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 September 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 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 November 7, 2011

COMMON STOCK NO PAR VALUE PER SHARE: 12,352,641 SHARES

 

 

 


Table of Contents

INDEX

 

      Page Number  

  PART I.

  FINANCIAL INFORMATION

  

  

ITEM 1 – Financial Statements (unaudited)

  

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

     1   

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

     2   

Consolidated Statements of Income – Nine months ended September 30, 2011 and 2010

     3   

Consolidated Statements of Comprehensive Income – Three and nine month periods ended September  30, 2011 and 2010

     4   

Consolidated Statements of Cash Flows – Nine months ended September 30, 2011 and 2010

     5   

Notes to Consolidated Financial Statements

     6   

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

     28   

ITEM 3 – Quantitative and Qualitative Disclosures about Market Risk

     37   

ITEM 4 – Controls and Procedures

     39   

  PART II.

  

  OTHER INFORMATION

  

ITEM 1 – Legal Proceedings

     39   

ITEM 1A – Risk Factors

     39   

ITEM 6 – Exhibits

     39   

Signatures

     40   


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.


Table of Contents

Part I Financial Information

Item 1. Financial Statements

CONSOLIDATED BALANCE SHEETS

Dollars in thousands

 

 

 

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

Cash and due from banks

   $ 37,549      $ 24,584   

Interest bearing deposits with other banks

     3,627        12,848   
  

 

 

   

 

 

 

Total cash and cash equivalents

     41,176        37,432   

Interest bearing time deposits with other banks

     224        2,817   

Securities available for sale

     592,505        500,677   

Trading securities

     2,756        2,351   

Loans held for sale

     1,049        4,451   

Loans

     838,503        797,009   

Less: unearned discount

     (2,837     (2,447

Less: allowance for loan losses

     (12,252     (10,820
  

 

 

   

 

 

 

Net loans

     823,414        783,742   

FHLB and other equity interests

     6,594        6,415   

Premises and equipment, net

     24,247        24,135   

Bank owned life insurance

     25,416        19,742   

Mortgage servicing rights

     927        908   

Goodwill

     10,821        10,821   

Accrued interest receivable and other assets

     14,543        20,020   
  

 

 

   

 

 

 

TOTAL

   $ 1,543,672      $ 1,413,511   
  

 

 

   

 

 

 
LIABILITIES AND SHAREHOLDERS’ EQUITY   

Non-interest bearing deposits

   $ 152,127      $ 140,836   

Interest bearing deposits

     1,145,435        1,022,032   
  

 

 

   

 

 

 

Total deposits

     1,297,562        1,162,868   

Treasury, tax and loan borrowings

     1,280        1,248   

FHLB and other borrowings

     74,144        105,259   

Subordinated debentures

     20,620        20,620   

Accrued interest payable and other liabilities

     19,635        13,871   
  

 

 

   

 

 

 

Total liabilities

     1,413,241        1,303,866   
  

 

 

   

 

 

 

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

     0        0   

Additional paid in capital

     44,458        44,676   

Retained earnings

     78,209        73,059   

Treasury stock, at cost (271,860 shares at September 30, 2011 and 362,342 shares at December 31, 2010)

     (4,023     (5,417

Accumulated other comprehensive income (loss)

     11,787        (2,673
  

 

 

   

 

 

 

Total shareholders’ equity

     130,431        109,645   
  

 

 

   

 

 

 

TOTAL

   $ 1,543,672      $ 1,413,511   
  

 

 

   

 

 

 

 

 

See Notes to Consolidated Financial Statements

 

1


Table of Contents

CONSOLIDATED STATEMENTS OF INCOME (unaudited)

Dollars in thousands, except per share data

 

 

 

     Three months ended
September 30,
 
     2011     2010  

INTEREST AND DIVIDEND INCOME:

    

Loans including fees

   $ 12,344      $ 11,813   

Deposits with banks

     20        25   

Securities:

    

Taxable

     3,689        3,270   

Tax-exempt

     732        683   

Dividends

     8        6   
  

 

 

   

 

 

 

Total interest and dividend income

     16,793        15,797   
  

 

 

   

 

 

 

INTEREST EXPENSE:

    

Deposits

     3,424        3,340   

Borrowed funds

     796        993   

Subordinated debentures

     195        201   
  

 

 

   

 

 

 

Total interest expense

     4,415        4,534   
  

 

 

   

 

 

 

NET INTEREST INCOME

     12,378        11,263   

PROVISION FOR LOAN LOSSES

     904        853   
  

 

 

   

 

 

 

NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES

     11,474        10,410   
  

 

 

   

 

 

 

NON-INTEREST INCOME:

    

Wealth and asset management fees

     415        431   

Service charges on deposit accounts

     1,097        1,120   

Other service charges and fees

     433        374   

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

     (313     15   

Mortgage banking

     172        116   

Bank owned life insurance

     213        200   

Other

     361        288   
  

 

 

   

 

 

 
     2,378        2,544   
  

 

 

   

 

 

 

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

     0        (821

Less portion of loss recognized in other comprehensive income

     0        0   
  

 

 

   

 

 

 

Net impairment losses recognized in earnings

     0        (821

Net realized gains on available-for-sale securities

     84        118   
  

 

 

   

 

 

 

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

     84        (703
  

 

 

   

 

 

 

Total non-interest income

     2,462        1,841   
  

 

 

   

 

 

 

NON-INTEREST EXPENSES:

    

Salaries and benefits

     4,402        3,998   

Net occupancy expense of premises

     1,076        1,053   

FDIC insurance premiums

     240        427   

Amortization of intangibles

     0        25   

Other

     2,592        2,610   
  

 

 

   

 

 

 

Total non-interest expenses

     8,310        8,113   
  

 

 

   

 

 

 

INCOME BEFORE INCOME TAXES

     5,626        4,138   

INCOME TAX EXPENSE

     1,559        1,032   
  

 

 

   

 

 

 

NET INCOME

   $ 4,067      $ 3,106   
  

 

 

   

 

 

 

EARNINGS PER SHARE:

    

Basic

   $ 0.33      $ 0.25   

Diluted

   $ 0.33      $ 0.25   

DIVIDENDS PER SHARE:

    

Cash dividends per share

   $ 0.165      $ 0.165   

 

 

See Notes to Consolidated Financial Statements

 

2


Table of Contents

CONSOLIDATED STATEMENTS OF INCOME (unaudited)

Dollars in thousands, except per share data

 

 

 

     Nine months ended
September 30,
 
     2011     2010  

INTEREST AND DIVIDEND INCOME:

    

Loans including fees

   $ 36,011      $ 34,940   

Deposits with banks

     102        88   

Securities:

    

Taxable

     10,640        8,539   

Tax-exempt

     2,128        1,706   

Dividends

     23        20   
  

 

 

   

 

 

 

Total interest and dividend income

     48,904        45,293   
  

 

 

   

 

 

 

INTEREST EXPENSE:

    

Deposits

     10,360        10,148   

Borrowed funds

     2,373        3,170   

Subordinated debentures

     582        586   
  

 

 

   

 

 

 

Total interest expense

     13,315        13,904   
  

 

 

   

 

 

 

NET INTEREST INCOME

     35,589        31,389   

PROVISION FOR LOAN LOSSES

     2,673        2,599   
  

 

 

   

 

 

 

NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES

     32,916        28,790   
  

 

 

   

 

 

 

NON-INTEREST INCOME:

    

Wealth and asset management fees

     1,225        1,255   

Service charges on deposit accounts

     3,129        3,117   

Other service charges and fees

     1,201        1,048   

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

     (216     (42

Mortgage banking

     506        365   

Bank owned life insurance

     674        602   

Other

     986        841   
  

 

 

   

 

 

 
     7,505        7,186   
  

 

 

   

 

 

 

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

     (398     (1,923

Less portion of loss recognized in other comprehensive income

     0        0   
  

 

 

   

 

 

 

Net impairment losses recognized in earnings

     (398     (1,923

Net realized gains on available-for-sale securities

     158        691   
  

 

 

   

 

 

 

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

     (240     (1,232
  

 

 

   

 

 

 

Total non-interest income

     7,265        5,954   
  

 

 

   

 

 

 

NON-INTEREST EXPENSES:

    

Salaries and benefits

     12,842        11,689   

Net occupancy expense of premises

     3,378        3,204   

FDIC insurance premiums

     969        1,202   

Amortization of intangibles

     0        75   

Other

     7,553        7,434   
  

 

 

   

 

 

 

Total non-interest expenses

     24,742        23,604   
  

 

 

   

 

 

 

INCOME BEFORE INCOME TAXES

     15,439        11,140   

INCOME TAX EXPENSE

     4,204        2,750   
  

 

 

   

 

 

 

NET INCOME

   $ 11,235      $ 8,390   
  

 

 

   

 

 

 

EARNINGS PER SHARE:

    

Basic

   $ 0.91      $ 0.83   

Diluted

   $ 0.91      $ 0.83   

DIVIDENDS PER SHARE:

    

Cash dividends per share

   $ 0.495      $ 0.495   

 

 

See Notes to Consolidated Financial Statements

 

3


Table of Contents

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (unaudited)

Dollars in thousands

 

 

 

     Three months ended
September 30,
    Nine months ended
September 30,
 
     2011     2010     2011     2010  

NET INCOME

   $ 4,067      $ 3,106      $ 11,235      $ 8,390   

Other comprehensive income, net of tax:

        

Change in fair value of interest rate swap agreements designated as cash flow hedges, net of tax of $237 and $33 for the three months ended September 30, 2011 and 2010, and $279 and $115 for the nine months ended September 30, 2011 and 2010

     (440     (61     (519     (213

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

        

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

        

Unrealized losses arising during the period, net of tax of $49 and $36 for the three months ended September 30, 2011 and 2010, and $17 and $172 for the nine months ended September 30, 2011 and 2010

     (91     (66     (31     (320

Reclassification adjustment for losses included in net income, net of tax of ($287) for the three months ended September 30, 2010, and ($139) and ($673) for the nine months ended September 30, 2011 and 2010

     0        534        259        1,250   
  

 

 

   

 

 

   

 

 

   

 

 

 
     (91     468        228        930   
  

 

 

   

 

 

   

 

 

   

 

 

 

Unrealized gains on other securities available for sale:

        

Unrealized gains arising during the period, net of tax of ($3,441) and ($3,315) for the three months ended September 30, 2011 and 2010, and ($7,998) and ($6,094) for the nine months ended September 30, 2011 and 2010

     6,391        6,156        14,854        11,317   

Reclassification adjustment for accumulated gains included in net income, net of tax of $29 and $41 for the three months ended ended September 30, 2011 and 2010, and $55 and $242 for the nine months ended September 30, 2011 and 2010

     (55     (77     (103     (449
  

 

 

   

 

 

   

 

 

   

 

 

 
     6,336        6,079        14,751        10,868   
  

 

 

   

 

 

   

 

 

   

 

 

 

Other comprehensive income

     5,805        6,486        14,460        11,585   
  

 

 

   

 

 

   

 

 

   

 

 

 

COMPREHENSIVE INCOME

   $ 9,872      $ 9,592      $ 25,695      $ 19,975   
  

 

 

   

 

 

   

 

 

   

 

 

 

 

 

See Notes to Consolidated Financial Statements

 

4


Table of Contents

CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited)

Dollars in thousands

 

 

 

     Nine months ended
September 30,
 
     2011     2010  

CASH FLOWS FROM OPERATING ACTIVITIES:

    

Net income

   $ 11,235      $ 8,390   

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

    

Provision for loan losses

     2,673        2,599   

Depreciation and amortization

     1,539        1,533   

Amortization, accretion and deferred loan fees and costs

     1,898        1,588   

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

     240        1,232   

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

     216        42   

Proceeds from sale of securities for which fair value was elected

     170        0   

Purchase of securities for which fair value was elected

     (899     0   

Gain on sale of loans

     (424     (270

Net gains on dispositions of premises and equipment and foreclosed assets

     (102     (101

Proceeds from sale of loans

     14,735        6,008   

Origination of loans held for sale

     (11,109     (11,932

Earnings on bank owned life insurance

     (674     (602

Stock-based compensation expense

     164        166   

Contribution of treasury stock

     90        0   

Changes in:

    

Accrued interest receivable and other assets

     (2,347     (2,602

Accrued interest payable and other liabilities

     4,966        (269
  

 

 

   

 

 

 

NET CASH PROVIDED BY OPERATING ACTIVITIES

     22,371        5,782   
  

 

 

   

 

 

 

CASH FLOWS FROM INVESTING ACTIVITIES:

    

Net decrease in interest bearing time deposits with other banks

     2,593        2,871   

Proceeds from maturities, prepayments and calls of securities

     75,791        86,330   

Proceeds from sales of securities

     43,763        51,507   

Purchase of securities

     (190,487     (279,073

Loan origination and payments, net

     (42,318     (36,251

Purchase of bank owned life insurance

     (5,000     (2,500

Redemption (purchase) of FHLB and other equity interests

     (179     181   

Purchase of premises and equipment

     (1,483     (1,542

Proceeds from the sale of premises and equipment and foreclosed assets

     245        287   
  

 

 

   

 

 

 

NET CASH USED IN INVESTING ACTIVITIES

     (117,075     (178,190
  

 

 

   

 

 

 

CASH FLOWS FROM FINANCING ACTIVITIES:

    

Net change in:

    

Checking, money market and savings accounts

     215,087        130,487   

Certificates of deposit

     (80,393     27,309   

Proceeds from sale of treasury stock

     922        923   

Proceeds from exercise of stock options

     0        69   

Proceeds from stock offering, net of issuance costs

     0        32,128   

Cash dividends paid

     (6,085     (4,916

Proceeds from long-term borrowings

     350        20,000   

Repayment of long-term borrowings

     (95     (36,085

Net change in short-term borrowings

     (31,338     10,927   
  

 

 

   

 

 

 

NET CASH PROVIDED BY FINANCING ACTIVITIES

     98,448        180,842   
  

 

 

   

 

 

 

NET INCREASE IN CASH AND CASH EQUIVALENTS

     3,744        8,434   

CASH AND CASH EQUIVALENTS, Beginning

     37,432        22,358   
  

 

 

   

 

 

 

CASH AND CASH EQUIVALENTS, Ending

   $ 41,176      $ 30,792   
  

 

 

   

 

 

 

SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:

    

Cash paid during the period for:

    

Interest

   $ 13,626      $ 14,207   

Income taxes

     3,317        3,314   

SUPPLEMENTAL NONCASH DISCLOSURES:

    

Transfers to other real estate owned

     93        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

 

5


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 September 30, 2011 and for the three and nine month periods ended September 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 periods presented. The financial performance reported for CNB Financial Corporation (the “Corporation”) for the three and nine month periods ended September 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 Annual Report on Form 10-K for the period ended December 31, 2010 (the “2010 Form 10-K”). All dollar 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 aggregate grants of 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 September 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 and nine month periods 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 $62 and $164 for the three and nine months ended September 30, 2011, and $44 and $166 for the three and nine months ended September 30, 2010. As of September 30, 2011, there was $447 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 September 30, 2011 follows:

 

     Shares     Weighted Average
Grant Date Fair Value
 

Nonvested at beginning of period

     40,281      $ 15.12   

Granted

     —          —     

Vested

     (1,319     14.81   

Forfeited

     —          —     
  

 

 

   

 

 

 

Nonvested at end of period

     38,962      $ 15.12   
  

 

 

   

 

 

 

 

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Table of Contents

A summary of changes in unvested restricted stock awards for the nine months ended September 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

     (9,148     14.59   

Forfeited

     (1,188     14.85   
  

 

 

   

 

 

 

Nonvested at end of period

     38,962      $ 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 losses that were included in earnings for the three and nine months ended September 30, 2011 were ($313) and ($226), respectively. Fair value changes attributable to unrealized gains that were included in earnings for the three and nine month ended September 30, 2010 were $23 and $26. Realized gains on the sale of securities for which the fair value option was elected were $0 and $10 during the three and nine months ended September 30, 2011. Realized losses on the sale of securities for which the fair value option was elected were ($8) and ($68) during the three and nine months ended September 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 $23 for the three and nine months ended September 30, 2011 and $6 and $20 for the three and nine months ended September 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 is similar to those that trade 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 September 30, 2011 and December 31, 2010:

 

            Fair Value Measurements at September 30, 2011 Using  

Description

   Total      Quoted Prices in
Active Markets for
Identical Assets
(Level 1)
     Significant Other
Observable Inputs
(Level 2)
     Significant
Unobservable
Inputs
(Level 3)
 

Assets:

           

Securities Available For Sale:

           

U.S. Treasury

   $ 8,162       $ —         $ 8,162       $ —     

U.S. Government sponsored entities

     97,912         6,000         91,912         —     

States and political subdivisions

     142,044         7,131         134,913         —     

Residential mortgage and asset backed

     280,428         21,056         259,372         —     

Commercial mortgage and asset backed

     2,050         —           2,050         —     

Corporate notes and bonds

     14,541         1,000         11,681         1,860   

Pooled trust preferred

     1,227         —           —           1,227   

Pooled SBA

     44,432         44,432         —           —     

Other securities

     1,709         1,709         —           —     
  

 

 

    

 

 

    

 

 

    

 

 

 

Total Securities Available For Sale

   $ 592,505       $ 81,328       $ 508,090       $ 3,087   
  

 

 

    

 

 

    

 

 

    

 

 

 

Trading Securities:

           

Equity securities – financial services

   $ 621       $ 621       $ —         $ —     

Equity securities – industrials

     323         323         —           —     

International mutual funds

     257         257         —           —     

Equity securities – health care

     186         186         —           —     

Equity securities – utilities

     171         171         —           —     

Certificates of deposit

     156         156         —           —     

Corporate notes and bonds

     150         —           150         —     

Large cap growth mutual funds

     138         138         —           —     

U.S. Government sponsored entities

     129         —           129         —     

Money market mutual funds

     111         111         —           —     

Real estate investment trust mutual funds

     105         105         —           —     

Equity securities – energy

     103         103         —           —     

Large cap value mutual funds

     97         97         —           —     

Equity securities – consumer staples

     62         62         —           —     

Equity securities – consumer discretionary

     49         49         —           —     

Mid cap mutual funds

     35         35         —           —     

Small cap mutual funds

     33         33         —           —     

Equity securities – materials

     30         30         —           —     
  

 

 

    

 

 

    

 

 

    

 

 

 

Total Trading Securities

   $ 2,756       $ 2,477       $ 279       $ —     
  

 

 

    

 

 

    

 

 

    

 

 

 

 

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Table of Contents
           Fair Value Measurements at September 30, 2011 Using  

Description

   Total     Quoted Prices in
Active Markets for
Identical Assets
(Level 1)
     Significant Other
Observable Inputs
(Level 2)
    Significant
Unobservable
Inputs
(Level 3)
 

Liabilities,

         

Interest rate swaps

   $ (1,665   $ —         $ (1,665   $ —     
  

 

 

   

 

 

    

 

 

   

 

 

 
           Fair Value Measurements at December 31, 2010 Using  

Description

   Total     Quoted Prices in
Active Markets for
Identical Assets
(Level 1)
     Significant Other
Observable Inputs
(Level 2)
    Significant
Unobservable
Inputs
(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 September 30, 2011:

 

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

Balance, July 1, 2011

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

Transfers out of Level 3 (a)(b)

     (3,988     —           —     

Total gains or losses (realized/unrealized):

       

Included in other comprehensive income

     —          —           (130

Purchases, issuances, sales, and settlements:

       

Settlements

     —          —           (5
  

 

 

   

 

 

    

 

 

 

Balance, September 30, 2011

   $ —        $ 1,860       $ 1,227   
  

 

 

   

 

 

    

 

 

 

 

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(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 nine months ended September 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 out of Level 3 (a)(b)

     (3,988     —           (2,000     —     

Total gains or losses (realized/unrealized):

         

Included in earnings

     —          —           —          (398

Included in other comprehensive income

     —          620         —          338   

Purchases, issuances, sales, and settlements:

         

Purchases

     1,917        —           —          —     

Settlements

     (198     —           —          (5
  

 

 

   

 

 

    

 

 

   

 

 

 

Balance, September 30, 2011

   $ —        $ 1,860       $ —        $ 1,227   
  

 

 

   

 

 

    

 

 

   

 

 

 

 

(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 nine months ended September 30, 2010:

 

     Three months ended
September 30, 2010
    Nine months ended
September 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

   $ 415      $ 1,300      $ 1,524      $ 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

     —          —          (821     —          —           (1,923

Included in other comprehensive income

     —          (20     709        —          240         1,436   

Purchases, issuances, sales, and settlements:

             

Sales

     —          —          —          —          —           —     

Settlements

     (52     —          —          (140     —           (10
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

Ending balance

   $ 363      $ 1,280      $ 1,412      $ 363      $ 1,280       $ 1,412   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

 

(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 nine months ended September 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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During the three months ended September 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

   $ —         $ 16,502   

States and political subdivisions

     —           11,085   

Residential mortgage and asset backed

     —           25,636   
  

 

 

    

 

 

 

Total

   $ —         $ 53,223   
  

 

 

    

 

 

 

During the nine months ended September 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       $ 18,643   

States and political subdivisions

     4,750         3,273   

Residential mortgage and asset backed

     20,405         5,625   
  

 

 

    

 

 

 

Total

   $ 27,155       $ 27,541   
  

 

 

    

 

 

 

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 nine months ended September 30, 2011, two pooled Small Business Administration (“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 September 30, 2011. During the three months ended September 30, 2010, one pooled SBA security that was classified as a Level 2 security at June 30, 2010 was transferred to the Level 1 category. The fair value on the date of transfer was $884. During the nine months ended September 30, 2010, two pooled SBA securities that were classified as Level 2 securities at December 31, 2009 were transferred to the Level 1 category. The fair value on the date of transfer was $1,798. 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 September 30, 2011 and December 31, 2010:

 

            Fair Value Measurements at September 30, 2011 Using  

Description

   Total      Quoted Prices in
Active  Markets for
Identical Assets
(Level 1)
     Significant Other
Observable  Inputs
(Level 2)
     Significant
Unobservable
Inputs
(Level 3)
 

Assets:

           

Impaired loans:

           

Commercial mortgages

   $ 13,822       $ —         $ —         $ 13,822   

Commercial, industrial, and agricultural

     2,426         —           —           2,426   

Residential real estate

     122         —           —           122   

 

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Table of Contents
            Fair Value Measurements at December 31, 2010 Using  

Description

   Total      Quoted Prices in
Active  Markets for
Identical Assets
(Level 1)
     Significant Other
Observable  Inputs
(Level 2)
     Significant
Unobservable
Inputs
(Level 3)
 

Assets:

           

Impaired loans:

           

Commercial mortgages

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

Commercial, industrial, and agricultural

     2,474         —           —           2,474   

Residential real estate

     166         —           —           166   

Impaired loans, which are measured for impairment using the fair value of collateral for collateral dependent loans, had a principal balance of $18,010 with a valuation allowance of $1,640 as of September 30, 2011, resulting in an additional provision for loan losses of $530 and $782 for the three and nine 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 Federal Home Loan Bank 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 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 assets such as, among other things, the estimated earnings power of core deposits, the earnings potential of trust accounts, the trained workforce, and customer goodwill, which typically are not recognized on the balance sheet may have value but are not included in the fair value disclosures.

 

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

 

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

ASSETS

        

Cash and cash equivalents

   $ 41,176      $ 41,176      $ 37,432      $ 37,432   

Interest bearing time deposits with other banks

     224        229        2,817        2,719   

Securities available for sale

     592,505        592,505        500,677        500,677   

Trading securities

     2,756        2,756        2,351        2,351   

Loans held for sale

     1,049        1,070        4,451        4,518   

Net loans

     823,414        844,580        783,742        807,972   

FHLB and other equity interests

     6,594        N/A        6,415        N/A   

Accrued interest receivable

     6,476        6,476        5,867        5,867   

LIABILITIES

        

Deposits

   $ (1,297,562   $ (1,301,803   $ (1,162,868   $ (1,167,071

FHLB, Treasury, tax and loan, and other borrowings

     (75,424     (83,771     (106,507     (109,963

Subordinated debentures

     (20,620     (10,746     (20,620     (10,660

Interest rate swaps

     (1,665     (1,665     (867     (867

Accrued interest payable

     (1,355     (1,355     (1,666     (1,666

SECURITIES

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

 

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

U.S. Treasury

   $ 8,078       $ 84       $ —        $ 8,162       $ 8,139       $ 66       $ -      $ 8,205   

U.S. Gov’t sponsored entities

     92,635         5,282         (5     97,912         104,328         2,016         (403     105,941   

State & political subdivisions

     133,580         8,464         —          142,044         117,928         1,011         (2,528     116,411   

Residential mortgage & asset backed

     272,196         8,427         (195     280,428         221,304         2,364         (1,249     222,419   

Commercial mortgage & asset backed

     2,079         —           (29     2,050         —           —           —          —     

Corporate notes & bonds

     17,354         —           (2,813     14,541         14,347         —           (3,596     10,751   

Pooled trust preferred

     1,787         —           (560     1,227         2,190         12         (910     1,292   

Pooled SBA

     43,102         1,330         —          44,432         33,788         266         (92     33,962   

Other securities

     1,670         39         —          1,709         1,670         26         —          1,696   
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Total

   $ 572,481       $ 23,626       $ (3,602   $ 592,505       $ 503,694       $ 5,761       $ (8,778   $ 500,677   
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

At September 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.

 

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Table of Contents

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

 

     September 30,
2011
     December 31,
2010
 

Corporate equity securities

   $ 1,545       $ 952   

International mutual funds

     257         430   

Certificates of deposit

     156         208   

Corporate notes and bonds

     150         96   

Large cap growth mutual funds

     138         139   

U.S. Government sponsored entities

     129         147   

Money market mutual funds

     111         75   

Real estate investment trust mutual funds

     105         —     

Large cap value mutual funds

     97         247   

Mid cap mutual funds

     35         28   

Small cap mutual funds

     33         29   
  

 

 

    

 

 

 

Total

   $ 2,756       $ 2,351   
  

 

 

    

 

 

 

Securities with unrealized losses at September 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):

 

September 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

     1,734         (5     —           —          1,734         (5

State & political subdivisions

     —           —          —           —          —           —     

Residential mortgage & asset backed

     25,154         (138     5,567         (57     30,721         (195

Commercial mortgage & asset backed

     2,050         (29     —           —          2,050         (29

Corporate notes & bonds

     995         (1     10,547         (2,812     11,542         (2,813

Pooled trust preferred

     —           —          240         (560     240         (560

Pooled SBA

     —           —          —           —          —           —     

Other securities

     —           —          —           —          —           —     
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 
   $ 29,933       $ (173   $ 16,354       $ (3,429   $ 46,287       $ (3,602
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 
     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.

 

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Table of Contents

At September 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.

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

 

     Adjusted
Amortized
Cost
     Unrealized
Gain (Loss)
    Fair
Value
     Credit Losses Realized
in Earnings Three
Months Ended
September 30, 2011
     Credit Losses Realized
in Earnings Nine
Months Ended
September 30, 2011
 

ALESCO Preferred Funding V, Ltd.

   $ 800       $ (560   $ 240       $ —         $ —     

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.

     987         —          987         —           —     
  

 

 

    

 

 

   

 

 

    

 

 

    

 

 

 

Total

   $ 1,787       $ (560   $ 1,227       $ —         $ 398   
  

 

 

    

 

 

   

 

 

    

 

 

    

 

 

 

A roll-forward of the other-than-temporary impairment amount related to credit losses for the three months ended September 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   
  

 

 

 

 

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Table of Contents

A roll-forward of the other-than-temporary impairment amount related to credit losses for the nine months ended September 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 September 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

   $ 2,517   

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

     821   

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

   $ 3,338   
  

 

 

 

A roll-forward of the other-than-temporary impairment amount related to credit losses for the nine months ended September 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

     759   

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

     1,164   
  

 

 

 

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

   $ 3,338   
  

 

 

 

At September 30, 2011, approximately 16% 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 SEC 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.

 

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Table of Contents

As of September 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; and

 

   

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 timely received.

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 September 30, 2011

   $ 20,153       $ 109       $ (25

Nine months ended September 30, 2011

     43,763         255         (97

Three months ended September 30, 2010

     13,442         121         ( 3

Nine months ended September 30, 2010

     51,507         708         (17

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

 

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

1 year or less

   $ 20,453       $ 20,586       $ 30,210       $ 30,184   

1 year – 5 years

     70,809         72,944         54,476         55,030   

5 years – 10 years

     104,510         112,597         105,057         105,145   

After 10 years

     100,764         102,191         90,977         86,203   
  

 

 

    

 

 

    

 

 

    

 

 

 
     296,536         308,318         280,720         276,562   

Residential mortgage & asset backed securities

     272,196         280,428         221,304         222,419   

Commercial mortgage & asset backed securities

     2,079         2,050         —           —     
  

 

 

    

 

 

    

 

 

    

 

 

 

Total debt securities

   $ 570,811       $ 590,796       $ 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 September 30, 2011 and December 31, 2010, securities carried at $247,622 and $127,364, respectively, were pledged to secure public deposits and for other purposes as provided by law.

 

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Table of Contents

LOANS

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

 

     September 30,
2011
    December 31,
2010
 

Commercial, industrial, and agricultural

   $ 247,628      $ 257,491   

Commercial mortgages

     238,965        212,878   

Residential real estate

     293,883        266,604   

Consumer

     54,766        53,202   

Credit cards

     2,968        2,870   

Overdrafts

     293        3,964   

Less:

 

unearned discount

     (2,837     (2,447
 

allowance for loan losses

     (12,252     (10,820
    

 

 

   

 

 

 

Loans, net

   $ 823,414      $ 783,742   
  

 

 

   

 

 

 

At September 30, 2011 and December 31, 2010, net unamortized loan costs and fees of ($49) 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.

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

 

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

Allowance for loan losses, July 1, 2011

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

Charge-offs

     (84     (12     (55     (221     (12     (50     (434

Recoveries

     3        —          12        31        3        18        67   

Provision for loan losses

     33        467        154        202        2        46        904   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Allowance for loan losses, September 30, 2011

   $ 3,722      $ 4,854      $ 2,011      $ 1,412      $ 97      $ 156      $ 12,252   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

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

 

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

Allowance for loan losses, January 1, 2011

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

Charge-offs

     (299     (100     (132     (683     (37     (165     (1,416

Recoveries

     7        —          12        76        8        72        175   

Provision for loan losses

     497        1,443        215        458        30        30        2,673   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Allowance for loan losses, September 30, 2011

   $ 3,722      $ 4,854      $ 2,011      $ 1,412      $ 97      $ 156      $ 12,252   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

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

 

Allowance for loan losses, July 1, 2010

   $ 10,415   

Charge-off

     (503

Recoveries

     65   

Provision for loan losses

     853   
  

 

 

 

Allowance for loan losses, September 30, 2010

   $ 10,830   
  

 

 

 

 

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Table of Contents

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

 

Allowance for loan losses, January 1, 2010

   $ 9,795   

Charge-off

     (1,759

Recoveries

     195   

Provision for loan losses

     2,599   
  

 

 

 

Allowance for loan losses, September 30, 2010

   $ 10,830   
  

 

 

 

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 September 30, 2011:

 

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

Allowance for loan losses:

                    

Ending allowance balance attributable to loans:

                    

Individually evaluated for impairment

   $ 40       $ 1,323       $ 43       $ —         $ —         $ —         $ 1,406   

Collectively evaluated for impairment

     3,682         3,297         1,968         1,412         97         156         10,612   

Modified in a troubled debt restructuring

     —           234         —           —           —           —           234   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total ending allowance balance

   $ 3,722       $ 4,854       $ 2,011       $ 1,412       $ 97       $ 156       $ 12,252   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Loans:

                    

Loans individually evaluated for impairment

   $ 2,466       $ 13,703       $ 165       $ —         $ —         $ —         $ 16,334   

Loans collectively evaluated for impairment

     245,162         218,983         293,718         54,766         2,968         293         815,890   

Loans modified in a troubled debt restructuring

     —           6,279         —           —           —           —           6,279   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total ending loans balance

   $ 247,628       $ 238,965       $ 293,883       $ 54,766       $ 2,968       $ 293       $ 838,503   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

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,
Industrial, and
Agricultural
     Commercial
Mortgages
     Residential
Real
Estate
     Consumer      Credit
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   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

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   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

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 nine months ended September 30, 2011:

 

     Unpaid
Principal
Balance
     Recorded
Investment
     Allowance for
Loan Losses
Allocated
 

With an allowance recorded:

        

Commercial, industrial, and agricultural

   $ 337       $ 337       $ 40   

Commercial mortgage

     6,648         5,772         1,323   

Residential real estate

     265         165         43   

With no related allowance recorded:

        

Commercial, industrial, and agricultural

     2,577         2,129         —     

Commercial mortgage

     9,404         7,931         —     

Residential real estate

     —           —           —     
  

 

 

    

 

 

    

 

 

 

Total

   $ 19,231       $ 16,334       $ 1,406   
  

 

 

    

 

 

    

 

 

 

 

19


Table of Contents
    

Three Months Ended

September 30, 2011

    

Nine Months Ended

September 30, 2011

 
     Average
Recorded
Investment
     Interest
Income
Recognized
     Cash Basis
Interest
Recognized
     Average
Recorded
Investment
     Interest
Income
Recognized
     Cash Basis
Interest
Recognized
 

With an allowance recorded:

                 

Commercial, industrial, and agricultural

   $ 1,097       $ —         $ —         $ 1,330       $ —         $ —     

Commercial mortgage

     6,554         —           —           8,050         16         16   

Residential real estate

     175         3         3         193         3         3   

With no related allowance recorded:

                 

Commercial, industrial, and agricultural

     1,525         —           —           1,738         —           —     

Commercial mortgage

     7,831         —           —           4,275         —           —     

Residential real estate

     —           —           —           —           —           —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 17,182       $ 3       $ 3       $ 15,586       $ 19       $ 19   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

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 September 30, 2010:

 

Average of individually impaired loans during period

   $ 14,669   

Interest income recognized during impairment

     26   

Cash basis interest income recognized during impairment

     26   

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

 

Average of individually impaired loans during period

   $ 14,239   

Interest income recognized during impairment

     366   

Cash basis interest income recognized during impairment

     366   

 

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Table of Contents

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 September 30, 2011 and December 31, 2010:

 

September 30, 2011    Nonaccrual      Past Due Over 90 Days
Still on Accrual
 

Commercial, industrial, and agricultural

   $ 2,466       $ 53   

Commercial mortgages

     13,562         1,495   

Residential real estate

     1,237         120   

Consumer

     5         146   

Credit cards

     —           20   
  

 

 

    

 

 

 

Total

   $ 17,270       $ 1,834   
  

 

 

    

 

 

 

 

December 31, 2010    Nonaccrual      Past Due Over 90 Days
Still on Accrual
 

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   
  

 

 

    

 

 

 

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 September 30, 2011 and December 31, 2010 by class of loans:

 

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

Commercial, industrial, and agricultural

   $ 152       $ 341       $ 8,718       $ 9,211       $ 238,417       $ 247,628   

Commercial mortgages

     1,344         1,982         8,858         12,184         226,781         238,965   

Residential real estate

     1,431         630         1,357         3,418         290,465         293,883   

Consumer

     437         128         151         716         54,050         54,766   

Credit cards

     27         3         20         50         2,918         2,968   

Overdrafts

     —           —           —           —           293         293   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 3,391       $ 3,084       $ 19,104       $ 25,579       $ 812,924       $ 838,503   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

December 31, 2010    30-59 Days
Past Due
     60-89 Days
Past Due
     Greater Than
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   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

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Troubled Debt Restructurings

The Corporation has allocated $234 and $243 of specific reserves to one commercial mortgage customer whose loan terms have been modified in troubled debt restructurings as of September 30, 2011 and December 31, 2010, respectively. The interest rate on the original loan was 6.60%. Due to financial difficulties experienced by the customer, the interest rate was reduced to 4.19% in the third quarter of 2010, resulting in an additional provision for loan losses of $253 thousand for the three and nine months ended September 30, 2010. The interest rate on this loan was further reduced to 4.07% in the third quarter of 2011, resulting in an additional provision for loan losses of $5 thousand for the three and nine months ended September 30, 2011. This loan had a total recorded investment of $1,676 and $1,714 as of September 30, 2011 and December 31, 2010, respectively.

In addition, the Corporation has one commercial mortgage customer whose loan relationships have interest-only terms that were extended during 2011. The original interest rates on the loans, which are also currently the market rates of interest, were not reduced; therefore, no additional provision for loan losses was required to be recorded. These loans have a total recorded investment of $4,603 at September 30, 2011.

In order to determine whether a borrower is experiencing financial difficulty, an evaluation is performed of the probability that the borrower will be in payment default on any of its debt in the foreseeable future without a loan modification. This evaluation is performed using the Corporation’s internal underwriting policies.

All loans modified in troubled debt restructurings are performing in accordance with their modified terms as of September 30, 2011. 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. Loans with an outstanding balance greater than $1 million are analyzed bi-annually and loans with an outstanding balance of less than $1 million are analyzed 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.

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.

 

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Table of Contents

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.

 

September 30, 2011           Special                       
   Pass      Mention      Substandard      Doubtful      Total  

Commercial, industrial, and agricultural

   $ 213,927       $ 14,974       $ 18,727         —         $ 247,628   

Commercial mortgages

     209,484         2,479         26,881         121         238,965   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 423,411       $ 17,453       $ 45,608       $ 121       $ 486,593   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

December 31, 2010           Special                       
   Pass      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”), a subsidiary that offers small balance unsecured and secured loans, primarily collateralized by automobiles and equipment, to borrowers with higher risk characteristics than are typical in the Bank’s consumer loan portfolio, are considered to be subprime loans. Holiday’s loan portfolio is summarized as follows at September 30, 2011 and December 31, 2010:

 

     September 30,
2011
    December 31,
2010
 

Consumer

   $ 17,649      $ 16,532   

Residential real estate

     1,019        1,149   

Less: unearned discount

     (2,837     (2,447
  

 

 

   

 

 

 

Total

   $ 15,831      $ 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 September 30, 2011 and December 31, 2010:

 

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

Performing

   $ 292,526       $ 54,615       $ 264,912       $ 53,048   

Non-performing

     1,357         151         1,692         154   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 293,883       $ 54,766       $ 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 September 30, 2011, the Corporation holds $5,502 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 September 30, 2011 and December 31, 2010 are summarized as follows (in thousands):

 

     Percentage               
     Change     September 30, 2011      December 31, 2010  

Checking, non-interest bearing

     8.0   $ 152,127       $ 140,836   

Checking, interest bearing

     7.8     306,753         284,538   

Savings accounts

     49.3     549,636         368,055   

Certificates of deposit

     (21.8 %)      289,046         369,439   
    

 

 

    

 

 

 
     11.6   $ 1,297,562       $ 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 nine months ended September 30, 2011, 107,375 and 75,500 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 nine months ended September 30, 2010, 119,875 and 86,750 shares issuable pursuant to outstanding stock options, respectively, 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

   

Nine months

ended

 
     September 30,     September 30,  
     2011     2010     2011     2010  

Basic earnings per common share computation:

        

Distributed earnings allocated to common stock

   $ 2,025      $ 2,008      $ 6,064      $ 4,900   

Undistributed earnings allocated to common stock

     2,030        1,090        5,137        3,462   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net earnings allocated to common stock

   $ 4,055      $ 3,098      $ 11,201      $ 8,362   
  

 

 

   

 

 

   

 

 

   

 

 

 

Weighted average common shares outstanding, including shares considered participating securities

     12,315        12,203        12,290        10,092   

Less: Average participating securities

     (31     (28     (35     (31
  

 

 

   

 

 

   

 

 

   

 

 

 

Weighted average shares

     12,284        12,175        12,255        10,061   
  

 

 

   

 

 

   

 

 

   

 

 

 

Basic earnings per common share

   $ 0.33      $ 0.25      $ 0.91      $ 0.83   
  

 

 

   

 

 

   

 

 

   

 

 

 

Diluted earnings per common share computation:

        

Net earnings allocated to common stock

   $ 4,055      $ 3,098      $ 11,201      $ 8,362   
  

 

 

   

 

 

   

 

 

   

 

 

 

Weighted average common shares outstanding for basic earnings per common share

     12,284        12,175        12,255        10,061   

Add: Dilutive effects of assumed exercises of stock options

     6        5        7        9   
  

 

 

   

 

 

   

 

 

   

 

 

 

Weighted average shares and dilutive potential common shares

     12,290        12,180        12,262        10,070   
  

 

 

   

 

 

   

 

 

   

 

 

 

Diluted earnings per common share

   $ 0.33      $ 0.25      $ 0.91      $ 0.83   
  

 

 

   

 

 

   

 

 

   

 

 

 

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 issued 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 September 30, 2011, the variable rate on the subordinated debt was 1.90% (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 September 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 nine months ended September 30, 2011 (in thousands):

 

As of September 30, 2011    Liability Derivative  
     Balance Sheet    Fair  
     Location    Value  

Interest rate contract

   Accrued interest payable
and other liabilities
   ($ 1,665

 

For the Three Months                             
Ended September 30, 2011    (a)     (b)    (c)     (d)    (e)  

Interest rate contract

   ($ 441   Interest expense –
subordinated debentures
   ($ 103   Other
income
   $ —     

 

For the Nine Months                             
Ended September 30, 2011    (a)     (b)    (c)     (d)    (e)  

Interest rate contract

   ($ 519   Interest expense –
subordinated debentures
   ($ 303   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)
(c) Amount of Gain or (Loss) Reclassified from Accumulated Other Comprehensive Loss into Income (Effective Portion)
(d) Location of Gain or (Loss) Recognized in Income on Derivative (Ineffective Portion and Amount Excluded from Effectiveness Testing)
(e) Amount of Gain or (Loss) Recognized in Income on Derivative (Ineffective Portion and Amount Excluded from Effectiveness Testing)

Amounts reported in accumulated other comprehensive loss related to the interest rate swap will be reclassified to interest expense as interest payments are made on the subordinated debentures. Such amounts reclassified from accumulated other comprehensive loss to interest expense in the next 12 months are expected to approximate $394.

 

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Table of Contents

RECENT ACCOUNTING PRONOUNCEMENTS

In December 2010, the FASB issued Accounting Standards Update No. 2010-29, “Disclosure of Supplementary Pro Forma Information for Business Combinations.” This update addresses diversity in practice about the interpretation of the pro forma revenue and earnings disclosure requirements for business combinations. The amendments in the update specify that if a public entity presents comparative financial statements, the entity should disclose revenue and earnings of the combined entity as though the business combination(s) that occurred during the current year had occurred as of the beginning of the comparable prior annual reporting period only. The amendments are effective prospectively for business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2010. The effect of adopting this new guidance did not have a material effect on the Corporation’s financial statements.

In April 2011, the FASB issued Accounting Standards Update No. 2011-02, “A Creditor’s Determination of Whether a Restructuring Is a Troubled Debt Restructuring.” This update clarifies guidance on a creditor’s evaluation of whether it has granted a concession to a borrower and a creditor’s evaluation of whether a borrower is experiencing financial difficulties. The amendments in this update are effective for the first interim or annual period beginning on or after June 15, 2011, and should be applied retrospectively to the beginning of the annual period of adoption. As a result of applying these amendments, an entity may identify receivables that are newly considered impaired. For purposes of measuring impairment of those receivables, an entity should apply the amendments prospectively for the first interim or annual period beginning on or after June 15, 2011. In addition, an entity should disclose the information required by Accounting Standards Codification paragraphs 310-10-50-33 through 50-34, which was deferred by Accounting Standards Update No. 2011-01, for interim and annual periods beginning on or after June 15, 2011. The effect of adopting this new guidance did not have a material effect on the Corporation’s financial statements.

In May 2011, the FASB issued Accounting Standards Update No. 2011-4, “Fair Value Measurement (Topic 820), Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs.” Some amendments in this update clarify the FASB’s intent about the application of existing fair value measurement requirements. Other amendments change a particular principle or requirement for measuring fair value or for disclosing information about fair value measurements. The amendments in this update are effective during interim and annual reporting periods beginning after December 15, 2011. The effect of adopting this new guidance is not expected to have a material effect on the Corporation’s financial statements.