EXHIBIT 13
Killbuck Bancshares, Inc.
Corporate Profile
Killbuck Bancshares, Inc. (the “Company”) was incorporated under the laws of the State of Ohio for the primary purpose of acquiring and holding all of the outstanding shares of The Killbuck Savings Bank Company (the “Bank”). The principal office of the Company is located at 165 N. Main Street, Killbuck, Ohio.
The Killbuck Savings Bank Company was established under the banking laws of the State of Ohio in September of 1900. The Bank is headquartered in Killbuck, Ohio, in Holmes County. Holmes County is located in northeastern Ohio. The Bank deposits are insured by the Federal Deposit Insurance Corporation (“FDIC”), and it is regulated by the Ohio Division of Financial Institutions (“ODFI”) and the Board of Governors of the Federal Reserve System (“FRB”).
The Bank provides customary retail and commercial banking services to its customers, including checking, savings and time deposit accounts, Health Savings Accounts (“HSA”), internet banking, bill payment, and safe deposit facilities, as well as a full complement of real estate, commercial and consumer loan products.
Stock Market Information
While there is no established public trading market for our common stock, our shares are currently quoted in the inter-dealer quotation, or “over-the-counter,” marketplace under the trading symbol “KILB.” Over-the-counter securities are generally considered to be any equity securities not otherwise listed on a national exchange, such as NASDAQ, NYSE or Amex. The principal over-the-counter market is operated by OTC Markets Group, Inc. (formerly Pink OTC Markets Inc.), which provides quotes for the Company on its middle tier, the OTCQB. All OTCQB companies are reporting with the SEC or a U.S. banking regulator, but there are no financial or qualitative standards to be in this tier. Community Banc Investments (“CBI”), a licensed intrastate securities dealer that specializes in marketing the stock of independent banks located in Ohio, also handles a limited amount of the Company’s stock transactions.
The common stock of the Company trades infrequently. Parties interested in buying or selling the Company’s stock are generally referred to CBI. The quarterly share price information in the table below was obtained from CBI and the OTC Markets Group, Inc.
| Quarter Ended | | High | | | Low | | | Cash Dividends Paid | |
| | | | | | | | | | | | | | |
| 2011 | March 31 | | $ | 107.27 | | | $ | 106.37 | | | | N/A | |
| | June 30 | | | 109.04 | | | | 108.01 | | | $ | 1.50 | |
| | September 30 | | | 110.95 | | | | 109.26 | | | | N/A | |
| | December 31 | | | 111.64 | | | | 110.29 | | | $ | 1.55 | |
| | | | | | | | | | | | | | |
| 2010 | March 31 | | $ | 106.39 | | | $ | 104.74 | | | | N/A | |
| | June 30 | | | 107.59 | | | | 106.72 | | | $ | 1.50 | |
| | September 30 | | | 108.83 | | | | 107.45 | | | | N/A | |
| | December 31 | | | 109.52 | | | | 107.71 | | | $ | 1.55 | |
At December 31, 2011, the Company had approximately 988 shareholders of record.
Management does not have knowledge of the prices paid in all transactions and has not verified the accuracy of those prices that have been reported. Because of the lack of an established market for the Company’s stock, these prices may not reflect the actual prices at which the stock would trade in a more active market.
Historically, the Company has paid dividends on a semi-annual basis.
Selected Consolidated Financial Data
The following table sets forth general information and ratios of the Company at the dates indicated (in thousands, except share data and shares).
| | | Year Ended December 31, | |
| For The Year: | | 2011 | | | 2010 | | | 2009 | | | 2008 | | | 2007 | |
| | | | | | | | | | | | | | | | |
| Total interest income | | $ | 14,571 | | | $ | 14,911 | | | $ | 15,865 | | | $ | 18,856 | | | $ | 21,680 | |
| Total interest expense | | | 3,812 | | | | 4,068 | | | | 4,477 | | | | 6,514 | | | | 8,068 | |
| Net interest income | | | 10,759 | | | | 10,843 | | | | 11,388 | | | | 12,342 | | | | 13,612 | |
| Provision for loan losses | | | -- | | | | 215 | | | | 2 | | | | 61 | | | | 127 | |
| Net interest income after provision for loan losses | | | 10,759 | | | | 10,628 | | | | 11,386 | | | | 12,281 | | | | 13,485 | |
| Total noninterest income | | | 1,770 | | | | 2,044 | | | | 1,673 | | | | 1,808 | | | | 1,482 | |
| Total noninterest expense | | | 9,049 | | | | 9,180 | | | | 9,089 | | | | 8,529 | | | | 8,169 | |
| Income before income taxes | | | 3,480 | | | | 3,492 | | | | 3,970 | | | | 5,560 | | | | 6,798 | |
| Income tax expense | | | 605 | | | | 513 | | | | 835 | | | | 1,104 | | | | 1,893 | |
| Net income | | $ | 2,875 | | | $ | 2,979 | | | $ | 3,135 | | | $ | 4,456 | | | $ | 4,905 | |
| Per share data | | | | | | | | | | | | | | | | | | | | |
| Earnings | | $ | 4.67 | | | $ | 4.83 | | | $ | 5.07 | | | $ | 7.12 | | | $ | 7.73 | |
| Dividends | | $ | 3.05 | | | $ | 3.05 | | | $ | 3.00 | | | $ | 2.95 | | | $ | 3.75 | |
| Book value (at year end) | | $ | 73.68 | | | $ | 70.91 | | | $ | 69.83 | | | $ | 69.09 | | | $ | 65.31 | |
| Average no. of shares outstanding | | | 615,060 | | | | 616,667 | | | | 618,497 | | | | 626,151 | | | | 634,458 | |
| Year-end balances: | | | | | | | | | | | | | | | | | | | | |
| Loans receivable, net | | $ | 224,333 | | | $ | 205,075 | | | $ | 207,575 | | | $ | 200,449 | | | $ | 196,520 | |
| Securities | | | 139,142 | | | | 115,377 | | | | 100,422 | | | | 83,718 | | | | 83,668 | |
| Total assets | | | 436,534 | | | | 405,070 | | | | 371,979 | | | | 341,338 | | | | 336,337 | |
| Deposits | | | 389,063 | | | | 356,189 | | | | 321,295 | | | | 288,947 | | | | 285,451 | |
| Borrowings | | | 1,361 | | | | 4,229 | | | | 6,872 | | | | 8,248 | | | | 8,282 | |
| Shareholders’ equity | | | 45,223 | | | | 43,680 | | | | 43,063 | | | | 42,935 | | | | 41,118 | |
| Significant ratios: | | | | | | | | | | | | | | | | | | | | |
| Return on average assets | | | 0.68 | % | | | 0.77 | % | | | 0.89 | % | | | 1.32 | % | | | 1.51 | % |
| Return on average shareholders’ equity | | | 6.58 | | | | 6.91 | | | | 7.42 | | | | 11.41 | | | | 12.88 | |
| Dividend payout | | | 65.31 | | | | 63.15 | | | | 59.17 | | | | 41.43 | | | | 48.51 | |
| Average shareholders’ equity to average assets | | | 10.37 | | | | 11.18 | | | | 12.04 | | | | 11.54 | | | | 11.75 | |
| Loan to deposits | | | 58.30 | | | | 57.57 | | | | 64.61 | | | | 69.37 | | | | 68.85 | |
| Allowance for loan losses to total loans | | | 1.00 | | | | 1.28 | | | | 1.16 | | | | 1.26 | | | | 1.23 | |
MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Killbuck Bancshares, Inc. is the holding company for its wholly-owned subsidiary, The Killbuck Savings Bank Company (the “Bank”) (hereinafter collectively the “Company”). The following discussion and analysis is intended to provide information about the financial condition and results of operations of the Company and should be read in conjunction with the audited Consolidated Financial Statements and Notes thereto, as well as other discussions appearing elsewhere in this Annual Report and the Company’s Form 10-K.
Certain information presented in this discussion and analysis and other statements concerning future performance, developments or events, and expectations for growth and market forecasts constitute forward-looking statements which are subject to a number of risks and uncertainties, including interest rate fluctuations, changes in local or national economic conditions, and government and regulatory actions which might cause actual results to differ materially from stated expectations or estimates.
Critical Accounting Policies
The Company’s accounting policies are integral to understanding the financial results reported. The Company’s accounting policies are described in detail in the Notes to the Consolidated Financial Statements. Our most complex accounting policies require a high degree of management’s judgment to ascertain the proper valuation of assets, liabilities, commitments and contingencies. We have established detailed policies and control procedures that are intended to ensure valuation methods which are well controlled and applied consistently from period to period. Further, the policies and procedures are intended to ensure that the process for changing accounting methodologies occurs in an appropriate manner. The following is a brief description of our current accounting policies involving significant management judgment.
Allowance for Loan Losses
Determining the appropriate level of the allowance for loan losses involves a significant degree of management’s judgment. The Company’s allowance for loan losses provides for probable losses based upon evaluations of known and inherent risks in the loan portfolio.
Management uses historical information to assess the adequacy of the allowance for loan losses, as well as prevailing business and other economic environmental factors that may impact the portfolio in a manner currently unforeseen. The allowance is increased by the provision for loan losses and by recoveries of loans previously charged-off, and reduced by loans charged-off. For a more comprehensive discussion of the Company’s methodology of assessing the adequacy of the allowance for loan losses, refer to “Notes to Consolidated Financial Statements” elsewhere herein.
Goodwill and Other Intangible Assets
The Company must assess goodwill and other intangible assets each year for impairment. Accounting standards allows a Company to first assess qualitative factors to determine whether it is necessary to perform the two-step goodwill impairment test. The two-step test entails estimating cash flows for future periods. If the future cash flows are insufficient to recover the recorded goodwill and other intangible asset balances, the Company would be required to take a charge against earnings to reflect the assets at the lower carrying value.
Financial Overview
Events in the domestic and global financial markets during the three year period under review have presented significant challenges to the Company, as well as all other banking institutions in the United Sates.
Specifically, a worldwide liquidity crisis reached its apex in the first quarter of 2009. The specter of a continuing international liquidity crisis mandated that the Company’s management carry excess liquid assets (cash and short term investments) throughout the years 2010 and 2011. This environmentally necessitated decision, integrated with the Fed’s easing of interest rates, negatively impacted the Company’s income in 2010 and 2011, as yields on investments and Federal funds sold declined precipitously as compared to prior years.
In addition, despite an absence of deteriorating asset quality, and despite maintaining the Bank’s status as a high performance financial institution, the Company was forced to pay for the clean-up of the banking system’s risk-takers. Over the past three years our FDIC insurance costs were $563 thousand in 2009, to $366 thousand in 2010 and $331 thousand in 2011.
The reported results of the Company, as further discussed below, are dependent on a variety of factors, including the general interest rate environment, competitive conditions in the industry, governmental policies and regulations and conditions in the markets for financial assets. Except as otherwise discussed herein, we are not aware of any market or institutional trends, events or uncertainties that are expected to have a material effect on liquidity, capital resources or operations. Net interest income is the largest component of net income, and consists of the difference between income generated on interest-earning assets and interest expense incurred on interest-bearing liabilities. Net interest income is primarily affected by the volume, interest rates and composition of interest-earning assets and interest-bearing liabilities
For 2011, we recorded net income of $2.9 million compared to $3.0 million for 2010 and $3.1 million for 2009.
Non-interest income was $1.8 million for 2011 compared to $2.0 million for 2010 and $1.7 million for 2009.
Total non-interest expenses were $9.0 million in 2011 compared to $9.2 million in 2010 and $9.1 million in 2009.
Earnings per share for 2011 were $4.67 compared to $4.83 for 2010 and $5.07 for 2009.
Comparison of Financial Condition at December 31, 2011 and 2010
The Company’s assets at December 31, 2011 totaled $436.5 million, an increase of $31.5 million, or 7.8% over 2010 totals.
The asset growth during 2011 generally reflects a $32.9 million, or 9.2% increase in total deposits. The noninterest-bearing demand deposits and interest-bearing demand deposits increased $12.8 million and $6.0 million, respectively. Money market deposits, savings deposits and time deposits increased $2.7 million, $8.9 million and $2.5 million, respectively. The increases are attributable to new deposit account growth and growth of existing accounts. The deposit growth is generally reflective of the Company’s continuing marketing efforts directed at profitable organic growth.
Cash and cash equivalents decreased by $11.7 million, while investment securities increased by $23.8 million at December 31, 2011. Management has felt compelled to maintain high liquid asset balances over the past few years due to economic uncertainty in the environment. During 2011, a portion of cash and cash equivalent funds were redeployed to the investment portfolio.
Loans receivable increased during 2011 by $19.3 million, or 9.4%, totaling $224.3 million at year-end. The Company experienced growth in the residential real estate, farm, commercial real estate and construction real estate portfolio of $10.1 million, $1.1 million, $6.9 million and $2.1 million, respectively. The commercial and other loans decreased $0.3 million and the consumer and credit card loan portfolio decreased $1.0 million. The growth in residential real estate can generally be attributable to the favorable residential mortgage rates available in 2011. The growth in commercial real estate loans reflects higher demand in that category.
The Company’s allowance for loan losses at December 31, 2011 totaled $2.3 million, or 1.00% of total loans, as compared to $2.7 million, or 1.28% of total loans at December 31, 2010. The decrease in portfolio coverage during 2011 is principally attributable to a decline in impaired loans, past due loans and loans classified as special mention and substandard.
The allowance for loan losses is management’s estimate of the amount of probable credit losses in the portfolio. The Company determines the allowance for loan losses based upon an ongoing evaluation. This evaluation is inherently subjective, as it requires material estimates, including the amounts and timing of cash flows expected to be received on impaired loans that may be susceptible to significant change. Increases to the allowance for loan losses are made by charges to the provision for loan losses. Loans deemed uncollectible are charged against the allowance for loan losses. Recoveries of previously charged-off amounts are credited to the allowance for loan losses.
The Company’s allowance for loan losses is the accumulation of various components calculated based upon independent methodologies. All components of the allowance for loan losses represent an estimation performed according to either Financial Accounting Standards Board Accounting Standards Codification Topic 450-Contingencies, or Topic 310-Receivables. Management’s estimate of each allowance component is based on certain observable data that management believes is the most reflective of the underlying loan losses being estimated. Changes in the amount of each component of the allowance for loan losses are directionally consistent with changes in the observable data and corresponding analyses. Some of the components that management factors in are current economic conditions, loan growth assumptions, credit concentrations, and levels of nonperforming loans.
A key element of the methodology for determining the allowance for loan losses is the Company’s credit-risk-evaluation process, which includes credit-risk grading of individual commercial loans. Loans are assigned credit-risk grades based on an internal assessment of conditions that affect a borrower’s ability to meet its contractual obligation under the loan agreement. The assessment process includes reviewing a borrower’s current financial information, historical payment experience, credit documentation, public information, and other information specific to each individual borrower. Certain commercial loans are reviewed on an annual or rotational basis or as management becomes aware of information affecting a borrower’s ability to fulfill its obligation.
Funds generated in 2011 from deposit growth and operations were partially deployed to reduce amortizing Federal Home Loan Bank advances by approximately $228,000, and retire short-term borrowings by $2.6 million, or 73.6%.
Shareholders’ equity increased by approximately $1.5 million during 2011, totaling $45.2 million at year-end, as compared to $43.7 million at December 31, 2010. The growth in shareholders’ equity during 2011 was comprised of period earnings of $2.9 million and an increase of $782,000 in accumulated other comprehensive income, which were partially offset by payment of $1.9 million in cash dividends and $238,000 of treasury stock purchases. The Company purchases treasury stock pursuant to financial objectives and guidelines set forth in its strategic planning process.
The following table sets forth, for the periods indicated, information regarding the total dollar amounts of interest income from average interest-earning assets and the resulting yields, the total dollar amount of interest expense on average interest-bearing liabilities and the resulting rate paid, net interest income, interest rate spread and the net yield on interest-earning assets (dollars in thousands):
Average Balance Sheet and Net Interest Analysis
| | | For the Year Ended December 31 | |
| | | 2011 | | | 2010 | | | 2009 | |
| | | Average Balance | | | Interest | | | Yield/ Rate | | | Average Balance | | | Interest | | | Yield/ Rate | | | Average Balance | | | Interest | | | Yield/ Rate | |
| Assets | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Interest-earning assets: | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Loans (1)(2) | | $ | 217,016 | | | $ | 11,000 | | | | 5.07 | % | | $ | 210,091 | | | $ | 11,432 | | | | 5.44 | % | | $ | 207,846 | | | $ | 12,267 | | | | 5.90 | % |
| Securities - taxable (3) | | | 80,182 | | | | 1,859 | | | | 2.32 | % | | | 63,947 | | | | 1,788 | | | | 2.80 | % | | | 61,845 | | | | 2,019 | | | | 3.26 | % |
| Securities – nontaxable | | | 42,459 | | | | 1,496 | | | | 3.52 | % | | | 38,652 | | | | 1,499 | | | | 3.88 | % | | | 34,385 | | | | 1,427 | | | | 4.15 | % |
| Securities – equity (3)(4) | | | 1,885 | | | | 86 | | | | 4.56 | % | | | 1,885 | | | | 84 | | | | 4.45 | % | | | 1,756 | | | | 102 | | | | 5.80 | % |
| Federal funds sold | | | 5,358 | | | | 4 | | | | 0.07 | % | | | 7,165 | | | | 9 | | | | 0.13 | % | | | 6,231 | | | | 9 | | | | 0.14 | % |
| Due from Federal Reserve Bank | | | 51,075 | | | | 126 | | | | 0.25 | % | | | 40,478 | | | | 99 | | | | 0.24 | % | | | 15,373 | | | | 41 | | | | 0.27 | % |
| Total interest - earnings assets | | | 397,975 | | | | 14,571 | | | | 3.66 | % | | | 362,218 | | | | 14,911 | | | | 4.12 | % | | | 327,436 | | | | 15,865 | | | | 4.85 | % |
| Noninterest-earning assets | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Cash and due from other institutions | | | 9,528 | | | | | | | | | | | | 9,555 | | | | | | | | | | | | 10,066 | | | | | | | | | |
| Premises and equipment, net | | | 5,606 | | | | | | | | | | | | 5,882 | | | | | | | | | | | | 6,152 | | | | | | | | | |
| Accrued interest receivable | | | 1,295 | | | | | | | | | | | | 1,355 | | | | | | | | | | | | 1,295 | | | | | | | | | |
| Other assets | | | 9,585 | | | | | | | | | | | | 9,403 | | | | | | | | | | | | 8,210 | | | | | | | | | |
| Less allowance for loan losses | | | (2,569 | ) | | | | | | | | | | | (2,564 | ) | | | | | | | | | | | (2,505 | ) | | | | | | | | |
| Total | | $ | 421,420 | | | | | | | | | | | $ | 385,849 | | | | | | | | | | | $ | 350,654 | | | | | | | | | |
| Liabilities and Shareholders’ Equity | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Interest-bearing liabilities: | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Interest-bearing demand | | | 30,706 | | | | 44 | | | | 0.14 | % | | | 27,126 | | | | 42 | | | | 0.15 | % | | | 26,303 | | | | 40 | | | | 0.15 | % |
| Money market accounts | | | 51,249 | | | | 257 | | | | 0.50 | % | | | 45,065 | | | | 332 | | | | 0.74 | % | | | 29,025 | | | | 249 | | | | 0.86 | % |
| Savings deposits | | | 55,028 | | | | 192 | | | | 0.35 | % | | | 45,776 | | | | 181 | | | | 0.40 | % | | | 41,248 | | | | 171 | | | | 0.42 | % |
| Time deposits | | | 171,193 | | | | 3,279 | | | | 1.92 | % | | | 159,752 | | | | 3,447 | | | | 2.16 | % | | | 151,181 | | | | 3,915 | | | | 2.59 | % |
| Short-term borrowings | | | 2,660 | | | | 6 | | | | 0.23 | % | | | 4,163 | | | | 10 | | | | 0.23 | % | | | 5,352 | | | | 12 | | | | 0.23 | % |
Average Balance Sheet and Net Interest Analysis (Continued)
| | | For the Year Ended December 31 | |
| | | 2011 | | | 2010 | | | 2009 | |
| | | Average Balance | | | Interest | | | Yield/ Rate | | | Average Balance | | | Interest | | | Yield/ Rate | | | Average Balance | | | Interest | | | Yield/ Rate | |
| Federal Home Loan Bank Advances | | | 518 | | | | 34 | | | | 6.61 | % | | | 877 | | | | 56 | | | | 6.41 | % | | | 1,507 | | | | 90 | | | | 5.97 | % |
| Total interest-bearing liabilities | | | 311,354 | | | | 3,812 | | | | 1.22 | % | | | 282,759 | | | | 4,068 | | | | 1.44 | % | | | 254,616 | | | | 4,477 | | | | 1.76 | % |
| Noninterest-bearing liabilities: | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Demand deposits | | | 64,943 | | | | | | | | | | | | 58,285 | | | | | | | | | | | | 51,887 | | | | | | | | | |
| Accrued expenses and other liabilities | | | 1,431 | | | | | | | | | | | | 1,686 | | | | | | | | | | | | 1,919 | | | | | | | | | |
| Shareholders’ equity | | | 43,692 | | | | | | | | | | | | 43,119 | | | | | | | | | | | | 42,232 | | | | | | | | | |
| Total | | $ | 421,420 | | | | | | | | | | | $ | 385,849 | | | | | | | | | | | $ | 350,654 | | | | | | | | | |
| Net interest income | | | | | | $ | 10,759 | | | | | | | | | | | $ | 10,843 | | | | | | | | | | | $ | 11,388 | | | | | |
| Interest rate spread (5) | | | | | | | | | | | 2.44 | % | | | | | | | | | | | 2.68 | % | | | | | | | | | | | 3.09 | % |
| Net yield on interest-earning assets (6) | | | | | | | | | | | 2.70 | % | | | | | | | | | | | 2.99 | % | | | | | | | | | | | 3.48 | % |
| (1) | The weighted average loan amounts outstanding are net of deferred loan origination fees. |
| (2) | Nonaccrual loans are included in loan totals and do not have a material impact on the information presented. |
| (3) | Average balance is computed using the carrying value of securities. The average yield has been computed using the historical amortized cost average balance for available for sale securities. |
| (4) | Equity securities are comprised of common stock of the Federal Home Loan Bank, Federal Reserve Bank, and Great Lakes Bankers’ Bank. |
| (5) | Interest rate spread represents the difference between the average yield on interest-earning assets and the average cost of interest-bearing liabilities. |
| (6) | Net yield on interest-earning assets represents net interest income as a percentage of average interest-earning assets. |
Rate/Volume Analysis
The table below sets forth certain information regarding changes in interest income and interest expense of the Company for the periods indicated. For each category of interest-earning assets and interest-bearing liabilities, information is provided on changes attributable to (i) changes in volume (changes in average volume multiplied by old rate) and (ii) changes in rates (changes in rate multiplied by old average volume). Changes which are not solely attributable to rate or volume are allocated to changes in rate due to rate sensitivity of interest-earning assets and interest-bearing liabilities (dollars in thousands).
| | | 2011 Compared to 2010 | | | 2010 Compared to 2009 | |
| | | Increase (Decrease) Due To | | | Increase (Decrease) Due To | |
| | | Volume | | | Rate | | | Net | | | Volume | | | Rate | | | Net | |
| Interest income | | | | | | | | | | | | | | | | | | |
| Loans | | $ | 377 | | | $ | (809 | ) | | $ | (432 | ) | | $ | 132 | | | $ | (967 | ) | | $ | (835 | ) |
| Securities-taxable | | | 455 | | | | (384 | ) | | | 71 | | | | 69 | | | | (300 | ) | | | (231 | ) |
| Securities-nontaxable | | | 148 | | | | (151 | ) | | | (3 | ) | | | 177 | | | | (105 | ) | | | 72 | |
| Securities-equities | | | - | | | | 2 | | | | 2 | | | | 7 | | | | (25 | ) | | | (18 | ) |
| Federal funds sold | | | (2 | ) | | | (3 | ) | | | (5 | ) | | | 1 | | | | (1 | ) | | | - | |
| Due from Federal Reserve | | | 25 | | | | 2 | | | | 27 | | | | 68 | | | | (10 | ) | | | 58 | |
Total interest-earning Assets | | | 1,003 | | | | (1,343 | ) | | | (340 | ) | | | 454 | | | | (1,408 | ) | | | (954 | ) |
| Interest expense | | | | | | | | | | | | | | | | | | | | | | | | |
| Interest bearing demand | | | 5 | | | | (3 | ) | | | 2 | | | | 2 | | | | -- | | | | 2 | |
| Money market accounts | | | 46 | | | | (121 | ) | | | (75 | ) | | | 138 | | | | (55 | ) | | | 83 | |
| Savings deposits | | | 37 | | | | (26 | ) | | | 11 | | | | 19 | | | | (9 | ) | | | 10 | |
| Time deposits | | | 247 | | | | (415 | ) | | | (168 | ) | | | 222 | | | | (690 | ) | | | (468 | ) |
| Short-term borrowing | | | (3 | ) | | | (1 | ) | | | (4 | ) | | | (3 | ) | | | 1 | | | | (2 | ) |
| Federal Home Loan Bank | | | | | | | | | | | | | | | | | | | | | | | | |
| Advances | | | (23 | ) | | | 1 | | | | (22 | ) | | | (38 | ) | | | 4 | | | | (34 | ) |
Total interest-bearing Liabilities | | | 309 | | | | (565 | ) | | | (256 | ) | | | 340 | | | | (749 | ) | | | (409 | ) |
| Net change in net interest income | | $ | 694 | | | $ | (778 | ) | | $ | (84 | ) | | $ | 114 | | | $ | (659 | ) | | $ | (545 | ) |
RESULTS OF OPERATIONS
Comparison of the Years Ended December 31, 2011 and 2010
Net Interest Income
The Company’s net interest income for the year ended December 31, 2011 totaled $10.8 million, a slight reduction of approximately $84,000, or 0.8% from 2010 levels. The principal factor underlying the net decline was a reduction in average yields on loans and investments, which were partially offset by a $35.8 million increase in the average volume of interest-earning assets, and a 0.22% decrease in the average cost of interest-bearing liabilities in 2011 (from 1.44% to 1.22%) as compared to 2010.
Total interest income in 2011 decreased by $340,000 or 2.3%, due primarily to a $432,000 or 3.8% decline in interest on loans. The decline in interest income generally reflects the effects of an overall reduction in interest rates in the economy resulting from the Fed’s easing of monetary policy.
Total interest expense for the year ended December 31, 2011 declined by $256,000 or 6.3%, as compared to 2010. The reduction was primarily due to a $168,000 or 4.9% decrease in the cost of time deposits and a $75,000 or 22.6% decrease in the cost of money market accounts. Similar to the earnings side, this decline in interest costs mirrors the overall reduction of interest rates in the economy. Interest expense on Federal Home Loan advances decreased $22,000 or 3.93% due to repayment of the advances.
The foregoing factors culminated in the Company’s attainment of an interest rate spread of 2.44% and a net yield on earning assets of 2.70% in 2011, compared to 2.68% and 2.99%, respectively, in 2010. Management believes the Company’s reduction in spread and margin in 2011 primarily stems from the low interest rate environment and the need to carry higher levels of liquidity during the year and does not represent a material adverse trend.
Provision for Loan Losses
The provision for loan losses totaled $0 for 2011, as compared to $215,000 for 2010. The decreased loss provision is principally attributable to a decline in impaired loans, past due loans and loans classified as special mention and substandard during 2011. As stated previously, the Company maintains the allowance at a level commensurate with the credit risks inherent in the portfolio.
Noninterest Income
Noninterest income decreased by $275,000 or 13.4% in 2011 as compared to 2010. The decrease in income was principally related to a $187,000 decrease in gains on sale of loans in the secondary market and a $248,000 decrease in earnings and recoveries on bank-owned life insurance, which were partially offset by a $253,000 gain on sale of a vacant branch facility during 2011.
Noninterest Expense
The Company’s management stringently monitors noninterest expenses. A continuation of these control efforts in 2011 culminated with a $131,000 or 1.4% decrease in total noninterest expense. Excluding an impairment loss of $457,000 recognized in 2010 on a mutual fund owned by the Company, total noninterest expenses increased $325,000 or 3.7%. Salary and employee benefits increased $330,000 or 6.7% in 2011 due primarily to higher employee group insurance costs.
Income Taxes
Income tax expense increased to $605,000 in 2011, representing a $92,000 or 17.9% increase from the $513,000 of income tax expense recorded in 2010. The year over year increase is primarily attributable to a decrease in tax exempt income, specifically, earnings and recoveries on bank-owned life insurance. The Company’s effective tax rate was 17.4% in 2011, as compared to 14.7% in 2010. The principal difference between the Company’s effective tax rate in 2011 and 2010 and the 34% statutory tax rate in effect for both years resulted from the beneficial effects of tax-exempt income.
Comparison of the Years Ended December 31, 2010 and 2009
Net Interest Income
The Company’s net interest income for the year ended December 31, 2010 totaled $10.8 million, a reduction of approximately $545,000, or 4.8% from 2009 levels. The principal factor underlying the net decline was a reduction in average yields on loans and taxable investments, which were partially offset by a $34.8 million increase in the volume of interest-earning assets, and a 0.32% decrease in the average cost of interest-bearing liabilities in 2010 as compared to 2009.
Total interest income in 2010 decreased by $954,000, or 6.0%, due primarily to a $249,000 or 11.8% decline in interest on taxable investments and an $835,000, or 6.8%, reduction in interest on loans. These declines in interest income generally reflect the effects of overall reduction in interest rates in the economy resulting from the Fed’s easing of monetary policy.
Total interest expense for the year ended December 31, 2010 declined by $409,000 or 9.1%, as compared to 2009. The reduction was due to a $468,000, or 11.6%, decrease in the cost of time deposits. Similar to the earnings side, this decline in interest costs mirrors the overall reduction of interest rates in the economy. The interest expense on money market accounts and savings deposits increased $83,000 and $10,000, respectively, due to higher average volume in these type of accounts. Interest expense on Federal Home Loan advances decreased $34,000 or 37.8% due to repayment of the advances.
The foregoing factors culminated in the Company’s attainment of an interest rate spread of 2.68% and a net yield on earning assets of 2.99% in 2010, compared to 3.09% and 3.48%, respectively, in 2009. Management believes the Company’s reduction in spread and margin in 2010 primarily stems from the need to carry higher levels of liquidity during the year and the lack of commercial loan demand, and does not represent a material adverse trend.
Provision for Loan Losses
The provision for loan losses totaled $215,000 for 2010, as compared to $2,000 for 2009. The increased loss provision is principally attributable to the increase in nonperforming loans during 2010, as well as an overall increase in other delinquent loans year over year. As stated previously, the Company maintains the allowance at a level commensurate with the credit risks inherent in the portfolio.
Noninterest Income
Noninterest income increased by $372,000, or 22.2%, in 2010 as compared to 2009. The increase in income was principally related to a $147,000 increase in gains on sale of loans in the secondary market and a $237,000 increase in earnings and recoveries on bank-owned life insurance, which were partially offset by a $85,000 decrease in fees on deposit accounts. Residential loan originations were enhanced during 2010 by favorable long-term mortgage rates.
Noninterest Expense
The Company’s management stringently monitors noninterest expenses. A continuation of these control efforts in 2010 culminated with a modest $92,000, or 1.0%, increase in all noninterest expense categories. Excluding an impairment loss of $457,000 recognized in 2010 on a mutual fund owned by the Company, total noninterest expenses declined $365,000 or 4.0%.
Income Taxes
Income tax expense declined to $513,000 in 2010, representing a $322,000, or 38.6%, reduction from the $835,000 of income tax expense recorded in 2009. The year over year decline is primarily attributable to a $478,000, or 12.0%, reduction in pre-tax income and a $73,000 or 5.1% increase in tax exempt income. The Company’s effective tax rate was 14.7% in 2010, as compared to 21.1% in 2009. The principal difference between the Company’s effective tax rate in 2010 and 2009 and the 34% statutory tax rate in effect for both years resulted from the beneficial effects of tax-exempt income.
QUANTITATIVE AND QUALITATIVE DISCLOSURE
ABOUT MARKET RISK
The Company’s primary market risk exposure is interest rate risk and, to a lesser extent, liquidity risk. Because of the nature of the Bank’s operations, the Bank is not subject to currency exchange or commodity price risk and, since the Bank has no trading portfolio, it is not subject to trading risk. The Bank’s loan portfolio, concentrated primarily within the surrounding market area, is subject to risks associated with the local economy. Since all of the interest-earning assets and interest-bearing liabilities are located at the Bank, all of the Company’s interest rate risk resides at the Bank level. As a result, interest rate risk management is conducted at the Bank level.
The Bank actively manages interest rate sensitivity and asset/liability products through an Asset/Liability Management Committee. The principal purposes of asset-liability management are to maximize current net interest income while minimizing the risk to future earnings of negative fluctuations in net interest margin and to insure adequate liquidity exists to meet operational needs.
In an effort to reduce interest rate risk and protect itself from the negative effects of rapid or prolonged changes in interest rates, the Bank has instituted certain asset and liability management measures, including underwriting long-term fixed rate loans that are saleable in the secondary market, offering longer term deposit products and diversifying the loan portfolio into shorter term consumer and commercial business loans. In addition, since the mid-1980’s, the Bank has originated variable rate loans and as of December 31, 2011, such loans comprised approximately 87% of the total loan portfolio.
One of the principal functions of the Bank’s asset/liability management program is to monitor the level to which the balance sheet is subject to interest rate risk. The goal of this program is to manage the relationship between interest-earning assets and interest-bearing liabilities to minimize the fluctuations in the net interest spread and achieve consistent growth in net interest income during periods of changing interest rates.
Interest rate sensitivity is measured as the difference between the volume of assets and liabilities that are subject to repricing in a future period. These differences are known as interest sensitivity gaps. The Bank utilizes gap management as the primary means of measuring interest rate risk. Gap analysis identifies and quantifies the Bank’s exposure or vulnerability to changes in interest rates in relationship to the Bank’s interest rate sensitivity position. A rate sensitive asset or liability is one, which is capable of being repriced (i.e., the interest rate can be adjusted or principal can be reinvested) within a specified period of time. Subtracting total rate sensitive liabilities (RSL) from total rate sensitive assets (RSA) within specified time horizons nets the Bank’s gap positions. These gaps reflect the Bank’s exposure to changes in market interest rates, as discussed below.
Because many of the Bank’s deposit liabilities are capable of being immediately repriced, the Bank offers variable rate loan products in order to help maintain a proper balance in its ability to reprice various interest bearing assets and liabilities. Furthermore, the Bank’s deposit rates are not tied to an external index. As a result, although changing market interest rates impact repricing, the Bank has retained much of its control over repricing.
The Bank also conducts rate sensitivity analysis using a simulation model, which also monitors earnings at risk by projecting earnings of the Bank based upon an economic forecast of the most likely interest rate movement. The model also calculates net interest income of the Bank based upon what are estimated to be the largest foreseeable rate increase and the largest foreseeable rate decrease. Such analysis translates interest rate movements and the Bank’s rate sensitivity position into dollar amounts by which net interest income may fluctuate as a result of rate changes. Based on December 31, 2011 data, the latest date for which such information is available, a 200 basis point immediate increase in interest rates would increase net interest income by 27.92% and a 200 basis point immediate decrease in interest rates would decrease net interest income by 14.07%.
The data included in the table that follows indicates that the Bank is asset sensitive within one year. Generally, an asset sensitive gap could negatively affect net interest income in an environment of declining interest rates as a greater amount of interest-bearing assets could reprice at lower rates. During times of rising interest rates, an asset sensitive gap could positively affect net interest income, as rates would be increased on a larger volume of assets as compared to deposits. As a result, interest income would increase more rapidly than interest expense. A liability sensitive gap indicates that declining interest rates could positively affect net interest income, as expense of liabilities would decrease more rapidly than interest income would decline. Conversely, rising rates could negatively affect net interest income, as income from assets would increase less rapidly than deposit costs. Although rate sensitivity analysis enables the Bank to minimize interest rate risk, the magnitude of rate increases or decreases on assets versus liabilities may not correlate directly. As a result, fluctuations in interest spreads can occur even when repricing capabilities are perfectly matched.
It is the policy of the Bank to generally maintain a gap ratio within a range that is minus 10 percent to plus 20 percent of total assets for the time horizon of one year. When management believes that interest rates will increase, it can take actions to increase the RSA/RSL ratios. Conversely, when management believes interest rates will decline, it can take actions to decrease the RSA/RSL ratio.
Changes in market interest rates can also affect the Bank’s liquidity position through the impact rate changes may have on the market value of the Bank’s investment portfolio. Rapid increases in market rates can negatively impact the market values of investment securities. As securities values decline, it becomes more difficult to sell investments to meet liquidity demands without incurring a loss. The Bank can address this by increasing liquid funds, which may be utilized to meet unexpected liquidity needs when a decline occurs in the value of securities.
The following table presents the Bank’s interest rate sensitivity gap position as of December 31, 2011 (dollars in thousands):
INTEREST RATE SENSITIVITY GAPS
| | | 2012 | | | 2013 | | �� | 2014 | | | 2015 | | | 2016 | | | Thereafter | | | Total | |
| Interest-earnings assets: | | | | | | | | | | | | | | | | | | | | | |
| Loans: | | | | | | | | | | | | | | | | | | | | | |
| Fixed | | $ | 8,439 | | | $ | 6,144 | | | $ | 4,375 | | | $ | 1,929 | | | $ | 1,537 | | | $ | 6,675 | | | $ | 29,099 | |
| Variable | | | 176,257 | | | | 11,403 | | | | 4,214 | | | | 1,756 | | | | 3,164 | | | | 932 | | | | 197,726 | |
| Securities: | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Fixed | | | 70,792 | | | | 20,355 | | | | 5,899 | | | | 7,925 | | | | 10,893 | | | | 23,278 | | | | 139,142 | |
| Other interest-earning assets | | | 44,836 | | | | -- | | | | -- | | | | -- | | | | -- | | | | -- | | | | 44,836 | |
| Total interest-earning assets | | | 300,324 | | | | 37,902 | | | | 14,488 | | | | 11,610 | | | | 15,594 | | | | 30,885 | | | | 410,803 | |
| Interest-bearing liabilities: | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Demand and savings deposits | | | 141,381 | | | | -- | | | | -- | | | | -- | | | | -- | | | | -- | | | | 141,381 | |
| Time deposits: | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Fixed | | | 86,671 | | | | 33,015 | | | | 16,957 | | | | 19,405 | | | | 15,755 | | | | 3 | | | | 171,806 | |
| Short-term borrowings | | | 945 | | | | -- | | | | -- | | | | -- | | | | -- | | | | -- | | | | 945 | |
| FHLB advances | | | 189 | | | | 85 | | | | 66 | | | | 59 | | | | 16 | | | | 1 | | | | 416 | |
| Total interest-bearing liabilities | | | 229,186 | | | | 33,100 | | | | 17,023 | | | | 19,464 | | | | 15,771 | | | | 4 | | | | 314,548 | |
| Interest rate sensitivity gap | | | 71,138 | | | | 4,802 | | | | (2,535 | ) | | | (7,854 | ) | | | (177 | ) | | | 30,881 | | | | | |
| Cumulative rate sensitivity gap | | $ | 71,138 | | | $ | 75,940 | | | $ | 73,405 | | | $ | 65,551 | | | $ | 65,374 | | | $ | 96,255 | | | | | |
| Cumulative interest rate sensitivity gap as a percent of interest- earning assets | | | 17.32 | % | | | 18.49 | % | | | 17.87 | % | | | 15.96 | % | | | 15.91 | % | | | 23.43 | % | | | | |
Liquidity
Liquidity represents our ability to meet normal cash flow requirements of our customers for the funding of loans and repayment of deposits. Both short-term and long-term liquidity needs are generally derived from the repayments and maturities of loans and investment securities, and the receipt of deposits. Management monitors liquidity daily, and on a monthly basis incorporates liquidity management into its asset/liability program. The assets defined as liquid are cash, cash equivalents, and the available for sale security portfolio. The liquidity ratio as of December 31, 2011 and 2010 are 35.0% and 35.2%, respectively.
Operating activities, as presented in the Statement of Cash Flows in the accompanying Consolidated Financial Statements, provided $3.6 million and $4.1 million in cash flows during 2011 and 2010 respectively, principally generated from net income.
Investing activities utilized $43.2 million of the Company’s cash flows during 2011. The majority of this total represents the funding of a $22.7 million increase in the investment securities portfolios plus a $19.3 million increase in loans receivable.
Financing activities in 2011 provided the Company with net cash inflows totaling $27.9 million. The vast majority of this total consists of a $32.9 million increase in deposits. This deposit growth was partially utilized in other financing activities to retire $2.9 million of borrowings and pay cash dividends of $1.9 million.
In addition to using the loan, investment, and deposit portfolios as sources of liquidity, the Company has access to funds from the Federal Home Loan Bank of Cincinnati. The Company also has a ready source of funds through the available-for-sale component of the investment securities portfolio.
Capital Resources
Capital adequacy is our ability to support growth while protecting the interests of shareholders and depositors. Bank regulatory agencies have developed certain capital adequacy requirements that are used to assist them in monitoring the safety and soundness of financial institutions. We continually monitor these capital requirements and believe the Company to be in compliance with these regulations at December 31, 2011.
Our regulatory capital position at December 31, 2011, as compared to the minimum regulatory capital requirements imposed on us by banking regulators at that date is presented in the Notes to the accompanying Consolidated Financial Statements. We are not aware of any actions contemplated by banking regulators, which would result in the Company being in non-compliance with the minimum capital requirements.
Impact of Inflation Changing Prices
The Consolidated Financial Statements and the accompanying Notes presented elsewhere in this document, have been prepared in accordance with accounting principles generally accepted in the United States of America, which require the measurement of financial position and operating results in terms of historical dollars without considering the change in the relative purchasing power of money over time and due to inflation. Unlike most industrial companies, virtually all of the assets and liabilities are monetary in nature. The impact of inflation is reflected in the increased cost of operations. As a result, interest rates have a greater impact on performance than do the effects of general levels of inflation. Interest rates do not necessarily move in the same direction or to the same extent as the prices of goods and services.
Killbuck Bancshares, Inc.
Killbuck, Ohio
Audit Report
December 31, 2011
Killbuck Bancshares, Inc.
AUDITED CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2011
| | | Page Number |
| | | |
| Report of Independent Registered Public Accounting Firm | | 2 |
| | | | |
| Financial Statements | | |
| | | | |
| | Consolidated Balance Sheet | | 3 |
| | | | |
| | Consolidated Statement of Income | | 4 |
| | | | |
| | Consolidated Statement of Changes in Shareholders’ Equity | | 5 |
| | | | |
| | Consolidated Statement of Cash Flows | | 6 |
| | | | |
| Notes to Consolidated Financial Statements | | 7-37 |
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
The Board of Directors and Shareholders
Killbuck Bancshares, Inc.
Killbuck, Ohio
We have audited the accompanying consolidated balance sheets of Killbuck Bancshares, Inc. and subsidiary (the "Company”) as of December 31, 2011 and 2010, and the related consolidated statements of income, changes in shareholders’ equity, and cash flows for each of the three years in the period ended December 31, 2011. 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 the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Killbuck Bancshares, Inc. and subsidiary as of December 31, 2011 and 2010, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 2011, in conformity with U.S. generally accepted accounting principles.
Wheeling, West Virginia
March 5, 2012
Killbuck Bancshares, Inc.
CONSOLIDATED BALANCE SHEET
| | | December 31, | |
| ASSETS | | 2011 | | | 2010 | |
| Cash and cash equivalents: | | | | | | |
| Cash and amounts due from depository institutions | | $ | 51,528,204 | | | $ | 61,711,145 | |
| Federal funds sold | | | 3,168,000 | | | | 4,713,000 | |
| Total cash and cash equivalents | | | 54,696,204 | | | | 66,424,145 | |
| Investment securities: | | | | | | | | |
| Securities available for sale | | | 98,102,214 | | | | 76,044,672 | |
| Securities held to maturity (fair value of $43,833,969 and $40,482,091) | | | 41,039,935 | | | | 39,332,164 | |
| Total investment securities | | | 139,142,149 | | | | 115,376,836 | |
Loans (net of allowance for loan losses of $2,275,176 and $2,665,607) | | | 224,333,021 | | | | 205,074,687 | |
| Loans held for sale, at lower of cost or market | | | -- | | | | 320,000 | |
| Premises and equipment, net | | | 5,460,594 | | | | 5,751,540 | |
| Accrued interest receivable | | | 1,121,007 | | | | 1,165,298 | |
| Bank-owned life insurance | | | 7,448,771 | | | | 5,727,399 | |
| Goodwill, net | | | 1,329,249 | | | | 1,329,249 | |
| Other assets | | | 3,003,406 | | | | 3,901,199 | |
| Total assets | | $ | 436,534,401 | | | $ | 405,070,353 | |
| LIABILITIES | | | | | | | | |
| Deposits: | | | | | | | | |
| Noninterest bearing demand | | $ | 75,875,791 | | | $ | 63,108,035 | |
| Interest bearing demand | | | 34,785,442 | | | | 28,812,536 | |
| Money market | | | 46,570,972 | | | | 43,906,637 | |
| Savings | | | 60,024,882 | | | | 51,094,094 | |
| Time | | | 171,806,036 | | | | 169,267,955 | |
| Total deposits | | | 389,063,123 | | | | 356,189,257 | |
| Short-term borrowings | | | 945,000 | | | | 3,585,000 | |
| Federal Home Loan Bank advances | | | 415,776 | | | | 643,735 | |
| Accrued interest and other liabilities | | | 887,671 | | | | 972,671 | |
| Total liabilities | | | 391,311,570 | | | | 361,390,663 | |
| SHAREHOLDERS’ EQUITY | | | | | | | | |
| Common stock – No par value: 1,000,000 shares authorized, 718,431 shares issued at December 31, 2011 and 2010 | | | 8,846,670 | | | | 8,846,670 | |
| Retained earnings | | | 45,840,968 | | | | 44,841,370 | |
| Accumulated other comprehensive income (loss) | | | 397,793 | | | | (383,669 | ) |
Treasury shares, at cost (104,660 and 102,486 shares at December 31, 2011 and 2010, respectively) | | | (9,862,600 | ) | | | (9,624,681 | ) |
| Total shareholders’ equity | | | 45,222,831 | | | | 43,679,690 | |
| Total liabilities and shareholders’ equity | | $ | 436,534,401 | | | $ | 405,070,353 | |
See accompanying notes to the consolidated financial statements.
Killbuck Bancshares, Inc.
CONSOLIDATED STATEMENT OF INCOME
| | | Year Ended December 31, | |
| | | 2011 | | | 2010 | | | 2009 | |
| INTEREST INCOME | | | | | | | | | |
| Interest and fees on loans | | $ | 11,000,462 | | | $ | 11,432,293 | | | $ | 12,267,389 | |
| Investment securities: | | | | | | | | | | | | |
| Taxable | | | 1,944,964 | | | | 1,871,510 | | | | 2,120,835 | |
| Exempt from federal income tax | | | 1,495,864 | | | | 1,499,193 | | | | 1,426,623 | |
| Federal funds sold and other | | | 129,535 | | | | 108,238 | | | | 50,291 | |
| Total interest income | | | 14,570,825 | | | | 14,911,234 | | | | 15,865,138 | |
| INTEREST EXPENSE | | | | | | | | | | | | |
| Deposits | | | 3,771,428 | | | | 4,001,920 | | | | 4,374,627 | |
| Short term borrowings | | | 6,105 | | | | 9,555 | | | | 12,297 | |
| Federal Home Loan Bank advances | | | 34,221 | | | | 56,195 | | | | 89,915 | |
| Total interest expense | | | 3,811,754 | | | | 4,067,670 | | | | 4,476,839 | |
| NET INTEREST INCOME | | | 10,759,071 | | | | 10,843,564 | | | | 11,388,299 | |
| Provision for loan losses | | | -- | | | | 215,182 | | | | 2,000 | |
NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES | | | 10,759,071 | | | | 10,628,382 | | | | 11,386,299 | |
| NONINTEREST INCOME | | | | | | | | | | | | |
| Service charges on deposit accounts | | | 1,029,854 | | | | 1,111,797 | | | | 1,155,300 | |
| Gain on sale of loans, net | | | 91,231 | | | | 278,117 | | | | 131,256 | |
| Gain on sale of fixed assets | | | 252,598 | | | | -- | | | | -- | |
| Earnings and recoveries on bank-owned life insurance | | | 226,322 | | | | 474,077 | | | | 237,147 | |
| Other income | | | 169,437 | | | | 180,379 | | | | 148,955 | |
| Total noninterest income | | | 1,769,442 | | | | 2,044,370 | | | | 1,672,658 | |
| NONINTEREST EXPENSE | | | | | | | | | | | | |
| Salaries and employee benefits | | | 5,232,176 | | | | 4,902,669 | | | | 5,005,181 | |
| Occupancy and equipment | | | 974,084 | | | | 960,570 | | | | 1,010,928 | |
| Impairment loss | | | | | | | 456,585 | | | | -- | |
| Other expense | | | 2,842,841 | | | | 2,860,389 | | | | 3,072,453 | |
| Total noninterest expense | | | 9,049,101 | | | | 9,180,213 | | | | 9,088,562 | |
| INCOME BEFORE INCOME TAXES | | | 3,479,412 | | | | 3,492,539 | | | | 3,970,395 | |
| Income taxes | | | 604,796 | | | | 513,063 | | | | 835,443 | |
| NET INCOME | | $ | 2,874,616 | | | $ | 2,979,476 | | | $ | 3,134,952 | |
| EARNINGS PER SHARE | | $ | 4.67 | | | $ | 4.83 | | | $ | 5.07 | |
| WEIGHTED AVERAGE SHARES OUTSTANDING | | | 615,060 | | | | 616,667 | | | | 618,497 | |
See accompanying notes to the consolidated financial statements.
Killbuck Bancshares, Inc.
CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS’ EQUITY
| | | Common Stock | | | Retained Earnings | | | Accumulated Other Comprehensive Income (Loss) | | | Treasury Shares | | | Total Shareholders’ Equity | | | Comprehensive Income | |
| BALANCE, JANUARY 1, 2009 | | $ | 8,846,670 | | | $ | 42,461,137 | | | $ | 643,359 | | | $ | (9,015,568 | ) | | $ | 42,935,598 | | | | |
| Net income | | | | | | | 3,134,952 | | | | | | | | | | | | 3,134,952 | | | $ | 3,134,952 | |
| Other comprehensive income: | | | | | | | | | | | | | | | | | | | | | | | | |
Unrealized loss on available for sale securities, net of tax benefits of $322,873 | | | | (626,754 | ) | | | | | | | (626,754 | ) | | | (626,754 | ) |
| Comprehensive income | | | | | | | | | | | | | | | | | | | | | | $ | 2,508,198 | |
| Cash dividends paid ($3.00 per share) | | | | | | | (1,853,242 | ) | | | | | | | | | | | (1,853,242 | ) | | | | |
| Purchase of treasury shares, at cost (4,776 shares) | | | | | | | | | | | | | | | (527,146 | ) | | | (527,146 | ) | | | | |
| BALANCE, DECEMBER 31, 2009 | | | 8,846,670 | | | | 43,742,847 | | | | 16,605 | | | | (9,542,714 | ) | | | 43,063,408 | | | | | |
| Net income | | | | | | | 2,979,476 | | | | | | | | | | | | 2,979,476 | | | $ | 2,979,476 | |
| Other comprehensive income: | | | | | | | | | | | | | | | | | | | | | | | | |
Unrealized loss on available for sale securities, net of tax benefits of $206,202 | | | | (400,274 | ) | | | | | | | (400,274 | ) | | | (400,274 | ) |
| Comprehensive income | | | | | | | | | | | | | | | | | | | | | | $ | 2,579,202 | |
| Cash dividends paid ($3.05 per share) | | | | | | | (1,880,953 | ) | | | | | | | | | | | (1,880,953 | ) | | | | |
| Purchase of treasury shares, at cost (761 shares) | | | | | | | | | | | | | | | (81,967 | ) | | | (81,967 | ) | | | | |
| BALANCE, DECEMBER 31, 2010 | | | 8,846,670 | | | | 44,841,370 | | | | (383,669 | ) | | | (9,624,681 | ) | | | 43,679,690 | | | | | |
| Net income | | | | | | | 2,874,616 | | | | | | | | | | | | 2,874,616 | | | $ | 2,874,616 | |
| Other comprehensive income: | | | | | | | | | | | | | | | | | | | | | | | | |
Unrealized gain on available for sale securities, net of tax of $402,571 | | | | | | | | 781,462 | | | | | | | | 781,462 | | | | 781,462 | |
| Comprehensive income | | | | | | | | | | | | | | | | | | | | | | $ | 3,656,078 | |
| Cash dividends paid ($3.05 per share) | | | | | | | (1,875,018 | ) | | | | | | | | | | | (1,875,018 | ) | | | | |
| Purchase of treasury shares, at cost (2,174 shares) | | | | | | | | | | | | | | | (237,919 | ) | | | (237,919 | ) | | | | |
| BALANCE, DECEMBER 31, 2011 | | $ | 8,846,670 | | | $ | 45,840,968 | | | $ | 397,793 | | | $ | (9,862,600 | ) | | $ | 45,222,831 | | | | | |
CONSOLIDATED STATEMENT OF CASH FLOWS
| | | Year Ended December 31, | |
| | | 2011 | | | 2010 | | | 2009 | |
| OPERATING ACTIVITIES | | | | | | | | | |
| Net income | | $ | 2,874,616 | | | $ | 2,979,476 | | | $ | 3,134,952 | |
| Adjustments to reconcile net income to net cash provided by operating activities: | | | | | | | | | |
| Provision for loan losses | | | - | | | | 215,182 | | | | 2,000 | |
| Depreciation, amortization and accretion, net | | | 442,341 | | | | 411,015 | | | | 1,058,352 | |
| Gain on sale of loans, net | | | (91,231 | ) | | | (278,117 | ) | | | (131,256 | ) |
| Gain on sale of fixed assets | | | (252,598 | ) | | | - | | | | - | |
| Origination of loans held for sale | | | (3,038,600 | ) | | | (12,606,910 | ) | | | (15,462,950 | ) |
| Proceeds from the sale of loans | | | 3,449,832 | | | | 12,836,026 | | | | 15,323,206 | |
| Impairment Loss | | | - | | | | 456,585 | | | | - | |
| Bank-owned life insurance benefit income | | | (221,372 | ) | | | (474,077 | ) | | | - | |
| Net changes in: | | | | | | | | | | | | |
| Accrued interest and other assets | | | 539,513 | | | | 527,291 | | | | (1,547,977 | ) |
| Accrued expenses and other liabilities | | | (85,000 | ) | | | 51,695 | | | | (243,122 | ) |
| Net cash provided by operating activities | | | 3,617,501 | | | | 4,118,166 | | | | 2,133,205 | |
| INVESTING ACTIVITIES | | | | | | | | | | | | |
| Investment securities available for sale: | | | | | | | | | | | | |
| Proceeds from maturities and repayments | | | 75,222,358 | | | | 67,721,234 | | | | 31,277,140 | |
| Purchases | | | (96,095,867 | ) | | | (79,494,115 | ) | | | (46,609,702 | ) |
| Investment securities held to maturity: | | | | | | | | | | | | |
| Proceeds from maturities and repayments | | | 6,222,806 | | | | 4,919,051 | | | | 6,008,345 | |
| Purchases | | | (8,072,731 | ) | | | (9,231,408 | ) | | | (8,967,419 | ) |
| Net (increase) decrease in loans | | | (19,258,334 | ) | | | 2,132,766 | | | | (7,150,927 | ) |
| Purchase of premises and equipment | | | (90,049 | ) | | | (108,599 | ) | | | (85,447 | ) |
| Proceeds from the sale of fixed assets | | | 333,405 | | | | - | | | | - | |
| Proceeds from sale of other real estate owned | | | - | | | | 175,000 | | | | - | |
| Bank-owned life insurance | | | | | | | | | | | | |
| Proceeds | | | - | | | | 390,111 | | | | - | |
| Purchases | | | (1,500,000 | ) | | | | | | | | |
| Net cash used in investing activities | | | (43,238,412 | ) | �� | | (13,495,960 | ) | | | (25,528,010 | ) |
| FINANCING ACTIVITIES | | | | | | | | | | | | |
| Net increase (decrease) in demand deposits | | | 18,740,662 | | | | (3,818,106 | ) | | | 15,395,029 | |
| Net increase in money market and savings deposits | | | 11,595,123 | | | | 23,357,719 | | | | 7,311,987 | |
| Net increase in time deposits | | | 2,538,081 | | | | 15,354,567 | | | | 9,641,155 | |
| Net change in short-term borrowings | | | (2,640,000 | ) | | | (2,075,000 | ) | | | (725,000 | ) |
| Repayment of Federal Home Loan Bank advances | | | (227,959 | ) | | | (568,265 | ) | | | (650,667 | ) |
| Purchase of treasury shares | | | (237,919 | ) | | | (81,967 | ) | | | (527,146 | ) |
| Cash dividends paid | | | (1,875,018 | ) | | | (1,880,953 | ) | | | (1,853,242 | ) |
| Net cash provided by financing activities | | | 27,892,970 | | | | 30,287,995 | | | | 28,592,116 | |
| Increase (decrease) in cash and cash equivalents | | | (11,727,941 | ) | | | 20,910,201 | | | | 5,197,311 | |
| Cash and cash equivalents at beginning of year | | | 66,424,145 | | | | 45,513,944 | | | | 40,316,633 | |
| Cash and cash equivalents at end of year | | $ | 54,696,204 | | | $ | 66,424,145 | | | $ | 45,513,944 | |
See accompanying notes to the consolidated financial statements.
Killbuck Bancshares, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
A summary of the significant accounting and reporting policies consistently applied in the presentation of the consolidated financial statements follows:
Nature of Operations and Basis of Presentation
Killbuck Bancshares, Inc. (the “Company”) is an Ohio corporation organized as the holding company of The Killbuck Savings Bank Company (the “Bank”). The Bank is an Ohio state-chartered bank. The Company and its subsidiary operate in the single industry of commercial banking and derive substantially all their income from banking and bank-related services which include interest earnings on residential real estate, commercial mortgage, commercial and consumer loan financing as well as interest earnings on investment securities and charges for deposit services to its customers through nine full service branches and one loan production office. The Board of Governors of the Federal Reserve System supervises the Company and Bank, while the Bank is also subject to regulation and supervision by the Ohio Division of Financial Institutions.
The consolidated financial statements of the Company include its wholly-owned subsidiary, the Bank. All intercompany transactions have been eliminated in consolidation. The investment in subsidiary on the parent company financial statements is carried at the parent company’s equity in the underlying net assets.
The accompanying consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America (GAAP). The preparation of consolidated financial statements, in conformity with GAAP, requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, and disclosures of contingent assets and liabilities, at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting periods. Material estimates that are particularly susceptible to significant change relate to the determination of the allowance for loan losses and identification of other-than-temporary impairment of securities. Management believes that the allowance for loan losses represents its best estimate of losses known and inherent in the loan portfolio that are both probable and reasonable to estimate. Additionally, management believes that the evaluation for other-than-temporary impairment of securities has been performed in accordance with GAAP. Actual results may differ from these estimates. The estimate for the loan loss allowance is particularity susceptible to significant near-term changes, including possible material increases in the allowance mandated by the Bank’s primary regulator.
Investment Securities
Investment securities are classified, at the time of purchase, based upon management’s intention and ability, as either securities held to maturity or securities available for sale. Debt securities acquired with the intent and ability to hold to maturity are stated at cost adjusted for amortization of premium and accretion of discount which are computed using the level yield method. Certain other debt and equity securities have been classified as available for sale to serve principally as a potential source of liquidity. Unrealized holding gains and losses on available for sale securities are reported as a separate component of shareholders’ equity, net of the related tax effects, until realized. Realized securities gains and losses are computed using the specific identification method. Interest and dividends on investment securities are recognized as income when earned.
Common stock of the Federal Home Loan Bank, Federal Reserve Bank and Great Lakes Bankers Bank represent ownership in institutions which are wholly-owned by other financial institutions. These securities are accounted for at cost and are classified with other assets.
Investment Securities (Continued)
As a member of the Federal Home Loan Bank (FHLB) of Cincinnati, the Bank is required to maintain a minimum investment in stock of the FHLB that varies with the level of advances outstanding with the FHLB. The stock is bought from and sold to the FHLB based on its $100 par value. The stock does not have a readily determinable fair value and as such is classified as restricted stock, carried at cost and evaluated for impairment by management. The stock’s value is determined by the ultimate recoverability of the par value rather than by recognizing temporary declines. The determination of whether the par value will ultimately be recovered is influenced by criteria such as the following: (a) The significance of the decline in net assets of the FHLB as compared to the capital stock amount and the length of time this situation has persisted (b) Commitments by the FHLB to make payments required by law or regulation and the levels of such payments in relation to the operating performance (c) The impact of legislative and regulatory changes on the customer base of the FHLB and (d) The liquidity position of the FHLB.
While the Federal Home Loan Bank’s have been negatively impacted by the current economic conditions, the FHLB of Cincinnati has reported profits for 2011, remains in compliance with regulatory capital and liquidity requirements, continues to pay dividends on the stock and make redemptions at the par value. With consideration given to these factors, management concluded that the stock was not impaired at December 31, 2011 or 2010.
Securities are periodically reviewed for other-than-temporary impairment based upon a number of factors, including, but not limited to, the length of time and extent to which the market value has been less than cost, the financial condition of the underlying issuer, the ability of the issuer to meet contractual obligations, the likelihood of the security’s ability to recover any decline in its market value, and management’s intent and ability to hold the security for a period of time sufficient to allow for a recovery in market value. Among the factors that are considered in determining management’s intent and ability is a review of the Company’s capital adequacy, interest rate risk position and liquidity. The assessment of a security’s ability to recover any decline in market value, the ability of the issuer to meet contractual obligations and management’s intent and ability requires considerable judgment. A decline in value that is considered to be other-than-temporary is recorded as a loss within noninterest expense in the Consolidated Statement of Income.
Bank-Owned Life Insurance
The Company has purchased life insurance policies on certain key employees. Bank-owned life insurance is recorded at its cash surrender value or the amount that can be realized.
Loans
Loans are stated at their outstanding principal, less the allowance for loan losses and any net deferred loan origination fees. Interest income on loans is recognized on the accrual method. Accrual of interest on loans is generally discontinued when it is determined that a reasonable doubt exists as to the collectability of principal, interest, or both. Loans are returned to accrual status when past due interest is collected, and the collection of principal is probable.
Loan origination and commitment fees, as well as certain direct loan origination costs, are deferred and amortized as a yield adjustment over the lives of the related loans using the interest method. Amortization of deferred loan origination fees is discontinued when a loan is placed on nonaccrual status.
Mortgage loans originated and held for sale in the secondary market are carried at the lower of cost or market value determined on an aggregate basis. Net unrealized losses are recognized in a valuation allowance through charges to income. Gains and losses on the sale of loans held for sale are determined using the specific identification method. All loans are sold to the Federal Home Loan Mortgage Corporation (“FHLMC”).
Allowance for Loan Losses
The allowance for loan losses represents the amount which management estimates is adequate to provide for probable losses inherent in its loan portfolio. Management uses a disciplined process and methodology to establish the allowance for loan losses. To determine the total allowance for loan losses, the Company estimates the reserves needed for each segment of the portfolio, including loans analyzed individually and loans analyzed on a pooled basis. The allowance for loan losses consists of amounts applicable to: (i) the commercial loan portfolio; (ii) the commercial real estate portfolio; (iii) the real estate portfolio; (iv) the consumer loan portfolio. To determine the balance of the allowance account, loans are pooled by portfolio and losses are modeled using historical experience.
The allowance method is used in providing for loan losses. Accordingly, all loan losses are charged to the allowance, and all recoveries are credited to it. The allowance for loan losses is established through a provision for loan losses which is charged to operations. The provision is based upon management’s periodic evaluation of individual loans, the overall risk characteristics of the various portfolio segments, past experience with losses, the impact of economic conditions on borrowers, and other relevant factors. The estimates used in determining the adequacy of the allowance for loan losses including the amounts and timing of future cash flows expected on impaired loans, are particularly susceptible to significant change in the near term.
Impaired loans are commercial and commercial real estate loans for which it is probable that the Company will not be able to collect all amounts due according to the contractual terms of the loan agreement. The Company individually evaluates such loans for impairment and does not aggregate loans by major risk classifications. The definition of “impaired loans” is not the same as the definition of “nonaccrual loans,” although the two categories overlap. The Company may choose to place a loan on nonaccrual status due to payment delinquency or uncertain collectability, while not classifying the loan as impaired, provided the loan is not a commercial or commercial real estate classification. Factors considered by management in determining impairment include payment status and collateral value. The amount of impairment for these types of loans is determined by the difference between the present value of the expected cash flows related to the loan, using the original interest rate, and its recorded value, or as a practical expedient in the case of collateralized loans, the difference between the fair value of the collateral and the recorded amount of the loans. When foreclosure is probable, impairment is measured based on the fair value of the collateral.
Mortgage loans secured by one-to-four family properties and all consumer loans are large groups of smaller balance homogeneous loans and are measured for impairment collectively. Loans that experience insignificant payment delays, which are defined as 90 days or less, generally are not classified as impaired. Management determines the significance of payment delays on a case-by-case basis, taking into consideration all of the circumstances concerning the loan, the creditworthiness and payment history of the borrower, the length of the payment delay, and the amount of shortfall in relation to the principal and interest owed.
Loan Charge-off Policies
Consumer loans are generally fully or partially charged down to the fair value of the collateral securing the asset when the loan is 180 days past due unless both well secured and in the process of collection.
Real estate loans are generally charged down to the net realizable value when the loan is 180 days past due.
Commercial real estate loans are generally charged down to the net realizable value when the loan is 180 days past due.
Commercial loans are generally charged-off when the loan is 180 days past due.
Other secured loans are generally fully or partially charged down to the net realizable value when the loan is 120 days past due.
Troubled Debt Restructurings (“TDRs”)
In situations where, for economic or legal reasons related to a borrower’s financial difficulties, management may grant a concession for other than an insignificant period of time to the borrower that would not otherwise be considered, the related loan is classified as a TDR. Management strives to identify borrowers in financial difficulty early and work with them to modify to more affordable terms before their loan reaches nonaccrual status. These modified terms may include rate reductions, principle forgiveness, payment forbearance and other actions intended to minimize the economic loss and to avoid foreclosure or repossession of the collateral. In cases where borrowers are granted new terms that provide for a reduction of either interest or principal, management measures any impairment on the restructuring as noted above for impaired loans.
Premises and Equipment
Premises and equipment are stated at cost, less accumulated depreciation. Depreciation is principally computed on the straight-line method over the estimated useful lives of the related assets, which range from three to ten years for furniture, fixtures and equipment and twenty-five to fifty years for building premises. Leasehold improvements are amortized over the shorter of the estimated useful lives or the respective lease terms, which range from seven to fifteen years. Expenditures for maintenance and repairs are charged against income as incurred. Costs of major additions and improvements are capitalized.
Real Estate Owned
Real estate acquired in settlement of loans is stated at the lower of the recorded investment in the property or its fair value minus estimated costs of sale. Prior to foreclosure, the value of the underlying collateral is written down by a charge to the allowance for loan losses if necessary. Any subsequent write-downs are charged against operating expenses. Operating expenses of such properties, net of related income and losses on disposition, are included in other expenses.
Goodwill
Goodwill represents the amount by which the market value of the Company’s stock issued in an acquisition exceeded the fair value of the net assets acquired. During 2011, the Company adopted Accounting Standards Update (ASU) 2011-08, Intangibles – Goodwill and Other Topics (Topic 350), Testing Goodwill for Impairment. The ASU allows a Company to first assess qualitative factors on an annual basis to determine whether it is necessary to perform the two-step goodwill impairment test. The two-step goodwill impairment test can cause volatility in the Company’s reported net income because impairment losses could occur irregularly and in varying amounts. As of December 31, 2011 and 2010, respectively, net goodwill totaled $1.3 million.
Mortgage Servicing Rights (“MSRs”)
The Company has agreements for the express purpose of selling loans in the secondary market. The Company maintains all servicing rights for these loans. Originated MSRs are recorded by allocating total costs incurred between the loans and servicing rights based on their relative fair values. MSRs are amortized in proportion to the estimated servicing income over the estimated life of the servicing portfolio. Impairment is evaluated based on the fair value of the right, based on portfolio interest rates and prepayment characteristics.
Employee Benefit Plan
The Bank maintains a profit sharing pension plan which is integrated with a 401(K) plan. The Bank’s contributions are based upon the plan’s contribution formula.
Income Taxes
Using the asset and liability method, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and the respective tax bases. To the extent that currently available evidence about the future raises doubt about the realization of a deferred tax asset, a valuation allowance is established. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income tax expense in the period that includes the enactment date.
The Company follows FASB guidance which provides clarification on accounting for uncertainty in income taxes recognized in an enterprise’s financial statements in accordance with FASB ASC 740. The guidance prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return, and also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. As a result of the Company’s evaluation of the FASB-issued guidance, no significant income tax uncertainties were identified. Therefore, the Company recognized no adjustment for unrecognized income tax benefits for the year ended December 31, 2011. Our policy is to recognize interest and penalties on unrecognized tax benefits in income tax expense in the Consolidated Statement of Income. The Company recognized no interest or penalties during the year ended December 31, 2011.
The Company and Bank account for income tax expense pursuant to a tax-sharing agreement whereby the Bank remits, or is refunded, income tax expense based on the Bank’s separate company tax liability.
Advertising Costs
Advertising costs are expensed as incurred.
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 (i) the assets have been isolated from the Company, (ii) 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 (iii) the Company does not maintain effective control over the transferred assets through an agreement to repurchase them before their maturity.
Concentrations of Risk
Financial instruments which potentially subject the Company and its subsidiary to concentrations of credit risk primarily consist of cash and cash equivalents and loans receivable. Cash and cash equivalents include deposits placed in other financial institutions. At December 31, 2011, the Company had $41.7 million on deposit with the Federal Reserve Bank of Cleveland and federal funds sold of $3.2 million with the Great Lakes Bankers’ Bank. The Bank’s lending activity is primarily concentrated in loans collateralized by real estate in northeastern Ohio. As a result, credit risk is broadly dependent on the real estate market and general economic conditions in that geographic area. Additionally, banking regulations and the Bank’s lending policies limit the amount of credit extended to any single borrower and their related interests thereby limiting the concentration of credit risk to any single borrower.
Earnings Per Share
The Company currently maintains a simple capital structure; therefore, there are no potential dilutive effects with respect to earnings per share. As a result, earnings per share are calculated using the weighted average number of shares outstanding for the period.
Comprehensive Income
The Company is required to present comprehensive income in a full set of general purpose financial statements for all periods presented. Other comprehensive income is comprised exclusively of net income and unrealized holding gains and losses on the available for sale securities portfolio. The Company has elected to report the effects of other comprehensive income as part of the Consolidated Statement of Changes in Shareholders’ Equity.
Cash Flow Information
For purposes of reporting cash flows, cash and cash equivalents include cash and amounts due from financial institutions and federal funds sold. Cash payments for interest in 2011, 2010 and 2009 were $3.8 million, $4.1 million, and $4.5 million respectively. Cash payments for income taxes for 2011, 2010, and 2009 were $420,000, $736,000 and $907,000, respectively.
Recent Accounting Pronouncements
In April 2011, the FASB issued ASU 2011-02, Receivables (Topic 310): A Creditor’s Determination of Whether a Restructuring Is a Troubled Debt Restructuring. The amendments in this Update provide additional guidance or clarification to help creditors in determining whether a creditor has granted a concession and whether a debtor is experiencing financial difficulties for purposes of determining whether a restructuring constitutes a troubled debt restructuring. The amendments in this Update are effective for the first interim or annual reporting period beginning on or after June 15, 2011, and should be applied retrospectively to the beginning 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. The Company has provided the necessary disclosures in Note 3.
In April 2011, the FASB issued ASU 2011-03, Transfers and Services (Topic 860): Reconsideration of Effective Control for Repurchase Agreements. The main objective in developing this Update is to improve the accounting for repurchase agreements (repos) and other agreements that both entitle and obligate a transferor to repurchase or redeem financial assets before their maturity. 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. The amendments in this Update apply to all entities, both public and nonpublic. The amendments affect all entities that enter into agreements to transfer financial assets that both entitle and obligate the transferor to repurchase or redeem the financial assets before their maturity. The guidance in this Update is effective for the first interim or annual period beginning on or after December 15, 2011 and should be applied prospectively to transactions or modifications of existing transactions that occur on or after the effective date. Early adoption is not permitted. This ASU is not expected to have a significant impact on the Company’s financial statements.
In May 2011, the FASB issued ASU 2011-04, Fair Value Measurement (Topic 820): Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs. The amendments in this Update result in common fair value measurement and disclosure requirements in U.S. GAAP and IFRSs. Consequently, the amendments change the wording used to describe many of the requirements in U.S. GAAP for measuring fair value and for disclosing information about fair value measurements. The amendments in this Update are to be applied prospectively. For public entities, the amendments are effective during interim and annual periods beginning after December 15, 2011. For nonpublic entities, the amendments are effective for annual periods beginning after December 15, 2011. Early application by public entities is not permitted. This ASU is not expected to have a significant impact on the Company’s financial statements.
Recent Accounting Pronouncements (Continued)
In June 2011, the FASB issued ASU 2011-05, Comprehensive Income (Topic 220): Presentation of Comprehensive Income. The amendments in this Update improve the comparability, clarity, consistency, and transparency of financial reporting and 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. GAAP and IFRS, the option to present components of other comprehensive income as part of the statement of changes in stockholders’ equity was eliminated. The amendments require that all non-owner changes in stockholders’ equity be presented either in a single continuous statement of comprehensive income or in two separate but consecutive statements. In the two-statement approach, the first statement should present total net income and its components followed consecutively by a second statement that should present total other comprehensive income, the components of other comprehensive income, and the total of comprehensive income. All entities that report items of comprehensive income, in any period presented, will be affected by the changes in this Update. For public entities, the amendments are effective for fiscal years, and interim periods within those years, beginning after December 15, 2011. For nonpublic entities, the amendments are effective for fiscal years ending after December 15, 2012, and interim and annual periods thereafter. The amendments in this Update should be applied retrospectively, and early adoption is permitted. This ASU is not expected to have a significant impact on the Company’s financial statements.
In September 2011, the FASB issued ASU 2011-08, Intangibles – Goodwill and Other Topics (Topic 350), 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 the 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 described in Topic 350. The more-likely-than-not threshold is defined as having a likelihood of more than 50 percent. Under the amendments in this Update, an entity is not required to calculate the fair value of a reporting unit unless the entity determines that it is more likely than not that its fair value is less than its carrying amount. The amendments in this Update apply to all entities, both public and nonpublic, that have goodwill reported in their financial statements and are effective for interim and annual goodwill impairment tests performed for fiscal years beginning after December 15, 2011. Early adoption is permitted, including for annual and interim goodwill impairment tests performed as of a date before September 15, 2011, if an entity’s financial statements for the most recent annual or interim period have not yet been issued or, for nonpublic entities, have not yet been made available for issuance. This ASU is not expected to have a significant impact on the Company’s financial statements.
In September 2011, the FASB issued ASU 2011-09, Compensation-Retirement Benefits-Multiemployer Plans (Subtopic 715-80):Disclosures about an Employer’s Participation in a Multiemployer Plan. The amendments in this Update will require additional disclosures about an employer’s participation in a multiemployer pension plan to enable users of financial statements to assess the potential 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 of fiscal years ending after December 15, 2012, with early adoption permitted. The amendments should be applied retrospectively for all prior periods presented. This ASU is not expected to have a significant impact on the Company’s financial statements.
Recent Accounting Pronouncements (Continued)
In December 2011, the FASB issued ASU 2011-10, Property, Plant, and Equipment (Topic 360): Derecognition of in Substance Real Estate-a Scope Clarification. The amendments in this Update affect entities that cease to have a controlling financial interest in a subsidiary that is in substance real estate as a result of default on the subsidiary's nonrecourse debt. Under the amendments in this Update, when a parent (reporting entity) ceases to have a controlling financial 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 consolidated financial statements until legal title to the real estate is transferred to legally satisfy the debt. The amendments in this Update should be applied on a prospective basis to deconsolidation events occurring after the effective date. Prior periods should not be adjusted even if the reporting entity has continuing involvement with previously derecognized in substance real estate entities. 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. This ASU is not expected to have a significant impact on the Company’s financial statements.
In December 2011, the FASB issued ASU 2011-11, Balance Sheet (Topic 210): Disclosures about Offsetting Assets and Liabilities. The amendments in this Update affect all entities that have financial instruments and derivative instruments that are either (1) offset in accordance with either Section 210-20-45 or Section 815-10-45 or (2) subject to an enforceable master netting arrangement or similar agreement. The requirements amend the disclosure requirements on offsetting in Section 210-20-50. This information will enable users of an entity's financial statements to evaluate the effect or potential effect of netting arrangements on an entity's financial position, including the effect or potential effect of rights of setoff associated with certain financial instruments and derivative instruments in the scope of this Update. An entity is required to apply the amendments for annual reporting periods beginning on or after January 1, 2013, and interim periods within those annual periods. An entity should provide the disclosures required by those amendments retrospectively for all comparative periods presented. This ASU is not expected to have a significant impact on the Company’s financial statements.
In December 2011, the FASB issued ASU 2011-12, Comprehensive Income (Topic 220): Deferral of the Effective Date for Amendments to the Presentation of Reclassifications of Items Out of Accumulated Other Comprehensive Income in Accounting Standards Update No. 2011-05. In order to defer only those changes in Update 2011-05 that relate to the presentation of reclassification adjustments, the paragraphs in this Update supersede certain pending paragraphs in Update 2011-05. 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, including the requirement to report comprehensive income either in a single continuous financial statement or in two separate but consecutive financial statements. Public entities should apply these requirements for fiscal years, and interim periods within those years, beginning after December 15, 2011. Nonpublic entities should begin applying these requirements for fiscal years ending after December 15, 2012, and interim and annual periods thereafter. This ASU is not expected to have a significant impact on the Company’s financial statements.
Reclassification of Comparative Amounts
Certain amounts in the prior year consolidated financial statements have been reclassified to conform to the current year presentation. These reclassifications had no effect on either shareholders’ equity or net income.
2. INVESTMENT SECURITIES
The amortized cost of securities and their estimated fair values are as follows:
Securities Available for Sale
| | | 2011 | |
| | | Amortized Cost | | | Gross Unrealized Gains | | | Gross Unrealized Losses | | | Fair Value | |
| | | | | | | | | | | | | |
Obligations of U.S. Government Agencies and Corporations | | $ | 96,956,082 | | | $ | 766,897 | | | $ | (123,959 | ) | | $ | 97,599,020 | |
| | | | | | | | | | | | | | | | | |
| Mutual funds | | | 543,415 | | | | -- | | | | (40,221 | ) | | | 503,194 | |
| | | | | | | | | | | | | | | | | |
| Total | | $ | 97,499,497 | | | $ | 766,897 | | | $ | (164,180 | ) | | $ | 98,102,214 | |
| | | 2010 | |
| | | Amortized Cost | | | Gross Unrealized Gains | | | Gross Unrealized Losses | | | Fair Value | |
| | | | | | | | | | | | | |
Obligations of U.S. Government Agencies and Corporations | | $ | 76,082,573 | | | $ | 414,509 | | | $ | (1,011,398 | ) | | $ | 75,485,684 | |
| | | | | | | | | | | | | | | | | |
| Mutual funds | | | 543,415 | | | | 15,573 | | | | -- | | | | 558,988 | |
| | | | | | | | | | | | | | | | | |
| Total | | $ | 76,625,988 | | | $ | 430,082 | | | $ | (1,011,398 | ) | | $ | 76,044,672 | |
Securities Held to Maturity
| | | 2011 | |
| | | Amortized Cost | | | Gross Unrealized Gains | | | Gross Unrealized Losses | | | Fair Value | |
| | | | | | | | | | | | | |
Obligations of States and Political Subdivisions | | $ | 41,039,935 | | | $ | 2,815,688 | | | $ | (21,654 | ) | | $ | 43,833,969 | |
| | | | | | | | | | | | | | | | | |
| Total | | $ | 41,039,935 | | | $ | 2,815,688 | | | $ | (21,654 | ) | | $ | 43,833,969 | |
| | | 2010 | |
| | | Amortized Cost | | | Gross Unrealized Gains | | | Gross Unrealized Losses | | | Fair Value | |
| | | | | | | | | | | | | |
Obligations of States and Political Subdivisions | | $ | 39,332,164 | | | $ | 1,368,278 | | | $ | (218,351 | ) | | $ | 40,482,091 | |
| | | | | | | | | | | | | | | | | |
| Total | | $ | 39,332,164 | | | $ | 1,368,278 | | | $ | (218,351 | ) | | $ | 40,482,091 | |
2. INVESTMENT SECURITIES (CONTINUED)
The amortized cost and fair values of debt securities at December 31, 2011, by contractual maturity, are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or repay obligations with or without call or prepayment penalties.
| | | Available For Sale | | | Held to Maturity | |
| | | Amortized Cost | | | Fair Value | | | Amortized Cost | | | Fair Value | |
| Due in one year or less | | $ | 875,643 | | | $ | 895,168 | | | $ | 2,537,661 | | | $ | 2,579,176 | |
| Due after one year through five years | | | 49,809,357 | | | | 50,253,179 | | | | 14,597,989 | | | | 15,479,922 | |
| Due after five through ten years | | | 42,892,015 | | | | 43,016,456 | | | | 23,048,051 | | | | 24,845,895 | |
| Due after ten years | | | 3,379,067 | | | | 3,434,217 | | | | 856,234 | | | | 928,976 | |
| | | $ | 96,956,082 | | | $ | 97,599,020 | | | $ | 41,039,935 | | | $ | 43,833,969 | |
Investment securities with an approximate carrying value of $58.4 million and $55.5 million at December 31, 2011 and 2010, respectively, were pledged to secure public deposits, securities sold under agreement to repurchase and for other purposes as required or permitted by law.
The following tables show the Company’s gross unrealized losses and fair value, aggregated by investment category and length of time that the individual securities have been in a continuous unrealized loss position, at December 31, 2011 and 2010. As of December 31, 2011, there were a total of 14 securities in an unrealized loss position.
| | | December 31, 2011 | |
| | | Less than Twelve Months | | | Twelve Months or Greater | | | Total | |
| | | | | | Gross | | | Number of | | | | | | Gross | | | Number of | | | | | | Gross | |
| | | Fair | | | Unrealized | | | Impaired | | | Fair | | | Unrealized | | | Impaired | | | Fair | | | Unrealized | |
| | | Value | | | Losses | | | Securities | | | Value | | | Losses | | | Securities | | | Value | | | Losses | |
| U. S. Government Agencies and Corporations | | $ | 32,709,685 | | | $ | (123,959 | ) | | | 8 | | | | -- | | | | -- | | | | -- | | | $ | 32,709,685 | | | $ | (123,959 | ) |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Obligations of States and Political Subdivisions | | | 1,400,448 | | | | (21,654 | ) | | | 5 | | | | -- | | | | -- | | | | -- | | | | 1,400,448 | | | | (21,654 | ) |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Total temporarily impaired debt securities | | | 34,110,133 | | | | (145,613 | ) | | | 13 | | | | -- | | | | -- | | | | -- | | | | 34,110,133 | | | | (145,613 | ) |
| Mutual Funds | | | 503,194 | | | | (40,221 | ) | | | 1 | | | | -- | | | | -- | | | | -- | | | | 503,194 | | | | (40,221 | ) |
| Total temporarily impaired equity securities | | | 503,194 | | | | (40,221 | ) | | | 1 | | | | -- | | | | -- | | | | -- | | | | 503,194 | | | | (40,221 | ) |
| Total of all securities | | $ | 34,613,327 | | | $ | (185,834 | ) | | | 14 | | | | -- | | | | -- | | | | -- | | | $ | 34,613,327 | | | $ | (185,834 | ) |
| | | December 31, 2010 | |
| | | Less than Twelve Months | | | Twelve Months or Greater | | | Total | |
| | | | | | Gross | | | Number of | | | | | | Gross | | | Number of | | | | | | Gross | |
| | | Fair | | | Unrealized | | | Impaired | | | Fair | | | Unrealized | | | Impaired | | | Fair | | | Unrealized | |
| | | Value | | | Losses | | | Securities | | | Value | | | Losses | | | Securities | | | Value | | | Losses | |
| U. S. Government Agencies and Corporations | | $ | 33,935,490 | | | $ | (1,011,398 | ) | | | 18 | | | | -- | | | | -- | | | | -- | | | $ | 33,935,490 | | | $ | (1,011,398 | ) |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Obligations of States and Political Subdivisions | | | 6,388,398 | | | | (218,351 | ) | | | 26 | | | | -- | | | | -- | | | | -- | | | | 6,388,398 | | | | (218,351 | ) |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Total temporarily impaired debt securities | | | 40,323,888 | | | | (1,229,749 | ) | | | 44 | | | | -- | | | | -- | | | | -- | | | | 40,323,888 | | | | (1,229,749 | ) |
| Total of all securities | | $ | 40,323,888 | | | $ | (1,229,749 | ) | | | 44 | | | | -- | | | | -- | | | | -- | | | $ | 40,323,888 | | | $ | (1,229,749 | ) |
2. INVESTMENT SECURITIES (CONTINUED)
At least quarterly the corporation conducts a comprehensive security level impairment assessment on all securities in an unrealized loss position to determine if other than temporary impairment (OTTI) exists. An unrealized loss exists when the current fair value of an individual security is less than its amortized cost basis. An OTTI loss must be recognized for a debt security in an unrealized loss position if the Corporation intends to sell the security or it is more likely than not that the corporation will be required to sell the security before recovery of its amortized cost basis. In this situation, the amount of loss recognized in income is equal to the difference between fair value and the amortized cost basis of the security. Even if the Corporation does not expect to sell the security, the Corporation must evaluate the expected cash flows to be received to determine if a credit loss has occurred. In the event of a credit loss, only the amount of impairment associated with the credit loss is recognized in income. The portion of the unrealized loss relating to other factors, such as liquidity conditions in the market or changes in the market interest rates, is recorded in other comprehensive income. Equity securities are also evaluated to determine whether the unrealized loss is expected to be recoverable based on whether evidence exists to support a realizable value equal to or greater than the amortized cost basis. If it is probable that the Corporation will not recover the amortized cost basis, taking into consideration the estimated recovery period and its ability to hold the equity security until recovery, OTTI is recognized. The security level assessment is performed on each security, regardless of the classification of the security as available for sale or held to maturity. The assessments are based on the nature of the securities, the financial condition of the issuer, the extent and duration of the securities, the extent and duration of the loss and whether Management intends to sell or it is more likely than not that it will be required to sell a security before recovery of its amortized cost basis, which may be maturity. For those securities for which the assessment shows the Corporation will recover the entire cost basis, Management does not intend to sell these securities and it is more likely than not that the Corporation will not be required to sell them before the anticipated recovery of the amortized cost basis, the gross unrealized losses are recognized in other comprehensive income, net of tax.
No impairment loss was recognized during 2011. An impairment loss of $457,000 was recognized during 2010 on a mutual fund owned by the Company. The non-publically traded mutual fund is comprised solely of community and regional financial institution stocks. The Company performed an assessment of the decline in the fair value of the mutual fund and determined that it should be recognized as other than temporary impairment.
3. LOANS
Major classifications of loans are summarized as follows as of December 31:
| | | 2011 | | | 2010 | |
| Real estate – residential | | $ | 97,583,238 | | | $ | 87,505,717 | |
| Real estate – farm | | | 11,028,432 | | | | 9,925,340 | |
| Real estate – commercial | | | 58,213,465 | | | | 51,310,626 | |
| Real estate – construction | | | 12,467,999 | | | | 10,406,156 | |
| Commercial and other loans | | | 41,666,625 | | | | 41,931,142 | |
| Consumer and credit card loans | | | 5,865,194 | | | | 6,866,408 | |
| | | | 226,824,953 | | | | 207,945,389 | |
| Less allowance for loan losses | | | (2,275,176 | ) | | | (2,665,607 | ) |
| Less net deferred loan origination fees | | | (216,756 | ) | | | (205,095 | ) |
| Loans, net | | $ | 224,333,021 | | | $ | 205,074,687 | |
| | | December 31, 2011 | |
| | | Loans Individually Evaluated for | | | Loans Collectively Evaluated for | | | Total | |
| | | | | | | | | | |
| Real estate - residential and farm | | $ | -- | | | $ | 108,611,670 | | | $ | 108,611,670 | |
| Real estate - commercial and construction | | | 545,040 | | | | 70,136,424 | | | | 70,681,464 | |
| Commercial and other loans | | | 481,706 | | | | 41,184,919 | | | | 41,666,625 | |
| Consumer and credit card loans | | | -- | | | | 5,865,194 | | | | 5,865,194 | |
| Total | | $ | 1,026,746 | | | $ | 225,798,207 | | | $ | 226,824,953 | |
| | | December 31, 2010 | |
| | | Loans Individually Evaluated for | | | Loans Collectively Evaluated for | | | Total | |
| | | | | | | | | | |
| Real estate - residential and farm | | | -- | | | $ | 97,431,057 | | | $ | 97,431,057 | |
| Real estate - commercial and construction | | $ | 957,590 | | | | 60,759,192 | | | | 61,716,782 | |
| Commercial and other loans | | | 639,218 | | | | 41,291,924 | | | | 41,931,142 | |
| Consumer and credit card loans | | | -- | | | | 6,866,408 | | | | 6,866,408 | |
| Total | | $ | 1,596,808 | | | $ | 206,348,581 | | | $ | 207,945,389 | |
Loans held for sale at December 31, 2011 and 2010 were $0 and $320,000, respectively. They were carried at cost. Real estate loans serviced for the Federal Home Loan Mortgage Corporation (FHLMC), which are not included in the consolidated balance sheet, totaled $43.8 million and $47.8 million at December 31, 2011 and 2010, respectively. The Bank is currently collecting a fee of .25% for servicing these loans.
The Company’s primary business activity is with customers located within its local trade area. Residential, commercial, personal, and agricultural loans are granted. The Company also selectively funds loans originated outside of its trade area provided such loans meet its credit policy guidelines. Although the Company has a diversified loan portfolio at December 31, 2011 and 2010, loans outstanding to individuals and businesses are dependent upon the local economic conditions in its immediate trade area.
The segments of the Bank’s loan portfolio are disaggregated to a level that allows management to monitor risk and performance. The residential real estate loan segment is further disaggregated into two classes: amortizing term loans, which are primarily first liens, and home equity lines of credit, which are generally second liens. The commercial real estate (“CRE”) loan segment is further disaggregated into two classes. Non-owner occupied CRE loans, which include loans secured by non-owner occupied nonfarm nonresidential properties, generally have a greater risk profile than all other CRE loans, which include loans secured by multifamily structures and owner-occupied commercial structures. The commercial and other loans segment consists of loans made for the purpose of financing the activities of commercial customers. The consumer loan segment consists primarily of installment loans (direct and indirect) and credit card loans.
Management evaluates individual loans in all of the commercial segments for possible impairment if the loan is greater than $250,000 or is part of a relationship that is greater than $500,000, and if the loan either is in nonaccrual status, or is risk rated Substandard and is greater than 60 days past due. Loans are considered to be impaired when, based on current information and events, it is probable that the Corporation 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 evaluating impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. 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. The Corporation does not separately evaluate individual consumer and residential mortgage loans for impairment, unless such loans are part of larger relationship that is impaired, or are classified as a troubled debt restructuring agreement.
Once the determination has been made that a loan is impaired, the determination of whether a specific allocation of the allowance is necessary is measured by comparing the recorded investment in the loan to the fair value of the loan using one of three methods: (a) the present value of expected future cash flows discounted at the loan’s effective interest rate; (b) the loan’s observable market price; or (c) the fair value of the collateral less selling costs. The method is selected on a loan-by loan basis, with management primarily utilizing the fair value of collateral method. The evaluation of the need and amount of a specific allocation of the allowance and whether a loan can be removed from impairment status is made on a quarterly basis. The Corporation’s policy for recognizing interest income on impaired loans does not differ from its overall policy for interest recognition.
The following tables present impaired loans by class, segregated by those for which a specific allowance was required and those for which a specific allowance was not necessary as of December 31, 2011 and December 31, 2010:
| December 31, 2011 | | Impaired Loans with Specific Allowance | | | | | | Total Impaired Loans | |
| | | | | | | | | | | | | | | Unpaid | |
| | | Recorded | | | Related | | | Recorded | | | Recorded | | | Principal | |
| | | Investment | | | Allowance | | | Investment | | | Investment | | | Balance | |
| | | | | | | | | | | | | | | | |
| Real estate - commercial and construction | | | -- | | | | -- | | | $ | 545,040 | | | $ | 545,040 | | | $ | 545,040 | |
| Commercial and other loans | | $ | 481,706 | | | $ | 358,662 | | | | -- | | | | 481,706 | | | | 481,706 | |
| Total Impaired Loans | | $ | 481,706 | | | $ | 358,662 | | | $ | 545,040 | | | $ | 1,026,746 | | | $ | 1,026,746 | |
| December 31, 2010 | | Impaired Loans with Specific Allowance | | | | | | Total Impaired Loans | |
| | | | | | | | | | | | | | | Unpaid | |
| | | Recorded | | | Related | | | Recorded | | | Recorded | | | Principal | |
| | | Investment | | | Allowance | | | Investment | | | Investment | | | Balance | |
| | | | | | | | | | | | | | | | |
| Real estate - commercial and construction | | $ | 957,590 | | | $ | 131,765 | | | | -- | | | $ | 957,590 | | | $ | 957,590 | |
| Commercial and other loans | | | 639,218 | | | | 231,491 | | | | -- | | | | 639,218 | | | | 639,218 | |
| Total Impaired Loans | | $ | 1,596,808 | | | $ | 363,256 | | | | -- | | | $ | 1,596,808 | | | $ | 1,596,808 | |
The following table presents the average recorded investment in impaired loans and related interest income recognized for the year 2011 and 2010:
| | | 2011 | | | 2010 | |
| | | | | | | |
| Average Investment in impaired loans: | | | | | | |
| Real estate – commercial | | $ | 751,315 | | | $ | 969,209 | |
| Commercial loans | | | 494,612 | | | | 543,367 | |
Interest income recognized on an accrual basis on impaired loans: | | | | | | | | |
| Real estate - commercial | | $ | -- | | | $ | 71,163 | |
| Commercial loans | | | 32,581 | | | | 33,389 | |
Interest income recognized on a cash basis on impaired loans | | | -- | | | | -- | |
Total nonaccrual loans and the related interest for the years ended December 31 are as follows.
| | | 2011 | | | 2010 | | | 2009 | |
| Principal outstanding | | $ | 596,376 | | | $ | 107,402 | | | $ | -- | |
| Contractual interest due | | $ | 54,166 | | | $ | 3,524 | | | $ | -- | |
| Interest income recognized | | $ | -- | | | $ | -- | | | $ | -- | |
The following tables present loans that are troubled debt restructurings as of December 31, 2011 and 2010:
| | | | | | | | | | | | | | | Troubled Debt | |
| | | | | | | | | | | | | | | Restructurings that | |
| | | Troubled Debt | | | New Troubled Debt | | | Subsequently | |
| | | Restructurings at | | | Restructurings in | | | Defaulted during Prior | |
| December 31, 2011 | | Period End | | | YTD Period | | | Twelve Months | |
| | | Number of | | | Recorded | | | Number of | | | Recorded | | | Number of | | | Recorded | |
| | | Contracts | | | Investment | | | Contracts | | | Investment | | | Contracts | | | Investment | |
| | | | | | | | | | | | | | | | | | | |
| Real estate - residential and farm | | | -- | | | | -- | | | | -- | | | | -- | | | | -- | | | | -- | |
| Real estate - commercial and construction | | | -- | | | | -- | | | | -- | | | | -- | | | | -- | | | | -- | |
| Commercial and other loans | | | 4 | | | $ | 481,707 | | | | 1 | | | $ | 244,546 | | | | -- | | | | -- | |
| Consumer and credit card loans | | | 1 | | | | 1,231 | | | | 1 | | | | 1,231 | | | | -- | | | | -- | |
| Total | | | 5 | | | $ | 482,938 | | | | 2 | | | $ | 245,777 | | | | -- | | | | -- | |
| | | | | | | | | | | | | | | Troubled Debt | |
| | | | | | | | | | | | | | | Restructurings that | |
| | | Troubled Debt | | | New Troubled Debt | | | Subsequently | |
| | | Restructurings at | | | Restructurings in | | | Defaulted during Prior | |
| December 31, 2010 | | Period End | | | YTD Period | | | Twelve Months | |
| | | Number of | | | Recorded | | | Number of | | | Recorded | | | Number of | | | Recorded | |
| | | Contracts | | | Investment | | | Contracts | | | Investment | | | Contracts | | | Investment | |
| | | | | | | | | | | | | | | | | | | |
| Real estate - residential and farm | | | -- | | | | -- | | | | -- | | | | -- | | | | -- | | | | -- | |
| Real estate - commercial and construction | | | -- | | | | -- | | | | -- | | | | -- | | | | -- | | | | -- | |
| Commercial and other loans | | | 3 | | | $ | 283,205 | | | | 3 | | | $ | 292,482 | | | | -- | | | | -- | |
| Consumer and credit card loans | | | -- | | | | -- | | | | -- | | | | -- | | | | -- | | | | -- | |
| Total | | | 3 | | | $ | 283,205 | | | | 3 | | | $ | 292,482 | | | | -- | | | | -- | |
Management uses an eight point internal risk rating system to monitor the credit quality of the overall loan portfolio. The first four categories are considered not criticized, and are aggregated as “Pass” rated. The criticized rating categories utilized by management generally follow bank regulatory definitions. The Special Mention category includes assets that are currently protected but are potentially weak, resulting in an undue and unwarranted credit risk, but not to the point of justifying a Substandard classification. Loans in the Substandard category have well-defined weaknesses that jeopardize the liquidation of the debt, and have a distinct possibility that some loss will be sustained if the weaknesses are not corrected. All loans greater than 90 days past due are considered Substandard. Any portion of a loan that has been charged off is placed in the Loss category.
To help ensure that risk ratings are accurate and reflect the present and future capacity of borrowers to repay a loan as agreed, the Bank has a structured loan rating process with several layers of internal and external oversight. Generally, consumer and residential mortgage loans are included in the Pass categories unless a specific action, such as bankruptcy, repossession, or death occurs to raise awareness of a possible credit event. The Bank’s Commercial Loan Officers are responsible for the timely and accurate risk rating of the loans in their portfolios at origination and on an ongoing basis. The Credit Department performs an annual review of all commercial relationships $250,000 or greater. Confirmation of the appropriate risk grade is included in the review on an ongoing basis. The Bank has an experienced Loan Review Department that continually reviews and assesses loans within the portfolio. The Bank engages an external consultant to conduct loan reviews on at least an annual basis. Generally, the external consultant reviews commercial relationships greater than $250,000 and all criticized relationships. Detailed reviews, including plans for resolution, are performed on loans classified as Substandard on a quarterly basis. Loans in the Special Mention and Substandard categories that are collectively evaluated for impairment are given separate consideration in the determination of the allowance.
The following table presents the classes of the loan portfolio summarized by the aggregate Pass and the criticized categories of Special Mention, Substandard and Doubtful within the internal risk rating system as of December 31, 2011 and 2010. Included in the Pass category are loans that have not been individually reviewed and graded on an annual basis.
| | | | | | Special | | | | | | | | | | |
| December 31, 2011 | | Pass | | | Mention | | | Substandard | | | Doubtful | | | Total | |
| | | | | | | | | | | | | | | | |
| Real estate - residential and farm | | $ | 105,915,706 | | | $ | 1,001,602 | | | $ | 1,694,362 | | | | -- | | | $ | 108,611,670 | |
| Real estate - commercial and construction | | | 63,836,573 | | | | 3,199,901 | | | | 3,644,990 | | | | -- | | | | 70,681,464 | |
| Commercial and other loans | | | 40,045,424 | | | | 497,806 | | | | 999,124 | | | $ | 124,271 | | | | 41,666,625 | |
| Consumer and credit card loans | | | 5,798,288 | | | | 42,142 | | | | 24,764 | | | | -- | | | | 5,865,194 | |
| Total | | $ | 215,595,991 | | | $ | 4,741,451 | | | $ | 6,363,240 | | | $ | 124,271 | | | $ | 226,824,953 | |
| | | | | | Special | | | | | | | | | | |
| December 31, 2010 | | Pass | | | Mention | | | Substandard | | | Doubtful | | | Total | |
| | | | | | | | | | | | | | | | |
| Real estate - residential and farm | | $ | 94,542,356 | | | $ | 1,392,351 | | | $ | 1,496,350 | | | | -- | | | $ | 97,431,057 | |
| Real estate - commercial and construction | | | 50,610,705 | | | | 6,559,073 | | | | 4,547,004 | | | | -- | | | | 61,716,782 | |
| Commercial and other loans | | | 39,304,012 | | | | 688,352 | | | | 1,803,409 | | | $ | 135,369 | | | | 41,931,142 | |
| Consumer and credit card loans | | | 6,808,388 | | | | 42,215 | | | | 15,805 | | | | -- | | | | 6,866,408 | |
| Total | | $ | 191,265,461 | | | $ | 8,681,991 | | | $ | 7,862,568 | | | $ | 135,369 | | | $ | 207,945,389 | |
Management further monitors the performance and credit quality of the loan portfolio by analyzing the age of the portfolio as determined by the length of time a recorded payment is past due. The following table presents the classes of the loan portfolio summarized by the aging categories of performing loans and nonaccrual loans as of December 31, 2011 and 2010:
| December 31, 2011 | | Current | | | | | | | | | | | | | | | | | | Total Loans | |
| | | | | | | | | | | | | | | | | | | | | | |
| Real estate – residential and farm | | $ | 108,388,429 | | | $ | 102,095 | | | $ | 82,371 | | | | -- | | | $ | 184,466 | | | $ | 38,775 | | | $ | 108,611,670 | |
| Real estate – commercial and construction | | | 70,136,424 | | | | -- | | | | -- | | | | -- | | | | -- | | | | 545,040 | | | | 70,681,464 | |
| Commercial and other loans | | | 41,584,712 | | | | 67,892 | | | | 3,274 | | | | -- | | | | 71,166 | | | | 10,747 | | | | 41,666,625 | |
| Consumer and credit card loans | | | 5,848,336 | | | | 10,250 | | | | 4,278 | | | $ | 516 | | | | 15,044 | | | | 1,814 | | | | 5,865,194 | |
| Total | | $ | 225,957,901 | | | $ | 180,237 | | | $ | 89,923 | | | $ | 516 | | | $ | 270,676 | | | $ | 596,376 | | | $ | 226,824,953 | |
| December 31, 2010 | | Current | | | | | | | | | | | | | | | | | | Total Loans | |
| | | | | | | | | | | | | | | | | | | | | | |
| Real estate – residential and farm | | $ | 97,253,887 | | | $ | 53,829 | | | $ | 15,939 | | | | -- | | | $ | 69,768 | | | $ | 107,402 | | | $ | 97,431,057 | |
| Real estate – commercial and construction | | | 60,618,420 | | | | 1,098,362 | | | | | | | | -- | | | | 1,098,362 | | | | -- | | | | 61,716,782 | |
| Commercial and other loans | | | 41,734,675 | | | | 178,788 | | | | 17,679 | | | | -- | | | | 196,467 | | | | -- | | | | 41,931,142 | |
| Consumer and credit card loans | | | 6,858,090 | | | | 5,585 | | | | 1,055 | | | $ | 1,678 | | | | 8,318 | | | | -- | | | | 6,866,408 | |
| Total | | $ | 206,465,072 | | | $ | 1,336,564 | | | $ | 34,673 | | | $ | 1,678 | | | $ | 1,372,915 | | | $ | 107,402 | | | $ | 207,945,389 | |
The Bank entered into transactions with certain directors, executive officers, significant stockholders, and their affiliates. A summary of loan activity for those directors, executive officers, and their associates with loan balances in excess of $60,000 for the year ended December 31, 2011 is as follows:
| | Balance | | | | | Amounts | | | Balance | |
| | December 31, 2010 | | Additions | | | Collected | | | December 31, 2011 | |
| | | | | | | | | | | |
| | $3,494,309 | | | $875,996 | | | | $1,499,508 | | | | $2,870,797 | |
| 4. | ALLOWANCE FOR LOAN LOSSES |
An allowance for loan losses (“ALL”) is maintained to absorb losses from the loan portfolio. The ALL is based on management’s continuing evaluation of the risk characteristics and credit quality of the loan portfolio, assessment of current economic conditions, diversification and size of the portfolio, adequacy of collateral, past and anticipated loss experience, and the amount of non-performing loans.
The Bank’s methodology for determining the ALL is based on the requirements of ASC Section 310-10-35 for loans individually evaluated for impairment (discussed above) and ASC Subtopic 450-20 for loans collectively evaluated for impairment, as well as the Interagency Policy Statements on the Allowance for Loan and Lease Losses and other bank regulatory guidance. The total of the two components represents the Bank’s ALL.
Loans that are collectively evaluated for impairment are analyzed with general allowances being made as appropriate. For general allowances, historical loss trends are used in the estimation of losses in the current portfolio. These historical loss amounts are modified by other qualitative factors.
| 4. | ALLOWANCE FOR LOAN LOSSES (CONTINUED) |
The classes described above provide the starting point for the ALL analysis. Management tracks the historical net charge-off activity for each class. A historical charge-off factor is calculated for each class utilizing a rolling 12 quarters.
“Pass” rated credits are segregated from “Criticized” credits for the application of qualitative factors. Management has identified a number of qualitative factors which it uses to supplement the historical charge-off factor because these factors are likely to cause estimated credit losses associated with the existing loan pools to differ from historical loss experience. The factors that are evaluated quarterly and updated using information obtained from internal, regulatory, and governmental sources are: national and local economic trends and conditions; levels of and trends in delinquency rates and non-accrual loans; trends in volumes and terms of loans; effects of changes in lending policies; experience, ability, and depth of lending staff; value of underlying collateral; and concentrations of credit from a loan type, industry and/or geographic standpoint.
Management reviews the loan portfolio on a quarterly basis using a defined, consistently applied process in order to make appropriate and timely adjustments to the ALL. When information confirms all or part of specific loans to be uncollectible, these amounts are promptly charged off against the ALL.
An analysis of the change in the allowance for loan losses follows:
| | | 2011 | | | 2010 | | | 2009 | |
| Balance, January 1 | | $ | 2,665,607 | | | $ | 2,441,169 | | | $ | 2,525,202 | |
| Add: | | | | | | | | | | | | |
| Provision charged to operations | | | -- | | | | 215,182 | | | | 2,000 | |
| Loan recoveries | | | 26,842 | | | | 69,651 | | | | 46,811 | |
| Less: Loans charged off | | | (417,273 | ) | | | (60,395 | ) | | | (132,844 | ) |
| Balance, December 31 | | $ | 2,275,176 | | | $ | 2,665,607 | | | $ | 2,441,169 | |
The following tables summarize the primary segments of the ALL, segregated into the amount required for loans individually evaluated for impairment and the amount required for loans collectively evaluated for impairment as of December 31, 2011 and 2010. Activity in the allowance is presented for the twelve months ended December 31, 2011 and 2010:
| | | Real Estate | | | Real Estate | | | Commercial | | | Consumer | | | | |
| | | Residential | | | Commercial | | | and | | | and | | | | |
| December 31, 2011 | | and Farm | | | and Construction | | | Other Loans | | | Credit Cards | | | Total | |
| | | | | | | | | | | | | | | | |
| Allowance for Loan Losses: | | | | | | | | | | | | | | | |
| Beginning Balance | | $ | 671,646 | | | $ | 985,042 | | | $ | 954,526 | | | $ | 54,393 | | | $ | 2,665,607 | |
| Charge-offs | | | (19,095 | ) | | | (392,830 | ) | | | -- | | | | (5,348 | ) | | | (417,273 | ) |
| Recoveries | | | 67 | | | | 3,600 | | | | 20,591 | | | | 2,584 | | | | 26,842 | |
| Provision | | | 21,287 | | | | 20,969 | | | | (42,256 | ) | | | -- | | | | -- | |
| Ending Balance | | $ | 673,905 | | | $ | 616,781 | | | $ | 932,861 | | | $ | 51,629 | | | $ | 2,275,176 | |
| | | | | | | | | | | | | | | | | | | | | |
Ending Balance: individually evaluated for impairment | | $ | 0 | | | $ | 0 | | | $ | 358,662 | | | $ | 0 | | | $ | 358,662 | |
| | | | | | | | | | | | | | | | | | | | | |
Ending Balance: collectively evaluated for impairment | | $ | 673,905 | | | $ | 616,781 | | | $ | 574,199 | | | $ | 51,629 | | | $ | 1,916,514 | |
| 4. | ALLOWANCE FOR LOAN LOSSES (CONTINUED) |
| | | Real Estate | | | Real Estate | | | Commercial | | | Consumer | | | | |
| | | Residential | | | Commercial | | | and | | | and | | | | |
| December 31, 2010 | | and Farm | | | and Construction | | | Other Loans | | | Credit Cards | | | Total | |
| | | | | | | | | | | | | | | | |
| Allowance for Loan Losses: | | | | | | | | | | | | | | | |
| Beginning Balance | | $ | 904,967 | | | $ | 646,940 | | | $ | 793,020 | | | $ | 96,242 | | | $ | 2,441,169 | |
| Charge-offs | | | (50,214 | ) | | | -- | | | | -- | | | | (10,181 | ) | | | (60,395 | ) |
| Recoveries | | | 563 | | | | 44,345 | | | | 18,470 | | | | 6,273 | | | | 69,651 | |
| Provision | | | (183,670 | ) | | | 293,757 | | | | 143,036 | | | | (37,941 | ) | | | 215,182 | |
| Ending Balance | | $ | 671,646 | | | $ | 985,042 | | | $ | 954,526 | | | $ | 54,393 | | | $ | 2,665,607 | |
| | | | | | | | | | | | | | | | | | | | | |
Ending Balance: individually evaluated for impairment | | $ | 0 | | | $ | 131,765 | | | $ | 231,491 | | | $ | 0 | | | $ | 363,256 | |
| | | | | | | | | | | | | | | | | | | | | |
Ending Balance: collectively evaluated for impairment | | $ | 671,646 | | | $ | 853,277 | | | $ | 723,035 | | | $ | 54,393 | | | $ | 2,302,351 | |
The allowance for loan losses is based on estimates, and actual losses will vary from current estimates. Management believes that the breakdown of the homogeneous pools and the related historical loss ratios and other qualitative factors, as well as the consistency in the application of assumptions, result in an ALL that is representative of the risk found in the components of the portfolio at any given date.
| 5. | PREMISES AND EQUIPMENT |
Premises and equipment are summarized as follows:
| | | 2011 | | | 2010 | |
| Land and improvements | | $ | 1,773,152 | | | $ | 1,822,652 | |
| Building and improvements | | | 5,585,438 | | | | 5,748,286 | |
| Leasehold improvements | | | 78,761 | | | | 78,761 | |
| Furniture, fixtures and equipment | | | 3,663,764 | | | | 3,638,390 | |
| | | | 11,101,115 | | | | 11,288,089 | |
| Less accumulated depreciation | | | (5,640,521 | ) | | | (5,536,549 | ) |
| Total | | $ | 5,460,594 | | | $ | 5,751,540 | |
Depreciation expense charged to operations was $293,000 for 2011, $329,000 for 2010, and $392,000 for 2009.
As of December 31, 2011 and 2010, goodwill had a gross carrying amount of $1.6 million and an accumulated amortization amount of $0.3 million resulting in a net carrying value of $1.3 million.
The carrying value of goodwill was tested for impairment in the fourth quarter of 2011 per Accounting Standards Update 2011-08, Intangibles – Goodwill and Other Topics (Topic 350), Testing Goodwill for Impairment issued in September 2011. The Company assessed relevant events and circumstances that occurred during 2011 such as macroeconomic conditions in the U.S., industry and market considerations, overall financial performance and other relevant Bank-specific events. Based on this analysis, it was determined that it was not more likely than not that the fair value of the reporting unit was less than its carrying amount, therefore no goodwill impairment loss was recognized.
Time deposits include certificates of deposit in denominations of $100,000 or more. Such deposits aggregated $81.5 million and $76.5 million at December 31, 2011 and 2010, respectively.
Interest expense on certificates of deposit $100,000 and over amounted to $1.5 million in 2011, $1.5 million in 2010, and $1.5 million in 2009.
The following table sets forth the remaining maturity of time certificates of deposits of $100,000 or more at December 31, 2011.
| 3 months or less | | $ | 11,765,647 | |
| Over 3 through 6 months | | | 9,508,364 | |
| Over 6 through 12 months | | | 17,372,460 | |
| Over 12 months | | | 42,865,800 | |
| Total | | $ | 81,512,271 | |
The following table sets forth the remaining maturity of all time deposits at December 31, 2011.
| 12 month or less | | $ | 86,615,773 | |
| 12 months through 24 months | | | 33,015,092 | |
| 24 months through 36 months | | | 16,956,540 | |
| 36 months through 48 months | | | 19,458,324 | |
| 48 months through 60 months | | | 15,755,933 | |
| Over 60 months | | | 4,374 | |
| | | $ | 171,806,036 | |
Short-term borrowings consist of securities sold under agreements to repurchase. These retail repurchase agreements are with customers in the Company’s respective market areas. These borrowings are collateralized with securities owned by the Company and held in their safekeeping account at an independent correspondent bank. The outstanding balances and related information for short-term borrowings are summarized as follows:
| | | 2011 | | | 2010 | |
| Short-term borrowings: | | | | | | |
| Ending balance | | $ | 945,000 | | | $ | 3,585,000 | |
| Maximum month-end balance during the year | | | 3,470,000 | | | | 5,020,000 | |
| Average month-end balance during the year | | | 2,632,000 | | | | 4,065,000 | |
| Weighted average rate at year end | | | 0.23 | % | | | 0.23 | % |
| Weighted average rate during the year | | | 0.23 | % | | | 0.23 | % |
The Company has pledged investment securities with carrying values of $4.1 million and $4.0 million as of December 31, 2011 and 2010, respectively, as collateral for the repurchase agreements.
| 9. | FEDERAL HOME LOAN BANK ADVANCES |
The Federal Home Loan Bank advances have monthly principal and interest payments due with maturity dates from 2012 through 2017. The weighted average rate paid on the advances is 6.36%. The scheduled aggregate minimum future principal payments on the advances outstanding as of December 31, 2011 are as follows:
| Year Ending December 31, | | Amount | |
| 2012 | | $ | 188,555 | |
| 2013 | | | 85,347 | |
| 2014 | | | 66,086 | |
| 2015 | | | 58,465 | |
| 2016 | | | 16,079 | |
| 2017 | | | 1,244 | |
| Total | | $ | 415,776 | |
The Bank maintains a credit arrangement with Federal Home Loan Bank of Cincinnati, Ohio (“FHLB”). The FHLB borrowings, when used, are collateralized by the Bank’s investment in Federal Home Loan Bank stock and a blanket collateral pledge agreement with the FHLB under which the Bank has pledged certain qualifying assets equal to 150 percent of the unpaid amount of the outstanding balances. At December 31, 2011, the Bank had additional borrowing capacity under the FHLB agreement of approximately $38.2 million.
| 10. | EMPLOYEE BENEFIT PLAN |
The Bank maintains a profit sharing pension plan which is integrated with a 401(k) plan. The plan covers substantially all employees who are 21 and have one year’s service.
Under the profit sharing pension plan contribution formula, the Bank, for each plan year, will contribute an amount equal to 8% of an employee’s compensation for the plan year and 5.7% of the amount of an employee’s excess compensation for the plan year. Excess compensation is a participant’s compensation in excess of the designated integration level. This designated integration level is 100% of the taxable wage base in effect at the beginning of the plan year. The federal government annually adjusts the taxable wage base. This plan does not permit nor require employees to make contributions to the plan.
The 401(k) plan allows employees to make salary reduction contributions to the plan up to the annual limit established by the IRS. For each plan year, the Bank may contribute to the plan an amount of matching contributions for a particular plan year. The Bank may choose not to make matching contributions for a particular plan year. For 2011 and 2010 the Bank matched 25% of the employees’ voluntary contributions up to 1% of the employee’s compensation.
The pension costs charged to operating expense for the years 2011, 2010 and 2009 amounted to $360,000, $337,000, and $352,000, respectively.
| 11. | OTHER OPERATING EXPENSE |
Other operating expense included the following:
| | | 2011 | | | 2010 | | | 2009 | |
| Professional fees | | $ | 122,114 | | | $ | 142,641 | | | $ | 146,142 | |
| Franchise tax | | | 533,251 | | | | 526,623 | | | | 522,588 | |
| Insurance and Bond Expense | | | 377,528 | | | | 452,524 | | | | 603,360 | |
| Telephone | | | 130,932 | | | | 120,009 | | | | 124,123 | |
| Stationery, supplies and printing | | | 136,996 | | | | 148,713 | | | | 146,555 | |
| Postage, express and freight | | | 220,760 | | | | 206,703 | | | | 202,223 | |
| Data processing | | | 232,196 | | | | 208,128 | | | | 204,683 | |
| Examination and Audit | | | 160,126 | | | | 153,298 | | | | 229,509 | |
| Other | | | 928,938 | | | | 901,750 | | | | 893,270 | |
| Total | | $ | 2,842,841 | | | $ | 2,860,389 | | | $ | 3,072,453 | |
The Bank leases the space housing the branch located in Berlin, Ohio. The lease expires in three years, with an option to automatically renew for an additional ten year period. Minimum future rental payments are as follows:
| Less than 1 year | | $ | 20,458 | |
| 1 to 3 years | | | 27,962 | |
| | | $ | 48,420 | |
The provision for federal income taxes for the years ended December 31 consist of:
| | | 2011 | | | 2010 | | | 2009 | |
| Current payable | | $ | 496,672 | | | $ | 788,813 | | | $ | 818,542 | |
| Deferred | | | 108,124 | | | | (275,750 | ) | | | 16,901 | |
| Total provision | | $ | 604,796 | | | $ | 513,063 | | | $ | 835,443 | |
The following is a reconciliation between the Company’s provision for federal income taxes and the amount of income taxes computed at the 34% statutory rate in effect for all years presented.
| | | 2011 | | | 2010 | | | 2009 | |
| | | Amount | | | % of Pre-Tax Income | | | Amount | | | % of Pre-Tax Income | | | Amount | | | % of Pre- Tax Income | |
| Provision at statutory rate | | $ | 1,183,000 | | | | 34.0 | % | | $ | 1,187,463 | | | | 34.0 | % | | $ | 1,349,934 | | | | 34.0 | % |
| Tax exempt income | | | (602,656 | ) | | | (17.3 | ) | | | (675,888 | ) | | | (19.4 | ) | | | (567,467 | ) | | | (14.3 | ) |
Non-deductible interest Expense | | | 28,573 | | | | 0.8 | | | | 40,853 | | | | 1.2 | | | | 42,271 | | | | 1.1 | |
| Other, net | | | (4,121 | ) | | | (0.1 | ) | | | (39,365 | ) | | | (1.1 | ) | | | 10,705 | | | | 0.3 | |
| Tax expense and effective rate | | $ | 604,796 | | | | 17.4 | % | | $ | 513,063 | | | | 14.7 | % | | $ | 835,443 | | | | 21.1 | % |
The tax effects of deductible and taxable temporary differences that gave rise to significant portions of the net deferred tax assets and liabilities at December 31 are as follows:
| | | 2011 | | | 2010 | |
| Deferred Tax Assets: | | | | | | |
| Allowance for loan losses | | $ | 575,428 | | | $ | 708,277 | |
| Net unrealized loss on securities | | | -- | | | | 202,942 | |
| Other | | | 166,189 | | | | 327,745 | |
| Deferred tax asset | | | 741,617 | | | | 1,238,964 | |
| Deferred Tax Liabilities: | | | | | | | | |
| Premise and equipment | | | 230,333 | | | | 233,102 | |
| Stock dividends | | | 243,814 | | | | 243,814 | |
| Net unrealized gain on securities | | | 49,686 | | | | -- | |
| Other, net | | | 4,128 | | | | 6,423 | |
| Deferred tax liabilities | | $ | 527,961 | | | $ | 483,339 | |
| Net deferred tax assets | | $ | 213,656 | | | $ | 755,625 | |
No valuation allowance was established at December 31, 2011 in view of certain tax strategies coupled with the anticipated future taxable income as evidenced by the company’s earnings potential.
| 14. | COMMITMENTS AND CONTINGENT LIABILITIES |
Commitments
In the normal course of business, the Company has outstanding commitments and contingent liabilities, such as commitments to extend credit and standby letters of credit, which are not included in the accompanying consolidated financial statements. The Company’s exposure to credit loss in the event of nonperformance by the other party to the financial instruments for commitments to extend credit and standby letters of credit is represented by the contractual or notional amount of those instruments. The Company uses the same credit policies in making such commitments as it does for instruments that are included in the consolidated balance sheet.
These commitments were comprised of the following at December 31:
| | | 2011 | | | 2010 | |
| Commitments to extend credit | | $ | 51,258,000 | | | $ | 42,833,000 | |
| Standby letters of credit | | | 834,000 | | | | 1,185,000 | |
| Total | | $ | 52,092,000 | | | $ | 44,018,000 | |
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 by the Company upon extension of credit, is based on management’s credit evaluation. Collateral held varies but may include accounts receivable, inventory, property and equipment, and income-producing commercial properties.
Standby letters of credit are conditional commitments issued by the Company to guarantee the performance of a customer to a third party. Standby letters of credit generally have fixed expiration dates or other termination clauses and may require payment of a fee. The fees earned from issuance of letters are recognized at the origination of the coverage period. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. The Company’s policy for obtaining collateral, and the nature of such collateral, is essentially the same as that involved in making commitments to extend credit.
The Company has not been required to perform any financial guarantees during the past two years. The Company has not incurred any losses on its commitments in 2011, 2010 or 2009.
Contingent Liabilities
The Company and its subsidiary are subject to claims and lawsuits which arise primarily in the ordinary course of business. It is the opinion of management that the disposition or ultimate resolution of such claims and lawsuits will not have a material adverse effect on the consolidated financial position of the Company.
The approval of regulatory authorities is required if the total of all dividends declared by the Bank in any calendar year exceeds net profits as defined for that year combined with its retained net profits for the two preceding calendar years less any required transfers to surplus. Under this formula, the amount available for payment of dividends by the Bank to the Company at December 31, 2011, without the approval of the regulatory authorities is $3.0 million.
Included in cash and due from banks are required federal reserves of $4.8 million and $4.1 million at December 31, 2011 and 2010, respectively, for facilitating the implementation of monetary policy by the Federal Reserve System. The required reserves are computed by applying prescribed ratios to the classes of average deposit balances. These are held in the form of cash on hand and/or balances maintained directly with the Federal Reserve Bank.
| 15. | REGULATORY MATTERS (CONTINUED) |
Federal law prevents the Company from borrowing from the Bank unless the loans are secured by specific obligations. Further, such secured loans are limited in amount to ten percent of the Bank’s capital. The Company had no such borrowings at December 31, 2011 and 2010.
| 16. | REGULATORY CAPITAL REQUIREMENTS |
Federal regulations require the Company and the Bank to maintain minimum amounts of capital. Specifically, each is required to maintain certain minimum dollar amounts and ratios of Total and Tier I capital to risk-weighted assets and of Tier I capital to average total assets.
In addition to the capital requirements, the Federal Deposit Insurance Corporation Improvement Act (“FDICIA”) established five capital categories ranging from “well-capitalized” to “critically undercapitalized.” Should any institution fail to meet the requirements to be considered “adequately capitalized,” it would become subject to a series of increasingly restrictive regulatory actions.
As of December 31, 2011 and 2010, the FDIC categorized the Bank as well-capitalized under the regulatory framework for prompt corrective action. To be classified as a well-capitalized financial institution, Total risk-based, Tier I risk-based, and Tier I Leverage capital ratios must be at least ten percent, six percent, and five percent, respectively. There have been no conditions or events since notification that management believes have changed this category.
The Company’s actual capital ratios are presented in the following table, which shows the Company met all regulatory capital requirements. The capital position of the Bank does not differ significantly from the Company’s.
| Amounts expressed in thousands | | 2011 | | | 2010 | |
| | | Amount | | | Ratio | | | Amount | | | Ratio | |
| Total Risk Based Capital (to Risk Weighted Assets) | | | | | | | | | | | | |
| Actual | | $ | 45,771 | | | | 18.00 | % | | $ | 45,400 | | | | 19.61 | % |
| For Capital Adequacy Purposes | | | 20,344 | | | | 8.00 | | | | 18,518 | | | | 8.00 | |
| To be well-capitalized | | | 25,430 | | | | 10.00 | | | | 23,148 | | | | 10.00 | |
| Tier 1 Capital (to Risk Weighted Assets) | | | | | | | | | | | | | | | | |
| Actual | | | 43,496 | | | | 17.10 | % | | | 42,734 | | | | 18.46 | % |
| For Capital Adequacy Purposes | | | 10,172 | | | | 4.00 | | | | 9,259 | | | | 4.00 | |
| To be well-capitalized | | | 15,258 | | | | 6.00 | | | | 13,889 | | | | 6.00 | |
| Tier 1 Capital (to Average Assets) | | | | | | | | | | | | | | | | |
| Actual | | | 43,496 | | | | 9.98 | % | | | 42,734 | | | | 10.58 | % |
| For Capital Adequacy Purposes | | | 17,427 | | | | 4.00 | | | | 16,160 | | | | 4.00 | |
| To be well-capitalized | | | 21,784 | | | | 5.00 | | | | 20,200 | | | | 5.00 | |
| 17. | FAIR VALUE MEASUREMENTS |
| | The Company utilizes a hierarchal disclosure framework associated with the level of pricing observability utilized in measuring assets and liabilities at fair value. The three broad levels defined under the literature are as follows: |
| Level I: | | Quoted prices are available in active markets for identical assets or liabilities as of the reported date. |
| | | |
| Level II: | | Pricing inputs are other than quoted prices in active markets, which are either directly or indirectly observable as of the reported date. The nature of these assets and liabilities include items for which quoted prices are available but traded less frequently, and items that are fair valued using other financial instruments, the parameters of which can be directly observed. |
| | | |
| Level III: | | Assets and liabilities that have little to no pricing observability as of the reported date. These items do not have two-way markets and are measured using management’s best estimate of fair value, where the inputs into the determination of fair value require significant management judgment or estimation. |
| | The following table presents the assets reported on the consolidated statements of financial condition at their fair value as of December 31, 2011 and 2010 by level within the fair value hierarchy. As required by the current accounting guidance, financial assets are classified in their entirety based on the lowest level of input that is significant to the fair value measurement. |
| | | December 31, 2011 | |
| | | Level I | | | Level II | | | Level III | | | Total | |
| | | (In thousands) | |
| Assets measured on a recurring basis: | | | | | | | | | | | | |
| Securities available for sale: | | | | | | | | | | | | |
| U.S. Government and Agency Obligations | | $ | -- | | | $ | 97,599 | | | $ | -- | | | $ | 97,599 | |
| Mutual Funds | | | -- | | | | 503 | | | | -- | | | | 503 | |
| | | | | | | | | | | | | | | | | |
| Assets measured on a nonrecurring basis: | | | | | | | | | | | | | | | | |
| Impaired loans | | | -- | | | | -- | | | $ | 668 | | | $ | 668 | |
| | | December 31, 2010 | |
| | | Level I | | | Level II | | | Level III | | | Total | |
| | | (In thousands) | |
| Assets measured on a recurring basis: | | | | | | | | | | | | |
| Securities available for sale: | | | | | | | | | | | | |
| U.S. Government and Agency Obligations | | $ | -- | | | $ | 75,486 | | | $ | -- | | | $ | 75,486 | |
| Mutual Funds | | | -- | | | | 559 | | | | -- | | | | 559 | |
| | | | | | | | | | | | | | | | | |
| Assets measured on a nonrecurring basis: | | | | | | | | | | | | | | | | |
| Impaired loans | | | -- | | | | -- | | | $ | 1,234 | | | $ | 1,234 | |
| 18. | FAIR VALUE DISCLOSURE OF FINANCIAL INSTRUMENTS |
The carrying amounts and estimated fair values at December 31 are as follows:
| | | 2011 | | | 2010 | |
| | | Carrying Amount | | | Fair Value | | | Carrying Amount | | | Fair Value | |
| | | (In thousands) | |
| Financial assets: | | | |
| Cash and due from depository institutions | | $ | 51,528 | | | $ | 51,528 | | | $ | 61,711 | | | $ | 61,711 | |
| Federal funds sold | | | 3,168 | | | | 3,168 | | | | 4,713 | | | | 4,713 | |
| Securities available for sale | | | 98,102 | | | | 98,102 | | | | 76,045 | | | | 76,045 | |
| Securities held to maturity | | | 41,040 | | | | 43,834 | | | | 39,332 | | | | 40,482 | |
| Loans | | | 224,333 | | | | 235,528 | | | | 205,075 | | | | 213,729 | |
| Loans held for sale | | | -- | | | | -- | | | | 320 | | | | 320 | |
| Accrued interest receivable | | | 1,121 | | | | 1,121 | | | | 1,165 | | | | 1,165 | |
| Regulatory stock | | | 1,884 | | | | 1,884 | | | | 1,884 | | | | 1,884 | |
| Bank-owned life insurance (“BOLI”) | | | 7,449 | | | | 7,449 | | | | 5,727 | | | | 5,727 | |
| Financial liabilities: | | | | | | | | | | | | | | | | |
| Deposits | | $ | 389,063 | | | $ | 393,054 | | | $ | 356,189 | | | $ | 359,687 | |
| Short term borrowings | | | 945 | | | | 945 | | | | 3,585 | | | | 3,585 | |
| Federal Home Loan Bank advances | | | 416 | | | | 483 | | | | 644 | | | | 755 | |
| Accrued interest payable | | | 160 | | | | 160 | | | | 185 | | | | 185 | |
| 18. | FAIR VALUE DISCLOSURE OF FINANCIAL INSTRUMENTS (CONTINUED) |
Financial instruments are defined as cash, evidence of ownership interest in an entity, or a contract which creates an obligation or right to receive or deliver cash or another financial instrument from/to a second entity on potentially favorable or unfavorable terms.
Fair value is defined as the amount at which a financial instrument could be exchanged in a current transaction between willing parties other than in a forced or liquidation sale. If a quoted market price is available for a financial instrument, the estimated fair value would be calculated based upon the market price per trading unit of the instrument.
If no readily available market exists, the fair value estimates for financial instruments should be based upon management’s judgment regarding current economic conditions, interest rate risk, expected cash flows, future estimated losses, and other factors as determined through various option pricing formulas or simulation modeling. As many of these assumptions result from judgments made by management based upon estimates which are inherently uncertain, the resulting estimated fair values may not be indicative of the amount realizable in the sale of a particular financial instrument. In addition, changes in assumptions on which the estimated fair values are based may have a significant impact on the resulting estimated fair values.
As certain assets and liabilities such as deferred tax assets and liabilities, premises and equipment and many other operational elements of the Company, are not considered financial instruments, but have value, this estimated fair value of financial instruments would not represent the full market value of the Company.
The Company employed simulation modeling in determining the estimated fair value of financial instruments for which quoted market prices were not available based upon the following assumptions:
Cash and Due from Depository Institutions, Federal Funds Sold, Accrued Interest Receivable, Regulatory Stock, BOLI, Short-Term Borrowings, and Accrued Interest Payable
The fair value approximates the current carrying value.
Investment Securities and Loans Held for Sale
The fair value of investment securities and loans held for sale are equal to the available quoted market price. If no quoted market price is available, fair value is estimated using the quoted market price for similar securities.
Loans, Deposits, and Federal Home Loan Bank Advances
The fair value is estimated by discounting future cash flows using current market inputs at which loans with similar terms and qualities would be made to borrowers of similar credit quality. Where quoted market prices were available, primarily for certain residential mortgage loans, such market rates were utilized as estimates for fair value. Demand, savings, and money market deposit accounts are valued at the amount payable on demand as of year end. The fair values of certificates of deposit and other borrowed funds are based on the discounted value of contractual cash flows. The discount rates are estimated using rates currently offered for similar instruments with similar remaining maturities.
Commitments to Extend Credit and Standby Letters of Credit
These financial instruments are generally not subject to sale, and estimated fair values are not readily available. The carrying value, represented by the net deferred fee arising from the unfunded commitment or letter of credit, and the fair value, determined by discounting the remaining contractual fee over the term of the commitment using fees currently charged to enter into similar agreements with similar credit risk, are not considered material for disclosure. The contractual amounts of unfunded commitments and letters of credit are presented previously in the commitments and contingent liabilities note.
The following are parent company only condensed financial statements:
CONDENSED BALANCE SHEET
| | | December 31, | |
| | | 2011 | | | 2010 | |
| ASSETS | | | | | | |
| Cash | | $ | 306,612 | | | $ | 250,511 | |
| Investment in Bank | | | 44,299,252 | | | | 42,769,534 | |
| Investments – available for sale | | | 503,194 | | | | 558,988 | |
| Deferred tax asset | | | 168,914 | | | | 149,944 | |
| Total assets | | $ | 45,277,972 | | | $ | 43,728,977 | |
| LIABILITIES AND SHAREHOLDERS’ EQUITY | | | | | | | | |
| Dividend checks outstanding | | $ | 55,141 | | | $ | 49,287 | |
| Shareholders’ equity | | | 45,222,831 | | | | 43,679,690 | |
| Total liabilities and shareholders’ equity | | $ | 45,277,972 | | | $ | 43,728,977 | |
CONDENSED STATEMENT OF INCOME
| | | Year Ended December 31, | |
| | | 2011 | | | 2010 | | | 2009 | |
| INCOME | | | | | | | | | |
| Dividends from Bank | | $ | 2,225,000 | | | $ | 1,950,000 | | | $ | 2,300,000 | |
| Operating expenses | | | 93,223 | | | | 65,586 | | | | 63,203 | |
| Impairment loss | | | -- | | | | 456,585 | | | | -- | |
| Income before income tax benefit | | | 2,131,777 | | | | 1,427,829 | | | | 2,236,797 | |
| Income tax benefit | | | (31,407 | ) | | | (177,181 | ) | | | (21,472 | ) |
| Income before equity in undistributed net income of subsidiary | | | 2,163,184 | | | | 1,605,010 | | | | 2,258,269 | |
| Equity in undistributed net income of Bank | | | 711,432 | | | | 1,374,466 | | | | 876,683 | |
| NET INCOME | | $ | 2,874,616 | | | $ | 2,979,476 | | | $ | 3,134,952 | |
| 19. | PARENT COMPANY (CONTINUED) |
CONDENSED STATEMENT OF CASH FLOWS
| | | Year Ended December 31, | |
| | | 2011 | | | 2010 | | | 2009 | |
| OPERATING ACTIVITIES | | | | | | | | | |
| Net income | | $ | 2,874,616 | | | $ | 2,979,476 | | | $ | 3,134,952 | |
| Adjustments to reconcile net income to net cash provided by operating activities: | | | | | | | | | |
| Equity in undistributed net income of subsidiary | | | (711,432 | ) | | | (1,374,466 | ) | | | (876,683 | ) |
| Impairment loss on securities | | | -- | | | | 456,585 | | | | - | |
| Increase in other assets | | | -- | | | | (155,239 | ) | | | - | |
| Increase (decrease) in other liabilities | | | 5,854 | | | | (18,223 | ) | | | (9,941 | ) |
| Net cash provided by operating activities | | | 2,169,038 | | | | 1,888,133 | | | | 2,248,328 | |
| INVESTING ACTIVITIES | | | | | | | | | | | | |
| Net cash used in investing activities | | | -- | | | | -- | | | | -- | |
| FINANCING ACTIVITIES | | | | | | | | | | | | |
| Purchase of treasury shares | | | (237,919 | ) | | | (81,967 | ) | | | (527,146 | ) |
| Dividends paid | | | (1,875,018 | ) | | | (1,880,953 | ) | | | (1,853,242 | ) |
| Net cash used in financing activities | | | (2,112,937 | ) | | | (1,962,920 | ) | | | (2,380,388 | ) |
| INCREASE (DECREASE) IN CASH | | | 56,101 | | | | (74,787 | ) | | | (132,060 | ) |
| CASH AT BEGINNING OF YEAR | | | 250,511 | | | | 325,298 | | | | 457,358 | |
| CASH AT END OF YEAR | | $ | 306,612 | | | $ | 250,511 | | | $ | 325,298 | |
| 20. | SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED) (IN THOUSANDS EXCEPT PER SHARE DATA) |
| | | Three Months Ended | |
| | | March 2011 | | | June 2011 | | | September 2011 | | | December 2011 | |
| Total interest income | | $ | 3,550 | | | $ | 3,599 | | | $ | 3,683 | | | $ | 3,739 | |
| Total interest expense | | | 985 | | | | 979 | | | | 942 | | | | 906 | |
| Net interest income | | | 2,565 | | | | 2,620 | | | | 2,741 | | | | 2,833 | |
| Provision for loan losses | | | -- | | | | -- | | | | -- | | | | -- | |
| Net interest income after provision for loans losses | | | 2,565 | | | | 2,620 | | | | 2,741 | | | | 2,833 | |
| Total noninterest income | | | 353 | | | | 387 | | | | 653 | | | | 377 | |
| Total noninterest expense | | | 2,301 | | | | 2,255 | | | | 2,233 | | | | 2,260 | |
| Income before income taxes | | | 617 | | | | 752 | | | | 1,161 | | | | 950 | |
| Income taxes | | | 49 | | | | 122 | | | | 245 | | | | 189 | |
| Net income | | $ | 568 | | | $ | 630 | | | $ | 916 | | | $ | 761 | |
| Per share data: | | | | | | | | | | | | | | | | |
| Net earnings | | $ | 0.92 | | | $ | 1.02 | | | $ | 1.49 | | | $ | 1.24 | |
| Weighted average shares outstanding | | | 615,897 | | | | 615,712 | | | | 614,827 | | | | 613,804 | |
| 20. | SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED) (CONTINUED) (IN THOUSANDS EXCEPT PER SHARE DATA) |
| | | Three Months Ended | |
| | | March 2010 | | | June 2010 | | | September 2010 | | | December 2010 | |
| Total interest income | | $ | 3,721 | | | $ | 3,766 | | | $ | 3,726 | | | $ | 3,698 | |
| Total interest expense | | | 994 | | | | 1,008 | | | | 1,034 | | | | 1,032 | |
| Net interest income | | | 2,727 | | | | 2,758 | | | | 2,692 | | | | 2,666 | |
| Provision for loan losses | | | -- | | | | 155 | | | | 60 | | | | -- | |
| Net interest income after provision for loans losses | | | 2,727 | | | | 2,603 | | | | 2,632 | | | | 2,666 | |
| Total noninterest income | | | 629 | | | | 423 | | | | 455 | | | | 537 | |
| Total noninterest expense | | | 2,249 | | | | 2,046 | | | | 2,753 | | | | 2,132 | |
| Income before income taxes | | | 1,107 | | | | 980 | | | | 334 | | | | 1,071 | |
| Income taxes (benefit) | | | 165 | | | | 164 | | | | (73 | ) | | | 257 | |
| Net income | | $ | 942 | | | $ | 816 | | | $ | 407 | | | $ | 814 | |
| Per share data: | | | | | | | | | | | | | | | | |
| Net earnings | | $ | 1.53 | | | $ | 1.32 | | | $ | 0.66 | | | $ | 1.32 | |
| Weighted average shares outstanding | | | 616,706 | | | | 616,706 | | | | 616,706 | | | | 616,551 | |
