Ending allowance balance attributable to loans:
Individually evaluated for impairment		$	460			$	125				338			$	252				—			$	1,175
Collectively evaluated for impairment			952				352				3,626				1,116				46				6,092
Total ending allowance balance		$	1,412			$	477			$	3,964			$	1,368			$	46			$	7,267

 

										Real Estate- Mortgage
December 31, 2011		Commercial and industrial				Real estate- construction				Residential				Commercial				Consumer installment				Total
Allowance for loan losses:
Ending allowance balance attributable to loans:
Individually evaluated for impairment		$	196			$	125				—			$	551				—			$	872
Collectively evaluated for impairment			1,100				313				3,731				755				48				5,947
Total ending allowance balance		$	1,296			$	438			$	3,731			$	1,306			$	48			$	6,819

The Company’s loan portfolio is segmented to a level that allows management to monitor risk and performance. The portfolio is segmented into Commercial and Industrial (“C&I”), Real Estate Construction, Real Estate—Mortgage which is further segmented into Residential and Commercial real estate, and Consumer Installment Loans. The C&I loan segment consists of loans made for the purpose of financing the activities of commercial customers. The residential mortgage loan segment consists of loans made for the purpose of financing the activities of residential homeowners. The commercial mortgage loan segment consists of loans made for the purposed of financing the activities of commercial real estate owners and operators. The consumer loan segment consists primarily of installment loans and overdraft lines of credit connected with customer deposit accounts.

Management evaluates individual loans in all of the commercial segments for possible impairment if the loan is greater than $150,000 and if the loan either is in nonaccrual status, or is risk rated Special Mention or Substandard and is greater than 90 days past due. Loans are considered to be impaired when, based on current information and events, it is probable that the Company will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Factors considered by management in evaluating impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record, and the amount of the shortfall in relation to the principal and interest owed. The Company does not separately evaluate individual consumer and residential mortgage loans for impairment, unless such loans are part of a larger relationship that is impaired.

 

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Once the determination has been made that a loan is impaired, the determination of whether a specific allocation of the allowance is necessary is measured by comparing the recorded investment in the loan to the fair value of the loan using one of three methods: (a) the present value of expected future cash flows discounted at the loan’s effective interest rate; (b) the loan’s observable market price; or (c) the fair value of the collateral less selling costs. The method is selected on a loan-by loan basis, with management primarily utilizing the fair value of collateral method. The evaluation of the need and amount of a specific allocation of the allowance and whether a loan can be removed from impairment status is made on a quarterly basis. The Company’s policy for recognizing interest income on impaired loans does not differ from its overall policy for interest recognition.

The following table presents impaired loans by class, segregated by those for which a specific allowance was required and those for which a specific allowance was not necessary (in thousands):

 

For the Three-months Ended March 31, 2012
		Impaired Loans
		Recorded Investment				Unpaid Principal Balance				Related Allowance				Average Recorded Investment				Interest Income Recognized
With no related allowance recorded:
Commercial and industrial		$	467			$	465			$	—			$	467			$	11
Real estate - construction			203				203				—				203				—
Real estate - mortgage:
Residential			2,469				2,474				—				2,469				27
Commercial			850				852				—				850				14
Consumer installment			28				—				—				28				1
With an allowance recorded:
Commercial and industrial		$	1,314			$	1,316			$	460			$	1,314			$	1
Real estate - construction			268				268				125				268				1
Real estate - mortgage:
Residential			340				341				338				340				—
Commercial			1,034				1,036				252				1,034				12
Consumer installment			—				28				—				—				—
Total:
Commercial and industrial		$	1,781			$	1,781			$	460			$	1,781			$	12
Real estate - construction			471				471				125				471				1
Real estate - mortgage:
Residential			2,809				2,815				338				2,809				27
Commercial			1,884				1,888				252				1,884				26
Consumer installment			28				28				—				28				1

 

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For the Year Ended December 31, 2011
		Impaired Loans
		Recorded Investment				Unpaid Principal Balance				Related Allowance				Average Recorded Investment				Interest Income Recognized
With no related allowance recorded:
Commercial and industrial		$	1,172			$	1,172			$	—			$	2,079			$	57
Real estate - construction			4,250				4,250				—				1,462				201
Real estate - mortgage:
Residential			3,188				3,193				—				1,153				157
Commercial			2,528				2,536				—				2,403				76
Consumer installment			24				24				—				13				2
With an allowance recorded:
Commercial and industrial		$	465			$	465			$	196			$	1,062			$	1
Real estate - construction			271				271				125				137				15
Real estate - mortgage:
Residential			—				—				—				287				—
Commercial			2,555				2,560				551				2,258				21
Total:
Commercial and industrial		$	1,637			$	1,637			$	196			$	3,141			$	58
Real estate - construction			4,521				4,521				125				1,599				216
Real estate - mortgage:
Residential			3,188				3,193				—				1,440				157
Commercial			5,083				5,096				551				4,660				97
Consumer installment			24				24				—				13				2

Management uses a nine point internal risk rating system to monitor the credit quality of the overall loan portfolio. The first five categories are considered not criticized, and are aggregated as “Pass” rated. The criticized rating categories used by management generally follow bank regulatory definitions. The Special Mention category includes assets that are currently protected but are potentially weak, resulting in an undue and unwarranted credit risk, but not to the point of justifying a Substandard classification. Loans in the Substandard category have well-defined weaknesses that jeopardize the liquidation of the debt, and have a distinct possibility that some loss will be sustained if the weaknesses are not corrected. All loans greater than 90 days past due are considered Substandard. Any portion of a loan that has been charged off is placed in the Loss category.

To help ensure that risk ratings are accurate and reflect the present and future capacity of borrowers to repay a loan as agreed, the Company has a structured loan rating process with several layers of internal and external oversight. Generally, consumer and residential mortgage loans are included in the Pass categories unless a specific action, such as bankruptcy, repossession, or death occurs to raise awareness of a possible credit event. The Company’s Commercial Loan Officers are responsible for the timely and accurate risk rating of the loans in their portfolios at origination and on an ongoing basis. The Credit Department performs an annual review of all commercial relationships $200,000 or greater. Confirmation of the appropriate risk grade is included in the review on an ongoing basis. The Company has an experienced Loan Review Department that continually reviews and assesses loans within the portfolio. The Company engages an external consultant to conduct loan reviews on a semi-annual basis. Generally, the external consultant reviews commercial relationships greater than $250,000 and/or criticized relationships greater than $125,000. Detailed reviews, including plans for resolution, are performed on loans classified as Substandard on a quarterly basis. Loans in the Special Mention and Substandard categories that are collectively evaluated for impairment are given separate consideration in the determination of the allowance.

 

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The following table presents the classes of the loan portfolio summarized by the aggregate Pass and the criticized categories of Special Mention, Substandard and Doubtful within the internal risk rating system (in thousands):

 

						Special												Total
March 31, 2012		Pass				Mention				Substandard				Doubtful				Loans
Commercial and industrial		$	55,671			$	1,024			$	4,229			$	—			$	60,924
Real estate - construction			20,948				—				496				—				21,444
Real estate - mortgage:
Residential			192,771				1,022				13,942				—				207,735
Commercial			101,399				1,758				6,784				—				109,941
Consumer installment			4,213				5				7				—				4,225
Total		$	375,002			$	3,809			$	25,458			$	—			$	404,269

 

						Special												Total
December 31, 2011		Pass				Mention				Substandard				Doubtful				Loans
Commercial and industrial		$	53,645			$	1,104			$	4,363			$	73			$	59,185
Real estate - construction			20,883				—				662				—				21,545
Real estate - mortgage:
Residential			192,534				1,100				14,505				—				208,139
Commercial			100,536				443				7,523				—				108,502
Consumer installment			4,495				6				8				—				4,509
Total		$	372,093			$	2,653			$	27,061			$	73			$	401,880

Management further monitors the performance and credit quality of the loan portfolio by analyzing the age of the portfolio as determined by the length of time a recorded payment is past due.

 

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The following table presents the classes of the loan portfolio summarized by the aging categories of performing loans and nonaccrual loans (in thousands):

 

						Still Accruing
						30-59 Days				60-89 Days				90 Days+				Total				Non-				Total
March 31, 2012		Current				Past Due				Past Due				Past Due				Past Due				Accrual				Loans
Commercial and industrial		$	58,027			$	1,188			$	89			$	213			$	1,490			$	1,407			$	60,924
Real estate - construction			20,605				—				—				343				343				496				21,444
Real estate - mortgage:
Residential			194,418				1,211				1,022				555				2,788				10,529				207,735
Commercial			105,686				795				251				—				1,046				3,209				109,941
Consumer installment			4,127				79				19				—				98				—				4,225
Total		$	382,863			$	3,273			$	1,381			$	1,111			$	5,765			$	15,641			$	404,269

 

						Still Accruing
						30-59 Days				60-89 Days				90 Days+				Total				Non-				Total
December 31, 2011		Current				Past Due				Past Due				Past Due				Past Due				Accrual				Loans
Commercial and industrial		$	57,291			$	258			$	16			$	44			$	318			$	1,576			$	59,185
Real estate - construction			20,862				20				—				—				20				663				21,545
Real estate - mortgage:
Residential			193,732				2,624				863				275				3,762				10,645				208,139
Commercial			104,086				83				412				—				495				3,921				108,502
Consumer installment			4,408				60				41				—				101				—				4,509
Total		$	380,379			$	3,045			$	1,332			$	319			$	4,696			$	16,805			$	401,880

An allowance for loan losses (“ALL”) is maintained to absorb losses from the loan portfolio. The ALL is based on management’s continuing evaluation of the risk characteristics and credit quality of the loan portfolio, assessment of current economic conditions, diversification and size of the portfolio, adequacy of collateral, past and anticipated loss experience, and the amount of non-performing loans.

The Company’s methodology for determining the ALL is based on the requirements of ASC Section 310-10-35 for loans individually evaluated for impairment (discussed above) and ASC Subtopic 450-20 for loans collectively evaluated for impairment, as well as the Interagency Policy Statements on the Allowance for Loan and Lease Losses and other bank regulatory guidance. The total of the two components represents the Company’s ALL.

Loans that are collectively evaluated for impairment are analyzed with general allowances being made as appropriate. For general allowances, historical loss trends are used in the estimation of losses in the current portfolio. These historical loss amounts are modified by other qualitative factors.

The classes described above, which are based on the purpose code assigned to each loan, provide the starting point for the ALL analysis. Management tracks the historical net charge-off activity at the purpose code level. A historical charge-off factor is calculated utilizing a defined number of consecutive historical quarters. Consumer and Commercial pools currently use a rolling 8 quarters.

Management has identified a number of additional qualitative factors which it uses to supplement the historical charge-off factor because these factors are likely to cause estimated credit losses associated with the existing loan pools to differ from historical loss experience. The additional factors that are evaluated quarterly and updated using information obtained from internal, regulatory, and governmental sources are: national and local economic trends and conditions; levels of and trends in delinquency rates and non-accrual loans; trends in volumes and terms of loans; effects of changes in lending policies; experience, ability, and depth of lending staff; value of underlying collateral; and concentrations of credit from a loan type, industry and/or geographic standpoint.

 

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Management reviews the loan portfolio on a quarterly basis using a defined, consistently applied process in order to make appropriate and timely adjustments to the ALL. When information confirms all or part of specific loans to be uncollectible, these amounts are promptly charged off against the ALL.

The following table summarizes the primary segments of the loan portfolio as of March 31, 2012 and 2011 (in thousands):

 

		Commercial and industrial				Real estate- construction				Real estate- residential mortgage				Real estate- commercial mortgage				Consumer installment				Total
ALL balance at December 31, 2011		$	1,296			$	438			$	3,731			$	1,306			$	48			$	6,819
Charge-offs			(1	)			—				(98	)			(53	)			(14	)			(166	)
Recoveries			3				—				3				—				8				14
Provision			114				39				328				115				4				600
ALL balance at March 31, 2012		$	1,412			$	477			$	3,964			$	1,368			$	46			$	7,267

 

		Commercial and industrial				Real estate- construction				Real estate- residential mortgage				Real estate- commercial mortgage				Consumer installment				Total
ALL balance at December 31, 2010			962			$	188			$	3,434			$	1,543			$	94			$	6,221
Charge-offs			(70	)			(6	)			(340	)			(10	)			(6	)			(432	)
Recoveries			13				—				—				—				18				31
Provision			134				26				477				215				13				865
ALL balance at March 31, 2011		$	1,039			$	208			$	3,571			$	1,748			$	119			$	6,685

The following tables summarize troubled debt restructurings (in thousands):

Modifications

As of March 31, 2012

 

Troubled Debt Restructurings		Number of Contracts				Pre-Modification Outstanding Recorded Investment				Post-Modification Outstanding Recorded Investment
Commercial and industrial			6			$	178			$	168
Real estate - construction			—				—				—
Real estate - mortgage:
Residential			3				94				88
Commercial			—				—				—
Consumer Installment			1				5				5

 

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Modifications

As of December 31, 2011

 

Troubled debt restructurings		Number of Contracts				Pre-Modification Outstanding Recorded Investment				Post-Modification Outstanding Recorded Investment
Commercial and industrial			8			$	586			$	586
Real estate - construction			2				3,883				3,883
Real estate - mortgage:
Residential			10				1,639				1,639
Commercial			2				1,625				1,625
Consumer installment			2				24				24

There were no troubled debt restructurings that subsequently defaulted as of March 31, 2012 and December 31, 2011.

NOTE 7 – SUBSEQUENT EVENTS

Middlefield Banc Corp. and Banc Opportunity Fund LLC entered into an August 15, 2011 Stock Purchase Agreement, which was amended by the First Amendment, dated September 29, 2011, the Second Amendment, dated October 20, 2011, the Third Amendment, dated November 28, 2011, the Fourth Amendment, dated December 21, 2011, and the Fifth Amendment, dated April 17, 2012. Subject to regulatory approval on the part of the Federal Reserve Bank of Cleveland and the Ohio Division of Financial Institutions, the Stock Purchase Agreement provides for the purchase by Bank Opportunity Fund of up to 24.9% of the common stock of Middlefield Banc Corp. As amended by the Fifth Amendment, the Stock Purchase Agreement provides for Bank Opportunity Fund’s ownership to rise to 24.9% in three stages: (1) ownership of 4.9%, which occurred with the purchase by a Bank Opportunity Fund affiliate of 93,050 shares at $16 per share on April 17, 2012, when the Fifth Amendment was entered into, (2) ownership of 9.9%, which occurred on April 30, 2012 with the purchase by the affiliate of 103,585 additional shares at $16 per share, and (3) assuming stockholder approval is obtained under the Ohio Control Share Acquisition Act, ownership of 24.9%, with the purchase of an estimated 393,600 shares at $17 per share, to occur on or before July 31, 2012. Subject to regulatory approval, Bank Opportunity Fund would also be entitled to designate one director for service on the board of Middlefield Banc Corp. and each of its subsidiary banks.

As previously reported by Middlefield Banc Corp. in a Form 8-K Current Report filed with the SEC on April 23, 2012 and in a Form 8-K Current Report filed with the SEC on May 4, 2012, Middlefield Banc Corp. has sold in a private offering to Bank Opportunity Fund LLC a total of 196,635 shares of common stock, representing 9.9% of shares outstanding immediately after the sale. The shares were purchased by Mr. Eric D. Hovde, an affiliate of Bank Opportunity Fund. Mr. Hovde controls Bank Opportunity Advisors LLC, a Delaware limited liability company that serves as the investment advisor for Bank Opportunity Fund. Mr. Hovde also controls Bank Acquisitions LLC, a Delaware limited liability company that serves as the managing member of Bank Opportunity Fund. Bank Acquisitions LLC controls Bank Opportunity Fund. Middlefield Banc Corp. anticipates that the shares purchased by Mr. Eric D. Hovde will be assigned by him to Bank Opportunity Fund if necessary regulatory approvals are obtained by Bank Opportunity Fund.

 

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The foregoing description of the Stock Purchase Agreement, as amended, is qualified in its entirety by reference to (x) the August 15, 2011 Stock Purchase Agreement (exhibit 10.26 to Middlefield Banc Corp.’s Form 10-K Annual Report for the year ended December 31, 2011), (y) the First, Second, Third, and Fourth Amendments to the Stock Purchase Agreement (exhibits 10.26.1, 10.26.2, 10.26.3, and 10.26.4 to Middlefield Banc Corp.’s Form 10-K Annual Report for the year ended December 31, 2011), and (z) the Fifth Amendment (exhibit 10.26.6 to Middlefield Banc Corp.’s Form 8-K Current Report filed with the SEC on April 23, 2012).

An institutional investor that acquired 4.9% of Middlefield Banc Corp.’s common stock in August of 2011 also has the right under its subscription agreement to purchase from Middlefield Banc Corp. additional shares at $16 per share in order to maintain the institutional investor’s 4.9% interest.

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

The following discussion and analysis provides further detail to the financial condition and results of operations of the Company. The MD&A should be read in conjunction with the notes and financial statements presented in this report.

CHANGES IN FINANCIAL CONDITION

General. The Company’s total assets ended the March 31, 2012 quarter at $657.9 million, an increase of $3.4 million or .5% from December 31, 2011. Investment securities available for sale decreased $10.2 million and net loans increased $2 million. The increase in total assets reflected a corresponding increase in total liabilities of $2.2 million or .4% and an increase in stockholders’ equity of $1.2 million or 2.6%. The increase in total liabilities was the result of deposit growth of $3.0 million or .5%. This was partially offset by decreases to other borrowings and other accrued interest and other liabilities of $270,000 and $491,000, respectively, for the quarter. The increase in stockholders’ equity resulted mostly from an increase in retained earnings and common stock of $1.1 million and $180,000, respectively. A partial offset resulted from a decrease in accumulated other comprehensive income of $40,000.

Cash on hand and due from banks. Cash on hand and due from banks and Federal funds sold represent cash and cash equivalents. Cash and cash equivalents increased $11.2 million or 32.6% to $45.6 million at March 31, 2012 from $34.4 million at December 31, 2011. Deposits from customers into savings and checking accounts, loan and security repayments and proceeds from borrowed funds typically increase these accounts. Decreases result from customer withdrawals, new loan originations, security purchases and repayments of borrowed funds.

Investment securities. Investment securities available for sale on March 31, 2012 totaled $183.8 million, a decrease of $10.2 million or 5.3% from $194.0 million at December 31, 2011. During this period the Company recorded purchases of available for sale securities of $8.6 million, consisting of mortgage-backed securities, municipal and U. S. government bonds. Offsetting the purchases of securities were repayments, calls, and maturities of $18.5 million.

 

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Loans receivable. The loans receivable category consists primarily of single family mortgage loans used to purchase or refinance personal residences located within the Company’s market area and commercial real estate loans used to finance properties that are used in the borrowers businesses or to finance investor-owned rental properties, and to a lesser extent, construction and consumer loans. Net loans receivable increased $1.9 million or .5% to $397.0 million as of March 31, 2012 from $395.1 million at December 31, 2011. Included in this amount was an increase in the commercial real estate mortgage segment of $1.4 million or 1.3% as well as the commercial and industrial loan portfolio of $1.7 million or 2.9% during the three months ended March 31, 2012. The Company’s lending philosophy centers around the growth of the commercial loan portfolio. The Company has taken a proactive approach in servicing the needs of both new and current clients. These relationships generally offer more attractive returns than residential loans and also offer opportunities for attracting larger balance deposit relationships. However, the shift in loan portfolio mix from residential real estate to commercial oriented loans may increase credit risk.

Allowance for Loan Losses and Asset Quality. In the first quarter of 2012, the weakness in real estate values and the economy appears to have curtailed somewhat. Small business customers have seen a marked improvement in revenue-producing activity. Delinquency has also improved due to additional staffing. These additions have led to more timely and personal collection contact with borrowers, positively impacting overall delinquency.

The Company increased the allowance for loan losses to $7.3 million, or 1.8% of total loans, at March 31, 2012, compared to $6.8 million, or 1.7%, at December 31, 2011. The increase in the allowance for loan losses is a continuation of the Company’s approach to accurately measure credits identified as troubled in quarters past. The impact of charge-offs remains, but has waned since the same period in 2011. First quarter 2012 net loan charge-offs totaled $152,000, or 0.04% of average loans, compared to $401,000, or 0.11%, for the first quarter of 2011. To maintain the adequacy of the allowance for loan losses, the Company recorded a first quarter provision for loan losses of $600,000, versus $865,000 for the first quarter of 2011.

Management analyzes the adequacy of the allowance for loan losses regularly through reviews of the performance of the loan portfolio considering economic conditions, changes in interest rates and the effect of such changes on real estate values and changes in the amount and composition of the loan portfolio. The allowance for loan losses is a material estimate that is particularly susceptible to significant changes in the near term. Such evaluation, which includes a review of all loans for which full collectability may not be reasonably assured, considers among other matters, historical loan loss experience, the estimated fair value of the underlying collateral, economic conditions, current interest rates, trends in the borrower’s industry and other factors that management believes warrant recognition in providing for an appropriate allowance for loan losses. Future additions to the allowance for loan losses will be dependent on these factors. Additionally, the Company uses an outside party to conduct an independent review of commercial and commercial real estate loans. The Company uses the results of this review to help determine the effectiveness of the existing policies and procedures, and to provide an independent assessment of the allowance for loan losses allocated to these types of loans. Management believes that the allowance for loan losses was appropriately stated at March 31, 2012. Based on the variables involved and the fact that management must make judgments about outcomes that are uncertain, the determination of the allowance for loan losses is considered a critical accounting policy.

 

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Non-performing assets. Non-performing assets includes non-accrual loans, troubled debt restructurings (TDRs), loans 90 days or more past due, assets purchased by EMORECO from EB, other real estate, and repossessed assets. A loan is classified as non-accrual when, in the opinion of management, there are serious doubts about collectability of interest and principal. Accrual of interest is discontinued on a loan when management believes, after considering economic and business conditions, the borrower’s financial condition is such that collection of principal and interest is doubtful. Payments received on nonaccrual loans are applied against principal according to management’s shadow accounting system. The shadow accounting system tracks interest on nonaccrual loan payments as though current. The shadow account splits principal and interest on payments while the actual account undergoes only a principal reduction. TDRs are those loans which the Company, for economic or legal reasons related to a borrower’s financial difficulties, grants a concession to the borrower that the Company would not otherwise consider. The Company has 41 TDRs with a total balance of $4.1 million as of March 31, 2012. Non-performing loans amounted to $17.7 million or 4.4% and $24.5 million or 6.1% of total loans at March 31, 2012 and December 31, 2011, respectively. The decrease in nonperforming loans has occurred primarily due to performance of previously classified TDRs. A TDR that yields market interest rate at the time of restructuring and is in compliance with its modified terms is no longer reported as TDR in calendar years after the year in which the restructuring took place. To be in compliance with its modified terms, a loan that is a TDR must not be in nonaccrual status and must be current or less than 30 days past due on its contractual principal and interest payments under the modified repayment terms. Non-performing loans secured by real estate totaled $16.6 million as of March 31, 2012, down $6.2 million from $22.8 million at December 31, 2011. The stabilization of the economy has somewhat alleviated this previously negative trend. Real estate owned is written down to fair value at its initial recording and continually monitored for changes in fair value.

 

(Dollar amounts in thousands)		3/31/2012				12/31/2011				9/30/2011				6/30/2011				3/31/2011
Nonperforming loans		$	17,677			$	24,546			$	22,725			$	22,469			$	22,014
Real estate owned			2,125				2,196				2,173				2,145				2,248
Nonperforming assets			19,802				26,742				24,898				24,614				24,262
Allowance for loan losses			7,267				6,819				7,574				7,027				6,685
Ratios
Nonperforming loans to total loans			4.37	%			6.11	%			5.85	%			5.83	%			5.85	%
Nonperforming assets to total assets			3.01	%			4.09	%			3.77	%			3.85	%			3.82	%
Allowance for loan losses to total loans			1.80	%			1.70	%			1.95	%			1.82	%			1.78	%
Allowance for loan losses to nonperforming loans			41.11	%			27.78	%			33.33	%			31.27	%			30.37	%

A major factor in determining the appropriateness of the allowance for loan losses is the type of collateral which secures the loans. Of the total nonperforming loans at March 31, 2012, 94.1% were secured by real estate. Although this does not insure against all losses, the real estate typically provides for at least partial recovery, even in a distressed-sale and declining-value environment. In response to the poor economic conditions which have eroded the performance of the Company’s loan portfolio, additional resources have been allocated to the loan workout process. The Company’s objective is to minimize the future loss exposure to the Company.

 

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Deposits. The Company considers various sources when evaluating funding needs, including but not limited to deposits, which are a significant source of funds totaling $583.9 million or 96.1% of the Company’s total funding sources at March 31, 2012. Total deposits increased $3.0 million or .5% to $583.9 million at March 31, 2012 from $581.0 million at December 31, 2011. The increase in deposits is primarily related to the growth of interest-bearing demand, noninterest-bearing demand, and savings accounts of $7.7 million or 13.7%, $1.2 million or 1.8%, and $5.0 million or 3.0%, respectively, at March 31, 2012. These increases were largely offset by a decline in certificates of deposit and money market deposit accounts of $6.3 million or 2.9% and $4.6 million or 6.0%, respectively, during the three months ended March 31, 2012.

Borrowed funds. The Company uses short and long-term borrowings as another source of funding used for asset growth and liquidity needs. These borrowings primarily include FHLB advances, junior subordinated debt, short-term borrowings from other banks and repurchase agreements. Short-term borrowings decreased $27,000 or .4% to $7.4 million as of March 31, 2012. Other borrowings, representing advances from the Federal Home Loan Bank of Cincinnati, declined $270,000 for the quarter. The decline in FHLB advances was the result of scheduled principal payments.

Stockholders’ equity. Stockholders’ equity increased $1.2 million or 2.6% to $48.5 million at March 31, 2012 from $47.3 million at December 31, 2011. This increase was the result of increases in common stock and retained earnings of $180,000 and $1.1 million, respectively. A partial offset resulted from dividends paid of $457,000 and a decrease in accumulated other comprehensive income, due to decreases in the market value of the Company’s securities available for sale portfolio, of $40,000. The increase in common stock was the result of issuing 9,349 shares via the Company’s dividend reinvestment plan at a price of $19.27 since December 31, 2011.

RESULTS OF OPERATIONS

General. Net income for the three months ended March 31, 2012, was $1.5 million, a $521,000, or 52.0% increase from the $1.0 million earned during the same period in 2011. Diluted earnings per share for the first quarter of 2012 was $0.86 compared to $0.62 for the same period in 2011.

The Company’s annualized return on average assets (ROA) and return on average equity (ROE) for the first quarter were 0.94% and 12.81%, respectively, compared with 0.63% and 10.50% for the first quarter of 2011.

The Company’s year-to-date earnings were positively impacted by an increase in loan income combined with a decrease in deposit interest expense. This was partially offset by an increase in non-interest expense.

Net interest income. Net interest income, the primary source of revenue for the Company, is determined by the Company’s interest rate spread, which is defined as the difference between income on earning assets and the cost of funds supporting those assets, and the relative amounts of interest-earning assets and interest-bearing liabilities. Management periodically adjusts the mix of assets and liabilities, as well as the rates earned or paid on those assets and liabilities in order to manage and improve net interest income. The level of interest rates and changes in the amount and composition of interest-earning assets and liabilities affect the Company’s net interest income. Historically from an interest rate risk perspective, it has been management’s goal to maintain a balance between steady net interest income growth and the risks associated with interest rate fluctuations.

 

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Net interest income for the three-months ended March 31, 2012 totaled $5.5 million, an increase of 10.5% from the $5.0 million reported for the comparable period of 2011. The net interest margin was 3.89% for the first quarter of 2012, up from the 3.68% reported for the same quarter of 2011. The increase is primarily attributable to lower interest-bearing liability costs, which decreased 51 basis points to 1.26%. Deposit growth at the Banks has primarily been in products such as savings and interest-bearing demand accounts, which generally carry lower interest costs than other deposit alternatives.

Interest income. Interest income decreased $127,000, or 1.7%, for the three months ended March 31, 2012, compared to the same period in the prior year. This can be attributed to a decrease in interest earned on taxable investment securities of $408,000.

Interest earned on loans receivable increased $236,000, or 4.5%, for the three months ended March 31, 2012, compared to the same period in the prior year. This increase was attributable to a $27.1 million or 7.3% increase in the average balance of loans receivable from March 31, 2011.

Interest earned on securities decreased $359,000, or 17.8%, for the three months ended March 31, 2012, compared to the same period in the prior year. This was primarily the result of a decrease in the average balance of the securities portfolio of $5.8 million, or 3.0%, to $189.3 million at March 31, 2012 from $195.1 million for the same period in the prior year. Interest income on investment securities was adversely affected by a decrease in the portfolio yield. The total investment securities portfolio yield of 4.35% for the three months ended March 31, 2012 decreased by 60 basis points from 4.95% for the same period in the prior year.

Interest expense. Interest expense decreased $655,000, or 28.0%, for the three months ended March 31, 2012, compared to the same period in the prior year. This can be attributed to decreases in interest incurred on deposits and trust preferred securities of $540,000 and $90,000, respectively. The reduction was exacerbated by the reduction of the rate paid on interest-bearing liabilities of 51 basis points when compared to the three-months ended March 31, 2011.

Interest incurred on deposits, the largest component of the Company’s interest-bearing liabilities, declined $540,000, or 26.5%, for the three months ended March 31, 2012, compared to the same period in the prior year. This decrease was attributed to a decline in average rate paid on deposits of 1.17% for the three months ended March 31, 2012 from 1.62% for the same period in the prior year. The improvement in interest cost due to rates was partially offset by increases in the average balance of interest-bearing deposits of $5.6 million, or 1.1%, to $515.4 million for the three months ended March 31, 2012, compared to $509.8 million for the same period in the prior year. This increase is reflected in the quarterly rate volume report presented below depicting the cost decrease associated with interest-bearing liabilities. The Company diligently monitors the interest rates on its products as well as the rates being offered by its competition and utilizing rate surveys to minimize total interest expense.

Interest incurred on borrowed funds, declined by $115,000, for the three months ended March 31, 2012, compared with the same period in the prior year. This decline was primarily attributable to a reduction of $90,000 in interest paid on trust preferred securities when compared to March 31, 2012.

Provision for loan losses. The provision for loan losses represents the charge to income necessary to adjust the allowance for loan losses to an amount that represents management’s assessment of the estimated probable incurred credit losses inherent in the loan portfolio. Each quarter management performs a review of estimated probable incurred credit losses in the loan portfolio. Based on this review, a provision for loan losses of $600,000 was recorded for the quarter ended March 31, 2012 compared to $865,000 for the quarter ended March 31, 2011. The provision for loan losses was lower for the current quarter due to decreases in net charge-offs and decreases in nonperforming and delinquent loans. Nonperforming loans were $17.7 million, or 4.37% of total loans at March 31, 2012 compared with $22.0 million, or 5.9% at March 31, 2011. Net charge-offs were $152,000 for the quarter ended March 31, 2012 compared with $401,000 for the quarter ended March 31, 2011. Total loans were $404.3 million at March 31, 2012 compared with $376.5 million at March 31, 2011.

 

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Non-interest income. Non-interest income increased $95,000 for the three-month period of 2012 over the comparable 2011 period. This increase was the result of an $85,000 gain on the sale of an Emerald Bank loan and increased revenue from investment services of $24,000. A partial offset is related to a decrease in EMORECO rental income of $36,000.

Non-interest expense. Non-interest expense of $3.8 million for the first quarter of 2012 was 2.1%, or $77,000 higher than the first quarter of 2011. The increase in salaries and employee benefits of $60,000 is primarily attributable to a 15.8% growth in salary related expenses, from $1.5 million to $1.3 million at March 31, 2012 and 2011, respectively. The growth in salary-related expenses is commensurate with the continued growth of the Company. This growth was offset by a reduction in group insurance of 32.4%, from $429,000 to $290,000 at March 31, 2012 and 2011, respectively. FDIC assessments were $18,000 higher than the same quarter last year. The loss on the sale of other real estate owned is $18,000 compared to a gain of $20,000 in the comparable 2011 period. Included in this total is the Company’s non-bank asset resolution subsidiary EMORECO which had $26,000 in loan and other real estate owned expenses as of March 31, 2012.

Provision for income taxes. The Company recognized $435,000 in income tax expense, which reflected an effective tax rate of 22.2% for the three months ended March 31, 2012, as compared to $145,000 with an effective tax rate of 12.6% for the respective 2011 period. The increase in the tax provision can be attributed to an increase in income before taxes of $811,000 or 70.7% when compared to the same quarter in the prior year.

CRITICAL ACCOUNTING ESTIMATES

The Company’s critical accounting estimates involving the more significant judgments and assumptions used in the preparation of the consolidated financial statements as of March 31, 2012, have remained unchanged from December 31, 2011.

Average Balance Sheet and Yield/Rate Analysis. The following table sets forth, for the periods indicated, information concerning the total dollar amounts of interest income from interest-earning assets and the resultant average yields, the total dollar amounts of interest expense on interest-bearing liabilities and the resultant average costs, net interest income, interest rate spread and the net interest margin earned on average interest-earning assets. For purposes of this table, average balances are calculated using monthly averages and the average loan balances include non-accrual loans and exclude the allowance for loan losses, and interest income includes accretion of net deferred loan fees. Interest and yields on tax-exempt securities (tax-exempt for federal income tax purposes) are shown on a fully tax equivalent basis utilizing a federal tax rate of 34%. Yields and rates have been calculated on an annualized basis utilizing monthly interest amounts.

 

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		For the Three Months Ended March 31,
		2012												2011
		Average								Average				Average								Average
(Dollars in thousands)		Balance				Interest				Yield/Cost				Balance				Interest				Yield/Cost
Interest-earning assets:
Loans receivable		$	401,047			$	5,537				5.55	%		$	373,916			$	5,301				5.75	%
Investment securities (3)			189,280				1,662				4.35	%			195,074				2,021				4.95	%
Interest-bearing deposits with other banks			23,049				33				0.58	%			24,119				37				0.62	%
Total interest-earning assets			613,376				7,232				4.99	%			593,109				7,359				5.28	%
Noninterest-earning assets			39,916												37,326
Total assets		$	653,292											$	630,435
Interest-bearing liabilities:
Interest—bearing demand deposits		$	57,976			$	60				0.42	%		$	49,950			$	80				0.65	%
Money market deposits			72,390				74				0.41	%			71,927				178				1.00	%
Savings deposits			168,575				166				0.40	%			151,029				337				0.90	%
Certificates of deposit			216,503				1,197				2.22	%			236,917				1,442				2.47	%
Borrowings			24,107				189				3.15	%			26,784				304				4.60	%
Total interest-bearing liabilities			539,551				1,686				1.26	%			536,607				2,341				1.77	%
Noninterest-bearing liabilities
Other liabilities			65,926								0.28	%			55,956								0.40	%
Stockholders’ equity			47,815												37,872
Total liabilities and stockholders’ equity		$	653,292											$	630,435
Net interest income						$	5,546											$	5,018
Interest rate spread (1)											3.74	%											3.51	%
Net yield on interest-earning assets (2)											3.89	%											3.68	%
Ratio of average interest-earning assets to average interest-bearing liabilities											113.68	%											110.53	%

 

(1)	Interest rate spread represents the difference between the average yield on interest-earning assets and the average cost of interest-bearing liabilities

(2)	Net interest margin represents net interest income as a percentage of average interest-earning assets.

(3)	Tax equivalent adjustments to interest incomefor tax-exempt securities was $385 and $360 for 2012 and 2011, respectively.

Analysis of Changes in Net Interest Income. The following table analyzes the changes in interest income and interest expense, between the three month periods ended March 31, 2012 and 2011, in terms of: (1) changes in volume of interest-earning assets and interest-bearing liabilities and (2) changes in yields and rates. The table reflects the extent to which changes in the Company’s interest income and interest expense are attributable to changes in rate (change in rate multiplied by prior period volume), changes in volume (changes in volume multiplied by prior period rate) and changes attributable to the combined impact of volume/rate (change in rate multiplied by change in volume). The changes attributable to the combined impact of volume/rate are allocated on a consistent basis between the volume and rate variances. Changes in interest income on securities reflects the changes in interest income on a fully tax-equivalent basis.

 

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		For the Three Months ended March 31,
		2012 versus 2011
		Increase (decrease) due to
(Dollars in thousands)		Volume				Rate				Total
Interest-earning assets:
Loans receivable		$	388			$	(152	)		$	236
Investment securities			(71	)			(288	)			(359	)
Interest-bearing deposits with other banks			(2	)			(2	)			(4	)
Total interest-earning assets			315				(442	)			(127	)
Interest-bearing liabilities:
Interest—bearing demand deposits			13				(33	)			(20	)
Money market deposits			1				(105	)			(104	)
Savings deposits			39				(210	)			(171	)
Certificates of deposit			(125	)			(120	)			(245	)
Borrowings			(31	)			(84	)			(115	)
Total interest-bearing liabilities			(103	)			(552	)			(655	)
Net interest income		$	418			$	110			$	528

LIQUIDITY

Management’s objective in managing liquidity is maintaining the ability to continue meeting the cash flow needs of its customers, such as borrowings or deposit withdrawals, as well as its own financial commitments. The principal sources of liquidity are net income, loan payments, maturing and principal reductions on securities and sales of securities available for sale, federal funds sold and cash and deposits with banks. Along with its liquid assets, the Company has additional sources of liquidity available to ensure that adequate funds are available as needed. These include, but are not limited to, the purchase of federal funds, and the ability to borrow funds under line of credit agreements with correspondent banks and a borrowing agreement with the Federal Home Loan Bank of Cincinnati, Ohio and the adjustment of interest rates to obtain depositors. Management believes the Company has the capital adequacy, profitability and reputation to meet the current and projected needs of its customers.

For the three months ended March 31, 2012, the adjustments to reconcile net income to net cash from operating activities consisted mainly of depreciation and amortization of premises and equipment, the provision for loan losses, net amortization of securities and net changes in other assets and liabilities. For a more detailed illustration of sources and uses of cash, refer to the condensed consolidated statements of cash flows.

INFLATION

Substantially all of the Company’s assets and liabilities relate to banking activities and are monetary in nature. The consolidated financial statements and related financial data are presented in accordance with U.S. Generally Accepted Accounting Principles (“GAAP”). GAAP currently requires the Company to measure the financial position and results of operations in terms of historical dollars, with the exception of securities available for sale, impaired loans and other real estate loans that are measured at fair value. Changes in the value of money due to rising inflation can cause purchasing power loss.

 

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Management’s opinion is that movements in interest rates affect the financial condition and results of operations to a greater degree than changes in the rate of inflation. It should be noted that interest rates and inflation do affect each other, but do not always move in correlation with each other. The Company’s ability to match the interest sensitivity of its financial assets to the interest sensitivity of its liabilities in its asset/liability management may tend to minimize the effect of changes in interest rates on the Company’s performance.

REGULATORY MATTERS

The Company is subject to the regulatory requirements of The Federal Reserve System as a multi-bank holding company. The affiliate banks are subject to regulations of the Federal Deposit Insurance Corporation (“FDIC”) and the State of Ohio, Division of Financial Institutions.

Effective February 11, 2010, the Board of Directors of the Company’s subsidiary, EB, entered into a Memorandum of Understanding (“MOU”) with the FDIC and the Ohio Division of Financial Institutions as a result of the joint examination by the FDIC and the Ohio Division of Financial Institutions completed in the fourth quarter of 2009. The MOU sets forth certain actions required to be taken by management of EB to rectify unsatisfactory conditions identified by the federal and state banking regulators that relate to EB’s concentration of credit for non-owner occupied 1—4 family residential mortgage loans. The MOU requires EB to reduce delinquent and classified loans and enhance credit administration for non-owner occupied residential real estate; to develop specific plans for the reduction of borrower indebtedness on classified and delinquent credits; to correct violations of laws and regulations listed in the joint examination report; to implement an earnings improvement plan; to maintain specified capital discussed below; to submit to the FDIC and the Ohio Division of Financial Institutions for review and comment a revised methodology for calculating and determining the adequacy of the allowance for loan losses; and to provide 30 days’ advance notification of proposed dividend payments.

Compliance with the terms of the MOU is a high priority for the Company. In anticipation of the requirements that would be imposed by the MOU executed February 11, 2010, management devoted significant resources to the preceding matters during the fiscal years ended December 31, 2010 and 2011, and intends to continue to do so during 2012. Specific actions taken included the evaluation and reorganization of lending and credit administration personnel, retention of collection and workout personnel, and the sale of $5.6 million of nonperforming assets to a sister, nonbank-asset resolution subsidiary established late in the fourth quarter of 2009. In 2010 and 2011, the Company invested $500,000 and $1.5 million in EB in the form of capital infusions to maintain Tier I capital at the level expected by the FDIC and the Ohio Division of Financial Institutions.

The MOU requires that EB submit plans and report to the Ohio Division of Financial Institutions and the FDIC regarding EB’s loan portfolio and profit plan, among other matters. The MOU also requires that the Bank maintain its Tier I Leverage Capital ratio at not less than 9 percent.

 

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The following table sets forth the capital requirements for EB under the FDIC regulations and EB’s capital ratios at March 31, 2012 and December 31, 2011:

 

		FDIC Regulations
Capital Ratio		Adequately Capitalized				Well Capitalized				March 31, 2012				December 31, 2011
Tier I Leverage Capital			4.00	%			5.00	%(1)			9.77	%			9.92	%
Risk-Based Capital:
Tier I			4.00				6.00				13.57				12.57
Total			8.00				10.00				14.85				13.82

 

(1)	9 percent required by the MOU.

REGULATORY CAPITAL REQUIREMENTS

The Company is subject to regulatory capital requirements administered by federal banking agencies. Capital adequacy guidelines and prompt corrective action regulations involve quantitative measures of assets, liabilities and certain off-balance sheet items calculated under regulatory accounting practices. Capital amounts and classifications are also subject to qualitative judgments by regulators about components, risk weightings and other factors and the regulators can lower classifications in certain cases. Failure to meet various capital requirements can initiate regulatory action that could have a direct material effect on the company’s operations.

The prompt corrective action regulations provide five classifications, including well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized and critically undercapitalized, although these terms are not used to represent overall financial condition. If adequately capitalized, regulatory approval is required to accept brokered deposits. If undercapitalized, capital distributions are limited, as is asset growth and expansion and plans for capital restoration are required.

 

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The following table illustrates the Company’s and Banks’ capital ratios at March 31, 2012:

 

		Middlefield Banc Corp.								The Middlefield Banking Co.								Emerald Bank
		March 31,								March 31,								March 31,
		2012								2012								2012
		Amount				Ratio				Amount				Ratio				Amount				Ratio
Total Capital
(to Risk-weighted Assets)
Actual		$	51,527				12.27	%		$	43,286				11.96	%		$	8,025				14.85	%
For Capital Adequacy Purposes			33,585				8.00				28,947				8.00				4,323				8.00
To Be Well Capitalized			41,981				10.00				36,183				10.00				5,404				10.00
Tier I Capital
(to Risk-weighted Assets)
Actual		$	46,254				11.02	%		$	38,756				10.71	%		$	7,331				13.57	%
For Capital Adequacy Purposes			16,792				4.00				14,473				4.00				2,162				4.00
To Be Well Capitalized			25,189				6.00				21,710				5.00				3,242				6.00
Tier I Capital
(to Average Assets)
Actual		$	46,254				7.22	%		$	38,756				6.89	%		$	7,331				9.77	%
For Capital Adequacy Purposes			25,631				4.00				22,499				4.00				3,001				4.00
To Be Well Capitalized			32,038				5.00				28,124				5.00				3,751				5.00

Item 3. Quantitative and Qualitative Disclosures about Market Risk

ASSET AND LIABILITY MANAGEMENT

The primary objective of the Company’s asset and liability management function is to maximize the Company’s net interest income while simultaneously maintaining an acceptable level of interest rate risk given the Company’s operating environment, capital and liquidity requirements, performance objectives and overall business focus. The principal determinant of the exposure of the Company’s earnings to interest rate risk is the timing difference between the repricing and maturity of interest-earning assets and the repricing or maturity of its interest-bearing liabilities. The Company’s asset and liability management policies are designed to decrease interest rate sensitivity primarily by shortening the maturities of interest-earning assets while at the same time extending the maturities of interest-bearing liabilities. The Board of Directors of the Company continues to believe in strong asset/liability management in order to insulate the Company from material losses as a result of prolonged increases in interest rates. As a result of this policy, the Company emphasizes a larger, more diversified portfolio of residential mortgage loans in the form of mortgage-backed securities. Mortgage-backed securities generally increase the quality of the Company’s assets by virtue of the insurance or guarantees that back them, are more liquid than individual mortgage loans and may be used to collateralize borrowings or other obligations of the Company.

 

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MB’s Board of Directors have established an Asset and Liability Management Committee consisting of four outside directors, the President and Chief Executive Officer, Executive/Vice President/ Chief Operating Officer, Senior Vice President/Chief Financial Officer and Senior Vice President/Commercial Lending. This committee, which meets quarterly, generally monitors various asset and liability management policies and strategies, which were implemented by the Company over the past few years. These strategies have included: (i) an emphasis on the investment in adjustable-rate and shorter duration mortgage-backed securities; (ii) an emphasis on the origination of single-family residential adjustable-rate mortgages (ARMs), residential construction loans and commercial real estate loans, which generally have adjustable or floating interest rates and/or shorter maturities than traditional single-family residential loans, and consumer loans, which generally have shorter terms and higher interest rates than mortgage loans; (iii) increase the duration of the liability base of the Company by extending the maturities of savings deposits, borrowed funds and repurchase agreements.

MB and EB have established the following guidelines for assessing interest rate risk:

Net interest income simulation. Given a 200 basis point parallel and gradual increase or decrease in market interest rates, net interest income may not change by more than 10% for a one-year period.

Portfolio equity simulation. Portfolio equity is the net present value of the Company’s existing assets and liabilities. Given a 200 basis point immediate and permanent increase or decrease in market interest rates, portfolio equity may not correspondingly decrease or increase by more than 20% of stockholders’ equity.

The following table presents the simulated impact of a 200 basis point upward and a 200 basis point downward shift of market interest rates on net interest income and the change in portfolio equity. This analysis was done assuming that the interest-earning asset and interest-bearing liability levels at March 31, 2012 remained constant. The impact of the market rate movements was developed by simulating the effects of rates changing gradually over a one-year period from the March 31, 2011 levels for net interest income. The impact of market rate movements was developed by simulating the effects of an immediate and permanent change in rates at March 31, 2012 for portfolio equity:

 

		Increase				Decrease
		200 Basis Points				200 Basis Points
Net interest income—increase			2.81	%			0.04	%
Portfolio equity—increase (decrease)			(16.75	)%			(6.82	)%

Item 4. Controls and Procedures

Controls and Procedures Disclosure

The Company maintains disclosure controls and procedures that are designed to ensure that information required to be disclosed in the Corporation’s reports that it files or submits under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms, and that such information is accumulated and communicated to the Company’s management, including its Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.

 

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As of the end of the period covered by this quarterly report, an evaluation was carried out under the supervision and with the participation of management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of our disclosure controls and procedures (as defined in Exchange Act Rules 13a-14(e) and 15d-14(e) under the Securities Exchange Act of 1934). Based on their evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that the Company’s disclosure controls and procedures are, to the best of their knowledge, effective to ensure that information required to be disclosed by the Corporation in reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms. Subsequent to the date of their evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that there were no significant changes in internal control or in other factors that could significantly affect its internal controls, including any corrective actions with regard to significant deficiencies and material weaknesses.

A material weakness is a significant deficiency (as defined in Public Company Accounting Oversight Board Auditing Standard No. 2), or a combination of significant deficiencies, that results in there being more than a remote likelihood that a material misstatement of the annual or interim financial statements will not be prevented or detected on a timely basis by management or employees in the normal course of performing their assigned functions.

Changes in Internal Control over Financial Reporting

There have not been any changes in the Company’s internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) that occurred during the Company’s most recent 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

None

Item 1a. There are no material changes to the risk factors set forth in Part I, Item 1A, “Risk Factors,” of the Company’s Annual Report on Form 10-K for the year ended December 31, 2011. Please refer to that section for disclosures regarding the risks and uncertainties related to the Company’s business.

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

None

Item 3. Defaults by the Company on its senior securities

None

Item 4. Mine Safety Disclosures

Item 5. Other information

None

Item 6. Exhibits

 

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Exhibit list for Middlefield Banc Corp.’s Form 10-Q Quarterly Report for the Period Ended March 31, 2012

 

exhibit number		description		location
3.1		Second Amended and Restated Articles of Incorporation of Middlefield Banc Corp., as amended		Incorporated by reference to Exhibit 3.1 of Middlefield Banc Corp.’s Annual Report on Form 10-K for the Fiscal Year Ended December 31, 2005, filed on March 29, 2006
3.2		Regulations of Middlefield Banc Corp.		Incorporated by reference to Exhibit 3.2 of Middlefield Banc Corp.’s registration statement on Form 10 filed on April 17, 2001
4.0		Specimen stock certificate		Incorporated by reference to Exhibit 4 of Middlefield Banc Corp.’s registration statement on Form 10 filed on April 17, 2001
4.1		Amended and Restated Trust Agreement, dated as of December 21, 2006, between Middlefield Banc Corp., as Depositor, Wilmington Trust Company, as Property trustee, Wilmington Trust Company, as Delaware Trustee, and Administrative Trustees		Incorporated by reference to Exhibit 4.1 of Middlefield Banc Corp.’s Form 8-K Current Report filed on December 27, 2006
4.2		Junior Subordinated Indenture, dated as of December 21, 2006, between Middlefield Banc Corp. and Wilmington Trust Company		Incorporated by reference to Exhibit 4.2 of Middlefield Banc Corp.’s Form 8-K Current Report filed on December 27, 2006
4.3		Guarantee Agreement, dated as of December 21, 2006, between Middlefield Banc Corp. and Wilmington Trust Company		Incorporated by reference to Exhibit 4.3 of Middlefield Banc Corp.’s Form 8-K Current Report filed on December 27, 2006

 

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exhibit number		description		location
10.1.0*		1999 Stock Option Plan of Middlefield Banc Corp.		Incorporated by reference to Exhibit 10.1 of Middlefield Banc Corp.’s registration statement on Form 10 filed on April 17, 2001
10.1.1*		2007 Omnibus Equity Plan		Incorporated by reference to Middlefield Banc Corp.’s definitive proxy statement for the 2008 Annual Meeting of Shareholders, Appendix A, filed on April 7, 2008
10.2*		Severance Agreement between Middlefield Banc Corp. and Thomas G. Caldwell, dated January 7, 2008		Incorporated by reference to Exhibit 10.2 of Middlefield Banc Corp.’s Form 8-K Current Report filed on January 9, 2008
10.3*		Severance Agreement between Middlefield Banc Corp. and James R. Heslop, II, dated January 7, 2008		Incorporated by reference to Exhibit 10.3 of Middlefield Banc Corp.’s Form 8-K Current Report filed on January 9, 2008
10.4.0*		Severance Agreement between Middlefield Banc Corp. and Jay P. Giles, dated January 7, 2008		Incorporated by reference to Exhibit 10.4 of Middlefield Banc Corp.’s Form 8-K Current Report filed on January 9, 2008
10.4.1*		Severance Agreement between Middlefield Banc Corp. and Teresa M. Hetrick, dated January 7, 2008		Incorporated by reference to Exhibit 10.4.1 of Middlefield Banc Corp.’s Form 8-K Current Report filed on January 9, 2008

 

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exhibit number		description		location
10.4.2*		Severance Agreement between Middlefield Banc Corp. and Jack L. Lester, dated January 7, 2008		Incorporated by reference to Exhibit 10.4.2 of Middlefield Banc Corp.’s Form 8-K Current Report filed on January 9, 2008
10.4.3*		Severance Agreement between Middlefield Banc Corp. and Donald L. Stacy, dated January 7, 2008		Incorporated by reference to Exhibit 10.4.3 of Middlefield Banc Corp.’s Form 8-K Current Report filed on January 9, 2008
10.4.4*		Severance Agreement between Middlefield Banc Corp. and Alfred F. Thompson Jr., dated January 7, 2008		Incorporated by reference to Exhibit 10.4.4 of Middlefield Banc Corp.’s Form 8-K Current Report filed on January 9, 2008
10.5		Federal Home Loan Bank of Cincinnati Agreement for Advances and Security Agreement dated September 14, 2000		Incorporated by reference to Exhibit 10.4 of Middlefield Banc Corp.’s registration statement on Form 10 filed on April 17, 2001
10.6*		Amended Director Retirement Agreement with Richard T. Coyne		Incorporated by reference to Exhibit 10.6 of Middlefield Banc Corp.’s Form 8-K Current Report filed on January 9, 2008
10.7*		Amended Director Retirement Agreement with Frances H. Frank		Incorporated by reference to Exhibit 10.7 of Middlefield Banc Corp.’s Form 8-K Current Report filed on January 9, 2008
10.8*		Amended Director Retirement Agreement with Thomas C. Halstead		Incorporated by reference to Exhibit 10.8 of Middlefield Banc Corp.’s Form 8-K Current Report filed on January 9, 2008

 

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exhibit number		description		location
10.9*		Director Retirement Agreement with George F. Hasman		Incorporated by reference to Exhibit 10.9 of Middlefield Banc Corp.’s Annual Report on Form 10-K for the Year Ended December 31, 2001, filed on March 28, 2002
10.10*		Director Retirement Agreement with Donald D. Hunter		Incorporated by reference to Exhibit 10.10 of Middlefield Banc Corp.’s Annual Report on Form 10-K for the Year Ended December 31, 2001, filed on March 28, 2002
10.11*		Director Retirement Agreement with Martin S. Paul		Incorporated by reference to Exhibit 10.11 of Middlefield Banc Corp.’s Annual Report on Form 10-K for the Year Ended December 31, 2001, filed on March 28, 2002
10.12*		Amended Director Retirement Agreement with Donald E. Villers		Incorporated by reference to Exhibit 10.12 of Middlefield Banc Corp.’s Form 8-K Current Report filed on January 9, 2008
10.13*		Executive Survivor Income Agreement (aka DBO agreement [death benefit only]) with Donald L. Stacy		Incorporated by reference to Exhibit 10.14 of Middlefield Banc Corp.’s Annual Report on Form 10-K for the Year Ended December 31, 2003, filed on March 30, 2004
10.14*		DBO Agreement with Jay P. Giles		Incorporated by reference to Exhibit 10.15 of Middlefield Banc Corp.’s Annual Report on Form 10-K for the Year Ended December 31, 2003, filed on March 30, 2004

 

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exhibit number		description		location
10.15*		DBO Agreement with Alfred F. Thompson Jr.		Incorporated by reference to Exhibit 10.16 of Middlefield Banc Corp.’s Annual Report on Form 10-K for the Year Ended December 31, 2003, filed on March 30, 2004
10.16*		Reserved
10.17*		DBO Agreement with Theresa M. Hetrick		Incorporated by reference to Exhibit 10.18 of Middlefield Banc Corp.’s Annual Report on Form 10-K for the Year Ended December 31, 2003, filed on March 30, 2004
10.18*		DBO Agreement with Jack L. Lester		Incorporated by reference to Exhibit 10.19 of Middlefield Banc Corp.’s Annual Report on Form 10-K for the Year Ended December 31, 2003, filed on March 30, 2004
10.19*		DBO Agreement with James R. Heslop, II		Incorporated by reference to Exhibit 10.20 of Middlefield Banc Corp.’s Annual Report on Form 10-K for the Year Ended December 31, 2003, filed on March 30, 2004
10.20*		DBO Agreement with Thomas G. Caldwell		Incorporated by reference to Exhibit 10.21 of Middlefield Banc Corp.’s Annual Report on Form 10-K for the Year Ended December 31, 2003, filed on March 30, 2004
10.21*		Form of Indemnification Agreement with directors of Middlefield Banc Corp. and with executive officers of Middlefield Banc Corp. and The Middlefield Banking Company		Incorporated by reference to Exhibit 99.1 of Middlefield Banc Corp.’s registration statement on Form 10, Amendment No. 1, filed on June 14, 2001

 

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exhibit number		description		location
10.22*		Annual Incentive Plan Summary		Incorporated by reference to the summary description of the annual incentive plan included as Exhibit 10.22 of Middlefield Banc Corp.’s Form 8-K Current Report filed on December 16, 2005
10.23*		Amended Executive Deferred Compensation Agreement with Thomas G. Caldwell		Incorporated by reference to Exhibit 10.23 of Middlefield Banc Corp.’s Form 8-K Current Report filed on May 9, 2008
10.24*		Amended Executive Deferred Compensation Agreement with James R. Heslop, II		Incorporated by reference to Exhibit 10.24 of Middlefield Banc Corp.’s Form 8-K Current Report filed on May 9, 2008
10.25*		Amended Executive Deferred Compensation Agreement with Donald L. Stacy		Incorporated by reference to Exhibit 10.25 of Middlefield Banc Corp.’s Form 8-K Current Report filed on May 9, 2008
31.1		Rule 13a-14(a) certification of Chief Executive Officer		filed herewith
31.2		Rule 13a-14(a) certification of Chief Financial Officer		filed herewith
32		Rule 13a-14(b) certification		filed herewith

 

*	management contract or compensatory plan or arrangement

 

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SIGNATURES

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

 

						MIDDLEFIELD BANC CORP.
Date: May 15, 2012				By:		/s/ Thomas G. Caldwell
						Thomas G. Caldwell
						President and Chief Executive Officer
Date: May 15, 2012				By:		/s/ Donald L. Stacy
						Donald L. Stacy
						Principal Financial and Accounting Officer

 

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