U.S. Securities and Exchange Commission
Washington, D.C. 20549
Form 10-K
(Mark One)
| x | Annual Report under Section 13 or 15(d) of the Securities Exchange Act of 1934 |
For the fiscal year ended December 31, 2011
or
| ¨ | Transition Report under Section 13 or 15(d) of the Securities Exchange Act of 1934 |
For the transition period from to
Commission file no. 0-28780
Cardinal Bankshares Corporation
| | |
| Virginia | | 54-1804471 |
| (State of Incorporation) | | (IRS Employer Identification No.) |
101 Jacksonville Circle
Floyd, Virginia 24091
(Address of principal executive offices)
(540) 745-4191
(Registrant’s telephone number)
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, par value $10.00 per share
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. ¨ Yes x No
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. ¨ Yes x No
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 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 (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x. No ¨.
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (229.405 of this chapter) is not contained herein, and will not be contained to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ¨.
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. (Check one):
| | | | | | | | |
| Large Accelerated Filer | | ¨ | | | | Accelerated Filer | | ¨ |
| | | | |
| Non-accelerated Filer | | ¨ | | | | Smaller Reporting Company | | x |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). ¨ Yes x No
The aggregate market value of the voting stock held by non-affiliates of the registrant was approximately $21,671,927 as of June 30, 2011.
1,535,733 shares of the registrant’s common stock were issued and outstanding as of March 16, 2012.
DOCUMENTS INCORPORATED BY REFERENCE
The issuer’s Proxy Statement dated March 22, 2012 is incorporated by reference into Form 10-K Part III, Items 10, 11, 12, 13 and 14.
Index
PART I
PART I
ITEM 1. BUSINESS
General
Cardinal Bankshares Corporation (“Cardinal” or the “Company”) was incorporated in Virginia on March 12, 1996 to acquire the stock of Bank of Floyd (the “Bank”). The Bank was acquired by the Company on June 30, 1996. Cardinal is a bank holding company headquartered in Floyd, Virginia. The Company serves the marketplace primarily through its wholly owned banking subsidiary, the Bank.
The Bank was organized as a Virginia- chartered bank on February 24, 1951 through the consummation of a plan of consolidation between two state chartered community banks then operating in Floyd County, Virginia.
The Bank and its wholly owned subsidiary, FBC, Inc., are incorporated and operate under the laws of the Commonwealth of Virginia. The Company is registered as a bank holding company under the Bank Holding Company Act of 1956 (the “BHCA”), and as such is subject to supervision and regulation by the Board of Governors of the Federal Reserve System (the “Federal Reserve”) and the Bureau of Financial Institutions of the Virginia State Corporation Commission (“BFI”).
As a state chartered bank, the Bank is subject to supervision by the BFI. As a member of the Federal Reserve System, the Bank is also subject to supervision by the Federal Reserve. Deposits of the Bank are insured by the Federal Deposit Insurance Corporation (“FDIC”) to the legal maximum amounts.
The holding company structure provides greater flexibility than a bank standing alone because it allows expansion and diversification of business activities through non-bank subsidiaries and may facilitate acquisitions. At present, the Company’s business is conducted principally through its subsidiary bank.
Business
The principal business of the Company and Bank is to provide individual and corporate banking services appropriate to its market through the Bank’s main office in Floyd, Virginia, and branch offices in Hillsville, Christiansburg, Roanoke, Salem, Willis and Fairlawn, Virginia. The emphasis is on providing these services through a locally headquartered, community bank which is responsive to the needs of the communities it serves while maintaining its status as a financially strong, stable and profitable financial institution The Bank’s wholly owned subsidiary, FBC, Inc., has interests in Virginia Title Center, LLC as well as Virginia Bankers Insurance Center, LLC, both of which act as title insurance companies.
The Bank is a retail commercial bank offering a wide range of services, including demand and time deposits as well as consumer and commercial lending services. The Bank conducts substantially all of the business operations of a typical independent commercial bank, including the acceptance of checking and savings deposits, and the making of commercial, real estate, personal, home improvement, automobile and other installment loans. The Bank also offers other related services, such as traveler’s checks, safe deposit boxes, depositor transfer, customer note payment, collection, notary public, escrow, drive-in and ATM facilities, and other customary banking services. The Bank does not offer trust services.
The Bank operates as a community bank emphasizing personal customer service and other advantages incident to banking with a locally owned and managed community bank where customers have ready access to the Bank’s ultimate decision makers. It relies on local advertising and the personal contacts of its experienced directors and employees and the shareholders in its communities to attract and retain customers and business. The Bank emphasizes a high degree of personalized service. The Bank’s marketing approach emphasizes the advantages of dealing with an independent, locally managed “hometown” bank to meet the particular needs of individuals, professionals and small to medium-sized businesses in its market. The Company is supported by and, in turn supports, the community where its employees live and work and believes that this approach has created strong customer loyalties through the years.
1
Competition
The banking business is highly competitive. The Company competes as a financial intermediary with other commercial banks, savings and loan associations, credit unions and money market mutual funds operating in its trade area. As of December 31, 2011, there were three commercial banks (one of which is the Bank) operating a total of three offices in Floyd County, Virginia. The two competing institutions are not locally owned and headquartered. The Company believes this gives the Bank a substantial advantage.
Floyd County generates approximately 51% of the Bank’s total deposits. In the other parts of the Bank’s trade area (the Virginia counties of Roanoke, Montgomery, Carroll and Pulaski and the Cities of Roanoke and Salem, Virginia), there are a number of locally owned community banks, statewide banking organizations, affiliate banks of southeast regional bank holding companies and nationwide bankholding companies in operation. The principal methods of competition in the banking industry for loans are interest rates, loan origination fees, and the range of lending services offered. The local nature of the Bank provides an advantage in our market area because of personal relationships we have in our communities that are desirable to large segments of customers, which has enabled the bank to compete very satisfactorily. We intend to continue to provide a high level of service with local decision-making focused solely on our local market.
Customers
The Bank benefits from long-standing relationships with its customers in part because of the stability of its employee base, management and the Board of Directors. Deposits are derived from a broad base of customers in our communities. The Bank has a diverse deposit base (including Federal, State, and local governments and agencies) and as a result is not reliant on a few large depositors.
The majority of loans, commitments to extend credit, and standby letters of credit have been granted to customers in the Company’s market area. The majority of such customers are also depositors and many are shareholders. The Company generally does not extend credit to any single borrower or group of related borrowers in excess of approximately $3.5 million. Although the Company has a reasonably diversified loan portfolio, it has a loan concentration relating to nonresidential buildings and real estate land developers. Total loans to this group amounted to approximately $25.8 million at December 31, 2011 and approximately $33.6 million at December 31, 2010. In addition, the Company has loan concentrations relating to hotels and motels. Total loans to this group amounted to approximately $13.6 million at December 31, 2011 and approximately $14.6 million at December 31, 2010.
Employees
The Company (including the Bank) had 31 officers, 37 full-time employees and 2 part-time employees as of December 31, 2011. We believe we have excellent relationships with our employees and no employees are represented by a labor union. Our strong employee relations are evidenced by the facts that 40% of our employees have been with us for over 10 years, 26% have been with us for over 20 years and 21% have been with us for over 25 years.
Regulation, Supervision and Government Policy
We are subject to state and federal banking laws and regulations that provide for general regulatory oversight of all aspects of their operations. A brief summary follows of certain laws, rules and regulations which affect us. Recent and expected changes in the laws and regulations governing banking and financial services could have an adverse effect on the business prospects of all financial institutions. The current economic environment has created uncertainty in this area, as legislators and regulators attempt to address rapidly changing problems which have lead to new laws and regulations affecting financial institutions.
2
Cardinal Bankshares
Cardinal is a bank holding company organized under the BHCA, which is administered by the Federal Reserve. Cardinal is required to file reports with and furnishes substantial information to the Federal Reserve and to the BFI in their role as Cardinal’s regulatory supervisors. The Federal Reserve and the BFI examine Cardinal.
The Bank Holding Company Act. Under the BHCA, a bank holding company is generally prohibited from engaging in nonbanking activities unless the Federal Reserve has found those activities to be incidental to banking. Bank holding companies also may not acquire more than 5% of the voting shares of any company engaged in nonbanking activities. With some limited exceptions, the BHCA requires a bank holding company to obtain prior approval from the Federal Reserve before acquiring or merging with a bank or before acquiring more than 5% of the voting shares of a bank unless it already controls a majority of shares.
The Virginia Banking Act. The Virginia Banking Act requires all Virginia bank holding companies to register with the BFI. Cardinal is required to report to the BFI with respect to financial condition, operations and management. The BFI may also examine a Virginia bank holding company and its subsidiaries.
The Gramm-Leach-Bliley Act. The Gramm-Leach-Bliley Act (“GLBA”) permits significant combinations among different sectors of the financial services industry, allows for expansion of financial service activities by bank holding companies and offers financial privacy protections to consumers. GLBA preempts most state laws that prohibit financial holding companies from engaging in insurance activities. GLBA permits affiliations between banks and securities firms in the same holding company structure, and it permits financial holding companies to directly engage in a broad range of securities and merchant banking activities. Cardinal is not a financial holding company.
The Sarbanes-Oxley Act. The Sarbanes-Oxley Act (“SOX”) enacted sweeping reforms of the federal securities laws intended to protect investors by improving the accuracy and reliability of corporate disclosures. It impacts all companies, like Cardinal, with securities registered under the Securities Exchange Act of 1934. SOX creates increased responsibilities for chief executive officers and chief financial officers with respect to the content of filings with the Securities and Exchange Commission (the “SEC”). SOX focused increased scrutiny by internal and external auditors on Cardinal’s systems of internal controls over financial reporting, which is designed to insure that those internal controls are effective in both design and operation. SOX sets out enhanced requirements for audit committees, including independence and expertise, and it includes stronger requirements for auditor independence and limits the types of non-audit services that auditors can provide. Finally, SOX contains additional and increased civil and criminal penalties for violations of securities laws.
Capital Requirements. The Federal Reserve has adopted risk-based capital guidelines that are applicable to Cardinal. The guidelines provide that the Company must maintain a minimum ratio of 8% of qualified total capital to risk-weighted assets (including certain off-balance sheet items, such as standby letters of credit). At least half of total capital must be comprised of Tier 1 capital, for a minimum ratio of Tier 1 capital to risk-weighted assets of 4%. In addition, the Federal Reserve has established minimum leverage ratio guidelines of 4% for banks that meet certain specified criteria. The leverage ratio is the ratio of Tier 1 capital to total average assets, less intangibles. Cardinal is expected to be a source of capital strength for the Bank, and regulators can undertake a number of enforcement actions against Cardinal if its subsidiary bank becomes undercapitalized. This emphasizes the importance of maintaining Cardinal’s current strong capital base.
Emergency Economic Stabilization Act of 2008. On October 14, 2008, the U. S. Treasury announced the Troubled Asset Relief Program (“TARP”) under the Emergency Economic Stabilization Act of 2008. Cardinal did not participate in TARP.
American Recovery and Reinvestment Act of 2009(“ARRA”). The ARRA was enacted in 2009 and includes a wide range of programs to stimulate economic recovery. In addition, it also imposed new executive compensation and corporate governance obligations on TARP Capital Purchase Program recipients. Because Cardinal did not participate in TARP it is not affected by these requirements.
Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”). The Dodd-Frank Act was signed into law on July 21, 2010. Its wide ranging provisions affect all federal financial regulatory agencies and nearly every aspect of the American financial services industry. Among the provisions of the Dodd-Frank Act that directly impact the Company is the creation of an independent Consumer Financial Protection Bureau, (“CFPB”),
3
which has the ability to write rules for consumer protections governing all financial institutions. All consumer protection responsibility formerly handled by other banking regulators is consolidated in the CFPB. It will also oversee the enforcement of all federal laws intended to ensure fair access to credit. For smaller financial institutions such as Cardinal and the Bank, the CFPB will coordinate its examination activities through their primary regulators.
Bank of Floyd
The Bank is a state chartered bank under the laws of Virginia and is subject to regulation and examination by the BFI, it primary regulator, and as a member of the Federal Reserve System by the Federal Reserve as well. The Bank’s deposits are insured by the Federal Deposit Insurance Corporation and accordingly the Bank is subject to regulation and examination by the FDIC. These areas include adequacy of capitalization and loss reserves, loans, deposits, business practices related to the charging and payment of interest, investments, borrowings, payment of dividends, security devices and procedures, establishment of branches, corporate reorganizations and maintenance of books and records. The Bank is required to maintain certain capital ratios. The Bank is well capitalized under regulatory capital classifications.
The Community Reinvestment Act. The Bank is subject to the provisions of the Community Reinvestment Act (“CRA”), which imposes an affirmative obligation on financial institutions to meet the credit needs of the communities they serve, including low and moderate income neighborhoods. The regulators monitor the Bank’s compliance with the CRA and assign public ratings based upon the Bank’s performance in meeting stated assessment goals. Unsatisfactory CRA ratings can result in restrictions on bank operations or expansion. The Bank received a “satisfactory” rating in its last CRA examination.
The Gramm-Leach-Bliley Act. In addition to other consumer privacy provisions, GLBA restricts the use by financial institutions of customers’ nonpublic personal information. At the inception of the customer relationship and annually thereafter, the Bank is required to provide its customers with information regarding its policies and procedures with respect to handling of customers’ nonpublic personal information. GLBA generally prohibits a financial institution from providing a customer’s nonpublic personal information to unaffiliated third parties without prior notice and approval by the customer.
The USA Patriot Act. The USA Patriot Act (“Patriot Act”) facilitates the sharing of information among government entities and financial institutions to combat terrorism and money laundering. The Patriot Act imposes an obligation on the Bank to establish and maintain anti-money laundering policies and procedures, including a customer identification program. The Bank is also required to screen all customers against government lists of known or suspected terrorists. There is additional regulatory oversight to insure compliance with the Patriot Act.
Consumer Laws and Regulations. There are a number of laws and regulations that regulate banks’ consumer loan and deposit transactions. Among these are the Truth in Lending Act, the Truth in Savings Act, the Expedited Funds Availability Act, the Equal Credit Opportunity Act, the Fair Housing Act, the Fair Credit Reporting Act, and the Fair Debt Collections Practices Act. The Bank is required to comply with these laws and regulations in its dealing with customers. There are numerous disclosure and other compliance requirements associated with the consumer laws and regulations.
Deposit Insurance. The Bank has deposits that are insured by the FDIC. The FDIC maintains the Deposit Insurance Fund (“DIF”) that is funded by risk-based insurance premium assessments on insured depository institutions. Assessments are determined based upon several factors, including the level of regulatory capital and the results of regulatory examinations. The FDIC may adjust assessments if the insured institution’s risk profile changes or if the size of the DIF declines in relation to the total amount of insured deposits. In 2011 and 2010, the Bank paid $ 303 thousand and $ 368 thousand, respectively, in FDIC assessments, which was a substantial increase over prior years.
In October 3, 2008, the FDIC announced that deposits at FDIC-insured institutions would be insured up to at least $250,000. It was extended to December 31, 2013, and then permanently.
FDIC announced its Transaction Account Guarantee Program on October 14, 2008. The Transaction Account Guarantee Program, which is a part of the Temporary Liquidity Guarantee Program, provides full coverage for non-interest bearing deposit accounts of FDIC-insured institutions that elected to participate. The Bank elected to participate in this program and opted to continue in the program. There are increased DIF assessments for program participants.
4
After giving primary regulators an opportunity to first take action, FDIC may initiate an enforcement action against any depository institution it determines is engaging in unsafe or unsound actions or which is in an unsound condition, and the FDIC may terminate that institution’s deposit insurance.
Availability of Information
The public may read and copy any material the Company files with the Commission at the SEC’s Public Reference Room at 100 F Street, NE, Washington, DC 20549, on official business days during the hours of 10:00 am to 3:00 pm, and the public may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330.
The SEC maintains an internet site (http://www.sec.gov) that contains reports, proxy and information statements, and other information, regarding issuers that file electronically with the SEC.
ITEM 1A. RISK FACTORS
Not Applicable
ITEM 1B. UNRESOLVED STAFF COMMENTS
Not Applicable
ITEM 2. PROPERTIES
The present headquarters of the Company consists of a three-story brick building, with approximately 21,200 square feet of floor space located at 101 Jacksonville Circle, Floyd, Virginia. The Bank also owns its branch offices in Hillsville, Christiansburg, Roanoke, and Fairlawn Virginia, which have drive-up facilities. The Bank’s Willis, Virginia and Salem, Virginia offices operate from a leased facility. The Bank has a limited service office located in Willis. The Roanoke office is in the Cave Spring area of Roanoke County. The Salem office is located on West Main Street in Salem, Virginia. The Hillsville office is located in Carroll County. The Christiansburg office serves Montgomery County. The Bank’s Pulaski County office is located in the Fairlawn community.
The Bank also owns a three-story brick building adjacent to its main office which serves as the Bank’s conference room, training room and which provides space for expansion of the financial services now offered.
We believe our facilities are well located to serve our intended markets and are well furnished and equipped for the services we provide.
ITEM 3. LEGAL PROCEEDINGS
NONE
ITEM 4. MINE SAFETY DISCLOSURES
NONE
5
PART II
ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
(A) The Company has 5,000,000 shares of common stock ($10 par) authorized of which 1,535,733 are outstanding as of December 31, 2011. There were approximately 630 shareholders as of December 31, 2011.
The Company’s stock is traded on the OTC Bulletin Board under the symbol CDBK. According to information obtained by Company management and believed to be reliable, the quarterly range of closing prices per share for the common stock during the last two fiscal years was as follows:
| | | | | | | | | | | | | | | | |
| | | 2011 | | | 2010 | |
| | High | | | Low | | | High | | | Low | |
First Quarter | | $ | 13.50 | | | $ | 8.30 | | | $ | 10.50 | | | $ | 7.17 | |
Second Quarter | | | 18.50 | | | | 12.80 | | | | 12.50 | | | | 9.10 | |
Third Quarter | | | 15.50 | | | | 13.50 | | | | 9.25 | | | | 8.20 | |
Fourth Quarter | | | 14.50 | | | | 13.25 | | | | 9.50 | | | | 8.20 | |
(B) The Company paid dividends semiannually totaling $246,000 (or $0.16 per share) in 2011 and 2010 respectively. The only source of dividends for the Company is dividends paid to the Company by the Bank. Therefore, the Company’s ability to pay dividends is dependent upon the Bank’s financial performance and its capital strength as well as the Company’s capital strength. The Bank and the Company’s strong capital base supports their safety and soundness, ability to growth and weather adverse economic conditions and, together with earnings, pay dividends. The laws and regulations governing the payment of dividends, discussed above also affect the ability to pay dividends. Because of the Company and Bank’s financial condition and earnings the Company currently expects that dividends will continue to be paid semi-annually in the foreseeable future; however, the Board of Directors retains the discretion over the amount, if any, and frequency of dividend payments.
ITEM 6. SELECTED FINANCIAL DATA
NOT APPLICABLE
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION
INTRODUCTION
A Warning About Forward-Looking Statements
This annual report contains forward-looking statements. The Company may also make written forward-looking statements in periodic reports to the Securities and Exchange Commission, proxy statements, offering circulars and prospectuses, press releases and other written materials and oral statements made by Cardinal Bankshares’ officers, directors or employees to third parties. Statements that are not historical facts, including statements about the Company’s beliefs and expectations, are forward-looking statements. These statements are based on beliefs and assumptions of the Company’s management, and on information currently available to such management. Forward-looking statements include statements preceded by, followed by or that include the words “believes,” “expects,” “estimates,” “anticipates,” “plans,” or similar expressions. Forward-looking statements speak only as of the date they are made, and the Company undertakes no obligation to update publicly any of them in light of new information or future events.
Forward-looking statements involve inherent risks and uncertainties. Management cautions the readers that a number of important factors could cause actual results to differ materially from those contained in any forward-looking statement. Such factors include, but are not limited to, the following: competitive pressures among depository and other financial institutions may increase significantly; changes in the interest rate environment may reduce margins; general economic or business conditions may lead to a deterioration in credit quality or a reduced
6
demand for credit; legislative or regulatory changes, including changes in accounting standards, may adversely affect the business in which Cardinal is engaged; changes may occur in the securities markets; and competitors of the Company may have greater financial resources and develop products that enable such competitors to compete more successfully than Cardinal.
Other factors that may cause actual results to differ from the forward-looking statements include the following: the timely development of competitive new products and services by the Company and the acceptance of such products and services by customers; changes in consumer spending and savings habits; the effects of competitors’ pricing policies; the Company’s success in managing the costs associated with the expansion of existing distribution channels and developing new ones, and in realizing increased revenues from such distribution channels, including cross-selling initiatives; and mergers and acquisitions and their integration into the Company and management’s ability to manage these other risks.
Management of Cardinal believes these forward-looking statements are reasonable; however undue reliance should not be placed on such forward-looking statements, which are based on current expectations.
Forward-looking statements are not guarantees of performance. They involve risks, uncertainties and assumptions. The future results and stockholder values of Cardinal may differ materially from those expressed in forward-looking statements contained in this report. Many of the factors that will determine these results and values are beyond the Company’s ability to control or predict.
Overview
The management of Cardinal, in conjunction with its Board of Directors, continues to focus on shareholder value while maintaining a safe and sound institution for its customers. Several aspects of Cardinal’s current financial condition demonstrate this core value.
Banks are evaluated in light of three major regulatory capital ratios. Cardinal maintains these ratios substantially in excess of the minimum standards required for both the holding company and bank. While capital ratios are an excellent indicator of a bank’s financial strength they are also an indicator of a bank’s ability to withstand financial turmoil such as the recent economic recession.
Cardinal’s management recognized the increased level of risk inherent in lending due to the aforementioned recession. Accordingly, Cardinal has prudently adjusted its allowance for loan losses as necessary. Cardinal’s capital position combined with its loan loss reserve allows the Company to address probable loan losses while continuing to maintain a solid financial position with which to serve its customers.
Cardinal maintains abundant liquidity in order to maintain adequate funding for customer withdrawals, loans, investments and daily clearing of transactions. Although the amount of liquidity has some negative impact on earnings, the highly liquid position allows Cardinal to have great flexibility to react to economic conditions.
Cardinal has continued to be profitable on a consistent basis, with the net income for 2011 13.4% ahead of 2010. This consistent profitability has been achieved by effective cost control, attention to and adjustment of rates paid on deposits and lending practices that in recent years have kept our credit losses below those of our peers. In addition, consistent profitability has allowed Cardinal to pay a regular semi-annual dividend while increasing equity and long-term shareholder value.
During a period of prolonged economic distress, in which many banks have failed or are faltering, Cardinal has improved its capital ratios, continuously been profitable and has paid a dividend. Finally, the company has achieved a Return on Equity and Return on Investment on par or exceeding its peer group.
The following discussion provides information about the major components of the financial condition, results of operations, asset quality, liquidity, and capital resources of Cardinal Bankshares. The discussion and analysis should be read in conjunction with the Consolidated Financial Statements.
Critical Accounting Policy
Management believes the policy with respect to the methodology for the determination of the allowance for loan losses involve a high degree of complexity. Management must make difficult and subjective judgments, assumptions or estimates that could cause reported results to differ materially. This critical policy and its application are periodically reviewed with the Audit Committee and Board of Directors.
7
FINANCIAL CONDITION
Cardinal reported net income for the year 2011 of $1.1 million, an increase of $130 thousand or 13.4% over 2010 net income of $969 thousand. The primary factor contributing to the increase in net income was the decrease in interest expense paid on deposits of $1.3 million versus 2010, as the bank continued to lower rates paid on deposits throughout the year. The decrease in interest expense, along with a decrease of $69 thousand in the amount added to the Allowance for Loan Losses versus 2010, offset a decrease of $259 thousand in total noninterest income versus 2010 and an increase of $204 thousand in total noninterest expense versus 2010. Net income per diluted share was $.72, $.09 higher than the $.63 reported for the prior year.
Net interest income, on a taxable equivalent basis, was $7.3 million, an increase $572 thousand from $6.8 million in 2010. This increase was driven primarily by the reduction in interest expense paid on deposit due to the bank lowering interest rates throughout the year in response to market conditions. Noninterest income decreased $259 thousand due to an other-than-temporary impairmant on investments. Noninterest expense increased $204 thousand to $5.7 million compared to $5.5 million in 2010. This increase is attributable to increased salaries and employee expense, increased legal and professional fees and a loss on sale of premises and equipment related to sale of the Tanglewood branch and replacement of ATM machines.
Earning assets averaged $237.5 million, compared to $231.4 million in 2010, due to increased investments in securities and federal funds sold as a result of increased deposits.
Interest-bearing liabilities averaged $188.3 million, compared to $184.0 million in 2010 driven by an increase of $21.2 million in Savings deposits. The increase in interest-bearing liabilities reflects the shift of funds from higher risk investments to an environment of less risk and greater stability.
Stockholders’ equity increased 3.2% to an average of $32.7 million in 2011 from $31.7 million in 2010. The return on average assets and average equity increased to .44% and 3.36%, respectively for 2011 compared to .40% and 3.06%, respectively, for 2010. Book value per share was $21.51 at December 31, 2011, compared to $20.76 at year-end 2010, representing an increase of 3.6%.
8
Table 1. Average Balances and Interest Rates (Taxable Equivalent Basis)
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Years ended December 31, (In thousands) | | 2011 | | | 2010 | | | 2009 | |
| | | Average
Balance | | | Interest
Income/
Expense | | | Yield/
Cost | | | Average
Balance | | | Interest
Income/
Expense | | | Yield/
Cost | | | Average
Balance | | | Interest
Income/
Expense | | | Yield/
Cost | |
Assets: | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Interest-earning assets: | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Deposits in other banks | | $ | 4,573 | | | $ | 2 | | | | .03 | % | | $ | 5,530 | | | $ | 7 | | | | .13 | % | | $ | 1,627 | | | $ | 2 | | | | .11 | % |
Taxable investment securities | | | 43,961 | | | | 1,361 | | | | 3.10 | % | | | 37,262 | | | | 1,252 | | | | 3.36 | % | | | 25,729 | | | | 1,166 | | | | 4.53 | % |
Nontaxable investment securities | | | 17,236 | | | | 910 | | | | 5.28 | % | | | 17,873 | | | | 972 | | | | 5.44 | % | | | 18,619 | | | | 1,170 | | | | 6.28 | % |
Federal funds sold | | | 29,318 | | | | 49 | | | | .17 | % | | | 20,556 | | | | 45 | | | | .22 | % | | | 24,322 | | | | 49 | | | | .20 | % |
Loans (3), (4) | | | 142,458 | | | | 8,082 | | | | 5.67 | % | | | 150,209 | | | | 8,885 | | | | 5.92 | % | | | 147,060 | | | | 9,138 | | | | 6.21 | % |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Total interest-earning assets | | | 237,546 | | | | 10,404 | | | | 4.38 | % | | | 231,430 | | | | 11,161 | | | | 4.82 | % | | | 217,357 | | | | 11.525 | | | | 5.30 | % |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Noninterest-earning assets: | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Cash and due from banks | | | 3,339 | | | | | | | | | | | | 3,303 | | | | | | | | | | | | 3,560 | | | | | | | | | |
Premises and equipment | | | 3,152 | | | | | | | | | | | | 3,854 | | | | | | | | | | | | 3,905 | | | | | | | | | |
Other assets | | | 9,388 | | | | | | | | | | | | 9,208 | | | | | | | | | | | | 7,700 | | | | | | | | | |
Allowance for loan losses | | | (3,076 | ) | | | | | | | | | | | (2,897 | ) | | | | | | | | | | | (1,807 | ) | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Total assets | | $ | 250,349 | | | | | | | | | | | $ | 244,898 | | | | | | | | | | | $ | 230,715 | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Liabilities and stockholders’ equity: | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Interest-bearing liabilities: | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Interest checking | | $ | 10,613 | | | | 14 | | | | 0.13 | % | | $ | 10,824 | | | | 32 | | | | 0.29 | % | | $ | 10,696 | | | | 53 | | | | 0.49 | % |
Savings deposits | | | 59,149 | | | | 644 | | | | 1.09 | % | | | 37,984 | | | | 488 | | | | 1.28 | % | | | 30,192 | | | | 431 | | | | 1.43 | % |
Time deposits | | | 64,968 | | | | 1,524 | | | | 2.34 | % | | | 71,700 | | | | 2,130 | | | | 2.97 | % | | | 78,465 | | | | 2,894 | | | | 3.69 | % |
Large denomination deposits | | | 53,559 | | | | 884 | | | | 1.64 | % | | | 63,500 | | | | 1,745 | | | | 2.74 | % | | | 52,802 | | | | 1,659 | | | | 3.13 | % |
Securities sold under agreements to repurchase | | | — | | | | — | | | | 0.00 | % | | | — | | | | — | | | | 0.00 | % | | | — | | | | — | | | | 0.00 | % |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Total interest-bearing liabilities | | | 188,289 | | | | 3,066 | | | | 1.63 | % | | | 184,008 | | | | 4,395 | | | | 2.39 | % | | | 172,155 | | | | 5,037 | | | | 2.93 | % |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Noninterest-bearing liabilities: | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Demand deposits | | | 29,199 | | | | | | | | | | | | 28,757 | | | | | | | | | | | | 27,220 | | | | | | | | | |
Other liabilities | | | 167 | | | | | | | | | | | | 447 | | | | | | | | | | | | 1,617 | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Total liabilities | | | 217,655 | | | | | | | | | | | | 213,212 | | | | | | | | | | | | 200,992 | | | | | | | | | |
Stockholders’ equity | | | 32,694 | | | | | | | | | | | | 31,686 | | | | | | | | | | | | 29,723 | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Total liabilities and stockholders’ equity | | $ | 250,349 | | | | | | | | | | | $ | 244,898 | | | | | | | | | | | $ | 230,715 | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Net interest earnings | | | | | | $ | 7,338 | | | | | | | | | | | $ | 6,766 | | | | | | | | | | | $ | 6,488 | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Net interest spread (1) | | | | | | | | | | | 2.75 | % | | | | | | | | | | | 2.43 | % | | | | | | | | | | | 2.37 | % |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Net interest margin (2) | | | | | | | | | | | 3.09 | % | | | | | | | | | | | 2.92 | % | | | | | | | | | | | 2.99 | % |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Taxable equivalent adjustment | | | | | | $ | 282 | | | | | | | | | | | $ | 314 | | | | | | | | | | | $ | 541 | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| (1) | Net interest spread is the difference between the average interest rate received on earning assets and the average interest rate paid for interest-bearing liabilities. |
| (2) | Net interest margin is calculated by dividing taxable equivalent net interest earnings by total average earning assets. |
| (3) | Average loan balances include nonaccrual loans. |
| (4) | Interest income includes deferred loan fees. |
9
Net Interest Income
Net interest income, the primary source of the Company’s earnings, is the amount by which interest and fee income generated by earning assets exceeds the interest paid on interest-bearing liabilities. Earning assets are comprised of loans, securities, federal funds sold and interest-bearing deposits in other banks. Interest-bearing liabilities consist of deposits, federal funds purchased and securities sold under agreements to repurchase. The volume and the general level of interest rates among earning assets and interest-bearing liabilities effect net interest income. Table 1 shows the average balance sheets for each of the years ended December 31, 2011, 2010 and 2009. In addition, the amounts of interest earned on earning assets, with related yields, and the interest paid on interest-bearing liabilities, together with rates, are shown. Loans placed on a nonaccrual status are included in the balances and were included in the computation of yields. Interest on earning assets is on a taxable equivalent basis, which is computed using the federal corporate income tax rate of 34% for all three years.
Net interest income, on a taxable equivalent basis, was $7.3 million, an increase of 8.5%, or $572 thousand from the $6.8 million in 2010. The net interest margin was 3.09% for 2011, up 17 basis points from the 2.92% reported in 2010.
As illustrated in Table 2, the effect of decreased rates affecting the Company’s total interest earning assets is evident in the $756 thousand decrease in interest income due primarily to rate.
During 2011, interest expense associated with interest bearing liabilities decreased by $1.3 million due to decreased rates paid on deposits.
Table 2. Rate/Volume Variance Analysis
| | | | | | | | | | | | | | | | | | | | | | | | |
| | | 2011 Compared to 2010 | | | 2010 Compared to 2009 | |
| | | | | | Increase (Decrease)
Due To | | | | | | Increase (Decrease)
Due To | |
December 31, (In thousands) | | Total | | | Rate | | | Volume | | | Total | | | Rate | | | Volume | |
Interest-earning assets: | | | | | | | | | | | | | | | | | | | | | | | | |
Deposits in other banks | | $ | (5 | ) | | $ | (4 | ) | | $ | (1 | ) | | $ | 5 | | | $ | — | | | $ | 5 | |
Taxable investment securities | | | 109 | | | | (116 | ) | | | 225 | | | | 86 | | | | (437 | ) | | | 523 | |
Nontaxable investment securities | | | (62 | ) | | | (27 | ) | | | (35 | ) | | | (198 | ) | | | (151 | ) | | | (47 | ) |
Federal funds sold | | | 4 | | | | (15 | ) | | | 19 | | | | (5 | ) | | | 3 | | | | (8 | ) |
Loans | | | (803 | ) | | | (346 | ) | | | (457 | ) | | | (252 | ) | | | (449 | ) | | | 197 | |
| | | | | | | | | | | | | | | | | | | | | | | | |
Total | | | (757 | ) | | | (508 | ) | | | (249 | ) | | | (364 | ) | | | (1,034 | ) | | | 670 | |
| | | | | | | | | | | | | | | | | | | | | | | | |
Interest-bearing liabilities: | | | | | | | | | | | | | | | | | | | | | | | | |
Interest checking | | | (18 | ) | | | (17 | ) | | | (1 | ) | | | (21 | ) | | | (22 | ) | | | 1 | |
Savings deposits | | | 156 | | | | (116 | ) | | | 272 | | | | 57 | | | | (54 | ) | | | 111 | |
Time deposits | | | (606 | ) | | | (405 | ) | | | (201 | ) | | | (764 | ) | | | (513 | ) | | | (251 | ) |
Large denomination deposits | | | (861 | ) | | | (588 | ) | | | (273 | ) | | | 86 | | | | (250 | ) | | | 336 | |
Securities sold under agreements to repurchase | | | — | | | | — | | | | — | | | | — | | | | — | | | | — | |
| | | | | | | | | | | | | | | | | | | | | | | | |
Total | | | (1,329 | ) | | | (1,126 | ) | | | (203 | ) | | | (642 | ) | | | (839 | ) | | | 197 | |
| | | | | | | | | | | | | | | | | | | | | | | | |
Net interest income | | $ | 572 | | | $ | 618 | | | $ | (46 | ) | | $ | 278 | | | $ | (195 | ) | | $ | 473 | |
| | | | | | | | | | | | | | | | | | | | | | | | |
10
Provision for Loan Losses
The allowance for loan losses represents the amount available for credit losses inherent in the Company’s loan portfolio. Loan losses and recoveries are charged or credited directly to the allowance. Management determines the provision for loan losses required to maintain an allowance adequate to provide for any probable losses. The factors considered in making this decision are the collectability of past due loans, the nature and volume of the loan portfolio, adverse situations that may affect the borrower’s ability to repay, estimated value of underlying collateral and general economic trends. In 2011, the provision for loan losses was $592 thousand, a decrease of $69 thousand from the $661 thousand recorded in 2010. Based upon management’s periodic reviews of the loan portfolio using the previously mentioned factors, the current year’s provision for loan losses was felt appropriate. Management believes the provision recorded in 2011 maintains the allowance at a level adequate to cover probable losses. The allowance for loan losses as a percentage of total loans was 2.20% at year-end. This level is greater than the 1.66% ratio averaged at year-end 2011 by the Company’s peer group, commercial banks with assets ranging between $100 million and $300 million. Loan charge-offs exceeded loan recoveries by $798 thousand for 2011, compared to loan charge-offs net of recoveries of $258 thousand for 2010.
Additional information regarding the Company’s allowance for loan losses is contained in Tables 13 and 14, and in the discussion concerning Analysis of the Allowance for Loan Losses.
Noninterest Income
Noninterest income consists of revenues generated from a number of different financial services and activities. Service charges on deposit accounts including charges for insufficient funds items and fees charged for nondeposit services make up a significant portion of noninterest income. Noninterest income also includes fees charged for services such as safe deposit box rentals, letters of credit, and gains realized on the sale of securities. Noninterest income totaled $424 thousand in 2011, a decrease of $259 thousand over the $683 thousand recorded in 2010. The decrease in noninterest income was due to a net other-than-temporary impairment on investments. The primary sources of noninterest income for the past three years are summarized in Table 3.
Table 3. Noninterest Income
| | | | | | | | | | | | |
Year ended December 31, (In thousands) | | 2011 | | | 2010 | | | 2009 | |
Deposit fees and charges | | $ | 208 | | | $ | 194 | | | $ | 186 | |
Other service charges and fees | | | 117 | | | | 124 | | | | 113 | |
Gain on the sale of securities | | | 115 | | | | 98 | | | | 50 | |
Net other-than-temporary impairment on investments | | | (300 | ) | | | — | | | | — | |
Bank owned life insurance | | | 158 | | | | 164 | | | | 164 | |
Other income | | | 126 | | | | 103 | | | | 141 | |
| | | | | | | | | | | | |
Total noninterest income | | $ | 424 | | | $ | 683 | | | $ | 654 | |
| | | | | | | | | | | | |
11
Noninterest Expense
Noninterest expense was $5.7 million for 2011, an increase of $204 thousand or 3.7% from the $5.5 million recorded in 2010. Salaries and employee benefits increased $260 thousand due to increased executive expense, occupancy and equipment decreased $72 thousand due to less maintenance expense, the sale of the Tanglewood branch, and replacement of ATM’s, legal and professional increased $130 thousand as a result increased filing and regulatory requirement, bank franchise tax increased $16 thousand, data processing service decreased $14 thousand, FDIC insurance premiums decreased $65 thousand due to a mandated change in the calculation of the premium, foreclosed assets, net decreased $84 thousand due to the collection of rental on OREO (other real estate owned), a loss on sale of premises and equipment resulted from the sale of the Tanglewood branch and the replacement of ATM’s and other operating expenses decreased $49 thousand.
Table 4 provides a further breakdown of noninterest expense for the past three years.
Table 4. Noninterest Expense
| | | | | | | | | | | | |
Year ended December 31, (In thousands) | | 2011 | | | 2010 | | | 2009 | |
Salaries and employee benefits | | $ | 3,496 | | | $ | 3,236 | | | $ | 2,777 | |
Occupancy and equipment | | | 607 | | | | 679 | | | | 640 | |
Legal and professional | | | 287 | | | | 157 | | | | 256 | |
Bank franchise tax | | | 172 | | | | 156 | | | | 141 | |
Data processing services | | | 227 | | | | 241 | | | | 186 | |
FDIC insurance premiums | | | 303 | | | | 368 | | | | 466 | |
Foreclosed assets, net | | | (33 | ) | | | 51 | | | | 1 | |
Loss on sale of premises and equipment | | | 82 | | | | — | | | | — | |
Other operating expense | | | 583 | | | | 632 | | | | 622 | |
| | | | | | | | | | | | |
Total noninterest expense | | $ | 5,724 | | | $ | 5,520 | | | $ | 5,089 | |
| | | | | | | | | | | | |
Income Taxes
Income tax expense is based on amounts reported in the statements of income, after adjustments for non-taxable income and non-deductible expenses, and consists of taxes currently due plus deferred taxes on temporary differences in the recognition of income and expense for tax and financial statement purposes. The deferred tax assets and liabilities represent the future Federal income tax return consequences of those differences, which will either be taxable or deductible when the assets and liabilities are recovered or settled.
Income tax expense (benefit), substantially all Federal, was $65 thousand in 2011, $(15) thousand in 2010 and $(265) thousand in 2009 representing 5.6%, (1.57%) and (92.7%) of income before income taxes, respectively. Cardinal Bankshares’ deferred income tax benefits and liabilities result primarily from temporary differences in provisions for credit losses, valuation reserves, depreciation, deferred compensation, deferred income, pension expense and investment security discount accretion.
Net deferred income tax assets of approximately $1.7 million and $1.6 million at December 31, 2011 and 2010, respectively, are included in other assets.
12
Earning Assets
In 2011, average earning assets increased to $237.5 million, $6.1 million higher than the 2010 average of $231.4 million. Total average earning assets represented 94.9% of total average assets in 2011. Average investment securities accounted for 24.5% of total average assets, while average loans remained the largest component of earning assets, accounting for 56.9% of total average assets in 2011, down from the 61.3% level reported in 2010. A summary of average assets for the past three years is shown below in Table 5.
Table 5. Average Asset Mix
| | | | | | | | | | | | | | | | | | | | | | | | |
December 31, (In thousands) | | 2011 | | | 2010 | | | 2009 | |
| | | Average
Balance | | | % | | | Average
Balance | | | % | | | Average
Balance | | | % | |
Interest-earning assets: | | | | | | | | | | | | | | | | | | | | | | | | |
Loans | | $ | 142,458 | | | | 56.9 | | | $ | 150,209 | | | | 61.3 | | | $ | 147,060 | | | | 63.7 | |
Investment securities | | | 61,197 | | | | 24.5 | | | | 55,135 | | | | 22.5 | | | | 44,348 | | | | 19.2 | |
Federal funds sold | | | 29,318 | | | | 11.7 | | | | 20,556 | | | | 8.4 | | | | 24,322 | | | | 10.5 | |
Deposits in other banks | | | 4,573 | | | | 1.8 | | | | 5,530 | | | | 2.3 | | | | 1,627 | | | | 0.8 | |
| | | | | | | | | | | | | | | | | | | | | | | | |
Total interest-earning assets | | | 237,546 | | | | 94.9 | | | | 231,430 | | | | 94.5 | | | | 217,357 | | | | 94.2 | |
| | | | | | | | | | | | | | | | | | | | | | | | |
Noninterest-earning assets: | | | | | | | | | | | | | | | | | | | | | | | | |
Cash and due from banks | | | 3,339 | | | | 1.3 | | | | 3,303 | | | | 1.3 | | | | 3,560 | | | | 1.5 | |
Premises and equipment | | | 3,152 | | | | 1.3 | | | | 3,854 | | | | 1.6 | | | | 3,905 | | | | 1.7 | |
Other assets | | | 6,312 | | | | 2.5 | | | | 6,311 | | | | 2.6 | | | | 5,893 | | | | 2.6 | |
| | | | | | | | | | | | | | | | | | | | | | | | |
Total noninterest-earning assets | | | 12,803 | | | | 5.1 | | | | 13,468 | | | | 5.5 | | | | 13,358 | | | | 5.8 | |
| | | | | | | | | | | | | | | | | | | | | | | | |
Total assets | | $ | 250,349 | | | | 100.0 | | | $ | 244,898 | | | | 100.0 | | | $ | 230,715 | | | | 100.0 | |
| | | | | | | | | | | | | | | | | | | | | | | | |
Loans
Average total loans were $142.5 million for 2011, an decrease of $7.8 million, or 5.2% from 2010. At December 31, 2011, the actual balance of loans secured by real estate represented the most significant portion of the loan portfolio at 90.1%. Total loans secured by 1-4 family residential properties represented 20.4% of total loans at the end of 2010, while nonfarm/nonresidential properties made up 58.3% of total loans. .
Along with quality, loan growth will continue to be a point of focus at Cardinal for 2012. The long-range strategic objective for meeting the Company’s loan growth aspirations will be achieved through continued hiring of additional loan officers, community involvement, expansion of the Company’s market footprint, broadening of the present array of loan products offered to include conforming fixed-rate mortgage loans, home equity lines of credit and SBA loans, and management’s strengthened efforts in offering small business financing and competively-priced products. Prudent business practices and stringent internal guidelines will continue to be followed in making lending decisions in order to balance the emphasis on loan growth with the desire to minimize exposure to loan losses.
Bank of Floyd makes both consumer and commercial loans to all neighborhoods within its market area, including the low-income and moderate-income areas. The Company’s market area is generally defined as the areas within the Virginia Counties of Floyd, Roanoke, Montgomery, Carroll and Pulaski and the Cities of Roanoke, Salem, and Christiansburg, Virginia. The Bank places emphasis on consumer based installment loans and commercial loans to small and medium sized businesses. Below market pricing, competition from unregulated organizations and a weak economy have also been factors associated with generating new loans. The amounts of loans outstanding by type at year-ends 2011 though 2007, and the maturity distribution of variable and fixed rate loans as of year-end 2011 are presented below in Table 6 and Table 7, respectively.
13
Loans, continued
During 2011 gross loans decreased $18.8 million, with nonfarm, nonresidential accounting for the greatest decrease. Nonfarm, nonresidential decreased due to a continued weak economy coupled with excess capacity creating a soft demand for existing construction and development projects.
Table 6. Loan Portfolio Summary
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
December 31, (In thousands) | | 2011 | | | 2010 | | | 2009 | | | 2008 | | | 2007 | |
| | | Amount | | | % | | | Amount | | | % | | | Amount | | | % | | | Amount | | | % | | | Amount | | | % | |
Real estate construction and development | | $ | 8,868 | | | | 6.8 | | | $ | 13,110 | | | | 8.8 | | | $ | 17,441 | | | | 11.6 | | | $ | 19,735 | | | | 13.3 | | | $ | 19,168 | | | | 15.4 | |
Farmland | | | 1,306 | | | | 1.0 | | | | 1,274 | | | | .9 | | | | 1,264 | | | | .8 | | | | 2,089 | | | | 1.4 | | | | 3,362 | | | | 2.7 | |
Real estate mortgage: | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
1-4 family residential | | | 26,568 | | | | 20.4 | | | | 29,961 | | | | 20.1 | | | | 30,039 | | | | 20.0 | | | | 28,671 | | | | 19.4 | | | | 23,584 | | | | 19.0 | |
Multifamily residential | | | 4,717 | | | | 3.6 | | | | 4,277 | | | | 2.9 | | | | 3,047 | | | | 2.0 | | | | 2,978 | | | | 2.0 | | | | 1,761 | | | | 1.4 | |
Nonfarm, nonresidential | | | 75,879 | | | | 58.3 | | | | 85,049 | | | | 57.1 | | | | 80,708 | | | | 53.8 | | | | 73,820 | | | | 49.9 | | | | 62,781 | | | | 50.5 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Total real estate | | | 117,338 | | | | 90.1 | | | | 133,671 | | | | 89.8 | | | | 132,499 | | | | 88.2 | | | | 127,293 | | | | 86.0 | | | | 110,656 | | | | 89.0 | |
Agricultural | | | 9 | | | | 0.1 | | | | 72 | | | | 0.1 | | | | 148 | | | | 0.1 | | | | 183 | | | | 0.1 | | | | 384 | | | | 0.3 | |
Commercial and industrial | | | 5,873 | | | | 4.5 | | | | 7,230 | | | | 4.8 | | | | 7,675 | | | | 5.1 | | | | 7,914 | | | | 5.4 | | | | 6,632 | | | | 5.3 | |
Consumer | | | 2,487 | | | | 1.9 | | | | 2,923 | | | | 1.9 | | | | 3,117 | | | | 2.1 | | | | 3,937 | | | | 2.7 | | | | 3,836 | | | | 3.1 | |
Other loans | | | 4,765 | | | | 3.6 | | | | 5,388 | | | | 3.6 | | | | 6,992 | | | | 4.7 | | | | 8,914 | | | | 6.0 | | | | 3,258 | | | | 2.6 | |
Leases | | | — | | | | 0.0 | | | | — | | | | 0.0 | | | | — | | | | 0.0 | | | | — | | | | 0.0 | | | | — | | | | 0.0 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Gross loans | | | 130,472 | | | | | | | | 149,284 | | | | | | | | 150,431 | | | | | | | | 148,241 | | | | | | | | 124,766 | | | | | |
Unearned income | | | (314 | ) | | | (0.2 | ) | | | (368 | ) | | | (0.2 | ) | | | (350 | ) | | | (0.2 | ) | | | (320 | ) | | | (0.2 | ) | | | (314 | ) | | | (0.3 | ) |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Total | | $ | 130,158 | | | | 100.0 | | | $ | 148,916 | | | | 100.0 | | | $ | 150,081 | | | | 100.0 | | | $ | 147,921 | | | | 100.0 | | | $ | 124,452 | | | | 100.0 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | �� | | | | | | |
Table 7. Loan Maturity Schedule
| | | | | | | | | | | | | | | | | | | | |
| | | 2011 | |
December 31, (In thousands) | | Commercial
Financial and
Agricultural | | | Construction
and
Development | | | Others | | | Total
Amount | | | % | |
Fixed rate loans: | | | | | | | | | | | | | | | | | | | | |
Within three months | | $ | 197 | | | $ | 28 | | | $ | 5,325 | | | $ | 5,550 | | | | 4.3 | |
After three but within twelve months | | | 492 | | | | — | | | | 7,989 | | | | 8,481 | | | | 6.5 | |
After one but within five years | | | 812 | | | | 7,737 | | | | 20,980 | | | | 29,529 | | | | 22.6 | |
Over five years | | | 1,153 | | | | 49 | | | | 45,051 | | | | 46,253 | | | | 35.5 | |
| | | | | | | | | | | | | | | | | | | | |
Total fixed rate loans | | | 2,654 | | | | 7,814 | | | | 79,345 | | | | 89,813 | | | | 68.9 | |
| | | | | | | | | | | | | | | | | | | | |
Variable rate loans: | | | | | | | | | | | | | | | | | | | | |
Within three months | | | 3,228 | | | | 340 | | | | 2,168 | | | | 5,736 | | | | 4.4 | |
After three but within twelve months | | | — | | | | — | | | | 9,641 | | | | 9,641 | | | | 7.4 | |
After one but within five years | | | — | | | | 594 | | | | 23,319 | | | | 23,913 | | | | 18.3 | |
Over five years | | | — | | | | 120 | | | | 1,249 | | | | 1,369 | | | | 1.0 | |
| | | | | | | | | | | | | | | | | | | | |
Total variable rate loans | | | 3,228 | | | | 1,054 | | | | 36,377 | | | | 40,659 | | | | 31.1 | |
| | | | | | | | | | | | | | | | | | | | |
Total loans: | | | | | | | | | | | | | | | | | | | | |
Within three months | | | 3,425 | | | | 368 | | | | 7,493 | | | | 11,286 | | | | 8.7 | |
After three but within twelve months | | | 492 | | | | — | | | | 17,630 | | | | 18,122 | | | | 13.9 | |
After one but within five years | | | 812 | | | | 8,331 | | | | 44,299 | | | | 53,442 | | | | 40.9 | |
Over five years | | | 1,153 | | | | 169 | | | | 46,300 | | | | 47,622 | | | | 36.5 | |
| | | | | | | | | | | | | | | | | | | | |
Total loans | | $ | 5,882 | | | $ | 8,868 | | | $ | 115,722 | | | $ | 130,472 | | | | 100.0 | |
| | | | | | | | | | | | | | | | | | | | |
14
Investment Securities
The investment securities portfolio is managed to optimize the yield on excess funds while providing liquidity for unexpected deposit decreases or increased loan generation and diversification in the overall asset management of the Company. At December 31, 2011, the Company had $57.1 million in securities available for sale, compared to $42.6 million at year-end 2010. The average yield on taxable investment securities decreased from 3.36% in 2010 to 3.10% in 2011 as a result of lower yielding securities and decreasing market rates of interest.
Management of the investment portfolio has always been conservative with virtually all investments taking the form of purchases of U.S. Treasury, Government Sponsored Enterprises, Mortgage Backed Securities and issuances of State and local bond issues. All securities are high quality and high grade. Management views the investment portfolio as a source of income, and generally purchases securities with the intent of retaining them until maturity. However, adjustments in the portfolio are necessary from time to time to provide a source of liquidity to meet funding requirements for loan demand, deposit fluctuations and to manage interest rate risk. Accordingly, to meet such objectives, management may sell certain securities prior to their scheduled maturity. Table 8 presents the investment portfolio at the end of 2011 by major types of investments and maturity ranges. Actual maturities may differ from scheduled maturities in mortgage backed securities because the mortgages underlying the securities may be called or repaid prior to the scheduled maturity date. Maturities on all other securities are based on the earlier of the contractual maturity or the call date, if any.
At December 31, 2011, the market value of the investment portfolio was $70.8 million, representing a $1.4 million unrealized gain above amortized cost.
At December 31, 2010, the market value of the investment portfolio was $57.4 million, representing a $333 thousand unrealized gain above amortized cost. This compared to a market value of $52.8 million and a $236 thousand unrealized loss below amortized cost a year earlier.
Table 8. Investment Securities
| | | | | | | | | | | | | | | | | | | | | | | | |
December 31, 2011 (In thousands) | | Amortized Cost Due | | | | | | | |
| | | Due
Within
One Year | | | After One
Through
Five Years | | | After Five
Through
Ten Years | | | After Ten
Years | | | Total | | | Market
Value | |
Investment securities | | | | | | | | | | | | | | | | | | | | | | | | |
Government sponsored enterprises and mortgage backed securities | | $ | 15 | | | $ | 561 | | | $ | 32 | | | $ | 47,643 | | | $ | 48,251 | | | $ | 48,905 | |
State and political subdivisions | | | 927 | | | | 4,833 | | | | 6,158 | | | | 6,233 | | | | 18,151 | | | | 19,130 | |
Other securities | | | — | | | | 1,000 | | | | — | | | | 1,957 | | | | 2,957 | | | | 2,732 | |
| | | | | | | | | | | | | | | | | | | | | | | | |
Total | | $ | 942 | | | $ | 6,394 | | | $ | 6,190 | | | $ | 55,833 | | | $ | 69,359 | | | $ | 70,767 | |
| | | | | | | | | | | | | | | | | | | | | | | | |
Weighted average yields | | | | | | | | | | | | | | | | | | | | | | | | |
Government sponsored enterprises and mortgage backed securities | | | 5.34 | % | | | 1.38 | % | | | 6.53 | % | | | 2.78 | % | | | | | | | | |
State and political subdivisions | | | 3.81 | % | | | 3.85 | % | | | 3.79 | % | | | 4.03 | % | | | | | | | | |
Other securities | | | 0.00 | % | | | 4.69 | % | | | 0.00 | % | | | 6.29 | % | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | |
Total securities | | | 3.81 | % | | | 3.76 | % | | | 3.80 | % | | | 3.03 | % | | | 3.18 | % | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | |
December 31, 2010 (In thousands) | | | | | | | | | | | | | | Book
Value | | | Market
Value | |
Investment securities | | | | | | | | | | | | | | | | | | | | | | | | |
Government sponsored enterprises and mortgage backed securities | | | | | | | | | | | | | | | | | | $ | 35,362 | | | $ | 35,726 | |
States and political subdivisions | | | | | | | | | | | | | | | | | | | 17,666 | | | | 17,802 | |
Other securities | | | | | | | | | | | | | | | | | | | 4,063 | | | | 3,896 | |
| | | | | | | | | | | | | | | | | | | | | | | | |
Total | | | | | | | | | | | | | | | | | | $ | 57,091 | | | $ | 57,424 | |
| | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | |
December 31, 2009 (In thousands) | | | | | | | | | | | | | | Book
Value | | | Market
Value | |
Investment securities | | | | | | | | | | | | | | | | | | | | | | | | |
Government sponsored enterprises and mortgage backed securities | | | | | | | | | | | | | | | | | | $ | 30,438 | | | $ | 30,551 | |
States and political subdivisions | | | | | | | | | | | | | | | | | | | 18,495 | | | | 18,736 | |
Other securities | | | | | | | | | | | | | | | | | | | 4,056 | | | | 3,466 | |
| | | | | | | | | | | | | | | | | | | | | | | | |
Total | | | | | | | | | | | | | | | | | | $ | 52,989 | | | $ | 52,753 | |
| | | | | | | | | | | | | | | | | | | | | | | | |
15
Deposits
Cardinal relies on deposits generated in its market area to provide the majority of funds needed to support lending activities and for investments in liquid assets. More specifically, core deposits (total deposits less certificates of deposits in denominations of $100,000 or more) are the primary funding source. The Company’s balance sheet growth is largely determined by the availability of deposits in the markets it serves, the cost of attracting the deposits, and the prospects of profitably utilizing the available deposits by increasing the loan or investment portfolios. The sustained low interest rate environment, coupled with a continued weak economy and uncertianty and volatility in the stock market have resulted in depositors shifting their emphasis from rate shopping to banks which offer soundness and security. Increased customer awareness of interest rates has added to the importance of effective interest rate management. Accordingly, management must continuously monitor market pricing and internal interest rate spreads to continue the Company’s growth and improve profitability. Cardinal Bankshares’ interest rate management goals include structuring rates in a manner that can promote both deposit and asset growth while increasing overall profitability of the Company.
Average total deposits for the year ended December 31, 2011 increased $4.7 million to $217.5 million compared to 2010. As shown in Table 9, the Company’s average interest-bearing deposits as a percent of total average deposits increased to 86.6% in 2011, compared to 86.4% in 2010. Average noninterest-bearing demand deposits increased to $29.2 million in 2011 from $28.8 million in 2010. Average deposits for the past three years are summarized in Table 9 below.
Table 9. Deposit Mix
| | | | | | | | | | | | | | | | | | | | | | | | |
December 31, (In thousands) | | 2011 | | | 2010 | | | 2009 | |
| | | Average
Balance | | | % | | | Average
Balance | | | % | | | Average
Balance | | | % | |
Interest-bearing deposits: | | | | | | | | | | | | | | | | | | | | | | | | |
Interest checking | | $ | 10,613 | | | | 4.9 | | | $ | 10,824 | | | | 5.1 | | | $ | 10,696 | | | | 5.4 | |
Money Market | | | 32,213 | | | | 14.8 | | | | 16,416 | | | | 7.7 | | | | 11,249 | | | | 5.6 | |
Savings deposits | | | 26,936 | | | | 12.4 | | | | 21,568 | | | | 10.1 | | | | 18,943 | | | | 9.5 | |
Time deposits | | | 64,968 | | | | 29.9 | | | | 71,700 | | | | 33.7 | | | | 78,465 | | | | 39.3 | |
Large denomination deposits | | | 53,559 | | | | 24.6 | | | | 63,500 | | | | 29.8 | | | | 52,802 | | | | 26.5 | |
| | | | | | | | | | | | | | | | | | | | | | | | |
Total interest-bearing deposits | | | 188,289 | | | | 86.6 | | | | 184,008 | | | | 86.4 | | | | 172,155 | | | | 86.3 | |
Noninterest-bearing deposits | | | 29,199 | | | | 13.4 | | | | 28,757 | | | | 13.6 | | | | 27,220 | | | | 13.7 | |
| | | | | | | | | | | | | | | | | | | | | | | | |
Total deposits | | $ | 217,488 | | | | 100.0 | | | $ | 212,765 | | | | 100.0 | | | $ | 199,375 | | | | 100.0 | |
| | | | | | | | | | | | | | | | | | | | | | | | |
The average balance of certificates of deposit issued in denominations of $100,000 or more decreased by approximately $9.9 million in 2011. Table 10 provides maturity information relating to Certificates of Deposit of $100,000 or more at December 31, 2011.
Table 10. Large Denomination Deposits $100,000 and Over
Analysis of time deposits of $100,000 or more at December 31, 2011 (In thousands):
| | | | |
Time remaining to maturity: | | | | |
Less than three months | | $ | 2,751 | |
Three months through one year | | | 16,198 | |
Over one year | | | 39,784 | |
| | | | |
Total time deposits of $100,000 or more | | $ | 58,733 | |
| | | | |
Capital Adequacy
The Company’s capital serves to support asset growth and provide protection against loss to depositors and creditors. Cardinal strives to maintain an optimum level of capital, commensurate with its risk profile, on which an attractive return to stockholders can be realized over both the near and long term, while serving depositors, creditors and regulatory needs.
16
Common stock, capital surplus and retained earnings net of dividends represent the stockholders’ investment in the Company and are a key source of capital. Total stockholders’ equity was $33.0 million at December 31, 2011, an increase of $1.1 million or 3.4% compared with $31.9 million for the same period in 2010. The increase consists of net income for the year of $1.1 million plus accumulated other comprehensive gain of $293 thousand less dividends paid of $246 thousand.
The FDIC has adopted capital guidelines to supplement the existing definitions of capital for regulatory purposes and to establish minimum capital standards. Specifically, the guidelines categorize assets and off-balance sheet items into four risk-weighted categories. The minimum ratio of qualifying total capital to risk-weighted assets is 8.0% of which at least 4.0% must be Tier 1 capital, composed of common equity, retained earnings and a limited amount of perpetual preferred stock, less certain goodwill items. Cardinal Bankshares had a ratio of total capital to risk-weighted assets of 22.51% at December 31, 2011 and a ratio of Tier 1 capital to risk-weighted assets of 21.25%. Both of these ratios well exceed the capital requirements adopted by the federal regulatory agencies and continue to be equal to or above most of our peer group.
In addition, a minimum leverage ratio of Tier I capital to average total assets for the previous quarter is required by federal bank regulators, ranging from 3% to 5%, subject to the regulator’s evaluation of the Company’s overall safety and soundness. As of December 31, 2011, Cardinal had a ratio of year-end Tier I capital to average total assets, as defined, of 12.90%.
Table 11 below sets forth summary information with respect to the capital ratios for Cardinal and the Bank at December 31, 2011 and 2010. All capital ratio levels indicate that Cardinal and the Bank are well capitalized.
Table 11. Year-end Risk-based Capital
| | | | | | | | | | | | | | | | |
December 31, (In thousands) | | 2011 | | | 2010 | |
| | | Consolidated | | | Bank of
Floyd | | | Consolidated | | | Bank of
Floyd | |
Tier I capital | | $ | 32,574 | | | $ | 23,426 | | | $ | 31,721 | | | $ | 22,061 | |
Qualifying allowance for loan losses (limited to 1.25% of risk-weighted assets) | | | 1,928 | | | | 1,850 | | | | 2,037 | | | | 1,949 | |
| | | | | | | | | | | | | | | | |
Total regulatory capital | | $ | 34,502 | | | $ | 25,276 | | | $ | 33,758 | | | $ | 24,010 | |
| | | | | | | | | | | | | | | | |
Total risk-weighted assets | | $ | 153,290 | | | $ | 147,259 | | | $ | 161,938 | | | $ | 155,168 | |
| | | | | | | | | | | | | | | | |
Tier I as a percent of risk-weighted assets | | | 21.25 | % | | | 15.91 | % | | | 19.59 | % | | | 14.22 | % |
Total regulatory capital as a percent of risk-weighted assets | | | 22.51 | % | | | 17.16 | % | | | 20.85 | % | | | 15.47 | % |
Leverage ratio* | | | 12.52 | % | | | 9.27 | % | | | 12.99 | % | | | 9.06 | % |
| * | Tier I capital divided by average total assets for the quarter ended December 31. |
Nonperforming and Problem Assets
Certain credit risks are inherent in making loans, particularly commercial and consumer loans. Management prudently assesses these risks and strives to manage them effectively. The Bank seeks to use shorter-term loans and, although a portion of the loans may be made based upon the value of collateral, it relies primarily on the cash flow of the borrower as the source of repayment rather than the value of the collateral.
The Bank also manages its repayment risks by adhering to internal credit policies and procedures. These policies and procedures include officer and customer limits, periodic loan documentation review and follow-up on exceptions to credit policies.
Nonperforming assets, as shown in Table 12 below, increased to $15.4 million at December 31, 2011 from $8.0 million at December 31, 2010. At year-end 2011, loans past due 90 days or more and still accruing increased to $2.7 million from zero a year earlier. Foreclosed assets increased to $3.4 million in 2011 from $509 thousand for 2010. Foreclosed assets at the end of 2011 consisted of a mixture of commercial property and residential property listed with an agent to be sold or in the process of being listed. Management does not intend to retain the property.
17
Table 12. Nonperforming Assets
| | | | | | | | | | | | | | | | | | | | |
December 31 (In thousands) | | 2011 | | | 2010 | | | 2009 | | | 2008 | | | 2007 | |
Nonaccrual loans | | $ | 9,298 | | | $ | 7,471 | | | $ | 5,302 | | | $ | 2,405 | | | $ | 646 | |
Loans past due 90 days or moreand still accruing | | | 2,700 | | | | — | | | | 382 | | | | 430 | | | | 245 | |
Foreclosed assets | | | 3,418 | | | | 509 | | | | 261 | | | | 289 | | | | 212 | |
| | | | | | | | | | | | | | | | | | | | |
Total nonperforming assets | | $ | 15,416 | | | $ | 7,980 | | | $ | 5,945 | | | $ | 3,124 | | | $ | 1,103 | |
| | | | | | | | | | | | | | | | | | | | |
Analysis of the Allowance for Loan Losses
The allowance for loan losses represents the amount available for credit losses inherent in the Company’s loan portfolio. The Company performs periodic systematic reviews of its portfolio to identify these inherent losses, and to assess the overall probability of collection of the portfolio. These reviews result in the identification and quantification of loss factors, which are used in determining the amount of the allowance for loan losses. In addition, the Company also evaluates the prevailing economic and business conditions affecting individual borrowers, changes in the size and characteristics of the loan portfolio and other pertinent factors. The allowance, and the methodology we utilize to determine it, are also subject to annual review by external auditors and regulatory examinations. Their evaluations of the adequacy of our allowance may take into account such factors as the size of the allowance in comparison to peer companies identified by regulatory agencies. The most recently completed regulatory reviews were conducted as of June 30, 2010 and June 30, 2011.
In addition, management took into account not only the current state of the economy, but information from various sources, which not only expected the current economic downturn to persist, but also expected continued significant losses in commercial real estate. Geographic location was taken into account regarding the depth of economic decline, valuation for certain loans and corresponding collateral. Management also collected additional financial data from certain customers to ascertain current financial strength and cash flow.
The Company is committed to the early recognition of problem loans and to providing an appropriate allowance. The Company believes the current allowance is adequate to cover inherent losses in the loan portfolio. However, the allowance may be materially increased or decreased in the future based upon management’s assessment of the factors outlined above. The allowance for loan losses was $2.9 million at December 31, 2011 and $3.1 million at December 31, 2010. The allowance as a percentage of period end loans was 2.20% at year-end 2011 and 2.06% at year-end 2010.
The provision for loan losses for the year ended December 31, 2011 was $592 thousand, a decrease of $69 thousand from the previous year. The loan loss reserve for 2011 decreased a total of $206 thousand due to write-offs incurred of $939 thousand less expense to provision of $592 thousand and recoveries of $141 thousand. Based upon management’s periodic reviews of the loan portfolio using the previously mentioned factors, the current year provision was considered appropriate. Management believes the provision recorded in 2011 maintains the allowance at a level adequate to cover probable losses.
18
The provision for loan losses, net charge-offs and the activity in the allowance for loan losses is detailed in Table 13.
Table 13. Loan Losses
| | | | | | | | | | | | | | | | | | | | |
Year ended December 31, (In thousands) | | 2011 | | | 2010 | | | 2009 | | | 2008 | | | 2007 | |
Balance at beginning of year | | $ | 3,073 | | | $ | 2,670 | | | $ | 1,659 | | | $ | 1,669 | | | $ | 1,640 | |
Provision charged to expense | | | 592 | | | | 661 | | | | 1,226 | | | | 94 | | | | (19 | ) |
| | | | | | | | | | | | | | | | | | | | |
| | | 3,665 | | | | 3,331 | | | | 2,885 | | | | 1,763 | | | | 1,621 | |
| | | | | |
Loans charged off: | | | | | | | | | | | | | | | | | | | | |
Commercial, financial and agricultural | | | 80 | | | | 262 | | | | 157 | | | | 105 | | | | — | |
Real estate – residential mortgage | | | 356 | | | | — | | | | 67 | | | | — | | | | — | |
Real estate – construction | | | 503 | | | | — | | | | — | | | | — | | | | — | |
Consumer and other | | | — | | | | 5 | | | | 3 | | | | 10 | | | | 5 | |
| | | | | | | | | | | | | | | | | | | | |
Total charge-offs | | | 939 | | | | 267 | | | | 227 | | | | 115 | | | | 5 | |
| | | | | | | | | | | | | | | | | | | | |
Recoveries of loans previously charged off: | | | | | | | | | | | | | | | | | | | | |
Commercial, financial and agricultural | | | 1 | | | | 4 | | | | 9 | | | | 4 | | | | 43 | |
Real estate – residential mortgage | | | 2 | | | | — | | | | — | | | | — | | | | — | |
Real estate – construction | | | 129 | | | | — | | | | — | | | | — | | | | — | |
Consumer and other | | | 9 | | | | 5 | | | | 3 | | | | 7 | | | | 10 | |
| | | | | | | | | | | | | | | | | | | | |
Total recoveries | | | 141 | | | | 9 | | | | 12 | | | | 11 | | | | 53 | |
| | | | | | | | | | | | | | | | | | | | |
Net (recoveries) charge – offs | | | 798 | | | | 258 | | | | 215 | | | | 104 | | | | (48 | ) |
| | | | | | | | | | | | | | | | | | | | |
Balance at end of year | | $ | 2,867 | | | $ | 3,073 | | | $ | 2,670 | | | $ | 1,659 | | | $ | 1,669 | |
| | | | | | | | | | | | | | | | | | | | |
The Company has allocated the allowance for loan losses based on estimates of the allowance needed for each component of the loan portfolio. The allocation of the allowance as shown in Table 14 below should not be interpreted as an indication that loan losses in future years will occur in the same proportions or that the allocation indicates future loan loss trends. The specific reserve on impaired loans for 2011 is $1.3 million and that specific reserve is set aside for the impaired loans. Furthermore, the portion allocated to each loan category is not the total amount available for future losses that might occur within such categories since the remaining allowance is a general allowance applicable to the entire portfolio.
Table 14. Allocation of the Allowance for Loan Losses
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
December 31, (In thousands) | | 2011 | | | 2010 | | | 2009 | | | 2008 | | | 2007 | |
| | | Amount | | | % | | | Amount | | | % | | | Amount | | | % | | | Amount | | | % | | | Amount | | | % | |
Balance at end of period applicable to: | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Commercial, commercial real estate,financial and agricultural | | $ | 1,293 | | | | 62.7 | | | $ | 762 | | | | 62.7 | | | $ | 623 | | | | 59.7 | | | $ | 944 | | | | 56.6 | | | $ | 623 | | | | 58.5 | |
Real estate, construction | | | 1,243 | | | | 7.8 | | | | 1,566 | | | | 8.8 | | | | 150 | | | | 11.6 | | | | 206 | | | | 13.3 | | | | 147 | | | | 15.4 | |
Real estate, residential mortgage | | | 155 | | | | 24.0 | | | | 661 | | | | 22.9 | | | | 1,762 | | | | 22.0 | | | | 392 | | | | 21.4 | | | | 822 | | | | 20.4 | |
Consumer and other loans | | | 176 | | | | 5.5 | | | | 84 | | | | 5.6 | | | | 135 | | | | 6.7 | | | | 117 | | | | 8.7 | | | | 77 | | | | 5.7 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Total | | $ | 2,867 | | | | 100.0 | | | $ | 3,073 | | | | 100.0 | | | $ | 2,670 | | | | 100.0 | | | $ | 1,659 | | | | 100.0 | | | $ | 1,669 | | | | 100.0 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Liquidity and Interest Rate Sensitivity
The principal goals of the Company’s asset and liability management strategy are the maintenance of adequate liquidity and the management of interest rate risk. Liquidity is the ability to convert assets to cash to fund depositors’ withdrawals or borrowers’ loans without significant loss. Interest rate risk management seeks to balance the effects of interest rate changes on assets that earn interest or liabilities on which interest is paid, to protect the Company from wide fluctuations in its net interest income.
Management must insure that adequate funds are available at all times to meet the needs of its customers. On the asset side of the balance sheet, maturing investments, loan payments, maturing loans, federal funds sold, and unpledged investment securities are principal sources of liquidity. On the liability side of the balance sheet, liquidity sources include core deposits, the ability to increase large denomination certificates, federal funds lines from correspondent banks, borrowings from the Federal Reserve Bank and the Federal Home Loan Bank, as well as the ability to generate funds through the issuance of long-term debt and equity.
The liquidity ratio, the level of liquid assets divided by total deposits plus short-term liabilities, is considered to be adequate by management.
19
Table 15. Interest Rate Sensitivity
| | | | | | | | | | | | | | | | | | | | |
| | | December 31, 2011
Maturities/Repricing | |
| | | 1-3
Months | | | 4-12
Months | | | 13-60
Months | | | Over 60
Months | | | Total | |
(In thousands) | | | | | | | | | | | | | | | |
Earning Assets: | | | | | | | | | | | | | | | | | | | | |
Loans | | $ | 11,286 | | | $ | 18,122 | | | $ | 53,442 | | | $ | 47,622 | | | $ | 130,472 | |
Investments | | | 228 | | | | 714 | | | | 6,394 | | | | 62,023 | | | | 69,359 | |
Interest-bearing deposits in banks | | | 14,758 | | | | — | | | | — | | | | — | | | | 14,758 | |
Federal funds sold | | | 33,700 | | | | — | | | | — | | | | — | | | | 33,700 | |
| | | | | | | | | | | | | | | | | | | | |
Total | | $ | 59,972 | | | $ | 18,836 | | | $ | 59,836 | | | $ | 109,645 | | | $ | 248,289 | |
| | | | | | | | | | | | | | | | | | | | |
Interest-bearing deposits: | | | | | | | | | | | | | | | | | | | | |
Interest checking | | $ | 11,251 | | | $ | — | | | $ | — | | | $ | — | | | $ | 11,251 | |
Money market | | | 37,056 | | | | — | | | | — | | | | — | | | | 37,056 | |
Savings | | | 27,996 | | | | — | | | | — | | | | — | | | | 27,996 | |
Certificates of deposit | | | 7,673 | | | | 37,448 | | | | 78,852 | | | | — | | | | 123,973 | |
| | | | | | | | | | | | | | | | | | | | |
Total | | $ | 83,976 | | | $ | 37,448 | | | $ | 78,852 | | | $ | — | | | $ | 200,276 | |
| | | | | | | | | | | | | | | | | | | | |
Interest sensitivity gap | | $ | (24,004 | ) | | $ | (18,612 | ) | | $ | (19,016 | ) | | $ | 109,645 | | | $ | 48,013 | |
Cumulative interest sensitivity gap | | $ | (24,004 | ) | | $ | (42,616 | ) | | $ | (61,632 | ) | | $ | 48,013 | | | $ | 48,013 | |
Ratio of cumulative interest sensitivity gap to total earning assets | | | (9.67 | )% | | | (17.16 | )% | | | (24.82 | )% | | | 19.34 | % | | | 19.34 | % |
Interest rate risk is the effect that changes in interest rates would have on interest income and interest expense as interest-sensitive assets and interest-sensitive liabilities either reprice or mature. Management attempts to maintain the portfolios of earning assets and interest-bearing liabilities with maturities or repricing opportunities at levels that will afford protection from erosion of net interest margin, to the extent practical, from changes in interest rates. Table 15 above shows the sensitivity of the Company’s balance sheet on December 31, 2011. This table reflects the sensitivity of the balance sheet as of that specific date and is not necessarily indicative of the position on other dates. At December 31, 2011, the Company appeared to be liability-sensitive with interest-bearing liabilities exceeding earning assets, subject to changes in interest rates, for the 1-3, 4-12, and 13-60 months column. The Company is in an asset-sensitive position for the over 60 months periods.
Matching sensitive positions alone does not ensure that Cardinal has no interest rate risk. The repricing characteristics of assets are different from the repricing characteristics of funding sources. Thus, net interest income can be impacted by changes in interest rates even if the repricing opportunities of assets and liabilities are perfectly matched.
Earnings and Balance Sheet Analysis
2010 Compared to 2009 – Net interest income, on a taxable equivalent basis, was $6.8 million, an increase of $278 thousand from $6.5 million in 2009. This increase was driven by decreased rates paid on the Company’s interest earning liabilities, which decreased by $642 thousand and more than offset the decrease in interest earning assets of $364 thousand. Noninterest income increased by 4.4% to $683 thousand for 2010 compared to $654 thousand for 2009 due primarily to an increase in net realized gains on sale of securities due to early calls by bond issuers to take advantage of declining interest rates. Noninterest expense increased by $431 thousand or 8.5% to $5.5 million compared to $5.1 million in 2009 primarily to an increase in salaries and employee benefits due to the change in accounting method in 2009, which caused a one-time income effect of $667 thousand.
Earning assets averaged $231.4 million, compared to $217.4 million in 2009, due to increases in deposits in banks of $3.9 million and taxable investment securities of $11.5 million due to increased deposits. Loans increased $3.1 million to $150.2 million in 2010.
Interest-bearing liabilities averaged $184.0 million, compared to $172.2 million in 2009 driven primarily by an increase of $10.7 million in large denomination depsoits. The increase in interest-bearing liabilities reflects the shift of funds from higher risk investments to an environment of less risk and greater stability.
20
Stockholders’ equity increased 6.7% to an average of $31.7 million in 2010 from $29.7 million in 2009. The return on average assets and average equity increased to .40% and 3.06%, respectively for 2010 compared to .24% and 1.85%, respectively, for 2009. Book value per share was $20.76 at December 31, 2010, compared to $20.00 at year-end 2009, representing an increase of 3.8%.
The allowance for loan losses at December 31, 2010 was $3.1 million compared to $2.7 million a year earlier. The allowance for loan losses as a percentage of period end loans was 2.06% compared to 1.78% at year-end 2009. The Company had charge-offs, net of recoveries, in the amount of $258 thousand for 2010. This compared to charge-offs, net of recoveries, in the amount of $215 thousand for 2009. Nonperforming assets totaled $8.0 million at December 31, 2010, an increase of $2.1 million from 2009.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
NOT APPLICABLE
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
21
| | | | |
| | HESS, STEWART & CAMPBELL, PLLC | | |
| | | | 940 4TH AVENUE |
JOHN G. HESS, CPA RICHARD M. STEWART, CPA | | CERTIFIED PUBLIC ACCOUNTANTS | | SUITE 250 P.O. BOX 1060 |
ROBERT C. CAMPBELL, CPA TOMI J. WEBER, CPA | | 252 GEORGE STREET | | HUNTINGTON, WV 25713 (304) 523-6464 |
CHARLES A. COOK, CPA C. MICHAEL BASS, CPA | | BECKLEY, WEST VIRGINIA 25801 | | (304) 523-4395 FAX |
__________ | | __________ | | |
STEPHEN D. HENSLEY, CPA DARRELL D. TUCKER, CPA | | (304) 255 – 1978 | | |
CARLA F. LOKANT, CPA JEFFREY M. MOLLOHAN, CPA | | Fax (304) 255 – 1971 | | |
AMANDA J.SERGENT,CPA RANDY H. WILLIAMS, CPA | | __________ | | |
ELIOTT R. WILSON, CPA, CVA TODD A. ROBINSON, CPA | | | | |
CHARLES “MATT” MORRIS, CPA ANGIE M. HAYNIE, CPA MERRILL L. MAY, CPA | | Email: hsc@hsc-cpa.com Web Site: hsc-cpa.com | | |
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors and Stockholders
Cardinal Bankshares Corporation
Floyd, Virginia
We have audited the accompanying consolidated balance sheets of Cardinal Bankshares Corporation and subsidiaries as of December 31, 2011 and 2010, and the related consolidated statements of income, changes in stockholders’ equity, and cash flows for the years then ended. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with auditing standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Cardinal Bankshares and subsidiaries as of December 31, 2011 and 2010, and the results of their operations and its cash flows for the two years in the period ended December 31, 2011, in conformity with accounting principles generally accepted in the United States of America.
We were not engaged to examine management’s assertion about the effectiveness of Cardinal Bankshares Corporation and subsidiaries’ internal control over financial reporting as of December 31, 2011 included in Form 10-K and, accordingly, we do not express an opinion thereon.
Beckley, West Virginia
March 14, 2012
22
Cardinal Bankshares Corporation and Subsidiaries
Consolidated Balance Sheet
| | | | | | | | |
December 31, (In thousands, except share data) | | 2011 | | | 2010 | |
Assets | | | | | | | | |
Cash and due from banks | | $ | 4,255 | | | $ | 2,948 | |
Interest-bearing deposits in banks | | | 14,758 | | | | 7,792 | |
Federal funds sold | | | 33,700 | | | | 21,550 | |
| | | | | | | | |
Total cash and cash equivalents | | | 52,713 | | | | 32,290 | |
| | | | | | | | |
Investment securities available for sale, at fair value | | | 57,105 | | | | 42,644 | |
Investment securities held to maturity (fair value approximates $13,662 and $14,780 at December 31, 2011 and 2010, respectively) | | | 12,950 | | | | 14,698 | |
Restricted equity securities | | | 592 | | | | 575 | |
| | |
Total loans | | | 130,158 | | | | 148,916 | |
Allowance for loan losses | | | (2,867 | ) | | | (3,073 | ) |
| | | | | | | | |
Net loans | | | 127,291 | | | | 145,843 | |
| | | | | | | | |
Bank premises and equipment, net | | | 2,895 | | | | 3,846 | |
Accrued interest receivable | | | 824 | | | | 954 | |
Foreclosed assets | | | 3,418 | | | | 509 | |
Bank owned life insurance | | | 5,437 | | | | 5,279 | |
Other assets | | | 2,935 | | | | 2,430 | |
| | | | | | | | |
Total assets | | $ | 266,160 | | | $ | 249,068 | |
| | | | | | | | |
Liabilities and Stockholders’ Equity | | | | | | | | |
| | |
Liabilities | | | | | | | | |
Noninterest-bearing deposits | | $ | 32,135 | | | $ | 28,264 | |
Interest-bearing deposits | | | 200,276 | | | | 188,721 | |
| | | | | | | | |
Total deposits | | | 232,411 | | | | 216,985 | |
| | |
Accrued interest payable | | | 88 | | | | 111 | |
Other liabilities | | | 628 | | | | 85 | |
| | | | | | | | |
Total liabilities | | | 233,127 | | | | 217,181 | |
| | | | | | | | |
Commitments and contingencies | | | — | | | | — | |
| | |
Stockholders’ equity | | | | | | | | |
Common stock, $10 par value; 5,000,000 shares authorized; 1,535,733 shares issued and outstanding at December 31, 2011 and 2010 | | | 15,357 | | | | 15,357 | |
Additional paid-in capital | | | 2,925 | | | | 2,925 | |
Retained earnings | | | 14,292 | | | | 13,439 | |
Accumulated other comprehensive gain (loss) | | | 459 | | | | 166 | |
| | | | | | | | |
Total stockholders’ equity | | | 33,033 | | | | 31,887 | |
| | | | | | | | |
Total liabilities and stockholders’ equity | | $ | 266,160 | | | $ | 249,068 | |
| | | | | | | | |
See Notes to Consolidated Financial Statements
23
Cardinal Bankshares Corporation and Subsidiaries
Consolidated Statements of Income
| | | | | | | | |
Years ended December 31, (In thousands, except share and per share data) | | 2011 | | | 2010 | |
Interest and dividend income | | | | | | | | |
Loans and fees on loans | | $ | 8,031 | | | $ | 8,818 | |
Federal funds sold | | | 49 | | | | 44 | |
Investment securities: | | | | | | | | |
Taxable | | | 1,346 | | | | 1,233 | |
Exempt from federal income tax | | | 679 | | | | 726 | |
Dividend income | | | 15 | | | | 19 | |
Deposits with banks | | | 2 | | | | 7 | |
| | | | | | | | |
Total interest income | | | 10,122 | | | | 10,847 | |
| | | | | | | | |
Interest expense | | | | | | | | |
Deposits | | | 3,066 | | | | 4,395 | |
| | | | | | | | |
Total interest expense | | | 3,066 | | | | 4,395 | |
| | | | | | | | |
Net interest income | | | 7,056 | | | | 6,452 | |
| | |
Provision for loan losses | | | 592 | | | | 661 | |
| | | | | | | | |
Net interest income after provision for loan losses | | | 6,464 | | | | 5,791 | |
| | | | | | | | |
Noninterest income | | | | | | | | |
Service charges on deposit accounts | | | 208 | | | | 194 | |
Other service charges and fees | | | 117 | | | | 124 | |
Net realized gains on sales of securities | | | 115 | | | | 98 | |
Net other-than-temporary impairment on investments | | | (300 | ) | | | — | |
Income on bank owned life insurance | | | 158 | | | | 164 | |
Other income | | | 126 | | | | 103 | |
| | | | | | | | |
Total noninterest income | | | 424 | | | | 683 | |
| | | | | | | | |
Noninterest expense | | | | | | | | |
Salaries and employee benefits | | | 3,496 | | | | 3,236 | |
Occupancy and equipment | | | 607 | | | | 679 | |
Legal and professional | | | 287 | | | | 157 | |
Bank franchise tax | | | 172 | | | | 156 | |
Data processing services | | | 227 | | | | 241 | |
FDIC insurance premiums | | | 303 | | | | 368 | |
Foreclosed assets, net | | | (33 | ) | | | 51 | |
Loss on sale of premises and equipment | | | 82 | | | | — | |
Other operating expense | | | 583 | | | | 632 | |
| | | | | | | | |
Total noninterest expense | | | 5,724 | | | | 5,520 | |
| | | | | | | | |
Income before income taxes | | | 1,164 | | | | 954 | |
Income tax expense (benefit) | | | 65 | | | | (15 | ) |
| | | | | | | | |
Net income | | $ | 1,099 | | | $ | 969 | |
| | | | | | | | |
Basic earnings per share | | $ | .72 | | | $ | .63 | |
| | | | | | | | |
Diluted earnings per share | | $ | .72 | | | $ | .63 | |
| | | | | | | | |
Weighted average basic shares outstanding | | | 1,535,733 | | | | 1,535,733 | |
| | | | | | | | |
Weighted average diluted shares outstanding | | | 1,535,733 | | | | 1,535,733 | |
| | | | | | | | |
See Notes to Consolidated Financial Statements
24
Cardinal Bankshares Corporation and Subsidiaries
Consolidated Statements of Stockholders’ Equity and Comprehensive Income
| | | | | | | | | | | | | | | | | | | | |
(In thousands) | | Common
Stock | | | Additional
Paid-in
Capital | | | Retained
Earnings | | | Accumulated
Other
Comprehensive
Income (Loss) | | | Total | |
Balance, December 31, 2009 | | $ | 15,357 | | | $ | 2,925 | | | $ | 12,716 | | | $ | (290 | ) | | $ | 30,708 | |
| | | | | |
Comprehensive income | | | | | | | | | | | | | | | | | | | | |
Net income | | | — | | | | — | | | | 969 | | | | — | | | | 969 | |
Net unrealized securities gains arising during the period, net of taxes of $268 | | | — | | | | — | | | | — | | | | 522 | | | | 522 | |
Realized securities gains, net of taxes of $(32) | | | — | | | | — | | | | — | | | | (66 | ) | | | (66 | ) |
| | | | | | | | | | | | | | | | | | | | |
Total comprehensive income | | | | | | | | | | | | | | | | | | | 1,425 | |
Cash dividends declared ($0.16 per share) | | | — | | | | — | | | | (246 | ) | | | — | | | | (246 | ) |
| | | | | | | | | | | | | | | | | | | | |
Balance, December 31, 2010 | | | 15,357 | | | | 2,925 | | | | 13,439 | | | | 166 | | | | 31,887 | |
| | | | | |
Comprehensive income | | | | | | | | | | | | | | | | | | | | |
Net income | | | — | | | | — | | | | 1,099 | | | | — | | | | 1,099 | |
Net unrealized securities gains arising during the period, net of taxes of $188 | | | — | | | | — | | | | — | | | | 370 | | | | 370 | |
Realized securities gains, net of taxes of $(38) | | | — | | | | — | | | | — | | | | (77 | ) | | | (77 | ) |
| | | | | | | | | | | | | | | | | | | | |
Total comprehensive income | | | | | | | | | | | | | | | | | | | 1,392 | |
Cash dividends declared ($0.16 per share) | | | — | | | | — | | | | (246 | ) | | | — | | | | (246 | ) |
| | | | | | | | | | | | | | | | | | | | |
Balance, December 31, 2011 | | $ | 15,357 | | | $ | 2,925 | | | $ | 14,292 | | | $ | 459 | | | $ | 33,033 | |
| | | | | | | | | | | | | | | | | | | | |
See Notes to Consolidated Financial Statements
.
25
Cardinal Bankshares Corporation and Subsidiaries
Consolidated Statements of Cash Flows
| | | | | | | | |
Years ended December 31, (In thousands) | | 2011 | | | 2010 | |
Cash flows from operating activities | | | | | | | | |
Net income | | $ | 1,099 | | | $ | 969 | |
Adjustments to reconcile net income to net cash provided by operations: | | | | | | | | |
Depreciation and amortization | | | 227 | | | | 259 | |
Accretion of discount on securities, net of amortization of premiums | | | 394 | | | | 416 | |
Provision for (recovery of) loan losses | | | 592 | | | | 661 | |
Deferred income taxes benefit (expense) | | | (219 | ) | | | (292 | ) |
Net realized (gain) loss on securities | | | (115 | ) | | | (98 | ) |
Net realized (gain) loss on sale of foreclosed assets | | | 20 | | | | 51 | |
Net realized (gain) loss on sale of premises and equipment | | | 82 | | | | — | |
Deferred compensation and pension expense (benefit) | | | 12 | | | | 67 | |
Income on bank owned life insurance | | | (158 | ) | | | (164 | ) |
Net other-than-temporary impairment on investments | | | 300 | | | | — | |
Changes in assets and liabilities: | | | | | | | | |
Accrued income | | | 130 | | | | 77 | |
Other assets | | | (449 | ) | | | 401 | |
Accrued interest payable | | | (23 | ) | | | (32 | ) |
Other liabilities | | | 543 | | | | (273 | ) |
| | | | | | | | |
Net cash provided by operating activities | | | 2,435 | | | | 2,042 | |
| | | | | | | | |
Cash flows from investing activities | | | | | | | | |
Purchases of available for sale securities | | | (30,685 | ) | | | (21,937 | ) |
Sales of available for sale securities | | | 4,890 | | | | 983 | |
Maturities, calls and paydowns of available for sale securities | | | 11,218 | | | | 15,375 | |
Purchases of held to maturity securities | | | (347 | ) | | | (2,601 | ) |
Maturities, calls and paydowns of held to maturity securities | | | 2,076 | | | | 3,756 | |
Call (purchase) of restricted equity securities | | | (17 | ) | | | — | |
Net decrease (increase) in loans | | | 14,821 | | | | 470 | |
Net purchases (sales) of premises and equipment | | | 642 | | | | (313 | ) |
Proceeds from sale of foreclosed assets | | | 210 | | | | 120 | |
| | | | | | | | |
Net cash provided (used) by investing activities | | | 2,808 | | | | (4,147 | ) |
| | | | | | | | |
Cash flows from financing activities | | | | | | | | |
Net increase in noninterest-bearing deposits | | | 3,871 | | | | 970 | |
Net increase in interest-bearing deposits | | | 11,555 | | | | 7,814 | |
Dividends paid | | | (246 | ) | | | (246 | ) |
| | | | | | | | |
Net cash provided by financing activities | | | 15,180 | | | | 8,538 | |
| | | | | | | | |
Net increase in cash and cash equivalents | | | 20,423 | | | | 6,433 | |
Cash and cash equivalents, beginning | | | 32,290 | | | | 25,857 | |
| | | | | | | | |
Cash and cash equivalents, ending | | $ | 52,713 | | | $ | 32,290 | |
| | | | | | | | |
Supplemental disclosures of cash flow information | | | | | | | | |
Interest paid | | $ | 3,089 | | | $ | 4,427 | |
| | | | | | | | |
Income taxes paid | | $ | 419 | | | $ | 250 | |
| | | | | | | | |
Supplemental disclosures of noncash activities | | | | | | | | |
Transfer of loans to foreclosed assets | | $ | 3,139 | | | $ | 437 | |
| | | | | | | | |
See Notes to Consolidated Financial Statements
26
Note 1. Organization and Summary of Significant Accounting Policies
Date of Management Review
Management has evaluated subsequent events through the date which the financial statements were available to be issued.
Organization
Cardinal Bankshares Corporation (the “Company”) was incorporated as a Virginia corporation on March 12, 1996 to acquire the stock of Bank of Floyd (the “Bank”). The Bank was acquired by the Company on June 30, 1996.
Bank of Floyd and its wholly-owned subsidiary, FBC, Inc., are incorporated and operate under the laws of the Commonwealth of Virginia. As a state chartered Federal Reserve member, the Bank is subject to regulation by the Virginia Bureau of Financial Institutions and the Federal Reserve. The Bank serves the counties of Floyd, Carroll, Montgomery, Roanoke and Pulaski, Virginia and the Cities of Roanoke, Christiansburg, and Salem, Virginia, through seven banking offices. FBC Inc.’s assets and operations consist primarily of annuity sales and minority interests in an insurance company and a title insurance company.
The accounting and financial reporting policies of the Company conform to generally accepted accounting principles and general practices within the financial services industry. Following is a summary of the more significant policies.
Principles of Consolidation
The consolidated financial statements of the Company include the accounts of the Company, the Bank and FBC, Inc. All material intercompany transactions and balances have been eliminated.
Critical Accounting Policy
Management believes the policy with respect to the methodology for the determination of the allowance for loan losses involves a high degree of complexity. Management must make difficult and subjective judgments which often require assumptions or estimates about highly uncertain matters. Changes in these judgments, assumptions or estimates could cause reported results to differ materially. This critical policy and its application are periodically reviewed with the Audit Committee and Board of Directors.
Business Segments
The Company reports its activities as a single business segment. In determining proper segment definition, the Company considers the materiality of the potential segment and components of the business about which financial information is available and regularly evaluated, relative to resource allocation and performance assessment.
Advertising Expense
The Company expenses advertising costs as they are incurred. Advertising expense for the years presented is not material to the financial statements.
Use of Estimates
The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions in the application of certain accounting policies that affect the reported amounts of assets and liabilities, and the disclosure of contingent assets and liabilities, at the date of the financial statements, as well as the reported amounts of revenues and expenses during the reporting period. As a result of unanticipated events or circumstances, actual results could differ from those estimates.
27
Note 1. Organization and Summary of Significant Accounting Policies, continued
Use of Estimates, continued
Material estimates that are particularly susceptible to significant change relate to the determination of the allowance for loan losses and the valuation of real estate acquired in connection with foreclosures or in satisfaction of loans. In connection with the determination of the allowances for loan and foreclosed real estate losses, management obtains independent appraisals for significant properties.
The majority of the Company’s loan portfolio consists of loans in Southwest Virginia. Accordingly, the ultimate collectability of a substantial portion of the Company’s loan portfolio and the recovery of a substantial portion of the carrying amount of foreclosed real estate are susceptible to changes in local market conditions. The regional economy is diverse, but is influenced by the agricultural and governmental segments.
While management uses available information to recognize loan and foreclosed real estate losses, future additions to the allowances may be necessary based on changes in local economic conditions. In addition, regulatory agencies, as a part of their routine examination process, periodically review the Company’s allowances for loan and foreclosed real estate losses. Such agencies may require additions to the allowances based on their judgments about information available to them at the time of their examinations. Because of these factors, it is reasonably possible that the allowances for loan and foreclosed real estate losses may change materially in the near term.
Cash and Cash Equivalents
For purpose of presentation in the consolidated statements of cash flows, cash and cash equivalents are defined as those amounts included in the balance sheet captions Cash and due from banks, Interest bearing deposits in banks and Federal funds sold.
Interest-Bearing Deposits in Banks
Interest-bearing deposits in banks mature within one year and are carried at cost.
Trading Securities
The Company does not hold securities for short-term resale and therefore does not maintain a trading securities portfolio.
Securities Held to Maturity
Bonds, notes, and debentures for which the Company has the positive intent and ability to hold to maturity are reported at cost, adjusted for premiums and discounts that are recognized in interest income using the interest method over the period to maturity or to call dates.
Securities Available for Sale
Available for sale securities are reported at fair value and consist of bonds, notes, debentures, and certain equity securities not classified as held to maturity securities.
Unrealized holding gains and losses, net of tax, on available for sale securities are reported as a net amount in a separate component of stockholders’ equity. Realized gains and losses on the sale of available for sale securities are recorded on the trade date and are determined using the specific identification method. Premiums and discounts are recognized in interest income using the interest method over the period to maturity or to call dates.
Declines in the fair value of individual held to maturity and available for sale securities below cost, that are other than temporary, are reflected as write-downs of the individual securities to fair value. Related write-downs are included in earnings as realized losses.
28
Note 1. Organization and Summary of Significant Accounting Policies, continued
Loans Receivable
Loans receivable that management has the intent and ability to hold for the foreseeable future or until maturity or pay-off, are reported at their outstanding principal amount adjusted for charge-offs, the allowance for loan losses, deferred fees or costs on originated loans, and unamortized premiums or discounts on purchased loans.
Loan origination fees and certain direct origination costs are deferred and recognized as an adjustment of the yield of the related loan. Discounts and premiums on any purchased residential real estate loans are amortized to income using the interest method over the remaining period to contractual maturity, adjusted for anticipated prepayments. Discounts and premiums on any purchased consumer loans are recognized over the expected lives of the loans using methods that approximate the interest method.
Interest is accrued and credited to income based on the principal amount outstanding. The accrual of interest on impaired loans is discontinued when, in management’s opinion, the borrower may be unable to meet payments as they become due. When interest accrual is discontinued, all unpaid accrued interest is reversed. Interest income is subsequently recognized only to the extent cash payments are received. When facts and circumstances indicate the borrower has regained the ability to meet required payments, the loan is returned to accrual status. Past due status of the loan is determined based on contractual terms.
Allowance for Loan Losses
The allowance for loan losses is established as losses are estimated to have occurred through a provision for loan losses charged to earnings. Loan losses are charged against the allowance when management believes the uncollectability of a loan balance is confirmed. Subsequent recoveries, if any, are credited to the allowance.
The allowance for loan losses is evaluated on a regular basis by management and is based upon management’s periodic review of the collectability of the loans in light of historical experience, the nature and volume of the loan portfolio, adverse situations that may affect the borrower’s ability to repay, estimated value of any underlying collateral and prevailing economic conditions. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available.
The allowance consists of specific, general and unallocated components. The specific component relates to loans that are classified as impaired, for which an allowance is established when the discounted cash flows (or collateral value or observable market price) of the impaired loan is lower than the carrying value of that loan. The general component covers non-impaired loans and is based on historical loss experience adjusted for qualitative factors. An unallocated component is maintained to cover uncertainties that could affect management’s estimate of probable losses. The unallocated component of the allowance reflects the margin of imprecision inherent in the underlying assumptions used in the methodologies for estimating specific and general losses in the portfolio.
A loan is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record, and the amount of the shortfall in relation to the principal and interest owed. Impairment is measured on a loan by loan basis for commercial and construction loans by either the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s obtainable market price, or the fair value of the collateral if the loan is collateral dependent.
29
Note 1. Organization and Summary of Significant Accounting Policies, continued
Large groups of smaller balance homogeneous loans are collectively evaluated for impairment. Accordingly, the Company does not separately identify individual consumer and residential loans for impairment disclosures.
Premises and Equipment
Land is carried at cost. Bank premises, furniture and equipment are carried at cost, less accumulated depreciation and amortization computed principally by the straight-line method over the following estimated useful lives:
| | | | |
| | | Years | |
Buildings and improvements | | | 20-40 | |
Furniture and equipment | | | 5-20 | |
Foreclosed Properties
Real estate properties acquired through, or in lieu of, loan foreclosure are to be sold and are initially recorded at fair value less cost to sell at the date of foreclosure. After foreclosure, valuations are periodically performed by management and the real estate is carried at the lower of carrying amount or fair value less cost to sell. Revenue and expenses from operations and changes in the valuation allowance are included in operations on foreclosed real estate. The historical average holding period for such properties is approximately 22 months.
Pension Plan
A noncontributory defined benefit pension plan is provided for all employees who meet eligibility requirements. To be eligible, an employee must have been hired prior to October 1, 2008, be 21 years of age and have completed one year of service. Plan benefits are based on final average compensation and years of service. The plan is funded in compliance with the Employee Retirement Income Security Act of 1974 and the Internal Revenue Code of 1986, as amended.
Transfers of Financial Assets
Transfers of financial assets are accounted for as sales, when control over the assets has been surrendered. Control over transferred assets is deemed to be surrendered when (1) the assets have been isolated from the Company, (2) the transferee obtains the right (free of conditions that constrain it from taking advantage of that right) to pledge or exchange the transferred assets, and (3) the Company does not maintain effective control over the transferred assets through an agreement to repurchase them before their maturity.
Income Taxes
Provision for income taxes is based on amounts reported in the statements of income (after exclusion of non-taxable income such as interest on state and municipal securities) and consists of taxes currently due plus deferred taxes on temporary differences in the recognition of income and expense for tax and financial statement purposes. Deferred tax assets and liabilities are included in the financial statements at currently enacted income tax rates applicable to the period in which the deferred tax assets or liabilities are expected to be realized or settled. As changes in tax laws or rates are enacted, deferred tax assets and liabilities are adjusted through the provision for income taxes.
Deferred income tax liability relating to unrealized appreciation (or the deferred tax asset in the case of unrealized depreciation) on investment securities available for sale is recorded in other liabilities (assets). Such unrealized appreciation or depreciation is recorded as an adjustment to equity in the financial statements and not included in income determination until realized. Accordingly, the resulting deferred income tax liability or asset is also recorded as an adjustment to equity.
30
Note 1. Organization and Summary of Significant Accounting Policies, continued
When tax returns are filed, it is highly certain that some positions taken would be sustained upon examination by the taxing authorities, while others are subject to uncertainty about the merits of the position taken or the amount of the position that would be ultimately sustained. The benefit of a tax position is recognized in the financial statements in the period during which, based on all available evidence, management believes it is more likely than not that the position will be sustained upon examination, including the resolution of appeals or litigation processes, if any. Tax positions taken are not offset or aggregated with other positions. Tax positions that meet the more-likely-than-not recognition threshold are measured as the largest amount of tax benefit that is more than 50% likely of being realized upon settlement with the applicable taxing authority. The portion of the benefits associated with tax positions taken that exceeds the amount measured as described above is reflected as a liability for unrecognized tax benefits in the accompanying balance sheet along with any associated interest and penalties that would be payable to the taxing authorities upon examination. Management is not aware of any material uncertain tax positions and no liability has been recognized at December 31, 2011. Interest and penalties associated with unrecognized tax benefits are classified as additional income taxes in the statement of income.
Basic Earnings per Share
Basic earnings per share is computed by dividing income available to common stockholders by the weighted average number of common shares outstanding during the period, after giving retroactive effect to stock splits and stock dividends.
Diluted Earnings per Share
The computation of diluted earnings per share is similar to the computation of basic earnings per share except that the denominator is increased to include the number of additional common shares that would have been outstanding if dilutive potential common shares had been issued. The numerator is adjusted for any changes in income or loss that would result from the assumed conversion of those potential common shares. For the years presented, the Company has no potentially dilutive securities outstanding.
Comprehensive Income
Annual comprehensive income reflects the change in the Company’s equity during the year arising from transactions and events other than investments by, and distributions to, stockholders. It consists of net income plus certain other changes in assets and liabilities that are reported as separate components of stockholders’ equity rather than as income or expense.
Financial Instruments
Derivatives that are used as part of the asset/liability management process are linked to specific assets or liabilities and have high correlation between the contract and the underlying item being hedged, both at inception and throughout the hedge period. In addition, forwards and option contracts must reduce an exposure’s risk, and for hedges of anticipatory transactions, the significant terms and characteristics of the transaction must be identified and the transactions must be probable of occurring. All derivative financial instruments held or issued by the Bank are held or issued for purposes other than trading.
In the ordinary course of business the Company has entered into off-balance sheet financial instruments consisting of commitments to extend credit and commercial and standby letters of credit. Such financial instruments are recorded in the financial statements when they are funded or related fees are incurred or received.
The Company does not utilize interest-rate exchange agreements or interest-rate futures contracts.
31
Note 1. Organization and Summary of Significant Accounting Policies, continued
Fair Value of Financial Instruments
Generally accepted accounting principles (“GAAP”) define fair value 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. The Company determines the fair values of its financial instruments based on the fair value hierarchy established per GAAP which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. Investment securities available-for-sale, loans held for sale and servicing assets are recorded at fair value on a recurring basis. Certain impaired loans are carried at fair value on a non-recurring basis.
Recently Issued Accounting Pronouncements
The following is a summary of recent authoritative pronouncements that could impact the accounting, reporting and or disclosure of financial information by the Company.
In January 2011, the Financial Accounting Standards Board issued Accounting Standards Update 2011-01,Deferral of the Effective Date of Disclosures about Troubled Debt Restructurings in Update No. 2010-20.Under the existing effective date in Update 2010-20, public-entity creditors would have provided disclosures about troubled debt restructurings for periods beginning on or after December 15, 2010. The amendments in this Update temporarily defers the effective date for interim and annual periods ending after June 15, 2011, enabling public-entity creditors to provide those disclosures after the Board clarifies the guidance for determining what constitutes a troubled debt restructuring. The deferral in this Update will result in more consistent disclosures about troubled debt restructurings. This amendment does not defer the effective date of the other disclosure requirements in Update 2010-20. The deferral in this amendment was effective upon issuance and did not have a significant impact on the Company.
In April, 2011, the Financial Accounting Standards Board issued Accounting Standards Update 2011-02,A Creditor’s Determination of Whether a Restructuring Is a Troubled Debt Restructuring.This update provides additional guidance and amendments to Subtopic 310-40,Receivables – Troubled Debt Restructurings by Creditors. In evaluating whether a restructuring constitutes a troubled debt restructuring, a creditor must separately conclude that both of the following exist; the restructuring constitutes a concession, and the debtor is experiencing financial difficulties. The amendments clarify the guidance on a creditor’s evaluation of whether it has granted a concession, and on a creditor’s evaluation of whether a debtor 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. An entity should disclose the total amount of receivables and the allowance for credit losses as of the end of the period of adoption related to those receivables that are newly considered impaired under Section 310-10-35 for which impairment was previously measured under Subtopic 450-20, Contingencies—Loss Contingencies. An entity should disclose the information required by paragraphs 310-10-50-33 through 50-34, which was deferred by Accounting Standards Update No. 2011-01,Receivables (Topic 310): Deferral of the Effective Date of Disclosures about Troubled Debt Restructurings in Update No. 2010-20,for interim and annual periods beginning on or after June 15, 2011. The amendments did not have a significant impact on the Company.
32
Note 1. Organization and Summary of Significant Accounting Policies, continued
Recently Issued Accounting Pronouncements, continued
In April 2011 the Financial Accounting Standards Board issued Accounting Standards Update 2011-03,Reconsideration of Effective Control for Repurchase Agreements. The amendments in this Update remove from the assessment of effective control (1) the criterion requiring the transferor to have the ability to repurchase or redeem the financial assets on substantially the agreed terms, even in the event of default by the transferee, and (2) the collateral maintenance implementation guidance related to that criterion. Other criteria applicable to the assessment of effective control are not changed by the amendments in this Update. Those criteria indicate that the transferor is deemed to have maintained effective control over the financial assets transferred (and thus must account for the transaction as a secured borrowing) for agreements that both entitle and obligate the transferor to repurchase or redeem the financial assets before their maturity when all of the listed conditions have been met. The amendments are not expected to have a significant impact on the Company.
In May 2011, the Financial Accounting Standards Board issued Accounting Standards Update 2011-04,Amendments to Achieve Common Fair Value Measurements and Disclosure Requirements in U.S GAAP and IFRSs. The amendments in this update explain how to measure fair value. They do not require additional fair value measurements and are not intended to establish valuation standards or affect valuation practices outside of financial reporting. The amendments apply to all reporting entities that are required or permitted to measure or disclose the fair value of an asset, a liability, or an instrument classified in a reporting entity’s shareholders’ equity in the financial statements. For public entities, the amendments are effective during interim and annual periods beginning after December 15, 2011. The amendments are not expected to have a significant impact on the Company.
In June 2011, the Financial Accounting Standards Board issued Accounting Standards Update 2011-05,Presentation of Comprehensive Income. This update seeks to improve comparability, consistency, and transparency of financial reporting and to increase the prominence of items reported in other comprehensive income. To increase the prominence of items reported in other comprehensive income and to facilitate convergence of U.S. generally accepted accounting principles (GAAP) and International Reporting Standards (IFRS), the FASB decided to eliminate the option to present components of other comprehensive income as part of the statement of changes in stockholders’ equity, among other amendments in this update. For public entities, the amendments are effective during interim and annual periods beginning after December 15, 2011. The amendments are not expected to have a significant impact on the Company.
In September 2011, the Financial Accounting Standards Board issued Accounting Standards Update 2011-08,Intangibles – Goodwill and Other Testing Goodwill for Impairment. The objective of this update is to simplify how entities, both public and nonpublic, test goodwill for impairment. The amendments in this update permit an entity to first assess qualitative factors to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount as a basis for determining whether it is necessary to perform the two step goodwill impairment test as described in previous guidance under Topic 350. The amendments are effective for fiscal years beginning December 15, 2011. Early adoption is permitted. The amendments are not expected to have a significant impact on the Company.
In September 2011, the Financial Accounting Standards Board issued Accounting Standards Update 2011-09,Compensation – Retirement Benefits – Multiemployer Plans. This update addresses concerns from various users of financial statements on the lack of transparency about an employer’s participation in a multiemployer pension plan. A unique characteristic of a multiemployer plan is that assets contributed by one employer may be used to provide benefits to employees of other participating employers. This is because the assets contributed by an employer are not specifically earmarked only for its employees. If a participating employer fails to make its required contributions, the unfunded obligations of the plan may be borne by the remaining participating employers. Similarly, in some cases, if an employer chooses to stop participating in a multiemployer plan, the withdrawing company may be required to pay to the plan a final payment (the withdrawal liability). Users of financial statements have requested additional disclosure to increase awareness of the commitments and risks involved with participating in multiemployer pension plans. The amendments in this update require additional disclosures about an employer’s participation in a multiemployer pension plan.
33
Note 1. Organization and Summary of Significant Accounting Policies, continued
Recently Issued Accounting Pronouncements, continued
Previously, disclosures were limited primarily to the historical contributions made to the plans. In developing the new guidance, the FASB’s goal was to help users of financial statements assess the potential future cash flow implications relating to an employer’s participation in multiemployer pension plans. The disclosures also will indicate the financial health of all of the significant plans in which the employer participates and assist a financial statement user to access additional information that is available outside the financial statements. For public entities, the amendments in this update are effective for annual periods for fiscal years ending after December 15, 2011, with early adoption permitted. For nonpublic entities, the amendments are effective for annual periods for fiscal years ending after December 15, 2012, with early adoption permitted. The amendments should be applied retrospectively for all periods presented. The amendments are not expected to have a significant impact on the Company.
In December 2011, the Financial Accounting Standards Board issued Accounting Standards Update 2011-10,Property, Plant and Equipment. Under the amendments in the Update, when a parent ceases to have a controlling interest in a subsidiary that is in substance real estate as a result of default on the subsidiary’s nonrecourse debt the reporting entity should apply the guidance in Subtopic 360-20 to determine whether it should derecognize the in substance real estate. Generally, a reporting entity would not satisfy the requirements to derecognize the in substance real estate before the legal transfer of the real estate to the lender and the extinguishment of the related nonrecourse indebtedness. That is, even if the reporting entity ceases to have a controlling financial interest under Subtopic 810-10, the reporting entity would continue to include the real estate, debt, and the results of the subsidiary’s operations in its consolidate financial statements until legal title to the real estate is transferred to legally satisfy the debt. For public entities, the amendments in this Update are effective for fiscal years, and interim periods within those years, beginning on or after June 15, 2012. For nonpublic entities, the amendments are effective for fiscal years ending after December 15, 2013, and interim and annual periods thereafter. Early adoption is permitted. The amendments are not expected to have any impact on the Company.
In December 2011, the Financial Accounting Standards Board issued Accounting Standards Update 2011-11,Balance Sheet. Offsetting (netting) assets and liabilities is an important aspect of presentation in financial statements. The differences in the offsetting requirements in U.S. generally accepted accounting principles (U.S GAAP) and International Financial Reporting Standards (IFRS) account for a significant difference in the amounts presented in statements of financial position prepared in accordance with U.S. GAAP and the amounts presented in those statements prepared in accordance with IFRS for certain institutions. The difference reduces the comparability of statements of financial position. The FASB and IASB are issuing joint requirements to enhance current disclosures. Entities are required to disclose both gross information and net information about both instruments and transactions eligible for offset in the statement of financial position and instruments and transactions subject to an agreement similar to a master netting arrangement. This scope would include derivatives, sale and repurchase agreements and reverse sale and repurchase agreements, and securities borrowing and securities lending arrangements. The amendments in this Update require an entity to disclose information about offsetting and related arrangements to enable users of financial statements to understand the effect of those arrangements on financial position. The amendments are effective for annual reporting periods beginning on or after January 1, 2013, and interim periods within those annual periods. The amendments are not expected to have a significant impact on the Company.
In December 2011, the Financial Accounting Standards Board issued Accounting Standards Update 2011-12,Comprehensive Income. This Update defers changes in Update 2011-05 that relate to the presentation of reclassification adjustments, and supersedes certain pending paragraphs in Update 2011-05. The amendments are being made to allow the Board time to redeliberate whether to present on the face of the financial statements the effects of reclassifications out of accumulated other comprehensive income on the components of net income and the other comprehensive income for all periods presented. While the Board is considering the operational concerns about the presentation requirements for reclassification adjustments and the needs of financial statement users for additional information about reclassification adjustments, entities should continue to report reclassifications out of accumulated other comprehensive income consistent with the presentation requirements in effect before Update 2011-05. All other requirements in Update 2011-05 are not affected by this Update. Public entities should apply these requirements for fiscal years, and interim periods within those years, beginning after December 15, 2011.
34
Note 1. Organization and Summary of Significant Accounting Policies, continued
Recently Issued Accounting Pronouncements, continued
Nonpublic entities should begin applying these requirements for fiscal years ending after December 15, 2012, and interim and annual periods thereafter. The amendments are not expected to have a significant impact on the Company.
Other accounting standards that have been issued or proposed by the FASB or other standards-setting bodies are not expected to have a material impact on the Company’s financial position, results of operations or cash flows.
35
Note 2. Restrictions on Cash and Due from Banks
To comply with banking regulations, the Company is required to maintain certain average cash reserve balances. The daily average cash reserve requirement was approximately $900 thousand for each of the two-week periods including December 31, 2011 and 2010.
Note 3. Securities
Debt and equity securities have been classified in the Consolidated Balance Sheets according to management’s intent. The carrying amount of securities and their approximate fair values at December 31 follow:
| | | | | | | | | | | | | | | | |
2011 (In thousands) | | Amortized
Cost | | | Unrealized
Gains | | | Unrealized
Losses | | | Fair
Value | |
Available for sale | | | | | | | | | | | | | | | | |
Government sponsored enterprises | | $ | 1,933 | | | $ | 21 | | | $ | 2 | | | $ | 1,952 | |
State and municipal securities | | | 5,226 | | | | 267 | | | | — | | | | 5,493 | |
Mortgage-backed securities | | | 46,293 | | | | 755 | | | | 120 | | | | 46,928 | |
Other securities | | | 2,957 | | | | 18 | | | | 243 | | | | 2,732 | |
| | | | | | | | | | | | | | | | |
| | $ | 56,409 | | | $ | 1,061 | | | $ | 365 | | | $ | 57,105 | |
| | | | | | | | | | | | | | | | |
Held to maturity | | | | | | | | | | | | | | | | |
State and municipal securities | | $ | 12,925 | | | $ | 712 | | | $ | — | | | $ | 13,637 | |
Mortgage-backed securities | | | 25 | | | | — | | | | — | | | | 25 | |
| | | | | | | | | | | | | | | | |
| | $ | 12,950 | | | $ | 712 | | | $ | — | | | $ | 13,662 | |
| | | | | | | | | | | | | | | | |
2010 (In thousands) | | | | | | | | | | | | |
Available for sale | | | | | | | | | | | | | | | | |
Government sponsored enterprises | | $ | 2,853 | | | $ | 30 | | | $ | 17 | | | $ | 2,866 | |
State and municipal securities | | | 2,994 | | | | 66 | | | | 11 | | | | 3,049 | |
Mortgage-backed securities | | | 32,483 | | | | 454 | | | | 104 | | | | 32,833 | |
Other securities | | | 4,063 | | | | 15 | | | | 182 | | | | 3,896 | |
| | | | | | | | | | | | | | | | |
| | $ | 42,393 | | | $ | 565 | | | $ | 314 | | | $ | 42,644 | |
| | | | | | | | | | | | | | | | |
Held to maturity | | | | | | | | | | | | | | | | |
State and municipal securities | | $ | 14,672 | | | $ | 279 | | | $ | 198 | | | $ | 14,753 | |
Mortgage-backed securities | | | 26 | | | | 1 | | | | — | | | | 27 | |
| | | | | | | | | | | | | | | | |
| | $ | 14,698 | | | $ | 280 | | | $ | 198 | | | $ | 14,780 | |
| | | | | | | | | | | | | | | | |
Restricted equity securities, carried at cost, consist of investments in stock of the Federal Home Loan Bank of Atlanta (“FHLB”) and The Federal Reserve of Richmond (Federal Reserve), which are upstream correspondents of the Bank. The FHLB requires financial institutions to make equity investments in the FHLB in order to borrow from it. The Bank is required to hold that stock so long as it borrows from the FHLB. The Federal Reserve requires banks to purchase stock as a condition of membership in the Federal Reserve System.
Investment securities with amortized cost of approximately $6.3 million and $7.1 million at December 31, 2011 and 2010, respectively, were pledged as collateral on public deposits and for other purposes as required or permitted by law.
Gross realized gains and losses for the years ended December 31 are as follows:
| | | | | | | | |
(In thousands) | | 2011 | | | 2010 | |
Realized gains, available for sale securities | | $ | 124 | | | $ | 94 | |
Realized losses, available for sale securities | | | (9 | ) | | | — | |
Realized gains, held to maturity securities | | | — | | | | 4 | |
| | | | | | | | |
| | $ | 115 | | | $ | 98 | |
| | | | | | | | |
36
Note 3. Securities, continued
The scheduled maturities of debt securities available for sale and held to maturity at December 31, 2011 were as follows:
| | | | | | | | | | | | | | | | |
(In thousands) | | Available for Sale | | | Held to Maturity | |
| | | Amortized
Cost | | | Fair
Value | | | Amortized
Cost | | | Fair
Value | |
Due in one year or less | | $ | 414 | | | $ | 422 | | | $ | 528 | | | $ | 536 | |
Due after one year through five years | | | 1,780 | | | | 1,706 | | | | 4,614 | | | | 4,773 | |
Due after five years through ten years | | | 2,983 | | | | 3,194 | | | | 3,207 | | | | 3,431 | |
Due after ten years | | | 51,232 | | | | 51,783 | | | | 4,601 | | | | 4,922 | |
| | | | | | | | | | | | | | | | |
| | $ | 56,409 | | | $ | 57,105 | | | $ | 12,950 | | | $ | 13,662 | |
| | | | | | | | | | | | | | | | |
For mortgage-backed securities, the Company reports maturities based on anticipated lives. Actual results may differ due to interest rate fluctuations.
The following table shows the unrealized losses and related fair values in the Company’s held to maturity and available for sale investment securities portfolios. This information is aggregated by investment category and by the length of time that individual securities have been in a continuous unrealized loss position at December 31, 2011 and 2010.
| | | | | | | | | | | | | | | | | | | | | | | | |
| | | Less Than 12 Months | | | 12 Months or More | | | Total | |
| | | Fair
Value | | | Unrealized
Losses | | | Fair
Value | | | Unrealized
Losses | | | Fair
Value | | | Unrealized
Losses | |
December 31, 2011 (In thousands) | | | | | | | | | | | | | | | | | | | | | | | | |
Government sponsored enterprises | | $ | 948 | | | $ | 2 | | | $ | — | | | $ | — | | | $ | 948 | | | $ | 2 | |
State and municipal securities | | | 275 | | | | — | | | | — | | | | — | | | | 275 | | | | — | |
Mortgage- backed securities | | | 9,936 | | | | 47 | | | | 4,652 | | | | 73 | | | | 14,588 | | | | 120 | |
Other Securities | | | 866 | | | | 151 | | | | 908 | | | | 92 | | | | 1,774 | | | | 243 | |
| | | | | | | | | | | | | | | | | | | | | | | | |
Total temporarily impaired securities | | $ | 12,025 | | | $ | 200 | | | $ | 5,560 | | | $ | 165 | | | $ | 17,585 | | | $ | 365 | |
| | | | | | | | | | | | | | | | | | | | | | | | |
December 31, 2010 (In thousands) | | | | | | | | | | | | | | | | | | | | | | | | |
Government sponsored enterprises | | $ | 982 | | | $ | 17 | | | $ | — | | | $ | — | | | $ | 982 | | | $ | 17 | |
State and municipal securities | | | 5,559 | | | | 158 | | | | 387 | | | | 51 | | | | 5,946 | | | | 209 | |
Mortgage- backed securities | | | 12,054 | | | | 100 | | | | 668 | | | | 4 | | | | 12,722 | | | | 104 | |
Other Securities | | | 1,016 | | | | 8 | | | | 1,327 | | | | 174 | | | | 2,343 | | | | 182 | |
| | | | | | | | | | | | | | | | | | | | | | | | |
Total temporarily impaired securities | | $ | 19,611 | | | $ | 283 | | | $ | 2,382 | | | $ | 229 | | | $ | 21,993 | | | $ | 512 | |
| | | | | | | | | | | | | | | | | | | | | | | | |
Management considers the nature of the investment, the underlying causes of the decline in market or fair value, the severity and duration of the decline and other evidence, on a security-by-security basis, in determining if the decline in fair value is other than temporary.
At December 31, 2011, the Company had one government-sponsored security with an aggregate unrealized loss of approximately $2 thousand, one state and municipal securities with no aggregate unrealized loss, 27 mortgaged-backed securities with an aggregate unrealized loss of approximately $120 thousand and five other securities with an aggregate unrealized loss of approximated $243 thousand. Management does not believe that gross unrealized losses, which totals 2.1% of the amortized costs of the related investment securities, represent an other-than-temporary impairment. The Company has both the ability and the intent to hold all of these securities for a period of time necessary to recover the amortized cost.
37
Note 4. Loans Receivable
The major components of loans in the Consolidated Balance Sheets are summarized below:
| | | | | | | | |
December 31, (In thousands) | | 2011 | | | 2010 | |
Commercial | | $ | 5,873 | | | $ | 7,230 | |
Real estate | | | | | | | | |
Construction and land development | | | 8,868 | | | | 13,110 | |
Residential, 1-4 families | | | 26,568 | | | | 29,961 | |
Residential, 5 or more families | | | 4,717 | | | | 4,277 | |
Farmland | | | 1,306 | | | | 1,274 | |
Nonfarm, nonresidential | | | 75,879 | | | | 85,049 | |
Agricultural | | | 9 | | | | 72 | |
Consumer | | | 2,487 | | | | 2,923 | |
Other | | | 4,765 | | | | 5,388 | |
| | | | | | | | |
Gross loans | | | 130,472 | | | | 149,284 | |
Unearned discount and net deferred loan fees and costs | | | (314 | ) | | | (368 | ) |
| | | | | | | | |
Total loans | | | 130,158 | | | | 148,916 | |
Allowance for loan losses | | | (2,867 | ) | | | (3,073 | ) |
| | | | | | | | |
Net loans | | $ | 127,291 | | | $ | 145,843 | |
| | | | | | | | |
Overdrafts that were reclassified as part of gross loans totaled $7 thousand and $12 thousand at December 31, 2011 and 2010, respectively.
As a part of the ongoing monitoring of the credit quality of the loan portfolio, management tracks certain credit quality indicators including trends related to (i) the risk grade assigned to commercial and consumer loans, (ii) the level of classified commercial loans, (iii) net charge-offs, (iv) nonperforming loans, and (v) the general economic conditions in the Company’s geographic markets.
The Company categorizes loans receivable 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 Company analyzes loans and leases individually by classifying the loans receivable as to credit risk. The Company uses the following definitions for risk ratings:
Pass - Loans in this category are considered to have a low likelihood of loss based on relevant information analyzed about the ability of the borrowers to service their debt and other factors.
Special Mention - Loans in this category are currently protected but are potentially weak, including adverse trends in borrower’s operations, credit quality or financial strength. Those loans constitute an undue and unwarranted credit risk but not to the point of justifying a substandard classification. The credit risk may be relatively minor yet constitute an unwarranted risk in light of the circumstances. Special mention loans have potential weaknesses which may, if not checked or corrected, weaken the loan or inadequately protect the Company’s credit position at some future date.
Substandard - A substandard loan is inadequately protected by the current sound net worth and paying capacity of the obligor or of the collateral pledged, if any. Loans classified as substandard must have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt; they are characterized by the distinct possibility that the institution will sustain some loss if the deficiencies are not corrected.
38
Note 4. Loans Receivable, continued
Doubtful - Loans classified Doubtful have all the weaknesses inherent in loans classified Substandard, plus 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.
The following table presents the loan portfolio by credit quality indicator (risk grade) as of December 31, 2011 and December 31, 2010.
| | | | | | | | | | | | | | | | | | | | |
December 31, 2011 (In thousands) | | Pass | | | Special
Mention | | | Sub-
Standard | | | Doubtful | | | Total
Loans | |
Commercial | | $ | 3,161 | | | $ | — | | | $ | 2,712 | | | $ | — | | | $ | 5,873 | |
Real Estate | | | | | | | | | | | | | | | | | | | | |
Construction and land development | | | 5,671 | | | | — | | | | 3,197 | | | | — | | | | 8,868 | |
Residential, 1-4 families | | | 25,730 | | | | — | | | | 838 | | | | — | | | | 26,568 | |
Residential, 5 or more families | | | 3,890 | | | | 827 | | | | — | | | | — | | | | 4,717 | |
Farmland | | | 1,306 | | | | — | | | | — | | | | — | | | | 1,306 | |
Nonfarm, nonresidential | | | 64,401 | | | | 2,436 | | | | 9,042 | | | | — | | | | 75,879 | |
Agriculture | | | 9 | | | | — | | | | — | | | | — | | | | 9 | |
Consumer | | | 2,487 | | | | — | | | | — | | | | — | | | | 2,487 | |
Other | | | 4,765 | | | | — | | | | — | | | | — | | | | 4,765 | |
| | | | | | | | | | | | | | | | | | | | |
Total loans | | $ | 111,420 | | | $ | 3,263 | | | $ | 15,789 | | | $ | — | | | $ | 130,472 | |
| | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | |
December 31, 2010 (In thousands) | | Pass | | | Special
Mention | | | Sub-
Standard | | | Doubtful | | | Total
Loans | |
Commercial | | $ | 7,077 | | | $ | — | | | $ | 153 | | | $ | — | | | $ | 7,230 | |
Real Estate | | | | | | | | | | | | | | | | | | | | |
Construction and land development | | | 6,309 | | | | — | | | | 4,475 | | | | 2,326 | | | | 13,110 | |
Residential, 1-4 families | | | 29,028 | | | | — | | | | 621 | | | | 312 | | | | 29,961 | |
Residential, 5 or more families | | | 4,277 | | | | — | | | | — | | | | — | | | | 4,277 | |
Farmland | | | 1,274 | | | | — | | | | — | | | | — | | | | 1,274 | |
Nonfarm, nonresidential | | | 79,425 | | | | 4,940 | | | | 325 | | | | 359 | | | | 85,049 | |
Agriculture | | | 72 | | | | — | | | | — | | | | — | | | | 72 | |
Consumer | | | 2,923 | | | | — | | | | — | | | | — | | | | 2,923 | |
Other | | | 5,388 | | | | — | | | | — | | | | — | | | | 5,388 | |
| | | | | | | | | | | | | | | | | | | | |
Total loans | | $ | 135,773 | | | $ | 4,940 | | | $ | 5,574 | | | $ | 2,997 | | | $ | 149,284 | |
| | | | | | | | | | | | | | | | | | | | |
A loan’s risk grade is assigned at the inception of the loan and is based on the financial strength of the borrower and the type of collateral. Loan risk grades are subject to reassessment at various times throughout the year as part of the Company’s ongoing loan review process. Loans with an assigned risk grade of substandard or below and an outstanding amount of $500 thousand or more are reassessed on a quarterly basis. During this reassessment process individual reserves may be identified and placed against certain loans that are considered impaired.
Loans are considered past due if the required principal and interest payments have not been received as of the date such payments were due. Generally, loans are placed on nonaccrual status if principal or interest payments become 90 days past due or when, in management’s opinion, the borrower may be unable to meet payment obligations as they become due, as well as when required by regulatory provision. Loans may be placed on nonaccrual status regardless of whether or not such loans are considered past due.
39
Note 4. Loans Receivable, continued
The following table represents an age analysis of past due loans and nonaccrual loans, segregated by class of loans, as of December 31, 2011 and December 31, 2010.
| | | | | | | | | | | | | | | | | | | | | | | | |
| | | Accruing Loans | | | | | | | | | | |
December 31, 2011 (In thousands) | | 30-89
Days
Past
Due | | | 90 Days
or
More
Past
Due | | | Total
Accruing
Loans
Past Due | | | Nonaccrual
Loans | | | Current
Loans | | | Total
Loans | |
Commercial | | $ | 1 | | | $ | 2,700 | | | $ | 2,701 | | | $ | — | | | $ | 3,172 | | | $ | 5,873 | |
Real Estate | | | | | | | | | | | | | | | | | | | | | | | | |
Construction and land development | | | — | | | | — | | | | — | | | | 3,197 | | | | 5,671 | | | | 8,868 | |
Residential, 1-4 families | | | — | | | | — | | | | — | | | | 612 | | | | 25,956 | | | | 26,568 | |
Residential, 5 or more families | | | — | | | | — | | | | — | | | | — | | | | 4,717 | | | | 4,717 | |
Farmland | | | — | | | | — | | | | — | | | | — | | | | 1,306 | | | | 1,306 | |
Nonfarm, nonresidential | | | 107 | | | | — | | | | 107 | | | | 5,489 | | | | 70,283 | | | | 75,879 | |
Agriculture | | | — | | | | — | | | | — | | | | — | | | | 9 | | | | 9 | |
Consumer | | | 3 | | | | — | | | | 3 | | | | — | | | | 2,484 | | | | 2,487 | |
Other | | | — | | | | — | | | | — | | | | — | | | | 4,765 | | | | 4,765 | |
| | | | | | | | | | | | | | | | | | | | | | | | |
Total loans | | $ | 111 | | | $ | 2,700 | | | $ | 2,811 | | | $ | 9,298 | | | $ | 118,363 | | | $ | 130,472 | |
| | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | |
| | | Accruing Loans | | | | | | | | | | |
December 31, 2010 (In thousands) | | 30-89
Days
Past
Due | | | 90 Days
or
More
Past
Due | | | Total
Accruing
Loans
Past Due | | | Nonaccrual
Loans | | | Current
Loans | | | Total
Loans | |
Commercial | | $ | 50 | | | $ | — | | | $ | 50 | | | $ | — | | | $ | 7,180 | | | $ | 7,230 | |
Real Estate | | | | | | | | | | | | | | | | | | | | | | | | |
Construction and land development | | | 2,546 | | | | — | | | | 2,546 | | | | 6,800 | | | | 3,764 | | | | 13,110 | |
Residential, 1-4 families | | | — | | | | — | | | | — | | | | 312 | | | | 29,649 | | | | 29,961 | |
Residential, 5 or more families | | | — | | | | — | | | | — | | | | — | | | | 4,277 | | | | 4,277 | |
Farmland | | | — | | | | — | | | | — | | | | — | | | | 1,274 | | | | 1,274 | |
Nonfarm, nonresidential | | | — | | | | — | | | | — | | | | 359 | | | | 84,690 | | | | 85,049 | |
Agriculture | | | — | | | | — | | | | — | | | | — | | | | 72 | | | | 72 | |
Consumer | | | — | | | | — | | | | — | | | | — | | | | 2,923 | | | | 2,923 | |
Other | | | — | | | | — | | | | — | | | | — | | | | 5,388 | | | | 5,388 | |
| | | | | | | | | | | | | | | | | | | | | | | | |
Total loans | | $ | 2,596 | | | $ | — | | | $ | 2,596 | | | $ | 7,471 | | | $ | 139,217 | | | $ | 149,284 | |
| | | | | | | | | | | | | | | | | | | | | | | | |
40
Note 4. Loans Receivable, continued
The following table details impaired loan data as of December 31, 2011 and December 31, 2010:
| | | | | | | | | | | | | | | | | | | | |
December 31, 2011 (In thousands) | | Impaired
Balance | | | Related
Allowance | | | Average
Recorded
Investment | | | Interest
Income
Recorded | | | Interest
Income
Collected | |
With No Related Allowance Recorded | | | | | | | | | | | | | | | | | | | | |
Commercial | | $ | — | | | $ | — | | | $ | — | | | $ | — | | | $ | — | |
Real Estate | | | | | | | | | | | | | | | | | | | | |
Construction and land development | | | 2,504 | | | | — | | | | 2,529 | | | | 87 | | | | 108 | |
Nonfarm, nonresidential | | | 2,500 | | | | — | | | | 2,500 | | | | (32 | ) | | | — | |
| | | | | | | | | | | | | | | | | | | | |
| | | 5,004 | | | | — | | | | 5,029 | | | | 55 | | | | 108 | |
| | | | | | | | | | | | | | | | | | | | |
With an Allowance Recorded | | | | | | | | | | | | | | | | | | | | |
Commercial | | | 12 | | | | 12 | | | | 12 | | | | — | | | | — | |
Real Estate | | | | | | | | | | | | | | | | | | | | |
Construction and land development | | | 3,197 | | | | 584 | | | | 3,902 | | | | — | | | | — | |
Residential, 1-4 families | | | 612 | | | | 73 | | | | 791 | | | | 13 | | | | 16 | |
Nonfarm, nonresidential | | | 4,961 | | | | 589 | | | | 5,233 | | | | 90 | | | | 149 | |
| | | | | | | | | | | | | | | | | | | | |
| | | 8,782 | | | | 1,258 | | | | 9,938 | | | | 103 | | | | 165 | |
| | | | | | | | | | | | | | | | | | | | |
Total | | | | | | | | | | | | | | | | | | | | |
Commercial | | | 12 | | | | 12 | | | | 12 | | | | — | | | | — | |
Real Estate | | | | | | | | | | | | | | | | | | | | |
Construction and land development | | | 5,701 | | | | 584 | | | | 6,431 | | | | 87 | | | | 108 | |
Residential, 1-4 families | | | 612 | | | | 73 | | | | 791 | | | | 13 | | | | 16 | |
Nonfarm, nonresidential | | | 7,461 | | | | 589 | | | | 7,733 | | | | 58 | | | | 149 | |
| | | | | | | | | | | | | | | | | | | | |
| | $ | 13,786 | | | $ | 1,258 | | | $ | 14,967 | | | $ | 158 | | | $ | 273 | |
| | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | |
December 31, 2010 (In thousands) | | Impaired
Balance | | | Related
Allowance | | | Average
Recorded
Investment | | | Interest
Income
Recorded | | | Interest
Income
Collected | |
With No Related Allowance Recorded | | | | | | | | | | | | | | | | | | | | |
Commercial | | $ | — | | | $ | — | | | $ | — | | | $ | — | | | $ | — | |
Real Estate | | | | | | | | | | | | | | | | | | | | |
Construction and land development | | | 2,546 | | | | — | | | | 2,546 | | | | 90 | | | | 126 | |
Nonfarm, nonresidential | | | 1,745 | | | | — | | | | 1,747 | | | | 79 | | | | 84 | |
| | | | | | | | | | | | | | | | | | | | |
| | | 4,291 | | | | — | | | | 4,293 | | | | 169 | | | | 210 | |
| | | | | | | | | | | | | | | | | | | | |
With an Allowance Recorded | | | | | | | | | | | | | | | | | | | | |
Commercial | | | 152 | | | | 17 | | | | 167 | | | | 12 | | | | 12 | |
Real Estate | | | | | | | | | | | | | | | | | | | | |
Construction and land development | | | 4,618 | | | | 1,053 | | | | 4,087 | | | | — | | | | — | |
Residential, 1-4 families | | | 312 | | | | 197 | | | | 275 | | | | — | | | | 4 | |
Nonfarm, nonresidential | | | 634 | | | | 122 | | | | 475 | | | | 33 | | | | 67 | |
| | | | | | | | | | | | | | | | | | | | |
| | | 5,716 | | | | 1,389 | | | | 5,004 | | | | 45 | | | | 83 | |
| | | | | | | | | | | | | | | | | | | | |
Total | | | | | | | | | | | | | | | | | | | | |
Commercial | | | 152 | | | | 17 | | | | 167 | | | | 12 | | | | 12 | |
Real Estate | | | | | | | | | | | | | | | | | | | | |
Construction and land development | | | 7,164 | | | | 1,053 | | | | 6,633 | | | | 90 | | | | 126 | |
Residential, 1-4 families | | | 312 | | | | 197 | | | | 275 | | | | — | | | | 4 | |
Nonfarm, nonresidential | | | 2,379 | | | | 122 | | | | 2,222 | | | | 112 | | | | 151 | |
| | | | | | | | | | | | | | | | | | | | |
| | $ | 10,007 | | | $ | 1,389 | | | $ | 9,297 | | | $ | 214 | | | $ | 293 | |
| | | | | | | | | | | | | | | | | | | | |
The Company is generally not committed to advance additional funds in connection with impaired loans.
41
Note 4. Loans Receivable, continued
As a result of adopting the amendments in ASU 2011-02, the Bank reassessed all loan restructurings that occurred on or after the beginning of the fiscal year of adoption, January 1, 2011, to determine whether they are considered troubled debt restructurings (“TDRs”) under the amended guidance. The determination is based on whether the restructuring constitutes a concession and whether the debtor is experiencing financial difficulty as both events must be present. The Bank identified as TDRs certain loans for which the allowance for loan losses had previously been measured under a general allowance methodology. Upon identifying those loans as TDRs, the Bank identified them as impaired under the guidance in ASC 310-10-35. The amendments in ASU 2011-02 require prospective application of the impairment measurement guidance in ASC 310-10-35 for those loans newly identified as impaired. At December 31, 2011, the recorded investment in loans for which the allowance was previously measured under a general allowance methodology and are now impaired under ASC 310-10-35 was $6.6 million, and the allowance for loan losses associated with those loans, on the basis of a current evaluation of loss exposure was approximately $620 thousand.
The following is a schedule of loans that are considered Trouble Debt Restructurings at December 31, 2011.
| | | | | | | | | | | | |
| | | Number of
Contracts | | | Pre-Modification
Outstanding
Recorded
Investment | | | Post-Modification
Outstanding
Recorded
Investment | |
| (In thousands) | | | | | | | | | |
Real Estate | | | 3 | | | $ | 6,570 | | | $ | 6,570 | |
| | | | | | | | | | | | |
Total | | | 3 | | | $ | 6,570 | | | $ | 6,570 | |
| | | | | | | | | | | | |
During the twelve months ended December 31, 2011, the Bank modified two loans that were considered to be troubled debt restructurings. We extended the maturity date term for none of these loans, lowered the interest rate for two of these loans, and entered into forbearance agreements on none of these loans.
The following is a schedule of loans that had been previously restructured and have subsequently defaulted at December 31, 2011.
| | | | | | | | | | | | |
| | | Number of
Contracts | | | Pre-Modification
Outstanding
Recorded
Investment | | | Post-Modification
Outstanding
Recorded
Investment | |
| (In thousands) | | | | | | | | | |
Real Estate | | | — | | | $ | — | | | $ | — | |
| | | | | | | | | | | | |
Total | | | — | | | $ | — | | | $ | — | |
| | | | | | | | | | | | |
During the twelve months ended December 31, 2011, one loan that had previously been restructured, was in default, none of which went into default in the quarter. The Bank considers a loan in default when it is 90 days or more past due or on nonaccrual status.
In the determination of the allowance for loan losses, management considers troubled debt restructurings and subsequent defaults in these restructurings. All troubled debt restructurings are considered impaired loans. Loss exposure related to these loans are determined by management quarterly.
At December 31, 2011 there were $6.6 million in loans that are classified as trouble debt restructurings compared to $2.3 million at December 31, 2010.
The Company generally does not make commitments to lend additional funds to customers classified as trouble debt restructures.
42
Note 5. Allowance for Loan Losses
The following tables detail activity in the allowance for loan losses, segregated by class of loan, for the nine-month periods ended December 31, 2011 and December 31, 2010. Allocation portion of the allowance to one category of loans does not preclude its activity to absorb losses in other loan categories and periodically may result in reallocation within the provision categories.
| | | | | | | | | | | | | | | | | | | | |
December 31, 2011 (In thousands) | | Beginning
Balance | | | Charge-
Offs | | | Recoveries | | | Provision | | | Ending
Balance | |
Commercial | | $ | 79 | | | $ | 80 | | | $ | 1 | | | $ | 35 | | | $ | 35 | |
Real Estate | | | | | | | | | | | | | | | | | | | | |
Construction and land development | | | 1,729 | | | | 503 | | | | 125 | | | | (108 | ) | | | 1,243 | |
Residential, 1-4 families | | | 385 | | | | 356 | | | | 2 | | | | 124 | | | | 155 | |
Residential, 5 or more families | | | — | | | | — | | | | — | | | | — | | | | — | |
Farmland | | | — | | | | — | | | | — | | | | — | | | | — | |
Nonfarm, nonresidential | | | 710 | | | | — | | | | 4 | | | | 541 | | | | 1,255 | |
Agriculture | | | 3 | | | | — | | | | — | | | | — | | | | 3 | |
Consumer | | | 47 | | | | — | | | | 3 | | | | — | | | | 50 | |
Other | | | 120 | | | | — | | | | 6 | | | | — | | | | 126 | |
| | | | | | | | | | | | | | | | | | | | |
| | $ | 3,073 | | | $ | 939 | | | $ | 141 | | | $ | 592 | | | $ | 2,867 | |
| | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | |
December 31, 2010 (In thousands) | | Beginning
Balance | | | Charge-
Offs | | | Recoveries | | | Provision | | | Ending
Balance | |
Commercial | | $ | 127 | | | $ | 19 | | | $ | 4 | | | $ | (33 | ) | | $ | 79 | |
Real Estate | | | | | | | | | | | | | | | | | | | | |
Construction and land development | | | 1,435 | | | | — | | | | — | | | | 294 | | | | 1,729 | |
Residential, 1-4 families | | | 310 | | | | — | | | | — | | | | 75 | | | | 385 | |
Residential, 5 or more families | | | — | | | | — | | | | — | | | | — | | | | — | |
Farmland | | | — | | | | — | | | | — | | | | — | | | | — | |
Nonfarm, nonresidential | | | 682 | | | | 243 | | | | — | | | | 325 | | | | 710 | |
Agriculture | | | 3 | | | | — | | | | — | | | | — | | | | 3 | |
Consumer | | | 52 | | | | 5 | | | | — | | | | — | | | | 47 | |
Other | | | 115 | | | | — | | | | 5 | | | | — | | | | 120 | |
| | | | | | | | | | | | | | | | | | | | |
| | $ | 2,670 | | | $ | 267 | | | $ | 9 | | | $ | 661 | | | $ | 3,073 | |
| | | | | | | | | | | | | | | | | | | | |
43
Note 5. Allowance for Loan Losses, continued
The following table indicates the allocation of the allowance for loan losses based on loans evaluated specifically for impairment and loans evaluated collectively for the years ended December 21, 2011 and 2010.
| | | | | | | | | | | | |
December 31, 2011 (In thousands) | | Individually
Evaluate
for
Impairment | | | Ending
Balance
Collectively
Evaluated
Impairment | | | Total | |
Commercial | | $ | 12 | | | $ | 23 | | | $ | 35 | |
Real Estate | | | | | | | | | | | | |
Construction and land development | | | 584 | | | | 659 | | | | 1,243 | |
Residential, 1-4 families | | | 73 | | | | 82 | | | | 155 | |
Residential, 5 or more families | | | — | | | | — | | | | — | |
Farmland | | | — | | | | — | | | | — | |
Nonfarm, nonresidential | | | 589 | | | | 666 | | | | 1,255 | |
Agriculture | | | — | | | | 3 | | | | 3 | |
Consumer | | | — | | | | 50 | | | | 50 | |
Other | | | — | | | | 126 | | | | 126 | |
| | | | | | | | | | | | |
Ending balance of allowance for loan losses | | $ | 1,258 | | | $ | 1,609 | | | $ | 2,867 | |
| | | | | | | | | | | | |
Ending balance to total allowance ratio | | | 43.88 | % | | | 56.12 | % | | | 100 | % |
| | | |
December 31, 2010 (In thousands) | | | | | | | | | |
Commercial | | $ | 17 | | | $ | 62 | | | $ | 79 | |
Real Estate | | | | | | | | | | | | |
Construction and land development | | | 1,052 | | | | 677 | | | | 1,729 | |
Residential, 1-4 families | | | 197 | | | | 188 | | | | 385 | |
Residential, 5 or more families | | | — | | | | — | | | | — | |
Farmland | | | — | | | | — | | | | — | |
Nonfarm, nonresidential | | | 123 | | | | 587 | | | | 710 | |
Agriculture | | | — | | | | 3 | | | | 3 | |
Consumer | | | — | | | | 47 | | | | 47 | |
Other | | | — | | | | 120 | | | | 120 | |
| | | | | | | | | | | | |
Ending Balance | | $ | 1,389 | | | $ | 1,684 | | | $ | 3,073 | |
| | | | | | | | | | | | |
Ending balance of allowance to total allowance | | | 45.20 | % | | | 54.80 | % | | | 100 | % |
44
Note 6. Bank Premises and Equipment
Bank premises and equipment included in the Consolidated Balance Sheets are as follows:
| | | | | | | | |
December 31, (In thousands) | | 2011 | | | 2010 | |
Land | | $ | 704 | | | $ | 929 | |
Bank premises | | | 3,666 | | | | 4,421 | |
Furniture and equipment | | | 970 | | | | 894 | |
| | | | | | | | |
Total | | | 5,340 | | | | 6,244 | |
Less accumulated depreciation | | | (2,445 | ) | | | (2,398 | ) |
| | | | | | | | |
Bank premises and equipment, net | | $ | 2,895 | | | $ | 3,846 | |
| | | | | | | | |
Depreciation expense was $227 thousand and $259 thousand for the years ended December 31, 2011 and 2010, respectively.
The Bank has entered into long-term leases for two of its branch banking facilities under agreements accounted for as operating leases. These leases were renewed in 2009, with the Salem lease expiring in 2014 and the Willis lease expiring in 2012. The Bank also entered into a long-term lease for land for one of its branches. The lease has an initial term of ten years, with automatic renewal in ten year increments terminating in 2046. Rental expense was $83 thousand and $81 thousand for 2011 and 2010, respectively. Future minimum lease payments are as follows:
| | | | |
| | | (In thousands) | |
2012 | | | 79 | |
2013 | | | 79 | |
2014 | | | 58 | |
2015 | | | 28 | |
2016 | | | 19 | |
Years thereafter | | | — | |
| | | | |
Total | | $ | 263 | |
| | | | |
Note 7. Deposits
The composition of deposits is as follows:
| | | | | | | | |
December 31, (In thousands) | | 2011 | | | 2010 | |
Demand deposits, noninterest bearing | | $ | 32,135 | | | $ | 28,264 | |
NOW and money market accounts | | | 48,307 | | | | 34,624 | |
Savings deposits | | | 27,996 | | | | 24,972 | |
Time certificates $100,000 or more | | | 58,733 | | | | 60,933 | |
Other time certificates | | | 65,240 | | | | 68,192 | |
| | | | | | | | |
Total deposits | | $ | 232,411 | | | $ | 216,985 | |
| | | | | | | | |
At December 31, 2011, the scheduled maturities of time deposits are as follows:
| | | | |
| | | (In thousands) | |
2012 | | | 45,121 | |
2013 | | | 33,489 | |
2014 | | | 8,508 | |
2015 | | | 19,623 | |
2016 | | | 17,232 | |
| | | | |
Total | | $ | 123,973 | |
| | | | |
45
Note 8. Borrowings
The Company has established various credit facilities to provide additional liquidity if and as needed. These include unsecured lines of credit with correspondent banks totaling $2.0 million and a secured line of credit with the Federal Home Loan Bank of Atlanta of approximately $29.5 million. Additional amounts are available from the Federal Home Loan Bank with additional collateral. At December 31, 2011 and 2010, there were no amounts outstanding under these agreements.
Note 9. Employee Benefit Plan
The Bank participates in the Pentegra Defined Benefit Plan for Financial Institutions (“Pentegra Plan”). The Pentegra Plan is a tax-qualified defined-benefit pension plan. The Pentegra Plan’s Employer Identification Number is 13-5645888 and the Plan Number is 333. The Pentegra Plan operates as a multi-employer plan for accounting purposes and is a multiple-employer plan under the Employee Retirement Income Security Act of 1974 and the Internal Revenue Code. There are no collective bargaining agreements in place that require contributions to the Pentegra Plan.
The Pentegra Plan is a single plan under Internal Revenue Code Section 413 (C) and, as a result, all of the assets stand behind all of the liabilities. Accordingly, under the Pentegra Plan contributions made by a participating employer may be used to provide benefits to participants of other participating employers.
Following is information regarding contributions to the Pentegra Plan for the years ended December 31, 2011 and 2010 and funding status as of July 1, 2011 and 2010 (plan year end):
| | | | | | | | |
| | | 2011 | | | 2010 | |
Contributions paid during the year | | $ | 257,991 | | | $ | 380,216 | |
| | |
Contributions represent more than 5% of total contributions made by all employers? | | | No | | | | No | |
| | |
Funded status per valuation reports | | | 85.24 | % | | | 82.62 | % |
46
Note 10. Deferred Compensation and Life Insurance
Deferred compensation plans have been adopted for certain members of the Board of Directors for future compensation upon retirement. Under plan provisions aggregate annual payments ranging from $2 thousand to $8 thousand are payable for ten years certain, generally beginning at age 65. The liability accrued for compensation deferred under the plan amounts to $11 thousand and $22 thousand at December 31, 2011 and 2010, respectively.
Charges to income are based on present value of future cash payments, discounted at 8%, and amounted to $1 thousand and $2 thousand for 2011 and 2010, respectively.
The Bank is owner and beneficiary of life insurance policies on these directors. Policy cash values, net of policy loans, totaled $79 thousand and $74 thousand at December 31, 2011 and 2010 respectively.
In 2002, the Bank adopted a supplemental executive retirement plan to provide benefits for a member of management. Under plan provisions, aggregate fixed payments of $45 thousand are payable for 20 years certain, beginning on the executive’s retirement date. The liability is calculated by discounting the anticipated future cash flows at 6.10%. The liability accrued for this obligation was $468 thousand at December 31, 2011 and 2010, respectively. Charges to income are based on changes in the cash value of insurance which funds the liability.
Note 11. Fair Value of Financial Instruments
The following methods and assumptions were used by the Company in estimating its fair value disclosures for financial instruments:
Cash and due from banks, interest-bearing deposits in banks, federal funds sold: The carrying amounts reported in the balance sheet for these items approximate their fair values.
Securities: Fair values for securities, excluding restricted equity securities, are based on quoted market prices, where available. If quoted prices are not available, fair values are measured using independent pricing models or other model-based valuation techniques such as the present value of future cash flows, adjusted for the security’s credit rating, prepayment assumptions and other factors such as credit loss assumptions. The carrying values of restricted equity securities approximate fair values.
Loans receivable: For variable-rate loans that re-price frequently and with no significant change in credit risk, fair values are based on carrying amounts. The fair values for other loans are estimated using discounted cash flow analysis, based on interest rates currently being offered for loans with similar terms to borrowers of similar credit quality. Loan fair value estimates include judgments regarding future expected loss experience and risk characteristics. The fair value of impaired loans is estimated using one of several methods, including the collateral value, market value of similar debt, enterprise value, liquidation value and discounted cash flows. The carrying amount of accrued interest receivable approximates its fair value.
Deposit liabilities: The fair values disclosed for demand and savings deposits are, by definition, equal to the amount payable on demand at the reporting date. The fair values for certificates of deposit are estimated using a discounted cash flow calculation that applies interest rates currently being offered on certificates to a schedule of aggregated contractual maturities on such time deposits. The carrying amount of accrued interest payable approximates fair value.
47
Note 11. Fair Value of Financial Instruments, continued
The estimated fair values of the Company’s financial instruments are as follows:
| | | | | | | | | | | | | | | | |
December 31, (In thousands) | | 2011 | | | 2010 | |
| | | Carrying
Amount | | | Fair Value | | | Carrying
Amount | | | Fair Value | |
Financial assets | | | | | | | | | | | | | | | | |
Cash and due from banks | | $ | 4,255 | | | $ | 4,255 | | | $ | 2,948 | | | $ | 2,948 | |
Interest-bearing deposits with banks | | | 14,758 | | | | 14,758 | | | | 7,792 | | | | 7,792 | |
Federal funds sold | | | 33,700 | | | | 33,700 | | | | 21,550 | | | | 21,550 | |
Securities, available for sale | | | 57,105 | | | | 57,105 | | | | 42,644 | | | | 42,644 | |
Securities, held to maturity | | | 12,950 | | | | 13,662 | | | | 14,698 | | | | 14,780 | |
Restricted equity securities | | | 592 | | | | 592 | | | | 575 | | | | 575 | |
Total loans | | | 130,158 | | | | 132,837 | | | | 148,916 | | | | 151,187 | |
Accrued interest receivable | | | 824 | | | | 824 | | | | 954 | | | | 954 | |
Financial liabilities | | | | | | | | | | | | | | | | |
Deposits | | | 232,411 | | | | 234,816 | | | | 216,985 | | | | 218,256 | |
Accrued interest payable | | | 88 | | | | 88 | | | | 111 | | | | 111 | |
Off-balance sheet assets (liabilities) | | | | | | | | | | | | | | | | |
Commitments to extend credit and standby letters of credit | | | — | | | | 11,912 | | | | — | | | | 10,097 | |
GAAP provides a framework for measuring and disclosing fair value which requires disclosures about the fair value of assets and liabilities recognized in the balance sheet, whether the measurements are made on a recurring basis (for example, available for sale investment securities) or on a nonrecurring basis (for example, impaired loans).
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. GAAP also establishes a fair value hierarchy, which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value.
The Company utilizes fair value measurements to record fair value adjustments to certain assets and to determine fair value disclosures. Securities available for sale are recorded at fair value on a recurring basis. Additionally, from time to time, the Company may be required to record at fair value other assets on a nonrecurring basis, such as loans held for sale, loans held for investment and certain other assets. These nonrecurring fair value adjustments typically involve application of lower of cost or market accounting or write-downs of individual assets.
Fair Value Hierarchy
The Company groups assets and liabilities at fair value in three levels, based on the markets in which the assets and liabilities are traded and the reliability of the assumptions used to determine the fair value. These levels are:
Level 1 - Valuation is based upon quoted prices for identical instruments traded in active markets.
Level 2 - Valuation is based upon quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-based valuation techniques for which all significant assumptions are observable in the market.
Level 3 - Valuation is generated from model-based techniques that use at least one significant assumption not observable in the market. These unobservable assumptions reflect estimates of assumptions that market participants would use in pricing the asset or liability. Valuation techniques include the use of option pricing models, discounted cash flow models and similar techniques.
48
Note 11. Fair Value of Financial Instruments, continued
Following is a description of valuation methodologies used for assets and liabilities recorded at fair value.
Investment Securities Available for Sale
Investment securities available for sale are recorded at fair value on a recurring basis. Fair value measurement is based upon quoted prices, if available. If quoted prices are not available, fair values are measured using independent pricing models or other model-based valuation techniques such as the present value of future cash flows, adjusted for the security’s credit rating, prepayment assumptions and other factors such as credit loss assumptions. Level 1 securities include those traded on an active exchange such as the New York Stock Exchange, Treasury securities that are traded by dealers or brokers in active over-the counter markets and money market funds. Level 2 securities include mortgage backed securities issued by government sponsored entities, municipal bonds and corporate debt securities. Securities classified as Level 3 include asset-backed securities in less liquid markets.
Loans
The Company does not record loans at fair value on a recurring basis, however, from time to time, a loan is considered impaired and an allowance for loan loss is established. Loans for which it is probable that payment of interest and principal will not be made in accordance with the contractual terms of the loan are considered impaired. Once a loan is identified as individually impaired, management measures impairment. The fair value of impaired loans is estimated using one of several methods, including the collateral value, market value of similar debt, enterprise value, liquidation value and discounted cash flows. Those impaired loans not requiring a specific allowance represents loans for which the fair value of expected repayments or collateral exceed the recorded investment in such loans. Impaired loans where an allowance is established based on the fair value of collateral require classification in the fair value hierarchy. When the fair value of the collateral is based on an observerable market price or a current appraised value, the Company records the loan as nonrecurring Level 2. When an appraised value is not available or management determines the fair value of the collateral is further impaired below the appraised value and there is no observable market price, the Company records the loan as nonrecurring Level 3.
Foreclosed Assets
Foreclosed assets are adjusted to fair value upon transfer of the loans to other real estate owned. Real estate acquired in settlement of loans is recorded initially at estimated fair value of the property less estimated selling costs at the date of foreclosure. The initial recorded value may be subsequently reduced by additional allowances, which are charged to earnings if the estimated fair value of the property less estimated selling costs declines below the initial recorded value. Fair value is based upon independent market prices, appraised values of the collateral or management’s estimation of the value of the collateral. When the fair value of the collateral is based on an observable market price or a current appraised value, the Bank records the foreclosed asset as nonrecurring Level 2. When an appraised value is not available or management determines the fair value of the collateral is further impaired below the appraised value and there is no observable market price, the Bank records the foreclosed asset as nonrecurring Level 3.
49
Note 11. Fair Value of Financial Instruments, continued
Assets and Liabilities Recorded as Fair Value on a Recurring Basis
The tables below present the recorded amount of assets measured at fair value on a recurring basis.
| | | | | | | | | | | | | | | | |
(In Thousands) December 31, 2011 | | Total | | | Level 1 | | | Level 2 | | | Level 3 | |
Government sponsored enterprises | | $ | 1,952 | | | $ | — | | | $ | 1,952 | | | | — | |
State and municipal securities | | | 5,493 | | | | 355 | | | | 5,138 | | | | — | |
Mortgage-backed securities | | | 46,928 | | | | — | | | | 46,928 | | | | — | |
Other securities | | | 2,732 | | | | — | | | | 2,732 | | | | — | |
| | | | | | | | | | | | | | | | |
Total assets at fair value | | $ | 57,105 | | | $ | 355 | | | $ | 56,750 | | | | — | |
| | | | | | | | | | | | | | | | |
| | | | |
(In Thousands) December 31, 2010 | | Total | | | Level 1 | | | Level 2 | | | Level 3 | |
Government sponsored enterprises | | $ | 2,866 | | | $ | — | | | $ | 2,866 | | | | — | |
State and municipal securities | | | 3,049 | | | | — | | | | 3,049 | | | | — | |
Mortgage-backed securities | | | 32,833 | | | | 1,040 | | | | 31,793 | | | | — | |
Other securities | | | 3,896 | | | | — | | | | 3,896 | | | | — | |
| | | | | | | | | | | | | | | | |
Total assets at fair value | | $ | 42,644 | | | $ | 1,040 | | | $ | 41,604 | | | | — | |
| | | | | | | | | | | | | | | | |
There were no liabilities measured at fair value on a recurring basis at December 31, 2011 and 2010.
Assets and Liabilities Recorded as Fair Value on a Nonrecurring Basis
The Company may be required from time to time, to measure certain assets at fair value on a non-recurring basis in accordance with U.S. generally accepted accounting principles. These include assets that are measured at the lower of cost or market that were recognized at fair value below cost at the end of the period. Assets measured at fair value on a nonrecurring basis are included in the tables below.
| | | | | | | | | | | | | | | | |
(In Thousands) December 31, 2011 | | Total | | | Level 1 | | | Level 2 | | | Level 3 | |
Impaired loans | | $ | 7,524 | | | | — | | | $ | 7,524 | | | | — | |
Foreclosed assets | | | 3,418 | | | | — | | | | 3,418 | | | | — | |
| | | | | | | | | | | | | | | | |
Total assets at fair value | | $ | 10,942 | | | | — | | | $ | 10,942 | | | | — | |
| | | | | | | | | | | | | | | | |
| | | | |
(In Thousands) December 31, 2010 | | Total | | | Level 1 | | | Level 2 | | | Level 3 | |
Impaired loans | | $ | 4,327 | | | | — | | | $ | 4,327 | | | | — | |
Foreclosed assets | | | 509 | | | | — | | | | 509 | | | | — | |
| | | | | | | | | | | | | | | | |
Total assets at fair value | | $ | 4,836 | | | | — | | | $ | 4,836 | | | | — | |
| | | | | | | | | | | | | | | | |
There were no liabilities measured at fair value on a nonrecurring basis at December 31, 2011 and 2010.
50
Note 12. Income Taxes
The components of income tax expense (benefit) are as follows:
| | | | | | | | |
Years ended December 31, (In thousands) | | 2011 | | | 2010 | |
Current taxes – federal | | $ | 284 | | | $ | 277 | |
Deferred taxes – federal | | | (219 | ) | | | (292 | ) |
| | | | | | | | |
Income tax expense (benefit) | | $ | 65 | | | $ | (15 | ) |
| | | | | | | | |
A reconciliation of the expected income tax expense computed by applying the federal statutory rate of 34% to income included in the consolidated statements of income follows:
| | | | | | | | |
Years ended December 31, (In thousands) | | 2011 | | | 2010 | |
Expected tax expense | | $ | 396 | | | $ | 324 | |
Tax exempt interest | | | (272 | ) | | | (307 | ) |
Income on bank owned life insurance | | | (55 | ) | | | (56 | ) |
Other | | | (4 | ) | | | 24 | |
| | | | | | | | |
Income tax expense (benefit) | | $ | 65 | | | $ | (15 | ) |
| | | | | | | | |
The Company has analyzed the tax positions taken or expected to be taken in its tax returns and does not believe it has any liability related to uncertain tax positions. The Company’s policy is to classify any interest or penalties recognized as interest expense or noninterest expense, respectively. The years ended December 31, 2011, 2010 and 2009 remains open for audit by all major jurisdictions.
The tax effects of temporary timing differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities are presented below:
| | | | | | | | |
December 31, (In thousands) | | 2011 | | | 2010 | |
Deferred tax assets | | | | | | | | |
Allowance for loan and other real estate losses | | $ | 894 | | | $ | 992 | |
Interest on non-accrual loans | | | 352 | | | | 218 | |
Deferred loan interest, fees | | | 107 | | | | 125 | |
Employee benefit liabilities | | | 254 | | | | 245 | |
Alternative minimum tax carryforward | | | 395 | | | | 301 | |
Other-than-temporary impairment valuation | | | 102 | | | | — | |
Net unrealized losses on securities available for sale | | | — | | | | — | |
| | | | | | | | |
Total deferred tax assets | | | 2,104 | | | | 1,881 | |
| | | | | | | | |
Deferred tax liabilities | | | | | | | | |
Prepaid expenses | | | 40 | | | | 48 | |
Depreciation | | | 118 | | | | 113 | |
Accretion of discount on investment securities | | | 59 | | | | 52 | |
Net unrealized gains on securities available for sale | | | 237 | | | | 85 | |
| | | | | | | | |
Total deferred tax liabilities | | | 454 | | | | 298 | |
| | | | | | | | |
Net deferred tax asset | | $ | 1,650 | | | $ | 1,583 | |
| | | | | | | | |
51
Note 12. Income Taxes, continued
Deferred tax assets or liabilities are initially recognized for differences between the financial statement carrying amount and the tax basis of asset and liabilities which will result in future deductible or taxable amounts and operating loss and tax credit carry-forwards. A valuation allowance is then established, as applicable, to reduce the deferred tax asset to the level at which it is “more likely than not” that the tax benefits will be realized. Realization of tax benefits of deductible temporary differences and operating loss or credit carry-forwards depends on having sufficient taxable income of an appropriate character within the carry-back and carry-forward periods. Sources of taxable income that may allow for the realization of tax benefits include (1) taxable income in the current year of prior years that is available through carry-back, (2) future taxable income that will result from the reversal of existing taxable temporary differences, and (3) taxable income generated by future operations. There is no valuation allowance for deferred tax assets as of December 31, 2011 and 2010. It is management’s belief that realization of the deferred tax asset is more likely than not.
Note 13. Commitments and Contingencies
Litigation
Various legal claims also arise from time to time in the normal course of business. In the opinion of management, there are no such claims at December 31, 2011 or 2010 that will have a material effect on the Company’s consolidated financial statements.
Financial Instruments with Off-Balance Sheet Risk
The Company’s exposure to loan loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit and standby letters of credit is represented by the contractual amount of those instruments. The Company uses the same credit policies in making commitments and conditional obligations as for on-balance-sheet instruments. A summary of commitments at December 31 is as follows:
| | | | | | | | |
December 31, (In thousands) | | 2011 | | | 2010 | |
Commitments to extend credit | | $ | 11,612 | | | $ | 9,594 | |
Standby letters of credit | | | 300 | | | | 503 | |
| | | | | | | | |
| | $ | 11,912 | | | $ | 10,097 | |
| | | | | | | | |
Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Company evaluates each customer’s creditworthiness on a case-by-case basis.
The amount of collateral obtained, if deemed necessary upon extension of credit, is based on management’s credit evaluation of the party. Collateral held varies, but may include accounts receivable, crops, livestock, inventory, property and equipment, residential or investment real estate and commercial properties.
Standby letters of credit are conditional commitments issued by the Company to guarantee the performance of a customer to a third party. Those guarantees are primarily issued to support public and private borrowing arrangements. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. Collateral held varies as specified above and is required in instances, which the Company deems necessary.
52
Note 13. Commitments and Contingencies, continued
Concentrations of Credit Risk
The majority of the Company’s loans, commitments to extend credit, and standby letters of credit have been granted to customers in the Company’s market area. The majority of such customers are depositors of the Bank. Investments in state and municipal securities involve governmental entities within and outside the Company’s market area. The concentrations of credit by type of loan are set forth in the Loans Receivable note. The distribution of commitments to extend credit approximates the distribution of loans outstanding. Standby letters of credit are granted primarily to commercial borrowers. The Company, as a matter of practice, does not extend credit to any single borrower or group of related borrowers in excess of approximately $3.5 million.
Although the Company has a reasonably diversified loan portfolio, a substantial portion of its debtors’ ability to honor their contracts is dependent upon economic conditions in and around Floyd, Carroll, Montgomery, Roanoke and Pulaski Counties and the Cities of Roanoke, Salem and Fairlawn, Virginia. A significant amount of the real estate loans set forth in the Loans Receivable note are secured by commercial real estate. The Company has a loan concentration relating to nonresidential buildings and real estate land developers. Total loans to this group amounted to approximately $25.8 million at December 31, 2011 and approximately $33.6 million at December 31, 2010. In addition, the Company has loan concentrations relating to hotels and motels. Total loans to this group amounted to approximately $13.6 million at December 31, 2011 and approximately $14.6 million at December 31, 2010.
The Company has cash and cash equivalents on deposit with financial institutions which exceed federally insured limits.
Note 14. Regulatory Matters
Dividends
The Company’s dividend payments are made from dividends received from the Bank. The Bank, as a Virginia banking corporation, may pay dividends only out of its retained earnings. However, regulatory authorities may limit payment of dividends by any bank when it is determined that such a limitation is in the public interest and is necessary to ensure financial soundness of the Bank.
Intercompany Transactions
The Bank’s legal lending limit on loans to the Company are governed by Federal Reserve Act 23A, and differ from legal lending limits on loans to external customers. Generally, a bank may lend up to 10% of its capital and surplus to its Parent, if the loan is secured. If collateral is in the form of stocks, bonds, debentures or similar obligations, it must have a market value when the loan is made of at least 20% more than the amount of the loan, and if obligations of a state or political subdivision or agency thereof, it must have a market value of at least 10% more than the amount of the loan. If such loans are secured by obligations of the United States or agencies thereof, or by notes, drafts, bills of exchange or bankers’ acceptances eligible for rediscount or purchase by a Federal Reserve Bank, requirements for collateral in excess of the loan amount do not apply. Under this definition, the legal lending limit for the Bank on loans to the Company was approximately $2.3 million at December 31, 2011. There were no intercompany loans at December 31, 2011 and 2010, respectively.
53
Note 14. Regulatory Matters, continued
Capital Requirements
The Company (on a consolidated basis) and the Bank are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Company’s and Bank’s financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company and the Bank must meet specific capital guidelines that involve quantitative measures of their assets, liabilities and certain off-balance-sheet items as calculated under regulatory accounting practices. The capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors. Prompt corrective action provisions are not applicable to bank holding companies.
Quantitative measures established by regulation to ensure capital adequacy require the Company and the Bank to maintain minimum amounts and ratios (set forth in the following table) of total and Tier 1 capital (as defined in the regulations) to risk-weighted assets (as defined) and of Tier 1 capital (as defined) to average assets (as defined). Management believes, as of December 31, 2011 and 2010, that the Company and the Bank met all capital adequacy requirements to which they are subject.
As of December 31, 2011, the most recent notification from the Federal Deposit Insurance Corporation categorized the Bank as well capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized, an institution must maintain minimum total risk-based, Tier 1 risk-based and Tier 1 leverage ratios as set forth in the following tables. There are no conditions or events since the notification that management believes have changed the Bank’s category.
54
Note 14. Regulatory Matters, continued
Capital Requirements, continued
The Company and the Bank’s actual capital amounts and ratios are also presented in the following table.
| | | | | | | | | | | | | | | | | | | | | | | | |
| | | Actual | | | Minimum
For Capital
Adequacy
Purposes | | | Minimum
To Be Well
Capitalized Under
Prompt Corrective
Action Provisions | |
In thousands | | Amount | | | Ratio | | | Amount | | | Ratio | | | Amount | | | Ratio | |
December 31, 2011 | | | | | | | | | | | | | | | | | | | | | | | | |
Total capital to risk-weighted assets Consolidated | | $ | 34,502 | | | | 22.51 | % | | $ | 12,263 | | | | 8.00 | % | | | n/a | | | | n/a | |
Bank of Floyd | | | 25,276 | | | | 17.16 | % | | | 11,781 | | | | 8.00 | % | | $ | 14,726 | | | | 10.00 | % |
Tier I capital to risk-weighted assets Consolidated | | | 32,574 | | | | 21.25 | % | | | 6,132 | | | | 4.00 | % | | | n/a | | | | n/a | |
Bank of Floyd | | | 23,426 | | | | 15.91 | % | | | 5,890 | | | | 4.00 | % | | | 8,836 | | | | 6.00 | % |
Tier I capital to average assets Consolidated | | | 32,574 | | | | 12.52 | % | | | 10,407 | | | | 4.00 | % | | | n/a | | | | n/a | |
Bank of Floyd | | | 23,426 | | | | 9.27 | % | | | 10,107 | | | | 4.00 | % | | | 12,634 | | | | 5.00 | % |
| | | | | | |
December 31, 2010 | | | | | | | | | | | | | | | | | | | | | | | | |
Total capital to risk-weighted assets Consolidated | | $ | 33,758 | | | | 20.85 | % | | $ | 12,955 | | | | 8.00 | % | | | n/a | | | | n/a | |
Bank of Floyd | | | 24,010 | | | | 15.47 | % | | | 12,413 | | | | 8.00 | % | | $ | 15,517 | | | | 10.00 | % |
Tier I capital to risk-weighted assets Consolidated | | | 31,721 | | | | 19.59 | % | | | 6,478 | | | | 4.00 | % | | | n/a | | | | n/a | |
Bank of Floyd | | | 22,061 | | | | 14.22 | % | | | 6,207 | | | | 4.00 | % | | | 9,310 | | | | 6.00 | % |
Tier I capital to average assets Consolidated | | | 31,721 | | | | 12.99 | % | | | 9,770 | | | | 4.00 | % | | | n/a | | | | n/a | |
Bank of Floyd | | | 22,061 | | | | 9.06 | % | | | 9,737 | | | | 4.00 | % | | | 12,171 | | | | 5.00 | % |
Note 15. Transactions with Related Parties
The Company has entered into transactions with its directors, significant shareholders and their affiliates (related parties). Such transactions were made in the ordinary course of business on substantially the same terms and conditions, including interest rates and collateral, as those prevailing at the same time for comparable transactions with other customers, and did not, in the opinion of management, involve more than normal credit risk or present other unfavorable features.
Aggregate loan transactions with related parties were as follows:
| | | | | | | | |
December 31, (In thousands) | | 2011 | | | 2010 | |
Balance, beginning | | $ | 476 | | | $ | 483 | |
Additions | | | 101 | | | | 27 | |
Repayments | | | (301 | ) | | | (34 | ) |
| | | | | | | | |
Balance, ending | | $ | 276 | | | $ | 476 | |
| | | | | | | | |
55
Note 15. Transactions with Related Parties, continued
Deposit transactions with related parties at December 31, 2011 and 2010 were not material to the company’s financial condition or its results of operations.
Note 16. Parent Company Financial Information
Condensed financial information of Cardinal Bankshares Corporation is presented as follows:
Balance Sheets
| | | | | | | | |
December 31, (In thousands) | | 2011 | | | 2010 | |
Assets | | | | | | | | |
Cash and due from banks | | $ | 1,765 | | | $ | 709 | |
Investment securities available for sale, at fair value | | | 1,412 | | | | 2,269 | |
| | |
Total loans | | | 5,546 | | | | 6,855 | |
Allowance for loan losses | | | (287 | ) | | | (342 | ) |
| | | | | | | | |
Net loans | | | 5,259 | | | | 6,513 | |
| | | | | | | | |
Investment in affiliate bank at equity | | | 23,910 | | | | 22,223 | |
Other assets | | | 694 | | | | 173 | |
| | | | | | | | |
Total assets | | $ | 33,040 | | | $ | 31,887 | |
| | | | | | | | |
Liabilities | | | | | | | | |
Other liabilities | | $ | 7 | | | $ | — | |
| | | | | | | | |
Total liabilities | | | 7 | | | | — | |
| | | | | | | | |
Stockholders’ equity | | | | | | | | |
Common stock | | | 15,357 | | | | 15,357 | |
Additional paid-in capital | | | 2,925 | | | | 2,925 | |
Retained earnings | | | 14,292 | | | | 13,439 | |
Accumulated other comprehensive loss | | | 459 | | | | 166 | |
| | | | | | | | |
Total stockholders’ equity | | | 33,033 | | | | 31,887 | |
| | | | | | | | |
Total liabilities and stockholders’ equity | | $ | 33,040 | | | $ | 31,887 | |
| | | | | | | | |
56
Note 16. Parent Company Financial Information, continued
Statements of Income
| | | | | | | | |
Years ended December 31, (In thousands) | | 2011 | | | 2010 | |
Income | | | | | | | | |
Dividends from affiliate bank | | $ | — | | | $ | — | |
Interest on loans | | | 306 | | | | 339 | |
Interest on investment securities | | | 113 | | | | 138 | |
Other income | | | 4 | | | | — | |
| | | | | | | | |
Total income | | | 423 | | | | 477 | |
| | | | | | | | |
Expenses | | | | | | | | |
Management and professional fees | | | 350 | | | | 345 | |
Provision for loan losses | | | 46 | | | | — | |
Other expenses | | | 449 | | | | 59 | |
| | | | | | | | |
Total expenses | | | 845 | | | | 404 | |
| | | | | | | | |
Income (loss) before income tax (expense) benefit and equity in undistributed net income of subsidiaries | | | (422 | ) | | | 73 | |
| | |
Income tax (expense) benefit | | | 156 | | | | (25 | ) |
| | | | | | | | |
Income (loss) before equity in undistributed net income of subsidiaries | | | (266 | ) | | | 48 | |
| | |
Equity in undistributed net income of subsidiaries | | | 1,365 | | | | 921 | |
| | | | | | | | |
Net income | | $ | 1,099 | | | $ | 969 | |
| | | | | | | | |
57
Note 16. Parent Company Financial Information, continued
Statements of Cash Flows
| | | | | | | | |
Years ended December 31, (In thousands) | | 2011 | | | 2010 | |
Cash flows from operating activities | | | | | | | | |
Net income | | $ | 1,099 | | | $ | 969 | |
Adjustments to reconcile net income to net cash (used) provided by operating activities: | | | | | | | | |
Accretion of discount on securities, net of amortization of premiums | | | 10 | | | | 3 | |
Provision for loan losses | | | 46 | | | | — | |
Net realized gains on securities | | | (9 | ) | | | — | |
Equity in undistributed income of subsidiaries | | | (1,365 | ) | | | (921 | ) |
Net other-than-temporary impairment on investments | | | 300 | | | | — | |
Net change in other assets | | | (70 | ) | | | (3 | ) |
Net change in other liabilities | | | 7 | | | | — | |
| | | | | | | | |
Net cash (used) provided by operating activities | | | 18 | | | | 48 | |
| | | | | | | | |
Cash flows from investing activities | | | | | | | | |
Net decrease (increase) in loans | | | 773 | | | | 685 | |
Sales of available for sale securities | | | 511 | | | | — | |
Capitalization of subsidiaries | | | — | | | | (1,000 | ) |
| | | | | | | | |
Net cash (used) provided by investing activities | | | 1,284 | | | | (315 | ) |
| | | | | | | | |
Cash flows from financing activities | | | | | | | | |
Dividends paid | | | (246 | ) | | | (246 | ) |
| | | | | | | | |
Net cash used by financing activities | | | (246 | ) | | | (246 | ) |
| | | | | | | | |
Net increase (decrease) in cash and cash equivalents | | | 1,056 | | | | (513 | ) |
Cash and cash equivalents, beginning | | | 709 | | | | 1,222 | |
| | | | | | | | |
Cash and cash equivalents, ending | | $ | 1,765 | | | $ | 709 | |
| | | | | | | | |
Supplemental disclosures of noncash activities Transfer of loans to foreclosed assets | | $ | 435 | | | $ | __— | |
| | | | | | | | |
58
Note 17. Subsequent Events
None.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
NONE
ITEM 9A. CONTROLS AND PROCEDURES
Disclosure Controls and Procedures
We maintain a system of disclosure controls and procedures that is designed to ensure that material information is accumulated and communicated to management, including our Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure. As of the end of the period covered by this report, we carried out an evaluation, under the supervision and with the participation of our management, including the Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the disclosure controls and procedures pursuant to Rule 13a-15 under the Securities Exchange Act of 1934, as amended. Based on that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that, as of the end of the period covered by this report, our disclosure controls and procedures were effective in enabling us to record, process, summarize and report in a timely manner the information required to be disclosed in reports we file under the Exchange Act.
Management’s Annual Report on Internal Control over Financial Reporting
Management is responsible for establishing and maintaining adequate internal control over financial reporting of Cardinal Bankshares Corporation, as such term is defined in theExchange Act Rules 13a-15(f). Cardinal’s internal control system was designed to provide reasonable assurance to management and the Board of Directors regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles.
All internal control systems, no matter how well designed, have inherent limitations. Because of these inherent limitations, internal control over financial reporting can provide only reasonable assurance with respect to financial statement preparation and presentation. Even excellent internal controls sometimes may not prevent or detect misstatements. Projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
Under the supervision and with the participation of management, including the principal executive officer and the principal financial officer, the Company’s management has evaluated the effectiveness of its internal control over financial reporting as of December 31, 2011 based on the criteria established in a report entitled“Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission”and the interpretive guidance issued by the Commission in Release No. 34-55929. Based on this evaluation, the Company’s management has concluded that the Company’s internal control over financial reporting was effective as of December 31, 2011.
This annual report does not include an attestation report of the Company’s independent registered public accounting firm regarding internal control over financial reporting. The Company’s registered public accounting firm was not required to issue an attestation on our internal controls over financial reporting pursuant to rules of the Securities and Exchange Commission.
Changes in Internal Control over Financial Reporting
The Company is continuously seeking to improve the efficiency and effectiveness of its operations and of its internal controls. This routinely results in modifications to its processes throughout the Company. However, there has been no change in its internal control over financial reporting that occurred during the Company’s most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting except as follows. Management implemented the following processes to enhance procedures associated with identification of newly adopted accounting disclosure standards applicable to the Company:
59
| | 1. | Management will meet to assess disclosures associated with new accounting disclosure requirements, loan portfolio and asset quality, operation risks, legal issues, and subsequent events. |
| | 2. | An additional level of internal review has been implemented on a quarterly basis prior to the filing of the quarterly and annual reports with the SEC. |
ITEM 9B. OTHER INFORMATION
NONE
PART III
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
The information required by Item 10 of Form 10-K appears in the Company’s Proxy Statement for the 2012 Annual Meeting and is incorporated herein by reference.
ITEM 11. EXECUTIVE COMPENSATION
The information required by Item 11 of Form 10-K appears in the Company’s Proxy Statement for the 2012 Annual Meeting and is incorporated herein by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
The information required by Item 12 of Form 10-K appears in the Company’s Proxy Statement for the 2012 Annual Meeting and is incorporated herein by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by Item 13 of Form 10-K appears in the Company’s Proxy Statement for the 2012 Annual Meeting and is incorporated herein by reference.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
The information required by Item 14 of Form 10-K appears in the Company’s Proxy Statement for the 2012 Annual Meeting and is incorporated herein by reference.
60
PART IV
ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
| | (a) | The following documents are filed as part of the report: |
Report of Independent Registered Public Accounting Firm
Consolidated Balance Sheets - December 31, 2011 and 2010
Consolidated Statements of Income -Years ended December 31, 2011 and 2010
Consolidated Statements of Stockholders’ Equity and Comprehensive Income - Years ended December 31, 2011 and 2010
Consolidated Statements of Cash Flows – Years ended December 31, 2011 and 2010
Notes to Consolidated Financial Statements
| | 2. | Financial Statement Schedules: |
All schedules are omitted as the required information is inapplicable or the information is presented in the Consolidated Financial Statements or related notes.
The exhibits filed as part of this report are listed on the Exhibit Index which is incorporated in this item by reference.
See Item 15(a) 3 above.
See Item 15(a) 2 above.
61
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
CARDINAL BANKSHARES CORPORATION
| | | | |
/s/ Ronald Leon Moore | | | | /s/ J. Alan Dickerson |
| Ronald Leon Moore | | | | J. Alan Dickerson |
| Chairman, President & | | | | Vice President & |
| Chief Executive Officer | | | | Chief Financial Officer |
| Date: March 16, 2012 | | | | Date: March 16, 2012 |
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
| | | | | | |
Signature | | | | Title | | Date |
| | | |
/s/ Ronald Leon Moore | | | | Director, Chairman, President & | | March 16, 2012 |
| Ronald Leon Moore | | | | Chief Executive Officer | | |
| | | |
/s/ Joseph Howard Conduff, Jr.* | | | | Director & Chairman of Audit Committee | | March 16, 2012 |
| Joseph Howard Conduff, Jr. | | | | | | |
| | | |
/s/ W. R. Gardner, Jr.* | | | | Vice-Chairman & Director | | March 16, 2012 |
| W. R. Gardner, Jr. | | | | | | |
| | | |
/s/ Michael D. Larrowe* | | | | Director & Executive Vice-President | | March 16, 2012 |
| Michael D. Larrowe | | | | | | |
| | | |
/s/ Kevin D. Mitchell* | | | | Director | | March 16, 2012 |
| Kevin D. Mitchell | | | | | | |
| | | |
/s/ G. Harris Warner, Jr.* | | | | Director | | March 16, 2012 |
| G. Harris Warner, Jr. | | | | | | |
| | | |
*/s/ J. Alan Dickerson | | | | | | |
| J. Alan Dickerson | | | | | | |
| Attorney in Fact | | | | | | |
62
INDEX TO EXHIBITS
| | |
Exhibit No. | | Description |
| |
3.(i) | | Articles of Incorporation – incorporated by reference from the Registrant’s Registration Statement on Form 8-A filed on August 16, 1996. |
| |
3.(ii) | | Bylaws of Registrant – dated December 1, 2001 (filed herewith). |
| |
10.1 | | Employment Agreement between the Registrant and Michael Larrowe dated July 20, 1996 (filed herewith). |
| |
10.2 | | Supplemental Executive Retirement Agreement between Registrant and R. Leon Moore dated December 31, 2008 (filed herewith). |
| |
14. | | Code of Ethics for Senior Officers of Registrant (filed herewith). |
| |
21. | | Subsidiaries of Registrant (filed herewith). |
| |
23. | | Consent of Hess, Stewart &Campbell, PLLC (filed herewith). |
| |
24. | | Power of Attorney (filed herewith). |
| |
31.1 | | Certification of Chief Executive Officer pursuant to 18 U.S.C Section 1350, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (filed herewith). |
| |
31.2 | | Certification of Chief Financial Officer pursuant to 18 U.S.C Section 1359, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (filed herewith). |
| |
32.1 | | Certification of Chief Executive officer and Chief Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (filed herewith). |
| |
101. | | The following materials from the Company’s 10-K Report for the year ended December 31, 2011, formatted in XBRL: (i) the Condensed Consolidated Balance Sheets, (ii) the Condensed Consolidated Statements of Income, (iii) the Condensed Consolidated Statements of Changes in Shareholders’ Equity and Comprehensive Income, (iv) the Condensed Consolidated Statements of Cash Flows, and (v) the Notes to the Condensed Consolidated Financial Statements, tagged as blocks of text.* |
63
