NOTES TO THE INTERIM CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2010
(Unaudited)
Note 1. BASIS OF PRESENTATION
The consolidated financial statements include the accounts of Neffs Bancorp, Inc. (the “Corporation”) and its wholly owned subsidiary, The Neffs National Bank (the “Bank”). All material intercompany accounts and transactions have been eliminated in consolidation.
The accompanying unaudited consolidated financial statements have been prepared in accordance with generally accepted accounting principles in the United States of America for interim financial statements and the rules and regulations of the Securities and Exchange Commission (“SEC”) for interim financial information. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments considered necessary for a fair presentation have been included and are of a normal, recurring nature. Operating results for the nine-month period ended September 30, 2010, are not necessarily indicative of the results that may be expected for the year ending December 3l, 2010. These statements should be read in conjunction with the financial statements and notes contained in the 2009 Annual Report to Shareholders.
In addition to historical information, this Form 10-Q Report contains forward-looking statements. The forward-looking statements contained herein are subject to certain risks and uncertainties that could cause actual results to differ materially from those projected in the forward-looking statements. Important factors that might cause such differences include, but are not limited to, those discussed in the section entitled “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” Readers are cautioned not to place undue reliance on these forward-looking statements, which reflect management’s analysis only as of the date hereof. Readers should carefully review the risk factors described in other documents the Corporation files from time to time with the SEC.
For further information, refer to the financial statements and footnotes thereto included in Neffs Bancorp, Inc.’s Annual Report to Shareholders for the year ended December 31, 2009.
Note 2. COMMITMENTS AND CONTINGENCIES
The Corporation is subject to certain routine legal proceedings and claims arising in the ordinary course of business. It is management’s opinion that the ultimate resolution of these claims will not have a material adverse effect on the Corporation’s financial position and results of operations.
Note 3. COMPREHENSIVE INCOME
The components of other comprehensive income and related tax effects for the three and nine months ended September 30, 2010 and 2009 are as follows:
|
|
|
Three Months
Ended
September 30,
|
|
|
Nine Months
Ended
September 30,
|
|
|
Dollars in thousands
|
|
2010
|
|
|
2009
|
|
|
2010
|
|
|
2009
|
|
|
|
|
|
|
|
Change in unrealized net gains on securities available for sale
|
|
$
|
(336
|
)
|
|
$
|
303
|
|
|
$
|
247
|
|
|
$
|
528
|
|
|
Change in unrealized losses on OTTI securities held to maturity
|
|
|
9
|
|
|
|
-
|
|
|
|
(502
|
)
|
|
|
-
|
|
|
Tax effect
|
|
|
111
|
|
|
|
(103
|
)
|
|
|
87
|
|
|
|
(180
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other comprehensive income (loss), net of tax
|
|
$
|
(216
|
)
|
|
$
|
200
|
|
|
$
|
(168
|
)
|
|
$
|
348
|
|
Note 4. EARNINGS PER SHARE
Earnings per share is based on the weighted average shares of common stock outstanding during each period. The Corporation currently maintains a simple capital structure and does not issue potentially dilutive securities; thus there are no dilutive effects on earnings per share.
Note 5. GUARANTEES
The Corporation does not issue any guarantees that would require liability recognition or disclosure, other than its standby letters of credit. Standby letters of credit written are conditional commitments issued by the Corporation to guarantee the performance of a customer to a third party. Generally, all letters of credit when issued have expiration dates within one year. The credit risks involved in issuing letters of credit are essentially the same as those that are involved in extending loan facilities to customers. The Corporation, generally, holds collateral and/or personal guarantees supporting these commitments. The Corporation had $714,000 of standby letters of credit as of September 30, 2010. Management believes that the proceeds obtained through a liquidation of collateral and the enforcement of guarantees would be sufficient to cover the potential amount of future payment required under the corresponding guarantees. The current amount of the liability as of September 30, 2010 for guarantees under standby letters of credit issued is not material.
Note 6. SECURITIES
The amortized cost and fair values of securities are as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Securities Available for Sale:
|
|
(In Thousands)
|
|
|
U.S. Treasury note
|
|
$
|
100
|
|
|
$
|
7
|
|
|
$
|
-
|
|
|
$
|
107
|
|
|
Mortgage-backed securities (Government agencies- residential)
|
|
|
36,869
|
|
|
|
1,456
|
|
|
|
(83
|
)
|
|
|
38,242
|
|
|
|
|
$
|
36,969
|
|
|
$
|
1,463
|
|
|
$
|
(83
|
)
|
|
$
|
38,349
|
|
|
Securities Held to Maturity:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Obligations of U.S. Government agencies
|
|
$
|
40,987
|
|
|
$
|
589
|
|
|
$
|
(162
|
)
|
|
$
|
41,414
|
|
|
Obligations of states and political subdivisions
|
|
|
60,767
|
|
|
|
2,466
|
|
|
|
(37
|
)
|
|
|
63,196
|
|
|
Corporate securities
|
|
|
1,350
|
|
|
|
90
|
|
|
|
-
|
|
|
|
1,440
|
|
|
Collateralized debt obligations
|
|
|
2,385
|
|
|
|
-
|
|
|
|
(1,781
|
)
|
|
|
604
|
|
|
Mortgage-backed securities (Government agencies- residential)
|
|
|
734
|
|
|
|
66
|
|
|
|
-
|
|
|
|
800
|
|
|
|
|
$
|
106,223
|
|
|
$
|
3,211
|
|
|
$
|
(1,980
|
)
|
|
$
|
107,454
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Securities Available for Sale:
|
|
(In Thousands)
|
|
|
U.S. Treasury note
|
|
$
|
100
|
|
|
$
|
4
|
|
|
$
|
-
|
|
|
$
|
104
|
|
|
Mortgage-backed securities (Government agencies- residential)
|
|
|
33,758
|
|
|
|
1,144
|
|
|
|
(15
|
)
|
|
|
34,887
|
|
|
|
|
$
|
33,858
|
|
|
$
|
1,148
|
|
|
$
|
(15
|
)
|
|
$
|
34,991
|
|
|
Securities Held to Maturity:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Obligations of U.S. Government agencies
|
|
$
|
59,576
|
|
|
$
|
231
|
|
|
$
|
(2,832
|
)
|
|
$
|
56,975
|
|
|
Obligations of states and political subdivisions
|
|
|
36,257
|
|
|
|
1,340
|
|
|
|
(139
|
)
|
|
|
37,458
|
|
|
Corporate securities
|
|
|
1,350
|
|
|
|
44
|
|
|
|
(5
|
)
|
|
|
1,389
|
|
|
Collateralized debt obligations
|
|
|
2,955
|
|
|
|
-
|
|
|
|
(2,122
|
)
|
|
|
833
|
|
|
Mortgage-backed securities (Government agencies- residential)
|
|
|
838
|
|
|
|
45
|
|
|
|
-
|
|
|
|
883
|
|
|
|
|
$
|
100,976
|
|
|
$
|
1,660
|
|
|
$
|
(5,098
|
)
|
|
$
|
97,538
|
|
The amortized cost and fair values of securities at September 30, 2010, by contractual maturity, are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
|
|
|
Available for Sale
|
|
|
Held to Maturity
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(In Thousands)
|
|
|
Due in one year or less
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
1,255
|
|
|
$
|
1,287
|
|
|
Due after one year through five years
|
|
|
100
|
|
|
|
107
|
|
|
|
6,951
|
|
|
|
7,249
|
|
|
Due after five years through ten years
|
|
|
-
|
|
|
|
-
|
|
|
|
12,928
|
|
|
|
13,468
|
|
|
Due after ten years
|
|
|
-
|
|
|
|
-
|
|
|
|
84,355
|
|
|
|
84,650
|
|
|
|
|
|
100
|
|
|
|
107
|
|
|
|
105,489
|
|
|
|
106,654
|
|
|
Mortgage-backed securities
|
|
|
36,869
|
|
|
|
38,242
|
|
|
|
734
|
|
|
|
800
|
|
|
|
|
$
|
36,969
|
|
|
$
|
38,349
|
|
|
$
|
106,223
|
|
|
$
|
107,454
|
|
There were no sales of securities during 2010 and 2009.
Securities with an amortized cost and fair value of approximately $12,000,000 and $12,747,000 at September 30, 2010 and $12,000,000 and $12,385,000 at December 31, 2009 were pledged to secure public deposits and for other purposes required or permitted by law.
The following tables show the Corporation’s investments’ gross unrealized losses and fair value, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, at September 30, 2010 and December 31, 2009:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
September 30, 2010:
|
|
(In Thousands)
|
|
|
Securities Available for Sale:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Mortgage-backed securities
|
|
$
|
10,614
|
|
|
$
|
83
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
10,614
|
|
|
$
|
83
|
|
|
Securities Held to Maturity:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Obligations of U.S. Government agencies
|
|
|
5,776
|
|
|
|
56
|
|
|
|
5,256
|
|
|
|
106
|
|
|
|
11,032
|
|
|
|
162
|
|
|
Obligations of states and political subdivisions
|
|
|
3,127
|
|
|
|
37
|
|
|
|
-
|
|
|
|
-
|
|
|
|
3,127
|
|
|
|
37
|
|
|
Collateralized debt obligations
|
|
|
-
|
|
|
|
-
|
|
|
|
604
|
|
|
|
1,781
|
|
|
|
604
|
|
|
|
1,781
|
|
|
Total Temporarily Impaired Securities
|
|
$
|
19,517
|
|
|
$
|
176
|
|
|
$
|
5,860
|
|
|
$
|
1,887
|
|
|
$
|
25,377
|
|
|
$
|
2,063
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31, 2009:
|
|
(In Thousands)
|
|
|
Securities Available for Sale:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Mortgage-backed securities
|
|
$
|
981
|
|
|
$
|
15
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
981
|
|
|
$
|
15
|
|
|
Securities Held to Maturity:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Obligations of U.S. Government agencies
|
|
|
39,065
|
|
|
|
2,379
|
|
|
|
9,672
|
|
|
|
453
|
|
|
|
48,737
|
|
|
|
2,832
|
|
|
Obligations of states and political subdivisions
|
|
|
5,422
|
|
|
|
137
|
|
|
|
297
|
|
|
|
2
|
|
|
|
5,719
|
|
|
|
139
|
|
|
Corporate securities
|
|
|
-
|
|
|
|
-
|
|
|
|
195
|
|
|
|
5
|
|
|
|
195
|
|
|
|
5
|
|
|
Collateralized debt obligations
|
|
|
-
|
|
|
|
-
|
|
|
|
832
|
|
|
|
2,122
|
|
|
|
832
|
|
|
|
2,122
|
|
|
Total Temporarily Impaired Securities
|
|
$
|
45,468
|
|
|
$
|
2,531
|
|
|
$
|
10,996
|
|
|
$
|
2,582
|
|
|
$
|
56,464
|
|
|
$
|
5,113
|
|
The Corporation had 43 and 107 securities in an unrealized loss position at September 30, 2010 and December 31, 2009, respectively. The decline in fair value is due mainly to interest rate fluctuations. Two securities were deemed to be other-than-temporarily impaired with no additional impairment charges this quarter, as discussed in Note 8. As the Corporation does not intend to sell nor is it expected to be required to sell its investments until maturity or market price recovery no other securities were deemed to be other-than-temporarily impaired.
Note 7. FAIR VALUE MEASUREMENTS
Below are estimated fair values of our financial instruments at September 30, 2010 and December 31, 2009, as required by ASC Topic 820. Such information is based on the requirements set forth in ASC Topic 820 and does not purport to represent the aggregate net fair value of the Corporation. It is the Corporation's general practice and intent to hold its financial instruments to maturity, except for certain securities designated as securities available for sale, and not to engage in trading activities. Many of the financial instruments lack an available trading market, as characterized by a willing buyer and seller engaging in an exchange transaction. Therefore, the Corporation had to use significant estimations and present value calculations to prepare this disclosure.
Changes in the assumptions or methodologies used to estimate fair values may materially affect the estimated amounts. Further, the fair value estimates are based on various assumptions, methodologies and subjective considerations, which vary widely among different financial institutions and which are subject to change.
The estimated fair value amounts have been measured as of their respective quarter ends, and have not been reevaluated or updated for purposes of these financial statements subsequent to those respective dates. As such, the estimated fair values of these financial instruments subsequent to the respective reporting dates may be different than the amounts reported at year end.
The following methods and assumptions were used by the Corporation in estimating financial instrument fair values:
Securities
ASC Topic 820 establishes a fair value hierarchy that prioritizes the inputs to valuation methods used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurements) and the lowest priority to unobservable inputs (Level 3 measurements). The three levels of the fair value hierarchy under ASC Topic 820 are as follows:
Level 1: Unadjusted quoted prices in active markets that are accessible at the measurement date for identical, unrestricted assets or liabilities.
Level 2: Quoted prices in markets that are not active, or inputs that are observable either directly or indirectly, for substantially the full term of the asset or liability.
Level 3: Prices or valuation techniques that require inputs that are both significant to the fair value measurement and unobservable (i.e. supported with little or no market activity).
An asset or liability’s level within the fair value hierarchy is based on the lowest level of input that is significant to the fair value measurement.
For assets measured at fair value on a recurring basis, the fair value measurements by level within the fair value hierarchy used are as follows:
|
Description
|
|
Total
|
|
|
(Level 1)
Quoted Prices in Active Markets for Identical Assets
|
|
|
(Level 2)
Significant Other Observable Inputs
|
|
|
(Level 3)
Significant Unobservable Inputs
|
|
|
|
|
|
|
|
(In Thousands)
|
|
|
|
|
|
|
|
|
September 30, 2010
|
|
|
|
|
|
|
|
|
|
|
|
|
|
U. S. Treasury note available for sale
|
|
$
|
107
|
|
|
$
|
107
|
|
|
|
-
|
|
|
|
-
|
|
|
Mortgage-backed securities available for sale
|
|
$
|
38,242
|
|
|
|
-
|
|
|
$
|
38,242
|
|
|
|
-
|
|
|
December 31, 2009
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
U. S. Treasury note available for sale
|
|
$
|
104
|
|
|
$
|
104
|
|
|
|
-
|
|
|
|
-
|
|
|
Mortgage-backed securities available for sale
|
|
$
|
34,887
|
|
|
|
-
|
|
|
$
|
34,887
|
|
|
|
-
|
|
For assets measured at fair value on a non-recurring basis, the fair value measurements by level within the fair value hierarchy used are as follows:
|
Description
|
|
Total
|
|
|
(Level 1)
Quoted Prices in Active Markets for Identical Assets
|
|
|
(Level 2)
Significant Other Observable Inputs
|
|
|
(Level 3)
Significant Unobservable Inputs
|
|
|
|
|
|
|
|
(In Thousands)
|
|
|
|
|
|
|
|
|
September 30, 2010
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Impaired trust preferred securities held to maturity
|
|
$
|
428
|
|
|
|
-
|
|
|
|
-
|
|
|
$
|
428
|
|
|
Impaired loans
|
|
$
|
2,429
|
|
|
|
-
|
|
|
$
|
2,249
|
|
|
|
-
|
|
|
Other real estate owned
|
|
$
|
468
|
|
|
|
-
|
|
|
$
|
468
|
|
|
|
-
|
|
|
December 31, 2009
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Impaired trust preferred security held to maturity
|
|
$
|
65
|
|
|
|
-
|
|
|
|
-
|
|
|
$
|
65
|
|
For the impaired held to maturity trust preferred securities the change in book value is as follows:
|
|
|
Impaired trust preferred securities held to maturity
|
|
|
|
|
(In Thousands)
|
|
|
Book/fair value of previously impaired held to maturity security at December 31, 2009
|
|
$
|
65
|
|
|
Book value of currently impaired held to maturity security at December 31, 2009
|
|
|
990
|
|
|
Credit related impairment
|
|
|
(114
|
)
|
|
Non-credit related impairment
|
|
|
(519
|
)
|
|
Accretion of impaired securities
|
|
|
16
|
|
|
Principal payment on impaired securities
|
|
|
(10
|
)
|
|
Book value of impaired securities at September 30, 2010
|
|
$
|
428
|
|
Fair values of unimpaired securities held to maturity and securities available for sale are determined by quoted prices in active markets that are accessible at the measurement date for identical, unrestricted assets or liabilities.
Impaired loans are considered impaired under the guidance of the loan impairment subsection of the Receivables Topic, ASC Section 310-10-35, under which the Corporation has measured impairment generally based on the fair value of the loan’s collateral. Fair value consists of the loan balance less its valuation allowance and is generally determined based on independent third-party appraisals of the collateral or discounted cash flows based upon the expected proceeds. These assets are included as Level 2 fair values based upon the lowest level of input that is significant to the fair value measurements.
Fair value of the foreclosed asset was based upon an independent third-party appraisal of the property less cost to sell. This value was determined based on the sales prices of similar properties in the approximate geographic area. This asset is included as Level 2 fair value based upon the lowest level of input that is significant to the fair value measurement.
The Corporation’s adoption of ASC Topic 820 applies to its financial instruments required to be reported at fair value. Except for the foreclosed asset, the Corporation does not have non-financial assets and non-financial liabilities for which adoption would apply in accordance with ASC Topic 820.
At September 30, 2010 we own four collateralized debt obligation securities totaling $2,385,000 book value and $604,000 fair value that are backed by trust preferred securities issued by banks, thrifts, and insurance companies (TRUP CDOs). These securities are included in corporate held to maturity securities. The market for these securities at September 30, 2010 is not active and markets for similar securities are also not active. The inactivity was evidenced first by a significant widening of the bid-ask spread in the brokered markets in which TRUP CDOs trade and then by a significant decrease in the volume of trades relative to historical levels. The new issue market is also inactive as no new TRUP CDOs have been issued since 2007. There are currently very few market participants who are willing and or able to transact for these securities. The Corporation analyzed the cash flow characteristics of these securities and determined that two securities are other-than-temporarily impaired with no additional impairment charges in the third quarter of 2010, as discussed in Note 8.
Cash and Due from Banks, Interest Bearing Deposits with Banks and Federal Funds Sold and Purchased
The statement of financial condition carrying amounts for cash and due from banks, interest bearing deposits with banks and federal funds sold and purchased approximate the estimated fair values of such assets.
Loans Receivable
Fair values of variable rate loans subject to frequent repricing and which entail no significant credit risk are based on the carrying amounts. The estimated fair values of other loans are estimated by discounting the future cash flows using interest rates currently offered for loans with similar terms to borrowers of similar credit quality.
Accrued Interest Receivable
The carrying amount of accrued interest is considered a reasonable estimate of fair value.
Deposit Liabilities
For deposits which are payable on demand, the carrying amount is a reasonable estimate of fair value. Fair values of fixed rate time deposits are estimated by discounting the future cash flows using interest rates currently being offered and a schedule of aggregate expected maturities.
Accrued Interest Payable
The carrying amount of accrued interest approximates its fair value.
Off-Balance Sheet Instruments
The fair value of commitments to extend credit and for outstanding letters of credit is estimated using the fees currently charged to enter into similar agreements, taking into account market interest rates, the remaining terms and present credit worthiness of the counterparties.
The estimated fair values of the Corporation’s financial instruments at September 30, 2010 and December 31, 2009 are as follows:
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(In Thousands)
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Financial assets:
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Cash and short-term
investments
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$
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2,840
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$
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2,840
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$
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2,288
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$
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2,288
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Federal funds sold
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|
|
-
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|
|
|
-
|
|
|
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2,933
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|
|
|
2,933
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|
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Securities available for sale
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38,349
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|
|
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38,349
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|
|
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34,991
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|
|
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34,991
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Securities held to maturity
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106,223
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|
|
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107,454
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|
|
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100,976
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|
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97,538
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Loans, net
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117,777
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|
|
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122,932
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|
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111,159
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|
|
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114,291
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Accrued interest receivable
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|
|
1,830
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|
|
|
1,830
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|
|
|
1,611
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|
|
|
1,611
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Financial liabilities:
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Deposits
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223,693
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|
|
|
227,631
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|
|
|
211,391
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|
|
|
214,651
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Accrued interest payable
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|
|
948
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|
|
|
948
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|
|
|
1,047
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|
|
|
1,047
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Off-balance sheet financial instruments:
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Commitments to extend credit
and letters of credit
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-
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-
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|
-
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|
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-
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Note 8. IMPAIRMENT
In instances when a determination is made that an other-than-temporary impairment exists but the investor does not intend to sell the debt security and it is not more likely than not that it will be required to sell the debt security prior to its anticipated recovery, the other-than-temporary impairment is separated into (a) the amount of other-than-temporary impairment related to a decrease in cash flows expected to be collected from the debt security (the credit loss) and (b) the amount of the total other-than-temporary impairment related to all other factors. The amount of the total other-than-temporary impairment related to the credit loss is recognized in earnings. The amount of the total other-than-temporary impairment related to all other factors is recognized in other comprehensive income.
The Corporation conducts other-than-temporary impairment analysis on a quarterly basis. The initial indication of other-than-temporary impairment for both debt and equity securities is a decline in the market value below the amount recorded for an investment. A decline in value that is considered to be other-than-temporary related to a decrease in cash flows is recorded as a loss within non-interest income in the consolidated statement of income.
In determining whether an impairment is other than temporary, the Corporation considers a number of factors, including, but not limited to, the length of time and extent to which the market value has been less than cost, recent events specific to the issuer, including investment downgrades by rating agencies and economic conditions of its industry, and the Corporation’s intent to sell or the likelihood it will be required to sell the security before a sufficient period of time to allow for a recovery in market value or maturity. Among the factors that are considered in determining the Corporation’s intent and ability is a review of its capital adequacy, interest rate risk position and liquidity.
The Corporation also considers the issuer’s financial condition, capital strength and near-term prospects. In addition, for debt securities and perpetual preferred securities that are treated as debt securities for the purpose of other-than-temporary analysis, the Corporation considers the cause of the price decline (general level of interest rates and industry- and issuer-specific factors), current ability to make future payments in a timely manner and the issuer’s ability to service debt.
The assessment of a security’s ability to recover any decline in market value, the ability of the issuer to meet contractual obligations and the Corporation’s intent to sell or the likelihood it will be required to sell the security before recovery in value require considerable judgment.
Certain of the corporate debt securities are accounted for under ASC 325, Recognition of Interest Income and Impairment on Purchased Beneficial Interests that Continue to Be Held by a Transferor in Securitized Financial Assets. For investments within the scope of ASC 325 at acquisition, the Corporation evaluates current available information in estimating the future cash flows of these securities and determines whether there have been favorable or adverse changes in estimated cash flows from the cash flows previously projected. The Corporation considers the structure and term of the pool and the financial condition of the underlying issuers. Specifically, the evaluation incorporates factors such as interest rates and appropriate risk premiums, the timing and amount of interest and principal payments and the allocation of payments to the various note classes. Current estimates of cash flows are based on the most recent trustee reports, announcements of deferrals or defaults, expected future default rates and other relevant market information related to the underlying securities and issuers.
There are two other-than-temporary impaired securities with no additional impairment charges recognized by the Corporation during the third quarter of 2010. There was one security deemed to be other-than-temporarily impaired for the third quarter of 2009. Based on several factors including credit ratings, principal coverage tests, break in yield analysis, and cash flow forecasts, management expects to recover the remaining amortized cost of these securities. A break in yield for a given tranche of a collateralized debt obligation (investment) means that deferrals/defaults have reached such a level that the tranche would not receive all of its contractual cash flows (principal and interest) by maturity (so not just a temporary interest shortfall, but an actual loss in yield on the investment). In other words, the magnitude of the defaults/deferrals has depleted all of the credit enhancement (excess interest and over-collateralization) beneath the given tranche. Based on this analysis and because the Corporation does not intend to sell and it is more likely than not that the Corporation will not be required to sell before its recovery of amortized cost basis, which may be at maturity, and, for investments within the scope of ASC 325, the Corporation determined that there was no adverse change in the cash flows as viewed by a market participant. Therefore, the Corporation does not consider the investments in the trust preferred assets to have additional other-than-temporarily impairment at September 30, 2010. However, there is a risk that such reviews could result in recognition of additional other-than-temporary impairment charges in the future.
The market values for these securities (and any securities other than those issued or guaranteed by the US Treasury) are very depressed relative to historical levels. The yield spreads for the broad market of investment grade and high yield corporate bonds recently reached all time wide levels and remain near those levels today. Thus in today’s market, a low market price for a particular bond may only provide evidence of stress in the credit markets in general versus being an indicator of credit problems with a particular issuer.
Given conditions in the debt markets today and the absence of observable transactions in the secondary and new issue markets, we determined:
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§
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the few observable transactions and market quotations that are available are not reliable for purposes of determining fair value at September 30, 2010,
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§
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an income valuation approach technique (present value technique) that maximizes the use of relevant observable inputs and minimizes the use of unobservable inputs will be equally or more representative of fair value than the market approach valuation technique used at prior measurement dates, and;
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§
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our Trust Preferred Collateralized Debt Obligations (TRUP CDOs) are classified within Level 3 of the fair value hierarchy because we determined that significant adjustments are required to determine fair value at the measurement date.
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Our TRUP CDO valuations were prepared by an independent third party. Their approach to determining fair value involved these steps:
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1.
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There were a number of assumptions used and the results of the modeling were highly dependent upon the assumptions.
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2.
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Credit and prepayment assumptions were used for each quarter.
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3.
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Forward interest rates were used to project future principal and interest payments. This allowed the analysts to model the impact of over- or under-collateralization for each transaction. (Higher interest rates generally increase the credit stress on under-collateralized transactions by reducing excess interest, which is the difference between the interest received from the underlying collateral and the interest paid on the rated bonds.)
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4.
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Original face purchased, current book value (as of September 30, 2010), purchase date, and purchase price were used to produce the calculations.
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5.
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The basic methodology of ASC 325 was to compare the present value of the cash flows from quarter to quarter. A decline in the present value versus that for the previous quarter was considered to be an “adverse change.”
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6.
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ASC 325 prescribes using a discount rate “equal to the current yield used to accrete the beneficial interest.” Original discount margin calculated as of the purchase date passed on purchase price was used to calculate the discount rate. The original discount margin is then added to the appropriate forward 3-month LIBOR rate to determine the discount rate. For fixed/floating securities, the original coupon is used as the discount rate for the remaining fixed-rate portion of the security’s estimated life.
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7.
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The discount rate was then used to calculate the present value for the current quarter’s projected cash flows.
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8.
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The result calculated for the current quarter was then compared to the previous quarter’s book value to determine if the change is “adverse.”
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9.
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The credit component of any impairment should be the difference between book value and the projected present value for the current quarter.
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We recalculated the overall effective discount rates for these valuations. The overall discount rates range from 7.30% to 42.20% and are highly dependent and reflected upon the credit quality of the collateral, the relative position of the tranche in the capital structure of the CDO and the prepayment assumptions.
As of September 30, 2010, management does not believe any unrealized loss in its other debt securities represents an other-than-temporary impairment. The unrealized losses at September 30, 2010 were primarily interest rate-related.
Note 9. NEW ACCOUNTING STANDARDS
In November 2008, the SEC released a proposed roadmap regarding the potential use by U.S. issuers of financial statements prepared in accordance with International Financial Reporting Standards (“IFRS”). IFRS is a comprehensive series of accounting standards published by the International Accounting Standards Board (“IASB”). Under the roadmap, the Corporation may be required to prepare financial statements in accordance with IFRS as early as 2014. The SEC is expected to make a determination in 2011 regarding the mandatory adoption of IFRS. The Corporation is currently assessing the impact that this potential change would have on its consolidated financial statements, and it will continue to monitor the development of the potential implementation of IFRS.
The FASB has issued ASU 2010-06, Fair Value Measurements and Disclosures (Topic 820): Improving Disclosures about Fair Value Measurements. This ASU requires some new disclosures and clarifies some existing disclosure requirements about fair value measurement as set forth in Codification Subtopic 820-10. The FASB’s objective is to improve these disclosures and, thus, increase the transparency in financial reporting. Specifically, ASU 2010-06 amends Codification Subtopic 820-10 to now require:
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§
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A reporting entity to disclose separately the amounts of significant transfers in and out of Level 1 and Level 2 fair value measurements and describe the reasons for the transfers; and
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§
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In the reconciliation for fair value measurements using significant unobservable inputs, a reporting entity should present separately information about purchases, sales, issuances, and settlements.
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In addition, ASU 2010-06 clarifies the requirements of the following existing disclosures:
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§
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For purposes of reporting fair value measurement for each class of assets and liabilities, a reporting entity needs to use judgment in determining the appropriate classes of assets and liabilities; and
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§
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A reporting entity should provide disclosures about the valuation techniques and inputs used to measure fair value for both recurring and nonrecurring fair value measurements.
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ASU 2010-06 is effective for interim and annual reporting periods beginning after December 15, 2009, except for the disclosures about purchases, sales, issuances, and settlements in the roll forward of activity in Level 3 fair value measurements. Those disclosures are effective for fiscal years beginning after December 15, 2010, and for interim periods within those fiscal years.
In April 2010, the FASB issued ASU 2010-18, Receivables (Topic 310): Effect of a Loan Modification When the Loan is a Part of a Pool That is Accounted for as a Single Asset – a consensus of the FASB Emerging Issues Task Force. ASU 2010-18 clarifies the treatment for a modified loan that was acquired as part of a pool of assets. Refinancing or restructuring the loan does not make it eligible for removal from the pool, the FASB said. The amendment will be effective for loans that are part of an asset pool and are modified during financial reporting periods that end July 15, 2010 or later. This is not expected to have a significant impact on the Corporation’s financial statements.
ASU 2010-20, Receivables (Topic 310): Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses, will help investors assess the credit risk of a company’s receivables portfolio and the adequacy of its allowance for credit losses held against the portfolios by expanding credit risk disclosures.
This ASU requires more information about the credit quality of financing receivables in the disclosures to financial statements, such as aging information and credit quality indicators. Both new and existing disclosures must be disaggregated by portfolio segment or class. The disaggregation of information is based on how a company develops its allowance for credit losses and how it manages its credit exposure.
The amendments in this Update apply to all public and nonpublic entities with financing receivables. Financing receivables include loans and trade accounts receivable. However, short-term trade accounts receivable, receivables measured at fair value or lower of cost or fair value, and debt securities are exempt from these disclosure amendments.
The effective date of ASU 2010-20 differs for public and nonpublic companies. For public companies, the amendments that require disclosures as of the end of a reporting period are effective for periods ending on or after December 15, 2010. The amendments that require disclosures about activity that occurs during a reporting period are effective for periods beginning on or after December 15, 2010. The adoption of this guidance is not expected to have a significant impact on the Corporation’s financial statements.
In August, 2010, the FASB issued ASU 2010-21, Accounting for Technical Amendments to Various SEC Rules and Schedules. This ASU amends various SEC paragraphs pursuant to the issuance of Release No. 33-9026: Technical Amendments to Rules, Forms, Schedules, and Codification of Financial Reporting Policies and is not expected to have a significant impact on the Corporation’s financial statements.
In August, 2010, the FASB issued ASU 2010-22, Technical Corrections to SEC Paragraphs – An announcement made by the staff of the U.S. Securities and Exchange Commission. This ASU amends various SEC paragraphs based on external comments received and the issuance of SAB 112, which amends or rescinds portions of certain SAB topics and is not expected to have a significant impact on the Corporation’s financial statements.
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Item 2.
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MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
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Management’s Discussion and Analysis of Financial Condition and Results of Operations analyzes the major elements of the Corporation’s balance sheets and statements of income. This section should be read in conjunction with the Corporation’s financial statements and accompanying notes.
Management of the Corporation has made forward-looking statements in this Form 10-Q. These forward-looking statements may be subject to risks and uncertainties. Forward-looking statements include the information concerning possible or assumed future results of operations of the Corporation and its subsidiary. When words such as "believes," "expects," "anticipates" or similar expressions occur in this Form 10-Q, management is making forward-looking statements.
Readers should note that many factors, some of which are discussed elsewhere in this report and in the documents that management incorporates by reference, could affect the future financial results of the Corporation and its subsidiary, both individually and collectively, and could cause those results to differ materially from those expressed in the forward-looking statements contained or incorporated by reference in this Form 10-Q. These factors include the following:
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v
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operating, legal and regulatory risks;
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v
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economic, political, and competitive forces affecting banking, securities, asset management and credit services businesses; and
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v
|
the risk that management’s analyses of these risks and forces could be incorrect and/or that the strategies developed to address them could be unsuccessful.
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The Corporation undertakes no obligation to publicly revise or update these forward-looking statements to reflect events or circumstances that arise after the date of this report. Readers should carefully review the risk factors described in other documents that the Corporation files periodically with the Securities and Exchange Commission.
CRITICAL ACCOUNTING POLICIES
Disclosure of the Corporation’s significant accounting policies is included in Note 1 to the financial statements of the Corporation’s Annual Report to Stockholders for the year ended December 31, 2009. Some of these policies are particularly sensitive, requiring significant judgments, estimates and assumptions to be made by management, most particularly in connection with determining the provision for loan losses, the appropriate level of the allowance for loan losses, and considerations of other-than-temporary impairment of investments. Additional information is contained in this discussion and analysis under the paragraphs titled “Provision for Loan Losses,” “Loan and Asset Quality and Allowance for Loan Losses,” and “Securities.”
OVERVIEW
Net income for the third quarter of 2010 increased 65.7% to $918,000 as compared to $554,000 for the third quarter of 2009. The increase in net income is due in part to the security impairment loss in the third quarter of 2009. Net income per common share increased 70.1% to $5.07 per share from $2.98 per share in the third quarter a year ago. This increase is due mainly to an increase in net income and a decrease in shares outstanding. At September 30, 2010, the Corporation had total assets of $271.9 million, total loans of $118.8 million, and total deposits of $223.7 million.
Net income for the first nine months of 2010 increased 21.6% to $2.8 million as compared to $2.3 million for the same period of 2009. The increase in net income is due mainly to an increase in net interest income and decrease in security impairment losses. Net income per common share increased 25.0% to $15.15 per share from $12.12 per share from the first three quarters of 2010 to the same period of 2009. This increase is due mainly to an increase in net income and a decrease in outstanding shares.
RESULTS OF OPERATIONS
Average Balances and Average Interest Rates
Interest earning assets averaged $256.3 million for the third quarter of 2010 as compared to $247.3 million for the same period in 2009. The growth in interest earning assets was mainly the result of an increase of $11.2 million in average total loans and an increase of $2.3 million in average investments. Average interest-bearing liabilities increased from $191.0 million during the third quarter of 2009 to $206.3 million during the third quarter of 2010. The increase in average interest bearing liabilities was due mainly to increases in savings and time deposits of $9.9 million and $4.2 million, respectively. This increase in deposits is due in part to the transfer of funds from investment accounts to deposit accounts due to current market conditions.
The average yield on earning assets was 5.3% for the third quarter of 2010 as compared to 5.5% for the same quarter in 2009. The average rate paid on interest-bearing liabilities was 2.5% for the third quarter of 2010 and 2.9% for the third quarter of 2009. This was the result of the decreasing interest rate environment.
Net Interest Income and Net Interest Margin
Net interest income is the difference between interest income earned on assets and interest expense incurred on liabilities used to fund those assets. Interest earning assets primarily include loans, securities and Federal funds sold. Liabilities used to fund such assets include deposits and borrowed funds. Changes in net interest income and margin result from the interaction between the volume and composition of earning assets, related yields and associated funding costs.
Interest income for the third quarter of 2010 increased by $12,000 or 0.4% over the third quarter of 2009 due mainly to an increase in loans and securities. Interest expense for the third quarter of 2010 decreased by $160,000 or 11.6%, as compared to the third quarter of 2009. The decrease was due mainly to decreases in deposit rates offset by increases in deposits.
Net interest income increased by $172,000 or 8.5% to $2.2 million for the third quarter of 2010 as compared to $2.0 million for the third quarter of 2009. This increase resulted from an increasing net spread between yields on average assets and average rate paid.
For the nine months ended September 30, 2010, interest income increased by $120,000 or 1.2% over the same period in 2009. The increase for the first nine months was mostly related to the increase in loans and securities. Interest earning assets for the first nine months of 2010 averaged $252.5 million versus $240.0 million for the comparable period in 2009. The yield on those assets was 5.4% for the first nine months of 2010 and 5.6% for the same period of 2009.
Interest expense for the first nine months of 2010 decreased $476,000 or 11.4% as compared to the first nine months of 2009. The level of average interest-bearing liabilities increased to $201.8 million for the three quarters of 2010 from $185.2 million for the same period of 2009. The average rate paid for the period was 2.4% and 3.0%, respectively.
Net interest income for the first nine months of 2010 increased by $596,000 or 10.1% over the same period in 2009. The Corporation’s net interest margin increased to 3.4% for the nine months ended September 30, 2010 from 3.3% for the same period last year.
Net interest margin represents the difference between interest income, including net loan fees earned, and interest expense, reflected as a percentage of average earning assets.
Net interest margin for the third quarter of 2010 was 3.4% compared to 3.3% for the third quarter of 2009. During the third quarter of 2010, the yield on earning assets was 5.3%, a 20 basis point decrease over the 5.5% reported in the third quarter of 2009. The average rate paid on interest-bearing deposits decreased to 2.4% as compared to 2.9% for the third quarter of 2009.
Provision for Loan Losses
Provision for loan losses increased from $60,000 for the third quarter of 2009 to $154,000 for the third quarter of 2010. The increase is due mainly to increases in loan volume, non-performing loans, and qualitative factors affecting the allowance as a result of the quarterly review.
For the nine months ending September 30, 2010, provision for loan losses increased to $274,000 compared to $61,000 in the same period of 2009. The increase is due mainly to increases in loan volume, non-performing loans, and qualitative factors affecting the allowance as a result of the quarterly review.
Management regularly assesses the appropriateness and adequacy of the allowance for loan losses in relation to credit exposure associated with individual borrowers, overall trends in the loan portfolio and other relevant factors, and believes the allowance is reasonable and adequate for each of the periods presented. The Corporation has no credit exposure to foreign countries or foreign borrowers. The Corporation has no exposure to subprime mortgage loans.
Non-interest Income
Non-interest income for the third quarter of 2010 increased to $64,000 from a loss of $461,000 the same period in 2009. The increase was due to impairment losses on securities in 2009. Non-interest income for the first three quarters of 2010 increased to $84,000 from a loss of $335,000 in the same period in 2009. This increase was attributable to a decrease in impairment charges on securities.
Non-interest Expense
For the third quarter of 2010, non-interest expenses increased by $82,000 or 9.8% to $916,000 compared to $834,000 over the same period in 2009. The increase was due mainly to increases in other expenses and salaries and employee benefits expense.
Salaries and employee benefits, which represent the largest component of non-interest expenses, increased by $33,000 or 9.0%, for the third quarter of 2010. This increase was due mainly to an increase in employee salaries.
Occupancy expense for the third quarter of 2010 increased by $9,000 or 14.3% as compared to the third quarter of 2009. This increase was mainly due to an increase in utilities expense.
Furniture and equipment expense decreased $3,000 or 4.4% to $65,000 for the third quarter of 2010 over the same period of 2009.
Pennsylvania shares tax remained at $118,000 for the third quarters of 2010 and 2009.
FDIC expense increased $6,000, or 12.8%, to $53,000 for the third quarter of 2010 over the third quarter of 2009. This increase is due to an increase in deposits and an increase in the assessment rates.
Other expenses increased by $37,000, or 21.4%, to $210,000 in the third quarter of 2010 from the same period in 2009. This increase is due mainly to third party consulting fees and expenses from other real estate owned in 2010.
Total non-interest expense was $2.7 million for the first nine months of 2010 compared to $2.6 million for the same period of 2009.
Salaries and employee benefits, which represent the largest component, 44.9%, of non-interest expenses, increased by $108,000 or 9.9% over the first nine months of 2009. This increase was due mainly to an increase in employee salaries.
Occupancy expense for the first nine months of 2010 increased by $12,000 or 7.2% as compared to the first nine months of 2009.
Furniture and equipment expense decreased by $7,000 or 3.4% to $198,000 for the first three quarters of 2010 as compared to 2009.
Pennsylvania shares tax increased by $6,000 or 1.7% for the first nine months of 2010 from the same period in 2009. This increase was mainly due to continued capital growth.
FDIC expense decreased $93,000 or 37.8% to $153,000 for the first nine months of 2010 over the same period of 2010. This decrease is due to the special assessment paid in 2009.
Other expenses increased by $75,000 or 14.7% for the first nine months of 2010 over the same period of 2009 due mainly to third party consulting fees and expenses from other real estate owned in 2010.
One key measure used to monitor progress in controlling overhead expenses is the ratio of net non-interest expenses to average assets. The ratio equals non-interest expenses (excluding foreclosed real estate expenses) less non-interest income (exclusive of non-recurring gains), divided by average assets. This ratio equaled 1.3% and 2.0% for the three months ended September 30, 2010 and 2009, respectively. The overhead expense ratio equaled 1.2% for the first nine months of 2010 and 1.5% for the same period in 2009.
Another productivity measure is the operating efficiency ratio. This ratio expresses the relationship of non-interest expense (excluding foreclosed real estate expenses) to net interest income plus non-interest income (excluding non-recurring gains). For the quarter ended September 30, 2010, the operating efficiency ratio was 40.6% compared to 53.5% for the same period in 2009. For the nine months ended September 30, 2010, this ratio was 39.9% compared to 46.2% for the nine months ended September 30, 2009. This decrease is due mainly to the increases in net interest income and other income.
Provision for Federal Income Taxes
The provision for federal income taxes was $268,000 for the third quarter of 2010 compared to $111,000 for this same period in 2009. For the first nine months the provision was $859,000 and $648,000 for 2010 and 2009, respectively. The effective tax rate, which is the ratio of income tax expense to income before income taxes, was 22.6% for the third quarter of 2010 and 16.7% for the same period in 2009. The effective tax rate is below 34% due to the number of tax-exempt securities held by the Corporation. The effective tax rate and provision for Federal income taxes increased due to the increase in pre-tax income while tax-exempt income declined.
Return on Average Assets
Return on average assets (ROA) measures the Corporation’s net income in relation to its total average assets. The Corporation’s annualized ROA for the third quarter of 2010 was 1.3% compared to 0.9% for the third quarter of 2009 and 1.4% for the first three quarters of 2010 compared to 1.2% for the same period in 2009. The increase in ROA was mainly due to the increase in net income period to period.
Return on Average Equity
Return on average equity (ROE) indicates how effectively the Corporation can generate net income on the capital invested by its stockholders. ROE is calculated by dividing net income by average stockholders’ equity. For purposes of calculating ROE, average stockholder’s equity included the effect of unrealized gains or losses, net of income taxes, on securities available for sale and other-than-temporary impaired securities held to maturity. The annualized ROE for the third quarter of 2010 and 2009 is 7.9% and 4.9%, respectively. The annualized ROE for the nine months of 2010 increased to 8.0% from 6.7% in the same period of 2009. This increase is due mainly to the increase in net income in 2010 over 2009 for the respective periods.
FINANCIAL CONDITION
Securities
Securities available for sale increased $3.4 million to $38.3 million as of September 30, 2010, from $35.0 million at December 31, 2009.
The securities available for sale portfolio had an unrealized gain of $911,000, net of taxes at the end of the third quarter of 2010, compared to an unrealized gain of $748,000, net of taxes, at December 31, 2009. This increase was mainly due to continued decrease in interest rates.
During the first nine months of 2010, the securities held to maturity portfolio increased $5.2 million to $106.2 million from $101.0 million at December 31, 2009, primarily due to the deployment of funds from increased deposits.
There are 43 debt securities in unrealized loss positions; however, the Corporation does not intend to sell nor be required to sell these securities. Two securities were deemed to be other-than-temporarily impaired at September 30, 2010 however there were no additional impairment charges recognized in the third quarter of 2010.
Net Loans Receivable
During the first three quarters of 2010, net loans receivable increased by $6.6 million from $111.2 million at December 31, 2009 to $117.8 million at September 30, 2010. This increase is due to increased loan demand and an additional loan officer. Net loans receivable represented 52.7% of total deposits and 43.1% of total assets at September 30, 2010 as compared to 52.6% and 43.1%, respectively, at December 31, 2009.
Loan and Asset Quality and Allowance for Loan Losses
Total non-performing loans (comprised of non-accruing loans and loans past due 90 days or more and still accruing interest) were $2,889,000 at September 30, 2010 as compared to $202,000 at December 31, 2009. The increase in non-performing loans is due mainly to the increase in delinquencies and loan relationships downgraded due to credit concerns. Non-accruing loans include $2,429,000 in commercial real estate loans and $23,000 in a residential real estate loan. Accruing loans past 90 days or more delinquent include $379,000 in commercial real estate loans, $37,000 in consumer home equity loans, and $21,000 in other consumer loans. Generally these loans are well collateralized therefore management does not expect to incur material losses due to the increase in nonperforming loans or overall increase in the loan portfolio. In addition, management believes the allowance for loan loss is sufficient to cover any such losses. Total non-performing loans may increase in the future. The Corporation held $468,000 in foreclosed real estate as of September 30, 2010 and no foreclosed real estate as of December 31, 2009. Management does not expect significant losses from foreclosed real estate. The Corporation had no restructured loans at September 30, 2010 and December 31, 2009.
The following summary table presents information regarding non-performing loans and assets as of September 30, 2010 and December 31, 2009:
Nonperforming Loans and Assets
(Dollars in Thousands)
|
|
|
September 30,
2010
|
|
|
December 31,
2009
|
|
|
Non-accruing loans
|
|
$
|
2,452
|
|
|
$
|
-
|
|
|
Accruing loans past 90 days or more
|
|
|
437
|
|
|
|
202
|
|
|
Total nonperforming loans
|
|
|
2,889
|
|
|
|
202
|
|
|
Foreclosed real estate/repossessed assets
|
|
|
468
|
|
|
|
-
|
|
|
Total nonperforming assets
|
|
$
|
3,357
|
|
|
$
|
202
|
|
|
|
|
|
|
|
|
|
|
|
|
Nonperforming loans to total loans
|
|
|
2.43
|
%
|
|
|
0.18
|
%
|
|
Nonperforming assets to total assets
|
|
|
1.23
|
%
|
|
|
0.08
|
%
|
The allowance for loan loss increased from $829,000 at December 31, 2009 to $1,031,000 at September 31, 2010 due to the increase in the provision for loan losses. The increase is due mainly to increases in loan volume, non-performing loans, and qualitative factors affecting the allowance as a result of the quarterly review.
The following table sets forth the Corporation’s provision and allowance for loan losses.
Allowance for Loan Losses
(Dollars in Thousands)
|
|
|
Nine Months Ended September 30,
|
|
|
|
|
2010
|
|
|
2009
|
|
|
Balance at beginning of period
|
|
$
|
829
|
|
|
$
|
761
|
|
|
Provisions charged to operating expenses
|
|
|
274
|
|
|
|
61
|
|
|
Recoveries of loans previously charged-off
|
|
|
|
|
|
|
|
|
|
Commercial real estate
|
|
|
-
|
|
|
|
-
|
|
|
Commercial non-real estate
|
|
|
-
|
|
|
|
-
|
|
|
Residential real estate
|
|
|
-
|
|
|
|
-
|
|
|
Other consumer
|
|
|
5
|
|
|
|
-
|
|
|
Total recoveries
|
|
|
5
|
|
|
|
-
|
|
|
Loans charged-off:
|
|
|
|
|
|
|
|
|
|
Commercial real estate
|
|
|
(23
|
)
|
|
|
-
|
|
|
Commercial non-real estate
|
|
|
-
|
|
|
|
-
|
|
|
Residential real estate
|
|
|
(39
|
)
|
|
|
-
|
|
|
Other consumer
|
|
|
(15
|
)
|
|
|
(14
|
)
|
|
Total charged-off
|
|
|
(77
|
)
|
|
|
(14
|
)
|
|
Net charge-offs
|
|
|
(72
|
)
|
|
|
(14
|
)
|
|
Balance at end of period
|
|
$
|
1,031
|
|
|
$
|
808
|
|
|
Net charge-offs as a percentage of average
|
|
|
|
|
|
|
|
|
|
loans outstanding
|
|
|
0.06
|
%
|
|
|
0.01
|
%
|
|
Allowance for loan losses as a percentage of
|
|
|
|
|
|
|
|
|
|
period-end loans
|
|
|
0.87
|
%
|
|
|
0.74
|
%
|
|
Allowance for loan losses as a percentage of
|
|
|
|
|
|
|
|
|
|
nonperforming loans
|
|
|
35.69
|
%
|
|
|
132.46
|
%
|
Deposits
Total deposits at September 30, 2010 were $223.7 million, an increase of $12.3 million, or 5.8%, over total deposits of $211.4 million at December 31, 2009. The outstanding balances by deposit classification at September 30, 2010 and 2009 are presented in the following table.
|
|
|
At September 30,
|
|
|
|
|
(Dollars in thousands)
|
|
|
|
|
2010
|
|
|
2009
|
|
|
|
|
Balance
|
|
|
Average
Yield
|
|
|
Balance
|
|
|
Average
Yield
|
|
|
Demand deposits:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Noninterest-bearing
|
|
$
|
17,855
|
|
|
|
|
|
$
|
17,326
|
|
|
|
|
|
Interest-bearing
|
|
|
7,217
|
|
|
|
0.34
|
%
|
|
|
6,960
|
|
|
|
0.44
|
%
|
|
Savings
|
|
|
64,760
|
|
|
|
0.95
|
%
|
|
|
56,608
|
|
|
|
1.33
|
%
|
|
Time deposits:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
<$100,000
|
|
|
86,147
|
|
|
|
2.86
|
%
|
|
|
81,194
|
|
|
|
3.57
|
%
|
|
>$100,000
|
|
|
47,714
|
|
|
|
3.70
|
%
|
|
|
45,200
|
|
|
|
3.96
|
%
|
|
Total deposits
|
|
$
|
223,693
|
|
|
|
|
|
|
$
|
207,288
|
|
|
|
|
|
Interest Rate Sensitivity
The management of interest rate sensitivity seeks to avoid fluctuating net interest margins and to provide consistent net interest income through periods of changing interest rates.
The Corporation’s risk of loss arising from adverse changes in the fair value of financial instruments, or market risk, is composed primarily of interest rate risk. The primary objective of the Corporation’s asset/liability management activities is to maximize net interest income while maintaining acceptable levels of interest rate risk. The Bank’s Asset/Liability Committee (ALCO) is responsible for establishing policies to limit exposure to interest rate risk, and to ensure procedures are established to monitor compliance with those policies. The Corporation’s Board of Directors approves the guidelines established by ALCO.
An interest rate sensitive asset or liability is one that, within a defined period, either matures or experiences an interest rate change in line with general market interest rates. Historically, the most common method of estimating interest rate risk was to measure the maturity and repricing relationships between interest-earning assets and interest-bearing liabilities at specific points in time (GAP), typically one year. Under this method, a company is considered liability sensitive when the amount of its interest-bearing liabilities exceeds the amount of its interest-bearing assets within the one-year horizon. However, assets and liabilities with similar repricing characteristics may not reprice at the same time or to the same degree. As a result, the Corporation’s GAP does not necessarily predict the impact of changes in general levels of interest rates on net interest income.
Management believes the simulation of net interest income in different interest rate environments provides a more meaningful measure of interest rate risk. Income simulation analysis captures not only the potential of all assets and liabilities to mature or reprice, but also the probability that they will do so. Income simulation also attends to the relative interest rate sensitivities of these items, and projects their behavior over an extended period of time. Finally, income simulation permits management to assess the probable effects on the balance sheet not only of changes in interest rates, but also of proposed strategies for responding to them.
The Corporation’s income simulation model analyzes interest rate sensitivity by projecting net interest income over the next 12 months in a flat rate scenario versus net income in alternative interest rate scenarios. Management continually reviews and refines its interest rate risk management process in response to the changing economic climate. Currently, the Corporation’s model projects a proportionate 200 basis point change during the next year.
The Corporation’s ALCO policy has established that income sensitivity will be considered acceptable if overall net income volatility in a plus or minus 200 basis point scenario is within 5% of net interest income in a flat rate scenario. At September 30, 2010, the Corporation’s simulation model indicated net interest income would increase 6.53% within the first year if rates increased as described above. The model projected that net interest income would decrease by 5.67% in the first year if rates decreased as described above.
Liquidity
Liquidity management involves the ability to generate cash or otherwise obtain funds at reasonable rates to support asset growth and reduce assets to meet deposit withdrawals, to maintain reserve requirements, and to otherwise operate the Corporation on an ongoing basis. Liquidity needs are generally met by converting assets into cash or obtaining sources of additional funds, mainly deposits. Primarily cash and federal funds sold, and the cash flow from the amortizing securities and loan portfolios provide liquidity sources from asset categories. The primary source of liquidity from liability categories is the generation of additional core deposit balances.
Additionally, the Bank has a $4 million federal funds line of credit with its main correspondent bank, Atlantic Central Bankers Bank. The Bank had no federal funds purchased under this line at September 30, 2010 or December 31, 2009. The Bank also has established a line of credit and other credit facilities with the Federal Home Loan Bank, which are reliable sources for short and long-term funds. Maximum borrowing capacity with the Federal Home Loan Bank is approximately $59 million. In view of the primary and secondary sources as previously mentioned, management believes that the Corporation is capable of meeting its anticipated liquidity needs.
Off-Balance Sheet Arrangements
The Corporation’s financial statements do not reflect off-balance sheet arrangements that are made in the normal course of business. Those off-balance sheet arrangements consist of unfunded loans and letters of credit made under the same standards as on-balance sheet instruments. These commitments, at September 30, 2010 totaled $12.1 million. This consisted of $4.6 million in tax-exempt loans, commercial real estate, construction, and land development loans, $6.5 million in home equity lines of credit, $714,000 in standby letters of credit and the remainder in other unused commitments. Because these instruments have fixed maturity dates, and because many of them will expire without being drawn upon, they do not generally present any significant liquidity risk to the Corporation.
Management believes that any amounts actually drawn upon can be funded in the normal course of operations. The Corporation has no investment in or financial relationship with any unconsolidated entities that are reasonably likely to have a material effect on liquidity or the availability of capital resources.
Capital Adequacy
At September 30, 2010, stockholders’ equity totaled $46.6 million, an increase of 2.2% over stockholders’ equity of $45.6 million at December 31, 2009. The increase in stockholders’ equity from December 31, 2009 to September 30, 2010 included an increase of $1.9 million in retained earnings offset by a net loss in accumulated other comprehensive income of $168,000 and a $716,000 increase in treasury stock.
Risk-based capital provides the basis for which all banks are evaluated in terms of capital adequacy. The risk-based capital standards require all banks to have Tier 1 capital of at least 4% and total capital, including Tier 1 capital, of at least 8% of risk-adjusted assets. Tier 1 capital includes common stockholders’ equity together with related surpluses and retained earnings. Total capital may be comprised of total Tier 1 capital plus qualifying debt instruments and the allowance for loan losses.
The following table provides a comparison of the Bank’s risk-based capital ratios and leverage ratios to the minimum regulatory requirements for the period indicated. The consolidated ratios are not materially different from those presented below.
|
|
|
September 30,
2010
|
|
|
December 31,
2009
|
|
|
For Capital
Adequacy
Purposes
|
|
|
To be Well
Capitalized
Under Prompt
Corrective Action
Provision
|
|
|
Risk-based capital ratios:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Tier 1 Capital
|
|
|
31.0
|
%
|
|
|
32.1
|
%
|
|
|
4.0
|
%
|
|
|
6.0
|
%
|
|
Total Capital
|
|
|
31.7
|
%
|
|
|
32.7
|
%
|
|
|
8.0
|
%
|
|
|
10.0
|
%
|
|
Leveraged Capital
|
|
|
16.8
|
%
|
|
|
17.5
|
%
|
|
|
4.0
|
%
|
|
|
5.0
|
%
|
At September 30, 2010, the capital levels of the Bank met the definition of a “well capitalized” institution.
|
Item 3.
|
Quantitative and Qualitative Disclosures about Market Risk
|
The Corporation’s exposure to market risk has not changed significantly since June 30, 2010. The market risk principally includes interest rate risk, which is discussed in the Management’s Discussion and Analysis above.
|
Item 4T.
|
Controls and Procedures
|
Management of the Corporation, including the Chief Executive Officer and the Principal Financial Officer, evaluated the effectiveness of the design and operation of the Corporation’s disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934) as of the end of the period covered by this report. Based upon that evaluation, the Corporation’s Chief Executive Officer and Principal Financial Officer concluded that the Corporation’s disclosure controls and procedures were effective as of the end of the period covered by this report.
There have not been any changes in the Corporation’s internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during the fiscal quarter ended September 30, 2010 that have materially affected, or are reasonably likely to materially affect, the Corporation’s internal control over financial reporting.
|
PART II.
|
OTHER INFORMATION
|
|
Item 1.
|
Legal Proceedings
|
In the opinion of the management of the Corporation, there are no proceedings pending to which the Corporation or its subsidiary are a party or to which their property is subject, which, if determined adversely to the Corporation or its subsidiary, would be material in relation to the Corporation’s or its subsidiary’s financial condition. There are no proceedings pending other than ordinary routine litigation incident to the business of the Corporation or its subsidiary. In addition, no material proceedings are pending or are known to be threatened or contemplated against the Corporation or its subsidiary by government authorities.
During 2008 through 2010 the capital and credit markets experienced severe volatility and disruption. From the third quarter of 2008 through the third quarter of 2010, the volatility and disruption reached unprecedented levels. Reflecting concern about the stability of the financial markets generally and the strength of counterparties, many lenders and institutional investors have reduced, and in some cases ceased to provide, funding to borrowers, including other financial institutions. Although to date we have not suffered liquidity problems, we are part of the financial system and a systemic lack of available credit, a lack of confidence in the financial sector, increased volatility in the financial markets and reduced business activity could materially and adversely affect our business, financial condition and results of operations.
In response to the turmoil in the banking system and financial markets, the U.S. government has taken unprecedented actions, including the U.S. Treasury's plan to inject capital into financial institutions for the purpose of stabilizing the financial markets generally or particular financial institutions. There is no assurance that government actions will achieve their purpose.
The failure to help stabilize the financial markets and a continuation or worsening of the current financial market conditions could have a material adverse affect on our business, our financial condition, the financial condition of our customers, our common stock trading price, as well as our ability to access credit. It could also result in further declines in our investment portfolio which could become other-than-temporary impairments.
Congress recently enacted the Dodd-Frank Wall Street Reform and Consumer Protection Act (The “Dodd-Frank Act”). This new law will significantly change the current bank regulatory structure and affect the lending, deposit, investment, trading and operating activities of financial institutions and their holding companies. The Dodd-Frank Act requires various federal agencies to adopt a broad range of new implementing rules and regulations, and to prepare numerous studies and reports for Congress. The federal agencies are given significant discretion in drafting the implementing rules and regulations, and consequently, many of the details and much of the impact of the Dodd-Frank Act may not be known for many months or years. Until the various regulations to be implemented have been formulated, we cannot estimate their impact on our business.
Also effective one year after the date of enactment is a provision of the Dodd-Frank Act that eliminates the federal prohibitions on paying interest on demand deposits, thus allowing businesses to have interest bearing checking accounts. Depending on competitive responses, this significant change to existing law could have an adverse effect on our interest expense.
The Dodd-Frank Act also broadens the base for Federal Deposit Insurance Corporation insurance assessments. Assessments will now be based on the average consolidated total assets less tangible equity capital of a financial institution. The Dodd-Frank Act also permanently increases the maximum amount of deposit insurance for banks, savings institutions and credit unions to $250,000 per depositor and non-interest bearing transaction accounts have unlimited deposit insurance from December 31, 2010 through December 31, 2012.
The Dodd-Frank Act will require publicly traded companies to give stockholders a non-binding vote on executive compensation and so-called “golden parachute” payments, and authorizes the Securities and Exchange Commission to promulgate rules that would allow stockholders to nominate their own candidates using a company’s proxy materials. The legislation also directs the Federal Reserve Board to promulgate rules prohibiting excessive compensation paid to bank holding company executives, regardless of whether the company is publicly traded or not.
The Dodd-Frank Act creates a new Consumer Financial Protection Bureau with broad powers to supervise and enforce consumer protection laws. The Consumer Financial Protection Bureau has broad rule-making authority for a wide range of consumer protection laws that apply to all banks and savings institutions, including the authority to prohibit “unfair, deceptive or abusive” acts and practices. The Consumer Financial Protection Bureau has examination and enforcement authority over all banks and savings institutions with more than $10 billion in assets. Banks and savings institutions with $10 billion or less in assets will be examined by their applicable bank regulators. The Dodd-Frank Act also weakens the federal preemption rules that have been applicable for national banks and federal savings associations, and gives state attorneys general the ability to enforce federal consumer protection laws. This could have an adverse effect on our operations.
Please refer to Part 1, Item 1A, “Risk Factors,” of the Corporation’s Form 10-K for the year ended December 31, 2009 for additional disclosures regarding the risks and uncertainties related to the Corporation’s business.
|
Item 2.
|
Unregistered Sales of Equity Securities and Use of Proceeds
|
In April 2009 the Corporation offered its shareholders a “No-Fee, Odd-Lot Sales Program,” which shareholders can use to sell Neffs Bancorp, Inc. common shares held by persons who are the owners of less than 100 shares. The price per share will equal the average closing price during the previous ninety-day period in which the shareholder’s instructions to sell are received in the corporate office. Shareholders owning 100 or more shares are not included in the offer and are ineligible to participate in the program. The program will expire at 5:00 P. M., Eastern Standard Time, on December 31, 2010, unless extended or earlier terminated. The Corporation reserves the right to terminate or extend the program at any time in its sole discretion.
The Corporation repurchased Bancorp stock during the quarter as presented in the table below.
|
|
|
Total Number of
Shares Purchased
|
|
|
Average Price
Paid per Share
|
|
|
Total Number
of Shares Purchased as Part of Publicly
Announced Plans
or Programs
|
|
Maximum Number
of Shares that may
yet be Purchased
Under the
Plans or Programs
|
|
July 1 through July 31, 2010
|
|
|
25
|
|
|
$
|
270
|
|
|
|
-
|
|
NA
|
|
August 1 through August 31, 2010
|
|
|
175
|
|
|
|
270
|
|
|
|
-
|
|
NA
|
|
September 1 through September 30, 2010
|
|
|
50
|
|
|
|
270
|
|
|
|
-
|
|
NA
|
|
Total
|
|
|
250
|
|
|
$
|
270
|
|
|
|
-
|
|
NA
|
|
Item 3.
|
Defaults Upon Senior Securities
|
Not applicable
|
Item 4.
|
Removed and Reserved
|
|
Item 5.
|
Other Information
|
None