SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

 

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES

EXCHANGE ACT OF 1934

 

FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2013

 

Commission file number: 000-33063

 

Sierra Bancorp

(Exact name of Registrant as specified in its charter)

   

California	33-0937517
(State of Incorporation)	(IRS Employer Identification No)

86 North Main Street, Porterville, California 93257

(Address of principal executive offices) (Zip Code)

 

(559) 782-4900

(Registrant’s telephone number, including area code)

 

Not Applicable

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

 

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days.

Yes þ           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).

Yes þ           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.    

Large accelerated filer ¨	Accelerated filer þ
Non-accelerated filer ¨ (Do not check if a smaller reporting company)	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 ¨          No þ

 

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

 

Common stock, no par value, 14,122,639 shares outstanding as of April 30, 2013

   

 

 

FORM 10-Q

 

Table of Contents

 

	Page
Part I - Financial Information	1
Item 1. Financial Statements (Unaudited)	1
Consolidated Balance Sheets	1
Consolidated Statements of Income	2
Consolidated Statements of Comprehensive Income	3
Consolidated Statements of Cash Flows	4
Notes to Unaudited Consolidated Financial Statements	5
Item 2. Management’s Discussion & Analysis of Financial Condition & Results of Operations	26
Forward-Looking Statements	26
Critical Accounting Policies	26
Overview of the Results of Operations and Financial Condition	27
Earnings Performance	28
Net Interest Income and Net Interest Margin	28
Provision for Loan and Lease Losses	31
Non-interest Revenue and Operating Expense	32
Provision for Income Taxes	34
Balance Sheet Analysis	34
Earning Assets	34
Investments	34
Loan Portfolio	35
Nonperforming Assets	37
Allowance for Loan and Lease Losses	38
Off-Balance Sheet Arrangements	40
Other Assets	40
Deposits and Interest-Bearing Liabilities	41
Deposits	41
Other Interest-Bearing Liabilities	42
Non-Interest Bearing Liabilities	43
Liquidity and Market Risk Management	43
Capital Resources	45
Item 3. Qualitative & Quantitative Disclosures about Market Risk	47
Item 4. Controls and Procedures	47
Part II - Other Information	48
Item 1. - Legal Proceedings	48
Item 1A. - Risk Factors	48
Item 2. - Unregistered Sales of Equity Securities and Use of Proceeds	48
Item 3. - Defaults upon Senior Securities	48
Item 4. - (Removed and Reserved)	48
Item 5. - Other Information	48
Item 6. - Exhibits	49
Signatures	50

 

 

PART I - FINANCIAL INFORMATION

Item 1 – Financial Statements   

SIERRA BANCORP
CONSOLIDATED BALANCE SHEETS
(dollars in thousands)
		March 31, 2013			December 31, 2012
		(unaudited)			(audited)
ASSETS
Cash and due from banks		$	45,163		$	42,079
Interest-bearing deposits in banks			2,786			19,739
Total Cash & Cash Equivalents			47,949			61,818
Investment securities available for sale			398,755			380,188
Loans held for sale			789			210
Loans and leases:
Gross loans and leases			827,301			879,795
Allowance for loan and lease losses			(13,199)			(13,873)
Deferred loan and lease fees, net			1,127			1,156
Net Loans and Leases			815,229			867,078
Premises and equipment, net			21,346			21,830
Operating leases, net			-			12
Foreclosed assets			15,747			19,754
Goodwill			5,544			5,544
Other assets			81,003			81,469
TOTAL ASSETS		$	1,386,362		$	1,437,903
LIABILITIES AND SHAREHOLDERS' EQUITY
LIABILITIES
Deposits:
Non-interest bearing		$	342,048		$	352,597
Interest bearing			813,886			821,437
Total Deposits			1,155,934			1,174,034
Federal funds purchased and repurchase agreements			2,673			1,419
Short-term borrowings			6,600			36,650
Long-term borrowings			-			5,000
Junior subordinated debentures			30,928			30,928
Other liabilities			14,685			15,980
TOTAL LIABILITIES			1,210,820			1,264,011
SHAREHOLDERS' EQUITY
Common stock, no par value; 24,000,000 shares authorized; 14,119,679 and    14,106,959 shares issued and outstanding at March 31, 2013 and
December 31, 2012, respectively			64,541			64,384
Additional paid in capital			2,720			2,660
Retained earnings			104,615			103,128
Accumulated other comprehensive income			3,666			3,720
TOTAL SHAREHOLDERS' EQUITY			175,542			173,892
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY		$	1,386,362		$	1,437,903

The accompanying notes are an integral part of these consolidated financial statements

1

SIERRA BANCORP

CONSOLIDATED  STATEMENTS OF INCOME

(dollars in thousands, except per share data, unaudited)

     

		For the Quarter			For the Quarter
		Ended March 31,			Ended March 31,
		2013			2012
Interest income:
Interest and fees on loans		$	10,907		$	11,144
Interest on investment securities:
Taxable			1,162			1,884
Tax-exempt			619			666
Interest on federal funds sold and interest-bearing deposits			28			14
Total interest income			12,716			13,708
Interest expense:
Interest on deposits			660			885
Interest on short-term borrowings			4			5
Interest on long-term borrowings			33			131
Interest on mandatorily redeemable trust preferred securities			177			199
Total interest expense			874			1,220
Net Interest Income			11,842			12,488
Provision for loan losses			1,600			2,750
Net Interest Income after Provision for Loan Losses			10,242			9,738
Non-interest revenue:
Service charges on deposit accounts			2,072			2,287
Gains on investment securities available-for-sale			6			70
Other income, net			2,037			1,745
Total other operating income			4,115			4,102
Other operating expense:
Salaries and employee benefits			5,920			5,665
Occupancy expense			1,551			1,489
Other			4,348			4,886
Total other operating expenses			11,819			12,040
Income before income taxes			2,538			1,800
Provision for income taxes			204			(79)
Net Income		$	2,334		$	1,879
PER SHARE DATA
Book value		$	12.43		$	12.07
Cash dividends		$	0.06		$	0.06
Earnings per share basic		$	0.17		$	0.13
Earnings per share diluted		$	0.16		$	0.13
Average shares outstanding, basic			14,113,502			14,101,879
Average shares outstanding, diluted			14,194,223			14,107,551
Total shareholder Equity (in thousands)		$	175,542		$	170,245
Shares outstanding			14,119,679			14,103,209
Dividends Paid		$	846,665		$	846,097

   

The accompanying notes are an integral part of these consolidated financial statements

 

SIERRA BANCORP

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(dollars in thousands, unaudited)

        

		For the Quarter			For the Quarter
		Ended March 31, 2013			Ended March 31, 2012
Net Income		$	2,334		$	1,879
Other comprehensive income, before tax:
Unrealized gains on securities:
Unrealized holding gains arising during period			(85)			1,119
Less: reclassification adjustment for gains (1) included in net income			(6)			(70)
Other comprehensive income, before tax			(91)			1,049
Income tax expense  related to items of other comprehensive income,
net of tax			37			(446)
Other comprehensive income			(54)			603
Comprehensive income		$	2,280		$	2,482

  

 

The accompanying notes are an integral part of these consolidated financial statements

 

 

SIERRA BANCORP

CONSOLIDATED STATEMENTS OF CASH FLOWS

(dollars in thousands, unaudited)

 

		Quarter Ended March 31,
		2013			2012
Cash flows from operating activities:
Net income		$	2,334		$	1,879
Adjustments to reconcile net income to net cash provided by operating
activities:
Gain on investment of securities			(6)			(70)
Gain on sales of loans			(36)			(50)
Loss on sale on foreclosed assets			488			126
Writedowns on foreclosed assets			87			851
Share-based compensation expense			93			67
Provision for loan losses			1,600			2,750
Depreciation and amortization			590			585
Net amortization on securities premiums and discounts			2,096			1,920
Decrease (Increase) in unearned net loan fees			29			(69)
Increase in cash surrender value of life insurance policies			(593)			(669)
Proceeds from sales of loans portfolio			1,257			2,224
Net Increase in loans held-for-sale			(1,800)			(1,583)
Decrease (Increase) in interest receivable and other assets			1,057			(218)
Decrease in other liabilities			(1,295)			(1,213)
Net Decrease in FHLB Stock			-			319
Deferred Income Tax Provision (Benefit)			4			(1)
Excess tax benefit from equity based compensation			(34)			(36)
Net cash provided by operating activities			5,871			6,812
Cash flows from investing activities:
Maturities of securities available for sale			140			135
Proceeds from sales/calls of securities available for sale			977			3,837
Purchases of securities available for sale			(47,006)			(38,308)
Principal pay downs on securities available for sale			25,141			23,139
Net Decrease in loans receivable, net			49,928			193
Purchases of premises and equipment, net			(94)			(616)
Proceeds from sales of foreclosed assets			3,725			2,012
Net cash provided by (used in) investing activities			32,811			(9,608)
Cash flows from financing activities:
(Decrease) Increase in deposits			(18,100)			36,610
Decrease in borrowed funds			(35,050)			(27,120)
Increase in repurchase agreements			1,254			2,808
Cash dividends paid			(847)			(846)
Stock options exercised			158			14
Excess tax benefit from equity based compensation			34			36
Net cash (used in) provided by financing activities			(52,551)			11,502
(Decrease) Increase in cash and due from banks			(13,869)			8,706
Cash and Cash Equivalents
Beginning of period			61,818			63,036
End of period		$	47,949		$	71,742

    

The accompanying notes are an integral part of these consolidated financial statements

4

Sierra Bancorp

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

March 31, 2013

 

Sierra Bancorp (the “Company”) is a California corporation headquartered in Porterville, California, and is a registered bank holding company under federal banking laws. The Company was formed to serve as the holding company for Bank of the Sierra (the “Bank”), and has been the Bank’s sole shareholder since August 2001. The Company exists primarily for the purpose of holding the stock of the Bank and of such other subsidiaries it may acquire or establish. At the present time, the Company’s only other subsidiaries are Sierra Statutory Trust II and Sierra Capital Trust III, which were formed in March 2004 and June 2006, respectively, solely to facilitate the issuance of capital trust pass-through securities (TRUPS). Pursuant to the Financial Accounting Standards Board’s (FASB’s) standard on the consolidation of variable interest entities, these trusts are not reflected on a consolidated basis in the financial statements of the Company. References herein to the “Company” include Sierra Bancorp and its consolidated subsidiary, the Bank, unless the context indicates otherwise.

 

The Bank is a California state-chartered bank headquartered in Porterville, California, that offers a full range of retail and commercial banking services primarily to communities in the central and southern regions of the San Joaquin Valley. Our branch footprint stretches from Fresno on the north to Bakersfield on the south, and on the southern end extends east through the Tehachapi plateau and into the northwestern tip of the Mojave Desert. The Bank was incorporated in September 1977 and opened for business in January 1978, and in the ensuing years has grown to be the largest independent bank headquartered in the South San Joaquin Valley. Our growth has primarily been organic, but includes the acquisition of Sierra National Bank in 2000. We currently operate 25 full service branch offices throughout our geographic footprint, as well as an internet branch which provides the ability to open deposit accounts online. The Bank’s most recent branching activity includes a new branch which opened for business in the city of Selma in February 2011, and the relocation of our Clovis branch to a larger facility in a more convenient location in the third quarter of 2012. In addition to our full-service branches, the Bank has a real estate industries group, an agricultural credit division, an SBA lending unit, and offsite ATM’s at six different non-branch locations. The Bank’s deposit accounts are insured by the Federal Deposit Insurance Corporation (FDIC) up to maximum insurable amounts.

 

The accompanying unaudited consolidated financial statements have been prepared in a condensed format, and therefore do not include all of the information and footnotes required by U.S. generally accepted accounting principles (GAAP) for complete financial statements. The information furnished in these interim statements reflects all adjustments that are, in the opinion of management, necessary for a fair statement of the results for such period. Such adjustments are of a normal recurring nature, unless otherwise disclosed in this Form 10-Q. In preparing the accompanying consolidated financial statements, management has taken subsequent events into consideration and recognized them where appropriate. The results of operations in the interim statements are not necessarily indicative of the results that may be expected for any other quarter, or for the full year. Certain amounts reported for 2012 have been reclassified to be consistent with the reporting for 2013. The interim financial information should be read in conjunction with the Company’s Annual Report on Form 10-K for the year ended December 31, 2012, as filed with the Securities and Exchange Commission.

Note 3 – Current Accounting Developments

 

In February 2013, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2013-02, Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income. The objective of ASU 2013-02 is to improve the reporting of reclassifications out of accumulated other comprehensive income. ASU 2013-02 does not change current requirements for reporting net income or other comprehensive income in financial statements. However, it requires an entity to provide information about the amounts reclassified out of accumulated other comprehensive income by component. In addition, if the amount reclassified is required under U.S. GAAP to be reclassified to net income in its entirety in the same reporting period, an entity is required to present significant amounts reclassified out of accumulated other comprehensive income by the respective line items of net income. For other amounts that are not required under U.S. GAAP to be reclassified in their entirety to net income, an entity is required to cross-reference to other disclosures that provide additional detail about those amounts. For public entities, this update is effective prospectively for reporting periods beginning after December 15, 2012. We adopted ASU 2013-02 effective the first quarter of 2013. The effect of adopting this standard enhanced our disclosures with regard to items reclassified out of accumulated comprehensive income.

5

 

During the three months ended March 31, 2013 and 2012, cash paid for interest due on interest-bearing liabilities was $993,000 and $1.477 million, respectively. There was no cash paid for income taxes during the three months ended March 31, 2013 and 2012. Assets totaling $293,000 and $3.283 million were acquired in settlement of loans for the three months ended March 31, 2013 and March 31, 2012, respectively. We received $3.333 million in cash from the sale of foreclosed assets during the first three months of 2013 relative to $1.587 million during the first three months of 2012, which represents sales proceeds less loans extended to finance such sales totaling $390,000 for the first three months of 2013 and $425,000 for the first three months of 2012.

 

The 2007 Stock Incentive Plan (the “2007 Plan”) was adopted by the Company in 2007. Our 1998 Stock Option Plan (the “1998 Plan”) was concurrently terminated, although options to purchase 167,750 shares that were granted prior to the termination of the 1998 Plan were still outstanding as of March 31, 2013 and remain unaffected by the termination. The 2007 Plan provides for the issuance of both “incentive” and “nonqualified” stock options to officers and employees, and of “nonqualified” stock options to non-employee directors of the Company. The 2007 Plan also provides for the potential issuance of restricted stock awards to these same classes of eligible participants, on such terms and conditions as are established at the discretion of the Board of Directors or the Compensation Committee. The total number of shares of the Company’s authorized but unissued stock reserved for issuance pursuant to awards under the 2007 Plan was initially 1,500,000 shares, although the number remaining available for grant as of March 31, 2013 was 742,440. The dilutive impact of stock options outstanding is discussed below in Note 6, Earnings per Share. No restricted stock awards have been issued by the Company.

 

Pursuant to FASB’s standards on stock compensation, the value of each option granted is reflected in our income statement as share-based compensation expense or directors’ expense, by amortizing it over the vesting period of such option or by expensing it as of the grant date for immediately vested options. The Company is utilizing the Black-Scholes model to value stock options, and the “multiple option” approach is used to allocate the resulting valuation to actual expense. Under the multiple option approach, an employee’s options for each vesting period are separately valued and amortized. This appears to be the preferred method for option grants with multiple vesting periods, which is the case for most options granted by the Company. A pre-tax charge of $94,000 was reflected in the Company’s income statement during the first quarter of 2013 and $67,000 was charged during the first quarter of 2012, as expense related to stock options.

 

The computation of earnings per share, as presented in the Consolidated Statements of Income, is based on the weighted average number of shares outstanding during each period. There were 14,113,502 weighted average shares outstanding during the first quarter of 2013, and 14,101,879 during the first quarter of 2012.

 

Diluted earnings per share include the effect of the potential issuance of common shares, which for the Company is limited to shares that would be issued on the exercise of “in-the-money” stock options. The dilutive effect of options outstanding was calculated using the treasury stock method, excluding anti-dilutive shares and adjusting for unamortized expense and windfall tax benefits. For the first quarter of 2013 the dilutive effect of options outstanding calculated under the treasury stock method totaled 80,721, which was added to basic weighted average shares outstanding for purposes of calculating diluted earnings per share. Likewise, for the first quarter of 2012 shares totaling 5,672 were added to basic weighted average shares outstanding in order to calculate diluted earnings per share.

6

Note 7 – Comprehensive Income

 

Comprehensive income, as presented in the Consolidated Statements of Comprehensive Income, includes net income and other comprehensive income. The Company’s only source of other comprehensive income is unrealized gains and losses on available-for-sale investment securities. Gains or losses on investment securities that were realized and included in net income of the current period, which had previously been included in other comprehensive income as unrealized holding gains or losses in the period in which they arose, are considered to be reclassification adjustments that are excluded from comprehensive income of the current period.

Note 8 – Financial Instruments with Off-Balance-Sheet Risk

 

The Company is a party to financial instruments with off-balance-sheet risk in the normal course of business, in order to meet the financing needs of its customers. Those financial instruments consist of commitments to extend credit, and standby letters of credit. They involve, to varying degrees, elements of risk in excess of the amount recognized in the balance sheet. The Company’s exposure to credit loss in the event of nonperformance by counterparties for commitments to extend credit and letters of credit is represented by the contractual amount of those instruments. The Company uses the same credit policies in making commitments and issuing letters of credit as it does for originating loans included on the balance sheet. The following financial instruments represent off-balance-sheet credit risk (dollars in thousands):   

		March 31, 2013			December 31, 2012
Commitments to extend credit		$	313,907		$	225,400
Standby letters of credit		$	6,727		$	6,690
Commercial letters of credit		$	8,536		$	8,539

Commitments to extend credit consist primarily of the following: Unfunded home equity lines of credit; commercial real estate construction loans, which are established under standard underwriting guidelines and policies and are secured by deeds of trust, with disbursements made over the course of construction; commercial revolving lines of credit, which have a high degree of industry diversification; the unused portions of mortgage warehouse lines of credit; and the unused portions of formalized (disclosed) deposit account overdraft lines. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many commitments are expected to expire without being drawn upon, the unused portions of committed amounts do not necessarily represent future cash requirements. Standby letters of credit are generally unsecured and are issued by the Company to guarantee the performance of a customer to a third party, while commercial letters of credit represent the Company’s commitment to pay a third party on behalf of a customer upon fulfillment of contractual requirements. The credit risk involved in issuing letters of credit is essentially the same as the risk involved in extending loans to customers.

 

The Company is also utilizing a $69 million letter of credit issued by the Federal Home Loan Bank on the Company’s behalf as security for certain deposits. The letter of credit is backed by specific loans which are pledged to the Federal Home Loan Bank by the Company.

Note 9 – Fair Value Disclosures and Reporting, the Fair Value Option and Fair Value Measurements

 

FASB’s standards on financial instruments, and on fair value measurements and disclosures, require all entities to disclose in their financial statement footnotes the estimated fair values of financial instruments for which it is practicable to estimate such values. In addition to those disclosure requirements, FASB’s standard on investments requires that our debt securities, which are classified as available for sale, and our equity securities that have readily determinable fair values, be measured and reported at fair value in our statement of financial position. Certain impaired loans are also reported at fair value, as explained in greater detail below, and foreclosed assets are carried at the lower of cost or fair value. FASB’s standard on financial instruments permits companies to report certain other financial assets and liabilities at fair value, but we have not elected the fair value option for any additional financial assets or liabilities.                         

 

 

 

Fair value measurements and disclosure standards also establish a framework for measuring fair value. 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. Further, they establish a fair value hierarchy that requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The standards describe three levels of inputs that may be used to measure fair value:  

⋅

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

 

⋅

Level 2: Significant observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities, quoted prices in markets that are not active, and 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 factors that market participants would likely consider in pricing an asset or liability.

 

Fair value estimates are made at a specific point in time based on relevant market data and information about the financial instruments. The estimates do not reflect any premium or discount that could result from offering the Company’s entire holdings of a particular financial instrument for sale at one time, nor do they attempt to estimate the value of anticipated future business related to the instruments. In addition, the tax ramifications related to realized gains and losses could have a significant effect on fair value estimates but have not been considered in any estimates. Because no market exists for a significant portion of the Company’s financial instruments, fair value disclosures are based on judgments regarding current economic conditions, risk characteristics of various financial instruments and other factors. The estimates are subjective and involve uncertainties and matters of significant judgment, and therefore cannot be determined with precision. Changes in assumptions could significantly affect the fair values presented. The following methods and assumptions were used by the Company to estimate the fair value of its financial instruments disclosed at March 31, 2013 and December 31, 2012:

 

⋅

Cash and cash equivalents and fed funds sold: For cash and cash equivalents and fed funds sold, the carrying amount is estimated to be fair value.

 

⋅

Investment securities: The fair values of investment securities are determined by obtaining quoted prices on nationally recognized securities exchanges or by matrix pricing, which is a mathematical technique used widely in the industry to value debt securities by relying on their relationship to other benchmark quoted securities when quoted prices for specific securities are not readily available.

 

⋅

Loans and leases: For variable-rate loans and leases that re-price frequently with no significant change in credit risk or interest rate spread, fair values are based on carrying values. Fair values for other loans and leases are estimated by discounting projected cash flows at interest rates being offered at each reporting date for loans and leases with similar terms, to borrowers of comparable creditworthiness. The carrying amount of accrued interest receivable approximates its fair value.

 

⋅

Loans held for sale: Since loans designated by the Company as available-for-sale are typically sold shortly after making the decision to sell them, realized gains or losses are usually recognized within the same period and fluctuations in fair values are thus not relevant for reporting purposes. If available-for-sale loans stay on our books for an extended period of time, the fair value of those loans is determined using quoted secondary-market prices.

 

⋅

Collateral-dependent impaired loans: Impaired loans carried at fair value are those for which it is probable that the bank will be unable to collect all amounts due (including both interest and principal) according to the contractual terms of the original loan agreement, and the carrying value has been written down to the fair value of the loan. The carrying value is equivalent to the fair value of the collateral, net of expected disposition costs where applicable, for collateral-dependent loans.

 

⋅

Cash surrender value of life insurance policies: The fair values are based on net cash surrender values at each reporting date.

   

  

⋅

Investments in, and capital commitments to, limited partnerships: The fair values of our investments in WNC Institutional Tax Credit Fund Limited Partnerships and any other limited partnerships are estimated using quarterly indications of value provided by the general partner. The fair values of undisbursed capital commitments are assumed to be the same as their book values.

 

⋅

Other investments: Certain long-term investments for which no secondary market exists are carried at cost, and the carrying amount for those investments approximates their estimated fair value.

 

⋅

Deposits: Fair values for demand deposits and other non-maturity deposits are equal to the amount payable on demand at the reporting date, which is the carrying amount. Fair values for fixed-rate certificates of deposit are estimated using a cash flow analysis, discounted at interest rates being offered at each reporting date by the Bank for certificates with similar remaining maturities. The carrying amount of accrued interest payable approximates its fair value.

 

⋅

Short-term borrowings: The carrying amounts approximate fair values for federal funds purchased, overnight FHLB advances, borrowings under repurchase agreements, and other short-term borrowings maturing within ninety days of the reporting dates. Fair values of other short-term borrowings are estimated by discounting projected cash flows at the Company’s current incremental borrowing rates for similar types of borrowing arrangements.

 

⋅

Long-term borrowings: The fair values of the Company’s long-term borrowings are estimated using projected cash flows discounted at the Company’s current incremental borrowing rates for similar types of borrowing arrangements.

 

⋅

Subordinated debentures: The fair values of subordinated debentures are determined based on the current market value for like instruments of a similar maturity and structure.

 

⋅

Commitments to extend credit and letters of credit: If funded, the carrying amounts for currently unused commitments would approximate fair values for the newly created financial assets at the funding date. However, because of the high degree of uncertainty with regard to whether or not those commitments will ultimately be funded, fair values for loan commitments and letters of credit in their current undisbursed state cannot reasonably be estimated, and only notional values are disclosed in the table below.

 

 

 

Estimated fair values for the Company’s financial instruments at the periods noted are as follows: 

 

Fair Value of Financial Instruments
(dollars in thousands, unaudited)		March 31, 2013
					Estimated Fair Value
		Carrying Amount				Quoted Prices in Active Markets for Identical Assets (Level 1)			Significant Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)				Total
Financial Assets:
Cash and cash equivalents		$	47,949		$	47,949		$	-		$	-		$	47,949
Investment securities available for sale			398,755			2,102			396,653			-			398,755
Loans and leases, net			789,709			-			839,394			-			839,394
Collateral dependent impaired loans			25,520			-			25,520			-			25,520
Loans held-for-sale			789			789			-			-			789
Cash surrender value of life insurance     policies			38,600			-			38,600			-			38,600
Other investments			6,370			-			6,370			-			6,370
Investment in Limited Partnership			10,095			-			10,095			-			10,095
Accrued interest receivable			4,771			-			4,771			-			4,771
Financial Liabilities:
Deposits:
Noninterest-bearing		$	342,048		$	342,048		$	-		$	-		$	342,048
Interest-bearing			813,886			-			814,289			-			814,289
Fed Funds Purchased and Repurchase     Agreements			2,673			-			2,673			-			2,673
Short-term borrowings			6,600			-			6,600			-			6,600
Long-term borrowings			-			-			-			-			-
Subordinated debentures			30,928			-			19,237			-			19,237
Limited partnership capital commitment			962			-			962			-			962
Accrued Interest Payable			186			-			186			-			186

 

     

		December 31, 2012
					Estimated Fair Value
		Carrying Amount			Quoted Prices in Active Markets for Identical Assets (Level 1)			Significant Observable Inputs (Level 2)			Significant Unobservable Inputs (Level 3)			Total
Financial Assets:
Cash and cash equivalents		$	61,818		$	61,818		$	-		$	-		$	61,818
Investment securities available for sale			380,188			1,809			378,379			-			380,188
Loans and leases, net			839,629			-			873,309			-			873,309
Collateral dependent impaired loans			27,449			-			27,449			-			27,449
Loans held-for-sale			210			210			-			-			210
Cash surrender value of life insurance    policies			38,007			-			38,007			-			38,007
Other Investments			6,370			-			6,370			-			6,370
Investment in Limited Partnership			10,316			-			10,316			-			10,316
Accrued Interest Receivable			5,095			-			5,095			-			5,095
Financial Liabilities:
Deposits:
Noninterest-bearing		$	352,597		$	352,597		$	-		$	-		$	352,597
Interest-bearing			821,437			-			821,911			-			821,911
Fed Funds Purchased and Repurchase    Agreements			1,419			-			1,419			-			1,419
Short-term borrowings			36,650			-			36,650			-			36,650
Long-term borrowings			5,000			-			5,038			-			5,038
Subordinated debentures			30,928			-			12,141			-			12,141
Limited partnership capital commitment			962			-			962			-			962
Accrued Interest Payable			304			-			304			-			304

 

  

      

For financial asset categories that were actually reported at fair value at March 31, 2013 and December 31, 2012, the Company used the following methods and significant assumptions:

 

⋅

Investment Securities: The fair values of securities available for sale are determined by obtaining quoted prices on nationally recognized securities exchanges or by matrix pricing, which is a mathematical technique used widely in the industry to value debt securities by relying on the their relationship to other benchmark quoted securities.

   

⋅

Collateral Dependent Impaired loans: Impaired loans carried at fair value are those for which it is probable that the bank will be unable to collect all amounts due (including both interest and principal) according to the contractual terms of the original loan agreement, and the carrying value has been written down to the fair value of the loan. The carrying value is equivalent to the fair value of the collateral based on current appraisals, net of expected disposition costs where applicable, for collateral-dependent loans.

 

⋅

Foreclosed assets: Repossessed real estate (OREO) and other assets are carried at the lower of cost or fair value. Fair value is the appraised value less expected selling costs for OREO and some other assets such as mobile homes, and for all other assets fair value is represented by the estimated sales proceeds as determined using reasonably available sources. Foreclosed assets for which appraisals can be feasibly obtained are periodically measured for impairment using updated appraisals. Fair values for other foreclosed assets are adjusted as necessary, subsequent to a periodic re-evaluation of expected cash flows and the timing of resolution. If impairment is determined to exist, the book value of a foreclosed asset is immediately written down to its estimated impaired value through the income statement, thus the carrying amount is equal to the fair value and there is no valuation allowance.

   

   

Assets reported at fair value on a recurring basis are summarized below:

    

Fair Value Measurements - Recurring
(dollars in thousands, unaudited)
		Fair Value Measurements at March 31, 2013, Using
		Quoted Prices in Active Markets for Identical Assets (Level 1)			Significant Observable Inputs (Level 2)			Significant Unobservable Inputs (Level 3)			Total
Investment Securities
U.S. Government agencies		$	-		$	4,684		$	-		$	4,684
Obligations of states and
political subdivisions			-			81,197			-			81,197
U.S. Government agencies
collateralized by mortgage
obligations			-			310,772			-			310,772
Other Securities			2,102			-			-			2,102
Total availabe-for-sale securities		$	2,102		$	396,653		$	-		$	398,755

   

		Fair Value Measurements at December 31, 2012, Using
		Quoted Prices in Active Markets for Identical Assets (Level 1)			Significant Observable Inputs (Level 2)			Significant Unobservable Inputs (Level 3)			Total
Investment Securities
U.S. Government agencies		$	-		$	2,973		$	-		$	2,973
Obligations of states and
political subdivisions			-			73,986			-			73,986
U.S. Government agencies
collateralized by mortgage
obligations			-			301,389			-			301,389
Other Securities			1,809			31			-			1,840
Total availabe-for-sale securities		$	1,809		$	378,379		$	-		$	380,188

 

12

  

Assets reported at fair value on a nonrecurring basis are summarized below:

   

Fair Value Measurements - Nonrecurring
(dollars in thousands, unaudited)
		Fair Value Measurements at March 31, 2013, Using
		Quoted Prices in Active Markets for Identical Assets (Level 1)			Significant Observable Inputs (Level 2)			Significant Unobservable Inputs (Level 3)			Total
Collateral Dependent Impaired Loans		$	-		$	25,520		$	-		$	25,520
Foreclosed Assets		$	-		$	15,747		$	-		$	15,747

   

		Fair Value Measurements at December 31, 2012, Using
		Quoted Prices in Active Markets for Identical Assets (Level 1)			Significant Observable Inputs (Level 2)			Significant Unobservable Inputs (Level 3)			Total
Collateral Dependent Impaired Loans		$	-		$	27,449		$	-		$	27,449
Foreclosed Assets		$	-		$	19,754		$	-		$	19,754

   

The table above only includes collateral-dependent impaired loan balances for which a specific reserve has been established or on which a write-down has been taken. Information on the Company’s total impaired loan balances, and specific loss reserves associated with those balances, is included in Note 11 below, and in Management’s Discussion and Analysis of Financial Condition and Results of Operation in the “Nonperforming Assets” and “Allowance for Loan and Lease Losses” sections.

 

The unobservable inputs are based on management’s best estimates of appropriate discounts in arriving at fair market value. Significant increases or decreases in any of those inputs could result in a significantly lower or higher fair value measurement. For example, a change in either direction of actual loss rates would have a directionally opposite change in the calculation of the fair value of impaired unsecured loans.       

Note 10 – Investments

 

Although the Company currently has the intent and the ability to hold the securities in its investment portfolio to maturity, the securities are all marketable and are classified as “available for sale” to allow maximum flexibility with regard to interest rate risk and liquidity management. Pursuant to FASB’s guidance on accounting for debt and equity securities, available for sale securities are carried on the Company’s financial statements at their estimated fair market values, with monthly tax-effected “mark-to-market” adjustments made vis-à-vis accumulated other comprehensive income in shareholders’ equity. The Company’s available-for-sale investment securities totaled $399 million at March 31, 2013, and $380 million at December 31, 2012.

 

13

  

Amortized Cost And Estimated Fair Value

 

The amortized cost and estimated fair value of investment securities available-for-sale are as follows

(dollars in thousands, unaudited): 

   

		March 31, 2013
		Amortized Cost			Gross Unrealized Gains			Gross Unrealized Losses			Estimated Fair Value
U.S. Government agencies		$	4,698		$	4		$	(18)		$	4,684
Obligations of state and political subdivisions			78,445			3,241			(489)			81,197
U.S. Government agencies collateralized by
mortgage obligations			308,044			3,779			(1,051)			310,772
Equity Securities			1,336			766			-			2,102
		$	392,523		$	7,790		$	(1,558)		$	398,755

            

		December 31, 2012
		Amortized Cost			Gross Unrealized Gains			Gross Unrealized Losses			Estimated Fair Value
U.S. Government agencies		$	2,987		$	3		$	(17)		$	2,973
Obligations of state and political subdivisions			70,736			3,430			(180)			73,986
U.S. Government agencies collateralized by
mortgage obligations			298,806			3,547			(964)			301,389
Equity Securities			1,336			508			(4)			1,840
		$	373,865		$	7,488		$	(1,165)		$	380,188

   

At March 31, 2013 and December 31, 2012, the Company had 130 securities and 89 securities, respectively, with unrealized losses. Management has evaluated those securities as of the respective dates, and does not believe that any of the associated unrealized losses are other than temporary. Information pertaining to our investment securities with unrealized losses, aggregated by investment category and length of time that individual securities have been in a continuous loss position, is disclosed in the table below.

 

14

 

Investment Portfolio - Unrealized Losses

(dollars in thousands, unaudited)

     

		March 31, 2013
		Less than Twelve Months						Over Twelve Months
		Gross Unrealized Losses			Fair Value			Gross Unrealized Losses			Fair Value
US Government Agencies		$	(18)		$	1,993		$	-		$	-
Obligations of State and Political Subdivisions			(475)			22,550			(15)			318
U.S. Government agencies collateralized by mortgage
obligations			(919)			112,437			(132)			11,942
Other Securities			-			-			-			-
Total		$	(1,412)		$	136,980		$	(147)		$	12,260

        

		December 31, 2012
		Less than Twelve Months						Over Twelve Months
		Gross Unrealized Losses			Fair Value			Gross Unrealized Losses			Fair Value
US Government Agencies		$	(17)		$	1,996		$	-		$	-
Obligations of State and Political Subdivisions			(180)			9,324			-			-
U.S. Government agencies collateralized by mortgage
obligations			(903)			106,799			(61)			6,965
Other Securities			(4)			242			-			-
Total		$	(1,104)		$	118,361		$	(61)		$	6,965

 

The Company monitors the credit quality of loans on a continuous basis using the regulatory and accounting classifications of pass, special mention, substandard and impaired to characterize the associated credit risk. Balances classified as “loss” are immediately charged off. The Company uses the following definitions of risk classifications:

 

⋅

Pass: Larger non-homogeneous loans not meeting the risk rating definitions below, and smaller homogeneous loans that are not assessed on an individual basis.

 

⋅

Special Mention: Loans which have potential issues that deserve the close attention of management. If left uncorrected, those potential weaknesses could eventually diminish the prospects for full repayment of principal and interest according to the contractual terms of the loan agreement, or could result in deterioration of the Company’s credit position at some future date.

 

⋅

Substandard: Loans that have at least one clear and well-defined weakness which could jeopardize the ultimate recoverability of all principal and interest, such as a borrower displaying a highly leveraged position, unfavorable financial operating results and/or trends, uncertain repayment sources or a deteriorated financial condition.

 

⋅

Impaired: A loan is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect all amounts due according to the contractual terms of the loan agreement. Impaired loans include all nonperforming loans, loans classified as restructured troubled debt, and certain other loans that are still being maintained on accrual status. If the Bank grants a concession to a borrower in financial difficulty, the loan falls into the category of a troubled debt restructuring (TDR). A TDR may be nonperforming or performing, depending on its accrual status and the demonstrated ability of the borrower to comply with restructured terms.

 

 

 

15

Credit quality classifications for the Company’s loan balances were as follows, as of the dates indicated:

 

Credit Quality Classifications

(dollars in thousands, unaudited)

		March 31, 2013
		Pass			Special Mention			Substandard			Impaired			Total
Real Estate:
1-4 Family residential construction		$	988		$	324		$	-		$	-		$	1,312
Other construction/Land			13,442			900			915			12,018			27,275
1-4 Family - closed end			69,821			2,237			792			23,291			96,141
Equity Lines			55,518			55			2,075			931			58,579
Multi-family residential			5,681			607			-			-			6,288
Commercial real estate - owner occupied			138,525			23,867			7,237			8,417			178,046
Commercial real estate - non-owner occupied			74,174			6,800			244			16,542			97,760
Farmland			82,583			2,205			3,499			1,923			90,210
Total Real Estate			440,732			36,995			14,762			63,122			555,611
Agricultural			25,659			449			-			659			26,767
Commercial and Industrial			183,516			4,570			371			4,850			193,307
Small Business Administration			15,176			1,624			731			3,146			20,677
Direct finance leases			3,743			4			-			150			3,897
Consumer loans			22,230			378			321			4,113			27,042
Total Gross Loans and Leases		$	691,056		$	44,020		$	16,185		$	76,040		$	827,301