Form 10-Q
Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10 - Q

 

 

 

x QUARTERLY REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2011

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 000-13396

 

 

CNB FINANCIAL CORPORATION

(Exact name of registrant as specified in its charter)

 

 

 

Pennsylvania   25-1450605

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification No.)

1 South Second Street

P.O. Box 42

Clearfield, Pennsylvania 16830

(Address of principal executive offices)

Registrant’s telephone number, including area code, (814) 765-9621

 

 

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

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (section 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    x  Yes    ¨  No

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

 

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

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

The number of shares outstanding of the issuer’s common stock as of August 5, 2011

COMMON STOCK NO PAR VALUE PER SHARE: 12,313,319 SHARES

 

 

 


Table of Contents

INDEX

PART I.

FINANCIAL INFORMATION

 

     Page Number  

ITEM 1 – Financial Statements (unaudited)

  

Consolidated Balance Sheets – June 30, 2011 and December 31, 2010

     4   

Consolidated Statements of Income – Three months ended June 30, 2011 and 2010

     5   

Consolidated Statements of Income – Six months ended June 30, 2011 and 2010

     6   

Consolidated Statements of Comprehensive Income – Three and six month periods Ended June  30, 2011 and 2010

     7   

Consolidated Statements of Cash Flows – Six months ended June 30, 2011 and 2010

     8   

Notes to Consolidated Financial Statements

     9   

ITEM  2 – Management’s Discussion and Analysis of Financial Condition and Results of Operations

     30   

ITEM 3 – Quantitative and Qualitative Disclosures about Market Risk

     39   

ITEM 4 – Controls and Procedures

     41   
PART II.   
OTHER INFORMATION   

ITEM 1 – Legal Proceedings

     41   

ITEM 1A – Risk Factors

     41   

ITEM 6 – Exhibits

     41   

Signatures

     42   

 

2


Table of Contents

Forward-Looking Statements

This document contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, with respect to our financial condition, liquidity, results of operations, future performance and business. These forward-looking statements are intended to be covered by the safe harbor for “forward-looking statements” provided by the Private Securities Litigation Reform Act of 1995. Forward-looking statements are those that are not historical facts. Forward-looking statements include statements with respect to beliefs, plans, objectives, goals, expectations, anticipations, estimates and intentions that are subject to significant risks and uncertainties and are subject to change based on various factors (some of which are beyond our control). Forward-looking statements often include words such as “believes,” “expects,” “anticipates,” “estimates,” “intends,” “plans” or similar expressions or future conditional verbs such as “may,” “will,” “should,” “would” and “could.” Such known and unknown risks, uncertainties and other factors that could cause the actual results to differ materially from the statements include, but are not limited to: changes in general business, industry or economic conditions or competition; changes in any applicable law, rule, regulation, policy, guideline or practice governing or affecting financial holding companies and their subsidiaries or with respect to tax or accounting principles or otherwise; adverse changes or conditions in capital and financial markets; changes in interest rates; higher than expected costs or other difficulties related to integration of combined or merged businesses; the inability to realize expected cost savings or achieve other anticipated benefits in connection with business combinations and other acquisitions; changes in the quality or composition of our loan and investment portfolios; adequacy of loan loss reserves; increased competition; loss of certain key officers; continued relationships with major customers; deposit attrition; rapidly changing technology; unanticipated regulatory or judicial proceedings and liabilities and other costs; changes in the cost of funds, demand for loan products or demand for financial services; and other economic, competitive, governmental or technological factors affecting our operations, markets, products, services and prices. Some of these and other factors are discussed in our annual and quarterly reports filed with the Securities and Exchange Commission. Such factors could cause actual results to differ materially from those in the forward-looking statements.

The forward-looking statements are based upon management’s beliefs and assumptions and are made as of the date of the filing of this document. We undertake no obligation to publicly update or revise any forward-looking statements included in this document or to update the reasons why actual results could differ from those contained in such statements, whether as a result of new information, future events or otherwise, except to the extent required by law. In light of these risks, uncertainties and assumptions, the forward-looking events discussed in this document might not occur and you should not put undue reliance on any forward-looking statements.

 

3


Table of Contents

Part I Financial Information

Item 1. Financial Statements

CONSOLIDATED BALANCE SHEETS

Dollars in thousands

 

     (unaudited)
June 30,
2011
    December 31,
2010
 
    
    
ASSETS     

Cash and due from banks

   $ 30,238      $ 24,584   

Interest bearing deposits with other banks

     13,379        12,848   
  

 

 

   

 

 

 

Total cash and cash equivalents

     43,617        37,432   

Interest bearing time deposits with other banks

     1,622        2,817   

Securities available for sale

     548,164        500,677   

Trading securities

     2,441        2,351   

Loans held for sale

     2,706        4,451   

Loans

     824,455        797,009   

Less: unearned discount

     (2,668     (2,447

Less: allowance for loan losses

     (11,715     (10,820
  

 

 

   

 

 

 

Net loans

     810,072        783,742   

FHLB and other equity interests

     6,581        6,415   

Premises and equipment, net

     24,661        24,135   

Bank owned life insurance

     25,203        19,742   

Mortgage servicing rights

     912        908   

Goodwill

     10,821        10,821   

Accrued interest receivable and other assets

     14,394        20,020   
  

 

 

   

 

 

 

TOTAL

   $ 1,491,194      $ 1,413,511   
  

 

 

   

 

 

 
LIABILITIES AND SHAREHOLDERS’ EQUITY     

Non-interest bearing deposits

   $ 148,022      $ 140,836   

Interest bearing deposits

     1,101,050        1,022,032   
  

 

 

   

 

 

 

Total deposits

     1,249,072        1,162,868   

Treasury, tax and loan borrowings

     1,080        1,248   

FHLB and other borrowings

     82,008        105,259   

Subordinated debentures

     20,620        20,620   

Accrued interest payable and other liabilities

     16,184        13,871   
  

 

 

   

 

 

 

Total liabilities

     1,368,964        1,303,866   
  

 

 

   

 

 

 

Common stock, $0 par value; authorized 50,000,000 shares; issued 12,599,603 shares

     0        0   

Additional paid in capital

     44,437        44,676   

Retained earnings

     76,175        73,059   

Treasury stock, at cost (293,964 shares at June 30, 2011 and 362,342 shares at December 31, 2010)

     (4,364     (5,417

Accumulated other comprehensive income (loss)

     5,982        (2,673
  

 

 

   

 

 

 

Total shareholders’ equity

     122,230        109,645   
  

 

 

   

 

 

 

TOTAL

   $ 1,491,194      $ 1,413,511   
  

 

 

   

 

 

 

See Notes to Consolidated Financial Statements

 

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Table of Contents

CONSOLIDATED STATEMENTS OF INCOME (unaudited)

Dollars in thousands, except per share data

 

     Three months ended
June 30,
 
     2011     2010  

INTEREST AND DIVIDEND INCOME:

    

Loans including fees

   $ 11,962      $ 11,815   

Deposits with banks

     40        31   

Securities:

    

Taxable

     3,693        2,929   

Tax-exempt

     714        547   

Dividends

     8        6   
  

 

 

   

 

 

 

Total interest and dividend income

     16,417        15,328   
  

 

 

   

 

 

 

INTEREST EXPENSE:

    

Deposits

     3,501        3,368   

Borrowed funds

     808        1,079   

Subordinated debentures

     196        196   
  

 

 

   

 

 

 

Total interest expense

     4,505        4,643   
  

 

 

   

 

 

 

NET INTEREST INCOME

     11,912        10,685   

PROVISION FOR LOAN LOSSES

     992        1,161   
  

 

 

   

 

 

 

NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES

     10,920        9,524   
  

 

 

   

 

 

 

NON-INTEREST INCOME:

    

Wealth and asset management fees

     395        429   

Service charges on deposit accounts

     1,069        1,052   

Other service charges and fees

     416        373   

Net realized and unrealized losses on securities for which fair value was elected

     (16     (210

Mortgage banking

     155        48   

Bank owned life insurance

     212        200   

Other

     385        293   
  

 

 

   

 

 

 
     2,616        2,185   
  

 

 

   

 

 

 

Total other-than-temporary impairment losses on available-for-sale securities

     0        (318

Less portion of loss recognized in other comprehensive income

     0        0   

Net impairment losses recognized in earnings

     0        (318

Net realized gains on available-for-sale securities

     0        141   
  

 

 

   

 

 

 

Net impairment losses recognized in earnings and realized gains on available-for-sale securities

     0        (177
  

 

 

   

 

 

 

Total non-interest income

     2,616        2,008   
  

 

 

   

 

 

 

NON-INTEREST EXPENSES:

    

Salaries and benefits

     4,197        3,714   

Net occupancy expense of premises

     1,103        1,016   

FDIC insurance premiums

     280        386   

Amortization of intangibles

     0        25   

Other

     2,561        2,190   
  

 

 

   

 

 

 

Total non-interest expenses

     8,141        7,331   
  

 

 

   

 

 

 

INCOME BEFORE INCOME TAXES

     5,395        4,201   

INCOME TAX EXPENSE

     1,504        1,077   
  

 

 

   

 

 

 

NET INCOME

   $ 3,891      $ 3,124   
  

 

 

   

 

 

 

EARNINGS PER SHARE:

    

Basic

   $ 0.32      $ 0.34   

Diluted

   $ 0.32      $ 0.34   

DIVIDENDS PER SHARE:

    

Cash dividends per share

   $ 0.165      $ 0.165   

See Notes to Consolidated Financial Statements

 

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Table of Contents

CONSOLIDATED STATEMENTS OF INCOME (unaudited)

Dollars in thousands, except per share data

 

    

Six months ended

June 30,

 
     2011     2010  

INTEREST AND DIVIDEND INCOME:

    

Loans including fees

   $ 23,667      $ 23,127   

Deposits with banks

     82        63   

Securities:

    

Taxable

     6,951        5,269   

Tax-exempt

     1,396        1,023   

Dividends

     15        14   
  

 

 

   

 

 

 

Total interest and dividend income

     32,111        29,496   
  

 

 

   

 

 

 

INTEREST EXPENSE:

    

Deposits

     6,936        6,808   

Borrowed funds

     1,577        2,177   

Subordinated debentures

     387        385   
  

 

 

   

 

 

 

Total interest expense

     8,900        9,370   
  

 

 

   

 

 

 

NET INTEREST INCOME

     23,211        20,126   

PROVISION FOR LOAN LOSSES

     1,769        1,746   
  

 

 

   

 

 

 

NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES

     21,442        18,380   
  

 

 

   

 

 

 

NON-INTEREST INCOME:

    

Wealth and asset management fees

     810        824   

Service charges on deposit accounts

     2,032        1,997   

Other service charges and fees

     768        674   

Net realized and unrealized gains (losses) on securities for which fair value was elected

     97        (90

Mortgage banking

     334        249   

Bank owned life insurance

     461        402   

Other

     625        553   
  

 

 

   

 

 

 
     5,127        4,609   
  

 

 

   

 

 

 

Total other-than-temporary impairment losses on available-for-sale securities

     (398     (1,102

Less portion of loss recognized in other comprehensive income

     0        0   
  

 

 

   

 

 

 

Net impairment losses recognized in earnings

     (398     (1,102

Net realized gains on available-for-sale securities

     74        573   
  

 

 

   

 

 

 

Net impairment losses recognized in earnings and realized gains on available-for-sale securities

     (324     (529
  

 

 

   

 

 

 

Total non-interest income

     4,803        4,080   
  

 

 

   

 

 

 

NON-INTEREST EXPENSES:

    

Salaries and benefits

     8,440        7,691   

Net occupancy expense of premises

     2,302        2,151   

FDIC insurance premiums

     729        775   

Amortization of intangibles

     0        50   

Other

     4,961        4,791   
  

 

 

   

 

 

 

Total non-interest expenses

     16,432        15,458   
  

 

 

   

 

 

 

INCOME BEFORE INCOME TAXES

     9,813        7,002   

INCOME TAX EXPENSE

     2,645        1,718   
  

 

 

   

 

 

 

NET INCOME

   $ 7,168      $ 5,284   
  

 

 

   

 

 

 

EARNINGS PER SHARE:

    

Basic

   $ 0.58      $ 0.59   

Diluted

   $ 0.58      $ 0.58   

DIVIDENDS PER SHARE:

    

Cash dividends per share

   $ 0.33      $ 0.33   

See Notes to Consolidated Financial Statements

 

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Table of Contents

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (unaudited)

Dollars in thousands

 

     Three months ended     Six months ended  
     June 30,     June 30,  
     2011     2010     2011     2010  

NET INCOME

   $ 3,891      $ 3,124      $ 7,168      $ 5,284   

Other comprehensive income, net of tax:

        

Change in fair value of interest rate swap agreements designated as cash flow hedges, net of tax of $78 and $50 for the three months ended June 30, 2011 and 2010, and $42 and $82 for the six months ended June 30, 2011 and 2010

     (145     (93     (78     (152

Net change in unrealized gains (losses) on securities available for sale:

        

Unrealized gains (losses) on other-than-temporarily impaired securities available for sale:

        

Unrealized losses arising during the period, net of tax of $129 for the three months ended June 30, 2010, and ($32) and $135 for the six months ended June 30, 2011 and 2010

     0        (240     60        (251

Reclassification adjustment for losses included in net income, net of tax of ($111) for the three months ended June 30, 2010, and ($139) and ($386) for the six months ended June 30, 2011 and 2010

     0        207        259        716   
  

 

 

   

 

 

   

 

 

   

 

 

 
     0        (33     319        465   
  

 

 

   

 

 

   

 

 

   

 

 

 

Unrealized gains (losses) on other securities available for sale:

        

Unrealized gains arising during the period, net of tax of ($3,881) and ($2,151) for the three months ended June 30, 2011 and 2010, and ($4,556) and ($2,777) for the six months ended June 30, 2011 and 2010

     7,208        3,994        8,462        5,158   

Reclassification adjustment for accumulated gains included in net income, net of tax of $50 for the three months ended ended June 30, 2010, and $26 and $200 for the six months ended June 30, 2011 and 2010

     0        (92     (48     (372
  

 

 

   

 

 

   

 

 

   

 

 

 
     7,208        3,902        8,414        4,786   
  

 

 

   

 

 

   

 

 

   

 

 

 

Other comprehensive income

     7,063        3,776        8,655        5,099   
  

 

 

   

 

 

   

 

 

   

 

 

 

COMPREHENSIVE INCOME

   $ 10,954      $ 6,900      $ 15,823      $ 10,383   
  

 

 

   

 

 

   

 

 

   

 

 

 

See Notes to Consolidated Financial Statements

 

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Table of Contents

CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited)

Dollars in thousands

 

    

Six months ended

June 30,

 
     2011     2010  

CASH FLOWS FROM OPERATING ACTIVITIES:

    

Net income

   $ 7,168      $ 5,284   

Adjustments to reconcile net income to net cash provided by operations:

    

Provision for loan losses

     1,769        1,746   

Depreciation and amortization

     1,016        1,017   

Amortization, accretion and deferred loan fees and costs

     1,337        1,054   

Net impairment losses realized in earnings and gains on sales of available-for-sale securities

     324        529   

Net realized and unrealized gains on securities for which fair value was elected

     (97     90   

Proceeds from sale of securities for which fair value was elected

     170        0   

Purchase of securities for which fair value was elected

     (197     0   

Gain on sale of loans

     (280     (183

Net gains on dispositions of premises and equipment and foreclosed assets

     (79     (88

Proceeds from sale of loans

     10,953        3,695   

Origination of loans held for sale

     (9,053     (5,750

Increase in bank owned life insurance

     (461     (402

Stock-based compensation expense

     102        122   

Contribution of treasury stock

     60        0   

Changes in:

    

Accrued interest receivable and other assets

     931        (1,172

Accrued interest payable and other liabilities

     2,193        2   
  

 

 

   

 

 

 

NET CASH PROVIDED BY OPERATING ACTIVITIES

     15,856        5,944   
  

 

 

   

 

 

 

CASH FLOWS FROM INVESTING ACTIVITIES:

    

Net decrease in interest bearing time deposits with other banks

     1,195        2,721   

Proceeds from maturities, prepayments and calls of securities

     49,626        52,476   

Proceeds from sales of securities

     23,610        38,065   

Purchase of securities

     (108,992     (201,759

Loan origination and payments, net

     (28,091     (24,210

Purchase of bank owned life insurance

     (5,000     (2,500

Redemption (purchase) of FHLB and other equity interests

     (166     124   

Purchase of premises and equipment

     (1,434     (1,307

Proceeds from the sale of premises and equipment and foreclosed assets

     196        263   
  

 

 

   

 

 

 

NET CASH USED IN INVESTING ACTIVITIES

     (69,056     (136,127
  

 

 

   

 

 

 

CASH FLOWS FROM FINANCING ACTIVITIES:

    

Net change in:

    

Checking, money market and savings accounts

     142,321        119,787   

Certificates of deposit

     (56,117     18,316   

Proceeds from sale of treasury stock

     652        608   

Proceeds from exercise of stock options

     0        42   

Proceeds from stock offering, net of issuance costs

     0        32,414   

Cash dividends paid

     (4,052     (2,902

Proceeds from long-term borrowings

     350        0   

Repayment of long-term borrowings

     (61     (16,057

Net change in short-term borrowings

     (23,708     (97
  

 

 

   

 

 

 

NET CASH PROVIDED BY FINANCING ACTIVITIES

     59,385        152,111   
  

 

 

   

 

 

 

NET INCREASE IN CASH AND CASH EQUIVALENTS

     6,185        21,928   

CASH AND CASH EQUIVALENTS, Beginning

     37,432        22,358   
  

 

 

   

 

 

 

CASH AND CASH EQUIVALENTS, Ending

   $ 43,617      $ 44,286   
  

 

 

   

 

 

 

SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:

    

Cash paid during the period for:

    

Interest

   $ 9,006      $ 9,537   

Income taxes

     1,493        1,986   

SUPPLEMENTAL NONCASH DISCLOSURES:

    

Transfers to other real estate owned

     69        333   

Loans transferred from held for sale to held for investment

     0        3,321   

Grant of restricted stock awards from treasury stock

     266        233   

See Notes to Consolidated Financial Statements

 

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Table of Contents

CNB FINANCIAL CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

 

 

BASIS OF PRESENTATION

The accompanying consolidated financial statements have been prepared pursuant to rules and regulations of the Securities and Exchange Commission (SEC) and in compliance with accounting principles generally accepted in the United States of America (GAAP). Because this report is based on an interim period, certain information and footnote disclosures normally included in financial statements prepared in accordance with GAAP have been condensed or omitted.

In the opinion of management of the registrant, the accompanying consolidated financial statements as of June 30, 2011 and for the three and six month periods ended June 30, 2011 and 2010 include all adjustments, consisting of only normal recurring adjustments, necessary for a fair presentation of the financial condition and the results of operations for the period. The financial performance reported for CNB Financial Corporation (the Corporation) for the three and six month periods ended June 30, 2011 is not necessarily indicative of the results to be expected for the full year. This information should be read in conjunction with the Corporation’s Form 10-K for the period ended December 31, 2010. All amounts are stated in thousands, except share data.

STOCK COMPENSATION

The Corporation has a stock incentive plan for key employees and independent directors. The Stock incentive plan, which is administered by a committee of the Board of Directors, provides for up to 500,000 shares of common stock in the form of nonqualified options or restricted stock. For key employees, the plan vesting is one-fourth of the granted options or restricted stock per year beginning one year after the grant date, with 100% vested on the fourth anniversary of the grant. For independent directors, the vesting schedule is one-third of the granted options per year beginning one year after the grant date, with 100% vested on the third anniversary of the grant.

At June 30, 2011, there was no unrecognized compensation cost related to nonvested stock options granted under this plan, and no stock options were granted during the three month period then ended.

Compensation expense for the restricted stock awards is recognized over the requisite service period noted above based on the fair value of the shares at the date of grant. Unearned restricted stock awards are recorded as a reduction of shareholders’ equity until earned. Compensation expense resulting from these restricted stock awards was $49 and $102 for the three and six months ended June 30, 2011, and $45 and $122 for the three and six months ended June 30, 2010. As of June 30, 2011, there was $509 of total unrecognized compensation cost related to unvested restricted stock awards.

A summary of changes in unvested restricted stock awards for the three months ended June 30, 2011 follows:

 

     Shares     Weighted Average
Grant Date Fair Value
 

Nonvested at beginning of period

     41,469      $ 15.11   

Granted

     —          —     

Vested

     —          —     

Forfeited

     (1,188     14.85   
  

 

 

   

 

 

 

Nonvested at end of period

     40,281      $ 15.12   
  

 

 

   

 

 

 

 

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Table of Contents

A summary of changes in unvested restricted stock awards for the six months ended June 30, 2011 follows:

 

     Shares     Weighted Average
Grant Date Fair Value
 

Nonvested at beginning of period

     31,398      $ 15.10   

Granted

     17,900        14.88   

Vested

     (7,829     14.55   

Forfeited

     (1,188     14.85   
  

 

 

   

 

 

 

Nonvested at end of period

     40,281      $ 15.12   
  

 

 

   

 

 

 

FAIR VALUE

Fair Value Option

Management elected to adopt the fair value option for its investment in certain equity securities in order to provide financial statement users with greater visibility into the Corporation’s financial instruments that do not have a defined maturity date.

Fair value changes attributable to unrealized gains (losses) that were included in earnings for the three and six months ended June 30, 2011 were ($16) and $87, respectively. Fair value changes attributable to unrealized losses that were included in earnings for the three and six month ended June 30, 2010 were ($139) and ($57). Realized gains on the sale of securities for which the fair value option was elected were $0 and $10 during the three and six months ended June 30, 2011. There were no sales of securities for which the fair value option was elected during the three and six months ended June 30, 2010.

Dividend income is recorded based on cash dividends and comprises the “Dividends” line item in the accompanying consolidated statement of income. Dividend income was $8 and $15 for the three and six months ended June 30, 2011 and $6 and $14 for the three and six months ended June 30, 2010.

Fair Value Measurement

Fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability (an 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. A fair value hierarchy has also been established which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The following three levels of inputs are used to measure fair value:

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

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 a company’s own assumptions about the assumptions that market participants would use in pricing an asset or liability.

The fair values of most trading securities and securities available for sale are determined by obtaining quoted prices on nationally recognized securities exchanges (Level 1 inputs) or matrix pricing, which is a mathematical technique widely used in the industry to value debt securities without relying exclusively on quoted prices for the specific securities but rather relying on the securities’ relationship to other benchmark quoted securities (Level 2 inputs). The fair values of certain residential mortgage-backed securities, one corporate bond, and one bond issued by a government sponsored entity classified as available for sale have been determined by using Level 3 inputs. The Corporation has engaged a valuation expert to price these securities using a proprietary model, which incorporates assumptions that market participants would use in pricing the securities, including bid/ask spreads and liquidity and credit premiums.

 

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Trust preferred securities which are issued by financial institutions and insurance companies are priced using Level 3 inputs. The decline in the level of observable inputs and market activity in this class of investments by the measurement date has been significant and resulted in unreliable external pricing. Broker pricing and bid/ask spreads, when available, vary widely, and the once active market has become comparatively inactive.

The Corporation engaged a third party consultant who has developed a model for pricing these securities. Information such as historical and current performance of the underlying collateral, deferral and default rates, collateral coverage ratios, break in yield calculations, cash flow projections, liquidity and credit premiums required by a market participant, and financial trend analysis with respect to the individual issuing financial institutions and insurance companies are utilized in determining individual security valuations. Due to the current market conditions as well as the limited trading activity of these securities, the market value of the securities is highly sensitive to assumption changes and market volatility.

The Corporation’s derivative instrument is an interest rate swap that trades in liquid markets. As such, significant fair value inputs can generally be verified and do not typically involve significant management judgments (Level 2 inputs).

The fair value of impaired loans with specific allocations of the allowance for loan losses is generally based on recent 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 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.

Assets and liabilities measured at fair value on a recurring basis are as follows at June 30, 2011 and December 31, 2010:

 

           Fair Value Measurements at June 30, 2011 Using  
           Quoted Prices in
Active Markets for
Identical Assets
     Significant Other
Observable Inputs
    Significant
Unobservable
Inputs
 

Description

   Total     (Level 1)      (Level 2)     (Level 3)  

Assets:

         

Securities Available For Sale:

         

U.S. Treasury

   $ 11,201      $ —         $ 11,201      $ —     

U.S. Government sponsored entities

     91,849        —           91,849        —     

States and political subdivisions

     121,934        —           121,934        —     

Residential mortgage and asset backed

     270,330        —           266,342        3,988   

Commercial mortgage and asset backed

     2,071        —           2,071        —     

Corporate notes and bonds

     12,312        —           10,452        1,860   

Pooled trust preferred

     1,362        —           —          1,362   

Pooled SBA

     35,391        33,448         1,943        —     

Other securities

     1,714        1,714         —          —     
  

 

 

   

 

 

    

 

 

   

 

 

 

Total Securities Available For Sale

   $ 548,164      $ 35,162       $ 505,792      $ 7,210   
  

 

 

   

 

 

    

 

 

   

 

 

 

Trading Securities:

         

Equity securities – financial services

   $ 541      $ 541       $ —        $ —     

International mutual funds

     346        346         —          —     

Equity securities – health care

     178        178         —          —     

U.S. Government sponsored entities

     176        —           176        —     

Large cap growth mutual funds

     166        166         —          —     

Certificates of deposit

     156        156         —          —     

Money market mutual funds

     151        151         —          —     

Equity securities – energy

     128        128         —          —     

Real estate investment trust mutual funds

     127        127         —          —     

Large cap value mutual funds

     113        113         —          —     

Equity securities – industrials

     111        111         —          —     

Corporate notes and bonds

     99        —           99        —     

Equity securities - utilities

     64        64         —          —     

Small cap mutual funds

     43        43         —          —     

Mid cap mutual funds

     42        42         —          —     
  

 

 

   

 

 

    

 

 

   

 

 

 

Total Trading Securities

   $ 2,441      $ 2,166       $ 275      $ —     
  

 

 

   

 

 

    

 

 

   

 

 

 

Liabilities,

         

Interest rate swaps

   $ (987   $ —         $ (987   $ —     
  

 

 

   

 

 

    

 

 

   

 

 

 

 

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Table of Contents
           Fair Value Measurements at December 31, 2010 Using  
           Quoted Prices in
Active Markets for
Identical Assets
     Significant Other
Observable Inputs
    Significant
Unobservable
Inputs
 

Description

   Total     (Level 1)      (Level 2)     (Level 3)  

Assets:

         

Securities Available For Sale:

         

U.S. Treasury

   $ 8,205      $ —         $ 8,205      $ —     

U.S. Government sponsored entities

     105,941        2,000         101,941        2,000   

States and political subdivisions

     116,411        4,750         111,661        —     

Residential mortgage and asset backed

     222,419        20,405         199,745        2,269   

Corporate notes and bonds

     10,751        —           9,511        1,240   

Pooled trust preferred

     1,292        —           —          1,292   

Pooled SBA

     33,962        28,489         5,473        —     

Other securities

     1,696        1,696         —          —     
  

 

 

   

 

 

    

 

 

   

 

 

 

Total Securities Available For Sale

   $ 500,677      $ 57,340       $ 436,536      $ 6,801   
  

 

 

   

 

 

    

 

 

   

 

 

 

Trading Securities:

         

Equity securities – financial services

   $ 523      $ 523       $ —        $ —     

International mutual funds

     430        430         —          —     

Large cap value mutual funds

     247        247         —          —     

Certificates of deposit

     208        208         —          —     

Equity securities – health care

     151        151         —          —     

U.S. Government sponsored entities

     147        —           147        —     

Large cap growth mutual funds

     139        139         —          —     

Equity securities – energy

     119        119         —          —     

Equity securities – industrials

     98        98         —          —     

Corporate notes and bonds

     96        —           96        —     

Money market mutual funds

     75        75         —          —     

Equity securities - utilities

     61        61         —          —     

Small cap mutual funds

     29        29         —          —     

Mid cap mutual funds

     28        28         —          —     
  

 

 

   

 

 

    

 

 

   

 

 

 

Total Trading Securities

   $ 2,351      $ 2,108       $ 243      $ —     
  

 

 

   

 

 

    

 

 

   

 

 

 

Liabilities,

         

Interest rate swap

   $ (867   $ —         $ (867   $ —     
  

 

 

   

 

 

    

 

 

   

 

 

 

The table below presents a reconciliation and income statement classification of gains and losses for all securities available for sale measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the three months ended June 30, 2011:

 

     Residential
mortgage and
asset backed
    Corporate
notes and
bonds
    Pooled
trust
preferred
 

Balance, April 1, 2011

   $ 4,106      $ 1,895      $ 1,402   

Transfers into Level 3

     —          —          —     

Transfers out of Level 3

     —          —          —     

Total gains or losses (realized/unrealized):

      

Included in earnings

     —          —          —     

Included in other comprehensive income

     —          (35     (40

Purchases, issuances, sales, and settlements:

      

Purchases

     —         

Sales

     —          —          —     

Settlements

     (118     —          —     
  

 

 

   

 

 

   

 

 

 

Balance, June 30, 2011

   $ 3,988      $ 1,860      $ 1,362   
  

 

 

   

 

 

   

 

 

 

 

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Table of Contents

The table below presents a reconciliation and income statement classification of gains and losses for all securities available for sale measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the six months ended June 30, 2011:

 

     Residential
mortgage and
asset backed
    Corporate
notes and
bonds
     U.S. Gov’t
Sponsored
Entities
    Pooled
trust
preferred
 

Balance, January 1, 2011

   $ 2,269      $ 1,240       $ 2,000      $ 1,292   

Transfers into Level 3

     —          —           —          —     

Transfers out of Level 3 (a)(b)

     —          —           (2,000     —     

Total gains or losses (realized/unrealized):

         

Included in earnings

     —          —           —          (398

Included in other comprehensive income

     —          620         —          468   

Purchases, issuances, sales, and settlements:

         

Purchases

     1,917           —       

Sales

     —          —           —          —     

Settlements

     (198     —           —          —     
  

 

 

   

 

 

    

 

 

   

 

 

 

Balance, June 30, 2011

   $ 3,988      $ 1,860       $ —        $ 1,362   
  

 

 

   

 

 

    

 

 

   

 

 

 

 

(a) Transferred from Level 3 to Level 2 since observable market data became available to value the security.
(b) The Corporation’s policy is to recognize transfers in and transfers out as of the actual date of the event or change in circumstances that caused the transfer.

The table below presents a reconciliation and income statement classification of gains and losses for all securities available for sale measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the three and six months ended June 30, 2010:

 

     Three months ended
June 30, 2010
    Six months ended
June 30, 2010
 
     Residential
mortgage and
asset backed
    Corporate
notes and
bonds
    Pooled
trust
preferred
    Residential
mortgage
and asset
backed
    Corporate
notes and
bonds
     Pooled
trust
preferred
 

Beginning balance

   $ 460      $ 1,360      $ 1,894      $ 503      $ —         $ 1,909   

Transfers into Level 3 (a) (b)

     —          —          —          —          1,040         —     

Transfers out of Level 3

     —          —          —          —          —           —     

Total gains or losses (realized/unrealized):

             

Included in earnings

     —          —          (318     —          —           (1,102

Included in other comprehensive income

     —          (60     (42     —          260         727   

Purchases, issuances, sales, and settlements:

             

Sales

     —          —          —          —          —           —     

Settlements

     (45     —          (10     (88     —           (10
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

Ending balance

   $ 415      $ 1,300      $ 1,524      $ 415      $ 1,300       $ 1,524   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

 

(a) Transferred from Level 2 to Level 3 because of lack of observable market data due to decrease in market activity for this security.
(b) The Corporation’s policy is to recognize transfers in and transfers out as of the actual date of the event or change in circumstances that caused the transfer.

The unrealized losses reported in earnings for the three and six months ended June 30, 2011 and 2010 for Level 3 assets that are still held at the balance sheet date relate to pooled trust preferred securities deemed to be other-than-temporarily impaired.

 

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Table of Contents

During the three months ended June 30, 2011 and 2010, the following available for sale securities reported as Level 1 securities as of the beginning of the period were transferred to the Level 2 category:

 

     2011      2010  

U.S. Treasury

   $ 4,053       $ —     

U.S. Government sponsored entities

     16,124         10,038   

States and political subdivisions

     4,929         10,248   

Residential mortgage and asset backed

     37,659         15,910   

Commercial mortgage and asset backed

     2,085         —     
  

 

 

    

 

 

 

Total

   $ 64,850       $ 36,196   
  

 

 

    

 

 

 

During the six months ended June 30, 2011 and 2010, the following available for sale securities reported as Level 1 securities as of the beginning of the period were transferred to the Level 2 category:

 

     2011      2010  

U.S. Government sponsored entities

   $ 2,000       $ 24,643   

States and political subdivisions

     4,750         3,273   

Residential mortgage and asset backed

     20,405         5,625   
  

 

 

    

 

 

 

Total

   $ 27,155       $ 33,541   
  

 

 

    

 

 

 

These securities were transferred from the Level 1 category to the Level 2 category since there were no longer quoted prices for identical assets in active markets that the Corporation had the ability to access.

During the six months ended June 30, 2011, two pooled SBA securities that were classified as Level 2 securities at December 31, 2010 were transferred to the Level 1 category. The fair value on the date of transfer was $3,437. There were no transfers of securities from the Level 2 category to the Level 1 category during the three months ended June 30, 2011. During the six months ended June 30, 2010, one Pooled SBA security that was classified as a Level 2 security at both December 31, 2009 and March 31, 2010 was transferred to the Level 1 category. The fair value on the date of transfer was $938. These securities were transferred since the Corporation was able to access a quoted price for identical assets in an active market.

Assets and liabilities measured at fair value on a non-recurring basis are as follows at June 30, 2011 and December 31, 2010:

 

            Fair Value Measurements at June 30, 2011 Using  
            Quoted Prices in
Active Markets for
Identical Assets
     Significant Other
Observable Inputs
     Significant
Unobservable
Inputs
 
Description    Total      (Level 1)      (Level 2)      (Level 3)  

Assets:

           

Impaired loans:

           

Commercial mortgages

   $ 14,134       $ —         $ —         $ 14,134   

Commercial, industrial, and agricultural

     1,299         —           —           1,299   

Residential real estate

     125         —           —           125   

 

            Fair Value Measurements at December 31, 2010 Using  
            Quoted Prices in
Active Markets for
Identical Assets
     Significant Other
Observable Inputs
     Significant
Unobservable
Inputs
 
Description    Total      (Level 1)      (Level 2)      (Level 3)  

Assets:

           

Impaired loans:

           

Commercial mortgages

   $ 9,721       $ —         $ —         $ 9,721   

Commercial, industrial, and agricultural

     2,474         —           —           2,474   

Residential real estate

     166         —           —           166   

 

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Table of Contents

Impaired loans, which are measured for impairment using the fair value of collateral for collateral dependent loans, had a principal balance of $16,679 with a valuation allowance of $1,121 as of June 30, 2011, resulting in an additional provision for loan losses of $345 and $263 for the three and six months then ended. Impaired loans had a principal balance of $13,324 with a valuation allowance of $963 as of December 31, 2010, resulting in an additional provision for loan losses of $951 for the year then ended.

Fair Value of Financial Instruments

Carrying amount is the estimated fair value for cash and cash equivalents, accrued interest receivable and payable, demand deposits, other borrowings, and variable rate loans, deposits or borrowings that reprice frequently and fully. For fixed rate loans or deposits and for variable rate loans or deposits with infrequent repricing or repricing limits, fair value is based on discounted cash flows using current market rates applied to the estimated life and credit risk. Fair value of loans held for sale is based on market quotes. Fair value of debt is based on current rates for similar financing. It is not practical to determine the fair value of FHLB stock and other equity interests due to restrictions placed on the transferability of these instruments. The fair value of off balance sheet items is based on the current fees or cost that would be charged to enter into or terminate such arrangements. The fair value of off balance sheet items is not material.

While these estimates of fair value are based on management’s judgment of the most appropriate factors as of the balance sheet date, there is no assurance that the estimated fair values would have been realized if the assets had been disposed of or the liabilities settled at that date, since market values may differ depending on various circumstances. The estimated fair values would also not apply to subsequent dates.

In addition, other assets and liabilities that are not financial instruments, such as premises and equipment, are not included in the disclosures. Also, non-financial instruments typically not recognized on the balance sheet may have value but are not included in the fair value disclosures. These include, among other items, the estimated earnings power of core deposits, the earnings potential of trust accounts, the trained workforce, customer goodwill, and similar items.

The following table presents the carrying amount and fair value of financial instruments at June 30, 2011 and December 31, 2010:

 

     June 30, 2011     December 31, 2010  
     Carrying
Amount
    Fair
Value
    Carrying
Amount
    Fair
Value
 

ASSETS

        

Cash and cash equivalents

   $ 43,617      $ 43,617      $ 37,432      $ 37,432   

Interest bearing time deposits with other banks

     1,622        1,705        2,817        2,719   

Securities available for sale

     548,164        548,164        500,677        500,677   

Trading securities

     2,441        2,441        2,351        2,351   

Loans held for sale

     2,706        2,752        4,451        4,518   

Net loans

     810,072        831,320        783,742        807,972   

FHLB and other equity interests

     6,581        N/A        6,415        N/A   

Accrued interest receivable

     5,959        5,959        5,867        5,867   

LIABILITIES

        

Deposits

   $ (1,249,072   $ (1,252,468   $ (1,162,868   $ (1,167,071

FHLB, Treasury, tax and loan, and other borrowings

     (83,088     (87,861     (106,507     (109,963

Subordinated debentures

     (20,620     (10,780     (20,620     (10,660

Interest rate swaps

     (987     (987     (867     (867

Accrued interest payable

     (1,560     (1,560     (1,666     (1,666

 

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Table of Contents

SECURITIES

Securities available for sale at June 30, 2011 and December 31, 2010 were as follows:

 

     June 30, 2011      December 31, 2010  
     Amortized
Cost
     Unrealized     Fair
Value
     Amortized
Cost
     Unrealized     Fair
Value
 
        Gains      Losses           Gains      Losses    

U.S. Treasury

   $ 11,113       $ 88       $ —        $ 11,201       $ 8,139       $ 66       $ —        $ 8,205   

U.S. Gov’t sponsored entities

     88,953         2,950         (54     91,849         104,328         2,016         (403     105,941   

State & political subdivisions

     118,912         3,324         (302     121,934         117,928         1,011         (2,528     116,411   

Residential mortgage & asset backed

     264,114         6,403         (187     270,330         221,304         2,364         (1,249     222,419   

Commercial mortgage & asset backed

     2,082         —           (11     2,071         —           —           —          —     

Corporate notes & bonds

     14,348         —           (2,036     12,312         14,347         —           (3,596     10,751   

Pooled trust preferred

     1,792         —           (430     1,362         2,190         12         (910     1,292   

Pooled SBA

     34,763         665         (37     35,391         33,788         266         (92     33,962   

Other securities

     1,670         44         —          1,714         1,670         26         —          1,696   
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Total

   $ 537,747       $ 13,474       $ (3,057   $ 548,164       $ 503,694       $ 5,761       $ (8,778   $ 500,677   
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

At June 30, 2011, there were no holdings of securities of any one issuer, other than the U.S. Government and its agencies, in an amount greater than 10% of shareholders’ equity.

Trading securities accounted for under the fair value option at June 30, 2011 and December 31, 2010 are as follows:

 

     June 30,
2011
     December 31,
2010
 

Corporate equity securities

   $ 1,022       $ 952   

International mutual funds

     346         430   

U.S. Government sponsored entities

     176         147   

Large cap growth mutual funds

     166         139   

Certificates of deposit

     156         208   

Money market mutual funds

     151         75   

Real estate investment trust mutual funds

     127         —     

Large cap value mutual funds

     113         247   

Corporate notes and bonds

     99         96   

Small cap mutual funds

     43         29   

Mid cap mutual funds

     42         28   
  

 

 

    

 

 

 

Total

   $ 2,441       $ 2,351   
  

 

 

    

 

 

 

Securities with unrealized losses at June 30, 2011 and December 31, 2010, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, are as follows (in thousands):

 

June 30, 2011    Less than 12 Months     12 Months or More     Total  

Description of Securities

   Fair
Value
     Unrealized
Loss
    Fair
Value
     Unrealized
Loss
    Fair
Value
     Unrealized
Loss
 

U.S. Treasury

   $ —         $ —        $ —         $ —        $ —         $ —     

U.S. Gov’t sponsored entities

     5,769         (54     —           —          5,769         (54

State & political subdivisions

     17,749         (292     1,554         (10     19,303         (302

Residential mortgage & asset backed

     30,548         (172     2,689         (15     33,237         (187

Commercial mortgage & asset backed

     2,071         (11     —           —          2,071         (11

Corporate notes & bonds

     —           —          12,312         (2,036     12,312         (2,036

Pooled trust preferred

     982         (10     380         (420     1,362         (430

Pooled SBA

     9,290         (37     —           —          9,290         (37

Other securities

     —           —          —           —          —           —     
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 
   $ 66,409       $ (576   $ 16,935       $ (2,481   $ 83,344       $ (3,057
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

 

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Table of Contents
     Less than 12 Months     12 Months or More     Total  
     Fair
Value
     Unrealized
Loss
    Fair
Value
     Unrealized
Loss
    Fair
Value
     Unrealized
Loss
 

December 31, 2010

               

U.S. Treasury

   $ —         $ —        $ —         $ —        $ —         $ —     

U.S. Gov’t sponsored entities

     11,077         (403     —           —          11,077         (403

State & political subdivisions

     61,312         (2,440     3,904         (88     65,216         (2,528

Residential mortgage & asset backed

     69,576         (1,228     5,770         (21     75,346         (1,249

Corporate notes & bonds

     992         (3     9,770         (3,593     10,762         (3,596

Pooled trust preferred

     —           —          288         (910     288         (910

Pooled SBA

     12,147         (92     —           —          12,147         (92

Other securities

     —           —          —           —          —           —     
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 
   $ 155,104       $ (4,166   $ 19,732       $ (4,612   $ 174,836       $ (8,778
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

The Corporation evaluates securities for other-than-temporary impairment on a quarterly basis, or more frequently when economic or market conditions warrant such an evaluation.

At June 30, 2011, management evaluated the structured pooled trust preferred securities for other-than-temporary impairment by estimating the cash flows expected to be received from each security within the collateral pool, taking into account future estimated levels of deferrals and defaults by the underlying issuers, and discounting those cash flows at the appropriate accounting yield. Management also assumed that all issuers in deferral will default prior to their next payment date. Trust preferred collateral is deeply subordinated within issuers’ capital structures, so large recoveries are unlikely. Accordingly, management assumed 10% recoveries on bank collateral and none on collateral issued by other companies. Due to the current crisis in the U.S. economy, management also added a baseline default rate of 2% annually for the next two years to our default projections for specific issuers. This percentage represents the peak, post-war bank default rate that occurred at the height of the savings and loan crisis, which we believe is an accurate proxy for the current environment. Management expects that credit markets will begin to normalize and that banks with the financial strength to survive will default at a .36% average annual rate, which represents Moody’s idealized default probability for BBB corporate credits, and is in line with historical bank failure rates. In addition, management expects prepayments to occur at a rate of approximately 5% over a five year period, with the exception of certain large institutions that are expected to begin calling their collateral in 2011 and 2012 as a result of the elimination of the Tier I capital treatment of trust preferred securities for institutions with greater than $15 billion in assets beginning in 2013.

Using this methodology, five of the Corporation’s structured pooled trust preferred securities are deemed to be other-than-temporarily impaired. An impairment loss for the entire cost basis of two of these securities was recognized in earnings prior to 2010, and impairment losses for the remaining securities were recognized in earnings during 2011 as disclosed in the table below. The Corporation separated the other-than-temporary impairment related to these structured pooled trust preferred securities into (a) the amount of the total impairment related to credit loss, which is recognized in the income statement, and (b) the amount of the total impairment related to all other factors, which is recognized in other comprehensive income. The Corporation measured the credit loss component of other-than-temporary impairment based on the difference between the cost basis and the present value of cash flows expected to be collected.

 

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Table of Contents

The following table provides detailed information related to the Corporation’s structured pooled trust preferred securities as of and for the three months ended June 30, 2011:

 

     Adjusted
Amortized
Cost
     Unrealized
Gain (Loss)
    Fair
Value
     Credit Losses
Realized in Earnings
Three Months

Ended June 30, 2011
     Credit Losses
Realized in Earnings
Six Months

Ended June 30, 2011
 

ALESCO Preferred Funding V, Ltd.

   $ 800       $ (420   $ 380       $ —         $ —     

ALESCO Preferred Funding XII, Ltd.

     —           —          —           —           280   

ALESCO Preferred Funding XVII, Ltd.

     —           —          —           —           —     

Preferred Term Securities XVI, Ltd.

     —           —          —           —           118   

US Capital Funding VI, Ltd.

     —           —          —           —           —     

MM Community Funding II, Ltd.

     992         (10     982         —           —     
  

 

 

    

 

 

   

 

 

    

 

 

    

 

 

 

Total

   $ 1,792       $ (430   $ 1,362       $ —         $ 398   
  

 

 

    

 

 

   

 

 

    

 

 

    

 

 

 

A roll-forward of the other-than-temporary impairment amount related to credit losses for the three months ended June 30, 2011 is as follows:

 

Balance of credit losses on debt securities for which a portion of other-than-temporary impairment was recognized in other comprehensive income, beginning of period

   $ 4,054   

Additional credit loss for which other-than-temporary impairment was not previously recognized

     —     

Additional credit loss for which other-than-temporary impairment was previously recognized

     —     
  

 

 

 

Balance of credit losses on debt securities for which a portion of other-than-temporary impairment was recognized in other comprehensive income, end of period

   $ 4,054   
  

 

 

 

A roll-forward of the other-than-temporary impairment amount related to credit losses for the six months ended June 30, 2011 is as follows:

 

Balance of credit losses on debt securities for which a portion of other-than-temporary impairment was recognized in other comprehensive income, beginning of period

   $ 3,656   

Additional credit loss for which other-than-temporary impairment was not previously recognized

     —     

Additional credit loss for which other-than-temporary impairment was previously recognized

     398   
  

 

 

 

Balance of credit losses on debt securities for which a portion of other-than-temporary impairment was recognized in other comprehensive income, end of period

   $ 4,054   
  

 

 

 

A roll-forward of the other-than-temporary impairment amount related to credit losses for the three months ended June 30, 2010 is as follows:

 

Balance of credit losses on debt securities for which a portion of other-than-temporary impairment was recognized in other comprehensive income, beginning of period

   $ 2,199   

Additional credit loss for which other-than-temporary impairment was not previously recognized

     318   
  

 

 

 

Balance of credit losses on debt securities for which a portion of other-than-temporary impairment was recognized in other comprehensive income, end of period

   $ 2,517   
  

 

 

 

 

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Table of Contents

A roll-forward of the other-than-temporary impairment amount related to credit losses for the six months ended June 30, 2010 is as follows:

 

Balance of credit losses on debt securities for which a portion of other-than-temporary impairment was recognized in other comprehensive income, beginning of period

   $ 1,415   

Additional credit loss for which other-than-temporary impairment was not previously recognized

     1,102   
  

 

 

 

Balance of credit losses on debt securities for which a portion of other-than-temporary impairment was recognized in other comprehensive income, end of period

   $ 2,517   
  

 

 

 

At June 30, 2011, approximately 14% of the total unrealized losses relate to structured pooled trust preferred securities, primarily from issuers in the financial services industry, which are not currently trading in an active, open market with readily observable prices. As a result, these securities were classified within Level 3 of the valuation hierarchy. The fair values of these securities have been calculated using a discounted cash flow model and market liquidity premium. With the current market conditions, the assumptions used to determine the fair value of Level 3 securities has greater subjectivity due to the lack of observable market transactions. The fair values of these securities have declined due to the fact that subsequent offerings of similar securities pay a higher market rate of return. This higher rate of return reflects the increased credit and liquidity risks in the marketplace. Except as described above, based on management’s evaluation of the structured pooled trust preferred securities, the present value of the projected cash flows is sufficient for full repayment of the amortized cost of the securities and, therefore, it is believed that the decline in fair value is temporary due to current market conditions. However, without recovery of these securities, other-than-temporary impairments may occur in future periods.

For all of the securities that comprise corporate notes and bonds and states and political subdivisions, management monitors publicly available financial information such as filings with the Securities and Exchange Commission in order to evaluate the securities for other-than-temporary impairment. For financial institution issuers, management also monitors information from quarterly “call” report filings that are used to generate Uniform Bank Performance Reports. When reviewing this information, management considers the financial condition and near term prospects of the issuer and whether downgrades by bond rating agencies have occurred. Management also considers the length of time and extent to which fair value has been less than cost and the intent and ability of the Corporation to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value.

As of June 30, 2011 and December 31, 2010, management concluded that the previously mentioned securities were not other-than-temporarily impaired for the following reasons:

 

   

There is no indication of any significant deterioration of the creditworthiness of the institutions that issued the securities.

 

   

The unrealized losses are predominantly attributable to liquidity disruptions within the credit markets and the generally stressed condition of the financial services industry.

 

   

All contractual interest payments on the securities have been received as scheduled, and no information has come to management’s attention through the processes previously described which would lead to a conclusion that future contractual payments will not be received timely.

The Corporation does not intend to sell and it is not more likely than not that it will be required to sell the securities in an unrealized loss position before recovery of its amortized cost basis.

Information pertaining to security sales is as follows:

 

     Proceeds      Gross Gains      Gross Losses  

Three months ended June 30, 2011

   $ —         $  —         $  —     

Six months ended June 30, 2011

     23,610         146         (72

Three months ended June 30, 2010

     11,095         141         ( -

Six months ended June 30, 2010

     38,065         587         (14

 

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Table of Contents

The following is a schedule of the contractual maturity of securities available for sale, excluding equity securities, at June 30, 2011 and December 31, 2010:

 

     June 30, 2011      December 31, 2010  
     Amortized
Cost
     Fair
Value
     Amortized
Cost
     Fair
Value
 

1 year or less

   $ 18,580       $ 18,665       $ 30,210       $ 30,184   

1 year – 5 years

     61,681         63,109         54,476         55,030   

5 years – 10 years

     96,905         100,146         105,057         105,145   

After 10 years

     92,715         92,129         90,977         86,203   
  

 

 

    

 

 

    

 

 

    

 

 

 
     269,881         274,049         280,720         276,562   

Residential mortgage & asset backed securities

     264,114         270,330         221,304         222,419   

Commercial mortgage & asset backed securities

     2,082         2,071         —           —     
  

 

 

    

 

 

    

 

 

    

 

 

 

Total debt securities

   $ 536,077       $ 546,450       $ 502,024       $ 498,981   
  

 

 

    

 

 

    

 

 

    

 

 

 

Mortgage and asset backed securities are not due at a single date; periodic payments are received based on the payment patterns of the underlying collateral.

On June 30, 2011 and December 31, 2010, securities carried at $170,202 and $127,364, respectively, were pledged to secure public deposits and for other purposes as provided by law.

LOANS

Total net loans at June 30, 2011 and December 31, 2010 are summarized as follows:

 

     June 30,
2011
    December 31,
2010
 

Commercial, industrial, and agricultural

   $ 251,530      $ 257,491   

Commercial mortgages

     235,409        212,878   

Residential real estate

     280,029        266,604   

Consumer

     53,894        53,202   

Credit cards

     2,976        2,870   

Overdrafts

     617        3,964   

Less: unearned discount

     (2,668     (2,447

allowance for loan losses

     (11,715     (10,820
  

 

 

   

 

 

 

Loans, net

   $ 810,072      $ 783,742   
  

 

 

   

 

 

 

At June 30, 2011 and December 31, 2010, net unamortized loan costs and fees of ($89) and ($167), respectively, have been included in the carrying value of loans.

The Corporation’s outstanding loans and related unfunded commitments are primarily concentrated within Central and Western Pennsylvania. The Bank attempts to limit concentrations within specific industries by utilizing dollar limitations to single industries or customers, and by entering into participation agreements with third parties. Collateral requirements are established based on management’s assessment of the customer.

 

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Table of Contents

Transactions in the allowance for loan losses for the three months ended June 30, 2011 were as follows:

 

     Commercial,           Residential                          
     Industrial, and     Commercial     Real           Credit              
     Agricultural     Mortgages     Estate     Consumer     Cards     Overdrafts     Total  

Allowance for loan losses, April 1, 2011

   $ 3,732      $ 3,879      $ 1,879      $ 1,507      $ 96      $ 131      $ 11,224   

Charge-offs

     (173     (41     (63     (202     (7     (62     (548

Recoveries

     3        —          —          21        3        20        47   

Provision (benefit) for loan losses

     208        561        84        74        12        53        992   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Allowance for loan losses, June 30, 2011

   $ 3,770      $ 4,399      $ 1,900      $ 1,400      $ 104      $ 142      $ 11,715   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Transactions in the allowance for loan losses for the six months ended June 30, 2011 were as follows:

 

     Commercial,           Residential                          
     Industrial, and     Commercial     Real           Credit              
     Agricultural     Mortgages     Estate     Consumer     Cards     Overdrafts     Total  

Allowance for loan losses, January 1, 2011

   $ 3,517      $ 3,511      $ 1,916      $ 1,561      $ 96      $ 219      $ 10,820   

Charge-offs

     (215     (88     (77     (462     (25     (115     (982

Recoveries

     4        —          —          45        5        54        108   

Provision (benefit) for loan losses

     464        976        61        256        28        (16     1,769   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Allowance for loan losses, June 30, 2011

   $ 3,770      $ 4,399      $ 1,900      $ 1,400      $ 104      $ 142      $ 11,715   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Transactions in the allowance for loan losses for the three months ended June 30, 2010 were as follows:

 

Allowance for loan losses, April 1, 2010

   $ 9,914   

Charge-off

     (715

Recoveries

     55   

Provision for loan losses

     1,161   
  

 

 

 

Allowance for loan losses, June 30, 2010

   $ 10,415   
  

 

 

 

Transactions in the allowance for loan losses for the six months ended June 30, 2010 were as follows:

 

Allowance for loan losses, January 1, 2010

   $ 9,795   

Charge-off

     (1,256

Recoveries

     130   

Provision for loan losses

     1,746   
  

 

 

 

Allowance for loan losses, June 30, 2010

   $ 10,415   
  

 

 

 

The following table presents the balance in the allowance for loan losses and the recorded investment in loans by portfolio segment and is based on the Corporation’s impairment method as of June 30, 2011:

 

     Commercial,             Residential                              
     Industrial, and      Commercial      Real             Credit                
     Agricultural      Mortgages      Estate      Consumer      Cards      Overdrafts      Total  

Allowance for loan losses:

                    

Ending allowance balance attributable to loans:

                    

Individually evaluated for impairment

   $ 130       $ 698       $ 59       $ —         $ —         $ —         $ 887   

Collectively evaluated for impairment

     3,640         3,467         1,841         1,400         104         142         10,594   

Modified in a troubled debt restructuring

     —           234         —           —           —           —           234   

Acquired with deteriorated credit quality

     —           —           —           —           —           —           —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total ending allowance balance

   $ 3,770       $ 4,399       $ 1,900       $ 1,400       $ 104       $ 142       $ 11,715   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Loans:

                    

Loans individually evaluated for impairment

   $ 1,429       $ 15,066       $ 184       $ —         $ —         $ —         $ 16,679   

Loans collectively evaluated for impairment

     250,101         215,592         279,845         53,894         2,976         617         803,025   

Loans modified in a troubled debt restructuring

     —           4,751         —           —           —           —           4,751   

Loans acquired with deteriorated credit quality

     —           —           —           —           —           —           —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total ending loans balance

   $ 251,530       $ 235,409       $ 280,029       $ 53,894       $ 2,976       $ 617       $ 824,455   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

21


Table of Contents

The following table presents the balance in the allowance for loan losses and the recorded investment in loans by portfolio segment and is based on the Corporation’s impairment method as of December 31, 2010:

 

     Commercial,             Residential                              
     Industrial, and      Commercial      Real             Credit                
     Agricultural      Mortgages      Estate      Consumer      Cards      Overdrafts      Total  

Allowance for loan losses:

                    

Ending allowance balance attributable to loans:

                    

Individually evaluated for impairment

   $ 142       $ 509       $ 69       $ —         $ —         $ —         $ 720   

Collectively evaluated for impairment

     3,375         2,759         1,847         1,561         96         219         9,857   

Modified in a troubled debt restructuring

     —           243         —           —           —           —           243   

Acquired with deteriorated credit quality

     —           —           —           —           —           —           —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total ending allowance balance

   $ 3,517       $ 3,511       $ 1,916       $ 1,561       $ 96       $ 219       $ 10,820   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Loans:

                    

Loans individually evaluated for impairment

   $ 2,616       $ 8,759       $ 235       $ —         $ —         $ —         $ 11,610   

Loans collectively evaluated for impairment

     254,875         202,405         266,369         53,202         2,870         3,964         783,685   

Loans modified in a troubled debt restructuring

     —           1,714         —           —           —           —           1,714   

Loans acquired with deteriorated credit quality

     —           —           —           —           —           —           —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total ending loans balance

   $ 257,491       $ 212,878       $ 266,604       $ 53,202       $ 2,870       $ 3,964       $ 797,009   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

The following tables present information related to loans individually evaluated for impairment by portfolio segment as of and for the three and six months ended June 30, 2011:

 

     Unpaid             Allowance for  
     Principal      Recorded      Loan Losses  
     Balance      Investment      Allocated  

With an allowance recorded:

        

Commercial, industrial, and agricultural

   $ 600       $ 509       $ 130   

Commercial mortgage

     8,185         7,336         932   

Residential real estate

     267         184         59   

With no related allowance recorded:

        

Commercial, industrial, and agricultural

     1,390         920         —     

Commercial mortgage

     9,490         7,730         —     

Residential real estate

     —           —           —     
  

 

 

    

 

 

    

 

 

 

Total

   $ 19,932       $ 16,679       $ 1,121   
  

 

 

    

 

 

    

 

 

 

 

     Three Months Ended June 30, 2011      Six Months Ended June 30, 2011  
     Average      Interest      Cash Basis      Average      Interest      Cash Basis  
     Recorded      Income      Interest      Recorded      Income      Interest  
     Investment      Recognized      Recognized      Investment      Recognized      Recognized  

With an allowance recorded:

                 

Commercial, industrial, and agricultural

   $ 1,183       $ —         $ —         $ 1,660       $ —         $ —     

Commercial mortgage

     8,835         14         14         8,810         16         16   

Residential real estate

     185         —           —           202         —           —     

With no related allowance recorded:

                 

Commercial, industrial, and agricultural

     2,411         —           —           1,607         —           —     

Commercial mortgage

     4,584         —           —           3,506         —           —     

Residential real estate

     —           —           —           —           —           —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 17,198       $ 14       $ 14       $ 15,785       $ 16       $ 16   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

22


Table of Contents

The following table presents information related to loans individually evaluated for impairment by portfolio segment as of December 31, 2010:

 

     Unpaid
Principal
Balance
     Recorded
Investment
     Allowance for
Loan Losses
Allocated
 

With an allowance recorded:

        

Commercial, industrial, and agricultural

   $ 3,041       $ 2,616       $ 142   

Commercial mortgage

     13,070         10,473         752   

Residential real estate

     339         235         69   

With no related allowance recorded:

        

Commercial, industrial, and agricultural

     —           —           —     

Commercial mortgage

     —           —           —     

Residential real estate

     —           —           —     
  

 

 

    

 

 

    

 

 

 

Total

   $ 16,450       $ 13,324       $ 963   
  

 

 

    

 

 

    

 

 

 

The unpaid principal balance of impaired loans includes the Corporation’s recorded investment in the loan and amounts that have been charged off.

The following table presents information for loans individually evaluated for impairment during the three months ended June 30, 2010:

 

Average of individually impaired loans during period

   $ 14,718   

Interest income recognized during impairment

     241   

Cash basis interest income recognized during impairment

     241   

The following table presents information for loans individually evaluated for impairment during the six months ended June 30, 2010:

 

Average of individually impaired loans during period

   $ 15,046   

Interest income recognized during impairment

     340   

Cash basis interest income recognized during impairment

     340   

The following tables present the recorded investment in nonaccrual loans and loans past due over 90 days still on accrual by portfolio segment as of June 30, 2011 and December 31, 2010:

 

     Nonaccrual      Past Due Over 90 Days
Still on Accrual
 

June 30, 2011

     

Commercial, industrial, and agricultural

   $ 7,195       $ 1,499   

Commercial mortgages

     7,539         125   

Residential real estate

     1,339         135   

Consumer

     25         116   

Credit cards

     —           34   
  

 

 

    

 

 

 

Total

   $ 16,098       $ 1,909   
  

 

 

    

 

 

 

 

     Nonaccrual      Past Due Over 90 Days
Still on Accrual
 

December 31, 2010

     

Commercial, industrial, and agricultural

   $ 2,344       $ 23   

Commercial mortgages

     8,276         321   

Residential real estate

     1,306         386   

Consumer

     —           154   

Credit cards

     —           5   
  

 

 

    

 

 

 

Total

   $ 11,926       $ 889   
  

 

 

    

 

 

 

 

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Nonaccrual loans and loans past due over 90 days still on accrual include both smaller balance homogeneous loans that are collectively evaluated for impairment and individually classified impaired loans.

The following tables present the aging of the recorded investment in past due loans as of June 30, 2011 and December 31, 2010 by class of loans:

 

                   Greater Than                       
June 30, 2011    30-59 Days
Past Due
     60-89 Days
Past Due
     90 Days
Past Due
     Total Past
Due
     Loans Not
Past Due
     Total  

Commercial, industrial, and agricultural

   $ 111       $ 344       $ 8,694       $ 9,149       $ 242,381       $ 251,530   

Commercial mortgages

     2,527         1,927         7,664         12,118         223,291         235,409   

Residential real estate

     1,249         342         1,474         3,065         276,964         280,029   

Consumer

     420         212         141         773         53,121         53,894   

Credit cards

     13         15         34         62         2,914         2,976   

Overdrafts

     —           —           —           —           617         617   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 4,320       $ 2,840       $ 18,007       $ 25,167       $ 799,288       $ 824,455   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

                   Greater Than                       
December 31, 2010    30-59 Days
Past Due
     60-89 Days
Past Due
     90 Days
Past Due
     Total Past
Due
     Loans Not
Past Due
     Total  

Commercial, industrial, and agricultural

   $ 225       $ 2,512       $ 2,367       $ 5,104       $ 252,387       $ 257,491   

Commercial mortgages

     129         1,184         8,597         9,910         202,968         212,878   

Residential real estate

     1,629         262         1,692         3,583         263,021         266,604   

Consumer

     455         145         154         754         52,448         53,202   

Credit cards

     20         10         5         35         2,835         2,870   

Overdrafts

     —           —           —           —           3,964         3,964   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 2,458       $ 4,113       $ 12,815       $ 19,386       $ 777,623       $ 797,009   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Troubled Debt Restructurings

The Corporation has allocated $234 and $243 of specific reserves to customers whose loan terms have been modified in troubled debt restructurings as of June 30, 2011 and December 31, 2010, respectively. The Corporation has no further loan commitments to customers whose loans are classified as a troubled debt restructuring.

Credit Quality Indicators

The Corporation classifies commercial, industrial, and agricultural loans and commercial mortgage 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. The Corporation analyzes loans individually by classifying the loans as to credit risk. This analysis includes loans with an outstanding balance greater than $1 million bi-annually and loans with an outstanding balance of less than $1 million at least annually.

The Corporation uses the following definitions for risk ratings:

Special Mention: Loans classified as special mention have a potential weakness that deserves management’s close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the loan or of the Corporation’s credit position at some future date.

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

 

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Table of Contents

Doubtful: Loans classified as doubtful have all the weaknesses inherent in those classified as substandard, with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions, and values, highly questionable and improbable.

Loans not rated as special mention, substandard, or doubtful are considered to be pass rated loans. All loans included in the following tables have been assigned a risk rating within 12 months of the balance sheet date.

 

June 30, 2011    Pass      Special
Mention
     Substandard      Doubtful      Total  

Commercial, industrial, and agricultural

   $ 217,377       $ 15,147       $ 19,006       $ —         $ 251,530   

Commercial mortgages

     213,103         4,635         17,550         121         235,409   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 430,480       $ 19,782       $ 36,556       $ 121       $ 486,939   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

December 31, 2010    Pass      Special
Mention
     Substandard      Doubtful      Total  

Commercial, industrial, and agricultural

   $ 223,196       $ 4,830       $ 29,450       $ 15       $ 257,491   

Commercial mortgages

     188,846         7,673         16,249         110         212,878   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 412,042       $ 12,503       $ 45,699       $ 125       $ 470,369   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

The Corporation’s portfolio of residential real estate and consumer loans maintained within Holiday Financial Services Corporation (“Holiday”), our subsidiary that offers small balance unsecured loans, primarily collateralized by automobiles and equipment, to borrowers with higher risk characteristics, are considered to be subprime loans. Holiday originates small balance unsecured loans and secured loans, primarily collateralized by automobiles and equipment, to borrowers with higher credit risk characteristics than are typical in the consumer loan portfolio held by the Bank. Holiday’s loan portfolio is summarized as follows at June 30, 2011 and December 31, 2010:

 

     June 30,
2011
    December 31,
2010
 

Consumer

   $ 17,040      $ 16,532   

Residential real estate

     1,059        1,149   

Less: unearned discount

     (2,668     (2,447
  

 

 

   

 

 

 

Total

   $ 15,431      $ 15,234   
  

 

 

   

 

 

 

The Corporation considers the performance of the loan portfolio and its impact on the allowance for loan losses. For residential real estate and consumer loan classes, the Corporation also evaluates credit quality based on the aging status of the loan, which was previously presented, and by payment activity. The following table presents the recorded investment in residential and consumer loans based on payment activity as of June 30, 2011 and December 31, 2010:

 

     June 30, 2011      December 31, 2010  
     Residential
Real Estate
     Consumer      Residential
Real Estate
     Consumer  

Performing

   $ 278,555       $ 53,753       $ 264,912       $ 53,048   

Non-performing

     1,474         141         1,692         154   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 280,029       $ 53,894       $ 266,604       $ 53,202   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

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Table of Contents

FEDERAL HOME LOAN BANK (FHLB) STOCK

As a member of the Federal Home Loan Bank of Pittsburgh (“FHLB”), the Corporation is required to purchase and hold stock in the FHLB to satisfy membership and borrowing requirements. This stock is restricted in that it can only be sold to the FHLB or to another member institution, and all sales of FHLB stock must be at par. As a result of these restrictions, FHLB stock is unlike other investment securities insofar as there is no trading market for FHLB stock and the transfer price is determined by FHLB membership rules and not by market participants.

As of June 30, 2011, the Corporation holds $5,418 of stock in FHLB. In December 2008, the FHLB voluntarily suspended dividend payments on its stock, as well as the repurchase of excess stock from members. The FHLB cited a significant reduction in the level of core earnings resulting from lower short-term interest rates, the increased cost of liquidity, and constrained access to the debt markets at attractive rates and maturities as the main reasons for the decision to suspend dividends and the repurchase of excess capital stock. The FHLB last paid a dividend in the third quarter of 2008.

FHLB stock is held as a long-term investment and its value is determined based on the ultimate recoverability of the par value. The Company evaluates impairment quarterly. The decision of whether impairment exists is a matter of judgment that reflects our view of the FHLB’s long-term performance, which includes factors such as the following:

 

   

its operating performance;

 

   

the severity and duration of declines in the fair value of its net assets related to its capital stock amount;

 

   

its commitment to make payments required by law or regulation and the level of such payments in relation to its operating performance;

 

   

the impact of legislative and regulatory changes on the FHLB, and accordingly, on the members of FHLB; and

 

   

its liquidity and funding position

After evaluating all of these considerations, the Corporation concluded that the par value of its investment in FHLB stock will be recovered. Accordingly, no impairment charge was recorded on these securities. Our evaluation of the factors described above in future periods could result in the recognition of impairment charges on FHLB stock.

DEPOSITS

Total deposits at June 30, 2011 and December 31, 2010 are summarized as follows (in thousands):

 

     Percentage
Change
    June 30, 2011      December 31, 2010  

Checking, non-interest bearing

     5.1   $ 148,022       $ 140,836   

Checking, interest bearing

     5.6     300,610         284,538   

Savings accounts

     32.3     487,118         368,055   

Certificates of deposit

     (15.2 %)      313,322         369,439   
    

 

 

    

 

 

 
     7.4   $ 1,249,072       $ 1,162,868   
    

 

 

    

 

 

 

EARNINGS PER SHARE

Basic earnings per share is computed by dividing net income by the weighted average number of shares outstanding during the applicable period, excluding outstanding participating securities. Diluted earnings per share is computed using the weighted average number of shares determined for the basic computation plus the dilutive effect of potential common shares issuable under certain stock compensation plans. For the three and six months ended June 30, 2011, 84,250 shares issuable pursuant to outstanding stock options were excluded from the diluted earnings per share calculations since they were anti-dilutive. For the three and six months ended June 30, 2010, 86,750 shares issuable pursuant to outstanding stock options were excluded from the diluted earnings per share calculations since they were anti-dilutive.

 

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Table of Contents

Unvested share-based payment awards that contain nonforfeitable rights to dividends or dividend equivalents (whether paid or unpaid) are participating securities and are included in the computation of earnings per share pursuant to the two-class method. The Corporation has determined that its outstanding non-vested stock awards are participating securities.

The computation of basic and diluted earnings per share is shown below (in thousands except per share data):

 

     Three months
ended
June 30,
    Six months
ended
June 30,
 
     2011     2010     2011     2010  

Basic earnings per common share computation:

        

Distributed earnings allocated to common stock

   $ 2,021      $ 1,447      $ 4,038      $ 2,892   

Undistributed earnings allocated to common stock

     1,558        1,665        3,107        2,371   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net earnings allocated to common stock

   $ 3,879      $ 3,112      $ 7,145      $ 5,263   
  

 

 

   

 

 

   

 

 

   

 

 

 

Weighted average common shares outstanding, including shares considered participating securities

     12,291        9,253        12,277        9,019   

Less: Average participating securities

     (36     (31     (37     (32
  

 

 

   

 

 

   

 

 

   

 

 

 

Weighted average shares

     12,255        9,222        12,240        8,987   
  

 

 

   

 

 

   

 

 

   

 

 

 

Basic earnings per common share

   $ 0.32      $ 0.34      $ 0.58      $ 0.59   
  

 

 

   

 

 

   

 

 

   

 

 

 

Diluted earnings per common share computation:

        

Net earnings allocated to common stock

   $ 3,879      $ 3,112      $ 7,145      $ 5,263   
  

 

 

   

 

 

   

 

 

   

 

 

 

Weighted average common shares outstanding for basic earnings per common share

     12,255        9,222        12,240        8,987   

Add: Dilutive effects of assumed exercises of stock options

     6        9        7        11   
  

 

 

   

 

 

   

 

 

   

 

 

 

Weighted average shares and dilutive potential common shares

     12,261        9,231        12,247        8,998   
  

 

 

   

 

 

   

 

 

   

 

 

 

Diluted earnings per common share

   $ 0.32      $ 0.34      $ 0.58      $ 0.58   
  

 

 

   

 

 

   

 

 

   

 

 

 

DERIVATIVE INSTRUMENTS

The Corporation records all derivatives on the balance sheet at fair value. The accounting for changes in the fair value of derivatives depends on the intended use of the derivative and the resulting designation. Derivatives used to hedge the exposure to changes in the fair value of an asset, liability, or firm commitment attributable to a particular risk, such as interest rate risk, are considered fair value hedges. Derivatives used to hedge the exposure to variability in expected future cash flows, or other types of forecasted transactions, are considered cash flow hedges.

For derivatives designated as cash flow hedges, the effective portion of the changes in the fair value of the derivative is initially reported in other comprehensive income (outside of earnings) and subsequently reclassified into earnings when the hedged transaction affects earnings, and the ineffective portion of changes in the fair value of the derivative is recognized directly in earnings. The Corporation assesses the effectiveness of each hedging relationship by comparing the changes in cash flows of the derivative hedging instrument with the changes in cash flows of the designated hedged item or transaction.

On August 1, 2008, the Corporation executed an interest rate swap agreement with a 5 year term and an effective date of September 15, 2008 in order to hedge $10 million of a subordinated note that was entered into by the Corporation during 2007 and elected cash flow hedge accounting for the agreement. The Corporation’s objective in using this derivative is to add stability to interest expense and to manage its exposure to interest rate risk. The interest rate swap involves the receipt of variable-rate amounts in exchange for fixed-rate payments from August 1, 2008 to September 15, 2013 without exchange of the underlying notional amount. At June 30, 2011, the variable rate on the subordinated debt was 1.80% (LIBOR plus 155 basis points) and the Corporation was paying 5.84% (4.29% fixed rate plus 155 basis points).

 

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Table of Contents

In anticipation of the expiration of the 5 year interest rate swap agreement discussed immediately above, on May 3, 2011, the Corporation executed an interest rate swap agreement with a 5 year term and an effective date of September 15, 2013 which as of that effective date, will hedge $10 million of the subordinated note discussed immediately above. As with the prior interest rate swap agreement, the Corporation’s objective in using this derivative is to add stability to interest expense and to manage its exposure to interest rate risk. The interest rate swap involves the receipt of variable-rate amounts in exchange for fixed-rate payments from September 15, 2013 to September 15, 2018 without exchange of the underlying notional amount. On the effective date, the variable rate on the subordinated debt will be LIBOR plus 155 basis points and the Corporation will be paying 5.57% (4.02% fixed rate plus 155 basis points).

As of June 30, 2011, no derivatives were designated as fair value hedges or hedges of net investments in foreign operations. Additionally, the Corporation does not use derivatives for trading or speculative purposes and currently does not have any derivatives that are not designated as hedges.

The following tables provide information about the amounts and locations of activity related to the interest rate swaps designated as cash flow hedges within the Corporation’s consolidated balance sheet and statement of income as of and for the three and six months ended June 30, 2011 (in thousands):

 

As of June 30, 2011

   Liability Derivative         
     Balance Sheet
Location
  Fair Value              

Interest rate contract

   Accrued interest payable

and other liabilities

  $ (987      

For the Three Months

          

Ended June 30, 2011

   (a)     (b)      (c)   (d)   (e)

Interest rate contract

   $(145)    

 

Interest expense –

subordinated debentures

  

  

  $(101)   Other income   $—
  

For the Six Months

          

Ended June 30, 2011

   (a)     (b)      (c)   (d)   (e)

Interest rate contract

   $(78)    

 

Interest expense –

subordinated debentures

  

  

  $(201)   Other income   $—
  

 

(a) Amount of Gain or (Loss) Recognized in Other Comprehensive Loss on Derivative (Effective Portion), net of tax
(b) Location of Gain or (Loss) Reclassified from Accumulated Other Comprehensive Loss into Income (Effective Portion)