The following table presents credit risk ratings by class of loan as of June 30, 2012 and December 31, 2011:
Note 5. Deposits
At June 30, 2012 and December 31, 2011, deposits consisted of the following:
| | | 2012 | | | 2011 | |
| Noninterest bearing | | $ | 29,361,309 | | | $ | 31,003,581 | |
| Interest bearing: | | | | | | | | |
| Checking | | | 5,646,296 | | | | 5,149,535 | |
| Money Market | | | 43,289,095 | | | | 47,728,069 | |
| Savings | | | 3,072,105 | | | | 2,838,736 | |
| Time certificates, less than $100,000 (1) | | | 12,033,754 | | | | 19,657,059 | |
| Time certificates, $100,000 or more (2) | | | 20,951,356 | | | | 26,253,701 | |
| Total interest bearing | | | 84,992,606 | | | | 101,627,100 | |
| Total deposits | | $ | 114,353,915 | | | $ | 132,630,681 | |
| (1) | Included in time certificates of deposit, less than $100,000, at June 30, 2012 and December 31, 2011 were brokered deposits totaling $553,926 and $3,976,764, respectively. |
| |
| (2) | Included in time certificates of deposit, $100,000 or more, at June 30, 2012 and December 31, 2011 were brokered deposits totaling $4,295,236 and $5,119,113, respectively. |
Brokered deposits at June 30, 2012 and December 31, 2011 were as follows:
| | | 2012 | | | 2011 | |
| | | | | | | |
Bank customer time certificates of deposit placed
through CDARS to ensure FDIC coverage | | $ | 4,387,893 | | | $ | 4,161,974 | |
Time certificates of deposit purchased by the
Bank through CDARS | | | 275,117 | | | | 2,180,568 | |
| Other brokered time certificates of deposit | | | 186,152 | | | | 2,753,335 | |
| Total brokered deposits | | $ | 4,849,162 | | | $ | 9,095,877 | |
As a result of the Consent Order described in Note 13, the Bank does not intend to renew or accept brokered deposits without obtaining prior regulatory approval during the period in which the Consent Order is in place.
Note 6. Available Borrowings
The Bank is a member of the Federal Home Loan Bank of Boston (“FHLB”). At June 30, 2012, the Bank had the ability to borrow from the FHLB based on a certain percentage of the value of the Bank’s qualified collateral, as defined in the FHLB Statement of Products Policy, at the time of the borrowing. In accordance with an agreement with the FHLB, the qualified collateral must be free and clear of liens, pledges and encumbrances. There were no borrowings outstanding with the FHLB at June 30, 2012.
The Bank is required to maintain an investment in capital stock of the FHLB in an amount that is based on a percentage of its outstanding residential first mortgage loans. The stock is bought from and sold to the Federal Home Loan Bank based upon 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. The stock’s value is determined by the ultimate recoverability of the par value rather than by recognizing temporary declines in value. 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 level of such payments in relation to its 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.
The FHLB incurred losses in 2008 and 2009 and suspended the payment of dividends and excess stock redemptions during those years. The losses suffered during 2008 and 2009 were primarily attributable to impairment of investment securities associated with the extreme economic conditions in place during those years. The FHLB announced in February 2011 that it was profitable during 2010 and reinstated dividend payments in 2011. Management evaluated the stock and concluded that the stock was not impaired for the periods presented herein. More consideration was given to the long-term prospects for the FHLB as opposed to the recent stress caused by the current extreme economic conditions. Management also considered that the FHLB’s regulatory capital ratios have increased from the prior year, liquidity appears adequate, and new shares of FHLB Stock continue to trade at the $100 par value.
Note 7. Shareholders’ Equity
Income (Loss) Per Share
The Company is required to present basic income (loss) per share and diluted income (loss) per share in its statements of operations. Basic per share amounts are computed by dividing net income (loss) by the weighted average number of common shares outstanding. Diluted per share amounts assume exercise of all potential common stock equivalents in weighted average shares outstanding, unless the effect is antidilutive. The Company is also required to provide a reconciliation of the numerator and denominator used in the computation of both basic and diluted income (loss) per share.
The following is information about the computation of (loss) income per share for the three months and six months ended June 30, 2012 and 2011:
| Three Months Ended June 30, | | 2012 | | | 2011 | |
| | | | | | Weighted | | | | | | | | | Weighted | | | | |
| | | Net | | | Average | | | Amount | | | Net | | | Average | | | Amount | |
| | | Loss | | | Shares | | | Per Share | | | Income | | | Shares | | | Per Share | |
| Basic (Loss) Income Per Share | | | | | | | | | | | | | | | | | | |
| (Loss) income available to common shareholders | | $ | (41,679 | ) | | | 2,735,359 | | | $ | (0.02 | ) | | $ | 176,789 | | | | 2,697,407 | | | $ | 0.07 | |
| Effect of Dilutive Securities | | | | | | | | | | | | | | | | | | | | | | | | |
| Warrants/Restricted Stock/Stock Options outstanding | | | — | | | | — | | | | — | | | | — | | | | 495 | | | | — | |
| Diluted Loss Income Per Share | | | | | | | | | | | | | | | | | | | | | | | | |
| (Loss) income available to common | | | | | | | | | | | | | | | | | | | | | | | | |
| shareholders plus assumed conversions | | $ | (41,679 | ) | | | 2,735,359 | | | $ | (0.02 | ) | | $ | 176,789 | | | | 2,697,902 | | | $ | 0.07 | |
For the three months ended June 30, 2012, common stock equivalents of 74,914 shares have been excluded from the computation of net loss per share because the inclusion of such common stock equivalents is anti-dilutive.
| Six Months Ended June 30, | | 2012 | | | 2011 | |
| | | | | | Weighted | | | | | | | | | Weighted | | | | |
| | | Net | | | Average | | | Amount | | | Net | | | Average | | | Amount | |
| | | Loss | | | Shares | | | Per Share | | | Loss | | | Shares | | | Per Share | |
| Basic Loss Per Share | | | | | | | | | | | | | | | | | | |
| Loss available to common shareholders | | $ | (99,313 | ) | | | 2,723,422 | | | $ | (0.04 | ) | | $ | (459,766 | ) | | | 2,697,156 | | | $ | (0.17 | ) |
| Effect of Dilutive Securities | | | | | | | | | | | | | | | | | | | | | | | | |
| Warrants/Restricted Stock/Stock Options outstanding | | | — | | | | — | | | | — | | | | — | | | | — | | | | — | |
| Diluted Loss Per Share | | | | | | | | | | | | | | | | | | | | | | | | |
| Loss available to common | | | | | | | | | | | | | | | | | | | | | | | | |
| shareholders plus assumed conversions | | $ | (99,313 | ) | | | 2,723,422 | | | $ | (0.04 | ) | | $ | (459,766 | ) | | | 2,697,156 | | | $ | (0.17 | ) |
For the six months ended June 30, 2012 and 2011, common stock equivalents of 51,040 shares and 746 shares, respectively, have been excluded from the computation of net loss per share because the inclusion of such common stock equivalents is anti-dilutive.
Restricted stock plan
A summary of the status of the Company’s nonvested restricted stock at June 30, 2012 and changes during the period then ended, is as follows:
| | | 2012 | |
| | | | | | Weighted- | |
| | | Number | | | Average | |
| | | of | | | Grant-Date | |
| | | Shares | | | Fair Value | |
Nonvested restricted stock at beginning of the year | | | | | | | | |
| | | | | | | | |
| | | | | | | | |
| | | | | | | | |
Nonvested restricted stock at June 30, 2012 | | | | | | | | |
For the six months ended June 30, 2012, there were 112,371 shares of time-based restricted stock granted to senior management. During the six months ended June 30, 2012, $139,337 of compensation cost related to restricted stock awards was recognized. As of June 30, 2012, there was $34,835 of unrecognized compensation cost related to non-vested restricted stock awards expected to be recognized over the remaining vesting period of less than one year. Of the 112,371 shares of restricted common stock, 37,457 shares vested on February 28, 2012, 37,457 shares vested on July 1, 2012 and the remaining 37,457 shares of restricted common stock will vest on January 1, 2013.
Note 8. Financial Instruments with Off-Balance-Sheet Risk
In the normal course of business, the Company is a party to financial instruments with off-balance sheet risk to meet the financing needs of its customers. These financial instruments include commitments to extend credit and involve, to varying degrees, elements of credit and interest rate risk in excess of the amounts recognized in the financial statements. The contractual amounts of these instruments reflect the extent of involvement the Company has in particular classes of financial instruments.
The contractual amounts of commitments to extend credit represent the amounts of potential accounting loss should the contract be fully drawn upon, the customer defaults, and the value of any existing collateral becomes worthless. The Company uses the same credit policies in making commitments and conditional obligations as it does for on-balance sheet instruments and evaluates each customer’s creditworthiness on a case-by-case basis.
The Company controls the credit risk of these financial instruments through credit approvals, credit limits, monitoring procedures and the receipt of collateral that it deems necessary.
Financial instruments whose contract amounts represent credit risk at June 30, 2012 and December 31, 2011 were as follows:
| | | June 30, | | | December 31, | |
| | | 2012 | | | 2011 | |
| Commitments to extend credit: | | | | | | |
| Future loan commitments | | $ | 2,860,000 | | | $ | 1,565,000 | |
| Unused lines of credit | | | 14,546,460 | | | | 17,569,186 | |
| Financial standby letters of credit | | | 2,279,806 | | | | 3,083,828 | |
| Undisbursed construction loans | | | 508,827 | | | | 508,827 | |
| | | $ | 20,195,093 | | | $ | 22,726,841 | |
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 to extend credit generally have fixed expiration dates or other termination clauses and may require payment of a fee by the borrower. Since these commitments could expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The amount of collateral obtained, if deemed necessary by the Company upon extension of credit, is based on management’s credit evaluation of the counter-party. Collateral held varies, but may include residential and commercial property, deposits and securities.
Standby letters of credit are written commitments issued by the Company to guarantee the performance of a customer to a third party. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. Guarantees that are not derivative contracts have been recorded on the Company’s consolidated balance sheet at their fair value at inception. The liability related to guarantees recorded at June 30, 2012 and December 31, 2011 was not significant.
Note 9. Fair Value
The Company uses fair value measurements to record fair value adjustments to certain assets and liabilities and to determine fair value disclosures. A description of the valuation methodologies used for assets and liabilities recorded at fair value, and for estimating fair value for financial and non-financial instruments not recorded at fair value, is set forth below.
Cash and due from banks, Federal funds sold, short-term investments, interest bearing certificates of deposit, accrued interest receivable, Federal Home Loan Bank stock, accrued interest payable and repurchase agreements
The carrying amount is a reasonable estimate of fair value. The Company does not record these assets at fair value on a recurring basis. Cash and due from banks, Federal funds sold, short-term investments, interest bearing certificates of deposit, accrued interest receivable, Federal Home Loan Bank stock, accrued interest payable and repurchase agreements are classified as Level 1 within the fair value hierarchy.
Available for sale securities
These financial instruments are recorded at fair value in the financial statements on a recurring basis. Where quoted prices are available in an active market, securities are classified within Level 1 of the valuation hierarchy. If quoted prices are not available, then fair values are estimated by using pricing models (i.e., matrix pricing) or quoted prices of securities with similar characteristics and are classified within Level 2 of the valuation hierarchy. Examples of such instruments include government agency bonds and mortgage-backed securities and common stock. Securities classified within level 3 of the valuation hierarchy are securities for which significant unobservable inputs are utilized. Available for sale securities are recorded at fair value on a recurring basis.
The Company’s available for sale securities, comprised of U.S. Treasury securities, are classified as Level 1 in the fair value hierarchy, as quoted prices are available in an active market.
Loans receivable
For variable rate loans that reprice frequently and have no significant change in credit risk, carrying values are a reasonable estimate of fair values, adjusted for credit losses inherent in the portfolios. The fair value of fixed rate loans is estimated by discounting the future cash flows using estimated period end market rates at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities, adjusted for credit losses inherent in the portfolios. The Company does not record loans at fair value on a recurring basis. However, from time to time, a loan is considered impaired and an allowance for credit losses is established. The specific reserves for collateral dependent impaired loans are based on the fair value of collateral less estimated costs to sell. The fair value of collateral is determined based on appraisals. In some cases, adjustments are made to the appraised values due to various factors including age of the appraisal, age of comparables included in the appraisal, and known changes in the market and in the collateral. When significant adjustments are based on unobservable inputs, the resulting fair value measurement is categorized as a Level 3 measurement.
At June 30, 2012 and December 31, 2011, the Company’s collateral dependent loans receivable considered impaired that were newly measured for fair value purposes during such periods, were categorized as Level 3 within the fair value hierarchy, and the balances, net of related specific reserves, were $609,149 and $3,678,296, respectively. The remainder of the balance of loans receivable is classified as Level 2 within the fair value hierarchy.
Servicing assets
The fair value is based on market prices for comparable servicing contracts, when available, or alternatively, is based on a valuation model that calculates the present value of estimated future net servicing income. The Company does not record these assets at fair value on a recurring basis. Servicing assets are classified as Level 2 within the fair value hierarchy.
Other assets held for sale and other real estate owned
Other assets held for sale represents real estate that is not intended for use in operations and real estate acquired through foreclosure, and are recorded at fair value on a nonrecurring basis. Fair value is based upon independent market prices, appraised values of the collateral or management’s estimation of the value of the collateral. When the fair value of the collateral is based on an observable market price or a current appraised value, the Company classifies the fair value measurement as Level 2. When an appraised value is not available or management determines the fair value of the collateral is further impaired below the appraised value and there is no observable market price, the Company classifies the fair value measurement as Level 3. The Company classified the other assets held for sale and other real estate owned as Level 2 within the fair value hierarchy, as the fair value of these assets was based upon current appraisals.
Other assets – derivative financial instruments
Derivative financial instruments represent an equity warrant asset held by the Bank which entitled the Bank to acquire stock in the issuer, a publicly traded company. The Bank held this asset for prospective investment gains. The Bank did not use it to hedge any economic risks nor does it use other derivative instruments to hedge economic risks. The equity warrant asset was recorded at fair value and classified as a derivative asset, which is a component of other assets, on the Company’s consolidated balance sheet at December 31, 2011. The Company classified the other assets – derivative financial instruments as Level 2 within the fair value hierarchy.
Interest only strips
The fair value is based on a valuation model that calculates the present value of estimated future cash flows. The Company does not record these assets at fair value on a recurring basis. Interest only strips are classified as Level 2 within the fair value hierarchy.
Deposits
The fair value of demand deposits, savings and money market deposits is the amount payable on demand at the reporting date. The fair value of certificates of deposit is estimated using a discounted cash flow calculation that applies interest rates currently being offered for deposits of similar remaining maturities, estimated using local market data, to a schedule of aggregated expected maturities on such deposits. The Company does not record deposits at fair value on a recurring basis. Demand deposits, savings and money market deposits are classified as Level 1 within the fair value hierarchy. Certificates of deposit are classified as Level 2 within the fair value hierarchy.
Off-balance-sheet instruments
Fair values for the Company’s off-balance-sheet instruments (lending commitments) are based on fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the counterparties’ credit standing. The Company does not record its off-balance-sheet instruments at fair value on a recurring basis. Off-balance-sheet instruments are classified as Level 3 within the fair value hierarchy.
The following tables detail the financial instruments carried at fair value and measured at fair value on a recurring basis as of June 30, 2012 and December 31, 2011 and indicate the fair value hierarchy of the valuation techniques utilized by the Company to determine the fair value:
| | | | | | | | | | | | | |
| | | Balance | | | Quoted Prices in Active Markets for | | | | | | Unobservable | |
| | | as of | | | Identical Assets | | | Inputs | | | Inputs | |
| | | June 30, 2012 | | | (Level 1) | | | (Level 2) | | | (Level 3) | |
| U.S. Treasury Bills | | $ | 2,249,955 | | | $ | 2,249,955 | | | $ | - | | | $ | - | |
| | | | | | | | | | | | | |
| | | Balance | | | Quoted Prices in Active Markets for | | | Observable | | | Unobservable | |
| | | as of | | | Identical Assets | | | Inputs | | | Inputs | |
| | | December 31, 2011 | | | (Level 1) | | | (Level 2) | | | (Level 3) | |
| U.S. Treasury Bills | | $ | 3,849,847 | | | $ | 3,849,847 | | | $ | - | | | $ | - | |
| Other Assets - derivatives | | $ | 86,434 | | | $ | - | | | $ | 86,434 | | | $ | - | |
The following tables detail the financial instruments carried at fair value and measured at fair value on a nonrecurring basis as of June 30, 2012 and December 31, 2011 and indicate the fair value hierarchy of the valuation techniques utilized by the Company to determine the fair value:
| | | | | | | | | | | | | |
| | | | | | Quoted Prices in Active Markets for | | | | | | | |
| | | | | | Identical Assets | | | Inputs | | | Inputs | |
| | | June 30, 2012 | | | (Level 1) | | | (Level 2) | | | (Level 3) | |
| Financial assets held at fair value | | | | | | | | | | | | |
| Impaired loans (1) | | $ | 609,149 | | | $ | - | | | $ | - | | | $ | 609,149 | |
| | | | | | | | | | | | | |
| | | | | | Quoted Prices in Active Markets for | | | Observable | | | Unobservable | |
| | | | | | Identical Assets | | | Inputs | | | Inputs | |
| | | December 31, 2011 | | | (Level 1) | | | (Level 2) | | | (Level 3) | |
| Financial assets held at fair value | | | | | | | | | | | | |
| Impaired loans (1) | | $ | 3,678,296 | | | $ | - | | | $ | - | | | $ | 3,678,296 | |
| (1) | Represents carrying value and related write-downs for which adjustments are based on appraised value. Management makes adjustments to the appraised values as necessary to consider declines in real estate values since the time of the appraisal. Such adjustments are based on management’s knowledge of the local real estate markets. | | |
The Company discloses fair value information about financial instruments, whether or not recognized in the statement of financial condition, for which it is practicable to estimate that value. Certain financial instruments are excluded from disclosure requirements. Accordingly, the aggregate fair value amounts presented do not represent the underlying value of the Company.
The estimated fair value amounts as of June 30, 2012 and December 31, 2011 have been measured as of their respective periods and have not been reevaluated or updated for purposes of these financial statements subsequent to those respective dates. As such, the estimated fair values of these financial instruments subsequent to the respective reporting dates may be different than amounts reported at such reporting dates.
The information presented should not be interpreted as an estimate of the fair value of the entire Company since a fair value calculation is only required for a limited portion of the Company’s assets and liabilities. Due to the wide range of valuation techniques and the degree of subjectivity used in making the estimates, comparisons between the Company’s disclosures and those of other companies may not be meaningful.
The following is a summary of the recorded book balances and estimated fair values of the Company’s financial instruments at June 30, 2012 and December 31, 2011:
| | | | June 30, 2012 | | | December 31, 2011 | |
| | Fair Value | | Recorded | | | | | | Recorded | | | | |
| | Hierarachy | | Book | | | | | | Book | | | | |
| | Level | | Balance | | | Fair Value | | | Balance | | | Fair Value | |
| Financial Assets: | | | | | | | | | | | | | |
| Cash and due from banks | Level 1 | | $ | 9,775,930 | | | $ | 9,775,930 | | | $ | 18,167,794 | | | $ | 18,167,794 | |
| Short-term investments | Level 1 | | | 6,065,606 | | | | 6,065,606 | | | | 6,764,409 | | | | 6,764,409 | |
| Interest bearing certificates of deposit | Level 1 | | | 655,265 | | | | 655,265 | | | | 99,426 | | | | 99,426 | |
| Available for sale securities | Level 1 | | | 2,249,955 | | | | 2,249,955 | | | | 3,849,847 | | | | 3,849,847 | |
| Federal Home Loan Bank stock | Level 1 | | | 60,600 | | | | 60,600 | | | | 66,100 | | | | 66,100 | |
| Loans receivable, net: | | | | | | | | | | | | | | | | | |
| Observable inputs | Level 2 | | | 99,076,079 | | | | 101,265,087 | | | | 106,893,215 | | | | 109,691,073 | |
| Unobservable inputs | Level 3 | | | 5,010,913 | | | | 5,010,913 | | | | 4,750,927 | | | | 4,750,927 | |
| Accrued interest receivable | Level 1 | | | 387,912 | | | | 387,912 | | | | 434,302 | | | | 434,302 | |
| Servicing rights | Level 2 | | | 6,925 | | | | 17,400 | | | | 7,991 | | | | 20,079 | |
| Interest only strips | Level 2 | | | 8,964 | | | | 14,459 | | | | 10,364 | | | | 16,717 | |
| Derivative financial instruments | Level 2 | | | - | | | | - | | | | 86,434 | | | | 86,434 | |
| | | | | | | | | | | | | | | | | | |
| Financial Liabilities: | | | | | | | | | | | | | | | | | |
| Noninterest-bearing deposits | Level 1 | | | 29,361,309 | | | | 29,361,309 | | | | 31,003,581 | | | | 31,003,581 | |
| Interest bearing checking accounts | Level 1 | | | 5,646,296 | | | | 5,646,296 | | | | 5,149,535 | | | | 5,149,535 | |
| Money market deposits | Level 1 | | | 43,289,095 | | | | 43,289,095 | | | | 47,728,069 | | | | 47,728,069 | |
| Savings deposits | Level 1 | | | 3,072,105 | | | | 3,072,105 | | | | 2,838,736 | | | | 2,838,736 | |
| Time certificates of deposits | Level 2 | | | 32,985,110 | | | | 32,897,000 | | | | 45,910,760 | | | | 46,787,000 | |
| Repurchase agreements | Level 1 | | | 172,285 | | | | 172,285 | | | | 68 | | | | 68 | |
| Accrued interest payable | Level 1 | | | 67,748 | | | | 67,748 | | | | 204,021 | | | | 204,021 | |
| | | | | | | | | | | | | | | | | | |
| Off-balance-sheet financial instruments: | | | | | | | | | | | | | | | | |
| Commitments to extend credit | Level 3 | | | - | | | | - | | | | - | | | | - | |
| Standby letters of credit | Level 3 | | | - | | | | - | | | | - | | | | - | |
Unrecognized financial instruments
Loan commitments on which the committed interest rate is less than the current market rate were insignificant at June 30, 2012 and December 31, 2011.
The Company assumes interest rate risk (the risk that general interest rate levels will change) as a result of its normal operations. As a result, fair values of the Company’s financial instruments will change when interest rate levels change and that change may be either favorable or unfavorable to the Company. Management attempts to match maturities of assets and liabilities to the extent management believes necessary to minimize interest rate risk. However, borrowers with fixed rate obligations are less likely to prepay in a rising rate environment and more likely to prepay in a falling rate environment. Conversely, depositors who are receiving fixed rates are more likely to withdraw funds before maturity in a rising rate environment and less likely to do so in a falling rate environment. Management monitors rates and maturities of assets and liabilities and attempts to minimize interest rate risk by adjusting terms of new loans and by investing in securities with terms that mitigate the Company’s overall interest rate risk.
Note 10. Commitments and Contingencies
Change in Control Agreement
Effective June 21, 2012, the Bank entered into a change in control agreement with its Senior Vice President of Retail Banking.
The agreement provides that in the event of (i) a “Change in Control” (as defined in the agreement) and (ii) the termination within twelve months of such ‘Change in Control” of the Senior Vice President of Retail Banking’s employment (a) for any reason other than for “Cause” (as defined in the agreement), death or “Disability” (as defined in the agreement) or (b) as result of his resignation for “Good Reason” (as defined in the agreement) following the cure period specified in the agreement, the Senior Vice President of Retail Banking will be entitled to receipt of an amount equal to one times his annual base salary immediately prior to his termination or employment or the “Change in Control,” whichever is higher. The Senior Vice President of Retail Banking will also be entitled to receipt of accrued but unpaid compensation and vacation time as well as an amount equal to one year’s medical and dental insurance premiums totaling approximately $20,000.
The agreement further provides that notwithstanding anything to the contrary contained in the agreement, no “Change in Control” payments will be made to the Senior Vice President of Retail Banking if such payments would constitute a “golden parachute payment” under regulations promulgated by the Federal Deposit Insurance Corporation.
Note 11. Segment Reporting
For the seven months ended July 31, 2010, the Company had three reporting segments for purposes of reporting business line results: Community Banking, Mortgage Brokerage and the Holding Company. The Community Banking segment is defined as all operating results of the Bank. The Mortgage Brokerage segment is defined as the results of Evergreen (through July 31, 2010) and subsequently, the continuation of mortgage brokerage activities through the Bank, and the Holding Company segment is defined as the results of Southern Connecticut Bancorp on an unconsolidated or standalone basis. The Company uses an internal reporting system to generate information by operating segment. Estimates and allocations are used for noninterest expenses. Effective August 1, 2010, the Company discontinued its licensed mortgage brokerage business associated with SCB Capital, Inc. Subsequent to July 31, 2010, the mortgage brokerage activities continued through the Bank.
Information about the reporting segments and reconciliation of such information to the consolidated financial statements was as follows:
| Three Months Ended June 30, 2012 | |
| | | Community | | | Mortgage | | | Holding | | | Elimination | | | Consolidated | |
| | | Banking | | | Brokerage | | | Company | | | Entries | | | Total | |
| Net interest income | | $ | 1,344,586 | | | $ | 763 | | | $ | 97 | | | $ | — | | | $ | 1,345,446 | |
| | | | | | | | | | | | | | | | | | | | | |
| Provision for loan losses | | | 180,254 | | | | — | | | | — | | | | — | | | | 180,254 | |
| | | | | | | | | | | | | | | | | | | | | |
| Net interest income after provision for loan losses | | | 1,164,332 | | | | 763 | | | | 97 | | | | — | | | | 1,165,192 | |
| | | | | | | | | | | | | | | | | | | | | |
| Noninterest income | | | 127,385 | | | | — | | | | 7,665 | | | | 435 | | | | 135,485 | |
| | | | | | | | | | | | | | | | | | | | | |
| Noninterest expense | | | 1,267,024 | | | | (379 | ) | | | 75,276 | | | | 435 | | | | 1,342,356 | |
| | | | | | | | | | | | | | | | | | | | | |
| Net (loss) income | | | 24,693 | | | | 1,142 | | | | (67,514 | ) | | | — | | | | (41,679 | ) |
| | | | | | | | | | | | | | | | | | | | | |
| Total assets as of June 30, 2012 | | | 127,084,192 | | | | 44,419 | | | | 11,598,657 | | | | (11,013,283 | ) | | | 127,713,985 | |
| Three Months Ended June 30, 2011 | |
| | | Community | | | Mortgage | | | Holding | | | Elimination | | | Consolidated | |
| | | Banking | | | Brokerage | | | Company | | | Entries | | | Total | |
| Net interest income | | $ | 1,301,097 | | | $ | 5,967 | | | $ | 554 | | | $ | — | | | $ | 1,307,618 | |
| | | | | | | | | | | | | | | | | | | | | |
| Provision for loan losses | | | (77,044 | ) | | | — | | | | — | | | | — | | | | (77,044 | ) |
| | | | | | | | | | | | | | | | | | | | | |
| Net interest income after provision for loan losses | | | 1,378,141 | | | | 5,967 | | | | 554 | | | | — | | | | 1,384,662 | |
| | | | | | | | | | | | | | | | | | | | | |
| Noninterest income | | | 130,149 | | | | — | | | | 6,000 | | | | — | | | | 136,149 | |
| | | | | | | | | | | | | | | | | | | | | |
| Noninterest expense | | | 1,314,016 | | | | 485 | | | | 29,521 | | | | — | | | | 1,344,022 | |
| | | | | | | | | | | | | | | | | | | | | |
| Net (loss) income | | | 194,274 | | | | 5,482 | | | | (22,967 | ) | | | — | | | | 176,789 | |
| | | | | | | | | | | | | | | | | | | | | |
| Total assets as of June 30, 2011 | | | 156,927,876 | | | | 111,991 | | | | 14,026,852 | | | | (13,459,558 | ) | | | 157,607,161 | |
| | | | | | | | | | | | | | | | |
| Six Months Ended June 30, 2012 | |
| | | Community | | | Mortgage | | | Holding | | | Elimination | | | Consolidated | |
| | | Banking | | | Brokerage | | | Company | | | Entries | | | Total | |
| Net interest income | | $ | 2,572,499 | | | $ | 2,183 | | | $ | 308 | | | $ | — | | | $ | 2,574,990 | |
| | | | | | | | | | | | | | | | | | | | | |
| Provision for loan losses | | | 210,254 | | | | — | | | | — | | | | — | | | | 210,254 | |
| | | | | | | | | | | | | | | | | | | | | |
| Net interest income after provision for loan losses | | | 2,362,245 | | | | 2,183 | | | | 308 | | | | — | | | | 2,364,736 | |
| | | | | | | | | | | | | | | | | | | | | |
| Noninterest income | | | 294,676 | | | | — | | | | 16,620 | | | | 435 | | | | 311,731 | |
| | | | | | | | | | | | | | | | | | | | | |
| Noninterest expense | | | 2,669,230 | | | | (187 | ) | | | 106,302 | | | | 435 | | | | 2,775,780 | |
| | | | | | | | | | | | | | | | | | | | | |
| Net (loss) income | | | (12,309 | ) | | | 2,370 | | | | (89,374 | ) | | | — | | | | (99,313 | ) |
| | | | | | | | | | | | | | | | | | | | | |
| Total assets as of June 30, 2012 | | | 127,084,192 | | | | 44,419 | | | | 11,598,657 | | | | (11,013,283 | ) | | | 127,713,985 | |
| Six Months Ended June 30, 2011 | |
| | | Community | | | Mortgage | | | Holding | | | Elimination | | | Consolidated | |
| | | Banking | | | Brokerage | | | Company | | | Entries | | | Total | |
| Net interest income | | $ | 2,624,482 | | | $ | 13,856 | | | $ | 1,361 | | | $ | — | | | $ | 2,639,699 | |
| | | | | | | | | | | | | | | | | | | | | |
| Provision for loan losses | | | 666,060 | | | | — | | | | — | | | | — | | | | 666,060 | |
| | | | | | | | | | | | | | | | | | | | | |
| Net interest income after provision for loan losses | | | 1,958,421 | | | | 13,856 | | | | 1,361 | | | | — | | | | 1,973,639 | |
| | | | | | | | | | | | | | | | | | | | | |
| Noninterest income | | | 259,710 | | | | — | | | | 12,000 | | | | — | | | | 271,710 | |
| | | | | | | | | | | | | | | | | | | | | |
| Noninterest expense | | | 2,653,599 | | | | 1,322 | | | | 50,194 | | | | — | | | | 2,705,115 | |
| | | | | | | | | | | | | | | | | | | | | |
| Net loss | | | (435,467 | ) | | | 12,534 | | | | (36,833 | ) | | | — | | | | (459,766 | ) |
| | | | | | | | | | | | | | | | | | | | | |
| Total assets as of June 30, 2011 | | | 156,927,876 | | | | 111,991 | | | | 14,026,852 | | | | (13,459,558 | ) | | | 157,607,161 | |
Note 12. Recent Accounting Pronouncements
In April 2011, the FASB amended its guidance relating to repurchase agreements. The amendments change the effective control assessment by removing the criterion that required the transferor to have the ability to repurchase or redeem financial assets on substantially the agreed terms, even in the event of default by the transferee. Instead, the amendments focus the assessment of effective control on the transferor’s rights and obligations with respect to the transferred financial assets and not whether the transferor has the practical ability to perform in accordance with those rights or obligations. The amended guidance became effective for the Company as it relates to transactions or modifications of existing transactions that occur in interim and annual periods beginning with the quarter ended March 31, 2012. These amendments did not have an impact on the Company’s consolidated financial statements.
In May 2011, the FASB issued Accounting Standards Update (ASU) 2011-04, Amendments to Achieve Common Fair Value Measurements and Disclosure Requirements in U.S. GAAP and IFRs, (ASU 2011-04). ASU 2011-04 converges the fair value measurement guidance in U.S. GAAP and International Financial Reporting Standards (IFRSs). Some of the amendments clarify the application of existing fair value measurement requirements, while other amendments change a particular principle in existing guidance. In addition, ASU 2011-04 requires additional fair value disclosures. The amendments are to be applied prospectively and are effective for interim and annual periods beginning after December 15, 2011. The Company adopted the methodologies prescribed by this ASU during the quarter ended March 31, 2012. Adoption of this guidance did not have a material effect on the Company’s financial statements.
In June 2011, the FASB issued new accounting guidance related to the presentation of comprehensive income that eliminates the option to present components of other comprehensive income as part of the statement of changes in stockholders’ equity. 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. The amendments do not change the items that must be reported in other comprehensive income or when an item of other comprehensive income must be reclassified to net income. This guidance is effective for fiscal years, and interim periods within those years, beginning after December 15, 2011. The Company adopted this guidance effective for the quarter ended March 31, 2012. The adoption of this guidance did not impact the Company’s financial position, results of operations or cash flows and only impacted the presentation of other comprehensive income in the financial statements.
Note 13. Subsequent Events
On July 2, 2012, the Bank entered into a stipulation and consent to the Issuance of a Consent Order with the Federal Deposit Insurance Corporation (“FDIC”) and the State of Connecticut Department of Banking (“Connecticut Department of Banking”). Thereafter, on July 3, 2012, the Bank entered into a Consent Order (the Consent Order) with the FDIC and the Connecticut Department of Banking.
By entering into the Consent Order, the Bank has agreed to take certain measures in a number of areas, including, without limitation, the following: (i) having and retaining qualified management and reviewing and revising its assessment of senior management; (ii) maintaining minimum specified capital levels and developing and submitting a capital plan in the event any of its capital ratios fall below such minimum specified capital levels; (iii) formulating and submitting a profit and budget plan consisting of goals and strategies consistent with sound banking practices and implementing such plan; (iv) formulating and submitting a plan to reduce classified assets and implementing such plan; (v) reviewing and improving the loan and credit risk management policies and procedures; (vi) developing and implementing action plans addressing all other recommendations identified within its most recent Report of Examination; (vii) complying with the Interagency Policy Statement on Internal Audit Function and its Outsourcing; and (viii) not accepting, renewing or rolling over any brokered deposits unless the Bank is in compliance with regulations governing the solicitation and acceptance of brokered deposits. The Consent Order also provides that the Bank will obtain prior regulatory approval before the payment of any dividends. The Bank has already adopted and implemented many of the actions prescribed in the Consent Order.
The Consent Order requires the Bank to maintain a minimum Tier 1 leverage ratio of at least 8.0%, a Tier 1 risk-based capital ratio of at least 9% and a total risk-based capital ratio of at least 10%. At June 30, 2012, the Bank’s capital ratios exceeded such minimums set forth in the Consent Order. In June 2012, the Bank submitted a revised capital plan outlining its strategy for increasing its capital amounts and ratios to the Federal Deposit Insurance Corporation and the State of Connecticut Department of Banking for their approval. The capital plan included a profit and budget plan and a plan to reduce classified assets. Following receipt of regulatory approval, the Company and the Bank will seek to implement the plan to increase capital as soon as practicable. Further regulatory action is possible if the Bank does not maintain the minimum capital ratios set forth in the Consent Order.
The Bank has an Oversight Committee that is responsible for supervising the implementation of the Consent Order. The Oversight Committee meets monthly and is currently composed of the Company’s Chairman of the Board, two additional directors, the Chief Executive Officer, the President and Chief Credit Officer and the Chief Financial Officer.
The Consent Order is the result of ongoing discussions between the Bank’s regulatory agencies and the Bank based on a regulatory examination conducted in early 2012. The Consent Order will remain in effect until it is modified or terminated by the FDIC and the Connecticut Department of Banking. The Bank’s customer deposits remain fully insured to the highest limit set by the FDIC.
| Management’s Discussion and Analysis of Financial Condition and Results of Operations |
The following discussion and analysis is intended to assist you in understanding the financial condition and results of operations of the Company. This discussion should be read in conjunction with the accompanying unaudited financial statements as of and for the three and six months ended June 30, 2012 and 2011 together with the audited financial statements as of and for the year ended December 31, 2011, included in the Company’s Form 10-K filed with the Securities and Exchange Commission on March 30, 2012.
Summary
As of June 30, 2012, the Company had $127.7 million of total assets, $106.3 million of gross loans receivable, and $114.4 million of total deposits. Total equity capital at June 30, 2012 was $11.6 million, and the Company’s Tier I Leverage Capital Ratio was 8.92%.
The Company had a net loss for the quarter ended June 30, 2012 of $42,000 (or basic and diluted loss per share of $0.02) as compared to net income of $177,000 (or basic and diluted income per share of $0.07) for the second quarter of 2011. The decline in the Company’s net income was largely attributable to an increase in the provision for loan losses to $180,000 for the three months ended June 30, 2012 compared to a credit to the provision for loan losses of $77,000 for the same period in 2011. The increase in the provision for loan losses was primarily related to an increase in net charge-offs during the second quarter of 2012 compared to the second quarter of 2011, including charge-offs against specific reserves relating to four impaired loans during the three months ended June 30, 2012. These changes, are in contrast to the credit to the provision for loan losses during the second quarter of 2011, which was primarily related to net decreases to the specific allowances on certain impaired loans resulting from payments received in excess of amounts previously estimated and the return to accrual status of one commercial real estate loan, for which a specific allowance of $100,000 was reversed as the loan had performed for over one year and no allowance was considered necessary.
In addition to the impact of the increase in the provision for loan losses, the Company’s operating results for the second quarter of 2012, when compared to the same period of 2011, were influenced by the following factors:
| | ● | Net interest income increased by $38,000 due to the combined effects of decreases in liability volumes, lower rates paid on interest bearing liabilities and an increase in yields on interest earning assets (primarily attributable to recognition of $42,000 in interest income on one commercial and industrial loan classified as a troubled debt restructuring which returned to accrual status during the quarter ended June 30, 2012 as it had performed in accordance with the terms of its restructuring agreement for a period of one year), which were partially offset by decreases in loan volume; |
| | | Noninterest income increased by $12,000 because of increases in other noninterest income (primarily loan fees) during the three months ended June 30, 2012 compared to the same period of 2011, which were partially offset by a decrease in service charges and fees resulting from changes in the business practices of customers of the Bank; and |
| | | Noninterest expenses increased by $12,000 during the second quarter of 2012 compared to the same period in 2011 primarily due to increases in salaries and benefits expense, professional services fees and insurance expense, which were partially offset by decreases in directors’ fees and data processing fees. The increase in salaries and benefits expense during the second quarter of 2012 when compared to the second quarter of 2011 was primarily attributable to restricted stock compensation expense recorded by the Company based upon the vesting schedule for restricted stock granted to the Chief Executive Officer under his employment agreement and restricted stock agreement executed on February 28, 2012. The increase in professional services fees was due to increased costs for internal auditing and consulting services performed during the quarter ended June 30, 2012 compared to the same period in 2011. Insurance expense increased due to increased costs in 2012 associated with insurance policies that the Company had entered into during a more favorable environment in July 2008. These unfavorable changes were partially offset by the impact of reductions in directors’ fees that were approved by the Company’s compensation committee effective January 1, 2012, as well as benefits the Company continued to realize during the second quarter of 2012 related to the renewal of certain data processing service contracts during the fourth quarter of 2011. |
The Company had a net loss for the six months ended June 30, 2012 of $99,000 (or basic and diluted loss per share of $.04) as compared to a net loss of $460,000 (or basic and diluted loss per share of $0.17) for the six months ended June 30, 2011. The decline in the Company’s net loss was largely attributable to a decrease in the provision for loan losses to $210,000 for the six months ended June 30, 2012 compared to a provision for loan losses of $666,000 for the same period in 2011. The decrease in the provision for loan losses during the six months ended June 30, 2012 compared to the same period in 2011 was primarily related to one commercial loan secured by real estate that was severely impacted by prevailing economic conditions in 2011.
In addition to the impact of the decrease in the provision for loan losses, the Company’s operating results for the six months ended June 30, 2012, when compared to the same period of 2011, were influenced by the following factors:
| | | Net interest income decreased by $65,000 due to the combined effects of decreases in loan volume and lower yields on interest earning assets (primarily attributable to a decline in yields in the loan portfolio), which were partially offset by decreases in liability volumes and lower rates paid on interest bearing liabilities; |
| | | Noninterest income increased by $54,000 because of loan prepayment fees received during the six months ended June 30, 2012 with no similar income recognized in the same period of 2011, as well as an increase in other noninterest income, which were partially offset by a decrease in service charges and fees resulting from changes in the business practices of customers of the Bank; and |
| | | Noninterest expenses increased by $84,000 during the first six months of 2012 compared to the same period in 2011 primarily due to increases in salaries and benefits expense, professional services fees and insurance expense, which were partially offset by decreases in directors’ fees and data processing fees. The increase in salaries and benefits expense during the first six months of 2012 when compared to the same period in 2011 was primarily attributable to restricted stock compensation expense recorded by the Company based upon the vesting schedule for restricted stock granted to the Chief Executive Officer under his employment agreement and restricted stock agreement executed on February 28, 2012. The increase in professional services fees was due to increased costs for loan review, internal audit and consulting services performed during the six months ended June 30, 2012, compared to the same period in 2011. Insurance expense increased due to increased costs in 2012 associated with insurance policies that the Company had entered into during a more favorable environment in July 2008. These unfavorable changes were partially offset by the impact of reductions in directors’ fees that were approved by the Company’s compensation committee effective January 1, 2012, as well as benefits the Company continued to realize during the first six months of 2012 related to the renewal of certain data processing service contracts during the fourth quarter of 2011. |
Critical Accounting Policy
In the ordinary course of business, the Company has made a number of estimates and assumptions relating to reporting the results of operations and financial condition in preparing its financial statements in conformity with accounting principles generally accepted in the United States of America. Actual results could differ significantly from those estimates under different assumptions and conditions. The Company believes the following discussion addresses the Company’s only critical accounting policy, which is the policy that is most important to the portrayal of the Company’s financial condition and results of operations, and requires management’s most difficult, subjective and complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain. The Company has reviewed this critical accounting policy and estimate with its audit committee. Refer to the discussion below under “Allowance for Loan Losses” and Note 1 to the audited financial statements as of and for the year ended December 31, 2011 included in the Company’s Form 10-K filed with the Securities and Exchange Commission on March 30, 2012.
Allowance for Loan Losses
The allowance for loan losses is established as losses are estimated to have occurred through a provision for loan losses charged to earnings. Loan losses are charged against the allowance when management believes the uncollectibility of a loan balance is confirmed. Subsequent recoveries, if any, are credited to the allowance.
The allowance for loan losses is evaluated on a regular basis by management and is based upon management’s periodic review of the collectability of the loans in light of historical experience, the nature and volume of the loan portfolio, adverse situations that may affect the borrower’s ability to repay, estimated value of any underlying collateral and prevailing economic conditions. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available.
The allowance consists of allocated and general components. The allocated component relates to loans that are considered impaired. For such impaired loans, an allowance is established when the discounted cash flows (or observable market price or collateral value if the loan is collateral dependent) of the impaired loan is lower than the carrying value of that loan. The general component covers all other loans, segregated generally by loan type (and further segregated by risk rating), and is based on historical loss experience with adjustments for qualitative factors which are made after an assessment of internal or external influences on credit quality that are not fully reflected in the historical loss data.
A loan is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record, and the amount of the shortfall in relation to the principal and interest owed. Impairment is measured on a loan by loan basis for commercial and real estate loans by either the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s observable market price, or the fair value of the collateral if the loan is collateral dependent.
Large groups of smaller balance homogeneous loans are collectively evaluated for impairment. Accordingly, the Company does not separately identify individual consumer loans for impairment disclosures, unless such loans are the subject of a restructuring agreement due to financial difficulties of the borrower.
Impaired loans also include loans modified in troubled debt restructurings where concessions have been granted to borrowers experiencing financial difficulties. These concessions could include a reduction in the interest rate on the loan, payment extensions, forgiveness of principal, forbearance or other actions intended to maximize collection.
A modified loan is considered a troubled debt restructuring (“TDR”) when two conditions are met: (1) the borrower is experiencing documented financial difficulty and (2) concessions are made by the Company that would not otherwise be considered for a borrower with similar credit characteristics. The most common types of modifications include interest rate reductions and/or maturity extensions. Modified terms are dependent upon the financial position and needs of the individual borrower, as the Bank does not employ modification programs for temporary or trial periods. All modifications are permanent. The modified loan does not revert back to its original terms, even if the modified loan agreement is violated. The Company’s workout committee continues to monitor the modified loan and if a re-default occurs, the loan is classified as a re-defaulted TDR and collection is pursued through liquidation of collateral, from guarantors, if any, or through other legal action.
Most TDRs are placed on nonaccrual status at the time of restructuring, and continue on nonaccrual status until they have performed under the revised terms of the modified loan agreement for a minimum of six months. In certain instances, for TDRs that are on accrual status at the time the loans are restructured, the Bank may continue to classify the loans as accruing loans based upon the terms and conditions of the restructuring.
Impairment analysis is performed on a loan by loan basis for all modified commercial loans, residential mortgages and consumer loans that are deemed to be TDRs, and related charge-offs are recorded or specific reserves are established as appropriate. Commercial loans include loans categorized as commercial loans secured by real estate, commercial loans, and construction and land loans. Impairment is measured by the present value of expected future cash flows discounted at the loan’s effective interest rate. The original contractual interest rate for the loan is used as the discount rate for fixed rate loan modifications. The current rate is used as the discount rate when the loan’s interest rate floats with a specified index. A change in terms or payments would be included in the impairment calculation.
The allowances established for losses on specific loans are based on a regular analysis and evaluation of problem loans. Loans are classified based on an internal credit risk grading process that evaluates, among other things: (i) the borrower’s ability to repay; (ii) the underlying collateral, if any; and (iii) the economic environment and industry in which the borrower operates. This analysis is performed by the credit department, in consultation with the loan officers, for all commercial loans. Specific valuation allowances are determined by analyzing the borrower’s ability to repay amounts owed, collateral deficiencies, the relative risk grade of the loan and economic conditions affecting the borrower’s industry, among other things.
General valuation allowances are calculated based on the historical loss experience of specific types of loans. A historical valuation allowance is established for each pool of similar loans based upon the product of the historical loss ratio and the total dollar amount of the loans in the pool. The Company’s pools of similar loans include analogous risk-graded groups of commercial and industrial loans, commercial real estate loans, consumer real estate loans and consumer and other loans.
Due to the relatively small asset size and loans outstanding of the Company, the Company uses readily available data from the FDIC regarding the loss experience of national banks with assets between $100 million and $300 million and combines this data with the Company’s actual loss experience to develop average loss factors by weighting the national banks’ loss experience and the Company’s loss experience. As both the Company’s asset size and outstanding loan balance increased significantly during 2010, beginning with the quarter ended March 31, 2011, the Company determined to place greater emphasis on the Company’s loss experience and to utilize the average loss experience for the prior four years instead of the prior three years used in the Company’s calculations through December 31, 2010. The Company increased the weighting of its loss experience from 25% to 50%. The Company intends to weight the Company’s loss experience more heavily in determining the allowance for loan loss provision as the size of the Company’s loan portfolio becomes more significant. The historical loss period was extended by an additional year from the loss period utilized through December 31, 2010, which is considered more representative of average annual losses inherent in the loan portfolio.
General valuation allowances are based on general economic conditions and other qualitative risk factors, both internal and external, to the Company. In general, such valuation allowances are determined by evaluating, among other things: (i) the experience, ability and effectiveness of the Bank’s lending management and staff; (ii) the effectiveness of the Company’s loan policies, procedures and internal controls; (iii) changes in asset quality; (iv) changes in loan portfolio volume; (v) the composition and concentrations of credit; and (vi) the impact of national and local economic trends and conditions. Management evaluates the degree of risk that each one of these components has on the quality of the loan portfolio on a quarterly basis. Each component is determined to have either a high, moderate or low degree of risk. The results are then entered into a general allocation matrix to determine an appropriate general valuation allowance.
Based upon this evaluation, management believes the allowance for loan losses of $2,185,000 or 2.06% of gross loans outstanding at June 30, 2012 is adequate, under prevailing economic conditions, to absorb losses on existing loans. At December 31, 2011, the allowance for loan losses was $2,300,000 or 2.02% of gross loans outstanding. The decrease in the allowance was attributable to a $115,000 decrease in the general component of the allowance. The decrease in the general component of the reserve was primarily due to a decline in loan volume during the six months ended June 30, 2012. In addition, the Company had $417,000 in charge-offs during the six months ended June 30, 2012, of which $384,000 was for loans that were not impaired at December 31, 2011 and $33,000 was related to a decline in collateral for a loan impaired at December 31, 2011. The charge-offs during the first six months of 2012 primarily relate to three commercial and industrial loans and one residential loan. The Company’s net loan charge-offs were adequately provided for during the six months ended June 30, 2012.
The accrual of interest on loans is discontinued at the time the loan is 90 days past due unless the loan is well-secured and in process of collection. Consumer installment loans are typically charged off no later than 180 days past due. Past due status is based on contractual terms of the loan. In all cases, loans are placed on nonaccrual status or charged-off at an earlier date if collection of principal or interest is considered doubtful. All interest accrued but not collected for loans that are placed on nonaccrual status or charged off is reversed against interest income. The interest on these loans is accounted for on the cash-basis method until qualifying for return to accrual status. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured.
Management considers all non-accrual loans and troubled-debt restructured loans to be impaired. In most cases, loan payments that are past due less than 90 days and the related loans are not considered to be impaired.
Allowance for Loan Losses and Non-Accrual, Past Due and Restructured Loans
The changes in the allowance for loan losses for the six months ended June 30, 2012 and 2011 are as follows:
| | | 2012 | | | 2011 | |
| Balance at beginning of year | | $ | 2,299,625 | | | $ | 2,786,641 | |
| Provision for loan losses | | | 210,254 | | | | 666,060 | |
| Recoveries of loans previously charged-off: | | | | | | | | |
| Commercial | | | 63,226 | | | | 4,104 | |
| Commercial loans secured by real estate | | | 29,114 | | | | | |
| Consumer | | | — | | | | 2,156 | |
| Total recoveries | | | 92,340 | | | | 6,260 | |
| Loans charged-off: | | | | | | | | |
| Commercial | | | (384,027 | ) | | | (134,699 | ) |
| Commercial loans secured by real estate | | | — | | | | (1,146,198 | ) |
| Residential mortgages | | | (33,192 | ) | | | — | |
| Consumer | | | — | | | | (9,115 | ) |
| Total charge-offs | | | (417,219 | ) | | | (1,290,012 | ) |
| Balance at end of period | | $ | 2,185,000 | | | $ | 2,168,949 | |
| | | | | | | | | |
| Net charge-offs to average loans | | | (0.30 | )% | | | (1.03 | %) |
Non-Performing Assets and Potential Problem Loans
The following table represents non-performing assets and potential problem loans at June 30, 2012 and December 31, 2011:
| | | 2012 | | | 2011 | |
| Non-accrual loans: | | | | | | | | |
| Commercial loans secured by real estate | | $ | 557,173 | | | $ | 787,311 | |
| Commercial | | | 1,813,525 | | | | 1,707,720 | |
| Construction and land | | | 1,394,116 | | | | 1,420,156 | |
| Residential mortgages | | | 722,216 | | | | 554,678 | |
| Consumer | | | — | | | | 1,460 | |
| Total non-accrual loans | | | 4,487,030 | | | | 4,471,325 | |
| | | | | | | | | |
| Troubled debt restructured (TDR) loans: | | | | | | | | |
| Non-accrual TDR loans not included in Total non-accrual loans above: | | | | | | | | |
| Commercial loans secured by real estate | | | 265,263 | | | | 1,314,030 | |
| Commercial | | | 258,620 | | | | 1,899,342 | |
| Accruing TDR impaired loans: | | | | | | | | |
| Commercial loans secured by real estate | | | 1,094,690 | | | | — | |
| Commercial | | | 1,667,878 | | | | — | |
| Foreclosed assets: | | | | | | | | |
| Commercial | | | 474,948 | | | | 374,211 | |
| Residential | | | 107,963 | | | | — | |
| Total non-performing assets | | $ | 8,356,392 | | | $ | 8,058,908 | |
| Ratio of non-performing assets to: | | | | | | |
| Total loans and foreclosed assets | | | 7.84 | % | | | 7.05 | % |
| Total assets | | | 6.54 | % | | | 5.52 | % |
| Accruing past due loans: | | | | | | | | |
| 30 to 89 days past due | | $ | 3,034,976 | | | $ | 1,392,936 | |
| 90 or more days past due | | | 134,902 | | | | — | |
| Total accruing past due loans | | $ | 3,169,878 | | | $ | 1,392,936 | |
| | | | | | | | | |
| Ratio of accruing past due loans to total net loans: | | | | | | | | |
| 30 to 89 days past due | | | 2.86 | % | | | 1.22 | % |
| 90 or more days past due | | | 0.13 | % | | | — | |
| Total accruing past due loans | | | 2.98 | % | | | 1.22 | % |
Recent Accounting Changes
In April 2011, the FASB amended its guidance relating to repurchase agreements. The amendments change the effective control assessment by removing the criterion that required the transferor to have the ability to repurchase or redeem financial assets on substantially the agreed terms, even in the event of default by the transferee. Instead, the amendments focus the assessment of effective control on the transferor’s rights and obligations with respect to the transferred financial assets and not whether the transferor has the practical ability to perform in accordance with those rights or obligations. The amended guidance became effective for the Company as it relates to transactions or modifications of existing transactions that occur in interim and annual periods beginning with the quarter ended March 31, 2012. These amendments did not have an impact on the Company’s consolidated financial statements.
In May 2011, the FASB issued Accounting Standards Update (ASU) 2011-04, Amendments to Achieve Common Fair Value Measurements and Disclosure Requirements in U.S. GAAP and IFRs, (ASU 2011-04). ASU 2011-04 converges the fair value measurement guidance in U.S. GAAP and International Financial Reporting Standards (IFRSs). Some of the amendments clarify the application of existing fair value measurement requirements, while other amendments change a particular principle in existing guidance. In addition, ASU 2011-04 requires additional fair value disclosures. The amendments are to be applied prospectively and are effective for interim and annual periods beginning after December 15, 2011. The Company adopted the methodologies prescribed by this ASU during the quarter ended March 31, 2012. Adoption of this guidance did not have a material effect on the Company’s financial statements.
In June 2011, the FASB issued new accounting guidance related to the presentation of comprehensive income that eliminates the option to present components of other comprehensive income as part of the statement of changes in stockholders’ equity. 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. The amendments do not change the items that must be reported in other comprehensive income or when an item of other comprehensive income must be reclassified to net income. This guidance is effective for fiscal years, and interim periods within those years, beginning after December 15, 2011. The Company adopted this guidance during the quarter ended March 31, 2012. The adoption of this guidance did not impact the Company’s financial position, results of operations or cash flows and only impacted the presentation of other comprehensive income in the financial statements.
Comparison of Financial Condition as of June 30, 2012 versus December 31, 2011
General
The Company’s total assets were $127.7 million at June 30, 2012, a decrease of $18.3 million over total assets of $146.0 million at December 31, 2011. The Bank’s net loans receivable decreased to $104.1 million at June 30, 2012 from $111.6 million at December 31, 2011, and cash and cash equivalents, including short term investments, decreased to $15.8 million as of June 30, 2012 from $24.9 million as of December 31, 2011. Total deposits decreased to $114.4 million as of June 30, 2012 from $132.6 million as of December 31, 2011. The decreases in net loans receivable and cash and cash equivalents corresponded with the decrease in deposit liabilities during the six months ended June 30, 2012.
Short-term investments
Short-term investments, consisting of money market investments, decreased to $6.1 million at June 30, 2012 compared to $6.8 million at December 31, 2011.
Investments
Available for sale securities, which consisted of U.S. Treasury Bills, decreased $1.6 million to $2.2 million at June 30, 2012 from $3.8 million at December 31, 2011. The Company uses the U.S. Treasury Bills included in its available for sale securities portfolio to meet pledge requirements for public deposits and repurchase agreements. The Company classifies its securities as “available for sale” to provide greater flexibility to respond to changes in interest rates as well as future liquidity needs.
