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EXCEL - IDEA: XBRL DOCUMENT - EMCLAIRE FINANCIAL CORPFinancial_Report.xls
EX-32.2 - EXHIBIT 32.2 - EMCLAIRE FINANCIAL CORPv392649_ex32-2.htm
EX-31.1 - EXHIBIT 31.1 - EMCLAIRE FINANCIAL CORPv392649_ex31-1.htm
EX-31.2 - EXHIBIT 31.2 - EMCLAIRE FINANCIAL CORPv392649_ex31-2.htm
EX-32.1 - EXHIBIT 32.1 - EMCLAIRE FINANCIAL CORPv392649_ex32-1.htm

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

(Mark One)

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

 

For the quarterly period ended September 30, 2014

 

or

 

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

 

For the transition period from _____________ to _____________

 

Commission File Number: 001-34527

 

EMCLAIRE FINANCIAL CORP

 

(Exact name of registrant as specified in its charter)

 

Pennsylvania 25-1606091
(State or other jurisdiction of incorporation or organization) (IRS Employer Identification No.)

 

612 Main Street, Emlenton, Pennsylvania 16373
(Address of principal executive offices) (Zip Code)

 

(844) 767-2311

 

(Registrant’s telephone number)

 

 

 

(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 ¨

 

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 as defined in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer ¨ Accelerated filer ¨ Non-accelerated filer ¨ Smaller reporting company x

 

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

 

The number of shares outstanding of the Registrant’s common stock was 1,772,158 at November 10, 2014.

 

 

  

 
 

  

EMCLAIRE FINANCIAL CORP

 

INDEX TO QUARTERLY REPORT ON FORM 10-Q

  

PART I – FINANCIAL INFORMATION
     
Item 1. Interim Financial Statements (Unaudited)  
     
  Consolidated Balance Sheets as of September 30, 2014 and December 31, 2013 1
     
  Consolidated Statements of Net Income for the three and nine months ended September 30, 2014 and 2013 2
     
  Consolidated Statements of Comprehensive Income (Loss) for the three and nine months ended September 30, 2014 and 2013 3
     
  Condensed Consolidated Statements of Cash Flows for the nine months ended September 30, 2014 and 2013 4
     
  Consolidated Statements of Changes in Stockholders’ Equity for the three and nine months ended September 30, 2014 and 2013 5
     
  Notes to Consolidated Financial Statements 6
     
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations 27
     
Item 3. Quantitative and Qualitative Disclosures About Market Risk 40
     
Item 4. Controls and Procedures 41
     
PART II – OTHER INFORMATION
     
Item 1. Legal Proceedings 41
     
Item 1A. Risk Factors 41
     
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 41
     
Item 3. Defaults Upon Senior Securities 41
     
Item 4. Mine Safety Disclosures 42
     
Item 5. Other Information 42
     
Item 6. Exhibits 42
     
Signatures 43

 

 
 

 

PART I - FINANCIAL INFORMATION

 

Item 1. Interim Financial Statements

 

Emclaire Financial Corp

Consolidated Balance Sheets

As of September 30, 2014 (Unaudited) and December 31, 2013

(Dollar amounts in thousands, except per share data)

 

   September 30,   December 31, 
   2014   2013 
         
Assets          
           
Cash and due from banks  $2,615   $2,485 
Interest earning deposits with banks   32,703    14,173 
Cash and cash equivalents   35,318    16,658 
Securities available for sale   150,321    117,304 
Loans receivable, net of allowance for loan losses of $5,130 and $4,869   368,219    352,430 
Federal bank stocks, at cost   2,791    3,977 
Bank-owned life insurance   10,644    10,401 
Accrued interest receivable   1,674    1,466 
Premises and equipment, net   14,294    12,310 
Goodwill   3,664    3,664 
Core deposit intangible, net   798    965 
Prepaid expenses and other assets   5,814    6,667 
           
Total Assets  $593,537   $525,842 
           
Liabilities and Stockholders' Equity          
           
Liabilities:          
Deposits:          
Non-interest bearing  $112,732   $104,269 
Interest bearing   407,176    327,737 
Total deposits   519,908    432,006 
Short-term borrowed funds   2,150    24,150 
Long-term borrowed funds   15,000    20,000 
Accrued interest payable   217    292 
Accrued expenses and other liabilities   8,321    4,322 
           
Total Liabilities   545,596    480,770 
           
Commitments and Contingent Liabilities   -    - 
           
Stockholders' Equity:          
Preferred stock, $1.00 par value, 3,000,000 shares authorized; Series B, non-cumulative preferred stock, $5,000 liquidation value, 5,000 shares issued and outstanding   5,000    5,000 
Common stock, $1.25 par value, 12,000,000 shares authorized; 1,873,175 and 1,870,675 shares issued; 1,771,158 and 1,768,658 shares outstanding, respectively   2,341    2,338 
Additional paid-in capital   19,650    19,478 
Treasury stock, at cost; 102,017 shares   (2,114)   (2,114)
Retained earnings   25,148    23,650 
Accumulated other comprehensive loss   (2,084)   (3,280)
           
Total Stockholders' Equity   47,941    45,072 
           
Total Liabilities and Stockholders' Equity  $593,537   $525,842 

 

See accompanying notes to consolidated financial statements.

 

1
 

  

Emclaire Financial Corp

Consolidated Statements of Net Income (Unaudited)

For the three and nine months ended September 30, 2014 and 2013

(Dollar amounts in thousands, except per share data)

 

   For the three months ended   For the nine months ended 
   September 30,   September 30, 
   2014   2013   2014   2013 
                 
Interest and dividend income:                    
Loans receivable, including fees  $4,140   $4,114   $12,259   $12,411 
Securities:                    
Taxable   521    440    1,417    1,328 
Exempt from federal income tax   244    314    763    875 
Federal bank stocks   33    18    112    52 
Interest earning deposits with banks   30    12    68    44 
Total interest and dividend income   4,968    4,898    14,619    14,710 
                     
Interest expense:                    
Deposits   616    662    1,784    2,305 
Borrowed funds   174    198    503    590 
Total interest expense   790    860    2,287    2,895 
                     
Net interest income   4,178    4,038    12,332    11,815 
Provision for loan losses   163    143    508    438 
                     
Net interest income after provision for loan losses   4,015    3,895    11,824    11,377 
                     
Noninterest income:                    
Fees and service charges   411    428    1,182    1,254 
Commissions on financial services   8    48    31    187 
Title premiums   16    6    40    55 
Net gain on sales of available for sale securities   91    107    748    291 
Net gain on sales of loans   -    9    -    9 
Earnings on bank-owned life insurance   97    97    289    290 
Other   306    307    911    877 
Total noninterest income   929    1,002    3,201    2,963 
                     
Noninterest expense:                    
Compensation and employee benefits   1,825    1,847    5,599    5,684 
Premises and equipment   634    516    1,837    1,586 
Intangible asset amortization   54    67    167    213 
Professional fees   142    158    488    513 
Federal deposit insurance   90    99    266    307 
Other   936    856    3,251    2,447 
Total noninterest expense   3,681    3,543    11,608    10,750 
                     
Income before provision for income taxes   1,263    1,354    3,417    3,590 
Provision for income taxes   241    272    675    711 
                     
Net income   1,022    1,082    2,742    2,879 
Preferred stock dividends   25    115    75    365 
                     
Net income available to common stockholders  $997   $967   $2,667   $2,514 
                     
Basic earnings per common share  $0.56   $0.55   $1.51   $1.43 
Diluted earnings per common share   0.56    0.54    1.49    1.42 
                     
Average common shares outstanding   1,770,821    1,762,810    1,770,128    1,761,972 

 

See accompanying notes to consolidated financial statements.

 

2
 

 

Emclaire Financial Corp

Consolidated Statements of Comprehensive Income (Loss) (Unaudited)

For the three and nine months ended September 30, 2014 and 2013

(Dollar amounts in thousands)

 

   For the three months ended   For the nine months ended 
   September 30,   September 30, 
   2014   2013   2014   2013 
                 
Net income  $1,022   $1,082   $2,742   $2,879 
                     
Other comprehensive income (loss)                    
Unrealized gains (losses) on securities:                    
Unrealized holding gain (loss) arising during the period   (194)   (800)   2,560    (5,271)
Reclassification adjustment for gains included in net income   (91)   (107)   (748)   (291)
    (285)   (907)   1,812    (5,562)
Tax effect   97    308    (616)   1,891 
                     
Net of tax   (188)   (599)   1,196    (3,671)
                     
Comprehensive income (loss)  $834   $483   $3,938   $(792)

 

See accompanying notes to consolidated financial statements.

 

3
 

 

Emclaire Financial Corp

Condensed Consolidated Statements of Cash Flows (Unaudited)

For the nine months ended September 30, 2014 and 2013

(Dollar amounts in thousands)

 

   For the nine months ended 
   September 30, 
   2014   2013 
         
Cash flows from operating activities          
Net income  $2,742   $2,879 
Adjustments to reconcile net income to net cash provided by operating activities:          
Depreciation and amortization   631    503 
Provision for loan losses   508    438 
Amortization of premiums, net   198    152 
Amortization of intangible assets and mortgage servicing rights   168    213 
Realized gains on sales of available for sale securities, net   (748)   (291)
Net gains on sales of loans   -    (9)
Net (gains) losses on foreclosed real estate   (11)   5 
Originations of loans sold   -    (202)
Proceeds from the sale of loans   -    211 
Restricted stock and stock option compensation   126    133 
Increase in bank-owned life insurance, net   (243)   (247)
Increase in accrued interest receivable   (208)   (74)
Decrease in prepaid expenses and other assets   232    1,159 
Decrease in accrued interest payable   (75)   (137)
Increase in accrued expenses and other liabilities   3,999    644 
Net cash provided by operating activities   7,319    5,377 
           
Cash flows from investing activities          
Loan originations and principal collections, net   (16,619)   (14,733)
Available for sale securities:          
Sales   22,462    21,015 
Maturities, repayments and calls   10,270    28,767 
Purchases   (63,189)   (60,116)
Redemption (purchase) of federal bank stocks   1,186    (822)
Proceeds from the sale of foreclosed real estate   139    167 
Write-down of foreclosed real estate   -    19 
Additions to premises and equipment   (2,615)   (2,692)
Net cash used in investing activities   (48,366)   (28,395)
           
Cash flows from financing activities          
Net increase in deposits   87,902    (3,017)
Repayments on Federal Home Loan Bank advances   (5,000)   - 
Net change in short-term borrowings   (22,000)   26,650 
Proceeds from exercise of stock options, including tax benefit   48    20 
Dividends paid   (1,243)   (1,423)
Redemption of preferred stock (Series B)   -    (5,000)
Net cash provided by financing activities   59,707    17,230 
           
Increase (decrease) in cash and cash equivalents   18,660    (5,788)
Cash and cash equivalents at beginning of period   16,658    20,424 
Cash and cash equivalents at end of period  $35,318   $14,636 
           
Supplemental information:          
Interest paid  $2,362   $3,032 
Income taxes paid   245    140 
           
Supplemental noncash disclosure:          
Transfers from loans to foreclosed real estate   124    159 

 

See accompanying notes to consolidated financial statements.

 

4
 

  

Emclaire Financial Corp

Consolidated Statements of Changes in Stockholders’ Equity (Unaudited)

For the three and nine months ended September 30, 2014 and 2013

(Dollar amounts in thousands, except per share data)

 

   For the three months ended   For the nine months ended 
   September 30,   September 30, 
   2014   2013   2014   2013 
                 
Balance at beginning of period  $47,457   $49,613   $45,072   $51,725 
                     
Net income   1,022    1,082    2,742    2,879 
                     
Other comprehensive income (loss)   (188)   (599)   1,196    (3,671)
                     
Stock compensation expense   42    34    126    133 
                     
Dividends declared on preferred stock   (25)   (115)   (75)   (365)
                     
Dividends declared on common stock   (390)   (352)   (1,168)   (1,058)
                     
Exercise of stock options, including tax benefit   23    -    48    20 
                     
Redemption of preferred stock (5,000 shares, Series B)   -    (5,000)   -    (5,000)
                     
Balance at end of period  $47,941   $44,663   $47,941   $44,663 
                     
Common cash dividend per share  $0.22   $0.20   $0.66   $0.60 

 

See accompanying notes to consolidated financial statements.

 

5
 

 

Emclaire Financial Corp

Notes to Consolidated Financial Statements (Unaudited)

 

1.Nature of Operations and Basis of Presentation

 

Emclaire Financial Corp (the Corporation) is a Pennsylvania corporation and the holding company of The Farmers National Bank of Emlenton (the Bank) and Emclaire Settlement Services, LLC (the Title Company). The Corporation provides a variety of financial services to individuals and businesses through its offices in Western Pennsylvania. Its primary deposit products are checking, savings and term certificate accounts and its primary lending products are residential and commercial mortgages, commercial business loans and consumer loans.

 

The consolidated financial statements include the accounts of the Corporation and its wholly owned subsidiaries, the Bank and the Title Company. All significant intercompany transactions and balances have been eliminated in preparing the consolidated financial statements.

 

The accompanying unaudited consolidated financial statements for the interim periods include all adjustments, consisting of normal recurring accruals, which are necessary, in the opinion of management, to fairly reflect the Corporation’s consolidated financial position and results of operations. Additionally, these consolidated financial statements for the interim periods have been prepared in accordance with instructions for the Securities and Exchange Commission’s (SEC’s) Form 10-Q and Article 10 of Regulation S-X and therefore do not include all information or footnotes necessary for a complete presentation of financial condition, results of operations and cash flows in conformity with accounting principles generally accepted in the United States of America (GAAP). For further information, refer to the audited consolidated financial statements and footnotes thereto for the year ended December 31, 2013, as contained in the Corporation’s Annual Report on Form 10-K for the year ended December 31, 2013 filed with the SEC.

 

The balance sheet at December 31, 2013 has been derived from the audited financial statements at that date but does not include all the information and footnotes required by GAAP for complete financial statements.

 

The preparation of financial statements, in conformity with GAAP, requires management to make estimates and assumptions that affect the reported amounts in the consolidated financial statements and accompanying notes. Actual results could differ from those estimates. Material estimates that are particularly susceptible to significant change in the near term relate to the determination of the allowance for loan losses, fair value of financial instruments, goodwill, real estate owned, the valuation of deferred tax assets and other-than-temporary impairment charges on securities. The results of operations for interim quarterly or year-to-date periods are not necessarily indicative of the results that may be expected for the entire year or any other period. Certain amounts previously reported may have been reclassified to conform to the current year’s financial statement presentation.

 

6
 

  

2.Participation in the Small Business Lending Fund (SBLF) of the U.S. Treasury Department (U.S. Treasury)

 

On August 18, 2011, the Corporation entered into a Securities Purchase Agreement (the Agreement) with the U.S. Treasury Department, pursuant to which the Corporation issued and sold to the U.S. Treasury 10,000 shares of Senior Non-Cumulative Perpetual Preferred Stock, Series B (Series B Preferred Stock), having a liquidation preference of $1,000 per share, for aggregate proceeds of $10.0 million, pursuant to the U.S. Treasury’s SBLF program. On September 17, 2013, with the approval of the Corporation’s primary federal banking regulator, the Corporation redeemed 5,000 shares, or 50%, of its Series B Preferred Stock held by the U.S. Treasury at an aggregate redemption price of $5.0 million, plus accrued but unpaid dividends. Following this redemption, the Treasury holds 5,000 shares of the Series B Preferred Stock, representing a remaining liquidation value of $5.0 million.

 

The Series B Preferred Stock is entitled to receive non-cumulative dividends payable quarterly on each January 1, April 1, July 1 and October 1, beginning October 1, 2011. The dividend rate, which is calculated on the aggregate liquidation amount, was initially set at 5% per annum based upon the current level of Qualified Small Business Lending (QSBL) by the Bank at that time. The dividend rate in the subsequent periods for the first two and one-half years through the quarter ending December 31, 2013 was based upon the percentage change in qualified lending between each dividend period and the baseline QSBL level established at the time the Agreement was entered into. Such dividend rate varied from 1% to 5% per annum. For the two year period beginning January 1, 2014, the dividend rate is fixed at a rate of 2% per annum. If the Series B Preferred Stock remains outstanding for more than four-and-one-half years, beginning January 1, 2016, the dividend rate will be fixed at 9%. The dividend rate was 2.0% and 5.0%, respectively, for the quarters ended September 30, 2014 and 2013. Such dividends are not cumulative, but the Corporation may only declare and pay dividends on its common stock (or any other equity securities junior to the Series B Preferred Stock) if it has declared and paid dividends for the current dividend period on the Series B Preferred Stock, and will be subject to other restrictions on its ability to repurchase or redeem other securities.

 

Holders of the Series B Preferred Stock have the right to vote as a separate class on certain matters relating to the rights of holders of Series B Preferred Stock and on certain corporate transactions. Except with respect to such matters, the Series B Preferred Stock does not have voting rights.

 

The Corporation may redeem the shares of Series B Preferred Stock, in whole or in part, at any time at a redemption price equal to the sum of the liquidation amount and the per-share amount of any unpaid dividends for the then-current period, subject to any required prior approval by the Corporation’s primary federal banking regulator. If redeemed in part, payments are required to be at least 25% of the original issuance.

 

3.Earnings per Common Share

 

Basic earnings per common share (EPS) excludes dilution and is computed by dividing net income available to common stockholders by the weighted average number of common shares outstanding during the period. Diluted EPS includes the dilutive effect of additional potential common shares for assumed issuance of restricted stock and shares issued under stock options.

7
 

  

3.Earnings per Common Share (continued)

 

The factors used in the Corporation’s earnings per common share computation follow:

 

(Dollar amounts in thousands, except for per share amounts)  For the three months ended   For the nine months ended 
   September 30,   September 30, 
   2014   2013   2014   2013 
Earnings per common share - basic                    
                     
Net income  $1,022   $1,082   $2,742   $2,879 
Less: Preferred stock dividends   25    115    75    365 
.                    
Net income available to common stockholders  $997   $967   $2,667   $2,514 
                     
Average common shares outstanding   1,770,821    1,762,810    1,770,128    1,761,972 
                     
Basic earnings per common share  $0.56   $0.55   $1.51   $1.43 
                     
Earnings per common share - diluted                    
                     
Net income available to common stockholders  $997   $967   $2,667   $2,514 
                     
Average common shares outstanding   1,770,821    1,762,810    1,770,128    1,761,972 
Add: Dilutive effects of assumed issuance of restricted stock and exercise of stock options   16,410    13,616    14,709    12,777 
                     
Average shares and dilutive potential common shares   1,787,231    1,776,426    1,784,837    1,774,749 
                     
Diluted earnings per common share  $0.56   $0.54   $1.49   $1.42 
                     
Stock options and restricted stock awards not considered in computing diluted earnings per share because they were antidilutive   66,000    67,000    67,000    67,000 

 

4.Securities

 

The following table summarizes the Corporation’s securities as of September 30, 2014 and December 31, 2013:

 

(Dollar amounts in thousands)      Gross   Gross     
   Amortized   Unrealized   Unrealized   Fair 
   Cost   Gains   Losses   Value 
                 
Available for sale:                    
September 30, 2014:                    
U.S. Treasury and federal agency  $3,470   $-   $(39)  $3,431 
U.S. government sponsored entities and agencies   35,448    19    (213)   35,254 
U.S. agency mortgage-backed securities: residential   37,664    565    -    38,230 
U.S. agency collateralized mortgage obligations: residential   38,730    21    (965)   37,785 
State and political subdivisions   31,668    688    (152)   32,204 
Corporate debt securities   2,006    -    (7)   2,000 
Equity securities   2,356    190    -    2,546 
   $151,342   $1,482   $(1,376)  $151,449 
December 31, 2013:                    
U.S. Treasury and federal agency  $4,466   $-   $(298)  $4,168 
U.S. government sponsored entities and agencies   23,637    -    (745)   22,892 
U.S. agency mortgage-backed securities: residential   11,020    341    -    11,361 
U.S. agency collateralized mortgage obligations: residential   41,751    2    (2,031)   39,722 
State and political subdivisions   36,657    830    (988)   36,499 
Corporate debt securities   250    -    (9)   241 
Equity securities   2,356    131    (66)   2,421 
   $120,137   $1,304   $(4,137)  $117,304 

 

8
 

  

4.Securities (continued)

 

The following table summarizes scheduled maturities of the Corporation’s debt securities as of September 30, 2014. Expected maturities may differ from contractual maturities because issuers may have the right to call or prepay obligations with or without call or prepayment penalties. Mortgage-backed securities and collateralized mortgage obligations are not due at a single maturity and are shown separately.

 

(Dollar amounts in thousands)  Available for sale 
   Amortized   Fair 
   Cost   Value 
         
Due in one year or less  $55   $56 
Due after one year through five years   42,026    41,871 
Due after five through ten years   27,992    28,191 
Due after ten years   2,519    2,453 
Mortgage-backed securities: residential   37,664    37,892 
Collateralized mortgage obligations: residential   38,730    37,314 
   $148,986   $147,777 

 

Information pertaining to securities with gross unrealized losses at September 30, 2014 and December 31, 2013, aggregated by investment category and length of time that individual securities have been in a continuous loss position are included in the table below:

 

(Dollar amounts in thousands)  Less than 12 Months   12 Months or More   Total 
   Fair   Unrealized   Fair   Unrealized   Fair   Unrealized 
Description of Securities  Value   Loss   Value   Loss   Value   Loss 
                         
September 30, 2014:                              
U.S. Treasury and federal agency  $-   $-   $3,338   $(132)  $3,338   $(132)
U.S. government sponsored entities and agencies   15,396    (64)   18,698    (292)   34,094    (356)
U.S. agency mortgage-backed securities: residential   7,534    (58)   -    -    7,534    (58)
U.S. agency collateralized mortgage obligations: residential   2,740    (31)   34,574    (1,385)   37,314    (1,416)
State and political subdivisions   559    (1)   11,030    (207)   11,589    (208)
Corporate debt securities   1,993    (13)   -    -    1,993    (13)
   $28,222   $(167)  $67,640   $(2,016)  $95,862   $(2,183)
                               
December 31, 2013:                              
U.S. Treasury and federal agency  $4,168   $(298)  $-   $-   $4,168   $(298)
U.S. government sponsored entities and agencies   22,891    (745)   -    -    22,891    (745)
U.S. agency mortgage-backed securities: residential   33,805    (1,729)   4,982    (302)   38,787    (2,031)
State and political subdivisions   13,262    (988)   -    -    13,262    (988)
Corporate debt securities   242    (9)   -    -    242    (9)
Equity securities   1,142    (66)   -    -    1,142    (66)
   $75,510   $(3,835)  $4,982   $(302)  $80,492   $(4,137)

 

Gains on sales of available for sale securities for the three and nine months ended September 30 were as follows:

 

(Dollar amounts in thousands)  For the three months   For the nine months 
   ended September 30,   ended September 30, 
   2014   2013   2014   2013 
                 
Proceeds  $903   $17,701   $22,462   $21,015 
Gains   91    107    748    291 
Tax provision related to gains   31    36    254    99 

 

9
 

 

4.Securities (continued)

 

Management evaluates securities for other-than-temporary impairment at least on a quarterly basis, and more frequently when economic, market or other conditions warrant 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, (3) whether the market decline was affected by macroeconomic conditions and (4) whether the Corporation has the intent to sell the security or more likely than not will be required to sell the security before recovery of its amortized cost basis. If the Corporation intends to sell an impaired security, or if it is more likely than not the Corporation will be required to sell the security before its anticipated recovery, the Corporation records an other-than-temporary loss in an amount equal to the entire difference between fair value and amortized cost. Otherwise, only the credit portion of the estimated loss on debt securities is recognized in earnings, with the other portion of the loss recognized in other comprehensive income. For equity securities determined to be other-than-temporarily impaired, the entire amount of impairment is recognized through earnings.

 

There were no equity securities in an unrealized loss position as of September 30, 2014. There were 111 debt securities in an unrealized loss position as of September 30, 2014, of which 83 were in an unrealized loss position for more than 12 months. Of these 111 securities, 6 were U.S. Treasury securities, 28 were U.S. government sponsored entity and agency securities, 5 were U.S. agency mortgage-backed securities, 27 were U.S agency collateralized mortgage obligations, 41 were state and political subdivision securities and 4 were corporate debt securities. The unrealized losses associated with these securities were not due to the deterioration in the credit quality of the issuer that would likely result in the non-collection of contractual principal and interest, but rather have been caused by a rise in interest rates from the time the securities were purchased. Based on that evaluation and other general considerations, and given that the Corporation’s current intention is not to sell any impaired securities and it is more likely than not it will not be required to sell these securities before the recovery of its amortized cost basis, the Corporation does not consider the debt securities with unrealized losses as of September 30, 2014 to be other-than-temporarily impaired.

 

5.Loans Receivable and Related Allowance for Loan Losses

 

The Corporation’s loans receivable as of the respective dates are summarized as follows:

 

(Dollar amounts in thousands)  September 30,   December 31, 
   2014   2013 
         
Mortgage loans on real estate:          
Residential first mortgages  $105,647   $105,541 
Home equity loans and lines of credit   88,515    87,928 
Commercial real estate   109,517    101,499 
    303,679    294,968 
Other loans:          
Commercial business   60,507    53,214 
Consumer   9,163    9,117 
    69,670    62,331 
           
Total loans, gross   373,349    357,299 
Less allowance for loan losses   5,130    4,869 
Total loans, net  $368,219   $352,430 

 

During the three months ended September 30, 2014, the Corporation purchased four syndicated national credits (SNCs) each having a principal amount of $1.0 million. The SNCs were purchased for a total of $4.0 million plus a net premium of $15,000 and other costs totaling $11,000 which are being amortized over the lives of the loans. The SNCs are recorded as commercial business loans and are collateralized by all business assets of the individual borrowers. These credits have been assigned allowance for loan losses equal to 125% of the Corporation’s normal allowance allocation for commercial business loans until sufficient historical performance data can be collected and analyzed.

 

10
 

  

5.Loans Receivable and Related Allowance for Loan Losses (continued)

 

The following table presents impaired loans by class, segregated by those for which a specific allowance was required and those for which a specific allowance was not necessary as of September 30, 2014:

 

(Dollar amounts in thousands) 
                         
   Impaired Loans with Specific Allowance 
                         
               For the three months 
   As of September 30, 2014   ended September 30, 2014 
                       Cash Basis 
   Unpaid           Average   Interest Income   Interest 
   Principal   Recorded   Related   Recorded   Recognized   Recognized 
   Balance   Investment   Allowance   Investment   in Period   in Period 
                         
Residential first mortgages  $171   $171   $28   $172   $1   $1 
Home equity and lines of credit   -    -    -    -    -    - 
Commercial real estate   3,681    2,740    223    2,724    3    - 
Commercial business   2,372    2,372    445    2,291    -    - 
Consumer   -    -    -    -    -    - 
                               
Total  $6,224   $5,283   $696   $5,187   $4   $1 

 

   For the nine months 
   ended September 30, 2014 
           Cash Basis 
   Average   Interest Income   Interest 
   Recorded   Recognized   Recognized 
   Investment   in Period   in Period 
             
Residential first mortgages  $126   $10   $10 
Home equity and lines of credit   -    -    - 
Commercial real estate   2,673    16    - 
Commercial business   1,250    53    - 
Consumer   -    -    - 
                
Total  $4,049   $79   $10 

 

   Impaired Loans with No Specific Allowance 
                         
               For the three months 
   As of September 30, 2014   ended September 30, 2014 
                       Cash Basis 
   Unpaid           Average   Interest Income   Interest 
   Principal   Recorded       Recorded   Recognized   Recognized 
   Balance   Investment       Investment   in Period   in Period 
                         
Residential first mortgages  $116   $116        $117   $-   $- 
Home equity and lines of credit   -    -         -    -    - 
Commercial real estate   1,269    870         980    -    - 
Commercial business   52    52         240    -    - 
Consumer   1,348    1,348         1,348    -    - 
                               
Total  $2,785   $2,386        $2,685   $-   $- 

 

   For the nine months 
   ended September 30, 2014 
           Cash Basis 
   Average   Interest Income   Interest 
   Recorded   Recognized   Recognized 
   Investment   in Period   in Period 
             
Residential first mortgages  $64   $2   $- 
Home equity and lines of credit   -    -    - 
Commercial real estate   835    14    3 
Commercial business   300    1    1 
Consumer   1,348    -    - 
                
Total  $2,547   $17   $4 

 

11
 

  

5.Loans Receivable and Related Allowance for Loan Losses (continued)

 

The following table presents impaired loans by class, segregated by those for which a specific allowance was required and those for which a specific allowance was not necessary as of December 31, 2013:

 

(Dollar amounts in thousands) 
                         
   Impaired Loans with Specific Allowance 
                         
               For the year ended 
   As of December 31, 2013   December 31, 2013 
                       Cash Basis 
   Unpaid           Average   Interest Income   Interest 
   Principal   Recorded   Related   Recorded   Recognized   Recognized 
   Balance   Investment   Allowance   Investment   in Period   in Period 
                         
Residential first mortgages  $82   $82   $21   $49   $5   $4 
Home equity and lines of credit   -    -    -    -    -    - 
Commercial real estate   3,462    2,521    181    3,202    13    13 
Commercial business   -    -    -    -    -    - 
Consumer   -    -    -    -    -    - 
                               
Total  $3,544   $2,603   $202   $3,251   $18   $17 

 

   Impaired Loans with No Specific Allowance 
                         
               For the year ended 
   As of December 31, 2013   December 31, 2013 
                       Cash Basis 
   Unpaid           Average   Interest Income   Interest 
   Principal   Recorded       Recorded   Recognized   Recognized 
   Balance   Investment       Investment   in Period   in Period 
                         
Residential first mortgages  $20   $20        $4   $1   $- 
Home equity and lines of credit   -    -         -    -    - 
Commercial real estate   1,074    675         584    5    5 
Commercial business   336    336         354    -    - 
Consumer   1,348    1,348         1,457    -    - 
                               
Total  $2,778   $2,379        $2,399   $6   $5 

 

12
 

  

5.Loans Receivable and Related Allowance for Loan Losses (continued)

 

The following table presents impaired loans by class, segregated by those for which a specific allowance was required and those for which a specific allowance was not necessary as of September 30, 2013:

 

(Dollar amounts in thousands) 
                         
   Impaired Loans with Specific Allowance 
                         
               For the three months 
   As of September 30, 2013   ended September 30, 2013 
                       Cash Basis 
   Unpaid           Average   Interest Income   Interest 
   Principal   Recorded   Related   Recorded   Recognized   Recognized 
   Balance   Investment   Allowance   Investment   in Period   in Period 
                         
Residential first mortgages  $82   $82   $21   $81   $2   $2 
Home equity and lines of credit   -    -    -    -    -    - 
Commercial real estate   3,633    2,692    209    2,708    2    2 
Commercial business   -    -    -    -    -    - 
Consumer   -    -    -    -    -    - 
                               
Total  $3,715   $2,774   $230   $2,789   $4   $4 

 

   For the nine months 
   ended September 30, 2013 
           Cash Basis 
   Average   Interest Income   Interest 
   Recorded   Recognized   Recognized 
   Investment   in Period   in Period 
             
Residential first mortgages  $41   $4   $4 
Home equity and lines of credit   -    -    - 
Commercial real estate   3,372    11    11 
Commercial business   -    -    - 
Consumer   -    -    - 
                
Total  $3,413   $15   $15 

 

   Impaired Loans with No Specific Allowance 
               For the three months 
   As of September 30, 2013   ended September 30, 2013 
                       Cash Basis 
   Unpaid           Average   Interest Income   Interest 
   Principal   Recorded       Recorded   Recognized   Recognized 
   Balance   Investment       Investment   in Period   in Period 
                         
Residential first mortgages  $-   $-        $-   $-   $- 
Home equity and lines of credit   -    -         -    -    - 
Commercial real estate   1,012    613         637    2    2 
Commercial business   346    346         351    -    - 
Consumer   1,348    1,348         1,348    -    - 
                               
Total  $2,706   $2,307        $2,336   $2   $2 

 

   For the nine months 
   ended September 30, 2013 
           Cash Basis 
   Average   Interest Income   Interest 
   Recorded   Recognized   Recognized 
   Investment   in Period   in Period 
             
Residential first mortgages  $-   $-   $- 
Home equity and lines of credit   -    -    - 
Commercial real estate   561    4    4 
Commercial business   359    -    - 
Consumer   1,484    -    - 
                
Total  $2,404   $4   $4 

 

Unpaid principal balance includes any loans that have been partially charged off but not forgiven. Accrued interest is not included in the recorded investment in loans based on the amounts not being material.

 

13
 

  

5.Loans Receivable and Related Allowance for Loan Losses (continued)

 

Troubled debt restructurings (TDR). The Corporation has certain loans that have been modified in order to maximize collection of loan balances. If, for economic or legal reasons related to the customer’s financial difficulties, management grants a concession compared to the original terms and conditions of the loan that it would not have otherwise considered, the modified loan is classified as a TDR. Concessions related to TDRs generally do not include forgiveness of principal balances. The Corporation generally does not extend additional credit to borrowers with loans classified as TDRs.

 

At September 30, 2014 and December 31, 2013, the Corporation had $6.9 million and $2.5 million, respectively, of loans classified as TDRs, which are included in impaired loans above. At September 30, 2014 and December 31, 2013, the Corporation had $511,000 and $56,000 of the allowance for loan losses allocated to these specific loans. At September 30, 2013, the Corporation had $2.1 million of loans classified as TDRs with $56,000 of the allowance for loan losses allocated to these specific loans.

 

During the nine month period ended September 30, 2014, the Corporation modified eleven loans to be identified as TDRs. One commercial relationship consisting of eight loans totaling $2.4 million was modified as the Corporation granted repayment concessions due to financial difficulties experienced by the borrower. Concessions on these eight loans included reduced monthly payments through the notes’ maturities. An additional commercial real estate relationship consisting of two loans totaling $2.1 million was modified as the Corporation granted a payment concession on one loan and interest rate concessions on both loans due to cash flow considerations caused by vacancy rates. In addition, the Corporation modified a residential mortgage loan with pre- and post-modification recorded investments of $76,000 and $93,000, respectively, due to a bankruptcy court order. The modifications included capitalization of $5,000 of accrued and unpaid interest and $13,000 of legal expenses, a reduction in the interest rate from 6.25% to 5.00% and a 15 year extension of the original term. Because these loans were previously impaired with specific reserves allocated to them, there was no impact to the provision for loan losses for the nine month period ended September 30, 2014 as a result of the modifications. During the three month period ended September 30, 2014, the Corporation did not modify any loans as TDRs.

 

During the nine month period ended September 30, 2013, the Corporation modified a residential mortgage loan with a pre- and post-modification recorded investment of $83,000 as a TDR due to financial difficulties experienced by the borrower. The modification included a reduction in the interest rate from 6.75% to 4.00% and a 65 month extension of the original term. During the three month period ended September 30, 2013, the Corporation did not modify any loans as TDRs.

 

A loan is considered to be in payment default once it is 30 days contractually past due under the modified terms. During the three and nine month periods ended September 30, 2014, there were defaults on four loans classified as TDRs which totaled $1.8 million at September 30, 2014. Of these, two loans totaling $344,000 were not past due, one loan for $81,000 was 30-59 days delinquent and one loan for $1.3 million was over 90 days past due at September 30, 2014. During the three and nine month periods ended September 30, 2013, the Corporation did not have any loans which were modified as TDRs for which there was a payment default within twelve months following the modification.

 

Credit Quality Indicators. Management categorizes loans into risk categories based on relevant information about the ability of borrowers to service their debt such as: current financial information, historical payment experience, credit documentation, public information and current economic trends, among other factors.

 

Commercial real estate and commercial business loans not identified as impaired are evaluated as risk rated pools of loans utilizing a risk rating practice that is supported by a quarterly special asset review. In this review process, strengths and weaknesses are identified, evaluated and documented for each criticized and classified loan and borrower, strategic action plans are developed, risk ratings are confirmed and the loan’s performance status is reviewed.

 

Management has determined certain portions of the loan portfolio to be homogeneous in nature and assigns like reserve factors for the following loan pool types: residential real estate, home equity loans and lines of credit, and consumer installment and personal lines of credit.

 

14
 

 

5.Loans Receivable and Related Allowance for Loan Losses (continued)

 

The reserve allocation for risk rated loan pools is developed by applying the following factors:

 

Historic: Management utilizes a computer model to develop the historical net charge-off experience which is used to formulate the assumptions employed in the migration analysis applied to estimate future losses in the portfolio. Outstanding balance and charge-off information are input into the model and historical loss migration rate assumptions are developed to apply to pass, special mention, substandard and doubtful risk rated loans. A twelve-quarter rolling weighted-average is utilized to anticipate probable incurred losses in the portfolios.

 

Qualitative: Qualitative adjustment factors for pass, special mention, substandard and doubtful ratings are developed and applied to risk rated loans to allow for: quality of lending policies and procedures; national and local economic and business conditions; changes in the nature and volume of the portfolio; experiences, ability and depth of lending management; changes in trends, volume and severity of past due, nonaccrual and classified loans and loss and recovery trends; quality of loan review systems; concentrations of credit and other external factors.

 

Management uses the following definitions for risk ratings:

 

Pass: Loans classified as pass typically exhibit good payment performance and have underlying borrowers with acceptable financial trends where repayment capacity is evident. These borrowers typically would have a sufficient cash flow that would allow them to weather an economic downturn and the value of any underlying collateral could withstand a moderate degree of depreciation due to economic conditions.

 

Special Mention: Loans classified as special mention are characterized by potential weaknesses that could jeopardize repayment as contractually agreed. These loans may exhibit adverse trends such as increasing leverage, shrinking profit margins and/or deteriorating cash flows. These borrowers would inherently be more vulnerable to the application of economic pressures.

 

Substandard: Loans classified as substandard exhibit weaknesses that are well-defined to the point that repayment is jeopardized. Typically, the Corporation is no longer adequately protected by both the apparent net worth and repayment capacity of the borrower.

 

Doubtful: Loans classified as doubtful have advanced to the point that collection or liquidation in full, on the basis of currently ascertainable facts, conditions and value, is highly questionable or improbable.

 

The following table presents the classes of the loan portfolio summarized by the aggregate pass and the criticized categories of special mention, substandard and doubtful within the Corporation’s internal risk rating system as of September 30, 2014 and December 31, 2013:

 

(Dollar amounts in thousands) 
                         
           Special             
   Not Rated   Pass   Mention   Substandard   Doubtful   Total 
                         
Septembert 30, 2014:                              
Residential first mortgages  $104,970   $-   $-   $677   $-   $105,647 
Home equity and lines of credit   88,216    -    -    299    -    88,515 
Commercial real estate   -    102,482    525    6,510    -    109,517 
Commercial business   -    55,739    1,544    3,224    -    60,507 
Consumer   7,815    -    -    1,348    -    9,163 
                               
Total  $201,001   $158,221   $2,069   $12,058   $-   $373,349 
                               
December 31, 2013:                              
Residential first mortgages  $104,983   $-   $-   $558   $-   $105,541 
Home equity and lines of credit   87,868    -    -    60    -    87,928 
Commercial real estate   -    93,973    256    7,270    -    101,499 
Commercial business   -    50,008    674    2,532    -    53,214 
Consumer   7,769    -    -    1,348    -    9,117 
                               
Total  $200,620   $143,981   $930   $11,768   $-   $357,299 

 

15
 

 

5.Loans Receivable and Related Allowance for Loan Losses (continued)

 

Management further monitors the performance and credit quality of the loan portfolio by analyzing the age of the portfolio as determined by the length of time a recorded payment is past due. The following table presents the classes of the loan portfolio summarized by the aging categories of performing loans and nonperforming loans as of September 30, 2014 and December 31, 2013:

 

(Dollar amounts in thousands) 
                         
   Performing   Nonperforming     
   Accruing   Accruing   Accruing   Accruing         
   Loans Not   30-59 Days   60-89 Days   90 Days +       Total 
   Past Due   Past Due   Past Due   Past Due   Nonaccrual   Loans 
                         
September 30, 2014:                              
Residential first mortgages  $103,184   $1,403   $267   $122   $671   $105,647 
Home equity and lines of credit   87,795    292    129    28    271    88,515 
Commercial real estate   106,266    82    -    -    3,169    109,517 
Commercial business   58,154    26    203    -    2,124    60,507 
Consumer   7,741    64    10    -    1,348    9,163 
                               
Total loans  $363,140   $1,867   $609   $150   $7,583   $373,349 
                               
December 31, 2013:                              
Residential first mortgages  $103,821   $884   $278   $38   $520   $105,541 
Home equity and lines of credit   87,302    394    172    -    60    87,928 
Commercial real estate   98,095    516    22    -    2,866    101,499 
Commercial business   52,581    258    -    24    351    53,214 
Consumer   7,682    61    26    -    1,348    9,117 
                               
Total loans  $349,481   $2,113   $498   $62   $5,145   $357,299 

 

The following table presents the Corporation’s nonaccrual loans by aging category as of September 30, 2014 and December 31, 2013:

 

(Dollar amounts in thousands) 
                     
   Not   30-59 Days   60-89 Days   90 Days +   Total 
   Past Due   Past Due   Past Due   Past Due   Loans 
                     
September 30, 2014:                         
Residential first mortgages  $286   $80   $-   $305   $671 
Home equity and lines of credit   -    -    -    271    271 
Commercial real estate   2,932    -    -    237    3,169 
Commercial business   2,086    -    -    38    2,124 
Consumer   -    -    -    1,348    1,348 
                          
Total loans  $5,304   $80   $-   $2,199   $7,583 
                          
December 31, 2013:                         
Residential first mortgages  $88   $-   $82   $350   $520 
Home equity and lines of credit   -    -    -    60    60 
Commercial real estate   412    2,148    -    306    2,866 
Commercial business   65    -    -    286    351 
Consumer   1,348    -    -    -    1,348 
                          
Total loans  $1,913   $2,148   $82   $1,002   $5,145 

 

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

 

16
 

  

5.Loans Receivable and Related Allowance for Loan Losses (continued)

 

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

 

The following table details activity in the ALL and the recorded investment by portfolio segment based on impairment method:

 

(Dollar amounts in thousands) 
                         
       Home Equity                 
   Residential   & Lines   Commercial   Commercial         
   Mortgages   of Credit   Real Estate   Business   Consumer   Total 
Three months ended September 30, 2014:                                 
Allowance for loan losses:                              
Beginning Balance  $917   $468   $2,375   $1,233   $53   $5,046 
Charge-offs   (38)   (30)   -    -    (24)   (92)
Recoveries   -    -    4    -    9    13 
Provision   62    101    (11)   (3)   14    163 
                               
Ending Balance  $941   $539   $2,368   $1,230   $52   $5,130 
                               
Nine months ended September 30, 2014:                                 
Allowance for loan losses:                              
Beginning Balance  $923   $625   $2,450   $822   $49   $4,869 
Charge-offs   (135)   (44)   (2)   (17)   (91)   (289)
Recoveries   -    -    13    7    22    42 
Provision   153    (42)   (93)   418    72    508 
                               
Ending Balance  $941   $539   $2,368   $1,230   $52   $5,130 
                               
At September 30, 2014:                              
Ending ALL balance attributable to loans:                              
Individually evaluated for impairment   28    -    223    445    -    696 
Collectively evaluated for impairment   913    539    2,145    785    52    4,434 
                               
Total loans:                              
Individually evaluated for impairment   287    -    3,610    2,424    1,348    7,669 
Collectively evaluated for impairment   105,360    88,515    105,907    58,083    7,815    365,680 
                               
At December 31, 2013:                              
Ending ALL balance attributable to loans:                              
Individually evaluated for impairment   21    -    181    -    -    202 
Collectively evaluated for impairment   902    625    2,269    822    49    4,667 
                               
Total loans:                              
Individually evaluated for impairment   102    -    3,196    336    1,348    4,982 
Collectively evaluated for impairment   105,439    87,928    98,303    52,878    7,769    352,317 
                               
Three months ended September 30, 2013:                                 
Allowance for loan losses:                              
Beginning Balance  $772   $621   $2,547   $677   $53   $4,670 
Charge-offs   (9)   (8)   -    -    (16)   (33)
Recoveries   -    -    2    -    5    7 
Provision   87    1    (110)   154    11    143 
                               
Ending Balance  $850   $614   $2,439   $831   $53   $4,787 
                               
Nine months ended September 30, 2013:                                 
Allowance for loan losses:                              
Beginning Balance  $828   $730   $3,090   $636   $66   $5,350 
Charge-offs   (26)   (8)   (941)   -    (72)   (1,047)
Recoveries   1    -    6    -    39    46 
Provision   47    (108)   284    195    20    438 
                               
Ending Balance  $850   $614   $2,439   $831   $53   $4,787 

 

The allowance for loan losses is based on estimates and actual losses may vary from current estimates. Management believes that the granularity of the homogeneous pools and the related historical loss ratios and other qualitative factors, as well as the consistency in the application of assumptions, result in an ALL that is representative of the risk found in the components of the portfolio at any given date.

 

17
 

 

6.Goodwill and Intangible Assets

 

The following table summarizes the Corporation’s acquired goodwill and intangible assets as of September 30, 2014 and December 31, 2013:

 

(Dollar amounts in thousands)  September 30, 2014   December 31, 2013 
   Gross Carrying
Amount
   Accumulated
Amortization
   Gross Carrying
Amount
   Accumulated
Amortization
 
                 
Goodwill  $3,664   $-   $3,664   $- 
Core deposit intangibles   4,027    3,229    4,027    3,062 
                     
Total  $7,691   $3,229   $7,691   $3,062 

 

Goodwill resulted from three previous branch acquisitions. Goodwill represents the excess of the total purchase price paid for the branch acquisitions over the fair value of the assets acquired, net of the fair value of the liabilities assumed. Goodwill is not amortized but is evaluated for impairment on an annual basis or whenever events or changes in circumstances indicate the carrying value may not be recoverable. Impairment exists when a reporting unit’s carrying value of goodwill exceeds its fair value. The Corporation has selected November 30 as the date to perform the annual impairment test. No goodwill impairment charges were recorded during 2013 or in the first nine months of 2014. The core deposit intangible asset is amortized using the double declining balance method over a weighted average estimated life of nine years and is not estimated to have a significant residual value. During the three and nine month periods ending September 30, 2014, the Corporation recorded intangible amortization expense totaling $54,000 and $167,000, respectively, compared to $67,000 and $213,000, respectively, for the same periods in 2013.

 

7.Stock Compensation Plans

 

In April 2014, the Corporation adopted the 2014 Stock Incentive Plan (the 2014 Plan), which is shareholder approved and permits the grant of restricted stock awards and options to its directors, officers and employees for up to 176,866 shares of common stock, of which 88,433 shares of restricted stock and 88,433 stock options remain available for issuance under the 2014 Plan.

 

In addition, the Corporation’s 2007 Stock Incentive Plan and Trust (the 2007 Plan), which is shareholder approved, permits the grant of restricted stock awards and options to its directors, officers and employees for up to 177,496 shares of common stock, of which 6,013 shares of restricted stock and 45,283 stock options remain available for issuance under the 2007 Plan.

 

Incentive stock options, non-incentive or compensatory stock options and share awards may be granted under the Plans. The exercise price of each option shall at least equal the market price of a share of common stock on the date of grant and have a contractual term of ten years. Options shall vest and become exercisable at the rate, to the extent and subject to such limitations as may be specified by the Corporation. Compensation cost related to share-based payment transactions must be recognized in the financial statements with measurement based upon the fair value of the equity instruments issued.

 

A summary of option activity under the Plans as of September 30, 2014, and changes during the period then ended is presented below:

 

           Aggregate   Weighted-Average 
       Weighted-Average   Intrinsic Value   Remaining Term 
   Options   Exercise Price   (in thousands)   (in years) 
                 
Outstanding as of January 1, 2014   79,250   $24.97   $-    3.8 
Granted   -    -    -    - 
Exercised   (2,500)   19.30    15,340    - 
Forfeited   -    -    -    - 
Outstanding as of September 30, 2014   76,750   $25.16   $59,205    3.0 
                     
Exercisable as of September 30, 2014   76,250   $25.22   $54,005    3.0 

 

18
 

  

7.Stock Compensation Plans (continued)

 

A summary of the status of the Corporation’s nonvested option shares as of September 30, 2014, and changes during the period then ended is presented below:

 

       Weighted-Average 
   Options   Grant-date Fair Value 
         
Nonvested at January 1, 2014   500   $1.44 
Granted   -    - 
Vested   -    - 
Forfeited   -    - 
Nonvested as of September 30, 2014   500   $1.44 

 

A summary of the status of the Corporation’s nonvested restricted stock awards as of September 30, 2014, and changes during the period then ended is presented below:

 

       Weighted-Average 
   Shares   Grant-date Fair Value 
         
Nonvested at January 1, 2014   25,800   $20.11 
Granted   -    - 
Vested   -    - 
Forfeited   100    25.50 
Nonvested as of September 30, 2014   25,700   $20.08 

 

For the three and nine month periods ended September 30, 2014, the Corporation recognized $42,000 and $126,000, respectively, in stock compensation expense, compared to $34,000 and $133,000, respectively, for the same periods in 2013. As of September 30, 2014, there was $224,000 of total unrecognized compensation cost related to nonvested share-based compensation arrangements granted under the Plans. That cost is expected to be recognized over a weighted-average period of 1.1 years. It is the Corporation’s policy to issue shares on the vesting date for restricted stock awards. Unvested restricted stock awards do not receive dividends declared by the Corporation.

 

8.Employee Benefit Plans

 

The Corporation provides pension benefits for eligible employees through a defined benefit pension plan. Substantially all employees participate in the retirement plan on a non-contributory basis, and are fully vested after three years of service. Effective January 1, 2009, the plan was closed to new participants.

 

The Corporation provided the requisite notice to plan participants on March 12, 2013 of the determination to freeze the plan (curtailment). While the freeze was not effective until April 30, 2013, management determined that participants would not satisfy, within the provisions of the plan, 2013 eligibility requirements based on minimum hours worked for 2013. Therefore, employees ceased to earn benefits as of January 1, 2013. This amendment to the plan will not affect benefits earned by the participants prior to the date of the freeze. The Corporation recorded a benefit associated with plan of $15,000 and $45,000, respectively, for the three and nine month periods ended September 30, 2014, compared to an expense of $2,000 and $5,000, respectively, for the three and nine month periods ended September 30, 2013.

 

9.Fair Value

 

Fair value is the exchange price that would be received for an asset or paid to transfer a liability (exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. There are three levels of inputs that may be used to measure fair value.

 

Level 1: Quoted prices (unadjusted) for identical assets or liabilities in active markets that the Corporation has the ability to access at the measurement date.

 

19
 

  

9.Fair Value (continued)

 

Level 2: Significant other observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data.

 

Level 3: Significant unobservable inputs that reflect the Corporation’s own assumptions about the assumptions that market participants would use in pricing an asset or liability.

 

An asset or liability’s level is based on the lowest level of input that is significant to the fair value measurement.

 

The Corporation used the following methods and significant assumptions to estimate fair value:

 

Cash and cash equivalents – The carrying value of cash, due from banks and interest bearing deposits approximates fair value and are classified as Level 1.

 

Securities available for sale – The fair value of all investment securities are based upon the assumptions market participants would use in pricing the security. If available, investment securities are determined by quoted market prices (Level 1). Level 1 includes U.S. Treasury, federal agency securities and certain equity securities. For investment securities where quoted market prices are not available, fair values are calculated based on market prices on similar securities (Level 2). Level 2 includes U.S. Government sponsored entities and agencies, mortgage-backed securities, collateralized mortgage obligations, state and political subdivision securities and corporate debt securities. For investment securities where quoted prices or market prices of similar securities are not available, fair values are calculated by using unobservable inputs (Level 3) and may include certain equity securities held by the Corporation. The Level 3 equity security valuations were supported by an analysis prepared by the Corporation which relies on inputs such as the security issuer’s publicly attainable financial information, multiples derived from prices in observed transactions involving comparable businesses and other market, financial and nonfinancial factors.

 

Loans – The fair value of loans receivable was estimated based on the discounted value of the future cash flows using the current rates being offered for loans with similar terms to borrowers of similar credit quality resulting in a Level 3 classification.

 

Impaired loans – At the time a loan is considered impaired, it is valued at the lower of cost or fair value. Impaired loans carried at fair value generally receive a specific allowance for loan losses. For collateral dependent loans, fair value is commonly based on real estate appraisals. These appraisals may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach. Adjustments are routinely made in the appraisal process by the independent appraisers to adjust for differences between the comparable sales and income data available. Such adjustments are usually significant and typically result in a Level 3 classification of the inputs for determining fair value. Non-real estate collateral may be valued using an appraisal, net book value per the borrower’s financial statements, or aging reports, adjusted or discounted based on management’s historical knowledge, changes in market conditions from the time of the valuation, and management’s expertise and knowledge of the client and client’s business, resulting in a Level 3 classification. Impaired loans are evaluated on a quarterly basis for additional impairment and adjusted accordingly. As of September 30, 2014, the fair value of impaired loans consists of loan balances of $2.7 million, net of a valuation allowance of $490,000, compared to loan balances of $2.5 million, net of a valuation allowance of $181,000, at December 31, 2013. There was $41,000 and $707,000 of additional provision for loan losses recorded for impaired loans during the three and nine month period ended September 30, 2014, respectively. There was no additional provision for loan losses and $21,000 of additional provision for loan losses recorded for impaired loans during the three and nine month periods ended September 30, 2013, respectively.

 

20
 

  

9.Fair Value (continued)

 

Other real estate owned (OREO) – Assets acquired through or instead of foreclosure are initially recorded at fair value less costs to sell when acquired, establishing a new cost basis. These assets are subsequently accounted for at lower of cost or fair value less estimated costs to sell. Fair value is commonly based on recent real estate appraisals. Management’s ongoing review of appraisal information may result in additional discounts or adjustments to the valuation based upon more recent market sales activity or more current appraisal information derived from properties of similar type and/or locale. Such adjustments are usually significant and typically result in a Level 3 classification of the inputs for determining fair value. At September 30, 2014, the Corporation had no OREO measured at fair value. As of December 31, 2013, OREO measured at fair value less costs to sell had a net carrying amount of $80,000, which was made up of the outstanding balance of $104,000 and write-downs of $24,000. There was no expense recorded during the three and nine months ended September 30, 2014 associated with the write-down of OREO, compared to $0 and $19,000 for the same periods in 2013.

 

Appraisals for both collateral-dependent impaired loans and OREO are performed by certified general appraisers (for commercial properties) or certified residential appraisers (for residential properties) whose qualifications and licenses have been reviewed by the Corporation. Once received, management reviews the assumptions and approaches utilized in the appraisal as well as the overall resulting fair value in comparison with independent data sources such as recent market data or industry-wide statistics. On an annual basis, the Corporation compares the actual selling price of OREO that has been sold to the most recent appraisal to determine what additional adjustment should be made to the appraisal value to arrive at fair value. The most recent analysis performed indicated that a discount of 10% should be applied.

 

Federal bank stock – It is not practical to determine the fair value of federal bank stocks due to restrictions placed on its transferability.

 

Deposits – The fair value of deposits with no stated maturity, such as non-interest bearing demand deposits, checking with interest, savings and money market accounts, is equal to the amount payable on demand resulting in either a Level 1 or Level 2 classification. The fair values of time deposits are based on the discounted value of contractual cash flows. The discount rate is estimated using the rates currently offered for deposits of similar maturities resulting in a Level 2 classification.

 

Borrowings – The fair value of borrowings with the FHLB is estimated using discounted cash flows based on current incremental borrowing rates for similar types of borrowing arrangements resulting in a Level 2 classification.

 

Accrued interest receivable and payable – The carrying value of accrued interest receivable and payable approximates fair value. The fair value classification is consistent with the related financial instrument.

 

21
 

  

9.Fair Value (continued)

 

For assets measured at fair value on a recurring basis, the fair value measurements by level within the fair value hierarchy are as follows:

 

(Dollar amounts in thousands)      (Level 1)   (Level 2)     
       Quoted Prices in   Significant   (Level 3) 
       Active Markets   Other   Significant 
       for Identical   Observable   Unobservable 
Description  Total   Assets   Inputs   Inputs 
September 30, 2014:                    
U.S. Treasury and federal agency  $3,431   $3,431   $-   $- 
U.S. government sponsored entities and agencies   35,254    -    35,254    - 
Mortgage-backed securities: residential   38,230    -    38,230    - 
Collateralized mortgage obligations: residential   37,785    -    37,785    - 
State and political subdivision   32,204    -    32,204    - 
Corporate debt securities   2,000    -    2,000    - 
Equity securities   2,546    1,893    -    653 
   $151,449   $5,324   $145,472   $653 
                     
December 31, 2013:                    
U.S. Treasury and federal agency  $4,168   $4,168   $-   $- 
U.S. government sponsored entities and agencies   22,892    -    22,892    - 
U.S. agency mortgage-backed securities: residential   11,361    -    11,361    - 
U.S. agency collateralized mortgage obligations: residential   39,722    -    39,722    - 
State and political subdivisions   36,499    -    36,499    - 
Corporate debt securities   241    241    -    - 
Equity securities   2,421    1,768    -    653 
   $117,304   $6,177   $110,474   $653 

 

The Corporation’s policy is to transfer assets or liabilities from one level to another when the methodology to obtain the fair value changes such that there are more or fewer unobservable inputs as of the end of the reporting period. During the three and nine month periods ended September 30, 2014, the Corporation had no transfers between levels. The following table presents changes in Level 3 assets measured on a recurring basis for the three and nine month periods ended September 30, 2014 and 2013:

 

(Dollar amounts in thousands)  Three months ended   Nine months ended 
   September 30,   September 30, 
   2014   2013   2014   2013 
Balance at the beginning of the period  $653   $653   $653   $653 
Total gains or losses (realized/unrealized):   -    -    -    - 
Included in earnings   -    -    -    - 
Included in other comprehensive income   -    -    -    - 
Issuances   -    -    -    - 
Transfers in and/or out of Level 3   -    -    -    - 
Balance at the end of the period  $653   $653   $653   $653 

 

22
 

  

9.Fair Value (continued)

 

For assets measured at fair value on a non-recurring basis, the fair value measurements by level within the fair value hierarchy are as follows:

 

(Dollar amounts in thousands)      (Level 1)   (Level 2)     
       Quoted Prices in   Significant   (Level 3) 
       Active Markets   Other   Significant 
       for Identical   Observable   Unobservable 
Description  Total   Assets   Inputs   Inputs 
September 30, 2014:                    
Impaired commercial real estate loans  $557   $-   $-   $557 
Impaired commercial business loans   1,662    -    -    1,662 
                     
   $2,219   $-   $-   $2,219 
                     
December 31, 2013:                    
Impaired commercial real estate loans  $2,340   $-   $-   $2,340 
Other residential real estate owned   80    -    -    80 
                     
   $2,420   $-   $-   $2,420 

 

The following table presents quantitative information about Level 3 fair value measurements for assets measured at fair value on a non-recurring basis:

 

(Dollar amounts in thousands)      Valuation  Unobservable   
       Techniques(s)  Input (s)  Range
              
September 30, 2014:              
Impaired commercial real estate loans  $557   Sales comparison approach/  Adjustment for differences  10%
       Contractual provision of USDA loan  between comparable sales   
Impaired commercial business loans   1,662   Liquidation value of business assets  Adjustment for differences  41% - 78%
           between comparable business assets   
               
December 31, 2013:              
Impaired commercial real estate loans   2,340   Sales comparison approach/  Adjustment for differences  0% - 10%
        Contractual provision of USDA loan  between comparable sales   
Other residential real estate owned   80   Sales comparison approach  Adjustment for differences  10%
           between comparable sales   

  

The two tables above exclude two impaired residential mortgage loans totaling $144,000, two impaired commercial real estate loans totaling $2.0 million and a $265,000 commercial business loan classified as TDRs which were measured at fair value using a discounted cash flow methodology at September 30, 2014.

 

Included in impaired commercial real estate loans is a loan guaranteed by the United States Department of Agriculture (USDA) with balances of $344,000 and $350,000 as of September 30, 2014 and December 31, 2013, respectively. The guarantee covers 90% of the principal balance outstanding. In determining the fair value of this loan, the Corporation considered the contractual provisions of the loan and did not rely on the fair value of the underlying collateral. As such, the Corporation applied a 10% discount to the loan which represents the portion of the loan at risk. The weighted average discount on impaired loans as of September 30, 2014 and December 31, 2013 was 37.9% and 1.5%, respectively.

 

23
 

 

9.Fair Value (continued)

 

The following table sets forth the carrying amount and estimated fair values of the Corporation’s financial instruments included in the consolidated balance sheet as of September 30, 2014 and December 31, 2013:

 

(Dollar amounts in thousands)        
   Carrying   Fair Value Measurements using: 
Description  Amount   Total   Level 1   Level 2   Level 3 
                     
September 30, 2014:                         
Financial Assets:                         
Cash and cash equivalents  $35,318   $35,318   $35,318   $-   $- 
Securities available for sale   150,321    151,449    5,324    145,472    653 
Loans, net   368,219    371,817    -    -    371,817 
Federal bank stock   2,791    N/A    N/A    N/A    N/A 
Accrued interest receivable   1,674    1,674    46    498    1,130 
    558,323    560,258    40,688    145,970    373,600 
Financial Liabilities:                         
Deposits   519,908    521,578    398,302    123,276    - 
Borrowed funds   17,150    18,130    -    18,130    - 
Accrued interest payable   217    217    7    210    - 
    537,275    539,925    398,309    141,616    - 

 

   Carrying   Fair Value Measurements using: 
   Amount   Total   Level 1   Level 2   Level 3 
December 31, 2013:                         
Financial Assets:                         
Cash and cash equivalents  $16,658   $16,658   $16,658   $-   $- 
Securities available for sale   117,304    117,304    5,936    110,715    653 
Loans, net   352,430    356,123    -    -    356,123 
Federal bank stock   3,977    N/A    N/A    N/A    N/A 
Accrued interest receivable   1,466    1,466    34    430    1,002 
    491,835    491,551    22,628    111,145    357,778 
Financial Liabilities:                         
Deposits   432,006    434,552    325,983    108,569    - 
Borrowed funds   44,150    45,241    -    45,241    - 
Accrued interest payable   292    292    5    287    - 
    476,448    480,085    325,988    154,097    - 

 

24
 

  

10.Accumulated Other Comprehensive Income (Loss)

 

The following tables summarize the changes within each classification of accumulated other comprehensive income (loss), net of tax, for the three months ended September 30, 2014 and 2013 and summarizes the significant amounts reclassified out of each component of accumulated other comprehensive income:

 

(Dollar amounts in thousands)  Unrealized Gains   Defined     
   and Losses on   Benefit     
   Available-for-Sale   Pension     
   Securities   Items   Totals 
             
Accumulated Other Comprehensive Loss at July 1, 2014  $(486)  $(1,410)  $(1,896)
                
Other comprehensive loss before reclassification   (128)   -    (128)
Amounts reclassified from accumulated other comprehensive income   (60)   -    (60)
Net current period other comprehensive loss   (188)   -    (188)
                
Accumulated Other Comprehensive Loss at September 30, 2014  $(674)  $(1,410)  $(2,084)

 

(Dollar amounts in thousands)  Amount Reclassified    
   from Accumulated    
   Other Comprehensive    
   Income   Affected Line Item in the
Details about Accumulated Other  For the three months   Statement Where Net
Comprehensive Income Components  ended September 30, 2014   Income is Presented
        
Unrealized gains and losses on available-for-sale securities  $91   Gain on sale of securities
    (31)  Tax expense
Total reclassifications for the period  $60   Net of tax

 

(Dollar amounts in thousands)  Unrealized Gains   Defined     
   and Losses on   Benefit     
   Available-for-Sale   Pension     
   Securities   Items   Totals 
             
Accumulated Other Comprehensive Loss at July 1, 2013  $(707)  $(1,795)  $(2,502)
                
Other comprehensive loss before reclassification   (528)   -    (528)
Amounts reclassified from accumulated other comprehensive income   (71)   -    (71)
Net current period other comprehensive loss   (599)   -    (599)
                
Accumulated Other Comprehensive Loss at September 30, 2013  $(1,306)  $(1,795)  $(3,101)

 

(Dollar amounts in thousands)  Amount Reclassified    
   from Accumulated    
   Other Comprehensive    
   Income   Affected Line Item in the
Details about Accumulated Other  For the three months   Statement Where Net
Comprehensive Income Components  ended September 30, 2013   Income is Presented
        
Unrealized gains and losses on available-for-sale securities  $107   Gain on sale of securities
    (36)  Tax expense
Total reclassifications for the period  $71   Net of tax

 

25
 

  

10.Accumulated Other Comprehensive Income (Loss) (continued)

 

The following tables summarize the changes within each classification of accumulated other comprehensive income (loss), net of tax, for the nine months ended September 30, 2014 and 2013 and summarizes the significant amounts reclassified out of each component of accumulated other comprehensive income:

 

(Dollar amounts in thousands)  Unrealized Gains   Defined     
   and Losses on   Benefit     
   Available-for-Sale   Pension     
   Securities   Items   Totals 
             
Accumulated Other Comprehensive Loss at January 1, 2014  $(1,870)  $(1,410)  $(3,280)
                
Other comprehensive income before reclassification   1,690    -    1,690 
Amounts reclassified from accumulated other comprehensive income   (494)   -    (494)
Net current period other comprehensive income   1,196    -    1,196 
                
Accumulated Other Comprehensive Loss at September 30, 2014  $(674)  $(1,410)  $(2,084)

 

(Dollar amounts in thousands)  Amount Reclassified    
   from Accumulated    
   Other Comprehensive    
   Income   Affected Line Item in the
Details about Accumulated Other  For the six months   Statement Where Net
Comprehensive Income Components  ended September 30, 2014   Income is Presented
        
Unrealized gains and losses on available-for-sale securities  $748   Gain on sale of securities
    (254)  Tax expense
Total reclassifications for the period  $494   Net of tax

 

(Dollar amounts in thousands)  Unrealized Gains   Defined     
   and Losses on   Benefit     
   Available-for-Sale   Pension     
   Securities   Items   Totals 
             
Accumulated Other Comprehensive Income at January 1, 2013  $2,365   $(1,795)  $570 
                
Other comprehensive loss before reclassification   (3,479)   -    (3,479)
Amounts reclassified from accumulated other comprehensive income   (192)   -    (192)
Net current period other comprehensive loss   (3,671)   -    (3,671)
                
Accumulated Other Comprehensive Loss at September 30, 2013  $(1,306)  $(1,795)  $(3,101)

 

(Dollar amounts in thousands)  Amount Reclassified    
   from Accumulated    
   Other Comprehensive    
   Income   Affected Line Item in the
Details about Accumulated Other  For the nine months   Statement Where Net
Comprehensive Income Components  ended September 30, 2013   Income is Presented
        
Unrealized gains and losses on available-for-sale securities  $291   Gain on sale of securities
    (99)  Tax expense
Total reclassifications for the period  $192   Net of tax

 

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11.New Accounting Standards

 

In May 2014, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2014-09, Revenue from Contracts with Customers (Topic 606). The ASU creates a new topic, Topic 606, to provide guidance on revenue recognition for entities that enter into contracts with customers to transfer goods or services or enter into contracts for the transfer of nonfinancial assets. The core principle of the guidance is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. Additional disclosures are required to provide quantitative and qualitative information regarding the nature, amount, timing and uncertainty of revenue and cash flows arising from contracts with customers. The new guidance is effective for annual reporting periods, and interim reporting periods within those annual periods, beginning after December 5, 2016. Early adoption is not permitted. Management is currently evaluating the impact of the adoption of this guidance on the Corporation’s financial statements.

 

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

 

This section discusses the consolidated financial condition and results of operations of Emclaire Financial Corp and its wholly owned subsidiaries, the Bank and the Title Company, for the three and nine months ended September 30, 2014, compared to the same periods in 2013 and should be read in conjunction with the Corporation’s Annual Report on Form 10-K for the year ended December 31, 2013, filed with the SEC and with the accompanying consolidated financial statements and notes presented on pages 1 through 26 of this Form 10-Q.

 

This Form 10-Q, including the financial statements and related notes, contains forward looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, or the Securities Act, and Section 21E of the Securities Exchange Act of 1934, as amended, or the Exchange Act. These forward looking statements represent plans, estimates, objectives, goals, guidelines, expectations, intentions, projections and statements of our beliefs concerning future events, business plans, objectives, expected operating results and the assumptions upon which those statements are based. Forward looking statements include without limitation, any statement that may predict, forecast, indicate or imply future results, performance or achievements, and are typically identified with words such as “may,” “could,” “should,” “will,” “would,” “believe,” “anticipate,” “estimate,” “expect,” “intend,” “plan” or words or phrases of similar meaning. We caution that the forward looking statements are based largely on our expectations and are subject to a number of known and unknown risks and uncertainties that are subject to change based on factors which are, in many instances, beyond our control. Actual results, performances or achievements could differ materially from those contemplated, expressed or implied by the forward looking statements. Therefore, we caution you not to place undue reliance on our forward looking information and statements. Except as required by applicable law or regulation, we will not update the forward looking statements to reflect actual results or changes in factors affecting the forward looking statements.

 

CHANGES IN FINANCIAL CONDITION

 

Total assets increased $67.7 million, or 12.9%, to $593.5 million at September 30, 2014 from $525.8 million at December 31, 2013. This increase resulted primarily from increases in cash and equivalents, securities and loans receivable of $18.7 million, $33.0 million and $15.8 million, respectively, which was funded by an $87.9 million increase in customer deposits. This deposit increase also funded a $27.0 million decrease in borrowed funds. The increase in loans receivable includes four $1.0 million syndicated national credits purchased during the three months ended September 30, 2014.

 

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Total liabilities increased $64.8 million, or 13.5%, to $545.6 million at September 30, 2014 from $480.8 million at December 31, 2013, resulting primarily from an $87.9 million increase in customer deposits, partially offset by a $27.0 million decrease in borrowed funds. Deposit growth consisted of an $8.5 million, or 8.1% increase in noninterest bearing deposits and a $79.4 million or 24.2%, increase in interest bearing deposits. The decrease in borrowed funds resulted from the repayment of a $5.0 million FHLB long term advance and $22.0 million of FHLB short term advances utilized to fund normal operating fluctuations. Additionally, accrued expenses and other liabilities increased $4.0 million, or 92.5%, to $8.3 million at September 30, 2014 from $4.3 million at December 31, 2013, resulting from the delayed settlement of the aforementioned syndicated national credits. Under the terms of the loan agreements, the loans transferred ownership to the Corporation during September 2014; however, the Corporation will not remit the payment for the loans until the administrative agent completes their due diligence processes.

 

Stockholders’ equity increased $2.9 million to $47.9 million at September 30, 2014 from $45.1 million at December 31, 2013. Book value and tangible book value per common share were $24.24 and $21.73, respectively, at September 30, 2014, compared to $22.66 and $20.04, respectively, at December 31, 2013.

 

At September 30, 2014, the Bank was considered “well-capitalized” under regulatory guidelines with a Tier 1 leverage ratio, Tier 1 risk-based capital ratio and total risk-based capital ratio of 7.76%, 13.53% and 14.79%, respectively, compared to 8.58%, 14.08% and 15.34%, respectively, at December 31, 2013.

 

RESULTS OF OPERATIONS

 

Comparison of Results for the Three Months Ended September 30, 2014 and 2013

 

General. Net income decreased $60,000, or 5.5%, to $1.0 million for the three months ended September 30, 2014 from $1.1 million for the same period in 2013. This decrease was the result of a decrease in noninterest income of $73,000 and increases in noninterest expense and the provision for loan losses of $138,000 and $20,000, respectively, partially offset by an increase in net interest income of $140,000 and a decrease in the provision for income taxes of $31,000. Net income available to common stockholders increased $30,000, or 3.1%, to $997,000 for the three months ended September 30, 2014 from $967,000 for the same period in the prior year following a $90,000 decrease in preferred stock dividends.

 

Net interest income. Net interest income on a tax equivalent basis increased $137,000, or 3.2%, to $4.4 million for the three months ended September 30, 2014 from $4.2 million for the three months ended September 30, 2013. This increase can be attributed to an increase in tax equivalent interest income of $67,000 and a decrease in interest expense of $70,000.

 

Interest income. Interest income on a tax equivalent basis increased $67,000, or 1.3%, to $5.2 million for the three months ended September 30, 2014 from $5.1 million for the same period in 2013. This increase can be attributed to increases in interest on loans, interest earned on interest-earning deposits with banks and dividends on federal bank stocks of $51,000, $18,000 and $15,000, respectively, partially offset by a decrease in interest on securities of $17,000.

 

Tax equivalent interest earned on loans receivable increased $51,000, or 1.2%, to $4.2 million for the three months ended September 30, 2014 and for the same period in 2013. This increase resulted from a $24.7 million, or 7.2% increase in average loans, accounting for an increase of $293,000 in interest income. Partially offsetting this favorable volume variance, the average yield on loans decreased 27 basis points to 4.58% for the three months ended September 30, 2014, versus 4.85% for the same period in 2013. This unfavorable yield variance accounted for a $242,000 decrease in interest income.

 

Interest earned on deposits with banks increased $18,000 to $30,000 for the three months ended September 30, 2014 compared to $12,000 for the three months ended September 30, 2013. The average balance of interest-earning deposits increased $38.3 million, causing a $27,000 increase in interest income. Partially offsetting this favorable variance, the average yield on these accounts decreased 25 basis points, causing a $9,000 decrease in interest income.

 

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Dividends on federal bank stocks increased $15,000 to $33,000 for the three months ended September 30, 2014 from $18,000 for the same period in 2013. This increased resulted from a 269 basis point increase in the average yield on federal bank stocks to 4.69% for the three months ended September 30, 2014, compared to 2.00% for the same period in 2013. The increase in the yield was the result of an increase in the FHLB’s dividend rate to 4.0% for the quarter ended September 30, 2014, compared to 1.0% for the same period in 2013.

 

Tax equivalent interest earned on securities decreased $17,000, or 1.9%, to $865,000 for the three months ended September 30, 2014 compared to $882,000 for the three months ended September 30, 2013. This decrease resulted from a 22 basis point decline in the average yield on securities to 2.31% for the three months ended September 30, 2014, versus 2.53% for the same period in 2013. This unfavorable yield variance accounted for a $78,000 decrease in interest income. Partially offsetting this unfavorable yield variance, the average balance of securities increased $9.9 million, or 7.2%, accounting for a $61,000 increase in interest income.

 

Interest expense. Interest expense decreased $70,000, or 8.1%, to $790,000 for the three months ended September 30, 2014 from $860,000 for the same period in 2013. This decrease in interest expense can be attributed to a decrease in interest incurred on deposits and borrowed funds of $46,000 and $24,000, respectively.

 

Interest expense incurred on deposits decreased $46,000, or 6.9%, to $616,000 for the three months ended September 30, 2014 compared to $662,000 for the same period in 2013. The average cost of interest-bearing deposits decreased 20 basis points to 0.59% for the three months ended September 30, 2014, compared to 0.79% for the same period in 2013, resulting in a $188,000 decrease in interest expense. This decrease in the cost of deposits was primarily due to deposits repricing during 2013 and the first nine months of 2014 in the prevailing low interest-rate environment. Partially offsetting this favorable variance, the average balance of interest-bearing deposits increased $81.6 million, or 24.5%, to $414.0 million for the three months ended September 30, 2014, compared to $332.4 million for the same period in 2013 causing a $142,000 increase in interest expense. Average noninterest bearing deposits increased $10.7 million, or 10.2%, to $115.5 million from $104.8 million, facilitating the overall decline in the Corporation’s cost of funds.

 

Interest expense incurred on borrowed funds decreased $24,000, or 12.1%, to $174,000 for the three months ended September 30, 2014, compared to $198,000 for the same period in the prior year. The average balance of long term borrowed funds decreased $5.0 million, or 25.0%, accounting for a $49,000 decrease in interest expense. This resulted from the early repayment of a $5.0 million FHLB long term advance during the first quarter of 2014. The Corporation recognized a $550,000 prepayment penalty associated with this early repayment. Partially offsetting the favorable volume variance, the average cost of long term borrowed funds increased 31 basis points to 3.98% for the three months ended September 30, 2014, compared to 3.67% for the same period in 2013, causing a $15,000 increase in interest expense. This was due primarily to no capitalization of interest during the quarter ended September 30, 2014 compared to the capitalization of $19,000 of interest related to the Cranberry Township banking office construction for the same period in 2013. Partially offsetting the favorable variance related to long term borrowings, the average cost of short term borrowed funds increased 396 basis points, which caused a $30,000 increase in interest expense. Partially offsetting the unfavorable rate variance, the average balance of short term borrowed funds decreased $12.4 million, accounting for a $20,000 decrease in interest expense. Short-term borrowings at September 30, 2014 included a $2.2 million line of credit balance with a correspondent bank with a rate of 4.25%. The Corporation advanced $2.2 million on this line of credit during the third quarter of 2013 and utilized the proceeds to partially fund the $5.0 million SBLF preferred stock redemption.

 

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Average Balance Sheet and Yield/Rate Analysis. The following table sets forth, for the periods indicated, information concerning the total dollar amounts of interest income from interest-earning assets and the resulting average yields, the total dollar amounts of interest expense on interest-bearing liabilities and the resulting average costs, net interest income, interest rate spread and the net interest margin earned on average interest-earning assets. For purposes of this table, average loan balances include nonaccrual loans and exclude the allowance for loan losses and interest income includes accretion of net deferred loan fees. Interest and yields on tax-exempt loans and securities (tax-exempt for federal income tax purposes) are shown on a fully tax equivalent basis. The information is based on average daily balances during the periods presented.

 

(Dollar amounts in thousands)  Three months ended September 30, 
   2014   2013 
   Average       Yield /   Average       Yield / 
   Balance   Interest   Rate   Balance   Interest   Rate 
                         
Interest-earning assets:                              
Loans, taxable  $340,810   $3,913    4.56%  $323,605   $3,946    4.84%
Loans, tax exempt   26,088    324    4.93%   18,567    240    5.12%
Total loans receivable   366,898    4,237    4.58%   342,172    4,186    4.85%
                               
Securities, taxable   114,147    521    1.81%   94,579    440    1.85%
Securities, tax exempt   34,156    344    3.99%   43,822    442    4.00%
Total securities   148,303    865    2.31%   138,401    882    2.53%
                               
Interest-earning deposits with banks   47,867    30    0.25%   9,559    12    0.50%
Federal bank stocks   2,791    33    4.69%   3,571    18    2.00%
Total interest-earning cash equivalents   50,658    63    0.49%   13,130    30    0.91%
                               
Total interest-earning assets   565,859    5,165    3.62%   493,703    5,098    4.10%
Cash and due from banks   2,403              2,076           
Other noninterest-earning assets   31,505              29,890           
                               
Total Assets  $599,767             $525,669           
                               
Interest-bearing liabilities:                              
Interest-bearing demand deposits  $292,847   $120    0.16%  $221,695   $94    0.17%
Time deposits   121,144    496    1.62%   110,697    568    2.03%
Total interest-bearing deposits   413,991    616    0.59%   332,392    662    0.79%
                               
Borrowed funds, short-term   2,150    23    4.31%   14,557    13    0.35%
Borrowed funds, long-term (1)   15,000    151    3.98%   20,000    185    3.67%
Total borrowed funds   17,150    174    4.02%   34,557    198    2.27%
                               
Total interest-bearing liabilities   431,141    790    0.73%   366,949    860    0.93%
                               
Noninterest-bearing demand deposits   115,485    -    -    104,795    -    - 
                               
Funding and cost of funds   546,626    790    0.57%   471,744    860    0.72%
                               
Other noninterest-bearing liabilities   5,415              5,425           
                               
Total Liabilities   552,041              477,169           
Stockholders' Equity   47,726              48,500           
                               
Total Liabilities and Stockholders' Equity  $599,767             $525,669           
                               
Net interest income       $4,375             $4,238      
                               
Interest rate spread (difference between weighted average rate on interest-earning assets and interest-bearing liabilities)             2.89%             3.17%
                               
Net interest margin (net interest income as a percentage of average interest-earning assets)             3.07%             3.41%

 

(1)Interest on long-term borrowed funds for the quarterly period ended September 30, 2013 was reduced by $19,000 related to capitalized interest costs on construction in progress.

 

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

 

(Dollar amounts in thousands)  Three months ended September 30, 
   2014 versus 2013 
   Increase (Decrease) due to 
   Volume   Rate   Total 
Interest income:               
Loans  $293   $(242)  $51 
Securities   61    (78)   (17)
Interest-earning deposits with banks   27    (9)   18 
Federal bank stocks   (5)   20    15 
                
Total interest-earning assets   376    (309)   67 
                
Interest expense:               
Interest-bearing deposits   142    (188)   (46)
Borrowed funds, short-term   (20)   30    10 
Borrowed funds, long-term   (49)   15    (34)
                
Total interest-bearing liabilities   73    (143)   (70)
                
Net interest income  $303   $(166)  $137 

 

Provision for loan losses. The Corporation records provisions for loan losses to maintain a level of total allowance for loan losses that management believes, to the best of its knowledge, covers all probable incurred losses estimable at each reporting date. Management considers historical loss experience, the present and prospective financial condition of borrowers, current conditions (particularly as they relate to markets where the Corporation originates loans), the status of nonperforming assets, the estimated underlying value of the collateral and other factors related to the collectability of the loan portfolio.

 

Information pertaining to the allowance for loan losses and nonperforming assets for the three months ended September 30, 2014 and 2013 is as follows:

 

(Dollar amounts in thousands)  As of or for the three months ended 
   September 30, 
   2014   2013 
Balance at the beginning of the period  $5,046   $4,670 
Provision for loan losses   163    143 
Charge-offs   (92)   (33)
Recoveries   13    7 
Balance at the end of the period  $5,130   $4,787 
           
Nonperforming loans  $7,733   $5,310 
Nonperforming assets   7,837    5,458 
Nonperforming loans to total loans   2.07%   1.51%
Nonperforming assets to total assets   1.32%   1.04%
Allowance for loan losses to total loans   1.37%   1.36%
Allowance for loan losses to non-performing loans   66.34%   90.14%

 

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Nonperforming loans increased $2.4 million to $7.7 million at September 30, 2014 from $5.3 million at September 30, 2013. The increase in nonperforming loans was primarily due to a $2.4 million loan relationship being placed on nonaccrual status during the quarter ended June 30, 2014 due to the borrower’s inadequate cash flow, working capital and liquidity sources. This relationship, which is considered impaired, consists of six commercial business loans, one commercial real estate loan and one residential mortgage. The loans are secured by commercial real estate, residential real estate, equipment, accounts receivable and inventory. This relationship had specific reserves of $271,000 at September 30, 2014. In addition, a $637,000 commercial relationship was placed on nonaccrual status during the quarter ended March 31, 2014, after the Corporation received information from the borrower which reflected a weakened financial condition. This relationship consists of a commercial real estate loan secured by a commercial property and a commercial line of credit secured by accounts receivable, inventory and other business assets, both of which were considered impaired at September 30, 2014. The commercial real estate loan and commercial line of credit had specific reserves of $45,000 and $140,000, respectively, at September 30, 2014. Partially offsetting these increases were principal reductions of $242,000 resulting from credit workouts and repayments. Of the $7.7 million in nonperforming loans, $5.3 million were not past due at September 30, 2014. At September 30, 2014, nonperforming loans remained unchanged at $7.7 million, compared to the same level recorded at June 30, 2014.

 

As of September 30, 2014, the Corporation’s classified and criticized assets amounted to $14.1 million, or 2.4% of total assets, with $12.1 million classified as substandard and $2.1 identified as special mention. This compares to classified and criticized assets of $12.7 million, or 2.4% of total assets, with $11.8 million classified as substandard and $930,000 identified as special mention at December 31, 2013. The $1.4 million increase in criticized and classified assets was primarily the result of two commercial loan relationships being downgraded to special mention during the quarter ended March 31, 2014.

 

The provision for loan losses increased $20,000, or 14.0%, to $163,000 for the three months ended September 30, 2014 from $143,000 for the same period in the prior year. While the Corporation’s average loan balances increased $24.7 million for the three months ended September 30, 2014 compared to the same period in the prior year, the provision for loan losses only increased marginally due a positive impact in the allowance for loan losses due to an improvement in the historical loss ratios.

 

Noninterest income. Noninterest income decreased $73,000, or 7.3%, to $929,000 for the three months ended September 30, 2014, compared to $1.0 million for the same period in the prior year. This decrease resulted from decreases in commissions on financial services, fees and service charges and net gains on the sale of securities of $40,000, $17,000 and $16,000, respectively. The decrease in commissions of financial services relates to the Corporation discontinuing retail brokerage and other investment services during the third quarter of 2013.

 

Noninterest expense. Noninterest expense increased $138,000, or 3.9%, to $3.7 million for the three months ended September 30, 2014, compared to $3.5 million for the same period in the prior year. This increase in noninterest expense can be attributed to increases in premises and equipment and other noninterest expense of $118,000 and $80,000, respectively, partially offset by decreases in compensation and employee benefits, professional fees, intangible asset amortization and FDIC expense of $22,000, $16,000, $13,000 and $9,000, respectively. Noninterest expense for the third quarter of 2014 included $175,000 related to the Bank’s new full-service branch banking offices in Cranberry Township, Pennsylvania and Saint Marys, Pennsylvania, which opened in May 2014 and October 2013, respectively. Excluding these new expenses, noninterest expense decreased $37,000, or 1.0%.

 

Compensation and employee benefits expense decreased $22,000, or 1.2%, to $1.8 million for the three months ended September 30, 2014 compared to the same period in the prior year. This decrease can be attributed to a $15,000 reduction in retirement benefits costs resulting from the 2013 curtailment of the Bank’s pension plan, a $14,000 decrease in commission expense as the Corporation discontinued providing retail brokerage and other investment services during the third quarter of 2013, and a $20,000 reduction in retirement benefits costs resulting from the 2013 curtailment of the Bank’s pension plan.

 

Premise and equipment expense increased $118,000, or 22.9%, to $634,000 for the three months ended September 30, 2014 compared to $516,000 for the same period in the prior year. Premise and equipment expense for the third quarter of 2014 included $69,000 in operating expenses related to the Bank’s new full-service branch banking offices in Cranberry Township, Pennsylvania and Saint Marys, Pennsylvania.

 

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Professional fees decreased $16,000, or 10.1%, to $142,000 for the three months ended September 30, 2014 compared to $158,000 for the same period in the prior year.

 

The Corporation recognized $54,000 of core deposit intangible amortization expense during the third quarter of 2014 compared to $67,000 for the same period in the prior year. This amortization relates to a branch acquisition completed in the third quarter of 2009. Further discussion of goodwill and intangible assets related to the branch office acquisition can be found in the “Notes to Consolidated Financial Statements” beginning on page 6.

 

FDIC insurance decreased $9,000, or 9.1%, to $90,000 for the three months ended September 30, 2014 compared to $99,000 for the same period in the prior year. The decrease was primarily the result of a decrease in the Bank’s FDIC insurance assessment rate.

 

Other noninterest expense increased $80,000, or 9.3%, to $936,000 for the three months ended September 30, 2014 compared to $856,000 for the same period in the prior year. Other noninterest expense for the third quarter of 2014 included $33,000 in operating expenses related to the Bank’s new branch offices in Cranberry Township, Pennsylvania and Saint Marys, Pennsylvania.

 

Provision for income taxes. The provision for income taxes decreased $31,000, or 11.4%, to $241,000 for the three months ended September 30, 2014 compared to $272,000 for the same period in the prior year. The Corporation’s effective tax rate decreased to 19.1% for the third quarter of 2014 from 20.1% for the same quarter in the prior year. The difference between the statutory rate of 34% and the Corporation’s effective tax rate of 19.1% for the quarter ended September 30, 2014 was due to tax-exempt income earned on certain tax-free loans and securities and bank-owned life insurance.

 

Comparison of Results for the Nine months Ended September 30, 2014 and 2013

 

General. Net income decreased $137,000, or 4.8%, to $2.7 million for the nine months ended September 30, 2014 from $2.9 million for the same period in 2013. This decrease was the result of increases in noninterest expense and the provision for loan losses of $858,000 and $70,000, respectively, partially offset by increases in net interest income and noninterest income of $517,000 and $238,000, respectively, and a decrease in the provision for income taxes of $36,000.

 

Net interest income. Net interest income on a tax equivalent basis increased $510,000, or 4.1%, to $12.9 million for the nine months ended September 30, 2014 from $12.4 million for the nine months ended September 30, 2013. This increase can be attributed to a decrease in interest expense of $608,000, partially offset by a decrease in tax equivalent interest income of $98,000.

 

Interest income. Interest income on a tax equivalent basis decreased $98,000 to $15.2 million for the nine months ended September 30, 2014 compared to $15.3 million for the nine months ended September 30, 2013. This decrease can be attributed to decreases in interest on loans and securities of $115,000 and $67,000, respectively, partially offset by an increase in interest-earning deposits with banks and interest earned on federal bank stocks of $24,000 and $60,000, respectively.

 

Tax equivalent interest earned on loans receivable decreased $115,000 to $12.5 million for the nine months ended September 30, 2014 compared to $12.6 million for the nine months ended September 30, 2013. This decrease resulted from a 28 basis point decline in the average yield on loans to 4.67% for the nine months ended September 30, 2014 versus 4.95% for the same period in 2013. This unfavorable yield variance accounted for a $733,000 decrease in interest income. Partially offsetting this unfavorable yield variance, average loans increased $17.1 million, or 5.0%, accounting for an increase of $618,000 in loan interest income.

 

Tax equivalent interest earned on securities decreased $67,000, or 2.6%, to $2.5 million for the nine months ended September 30, 2014 compared to $2.6 million for the nine months ended September 30, 2013. This decrease resulted from a 16 basis point decline in the average yield on securities to 2.43% for the nine months ended September 30, 2014 versus 2.59% for the same period in 2013, due primarily to the sale of higher-yielding securities in a strategy designed to redeem a $5.0 million higher cost FHLB long term advance. This unfavorable yield variance accounted for a $171,000 decrease in interest income. Partially offsetting this unfavorable yield variance, the average balance of securities increased $5.5 million, or 4.2%, accounting for a $104,000 increase in interest income.

 

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Interest expense. Interest expense decreased $608,000, or 21.0%, to $2.3 million for the nine months ended September 30, 2014 from $2.9 million for the same period in 2013. This decrease in interest expense can be attributed to a decrease in interest incurred on deposits and borrowed funds of $521,000 and $87,000, respectively.

 

Interest expense incurred on deposits decreased $521,000, or 22.6%, to $1.8 million for the nine months ended September 30, 2014 compared to $2.3 million for the same period in 2013. The average cost of interest-bearing deposits decreased 29 basis points to 0.63% for the nine months ended September 30, 2014, compared to 0.92% for the same period in 2013, resulting in an $810,000 decrease in interest expense. This decrease in the cost of deposits was primarily due to deposits repricing during 2013 and the first nine months of 2014 in the prevailing low interest-rate environment. Partially offsetting this favorable variance, the average balance of interest-bearing deposits increased $46.5 million, or 13.9%, to $381.0 million for the nine months ended September 30, 2014, compared to $334.5 million for the same period in 2013 causing a $289,000 increase in interest expense. Average noninterest bearing deposits increased $8.6 million, or 8.3%, to $111.9 million from $103.3 million, facilitating the overall decline in the Corporation’s cost of funds.

 

Interest expense incurred on borrowed funds decreased $87,000, or 14.7%, to $503,000 for the nine months ended September 30, 2014 compared to $590,000 for the same period in the prior year. The average balance of long term borrowed funds decreased $3.9 million, or 19.4%, accounting for a $106,000 decrease in interest expense. This resulted from the early repayment of a $5.0 million FHLB long term advance during the first quarter of 2014. The Corporation recognized a $550,000 prepayment penalty associated with this early repayment which was fully offset with gains from the sale of securities. Additionally, the average cost of long term borrowed funds decreased 27 basis points to 3.58% for the nine months ended September 30, 2014 compared to 3.85% for the same period in 2013, causing a $39,000 decrease in interest expense. This was due primarily to the capitalization of $53,000 of interest during the nine months ended September 30, 2014 related to the Cranberry Township banking office construction compared to $29,000 for the same period in the prior year. Partially offsetting the favorable variance related to long term borrowings, the average cost of short term borrowed funds increased 235 basis points to 2.69% for the nine months ended September 30, 2014 compared to 0.34% for the same period in 2013, causing a $64,000 increase in interest expense. The average balance of short term borrowed funds decreased $1.9 million, accounting for a $6,000 decrease in interest expense. Short-term borrowings at September 30, 2014 included a $2.2 million line of credit balance with a correspondent bank with a rate of 4.25% advanced by the Corporation during the third quarter of 2013 to partially fund the $5.0 million SBLF preferred stock redemption.

 

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Average Balance Sheet and Yield/Rate Analysis. The following table sets forth, for the periods indicated, information concerning the total dollar amounts of interest income from interest-earning assets and the resulting average yields, the total dollar amounts of interest expense on interest-bearing liabilities and the resulting average costs, net interest income, interest rate spread and the net interest margin earned on average interest-earning assets. For purposes of this table, average loan balances include nonaccrual loans and exclude the allowance for loan losses and interest income includes accretion of net deferred loan fees. Interest and yields on tax-exempt loans and securities (tax-exempt for federal income tax purposes) are shown on a fully tax equivalent basis. The information is based on average daily balances during the periods presented.

 

(Dollar amounts in thousands)  Nine months ended September 30, 
                         
   2014   2013 
   Average       Yield /   Average       Yield / 
   Balance   Interest   Rate   Balance   Interest   Rate 
                         
Interest-earning assets:                              
Loans, taxable  $336,455   $11,685    4.64%  $322,675   $11,923    4.94%
Loans, tax exempt   21,572    821    5.09%   18,204    698    5.13%
Total loans receivable   358,027    12,506    4.67%   340,879    12,621    4.95%
                               
Securities, taxable   102,382    1,417    1.85%   91,020    1,328    1.95%
Securities, tax exempt   35,090    1,077    4.10%   40,937    1,233    4.03%
Total securities   137,472    2,494    2.43%   131,957    2,561    2.59%
                               
Interest-earning deposits with banks   32,511    68    0.28%   13,295    44    0.44%
Federal bank stocks   3,013    112    4.97%   3,124    52    2.23%
Total interest-earning cash equivalents   35,524    180    0.68%   16,419    96    0.78%
                               
Total interest-earning assets   531,023    15,180    3.82%   489,255    15,278    4.17%
Cash and due from banks   2,243              2,023           
Other noninterest-earning assets   31,127              28,167           
                               
Total Assets  $564,393             $519,445           
                               
Interest-bearing liabilities:                              
Interest-bearing demand deposits  $261,903   $306    0.16%  $215,136   $258    0.16%
Time deposits   119,057    1,478    1.66%   119,327    2,047    2.29%
Total interest-bearing deposits   380,960    1,784    0.63%   334,463    2,305    0.92%
                               
Borrowed funds, short-term   3,574    72    2.69%   5,438    14    0.34%
Borrowed funds, long-term (1)   16,117    431    3.58%   20,000    576    3.85%
Total borrowed funds   19,691    503    3.42%   25,438    590    3.10%
                               
Total interest-bearing liabilities   400,651    2,287    0.76%   359,901    2,895    1.08%
                               
Noninterest-bearing demand deposits   111,854    -    -    103,255    -    - 
                               
Funding and cost of funds   512,505    2,287    0.60%   463,156    2,895    0.84%
                               
Other noninterest-bearing liabilities   4,954              5,594           
                               
Total Liabilities   517,459              468,750           
Stockholders' Equity   46,934              50,695           
                               
Total Liabilities and Stockholders' Equity  $564,393             $519,445           
                               
Net interest income       $12,893             $12,383      
                               
Interest rate spread (difference between weighted average rate on interest-earning assets and interest-bearing liabilities)             3.06%             3.09%
                               
Net interest margin (net interest income as a percentage of average interest-earning assets)             3.25%             3.38%

 

(1)Interest on long-term borrowed funds for the periods ended September 30, 2014 and 2013 was reduced by $53,000 and $29,000, respectively, related to capitalized interest costs on construction in progress.

 

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

 

(Dollar amounts in thousands)  Nine months ended September 30, 
   2014 versus 2013 
   Increase (Decrease) due to 
   Volume   Rate   Total 
Interest income:               
Loans  $618   $(733)  $(115)
Securities   104    (171)   (67)
Interest-earning deposits with banks   45    (21)   24 
Federal bank stocks   (2)   62    60 
                
Total interest-earning assets   765    (863)   (98)
                
Interest expense:               
Interest-bearing deposits   289    (810)   (521)
Borrowed funds, short-term   (6)   64    58 
Borrowed funds, long-term   (106)   (39)   (145)
                
Total interest-bearing liabilities   177    (785)   (608)
                
Net interest income  $588   $(78)  $510 

 

Provision for loan losses. The Corporation records provisions for loan losses to maintain a level of total allowance for loan losses that management believes, to the best of its knowledge, covers all probable incurred losses estimable at each reporting date. Management considers historical loss experience, the present and prospective financial condition of borrowers, current conditions (particularly as they relate to markets where the Corporation originates loans), the status of nonperforming assets, the estimated underlying value of the collateral and other factors related to the collectability of the loan portfolio.

 

Information pertaining to the allowance for loan losses and nonperforming assets for the nine months ended September 30, 2014 and 2013 is as follows:

 

(Dollar amounts in thousands)  As of or for the nine months ended 
   September 30, 
   2014   2013 
Balance at the beginning of the period  $4,869   $5,350 
Provision for loan losses   508    438 
Charge-offs   (289)   (1,047)
Recoveries   42    46 
Balance at the end of the period  $5,130   $4,787 
           
Non-performing loans  $7,733   $5,310 
Non-performing assets   7,837    5,458 
Non-performing loans to total loans   2.07%   1.51%
Non-performing assets to total assets   1.32%   1.04%
Allowance for loan losses to total loans   1.37%   1.36%
Allowance for loan losses to non-performing loans   66.34%   90.14%

 

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Nonperforming loans increased $2.4 million to $7.7 million at September 30, 2014 from $5.3 million at September 30, 2013. The increase in nonperforming loans was primarily due to a $2.4 million loan relationship being placed on nonaccrual status during the quarter ended June 30, 2014. This relationship, which is considered impaired, consists of six commercial business loans, one commercial real estate loan and one residential mortgage. This relationship had specific reserves of $271,000 at September 30, 2014. In addition, a $637,000 commercial relationship was placed on nonaccrual status during the quarter ended March 31, 2014, after the Corporation received information from the borrower which reflected a weakened financial condition. This relationship consists of a commercial real estate loan secured by a commercial property and a commercial line of credit secured by accounts receivable, inventory and other business assets, both of which were considered impaired at September 30, 2014. The commercial real estate loan and commercial line of credit had specific reserves of $45,000 and $140,000, respectively, at September 30, 2014. Partially offsetting these increases were principal reductions resulting from credit workouts and repayments. Of the $7.7 million in nonperforming loans, $5.3 million were not past due at September 30, 2014. During the nine months ended September 30, 2014, nonperforming loans increased $2.5 million, primarily due to the aforementioned loan relationships being put on nonaccrual status during the period.

 

As of September 30, 2014, the Corporation’s classified and criticized assets amounted to $14.1 million, or 2.4% of total assets, with $12.1 million classified as substandard and $2.1 identified as special mention. This compares to classified and criticized assets of $12.7 million, or 2.4% of total assets, with $11.8 million classified as substandard and $930,000 identified as special mention at December 31, 2013. The overall increase in criticized and classified assets was primarily the result of two commercial loan relationships being downgraded to special mention during the nine months ended September 30, 2014.

 

The provision for loan losses increased $70,000, or 16.0%, to $508,000 for the nine months ended September 30, 2014 from $438,000 for the same period in the prior year. While the Corporation has $456,000 of the allowance for loan losses allocated to the aforementioned loans placed on nonaccrual status and recognized as impaired during the nine months ended September 30, 2014, the provision for loan losses only increased marginally as the general reserve pool previously had amounts attributable to these loans and there was a positive impact in the allowance for loan losses due to an improvement in the historical loss ratios.

 

Noninterest income. Noninterest income increased $238,000, or 8.0%, to $3.2 million for the nine months ended September 30, 2014 compared to $3.0 million for the same period in the prior year. This increase resulted from a $457,000 increase in net gains on the sale of securities. During the nine months ended September 30, 2014, the Corporation realized securities gains of $748,000; $657,000 of which related to a balance sheet management strategy whereby securities were sold to prepay a $5.0 million FHLB long term advance and associated securities gains were used to offset the impact of prepayment penalties associated with the early retirement of the advance. During the nine months ended September 30, 2013, the Corporation realized securities gains of $291,000 related to the sale of certain mortgage backed securities that were experiencing accelerated prepayments. Partially offsetting this increase related to security gains, commissions on financial services and fees and service charges decreased $156,000 and $72,000, respectively.

 

Noninterest expense. Noninterest expense increased $858,000, or 8.0%, to $11.6 million for the nine months ended September 30, 2014 compared to $10.8 million for the same period in the prior year. This increase in noninterest expense can be attributed primarily to an increase in other noninterest expense of $804,000, primarily related to a $550,000 prepayment penalty assessed on the aforementioned early retirement of debt. Also contributing to the increase in noninterest expense was an increase in premises and equipment of $251,000, primarily related to normal operating expenses for two new full-service branch banking offices opened during the fourth quarter of 2013 and the second quarter of 2014, respectively. These increases were partially offset by decreases in compensation and employee benefits, intangible asset amortization, professional fees and FDIC expense of $85,000, $46,000, $25,000 and $41,000, respectively. Excluding the aforementioned prepayment penalty and $408,000 of normal operating expenses related to the new banking offices, noninterest expense decreased $100,000.

 

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Compensation and employee benefits expense decreased $85,000, or 1.5%, to $5.6 million for the nine months ended September 30, 2014 compared to $5.7 million for the same period in the prior year. This decrease can be attributed to a $72,000 decrease in commission expense as the Corporation discontinued providing retail brokerage and other investment services during the third quarter of 2013 and a $57,000 reduction in retirement benefits costs resulting primarily from the 2013 curtailment of the Bank’s pension plan. Payroll taxes also decreased $30,000 primarily from the receipt of a refund from prior year overpayments of state unemployment taxes.

 

Premise and equipment expense increased $251,000, or 15.8%, to $1.8 million for the nine months ended September 30, 2014 compared to $1.6 million for the same period in the prior year. Premise and equipment expense for the first nine months of 2014 included $153,000 in expenses related to the Bank’s new branch offices in Saint Marys and Cranberry Township, Pennsylvania.

 

Professional fees decreased $25,000, or 4.9%, to $488,000 for the nine months ended September 30, 2014 compared to $513,000 for the same period in the prior year.

 

The Corporation recognized $167,000 of core deposit intangible amortization expense during the first nine months of 2014 compared to $213,000 for the same period in the prior year. This amortization relates to a branch acquisition completed in the third quarter of 2009. Further discussion of goodwill and intangible assets related to the branch office acquisition can be found in the “Notes to Consolidated Financial Statements” beginning on page 6.

 

FDIC insurance decreased $41,000, or 13.4%, to $266,000 for the nine months ended September 30, 2014 compared to $307,000 for the same period in the prior year. The decrease was primarily the result of a decrease in the Bank’s FDIC insurance assessment rate.

 

Provision for income taxes. The provision for income taxes decreased $36,000, or 5.1%, to $675,000 for the nine months ended September 30, 2014 compared to $711,000 for the same period in the prior year. The Corporation’s effective tax rate was 19.8% for the first nine months of 2014, unchanged from the same period in the prior year. The difference between the statutory rate of 34% and the Corporation’s effective tax rate of 19.8% for the nine months ended September 30, 2014 was due to tax-exempt income earned on certain tax-free loans and securities and bank-owned life insurance.

 

LIQUIDITY

 

The Corporation’s primary sources of funds generally have been deposits obtained through the offices of the Bank, borrowings from the FHLB and Federal Reserve, and amortization and prepayments of outstanding loans and maturing securities. During the nine months ended September 30, 2014, the Corporation used its sources of funds primarily to fund security purchases and loan advances and to repay borrowed funds. As of September 30, 2014, the Corporation had outstanding loan commitments, including undisbursed loans and amounts available under credit lines, totaling $52.4 million, and standby letters of credit totaling $578,000.

 

At September 30, 2014, time deposits amounted to $121.6 million, or 23.4% of the Corporation’s total consolidated deposits, including approximately $38.3 million of which are scheduled to mature within the next year. Management of the Corporation believes (i) it has adequate resources to fund all of its commitments, (ii) all of its commitments will be funded as required by related maturity dates and (iii) based upon past experience and current pricing policies, it can adjust the rates of time deposits to retain a substantial portion of maturing liabilities if necessary.

 

Aside from liquidity available from customer deposits or through sales and maturities of securities, the Corporation has alternative sources of funds such as a term borrowing capacity from the FHLB and the Federal Reserve’s discount window. At September 30, 2014, the Corporation had borrowed funds of $17.2 million consisting of $15.0 million in long-term FHLB advances and a $2.2 million short-term advance on a line of credit with a correspondent bank. At September 30, 2014, the Corporation’s borrowing capacity with the FHLB, net of funds borrowed and other commitments, was $147.0 million.

 

Management is not aware of any conditions, including any regulatory recommendations or requirements, which would adversely impact its liquidity or its ability to meet funding needs in the ordinary course of business.

 

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RECENT REGULATORY DEVELOPMENTS

 

In July 2013, the Office of the Comptroller of the Currency and the other federal bank regulatory agencies issued a final rule that will revise their leverage and risk-based capital requirements and the method for calculating risk-weighted assets to make them consistent with agreements that were reached by the Basel Committee on Banking Supervision and certain provisions of the Dodd-Frank Act. Among other things, the rule established a new common equity Tier 1 minimum capital requirement (4.5% of risk-weighted assets), increases the minimum Tier 1 capital to risk-based assets requirement (from 4% to 6% of risk-weighted assets), phases out certain kinds of intangibles and instruments treated as capital and assigns a higher risk weight (150%) to exposures that are more than 90 days past due or are on nonaccrual status and to certain commercial real estate facilities that finance acquisition, development or construction of real property. The final rule also requires unrealized gains and losses on certain “available-for-sale” securities holdings to be included for purposes of calculating regulatory capital requirements unless a one-time opt-out is exercised. The rule limits a banking organization’s capital distributions and certain discretionary bonus payments if the banking organization does not hold a “capital conservation buffer” consisting of 2.5% of common equity Tier 1 capital to risk-weighted assets in addition to the amount necessary to meet its minimum risk-based capital requirements. The new capital rules maintain the general structure of the prompt corrective action rules, but incorporate the new common equity Tier 1 capital requirement and the increased Tier 1 risk-weighted asset requirement into the prompt corrective action framework.

 

The final rule becomes effective for the Bank on January 1, 2015. The capital conservation buffer requirement will be phased in beginning January 1, 2016 and ending January 1, 2019, when the full capital conservation buffer requirement will be effective. The final rule also implements consolidated capital requirements for bank holding companies, such as the Corporation, effective January 1, 2015.

 

CRITICAL ACCOUNTING POLICIES

 

The Corporation’s consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States of America and follow general practices within the industry in which it operates. Application of these principles requires management to make estimates or judgments that affect the amounts reported in the financial statements and accompanying notes. These estimates are based on information available as of the date of the financial statements; accordingly, as this information changes, the financial statements could reflect different estimates or judgments. Certain policies inherently have a greater reliance on the use of estimates, and as such have a greater possibility of producing results that could be materially different than originally reported. Estimates or judgments are necessary when assets and liabilities are required to be recorded at fair value, when a decline in the value of an asset not carried on the financial statements at fair value warrants an impairment write-down or valuation reserve to be established or when an asset or liability needs to be recorded contingent upon a future event. Carrying assets and liabilities at fair value inherently results in more financial statement volatility. The fair values and the information used to record valuation adjustments for certain assets and liabilities are based either on quoted market prices or are provided by third-party sources, when available. When third-party information is not available, valuation adjustments are estimated in good faith by management primarily though the use of internal cash flow modeling techniques.

 

The most significant accounting policies followed by the Corporation are presented in Note 1 to the consolidated financial statements included in the Corporation’s Annual Report on Form 10-K for the year ended December 31, 2013. These policies, along with the disclosures presented in the other financial statement notes provide information on how significant assets and liabilities are valued in the financial statements and how those values are determined. Management views critical accounting policies to be those which are highly dependent on subjective or complex judgments, estimates and assumptions and where changes in those estimates and assumptions could have a significant impact on the financial statements. Management has identified the following as critical accounting policies.

 

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Allowance for loan losses. The Corporation considers that the determination of the allowance for loan losses involves a higher degree of judgment and complexity than its other significant accounting policies. The balance in the allowance for loan losses is determined based on management’s review and evaluation of the loan portfolio in relation to past loss experience, the size and composition of the portfolio, current economic events and conditions and other pertinent factors, including management’s assumptions as to future delinquencies, recoveries and losses. All of these factors may be susceptible to significant change. Among the many factors affecting the allowance for loan losses, some are quantitative while others require qualitative judgment. Although management believes its process for determining the allowance adequately considers all of the potential factors that could potentially result in credit losses, the process includes subjective elements and may be susceptible to significant change. To the extent actual outcomes differ from management’s estimates, additional provisions for loan losses may be required that would adversely impact the Corporation’s financial condition or earnings in future periods.

 

Other-than-temporary impairment. Management evaluates securities for other-than-temporary impairment at least on a quarterly basis, and more frequently when economic, market or other concerns warrant 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, (3) whether the market decline was affected by macroeconomic conditions and (4) whether the Corporation has the intent to sell the debt security or more likely than not will be required to sell the debt security before its anticipated recovery.

 

Goodwill and intangible assets. Goodwill represents the excess cost over fair value of assets acquired in a business combination. Goodwill and intangible assets acquired in a purchase business combination and determined to have an indefinite useful life are not amortized, but instead tested for impairment at least annually. Intangible assets with estimable useful lives are amortized over their respective estimated useful lives to their estimated residual values. The impairment test is a two-step process that begins with an initial impairment evaluation. If the initial evaluation suggests that an impairment of the asset value exists, the second step is to determine the amount of the impairment. If the tests conclude that goodwill is impaired, the carrying value is adjusted and an impairment charge is recorded. As of November 30, 2013, the required annual impairment test of goodwill was performed and management concluded that no impairment existed as of that date.

 

Item 3. Quantitative and Qualitative Disclosures About Market Risk

 

Market risk for the Corporation consists primarily of interest rate risk exposure and liquidity risk. Since virtually all of the interest-earning assets and interest-bearing liabilities are at the Bank, virtually all of the interest rate risk and liquidity risk lies at the Bank level. The Bank is not subject to currency exchange risk or commodity price risk, and has no trading portfolio, and therefore, is not subject to any trading risk. In addition, the Bank does not participate in hedging transactions such as interest rate swaps and caps. Changes in interest rates will impact both income and expense recorded and also the market value of long-term interest-earning assets and interest-bearing liabilities. Interest rate risk and liquidity risk management is performed at the Bank level. Although the Bank has a diversified loan portfolio, loans outstanding to individuals and businesses depend upon the local economic conditions in the immediate trade area.

 

One of the primary functions of the Corporation’s asset/liability management committee is to monitor the level to which the balance sheet is subject to interest rate risk. The goal of the asset/liability committee is to manage the relationship between interest rate sensitive assets and liabilities, thereby minimizing the fluctuations in the net interest margin, which achieves consistent growth of net interest income during periods of changing interest rates.

 

Interest rate sensitivity is the result of differences in the amounts and repricing dates of the Bank’s rate sensitive assets and rate sensitive liabilities. These differences, or interest rate repricing “gap”, provide an indication of the extent that the Corporation’s net interest income is affected by future changes in interest rates. A gap is considered positive when the amount of interest rate-sensitive assets exceeds the amount of interest rate-sensitive liabilities and is considered negative when the amount of interest rate-sensitive liabilities exceeds the amount of interest rate-sensitive assets. Generally, during a period of rising interest rates, a negative gap would adversely affect net interest income while a positive gap would result in an increase in net interest income. Conversely, during a period of falling interest rates, a negative gap would result in an increase in net interest income and a positive gap would adversely affect net interest income. The closer to zero that gap is maintained, generally, the lesser the impact of market interest rate changes on net interest income.

 

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Assumptions about the timing and variability of cash flows are critical in gap analysis. Particularly important are the assumptions driving mortgage prepayments and the expected attrition of the core deposits portfolios. These assumptions are based on the Corporation’s historical experience, industry standards and assumptions provided by a federal regulatory agency, which management believes most accurately represents the sensitivity of the Corporation’s assets and liabilities to interest rate changes. As of September 30, 2014, the Corporation’s interest-earning assets maturing or repricing within one year totaled $189.9 million while the Corporation’s interest-bearing liabilities maturing or repricing within one-year totaled $188.9 million, providing an excess of interest-earning assets over interest-bearing liabilities of $1.0 million. At September 30, 2014, the percentage of the Corporation’s assets to liabilities maturing or repricing within one year was 100.5%.

 

For more information, see “Market Risk Management” in the Corporation’s Annual Report on Form 10-K for the year ended December 31, 2013.

 

Item 4. Controls and Procedures

 

The Corporation maintains disclosure controls and procedures that are designed to ensure that information required to be disclosed in the Corporation’s Exchange Act reports is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to the Corporation’s management, including its Chief Executive Officer (CEO) and Chief Financial Officer (CFO), as appropriate, to allow timely decisions regarding required disclosure based on the definition of “disclosure controls and procedures” in Rule 13a-15(e).

 

As of September 30, 2014, the Corporation carried out an evaluation, under the supervision and with the participation of the Corporation’s management, including the Corporation’s CEO and CFO, of the effectiveness of the design and operation of the Corporation’s disclosure controls and procedures. Based on the foregoing, the Corporation’s CEO and CFO concluded that the Corporation’s disclosure controls and procedures were effective. There have been no significant changes in the Corporation’s internal controls or in other factors that could significantly affect the internal controls subsequent to the date the Corporation completed its evaluation.

 

There has been no change made in the Corporation’s internal control over financial reporting during the period covered by this report that has materially affected, or is reasonably likely to materially affect, the Corporation’s internal control over financial reporting.

 

PART II - OTHER INFORMATION

 

Item 1. Legal Proceedings

 

The Corporation is involved in various legal proceedings occurring in the ordinary course of business. It is the opinion of management, after consultation with legal counsel, that these matters will not materially affect the Corporation’s consolidated financial position or results of operations.

 

Item 1A. Risk Factors

 

Not applicable.

 

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

 

None.

 

Item 3. Defaults Upon Senior Securities

 

None.

 

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Item 4. Mine Safety Disclosures

 

Not applicable.

 

Item 5. Other Information

 

(a)Not applicable.

 

(b)Not applicable.

 

Item 6. Exhibits

 

Exhibit 31.1Rule 13a-14(a) Certification of Principal Executive Officer
Exhibit 31.2Rule 13a-14(a) Certification of Principal Financial Officer
Exhibit 32.1CEO Certification Pursuant to 18 U.S.C. Section 1350
Exhibit 32.2CFO Certification Pursuant to 18 U.S.C. Section 1350
101.INSXBRL Instance Document
101.SCHXBRL Taxonomy Extension Schema Document
101.CALXBRL Taxonomy Extension Calculation Linkbase Document
101.DEFXBRL Taxonomy Extension Definitions Linkbase Document
101.LABXBRL Taxonomy Extension Label Linkbase Document
101.PREXBRL Taxonomy Extension Presentation Linkbase Document

 

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Signatures

 

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

 

  EMCLAIRE FINANCIAL CORP
   
Date:  November 10, 2014 By:    /s/ William C. Marsh
  William C. Marsh
  Chairman of the Board,
  President and Chief Executive Officer
   
Date:  November 10, 2014 By:    /s/ Matthew J. Lucco
  Matthew J. Lucco
  Chief Financial Officer
  Treasurer

 

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