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EX-32 - FIRST FARMERS & MERCHANTS CORPe32.htm
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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C.  20549

 

FORM 10-Q

(Mark one)

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

 

For the quarterly period ended June 30, 2012

or

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

 

For the transition period from _______________ to _______________________

 

Commission File Numbers: 000-10972

 

First Farmers and Merchants Corporation

(Exact name of registrant as specified in its charter)

 

Tennessee  

62-1148660

(State or other jurisdiction of incorporation or organization) 

 (I.R.S. Employer Identification No.)

 

 

                816 South Garden Street

 

                Columbia, Tennessee

38402-1148

(Address of principal executive offices)  

 (Zip Code)

 

931-388-3145

(Registrant’s telephone number, including area code)

 

 

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

             

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

 

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

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

Large accelerated filer [    ] 

Accelerated filer [ X ]

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

Smaller reporting company [    ]

   

 

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

 

As of August 6, 2012, the registrant had 5,330,000 shares of common stock outstanding.

 

 

 

 

 

 

 

 

1


 


 

 

 

 

 

PART I - FINANCIAL INFORMATION

 

 

Item 1. Financial Statements.

 

 

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

 

Condensed consolidated balance sheets – June 30, 2012 and December 31, 2011.

 

Condensed consolidated statements of income - For the three months and six months ended June 30, 2012 and June 30, 2011.

 

Condensed consolidated statements of comprehensive income - For the three months and six months ended June 30, 2012 and June 30, 2011.

 

Condensed consolidated statements of cash flows - For the six months ended June 30, 2012 and June 30, 2011.

 

Selected notes to condensed consolidated financial statements.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2


 


 

 

 

 

 

FIRST FARMERS AND MERCHANTS CORPORATION AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

 

 

June 30,

 

December 31,

 

 

2012

 

2011

 

(Dollars in Thousands, Except Per Share Data)

(Unaudited)

 

(1)

ASSETS

Cash and due from banks

 $         18,442

 

 $         17,927

 

Interest-bearing due from banks

            19,560

 

            16,500

 

Federal funds sold

            15,000

 

            38,594

 

              Total cash and cash equivalents

            53,002

 

            73,021

 

Securities

 

 

 

 

     Available-for-sale (amortized cost $360,392

 

 

 

 

       and $309,374, respectively)

         364,535

 

          314,270

 

     Held-to-maturity (fair market value $34,238

 

 

 

 

       and $37,275, respectively)

            32,429

 

            35,214

 

          Total securities

          396,964

 

          349,484

 

Loans, net of deferred fees

          518,687

 

          517,802

 

     Allowance for loan and lease losses

            (8,772)

 

             (9,200)

 

          Net loans

         509,915

 

          508,602

 

 

 

 

 

 

Bank premises and equipment, net

            26,947

 

            25,537

 

Other real estate owned

              8,243

 

              8,827

 

Bank owned life insurance

            24,742

 

            23,621

 

Goodwill

              9,018

 

              9,018

 

Other assets

            17,729

 

            19,339

 

          TOTAL ASSETS

 $   1,046,560

 

 $    1,017,449

LIABILITIES

Deposits

 

 

 

 

     Noninterest-bearing

 $      150,155

 

 $       144,003

 

     Interest- bearing

         737,293

 

          712,427

 

          Total deposits

         887,448

 

          856,430

 

 

 

 

 

 

Securities sold under agreements to repurchase

            18,670

 

            16,347

 

Accounts payable and accrued liabilities

            17,071

 

            16,265

 

Federal Home Loan Bank advances

            10,100

 

            17,100

 

TOTAL LIABILITIES

          933,289

 

          906,142

SHAREHOLDERS'

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

 

 

 

EQUITY

        authorized; 5,330,000  shares issued

 

 

 

 

        and outstanding as of  June 30, 2012 and

 

 

 

 

         December 31, 2011

            53,300

 

            53,300

 

Retained earnings

            57,328

 

            54,890

 

Accumulated other comprehensive income

              2,548

 

              3,022

 

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

         113,176

 

          111,212

 

Noncontrolling interest - preferred stock of subsidiary

                  95

 

                   95

 

TOTAL SHAREHOLDERS' EQUITY

         113,271

 

          111,307

 

        TOTAL LIABILITIES AND

 

 

 

 

           SHAREHOLDERS' EQUITY

 $   1,046,560

 

 $    1,017,449

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

 

 

 

(1) Derived from audited financial statements.

 

 

 

 

 

3


 


 

 

FIRST FARMERS AND MERCHANTS CORPORATION AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF INCOME (unaudited)

 

 

 

Three Months Ended

Six Months Ended

 

(Dollars in Thousand, Except Per Share Data)

 

June 30,

June 30,

 

 

2012

 

2011

2012

2011

INTEREST AND

     Interest and fees on loans

 

 $

6,968 

 

 $

7,528 

 $

13,948 

 $

15,065 

DIVIDEND INCOME

     Income on investment securities

 

 

 

 

 

 

 

            Taxable interest

 

1,250 

 

1,143 

2,434 

2,068 

 

            Exempt from federal income tax

 

778 

 

910 

1,587 

1,843 

 

            Dividends

 

64 

 

88 

112 

136 

 

Other interest income

 

35 

 

11 

79 

29 

 

          Total interest income

 

9,095 

 

9,680 

18,160 

19,141 

INTERST EXPENSE

     Interest on deposits

 

855 

 

1,077 

1,759 

2,242 

 

     Interest on other borrowings

 

124 

 

178 

291 

385 

 

          Total interest expense

 

979 

 

1,255 

2,050 

2,627 

 

Net interest income

 

8,116 

 

8,425 

16,110 

16,514 

 

Provision for loan and lease losses

 

520 

 

750 

1,120 

1,475 

 

Net interest income after provision

 

7,596 

 

7,675 

14,990 

15,039 

NONINTEREST

     Gain on loans sold

 

129 

 

70 

248 

243 

     INCOME

     Trust department income

 

500 

 

498 

1,036 

1,024 

 

     Service fees on deposit accounts

 

1,642 

 

1,713 

3,290 

3,316 

 

     Brokerage fees

 

68 

 

110 

 

     Earnings on bank owned life insurance

 

216 

 

180 

335 

357 

 

     Gain on sale of securities

 

943 

 

374 

2,155 

434 

 

     Loss on foreclosed property

 

(112)

 

(237)

(526)

(457)

 

     Other non-interest income

 

(26)

 

96 

91 

199 

 

          Total noninterest income

 

3,360 

 

2,694 

6,739 

5,116 

NONINTEREST

     Salaries and employee benefits

 

4,430 

 

4,144 

8,703 

8,278 

    EXPENSE

     Net occupancy expense

 

521 

 

497 

989 

975 

 

     Depreciation expense

 

358 

 

332 

686 

638 

 

     Data processing expense

 

506 

 

483 

981 

947 

 

     Legal and professional fees

 

311 

 

273 

499 

549 

 

     Stationary and office supplies

 

72 

 

90 

121 

165 

 

     Advertising and promotions

 

292 

 

344 

586 

677 

 

     FDIC insurance premium expense

 

356 

 

383 

712 

767 

 

     Other real estate expense

 

47 

 

182 

158 

293 

 

     Other noninterest expense

 

1,523 

 

1,319 

2,735 

2,671 

 

          Total noninterest expenses

 

8,416 

 

8,044 

16,170 

15,960 

 

     Income before provision for income taxes

 

2,540 

 

2,325 

5,559 

4,195 

 

Provision for income taxes

 

451 

 

306 

1,141 

631 

 

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

 

2,089 

 

2,019 

4,418 

3,564 

 

Noncontrolling interest - dividends on preferred stock of subsidiary

 

 

 

Net income for common shareholders

 

 $

2,081 

 

 $

2,011 

 $

4,410 

 $

3,556 

 

Weighted average shares outstanding

 

5,330,000 

 

5,392,760 

5,330,000 

5,410,205 

 

Earnings per share

 

 $

0.39 

 

 $

0.37 

 $

0.83 

 $

0.66 

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

 

 

 

 

 

 

4


 


 

 

 

 

FIRST FARMERS AND MERCHANTS CORPORATION AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (unaudited)

 

 

Three Months Ended

 

Six Months Ended

 

 June 30,

 

June 30,

 

 2012

 2011

 

2012

2011

Net Income

 $

2,081 

 $

2,011 

 

 $

4,410 

 $

3,556 

Comprehensive Income

 

 

 

 

 

Unrealized appreciation (depreciation) on available-for-sale securities, net of taxes of $953 and $1,210 for 2012 and 2011, respectively for three months and net of taxes of $533 and $1,213 for six months

1,522 

1,934 

 

852 

1,938 

Less:  reclassification adjustment for realized (gains) losses included in net income, net of taxes of $363 and $144, for 2012 and 2011, respectively for three months and net of taxes of  ($830) and ($167) for six months

(580)

(230)

 

(1,325)

(267)

Net unrealized gain (loss) on available-for-sale securities

942 

1,704 

 

(473)

1,671 

Comprehensive Income

3,023 

3,715 

 

3,937 

5,227 

Less:  comprehensive income attributable to the noncontrolling interest

-   

-   

 

-   

-   

Total Comprehensive Income

 $

3,023 

 $

3,715 

 

 $

3,937 

 $

5,227 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

5


 


 

 

 

 

 

FIRST FARMERS AND MERCHANTS CORPORATION AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS 

 

(Dollars in Thousands)

Six months ended June 30,

 

 (unaudited)

2012

2011

OPERATING

Net income available for common shareholders

 $                     4,410

 $          3,556

ACTIVITIES

   Adjustments to reconcile net income to net cash provided

 

 

 

     by (used in) operating activities

 

 

 

       Provision for loan losses

                        1,120

             1,475

 

       Provision for depreciation and amortization of

 

 

 

          premises and equipment

                           686

                639

 

       Deferred tax expense

                           (50)

                102

 

       Net securities gains

                      (2,155)

              (434)

 

       Gains on loans sold

                         (248)

                     -

 

       Proceeds from sale of mortgage loans held for sale

                      14,165

                     -

 

       Funding of mortgage loans held for sale

                    (12,597)

                     -

 

      Gain on sale of OREO

                           526

                     -

 

      Gain on sale of assets

                           (10)

                     -

 

       Amortization of deposit base intangibles

                               -

                  18

 

       Amortization of investment security premiums,

 

 

 

          net of accretion of discounts

                        2,128

                718

 

       Increase in cash surrender value of life insurance contracts

                         (335)

              (615)

 

       (Increase) decrease in

 

 

 

          Other assets

                           814

             4,105

 

       Increase (decrease) in

 

 

 

          Other liabilities

                           637

                648

 

               Total adjustments

                        4,665

             6,656

 

               Net cash provided by operating activities

                        9,091

           10,212

INVESTING

Proceeds from sales of available-for-sale securities

                    339,076

           83,446

ACTIVITIES

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

                      35,045

                     -

 

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

                        2,770

             2,655

 

Purchases of investment securities

 

 

 

      available-for-sale

                  (425,115)

       (107,025)

 

Net (increase) decrease in loans

                      (3,698)

           10,713

 

Proceeds from sale of OREO

                        1,323

                     -

 

Purchase of life insurance premium

                         (786)

                     -

 

Purchases of premises and equipment

                      (2,086)

           (2,463)

 

               Net cash used in investing activities

                    (53,471)

         (12,674)

FINANCING

Net increase in deposits

                      31,018

           22,662

ACTIVITIES

Net increase in securities sold under agreements to repurchase

                        2,323

             5,985

 

Payments to FHLB borrowings

                      (7,000)

           (7,000)

 

Repurchase of common stock

                               -

           (1,511)

 

Cash dividends paid on preferred stock

                             (8)

                  (8)

 

Cash dividends paid on common stock

                      (1,972)

                     -

 

               Net cash provided by financing activities

                      24,361

           20,128

 

Increase (decrease) in cash and cash equivalents

                    (20,019)

           17,666

 

Cash and cash equivalents at beginning of period

                      73,021

           32,499

 

Cash and cash equivalents at end of period

 $                   53,002

 $        50,165

 

Supplemental disclosures of cash flow information

 

 

 

Cash paid during the period for expenses

 

 

 

       Interest on deposits and borrowed funds

 $                   1,993

 $        7,107

 

       Income Taxes

                      1,563

            1,607

 

Loans to facilitate sale

                            74

                     -

 

Real estate acquired in settlement of taxes

                      1,191

            1,375

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

 

 

 

 

6


 


 

 

 

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

 

NOTE 1 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

 

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

           

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

 

Reclassifications:  Certain reclassifications considered to be immaterial have been made in the prior year condensed consolidated financial statements to conform to current year presentation.  These reclassifications had no effect on net income.

 

NOTE 2 – FAIR VALUE MEASUREMENT

 

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

 

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

 

  • Level 2 Inputs - Inputs other than quoted prices included in Level 1 that are observable for the asset or liability, either directly or indirectly. These might include quoted prices for similar assets or liabilities in active markets, quoted prices for identical or similar assets or liabilities in markets that are not active, inputs other than quoted prices that are observable for the asset or liability (such as interest rates, volatilities, market consensus, prepayment speeds, credit risks, etc.) or inputs that are derived principally from or corroborated by market data by correlation or other means.

 

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

 

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

 

 

7


 


 

 

 

 

Recurring Measurements

 

The following table summarizes financial assets measured at fair value on a recurring basis as of June 30, 2012 and December 31, 2011, and by the level within the fair value hierarchy utilized to measure fair value (dollars in thousands):

 

Assets measured at fair value on a recurring basis as of June 30, 2012

 

 

 

Available-For-Sale Securities

Level 1

Level 2

Level 3

Total

    U.S. Government agencies

 $

 $

79,893 

 $

 $

79,893 

    U.S. government sponsored agency mortgage backed securities

213,796 

213,796 

    States and political subdivisions

51,972 

51,972 

    Corporate bonds

18,874 

18,874 

    Total assets at fair value

 $

 $

364,535 

 $

 $

364,535 

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

 

 

 

Available-For-Sale Securities

Level 1

Level 2

Level 3

Total

    U.S.Government agencies

 $

 $

59,001 

 $

 $

59,001 

    U.S.Government sponsored agency mortgage backed securities

176,050 

176,050 

    States and political subdivisions

59,946 

59,946 

    Corporate bonds

19,273 

19,273 

    Total assets at fair value

 $

 $

314,270 

 $

 $

314,270 

 

The following is a description of the valuation methodologies and inputs used for assets measured at fair value on a recurring basis and recognized in the accompanying balance sheets, as well as the general classification of such assets pursuant to the valuation hierarchy.  There have been no significant changes in the valuation techniques during the three months ended June 30, 2012. 

 

Available-for-Sale Securities

 

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

 

Nonrecurring Measurements:

 

The following table summarizes financial assets measured at fair value on a nonrecurring basis as of June 30, 2012 and December 31, 2011, and by the level within the fair value hierarchy utilized to measure fair value (dollars in thousands):

 

Assets measured at fair value on a nonrecurring basis as of June 30, 2012

 

 

 

 

Level 1

Level 2

Level 3

Total

    Impaired loans (collateral dependent)

 $

 $

 $

     6,721     

 $

7,265    

    Other real estate owned

               905    

905    

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

 

 

 

 

Level 1

Level 2

Level 3

Total

    Impaired loans (collateral dependent)

 $

 $

 $

13,604     

 $

13,604    

    Other real estate owned

8,827     

8,827    

 

 

8


 


 

 

 

 

 

Impaired Loans (Collateral Dependent)

 

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

 

The Corporation considers the appraisal or evaluation as the starting point for determining fair value and then considers other factors and events in the environment that may affect the fair value.  Appraisals of the collateral underlying collateral-dependent loans are obtained when the loan is determined to be collateral-dependent and subsequently as deemed necessary by the Chief Credit Officer.  Appraisals are reviewed for accuracy and consistency by the Chief Credit Officer.  Appraisers are selected from the list of approved appraisers maintained by management.  The appraised values are reduced by discounts to consider lack of marketability and estimated cost to sell if repayment or satisfaction of the loan is dependent on the sale of the collateral.  These discounts and estimates are developed by the Chief Credit Officer by comparison to historical results.  Fair value adjustments for the six months ended June 30, 2012 and 2011 were $1.4 million and approximately $448,000, respectively, and $1.2 million for the year ended December 31, 2011.

 

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

 

Other Real Estate Owned

 

Other real estate owned (“OREO”) is initially recorded at fair value at the time of acquisition, as determined by independent appraisal or evaluation by the Corporation, less costs to sell when the real estate is acquired in settlement of loans.  Quarterly evaluations of OREO are performed to determine if there has been any subsequent decline in the value of OREO properties.  Estimated fair value of OREO is based on appraisals or evaluations, less costs to sell.  OREO is classified within Level 3 of the fair value hierarchy.  OREO assets are subject to nonrecurring fair value adjustments to reflect subsequent partial write-downs that are based on the observable market price or current appraised value of the collateral.  Fair value adjustments for the six months ended June 30, 2012 and 2011 were approximately $454,000 and $473,000, respectively, and $1.1 million for the year ended December 31, 2011.

 

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

 

Unobservable (Level 3) Inputs

 

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

 

 

Quantitative Information about Level 3 Fair Value Measurements

 

Fair Value at
June 30, 2012

Valuation
Technique(s)

Unobservable
Input

Range
(Weighted
Average)

Impaired loans (collateral-dependent)

 $                   7,265

 Market
comparable
properties

 Marketability
discount

 5.0% -
10.0% (7%)

Other real estate/assets owned

 $                      905

 Market
comparable
properties

 Marketability
discount

 5.0% -
10.0% (7%)

 

9


 


 

 

 

 

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

 

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

 

Cash and due from banks – The carrying amount approximates fair value.

 

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

 

Federal funds sold – The carrying amount approximates fair value.

 

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

 

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

 

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

 

Federal Home Loan Bank stock – The carrying value of Federal Home Loan Bank (“FHLB”) stock approximates fair value based on the redemption provisions of the FHLB.

 

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

 

Accrued interest receivable – The carrying amount approximates fair value.

 

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

 

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

 

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

 

Accrued interest payable – The carrying amount approximates fair value.

 

Commitments to extend credit and letters of credit – The fair value of commitments to originate loans is estimated using the fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the present creditworthiness of the counterparties.  For fixed-rate loan commitments, fair value also considers the difference between current levels of interest rates and the committed rates.   The fair values of letters of credit and lines of credit are based on fees currently charged for similar agreements or on the estimated cost to terminate or otherwise settle the obligations with the counterparties at the reporting date.  The fair values of these commitments are not material.

 

 

 

10


 


 

 

 

 

The following table presents estimated fair values of the Corporation’s financial instruments as of June 30, 2012 and indicates the level within the fair value hierarchy of the valuation techniques (dollars in thousands).

 

 

Fair Value Measurements at June 30, 2012 Using

 

Carrying
Amount

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

Significant
Other
Observable
Inputs (Level 2)

Significant
Unobservable
Inputs   (Level 3)

Financial assets

 

 

 

 

      Cash and cash equivalents

 $ 18,442

 $     18,442

 $                      -

 $                   -

      Interest-bearing deposits in other banks

    19,560

        19,560

 

 

      Federal funds sold

    15,000

        15,000

 

 

      Federal Home Loan Bank and Federal Reserve bank stock

      3,879

 

                3,879

 

      Securities available-for-sale

  364,535

 

            364,535

 

      Securities held-to-maturity

    32,429

 

              34,238

 

      Loans held for sale

      1,185

 

                1,185

 

      Loans, net

  509,915

 

 

         525,568

      Accrued interest receivable

       4,141

 

                4,141

 

Financial liabilities

 

 

 

 

      Non-interest bearing deposits

  150,155

      152,968

 

 

     Interest bearing deposits

  737,293

 

            739,626

 

      Repurchase agreements

    18,670

 

              18,670

 

     Advances from Federal Home Loan Bank

    10,100

 

              10,337

 

      Accrued interest payable

          821

 

                    821

 

Off-balance sheet credit related instruments:

 

 

 

 

      Commitments to extend credit

 

 

                    119

 

 

 

 

 

 

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

 

 

 

 

 

 

December 31, 2011

 

Carrying

Fair

 

Amount

Value

Financial assets

 

 

      Cash and due from banks

 $

17,927 

 $

17,927 

      Interest-bearing deposits in banks

38,594 

38,594 

      Federal funds sold

16,500 

16,500 

      Securities available-for-sale

318,166 

318,166 

      Securities held-to-maturity

35,214 

37,276 

      Loans, net

508,602 

523,847 

      Accrued interest receivable

4,095 

4,095 

Financial liabilities

 

 

      Deposits

856,430 

858,775 

      Federal funds purchased and

 

 

            securities sold under agreements

 

 

            to repurchase

16,347 

16,347 

      Other short term liabilities

      Advances from FHLB

17,100 

17,521 

      Accrued interest payable

878 

878 

Off-balance sheet credit related instruments:

 

 

      Commitments to extend credit

109 

 

11


 


 

 

NOTE 3 – SECURITIES

 

            The amortized cost and estimated fair value of securities at June 30, 2012 and December 31, 2011 were as follows (dollars in thousands):

 

 

Amortized

Gross Unrealized

Fair

June 30, 2012

Cost

Gains

Losses

Value

Available-for-sale securities

 

 

 

 

    U.S. Government agencies

 $

79,780 

 $

226 

 $

113 

 $

79,893 

    U.S. Government sponsored agency mortgage backed securities

213,438 

801 

443 

213,796 

    States and political subdivisions

48,824 

3,148 

51,972 

    Corporate bonds

18,350 

537 

13 

18,874 

 

 $

360,392 

 $

4,712 

 $

569 

 $

364,535 

Held-to-maturity securities

 

 

 

 

    States and political subdivisions

 $

32,429 

 $

1,809 

 $

 $

34,238 

 

 

 

 

 

 

Amortized

Gross Unrealized

Fair

December 31, 2011

Cost

Gains

Losses

Value

Available-for-sale securities

 

 

 

 

    U.S. Government agencies

 $

58,793 

 $

214 

 $

 $

59,001 

    U.S. Government sponsored agency mortgage backed securities

175,352 

843 

145 

176,050 

    States and political subdivisions

56,452 

3,494 

59,946 

    Corporate bonds

18,741 

582 

68 

19,273 

 

 $

309,338 

 $

5,133 

 $

219 

 $

314,270 

Held-to-maturity securities

 

 

 

 

    States and political subdivisions

 $

35,214 

 $

2,061 

 $

 $

37,275 

 

           

            Certain investments in debt securities are reported in the financial statements at an amount less than their historical cost.  Total fair value of these investments at June 30, 2012 and December 31, 2011, was approximately $130,636 and $85,009, which was approximately 33% and 24%, respectively, of the Corporation’s available-for-sale and held-to-maturity investment portfolio.  The Corporation evaluates its investment portfolio on a quarterly basis for impairment.  The analysis performed as of June 30, 2012 and December 31, 2011 indicated that all impairment was considered temporary, market driven due primarily to fluctuations in market interest rates and not credit-related.

 

The following table shows the Corporation’s investments’ gross unrealized losses and fair value of the Corporation’s investments with unrealized losses that were not deemed to be other-than-temporarily impaired, aggregated by investment class and length of time that individual securities had been in a continuous unrealized loss position at June 30, 2012 and December 31, 2011 (dollars in thousands):

 

 

June 30, 2012

Less than 12 months

12 months or Greater

Total

 

Fair

Unrealized

Fair

Unrealized

Fair

Unrealized

Type of Security

Value

Losses

Value

Losses

Value

Losses

     U.S. Government agencies

 $

29,972 

 $

113 

 $

              - 

 $

               - 

 $

29,972 

 $

113 

    U.S. Government sponsored agency mortgage

98,560 

443 

                  -

                    -

98,560 

443 

       backed securities

 

 

 

 

 

 

    Corporate bonds

1,960 

144 

2,104 

13 

 

 $

130,,492 

 $

565 

 $

144 

 $

 $

130,636 

 $

569 

 

 

12


 


 

 

 

 

 

 

 

 

December 30, 2011

Less than 12 months

12 months or Greater

Total

 

Fair

Unrealized

Fair

Unrealized

Fair

Unrealized

Type of Security

Value

Losses

Value

Losses

Value

Losses

     U.S. Government agencies

 $

15,063 

 $

 $

 $

 $

15,063 

 $

    U.S. Government sponsored agency mortgage

40,792 

145 

 

 

40,792 

145 

       backed securities

 

 

 

 

 

67 

    Corporate bonds

29,154 

67 

29,154 

 

 $

85,009 

 $

219 

 $

 $

 $

85,009 

 $

219 

 

The amortized cost and fair value of available-for-sale securities and held-to-maturity securities at June 30, 2012, by contractual maturity, are shown below.  Expected maturities will differ from contractual maturities because issuers may have the right to call or prepay obligations with or without call or prepayment penalties.

 

 

Available for Sale

 

Held to Maturity

June 30, 2012

Amortized

Estimated

 

Amortized

Estimated

 

Cost

Fair Value

 

Cost

Fair Value

Within one year

 $      9,138

 $     9,229

 

 $     2,325

 $         2,357

One to five years

       24,198

      24,821

 

        8,503

            8,945

Five to ten years

       82,061

      82,929

 

      11,371

          12,093

After ten years

       31,557

      33,760

 

      10,230

          10,843

Mortgage-backed securities

     213,438

    213,796

 

               -

                    -

Total

 $  360,392

 $ 364,535

 

 $   32,429

 $       34,238

 

The carrying value of securities pledged as collateral to secure public deposits and for other purposes was $222.7 million at June 30, 2012 and $196.1 million at December 31, 2011.

The book value of securities sold under agreements to repurchase amounted to $26.5 million and $22.2 million at June 30, 2012 and December 31, 2011, respectively.

Gross gains of approximately $943,000, $374,000, $2.2 million and $434,000 resulting from sales of available-for-sale securities were realized for the three months and six month periods ended June 30, 2012 and 2011, respectively.

NOTE 4 – LOANS

 

            The following table presents the Corporation’s loans by class as of June 30, 2012 and December 31, 2011 (dollars in thousands):

 

 

June 30, 2012

December 31, 2011

Commercial

 

 

Commercial and industrial

 $        64,875

 $          60,448

Non-farm, non-residential real estate

         146,697

           140,147

Construction and development

           30,884

             29,042

Commercial loans secured by real estate

             9,578

               6,161

Other commercial

           39,190

             45,630

 

         291,224

           281,428

Retail

 

 

Consumer

           12,656

             14,297

Single family residential

         194,830

           196,913

Other retail

           19,977

             25,700

 

 $      227,463

 $      236,910

Total

 $      518,687

 $        518,338

 

13


 


 

 

 

 

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

 

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

 

Commercial real estate loans are subject to underwriting standards and processes similar to commercial and industrial loans, in addition to those of real estate loans. These loans are viewed primarily as loans secured by real estate. Commercial real estate lending typically involves higher loan principal amounts and the repayment of these loans is generally largely dependent on the successful operation of the property securing the loan or the business conducted on the property securing the loan. Commercial real estate loans may be more adversely affected by conditions in the real estate markets or in the general economy. Management monitors and evaluates commercial real estate loans based on collateral, geography and risk grade criteria. As a general rule, the Corporation avoids financing single-purpose projects unless other underwriting factors are present to help mitigate risk. The Corporation also utilizes third-party experts to provide insight and guidance about economic conditions and trends affecting market areas it serves. In addition, management tracks the level of owner-occupied commercial real estate loans versus non-owner occupied loans. At June 30, 2012, approximately half of the outstanding principal balance of the Corporation’s commercial real estate loans were secured by owner-occupied properties. 

 

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

 

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

 

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

 

 

14


 


 

 

 

 

 

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

 

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

 

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

 

Non-Accrual and Past Due Loans.  Loans are considered past due if the required principal and interest payments have not been received as of the date such payments were due. Loans are placed on non-accrual status when,  (i) principal or interest has been in default for a period of 90 days or more, or (ii) full payment of principal and interest is not expected. Loans may be placed on non-accrual status regardless of whether or not such loans are considered past due. When interest accrual is discontinued, all unpaid accrued interest is reversed. Interest income on non-accrual loans is recognized only to the extent that cash payments are received in excess of principal due. A loan may be returned to accrual status when all the principal and interest amounts contractually due are brought current and future principal and interest amounts contractually due are reasonably assured, which is typically evidenced by a sustained period (three to six months) of repayment performance by the borrower.  The Corporation had no loans that were 90 days or more past due that were not included in nonaccrual loans as of June 30, 2012.

 

 

The following table provides details regarding the aging of the Corporation’s loan portfolio as of June 30, 2012 and December 31, 2011 (dollars in thousands):

 

June 30, 2012

30 - 89 Days
Past Due

90 Days and
Greater Past
Due*

Total Past Dues

Current

Total Loans

Retail

 

 

 

 

 

  Consumer

 $

28 

 $

43 

 $

71 

 $

12,585 

 $

12,656 

  Single family residential

613 

2,789 

3,402 

191,428 

194,830 

  Other retail

17 

329 

346 

19,631 

19,977 

Retail total

 $

658 

 $

3,161 

 $

3,819 

 $

223,644 

 $

227,463 

Commercial

 

 

 

 

 

  Commercial and industrial

 $

209 

 $

3,922 

 $

4,131 

 $

60,744 

 $

64,875 

  Non-farm, non-residential real estate

384 

1,632 

2,016 

144,681 

146,697 

  Construction and development

 

2,253 

2,253 

28,631 

30,884 

  Commercial loans secured by real estate

9,578 

9,578 

  Other commercial

39,190 

39,190 

Commercial total

 $

593 

 $

7,807 

 $

8,400 

 $

282,824 

 $

291,224 

TOTAL

 $

1,251 

 $

10,968 

 $

12,219 

 $

506,468 

 $

518,687 

 

 

 

 

 

 

 

15


 


 

 

 

 

 

December 31, 2011

30 - 89 Days
Past Due

90 Days and
Greater Past Due*

Total Past Due

Current

Total Loans

Retail

 

 

 

 

 

  Consumer

 $

73 

 $

 $

77 

 $

14,220 

 $

14,297 

  Single Family Residential

5,131 

1,002 

6,133 

190,780 

196,913 

  Other retail

25,699 

25,700 

Retail total

 $

5,205 

 $

1,006 

 $

6,211 

 $

230,699 

 $

236,910 

Commercial

 

 

 

 

 

  Commercial and industrial

 $

3,858 

 $

1,419 

 $

5,277 

 $

55,171 

 $

60,448 

  Non-farm, non-residential real estate

2,166 

320 

2,486 

137,661 

140,147 

  Construction and development

44 

44 

28,998 

29,042 

  Other commercial

1,441 

159 

1,600 

50,191 

51,791 

Commercial total

 $

7,509 

 $

1,898 

 $

9,407 

 $

272,021 

 $

281,428 

TOTAL

 $

12,714 

 $

2,904 

 $

15,618 

 $

502,720 

 $

518,338 

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

 

The following table summarizes the impaired loans by loan type as of June 30, 2012 and December 31, 2011 (dollars in thousands):

 

 

 

 

 

 

Average Recorded Investment

June 31, 2012

Unpaid
Contractual
Principal Balance

Recorded
Investment with
no allowance

Recorded
Investment with
allowance

Total
Recorded
Investment

Related
Allowance

Quarter
To Date

Year
to Date

Commercial

 

 

 

 

 

 

 

Commercial and industrial

 $

4,795 

 $

374 

 $

3,436 

 $

3,810 

 $

167 

 $

3,792 

 $

4,318 

Non-farm, non-residential real estate

3,203 

1,219 

1,219 

1,215 

1,978 

Construction & development

719 

719 

719 

53 

719 

670 

Other Commercial

1,379 

1,379 

1,379 

3,107 

1,379 

Commercial total

 $

10,096 

 $

1,593 

 $

5,534 

 $

7,127 

 $

220 

 $

8,833 

 $

8,345 

Residential

 

 

 

 

 

 

 

Consumer loans

 $

 

 $

 $

 $

 $

 $

Single Family Residential

3,418 

2,344 

637 

2,981 

105 

1,249 

3,018 

Other retail

 

 

Retail total

 $

3,418 

 $

2,344 

 $

637 

 $

2,981 

 $

105 

 $

1,249 

 $

3,018 

Total

 $

13,514 

 $

3,937 

 $

6,171 

 $

10,108 

 $

325 

 $

10,082 

$

11,363

 

 

 

 

 

 

16


 


 

 

 

 

 

 

Average Recorded Investment

December 31, 2011

Unpaid
Contractual
Principal Balance

Recorded
Investment
with
no allowance

Recorded Investment
with
allowance

Total
Recorded
Investment

Related
Allowance

Quarter
To Date

Year to
Date

Commercial

 

 

 

 

 

 

 

Commercial and industrial

 $

5,839 

 $

738 

 $

5,678 

 $

5,446 

 $

601 

 $

5,069 

 $

5,069 

Non-farm, non-residential real estate

4,378 

2,986 

2,115 

4,573 

307 

5,232 

5,232 

Construction & development

870 

870 

870 

203 

941 

941 

Other Commercial

3,238 

1,498 

1,527 

1,527 

Commercial total

 $

14,325 

 $

3,724 

 $

8,663 

 $

12,387 

 $

1,111 

 $

12,769 

 $

12,769 

Residential

 

 

 

 

 

 

 

Consumer loans

 $

 $

 $

 $

 $

 $

 $

Single Family Residential

1,388 

142 

1,075 

1,217 

131 

1,269 

1,269 

Other retail

 

Retail total

 $

1,388 

 $

142 

 $

1,075 

 $

1,217 

 $

131 

 $

1,269 

 $

1,269 

Total

 $

15,713 

 $

3,866 

 $

9,738 

 $

13,604 

 $

1,242 

 $

14,038 

$

14,038

 

 

June 31, 2011

Unpaid
Contractual
Principal Balance

Recorded
Investment
with
no allowance

Recorded Investment
with
allowance

Total
Recorded
 Investment

Related
Allowance

Average
Recorded
Investment

Commercial

 

 

 

 

 

 

Commercial and industrial

 $

11,505 

 $

4,032 

 $

995 

 $

10,038 

 $

340 

 $

8,703 

Non-farm, non-residential real estate

7,685 

13,143 

3,212 

6,384 

Construction & development

1,725 

208 

1,894 

108 

1,548 

Other Commercial

3,309 

400 

3,634 

3,200 

Commercial total

 $

24,224 

 $

17,175 

 $

1,603 

 $

18,778 

 $

448 

 $

19,835 

Residential

 

 

 

 

 

 

Consumer loans

 $

 

 $

 $

 $

 $

Single Family Residential

1,328 

457 

668 

1,125 

103 

1,275 

Other retail

 

 

Retail total

 $

1,328 

 $

457 

 $

668 

 $

1,125 

 $

103 

 $

1,275 

Total

 $

25,552 

 $

17,632 

 $

2,271 

 $

19,903 

 $

551 

 $

21,110 

 

 

Impaired Loans.  Loans are considered impaired when, based on current information and events, it is probable the Corporation will be unable to collect all amounts due in accordance with the original contractual terms of the loan agreement, including scheduled principal and interest payments. Impairment is evaluated in total for smaller-balance loans of a similar nature and on an individual loan basis for other loans. If a loan is impaired, a specific valuation allowance is allocated, if necessary, so that the loan is reported net, at the present value of estimated future cash flows using the loan’s existing rate or at the fair value of collateral if repayment is expected solely from the collateral. Interest payments on impaired loans are typically applied to principal unless collectability of the principal amount is reasonably assured, in which case interest is recognized on a cash basis. Impaired loans, or portions thereof, are charged off when deemed uncollectible.  Interest income recognized on impaired loans (which approximates cash basis interest received on impaired loans) was approximately $225,000 and $578,000 for the six-month periods ended June 30, 2012 and 2011, respectively.  The average balance of impaired loans for the six-month period ending June 30, 2012 was $8.4 million for commercial loans and $3.0 million for residential real estate loans, totaling $11.4 million.

 

 

17


 


 

 

 

 

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

           

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

 

As of June 30, 2012, the Corporation did not have any commitments to extend additional funds to borrowers with loans modified and included as a troubled debt restructuring.

 

During 2012, certain loans were modified in troubled debt restructurings, where economic concessions were granted to borrowers consisting of reductions in the interest rates, payment extensions, forgiveness of principal, and forbearances.  Presented below, segregated by class of loans, are troubled debt restructurings that occurred during the six months and three months ended June 30, 2012 (dollars in thousands):

 

 

Three Months Ended June 30, 2012

 

 

Post-

 

 

 

Modification

Net Charge-offs

 

Number of

Outstanding

Resulting from

 

Loans

Balance

Modifications

Retail:

 

 

 

Single family residential

2

 $                   158

 $                             -

Total trouble debt restructurings

2

 $                   158

 $                             -

 

Six Months Ended June 30, 2012

 

 

Post-

 

 

 

Modifications

Net Charge-offs

 

Number of

Outstanding

Resulting from

 

Loans

Balance

Modifications

Commercial:

 

 

 

  Commercial and industrial

3

 $                   554

 $                        197

  Non-farm non-residential real estate

1

                           -

                           222

Retail:

 

 

 

  Single family residential

2

                      158

 

Total trouble debt restructurings

6

 $                   712

 $                        419

 

18


 


 

 

 

 

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

 

As of June 30, 2012, the Corporation did not have any loans that were modified in troubled debt restructurings that have subsequently defaulted.

 

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

 

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

Risk Rating 1        Minimal Risk

 

General Characteristics:

  • Substantially risk free

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

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

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

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

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

  • Industry conditions and trends are positive and strong.

  • Borrower has strong management with evidence of management succession.

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

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

Risk Rating 2             Modest Risk

 

General Characteristics:

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

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

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

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

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

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

  • Borrower can withstand major market instabilities of short duration.

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

Risk Rating 3             Average Risk

 

General Characteristics:

19


 


 

 

 

 

 

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

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

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

  • Borrower has good management with acceptable management succession.

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

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

  • Credit extensions are generally secured by acceptable collateral.

Risk Rating 4             Acceptable Risk

 

General Characteristics:

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

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

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

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

  • Borrower can obtain similar financing from other financial institutions.

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

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

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

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

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

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

  • Credit extensions are generally secured by acceptable collateral.

Risk Rating 5             Pass / Watch 

 

General Characteristics:

 

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

 

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

 

20


 


 

 

 

 

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

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

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

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

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

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

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

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

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

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

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

Risk Rating 6                 Special Mention

 

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

 

General Characteristics:

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

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

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

  • Borrower generally shows limited liquidity or high leverage.

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

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

  • Borrower’s management lacks depth and succession.

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

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

Risk Rating 7             Substandard

 

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

 

21


 


 

General Characteristics:

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

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

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

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

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

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

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

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

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

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

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

 

Risk Rating 8        Doubtful

 

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

 

General Characteristics:

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

  • Borrower has the same weaknesses found in Substandard borrowers.

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

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

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

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

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

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

  • No alternative financing sources exist for borrower.

 

The following tables present risk grades and classified loans by class of commercial loan in the Corporation’s portfolios as of June 30, 2012 (dollars in thousands):

 

 

 

22


 


 

 

 

 

 

 

June 30, 2012

 

 

 

 

 

 

Commercial Loan Portfolio:  Credit risk profile by internally assigned grade

Commercial
& Industrial

Non-Farm,
Non-Residential
Real Estate

Construction
& Development

Commercial Loans
Secured by
Real Estate

Other
Commercial

Commercial
Loan Totals

 

 

 

 

 

 

 

  Pass

 $

57,934 

 $

143,470 

 $

29,509 

 $

8,402 

 $

36,335 

 $

275,650 

  Special Mention

2,749 

1,350 

601 

409 

5,109 

  Substandard

1,124 

1,877 

774 

767 

1,476 

6,018 

  Doubtful

3,068 

1,379 

4,447 

TOTALS

 $

64,875 

 $

146,697 

 $

30,884 

 $

9,578 

 $

39,190 

 $

291,224 

 

 

 

 

 

 

 

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

Consumer

Single-Family
Residential**

Other Retail

Retail Loan
Totals

 

 

  Performing

 $

12,588 

 $

190,757 

 $

19,623 

 $

222,968 

 

 

  Non-performing*

68 

4,073 

354 

4,495 

 

 

TOTALS

 $

12,656 

 $

194,830 

 $

19,977 

 $

227,463 

 

 

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

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

 

December 31, 2011

 

 

 

 

 

 

Commercial Loan Portfolio:  Credit risk profile by internally assigned grade

Commercial
& Industrial

Non-Farm,
Non-Residential
Real Estate

Construction
& Development

Commercial Loans
Secured by
Real Estate

Other
Commercial

Commercial
Loan Totals

 

 

 

 

 

 

 

  Pass

 $

50,163 

 $

132,291 

 $

27,613 

 $

2,979 

 $

44,837 

 $

257,883 

  Special Mention

4,137 

4,232 

504 

439 

9,312 

  Substandard

1,692 

2,033 

925 

677 

1,480 

6,807 

  Doubtful

4,456 

1,591 

1,379 

7,426 

TOTALS

 $

60,448 

 $

140,147 

 $

29,042 

 $

4,095 

 $

47,696 

 $

281,428 

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

Consumer

Single-Family
Residential**

Other Retail

Retail Loan
Totals

 

 

  Performing

 $

14,225 

 $

193,784 

 $

25,368 

 $

233,377 

 

 

  Non-performing*

72 

3,129 

332 

3,533 

 

 

TOTALS

 $

14,297 

 $

196,913 

 $

25,700 

 $

236,910 

 

 

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

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

 

 

23


 


 

 

 

 

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

 

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

 

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

 

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

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

 

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

           

The components of the general valuation allowance include (i) the additional reserves allocated to specific loan portfolio segments as a result of applying an environmental risk adjustment factor to the base historical loss allocation and (ii) the additional reserves that are not allocated to specific loan portfolio segments including allocations for groups of similar loans with risk characteristics that exceed certain concentration limits established by management.

 

There is an inherent imprecision in calculating the specific portion of the allowance for loan and lease losses (“ALLL”).  Therefore, a factor may be added to the allocation of each of the identified segments of the loan portfolio to account for the imprecision.

 

 

24


 


 

 

Included in the general valuation allowances are allocations for groups of similar loans with risk characteristics that exceed certain concentration limits established by management. Concentration risk limits have been established, among other things, for certain industry concentrations, large balance and highly leveraged credit relationships that exceed specified risk grades, and loans originated with policy exceptions that exceed specified risk grades.

 

The allowance for loan losses is maintained at a level considered adequate to provide for the losses that can be reasonably anticipated.  Management’s periodic evaluation of the adequacy of the allowance is based on the Corporation’s past loan loss experience, know and inherent risks in the portfolio, adverse situations that may affect the borrower’s ability to repay, the estimated value of any underlying collateral, composition of the loan portfolio, current economic conditions and other relevant factors.  This evaluation is inherently subjective as it requires material estimates that may be susceptible to change.  During the first quarter of 2012, as part of the quantitative analysis of the adequacy of the allowance for loan losses, management adjusted its projection of probable loan losses.  In prior years, the Corporation used a historic loss period of four quarters for all segments when estimating the historic charge off rates calculated in accordance with ASC Topic 450.  During the first quarter 2012, the Corporation changed the historic period to a rolling eight quarter historic look back period to better reflect the risk related to each individual segment of loans.  This change did not have a significant impact on the recorded amount of the allowance for loan losses.

 

The following table summarizes the allocation in the allowance for loan losses by loan segment for the six months ended June 30, 2012 and June 30, 2011 and the year ended December 31, 2011 (dollars in thousands): 

 

 

 

Residential

Consumer &

 

 

Three Months Ended

Commercial

real estate

other retail

Unallocated

Totals

Beginning ALLL balance - 3/31/12

 $

6,648 

 $

1,521 

 $

170 

 $

360 

 $

8,699 

  Less: Charge-offs

(516)

(41)

(557)

  Add: Recoveries

108 

110 

  Add: Provisions

437 

83 

(12)

12 

520 

Ending ALLL balance - 06/30/12

 $

6,677 

 $

1,564 

 $

159 

 $

372 

 $

8,772 

 

 

 

 

 

 

Six Months Ended

 

 

 

 

 

Beginning ALLL balance - 12/31/11

 $

5,957 

 $

2,113 

 $

192 

 $

938 

 $

9,200 

  Less: Charge-offs

(1,532)

(147)

(5)

(1,684)

  Add: Recoveries

131 

136 

  Add: Provisions

2,121 

(404)

(31)

(566)

1,120 

Ending ALLL balance - 06/30/12

 $

6,677 

 $

1,564 

 $

159 

 $

372 

 $

8,772 

 

 

 

 

 

 

Three Months Ended

 

 

 

 

 

Beginning ALLL balance - 3/31/11

$

5,594

$

1,723

$

279

$

98

$

7,694

  Less: Charge-offs

(464)

(14)

(31)

(509)

  Add: Recoveries

35 

33 

69 

  Add: Provisions

273 

235 

(16)

258 

750 

Ending ALLL balance - 06/30/11

 $

5,438 

 $

1,945 

 $

265 

 $

356 

 $

8,004 

 

 

 

 

 

 

Six Months Ended

 

 

 

 

 

Beginning ALLL balance - 12/31/10

 $

6,915 

 $

2,001 

 $

408 

 $

96 

 $

9,420 

  Less: Charge-offs

(2,621)

(258)

(127)

(3,006)

  Add: Recoveries

73 

40 

114 

  Add: Provisions

1,071 

201 

(56)

260 

1,476 

Ending ALLL balance - 06/30/11

 $

5,438 

 $

1,945 

 $

265 

 $

356 

 $

8,004 

 

 

 

 

 

 

Beginning ALLL balance - 1/1/11

 $

6,915 

 $

2,001 

 $

408 

 $

96 

 $

9,420 

  Less: Charge-offs

(3,353)

(52)

(147)

(3,552)

  Add: Recoveries

103 

104 

207 

  Add: Provisions

2,292 

164 

(173)

842 

3,125 

Ending ALLL balance - 12/31/11

 $

5,957 

 $

2,113 

 $

192 

 $

938 

 $

9,200 

           

25


 


The following table details the amount of the allowance for loan losses allocated to each portfolio segment as of June 30, 2012, June 30, 2011 and December 31, 2011, disaggregated on the basis of the Corporation’s impairment methodology (dollars in thousands).

 

 

 

Residential

Consumer &

 

 

Ending ALLL balance - 6/30/12

Commercial

Real Estate

Other Retail

Unallocated

Total

Loans individually evaluated for impairment

 $

219

 $

106

 $

-

 $

-

 $

325

Loans collectively evaluated for impairment

6,458

1,458

159

372

8,447

Balance

 $

6,677

 $

1,564

 $

159

 $

372

 $

8,772

Ending ALLL balance 6/30/11

 

 

 

 

 

Loans individually evaluated for impairment

 $

345

 $

-

 $

-

 $

-

 $

345

Loans collectively evaluated for impairment

5,093

1,945

265

356

7,659

Balance

 $

5,438

 $

1,945 

 $

265

 $

356

 $

8,004

Ending ALLL balance - 12/31/11  $ 1,111  $

131

 $

-

 $  

-

 $   1,242
Loans individually evaluated for impairment   4,846   1,982  

192

 

938

 

7,958

Loans collectively evaluated for impairment  $ 5,957  $ 2,113  $

192

 $  

938

 $   9,200

  Balance

 

 

The following table shows loans related to each balance in the allowance for loan losses by portfolio segment and disaggregated on the basis of the Corporation’s impairment methodology (dollars in thousands):

 

 

 

Residential

Consumer &

Other

 

June 30, 2012

Commercial

Real Estate

Other Retail

 

Totals

Loans individually evaluated for impairment

 $

2,662 

 $

1,274 

 $

-   

 $

-   

 $

3,936 

Loans collectively evaluated for impairment

 $

288,887 

 $

211,389 

13,637 

838 

514,751 

Balance

 $

291,549 

 $

212,663 

 $

13,637 

 $

838 

 $

518,687 

June 30, 2011

 

 

 

 

 

Loans individually evaluated for impairment

 $

17,653 

 $

1,125 

 $

-   

 $

-   

 $

18,778 

Loans collectively evaluated for impairment

280,511 

230,309 

 $

14,838 

 $

1,139 

526,797 

Balance

 $

298,164 

 $

231,434 

 $

14,837 

 $

1,139 

 $

545,575 

December 31, 2011

 

 

 

 

 

Loans individually evaluated for impairment

 $

12,625 

 $

1,217 

 $

-   

 $

-   

 $

13,842 

Loans collectively evaluated for impairment

268,796 

219,881 

14,055 

1,228 

503,960 

Balance

 $

281,421 

 $

221,098 

 $

14,055 

 $

1,228 

 $

517,802 

 

 

 

 

 

NOTE 5 – BORROWED FUNDS

 

The Corporation is a party to the Blanket Agreement for Advances and Security Agreement (the “Blanket Agreement”) with the FHLB of Cincinnati.  Advances made to the Corporation under the Blanket Agreement are collateralized by the FHLB stock and qualifying residential mortgage loans totaling 150% of the outstanding amount borrowed. These collateralization matters are outlined in the Blanket Agreement dated June 20, 2006 between the Corporation and the FHLB.  The advances mature at varying dates throughout 2013 at interest rates ranging from 2.61% - 3.76%.

 

26


 


 

 

 

 

Scheduled annual principal maturities and interest rate terms of borrowings under this credit line as of June 30, 2012 for the next year were as follows (dollars in thousands):

 

2013 

 

$10,100

 

FHLB stock totaling $3,009,000 at June 30, 2012 was carried at cost.  The stock is restricted and can only be sold back to the FHLB at par value.

 

The Corporation also has a Cash Management Advance Line of Credit Agreement (the “CMA”), dated June 21, 2010, with the Federal Home Loan Corporation.  The CMA is a component of the Blanket Agreement.  The purpose of the CMA is to assist with short-term liquidity management.  Under the terms of the CMA, the Corporation may borrow a maximum of $40 million, selecting a variable rate of interest for up to 90 days or a fixed rate for a maximum of 30 days.  There were no borrowings outstanding under the CMA as of June 30, 2012.

 

NOTE 6 – POST-RETIREMENT BENEFIT PLAN

 

 

Six months ended

(dollars in thousands)

June 30, 2012

June 30, 2011

Service cost

 $                        46

 $                        12

Interest cost

                         192

                           78

Expected return on plan assets

                              -

                              -

Amortization of prior service cost

                            (8)

                         (120)

Amortization of net loss

                              -

                              -

Net periodic pension cost

 $                       230

 $                       (30)

 

The Corporation currently expects to contribute approximately $472,000 to its post retirement benefit plan during the year ending December 31, 2012, of which approximately $78,000 was contributed in the first six months of 2012. 

 

 

NOTE 7 – RECENT ACCOUNTING PRONOUNCEMENTS

 

ASU No. 2011-03, “Transfers and Servicing (Topic 860) - Reconsideration of Effective Control for Repurchase Agreements.” ASU 2011-03 is intended to improve financial reporting of repurchase agreements and other agreements that both entitle and obligate a transferor to repurchase or redeem financial assets before their maturity. ASU 2011-03 removes from the assessment of effective control (i) 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 (ii) the collateral maintenance guidance related to that criterion. ASU 2011-03 was adopted on January 1, 2012 and did not have a significant impact on the Corporation’s financial statements.

 

ASU 2011-04, “Fair Value Measurement (Topic 820) - Amendments to Achieve Common Fair Value Measurements and Disclosure Requirements in U.S. GAAP and IFRSs.” ASU 2011-04 amends ASC Topic 820, to converge the fair value measurement guidance in U.S. generally accepted accounting principles (“GAAP”)  and International Financial Reporting Standards. ASU 2011-04 clarifies the application of existing fair value

measurement requirements, changes certain principles in ASC Topic 820 and requires additional fair value disclosures. ASU 2011-04 was effective for interim and annual periods beginning after December 15, 2011, and the adoption of this ASU did not have a significant impact on the Corporation’s financial statements. 

 

 

 

27


 


 

 

 

 

ASU 2011-05, “Comprehensive Income (Topic 220) - Presentation of Comprehensive Income.” ASU 2011-05 amends Topic 220, “Comprehensive Income,” to require that all non-owner changes in stockholders’ equity be presented in either a single continuous statement of comprehensive income or in two separate but consecutive statements. Additionally, ASU 2011-05 requires entities to present, on the face of the financial statements, reclassification adjustments for items that are reclassified from other comprehensive income to net income in the statement or statements where the components of net income and the components of other comprehensive income are presented. The option to present components of other comprehensive income as part of the statement of changes in stockholders’ equity was eliminated. ASU 2011-05 is effective for interim and annual periods beginning after December 15, 2011 and the adoption of this ASU did not have a significant impact on the Corporation’s financial statements.

 

ASU 2011-08, “Intangibles - Goodwill and Other (Topic 350) - Testing Goodwill for Impairment.” ASU 2011-08 amends Topic 350, “Intangibles – Goodwill and Other,” to give entities the option to first assess qualitative factors to determine whether the existence of events or circumstances leads to a determination that it is more likely than not that the fair value of a reporting unit is less than its carrying amount. If, after assessing the totality of events or circumstances, an entity determines it is not more likely than not that the fair value of a reporting unit is less than its carrying amount, then performing the two-step impairment test is unnecessary. However, if an entity concludes otherwise, then it is required to perform the first step of the two-step impairment test by calculating the fair value of the reporting unit and comparing the fair value with the carrying amount of the reporting unit. ASU 2011-08 is effective for annual and interim impairment tests beginning after December 15, 2011, and is not expected to have a significant impact on the Corporation’s financial statements.

 

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

 

ASU 2011-12 “Comprehensive Income (Topic 220) - Deferral of the Effective Date for Amendments to the presentation of Reclassifications of Items Out of Accumulated Other Comprehensive Income in Accounting Standards Update No. 2011-05.” ASU 2011-12 defers changes in ASU No. 2011-05 that relate to the presentation of reclassification adjustments to allow the FASB time to deliberate whether to require presentation of such adjustments on the face of the financial statements to show the effects of reclassifications out of accumulated other comprehensive income on the components of net income and other comprehensive income. ASU 2011-12 allows entities to continue to report reclassifications out of accumulated other comprehensive income consistent with the presentation requirements in effect before ASU No. 2011-05. All other requirements in ASU No. 2011-05 are not affected by ASU No. 2011-12. ASU 2011-12 became effective for the Corporation on January 1, 2012 and did not have a significant impact on the Corporation’s financial statements.

 

 

 

 

 

 

 

 

28


 


 

 

 

 

 

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

 

FORWARD-LOOKING STATEMENTS

 

Certain statements contained in this report may not be based on historical facts and are “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). These forward-looking statements may be identified by, among other things, the use of forward-looking terminology such as “could,” “would,” “expect,” “believe,” “intend,”  “may,” “will,” “can,” or “should” or future or conditional verb tenses, and variations or  negatives of such terms.  These forward-looking statements include, without limitation, those relating to the Corporation’s valuation methodologies, contributions to the Corporation’s post-retirement benefit plan and returns on the plan’s assets, characterization of accrual and non-accrual loans, concessions granted for troubled debt restructurings, impairment of securities, repayment of loans, loan portfolio concentrations, fair value of impaired loans, satisfaction of capital adequacy requirements, payments on advances from the FHLB, risk rating classifications of loans, calculation of our allowance for loan losses, adequacy of traditional sources of cash generated from operating activities to meet liquidity needs and the realization of deferred income tax assets.  We caution you not to place undue reliance on such forward-looking statements in this report because results could differ materially from those anticipated due to a variety of factors.  These factors include, but are not limited to, conditions in the financial market, liquidity needs, the sufficiency of our allowance for loan  losses, economic conditions in the communities in the State of Tennessee where the Corporation does business, the impact of government regulation and supervision, interest rate risk, including changes in monetary policy and fluctuating interest rates, the Corporation’s ability to attract and retain key personnel, competition from other financial services, other factors generally understood to affect the financial results of financial services companies and other factors detailed from time to time in our filings with the Securities and Exchange Commission (the “SEC”). We undertake no obligation to update these forward-looking statements to reflect events or circumstances that occur after the date of this report.

 

EXECUTIVE OVERVIEW

 

At June 30, 2012, the consolidated total assets of the Corporation were $1.1 billion, its consolidated net loans were $509.9 million, its total deposits were $887.4 million and its total shareholders' equity was $113.2 million.  The Corporation’s loan portfolio at June 30, 2012 reflected an increase of approximately $400,000, or .06%, compared to December 31, 2011.  Total deposits increased $31.0 million, or 3.6%, and shareholders’ equity increased by 1.8% during the first six months of 2012.  Total shareholders’ equity includes an unrealized gain, net of tax, on available-for-sale securities of $2.5 million. 

 

FINANCIAL CONDITION

 

Average earning assets for the quarter ended June 30, 2012 were up 7.8%, or $68.0 million, from average earning assets for the quarter ended December 31, 2011.  Average overnight investments for the quarter ended June 30, 2012 were up 19.3% compared to the quarter ended December 31, 2011.  Average investment securities for the quarter ended June 30, 2012 were up 25.9% compared to the quarter ended December 31, 2011.  Average total assets were up 7.3% or $71.4 million, from $975.3 million for the quarter ended December 31, 2011 to $1.047 billion for the quarter ended June 30, 2012. 

 

Securities

 

Available-for-sale securities are an integral part of the asset/liability management process of the Corporation.  Accordingly, they represent an important source of liquidity available to fund loans and accommodate asset reallocation strategies dictated by changes in the Corporation’s operating and tax plans, shifting yield spread relationships and changes in configuration of the yield curve.  At June 30, 2012, the Corporation's investment securities portfolio had $364.5 million of available-for-sale securities, which are valued at fair market value, and $32.4 million of held-to-maturity securities, which are valued at cost on the balance sheet. These compare to $314.2 million of available-for-sale securities and $35.2 million of held-to-maturity securities as of December 31, 2011. 

 

29


 


 

Loans and Loan Losses

 

The loan portfolio is the largest component of earning assets for the Corporation and, consequently, provides the largest amount of revenue for the Corporation.  The loan portfolio also contains the highest exposure to risk as a result of the possibility of unexpected deterioration in the credit quality of borrowers.  When analyzing potential loans, management of the Corporation assesses both interest rate objectives and credit quality objectives in determining whether to make a given loan and the appropriate pricing for that loan.  All loans are expected to be repaid from cash flow or proceeds from the sale of selected assets of the borrowers.  Collateral requirements for the loan portfolio are based on credit evaluation of the borrowers.

 

Loan volume was up in the second quarter of 2012, with total loans increasing by approximately $885,000, or 0.2% during the six month period.  Commercial loans increased by $9.8 million, or 3.5%, in the second quarter, and the retail portfolio declined by $9.5 million, or 3.8%.  At $518.7 million, total loans outstanding were down by $26.9 million for the six months ended June 30, 2012 compared to the same period in 2011.   Loan demand remains weak across all segments of the portfolio, while competition for top quality commercial credit is high.  

 

The Corporation continues to reserve more heavily against its construction and development portfolio than any other segment of the commercial portfolio, given the comparatively high level of losses that have been incurred within this segment of the portfolio over the previous year.  Additionally, higher reserves are being placed against property types which are believed to be higher risk, such as retail and multi-family real estate.

 

Loans identified with losses by management, internal loan review and/or Corporation examiners are charged off. Furthermore, consumer loan accounts are charged off automatically based on regulatory requirements.

 

The allowance for loan losses is a reserve established through a provision for loan losses charged to expense, which represents management’s best estimate of probable losses that have been incurred within the existing portfolio of loans. The allowance, in the judgment of management, is necessary to reserve for estimated loan losses and risks inherent in the loan portfolio. The Corporation’s allowance for loan loss methodology includes allowance allocations calculated in accordance with ASC Topic 310, and allowance allocations calculated in accordance with ASC Topic 450.  Accordingly, the methodology is based on historical loss experience by type of credit and internal risk grade, specific homogeneous risk pools and specific loss allocations, with adjustments for current events and conditions. The Corporation’s process for determining the appropriate level of the allowance for loan losses is designed to account for credit deterioration as it occurs. The provision for loan losses reflects loan quality trends, including the levels of and trends related to non-accrual loans, past due loans, potential problem loans, classified and criticized loans and net charge-offs or recoveries, among other factors. The provision for loan losses also reflects the totality of actions taken on all loans for a particular period. In other words, the amount of the provision reflects not only the necessary increases in the allowance for loan losses related to newly identified criticized loans, but it also reflects actions taken related to other loans including, among other things, any necessary increases or decreases in required allowances for specific loans or loan pools. The unallocated portion of the allowance for loan losses represents general valuation allowances that are not allocated to specific loan portfolio segments.  See Note 4 - Loans in the accompanying notes to consolidated financial statements included elsewhere in this report for further details regarding the Corporation’s methodology for estimating the appropriate level of the allowance for loan losses.

 

 

 

 

 

30


 


 

 

 

 

Collectability.  A formal process is in place to enhance control over the underwriting of loans and to monitor loan collectability.  This process includes education and training of personnel about the Corporation's loan policies and procedures, assignment of credit analysts to support lenders, timely identification of loans with adverse characteristics, control of corrective actions and objective monitoring of loan reviews.  The Special Assets Department of the Corporation identifies and monitors assets that need special attention.  At June 30, 2012, this process identified loans totaling $5.1 million that were classified as other assets especially mentioned compared to loans totaling $9.3 million at December 31, 2011.  Loans totaling $6.0 million were classified as substandard at June 30, 2012, compared to loans totaling $6.8 million at December 31, 2011.  Loans totaling $4.4 million were classified as doubtful at June 30, 2012, compared to loans totaling $7.4 million at December 31, 2011.

 

             Loans having average recorded investments of $11.4 million and $14.0 million at June 30, 2012 and December 31, 2011, respectively, have been identified as impaired.  Nonaccrual loans amounting to $11.0 million and $11.5 million at June 30, 2012 and December 31, 2011, respectively, were not accruing interest.  Interest received on these loans during the second quarter of 2012 was approximately $225,000, compared to approximately $255,000 over the same period in 2011.  The gross interest income that would have been recorded if the loans had been current in accordance with their original terms and had been outstanding throughout the period or since origination, if held for part of the period, was approximately $392,000, and $326,000 for the six-month period ended June 30, 2012 and the six-month period ended June 30, 2011, respectively. The Corporation had no loans that were 90 days or more past due that were not included in nonaccrual loans as of June 30, 2012. 

 

   

Deposits

 

            The Corporation does not have any foreign offices and all deposits are serviced in its 18 domestic offices.  The Corporation's average deposits increased 8.2% during the first six months of 2012 compared to an increase of 1.5% in the first six months of 2011.  Average total noninterest-bearing deposits were 16.8% of total deposits at June 30, 2012, contributing to the Corporation's low cost of deposits, compared to 16.5% at December 31, 2011.

 

 

Regulatory Requirements for Capital

 

The Corporation and First Farmers and merchants Bank, the Corporation’s sole direct subsidiary (“the Bank”), are subject to federal regulatory capital adequacy standards.  Failure to meet capital adequacy requirements could result in certain mandatory, and possibly additional discretionary, actions by regulators that could have a direct material adverse effect on the financial condition of the Corporation and the Bank.  Federal regulations require the Corporation and the Bank to meet specific capital adequacy guidelines that involve quantitative measures of assets, liabilities and certain off-balance-sheet items as calculated under regulatory accounting practices.  The capital classification is also subject to qualitative judgments by the regulators about components, risk weightings and other factors.

 

            Under federal regulatory standards, to be “well-capitalized,” the Corporation’s and the Bank’s Tier 1 Risk-Based Capital Ratio (ratio of Tier 1 Capital to risk-weighted assets) must be at least 6%, its Total Risk-Based Capital Ratio (ratio of total capital to risk-weighted assets) must be at least 10%, and its Tier 1 Leverage Capital Ratio (ratio of Tier 1 Capital to average assets) must be at least 5%.  Equity capital (net of certain adjustments for intangible assets and investments in non-consolidated subsidiaries and certain classes of preferred stock) and other certain equity like instruments are considered Tier 1 Capital.  Tier 2 Capital consists of core capital plus supplementary or temporary capital such as subordinated debt, some types of preferred stock, and a defined percentage of the allowance for loan losses.

 

            As of June 30, 2012, the Bank's Tier 1 Risk-Based Capital Ratio, Total Risk-Based Capital Ratio and Tier 1 Leverage Capital Ratios were 15.4%, 16.6%, and 9.5%, respectively, compared to 15.2%, 16.5%, and 9.7% at December 31, 2011. At June 30, 2012, the Corporation's Tier 1 Risk-Based Capital Ratio, Total Risk-Based Capital Ratio and Tier 1 Leverage Capital Ratios were 15.7%, 17.0% and 9.8%, respectively.  The ratios were 15.6%, 16.8% and 10.0%, respectively, at December 31, 2011.  Management believes, as of June 30, 2012, that the Corporation and the Bank each met all capital adequacy requirements to which they are subject.

 

LIQUIDITY AND CAPITAL RESOURCES

 

            Most of the capital needs of the Corporation historically have been financed with retained earnings and deposits received.

 

31


 


 

 

 

 

The Corporation and subsidiary Bank is subject to Tennessee statutes and regulations that impose restrictions on the amount of dividends that may be declared.  Furthermore, any dividend payments are subject to the continuing ability of the Corporation to maintain its compliance with minimum federal regulatory capital requirements and to retain its characterization under federal regulations as a “well-capitalized” institution.  The Corporation’s Board of Directors has adopted a liquidity policy that outlines specific liquidity target balances.  Compliance with this policy is reviewed quarterly by the Corporation’s Asset/Liability Committee and results are reported to the Corporation’s Board of Directors.

 

The Corporation’s formal asset and liability management process is used to manage interest rate risk and assist management in maintaining reasonable stability in the gross interest margin as a result of changes in the level of interest rates and/or the spread relationships among interest rates.  The Corporation uses an earnings simulation model to evaluate the impact of different interest rate scenarios on the gross margin.  Each quarter, the Corporation’s Asset/Liability Committee monitors the relationship of rate sensitive earning assets to rate sensitive interest-bearing liabilities (interest rate sensitivity), which is the principal factor in determining the effect that fluctuating interest rates will have on future net interest income.  Rate sensitive earning assets and interest bearing liabilities are financial instruments that can be repriced to current market rates within a defined time period.

 

Management believes that the Corporation’s traditional sources of cash generated from operating activities are adequate to meet the liquidity needs for normal ongoing operations; however, the Corporation also has access to additional liquidity, if necessary, through additional advances from the FHLB or the CMA with the FHLB. The borrowings from the FHLB have been used generally for investment strategies to enhance the Corporation’s portfolio. At June 30, 2012, the Corporation had $64.7 million in borrowing capacity. 

 

CRITICAL ACCOUNTING POLICIES

 

The accounting principles the Corporation follows and the methods of applying these principles conform with GAAP and with general practices within the banking industry.  In connection with the application of those principles, the Corporation’s management has made judgments and estimates that with respect to the determination of the ALLL and the recognition of deferred income tax assets, have been critical to the determination of the Corporation’s financial position, results of operations and cash flows. 

 

Allowance for Loan  Losses

 

           The Corporation’s management assesses the adequacy of the ALLL prior to the end of each month and prepares a more formal review quarterly to assess the risk in the Corporation's loan portfolio.  This assessment includes procedures to estimate the allowance and test the adequacy and appropriateness of the resulting balance.  The ALLL represents calculated amounts for specifically identified credit exposure and exposures readily predictable by historical or comparative experience.  Even though this calculation considers specific credits, the entire allowance is available to absorb any credit losses.

 

           These calculated amounts are determined by assessing loans identified as not in compliance with loan agreements.  These loans are generally in two different risk groups.  One group is unique loans (commercial loans, including those loans considered impaired).  The second group consists of pools of homogenous loans (generally retail and mortgage loans).  The calculation for unique loans is based primarily on risk rating grades assigned to each of these loans as a result of the Corporation’s loan management and review processes.  Each risk-rating grade is assigned a loss ratio, which is determined based on the experience of management, discussions with banking regulators and the independent loan review process.  The amount allocated for an impaired loan is based on estimated cash flows discounted at the loan's original effective interest rate or the underlying collateral value.  Historical data, including actual loss experience on specific types of homogenous loans, is used to allocate amounts for loans or groups of loans meeting the specified criteria.  Management has implemented procedures that give more detailed historical data by category of retail and consumer credit and performance characteristics to broaden the analysis and improve monitoring of potential credit risk.

 

           Criteria considered and processes utilized in evaluating the adequacy of the ALLL are:

 

 

32


 


 

 

  • Portfolio quality trends;

  • Changes in the nature and volume of the portfolio;

  • Present and prospective economic and business conditions, locally and nationally;

  • Management review systems and board oversight, including external loan review processes;

  • Changes in credit policy, credit administration, portfolio management and procedures;

  • Changes in personnel, management and staff; and

  • Existence and effect of any concentrations of credit.

           In assessing the adequacy of the ALLL, the risk characteristics of the entire loan portfolio are evaluated.  This process includes the judgment of the Corporation’s management, input from independent loan reviews and reviews that may have been conducted by Corporation regulators as part of their usual examination process.

 

 

Results of Operations

 

Total interest income for the six months ended June 30, 2012 was $18.2 million compared to $19.1 million for the six months ended June 30, 2011 and $9.1 million for the three months ended June 30, 2012 compared to $9.7 million for the three months ended June 30, 2011.   Interest and fees earned on loans and investments are the primary components of total interest income.  Interest and fees earned on loans were $14.0 million, a decrease of $1.1 million, or 7.4%, during the six months ended June 30, 2012 compared to the six months ended June 30, 2011 and $7.0 million for the three months ended June 30, 2012 compared to $7.5 million for the three months ended June 30, 2011.  Nominal interest earned on investment securities and other earning assets was $4.2 million, an increase of approximately $136,000, or 3.3%, during the six months ended June 30, 2012 compared to the six months ended June 30, 2011 and  $2.1 million for the three months ended June 30, 2012 compared to $2.2 million for the three months ended June 30, 2011.

 

            Total interest expense in the six months ended June 30, 2012 was $2.1 million, a decrease of approximately $577,000, or 22.0%, compared to the six months ended June 30, 2011 and  approximately $980,000 for the three months ended June 30, 2012 compared to $1.3 million for the three months ended June 30, 2011.  The lower interest rates for certificates of deposits and public funds during the second quarter of 2012 were the primary reason for the lower expense.  As a policy, budgeted financial goals are monitored on a quarterly basis by the Corporation’s Asset/Liability Committee, which reviews the actual dollar change in net interest income for different interest rate movements.  A negative dollar change in net interest income for a 12-month and 24-month period of less than 10.0% of net interest income given a 100 to 200 basis point shift in interest rates is considered an acceptable rate risk position.  The rate risk analysis for the 24-month period beginning July 1, 2012 and ending June 30, 2014 showed a worst-case potential change to net interest income, in the very unlikely event of a negative 100 basis point shift in interest rates, of 6.9%, or a decrease in net interest income of $2.2 million by the end of the period.

 

            Net interest income of the Corporation on a fully taxable equivalent basis is influenced primarily by changes in:

(1)             the volume and mix of earning assets and sources of funding;

(2)             market rates of interest; and

(3)             income tax rates.

 

            The impact of some of these factors can be controlled by management policies and actions.  External factors also can have a significant impact on changes in net interest income from one period to another.  Some examples of such factors are:

(1)             the strength of credit demands by customers;

(2)             Federal Reserve Board monetary policy; and

(3)             fiscal and debt management policies of the federal government, including changes in tax laws.

 

            The net interest margin, on a tax equivalent basis, at June 30, 2012, March 31, 2012, and December, 31, 2011 was 3.65%, 3.66% and 4.07%, respectively.  The decline is due, in part, to lower yields on earnings assets and a declining loan portfolio.

 

 

 

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            Additions of approximately $520,000 were made to the provision for loan losses in the second quarter of 2012, compared to $750,000 in the second quarter of 2011.  The 2012 additions were lower because of the net charge-off ratios trending down.

 

            Noninterest income was $6.7 million, an increase of $1.6 million, or 31.7%, during the six months ended June 30, 2012 compared to the six months ended June 30, 2011 and $3.4 million for the three months ended June 30, 2012 compared to $2.7 million for the three months ended June 30, 2011.  The gain on sales of securities for the six months ended June 30, 2012 was $2.2 million, an increase of $1.7 million compared to the gain on sales for the six months ended June 30, 2011, and accounted for most of the increase in noninterest income over the periods, but was somewhat offset by an increase of approximately $70,000 in losses of other real estate owned.

 

            Noninterest expense, excluding the provision for loan losses, was $16.2 million in the six months ended June 30, 2012, an increase of approximately $210,000, or 1.3%, as compared to the interest expense for the six months ended June 30, 2011 and  $8.4 million for the three months ended June 30, 2012 compared to $8.0 million for the three months ended June 30, 2011.  An increase in salary benefits contributed to the higher noninterest expense.

           

Net income for the six months ended June 30, 2012 was $4.4 million, compared to $3.6 million for the six months ended June 30, 2011 and  $2.1 million for the three months ended June 30, 2012 compared to $2.0 million for the three months ended June 30, 2011.  The gain on sales of securities contributed to the increases.  The Corporation earned $0.83 per share for the six months ended in June 30, 2012, compared to $0.66 per share for the six months ended June 30, 2011. 

 

OFF-BALANCE SHEET ARRANGEMENTS

 

The Corporation is a party to financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of its customers.  These financial instruments include commitments to extend credit and stand-by letters of credit.  These instruments involve, to varying degrees, elements of credit risk in excess of the amount recognized in the balance sheet.  The contract or notional amounts of those instruments reflect the extent of involvement the Corporation has in those financial instruments.  Loan commitments are agreements to lend to a customer as long as there is not a violation of any condition established in the loan commitment contract.  Stand-by letters of credit are conditional commitments issued by the Corporation to guarantee the performance of a customer to a third party.  Those guarantees are primarily issued to support public and private borrowing arrangements, including commercial paper, bond financing and similar transactions.  The credit risk involved in issuing letters of credit is essentially the same as that involved in making a loan.

 

The total outstanding balance of loan commitments and stand-by letters of credit in the normal course of business at June 30, 2012 were $118.9 million and $8.5 million, respectively.

 

At June 30, 2012, the Corporation and the Bank did not have any off-balance sheet arrangements other than commitments to extend credit and stand-by letters of credit.

 

Item 3.  Quantitative and Qualitative Disclosures About Market Risk.

 

During the three months  ended June 30, 2012, there were no material changes in the quantitative and qualitative disclosures about market risk presented in the Corporation's Annual Report on Form 10-K for the year ended December 31, 2011.

 

Item 4.  Controls and Procedures.

 

(a) Evaluation of Disclosure Controls and Procedures.  The Corporation, with the participation of its management, including the Corporation’s Chief Executive Officer and  Treasurer (principal financial officer), carried out an evaluation of the effectiveness of the design and operation of its disclosure controls and procedures (as defined in Rules 13a-15e and 15d-15e under the Exchange Act) as of the end of the period covered by this report.  Based upon that evaluation and as of the end of the period covered by this report, the Corporation’s Chief Executive Officer and Treasurer (principal financial officer) concluded that the Corporation’s disclosure controls and procedures were effective in ensuring that information required to be disclosed in its reports that the Corporation files or submits to the SEC under the Exchange Act is recorded, processed, summarized and reported on a timely basis.

 

 

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(b) Changes in Internal Control Over Financial Reporting.  There has been no change in the Corporation's internal control over financial reporting that occurred during the second quarter of 2012 that has materially affected, or is reasonably likely to materially affect, the Corporation's internal control over financial reporting.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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PART II - OTHER INFORMATION

 

Item 1A. Risk Factors.

 

There have been no material changes in the risk factors previously disclosed in the Corporation’s Annual Report on Form 10-K for the year ended December 31, 2011.

 

Item 6.  Exhibits.

 

EXHIBIT

 

NUMBER

DESCRIPTION

3.1

Charter. (1)

3.2

Articles of Amendment to Charter. (1)

3.3

Second Amended and Restated By-laws. (2)

31.1

Certification of the Chief Executive Officer of First Farmers and Merchants Corporation Pursuant to Rule 13a-14 of the Securities Exchange Act of 1934, as amended, as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

31.2

Certification of the Treasurer (principal financial officer) of First Farmers and Merchants Corporation Pursuant to Rule 13a-14 of the Securities Exchange Act of 1934, as amended, as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

32

Certification of the Chief Executive Officer and Treasurer (principal financial officer) of First Farmers and Merchants Corporation Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

                              

(1)  Incorporated by reference from the First Farmers and Merchants Corporation Amendment No. 1 to the Annual Report on Form 10-K/A for the year ended December 31, 2003, as filed with the Securities and Exchange Commission on May 7, 2004 (File Number 000-10972).

(2)  Incorporated by reference from the First Farmers and Merchants Corporation Annual Report on Form 10-K, as filed with the Securities and Exchange Commission on March 15, 2011 (File Number 000-10972).

 

 

 

 

 

 

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SIGNATURES

 

 

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

 

 

 

 

FIRST FARMERS AND MERCHANTS CORPORATION

(Registrant)

 

 

 

 

Date             August 6, 2012

                   /s/ T. Randy Stevens                               

 

T. Randy Stevens, Chief Executive Officer

 

 

 

 

 

 

 

 

Date             August 6, 2012

             /s/ Patricia P. Bearden                                     

 

Patricia P. Bearden, Treasurer (principal financial officer and principal accounting officer)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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EXHIBIT

 

NUMBER

DESCRIPTION

3.1

Charter. (1)

3.2

Articles of Amendment to Charter. (1)

3.3

Second Amended and Restated By-laws. (2)

31.1

Certification of the Chief Executive Officer of First Farmers and Merchants Corporation Pursuant to Rule 13a-14 of the Securities Exchange Act of 1934, as amended, as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

31.2

Certification of the Treasurer (principal financial officer) of First Farmers and Merchants Corporation Pursuant to Rule 13a-14 of the Securities Exchange Act of 1934, as amended, as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

32

Certification of the Chief Executive Officer and Treasurer (principal financial officer) of First Farmers and Merchants Corporation Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

                              

(1)  Incorporated by reference from the First Farmers and Merchants Corporation Amendment No. 1 to the Annual Report on Form 10-K/A for the year ended December 31, 2003, as filed with the Securities and Exchange Commission on May 7, 2004 (File Number 000-10972).

(2)  Incorporated by reference from the First Farmers and Merchants Corporation Annual Report on Form 10-K, as filed with the Securities and Exchange Commission on March 15, 2011 (File Number 000-10972).

 

 

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