ITEM 2 – MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Management’s discussion and analysis contains forward-looking statements that are provided to assist in the understanding of anticipated future financial performance. Forward-looking statements provide current expectations or forecasts of future events and are not guarantees of future performance. We have tried, whenever possible, to identify such statements by using words such as “anticipate,” “estimate,” “expect,” “forecast,” “project,” “intend,” “plan,” “believe,” and similar expressions in connection with any discussion of future operating or financial performance. The forward-looking statements are based on management’s current expectations and are subject to a number of risks and uncertainties. Although management believes that the expectations reflected in such forward-looking statements are reasonable, actual results may differ materially from those expressed or implied in such statements. Risks and uncertainties that could cause actual results to differ materially include, without limitation: Park’s ability to execute its business plan successfully and within the expected timeframe; deterioration in the asset value of our loan portfolio may be worse than expected due to a number of factors, such as adverse changes in economic conditions that impair the ability of borrowers to repay their loans, the underlying value of the collateral could prove less valuable than assumed and cash flows may be worse than expected; Park’s ability to sell OREO properties at prices as favorable as anticipated; changes in general economic and financial market conditions, and weakening in the economy, specifically the real estate market and credit markets, either nationally or in the states in which Park and its subsidiaries do business, may be worse than expected which could decrease the demand for loan, deposit and other financial services and increase loan delinquencies and defaults; the effects of the Gulf of Mexico oil spill; changes in interest rates and prices may adversely impact the value of securities, loans, deposits and other financial instruments and the interest rate sensitivity of our consolidated balance sheet; changes in consumer spending, borrowing and saving habits; our liquidity requirements could be adversely affected by changes in our assets and liabilities; competitive factors among financial institutions increase significantly, including product and pricing pressures and Park’s ability to attract, develop and retain qualified bank professionals; the nature, timing and effect of changes in banking regulations or other regulatory or legislative requirements affecting the respective businesses of Park and its subsidiaries, including changes in laws and regulations concerning taxes, accounting, banking, securities and other aspects of the financial services industry, specifically the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010; the effect of fiscal and governmental policies of the United States federal government; demand for loans in the respective market areas served by Park and its subsidiaries; and other risk factors relating to the banking industry as detailed from time to time in Park’s reports filed with the Securities and Exchange Commission (“SEC”) including those described in “Item 1A. Risk Factors” of Part I of Park’s Annual Report on Form 10-K for the fiscal year ended December 31, 2010, in “Item 1A. Risk Factors” of Part II of Park’s Quarterly Report on Form 10-Q for the period ended March 31, 2011 and in “Item 1A. Risk Factors” of Part II of this Quarterly Report on Form 10-Q. Undue reliance should not be placed on the forward-looking statements, which speak only as of the date of this Quarterly Report on Form 10-Q. Park does not undertake, and specifically disclaims any obligation, to publicly release the result of any revisions that may be made to update any forward-looking statement to reflect the events or circumstances after the date on which the forward-looking statement is made, or reflect the occurrence of unanticipated events, except to the extent required by law.
Critical Accounting Policies
Note 1 of the Notes to Consolidated Financial Statements included in Park’s 2010 Annual Report to Shareholders (“2010 Annual Report”) lists significant accounting policies used in the development and presentation of Park’s consolidated financial statements. The accounting and reporting policies of Park conform with U.S. generally accepted accounting principles (GAAP) and general practices within the financial services industry. The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the amounts reported in the financial statements and the accompanying notes. Actual results could differ from those estimates.
Park believes the determination of the allowance for loan losses involves a higher degree of judgment and complexity than its other significant accounting policies. The allowance for loan losses is calculated with the objective of maintaining a reserve level believed by management to be sufficient to absorb probable incurred credit losses in the loan portfolio. Management’s determination of the adequacy of the allowance for loan losses is based on periodic evaluations of the loan portfolio and of current economic conditions. However, this evaluation is inherently subjective as it requires material estimates, including expected default probabilities, the loss given default, the amounts and timing of expected future cash flows on impaired loans, and estimated losses on consumer loans and residential mortgage loans based on historical loss experience and current economic conditions. All of these factors may be susceptible to significant change. To the extent that actual results differ from management estimates, additional loan loss provisions may be required that would adversely impact earnings for future periods. (Refer to the “Provision for Loan Losses” section within this MD&A for additional discussion.)
Other real estate owned (“OREO”), property acquired through foreclosure, is recorded at estimated fair value less anticipated selling costs (net realizable value). If the net realizable value is below the carrying value of the loan on the date of transfer, the difference is charged to the allowance for loan losses. Subsequent declines in value, OREO devaluations, are reported as adjustments to the carrying amount of OREO and are expensed within other income. Gains or losses not previously recognized, resulting from the sale of OREO, are recognized in other income on the date of sale. At June 30, 2011, OREO totaled $48.0 million, representing an 8.4% increase compared to $44.3 million at December 31, 2010. The $3.7 million net increase in OREO during the first six months of 2011 was a result of $23.9 million in new OREO offset by sales of $10.5 million and devaluations of $9.7 million.
U.S. GAAP requires management to establish a fair value hierarchy, which has the objective of maximizing the use of observable market inputs. U.S. GAAP also requires enhanced disclosures regarding the inputs used to calculate fair value. These are classified as Level 1, 2, and 3. Level 3 inputs are those with significant unobservable inputs that reflect a company’s own assumptions about the market for a particular instrument. Some of these inputs could be based on internal models and cash flow analyses. At June 30, 2011, the fair value of assets based on Level 3 inputs for Park was approximately $146.3 million. This was 11.5% of the total amount of assets measured at fair value as of the end of the second quarter. The fair value of impaired loans was approximately $97.6 million (or 66.7%) of the total amount of Level 3 inputs. Additionally, there were $70.0 million of loans that were impaired and carried at cost, as fair value exceeded book value for each individual credit. The large majority of Park’s Level 2 inputs consist of available-for-sale (“AFS”) securities. The fair value of these AFS securities is obtained largely through the use of matrix pricing, which is a mathematical technique widely used in the financial services industry to value debt securities without relying exclusively on quoted market prices for the specific securities but rather by relying on the securities’ relationship to other benchmark quoted securities.
Management believes that the accounting for goodwill and other intangible assets also involves a higher degree of judgment than most other significant accounting policies. U.S. GAAP establishes standards for the amortization of acquired intangible assets and the impairment assessment of goodwill. Goodwill arising from business combinations represents the value attributable to unidentifiable intangible assets in the business acquired. Park’s goodwill relates to the value inherent in the banking industry and that value is dependent upon the ability of Park’s banking subsidiaries to provide quality, cost-effective banking services in a competitive marketplace. The goodwill value is supported by revenue that is in part driven by the volume of business transacted. A decrease in earnings resulting from a decline in the customer base, the inability to deliver cost-effective services over sustained periods or significant credit problems can lead to impairment of goodwill that could adversely impact earnings in future periods. U.S. GAAP requires an annual evaluation of goodwill for impairment, or more frequently if events or changes in circumstances indicate that the asset might be impaired. Park’s most recent evaluation was completed during the second quarter of 2011 and resulted in no impairment of goodwill. The fair value of the goodwill, which resides on the books of Park’s subsidiary banks, is estimated by reviewing the past and projected operating results for the Park subsidiary banks, deposit and loan totals for the Park subsidiary banks and banking industry comparable information. At June 30, 2011, on a consolidated basis, Park had core deposit intangibles of $4.7 million subject to amortization and $72.3 million of goodwill, which was not subject to periodic amortization. The core deposit intangibles recorded on the balance sheet of PNB totaled $1.2 million and the core deposit intangibles at Vision Bank were $3.5 million. The goodwill asset of $72.3 million is carried on the balance sheet of PNB. Please see Note 3 – Goodwill and Intangible Assets of the Notes to Unaudited Consolidated Condensed Financial Statements in this Quarterly Report on Form 10-Q for additional information on intangible assets.
Comparison of Results of Operations
For the Three and Six Months Ended June 30, 2011 and 2010
Summary Discussion of Results
Net income for the three months ended June 30, 2011 was $20.3 million compared to $21.2 million for the second quarter of 2010, a decrease of $849,000 or 4.0%. Net income available to common shareholders (which is net of the preferred stock dividends and the related accretion) was $18.9 million for the second quarter of 2011 compared to $19.7 million for the three months ended June 30, 2010, a decrease of $862,000 or 4.4%. Preferred stock dividends and the related accretion of the discount on the preferred stock, pertaining to the $100 million of preferred stock issued to the U.S. Treasury on December 23, 2008, were $1.46 million for the second quarter of 2011 and $1.45 million for the same quarter in 2010.
Diluted earnings per common share were $1.22 for the second quarter of 2011 compared to $1.30 for the second quarter of 2010, a decrease of $0.08 per share or 6.2%. Weighted average common shares outstanding were 15,398,919 for the three months ended June 30, 2011 compared to 15,114,846 common shares for the second quarter of 2010, an increase of 284,073 common shares or 1.9%. Park sold a total of 509,184 common shares, issued from treasury shares, during the last three quarters of 2010. Most of the sales of common shares (437,200) resulted from the exercise of Series A and Series B Common Share Warrants issued in connection with the registered direct public offering which closed on October 30, 2009. In addition, Park sold 71,984 common shares, issued from treasury shares, in connection with a registered direct public offering which closed on December 10, 2010.
Net income for the six months ended June 30, 2011 was $41.7 million compared to $41.9 million for the first half of 2010, a decrease of $250,000 or 0.6%. Net income available to common shareholders was $38.8 million for the first six months of 2011 compared to $39.0 million for the same period in 2010, a decrease of $275,000 or 0.7%. Preferred stock dividends and the related accretion of the discount on the preferred stock issued to the U.S. Treasury totaled $2.9 million for the first half of both 2011 and 2010.
Diluted earnings per common share were $2.52 for the six months ended June 30, 2011 compared to $2.60 for the first half of 2010, a decrease of $0.08 per share or 3.1%. Weighted average common shares outstanding were 15,398,925 for the six months ended June 30, 2011 compared to 14,998,810 common shares for the six months ended 2010, an increase of 400,115 common shares or 2.7%.
The following tables compare the components of net income for the three and six month periods ended June 30, 2011 with the components of net income for the three and six month periods ended June 30, 2010. This information is provided for Park, Vision Bank and Park excluding Vision Bank (“Park’s Ohio-based operations”). In general, for the first six months of 2011, the operating results for Park’s Ohio-based operations were a little stronger than management projected, but the results for Vision Bank were weaker than anticipated.
| Park – Summary Income Statement | |
| | | Three months ended June 30, | | | Six months ended June 30, | |
| (in thousands) | | 2011 | | | 2010 | | | % Change | | | 2011 | | | 2010 | | | % Change | |
| Net interest income | | $ | 70,022 | | | $ | 68,721 | | | | 1.89 | % | | $ | 139,335 | | | $ | 136,101 | | | | 2.38 | % |
| Provision for loan losses | | | 23,900 | | | | 13,250 | | | | 80.38 | % | | | 37,400 | | | | 29,800 | | | | 25.50 | % |
| Total other income | | | 13,236 | | | | 16,647 | | | | -20.49 | % | | | 26,407 | | | | 33,357 | | | | -20.84 | % |
| Gain on sale of securities | | | 15,362 | | | | 3,515 | | | | 337.04 | % | | | 21,997 | | | | 11,819 | | | | 86.12 | % |
| Total other expense | | | 47,007 | | | | 47,001 | | | | 0.01 | % | | | 93,353 | | | | 94,891 | | | | -1.62 | % |
| Income before taxes | | $ | 27,713 | | | $ | 28,632 | | | | -3.21 | % | | $ | 56,986 | | | $ | 56,586 | | | | 0.71 | % |
| Income taxes | | | 7,396 | | | | 7,466 | | | | -0.94 | % | | | 15,291 | | | | 14,641 | | | | 4.44 | % |
| Net income | | $ | 20,317 | | | $ | 21,166 | | | | -4.01 | % | | $ | 41,695 | | | $ | 41,945 | | | | -0.60 | % |
The following table compares the guidance for 2011 that management provided in Park’s 2010 Annual Report with the actual results for the six month period ended June 30, 2011. This guidance was included in Park’s 2010 Annual Report in the “Financial Review” section on pages 38 through 40.
| (in thousands) | Projected results for 2011 | 50% of annual projection | Actual results for the first half of 2011 |
| Net interest income | $268,000 to $278,000 | $134,000 - $139,000 | $139,335 |
| Provision for loan losses | $47,000 to $57,000 | $23,500 - $28,500 | $37,400 |
| Total other income | $63,000 to $67,000 | $31,500 - $33,500 | $26,407 |
| Total other expense | $183,000 to $187,000 | $91,500- $93,500 | $93,353 |
Park’s management believes that the guidance previously provided for net interest income and total other expense continues to be a good estimate for 2011.
The provision for loan losses for the second quarter of 2011 was $23.9 million and was $37.4 million for the first six months of 2011. The loan loss provision for the first half of 2011 was $8.9 million above management’s initial guidance provided in the 2010 Annual Report. Park filed a Current Report on Form 8-K on June 30, 2011, indicating that the provision for loan losses at Vision Bank for the second quarter was going to be somewhat higher than management projected. As a result, Park’s management has increased the range for the projected loan loss provision for the year ending December 31, 2011 by $9 million to a new range of $56 million to $66 million. The provision for loan losses at Vision Bank for the second quarter of 2011 was $18.4 million, compared to $8.9 million for the same period in 2010.
Total other income was $13.2 million for the second quarter of 2011 and was $26.4 million for the first six months of 2011. Total other income for the first half of 2011 was $5.1 million below the bottom of the range for management’s guidance for the first half of 2011. The poor performance in total other income has primarily been due to the large devaluations of other real estate owned (“OREO”) at Vision Bank. OREO devaluations for Park were $5.3 million for the second quarter of 2011 and $9.7 million for the first six months of 2011. As a result of these devaluations, Park’s management has reduced the range for projected total other income for 2011 by $5 million to a range of $58 million to $62 million.
Park’s management sold $192 million of 15-year U.S. Government sponsored entity mortgage-backed securities for a pre-tax gain of $15.4 million late in the second quarter of 2011. These securities were sold at a price of approximately 107.4% of the principal balance, with an estimated yield to the buyer of 1.92%. These securities had a weighted average yield to Park of 5.25% and a remaining average maturity of 2.6 years. Management expects to complete the reinvestment of the proceeds from the June 2011 sales by August 31, 2011 in U.S. Government sponsored entity collateralized mortgage obligations. During the first quarter of 2011, Park sold $105 million of 15-year U.S. Government sponsored entity mortgage-backed securities for a pre-tax gain of $6.6 million. Collectively for the first two quarters of 2011, Park has sold $297 million of U.S. Government sponsored entity mortgage-backed securities for a pre-tax gain of $22.0 million.
Management does not currently forecast the sale of additional securities in 2011. However, the sale of additional securities for a gain in 2011 is possible. At June 30, 2011, Park owned approximately $55 million of U.S. Government sponsored entity mortgage-backed securities with a coupon interest rate of 5.00% or higher. This portion of the investment portfolio has a weighted average book yield of 5.63% and an unrealized gain of $4.9 million.
The following table provides a summary income statement for Vision Bank.
| Vision Bank – Summary Statement of Operations | |
| | | Three Months Ended June 30, | | | Six Months Ended June 30, | |
| (in thousands) | | 2011 | | | 2010 | | | % Change | | | 2011 | | | 2010 | | | % Change | |
| Net interest income | | $ | 7,000 | | | $ | 6,914 | | | | 1.24 | % | | $ | 13,755 | | | $ | 13,805 | | | | -0.36 | % |
| Provision for loan losses | | | 18,400 | | | | 8,900 | | | | 106.74 | % | | | 26,400 | | | | 20,200 | | | | 30.69 | % |
| Other income | | | (2,074 | ) | | | (756 | ) | | | -174.34 | % | | | (5,250 | ) | | | (605 | ) | | | -767.77 | % |
| Gain on sale of securities | | | 1,828 | | | | ----- | | | N.M. | | | | 1,828 | | | | ---- | | | N.M. | |
| Other expense | | | 8,174 | | | | 8,237 | | | | -0.76 | % | | | 15,599 | | | | 16,091 | | | | -3.06 | % |
| Loss before taxes | | $ | (19,820 | ) | | $ | (10,979 | ) | | | -80.53 | % | | $ | (31,666 | ) | | $ | (23,091 | ) | | | -37.14 | % |
| Income tax credits | | | (6,965 | ) | | | (4,223 | ) | | | -64.93 | % | | | (11,147 | ) | | | (8,879 | ) | | | -25.54 | % |
| Net loss | | $ | (12,855 | ) | | $ | (6,756 | ) | | | -90.28 | % | | $ | (20,519 | ) | | $ | (14,212 | ) | | | -44.38 | % |
N.M. – Not Meaningful
The operating results for Vision Bank for the second quarter of 2011 and for the six months ended June 30, 2011 were worse than management forecast. As previously mentioned, the loan loss provision for the second quarter of 2011 was $18.4 million, compared to $8.9 million for the second quarter of 2010. The $18.4 million loan loss provision for the quarter was primarily due to the reappraisal of collateral and management’s typical quarterly procedures related to expected future cash flows on certain nonaccrual loans. Total other income for Vision Bank was a loss of $2.1 million for the second quarter of 2011 and a loss of $5.3 million for the first six months of 2011. These losses were largely due to $3.3 million in OREO devaluations during the three months ended June 30, 2011 and $7.6 million for the first six months of 2011. Management expects that devaluations of OREO will be much less during the second half of 2011, as most of the OREO has already been reappraised in 2011.
The following table provides a summary income statement for Park excluding Vision Bank.
| Park Excluding Vision Bank – Summary Income Statement |
| | | Three Months Ended June 30, | | | Six Months Ended June 30, | |
| (in thousands) | | 2011 | | | 2010 | | | % Change | | | 2011 | | | 2010 | | | % Change | |
| Net interest income | | $ | 63,022 | | | $ | 61,807 | | | | 1.97 | % | | $ | 125,580 | | | $ | 122,296 | | | | 2.69 | % |
| Provision for loan losses | | | 5,500 | | | | 4,350 | | | | 26.44 | % | | | 11,000 | | | | 9,600 | | | | 14.58 | % |
| Other income | | | 15,310 | | | | 17,403 | | | | -12.03 | % | | | 31,657 | | | | 33,962 | | | | -6.79 | % |
| Gain on sale of securities | | | 13,534 | | | | 3,515 | | | | 285.04 | % | | | 20,169 | | | | 11,819 | | | | 70.65 | % |
| Other expense | | | 38,833 | | | | 38,764 | | | | 0.18 | % | | | 77,754 | | | | 78,800 | | | | -1.33 | % |
| Income before taxes | | $ | 47,533 | | | $ | 39,611 | | | | 20.00 | % | | $ | 88,652 | | | $ | 79,677 | | | | 11.26 | % |
| Income taxes | | | 14,361 | | | | 11,689 | | | | 22.86 | % | | | 26,438 | | | | 23,520 | | | | 12.41 | % |
| Net income | | $ | 33,172 | | | $ | 27,922 | | | | 18.80 | % | | $ | 62,214 | | | $ | 56,157 | | | | 10.79 | % |
The operating results for Park’s Ohio-based banking divisions were better than management’s forecast for the first half of 2011. Excluding the after-tax impact of security gains, net income would have been $49.1 million for the first half of 2011 compared to $48.5 million for the first six months of 2010.
Net Interest Income Comparison for the Second Quarter of 2011 and 2010
Park’s principal source of earnings is net interest income, the difference between total interest income and total interest expense. Net interest income results from average balances outstanding for interest earning assets and interest bearing liabilities in conjunction with the average rates earned and paid on them. Net interest income increased by $1.3 million or 1.9% to $70.0 million for the second quarter of 2011 compared to $68.7 million for the second quarter of 2010.
The following table compares the average balance and tax equivalent yield on interest earning assets and the average balance and cost of interest bearing liabilities for the second quarter of 2011 with the same quarter in 2010.
| Three months ended June 30, | |
| | | 2011 | | | 2010 | |
(in thousands) | | Average balance | | | Tax equivalent % | | | Average balance | | | Tax equivalent % | |
| Loans (1) | | $ | 4,743,696 | | | | 5.61 | % | | $ | 4,604,481 | | | | 5.84 | % |
| Taxable investments | | | 1,972,676 | | | | 3.86 | % | | | 1,751,343 | | | | 4.64 | % |
| Tax exempt investments | | | 8,179 | | | | 7.01 | % | | | 17,601 | | | | 7.23 | % |
| Money market instruments | | | 21,239 | | | | 0.15 | % | | | 94,669 | | | | 0.22 | % |
| Interest earning assets | | $ | 6,745,790 | | | | 5.08 | % | | $ | 6,468,094 | | | | 5.44 | % |
| | | | | | | | | | | | | | | | | |
| Interest bearing deposits | | $ | 4,301,872 | | | | 0.67 | % | | $ | 4,288,551 | | | | 1.04 | % |
| Short-term borrowings | | | 290,293 | | | | 0.27 | % | | | 283,686 | | | | 0.43 | % |
| Long-term debt | | | 881,534 | | | | 3.44 | % | | | 729,320 | | | | 3.92 | % |
| Interest bearing liabilities | | $ | 5,473,699 | | | | 1.09 | % | | $ | 5,301,557 | | | | 1.40 | % |
| Excess interest earning assets | | $ | 1,272,091 | | | | | | | $ | 1,166,537 | | | | | |
| Net interest spread | | | | | | | 3.99 | % | | | | | | | 4.04 | % |
| Net interest margin | | | | | | | 4.19 | % | | | | | | | 4.29 | % |
(1) For purposes of the computation, nonaccrual loans are included in the average balance.
Average interest earning assets for the second quarter of 2011 increased by $278 million or 4.3% to $6,746 million compared to $6,468 million for the second quarter of 2010. The average yield on interest earning assets decreased by 36 basis points to 5.08% for the second quarter of 2011 compared to 5.44% for the second quarter of 2010.
Average interest bearing liabilities for the second quarter of 2011 increased by $172 million or 3.2% to $5,474 million compared to $5,302 million for the second quarter of 2010. The average cost of interest bearing liabilities decreased by 31 basis points to 1.09% for the second quarter of 2011 compared to 1.40% for the second quarter of 2010.
Interest Rates
Short-term interest rates continue to be extremely low. The average federal funds rate was .13% for the first half of 2011, compared to .16% for the first six months of 2010.
In December 2008, the Federal Open Market Committee (“FOMC”) of the Federal Reserve lowered the targeted federal funds rate to a range of 0% to .25% in response to a severe recession in the U.S. economy. Economic conditions began to improve in the second half of 2009 and continued to improve throughout 2010. The economic recovery has continued during the first half of 2011, but the U.S. unemployment rate continues to be relatively high at 9.2% as of June 30, 2011.
Park’s management expects that the FOMC will continue to maintain the targeted federal funds interest rate in the range of 0% to .25% during the last six months of 2011. The annual average federal funds rate was .16% for 2009 and .18% for 2010.
Discussion of Loans, Investments, Deposits and Borrowings
Average loan balances increased by $140 million or 3.0% to $4,744 million for the three months ended June 30, 2011, compared to $4,604 million for the second quarter of 2010. The average yield on the loan portfolio decreased by 23 basis points to 5.61% for the second quarter of 2011 compared to 5.84% for the second quarter of 2010.
Total loan balances outstanding at June 30, 2011 were $4,711 million compared to $4,733 million at December 31, 2010, a decrease of $22 million or 0.5%. This decrease in loan balances in 2011 was due to a decrease in loan balances at Vision Bank. Total loan balances at Vision Bank decreased by approximately $75 million to $565 million at June 30, 2011. Approximately $54 million of this decrease in loan balances at Vision Bank was due to a reduction in nonaccrual loans. Park’s management continues to forecast modest loan growth for Park in 2011 with a projected increase of 1% to 3% for the year.
The average balance of taxable investment securities increased by $222 million or 12.7% to $1,973 million for the second quarter of 2011 compared to $1,751 million for the second quarter of 2010. The average yield on taxable investment securities was 3.86% for the second quarter of 2011 compared to 4.64% for the second quarter of 2010.
The average balance of tax exempt investment securities decreased by $9.4 million or 53.4% to $8.2 million for the second quarter of 2011 compared to $17.6 million for the second quarter of 2010. The tax equivalent yield on tax exempt investment securities was 7.01% for the second quarter of 2011 and 7.23% for the second quarter of 2010. Park has not purchased any tax exempt investment securities for the past several quarters and does not plan to purchase tax exempt securities in the second half of 2011.
The average balance of money market instruments decreased by $74 million or 77.9% to $21 million for the second quarter of 2011 compared to $95 million for the second quarter of 2010. The average yield on money market instruments was 0.15% for the second quarter of 2011 compared to 0.22% for the second quarter of 2010.
The amortized cost of total investment securities was $1,951 million at June 30, 2011, compared to $2,017 million at December 31, 2010. At June 30, 2011, the tax equivalent yield on Park’s investment portfolio was 3.62% and the remaining average life was 3.2 years.
Average interest bearing deposit accounts increased by $13 million or 0.3% to $4,302 million for the second quarter of 2011 compared to $4,289 million for the second quarter of 2010. The average interest rate paid on interest bearing deposits decreased by 37 basis points to 0.67% for the second quarter of 2011 compared to 1.04% for the second quarter last year.
Average total borrowings were $1,172 million for the three months ended June 30, 2011, compared to $1,013 million for the second quarter of 2010, an increase of $159 million or 15.7%. The average interest rate paid on total borrowings was 2.65% for the second quarter of 2011 compared to 2.94% for the second quarter of 2010.
The net interest spread (the difference between the tax equivalent yield on interest earning assets and the cost of interest bearing liabilities) decreased by 5 basis points to 3.99% for the second quarter of 2011 compared to 4.04% for the second quarter last year. The net interest margin (the annualized tax equivalent net interest income divided by average interest earning assets) was 4.19% for the second quarter of 2011 compared to 4.29% for the second quarter of 2010.
Net Interest Income Comparison for the First Half of 2011 and 2010
Net interest income increased by $3.2 million or 2.4% to $139.3 million for the first six months of 2011 compared to $136.1 million for the first half of 2010. The following table compares the average balance and the annualized tax equivalent yield on interest earning assets and the average balance and cost of interest bearing liabilities for the first six months of 2011 with the first half of 2010.
| Six Months Ended June 30, | |
| | | 2011 | | | 2010 | |
(in thousands) | | Average balance | | | Tax equivalent % | | | Average balance | | | Tax equivalent % | |
Loans (1) | | $ | 4,743,387 | | | | 5.62 | % | | $ | 4,610,944 | | | | 5.86 | % |
| Taxable investments | | | 1,956,365 | | | | 3.92 | % | | | 1,758,951 | | | | 4.67 | % |
| Tax exempt investments | | | 10,198 | | | | 7.38 | % | | | 17,915 | | | | 7.36 | % |
| Money market instruments | | | 24,078 | | | | .12 | % | | | 110,146 | | | | .22 | % |
| Interest earning assets | | $ | 6,734,028 | | | | 5.11 | % | | $ | 6,497,956 | | | | 5.44 | % |
| | | | | | | | | | | | | | | | | |
| Interest bearing deposits | | $ | 4,273,720 | | | | .70 | % | | $ | 4,327,567 | | | | 1.10 | % |
| Short-term borrowings | | | 340,550 | | | | .27 | % | | | 294,914 | | | | .44 | % |
| Long-term debt | | | 864,760 | | | | 3.48 | % | | | 729,468 | | | | 3.92 | % |
| Interest bearing liabilities | | $ | 5,479,030 | | | | 1.11 | % | | $ | 5,351,949 | | | | 1.44 | % |
| Excess interest earning assets | | $ | 1,254,998 | | | | | | | $ | 1,146,007 | | | | | |
| Net interest spread | | | | | | | 4.00 | % | | | | | | | 4.00 | % |
| Net interest margin | | | | | | | 4.20 | % | | | | | | | 4.25 | % |
(1) For purposes of the computation, nonaccrual loans are included in the average balance.
Average interest earning assets increased by $236 million or 3.6% to $6,734 million for the first six months of 2011 compared to $6,498 million for the first half of 2010. The average yield on interest earning assets was 5.11% for the six months ended June 30, 2011 compared to 5.44% for the same period in 2010.
Average loans increased by $132 million or 2.9% to $4,743 million for the first half of 2011 compared to $4,611 million for the same period in 2010. The average yield on loans was 5.62% for the first half of 2011 compared to 5.86% for the same period in 2010.
Average investment securities, including money market instruments, were $1,991 million for the first six months of 2011 compared to $1,887 million for the first half of 2010. The average yield on taxable investment securities was 3.92% for the first half of 2011 and 4.67% for the first half of 2010 and the average tax equivalent yield on tax exempt securities was 7.38% in 2011 and 7.36% in 2010.
Average interest bearing liabilities increased by $127 million or 2.4% to $5,479 million for the first half of 2011 compared to $5,352 million for the same period in 2010. The average cost of interest bearing liabilities was 1.11% for the first half of 2011 compared to 1.44% for the first six months of 2010.
Average interest bearing deposits decreased by $54 million or 1.2% to $4,274 million for the first six months of 2011 compared to $4,328 million for the first half of 2010. The average interest rate paid on interest bearing deposit accounts was .70% for the first half of 2011 compared to 1.10% for the first half of 2010.
Average total borrowings were $1,205 million for the first half of 2011 compared to $1,024 million for the first six months of 2010. The average interest rate paid on total borrowings was 2.57% for the first half of 2011 compared to 2.92% for the same period in 2010.
The net interest spread was 4.00% for the first half of 2011 and 2010. The net interest margin decreased by 5 basis points to 4.20% for the six months ended June 30, 2011 compared to 4.25% for the first six months of 2010.
Guidance on Net Interest Income for 2011
Management provided guidance in Park’s 2010 Annual Report (page 38) that net interest income for 2011 would be approximately $268 million to $278 million, the tax equivalent net interest margin would be approximately 4.10% to 4.20% and the average interest earning assets for 2011 would be approximately $6,550 million.
The actual results for the first six months of 2011 were slightly above management’s guidance. Net interest income for the first six months of 2011 was $139.3 million, which annualized would be approximately $281 million for 2011. The tax equivalent net interest margin was 4.20% and average interest earning assets were $6,734 million for the first six months of 2011.
The following table displays for the past five quarters the average balance of interest earning assets, net interest income and the tax equivalent net interest margin.
| (in thousands) | Average interest earning assets | Net interest income | Tax equivalent net interest margin |
| June 2010 | $6,468,094 | $68,721 | 4.29% |
| September 2010 | $6,484,941 | $69,445 | 4.28% |
| December 2010 | $6,447,046 | $68,498 | 4.25% |
| March 2011 | $6,722,136 | $69,313 | 4.21% |
| June 2011 | $6,745,790 | $70,022 | 4.19% |
Management’s current forecast projects that net interest income for 2011 will be near the top of the range of $268 million to $278 million. Management also expects that average interest earning assets will be approximately $6,700 million for the remaining six months of 2011 and that the tax equivalent net interest margin will be about 4.05% for the last six months of 2011.
Provision for Loan Losses
The provision for loan losses was $23.9 million for the three months ended June 30, 2011, compared to $13.3 million for the same period in 2010. Net loan charge-offs were $40.6 million for the second quarter of 2011, compared to $12.2 million for the second quarter of 2010. The annualized ratio of net loan charge-offs to average loans was 3.43% for the three months ended June 30, 2011, compared to 1.07% for the same period in 2010.
For the first six months of 2011, the provision for loan losses increased by $7.6 million to $37.4 million, compared to $29.8 million for the same period in 2010. Net loan charge-offs were $48.6 million for the six months ended June 30, 2011, or 2.07% of average loans on an annualized basis, compared to $25.8 million, or 1.13% of average loans on an annualized basis, for the first six months of 2010.
The following table provides additional information related to Park’s allowance for loan losses, including information related to specific reserves and general reserves, at June 30, 2011, December 31, 2010 and June 30, 2010.
| Park National Corporation – Allowance for Loan & Lease Losses (ALLL) | |
| (in thousands) | | June 30, 2011 | | | December 31, 2010 | | | June 30, 2010 | |
| Total ALLL | | $ | 110,187 | | | $ | 121,397 | | | $ | 120,676 | |
| Less specific reserves at Park’s Ohio-based operations | | | 14,132 | | | | 12,976 | | | | 6,059 | |
| Less specific reserves at Vision Bank | | | 18,678 | | | | 30,483 | | | | 32,708 | |
| General reserves | | $ | 77,377 | | | $ | 77,938 | | | $ | 81,909 | |
| | | | | | | | | | | | | |
| Total loans | | $ | 4,710,513 | | | $ | 4,732,685 | | | $ | 4,655,997 | |
| Less impaired commercial loans | | | 200,400 | | | | 250,933 | | | | 203,574 | |
| Non-impaired loans | | $ | 4,510,113 | | | $ | 4,481,752 | | | $ | 4,452,423 | |
| | | | | | | | | | | | | |
| Total ALLL to total loan ratio | | | 2.34 | % | | | 2.57 | % | | | 2.59 | % |
| General reserves as a % of non-impaired loans | | | 1.72 | % | | | 1.74 | % | | | 1.84 | % |
As a result of the passage of time and more clarity on the characteristics of many of the impaired commercial loans at Vision Bank, during the second quarter of 2011, management determined that it was appropriate to charge-off many of the specific reserves previously established on impaired commercial loans. Of the $47.3 million of specific reserves at March 31, 2011, management determined it was appropriate to charge-off $29.3 million in the second quarter of 2011. These charge-offs of specific reserves, along with other charge-offs during the second quarter, resulted in the previously discussed 3.43% annualized charge-off ratio for the quarter. Finally, partially off-setting the $29.3 million reduction in the specific reserves due to charge-offs, new specific reserves were established in the amount of $14.8 million as a result of management’s typical quarterly evaluation of impaired commercial loans. This quarterly evaluation includes a detailed review of the expected cash flows and the current estimate of the collateral value for all impaired commercial loans. As a result of the second quarter evaluation, management noted some deterioration in either collateral value or expected cash flows within certain of the larger impaired commercial, land and development loans at Vision Bank and increased the specific reserves established for these loans.
The loan loss provision for Vision Bank was $18.4 million for the three months ended June 30, 2011, compared to $8.9 million for the same quarter in 2010. Vision Bank had net loan charge-offs of $32.0 million, or an annualized 21.05% of average loans for the second quarter of 2011, compared to net loan charge-offs of $6.5 million, or 3.92% of average loans for the same period in 2010. As discussed above, during the second quarter of 2011 Vision Bank charged off a significant portion of previously established specific reserves, resulting in the significant increase in net charge-offs compared to the second quarter of 2010.
Park’s Ohio-based operations had a provision for loan losses of $5.5 million for the second quarter of 2011, compared to $4.4 million for the second quarter of 2010. Net loan charge-offs for Park’s Ohio-based operations were $8.6 million, or an annualized 0.84% of average loans for the second quarter of 2011, compared to $5.7 million, or an annualized 0.58% of average loans for the second quarter of 2010.
The following table compares Park National Corporation’s nonperforming assets at June 30, 2011, December 31, 2010 and June 30, 2010.
| Park National Corporation - Nonperforming Assets | |
| (in thousands) | | June 30, 2011 | | | December 31, 2010 | | | June 30, 2010 | |
| Nonaccrual loans | | $ | 238,690 | | | $ | 289,268 | | | $ | 237,640 | |
| Renegotiated loans | | | 33 | | | | - | | | | 214 | |
| Loans past due 90 days or more | | | 3,142 | | | | 3,590 | | | | 17,283 | |
| Total nonperforming loans | | $ | 241,865 | | | $ | 292,858 | | | $ | 255,137 | |
| | | | | | | | | | | | | |
| Other Real Estate Owned – Park National Bank | | | 10,309 | | | | 8,385 | | | | 9,554 | |
| Other Real Estate Owned – SE Property Holdings | | | 32,638 | | | | - | | | | - | |
| Other Real Estate Owned – Vision Bank | | | 5,050 | | | | 35,940 | | | | 36,902 | |
| Total nonperforming assets | | $ | 289,862 | | | $ | 337,183 | | | $ | 301,593 | |
| | | | | | | | | | | | | |
| Percentage of nonperforming loans to total loans | | | 5.13 | % | | | 6.19 | % | | | 5.48 | % |
| Percentage of nonperforming assets to total loans | | | 6.15 | % | | | 7.12 | % | | | 6.48 | % |
| Percentage of nonperforming assets to total assets | | | 3.96 | % | | | 4.62 | % | | | 4.25 | % |
During the first quarter of 2011, Park formed a limited liability company, organized under the laws of the state of Ohio, called SE Property Holdings, LLC (“SE Property Holdings”), as a direct subsidiary of Park. The purpose of SE Property Holdings is to purchase other real estate owned (“OREO”) from Vision Bank and continue to market such property for sale. As of June 30, 2011, approximately $32.6 million of OREO was held by SE Property Holdings, purchased from Vision Bank (at the then current fair market value) during 2011. Management expects that the remaining $5.1 million of OREO held by Vision Bank as of June 30, 2011 will be purchased by SE Property Holdings (at the then current fair market value) during the third quarter of 2011. Management plans to continue marketing the properties held by SE Property Holdings and sell such properties in an efficient manner.
Vision Bank’s nonperforming assets at June 30, 2011, December 31, 2010 and June 30, 2010, were as follows:
| Vision Bank - Nonperforming Assets | |
| (in thousands) | | June 30, 2011 | | | December 31, 2010 | | | June 30, 2010 | |
| Nonaccrual loans | | $ | 117,562 | | | $ | 171,453 | | | $ | 152,698 | |
| Renegotiated loans | | | - | | | | - | | | | - | |
| Loans past due 90 days or more | | | 980 | | | | 364 | | | | 9,616 | |
| Total nonperforming loans | | $ | 118,542 | | | $ | 171,817 | | | $ | 162,314 | |
| | | | | | | | | | | | | |
| Other Real Estate Owned | | | 5,050 | | | | 35,940 | | | | 36,902 | |
| Total nonperforming assets | | $ | 123,592 | | | $ | 207,757 | | | $ | 199,216 | |
| | | | | | | | | | | | | |
| Percentage of nonperforming loans to total loans | | | 20.97 | % | | | 26.82 | % | | | 24.16 | % |
| Percentage of nonperforming assets to total loans | | | 21.87 | % | | | 32.43 | % | | | 29.66 | % |
| Percentage of nonperforming assets to total assets | | | 16.46 | % | | | 25.71 | % | | | 23.08 | % |
Nonperforming assets for Park, excluding Vision Bank at June 30, 2011, December 31, 2010 and June 30, 2010, are included in the following table:
| Park, excluding Vision Bank - Nonperforming Assets | |
| (in thousands) | | June 30, 2011 | | | December 31, 2010 | | | June 30, 2010 | |
| Nonaccrual loans | | $ | 121,128 | | | $ | 117,815 | | | $ | 84,942 | |
| Renegotiated loans | | | 33 | | | | - | | | | 214 | |
| Loans past due 90 days or more | | | 2,162 | | | | 3,226 | | | | 7,667 | |
| Total nonperforming loans | | $ | 123,323 | | | $ | 121,041 | | | $ | 92,823 | |
| | | | | | | | | | | | | |
| Other Real Estate Owned – Park National Bank | | | 10,309 | | | | 8,385 | | | | 9,554 | |
| Other Real Estate Owned – SE Property Holdings | | | 32,638 | | | | - | | | | - | |
| Total nonperforming assets | | $ | 166,270 | | | $ | 129,426 | | | $ | 102,377 | |
| | | | | | | | | | | | | |
| Percentage of nonperforming loans to total loans | | | 2.97 | % | | | 2.96 | % | | | 2.33 | % |
| Percentage of nonperforming assets to total loans | | | 4.01 | % | | | 3.16 | % | | | 2.57 | % |
| Percentage of nonperforming assets to total assets | | | 2.53 | % | | | 1.99 | % | | | 1.64 | % |
Park’s allowance for loan losses includes an allocation for loans specifically identified as impaired under U.S. GAAP. At June 30, 2011, loans considered to be impaired consisted substantially of commercial loans graded as “doubtful” and placed on nonaccrual status. As a result of significant losses within Vision Bank’s CL&D loan portfolio over the past three and a half years, management continues to believe it is necessary to segregate this portion of the portfolio for both impaired credits, as well as those accruing CL&D loans at June 30, 2011. Cumulative charge-offs within Vision Bank’s impaired CL&D loan portfolio at June 30, 2011 was $49.7 million. Additionally, at June 30, 2011, management had established a specific reserve of $11.8 million related to those CL&D loans at Vision Bank that were deemed to be impaired. The aggregate of cumulative prior charge-offs on impaired Vision Bank CL&D loans, along with the specific reserves at June 30, 2011, totaled $61.5 million. The following table summarizes the CL&D loan portfolio at Vision Bank:
| Vision Bank CL&D Loan Portfolio | |
| (in thousands) - end of each respective period | | June 30, 2011 | | | Dec. 31, 2010 | | | Dec. 31, 2009 | | | Dec. 31, 2008 | |
| CL&D loans | | $ | 111,054 | | | $ | 170,989 | | | $ | 218,263 | | | $ | 251,443 | |
| Performing CL&D loans | | | 64,207 | | | | 84,498 | | | | 132,380 | | | | 191,712 | |
| Impaired CL&D loans | | $ | 46,847 | | | $ | 86,491 | | | $ | 85,883 | | | $ | 59,731 | |
| | | | | | | | | | | | | | | | | |
| Specific reserve on impaired CL&D loans | | $ | 11,763 | | | $ | 23,585 | | | $ | 21,802 | | | $ | 3,134 | |
| Cumulative charge-offs on impaired CL&D loans | | | 49,692 | | | | 28,652 | | | | 24,931 | | | | 18,839 | |
| Specific reserves plus cumulative charge-offs | | $ | 61,455 | | | $ | 52,237 | | | $ | 46,733 | | | $ | 21,973 | |
| | | | | | | | | | | | | | | | | |
| Specific reserves plus cumulative charge-offs as a percentage of impaired CL&D loans plus cumulative charge-offs | | | 63.7 | % | | | 45.4 | % | | | 42.2 | % | | | 28.0 | % |
When determining the quarterly loan loss provision, Park reviews the grades of commercial loans. These loans are graded from 1 to 8. A grade of 1 indicates little or no credit risk and a grade of 8 is considered a loss. Commercial loans with grades of 1 to 4 (pass-rated) are considered to be of acceptable credit risk. Commercial loans graded a 5 (special mention) are considered to be watch list credits and a higher loan loss reserve percentage is allocated to these loans. Commercial loans graded 6 (substandard), also considered watch list credits, are considered to represent higher credit risk and, as a result, a higher loan loss reserve percentage is allocated to these loans. Generally, commercial loans that are graded a 6 are considered for partial charge-off. Commercial loans that are graded a 7 (doubtful) are shown as nonperforming and Park generally charges these loans down to their fair value by taking a partial charge-off or recording a specific reserve. Any commercial loan graded an 8 (loss) is completely charged-off.
A significant portion of Park’s allowance for loan losses is allocated to commercial loans classified as “special mention” or “substandard.” “Special mention” loans are loans that have potential weaknesses that may result in loss exposure to Park. “Substandard” loans are those that exhibit a well defined weakness, jeopardizing repayment of the loan, resulting in a higher probability that Park will suffer a loss on the loan unless the weakness is corrected. As previously discussed, management believes it is appropriate to segregate the Vision Bank CL&D loans from other commercial loans that are still accruing. The Vision CL&D loans that were still accruing at June 30, 2011 totaled $64.2 million compared to $84.5 million at December 31, 2010. Park’s loss experience, defined as charge-offs plus changes in specific reserves, on CL&D loans for the 36 months ended December 31, 2010 was an annual rate of 12.55%. Management has allocated an allowance for loan losses to the $64.2 million of accruing CL&D loans based on this historical loss experience, judgmentally increased to cover approximately 1.25 years of probable incurred losses, for a total reserve of $9.9 million or 15.4%. Further, we have allocated 15.4% to the $64.2 million of CL&D loans, regardless of the current loan grade, as this portion of the loan portfolio has experienced significant declines in collateral values, and thus if management determines that borrowers are unable to pay in accordance with the contractual terms of the loan agreement, significant specific reserves have typically been necessary. Park’s 36-month loss experience through the year ended December 31, 2010, defined as charge-offs plus changes in specific reserves, within the remaining commercial loan portfolio (excluding Vision Bank’s CL&D loans) was 1.14% of the principal balance of these loans. Park’s management believes it is appropriate to cover approximately 1.5 years worth of probable incurred losses within the other accruing commercial loan portfolio, thus the total reserve for loan losses is $40.0 million or 1.61% of the outstanding principal balance of other accruing commercial loans at June 30, 2011. The overall reserve of 1.61% for other accruing commercial loans breaks down as follows: pass-rated commercial loans are reserved at 1.06%; special mention commercial loans are reserved at 3.97%; and substandard commercial loans are reserved at 14.40%.
Generally, consumer loans are not individually graded. Consumer loans include: (1) mortgage and installment loans included in the construction real estate segment of the loan portfolio; (2) mortgage, home equity lines of credit (HELOC), and installment loans included in the residential real estate segment of the loan portfolio; and (3) all loans included in the consumer segment of the loan portfolio. The amount of loan loss reserve assigned to these loans is based on historical loss experience over the 36 months ended December 31, 2010, judgmentally increased to cover approximately 1.5 years of probable incurred losses.
The judgmental increases discussed above incorporate management’s evaluation of the impact of environmental qualitative factors which pose additional risks and assign a component of the allowance for loan losses in consideration of these factors. Such environmental factors include: national and local economic trends and conditions; experience, ability and depth of lending management and staff; effects of any changes in lending policies and procedures; and levels of and trends in consumer bankruptcies, delinquencies, impaired loans and charge-offs and recoveries. The determination of this component of the allowance for loan losses requires considerable management judgment. As always, management is working to address weaknesses in those loans that may result in future loss. Actual loss experience may be more or less than the amount allocated.
Management provided guidance in Park’s 2010 Annual Report (page 40) that the loan loss provision for 2011 would be approximately $47 million to $57 million. In the Current Report on Form 8-K filed on June 30, 2011, management projected that the provision for loan losses for the year ending December 31, 2011 would be approximately $56 million to $66 million. The actual results for the loan loss provision in the first six months of 2011 were $37.4 million. Park’s most recent projection continues to indicate that the loan loss provision for 2011 will be $56 million to $66 million. However, if Park experiences a significant increase in nonperforming loans, there is a risk that management’s projected loan loss provision could be higher.
Total Other Income
Total other income exclusive of securities gains decreased by $3.4 million or 20.5% to $13.2 million for the quarter ended June 30, 2011, compared to $16.6 million for the second quarter of 2010. For the six months ended June 30, 2011, total other income decreased by $6.9 million or 20.8% to $26.4 million compared to $33.3 million for the same period in 2010.
The following table is a summary of the changes in the components of total other income.
(in thousands) | | Three months ended June 30, | | | Six months ended June 30, | |
| | | 2011 | | | 2010 | | | Change | | | 2011 | | | 2010 | | | Change | |
| Income from fiduciary activities | | $ | 3,929 | | | $ | 3,528 | | | $ | 401 | | | $ | 7,651 | | | $ | 6,950 | | | $ | 701 | |
| Service charges on deposits | | | 4,525 | | | | 5,092 | | | | (567 | ) | | | 8,770 | | | | 9,838 | | | | (1,068 | ) |
| Other service income | | | 2,734 | | | | 3,476 | | | | (742 | ) | | | 5,035 | | | | 6,458 | | | | (1,423 | ) |
| Checkcard fee income | | | 3,251 | | | | 2,765 | | | | 486 | | | | 6,227 | | | | 5,209 | | | | 1,018 | |
| Bank owned life insurance income | | | 1,228 | | | | 1,254 | | | | (26 | ) | | | 2,457 | | | | 2,470 | | | | (13 | ) |
| ATM fees | | | 682 | | | | 832 | | | | (150 | ) | | | 1,336 | | | | 1,597 | | | | (261 | ) |
| OREO devaluations | | | (5,257 | ) | | | (1,919 | ) | | | (3,338 | ) | | | (9,651 | ) | | | (3,064 | ) | | | (6,587 | ) |
| Other | | | 2,144 | | | | 1,619 | | | | 525 | | | | 4,582 | | | | 3,899 | | | | 683 | |
| Total other income | | $ | 13,236 | | | $ | 16,647 | | | $ | (3,411 | ) | | $ | 26,407 | | | $ | 33,357 | | | $ | (6,950 | ) |
Income from fiduciary activities, which represents revenue earned from Park’s trust activities, increased by $401,000, or 11.4%, to $3.9 million for the three months ended June 30, 2011, compared to $3.5 million for the same period in 2010. For the six months ended June 30, 2011, income from fiduciary activities increased by $701,000 or 10.1% to $7.7 million compared to $7.0 million in 2010. Fiduciary fees are generally charged based on the market value of customer accounts. The market value for assets under management at June 30, 2011, has increased by approximately 15.6% compared to June 30, 2010.
Service charges on deposits decreased by $567,000, or 11.1%, to $4.5 million for the three month period ended June 30, 2011, compared to $5.1 million for the same period in 2010. Through the first six months of 2011, service charges declined $1.1 million, or 10.9%, to $8.8 million, compared to $9.8 million in 2010. This decrease was primarily attributable to a decline in non-sufficient funds (“NSF”) and overdraft charges during the first half of 2011 compared to the same period in 2010.
Fee income earned from origination and sale into the secondary market of long-term fixed-rate mortgage loans is included within other non-yield related fees in the subcategory “Other service income”. Other service income decreased by $742,000, or 21.3%, to $2.7 million for the three months ended June 30, 2011, compared to $3.5 million for the same period in 2010. For the six months ended June 30, 2011, other service income decreased $1.4 million, or 22.0%, to $5.0 million, compared to $6.5 million in 2010. This decrease was due to a decline in the volume of fixed-rate residential mortgage loans that Park originated and sold into the secondary market in the first half of 2011 compared to the same period in 2010.
Checkcard fee income, which is generated from debit card transactions, increased $486,000, or 17.6%, to $3.3 million for the three months ended June 30, 2011, compared to $2.8 million for the same period in 2010. For the six months ended June 30, 2011, checkcard fee income increased $1.0 million, or 19.5%, to $6.2 million compared to $5.2 million in 2010. This increase is attributable to continued increases in the volume of debit card transactions.
OREO devaluations increased by $3.3 million to $5.3 million for the three months ended June 30, 2011, compared to $1.9 million for the same period in 2010. For the six months ended June 30, 2011, OREO devaluations increased $6.6 million to $9.7 million compared to $3.1 million in 2010. The increase was largely due to devaluations of other real estate owned at Vision Bank of approximately $7.6 million through the first six months of 2011, compared to $2.7 million in devaluations for the same period in 2010. Management does not believe the devaluations for the first half of 2011 to be representative of the second half of 2011, based on management’s decision to accelerate the appraisal dates for much of the OREO property at Vision Bank, in order to expedite the transfer of OREO to SE Property Holdings, LLC.
The following table breaks out the change in total other income between Park’s Ohio-based operations and Vision Bank.
| | | Three months ended June 30, 2011 | | | Six months ended June 30, 2011 | |
(In thousands) | | Ohio-based operations | | | Vision Bank | | | Total | | | Ohio-based operations | | | Vision Bank | | | Total | |
| Income from fiduciary activities | | $ | 396 | | | $ | 5 | | | $ | 401 | | | $ | 695 | | | $ | 6 | | | $ | 701 | |
| Service charges on deposits | | | (478 | ) | | | (89 | ) | | | (567 | ) | | | (835 | ) | | | (233 | ) | | | (1,068 | ) |
| Non-yield loan fee income | | | (795 | ) | | | 53 | | | | (742 | ) | | | (1,485 | ) | | | 62 | | | | (1,423 | ) |
| Checkcard fee income | | | 274 | | | | 212 | | | | 486 | | | | 604 | | | | 414 | | | | 1,018 | |
| Bank owned life insurance income | | | (26 | ) | | | - | | | | (26 | ) | | | (8 | ) | | | (5 | ) | | | (13 | ) |
| ATM fees | | | 3 | | | | (153 | ) | | | (150 | ) | | | 17 | | | | (278 | ) | | | (261 | ) |
| OREO devaluations | | | (1,709 | ) | | | (1,629 | ) | | | (3,338 | ) | | | (1,683 | ) | | | (4,904 | ) | | | (6,587 | ) |
| Other | | | 241 | | | | 284 | | | | 525 | | | | 391 | | | | 292 | | | | 683 | |
| Total | | $ | (2,094 | ) | | $ | (1,317 | ) | | $ | (3,411 | ) | | $ | (2,304 | ) | | $ | (4,646 | ) | | $ | (6,950 | ) |
Management provided guidance in Park’s 2010 Annual Report (page 39) that total other income would be approximately $63 million to $67 million for 2011. On page 52 of the first quarter Form 10-Q, management updated the guidance for total other income, projecting it would be between $60 million and $64 million. Further, in the July 25, 2011 Form 8-K, management projected total other income of $58 million to $62 million, which is consistent with management’s most recent projection. The latest projection as compared to the projection in the 2010 Annual Report is primarily a result of larger devaluations with respect to other real estate owned.
Gain on Sale of Securities
During the three months ended June 30, 2011, Park sold $192 million of U.S. Government sponsored entity mortgage-backed securities for a pre-tax gain of $15.4 milion. During the second quarter of 2010, Park recognized a pre-tax gain of $3.5 million from the sale of $57 million of U.S. Government sponsored entity mortgage-backed securities.
For the six months ended June 30, 2011, Park sold a total of $297 million of U.S. Government sponsored entity mortgage-backed securities for a pre-tax gain of $22.0 million. For the first six months of 2010, Park sold $258 million of U.S. Government sponsored entity mortgage-backed securities for a pre-tax gain of $11.8 million. Additionally, $75 million of U.S. Government sponsored entity callable notes were sold during the first quarter of 2010 at their book value.
Total Other Expense
The following table is a summary of the changes in the components of total other expense.
| | | Three months ended June 30, | | | Six months ended June 30, | |
| (in thousands) | | 2011 | | | 2010 | | | Change | | | 2011 | | | 2010 | | | Change | |
| Salaries and employee benefits | | $ | 25,253 | | | $ | 24,013 | | | $ | 1,240 | | | $ | 50,317 | | | $ | 49,184 | | | $ | 1,133 | |
| Occupancy expense | | | 2,764 | | | | 2,793 | | | | (29 | ) | | | 5,764 | | | | 5,910 | | | | (146 | ) |
| Furniture and equipment expense | | | 2,785 | | | | 2,564 | | | | 221 | | | | 5,442 | | | | 5,196 | | | | 246 | |
| Data processing fees | | | 1,135 | | | | 1,394 | | | | (259 | ) | | | 2,388 | | | | 2,987 | | | | (599 | ) |
| Professional fees and services | | | 5,320 | | | | 5,299 | | | | 21 | | | | 10,194 | | | | 10,155 | | | | 39 | |
| Amortization of intangibles | | | 669 | | | | 842 | | | | (173 | ) | | | 1,338 | | | | 1,778 | | | | (440 | ) |
| Marketing | | | 728 | | | | 946 | | | | (218 | ) | | | 1,351 | | | | 1,848 | | | | (497 | ) |
| Insurance | | | 2,345 | | | | 2,333 | | | | 12 | | | | 4,614 | | | | 4,531 | | | | 83 | |
| Communication | | | 1,485 | | | | 1,647 | | | | (162 | ) | | | 3,041 | | | | 3,416 | | | | (375 | ) |
| State taxes | | | 488 | | | | 838 | | | | (350 | ) | | | 945 | | | | 1,683 | | | | (738 | ) |
| Other | | | 4,035 | | | | 4,332 | | | | (297 | ) | | | 7,959 | | | | 8,203 | | | | (244 | ) |
| Total other expense | | $ | 47,007 | | | $ | 47,001 | | | $ | 6 | | | $ | 93,353 | | | $ | 94,891 | | | $ | (1,538 | ) |
Other expenses have decreased by $1.5 million for the six months ended June 30, 2011 compared to the same period in 2010. This decrease was primarily due to declines in state taxes ($738,000), data processing expenses ($599,000), marketing expense ($497,000) and communications expense ($375,000), which is the result of management’s continued efforts to reduce expenses and increase efficiency. Additionally, amortization of intangibles declined by $440,000, as certain intangibles related to Park’s Ohio acquisitions are now fully amortized. Offsetting these declines, salary and employee benefits increased by $1.1 million through the first six months of 2011 compared to the same period in 2010, mostly due to an increase in medical insurance claims during the first half of 2011.
The following table breaks out the change in total other expense between Park’s Ohio-based operations and Vision Bank.
| | | Three months ended June 30, 2011 | | | Six months ended June 30, 2011 | |
| (in thousands) | | Ohio-based operations | | | Vision Bank | | | Total | | | Ohio-based operations | | | Vision Bank | | | Total | |
| Salaries and employee benefits | | $ | 1,285 | | | $ | (45 | ) | | $ | 1,240 | | | $ | 1,210 | | | $ | (77 | ) | | $ | 1,133 | |
| Occupancy expense | | | (64 | ) | | | 35 | | | | (29 | ) | | | (154 | ) | | | 8 | | | | (146 | ) |
| Furniture and equipment expense | | | 235 | | | | (14 | ) | | | 221 | | | | 338 | | | | (92 | ) | | | 246 | |
| Data processing fees | | | (104 | ) | | | (155 | ) | | | (259 | ) | | | (320 | ) | | | (279 | ) | | | (599 | ) |
| Professional fees and services | | | 79 | | | | (58 | ) | | | 21 | | | | 245 | | | | (206 | ) | | | 39 | |
| Amortization of intangibles | | | (173 | ) | | | - | | | | (173 | ) | | | (440 | ) | | | - | | | | (440 | ) |
| Marketing | | | (192 | ) | | | (26 | ) | | | (218 | ) | | | (455 | ) | | | (42 | ) | | | (497 | ) |
| Insurance | | | 120 | | | | (108 | ) | | | 12 | | | | 270 | | | | (187 | ) | | | 83 | |
| Communication | | | (189 | ) | | | 27 | | | | (162 | ) | | | (389 | ) | | | 14 | | | | (375 | ) |
| State taxes | | | (365 | ) | | | 15 | | | | (350 | ) | | | (754 | ) | | | 16 | | | | (738 | ) |
| Other | | | (563 | ) | | | 266 | | | | (297 | ) | | | (597 | ) | | | 353 | | | | (244 | ) |
| Total other expense | | $ | 69 | | | $ | (63 | ) | | $ | 6 | | | $ | (1,046 | ) | | $ | (492 | ) | | $ | (1,538 | ) |
Management provided guidance in Park’s 2010 Annual Report (page 39) that total other expense would be approximately $183 to $187 million for 2011. The amount of total other expense for the first six months of 2011 was slightly higher than management’s projection. Management’s latest projection for total other expense is unchanged from the guidance in Park’s 2010 Annual Report.
Income Tax
For the three months ended June 30, 2011, federal income tax expense was $7.4 million and no state income tax benefit was recognized, compared to federal income tax expense of $8.0 million and a state income tax benefit of $0.6 million for the second quarter of 2010. For the six months ended June 30, 2011, federal income tax was $15.3 million and no state income tax benefit was recognized, compared to federal income tax of $15.8 million and a state income tax benefit of $1.2 million for the first six months of 2010.
Vision Bank is subject to state income tax in Alabama and Florida. A state income tax benefit of $969,000 and a valuation allowance for the same amount were recorded during the second quarter of 2011. For the first six months of 2011, a state income tax benefit of $1.5 million and a valuation allowance for the same amount were recorded at Vision Bank. Management has determined that the likelihood of realizing the full deferred tax asset on the state net operating loss carry-forward at Vision Bank fails to meet the “more likely than not” level. The net operating loss carry-forward periods for the states of Alabama and Florida are 8 years and 20 years, respectively. A merger of Vision Bank into Park National Bank would ensure the future utilization of the state net operating loss carry-forward at Vision Bank. However, management is not certain when a merger of Vision Bank into Park National Bank can take place and as a result has decided not to record the additional state tax benefit of losses at Vision Bank until management has a better understanding of the timing and likelihood of a merger of Vision Bank into Park National Bank. Park and its Ohio-based subsidiaries do not pay state income tax to the state of Ohio, but pay a franchise tax based on year-end equity. The franchise tax expense is included in “state taxes” as part of total other expense on Park’s Consolidated Condensed Statements of Income.
Federal income tax expense as a percentage of income before taxes was 26.7% for the second quarter of 2011, compared to 28.0% for the same period in 2010. For the first six months of 2011, federal income tax expense as a percentage of income before taxes was 26.8%, compared to 27.9% for the same period in 2010. The federal effective income tax rate is lower than the statutory rate of 35% primarily due to tax-exempt interest income from state and municipal investments and loans, low income housing tax credits and income from bank owned life insurance.
Management provided guidance in Park’s 2010 Annual Report (page 40) that the federal effective income tax rate for 2011 will be approximately 26% to 28%. Management’s latest projection of the federal effective income tax is consistent with the guidance in the 2010 Annual Report.
Comparison of Financial Condition
At June 30, 2011 and December 31, 2010
Changes in Financial Condition and Liquidity
Total assets increased by $31 million or 0.4% to $7,329 million at June 30, 2011, compared to $7,298 million at December 31, 2010. This increase in total assets was due to increases in cash and cash equivalents and other miscellaneous assets, offset by declines in investment securities and loan balances.
Total investment securities decreased by $79 million or 3.9% to $1,961 million at June 30, 2011, compared to $2,040 million at December 31, 2010. Loan balances decreased by $22 million to $4,711 million at June 30, 2011 compared to $4,733 million at December 31, 2010.
Total liabilities increased by $28 million or 0.4% during the first half of 2011 to $6,581 million at June 30, 2011 from $6,553 million at December 31, 2010. The increase in total liabilities was due to an increase in total deposits, offset by a decline in total borrowings.
Total deposits increased by $163 million or 3.2% during the first half of 2011 to $5,258 million at June 30, 2011 from $5,095 million at December 31, 2010. The increase was primarily due to a $205 million increase in interest bearing transaction and money market accounts, a $52 million increase in savings deposits and a $46 million increase in non-interest bearing checking accounts, offset by a decrease of $141 million in certificate of deposit balances.
Short-term borrowings decreased by $430 million or 64.8% to $234 million at June 30, 2011 from $664 million at December 31, 2010. Conversely, long-term borrowings increased by $184 million to $821 million at June 30, 2011 compared to $637 million at December 31, 2010. The net decrease in borrowings was primarily due to the increase in deposits during the first half of the year.
Other liabilities increased by $112 million or 149.3% to $187 million at June 30, 2011 from $75 million at December 31, 2010. This increase in other liabilities was primarily due to a payable at June 30, 2011 for the purchase of $113 million of investment securities that settled in the month of July.
Total stockholders’ equity increased by $2 million or 0.27% to $747.8 million at June 30, 2011, from $745.8 million at December 31, 2010. Retained earnings increased by $9.9 million during the period as a result of: net income of $41.7 million; offset by common stock dividends of $29.0 million, and accretion and dividends on the preferred stock of $2.9 million. Preferred stock increased by $428,000 during the first six months of 2011 as a result of the accretion of the discount on preferred stock. Accumulated other comprehensive income/(loss) decreased by $8.3 million during the first half of 2011 to a loss of $10.2 million at June 30, 2011. The unrealized holding gains in the investment portfolio decreased by $8.5 million, net of taxes, as a result of the mark-to-market at June 30, 2011 and Park also recognized a $193,000 decline in the unrealized holding loss on the cash flow hedge.
Increases or decreases in the investment securities portfolio, short-term borrowings and long-term debt are greatly dependent upon the growth in loans and deposits. The primary objective of management is to grow loan and deposit totals. To the extent that management is unable to grow loan totals at a desired growth rate, additional investment securities may be acquired. Likewise, both short-term borrowings and long-term debt are utilized to fund the growth in earning assets if the growth in deposits and cash flow from operations are not sufficient to do so.
Effective liquidity management ensures that the cash flow requirements of depositors and borrowers, as well as the operating cash needs of the Corporation, are met. Funds are available from a number of sources, including the securities portfolio, the core deposit base, Federal Home Loan Bank borrowings, and the capability to securitize or package loans for sale. The Corporation’s loan to asset ratio was 64.3% at June 30, 2011, compared to 64.8% at December 31, 2010 and 65.6% at June 30, 2010. Cash and cash equivalents were $217.1 million at June 30, 2011, compared to $133.8 million at December 31, 2010 and $201.5 million at June 30, 2010. Management believes that the present funding sources provide more than adequate liquidity for the Corporation to meet its cash flow needs.
On a monthly basis, Park’s Treasury Department forecasts the financial statements for the next twelve months. The projected liquidity position for the Corporation is reviewed each month to ensure that adequate liquidity is maintained. Management targets that the Corporation would have a minimum of $800 million of funds available to handle liquidity needs on a daily basis. This $800 million liquidity “war chest” consists of currently available additional borrowing capacity from the Federal Home Loan Bank, federal funds sold and unpledged U.S. Government Agency securities.
Capital Resources
Total stockholders’ equity at June 30, 2011 was $748 million, or 10.2% of total assets, compared to $746 million, or 10.2% of total assets, at December 31, 2010 and $750 million, or 10.6% of total assets, at June 30, 2010. Common equity, which is stockholders’ equity excluding the preferred stock, was $650 million at June 30, 2011, or 8.9% of total assets, compared to $649 million, or 8.9% of total assets, at December 31, 2010.
Financial institution regulators have established guidelines for minimum capital ratios for banks, thrifts and bank holding companies. The net unrealized gain or loss on available-for-sale securities is generally not included in computing regulatory capital. The minimum leverage capital ratio (defined as stockholders’ equity less intangible assets divided by tangible assets) is 4% and the well capitalized ratio is greater than or equal to 5%. Park’s leverage ratio was 9.54% at June 30, 2011 and 9.77% at December 31, 2010. The minimum Tier 1 risk-based capital ratio (defined as leverage capital divided by risk-adjusted assets) is 4% and the well capitalized ratio is greater than or equal to 6%. Park’s Tier 1 risk-based capital ratio was 13.72% at June 30, 2011 and 13.52% at December 31, 2010. The minimum total risk-based capital ratio (defined as leverage capital plus supplemental capital divided by risk-adjusted assets) is 8% and the well capitalized ratio is greater than or equal to 10%. Park’s total risk-based capital ratio was 16.18% at June 30, 2011 and 15.98% at December 31, 2010.
The financial institution subsidiaries of Park each met the well capitalized ratio guidelines at June 30, 2011. The following table indicates the capital ratios for each financial institution subsidiary and Park at June 30, 2011.
| | | Leverage | | | Tier 1 Risk Based | | | Total Risk-Based | |
| The Park National Bank | | | 6.56 | % | | | 9.63 | % | | | 11.57 | % |
| Vision Bank | | | 15.29 | % | | | 21.05 | % | | | 22.37 | % |
| Park National Corporation | | | 9.54 | % | | | 13.72 | % | | | 16.18 | % |
| Minimum capital ratio | | | 4.00 | % | | | 4.00 | % | | | 8.00 | % |
| Well capitalized ratio | | | 5.00 | % | | | 6.00 | % | | | 10.00 | % |
Contractual Obligations and Commitments
In the ordinary course of operations, Park enters into certain contractual obligations. Such obligations include the funding of operations through debt issuances as well as leases for premises. See page 44 of Park’s 2010 Annual Report (Table 24) for disclosure concerning contractual obligations and commitments at December 31, 2010. There were no significant changes in contractual obligations and commitments during the first six months of 2011.
Financial Instruments with Off-Balance Sheet Risk
Park’s subsidiary banks are parties to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of their respective customers. These financial instruments include loan commitments and standby letters of credit. The instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the consolidated financial statements.
The exposure to credit loss (for the subsidiary banks of Park) in the event of nonperformance by the other party to the financial instrument for loan commitments and standby letters of credit is represented by the contractual amount of those instruments. Park and each of its subsidiary banks use the same credit policies in making commitments and conditional obligations as they do for on-balance sheet instruments. Since many of the loan commitments may expire without being drawn upon, the total commitment amount does not necessarily represent future cash requirements. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan commitments to customers.
The total amounts of off-balance sheet financial instruments with credit risk were as follows:
| (in thousands) | | June 30, 2011 | | | December 31, 2010 | |
| Loan commitments | | $ | 829,453 | | | $ | 716,598 | |
| Standby letters of credit | | $ | 21,228 | | | $ | 24,462 | |
ITEM 3 – QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Management reviews interest rate sensitivity on a bi-monthly basis by modeling the consolidated financial statements under various interest rate scenarios. The primary reason for these efforts is to guard Park from adverse impacts of unforeseen changes in interest rates. Management continues to believe that further changes in interest rates will have a small impact on net income, consistent with the disclosure on pages 43 and 44 of Park’s 2010 Annual Report.
On page 43 (Table 23) of Park’s 2010 Annual Report, management reported that Park’s twelve month cumulative rate sensitivity gap was a positive (assets exceeding liabilities) $647.8 million or 9.53% of interest earning assets at December 31, 2010. At June 30, 2011, Park’s twelve month cumulative rate sensitivity gap was a positive (assets exceeding liabilities) $491 million or 7.3% of interest earning assets.
Management supplements the interest rate sensitivity gap analysis with periodic simulations of balance sheet sensitivity under various interest rate and what-if scenarios to better forecast and manage the net interest margin. Management uses a 50 basis point change in market interest rates per quarter for a total of 200 basis points per year in evaluating the impact of changing interest rates on net interest income and net income over a twelve month horizon.
On page 44 of Park’s 2010 Annual Report, management reported that at December 31, 2010, the earnings simulation model projected that net income would increase by 2.4% using a rising interest rate scenario and decrease by 1.4% using a declining interest rate scenario over the next year. At June 30, 2011, the earnings simulation model projected that net income would decrease by 3.07% using a rising interest rate scenario and would decrease by 1.14% in a declining interest rate scenario. At June 30, 2011, management continues to believe that gradual changes in interest rates (50 basis points per quarter for a total of 200 basis points per year) will have a small impact on net income.
ITEM 4 – CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures
With the participation of the Chairman of the Board and Chief Executive Officer (the principal executive officer) and the Chief Financial Officer (the principal financial officer) of Park, Park’s management has evaluated the effectiveness of Park’s disclosure controls and procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) as of the end of the quarterly period covered by this Quarterly Report on Form 10-Q. Based on that evaluation, Park’s Chairman of the Board and Chief Executive Officer and Park’s Chief Financial Officer have concluded that:
| · | information required to be disclosed by Park in this Quarterly Report on Form 10-Q and other reports that Park files or submits under the Exchange Act would be accumulated and communicated to Park’s management, including its principal executive officer and principal financial officer, as appropriate to allow timely decisions regarding required disclosure; |
| · | information required to be disclosed by Park in this Quarterly Report on Form 10-Q and the other reports that Park files or submits under the Exchange Act would be recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms; and |
| · | Park’s disclosure controls and procedures were effective as of the end of the quarterly period covered by this Quarterly Report on Form 10-Q. |
Changes in Internal Control Over Financial Reporting
When Park’s management assessed the effectiveness of the Company’s internal control over financial reporting as of December 31, 2010, they identified a deficiency in internal controls. Specifically, management utilized the work of a third-party contractor, which was not a licensed appraiser, when calculating the fair value of collateral for certain impaired loans and the fair value of certain other real estate owned (“OREO”) at Vision Bank (“Vision”), and management did not have sufficient documentation to support the estimates of this third-party contractor. In addition, management had relied on internal estimates of collateral value when calculating specific reserves for impaired loans at Vision when, at times, such internal estimates were more than a year old. Economic conditions had changed in certain instances and the internal estimates of value were not updated. At first, management believed that this deficiency constituted a significant deficiency.
Park reported in a Current Report on Form 8-K dated and filed June 30, 2011 (the “June 30, 2011 Form 8-K”) and again in a Current Report on Form 8-K dated and filed July 25, 2011 (the “July 25, 2011 Form 8-K”) that the Federal Deposit Insurance Corporation (“FDIC”) and the Florida Office of Financial Regulation (“OFR”) have communicated their preliminary examination results to Vision management. As of the date of filing this Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2011, Vision management has received the report of examination from the OFR, which was consistent with the preliminary findings communicated to Vision management at the on-site exit meeting. The most significant finding of the OFR and the FDIC pertains to Vision’s accounting treatment related to guarantor support underlying certain impaired loans and the calculation of the allowance for loan losses to be made with respect to impaired loans.
As a result of the preliminary examination findings, management initiated a thorough review of the guarantor support underlying impaired loans at Vision as of December 31, 2010. As a result of this review, management has determined that no changes to Park’s consolidated financial statements as of and for the fiscal year ended December 31, 2010 were necessary. However, as a result of the review of the impaired loan measurements as of year end, management has determined that the significant deficiency determined to exist at December 31, 2010 was more appropriately characterized as a material weakness in the Company’s internal control over financial reporting. A material weakness is a deficiency in internal control over financial reporting such that there is a reasonable possibility that a material misstatement would not be prevented or detected in a timely manner.
Management of Park expects to file an amended Annual Report on Form 10-K/A as promptly as possible to reflect the determination that the significant deficiency that was identified as of February 28, 2011, the date of the filing of the Annual Report on Form 10-K for the fiscal year ended December 31, 2010, was more appropriately characterized as a material weakness.
Throughout the first six months of 2011, management has made significant process improvements in an effort to address the above mentioned material weakness. These process improvements include:
· | Management has discontinued the use of value-related information received from a third-party contractor, who is not a licensed appraiser. While management continues to consult with this third-party contractor on the current status of loan workouts and progress related to the pursuit of legally bound borrowers and guarantors, management no longer utilizes the third-party contractor’s estimates of value to determine the specific reserves that should be established on impaired loans. |
| · | Management has discontinued the use of information received from the third-party contractor to value OREO properties. Currently, OREO properties are valued based on external appraisals that are no more than 12 months old and were prepared by external licensed appraisers. |
| · | Management has discontinued the use of retail lot values (discounted by management’s standard bulk sale discount) on lot development projects and is now utilizing the bulk sale value provided by external licensed appraisers, which in certain cases applies a larger discount. |
| · | In addition to the real estate appraisal policy in place as of December 31, 2010, management has enhanced its commercial loan policy to formalize the requirements for the frequency and dollar threshold for which updated real estate appraisals are to be obtained from qualified licensed appraisers with respect to impaired loans and OREO properties. This enhancement to the commercial loan policy also discusses those situations where internally prepared valuations (“IPV”) are considered appropriate, the documentation that should accompany IPVs and the frequency of evaluating the accuracy of the assumptions and data used in the IPV estimates. |
As of the filing date for this Quarterly Report on Form 10-Q, management believes that the enhancements to our internal control processes represent significant progress in addressing the material weakness that existed as of December 31, 2010. Management continues to evaluate enhancements which may be made to remediate the material weakness. Management has also communicated these matters to the Company's independent registered public accounting firm, Crowe Horwath LLP ("Crowe Horwath"), who is also investigating the issues described above. Crowe Horwath has indicated that its report, dated February 28, 2011 on internal control over financial reporting should no longer be relied upon.
PARK NATIONAL CORPORATION
PART II – OTHER INFORMATION
Item 1. Legal Proceedings
There are no pending legal proceedings to which Park or any of its subsidiaries is a party or to which any of their property is subject, except for routine legal proceedings to which Park’s subsidiary banks are parties incidental to their respective banking businesses. Park considers none of those proceedings to be material.
Item 1A. Risk Factors
There are certain risks and uncertainties in our business that could cause our actual results to differ materially from those anticipated. In “ITEM 1A. RISK FACTORS” of Part I of Park’s Annual Report on Form 10-K for the fiscal year ended December 31, 2010 (the “2010 Form 10-K”), we included a detailed discussion of our risk factors. The following information updates certain of our risk factors and should be read in conjunction with the risk factors disclosed in the 2010 Form 10-K. These risk factors should be read carefully in connection with evaluating our business and in connection with the forward-looking statements contained in this Quarterly Report on Form 10-Q. Any of the risks described below or in the 2010 Form 10-K could materially adversely affect our business, financial condition or future results and the actual outcome of matters as to which forward-looking statements are made. These are not the only risks we face. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial also may materially adversely affect our business, financial condition and/or operating results.
Changes in economic and political conditions could adversely affect our earnings, as our borrowers’ ability to repay loans and the value of the collateral securing our loans decline.
Our success depends, to a certain extent, upon economic and political conditions, local and national, as well as governmental fiscal and monetary policies. Conditions such as inflation, recession, unemployment, changes in interest rates, money supply and other factors beyond our control may adversely affect our asset quality, deposit levels and loan demand and, therefore, our earnings and our capital. Because we have a significant amount of real estate loans, additional decreases in real estate values could adversely affect the value of property used as collateral and our ability to sell the collateral upon foreclosure. Adverse changes in the economy may also have a negative effect on the ability of our borrowers to make timely repayments of their loans, which would have an adverse impact on our earnings and cash flows. The substantial majority of the loans made by our subsidiaries are to individuals and businesses in Ohio or in Gulf Coast communities in Alabama and the Florida panhandle. Consequently, a significant decline in the economy in Ohio or in Gulf Coast communities in Alabama or the panhandle of Florida could have a materially adverse effect on our financial condition and results of operations.
As disclosed earlier within this Form 10-Q, we continue to experience difficult credit conditions in the Alabama and Florida markets in which we operate. For the six month period ended June 30 2011, Vision Bank has experienced $35.9 million in net loan charge-offs, or an annualized 11.66% of average loans. For the first six months of 2010, net loan charge-offs for Vision Bank were $15.6 million, or an annualized 4.66% of average loans. The loan loss provision for Vision Bank was $26.4 million for the six months ended June 30, 2011. Park’s nonperforming loans, defined as loans that are 90 days past due, nonaccrual and renegotiated loans, were $241.9 million or 5.13% of total loans at June 30, 2011, $292.9 million or 6.19% of loans at December 31, 2010 and $255.1 million or 5.48% of total loans at June 30, 2010. At June 30, 2011, Vision Bank had non-performing loans of $118.5 million or 20.97% of total loans, compared to $171.8 million or 26.82% of total loans at December 31, 2010 and $162.3 million or 24.16% of total loans at June 30, 2010. While we continue to generate net earnings on a consolidated basis, Vision Bank continues to generate net losses and may generate net losses in the future. For the six months ended June 30, 2011, Vision Bank had a net loss of $20.5 million and Park contributed capital of $21.0 million to Vision Bank. Given the current economic environment in Vision Bank’s market, Park’s management has agreed to maintain the leverage ratio at Vision Bank at 12% and to maintain the total risk-based capital ratio at Vision Bank at 16%. It remains uncertain when the negative credit trends at Vision Bank will reverse. As a result, Park’s future earnings continue to be susceptible to further declining credit conditions in the markets in which we operate.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
| (c.) | No purchases of Park’s common shares were made by or on behalf of Park or any “affiliated purchaser” as defined in Rule 10b-18(a)(3) under the Securities Exchange Act of 1934, as amended, during the three months ended June 30, 2011. The following table provides information concerning changes in the maximum number of common shares that may be purchased under Park’s previously announced repurchase programs as a result of the forfeiture of previously outstanding incentive stock options: |
| Period | Total number of common shares purchased | Average price paid per common share | Total number of common shares purchased as part of publicly announced plans or programs | Maximum number of common shares that may yet be purchased under the plans or programs (1) |
April 1 through April 30, 2011 | - | - | - | 1,047,231 |
May 1 through May 31, 2011 | - | - | - | 1,047,231 |
June 1 through June 30, 2011 | - | - | - | 1,011,239 |
| Total | - | - | - | 1,011,239 |
| | | | | |
| | (1) | The number shown represents, as of the end of each period, the maximum number of common shares that may yet be purchased as part of Park’s publicly announced stock repurchase authorization to fund the Park National Corporation 2005 Incentive Stock Option Plan. |
The Park National Corporation 2005 Incentive Stock Option Plan (the “2005 Plan”) was adopted by the Board of Directors of Park on January 18, 2005 and was approved by the Park shareholders at the Annual Meeting of Shareholders on April 18, 2005. Under the 2005 Plan, 1,500,000 common shares are authorized for delivery upon the exercise of incentive stock options granted under the 2005 Plan. All of the common shares delivered upon the exercise of incentive stock options granted under the 2005 Plan are to be treasury shares. As of June 30, 2011, incentive stock options covering 75,545 common shares were outstanding and 1,424,455 common shares were available for future grants.
With 488,761 common shares held as treasury shares for purposes of the 2005 Plan at June 30, 2011, an additional 1,011,239 common shares remained authorized for repurchase for purposes of funding the 2005 Plan.
Item 3. Defaults Upon Senior Securities
Not applicable.
Item 4. [Reserved]
Item 5. Other Information
(a), (b) Not applicable.
Item 6. Exhibits
| 3.1(a) | Articles of Incorporation of Park National Corporation as filed with the Ohio Secretary of State on March 24, 1992 (Incorporated herein by reference to Exhibit 3(a) to Park National Corporation’s Form 8-B, filed on May 20, 1992 (File No. 0-18772) (“Park’s Form 8-B”) |
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| 3.1(b) | Certificate of Amendment to the Articles of Incorporation of Park National Corporation as filed with the Ohio Secretary of State on May 6, 1993 (Incorporated herein by reference to Exhibit 3(b) to Park National Corporation’s Annual Report on Form 10-K for the fiscal year ended December 31, 1993 (File No. 0-18772)) |
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| 3.1(c) | Certificate of Amendment to the Articles of Incorporation of Park National Corporation as filed with the Ohio Secretary of State on April 16, 1996 (Incorporated herein by reference to Exhibit 3(a) to Park National Corporation’s Quarterly Report on Form 10-Q for the quarterly period ended March 31, 1996 (File No. 1-13006)) |
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| 3.1(d) | Certificate of Amendment by Shareholders to the Articles of Incorporation of Park National Corporation as filed with the Ohio Secretary of State on April 22, 1997 (Incorporated herein by reference to Exhibit 3(a)(1) to Park National Corporation’s Quarterly Report on Form 10-Q for the quarterly period ended June 30, 1997 (File No. 1-13006) (“Park’s June 30, 1997 Form 10-Q”)) |
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| 3.1(e) | Certificate of Amendment by Shareholders or Members as filed with the Secretary of State of the State of Ohio on December 18, 2008 in order to evidence the adoption by the shareholders of Park National Corporation on December 18, 2008 of an amendment to Article FOURTH of Park National Corporation’s Articles of Incorporation to authorize Park National Corporation to issue up to 200,000 preferred shares, without par value (Incorporated herein by reference to Exhibit 3.1 to Park National Corporation’s Current Report on Form 8-K dated and filed December 19, 2008 (File No. 1-13006)) |
| 3.1(f) | Certificate of Amendment by Directors or Incorporators to Articles as filed with the Secretary of State of the State of Ohio on December 19, 2008, evidencing adoption of amendment by Board of Directors of Park National Corporation to Article FOURTH of Articles of Incorporation to establish express terms of Fixed Rate Cumulative Perpetual Preferred Shares, Series A, each without par value, of Park National Corporation (Incorporated herein by reference to Exhibit 3.1 to Park National Corporation’s Current Report on Form 8-K dated and filed December 23, 2008 (File No. 1-13006)) |
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3.1(g) 3.1 (h) | Certificate of Amendment by Shareholders or Members filed with the Secretary of State of the State of Ohio on April 18, 2011 in order to evidence the adoption by Park National Corporation’s shareholders of an amendment to Article SIXTH of Park National Corporation’s Articles of Incorporation in order to provide that shareholders do not have preemptive rights (Incorporated herein by reference to Exhibit 3.1 to Park National Corporation’s Current Report on Form 8-K dated and filed April 19, 2011 (File No. 1-13006)) Articles of Incorporation of Park National Corporation (reflecting amendments through April 18, 2011) [for SEC reporting compliance purposes only – not filed with Ohio Secretary of State] (Incorporated herein by reference to Exhibit 3.1(h) to Park National Corporation’s Quarterly Report on Form 10-Q for the quarterly period ended March 31, 2011 (File No. 1-13006)) |
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| 3.2(a) | Regulations of Park National Corporation (Incorporated herein by reference to Exhibit 3(b) to Park’s Form 8-B) |
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| 3.2(b) | Certified Resolution regarding Adoption of Amendment to Subsection 2.02(A) of the Regulations of Park National Corporation by Shareholders on April 21, 1997 (Incorporated herein by reference to Exhibit 3(b)(1) to Park’s June 30, 1997 Form 10-Q) |
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| 3.2(c) | Certificate Regarding Adoption of Amendments to Sections 1.04 and 1.11 of Park National Corporation’s Regulations by the Shareholders on April 17, 2006 (Incorporated herein by reference to Exhibit 3.1 to Park National Corporation’s Current Report on Form 8-K dated and filed on April 18, 2006 (File No. 1-13006)) |
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| 3.2(d) | Certificate Regarding Adoption by the Shareholders of Park National Corporation on April 21, 2008 of Amendment to Regulations to Add New Section 5.10 to Article Five (Incorporated herein by reference to Exhibit 3.2(d) to Park National Corporation’s Quarterly Report on Form 10-Q for the quarterly period ended March 31, 2008 (File No. 1-13006) (“Park’s March 31, 2008 Form 10-Q”)) |
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| 3.2(e) | Regulations of Park National Corporation (reflecting amendments through April 21, 2008) [For purposes of SEC reporting compliance only] (Incorporated herein by reference to Exhibit 3.2(e) to Park’s March 31, 2008 Form 10-Q) |
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| 12 | Computation of Ratios of Earnings to Fixed Charges and of Earnings to Fixed Charges and Preferred Share Dividends (filed herewith) |
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| 31.1 | Rule 13a – 14(a) / 15d – 14(a) Certifications (Principal Executive Officer) (filed herewith) |
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| 31.2 | Rule 13a – 14(a) / 15d – 14(a) Certifications (Principal Financial Officer) (filed herewith) |
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| 32.1 | Section 1350 Certifications Pursuant to Section 1350 of Chapter 63 of Title 18 of the United States Code (Principal Executive Officer) (furnished herewith) |
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| 32.2 | Section 1350 Certifications Pursuant to Section 1350 of Chapter 63 of Title 18 of the United States Code (Principal Financial Officer) (furnished herewith) |
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
| | PARK NATIONAL CORPORATION |
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| DATE: August 15, 2011 | /s/ C. Daniel DeLawder |
| | C. Daniel DeLawder |
| | Chairman of the Board and Chief Executive Officer |
| DATE: August 15, 2011 | /s/ John W. Kozak |
| | John W. Kozak |
| | Chief Financial Officer |
