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EX-99 - REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM - DIMECO INCv320978_ex99.htm
EX-31.2 - SECTION 302 CFO CERTIFICATION - DIMECO INCv320978_ex31-2.htm
EX-31.1 - SECTION 302 CEO CERTIFICATION - DIMECO INCv320978_ex31-1.htm
EX-32.1 - SECTION 906 CEO AND CFO CERTIFICATION - DIMECO INCv320978_ex32-1.htm

 

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

 

Form 10-Q

 

x QUARTERLY REPORT UNDER SECTION 13 OF 15(D) OF THE SECURITIES

EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2012

 

or

 

¨ TRANSITION REPORT UNDER SECTION 13 OF 15(d) OF THE EXCHANGE ACT

Or the transition period from ________ to ________

 

Commission File Number 33-58936

 

Dimeco, Inc.

(Exact name of registrant as specified in its charter)

 

Pennsylvania 23-2250152
(State or other jurisdiction of (I.R.S. Employer
Incorporation or organization) identification No.)

 

820 Church Street

Honesdale, PA 18431

(Address of principal executive officers)

 

(570) 253-1970

(Issuer’s Telephone Number)

 

Not Applicable

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

 

Check whether the issuer (1) filed all reports required to be filed by Sections 13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

Yes x No ¨

 

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

 

  Large accelerated filer ¨   Accelerated filer ¨
 

Non-accelerated filer ¨

(Do not check if a smaller reporting company)

  Smaller reporting company x

 

Indicate by check mark whether the registrant is a shell company (as defined by Rule 12b-2 of the Exchange Act)

Yes ¨ No x

 

As of July 25, 2012 the registrant had outstanding 1,599,646 shares of its common stock, par value $.50 share.

 

 
 

 

Dimeco, Inc.

INDEX

 

    Page
PART  I – FINANCIAL INFORMATION  
     
Item 1. Financial Statements  
     
  Consolidated Balance Sheet (unaudited) as of June 30, 2012 and December 31, 2011 3
     
  Consolidated Statement of Income (unaudited) for the three and six months ended June 30, 2012 and 2011 4
     
  Consolidated Statement of Comprehensive Income (unaudited) for the three and six months ended June 30, 2012 and 2011 5
     
  Consolidated Statement of Changes in Stockholders' Equity (unaudited) for the six months ended June 30, 2012 6
     
  Consolidated Statement of Cash Flows (unaudited) for the six months ended June 30, 2012 and 2011 7
     
  Notes to Consolidated Financial Statements (unaudited) 8 - 23
     
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations 24 - 28
     
Item 3. Quantitative and Qualitative Disclosures about Market Risk 28 - 30
     
Item 4. Controls and Procedures 30
     
PART II - OTHER INFORMATION  
     
Item 1. Legal Proceedings 31
     
Item 1a. Risk Factors 31
     
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 31
     
Item 3. Defaults Upon Senior Securities 31
     
Item 4. Mine Safety Disclosures 31
     
Item 5. Other Information 31
     
Item 6. Exhibits 31
     
SIGNATURES 32

 

2
 

 

Dimeco, Inc.

CONSOLIDATED BALANCE SHEET (unaudited)

 

(in thousands)  June 30, 2012   December 31, 2011 
Assets          
Cash and due from banks  $6,097   $5,348 
Interest-bearing deposits in other banks   1,451    4,575 
Total cash and cash equivalents   7,548    9,923 
           
Investment securities available for sale   106,541    95,619 
           
Loans   465,511    447,254 
Less allowance for loan losses   9,144    8,316 
Net loans   456,367    438,938 
           
Premises and equipment   9,864    9,997 
Accrued interest receivable   1,868    1,805 
Bank-owned life insurance   10,241    10,060 
Other real estate owned   3,264    3,467 
Other assets   12,850    12,085 
TOTAL ASSETS  $608,543   $581,894 
Liabilities          
Deposits :          
Noninterest-bearing  $57,610   $52,217 
Interest-bearing   440,653    432,067 
Total deposits   498,263    484,284 
           
Short-term borrowings   31,587    20,686 
Other borrowed funds   16,619    17,618 
Accrued interest payable   529    542 
Other liabilities   4,069    3,664 
TOTAL LIABILITIES   551,067    526,794 
           
Stockholders' Equity          
Common stock, $.50 par value; 5,000,000 shares authorized; 1,653,746 shares issued   827    827 
Capital surplus   6,604    6,451 
Retained earnings   50,274    48,193 
Accumulated other comprehensive income   1,838    1,696 
Treasury stock, at cost (54,100 shares)   (2,067)   (2,067)
TOTAL STOCKHOLDERS' EQUITY   57,476    55,100 
TOTAL LIABILITES AND STOCKHOLDERS' EQUITY  $608,543   $581,894 

 

See accompanying notes to the unaudited consolidated financial statements.

 

3
 

 

Dimeco, Inc.

CONSOLIDATED STATEMENT OF INCOME (unaudited)

 

   For the three months ended June 30,   For the six months ended June 30, 
(in thousands, except per share)  2012   2011   2012   2011 
Interest Income                    
Interest and fees on loans  $5,865   $5,515   $11,562   $10,960 
Investment securities:                    
Taxable   320    320    644    610 
Exempt from federal income tax   314    303    629    593 
Other   3    3    5    7 
Total interest income   6,502    6,141    12,840    12,170 
                     
Interest Expense                    
Deposits   904    1,066    1,837    2,205 
Short-term borrowings   31    38    50    61 
Other borrowed funds   180    214    366    433 
Total interest expense   1,115    1,318    2,253    2,699 
                     
Net Interest Income   5,387    4,823    10,587    9,471 
                     
Provision for loan losses   700    275    1,350    700 
                     
Net Interest Income After Provision for  Loan Losses   4,687    4,548    9,237    8,771 
                     
Noninterest Income                    
Service charges on deposit accounts   221    257    456    528 
Mortgage loans held for sale gains, net   185    66    324    148 
Investment securities gains (losses)   40    (26)   109    (28)
Brokerage commissions   183    157    330    338 
Earnings on bank-owned life insurance   109    107    216    213 
Debit card fees   161    154    310    291 
Other  income   214    274    385    453 
Total noninterest income   1,113    989    2,130    1,943 
                     
Noninterest Expense                    
Salaries and employee benefits   1,899    1,843    3,826    3,620 
Occupancy expense, net   279    265    577    571 
Furniture and equipment expense   109    113    200    218 
Professional fees   231    183    396    493 
Data processing expense   163    178    326    357 
Other expense   919    780    1,827    1,700 
Total noninterest expense   3,600    3,362    7,152    6,959 
                     
Income before income taxes   2,200    2,175    4,215    3,755 
Income taxes   519    509    965    819 
                     
NET INCOME  $1,681   $1,666   $3,250   $2,936 
                     
Earnings per Share - basic  $1.05   $1.04   $2.03   $1.84 
Earnings per Share - diluted  $1.05   $1.04   $2.03   $1.84 
Dividends per share  $0.36   $0.36   $0.72   $0.72 
Average shares outstanding - basic   1,599,646    1,598,218    1,599,646    1,598,218 
Average shares outstanding - diluted   1,601,680    1,599,205    1,600,362    1,599,739 

 

See accompanying notes to the unaudited consolidated financial statements.

 

4
 

 

Dimeco, Inc.

CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME (unaudited)

 

   For the three months ended June 30,   For the six months ended June 30, 
   2012   2011   2012   2011 
Net income  $1,681   $1,666   $3,250   $2,936 
Other comprehensive income:                    
Unrealized gain on available for sale securities   305    855    324    1,033 
Tax expense   (104)   (291)   (110)   (351)
    201    564    214    682 
Loss (gain) recognized in earnings   (40)   26    (109)   28 
Tax (benefit) expense   14    (9)   37    (10)
    (26)   17    (72)   18 
Other comprehensive income,  net of tax   175    581    142    700 
Comprehensive income  $1,856   $2,247   $3,392   $3,636 

 

See accompanying notes to the unaudited consolidated financial statements.

 

5
 

 

Dimeco, Inc.

CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS’ EQUITY (unaudited)

 

               Accumulated         
               Other       Total 
   Common   Capital   Retained   Comprehensive   Treasury   Stockholders' 
(in thousands)  Stock   Surplus   Earnings   Income   Stock   Equity 
Balance, December 31, 2011  $827   $6,451   $48,193   $1,696   $(2,067)  $55,100 
                               
Net income             3,250              3,250 
Unrealized gain on available for sale securities, net of tax expense of $73                  142         142 
Stock compensation expense        153                   153 
Cash dividends ($.72 per share)             (1,169)             (1,169)
                               
Balance, June 30, 2012  $827   $6,604   $50,274   $1,838   $(2,067)  $57,476 

 

See accompanying notes to the unaudited consolidated financial statements.

 

6
 

 

Dimeco, Inc.

CONSOLIDATED STATEMENT OF CASH FLOWS (unaudited)

 

   For the six months ended June 30, 
(in thousands)  2012   2011 
Operating Activities          
Net income  $3,250   $2,936 
Adjustments to reconcile net income to net cash provided by operating activities:          
Provision for loan losses   1,350    700 
Depreciation and amortization   456    449 
Amortization of premium and discount on investment securities, net   402    285 
Amortization of net deferred loan origination fees   (83)   (81)
Investment securities (gains) losses, net   (109)   28 
Origination of loans held for sale   (10,339)   (6,077)
Proceeds from sale of loans   10,663    6,145 
Mortgage loans held for sale gains, net   (324)   (148)
Impairment of other real estate owned   46    - 
Increase in accrued interest receivable   (63)   (39)
Decrease in accrued interest payable   (13)   (65)
Deferred federal income taxes   (482)   20 
Earnings on bank-owned life insurance   (216)   (213)
Decrease in prepaid FDIC insurance   240    302 
Stock compensation expense   153    - 
Other, net   (310)   (473)
Net cash provided by operating activities   4,621    3,769 
           
Investing Activities          
Investment securities available for sale:          
Proceeds from sales or mergers   3,048    66 
Proceeds from maturities or paydowns   47,909    61,653 
Purchases   (61,541)   (68,589)
Redemption of Federal Home Loan Bank stock   213    18 
Purchase of Federal Home Loan Bank stock   (204)   (526)
Net increase in loans   (19,374)   (12,227)
Investment in limited partnership   (371)   (262)
Purchase of bank-owned life insurance   -    (141)
Proceeds from the sale of other real estate owned   830    34 
Purchase of premises and equipment   (218)   (55)
Net cash used for investing activities   (29,708)   (20,029)
           
Financing Activities          
Net increase (decrease) in deposits   13,979    (3,039)
Increase in short-term borrowings   10,901    20,151 
Repayment of other borrowed funds   (999)   (956)
Cash dividends paid   (1,169)   (1,151)
Net cash used for financing activities   22,712    15,005 
Decrease in cash and cash equivalents   (2,375)   (1,255)
           
Cash and cash equivalents at beginning of period   9,923    10,652 
Cash and cash equivalents at end of period  $7,548   $9,397 
           
Amount paid for interest  $2,266   $2,764 
Amount paid for income taxes  $1,550   $642 
           
Noncash investing activities:          
Transfer of loans to other real estate owned  $678   $3,267 
Loans to facilitate sale of other real estate owned  $1,100   $- 
Changes in the unrealized holding gains and losses on available-for-sale securities  $215   $1,060 
Investment purchases not settled  $415   $- 

 

See accompanying notes to the unaudited consolidated financial statements.

 

7
 

 

Dimeco, Inc.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

 

NOTE 1 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

 

Basis of Presentation

 

The consolidated financial statements include the accounts of Dimeco, Inc. (the "Company") and its wholly-owned subsidiary, The Dime Bank (the "Bank"). The financial statements of The Dime Bank include the consolidated financial statements of the Bank’s wholly-owned subsidiary, TDB Insurance Services, LLC. All significant intercompany balances and transactions have been eliminated in the consolidation.

 

The accompanying unaudited consolidated financial statements have been prepared in accordance with the instructions to Form 10-Q and, therefore, do not necessarily include all information that would be included in audited financial statements. The information furnished reflects all adjustments which are, in the opinion of management, necessary for a fair statement of the results of operations. All such adjustments are of a normal recurring nature. The results of operations for the interim periods are not necessarily indicative of the results to be expected for the full year.

 

Certain comparative amounts for prior periods have been reclassified to conform to current year presentation. The reclassifications did not affect net income or equity capital.

 

Recent Accounting Pronouncements

 

In May 2011, the FASB issued ASU 2011-04, Fair Value Measurement (Topic 820): Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs. The amendments in this Update result in common fair value measurement and disclosure requirements in U.S. GAAP and IFRSs. Consequently, the amendments change the wording used to describe many of the requirements in U.S. GAAP for measuring fair value and for disclosing information about fair value measurements. The amendments in this Update are to be applied prospectively. For public entities, the amendments are effective during interim and annual periods beginning after December 15, 2011. For nonpublic entities, the amendments are effective for annual periods beginning after December 15, 2011. Early application by public entities is not permitted. The Company has provided the necessary disclosure in Note 7.

 

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

 

In December 2011, the FASB issued ASU 2011-10, Property, Plant, and Equipment (Topic 360): Derecognition of in Substance Real Estate-a Scope Clarification. The amendments in this Update affect entities that cease to have a controlling financial interest in a subsidiary that is in substance real estate as a result of default on the subsidiary's nonrecourse debt. Under the amendments in this Update, when a parent (reporting entity) ceases to have a controlling financial interest in a subsidiary that is in substance real estate as a result of default on the subsidiary's nonrecourse debt, the reporting entity should apply the guidance in Subtopic 360-20 to determine whether it should derecognize the in substance real estate. Generally, a reporting entity would not satisfy the requirements to derecognize the in substance real estate before the legal transfer of the real estate to the lender and the extinguishment of the related nonrecourse indebtedness. That is, even if the reporting entity ceases to have a controlling financial interest under Subtopic 810-10, the reporting entity would continue to include the real estate, debt, and the results of the subsidiary's operations in its consolidated financial statements until legal title to the real estate is transferred to legally satisfy the debt. The amendments in this Update should be applied on a prospective basis to deconsolidation events occurring after the effective date. Prior periods should not be adjusted even if the reporting entity has continuing involvement with previously derecognized in substance real estate entities. For public entities, the amendments in this Update are effective for fiscal years, and interim periods within those years, beginning on or after June 15, 2012. For nonpublic entities, the amendments are effective for fiscal years ending after December 15, 2013, and interim and annual periods thereafter. Early adoption is permitted. This ASU is not expected to have a significant impact on the Company’s financial statements.

 

8
 

 

In December 2011, the FASB issued ASU 2011-12, Comprehensive Income (Topic 220): Deferral of the Effective Date for Amendments to the Presentation of Reclassifications of Items Out of Accumulated Other Comprehensive Income in Accounting Standards Update No. 2011-05. In order to defer only those changes in Update 2011-05 that relate to the presentation of reclassification adjustments, the paragraphs in this Update supersede certain pending paragraphs in Update 2011-05. Entities should continue to report reclassifications out of accumulated other comprehensive income consistent with the presentation requirements in effect before Update 2011-05. All other requirements in Update 2011-05 are not affected by this Update, including the requirement to report comprehensive income either in a single continuous financial statement or in two separate but consecutive financial statements. Public entities should apply these requirements for fiscal years, and interim periods within those years, beginning after December 15, 2011. Nonpublic entities should begin applying these requirements for fiscal years ending after December 15, 2012, and interim and annual periods thereafter. The Company has provided the necessary disclosure in Statement of Comprehensive Income.

 

Stock Options

 

The Company maintains a stock option plan for key officers and non-employee directors. There were no options granted in the first six months of 2012 or 2011.

 

As of June 30, 2012, the following was expensed as compensation expense relating to share-based compensation (in thousands):

 

   Directors   Officers   Total 
Stock options  $16   $15   $31 
Restricted Stock  $61   $61   $122 

 

For the first six months of 2012, the Company recognized $153 of compensation expense for stock options and restricted stock awards granted on September 21, 2011. This expense was unmatched for the first six months of 2011 as all outstanding options granted prior to the 2011 grant were vested at January 1, 2006.

 

As of June 30, 2012, the following is unrecognized compensation expense (in thousands):

 

   Directors   Officers   Total 
Stock options  $37   $128   $165 
Restricted stock  $142   $510   $652 

 

A summary of the Company’s stock award activity for the six months ended June 30 is as follows:

 

   For the six months ended June 30, 
       Weighted-       Weighted- 
       Average       Average 
       Exercise       Exercise 
   2012   Price   2011   Price 
                 
Stock options:                    
Outstanding, beginning of year   101,414   $35.06    28,342   $35.18 
Granted   -    -    -    - 
Exercised   -    -    -    - 
Forfeited   (850)   35.00    -    - 
                     
Outstanding, end of year   100,564   $35.06    28,342   $35.18 
                     
Exercisable at June 30,   26,914   $35.24    28,342   $35.18 
                     
Restricted stock awards:                    
Nonvested, beginning of year   24,460   $35.00           
Granted   -    -           
Exercised   -    -           
Forfeited   (300)   35.00           
                     
Nonvested, June 30,   24,160   $35.00           
                     
Total intrinsic value of restricted shares granted       $908,416           

 

9
 

  

The following table summarizes characteristics of stock options outstanding at June 30, 2012:

 

    Outstanding   Exercisable 
        Average   Average       Average 
Exercise       Remaining   Exercise       Exercise 
Price   Shares   Life   Price   Shares   Price 
                      
$32.55    2,000    1.36   $32.55    2,000   $32.55 
$34.00    6,284    3.46   $34.00    6,284   $34.00 
$35.00    73,650    9.23   $35.00    -   $- 
$35.95    18,630    3.23   $35.95    18,630   $35.95 
                            
 Total    100,564         Total    26,914      

 

NOTE 2 – EARNINGS PER SHARE

 

There are no convertible securities which would affect the numerator in calculating basic and diluted earnings per share; therefore, net income as presented on the Consolidated Statement of Income (unaudited) will be used as the numerator. The following table sets forth the composition of the weighted-average common shares (denominator) used in the basic and diluted earnings per share computation:

 

   Three months ended June 30,   Six months ended June 30, 
   2012   2011   2012   2011 
Weighted average common stock outstanding   1,653,746    1,652,318    1,653,746    1,652,318 
Average treasury stock   (54,100)   (54,100)   (54,100)   (54,100)
Weighted average common stock and common stock equivalents used to calculate basic earnings per share   1,599,646    1,598,218    1,599,646    1,598,218 
Additional common stock equivalents (nonvested stock) used to calculate diluted earnings per share   209    -    -    - 
Additional common stock equivalents (stock options) used to calculate diluted earnings per share   1,825    987    716    1,521 
Weighted average common stock and common stock equivalents used to calculate diluted earnings per share   1,601,680    1,599,205    1,600,362    1,599,739 

 

Options to purchase 74,500 shares of common stock at a price greater than the current market value were outstanding at June 30, 2012 but were not included in the computation of diluted earnings per share because to do so would have been antidilutive. There were no options outstanding at June 30, 2011 which would have an antidilutive effects on earnings per share.

 

10
 

 

NOTE 3 – INVESTMENTS

 

The amortized cost and estimated fair value of investment securities are summarized as follows (in thousands):

 

   June 30, 2012 
       Gross   Gross     
   Amortized   Unrealized   Unrealized   Fair 
   Cost   Gains   Losses   Value 
AVAILABLE FOR SALE                    
U.S. government agencies  $8,468   $143   $(5)  $8,606 
Mortgage-backed securities of government - sponsored entities   28,508    637    (30)   29,115 
Collateralized mortgage obligations of government - sponsored entities   7,886    19    (40)   7,865 
Obligations of states and political subdivisions:                    
Taxable   1,437    165    -    1,602 
Tax-exempt   34,118    1,517    (25)   35,610 
Corporate securities   5,191    362    (2)   5,551 
Commercial paper   17,688    -    -    17,688 
Total debt securities   103,296    2,843    (102)   106,037 
                     
Equity securities of financial institutions   461    78    (35)   504 
Total  $103,757   $2,921   $(137)  $106,541 

 

   December 31, 2011 
       Gross   Gross     
   Amortized   Unrealized   Unrealized   Fair 
   Cost   Gains   Losses   Value 
AVAILABLE FOR SALE                    
U.S. government agencies  $10,999   $195   $(3)  $11,191 
Mortgage-backed securities of government - sponsored entities   28,119    499    (40)   28,578 
Collateralized mortgage obligations of government - sponsored entities   5,233    7    (65)   5,175 
Obligations of states and political subdivisions:                    
Taxable   1,440    142    -    1,582 
Tax-exempt   31,085    1,425    (2)   32,508 
Corporate securities   3,686    400    (4)   4,082 
Commercial paper   11,998    -    -    11,998 
Total debt securities   92,560    2,668    (114)   95,114 
                     
Equity securities of financial institutions   489    62    (46)   505 
Total  $93,049   $2,730   $(160)  $95,619 

 

11
 

 

The following table shows the Company’s fair value and gross unrealized losses, aggregated by investment category and length of time that the individual securities have been in a continuous unrealized loss position (in thousands):

 

   June 30, 2012 
   Less than Twelve Months   Twelve Months or Greater   Total 
       Gross       Gross       Gross 
   Fair   Unrealized   Fair   Unrealized   Fair   Unrealized 
   Value   Losses   Value   Losses   Value   Losses 
                         
U.S. Government agencies  $437   $2   $728   $3   $1,165   $5 
Mortgage-backed securities of government - sponsored entities   4,962    30    -    -    4,962    30 
Collateralized mortgage obligations of government - sponsored entities   4,049    29    862    11    4,911    40 
Obligations of states and political subdivisions   2,712    25    -    -    2,712    25 
Corporate securities   495    2    -    -    495    2 
Total debt securities   12,655    88    1,590    14    14,245    102 
                               
Equity securities of financial institutions   71    5    95    30    166    35 
Total  $12,726   $93   $1,685   $44   $14,411   $137 

 

   December 31, 2011 
   Less than Twelve Months   Twelve Months or Greater   Total 
       Gross       Gross       Gross 
   Fair   Unrealized   Fair   Unrealized   Fair   Unrealized 
   Value   Losses   Value   Losses   Value   Losses 
                         
U.S. Government agencies  $348   $2   $456   $1   $804   $3 
Mortgage-backed securities of government - sponsored entities   5,678    25    1,407    15    7,085    40 
Collateralized mortgage obligations of government - sponsored entities   4,685    65    -    -    4,685    65 
Obligations of states and political subdivisions   -    -    300    2    300    2 
Corporate securities   236    4    -    -    236    4 
Total debt securities   10,947    96    2,163    18    13,110    114 
                               
Equity securities of financial institutions   106    12    96    34    202    46 
Total  $11,053   $108   $2,259   $52   $13,312   $160 

 

The Company reviews its position quarterly and has asserted that at June 30, 2012, the declines outlined in the above table represent temporary declines and the Company does not intend to sell and does not believe it will be required to sell these securities before recovery of its cost basis, which may be at maturity. There were 29 positions that were temporarily impaired at both June 30, 2012 and December 31, 2011. The Company has concluded that the unrealized losses disclosed above are not other than temporary, but are the result of interest rate changes, sector credit ratings changes or company-specific ratings changes that are not expected to result in the non-collection of principal and interest during the period in consideration for debt securities. Determination of other than temporary losses in the financial services equity portfolio includes consideration of the length of time in a loss position, analysis of the capital structure of the entity and review of publicly available regulatory actions and published financial reports.

 

The following table is a summary of proceeds received, gross gains and gross losses realized on the sale, call or merger of investment securities for the three months ended June (in thousands):

 

   June 30, 2012   June 30, 2011 
Proceeds  $2,222   $44 
Gross gains  $40   $4 
Gross losses  $-   $- 

 

12
 

 

The following table is a summary of proceeds received, gross gains and gross losses realized on the sale, call or merger of investment securities for the six months ended June (in thousands):

 

   June 30, 2012   June 30, 2011 
Proceeds  $3,048   $66 
Gross gains  $109   $5 
Gross losses  $-   $3 
Other than temporarily impaired expense   -    30 

 

The amortized cost and estimated fair value of debt securities at June 30, 2012, by contractual maturity, are shown below. Expected maturities of mortgage-backed securities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepay penalties (in thousands):

 

   Available for Sale 
   Amortized   Fair 
   Cost   Value 
Due in one year or less  $33,073   $33,223 
Due after one year through five years   29,519    30,174 
Due after five years through ten years   24,314    25,485 
Due after ten years   16,390    17,155 
Total debt securities  $103,296   $106,037 

 

NOTE 4 – LOANS

 

Major classifications of loans at June 30, 2012 and December 31, 2011 are as follows (in thousands):

 

   June 30, 2012   December 31, 2011 
Loans secured by real estate:          
Construction and development  $16,340   $14,571 
Secured by farmland   3,513    3,585 
Secured by 1-4 family residential properties:          
Revolving, open-end loans   11,391    11,215 
All other 1-4 family   89,545    87,088 
Secured by non-farm, non-residential properties   278,651    269,248 
           
Commercial and industrial loans   49,939    45,312 
           
Loans to individuals for household, family and other personal expenditures:          
Ready credit loans   507    494 
Other consumer loans   8,609    9,327 
           
Other loans:          
Agricultural loans   1,311    955 
All other loans   5,705    5,459 
Total loans   465,511    447,254 
           
Allowance for loan losses   9,144    8,316 
           
Total Net Loans  $456,367   $438,938 

 

13
 

 

NOTE 5 – ALLOWANCE FOR LOAN LOSSES

 

The total allowance reflects management's estimate of loan losses inherent in the loan portfolio at the balance sheet date. The Company considers the allowance for loan losses adequate to cover loan losses inherent in the loan portfolio. The following table presents by portfolio segment, the allowance for loan losses as of June 30, 2012 and June 30, 2011 (in thousands):

 

   Three months ended June 30, 2012 
       Construction &   Commercial       Residential     
   Commercial   Development   Real Estate   Consumer   Real Estate   Total 
Allowance for loan losses:                              
Beginning balance  $512   $289   $6,856   $154   $1,007   $8,818 
Charge-offs   (53)   -    (278)   (7)   (45)   (383)
Recoveries   1    -    -    8    1    10 
Provision   146    32    590    (19)   (50)   699 
Ending balance  $606   $321   $7,168   $136   $913   $9,144 

 

   Three months ended June 30, 2011 
       Construction &   Commercial       Residential     
   Commercial   Development   Real Estate   Consumer   Real Estate   Total 
Allowance for loan losses:                              
Beginning balance  $614   $223   $4,900   $201   $1,177   $7,115 
Charge-offs   (12)   -    (1)   (48)   -    (61)
Recoveries   -    -    -    9    5    14 
Provision   7    105    213    44    (94)   275 
Ending balance  $609   $328   $5,112   $206   $1,088   $7,343 

 

   Six months ended June 30, 2012 
       Construction &   Commercial       Residential     
   Commercial   Development   Real Estate   Consumer   Real Estate   Total 
Allowance for loan losses:                              
Beginning balance  $474   $283   $6,425   $158   $976   $8,316 
Charge-offs   (67)   -    (305)   (53)   (122)   (547)
Recoveries   1    -    -    23    2    26 
Provision   198    38    1,048    8    57    1,349 
Ending balance  $606   $321   $7,168   $136   $913   $9,144 

 

   Six months ended June 30, 2011 
       Construction &   Commercial       Residential     
   Commercial   Development   Real Estate   Consumer   Real Estate   Total 
Allowance for loan losses:                              
Beginning balance  $634   $223   $5,719   $194   $971   $7,741 
Charge-offs   (262)   -    (747)   (118)   -    (1,127)
Recoveries   -    -    -    23    6    29 
Provision   237    105    140    107    111    700 
Ending balance  $609   $328   $5,112   $206   $1,088   $7,343 

 

14
 

 

The following tables summarize the allowance for loan losses on the basis of the Company’s impairment method as of June 30, 2012 and December 31, 2011 (in thousands):

 

   June 30, 2012 
       Construction &   Commercial       Residential     
   Commercial   Development   Real Estate   Consumer   Real Estate   Total 
Ending allowance balance:                              
Loans individually evaluated for impairment  $-   $-   $3,523   $-   $-   $3,523 
                               
Loans collectively evaluated for impairment   606    321    3,645    136    913    5,621 
Total  $606   $321   $7,168   $136   $913   $9,144 
                               
Ending loan balance:                              
Loans individually evaluated for impairment  $375   $1,061   $17,149   $-   $276   $18,861 
                               
Loans collectively evaluated for impairment   56,580    15,279    265,015    9,116    100,660    446,650 
Total  $56,955   $16,340   $282,164   $9,116   $100,936   $465,511 

 

   December 31, 2011 
       Construction &   Commercial       Residential     
   Commercial   Development   Real Estate   Consumer   Real Estate   Total 
Ending allowance balance:                              
Loans individually evaluated for impairment  $-   $-   $3,626   $-   $-   $3,626 
                               
Loans collectively evaluated for impairment   474    283    2,799    158    976   $4,690 
Total  $474   $283   $6,425   $158   $976   $8,316 
                               
Ending loan balance:                              
Loans individually evaluated for impairment  $-   $1,105   $16,041   $-   $276   $17,422 
                               
Loans collectively evaluated for impairment   51,726    13,466    256,792    9,821    98,027    429,832 
Total  $51,726   $14,571   $272,833   $9,821   $98,303   $447,254 

 

Credit Quality Information

 

The following tables represent credit exposures by assigned grades as of June 30, 2012 and December 31, 2011. The grading analysis estimates the capability of the borrower to repay the contractual obligations of the loan agreements as scheduled or at all. The Company's internal credit risk grading system is based on experiences with similarly graded loans.

 

The Company's internally assigned grades are as follows:

 

Pass – loans which are protected by the current net worth and paying capacity of the obligor or by the value of the underlying collateral.

 

Special Mention – loans where a potential weakness or risk exists, which could cause a more serious problem if not corrected.

 

Substandard – loans that have a well-defined weakness based on objective evidence and are characterized by the distinct possibility that the Bank will sustain some loss if the deficiencies are not corrected.

 

Doubtful – loans classified as doubtful have all the weaknesses inherent in a substandard asset. In addition, these weaknesses make collection or liquidation in full highly questionable and improbable, based on existing circumstances.

 

15
 

 

Loss – loans classified as a loss are considered uncollectable, or of such value that continuance as an asset is not warranted.

 

Loans are graded by either independent loan review or internal review. Internally reviewed loans were assigned a risk weighting by the loan officer and approved by the loan committee, but have not undergone a formal loan review by an independent party. These loans are typically smaller dollar balances that have not experienced delinquency issues. Balances include gross loan value before unearned income and excluding overdrafts as of June 30, 2012 and December 31, 2011 (in thousands):

 

   June 30, 2012 
       Construction &   Commercial       Residential     
   Commercial   Development   Real Estate   Consumer   Real Estate   Total 
Loans Independently Reviewed:                              
Pass  $19,704   $1,914   $150,494   $50   $7,449   $179,611 
Special Mention   419    1,362    7,277    42    469    9,569 
Substandard   4,010    3,486    36,121    43    2,517    46,177 
Doubtful   17    -    -    -    -    17 
Loss   -    -    -    -    -    - 
                               
Total  $24,150   $6,762   $193,892   $135   $10,435   $235,374 
                               
Loans Internally Reviewed:                              
Pass  $32,753   $9,582   $89,237   $8,981   $90,678   $231,231 
Special Mention   -    -    -    -    -    - 
Substandard   -    -    -    -    -    - 
Doubtful   -    -    -    -    -    - 
Loss   -    -    -    -    -    - 
                               
Total  $32,753   $9,582   $89,237   $8,981   $90,678   $231,231 

 

   December 31, 2011 
       Construction &   Commercial       Residential     
   Commercial   Development   Real Estate   Consumer   Real Estate   Total 
Loans Independently Reviewed:                              
Pass  $20,136   $1,914   $158,723   $57   $8,172   $189,002 
Special Mention   417    1,635    9,021    57    618    11,749 
Substandard   2,660    3,531    34,192    50    2,389    42,822 
Doubtful   17    -    -    -    -    17 
Loss   -    -    -    -    -    - 
                               
Total  $23,230   $7,080   $201,936   $164   $11,179   $243,589 
                               
Loans Internally Reviewed:                              
Pass  $28,365   $7,502   $71,850   $9,660   $87,318   $204,695 
Special Mention   -    -    -    -    -    - 
Substandard   -    -    -    -    -    - 
Doubtful   -    -    -    -    -    - 
Loss   -    -    -    -    -    - 
                               
Total  $28,365   $7,502   $71,850   $9,660   $87,318   $204,695 

 

16
 

 

Age Analysis of Past Due Loans by Class

 

The following is a table which includes an aging analysis of the recorded investment of past due loans as of June 30, 2012 and December 31, 2011 including loans which are in nonaccrual status (in thousands):

 

   June 30, 2012 
                           Recorded 
                           Investment > 
   30-59 Days   60-89 Days   90 Days   Total Past       Total   90 Days and 
   Past Due   Past Due   Or Greater   Due   Current   Loans   Accruing 
                             
Commercial  $1,192   $186   $229   $1,607   $55,348   $56,955   $3 
Construction and development   585    -    -    585    15,755    16,340    - 
Commercial real estate   445    200    5,555    6,200    275,964    282,164    8 
Consumer   146    27    49    222    8,894    9,116    32 
Residential real estate   703    494    835    2,032    98,904    100,936    12 
                                    
Total  $3,071   $907   $6,668   $10,646   $454,865   $465,511   $55 

 

   December 31, 2011 
                           Recorded 
                           Investment > 
   30-59 Days   60-89 Days   90 Days   Total Past       Total   90 Days and 
   Past Due   Past Due   Or Greater   Due   Current   Loans   Accruing 
                             
Commercial  $248   $214   $200   $662   $51,064   $51,726   $163 
Construction and development   -    -    -    -    14,571    14,571    - 
Commercial real estate   175    1,611    4,526    6,312    266,521    272,833    346 
Consumer   180    32    35    247    9,574    9,821    2 
Residential real estate   790    191    695    1,676    96,627    98,303    40 
                                    
Total  $1,393   $2,048   $5,456   $8,897   $438,357   $447,254   $551 

 

Impaired Loans

 

Management considers commercial loans and commercial real estate loans which are 90 days or more past due as impaired, and if warranted, includes the entire customer relationship in that status. These loans are analyzed to determine if it is probable that all amounts will not be collected according to the contractual terms of the loan agreement. If management determines that the value of the impaired loan is less than the recorded investment in the loan (net of previous charge-offs, deferred loan fees or costs and unamortized premium or discount), impairment is recognized through an allowance estimate or a charge-off to the allowance.

 

17
 

 

The following tables include the recorded investment and unpaid principal balances for impaired loans with the associated allowance amount, if applicable, as of June 30, 2012 and December 31, 2011 (in thousands):

 

   June 30, 2012 
       Unpaid       Average   Interest 
   Recorded   Principal   Related   Recorded   Income 
   Investment   Balance   Allowance   Investment   Recognized 
                     
With no related allowance recorded:                         
Commercial  $375   $375   $-   $284   $- 
Construction and development   1,061    1,061    -    1,082    - 
Commercial real estate   8,156    9,046    -    7,222    90 
Residential real estate   276    276    -    276    - 
                          
With an allowance recorded:                         
Commercial real estate   8,993    8,993    3,523    9,010    - 
                          
Total:  $18,861   $19,750   $3,523   $17,874   $90 

 

   December 31, 2011 
       Unpaid       Average   Interest 
   Recorded   Principal   Related   Recorded   Income 
   Investment   Balance   Allowance   Investment   Recognized 
                     
With no related allowance recorded:                         
Commercial  $-   $-   $-   $-   $- 
Construction and development   1,105    1,105    -    356    - 
Commercial real estate   6,364    7,314    -    882    - 
Residential real estate   276    276    -    64    - 
                          
With an allowance recorded:                         
Commercial real estate   9,677    9,677    3,626    7,529    - 
                          
Total:  $17,422   $18,372   $3,626   $8,831   $- 

 

Nonaccrual Loans

 

Loans are considered nonaccrual upon reaching 90 days delinquency, although the Company may be receiving partial payments of interest and partial repayments of principal on such loans. Loans that are well secured and in the process of collection may not be placed on nonaccrual status based on management’s review of the specific loan. When a loan is placed in nonaccrual status, previously accrued but unpaid interest is deducted from interest income.

 

In the following table are loans, presented by class, on nonaccrual status as of June 30, 2012 and December 31, 2011 (in thousands):

 

   June 30, 2012   December 31, 2011 
         
Commercial  $243   $38 
Construction and development   1,061    1,105 
Commercial real estate   12,991    11,669 
Consumer   37    48 
Residential real estate   1,022    655 
           
Total  $15,354   $13,515 

 

18
 

 

Troubled Debt Restructurings

 

Loan modifications that are considered troubled debt restructurings completed during the year are as follows (dollars in thousands):

 

   Three months ended June 30, 2012   Six months ended June 30, 2012 
   Number of
Contracts
   Pre-
Modification
Outstanding
Recorded
Investment
   Post-
Modification
Outstanding
Recorded
Investment
   Number of
Contracts
   Pre-
Modification
Outstanding
Recorded
Investment
   Post-
Modification
Outstanding
Recorded
Investment
 
Commercial   1   $388   $388    1   $388   $388 
Residential real estate   3    230    230    3    230    230 
                               
Total   4   $619   $619    4   $619   $619 

 

The commercial real estate modification was a consolidation of two loans at current market rates. There was no principal reduction made. The residential real estate loans were modified by lowering the stated interest rate on the original loans. No principal reduction was made. Additional interest income of $2 would have been recognized at the original interest rate compared to the adjusted interest rate on all of the above loans.

 

There were no trouble debt restructurings for the comparative period of 2011.

 

NOTE 6 – FAIR VALUE MEASUREMENTS

 

The following disclosures show the hierarchal disclosure framework associated with the level of pricing observations utilized in measuring assets and liabilities at fair value. The three broad levels defined by U.S. generally accepted accounting principles are as follows:

 

Level I:   Quoted prices are available in active markets for identical assets or liabilities as of the reported date.
     
Level II:   Pricing inputs are other than quoted prices in active markets, which are either directly or indirectly observable as of the reported date. The nature of these assets and liabilities include items for which quoted prices are available but traded less frequently, and items that are fair valued using other financial instruments, the parameters of which can be directly observed.
     
Level III:   Assets and liabilities that have little to no pricing observability as of the reported date. These items do not have two-way markets and are measured using management’s best estimate of fair value, where the inputs into the determination of fair value require significant management judgment or estimation.

 

This hierarchy requires the use of observable market data when available. 

 

The following is a description of the valuation methodologies the Company uses for financial instruments recorded at fair value on either a recurring or nonrecurring basis:

 

Securities Available for Sale

 

Securities available for sale consists of both debt and equity securities. These securities are recorded at fair value on a recurring basis. At June 30, 2012 and December 31, 2011, all of these securities used valuation methodologies involving market based or market derived information, collectively Level I and Level II measurements, to measure fair value.

 

The Company closely monitors market conditions involving assets that have become less actively traded. If the fair value measurement is based upon recent observable market activity of such assets or comparable assets (other than forced or distressed transactions) that occur in sufficient volume, and do not require significant adjustment using unobservable inputs, those assets are classified as Level I or Level II; if not, they are classified as Level III. Making this assessment requires significant judgment.

 

The Company uses prices from independent pricing services and, to a lesser extent, indicative (non-binding) quotes from independent brokers to measure securities.

 

The following tables present the assets reported on the consolidated statements of financial condition at their fair value as of June 30, 2012 and December 31, 2011 by level within the fair value hierarchy. As required by ASC 820, financial assets and liabilities are classified in their entirety based on the lowest level of input that is significant to the fair value measurement (in thousands).

 

19
 

 

   June 30, 2012 
   Level I   Level II   Level III   Total 
Assets:                    
U.S. government agencies  $-   $8,606   $-   $8,606 
Mortgage-backed securities of government - sponsored entities   -    29,115    -    29,115 
Collateralized mortgage obligations of government - sponsored entities   -    7,865    -    7,865 
Obligations of states and political subdivisions:                    
Taxable   -    1,602    -    1,602 
Tax-exempt   -    35,610    -    35,610 
Corporate securities   -    5,551    -    5,551 
Commercial paper   17,688    -    -    17,688 
Total debt securities   17,688    88,349    -    106,037 
Equity securities of financial institutions   504    -    -    504 
Total  $18,192   $88,349   $-   $106,541 

 

   December 31, 2011 
   Level I   Level II   Level III   Total 
Assets:                    
U.S. government agencies  $-   $11,191   $-   $11,191 
Mortgage-backed securities of government - sponsored entities   -    28,578    -    28,578 
Collateralized mortgage obligations of government - sponsored entities   -    5,175    -    5,175 
Obligations of states and political subdivisions:                    
Taxable   -    1,582    -    1,582 
Tax-exempt   -    32,508    -    32,508 
Corporate securities   -    4,082    -    4,082 
Commercial paper   11,998    -    -    11,998 
Total debt securities   11,998    83,116    -    95,114 
Equity securities of financial institutions   505    -    -    505 
Total  $12,503   $83,116   $-   $95,619 

 

The following table presents the assets measured on a nonrecurring basis on the consolidated statements of financial condition at their fair value as of June 30, 2012 and December 31, 2011, by level within the fair value hierarchy. Impaired loans that are collateral dependent are written down to fair value through the establishment of specific reserves. Techniques used to value the collateral that secure the impaired loan include: quoted market prices for identical assets classified as Level I inputs; observable inputs, employed by certified appraisers, for similar assets classified as Level II inputs. For mortgage servicing rights, the fair value is estimated by discounting future cash flows using current market inputs at which loans with similar terms and qualities would be made to borrowers of similar credit quality. In cases where valuation techniques included inputs that are unobservable and are based on estimates and assumptions developed by management based on the best information available under each circumstance, the asset valuation is classified as Level III inputs (in thousands).

 

20
 

 

   June 30, 2012 
   Level I   Level II   Level III   Total 
Assets measured on a nonrecurring basis:                    
                     
Impaired loans  $-   $-   $15,338   $15,338 
Other real estate owned  $-   $-   $3,264   $3,264 
Mortgage servicing rights  $-   $-   $519   $519 

 

   December 31, 2011 
   Level I   Level II   Level III   Total 
Assets measured on a nonrecurring basis:                    
                     
Impaired loans  $-   $-   $13,796   $13,796 
Other real estate owned  $673   $-   $2,794   $3,467 
Mortgage servicing rights  $-   $-   $540   $540 

 

The following table provides information describing the valuation processes used to determine nonrecurring fair value measurements categorized within Level III of the fair value hierarchy (in thousands):

 

        Valuation   Unobservable    
    Fair Value   Technique   Input   Range
Impaired loans   $ 15,338   Propery appraisals   Management discount for property type and recent market volatality   10% - 30% discount
                   
          Discounted cash flows   Market Rates   3.75%
                   
Other real estate owned   $ 3,264   Property appraisals   Management discount for property type and recent market volatality   10% - 30% discount
                   
Mortgage servicing rights   $ 519   Discounted cash flows   Computer pricing model with estimated prepayment speeds   4.9 - 22.0 CPR

 

 

21
 

 

 

NOTE 7 – FAIR VALUE DISCLOSURE

 

The estimated fair values of the Company’s financial instruments are as follows (in thousands):

 

   June 30, 2012 
   Carrying Value   Level I   Level II   Level III   Total Fair
Value
 
Financial Assets:                         
Cash and cash equivalents  $7,548   $7,548   $-   $-   $7,548 
Investment securities   106,541    18,192    88,349    -    106,541 
Fixed annuity   1,604    1,604    -    -    1,604 
Net loans   456,367    -    481,891    -    481,891 
Accrued interest receivable   1,868    1,868    -    -    1,868 
Regulatory stock   2,170    2,170    -    -    2,170 
Bank-owned life insurance   10,241    10,241    -    -    10,241 
Mortgage servicing rights   519    -    -    519    519 
                          
Financial liabilities:                         
Deposits  $498,263   $-   $-   $500,909   $500,909 
Short-term borrowings   31,587    -    31,587    -    31,587 
Other borrowed funds   16,619    -    18,175    -    18,175 
Accrued interest payable   529    529    -    -    529 
                          
     December 31, 2011                
    Carrying Value    Fair Value                
Financial Assets:                         
Cash and cash equivalents  $9,923   $9,923                
Investment securities   95,619    95,619                
Fixed annuity   1,581    1,581                
Net loans   438,938    460,705                
Accrued interest receivable   1,805    1,805                
Regulatory stock   2,180    2,180                
Bank-owned life insurance   10,060    10,060                
Mortgage servicing rights   540    540                
                          
Financial liabilities:                         
Deposits  $484,284   $486,913                
Short-term borrowings   20,686    20,685                
Other borrowed funds   17,618    19,171                
Accrued interest payable   542    542                

 

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

 

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

 

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

 

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

 

22
 

 

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

 

Cash and Cash Equivalents, Accrued Interest Receivable, Regulatory Stock, and Accrued Interest Payable

The fair value is equal to the current carrying value.

 

Investment Securities

The fair value of investment securities available for sale is equal to the available quoted market price. If no quoted market price is available, fair value is estimated using the quoted market price for similar securities.

 

Fixed Annuity

The fair value is equal to the current carrying value.

 

Net Loans and Mortgage Loans Held for Sale

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

 

Mortgage Servicing Rights

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

 

Deposits, Short Term Borrowings and Other Borrowed Funds

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

 

Bank-Owned Life Insurance

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

 

Commitments to Extend Credit and Standby Letters of Credit

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

 

23
 

 

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION

AND RESULTS OF OPERATIONS

 

Forward Looking Statement

 

The Private Securities Litigation Act of 1995 contains safe harbor provisions regarding forward-looking statements. When used in this discussion, the words, "believes," "anticipates," "contemplated," "expects," and similar expressions are intended to identify forward-looking statements. Such statements are subject to certain risks and uncertainties that could cause actual results to differ materially from those projected. Those risks and uncertainties include changes in interest rates, the ability to control costs and expenses, and general economic conditions. The Company undertakes no obligation to publicly release the results of any revisions to those forward-looking statements which may be made to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events.

 

Financial Condition

 

Total assets at June 30, 2012 were $608,543,000, an increase of $26,649,000 or 4.6% greater than at December 31, 2011.

 

Total cash and cash equivalents declined $2,375,000 or 23.9%, which was primarily due to an increase of $664,000 or 19.3% in balances at the Federal Reserve Bank of Philadelphia (the “Fed”) and the transfer of $3,124,000 or 68.3% from interest-bearing balances due from other banks into higher yielding assets.

 

Investment securities available for sale increased $10,922,000 or 11.4 % from balances at December 31, 2011. Our philosophy for investments is that we purchase bonds to gain the most attractive return using not only the interest rate offered but also the projected value of the bond as interest rates vary over time. Our portfolio increased in part over the first six months of 2012 due to purchases of short term commercial paper pledged for municipal deposits that we expect to be withdrawn in six to nine months. We typically utilize these short term bonds to supplement liquidity and for pledging when needed, therefore commercial paper balances increased $5,690,000 or 47.4% since December 31, 2011. We continued to purchase tax-exempt municipal bonds throughout the first half of 2012 as we located bonds to fit our portfolio, with balances of these securities growing $3,102,000 or 9.5%. In addition, we increased balances of government-sponsored collateralized mortgage obligations in the first half of 2012 by $2,690,000 or 52.0% and mortgage backed securities of government sponsored entities by $537,000 or 1.9%, net of receipt of principal payments. We made a strategic decision to purchase more of these bonds several years ago as principal payments served to give us the ability to invest the cash flows in assets at current market rates. Corporate bond balances increased $1,469,000 or 36.0% with the addition of three bonds that fit our investment profile in the first half of 2012.

 

Total loans increased $18,257,000 or 4.1% during the first half of 2012. The largest increase was in the balance of commercial real estate loans which grew $9,403,000 or 3.5%. Loans were granted to borrowers in various business segments including chain restaurants, children’s summer camps, grocery stores, and other hotel/restaurants. Commercial loans increased $4,627,000 or 10.2% with loans granted to customers in a variety of businesses and included funds for inventory, equipment, and operating capital. Balances of residential real estate loans increased $2,457,000 or 2.8%. As an employee benefit, the Bank offered a reduced fee product to employees to modify their residential mortgage, buying back several from the secondary market and then holding the modified loan, accounting for $1,780,000 of this increase. Due to historically low interest rates for residential mortgages, mortgage volume continued to be robust during 2012. Construction and development loans increased $1,769,000 or 12.1% primarily from our involvement in two hotel projects located within the Marcellus Shale region.

 

Total deposits increased $13,979,000 or 2.9% during the first half of 2012. Noninterest-bearing deposits increased $5,393,000 or 10.3% during the period. This growth was primarily due to temporary seasonal increases for several commercial customers which will be drawn down as the year progresses. Interest-bearing deposits increased $8,586,000 or 2.0%. The greatest growth was in interest-bearing checking accounts, showing an increase of $17,791,000 or 32.7% at June 30, 2012 compared to the end of 2011. The majority of this increase was for a municipal customer who will draw down the balance by year end. Money market deposit balances increased $3,993,000 or 6.1% due to a combination of seasonal balance increases for commercial customers along with several new accounts established in the first half of 2012. Savings balances increased $2,961,000 or 6.8% with no one customer having a significantly greater balance but rather a general increase in the majority of customer’s savings accounts. Certificates of deposit decreased $16,160,000 or 6.0% from year end balances with the primary decline related to $25,225,000 in school district certificates of deposits that matured during the period, as is consistent with our experience in previous years. The Bank received a $9,000,000 certificate of deposit balance from another municipal customer which will be used for construction beginning in 2013.

 

At June 30, 2012, short-term borrowings increased $10,901,000 or 52.7% from balances at year end 2011. Securities sold under agreement to repurchase increased $15,900,000 or 108.3%. Several commercial customers have larger balances as the recreational season is starting and expect these customers to utilize these funds over the next six months. Offsetting that increase, short term borrowings of $5,000,000 were repaid to the Federal Home Loan Bank of Pittsburgh (“FHLB”) during the second quarter of 2012.

 

Stockholders’ equity increased $2,376,000 or 4.3% during the first half of 2012. Net income of $3,250,000 was offset by dividends declared of $1,169,000. Costs of $153,000 in connection with stock options granted in September 2011 added to capital surplus in the first half of 2012. The market value of our investment portfolio increased $142,000 net of income taxes; serving to increase the balance of accumulated other comprehensive income. Regulatory capital ratios remain strong with 12.3% total risk-based capital, 11.0% Tier I capital and a Tier I leverage ratio of 9.3%. The regulatory minimums to be well capitalized for these ratios are 10.0%, 6.0% and 5.0%, respectively.

 

24
 

 

Results of Operations

 

Comparison of the three months ended June 30, 2012 and 2011

 

The Company reported net income of $1,681,000 for the quarter ended June 30, 2012, representing a slight increase of $15,000 or .9% greater than in the second quarter of 2011.

 

Net interest income, the largest portion of income, was $5,387,000 for the second quarter of 2012, an increase of $564,000 or 11.7% greater than recorded for the second quarter of 2011.

 

Total interest income increased $361,000 or 5.9% during the second quarter of 2012 compared to the same period in 2011. Interest and fees earned on loans increased $350,000 or 6.3% in 2012 over 2011 while the average balance of the loan portfolio increased by $39,598,000 or 9.4%. The average interest rate of the portfolio showed a slight decline of .2%, resulting in the average rate earned of 5.1% during the second quarter of 2012. In general, as loans that were originated in pre-recession years are reaching maturity, they are being replaced with new loans at current interest rates that are usually lower than the interest rates earned on matured loans. In addition, we would have earned interest of $197,000 on loans that were classified as nonaccrual at June 30, 2012 compared to$128,000 for loans in nonaccrual status at June 30, 2011.

 

Interest earned on taxable investment securities was constant for both the second quarter of 2012 and 2011. The average balance of these investments increased $12,021,000 or 22.9% for the second quarter of 2012 compared to a year earlier while the average yield decreased .5% in 2012 as compared to 2011. Just as was experienced in the loan portfolio, bonds which were purchased in higher market interest rate periods matured and were replaced with investments at current interest rates. In addition, we increased the average balance of tax exempt investments by $2,377,000 or 7.4% in the second quarter of 2012 as compared to a year earlier resulting in an increase of $11,000 in income earned on these bonds.

 

Interest expense declined $203,000 or 15.4% in the second quarter of 2012 as compared to the same period of 2011. Interest paid on deposits declined $162,000 or 15.2% as the average balance of total interest-costing liabilities increased $35,476,000 or 8.9% and the average interest rate paid on these deposits declined .2%. The average balances of time deposits increased $23,124,000 or 9.8% in the second quarter of 2012 as compared to the same quarter of 2011. Simultaneously, the average interest rate paid on those deposits decreased by .4% over the period. Management has increased usage of the CDARS program to acquire certificates of deposit without a reciprocal origination of deposits in our market, resulting in $21,608,000 greater average balances of these funds in the second quarter of 2012 than a year earlier. The average interest rate paid on CDARS deposits was .54% in the second quarter of 2012 when the average interest rate for all certificates of deposit was 1.20%. In the second quarter of 2011, the average rate paid for CDARS deposits was .50% compared to the total for all certificates of deposit of 1.55%. Even though the average interest rate paid for these funds has increased year over year, in each period the cost was significantly lower than rates paid for other deposits. In addition, we continue to see increases in other interest-costing deposits while lowering the average interest rate paid for these deposits as the economic stalemate continues.

 

The provision for loan losses is charged to operations to bring the total allowance for loan losses to a level that represents management’s best estimates of the losses inherent in the portfolio, based on:

 

·historical experience;
·volume;
·type of lending conducted by the Bank;
·industry standards;
·the level and status of past due and non-performing loans;
·the general economic conditions in the Bank’s lending area along with national trends; and
·other factors affecting the collectability of the loans in its portfolio.

 

Provision for loan losses of $700,000 was $425,000 or 154.5% greater in the second quarter of 2012 than the same quarter of 2011. In our continual review of the loan portfolio during this extended economic downturn, we are finding a greater number of loans that are internally downgraded, requiring additional amounts in the allowance for loan losses. Higher balances in the allowance for loan losses are accomplished by increasing provision expense. Based on our analysis, we believe that the balance of the allowance for loan losses is adequate.

 

25
 

 

Total noninterest income of $1,113,000 was $124,000 or 12.5% greater in the second quarter of 2012 compared to the same quarter of 2011. Service charges on deposit accounts have continued to decline each quarter over the past few years. This income was $36,000 or 14.0% less in the second quarter of 2012 than a year earlier. This decline is due to both regulatory changes that affected our ability to levy service charges on checking accounts and a general increase in our customer’s diligence in monitoring their balances to avoid service charges on their accounts. Gains on the sale of residential loans sold in the secondary market increased $119,000 or 180.3% over income earned during the same quarter a year earlier due to a greater number of loan originations in 2012 as compared to 2011. With residential mortgage interest rates at historic lows, many customers are refinancing existing home mortgages. During the second quarter of 2012, we sold a government agency bond at a gain of $41,000 in order to begin to restructure the portfolio for future benefit. In the second quarter of 2011 we recorded small gains of $3,000 on bond redemptions along with a charge of $29,000 for other than temporary impairment on an equity security. Other noninterest income combines many other sources of revenue for the Company. This revenue declined $60,000 or 21.9% for the second quarter of 2012 compared to the same quarter in 2011. In the second quarter of 2011 we recorded an increase of $50,000 in the market value of mortgage servicing rights which was unmatched in 2012. As residential mortgages were refinanced in 2012, we increased the amortization of mortgage servicing rights due to payoffs of previously sold loans, thereby decreasing other income by $31,000 in the second quarter of 2012 compared to a year earlier. Smaller increases in the other components of other noninterest income were responsible for the remaining difference in income.

 

Salaries and employee benefits increased $56,000 or 3.0% for the second quarter of 2012 as compared to 2011. Wages increased $69,000 or 5.6% in 2012 as compared to 2011 which was primarily due to a combination of the addition of five full time equivalent employees since June 30, 2011 and annual salary increases for all other employees. Total employee benefits decreased $12,000 or 1.9% for the second quarter of 2012 compared to 2011. In spite of an increase in the number of employees covered by our health insurance plan, the costs associated with health insurance declined by $63,000 or 23.1% in the second quarter of 2012 due to timing issues for expenses in the Pennsylvania Bankers Association consortium self-funded health insurance plan. Costs associated with grants in September 2011 of restricted stock and stock options to officers were $38,000 for the second quarter of 2012. There were no similar costs in the second quarter of 2011. The remaining difference is due to smaller variances in other employee benefit accounts.

 

Other expense increased $139,000 or 17.8% for the second quarter of 2012 compared to the same period in 2011. Costs associated with other real estate owned increased $62,000 or 133.1% and legal expenses related to loan collection efforts were $34,000 or 73.9% greater than a year earlier. We have taken possession of several commercial and residential properties which have increased these expenses. In the second quarter of 2012, we incurred expense of $38,000 in connection with the September 2011 grants of restricted stock to directors which was unmatched in 2011. Smaller variances in other expense items were responsible for the remaining differences.

 

Comparison of the six months ended June 30, 2012 and 2011

 

Net income increased $314,000 or 10.7% for the first half of 2012 compared to the same period in 2011. The primary source of additional income was a decrease in interest expense, thereby producing greater net interest income.

 

Interest income of $12,840,000 was $670,000 or 5.5% greater than a year earlier. The primary increase in interest income was from interest and fees on loans, which was $602,000 or 5.5% greater than the second quarter of 2011. The average balance of loans increased $34,200,000 or 8.1% in the first half of 2012 while the average interest yield on those assets declined .2% over the same time frame. As principal reductions occur on loans that were originated in pre-recession years, new loans are booked at current interest rates that are usually lower than the interest rates earned on older loans.

 

Interest expense declined $446,000 or 16.5% for the first six months of 2012 as compared to the same period in 2011. Interest rates were lower in each interest-bearing deposit category with the largest component related to certificates of deposit. The average balance of certificates of deposit rose $16,782,000 or 6.9% and the average interest rate paid for these funds decreased 36 basis points. The largest component of the increase in certificates of deposit was $23,357,000 or 112.8% more in brokered deposits, primarily those generated through CDARS. We have increased usage of this funding source due to their pricing at lower costs than we can obtain in our markets or through other borrowings. As the economy continues to languish, customers are either utilizing their certificates of deposit for their expenses or investing in non-bank products. We were able to pay lower rates on most other interest-bearing deposit products during the first half of 2012 than in the same period of 2011 even though the average balance of each product line showed an increase over the same period last year. As principal reductions were made on FHLB term borrowings, the average balanced declined $1,956,000 and the average interest rate paid decreased 29 basis points, producing a decline of $67,000 or 15.5% in interest expense.

 

The provision for loan losses was $650,000 or 92.9% greater in the first half of 2012 than a year earlier. Provision for loan losses expense is the result of our analysis of the appropriate balance in the allowance for loan loss. The most significant factor that changed in that calculation was an increase in the balance of impaired loans of $6,395,000 since June 30, 2011. These loans are each measured independently to determine the appropriate balance in the allowance and thereby a higher balance in the allowance for loan loss was necessary. We use a complex analysis to determine the appropriate level for the allowance for loan losses and believe that the level of the allowance for loan losses is adequate.

 

Noninterest income increased $187,000 or 9.6% for the first half of 2012 compared to the same period in 2011. Service charges on deposit accounts were $72,000 or 13.6% lower in the current year due to regulatory changes in the process to assess these fees along with our customers increased diligence in monitoring their checking accounts thereby utilizing overdraft protection less frequently. We realized $176,000 or 118.9% greater gains on the sale of mortgage loans in 2012 than in 2011 as mortgage activity increased in this historically low interest rate environment. The sale of investments contributed $109,000 to other income, an increase of $137,000 compared to a net loss of $28,000 in 2011. In 2011 we recognized a charge for other than temporary impairment that was not matched in 2012. Other income is comprised of many smaller items and showed a decline of $68,000 or 15.0% for the second half of 2012 compared to the same period of 2011. The most significant changes are an increase in the amortization of mortgage servicing rights, which is a contra income account, of $27,000 or 46.1% due to a larger volume of refinances of residential mortgages that we sold in prior periods. In the first half of 2011 we recognized an increase of $50,000 in the market value of mortgage servicing rights which was unmatched in 2012. Offsetting those declines, merchant credit card fees increased $29,000 or 36.0% in the current year compared to last due to an increase in the number of transactions processed. Smaller variances in other income items were responsible for the remaining differences.

 

26
 

 

Noninterest expense increased $193,000 or 2.8% in the first six months of 2012 compared to the same period in 2011. Salaries and employee benefits, the largest noninterest expense for the Company, increased $206,000 or 5.7% in the first half of 2012 compared to the same period in 2011. The primary reason for the increase was $132,000 or 5.4% due to the addition of five full time equivalent employees since June 2011 along with annual salary increases. We recorded expense of $77,000 in the first half of 2012 due to grants of stock and restricted stock options in September 2011; we had no similar expense in the first half of 2011. Smaller variances in other payroll related expenses are responsible for the remaining difference.

 

Professional fees declined $97,000 or 19.7% for the first six months of 2012 compared to the same period in 2011 primarily due to lower costs associated with delinquent loans and foreclosure actions in the current period than a year earlier. The category of other noninterest expense includes many smaller dollar amount expenses including advertising, bank supplies, telephone, and travel among others. This expense increased $127,000 or 7.5% for the first half of 2012 versus the same period in 2011. The largest increase in these expenses was in relation to other real estate owned, which accounted for $26,000 additional expense and was 14.5% greater than in the same period of 2011. The next largest increase in other noninterest expense was for Pennsylvania shares tax. This tax is assessed on Bank capital and increased $26,000 or 11.4% for the 2012 period due to increases in our capital position over the assessment period. Smaller changes in other expense accounts were responsible for the remaining increase in total other noninterest expense.

 

Liquidity and Cash Flows

 

To ensure that the Company can satisfy customer credit needs for current and future commitments and deposit withdrawal requirements, we manage the liquidity position by ensuring that there are adequate short-term funding sources available for those needs. Liquid assets consist of cash and due from banks, federal funds sold, interest-bearing deposits with other banks and investment securities maturing in one year or less. The following table shows these liquidity sources, minus short-term borrowings, as of June 30, 2012 compared to December 31, 2011:

 

   June 30,   December 31, 
   2012   2011 
( in thousands)          
Cash and due from banks  $6,097   $5,348 
Interest-bearing deposits with other banks   1,451    4,575 
Investment securities maturing in one year or less, including scheduled principal reductions   30,236    21,884 
    37,784    31,807 
Less short-term borrowings   31,587    20,686 
Net liquidity position  $6,197   $11,121 
           
As a percent of total assets   1.0%   1.9%

 

With liquidity of 1.0% at the end of the quarter, management acknowledges that our assets are not as liquid as they have been in the past. The table does not include additional possible sources of liquidity such as the balance of our available for sale securities that is not maturing in one year or less of $76,305,000 which could be sold to generate additional cash. We would expect to gather additional deposits if we set the interest rate higher than the local competition and would consider this as opportunities arose for greater loan originations. In addition, the Bank has the ability to borrow from the Federal Home Loan Bank of Pittsburgh with the maximum borrowing capacity at June 30, 2012 of $221 million with an available balance of $197 million. Other sources of liquidity are cash flows from regularly scheduled payments and prepayments of loans, sales or maturities in the investment portfolio, sales of residential mortgages in the secondary market, operating income, deposit growth and access to lines of credit with correspondent banks. The Consolidated Statement of Cash Flows specifically details the current contribution of each source.

 

Management monitors liquidity on a consistent basis and feels that liquidity levels are adequate. We are not aware of any known trends, events or uncertainties that will have or is reasonably likely to have a material effect on the Company's liquidity, capital resources or operations; nor are we aware of any current recommendations by regulatory authorities, which if implemented, would have such an effect.

 

27
 

 

Risk Elements

 

The table below presents information concerning nonperforming assets including nonaccrual loans and loans 90 days or more past due at June 30, 2012 and December 31, 2011. A loan is classified as nonaccrual when, in the opinion of management, there are doubts about collectability of interest and principal. At the time the accrual of interest is discontinued, future income is recognized only when cash is received.

   June 30, 2012 
(in thousands)  Past due 90
days or
more and
accruing
   Nonaccrual 
Real estate-construction loans  $-   $1,061 
Real estate-mortgage loans   20    14,013 
Commercial and industrial loans   3    243 
Installment loans to individuals   32    37 
Other loans   -    - 
Total  $55   $15,354 

 

   December 31, 2011 
(in thousands)  Past due 90
days or
 more and
accruing
   Nonaccrual 
Real estate-construction loans  $-   $1,105 
Real estate-mortgage loans   386    12,324 
Commercial and industrial loans   163    38 
Installment loans to individuals   2    48 
Total  $551   $13,515 

 

 

Interest income of $381,000 in the first half of 2012 and $204,000 in the same period of 2011 would have been recognized on nonaccrual loans if they had been performing in accordance with their original terms. The Company did not recognize any income on loans in nonaccrual status in 2012 but did recognize $107,000 of interest income on a relationship that made timely payments enabling recognition of interest income on the cash basis in 2011.

 

Management believes the level of the allowance for loan losses at June 30, 2012 is adequate to cover probable losses inherent in the loan portfolio. The relationship between the allowance for loan losses and outstanding loans is a function of the credit quality and known risk attributed to the loan portfolio. The on-going loan review program, along with management analysis, is used to determine the adequacy of the allowance for loan losses.

 

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

A key function of management in its role as the Asset/Liability Committee (“ALCO”) is to evaluate the Company’s exposure to interest rate risk. The primary business of the Company in the financial services industry is to act as a depository financial intermediary. In this role, an integral element of risk involves the chance that prevailing interest rates will adversely affect assets, liabilities, capital, income and/or expense at different times and in different amounts. The ALCO is comprised of all senior officers of the Bank and other key officers. This committee reports directly to the Board of Directors on at least a quarterly basis.

 

Two separate reports are used to assist in measuring interest rate risk. The first is the Statement of Interest Sensitivity Gap report. This report matches all interest-earning assets and all interest-bearing liabilities by the time frame in which funds can be reinvested or repriced. The second report is the Interest Rate Shock Analysis discussed in more detail below. In both reports, there are inherent assumptions that must be used in the evaluation. These assumptions include the maturity or repricing times of deposits, even though all deposits, other than time deposits, have no stated maturity and the reference that interest rate shifts will be parallel, with the rates of assets and liabilities shifting in the same amount in the same time frame. In reality, various assets and various liabilities will react differently to changes in interest rates, with some lagging behind the change and some anticipating the upcoming change and reacting before any actual change occurs. Each tool also suggests that there is a propensity to replace assets and liabilities with similar assets and liabilities rather than taking into consideration management’s ability to reallocate the Balance Sheet. In addition, the models used do not include any elements to determine how an action by management to increase or decrease interest rates charged on loans or paid on deposits or to increase borrowings at the FHLB will affect the results of the analysis. In spite of these limitations, these analyses are still very good tools to assist in management of the Company and similar versions of these same reports are used by all financial institutions.

 

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Statement of Interest Sensitivity Gap

June 30, 2012

 

   90 days   >90 days   1 - 5         
   or less   but < 1 year   years   >5 years   Total 
Assets:                         
Interest-bearing deposits in other banks and federal funds sold  $1,451   $-   $-   $-   $1,451 
Investment securities available for sale (5)   29,330    10,398    29,389    37,424    106,541 
Fixed annuity investment   -    -    1,604    -    1,604 
Loans (1) (4)   89,082    97,285    103,643    161,240    451,250 
                          
Rate sensitive assets  $119,863   $107,683   $134,636   $198,664   $560,846 
                          
Liabilities:                         
Interest-bearing deposits:                         
Interest-bearing demand (2)  $5,773   $18,040   $48,346   $-   $72,159 
Money market (3)   11,900    35,002    23,101    -    70,003 
Savings (2)   3,712    11,600    31,088    -    46,400 
Time deposits   74,385    89,305    88,401    -    252,091 
Short-term borrowings   31,587    -    -    -    31,587 
Other borrowings (6)   2,008    1,559    5,047    8,005    16,619 
                          
Rate sensitive liabilities  $129,365   $155,506   $195,983   $8,005   $488,859 
                          
Interest sensitivity gap  $(9,502)  $(47,823)  $(61,347)  $190,659   $71,987 
Cumulative gap  $(9,502)  $(57,325)  $(118,672)  $71,987      
Cumulative gap to total assets   -1.56%   (9.42%)   (19.50%)   11.83%     

 

(1)Loans are included in the earlier period in which interest rates are next scheduled to adjust or in which they are due. No adjustment has been made for scheduled repayments or for anticipated prepayments.
(2)Interest-bearing demand deposits and savings are segmented based on the percentage of decay method. The decay rates used include "90 days or less" 8%, " >90 days but <1 year" 25% and "1-5 years" 67%.
(3)Money market deposits are segmented based on the percentage of decay method. The decay rates used include "90 days or less" 17%, ">90 days but < 1 year" 50% and "1-5 years" 33%.
(4)Does not include loans in nonaccrual status, deposit overdrafts, unposted items or deferred fees on loans.
(5)Variable interest rate investments are included in the period in which interest rates are next scheduled to adjust, while fixed interest rate investments are included in each period according to the contractual repayment schedule.
(6)Borrowings are included in each period according to the contractual repayment schedule.

 

As this report shows, the Company was liability sensitive in the one year period at June 30, 2012 with $57,325,000 of liabilities maturing or repricing before assets in this timeframe. We expect that interest rates will increase at some point; and as that occurs, the variable interest rate loans will reprice upward. In the meantime, there will be some level of downward repricing in time deposits as those liabilities mature and are replaced with certificates of deposit at the current, lower rates. We would also expect liabilities to extend in maturity as interest rates increase, offering customers a more significant benefit to extend.

 

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The second report used to monitor interest rate risk is the Analysis of Sensitivity to Changes in Market Interest Rates. This tool attempts to determine the affect on income of various shifts in the interest rate environment. We have presented this analysis for three different scenarios, a change in rates of 100, 200 or 300 basis points in order to offer a more in-depth analysis. The reports shows that our greatest risk would be if interest rates increased by 300 basis points. Net interest income would decrease by $1,431,000 or 6.27% while net income would decrease $968,000 or 14.33%. This analysis makes the shift automatic and equal for both assets and liabilities and does not take into consideration management’s ability to change the rates for deposits in a different fashion. We would not expect to make this parallel shift in deposit interest rates. Even given that this analysis does not actually assimilate the reality of our actions when rates do increase, the results of a potential shift of 300 basis points in either direction are within internal policy guidelines. If the results were not tolerable, our policy would determine that management should reallocate the balance sheet in order to maintain compliance with the policy. If interest rates were to immediately increase by 300 basis points, the economic value of equity (EVE) would decrease by $15,202,000 or 19.98%, which is within our policy guidelines. The EVE is sometimes referred to as the present value of equity and is presented as one more statistic to monitor in managing interest rate risk.

 

ANALYSIS OF SENSITIVITY TO CHANGES IN MARKET INTEREST RATES

 

(amounts in thousands)  100 basis points 
   Up   Down 
   Amount   %   Amount   % 
                 
Net interest income  $(742)   -3.25%  $463    2.03%
Net income  $(494)   -7.32%  $302    4.46%
EVE  $(7,883)   -10.36%  $10,650    14.00%

 

   200 basis points 
   Up   Down 
   Amount   %   Amount   % 
                 
Net interest income  $(1,106)   -4.84%  $(227)   -1.00%
Net income  $(744)   -11.02%  $(156)   -2.31%
EVE  $(10,916)   -14.34%  $18,657    24.52%

 

   300 basis points 
   Up   Down 
   Amount   %   Amount   % 
                 
Net interest income  $(1,431)   -6.27%  $(781)   -3.42%
Net income  $(968)   -14.33%  $(523)   -7.75%
EVE  $(15,202)   -19.98%  $23,895    31.40%

 

CONTROLS AND PROCEDURES

 

Evaluation of disclosure controls and procedures

 

As of June 30, 2012 an evaluation was performed under the supervision and with the participation of the Company’s management, including the CEO and CFO, on the effectiveness of the design and operation of the Company’s disclosure controls and procedures. Based on that evaluation, the Company’s management, including the CEO and CFO, concluded that the Company’s disclosure controls and procedures were effective as of June 30, 2012. There have been no significant changes in the Company’s internal controls over financial reporting or in other factors that could significantly affect internal controls during the quarter.

 

Disclosure controls and procedures are the controls and other procedures that are designed to ensure that the information required to be disclosed by the Company in its reports filed and submitted under the Securities Exchange Act of 1934, as amended (“Exchange Act”) is recorded, processed, summarized and reported, within the time periods specified in the Securities and Exchange Commission’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by the Company in its reports filed under the Exchange Act is accumulated and communicated to the Company’s management, including the principal executive officer and principal financial officer, as appropriate to allow timely decisions regarding required disclosure.

 

Changes in internal controls

 

There were no significant changes in the Registrant's internal controls or in other factors that could significantly affect these controls subsequent to the date of their evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.

 

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PART II - OTHER INFORMATION

     
Item 1   - Legal Proceedings
    NONE
     
Item 1a.   - Risk Factors
    There were no material changes to the risk factors described in Item 1a. of Dimeco’s Annual Report on Form 10-K for the period ended December 31, 2011.
     
Item 2 -

Unregistered Sales of Equity Securities and Use of Proceeds 

    NONE
     
Item 3 - Defaults upon Senior Securities
    NONE
     
Item 4 - Mine Safety Disclosures
    NONE
     
Item 5   - Other Information
    NONE
     
Item 6   -

Exhibits

 

    Form 8-K – Report on July 20, 2012 – News Release of Registrant

 

Exhibit Number:  
   
     31.1 Certification Pursuant to 15 U.S.C. Section 10A, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2003
     31.2 Certification Pursuant to 15 U.S.C. Section 10A, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2003
     32 Certification Pursuant to 18 U.S.C. Section 1350
     99 Report of Independent Registered Public Accounting Firm
   

The following exhibits are included in this Report or incorporated herein by reference:

 

3(i)  Articles of Incorporation of Dimeco, Inc.*

3(ii)  Amended Bylaws of Dimeco, Inc.****

10.1    2000 Independent Directors Stock Option Plan**

10.22000 Stock Incentive Plan***

10.3Form of Salary Continuation Plan for Executive Officers****

10.42010 Equity Incentive Plan *****

 

*         Incorporated by reference to the Exhibit 3A to the Form S-4 (File No. 333-58936) filed with the Commission on February 26, 1993.

**       Incorporated by reference to Exhibit 99.1 to the Form S-8 (File No. 333-69420) filed with the Commission on September 14, 2002.

***     Incorporated by reference to Exhibit 99.1 to the Form S-8 (File No. 333-69416) filed with the Commission on September 14, 2002.

****   Incorporated by reference to identically numbered exhibit to the Registrant’s Form 8-K filed July 2, 2007.

***** Incorporated by reference to Exhibit 10.1 to Form S -8 (File No. 333-169454) filed with the Commission on September 17, 2010.

 

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SIGNATURES

 

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

 

  DIMECO, INC.
     
Date: August 13, 2012 By:   /s/ Gary C. Beilman
    Gary C. Beilman
    President and Chief Executive Officer
     
Date: August 13, 2012 By:  

/s/ Maureen H. Beilman 

    Maureen H. Beilman
   

Chief Financial Officer

 

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