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	27
Forward-Looking Statements	27
Critical Accounting Policies	27
Overview of the Results of Operations and Financial Condition	28
Earnings Performance	29
Net Interest Income and Net Interest Margin	29
Provision for Loan and Lease Losses	33
Non-interest Income and Non-Interest Expense	34
Provision for Income Taxes	36
Balance Sheet Analysis	37
Earning Assets	37
Investments	37
Loan and Lease Portfolio	38
Nonperforming Assets	40
Allowance for Loan and Lease Losses	41
Off-Balance Sheet Arrangements	43
Other Assets	43
Deposits and Interest-Bearing Liabilities	44
Deposits	44
Other Interest-Bearing Liabilities	45
Non-Interest Bearing Liabilities	46
Liquidity and Market Risk Management	46
Capital Resources	48
Item 3. Qualitative & Quantitative Disclosures about Market Risk 50
Item 4. Controls and Procedures	50
Part II - Other Information	51
Item 1. - Legal Proceedings	51
Item 1A. - Risk Factors	51
Item 2. - Unregistered Sales of Equity Securities and Use of Proceeds	51
Item 3. - Defaults upon Senior Securities	51
Item 4. - (Removed and Reserved)	51
Item 5. - Other Information	51
Item 6. - Exhibits	52
Signatures	53

 

 

(dollars in thousands)

 

		September 30, 2013			December 31, 2012
		(unaudited)			(audited)
ASSETS
Cash and due from banks		$	48,651		$	42,079
Interest-bearing deposits in banks			12,318			19,739
Total Cash & Cash Equivalents			60,969			61,818
Investment securities available for sale			406,089			380,188
Loans held for sale			267			210
Loans and leases:
Gross loans and leases			810,328			879,795
Allowance for loan and lease losses			(11,824)			(13,873)
Deferred loan and lease fees, net			1,246			1,156
Net Loans and Leases			799,750			867,078
Premises and equipment, net			20,493			21,830
Operating leases, net			-			12
Foreclosed assets			8,904			19,754
Goodwill			5,544			5,544
Other assets			81,283			81,469
TOTAL ASSETS		$	1,383,299		$	1,437,903
LIABILITIES AND SHAREHOLDERS' EQUITY
LIABILITIES
Deposits:
Non-interest bearing		$	354,814		$	352,597
Interest bearing			796,664			821,437
Total Deposits			1,151,478			1,174,034
Federal funds purchased and repurchase agreements			5,696			1,419
Short-term borrowings			-			36,650
Long-term borrowings			-			5,000
Junior subordinated debentures			30,928			30,928
Other liabilities			17,141			15,980
TOTAL LIABILITIES			1,205,243			1,264,011
SHAREHOLDERS' EQUITY
Common stock, no par value; 24,000,000 shares   authorized; 14,194,659 and 14,106,959 shares issued   and outstanding at September 30, 2013 and			65,505			64,384
December 31, 2012, respectively
Additional paid in capital			2,624			2,660
Retained earnings			109,942			103,128
Accumulated other comprehensive (loss) income			(15)			3,720
TOTAL SHAREHOLDERS' EQUITY			178,056			173,892
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY		$	1,383,299		$	1,437,903

 

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

 

 

	1

		Three Months Ended September 30,						Nine Months Ended September 30,
		2013			2012			2013			2012
Interest income:
Interest and fees on loans		$	10,932		$	11,954		$	33,207		$	34,251
Interest on investment securities:
Taxable			1,132			1,523			3,328			5,159
Tax-exempt			699			700			1,990			2,052
Interest on federal funds sold and interest-     bearing deposits			28			15			72			51
Total interest income			12,791			14,192			38,597			41,513
Interest expense:
Interest on deposits			606			796			1,894			2,490
Interest on short-term borrowings			4			23			16			41
Interest on long-term borrowings			-			51			33			231
Interest on mandatorily redeemable trust preferred securities			180			193			536			586
Total interest expense			790			1,063			2,479			3,348
Net Interest Income			12,001			13,129			36,118			38,165
Provision for loan losses			800			4,700			2,850			10,610
Net Interest Income after Provision for Loan Losses			11,201			8,429			33,268			27,555
Non-interest income:
Service charges on deposit accounts			2,354			2,525			6,642			7,229
Gains on investment securities available-for-sale			-			90			6			161
Other income, net			1,965			1,765			5,808			5,213
Total non-interest income			4,319			4,380			12,456			12,603
Non-interest expense:
Salaries and employee benefits			5,394			5,278			16,717			15,855
Occupancy expense			1,554			1,669			4,702			4,721
Other			4,542			4,548			12,608			13,441
Total non-interest expenses			11,490			11,495			34,027			34,017
Income before income taxes			4,030			1,314			11,697			6,141
Provision for income taxes			663			(321)			2,198			54
Net Income		$	3,367		$	1,635		$	9,499		$	6,087
PER SHARE DATA
Book value		$	12.54		$	12.37		$	12.54		$	12.37
Cash dividends		$	0.07		$	0.06		$	0.19		$	0.18
Earnings per share basic		$	0.24		$	0.12		$	0.67		$	0.43
Earnings per share diluted		$	0.23		$	0.12		$	0.67		$	0.43
Average shares outstanding, basic			14,176,732			14,103,543			14,139,697			14,102,880
Average shares outstanding, diluted			14,329,177			14,138,682			14,256,782			14,114,962
Total shareholder Equity (in thousands)		$	178,056		$	174,473		$	178,056		$	174,473
Shares outstanding			14,194,659			14,103,849			14,194,659			14,103,849
Dividends Paid (in thousands)		$	992		$	846		$	2,686		$	2,538

(dollars in thousands, unaudited)

 

		Three Months Ended September 30,						Nine Months Ended September 30,
		2013			2012			2013			2012
Net Income		$	3,367		$	1,635		$	9,499		$	6,087
Other comprehensive income, before tax:
Unrealized gains on securities:
Unrealized holding (losses) gains arising during period			(100)			1,926			(6,342)			3,635
Less: reclassification adjustment for gains (1) included in net income			-			(90)			(6)			(161)
Other comprehensive (loss) income, before tax			(100)			1,836			(6,348)			3,474
Income tax expense related to items of other    comprehensive (loss) income, net of tax			41			(756)			2,613			(1,434)
Other comprehensive (loss) income			(59)			1,080			(3,735)			2,040
Comprehensive income		$	3,308		$	2,715		$	5,764		$	8,127

 

⁽¹⁾ Amounts are included in net gains on investment securities available-for-sale on the Consolidated Statements of Income in non-interest revenue. Income tax expense associated with the reclassification adjustment for the quarters ended September 30, 2013 and 2012 was zero and $37 thousand, respectively. Income tax expense associated with the reclassification adjustment for the nine months ended September 30, 2013 and 2012 was $2 thousand and $66 thousand, respectively.

 

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

 

 

	3

 

(dollars in thousands, unaudited)

 

		Nine Months Ended September 30,
		2013			2012
Cash flows from operating activities:
Net income		$	9,499		$	6,087
Adjustments to reconcile net income to net cash      provided by operating activities:
Gain on sales of securities			(6)			(161)
Gain on sales of loans			(92)			(139)
(Gain) Loss on disposal of fixed assets			(15)			10
Loss on sale on foreclosed assets			568			709
Writedowns on foreclosed assets			695			1,610
Share-based compensation expense			218			183
Provision for loan losses			2,850			10,610
Depreciation			1,639			1,813
Net amortization on securities premiums and discounts			6,441			6,214
Increase in unearned net loan fees			(90)			(304)
Increase in cash surrender value of life insurance policies			(1,389)			(30)
Proceeds from sales of loans portfolio			3,662			5,717
Increase in loans held-for-sale			(3,627)			(4,842)
Decrease (Increase) in interest receivable and other assets			3,119			(677)
Increase in other liabilities			1,161			1,179
Net Decrease in FHLB Stock			438			670
Deferred Income Tax Provision			378			318
Excess tax benefit from equity based compensation			(253)			(39)
Net cash provided by operating activities			25,196			28,928
Cash flows from investing activities:
Maturities of securities available for sale			1,399			1,080
Proceeds from sales/calls of securities available for sale			3,454			11,319
Purchases of securities available for sale			(120,352)			(99,084)
Principal pay downs on securities available for sale			76,815			75,953
Net Decrease (Increase) in loans receivable, net			61,039			(125,316)
Purchases of premises and equipment, net			(275)			(3,204)
Proceeds from sales of foreclosed assets			13,116			13,898
Net cash provided by (used in) investing activities			35,196			(125,354)
Cash flows from financing activities:
(Decrease) Increase in deposits			(22,556)			59,585
(Decrease) Increase in borrowed funds			(41,650)			20,780
Increase in repurchase agreements			4,277			597
Cash dividends paid			(2,686)			(2,538)
Stock options exercised			1,121			22
Excess tax benefit from equity based compensation			253			39
Net cash (used in) provided by financing activities			(61,241)			78,485
Decrease in cash and due from banks			(849)			(17,941)
Cash and Cash Equivalents
Beginning of period			61,818			63,036
End of period		$	60,969		$	45,095

 

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

 

 

	4

 

 

Note 4 – Supplemental Disclosure of Cash Flow Information

 

During the nine months ended September 30, 2013 and 2012, cash paid for interest due on interest-bearing liabilities was $2.621 million and $3.087 million, respectively. There was no cash paid for income taxes during the nine months ended September 30, 2013 and 2012. Assets totaling $4.068 million and $20.724 million were acquired in settlement of loans for the nine months ended September 30, 2013 and September 30, 2012, respectively. We received $11.926 million in cash from the sale of foreclosed assets during the first nine months of 2013 relative to $10.134 million during the first nine months of 2012, which represents sales proceeds less loans extended to finance such sales totaling $1.190 million for the first nine months of 2013 and $3.735 million for the first nine months of 2012.

Note 5 – Share Based Compensation

 

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 149,350 shares that were granted under the 1998 Plan were still outstanding as of September 30, 2013 and remain unaffected by that plan’s 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 September 30, 2013 was 774,640. 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 employee compensation or directors’ expense, by amortizing the value 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 graded vesting, which is applicable for most options granted by the Company. A pre-tax charge of $67,000 was reflected in the Company’s income statement during the third quarter of 2013 and $61,000 was charged during the third quarter of 2012, as expense related to stock options. For the first nine months, the charges amounted to $218,000 in 2013 and $183,000 in 2012.

Note 6 – Earnings per Share

 

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 14,176,732 weighted average shares outstanding during the third quarter of 2013, and 14,103,543 during the third quarter of 2012. There were 14,139,697 weighted average shares outstanding during the first nine months of 2013, and 14,102,880 during the first nine months 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 third quarter and first nine months of 2013 the dilutive effect of options outstanding calculated under the treasury stock method totaled 152,445 and 117,085, respectively, which were added to basic weighted average shares outstanding for purposes of calculating diluted earnings per share. Likewise, for the third quarter and first nine months of 2012 shares totaling 35,139 and 12,082, respectively, were added to basic weighted average shares outstanding in order to calculate diluted earnings per share.

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 unused 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):

 

		September 30, 2013			December 31, 2012
Commitments to extend credit		$	438,054		$	225,400
Standby letters of credit		$	8,616		$	6,690
Commercial letters of credit		$	8,071		$	8,539

 

Commitments to extend credit consist primarily of the unused or unfunded portions of the following: home equity lines of credit; commercial real estate construction loans, where disbursements are made over the course of construction; commercial revolving lines of credit; mortgage warehouse lines of credit; unsecured personal lines of credit; and 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 $78 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:

 

   

 

	7

 

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 September 30, 2013 and December 31, 2012:

 

 

 

	8

 

 

	9

Estimated fair values for the Company’s financial instruments are as follows, as of the dates noted:

 

Fair Value of Financial Instruments
(dollars in thousands, unaudited)
		September 30, 2013
					Estimated Fair Value
					Quoted Prices in
					Active Markets			Significant			Significant
					for			Observable			Unobservable
		Carrying			Identical Assets			Inputs			Inputs
		Amount			(Level 1)			(Level 2)			(Level 3)			Total
Financial Assets:
Cash and cash equivalents		$	60,969		$	60,969		$	-		$	-		$	60,969
Investment securities available for sale			406,089			2,089			404,000			-			406,089
Loans and leases, net			784,330			-			825,383			-			825,383
Collateral dependent impaired loans			15,420			-			15,420			-			15,420
Loans held-for-sale			267			267			-			-			267
Cash surrender value of life insurance policies			39,396			-			39,396			-			39,396
Other investments			5,932			-			5,932			-			5,932
Investment in Limited Partnership			9,551			-			9,551			-			9,551
Accrued interest receivable			4,897			-			4,897			-			4,897
Financial Liabilities:
Deposits:
Noninterest-bearing		$	354,814		$	354,814		$	-		$	-		$	354,814
Interest-bearing			796,664			-			718,978			-			718,978
Fed Funds Purchased and      Repurchase Agreements			5,696			-			5,696			-			5,696
Short-term borrowings			-			-			-			-			-
Long-term borrowings			-			-			-			-			-
Subordinated debentures			30,928			-			19,373			-			19,373
Limited partnership capital commitment			1,015			-			1,015			-			1,015
Accrued Interest Payable			162			-			162			-			162

  

		Notional Amount
Off-balance-sheet financial instruments:
Commitments to extend credit		$	438,054
Standby letters of credit			8,616
Commercial lines of credit			8,071

 

		December 31, 2012
					Estimated Fair Value
					Quoted Prices in
					Active Markets			Significant			Significant
					for			Observable			Unobservable
		Carrying			Identical Assets			Inputs			Inputs
		Amount			(Level 1)			(Level 2)			(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

 

		Notional Amount
Off-balance-sheet financial instruments:
Commitments to extend credit		$	225,400
Standby letters of credit			6,690
Commercial lines of credit			8,539

 

 

	10

For financial asset categories that were actually reported at fair value at September 30, 2013 and December 31, 2012, the Company used the following methods and significant assumptions:

 

 

 

	11

Fair Value Measurements - Recurring
(dollars in thousands, unaudited)
		Fair Value Measurements at September 30, 2013, Using
		Quoted Prices in
		Active Markets			Significant			Significant
		for			Observable			Unobservable
		Identical Assets			Inputs			Inputs
		(Level 1)			(Level 2)			(Level 3)			Total
Investment Securities
U.S. Government agencies		$	-		$	4,030		$	-		$	4,030
Obligations of states and     political subdivisions			-			91,726			-			91,726
U.S. Government agencies     collateralized by mortgage     obligations			-			307,968			-			307,968
Other Securities			2,089			276			-			2,365
Total availabe-for-sale securities		$	2,089		$	404,000		$	-		$	406,089

		Fair Value Measurements at December 31, 2012, Using
		Quoted Prices in
		Active Markets			Significant			Significant
		for			Observable			Unobservable
		Identical Assets			Inputs			Inputs
		(Level 1)			(Level 2)			(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

Fair Value Measurements - Nonrecurring
(dollars in thousands, unaudited)
		Fair Value Measurements at September 30, 2013, Using
		Quoted Prices in
		Active Markets			Significant			Significant
		for			Observable			Unobservable
		Identical Assets			Inputs			Inputs
		(Level 1)			(Level 2)			(Level 3)			Total
Collateral Dependent Impaired Loans		$	-		$	15,420		$	-		$	15,420
Foreclosed Assets		$	-		$	8,904		$	-		$	8,904

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