The purpose of this discussion is to provide an analysis of the financial condition and results of operations of Ohio Valley Banc Corp. (“Ohio Valley” or the “Company”) that is not otherwise apparent from the audited consolidated financial statements included in this report. The accompanying consolidated financial information has been prepared by management in conformity with U.S. generally accepted accounting principles (“US GAAP”) and is consistent with that reported in the consolidated statements. Reference should be made to those statements and the selected financial data presented elsewhere in this report for an understanding of the following tables and related discussion. All dollars are reported in thousands, except share and per share data.
RESULTS OF OPERATIONS:
SUMMARY
Ohio Valley generated net income of $5,835 for 2011, an increase of 14.5% from 2010. Earnings per share were $1.46 for 2011, an increase of 14.1% from 2010. The increase in net income and earnings per share for 2011 was primarily due to higher noninterest income combined with improvements in higher net interest income and lower provision for loan loss expense. Noninterest income grew $1,068, or 17.4%, during 2011, largely from the Company’s tax processing fees. The Company generates fee income by facilitating tax refund payments in the form of electronic refund check/deposit (“ERC/ERD”) transactions. ERC/ERD transactions involve the issuing of a tax refund to the taxpayer after the Bank has received the refund from the federal/state government. In 2011, ERC/ERD fees increased $1,779 over the previous year due to the significant growth in transaction volume of processing tax refund payments during the first half of 2011. This activity was mostly seasonal and had little impact on Company earnings during the third and fourth quarters of 2011.
Further contributing to the Company’s successful year in net income was lower provision for loan loss expense, which decreased $975, or 16.6%, during 2011 as compared to the previous year. The decrease was in large part due to significant recoveries of commercial loans experienced in 2011 as well as larger impairment charges recorded in 2010. Net charge-offs during 2011 were up $2,255, or 48.2%, over 2010, but the majority of these charge-offs had already been specifically allocated for within the allowance for loan losses. As a result, no provision expense was required to be taken against the majority of these additional charge-offs. Conversely, recoveries of loans did have an immediate impact on lowering provision expense. Total recoveries during 2011 were $3,484, which increased $2,288, or 191.3%, from 2010, in large part due to successful collection efforts of commercial loan balances that had been previously charged off. Provision expense also benefited from impairment charges recorded during 2010 that had an opposite effect in 2011. During the fourth quarter of 2010, the Company identified asset impairment of $1,406 related to one commercial loan relationship with two loans classified as troubled debt restructurings (“TDR’s”). This impairment charge required specific reserves within the allowance for loan losses, which required a corresponding increase in provision for loan loss expense in 2010 that had the effect of lowering provision expense during 2011.
Further contributing to higher earnings in 2011 was an improved net interest income, which increased $904, or 2.7%, over 2010. The sustained low-rate environment continues to have an impact in lowering funding costs, as well as causing management to emphasize growing lower-costing, core deposit relationship balances. As a result, interest expense decreased $3,378 during 2011, as compared to 2010. This cost savings completely offset the decrease in interest income of $2,474 during 2011, as compared to 2010.
Partially offsetting the benefits from higher ERC/ERD fees, lower provision expense and higher net interest income were increases in other real estate owned (“OREO”) losses, as well as increases in salaries and employee benefit and foreclosed asset expenses. OREO losses finished at $1,224 at year-end 2011, up from $177 in losses at year-end 2010. Higher OREO losses were impacted most by impairment charges taken on two commercial real estate foreclosed properties classified as OREO. These losses were the result of re-evaluations of the carrying values in 2011 for both OREO properties, which identified $1,266 in total asset impairment. The impairment charges were recorded as write-downs to the carrying values of both properties and limited the growth in noninterest income during 2011. Salaries and employee benefit expense increased $1,003, or 6.4%, during 2011, as compared to 2010, in large part due to annual merit increases, higher health insurance premiums and a larger number of employees. The Company’s foreclosed asset costs also grew to $650 during 2011, an increase of $583 from the previous year. The increase was mostly related to the foreclosure expenses of two commercial real estate properties, which included taxes and other general costs to maintain both properties.
During 2010, Ohio Valley generated net income of $5,096, a decrease of 23.3% from 2009. Earnings per share were $1.28 for 2010, a decrease of 23.4% from 2009. The decrease in net income and earnings per share for 2010 was primarily due to a higher provision for loan loss expense, representing a $2,659, or 82.8%, increase over 2009. Provision expense increased over 2009 in large part due to increases in both net charge-offs and specific allocations on impaired loans. Net charge-offs were impacted by partial charge-offs of $2,480 recorded on two commercial loans, while specific allocations were impacted by an impairment charge of $1,406 related to two commercial TDR’s. Further contributing to lower earnings in 2010 were decreases in other noninterest income sources, including service charges on deposit accounts (down $614, or 21.8%), income from bank owned life insurance (down $570, or 43.5%) and mortgage banking income (down $396, or 52.2%). Service charge income was mostly impacted by a lower volume of overdrafts being assessed as well as the adoption of new regulatory guidance that limits daily and annual overdraft fees. The declining effects from bank owned life insurance (“BOLI”) and mortgage banking income during 2010 were the results of timing differences of events that occurred during 2009 that had a limited effect in 2010. These events included life insurance proceeds of $556 that were received in 2009 and a significant period of mortgage refinancing during the first half of 2009.
Partially offsetting these negative effects of higher provision expense and lower noninterest income was improvement in the Company’s net interest income, which increased $2,276, or 7.4%, over 2009. Net interest income for the Company grew in large part due to an increase in the Company’s average earning assets and net interest margin improvement. Average earning asset growth was mostly affected by commercial loans while the net interest margin improvement was mostly affected by a shift from short-term, lower yielding assets being re-invested into higher yielding, longer-term assets combined with a continued decline in the Company’s interest expense in both deposits and borrowings due to the sustained low interest rate environment.
NET INTEREST INCOME
The most significant portion of the Company's revenue, net interest income, results from properly managing the spread between interest income on earning assets and interest expense incurred on interest-bearing liabilities. The Company earns interest and dividend income from loans, investment securities and short-term investments while incurring interest expense on interest-bearing deposits, securities sold under agreements to repurchase (“repurchase agreements”) and short- and long-term borrowings. Net interest income is affected by changes in both the average volume and mix of assets and liabilities and the level of interest rates for financial instruments. Changes in net interest income are measured by net interest margin and net interest spread. Net interest margin is expressed as net interest income divided by average interest-earning assets. Net interest spread is the difference between the average yield earned on interest-earning assets and the average rate paid on interest-bearing liabilities. Both of these are reported on a fully tax-equivalent (“FTE”) basis. Net interest margin is greater than net interest spread due to the interest earned on interest-earning assets funded from noninterest-bearing funding sources, primarily demand deposits and shareholders' equity. Following is a discussion of changes in interest-earning assets, interest-bearing liabilities and the associated impact on interest income and interest expense for the three years ended December 31, 2011. Tables I and II have been prepared to summarize the significant changes outlined in this analysis.
Net interest income on an FTE basis increased $940 in 2011, or 2.8%, compared to the $33,360 earned in 2010, while the Company’s FTE net interest margin increased 7 basis points from 4.16% in 2010 to 4.23% in 2011. The improvements in both net interest income and net interest margin were mainly due to lower rates paid on interest-bearing deposits, a change in deposit mix to lower-cost core deposits and an increase in the Company’s average earning assets. The Federal Reserve continues to hold the prime interest rate at 3.25%, and the target federal funds rate remains at a range from 0.0% to 0.25%. The sustained low short-term rates have continued to impact the repricings of various Bank deposit products, including public fund NOW, Gold Club and Market Watch accounts. Interest rates on certificate of deposit (“CD”) balances have also repriced to lower rates (as a lagging effect to the Federal Reserve’s action to maintain short-term interest rates at their low levels) which continues to lower funding costs. Management continues to emphasize lower-cost core deposit relationship balances which contributed to higher average NOW, savings and money market balances in 2011 (increasing $36,898) while experiencing a lower level of higher-cost time deposit and other borrowed money balances (decreasing $57,817). Average earning assets grew 1.1% during 2011 compared to 2010, largely from higher average balances being carried at the Federal Reserve and growth in average securities.
Net interest income on an FTE basis increased $2,314 in 2010, or 7.5%, compared to the $31,046 earned in 2009, while the FTE net interest margin increased 16 basis points from 4.00% in 2009 to 4.16% in 2010. As in 2011, the improvements in 2010 were primarily attributable to lower rates paid on deposits, a shift in deposit composition to lower-cost core deposits and average earning asset growth. The Company continued to benefit from a sustained low interest rate environment in 2010 that permitted its interest expense to decline, with deposits and borrowings readjusting to current market rates. The Company also benefited from a deposit composition shift from higher-costing time deposits and other borrowed money (decreasing 4.2% from 2009) to lower-costing NOW, savings and money market deposit accounts (increasing 15.8%). During 2010, the Company also benefited from the deployment of short-term assets into higher-yielding longer-term assets, such as loans. The Company’s average earning assets increased 3.4% in 2010, particularly within the higher-yielding loans portfolio.
For 2011, average earning assets grew $8,756, or 1.1%, as compared to growth of $26,518, or 3.4%, in 2010. Driving this continued growth in earning assets for 2011 was average interest-bearing balances with banks, increasing to $67,947 at year-end 2011, up from $43,450 at year-end 2010 and $27,077 at year-end 2009. The increasing trend of larger interest-bearing balances with banks is primarily due to seasonal excess funds resulting from the clearing of tax refund checks and deposits. These ERC/ERD deposits occurred primarily during the first half of 2011 and 2010 and are the result of the Company’s relationship with a third-party tax software provider. The Company acts as the facilitator for these ERC/ERD transactions and earns a fee for each cleared item. For the short time the Company holds such refunds, constituting noninterest-bearing deposits, the Company increases its deposits with the Federal Reserve. This has caused the interest-bearing balances with banks to represent a large percentage of earning assets during the time the Company holds the refunds, although such balances decrease at year-end. For the year-end December 31, 2011, average interest-bearing balances with banks totaled 8.4% of earning assets, as compared to 5.4% for 2010 and 3.5% for 2009. As loan growth was challenged during 2011, the Company re-invested a portion of its short-term Federal Reserve balances into longer-term investment securities. As a result, the Company’s average investment securities, both taxable and tax exempt, increased during 2011, with its percentage of earning assets averaging 14.5% for the year, compared to 13.2% in 2010. The Company’s average investment securities did not change significantly during 2010, with its percentage of earning assets averaging 13.2%, compared to 13.8% for 2009. Average loans continue to be the Company’s highest portion of earning assets. During 2011, average loans decreased $27,954, or 4.3%, compared to 2010. Average loans during 2010 were limited to an $11,679, or 1.8%, increase from 2009. The Company’s market area for lending continues to be limited due to economic pressures that have negatively impacted consumer spending and have decreased loan demand. The Company’s installment and real estate portfolios have been affected the most during 2011 and 2010 by these negative factors. As a result, average loans as a percentage of earning assets have decreased to 77.1% for 2011, as compared to 81.4% for 2010 and 82.7% for 2009, as most of the average earning asset growth in 2011 and 2010 has came from short-term balances with banks and investment securities.
Management continues to focus on generating loan growth as this portion of earning assets provides the greatest return to the Company. Although loans make up the largest percentage of earning assets, management is comfortable with the current level of loans based on collateral values, the balance of the allowance for loan losses, strict underwriting standards and the Company's well-capitalized status. Management maintains securities at a dollar level adequate enough to provide ample liquidity and cover pledging requirements.
Average interest-bearing liabilities decreased 4.3% between 2010 and 2011 due to decreasing time deposits, and increased 3.0% between 2009 and 2010 due to increasing savings and money market accounts. The fluctuations of interest-bearing deposits since 2009 are in large part due to the Company’s preference of core deposit relationship balances over higher-costing time deposits and other borrowing liabilities, which have changed the funding composition mix during this time. Interest-bearing liabilities continue to be comprised largely of time deposits, which represented 44.0% of total interest-bearing liabilities in 2011. This composition mix, however, has decreased the most since 2009, which represented 48.9% and 51.0% of total interest-bearing liabilities in 2010 and 2009, respectively. As interest rates on time deposits continued to readjust to current market rates in 2011, competitive pricing pressures grew and contributed to a significant maturity runoff of CD’s during 2011. In addition, other borrowings lowered to 3.8% of total interest-bearing liabilities in 2011, as compared to 5.5% in 2010 and 7.5% in 2009. Conversely, the Company’s core deposit segment of interest-bearing liabilities, which include NOW and savings and money market accounts, together represented 47.1% of total interest-bearing liabilities in 2011, as compared to 39.5% in 2010 and 35.2% in 2009. The primary reason for this composition increase has particularly been in the Company's Market Watch product. The Market Watch product is a limited transaction investment account with tiered rates that competes with current market rate offerings and serves as an alternative to certificates of deposit for some customers. With an added emphasis on further building and maintaining core deposit relationships, the Company has marketed several attractive incentive offerings in the past several years to draw customers to this particular product. The consumer preference for this product has generated a significant amount of funding dollars which have helped to support earning asset growth, maturity runoff of time deposits and payoffs on other borrowed funds. This composition shift from 2009 to 2011 with higher NOW, savings and money market balances and lower time deposits and other borrowed money has served as a cost effective contribution to the net interest margin. The average cost of the “growing” NOW, savings and money market account core segment was 0.90%, 1.14% and 1.30% during the years ended 2011, 2010 and 2009, respectively. The higher average costs of time deposits and other borrowed money segment were 2.08%, 2.58% and 3.37% during the years ended 2011, 2010 and 2009, respectively.
The net interest margin increased to 4.23% in 2011 from 4.16% in 2010 and 4.00% in 2009. The 7 basis point and 16 basis point improvement from 2011 and 2010 was largely the result of lower average costs on interest-bearing liabilities completely offsetting the lower yields on earning assets, which improved the Company’s net interest rate spread. During 2011, the net interest rate spread increased 7 basis points to 3.89%, resulting from the decrease in average cost of interest-bearing liabilities of 44 basis points from 2.03% to 1.59%, completely offsetting the decrease in average yield on interest-earning assets of 37 basis points from 5.85% to 5.48%. During 2010, the net interest rate spread increased 25 basis points to 3.82%, resulting from the decrease in average cost of interest-bearing liabilities of 58 basis points from 2.61% to 2.03% completely offsetting the decrease in average yield on interest-earning assets of 33 basis points from 6.18% to 5.85%. Partially offsetting the net interest rate spread increase in 2010 was a 9 basis point decrease in contributions of interest-free funds (i.e., demand deposits, shareholders' equity), which lowered from 0.43% in 2009 to 0.34% in 2010.
Lower asset yields caused interest income on an FTE basis to decrease $2,438, or 5.2%, during 2011, and $1,071, or 2.2%, during 2010. This decline reflects higher liquidity levels and lower loan demand. During 2010 and 2011, average loan balances experienced limited to declining growth while excess funds increased as a result of interest-bearing core deposit growth and an increased volume of short-term tax refund deposits. The Company continues to invest the majority of its excess funds into its interest-bearing Federal Reserve Bank clearing account, yielding just 0.25%. While these increases in Federal Reserve Bank balances contributed most to the Company’s average earning asset growth during 2011 and 2010, these balances also contributed most to the decrease in earning asset yields, with the majority of the Company’s earning asset growth yielding just 0.25%. The intention for these short-term Federal Reserve Bank balances that were not related to tax refund clearing items or other seasonal deposits was to re-invest them into future loan growth or longer-term securities with higher interest rate yields to improve the net interest margin. Further contributing to lower asset yields were yields on loans decreasing 5 basis points from 2010 to 2011 and 22 basis points from 2009 to 2010. This decrease reflects the extended low interest rate environment the Federal Reserve has been maintaining since it began reducing short-term rates in 2008. The Company's commercial, participation and real estate loan portfolios have been most sensitive to these decreases in short-term interest rates since that time, particularly the prime interest rate, which remained at 3.25% at year-end 2011.
Further contributing to lower interest income during 2011 and 2010 were decreases in mortgage loan volume as a result of management’s strategy to sell most of its long-term, fixed-rate real estate loans to the secondary market, while retaining the servicing rights to these loans. As previously discussed, the Federal Reserve continues to maintain interest rates at their low levels, which has had an impact on long-term interest rates that affect mortgage loan pricing. The lower rates have contributed to a consumer demand for mortgage loan refinancing to help lower their monthly costs. The interest rate risks associated with satisfying this demand for long-term fixed-rate mortgages prompted management to sell the majority of these real estate loans to the secondary market, while retaining the servicing rights. This action continues to generate loan sale and servicing fee revenue within noninterest income, but has resulted in an $889, or 5.7%, decrease in real estate interest and fee income during 2011, as compared to 2010. In addition, 2010 real estate interest and fee income decreased $999, or 6.0%, from 2009.
Included in consumer loan interest income were fees associated with the Company’s refund anticipation loan (“RAL”) tax loan originations. The Company’s participation with a third-party tax software provider has given the Bank the opportunity to make RALs during the tax refund loan season, typically from January through March. RALs are short-term cash advances against a customer's anticipated income tax refund. During 2011, the Company recognized $561 in RAL fees, compared to $655 during 2010, a decrease of $94, or 14.4%. The Company had an increase of $258, or 65.1%, in RAL fees during 2010 compared to 2009.
The Bank also has a separate agreement with the tax software provider for the Company’s ERC/ERD clearing services. Through the ERC/ERD agreement, the Company serves as a facilitator for the clearing of tax refunds. In recent years, the RAL business has been subject to scrutiny by various governmental and consumer groups who have questioned the fairness and legality of RAL fees and the underwriting risks associated with originating RALs. The ERC/ERD service does not subject the Bank to the risks related to the RALs and has not been subject to the same scrutiny.
On February 3, 2011, the Bank received a recommendation from the FDIC to discontinue offering RAL loans through third parties following the completion of the 2011 tax filing season. The FDIC expressed concerns regarding the underwriting of RALs based on the 2010 decision by the Internal Revenue Service (the "IRS") to cease providing debt indicator information. In response to the FDIC's expressions of concern, on February 8, 2011, the Bank determined to discontinue offering RALs through unrelated third-party vendors after April 19, 2011. Thus, the Bank’s termination of this product will negatively affect the Company’s results of operations in 2012. The FDIC's concern and recommendation does not affect the Bank's offering of other tax refund products, such as ERC’s and ERD’s. The Bank will, therefore, continue offering ERC’s and ERD’s. Furthermore, the FDIC’s recommendation does not affect the offerings of RALs by Loan Central.
In relation to lower earning asset yields for 2011 and 2010, the Company’s interest-bearing liability costs also decreased 44 basis points during 2011 and 58 basis points during 2010. The lower costs have caused interest expense to drop $3,378, or 24.9%, from 2010 to 2011 and $3,385, or 20.0%, from 2009 to 2010 as a result of lower rates paid on interest-bearing liabilities. Since the beginning of 2008, the Federal Reserve Board has reduced the prime and federal funds interest rates by 400 basis points. Since December 2008, the prime interest rate has been at 3.25% and the target federal funds rate has been in a range of 0.0% to 0.25%. The sustained low short-term rates have continued to impact the repricings of various Bank deposit products, including public fund NOW, Gold Club and Market Watch accounts. However, contributing most to the decrease in funding costs were interest rates on time deposit balances, which continued to reprice at lower rates during 2011 and 2010 (as a continued lagging effect to the Federal Reserve action to drop short-term interest rates). The year-to-date weighted average costs of the Company’s time deposits have decreased from 3.24% at year-end 2009 to 2.46% at year-end 2010 and 2.03% at year-end 2011.
Further contributing to lower time deposit expenses has been the Company’s continued emphasis on growing core deposits during 2011 and 2010. This emphasis has created a deposit composition shift from higher-costing time deposit balances to lower-costing core deposits in NOW, savings and money market balances. As a result of decreases in the average market interest rates mentioned above and the deposit composition shift to lower-costing deposit balances, the Company’s total weighted average funding costs have decreased to 1.59% at year-end 2011 as compared to 2.03% at year-end 2010 and 2.61% at year-end 2009.
The Company has experienced margin improvement during 2011 and 2010 due to a higher deposit mix of lower-costing NOW and money market balances while also benefiting from a sustained low interest rate environment. However, the pace of improvement lowered in 2011, as the net interest margin increased 7 basis points as compared to a 16 basis point improvement in 2010. The lower pace of improvement was largely due to higher average balances being carried at the Federal Reserve yielding just 0.25% during 2011. This, combined with declining average loan balances, has placed increased pressure on net interest margin growth during 2011.
The Company will continue to focus on re-deploying these Federal Reserve balances into higher yielding instruments as opportunities arise. Net interest margin will benefit if these deposits with the Federal Reserve Bank can be re-invested in loans and other longer-term, higher yielding investments. It is difficult to speculate on future changes in net interest margin and the frequency and size of changes in market interest rates. The past several years has seen the banking industry under continued stress due to declining real estate values and asset impairments. Earlier in 2012, the Federal Reserve announced it would maintain the current state of low interest rates through 2014 or longer to help boost the economy as its recovery has been short of expectations. However, further decreases in interest rates by the Federal Reserve are estimated to have a negative effect on the Company’s net interest income, as most of its deposit balances are perceived to be at or near their interest rate floors. The Company will also continue to face pressure on its net interest income and margin improvement unless loan balances begin to expand and become a larger component of overall earning assets. For additional discussion on the Company's rate sensitive assets and liabilities, please see “Interest Rate Sensitivity and Liquidity” and “Table VIII” within this Management's Discussion and Analysis.
PROVISION EXPENSE
Credit risk is inherent in the business of originating loans. The Company sets aside an allowance for loan losses through charges to income, which are reflected in the consolidated statement of income as the provision for loan losses. This provision charge is recorded to achieve an allowance for loan losses that is adequate to absorb losses in the Company’s loan portfolio. Management performs, on a quarterly basis, a detailed analysis of the allowance for loan losses that encompasses loan portfolio composition, loan quality, loan loss experience and other relevant economic factors.
The Company’s earnings benefited from lower provision expense during 2011, decreasing $975, or 16.6%, as compared to 2010. Conversely, during 2010, provision expense increased significantly by $2,659, or 82.8%, as compared to 2009. The impact to provision expense during both 2011 and 2010 is largely related to the changes in specific allocations, net charge-offs and general allocations of the allowance for loan losses. During 2010, the Company’s increase in provision expense was largely the result of partial charge-offs taken on one commercial loan classified as impaired. Partial charge-offs of $1,995 were recorded on one commercial real estate loan due to a continued deterioration in collateral values. At the time of charge-off, the Company had specific allocations of $1,825 within the allowance for loan losses, for which approximately $820 had been recognized prior to 2010. As a result, the $1,995 in partial charge-offs led to $990 in additional provision expense charges during 2010. This action had an opposite effect in 2011, contributing to the Company’s lower provision expense.
Also contributing to higher provision expense in 2010 were specific allocations recorded on two commercial loans classified as impaired. In 2010, the Company identified additional asset impairment of $1,406 related to two commercial and industrial loans from one relationship classified as a TDR. The Company continues to monitor and make loan modifications to certain troubled loans that will ease payment performance pressures off of the borrower. GAAP guidance requires an impairment analysis to be performed on loans classified as TDR’s. This analysis is measured by comparing the present value of expected future cash flows discounted at the loan’s effective interest rate to the cash flows based on the original contractual terms of the loan. The difference between the two measurements results in an impairment charge. The additional impairment charges on the two commercial and industrial loans previously mentioned required a specific allocation of the allowance for loan losses and a corresponding increase to provision for loan losses expense. Partially offsetting this provision expense benefit in 2011 was a continued deterioration in collateral values on the two TDR commercial loans previously mentioned. During the first quarter of 2011, a current analysis of both loans’ collateral values revealed a $933 impairment that required a corresponding increase to provision expense during 2011.
Beginning in 2011, the Company began to take partial charge-offs more quickly on collateral dependent impaired loans. As management further evaluated the trends in the real estate market, as well as the status of long-term, collateral dependent impaired loans, the decision to charge off these specific allocations was made. This led to increased charge-offs during 2011 of $4,543 and also significantly reduced the specific reserve allocations within the allowance for loan losses from $5,230 at December 31, 2010 to $655 at December 31, 2011. While most of this increase in charge-offs in 2011 did not require a corresponding provision expense entry due to the use of specific reserves that were already recorded prior to 2011, these charge-offs did have an immediate impact on the Company’s general allocations related to its historical loan loss factor. The general allocation, among other things, evaluates the average historical loan losses over the past 36 months. As a result, the general allocation for commercial and residential real estate loans increased to $5,334 at December 31, 2011 from $2,699 at December 31, 2010, requiring an increase in provision expense. These charge-off amounts will impact the amount of the Company’s loan loss allowance for three years. The general allocation also evaluates other factors, such as economic risk, as well as changes in classified and criticized assets.
During 2011, the Company was successful in recovering amounts on previously charged-off loans. During 2011, total loan recoveries were $3,484, an increase of 2,288, or 191.3%, over 2010. The majority of loan recoveries were from commercial real estate and commercial and industrial loan balances that had been previously charged off. The increase in loan recoveries lowered provision expense during 2011.
In large part due to the increase in net charge-offs during 2011, the allowance for loan losses finished at 1.23% of total loans at December 31, 2011, as compared to 1.46% at December 31, 2010. Management believes that the allowance for loan losses was adequate at December 31, 2011 to absorb probable losses in the portfolio. Furthermore, the increase in net charge-offs has increased the Company’s general allocations within the allowance for loan losses, with general allocations to total loans increasing from 0.65% at December 31, 2010 to 1.12% at December 31, 2011. Future provisions to the allowance for loan losses will continue to be based on management’s quarterly in-depth evaluation that is discussed in further detail under the caption “Critical Accounting Policies - Allowance for Loan Losses” within this Management’s Discussion and Analysis.
NONINTEREST INCOME
Total noninterest income increased $1,068, or 17.4%, in 2011 as compared to 2010. Contributing most to the 2011 growth in noninterest income were increases in seasonal tax refund processing fees and debit/credit card interchange income, partially offset by higher OREO losses.
The successful growth in noninterest revenue was largely due to increased ERC/ERD fees. During 2011, the Company’s ERC/ERD fees increased by $1,779, or 228.1%, as compared to the same period in 2010. The increase was due to a volume increase in the number of ERC/ERD transactions that were processed during the first and second quarters of 2011. For the 2011 tax season, the tax software provider was able to expand the number of tax preparers utilizing its software, which contributed to the volume increase. Because ERC/ERD fee activity is mostly seasonal, the majority of income was recorded during the first half of 2011, with only minimal income recorded thereafter.
The Company also experienced noninterest income growth from its debit and credit interchange income, which increased $389, or 39.0%, during the year ended 2011 as compared to 2010. The volume of transactions utilizing the Company’s credit card and Jeanie® Plus debit card continued to increase from a year ago. Beginning in the second half of 2010, the Company began offering incentive-based credit cards that would permit its users to redeem accumulated points for merchandise, as well as cash incentives paid, particularly to business users based on transaction criteria. In addition, similar incentives were introduced to the Company’s Jeanie® Plus debit cards during the first quarter of 2011 to promote customer spending. While incenting debit/credit card customers has increased customer use of electronic payments, which has contributed to higher interchange revenue, the strategy also fits well with the Company’s emphasis on growing and enhancing its customer relationships.
Partially offsetting the noninterest revenue improvements in 2011 from ERC/ERD and debit/credit card interchange fees were higher net losses on the sales of OREO. During the year ended 2011, sales of OREO resulted in a net loss of $1,224, which was up from the $177 in net OREO losses experienced during the year ended 2010. The increase in net losses during 2011 was largely attributed to impairment charges taken on two commercial real estate foreclosed properties. These losses were the result of recent re-evaluations of the carrying values for both properties. Based on weakened market conditions, management applied a discount to the appraised value of the properties and increased the estimated liquidation expenses associated with both properties. The results were a $480 impairment charge recorded in September 2011 and a $786 impairment charge recorded in December 2011. Collectively, these charges taken on both commercial real estate properties contributed most to the higher year-to-date OREO losses in 2011 as compared to 2010.
The remaining noninterest income categories were down $53, or 1.2%, during the year ended 2011, as compared to 2010. These changes were due mostly to lower trust fee income, lower earnings from tax-free BOLI investments and lower loan insurance income due to the decline in loan demand, which has limited insurance sale opportunities.
In 2010, total noninterest income decreased $1,444, or 19.0%, as compared to 2009. This decrease in noninterest income was mostly led by a $614, or 21.8%, decrease in the Company’s service charges on deposit accounts from 2009, particularly overdraft fees. The volume of overdraft balances decreased in 2010 as customers continued to present fewer checks against non-sufficient funds. New regulatory guidance adopted in July 2010 placed daily and annual limits on the amount of overdraft fees a customer can be assessed, which also contributed to the decline in overdraft volume. Decreases in noninterest income during 2010 also came from lower earnings from tax-free BOLI investments, which decreased $570, or 43.5%, during 2010. BOLI investments are maintained by the Company to fund various benefit plans, including deferred compensation plans, director retirement plans and supplemental retirement plans. Largely contributing to lower BOLI earnings in 2010 was the collection of $556 in life insurance proceeds during the third quarter of 2009, whereas no life insurance proceeds were received during 2010. Further decreasing noninterest revenue during 2010 was lower mortgage banking income, which decreased $396, or 52.2%, affected by a reduction in the volume of real estate loans sold to the secondary market. Historic low interest rates on long-term fixed-rate mortgage loans contributed to an increased consumer demand to refinance their existing mortgages in 2009. To help manage this consumer demand for longer-termed, fixed-rate real estate mortgages, the Company sold most real estate loans it originated during that period. This decision to sell long-term fixed-rate mortgages at lower rates was also effective in minimizing the interest rate risk exposure to rising rates. The Company also experienced higher net losses on the sales of OREO during 2010, which lowered noninterest income by $215, or 565.8%. The increase in net losses was largely due to the sale of one property during the second quarter of 2010 that resulted in a net loss of $148. Partially offsetting these noninterest income decreases in 2010 was growth in the Company’s ERC/ERD fees of $252, or 47.7%, affected mostly by a larger volume of transactions that were processed.
NONINTEREST EXPENSE
Management continues to work diligently to minimize the growth in noninterest expense. For 2011, total noninterest expense increased $1,656, or 6.2%. Contributing most to the growth in net overhead expense were higher salaries and employee benefits, as well as increases in foreclosure and data processing costs.
The Company’s largest noninterest expense item, salaries and employee benefits, increased $1,003, or 6.4%, during 2011 as compared to 2010. The increase was largely due to annual merit increases, higher health insurance premiums and an increase in the number of employees. During 2011, the Company experienced a higher full-time equivalent employee base, increasing from 279 employees at year-end 2010 to 285 employees at year-end 2011, increasing salaries and employee benefit expenses during 2011. During 2010, salary and employee benefits increased $823, or 5.6%, from 2009. The increase was largely due to annual merit increases, increased health insurance benefit costs and an increase in the number of employees. The Company’s full-time equivalent employees increased from 270 employees at year-end 2009 to 279 employees at year-end 2010.
Also contributing to additional noninterest expense during 2011 were foreclosed asset costs which totaled $650 during the year ended 2011, as compared to $67 during the year ended 2010. This $583 increase in foreclosed asset costs in 2011 was related mostly to two commercial real estate properties. Foreclosure expenses include the costs in maintaining the properties, which consist of taxes and general maintenance. During 2010, foreclosed asset expense decreased $83, or 55.3%, as compared to 2009.
The Company also realized increases to its data processing expenses, which increased $206, or 30.1%, during 2011. The Company continues to take great strides in utilizing the growing technology offered to financial institutions to enhance its loan and deposit products to better serve its customers. Data processing costs include processing services for the Company’s debit and credit cards as well as online and mobile banking technology. During 2010, data processing expense increased $15, or 2.2%, as compared to 2009.
Various noninterest expense categories decreased from a year ago to partially offset the salary and employee benefit, data processing and foreclosed asset expenses. Occupancy and furniture/equipment costs decreased $95, or 3.4%, during 2011. This decrease was largely due to lower depreciation expense on purchased equipment from prior years based on a declining balance method that accelerates depreciation costs in the early stages of the assets’ useful life. With no significant equipment purchases during 2011, the acceleration effect of depreciation has decreased. During 2010, occupancy and furniture/equipment expense increased $20, or 0.7%, as compared to 2009.
Also partially offsetting the overhead expense increase during 2011 was a $32, or 3.0%, decrease in FDIC premium expense as compared to 2010. During the fourth quarter of 2009, the FDIC approved an alternative to future special assessments, which was to have all banks prepay twelve quarters worth of FDIC assessments. On December 30, 2009, the Company prepaid its assessment in the amount of $3,567. The prepayment, which included assumptions about future deposit and assessment rate growth, was based on third quarter 2009 deposits. The prepaid amount is being amortized over the entire prepayment period. The monthly expense associated with this prepaid FDIC insurance increased during the first and second quarters of 2011 in relation to growing deposit and assessment assumptions. Beginning April 1, 2011, the assessment base for deposit insurance premiums changed from total domestic deposits to average total assets minus average tangible equity, and the assessment rate schedules changed. The new assessment method has afforded the Company lower net premium assessments during the third and fourth quarters of 2011. While the Company has benefited from having its FDIC insurance expense amortized over twelve quarters, continued declines in the Deposit Insurance Fund could result in the FDIC imposing additional assessments in the future, which could adversely affect the Company's capital levels and earnings. During 2010, FDIC premium expense decreased $564, or 34.7%, as compared to 2009. This change in lower deposit insurance expense was due to increases in fee assessment rates in 2009 combined with a special assessment of $373 that was applied to all FDIC insured institutions during 2009.
In 2011, the Company’s other noninterest expense decreased $8, or 0.1%, largely from changes in donations, legal, accounting and consulting fees. In 2010, other noninterest expense increased $157, or 2.8%, from 2009. The increase was mostly impacted by legal, accounting and consulting fees, which were collectively up $274, or 60.1%, during 2010 as compared to 2009. This growth was primarily due to various capital planning costs incurred by Ohio Valley, the parent company, during the first half of 2010. Also impacting other noninterest expense were increases in donations of $214, or 202.0%, over 2009 largely due to local school contributions within Gallia County, Ohio. These increasing factors were partially offset by decreases in the Company’s stationary, supplies and postage expenses, which were collectively down $260, or 12.2%, from 2009, which demonstrated management’s cost savings focus on maintaining limited growth in overhead expense to help offset the negative effects of higher provision expense and lower noninterest revenue.
The Company’s efficiency ratio is defined as noninterest expense as a percentage of fully tax-equivalent net interest income plus noninterest income. Management continues to place emphasis on managing its balance sheet mix and interest rate sensitivity to help expand the net interest margin as well as developing more innovative ways to generate noninterest revenue. A strong net interest income due to lower funding costs combined with higher noninterest income from ERC/ERD fees has had a positive effect on efficiency during 2011. However, the Company also experienced non-recurring OREO impairment charges of $1,266 which limited the growth in noninterest revenue during 2011. Furthermore, the Company experienced increased foreclosure costs of $583, primarily during the fourth quarter of 2011, on two commercial real estate properties which contributed to higher overhead expense. As a result, overhead expense for 2011 has outpaced revenue levels, which has caused the year-to-date efficiency ratio to worsen from the prior period. The efficiency ratio during 2011 increased to 68.2% from the 67.4% experienced during 2010.
FINANCIAL CONDITION:
CASH AND CASH EQUIVALENTS
The Company’s cash and cash equivalents consist of cash, interest- and non-interest bearing balances due from banks and federal funds sold. The amounts of cash and cash equivalents fluctuate on a daily basis due to customer activity and liquidity needs. At December 31, 2011, cash and cash equivalents had decreased $8,121, or 13.6%, to $51,630 as compared to $59,751 at December 31, 2010. The decrease in cash and cash equivalents was largely affected by the Company’s decrease in interest-bearing Federal Reserve Bank clearing account balances. While loan demand remains challenged, the Company continues to utilize its interest-bearing Federal Reserve Bank clearing account to manage its excess funds during periods of significant liquidity. Heading into 2011, the Company saw its deposit liabilities, both interest- and noninterest-bearing, increase $22,259, or 3.3%, during the second half of 2010, which contributed to excess fund levels. In addition, during the first quarter of 2011, the Company experienced higher levels of excess funds due to increased tax refund deposits from its RAL and ERC/ERD tax business. Liquidity levels normalized during the second and third quarters of 2011 as these short-term tax refund deposits were fully disbursed from the Federal Reserve Bank clearing account. During this time, the Company also utilized its Federal Reserve Bank clearing account to manage both investment security purchases and maturities, as well as to fund continued maturities of retail and wholesale CD’s. The interest rate paid on both the required and excess reserve balances of the Company’s Federal Reserve Bank clearing account is based on the targeted federal funds rate established by the Federal Open Market Committee. As of the filing date of this report, the interest rate calculated by the Federal Reserve continues to be 0.25%. This interest rate is similar to what the Company would have received from its investments in federal funds sold, currently in a range of less than 0.25%. Furthermore, Federal Reserve Bank balances are 100% secured.
As liquidity levels vary continuously based on consumer activities, amounts of cash and cash equivalents can vary widely at any given point in time. The Company’s focus will be to continue to re-invest these liquid funds back into longer-term, higher yielding assets, such as loans and investment securities during 2012 when the opportunities arise. Further information regarding the Company’s liquidity can be found under the caption “Liquidity” in this Management’s Discussion and Analysis.
SECURITIES
Management's goal in structuring the portfolio is to maintain a prudent level of liquidity while providing an acceptable rate of return without sacrificing asset quality. Maturing securities have historically provided sufficient liquidity such that management has not sold a debt security in several years, other than renewals or replacements of maturing securities.
During 2011, the balance of total securities did not change significantly on a net basis, increasing just $501, or 0.5%, as compared to 2010, with the ratio of securities to total assets also increasing to 13.5% at December 31, 2011, compared to 12.7% at December 31, 2010. The Company’s investment securities portfolio consists of U.S. Treasury securities, U.S. Government sponsored entity (“GSE”) securities, U.S. Government agency mortgage-backed securities and obligations of states and political subdivisions. During the first half of 2011, the Company experienced a significant increase in excess funds resulting from core deposit liability growth during the second half of 2010 and tax refund deposits during the first quarter of 2011. With loan demand remaining challenged, the Company invested a portion of its excess funds into long-term Agency mortgage-backed securities, which have increased $16,563, or 27.1%, from year-end 2010. Typically, the primary advantage of Agency mortgage-backed securities has been the increased cash flows due to the more rapid monthly repayment of principal as compared to other types of investment securities, which deliver proceeds upon maturity or call date. However, with the current low interest rate environment and loan balances on a declining pace, the cash flow that is being collected is being reinvested at lower rates. Principal repayments from Agency mortgage-backed securities totaled $18,920 during 2011.
While security growth has been evident within the Company’s Agency mortgage-backed securities portfolio, it has experienced offsetting decreases in its U.S. Treasury and GSE securities balances, which have decreased $11,566, or 67.7%, and $5,172, or 66.9%, respectively, from year-end 2010. In addition to helping achieve diversification within the Company’s investment securities portfolio, U.S. Treasury and GSE securities have also been used to satisfy pledging requirements for repurchase agreements. During the third quarter of 2011, however, newly enacted legislation permitted business checking accounts to earn interest on their deposits. This legislation has prompted all of the Company’s repurchase agreement accounts to reinvest into either interest-bearing demand accounts subject to normal FDIC insurance coverage or noninterest-bearing demand accounts with unlimited FDIC insurance coverage until the end of 2012. As a result, at December 31, 2011, the Company’s repurchase agreement balance was $0. With the general decrease in interest rates evident since 2008, the reinvestment rates on debt securities continue to show lower returns during 2011. The weighted average FTE yield on debt securities at year-end 2011 was 2.36%, as compared to 2.94% at year-end 2010 and 3.38% at year-end 2009. As a result, the Company’s focus will be to generate interest revenue primarily through loan growth, as loans generate the highest yields of total earning assets. Table III provides a summary of the portfolio by category and remaining contractual maturity. Issues classified as equity securities have no stated maturity date and are not included in Table III.
LOANS
In 2011, the Company's primary category of earning assets and most significant source of interest income, total loans, decreased $43,014, or 6.7%, to finish at $598,308. Lower loan balances were mostly influenced by total consumer loans, which were down $15,353, or 12.5%, from year-end 2010 to total $107,163. The Company’s consumer loans are primarily secured by automobiles, mobile homes, recreational vehicles and other personal property. Personal loans and unsecured credit card receivables are also included as consumer loans. The decrease in consumer loans came mostly from the Company’s automobile lending portfolio, which decreased $12,569, or 21.6%, from year-end 2010. The automobile lending component comprises the largest portion of the Company’s consumer loan portfolio, representing 42.7% of total consumer loans at December 31, 2011. In recent years, growing economic factors have weakened the economy and have limited consumer spending. During this time of economic challenge, the Company continues to maintain a strict loan underwriting process on its consumer auto loan offerings to limit future loss exposure. The Company’s interest rates offered on indirect automobile opportunities have struggled to compete with the more aggressive lending practices of local banks and alternative methods of financing, such as captive finance companies offering loans at below-market interest rates related to this segment. The decreasing trend of auto loan balances should continue during 2012, as the larger institutions and captive finance companies will continue to aggressively compete for a larger share of the market.
The remaining consumer loan products were collectively down $2,784, or 4.3%, which included general decreases in loan balances from recreational vehicles, mobile homes, home equity lines of credit and unsecured loans. Management will continue to place more emphasis on other loan portfolios (i.e. commercial and, to a smaller extent, residential real estate) that will promote increased profitable loan growth and higher returns. Indirect automobile loans bear additional costs from dealers that partially offset interest revenue and lower the rate of return.
Generating residential real estate loans remains a key focus of the Company’s lending efforts. Residential real estate loan balances comprise the largest portion of the Company’s loan portfolio and consist primarily of one- to four-family residential mortgages and carry many of the same customer and industry risks as the commercial loan portfolio. During 2011, total residential real estate loan balances decreased $10,389, or 4.4%, from year-end 2010 to total $226,489. The decrease was mostly from the Company’s 15-, 20- and 30-year fixed-rate loans, which were down $12,345, or 7.0%, from year-end 2010. Long-term interest rates continue to remain at historic low levels. In recent years, the Company has experienced periods of increased refinancing demand for long-term, fixed-rate real estate loans, particularly during the first half of 2009 and the second half of 2010, as a result of the historic low rates. Management has determined that originating 100% of the demand for long-term fixed-rate real estate loans at such low rates would present an unacceptable level of interest rate risk. Therefore, to help manage interest rate risk while also satisfying the demand for long-term, fixed-rate real estate loans, the Company has strategically chosen to originate and sell most of its fixed-rate mortgages to the secondary market. During these heavy periods of increased refinancing in 2009 and 2010, consumers were able to take advantage of low rates and reduce their monthly costs. As a result, during the year ended December 31, 2011, refinancing volume that led to secondary market sales trended down, with 118 loans sold totaling $13,637 as compared to 133 loans sold totaling $16,825 during the year ended December 31, 2010. This trend of secondary market emphasis also contributed to a lower balance of one-year adjustable-rate mortgages, which were down $2,611, or 10.8%, from year-end 2010. The remaining real estate loan portfolio balances increased $4,567 primarily from the Company’s other variable-rate products. The Company believes it has limited its interest rate risk exposure due to its practice of promoting and selling residential mortgage loans to the secondary market. The Company will continue to follow this secondary market strategy until long-term interest rates increase back to a range that falls within an acceptable level of interest rate risk.
Further impacting lower loan balances were decreases in the Company’s commercial loan portfolio, which include both commercial real estate and commercial and industrial loans. At December 31, 2011, commercial and industrial and commercial real estate loans decreased $10,106, or 18.3%, and $7,166, or 3.2%, respectively, from year-end 2010. While commercial loans were down, management continues to place emphasis on its commercial lending, which generally yields a higher return on investment as compared to other types of loans. During 2011, the Company’s 18.3% decrease in the commercial and industrial loan portfolio was largely due to charge-offs and decreasing loan demand. Commercial and industrial loans consist of loans to corporate borrowers primarily in small to mid-sized industrial and commercial companies that include service, retail and wholesale merchants. Collateral securing these loans includes equipment, inventory, and stock.
Commercial real estate, the Company’s largest segment of commercial loans, also decreased $7,166, or 3.2%, from year-end 2010, largely due to charge-offs and decreasing loan demand. This segment of loans consists of owner-occupied, nonowner-occupied and construction loans. Commercial real estate also includes loan participations with other banks outside the Company’s primary market area. Although the Company is not actively seeking to participate in loans originated outside its primary market area, it has taken advantage of the relationships it has with certain lenders in those areas where the Company believes it can profitably participate with an acceptable level of risk. Commercial real estate loans were down largely from its owner-occupied portfolio during 2011, which decreased $6,476, or 4.3%, from year-end 2010. Owner-occupied loans consist of nonfarm, nonresidential properties. A commercial owner-occupied loan is a borrower purchased building or space for which the repayment of principal is dependent upon cash flows from the ongoing operations conducted by the party, or an affiliate of the party, who owns the property. Owner-occupied loans of the Company include loans secured by hospitals, churches, and hardware and convenience stores. Nonowner-occupied commercial loans are property loans for which the repayment of principal is dependent upon rental income associated with the property or the subsequent sale of the property, such as apartment buildings, condominiums, hotels and motels. These loans are primarily impacted by local economic conditions, which dictate occupancy rates and the amount of rent charged. Commercial construction loans are extended to individuals as well as corporations for the construction of an individual property or multiple properties and are secured by raw land and the subsequent improvements.
The total commercial loan portfolio, including participation loans, consists primarily of rental property loans (26.5% of portfolio), medical industry loans (11.3% of portfolio), hotel and motel loans (6.7% of portfolio) and land development loans (5.2% of portfolio). During 2011, the primary market areas for the Company’s commercial loan originations, excluding loan participations, were in the areas of Gallia, Jackson, Pike and Franklin counties of Ohio, which accounted for 44.5% of total originations. The growing West Virginia markets also accounted for 42.7% of total originations for the same time period. While management believes lending opportunities exist in the Company’s markets, future commercial lending activities will depend upon economic and related conditions, such as general demand for loans in the Company’s primary markets, interest rates offered by the Company, the effects of competitive pressure and normal underwriting considerations.
The Company continues to monitor the pace of its loan volume. The well-documented housing market crisis and other disruptions within the economy have negatively impacted consumer spending, which has continued to limit the lending opportunities within the Company's market locations. Declines in the housing market since 2009, with falling home prices and increasing foreclosures and unemployment, have continued to result in significant write-downs of asset values by financial institutions. To combat this ongoing potential for loan loss, the Company will remain consistent in its approach to sound underwriting practices and a focus on asset quality. The Company anticipates its overall loan growth in 2012 to be challenged.
ALLOWANCE FOR LOAN LOSSES
Tables IV and V have been provided to enhance the understanding of the loan portfolio and the allowance for loan losses. Management evaluates the adequacy of the allowance for loan losses quarterly based on several factors, including, but not limited to, general economic conditions, loan portfolio composition, prior loan loss experience, and management's estimate of probable incurred losses. Management continually monitors the loan portfolio to identify potential portfolio risks and to detect potential credit deterioration in the early stages, and then establishes reserves based upon its evaluation of these inherent risks. Actual losses on loans are reflected as reductions in the reserve and are referred to as charge-offs. The amount of the provision for loan losses charged to operating expenses is the amount necessary, in management's opinion, to maintain the allowance for loan losses at an adequate level that is reflective of probable and inherent loss. The allowance required is primarily a function of the relative quality of the loans in the loan portfolio, the mix of loans in the portfolio and the rate of growth of outstanding loans. Impaired loans, which include loans classified as TDR’s, are considered in the determination of the overall adequacy of the allowance for loan losses.
The continued struggles of our U.S. economy are having a direct impact on the Company’s borrowers, as they continue to experience financial difficulties and liquidity strains. The Company is faced with the ongoing decision of whether to foreclose on these troubled loans and take possession of the collateral or to work with the borrower to modify the original terms of the loan. A successful loan modification not only avoids costly foreclosure proceedings but, more importantly, could result in the full repayment of the loan principal amount. The Company continues to monitor and make loan modifications to certain troubled loans that would ease payment pressures on the borrower. Most generally, the modification “period” of the original terms of the loan is only temporary (i.e. 12 months), after which the loan would resume under the original contractual terms of the loan. GAAP and regulatory guidance identifies certain loan modifications that would be classified as TDR’s, which, in general, is when a bank, for reasons related to a borrower’s financial difficulties, grants a concession to the borrower that the bank would not otherwise consider. One such qualification would be if the bank modified the original terms of the loan for the remaining original life of the debt. Modifications of the original terms would include temporarily adjusting the contractual interest rate of the loan or converting the payment method from principal and interest amortization payments to interest-only for a temporary period of time.
During 2011, the Company’s allowance for loan losses decreased $2,042 to finish at $7,344, as compared to $9,386 at year-end 2010. This decrease in reserves was largely due to the partial charge-offs during the first half of 2011 of various commercial and residential real estate loans classified as impaired and TDR’s. Beginning in 2011, the Company began to take partial charge-offs more quickly on collateral dependent loans. As management further evaluated the trends in the real estate market, as well as the status of long-term, collateral dependent impaired loans, the decision to charge off these specific allocations was made. As a result, net charge-offs during 2011 grew to $6,938, an increase from $4,683 in net charge-offs recorded during 2010. The majority of net charge-offs were recorded during the first and second quarters of 2011, which totaled $4,278 and $2,332, respectively.
Partially offsetting the growth in net charge-offs and lowering provision expense was an increase in loan recoveries. In 2011, the Company was successful in recovering amounts on previously charged-off loans. During 2011, total loan recoveries were $3,484, an increase of $2,288, or 191.3%, over 2010. The majority of loan recoveries were from commercial real estate and commercial and industrial loan balances that had been previously charged off.
Net charge-offs during the first quarter of 2011 were mostly from two commercial TDR loans with one borrower, for which a $3,839 partial charge-off was recorded due to declining asset values. Of this $3,839 in TDR loan charge-offs, approximately $2,906 had been previously allocated within the allowance for loan losses causing no additional provision expense to be charged. This previous allocation of the allowance for loan losses was the result of GAAP and regulatory guidance, which requires the Company to perform impairment analysis of the asset values on collateral-based TDR loans. This impairment analysis from prior periods resulted in specific allocation increases to the allowance for loan losses and corresponding increases to provision for loan losses expense. Yet, during the first quarter of 2011, a current impairment analysis revealed further deterioration in the collateral values associated with both commercial loans. As a result, it was determined an additional $933 in provision expense was necessary to account for this impairment. During the fourth quarter of 2011, the Company was successful in obtaining payoff from both of these commercial loans which led to the increase in loan recoveries previously mentioned. The Company will continue to perform the required impairment analysis on both commercial loans and make adjustments to the allowance for loan losses as necessary.
Net charge-offs during the second quarter of 2011 were largely recorded on various collateral-based impaired loans during the month of June, using reserves that had previously been allocated for these loans within the allowance for loan losses. This action came after further cash flow analysis by management and additional feedback from regulators. In the near term, management expects to timely charge off specific reserves on collateral dependent loans.
As a result of the previously mentioned TDR loan charge-offs during the first quarter of 2011, as well as other charge-offs taken during the second quarter of 2011 on various collateral dependent impaired loans, the specific reserve allocations on both TDR and impaired loans decreased from $5,230 at December 31, 2010 to just $655 at December 31, 2011. Given that a majority of these loan losses had been previously identified and specifically allocated for in periods prior to 2011, increases in provision expense were not required. However, these TDR and impaired loan charge-offs had an immediate impact on the Company’s general allocations related to the historical loan loss factor. This general allocation evaluates the average historical loan losses over the past 36 months and requires general allocations of the allowance for loan losses to be recorded as average loan losses increase. During 2011, the Company’s annualized ratio of net charge-offs to average loans grew to 1.11% as compared to 0.72% during 2010. This change in ratio had an immediate impact on the overall increase to the Company’s general charge-off allocation, which increased $1,099 from year-end 2010, primarily within the commercial real estate and commercial and industrial loan portfolios. Further affecting increases to the general allocations within the allowance for loan losses were the Company’s economic risk factor, classified and criticized asset allocations, which collectively increased $1,434 from December 31, 2010 to December 31, 2011.
The Company’s impaired loans decreased $11,534 from year-end 2010 in large part due to the commercial and residential real estate loan charge-offs previously mentioned. The portions of impaired loans for which there are specific allocations reflect losses that the Company expects to incur, as they will not likely be able to collect all amounts due according to the contractual terms of the loan. Although impaired loans have been identified as potential problem loans, they may never become delinquent or classified as nonperforming. This was the case with the previously mentioned commercial loans that were partially charged-off during the first quarter of 2011.
The Company was successful in lowering its nonperforming loans to total loans, finishing at 0.52% at December 31, 2011 as compared to 0.78% at December 31, 2010. Nonperforming loans consist of nonaccruing loans and accruing loans past due 90 days or more. Nonperforming loans finished at $3,137 at December 31, 2011, compared to $5,009 at year-end 2010. Lowering nonperforming loans also had an impact on lowering both the specific allocations of the allowance and corresponding provision expenses for the portfolio risks and credit deterioration of these nonperforming credits. The Company’s nonperforming assets (which includes nonperforming loans and OREO) to total assets ratio also lowered, finishing at 0.92% at December 31, 2011 as compared to 1.11% at December 31, 2010. Approximately 39.9% of nonperforming assets is related to two loans with one commercial borrower totaling $2,948 that was transferred into OREO during the second quarter of 2008. After a re-evaluation of the asset values of both properties during 2011, an impairment write-down of $1,266 was recorded and contributed to the decrease in nonperforming assets from year-end 2010. Both nonperforming loans and nonperforming assets at December 31, 2011 continue to be in various stages of resolution for which management believes such loans are adequately collateralized or otherwise appropriately considered in its determination of the adequacy of the allowance for loan losses.
As a result of the specific reserve allocations used in the partial charge-offs of both TDR and impaired loans during the first half of 2011, the ratio of the allowance for loan losses to total loans decreased to 1.23% at December 31, 2011, compared to 1.46% at December 31, 2010. Because of the increase in net charge-offs, the Company has seen its general allocations within the allowance for loan losses increase, with its general allocations to total loans increasing from 0.65% at December 31, 2010 to 1.12% at December 31, 2011. Management believes that the allowance for loan losses at December 31, 2011 was adequate and reflected probable incurred losses in the loan portfolio. There can be no assurance, however, that adjustments to the allowance for loan losses will not be required in the future. Changes in the circumstances of particular borrowers, as well as adverse developments in the economy are factors that could change and make adjustments to the allowance for loan losses necessary. Asset quality will continue to remain a key focus, as management continues to stress not just loan growth, but quality in loan underwriting as well
DEPOSITS
Deposits are used as part of the Company’s liquidity management strategy to meet obligations for depositor withdrawals, to fund the borrowing needs of loan customers, and to fund ongoing operations. Deposits, both interest- and noninterest-bearing, continue to be the most significant source of funds used by the Company to support earning assets. The Company seeks to maintain a proper balance of “core” deposit relationships on hand while also utilizing various wholesale deposit sources, such as brokered and internet CD balances, as an alternative funding source to manage efficiently the net interest margin. Deposits are influenced by changes in interest rates, economic conditions and competition from other banks. The accompanying table VII shows the composition of total deposits as of December 31, 2011. Total deposits decreased $6,895, or 1.0%, to finish at $687,886 at December 31, 2011, resulting mostly from a net decrease in the Company’s time deposit balances due to increased maturity runoff of CD’s. This change in time deposits from year-end 2010 fits within management’s strategy of focusing on more core deposit balances that include interest-bearing demand, savings, money market and noninterest-bearing deposit balances. Core relationship deposits are considered by management as a primary source of the Bank’s liquidity. The Bank focuses on these kinds of deposit relationships with consumers from local markets who can maintain multiple accounts and services at the Bank. The Company views core deposits as the foundation of its long-term funding sources because it believes such core deposits are more stable and less sensitive to changing interest rates and other economic factors. As a result, the Bank’s core customer relationship strategy has resulted in a higher portion of its deposits being held in NOW, savings and money market accounts at December 31, 2011 than at December 31, 2010, while a lesser portion was being held in brokered and retail time deposits at December 31, 2011 than at December 31, 2010. Furthermore, the Company’s core noninterest-bearing demand accounts increased from year-end 2010.
Deposit decreases from year-end 2010 came mostly from the Company’s time deposits. Historically, time deposits, particularly CD’s, had been the most significant source of funding for the Company’s earning assets, making up 44.5% of total deposits at December 31, 2010. However, these funding sources continue to be less emphasized due to lower market rates and the Company’s focus on growing its core deposit balances. As a result, time deposits represented 36.0% of total deposits at December 31, 2011. During 2011, time deposits decreased $61,319, or 19.8%, from year-end 2010. With loan balances down 6.7% from year-end 2010, the Company has not needed to employ aggressive funding measures, such as offering higher rates, to attract customer investments in CD’s. Furthermore, as market rates remain at low levels from 2009 and 2010, the Company has seen the cost of its retail CD balances continue to reprice downward (as a lagging effect to the actions by the Federal Reserve) to reflect current deposit rates. As the Company’s CD rate offerings have fallen considerably from a year ago, the Bank’s CD customers have been more likely to consider re-investing their matured CD balances into other short-term deposit products or with other institutions offering the most attractive rates. This has led to an increased maturity runoff within its “customer relation” retail CD portfolio. Furthermore, with the significant downturn in economic conditions, the Bank’s CD customers in general have experienced reduced funds available to deposit with structured terms, choosing to remain more liquid. As a result, the Company has experienced a decrease within its retail CD balances, which were down $39,767 from year-end 2010. The Company’s preference of core deposit funding sources has created a lesser reliance on brokered and internet CD issuances, which were also down $21,552 from year-end 2010. The Company will continue to evaluate its use of brokered CD’s to manage interest rate risk associated with longer-term, fixed-rate asset loan demand.
While time deposits decreased during 2011, the Company’s remaining deposits, both interest- and noninterest-bearing, collectively increased $54,424, or 14.1%, from year-end 2010. The increase came mostly from a significant portion of the Company’s repurchase agreement funds reinvesting into interest- and noninterest-bearing checking accounts during the second half of 2011. Prior to 2011, banking regulations prohibited the payment of interest on commercial demand deposit accounts. In 2010, the Dodd-Frank Wall Street Reform and Consumer Protection Act was enacted, which created significant financial reform. One of those changes, which took effect in the third quarter of 2011, now permits banks to pay interest on business checking accounts. The Company evaluated the effects of this change to its business deposit account relationships, particularly within its repurchase agreement borrowings. Repurchase agreements are financing arrangements with business accounts that have overnight maturity terms. These overnight funds are paid a rate of interest and require various securities to be pledged as collateral. During the third quarter of 2011, the Company began offering to its repurchase agreement depositors the opportunity to reinvest their balances into one of two products: 1) a higher-yielding, interest-bearing demand deposit (Commercial NOW) account that would be subject to standard FDIC insurance coverage, or 2) a noninterest-bearing demand deposit (business checking) account that would have unlimited FDIC insurance coverage up to the end of 2012. As a result, the Company saw 100% of its repurchase agreement balances shift into its core deposit segment. At December 31, 2011, the Company’s interest-free funding source, noninterest-bearing demand deposits, had increased $46,194, or 50.2%, from year-end 2010, with the majority coming from its business checking account growth from the reinvestment of repurchase agreement balances. Also at December 31, 2011, the Company’s interest-bearing demand deposit (NOW) accounts increased $74, or 0.1%, from year-end 2010, mostly within commercial NOW accounts that received reinvested dollars from repurchase agreement balances. Not only does this provide the Company’s business account relationships with options to better suit their needs, it also fits in its preference to grow core deposits and to establish more solid customer relationships.
Partially offsetting core deposit growth within the Company’s NOW account deposits in 2011 were decreases in public fund account balances, which were down $7,627, or 13.4%, from year-end 2010. This decrease was largely driven by public fund balances related to local city and county school construction projects within Gallia County, Ohio. While the Company feels confident in the relationships it has with its public fund customers, these balances will continue to experience “larger” fluctuations than other deposit account relationships due to the nature of the account activity. Larger public fund balance fluctuations are, at times, seasonal and can be predicted while most other large fluctuations are outside of management’s control. The Company values these public fund relationships it has secured and will continue to market and service these accounts to maintain its long-term relationship.
Interest-bearing deposit growth also came from money market accounts, which were up $4,115, or 2.8%, from year-end 2010. The increase came largely from the Company’s Market Watch product. The Market Watch product is a limited transaction investment account with tiered rates that competes with current market rate offerings and serves as an alternative to certificates of deposit for some customers. With an added emphasis on further building and maintaining core deposit relationships, the Company has marketed several attractive incentive offerings in the past several years to draw customers to this particular product. Most recently, the Company offered a special six-month introductory rate offer of 2.00% APY during 2010’s third quarter for new Market Watch accounts. This special offer was well received by the Bank’s customers and contributed to elevating money market balances during the second half of 2010. The promotion ended during the first quarter of 2011, and the interest rate adjusted down to a current market rate. A portion of deposits have been retained since the lowering of the rate as Market Watch balances are up $4,017, or 2.8%, from year-end 2010.
Additional interest-bearing core deposit growth also came from the Company’s savings account balances, which increased $4,041, or 9.5%, from year-end 2010, coming primarily from its statement savings product. The increase in savings account balances reflects the customer’s preference to remain liquid while the opportunity for market rates to rise in the near future still exists. As CD market rates continue to adjust downward, the spread between a short-term CD rate and a statement savings rate have become close enough for customers to invest their balances into the more liquid statement savings account.
The Company will continue to experience increased competition for deposits in its market areas, which should challenge its net growth. The Company will continue to emphasize growth in its core deposit relationships during 2012, reflecting the Company’s efforts to reduce its reliance on higher cost funding and improving net interest income.
SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE
Repurchase agreements, which are financing arrangements that have overnight maturity terms, decreased from $38,107 at December 31, 2010 to $0 at December 31, 2011. As previously mentioned, the re-distribution of 100% of the Company’s repurchase agreements to other deposit products was due to newly enacted legislation during the third quarter of 2011 which permits banks to now pay interest on its business checking accounts. All of the Company’s repurchase agreement depositors took advantage of two interest-bearing and noninterest-bearing products to reinvest their dollars. Not only does this provide the Company’s business account relationships with options to better suit their needs, it also fits in its preference to grow core deposits and to establish more solid customer relationships.
OTHER BORROWED FUNDS
The Company also accesses other funding sources, including short-term and long-term borrowings, to fund asset growth and satisfy short-term liquidity needs. Other borrowed funds consist primarily of Federal Home Loan Bank (“FHLB”) advances and promissory notes. During 2011, other borrowed funds were down $7,447, or 26.8%, from year-end 2010. While net loan demand was on a declining pace during 2011, management used the retained deposit proceeds from the first quarter’s seasonal tax activity to repay FHLB borrowings. While deposits continue to be the primary source of funding for growth in earning assets, management will continue to utilize various wholesale borrowings to help manage interest rate sensitivity and liquidity.
OFF-BALANCE SHEET ARRANGEMENTS
As discussed in Notes G and J, the Company engages in certain off-balance sheet credit-related activities, including commitments to extend credit and standby letters of credit, which could require the Company to make cash payments in the event that specified future events occur. Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Standby letters of credit are conditional commitments to guarantee the performance of a customer to a third party. While these commitments are necessary to meet the financing needs of the Company’s customers, many of these commitments are expected to expire without being drawn upon. Therefore, the total amount of commitments does not necessarily represent future cash requirements.
CAPITAL RESOURCES
The Company maintains a capital level that exceeds regulatory requirements as a margin of safety for its depositors. As detailed in Note N to the financial statements at December 31, 2011, the Bank’s capital exceeded the requirements to be deemed “well capitalized” under applicable prompt corrective action regulations. Total shareholders' equity at December 31, 2011 of $71,843 was up $3,715, or 5.5%, as compared to the balance of $68,128 at December 31, 2010. Contributing most to this increase was year-to-date net income of $5,835, partially offset by cash dividends paid of $3,360, or $.83 per share. The Company had treasury stock totaling $15,712 at December 31, 2011, unchanged from year-end 2010.
INTEREST RATE SENSITIVITY AND LIQUIDITY
The Company’s goal for interest rate sensitivity management is to maintain a balance between steady net interest income growth and the risks associated with interest rate fluctuations. Interest rate risk (“IRR”) is the exposure of the Company’s financial condition to adverse movements in interest rates. Accepting this risk can be an important source of profitability, but excessive levels of IRR can threaten the Company’s earnings and capital.
The Company evaluates IRR through the use of an earnings simulation model to analyze net interest income sensitivity to changing interest rates. The modeling process starts with a base case simulation, which assumes a static balance sheet and flat interest rates. The base case scenario is compared to rising and falling interest rate scenarios assuming a parallel shift in all interest rates. Comparisons of net interest income and net income fluctuations from the flat rate scenario illustrate the risks associated with the current balance sheet structure.
The Company’s Asset/Liability Committee monitors and manages IRR within Board approved policy limits. The current IRR policy limits anticipated changes in net interest income to an instantaneous increase or decrease in market interest rates over a 12 month horizon to +/- 5% for a 100 basis point rate shock, +/- 7.5% for a 200 basis point rate shock and +/- 10% for a 300 basis point rate shock. Based on the level of interest rates, management did not test interest rates down 200 or 300 basis points.
The estimated percentage change in net interest income due to a change in interest rates was within the policy guidelines established by the Board. With the historical low interest rate environment, management generally has been focused on limiting the duration of assets, while trying to extend the duration of our funding sources to the extent customer preferences will permit us to do so. The exposure to rising interest rates is primarily related to the level of fixed-rate mortgages, which have contractual terms as long as 30 years. Presently, management attempts to sell most fixed-rate residential mortgages to the secondary market. However, the underwriting criteria for secondary market loans continues to become more restrictive. As a result, we booked a portion of the fixed-rate mortgages originated. During the later part of 2011, management began limiting the maximum term to 15 years for fixed-rate real estate loans placed in the portfolio, which will reduce the duration of the mortgage portfolio over time. The exposure to rising interest rates at December 31, 2011 was comparable to the prior year end. Net interest income decreases in a declining rate environment due to the interest rate on many deposit accounts not being able to adjust downward. With interest rates so low, deposit accounts are perceived to be at or near an interest rate floor. Overall, management is comfortable with the current interest rate risk profile which reflects minimal exposure to interest rate changes.
Liquidity relates to the Company's ability to meet the cash demands and credit needs of its customers and is provided by the ability to readily convert assets to cash and raise funds in the market place. Total cash and cash equivalents, held to maturity securities maturing within one year and available for sale securities, totaling $137,948, represented 17.2% of total assets at December 31, 2011. In addition, the FHLB offers advances to the Bank, which further enhances the Bank's ability to meet liquidity demands. At December 31, 2011, the Bank could borrow an additional $137,038 from the FHLB, of which $95,000 could be used for short-term, cash management advances. Furthermore, the Bank has established a borrowing line with the Federal Reserve. At December 31, 2011, this line had total availability of $45,059. Lastly, the Bank also has the ability to purchase federal funds from a correspondent bank. For further cash flow information, see the condensed consolidated statement of cash flows. Management does not rely on any single source of liquidity and monitors the level of liquidity based on many factors affecting the Company’s financial condition.
INFLATION
Consolidated financial data included herein has been prepared in accordance with US GAAP. Presently, US GAAP requires the Company to measure financial position and operating results in terms of historical dollars with the exception of securities available for sale, which are carried at fair value. Changes in the relative value of money due to inflation or deflation are generally not considered.
In management's opinion, changes in interest rates affect the financial institution to a far greater degree than changes in the inflation rate. While interest rates are greatly influenced by changes in the inflation rate, they do not change at the same rate or in the same magnitude as the inflation rate. Rather, interest rate volatility is based on changes in the expected rate of inflation, as well as monetary and fiscal policies. A financial institution's ability to be relatively unaffected by changes in interest rates is a good indicator of its capability to perform in today's volatile economic environment. The Company seeks to insulate itself from interest rate volatility by ensuring that rate sensitive assets and rate sensitive liabilities respond to changes in interest rates in a similar time frame and to a similar degree.
CRITICAL ACCOUNTING POLICIES
The most significant accounting policies followed by the Company are presented in Note A to the consolidated financial statements. These policies, along with the disclosures presented in the other financial statement notes, provide information on how significant assets and liabilities are valued in the financial statements and how those values are determined. Management views critical accounting policies to be those that are highly dependent on subjective or complex judgments, estimates and assumptions, and where changes in those estimates and assumptions could have a significant impact on the financial statements. Management currently views the adequacy of the allowance for loan losses to be a critical accounting policy.
The allowance for loan losses is a valuation allowance for probable incurred credit losses. Loan losses are charged against the allowance when management believes the uncollectibility of a loan balance is confirmed. Subsequent recoveries, if any, are credited to the allowance. Management estimates the allowance balance required using past loan loss experience, the nature and volume of the portfolio, information about specific borrower situations and estimated collateral values, economic conditions, and other factors. Allocations of the allowance may be made for specific loans, but the entire allowance is available for any loan that, in management’s judgment, should be charged off.
The allowance consists of specific and general components. The specific component relates to loans that are individually classified as impaired. A loan is impaired when, based on current information and events, it is probable that the Company will be unable to collect all amounts due according to the contractual terms of the loan agreement. Impaired loans generally consist of loans with balances of $200 or more on nonaccrual status or nonperforming in nature. Loans for which the terms have been modified, and for which the borrower is experiencing financial difficulties, are considered troubled debt restructurings and classified as impaired.
Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length and reasons for the delay, the borrower’s prior payment record, and the amount of shortfall in relation to the principal and interest owed.
Commercial and commercial real estate loans are individually evaluated for impairment. If a loan is impaired, a portion of the allowance is allocated so that the loan is reported, net, at the present value of estimated future cash flows using the loan’s existing rate or at the fair value of collateral if repayment is expected solely from the collateral. Smaller balance homogeneous loans, such as consumer and most residential real estate, are collectively evaluated for impairment, and accordingly, they are not separately identified for impairment disclosure. Troubled debt restructurings are measured at the present value of estimated future cash flows using the loan’s effective rate at inception. If a troubled debt restructuring is considered to be a collateral dependent loan, the loan is reported, net, at the fair value of the collateral. For troubled debt restructurings that subsequently default, the Company determines the amount of reserve in accordance with the accounting policy for the allowance for loan losses.
The general component covers non-impaired loans and impaired loans that are not individually reviewed for impairment and is based on historical loss experience adjusted for current factors. The historical loss experience is determined by portfolio segment and is based on the actual loss history experienced by the Company over the most recent 3 years. This actual loss experience is supplemented with other economic factors based on the risks present for each portfolio segment. These economic factors include consideration of the following: levels of and trends in delinquencies and impaired loans; levels of and trends in charge-offs and recoveries; trends in volume and terms of loans; effects of any changes in risk selection and underwriting standards; other changes in lending policies, procedures, and practices; experience, ability, and depth of lending management and other relevant staff; national and local economic trends and conditions; industry conditions; and effects of changes in credit concentrations. The following portfolio segments have been identified: Commercial Real Estate, Commercial and Industrial, Residential Real Estate, and Consumer.
Commercial and industrial loans consist of borrowings for commercial purposes to individuals, corporations, partnerships, sole proprietorships, and other business enterprises. Commercial and industrial loans are generally secured by business assets such as equipment, accounts receivable, inventory, or any other asset excluding real estate and generally made to finance capital expenditures or operations. The Company’s risk exposure is related to deterioration in the value of collateral securing the loan should foreclosure become necessary. Generally, business assets used or produced in operations do not maintain their value upon foreclosure, which may require the Company to write-down the value significantly to sell.
Commercial real estate consists of nonfarm, nonresidential loans secured by owner-occupied and nonowner-occupied commercial real estate as well as commercial construction loans. An owner-occupied loan relates to a borrower purchased building or space for which the repayment of principal is dependent upon cash flows from the ongoing business operations conducted by the party, or an affiliate of the party, who owns the property. Owner-occupied loans that are dependent on cash flows from operations can be adversely affected by current market conditions for their product or service. A nonowner-occupied loan is a property loan for which the repayment of principal is dependent upon rental income associated with the property or the subsequent sale of the property. Nonowner-occupied loans that are dependent upon rental income are primarily impacted by local economic conditions which dictate occupancy rates and the amount of rent charged. Commercial construction loans consist of borrowings to purchase and develop raw land into one- to four-family residential properties. Construction loans are extended to individuals as well as corporations for the construction of an individual or multiple properties and are secured by raw land and the subsequent improvements. Repayment of the loans to real estate developers is dependent upon the sale of properties to third parties in a timely fashion upon completion. Should there be delays in construction or a downturn in the market for those properties, there may be significant erosion in value which may be absorbed by the Company.
Residential real estate loans consist of loans to individuals for the purchase of one- to four-family primary residences with repayment primarily through wage or other income sources of the individual borrower. The Company’s loss exposure to these loans is dependent on local market conditions for residential properties as loan amounts are determined, in part, by the fair value of the property at origination.
Consumer loans are comprised of loans to individuals secured by automobiles, open-end home equity loans and other loans to individuals for household, family, and other personal expenditures, both secured and unsecured. These loans typically have maturities of 5 years or less with repayment dependent on individual wages and income. The risk of loss on consumer loans is elevated as the collateral securing these loans, if any, rapidly depreciate in value or may be worthless and/or difficult to locate if repossession is necessary. During the last several years, one of the most significant portions of the Company’s net loan charge-offs have been from consumer loans. Never the less, the Company has allocated the highest percentage of its allowance for loan losses as a percentage of loans to the other identified loan portfolio segments due to the larger dollar balances associated with such portfolios.
CONCENTRATIONS OF CREDIT RISK
The Company maintains a diversified credit portfolio, with residential real estate loans currently comprising the most significant portion. Credit risk is primarily subject to loans made to businesses and individuals in southeastern Ohio and western West Virginia. Management believes this risk to be general in nature, as there are no material concentrations of loans to any industry or consumer group. To the extent possible, the Company diversifies its loan portfolio to limit credit risk by avoiding industry concentrations.
FORWARD LOOKING STATEMENTS
Except for the historical statements and discussions contained herein, statements contained in this report constitute "forward looking statements" within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Act of 1934 and as defined in the Private Securities Litigation Reform Act of 1995. Such statements are often, but not always, identified by the use of such words as "believes," "anticipates," "expects," and similar expressions. Such statements involve various important assumptions, risks, uncertainties, and other factors, many of which are beyond our control that could cause actual results to differ materially from those expressed in such forward looking statements. These factors include, but are not limited to: changes in political, economic or other factors such as inflation rates, recessionary or expansive trends, and taxes; competitive pressures; fluctuations in interest rates; the level of defaults and prepayment on loans made by the Company; unanticipated litigation, claims, or assessments; fluctuations in the cost of obtaining funds to make loans; and regulatory changes. Additional detailed information concerning a number of important factors which could cause actual results to differ materially from the forward-looking statements contained in management’s discussion and analysis is available in the Company’s filings with the Securities and Exchange Commission, under the Securities Exchange Act of 1934, including the disclosure under the heading “Item 1A. Risk Factors” of Part 1 of the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2011. Readers are cautioned not to place undue reliance on such forward looking statements, which speak only as of the date hereof. The Company undertakes no obligation and disclaims any intention to republish revised or updated forward looking statements, whether as a result of new information, unanticipated future events or otherwise.
