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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

FORM 10-Q

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the quarterly period ended June 30, 2014
 
OR

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

For the transition period from _________________to___________________________

Commission file number 0-13507

SB FINANCIAL GROUP, INC.

(Exact name of registrant as specified in its charter)

Ohio
 
34-1395608
(State or other jurisdiction of
 
(I.R.S. Employer
incorporation or organization)
 
Identification No.)

401 Clinton Street, Defiance, Ohio 43512
(Address of principal executive offices)
(Zip Code)

(419) 783-8950
(Registrant’s telephone number, including area code)

N/A
(Former name, former address and former fiscal year, if changed since last report.)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No o
 
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 o
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
 
Large Accelerate Filer o Accelerated Filer o Non-Accelerated Filer o Smaller Reporting Company x
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes o No x
 
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

Common Shares, without par value
 
4,875,131 shares
(class)
 
(Outstanding at August 13, 2014)



 
 

 
 
SB FINANCIAL GROUP, INC.

FORM 10-Q

TABLE OF CONTENTS

PART I – FINANCIAL INFORMATION
 
     
Item 1.
Financial Statements
3
Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
28
Item 3.
Quantitative and Qualitative Disclosures About Market Risk
39
Item 4.
Controls and Procedures
39
     
PART II – OTHER INFORMATION
 
     
Item 1.
Legal Proceedings
40
Item 1A.
Risk Factors
40
Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds
40
Item 3.
Defaults Upon Senior Securities
40
Item 4.
Mine Safety Disclosures
40
Item 5.
Other Information
40
Item 6.
Exhibits
40
     
Signatures
41
 
 
 

 
 
PART I – FINANCIAL INFORMATION

Item 1. Financial Statements

SB Financial Group, Inc.
Condensed Consolidated Balance Sheets
June 30, 2014 and December 31, 2013
 
   
June
   
December
 
($ in Thousands)
 
2014
   
2013
 
   
(unaudited)
       
ASSETS
           
Cash and due from banks
  $ 13,778     $ 13,137  
                 
Securities available for sale, at fair value
    85,586       89,793  
                 
Loans held for sale
    8,290       3,366  
                 
Loans, net of unearned income
    506,127       477,303  
Allowance for loan losses
    (6,568 )     (6,964 )
Net loans
    499,559       470,339  
                 
Premises and equipment, net
    13,281       12,607  
Other securities - FRB and FHLB Stock
    3,748       3,748  
Cash surrender value of life insurance
    13,059       12,906  
Goodwill
    16,353       16,353  
Core deposits and other intangibles
    393       655  
Foreclosed assets held for sale, net
    516       651  
Mortgage servicing rights
    5,375       5,180  
Accrued interest receivable
    1,456       1,281  
Other assets
    1,106       1,738  
Total assets
  $ 662,500     $ 631,754  
                 
LIABILITIES AND EQUITY
               
Deposits
               
Non interest bearing demand
  $ 87,706     $ 81,570  
Interest bearing demand
    116,765       119,551  
Savings
    63,199       61,652  
Money market
    80,288       79,902  
Time deposits
    176,109       175,559  
Total deposits
    524,067       518,234  
                 
Notes payable
    -       589  
Advances from Federal Home Loan Bank
    37,000       16,000  
Repurchase agreements
    17,246       14,696  
Trust preferred securities
    20,620       20,620  
Accrued interest payable
    655       639  
Other liabilities
    3,902       4,707  
Total liabilities
    603,490       575,485  
Commitments and contingent liabilities
     -        -  
Equity
               
Preferred stock
    -       -  
Common stock
    12,569       12,569  
Additional paid-in capital
    15,403       15,412  
Retained earnings
    31,757       29,899  
Accumulated other comprehensive income
    908       74  
Treasury stock
    (1,627 )     (1,685 )
Total equity
    59,010       56,269  
                 
Total liabilities and equity
  $ 662,500     $ 631,754  
 
See notes to condensed consolidated financial statements (unaudited)
 
Note: The balance sheet at December 31, 2013 has been derived from the audited consolidated financial statements at that date
 
 
3

 
 
SB FINANCIAL GROUP, INC.
Condensed Consolidated Statements of Income (Unaudited)
                         
($ in thousands, except share data)
  Three Months Ended     Six Months Ended  
   
June 30,
   
June 30,
   
June 30,
   
June 30,
 
Interest income
 
2014
   
2013
   
2014
   
2013
 
Loans
                       
Taxable
  $ 5,654     $ 5,874     $ 10,895     $ 11,757  
Nontaxable
    13       16       29       40  
Securities
                               
Taxable
    310       296       619       626  
Nontaxable
    179       174       354       344  
Total interest income
    6,156       6,360       11,897       12,767  
                                 
Interest expense
                               
Deposits
    503       573       1,001       1,179  
Repurchase Agreements & Other
    4       15       15       31  
Federal Home Loan Bank advances
    71       84       145       174  
Trust preferred securities
    330       338       663       741  
Total interest expense
    908       1,010       1,824       2,125  
                                 
Net interest income
    5,248       5,350       10,073       10,642  
                                 
Provision for loan losses
    150       200       150       499  
                                 
Net interest income after provision for loan losses
    5,098       5,150       9,923       10,143  
                                 
Noninterest income
                               
Wealth Management Fees
    649       652       1,281       1,295  
Customer service fees
    665       639       1,275       1,255  
Gain on sale of mtg. loans & OMSR's
    1,211       1,450       1,783       2,934  
Mortgage loan servicing fees, net
    156       418       401       597  
Gain on sale of non-mortgage loans
    84       82       107       238  
Data service fees
    322       458       628       872  
Net gain on sales of securities
    56       -       56       20  
Gain/(loss) on sale/disposal of assets
    (15 )     (129 )     (49 )     (234 )
Other income
    167       250       372       410  
Total non-interest income
    3,295       3,820       5,854       7,387  
                                 
Noninterest expense
                               
Salaries and employee benefits
    3,451       3,688       6,571       7,127  
Net occupancy expense
    485       513       1,058       1,054  
Equipment expense
    645       703       1,284       1,458  
Data processing fees
    249       194       460       271  
Professional fees
    465       499       803       928  
Marketing expense
    170       92       293       200  
Telephone and communication
    107       158       219       316  
Postage and delivery expense
    187       209       391       424  
State, local and other taxes
    95       138       187       272  
Employee expense
    140       126       255       278  
Intangible amortization expense
    131       153       262       306  
OREO Impairment
    -       -       -       33  
Other expenses
    502       607       922       1,083  
                                 
Total non-interest expense
    6,627       7,080       12,705       13,750  
                                 
Income before income tax expense
    1,766       1,890       3,072       3,780  
Income tax expense
    521       571       847       1,143  
                                 
Net income
  $ 1,245     $ 1,319     $ 2,225     $ 2,637  
                                 
Common share data:
                               
Basic earnings per common share
  $ 0.26     $ 0.27     $ 0.46     $ 0.54  
                                 
Diluted earnings per common share
  $ 0.25     $ 0.27     $ 0.46     $ 0.54  
 
See notes to condensed consolidated financial statements (unaudited)
 
4

 
 
SB Financial Group, Inc.
Condensed Consolidated Statements of Comprehensive Income (unaudited)
 
   
Three Months Ended June 30,
   
Six Months Ended June 30,
 
($'s in thousands)
 
2014
   
2013
   
2014
   
2013
 
                         
Net income
  $ 1,245     $ 1,319     $ 2,225     $ 2,637  
Other comprehensive (loss)/income:
                               
Available-for-sale investment securities:
                               
Gross unrealized holding (loss) gain arising in the period     815       (1,708 )     1,320       (2,001 )
Related tax (expense) benefit     (277 )     581       (449 )     680  
Less: reclassification adjustment for loss realized in income     (56 )     -       (56 )     (20 )
Related tax benefit     19       -       19       7  
Net effect on other comprehensive (loss) income     501       (1,127 )     834       (1,334 )
Total comprehensive income
  $ 1,746     $ 192     $ 3,059     $ 1,303  
 
SB Financial Group, Inc.
Condensed Consolidated Statements of Shareholders’ Equity (unaudited)
 
 
 
Preferred
   
Common
   
Additional
   
Retained
   
Accumulated Other Comprehensive
   
Treasury
       
($'s in thousands except per share data)
 
Stock
   
Stock
   
Paid-in Capital
   
Earnings
   
Income (Loss)
   
Stock
   
Total
 
                                           
Balance, January 1, 2014
  $ -     $ 12,569     $ 15,412     $ 29,899     $ 74     $ (1,685 )   $ 56,269  
Net Income
                            2,225                       2,225  
Other Comprehensive Income
                                    834               834  
Dividends on Common Stk., $0.075 per share
                            (367 )                     (367 )
Restricted Stock Issuance
                                            33       33  
Stock options exercised
                    (41 )                     25       (16 )
Expense of stock option plan
                    32                               32  
Balance, June 30, 2014
  $ -     $ 12,569     $ 15,403     $ 31,757     $ 908     $ (1,627 )   $ 59,010  
                                                         
Balance, January 1, 2013
  $ -     $ 12,569     $ 15,374     $ 25,280     $ 1,830     $ (1,769 )   $ 53,284  
Net Income
                            2,637                       2,637  
Other Comprehensive Loss
                                    (1,334 )             (1,334 )
Dividends on Common Stk., $0.025 per share
                            (269 )                     (269 )
Stock options exercised
                    (34 )                     51       17  
Expense of stock option plan
                    52                               52  
Balance, June 30, 2013
  $ -     $ 12,569     $ 15,392     $ 27,648     $ 496     $ (1,718 )   $ 54,387  
 
See notes to condensed consolidated financial statements (unaudited)

 
5

 
 
SB Financial Group, Inc.
Condensed Consolidated Statements of Cash Flows (Unaudited)
 
   
Six Months Ended June 30,
 
($'s in thousands)
 
2014
   
2013
 
Operating Activities
           
     Net Income
  $ 2,225     $ 2,637  
     Items (using)/providing cash
               
          Depreciation and amortization
    571       501  
          Provision for loan losses
    150       499  
          Expense of share-based compensation plan
    32       52  
          Amortization of premiums and discounts on securities
    481       543  
          Amortization of intangible assets
    262       306  
          Amortization of originated mortgage servicing rights
    117       535  
          Recapture of originated mortgage servicing rights impairment
    -       (444 )
          Proceeds from sale of loans held for sale
    100,276       150,295  
          Originations of loans held for sale
    (100,165 )     (153,912 )
          Impairment of mortgage servicing rights
    101       -  
          Gain from sale of loans
    (1,890 )     (3,172 )
          Gain on sales of available for sale securities
    (56     (20 )
          Loss on sale of assets
    52       177  
          OREO impairment
    -       33  
     Changes in
               
          Interest receivable
    (175 )     (340 )
          Other assets
    (3,925 )     1,704  
          Income from bank owned life insurance
    (153 )     (165 )
          Interest payable and other liabilities
    (156 )     (226 )
                 
               Net cash used in operating activities
    (2,253 )     (997 )
                 
Investing Activities
               
     Purchases of available-for-sale securities
    (9,685 )     (16,835 )
     Proceeds from maturities of available-for-sale securities
    10,377       16,360  
     Proceeds from sales of available-for-sale-securities
    4,298       1,235  
     Net change in loans
    (29,522 )     (277 )
     Purchase of premises and equipment and software
    (1,255 )     (499 )
     Proceeds from sales or disposal of premises and equipment
    -       239  
     Proceeds from sale of foreclosed assets
    238       828  
 
               
              Net cash (used in) provided by investing activities
    (25,549 )     1,051  
                 
Financing Activities
               
     Net  increase in demand deposits, money market, interest checking and savings accounts
    5,283       2,382  
     Net increase (decrease) in certificates of deposit
    550       (18,005 )
     Net increase (decrease) in securities sold under agreements to repurchase
    2,550       (1,019 )
     Repayment of Federal Home Loan Bank advances
    (2,000 )     -  
     Proceeds from Federal Home Loan Bank advances
    23,000       9,000  
     Proceeds from stock options exercised
    16       17  
     Dividends on Common Stock
    (367 )     (269 )
     Repayment of notes payable
    (589 )     (554 )
                 
          Net cash provided by (used in) financing activities
    28,443       (8,448 )
                 
Increase (decrease) in Cash and Cash Equivalents
    641       (8,394 )
                 
Cash and Cash Equivalents, Beginning of Year
    13,137       19,144  
                 
Cash and Cash Equivalents, End of Period
  $ 13,778     $ 10,750  
                 
Supplemental Cash Flows Information
               
                 
     Interest paid
  $ 1,808     $ 1,548  
     Income taxes paid
  $ 780     $ 550  
     Transfer of loans to foreclosed assets
  $ 153     $ 626  
 
See notes to condensed consolidated financial statements (unaudited)
 
 
6

 
 
SB FINANCIAL GROUP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

NOTE 1—BASIS OF PRESENTATION

SB Financial Group, Inc. (the “Company”) is a bank holding company whose principal activity is the ownership and management of its wholly-owned subsidiaries, The State Bank and Trust Company (“State Bank”), RFCBC, Inc. (“RFCBC”), Rurbanc Data Services, Inc. dba RDSI Banking Systems (“RDSI”), Rurban Statutory Trust I (“RST I”), and Rurban Statutory Trust II (“RST II”).  State Bank owns all of the outstanding stock of Rurban Mortgage Company (“RMC”), and State Bank Insurance, LLC (“SBI”).

The consolidated financial statements include the accounts of the Company, State Bank, RFCBC, RDSI, RMC, and SBI.  All significant intercompany accounts and transactions have been eliminated in consolidation.

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions for Form 10-Q.  Accordingly, they do not include all the information and footnotes required by generally accepted accounting principles for complete financial statements.  The financial statements reflect all adjustments that are, in the opinion of management, necessary to fairly present the financial position, results of operations and cash flows of the Company.  Those adjustments consist only of normal recurring adjustments.  Results of operations for the six months ended June 30, 2014, are not necessarily indicative of results for the complete year.

The condensed consolidated balance sheet of the Company as of December 31, 2013 has been derived from the audited consolidated balance sheet of the Company as of that date.

For further information, refer to the consolidated financial statements and footnotes included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2013.

The following paragraphs summarize the impact of new accounting pronouncements:
 
ASU No. 2014-06: Technical Corrections and Improvements Related Glossary Terms.
 
A standing project exists on the FASB’s agenda to address feedback and to make other incremental improvements to U.S. GAAP. This perpetual project should eliminate the need for periodic agenda requests for narrow and incremental items. The Board decided that the types of issues that it will consider through this project are changes to clarify the Codification or correct unintended application of guidance that are not expected to have a significant effect on current accounting practice or create a significant administrative cost to most entities. This Update is limited to those amendments related to the Master Glossary, including technical corrections related to glossary links, glossary term deletions, and glossary term name changes. In addition, this Update includes more substantive, limited-scope improvements to reduce instances of the same term appearing multiple times in the Master Glossary with similar, but not entirely identical, definitions. Management does not believe these technical corrections will have a material impact on the Company’s Consolidated Financial Statements.
 
 
7

 

ASU No. 2014-04, Receivables (Topic 310): Reclassification of Residential Real Estate Collateralized Consumer Mortgage Loans upon Foreclosure.
 
The ASU clarifies that an in substance repossession or foreclosure occurs upon either the creditor obtaining legal title to the residential real estate property or the borrower conveying all interest in the residential real estate property to the creditor to satisfy that loan through completion of a deed in lieu of foreclosure or through a similar legal agreement. The amendments are effective for annual periods, and interim reporting periods within those annual periods, beginning after December 15, 2014. The amendments may be adopted using either a modified retrospective transition method or a prospective transition method. Early adoption is permitted. Management does not believe the amendments will have a material impact on the Company’s Consolidated Financial Statements.

NOTE 2—EARNINGS PER SHARE

Earnings per share (EPS) have been computed based on the weighted average number of shares outstanding during the periods presented. For the period ended June 30, 2014, share based awards totaling 66,570 common shares were not considered in computing diluted EPS as they were anti-dilutive.  For the period ended June 30, 2013, share based awards totaling 151,349 common shares were not considered in computing diluted EPS as they were anti-dilutive. The average number of shares used in the computation of basic and diluted earnings per share were:

   
Three Months Ended
   
Six Months Ended
 
(shares in thousands)
 
June 30,
   
June 30,
 
   
2014
   
2013
   
2014
   
2013
 
Basic earnings per share
    4,875       4,866       4,873       4,864  
Diluted earnings per share
    4,893       4,870       4,894       4,870  
 
NOTE 3 - SECURITIES

The amortized cost and appropriate fair values, together with gross unrealized gains and losses, of securities at June 30, 2014 and December 31, 2013 are as follows:
 
         
Gross
   
Gross
       
 
 
Amortized
   
Unrealized
   
Unrealized
   
Approximate
 
($'s in thousands)
 
Cost
   
Gains
   
Losses
   
Fair Value
 
Available-for-Sale Securities:
                       
June 30, 2014:
                       
U.S. Treasury and Government agencies
  $ 18,621     $ 159     $ (53 )   $ 18,727  
Mortgage-backed securities
    47,393       630       (285 )     47,738  
State and political subdivisions
    18,172       963       (37 )     19,098  
Equity securities
    23       -       -       23  
    $ 84,209     $ 1,752     $ (375 )   $ 85,586  
 
 
8

 
 
         
Gross
   
Gross
       
 
 
Amortized
   
Unrealized
   
Unrealized
       
($ in thousands)
 
Cost
   
Gains
   
Losses
   
Fair Value
 
Available-for-Sale Securities:
                       
December 31, 2013:
                       
U.S. Treasury and Government agencies
  $ 11,305     $ 120     $ (125 )   $ 11,300  
Mortgage-backed securities
    57,322       417       (516 )     57,223  
State and political subdivisions
    17,937       546       (328 )     18,155  
Money Market Mutual Fund
    3,092       -       -       3,092  
Equity securities
    23       -       -       23  
    $ 89,679     $ 1,083     $ (969 )   $ 89,793  
 
The amortized cost and fair value of securities available for sale at June 30, 2014, by contractual maturity, are shown below.  Expected maturities will differ from contractual maturities because issuers may have the right to call or prepay obligations with or without call or prepayment penalties.
 
   
Available for Sale
 
   
Amortized
   
Fair
 
($'s in thousands)
 
Cost
   
Value
 
June 30, 2014:
           
Within one year
  $ 486     $ 498  
Due after one year through five years
    1,587       1,647  
Due after five years through ten years
    7,771       7,976  
Due after ten years
    26,949       27,704  
      36,793       37,825  
                 
Mortgage-backed securities & equity securities
    47,416       47,761  
    $ 84,209     $ 85,586  

The fair value of securities pledged as collateral, to secure public deposits and for other purposes, was $65.3 million at June 30, 2014 and $42.3 million at December 31, 2013.  The fair value of securities delivered for repurchase agreements was $19.3 million at June 30, 2014 and $17.5 million at December 31, 2013.

Gross gains of $0.06 million resulting from sales of available-for-sale securities, were realized during the six-month period ending June 30, 2014. There were realized gains of $0.02 million from sales of available-for-sale securities for the six-month period ending June 30, 2013. The $0.06 million and the $0.02 million gain on sale was a reclassification from accumulated other comprehensive income (OCI) and is included in the net gain on sales of securities. The related $0.02 million and the $0.01 million in tax expense is a reclassification from OCI and is included in the income tax expense line item in the income statement.

Certain investments in debt securities are reported in the financial statements at an amount less than their historical cost.  Total fair value of these investments was $21.6 million at June 30, 2014, and $35.8 million at December 31, 2013, which was approximately 25.2 and 39.9 percent, respectively, of the Company’s available-for-sale investment portfolio at such dates.  Based on evaluation of available evidence, including recent changes in market interest rates, credit rating information and information obtained from regulatory filings, management believes the declines in fair value for these securities are temporary.  Should the impairment of any of these securities become other than temporary, the cost basis of the investment will be reduced and the resulting loss recognized in net income in the period the other-than-temporary impairment is identified.

 
9

 

Securities with unrealized losses, aggregated by investment class and length of time that individual securities have been in a continuous unrealized loss position, at June 30, 2014 and December 31, 2013 are as follows:
 
($ in thousands)
 
Less than 12 Months
   
12 Months or Longer
   
Total
 
June 30, 2014
 
Fair Value
   
Unrealized
Losses
   
Fair Value
   
Unrealized
Losses
   
Fair Value
   
Unrealized
Losses
 
Available-for-Sale Securities:
                                   
U.S. Treasury and  Government agencies   $ 3,315     $ (19 )   $ 2,966     $ (34 )   $ 6,281     $ (53 )
Mortgage-backed securities     5,886       (21 )     7,735       (264 )     13,621       (285 )
State and political subdivisions     -       -       1,672       (37 )     1,672       (37 )
    $ 9,201     $ (40 )   $ 12,373     $ (335 )   $ 21,574     $ (375 )
 
($ in thousands)
 
Less than 12 Months
   
12 Months or Longer
   
Total
December 31, 2013
 
Fair Value
   
Unrealized
Losses
   
Fair Value
   
Unrealized
Losses
   
Fair Value
   
Unrealized
Losses
 
Available-for-Sale Securities:
                                   
                                     
U.S. Treasury and Government agencies   $ 3,834     $ (125 )   $ -     $ -     $ 3,834     $ (125 )
Mortgage-backed securities   $ 24,773     $ (410 )   $ 2,333     $ (106 )   $ 27,106     $ (516 )
State and politicalsubdivisions     4,868       (328 )     -       -       4,868       (328 )
    $ 33,475     $ (863 )   $ 2,333     $ (106 )   $ 35,808     $ (969 )
 
The total unrealized loss as of June 30, 2014 in the securities portfolio is contained in 25 percent of the portfolio with a potential loss of $0.4 million, which is down from the $1.0 million unrealized loss at December 31, 2013. The unrealized losses are contained within 19 individual securities and are not segregated by type or duration of security.  Management evaluates securities for other-than-temporary impairment at least on a quarterly basis, and more frequently when economic or market concern warrants such evaluation.  Consideration is given to (1) the length of time and the extent to which the fair value has been less than cost, (2) the financial condition and near-term prospects of the issuer, and (3) the intent of the Company to not sell the investment and whether it is more likely than not that the Company will be required to sell the security before recovery of its amortized cost.  Management has determined there is no other-than-temporary-impairment on these securities.

NOTE 4 – LOANS AND ALLOWANCE FOR LOAN LOSSES

Loans that management has the intent and ability to hold for the foreseeable future, or until maturity or payoffs, are reported at their outstanding principal balances adjusted for any charge-offs, the allowance for loan losses, any deferred fees or costs on originated loans and unamortized premiums or discounts on purchased loans.  Interest income is reported on the interest method and includes amortization of net deferred loan fees and costs over the loan term.  Generally, all loan classes are placed on non-accrual status not later than 90 days past due, unless the loan is well-secured and in the process of collection.  All interest accrued, but not collected for loans that are placed on non-accrual or charged-off, is reversed against interest income.  The interest on these loans is accounted for on the cash-basis or cost-recovery method, until qualifying for return to accrual.  Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured.
 
 
10

 
 
The allowance for loan losses is established as losses are estimated to have occurred through a provision for loan losses charged to income.  Loan losses are charged against the allowance when management believes the non-collectability of a loan balance is probable.  Subsequent recoveries, if any, are credited to the allowance.
 
The allowance for loan losses is evaluated on a regular basis by management and is based upon management’s periodic review of the collectability of the loans in light of historical experience, the nature and volume of the loan portfolio, adverse situations that may affect the borrower’s ability to repay, estimated value of any underlying collateral and prevailing economic conditions.  This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as new information becomes available.
 
The allowance consists of allocated and general components.  The allocated component relates to loans that are classified as impaired.  For those loans that are classified as impaired, an allowance is established when the discounted cash flows (or collateral value or observable market price) of the impaired loan is lower than the carrying value of that loan.  The general component covers nonclassified loans and is based on historical charge-off experience and expected loss given default derived from the Company’s internal risk rating process.  Other adjustments may be made to the allowance for pools of loans after an assessment of internal or external influences on credit quality that are not fully reflected on the historical loss or risk rating data.
 
A loan is considered impaired when, based on current information and events, it is probable that State Bank will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement.  Factors considered by management in determining impairment include payment status, collateral value and the probability of collecting scheduled principal and interest payments when due.  Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired.  Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration each of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record and the amount of the shortfall in relation to the principal and interest owed.  Impairment is measured on a loan-by-loan basis for commercial, agricultural, and construction loans by either the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s obtainable market price or the fair value of the collateral if the loan is collateral dependent.
 
When State Bank moves a loan to non-accrual status, total unpaid interest accrued to date is reversed from income.  Subsequent payments are applied to the outstanding principal balance with the interest portion of the payment recorded on the balance sheet as a contra-loan.  Interest received on impaired loans may be realized once all contractual principal amounts are received or when a borrower establishes a history of six consecutive timely principal and interest payments.  It is at the discretion of management to determine when a loan is placed back on accrual status upon receipt of six consecutive timely payments.
 
Large groups of smaller balance homogenous loans are collectively evaluated for impairment.  Accordingly, State Bank does not separately identify individual consumer and residential loans for impairment measurements, unless such loans are the subject of a restructuring agreement due to financial difficulties of the borrower.
 
 
11

 
 
Categories of loans at June 30, 2014 and December 31, 2013 include:
 
($ in thousands)
 
Total Loans
   
Non-Accrual Loans
 
   
Jun. 2014
   
Dec. 2013
   
Jun. 2014
   
Dec. 2013
 
Commercial & Industrial
  $ 92,424     $ 85,368       1,485       2,316  
Commercial RE & Construction
    215,824       205,301       699       532  
Agricultural & Farmland
    43,475       39,210       -       -  
Residential Real Estate
    105,054       99,620       1,534       1,651  
Consumer & Other
    49,350       47,804       288       345  
Total loans, net of unearned income
  $ 506,127     $ 477,303     $ 4,006     $ 4,844  
                                 
Allowance for loan losses
  $ (6,568 )   $ (6,964 )                
 
The following tables present the activity in the allowance for loan losses and the recorded investment in loans based on portfolio segment and impairment method as of June 30, 2014, December 31, 2013 and June 30, 2013.
 
For the Three Months Ended
June 30, 2014
($'s in thousands)
 
Commercial
& Industrial
   
Commercial RE
& Construction
 
Agricultural
& Farmland
   
Residential
Real Estate
   
Consumer
& Other
   
Total
 
                                     
ALLOWANCE FOR LOAN AND LEASE LOSSES
                   
                                     
Beginning balance
  $ 1,902     $ 2,751     $ 177     $ 1,161     $ 735     $ 6,726  
Charge Offs
    (300 )     (1 )     -       -       (29 )   $ (330 )
Recoveries
    2       8       1       9       2       22  
Provision
    56       (101 )     16       96       83       150  
Ending Balance
  $ 1,660     $ 2,657     $ 194     $ 1,266     $ 791     $ 6,568  
 
For the Six Months Ended
June 30, 2014
($'s in thousands)
 
Commercial
& Industrial
   
Commercial RE
& Construction
 
Agricultural
& Farmland
   
Residential
Real Estate
   
Consumer
& Other
   
Total
 
                                                 
ALLOWANCE FOR LOAN AND LEASE LOSSES
                         
                                                 
Beginning balance
  $ 2,175     $ 2,708     $ 159     $ 1,067     $ 855     $ 6,964  
Charge Offs
    (607 )     (1 )     -       (15 )     (30 )   $ (653 )
Recoveries
    12       60       1       14       20       107  
Provision
    80       (110 )     34       200       (54 )     150  
Ending Balance
  $ 1,660     $ 2,657     $ 194     $ 1,266     $ 791     $ 6,568  
 
Loans Receivable at June 30, 2014
 
Allowance:
Ending balance:
                                   
individuallye valuated for impairment
  $ 337     $ 17     $ -     $ 168     $ 53     $ 575  
Ending balance:
                                               
collectivelye valuated for impairment
  $ 1,323     $ 2,640     $ 194     $ 1,098     $ 738     $ 5,993  
Loans:
                                               
Ending balance:
                                               
individually evaluated for impairment
  $ 1,308     $ 606     $ -     $ 1,816     $ 570     $ 4,300  
Ending balance:
                                               
collectivelye valuated for impairment
  $ 91,116     $ 215,218     $ 43,475     $ 103,238     $ 48,780     $ 501,827  
 
 
12

 
 
December 31, 2013
($'s in thousands)
 
Commercial
& Industrial
   
Commercial RE
& Construction
   
Agricultural
& Farmland
   
Residential
Real Estate
   
Consumer
& Other
   
Total
 
                                     
Loans Receivable at December 31, 2013
                   
Allowance:
                                   
Ending balance:
                                   
individually evaluated for impairment
  $ 1,079     $ 56     $ -     $ 192     $ 168     $ 1,495  
Ending balance:
                                               
collectively evaluated for impairment
  $ 1,096     $ 2,652     $ 159     $ 875     $ 687     $ 5,469  
Loans:
                                               
Ending balance:
                                               
individually evaluated for impairment
  $ 2,116     $ 649     $ -     $ 1,985     $ 590     $ 5,340  
Ending balance:
                                               
collectively evaluated for impairment
  $ 83,252     $ 204,652     $ 39,210     $ 97,635     $ 47,214     $ 471,963  
 
         
Commercial
                         
   
Commercial
   
RE &
   
Agricultural
   
Residential
   
Consumer
       
($'s in thousands)
 
& Industrial
   
Construction
   
& Farmland
   
Real Estate
   
& Other
   
Total
 
                     
ALLOWANCE FOR LOAN AND LEASE LOSSES
                   
   
For the Three Months Ended
                         
June 30, 2013
                                   
                                     
Beginning balance
  $ 1,480     $ 3,266     $ 179     $ 1,110     $ 957     $ 6,992  
Charge Offs
    (1 )     -       -       (98 )     (114 )     (213 )
Recoveries
    11       2       1       19       1       34  
Provision
    57       (209 )     -       152       200       200  
Ending Balance
  $ 1,547     $ 3,059     $ 180     $ 1,183     $ 1,044     $ 7,013  
 
For the Six Months Ended
                         
June 30, 2013
                                   
                                     
Beginning balance
  $ 1,561     $ 3,034     $ 186     $ 1,088     $ 942     $ 6,811  
Charge Offs
    (1 )     (5 )     -       (98 )     (245 )     (349 )
Recoveries
    14       15       2       19       2       52  
Provision
    (27 )     15       (8 )     174       345       499  
Ending Balance
  $ 1,547     $ 3,059     $ 180     $ 1,183     $ 1,044     $ 7,013  
 
The risk characteristics of each loan portfolio segment are as follows:

Commercial and Agricultural

Commercial and agricultural loans are primarily based on the identified cash flows of the borrower and secondarily on the underlying collateral provided by the borrower.  The cash flows of borrowers, however, may not be as expected and the collateral securing these loans may fluctuate in value.  Most commercial loans are secured by the assets being financed or other business assets, such as accounts receivable or inventory, and may include a personal guarantee.  Short-term loans may be made on an unsecured basis.  In the case of loans secured by accounts receivable, the availability of funds for the repayment of these loans may be substantially dependent on the ability of the borrower to collect amounts due from its customers.
 
 
13

 
 
Commercial Real Estate including Construction

Commercial real estate loans are viewed primarily as cash flow loans and secondarily as loans secured by real estate.  Commercial real estate lending typically involves higher loan principal amounts and the repayment of these loans is generally dependent on the successful operation of the property securing the loan or the business conducted on the property securing the loan.  Commercial real estate loans may be more adversely affected by conditions in the real estate markets or in the general economy.  The characteristics of properties securing the Company’s commercial real estate portfolio are diverse, but with geographic location almost entirely in the Company’s market area.  Management monitors and evaluates commercial real estate loans based on collateral, geography and risk grade criteria.  In general, the Company avoids financing single purpose projects unless other underwriting factors are present to help mitigate risk.  In addition, management tracks the level of owner-occupied commercial real estate versus non-owner-occupied loans.

Construction loans are underwritten utilizing feasibility studies, independent appraisal reviews and financial analysis of the developers and property owners.  Construction loans are generally based on estimates of costs and value associated with the completed project.  These estimates may be inaccurate.  Construction loans often involve the disbursement of substantial funds with repayment substantially dependent on the success of the ultimate project.  Sources of repayment for these types of loans may be pre-committed permanent loans from approved long-term lenders, sales of developed property or an interim loan commitment from the Company until permanent financing is obtained.  These loans are closely monitored by on-site inspections and are considered to have higher risks than other real estate loans due to their ultimate repayment being sensitive to interest rate changes, governmental regulation of real property, general economic conditions and the availability of long-term financing.

Residential and Consumer

Residential and consumer loans consist of two segments – residential mortgage loans and personal loans.  Residential mortgage loans are secured by 1-4 family residences and are generally owner-occupied, and the Company generally establishes a maximum loan-to-value ratio and requires private mortgage insurance if that ratio is exceeded.  Home equity loans are typically secured by a subordinate interest in 1-4 family residences, and consumer personal loans are secured by consumer personal assets, such as automobiles or recreational vehicles.  Some consumer personal loans are unsecured, such as small installment loans and certain lines of credit.  Repayment of these loans is primarily dependent on the personal income of the borrowers, which can be impacted by economic conditions in their market areas, such as unemployment levels.  Repayment can also be impacted by changes in property values on residential properties.  Risk is mitigated by the fact that these loans are of smaller individual amounts and spread over a large number of borrowers.

The following tables present the credit risk profile of the Company’s loan portfolio based on rating category and payment activity as of June 30, 2014 and December 31, 2013.
 
June 30, 2014
 
Commercial
   
Commercial RE
   
Agricultural
   
Residential
   
Consumer
       
Loan Grade
 
& Industrial
   
& Construction
   
& Farmland
   
Real Estate
   
& Other
   
Total
 
($ in thousands)
                                   
1-2
  $ 1,457     $ 73     $ 72     $ -     $ -     $ 1,602  
   3
    21,761       51,738       9,184       96,419       44,127       223,229  
   4
    64,703       151,136       34,219       5,807       4,862       260,727  
    Total Pass
    87,921       202,947       43,475       102,226       48,989       485,558  
                                                 
Special Mention
    2,505       7,344       -       1,036       7       10,892  
Substandard
    775       4,834       -       258       66       5,933  
Doubtful
    1,223       699       -       1,534       288       3,744  
Loss
    -       -       -       -       -       -  
    Total Loans
  $ 92,424     $ 215,824     $ 43,475     $ 105,054     $ 49,350     $ 506,127  
 
 
14

 
 
December 31, 2013
 
Commercial
   
Commercial RE
   
Agricultural
   
Residential
   
Consumer
       
Loan Grade
 
& Industrial
   
& Construction
   
& Farmland
   
Real Estate
   
& Other
   
Total
 
($ in thousands)
                                   
1-2
  $ 1,345     $ 81     $ 76     $ -     $ 87     $ 1,589  
   3
    22,328       44,095       6,543       90,606       43,250       206,822  
   4
    56,188       146,861       32,591       5,700       3,782       245,122  
    Total Pass
    79,861       191,037       39,210