UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C.  20549

 

FORM 10-Q

(Mark one)

[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended March 31, 2014.

or

[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from _______________ to _______________________

 

Commission File Numbers: 000-10972

 

(Exact name of registrant as specified in its charter)

 

Tennessee	62-1148660
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification No.)
816 South Garden Street
Columbia, Tennessee	38402-1148
(Address of principal executive offices)	(Zip Code)

(Registrant’s telephone number, including area code)

 

(Former name, former address and former fiscal year, if changed since last report)

             

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.               []Yes             [ X ] No

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  [X]Yes  [  ] No

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer [    ]	Accelerated filer [ X ]
Non-accelerated filer [    ] (Do not check if a smaller reporting company)	Smaller reporting company [    ]

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). [ ] Yes [X] No

 

As of May 5, 2014, the registrant had 4,981,999 shares of common stock outstanding.

 

 

 

 

 

 

 

 

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PART I - FINANCIAL INFORMATION

 

 

Item 1. Financial Statements.

 

 

The following unaudited condensed consolidated financial statements of the Registrant are included in this Report:

 

Condensed consolidated balance sheets – March 31, 2014 and December 31, 2013.

 

Condensed consolidated statements of income - For the three months ended March 31, 2014 and March 31, 2013.

 

Condensed consolidated statements of comprehensive income - For the three months ended March 31, 2014 and March 31, 2013.

 

Condensed consolidated statements of cash flows - For the three months ended March 31, 2014 and March 31, 2013.

 

Selected notes to condensed consolidated financial statements.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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FIRST FARMERS AND MERCHANTS CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
				March 31,						December 31,
				2014						2013
	(Dollars in Thousands Except Share and Per Share Data)			(unaudited)						(1)
ASSETS	Cash and due from banks			$		27,056				$	20,391
	Interest-bearing deposits			27,539						25,167
	Federal funds sold			14,400						9,850
	Total cash and cash equivalents			68,995						55,408
	Securities:
	Available-for-sale (amortized cost $351,800
	and $346,892 as of March 31, 2014 and December 31, 2013, respectively)			339,504						329,714
	Held-to-maturity (fair market value $27,583
	and $28,595 as of March 31, 2014 and December 31, 2013, respectively)			26,912						27,839
	Total securities			366,416						357,553
	Loans, net of deferred fees			620,457						606,766
	Allowance for loan and lease losses			(8,621)						(8,595)
	Net loans			611,836						598,171
	Bank premises and equipment, net			24,767						24,868
	Other real estate owned			1,062						1,438
	Bank owned life insurance			26,153						25,867
	Goodwill			9,018						9,018
	Deferred tax asset			9,016						10,905
	Other assets			10,902						10,605
	TOTAL ASSETS			$		1,128,165				$	1,093,833
LIABILITIES	Deposits
	Noninterest-bearing			$		186,110				$	179,823
	Interest-bearing			800,064						777,514
	Total deposits			986,174						957,337
	Securities sold under agreements to repurchase			20,060						18,095
	Accounts payable and accrued liabilities			14,941						15,728
	TOTAL LIABILITIES			1,021,175						991,160
SHAREHOLDERS'	Common stock - $10 par value per share, 8,000,000 shares
EQUITY	authorized; 4,981,999 and 5,021,012 shares issued
	and outstanding as of  March 31, 2014 and
	December 31, 2013, respectively			49,820						50,210
	Retained earnings			63,045						61,369
	Accumulated other comprehensive loss			(5,970)						(9,001)
	TOTAL SHAREHOLDERS’ EQUITY BEFORE NONCONTROLLING INTEREST - PREFERRED STOCK OF SUBSIDIARY			106,895						102,578
	Noncontrolling interest - preferred stock of subsidiary			95						95
	TOTAL SHAREHOLDERS’ EQUITY			106,990						102,673
	TOTAL LIABILITIES AND
	SHAREHOLDERS’ EQUITY			$		1,128,165				$	1,093,833
(1) Derived from audited financial statements.
The accompanying notes are an integral part of the condensed consolidated financial statements.
3           FIRST FARMERS AND MERCHANTS CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
			Three Months Ended March 31,
		(Unaudited) (Dollars in Thousands, Except Per Share Data)	2014					2013
INTEREST AND		Interest and fees on loans	$		6,936			$                 6,962
DIVIDEND		Income on investment securities
INCOME		Taxable interest	1,354					1,437
		Exempt from federal income tax	679					746
		Dividends	73					78
		Total interest income	9,042					9,223
INTEREST		Interest on deposits	604					735
EXPENSE		Interest on other borrowings	16					99
		Total interest expense	620					834
		Net interest income	8,422					8,389
		Provision for loan and lease losses	-					-
		Net interest income after provision	8,422					8,389
NONINTEREST		Gain on loans sold	36					179
INCOME		Trust department income	670					596
		Service fees on deposit accounts	1,520					1,565
		Brokerage fees	104					107
		Earnings on bank owned life insurance	111					87
		Gain on sale of securities	45					823
		Gain (loss) on foreclosed property	6					(139)
		Other noninterest income	159					111
		Total noninterest income	2,651					3,329
NONINTEREST		Salaries and employee benefits	4,521					4,472
EXPENSE		Net occupancy expense	467					523
		Depreciation expense	360					380
		Data processing expense	588					544
		Legal and professional fees	228					183
		Stationary and office supplies	70					74
		Advertising and promotions	328					253
		FDIC insurance premium expense	129					186
		Other real estate expense	7					21
		Other noninterest expense	1,400					1,469
		Total noninterest expenses	8,098					8,105
		Income before provision for income taxes	2,975					3,613
		Provision for income taxes	713					557
		Net income before noncontrolling interest - dividends on preferred stock of subsidiary	2,262					3,056
		Noncontrolling interest-dividends on preferred stock subsidiary	-					-
		Net income for common shareholders	$		2,262			$	3,056
PER SHARE		Weighted Average Shares Outstanding	5,017,789					5,178,759
			$		0.45			$	0.59
The accompanying notes are an integral part of the condensed consolidated financial statements.

 

 

 

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FIRST FARMERS AND MERCHANTS CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(unaudited) dollars in thousands
	Three Months Ended
	March 31,
	2014			2013
Net Income	$	2,262		$	3,056
Comprehensive Loss
Unrealized depreciation on available-for-sale securities, net of taxes of $1,897 and $1,020 for 2014 and 2013, respectively	3,030			(1,629)
Less:  reclassification adjustment for realized gain included in net income, net of taxes of $17 and $317, for 2014 and 2013, respectively	(28)			(506)
Change in unfunded portion of postretirement benefit obligations, net of taxes of  $18, $29 , for 2014 and 2013 respectively	29			(47)
Other Comprehensive Income (Loss)	3,031			(2,182)
Comprehensive Income (Loss)	5,293			874
Less:  comprehensive income attributable to the noncontrolling interest	-			-
Total Comprehensive Income	$	5,293		$	874
The accompanying notes are an integral part of the condensed consolidated financial statements

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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FIRST FARMERS AND MERCHANTS CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
(Dollars in Thousands)
		Three Months Ended March 31,
		2014		2013
OPERATING	Net income available for common shareholders	$	2,262	$	3,056
ACTIVITIES	Adjustments to reconcile net income to net cash provided
	by (used in) operating activities:
	Provision for loan losses	-		-
	Provision for depreciation and amortization of
	premises and equipment	360		380
	Deferred tax expense	(67)		(212)
	Net securities gains	(45)		(823)
	Gains on loans sold	(36)		(179)
	Proceeds from sale of mortgage loans held for sale	1,217		10,156
	Funding of mortgage loans held for sale	(1,109)		(10,301)
	(Gain) loss on other real estate owned	(6)		139
	Gain on sale of assets	-		16
	Amortization of investment security premiums,
	net of accretion of discounts	247		339
	Increase in cash surrender value of life insurance contracts	(111)		(87)
	(Increase) decrease in:
	Other assets	(311)		(492)
	Increase (decrease) in:
	Other liabilities	1,124		(676)
	Total adjustments	1,263		(1,740)
	Net cash provided by operating activities	3.525		1,316
INVESTING	Proceeds from sales of available-for-sale securities	754		72,447
ACTIVITIES	Proceeds from maturities and calls of available-for-sale securities	8,514		16,629
	Proceeds from maturities and calls of held-to-maturity securities	925		765
	Purchases of investment securities
	available-for-sale	(14,376)		(129,012)
	Net (increase) decrease in loans	(13,665)		(4,765)
	Purchase of bank owned life insurance	(175)		-
	Proceeds from sale of other real estate owned	376		287
	Proceeds from sale of assets	-		(486)
	Purchases of premises and equipment	(259)		(57)
	Net cash used in investing activities	(17,906)		(44,192)
FINANCING	Net increase in deposits	28,837		30,655
ACTIVITIES	Net increase (decrease) in securities sold under agreements to repurchase	1,965		1,698
	Payments to FHLB borrowings	-		(7,000)
	Repurchase of common stock	(976)		(1,028)
	Cash dividends paid on common stock	(1,858)		-
	Net cash provided by financing activities	27,968		24,325
	Increase (decrease) in cash and cash equivalents	13,587		(18,551)
	Cash and cash equivalents at beginning of period	55,408		70,396
	Cash and cash equivalents at end of period	$	68,995	$	51,845
	Supplemental disclosures of cash flow information
	Cash paid during the period for:expenses
	Interest on deposits and borrowed funds	$	693	$	780
	Income taxes	137		(201)
	Loans to facilitate sale of other real estate owned	-		1,760
	Real estate acquired in settlement of loans	-		42
The accompanying notes are an integral part of the consolidated financial statements.

 

 

 

 

 

6

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

NOTE 1 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

 

The accompanying unaudited condensed consolidated financial statements reflect all adjustments that are, in the opinion of management of First Farmers and Merchants Corporation (the “Corporation”), necessary to fairly present the financial position, results of operations and cash flows of the Corporation.  Those adjustments consist only of normal recurring adjustments.

           

The accompanying condensed consolidated financial statements are presented in accordance with the requirements of Form 10-Q and consequently do not include all of the disclosures normally required by accounting principles generally accepted in the United States of America or those normally made in the Corporation’s Annual Report on Form 10-K.  Accordingly, the reader of this Quarterly Report on Form 10-Q should refer to the Corporation’s Annual Report on Form 10-K for the year ended December 31, 2013 for further information in this regard.  The condensed consolidated balance sheet of the Corporation as of December 31, 2013 has been derived from the audited consolidated balance sheet of the Corporation as of that date.  The results of operations for the period are not necessarily indicative of the results to be expected for the full year.

 

Reclassifications:  Certain reclassifications considered to be immaterial have been made in the prior year condensed consolidated financial statements to conform to current year presentation.  These reclassifications had no effect on net income.

 

NOTE 2 –ACCUMULATED OTHER COMPREHENSIVE INCOME (“AOCI”) BY COMPONENT

 

            Amounts reclassified from AOCI and the affected line items in the statements of income during the periods ended March 31, 2014 and 2013, were as follows (dollars in thousands):

 

	Amounts Reclassified from AOCI				Affected Line Item in the
	March 31, 2014		March 31, 2013		Statements of Income
Unrealized gains  on available-for-sale securities
	$	45	$	823	Realized gain on sale of securities
	45		823		Total reclassified amount before tax and noncontrolling interest
	(17)		(317)		Tax expense
	$	28	$	506	Net reclassified amount
Amortization of defined benefit pension items
Actuarial losses	$	(47)	$	(47)
	(47)		(47)		Total reclassified amount before tax
	18		-		Tax benefit
	$	(29)	$	(47)	Net reclassified amount
Total reclassifications out of AOCI	$	(1)	$	459

 

               

 

 

 

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                The components of accumulated other comprehensive income, included in shareholder’s equity, are as follows (dollars in thousands):

	March 31, 2014		December 31, 2013
Net unrealized losses on available-for-sale securities	$	(12,296)	(17,178)
Net actuarial gain on unfunded portion of postretirement benefit obligation	2,588		2,542
	(9,708)		(14,636)
Tax effect	3,738		5,635
Accumulated other comprehensive loss	$	(5,970)	$	(9,001)

 

 

NOTE 3 – FAIR VALUE MEASUREMENTS

 

The fair value of an asset or liability is the price that would be received to sell that asset or paid to transfer that liability in an orderly transaction occurring in the principal market (or most advantageous market in the absence of a principal market) for such asset or liability. Fair value measurement must maximize the use of observable inputs and minimize the use of unobservable inputs.  In estimating fair value, the Corporation utilizes valuation techniques that are consistent with the market approach, the income approach and/or the cost approach. Such valuation techniques are consistently applied. Inputs to valuation techniques include the assumptions that market participants would use in pricing an asset or liability. Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Topic 820, “Fair Value Measurements and Disclosures” (“ASC Topic 820”) establishes a fair value hierarchy for valuation inputs that gives the highest priority to quoted prices in active markets for identical assets or liabilities and the lowest priority to unobservable inputs. The fair value hierarchy is as follows:

 

• Level 1 Inputs - Unadjusted quoted prices in active markets for identical assets or liabilities.

 

• Level 2 Inputs - Inputs other than quoted prices included in Level 1 that are observable for the asset or liability, either directly or indirectly. These might include quoted prices for similar assets or liabilities in active markets, quoted prices for identical or similar assets or liabilities in markets that are not active, inputs other than quoted prices that are observable for the asset or liability (such as interest rates, volatilities, market consensus, prepayment speeds, credit risks, etc.) or inputs that are derived principally from or corroborated by market data by correlation or other means.

 

• Level 3 Inputs - Unobservable inputs for determining the fair values of assets or liabilities that reflect an entity’s own assumptions about the assumptions that market participants would use in pricing the assets or liabilities.

 

Transfers between levels of the fair value hierarchy are recognized on the actual date of the event or circumstances that caused the transfer, which generally coincides with the Corporation’s monthly and/or quarterly valuation process.

 

 

 

 

 

 

 

 

 

 

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The following table summarizes financial assets measured at fair value on a recurring basis as of March 31, 2014 and December 31, 2013, and by the level within the fair value hierarchy utilized to measure fair value (dollars in thousands):

 

 

 

Assets  measured at fair value on a recurring basis as of March 31, 2014
Available-For-Sale Securities	Level 1		Level 2		Level 3		Total
U.S. Government agencies	$	-	$	109,467	$	-	$	109,467
U.S. government sponsored agency mortgage backed securities	-		165,986		-		165,986
States and political subdivisions	-		44,360		-		44,360
Corporate bonds	-		19,691		-		19,691
Total assets at fair value	$	-	$	339,504	$	-	$	339,504
Assets  measured at fair value on a recurring basis as of December 31, 2013
Available-For-Sale Securities	Level 1		Level 2		Level 3		Total
U.S. Government agencies	$	-	$	105,072	$	-	$	105,072
U.S. government sponsored agency mortgage backed securities	-		157,423		-		157,423
States and political subdivisions	-		46,337		-		46,337
Corporate bonds	-		20,882		-		20,882
Total assets at fair value	$	-	$	329,714	$	-	$	329,714

 

 

Below is a description of the valuation methodologies and inputs used for assets measured at fair value on a recurring basis and recognized in the accompanying balance sheets, as well as the general classification of such assets pursuant to the valuation hierarchy.  There were no significant changes in the valuation techniques during the three months ended March 31, 2014. 

 

Available-for-Sale Securities

 

Where quoted market prices are available in an active market, securities are classified within Level 1 of the valuation hierarchy.  If quoted market prices are not available, the Corporation obtains fair value measurements from an independent pricing service, such as Interactive Data, which utilizes pricing models to determine fair value measurement.  The Corporation reviews the pricing quarterly to verify the reasonableness of the pricing.  The fair value measurements consider observable data that may include dealer quotes, market spreads, cash flows, the U.S. Treasury yield curve, live trading levels, trade execution data, market consensus prepayment speeds, credit information and the bond’s terms and conditions, among other factors.  U.S. government agencies, state and political subdivisions, U.S. government sponsored agency mortgage-backed securities and corporate bonds are classified as Level 2 inputs.

 

 

 

 

 

 

 

 

 

 

 

 

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Nonrecurring Measurements

 

The following table summarizes financial assets measured at fair value on a nonrecurring basis as of March 31, 2014 and December 31, 2013, by the level within the fair value hierarchy utilized to measure fair value (dollars in thousands):

 

March 31, 2014	Level 1		Level 2		Level 3		Total
Impaired loans (collateral-dependent)	$	-	$	-	$	4,136	$	3,507
Other real estate owned	-		-		-		-
December 31, 2013	Level 1		Level 2		Level 3		Total
Impaired loans (collateral-dependent)	$	-	$	-	$	2,214	$	2,214
Other real estate owned	-		-		208		208

 

Impaired Loans (Collateral Dependent)

 

The estimated fair value of collateral-dependent impaired loans is based on the appraised fair value of the collateral, less estimated cost to sell.  Collateral-dependent impaired loans are classified within Level 3 of the fair value hierarchy.

 

The Corporation considers the appraisal or evaluation as the starting point for determining fair value and then considers other factors and events that may affect the fair value.  Appraisals of the collateral underlying collateral-dependent loans are obtained when the loan is determined to be collateral-dependent and subsequently as deemed necessary by the Chief Credit Officer.  Appraisals are reviewed for accuracy and consistency by the Chief Credit Officer.  Appraisers are selected from the list of approved appraisers maintained by management.  The appraised values are reduced by discounts to consider lack of marketability and estimated cost to sell if repayment or satisfaction of the loan is dependent on the sale of the collateral.  These discounts and estimates are developed by the Chief Credit Officer by comparison to historical results.  Fair value adjustments for collateral-dependent impaired loans for each of the three months ended March 31, 2014 and 2013 were $1,104 and $48, respectively, and $79 for the year ended December 31, 2013.

 

            Loans considered impaired under ASC 310-35, “Impairment of a Loan,” are loans for which, based on current information and events, it is probable that the Corporation will be unable to collect all amounts due according to the contractual terms of the loan agreement.  Impaired loans are subject to nonrecurring fair value adjustments to reflect (1) subsequent partial write-downs that are based on the observable market price or current appraised value of the collateral or (2) changes in the specific reserve.

 

Other Real Estate Owned

 

Other real estate owned (“OREO”) is initially recorded at fair value at the time of acquisition, as determined by independent appraisal or evaluation by the Corporation, less costs to sell when the real estate is acquired in settlement of loans.  Quarterly evaluations of OREO are performed to determine if there has been any subsequent decline in the value of OREO properties.  Estimated fair value of OREO is based on appraisals or evaluations, less costs to sell.  OREO is classified within Level 3 of the fair value hierarchy.  OREO assets are subject to nonrecurring fair value adjustments to reflect subsequent partial write-downs that are based on the observable market price or current appraised value of the collateral.  There were no fair value adjustments for OREO for the three months ended March 31, 2014.  Fair value adjustments for OREO for the three months ended March 31, 2013 were $250, and $395 for the year ended December 31, 2013.

            Appraisals of OREO are obtained when the real estate is acquired and subsequently as deemed necessary by the Chief Credit Officer.  Appraisals are required annually and reviewed for accuracy and consistency by the Chief Credit Officer.  The appraised values are reduced by discounts to consider lack of marketability and estimated cost to sell.  Appraisers are selected from the list of approved appraisers maintained by management.

 

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Unobservable (Level 3) Inputs

 

The following table presents quantitative information about unobservable inputs used in nonrecurring Level 3 fair value measurements (dollars in thousands):

	Fair Value at March 31, 2014	Valuation Technique(s)	Unobservable Input	Range (Weighted Average)
Impaired loans (collateral-dependent)	$             4,136	Market comparable properties	Marketability discount	5.0-37.0% (35%)
Other real estate owned	$                     -	Market comparable properties	Marketability discount	N/A

 

	Fair Value at December 31, 2013	Valuation Technique(s)	Unobservable Input	Range (Weighted Average)
Impaired loans (collateral-dependent)	$           2,414	Market comparable properties	Marketability discount	5.0% - 10.0% (7%)
Other real estate/assets owned	$              208	Market comparable properties	Marketability discount	5.0% - 10.0% (7%)

 

            ASC Topic 825, “Financial Instruments,” requires disclosure of the fair value of financial assets and liabilities, including those financial assets and liabilities that are not measured and reported at fair value on a recurring basis or non-recurring basis.

 

            The following methods and assumptions were used to estimate the fair value of each class of financial instruments for which it was practicable to estimate that value:

 

Cash and due from banks – The carrying amount approximates fair value.

 

Interest bearing deposits in other banks – The carrying amount approximates fair value.

 

Federal Home Loan Bank stock – The carrying value of Federal Home Loan Bank (“FHLB”) stock approximates fair value based on the redemption provisions of the FHLB.

 

Federal Reserve Bank stock – The carrying value of Federal Reserve Bank stock approximates fair value based on the redemption provisions of the Federal Reserve Bank.

 

Federal funds sold – The carrying amount approximates fair value.

 

Securities available for sale – The carrying amount approximates fair value.

 

Securities held-to-maturity – Fair values are based on quoted market prices, if available.  If a quoted price is not available, fair value is estimated using quoted prices for similar securities.  The fair value estimate is provided to management from a third party using modeling assumptions specific to each type of security that are reviewed and approved by management.  Quarterly sampling of fair values provided by additional third parties supplement the fair value review process.

 

Loans held for sale – The fair value is predetermined at origination based on sale price.

 

 

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Loans (net of the allowance for loan and leases losses) – The fair value of fixed rate loans and variable rate mortgage loans is estimated by discounting the future cash flows using current rates at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities.  For other variable rate loans, the carrying amount approximates fair value.

  

Accrued interest receivable – The carrying amount approximates fair value.

 

Deposits – The fair value of fixed maturity time deposits is estimated by discounting the future cash flows using the rates currently offered for deposits of similar remaining maturities.  For deposits including demand deposits, savings accounts, NOW accounts and certain money market accounts, the carrying value approximates fair value.

 

Repurchase agreements – The fair value is estimated by discounting future cash flows using current rates.

 

Advances from FHLB – The fair value of these fixed-maturity advances is estimated by discounting future cash flows using rates currently offered for advances of similar remaining maturities.

 

Accrued interest payable – The carrying amount approximates fair value.

 

Commitments to extend credit and letters of credit – The fair value of commitments to originate loans is estimated using the fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the present creditworthiness of the counterparties.  For fixed-rate loan commitments, fair value also considers the difference between current levels of interest rates and the committed rates.  The fair values of letters of credit and lines of credit are based on fees currently charged for similar agreements or on the estimated cost to terminate or otherwise settle the obligations with the counterparties at the reporting date.  The fair values of these commitments are not material.

 

The following table presents estimated fair values of the Corporation’s financial instruments as of March 31, 2014 and December 31, 2013, and indicates the level within the fair value hierarchy of the valuation techniques (dollars in thousands):

 

 

 

Fair Value Measurements at March 31, 2014 Using
	Carrying Amount		Quoted Prices in Active Markets for Identical Assets ( Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs   (Level 3)
Financial assets
Cash and due from banks	$	27,056	$	27,056	$	-	$	-
Interest-bearing deposits in other banks	27,539		27,539		-		-
Federal funds sold	14,400		14,400		-		-
Federal Home Loan Bank and Federal Reserve Bank stock	3,879		-		3,879		-
Securities available-for-sale	339,504		-		339,504		-
Securities held-to-maturity	26,912		-		27,583		-
Loans held for sale	249		-		249		-
Loans, net	611,836		-		-		617,175
Accrued interest receivable	4,692		-		4,692		-
Financial liabilities
Non-interest bearing deposits	186,110		186,110		-		-
Interest bearing deposits	800,064		-		801,042		-
Repurchase agreements	20,060		-		20,060		-
Accrued interest payable	590		-		590		-
Off-balance sheet credit related instruments:
Commitments to extend credit			-		-		-

 

 

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Fair Value Measurements at December 31, 2013 Using
	Carrying Amount		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs   (Level 3)
Financial assets
Cash and due from banks	$	20,391	$	20,391	$	-	$	-
Interest-bearing deposits in other banks	25,167		25,167		-		-
Federal funds sold	9,850		9,850		-		-
Federal Home Loan Bank and Federal Reserve Bank stock	3,879		-		3,879		-
Securities available-for-sale	329,714		-		329,714		-
Securities held-to-maturity	27,839		-		28,595		-
Loans held for sale	327		-		327		-
Loans, net	598,171		-		-		607,113
Accrued interest receivable	4,183		-		4,183		-
Financial liabilities
Non-interest bearing deposits	179,823		179,823		-		-
Interest bearing deposits	777,514		-		779,224		-
Repurchase agreements	18,095		-		18,095		-
Accrued interest payable	663		-		663		-
Off-balance sheet credit related instruments:
Commitments to extend credit			-		-		-

 

NOTE 4 – SECURITIES

 

            The amortized cost and estimated fair value of securities at March 31, 2014 and December 31, 2013 were as follows (dollars in thousands):

	Amortized		Gross Unrealized				Fair
March 31, 2014	Cost		Gains		Losses		Value
Available-for-sale securities
U.S. Government agencies	$	115,385	$	-	$	5,918	$	109,467
U.S. Government sponsored agency mortgage backed securities	174,058		52		8,124		165,986
States and political subdivisions	42,814		1,626		80		44,360
Corporate bonds	19,543		224		76		19,691
	$	351,800	$	1,902	$	14,198	$	339,504
Held-to-maturity securities
States and political subdivisions	$	26,912	$	671	$	-	$	27,583
	Amortized		Gross Unrealized				Fair
December 31, 2013	Cost		Gains		Losses		Value
Available-for-sale securities
U.S. Government agencies	$	112,863	$	-	$	7,791	$	105,072
U.S. Government sponsored agency mortgage backed securities	168,045		27		10,649		157,423
States and political subdivisions	45,237		1,240		140		46,337
Corporate bonds	20,747		280		145		20,882
	$	346,892	$	1,547	$	18,725	$	329,714
Held-to-maturity securities
States and political subdivisions	$	27,839	$	756	$	-	$	28,595

           

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            Certain investments in debt securities are reported in the financial statements at an amount less than their historical cost.  Total fair value of these investments at March 31, 2014 and December 31, 2013 was $280,885 and $269,691, which was 77% and 75%, respectively, of the Corporation’s available-for-sale and held-to-maturity investment portfolio.  The Corporation evaluates its investment portfolio on a quarterly basis for impairment.  The analysis performed as of March 31, 2014 and December 31, 2013 indicated that all impairment was considered temporary, market driven due primarily to fluctuations in market interest rates and not credit-related.

 

            The following table shows the Corporation’s investments’ gross unrealized losses and fair value of the Corporation’s investments with unrealized losses that were not deemed to be other-than-temporarily impaired, aggregated by investment class and length of time that individual securities had been in a continuous unrealized loss position at March 31, 2014 and December 31, 2013 (dollars in thousands):

 

	Less than 12 months				12 months or Greater						Total
March 31, 2014	Fair		Unrealized		Fair				Unrealized		Fair		Unrealized
Type of Security	Value		Losses		Value				Losses		Value		Losses
US Government agencies	$	104,727	$	5,658	$	4,740			$	260	$	109,467	$	5,918
US Government sponsored agency mortgage
backed securities	117,344		5,285		44,269				2,839		161,613		8,124
States and political subdivisions	2,205		72		228				8		2,433		80
Corporate bonds	4,924		41		2,448				35		7,372		76
	$	229,200	$	11,056	$	51,685			$	3,142	$	280,885	$	14,198
December 31, 2013	Less than 12 months				12 months or Greater						Total
	Fair		Unrealized		Fair				Unrealized		Fair		Unrealized
Type of Security	Value		Losses		Value				Losses		Value		Losses
US Government agencies	$	100,533	$	7,330	$	4,539			$	461	$	105,072	$	7,791
US Government sponsored agency mortgage
backed securities	144,134		10,073		8,698				576		152,832		10,649
States and political subdivisions	2,615		140		-				-		2,615		140
Corporate bonds	8,590		121		582				24		9,172		145
	$	255,872	$	17,664	$	13,819			$	1,061	$	269,691	$	18,725

 

The amortized cost and fair value of available-for-sale securities and held-to-maturity securities at March 31, 2014, by contractual maturity, are shown below (dollars in thousands).  Expected maturities will differ from contractual maturities because issuers may have the right to call or prepay obligations with or without call or prepayment penalties.

	Available for Sale					Held to Maturity
March 31, 2014	Amortized		Estimated			Amortized		Estimated
	Cost		Fair Value			Cost		Fair Value
Within one year	$	3,795	$	3,845		$	4,082	$	4,176
One to five years	28,044		28,213			6,098		6,285
Five to ten years	132,136		127,015			15,625		15,991
After ten years	13,767		14,445			1,107		1,131
Mortgage-backed securities	174,058		165,986			-		-
Total	$	351,800	$	339,504		$	26,912	$	27,583

 

The carrying value of securities pledged as collateral to secure public deposits and for other purposes was $221,524 at March 31, 2014 and $210,494 at December 31, 2013.

 

The book value of securities sold under agreements to repurchase amounted to $34,976 at March 31, 2014 and $34,978 at December 31, 2013.

 

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Gross gains of $45 and $823 resulting from sales of available-for-sale securities were realized for the three month periods ended March 31, 2014 and 2013, respectively.

 

NOTE 5 – LOANS

 

            The following table presents the Corporation’s loans by class as of March 31, 2014 and December 31, 2013 (dollars in thousands):

	March 31, 2014		December 31, 2013
Commercial
Commercial and industrial	$	90,319	$	94,702
Non-farm, nonresidential real estate	176,016		176,213
Construction and development	40,819		29,938
Commercial loans secured by real estate	31,739		26,940
Other commercial	24,838		26,582
Total commercial	363,731		354,375
Residential
Consumer loans	10,171		10,957
Single family residential	218,183		213,763
Other retail	28,372		27,671
Total residential and consumer	256,726		252,391
Total gross loans	$	620,457	$	606,766

 

The amount of capitalized fees and costs under ASC 310-20, included in the above loan totals were $824 and $831 at March 31, 2014 and December 31, 2013.

 

Loan Origination/Risk Management. The Corporation has certain lending policies and procedures in place that are designed to maximize loan income within an acceptable level of credit risk. Management reviews and approves these policies and procedures on a regular basis. A reporting system supplements the review process by providing management with frequent reports related to loan production, loan quality, concentrations of credit, loan delinquencies and non-performing and potential problem loans. Diversification in the loan portfolio is a means of managing risk associated with fluctuations in economic conditions.

 

Commercial and industrial loans are underwritten after evaluating and understanding a borrower’s ability to operate profitably and expand its business prudently. Underwriting standards are designed to promote relationship banking rather than transactional banking. Once it is determined that the borrower’s management possesses sound ethics and solid business acumen, the Corporation’s management examines current and projected cash flows to determine the ability of the borrower to repay their obligations as agreed. Commercial and industrial loans are primarily made based on the identified cash flows of the borrower and secondarily on the underlying collateral provided by the borrower. The cash flows of borrowers, however, may not be as expected and the collateral securing these loans may fluctuate in value. Most commercial and industrial loans are secured by the assets being financed or other business assets such as accounts receivable or inventory and may incorporate a personal guarantee; however, some short-term loans may be made on an unsecured basis. In the case of loans secured by accounts receivable, the availability of funds for the repayment of these loans may be substantially dependent on the ability of the borrower to collect amounts due from its customers.

 

 

 

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Commercial real estate loans are subject to underwriting standards and processes similar to commercial and industrial loans, in addition to those of real estate loans. These loans are viewed primarily as loans secured by real estate. Commercial real estate lending typically involves higher loan principal amounts and the repayment of these loans is generally largely dependent on the successful operation of the property securing the loan or the business conducted on the property securing the loan. Commercial real estate loans may be more adversely affected by conditions in the real estate markets or in the general economy. Management monitors and evaluates commercial real estate loans based on collateral, geography and risk grade criteria. As a general rule, the Corporation avoids financing single-purpose projects unless other underwriting factors are present to help mitigate risk. The Corporation also utilizes third-party experts to provide insight and guidance about economic conditions and trends affecting market areas it serves. In addition, management tracks the level of owner-occupied commercial real estate loans versus non-owner occupied loans. At March 31, 2014, approximately half of the outstanding principal balance of the Corporation’s commercial real estate loans was secured by owner-occupied properties. 

 

With respect to loans to developers and builders (construction and development) that are secured by non-owner occupied properties that the Corporation may originate from time to time, the Corporation generally requires the borrower to have had an existing relationship with the Corporation and have a proven record of success. Construction loans are underwritten utilizing feasibility studies, independent appraisal reviews, sensitivity analysis of absorption and lease rates and financial analysis of the developers and property owners. Construction loans are generally based upon estimates of costs and value associated with the complete project. These estimates may be inaccurate. Construction loans often involve the disbursement of substantial funds with repayment substantially dependent on the success of the ultimate project. Sources of repayment for these types of loans may be pre-committed permanent loans from approved long-term lenders, sales of developed property or an interim loan commitment from the Corporation until permanent financing is obtained. These loans are closely monitored by on-site inspections and are considered to have higher risks than other real estate loans because of their ultimate repayment being sensitive to interest rate changes, governmental regulation of real property, general economic conditions and the availability of long-term financing.

 

The Corporation originates consumer retail loans utilizing a computer-based credit scoring analysis to supplement the underwriting process. To monitor and manage consumer retail loan risk, policies and procedures are developed and modified, as needed, jointly by line and staff personnel. This activity, coupled with relatively small loan amounts that are spread across many individual borrowers, minimizes risk. Additionally, trend and outlook reports are reviewed by management on a regular basis. Underwriting standards for home equity loans are heavily influenced by statutory requirements, which include, but are not limited to, a maximum loan-to-value percentage of 80%, collection remedies, the number of such loans a borrower can have at one time and documentation requirements.

 

The Corporation contracts with a third party vendor to perform loan reviews.  The Corporation reviews and validates the credit risk program on an annual basis. Results of these reviews are presented to management.  The loan review process complements and reinforces the risk identification and assessment decisions made by lenders and credit personnel, as well as the Corporation’s policies and procedures.

 

A concentration of credit occurs when obligations, direct or indirect, of the same or affiliated interests represent 15% or more of the Corporation's capital structure. The Board of Directors recognizes that the Corporation's geographic market area imposes some limitations regarding loan diversification if the Corporation is to perform the function for which it has been chartered. Specifically, lending to qualified borrowers within the Corporation's market area will naturally cause concentrations of real estate loans in the primary communities served by the Corporation and loans to employees of major employers in the area.

 

All closed-end commercial loans (excluding loans secured by real estate) are charged off no later than 90 days delinquent.  If a loan is considered uncollectable, it is charged off earlier than 90 days delinquent.  When a commercial loan secured by real estate is past due, a current assessment of the value of the real estate is made.  If the balance of the loan exceeds the fair value of the property, the loan is placed on nonaccrual with a specific reserve equal to the difference between book value and fair value assigned to the credit until such time as the property has been foreclosed.  When the foreclosed property has been legally assigned to the Corporation, a charge-off is taken with the remaining balance, reflecting the fair value less estimated costs to sell, transferred to other real estate owned. 

 

            All closed-end consumer loans (excluding conventional 1-4 family residential loans and installment and revolving loans secured by real estate) are charged off no later than 120 days (five monthly payments) delinquent.  If a loan is considered uncollectable, it is charged off earlier than 120 days delinquent.  For conventional 1-4 family residential loans and installment and revolving loans secured by real estate, when a loan is 90 days past due, a current assessment of the value of the real estate is made.  If the balance of the loan exceeds the fair value of the property, the loan is placed on nonaccrual and foreclosure proceedings are initiated.  When the foreclosed property has been legally assigned to the Corporation, a charge-off is taken with the remaining balance reflecting the fair value less estimated costs to sell transferred to other real estate owned.

 

 

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             Non-Accrual and Past Due Loans.  Loans are considered past due if the required principal and interest payments have not been received as of the date such payments were due. Loans are placed on non-accrual status when (i) principal or interest has been in default for a period of 90 days or more or (ii) full payment of principal and interest is not expected. Loans may be placed on non-accrual status regardless of whether or not such loans are considered past due. When interest accrual is discontinued, all unpaid accrued interest is reversed. Interest income on non-accrual loans is recognized only to the extent that cash payments are received in excess of principal due. A loan may be returned to accrual status when all the principal and interest amounts contractually due are brought current and future principal and interest amounts contractually due are reasonably assured, which is typically evidenced by a sustained period (three to six months) of repayment performance by the borrower.  The Corporation had no loans that were 90 days or more past due that was not included in nonaccrual loans as of March 31, 2014.

 

             The following tables provide details regarding the aging of the Corporation’s loan portfolio as of March 31, 2014 and December 31, 2013 (dollars in thousands):

 

March 31, 2014	30 - 89 Days past due		90 Days and greater Past Due		Total past due				Current			Total loans
Retail
Consumer	$	76	$	-	$	76			$	10,095		$	10,171
Single family residential	2,927		102		3,029					215,154		218,183
Other retail	344		5		349					28,023		28,372
Retail total	$	3,347	$	107	$			3,454	$		253,272	$		256,726
Commercial
Commercial and industrial	$	765	$	1,313	$	2,078			$	88,241		$	90,319
Non-farm, non-residential real estate	484		24		508				175,508			176,016
Construction and development	-		-		-				40,819			40,819
Commercial loans secured by real estate	65		176		241				31,498			31,739
All other commercial	-		1,210		1,210				23,628			24,838
Commercial total		1,314		2,723	$		4,037		$		359,694	$		363,731
Total	$	4,661	$	2,830	$		7,491		$		612,966	$		620,457
December 31, 2013	30 - 89 Days Past Due		Greater Than 90 Days Past Due		Total Past Dues				Current			Total Loans
Retail
Consumer loans	$	182	$	3	$	185			$	10,772		$	10,957
Single family residential	3,805		83		3,876				209,887			213,763
Other retail	319		28		359				27,312			27,671
Retail Total	$	4,306	$	114	$	4,420			$	247,971		$	252,391
Commercial
Commercial and industrial	$	428	$	1,328	$	1,756			$	92,946		$	94,702
Non-farm, non-residential real estate	393		-		393				175,820			176,213
Construction and development	-		28		28				29,910			29,938
Commercial loans secured by real estate	38		178		216				26,724			26,940
Other commercial	-		1,249		1,249				25,333			26,582
Commercial total	$	859	$	2,783	$	3,642			$	350,733		$	354,375
Total	$	5,165	$	2,897	$	8,062			$	598,704		$	606,766

 

 

 

 

 

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The following tables summarize the impaired loans by loan type as of March 31, 2014, December 31, 2013 and March 31, 2013 (dollars in thousands):

March 31, 2014	Unpaid Contractual Principal Balance			Recorded Investment With No Allowance			Recorded Investment With Allowance		Total Recorded Investment			Related Allowance			Average Recorded Investment Year To Date			Interest Received			Interest Accrued
Commercial
Commercial and industrial	$		3,222	$		2,602	$	-	$	2,602		$	-		$	2,720		$	19		$	46
Non-farm, non-residential real estate	7,136			894			5,727		6,621			1,364			6,681			88			92
Construction and development	391			391			-		391			-			437			6			6
Other commercial	2,020			1,652			176		1,828			43			1,865			31			32
Commercial total	12,769			5,539			5,903		11,442			1,407			11,703			144			176
Retail
Single family residential	1,767			737			736		1,473			194			1,482			22			24
Retail total	1,767			737			736		1,473			194			1,482			22			24
Total	$		14,536	$		6,276	$	6,639	$	12,915		$	1,601		$	13,184		$	166		$	200
December 31, 2013	Unpaid Contractual Principal Balance			Recorded Investment With No Allowance			Recorded Investment With Allowance		Total Recorded Investment			Related Allowance			Average Recorded Investment Year To Date			Interest Received			Interest Accrued
Commercial
Commercial and industrial	$		2,190	$		1,338	$	234	$	1,572		$	16		$	1,620		$	23		$	134
Non-farm, non-residential real estate	3,236			1,155			1,551		2,706			282			2,819			157			168
Construction and development	461			461			-		461			44			556			30			30
Other commercial	3,834			3,310			178		3,488			-			3,704			225			241
Commercial total	9,721			6,264			1,963		8,227			342			8,699			435			573
Retail
Single family residential	1,121			568			419		987			118			1,044			52			55
Other retail	11			-			11		11			11			11
Retail total	1,132			568			430		998			129			1,055			52			55
Total	$	10,853		$	6,832		$	2,393	$	9,225		$	471		$	9,754		$	487		$	628
March 31, 2013	Unpaid Contractual Principal Balance			Recorded  Investment With No Allowance			Recorded Investment With Allowance		Total Recorded Investment			Related Allowance			Average Recorded Investment Year To Date			Interest Received			Interest Accrued
Commercial
Commercial and industrial	$	2,311		$	416		$	1,305	$	1,721		$	120		$	1,727		$	6		$	134
Non-farm, non-residential real estate	2,804			2,348			-		2,348			-			2,393			32			128
Construction and development	842			188			653		841			147			841			9			30
Other commercial	3,845			3,846			-		3,846			-			3,856			37			240
Commercial total	9,802			6,798			1,958		8,756			267			8,817			84			532
Retail
Single family residential	2,111			826			918		1,744			227			1,768			29			314
Retail total	2,111			826			918		1,744			227			1,768			29			314
Total	$	11,913		$	7,624		$	2,876	$		10,500	$		494	$		10,585	$		113	$	846

 

 

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The following table summarizes the nonaccrual loans by loan type as of March 31, 2014 and December 31, 2013 (dollars in thousands):

	March 31, 2014		December 31, 2013
Retail
Consumer	$	22	$	21
Single family residential	1,508		1,667
Retail total	1,530		1,688
Commercial
Commercial and industrial	$	1,622	$	1,649
Nonfarm, nonresidential	5,138		737
Construction and development	-		68
Commercial real estate	176		6
Other commercial	1,233		1,248
Commercial total	8,169		3,708
Total	$	9,699	$	5,396

 

               

Impaired Loans.  Loans are considered impaired when, based on current information and events, it is probable the Corporation will be unable to collect all amounts due in accordance with the original contractual terms of the loan agreement, including scheduled principal and interest payments. Impairment is evaluated in total for smaller-balance loans of a similar nature and on an individual loan basis for other loans. If a loan is impaired, a specific valuation allowance is allocated, if necessary, 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. Interest payments on impaired loans are typically applied to principal unless collectability of the principal amount is reasonably assured, in which case interest is recognized on a cash basis. Impaired loans, or portions thereof, are charged off when deemed uncollectible. 

 

Troubled Debt Restructurings.  Included in certain categories of impaired loans are certain loans that have been modified in a troubled debt restructuring where economic concessions have been granted to borrowers who have experienced financial difficulties.  These concessions typically result from our loss mitigation activities and could include reductions in the interest rate, payment extensions, forgiveness of principal, forbearance or other actions.  Modifications of terms for our loans and their inclusion as troubled debt restructurings are based on individual facts and circumstances.  Loan modifications that are included as troubled debt restructurings may involve either an increase or reduction of the interest rate, extension of the term of the loan, or deferral of principal or interest payments, regardless of the period of the modification.  All of the loans identified as troubled debt restructuring were modified as a result of financial stress of the borrower.  In order to determine if a borrower is experiencing financial difficulty, an evaluation is performed to determine the probability that the borrower will be in payment default on any of its debt in the foreseeable future with the modification.  This evaluation is performed under the Corporation’s internal underwriting policy.

           

When the Corporation modifies loans in a troubled debt restructuring, the Corporation evaluates any possible impairment similar to other impaired loans based on the present value of expected future cash flows, discounted at the contractual interest rate of the original loan or lease agreement, or use the current fair value of the collateral, less selling costs for collateral dependent loans. If the Corporation determines that the value of the modified loan is less than the recorded investment in the loan, impairment is recognized through an allowance estimate or a charge-off to the allowance.  In periods subsequent to modification, the Corporation evaluates all troubled debt restructuring, including those that have payment defaults, for possible impairment and recognize impairment through the allowance.

 

 

During the three months ended March 31, 2014, there were no loans modified in troubled debt restructurings, where economic concessions were granted to borrowers consisting of reductions in the interest rates, payment extensions, forgiveness of principal, and forbearances.  In addition, there were no troubled debt restructuring loans that subsequently defaulted during the three months ended March 31, 2014 and 2013 and year ended December 31, 2013. 

 

 

 

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Presented below, segregated by class of loans, are troubled debt restructurings that occurred during the three months ended March 31, 2013 and the year ended December 31, 2013 (dollars in thousands):

 

 

	Year Ended December 31, 2013
		Post-
		Modification		Net Charge-offs
	Number of	Outstanding		Resulting from
(dollars in thousands)	Loans	Balance		Modifications
Retail:
Consumer	3	$	8	$	-
Single family residential	3	167		6
Total trouble debt restructurings	6	$	175	$	6
	Year Ended March 31, 2013
		Post-
		Modification		Net Charge-offs
	Number of	Outstanding		Resulting from
(dollars in thousands)	Loans	Balance		Modifications
Retail:
Single family residential	1	$	130	-

 

Loans retain their accrual status at the time of their modification.  As a result, if a loan is on non-accrual status at the time it is modified, it stays as non-accrual status, and if a loan is on accrual status at the time of the modification, it generally stays on accrual status.  Commercial and consumer loans modified in a troubled debt restructuring are closely monitored for delinquency as an early indicator of possible future default.  If loans modified in a troubled debt restructuring subsequently default, the Corporation evaluates the loan for possible further impairment.  The allowance for loan and lease losses (“ALLL”) may be increased, adjustments may be made in the allocation of the allowance or partial charge-offs may be taken to further write-down the carrying value of the loan.  The Corporation considers a loan in default when it is 90 days or more past due and still accruing or transferred to nonaccrual status. 

 

Credit Quality Indicators. As part of the ongoing monitoring of the credit quality of the Corporation’s loan portfolio, management tracks certain credit quality indicators including trends related to (i) the weighted-average risk grade of commercial loans, (ii) the level of classified commercial loans, (iii) net charge-offs, (iv) non-performing loans  and (v) the general economic conditions in the State of Tennessee.

 

The Corporation uses a risk grading matrix to assign a risk grade to each of its commercial loans.  Loans are graded on a scale of 1 through 8.  A description of the general characteristics of the eight risk grades is as follows:

Risk Rating 1              Minimal Risk

 

General Characteristics:

• Substantially risk free.

• Federal, state, or municipal subdivisions with acceptable investment grade credit rating.

• Large national, regional, or local entity with proven access to capital markets.

• Diversity in borrower’s line of business with stable and diversified sales base.

• Borrower is considered to be an industry leader with many consecutive years of strong profits and exhibits a financial condition, equity position, liquidity, and debt service capacity far exceeding industry norms.

 

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• Borrower has an abundance of unpledged financeable assets coupled with superior cash generation capabilities.

• Industry conditions and trends are positive and strong.

• Borrower has strong management with evidence of management succession.

• A credit rating by Moody’s, Standard & Poor’s, or other qualified rating agency that is grade A or higher.

• A cash secured loan with the cash on deposit in the Corporation or a guaranty from the federal government also warrants this risk rating.

Risk Rating 2             Modest Risk

 

General Characteristics:

• Borrower shows strong profitability, liquidity, and capitalization better than industry norms and a strong market position in the region.

• Borrower may have limited access to public markets for short-term needs or capital requirements, but has ready access to alternative financing.

• Loans may be unsecured based on the financial strength of the borrower or secured by collateral that is considered liquid and marketable.

• Borrower has a proven history of profitability and financial stability.

• Borrower has a strong market position in its industry and has an abundance of financeable assets available to protect the Corporation’s position.

• Borrower’s proven and steady management with good management succession.

• Borrower can withstand major market instabilities of short duration.

• Credit rating by Moody’s, Standard & Poor’s, or other qualified rating agency that is grade BAA or higher.

Risk Rating 3             Average Risk

 

General Characteristics:

• Borrower shows a stable earnings history and financial condition in line with industry norms with indications that these trends will continue.

• The credit extension is considered sound; however, elements may be present which suggest the borrower may not be free from temporary impairments in the future.

• Borrower’s liquidity and leverage is in line with industry norms.

• Borrower has good management with acceptable management succession.

• Under most economic and business conditions, borrower has access to alternative financing but limited or no access to capital markets for short-term or capital needs.

• Borrower may be an individual with a sound financial condition and liquidity with proven historical income to repay the debt as scheduled.

• Credit extensions are generally secured by acceptable collateral.

Risk Rating 4              Acceptable Risk

 

General Characteristics:

• Credit is to a borrower with smaller margins of debt service coverage and with some elements of reduced financial strength.

• Borrower is generally in a lower average market position in its industry.

• Borrower shows satisfactory asset quality and liquidity, good debt capacity and coverage, and good management in critical positions.

• Borrower’s management is of unquestioned character but management succession may be questionable.

• Borrower can obtain similar financing from other financial institutions.

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• Interim losses or moderately declining earnings trends may occur, but the borrower has sufficient strength and financial flexibility to offset these issues.

• Credit may be to individuals with a moderately leveraged financial condition but with satisfactory liquidity and income to cover debt repayment requirements.

• Business borrowers may have moderate leverage, but must have historically consistent cash flow to cover debt service and other operating needs.

• Business borrowers may also have erratic or cyclical operating performances but should demonstrate strong equity positions to support these profitability swings.

• Asset-based loans that have stabilized and proven performance with the financial capacity to provide for annual clean up may qualify for this rating.

• Borrower has no access to capital markets but would be financeable by another financial institution or finance company.

• Credit extensions are generally secured by acceptable collateral.

Risk Rating 5              Pass / Watch 

 

General Characteristics:

 

Loans considered for this risk rating require a heightened level of supervision. 

 

A) Transitional, Event Driven – This category of risk rated 5 loans captures responses to early warning signals from a relationship and, therefore, signifies a specific, event-driven, transitional credit grade. The event is generally something unplanned or unexpected such as a death, a disaster, the loss of a major client, product line, or key employee; divorce, or health condition of the owner or key management person. This category may be used in transitional upgrades as well as transitional downgrades of credit relationships.  Under these criteria, this category necessitates a plan of action to either upgrade the credit to a “Pass” rating (i.e., Risk Rating 1-4), downgrade the credit to a criticized asset, or exit the relationship within six months.

 

B) Ongoing Supervision Warranted - This category may also be utilized to identify loans having inherent characteristics which warrant more than the normal level of supervision.  Loans meeting these criteria may include larger, more complex loans with unusual structures.  Loans, which, due to structure or nature of the collateral require above average servicing, may also be considered for this risk rating.  Unlike other criteria listed previously for this category, these particular characteristics tend not to be one-time or transitional in nature; therefore, these loans may be expected to remain in this risk rating category longer than six months.  A loan might remain in this risk rating category for its life or until the characteristic warranting the rating can be eliminated or effectively mitigated.

• Borrower may exhibit declining earnings, strained cash flow, increasing leverage, or weakening market positions that indicate a trend toward an unacceptable risk.

• Borrower’s liquidity, leverage, and earnings performance is below or trending below industry norms.

• Interim losses and other adverse trends may occur but not to the level that would impair the Corporation’s position.

• Borrower may be a newly formed company or in a new line of business or may be an established business with new or unproven management.  Borrower should be adequately capitalized, but may not yet have achieved stabilized cash flow.

• Borrower generally has a small market position in its industry.

• Borrower may be engaged in an industry that is experiencing an economic downturn or is particularly susceptible to uncontrollable external factors.

• Borrower management is of good character although some management weakness may exist, including lack of depth or succession.

• Borrower generally has limited additional debt capacity and modest coverage, and average or below-average asset quality, margins, and market share.

• Borrower’s ability to obtain financing from other financial institutions may be impaired.

 

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• Credit to individuals with marginal financial condition and liquidity but with income still sufficient to service the debt.

Risk Rating 6              Special Mention

 

A special mention asset has potential weaknesses that deserve management’s close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the asset or in the institution’s credit position at some future date. Special mention assets are not adversely classified and do not expose an institution to sufficient risk to warrant adverse classification.

 

General Characteristics:

• Borrower’s cash flow may not be sufficient to fund anticipated cash needs.

• Sufficient or modestly sufficient financeable assets are available to protect the Corporation’s position.

• Adverse trends in borrower’s operations/profits or unbalanced position in borrower’s balance sheet but not to the point where repayment is in jeopardy.

• Borrower generally shows limited liquidity or high leverage.

• Borrower’s financial position is in the lower quartile of industry norms.

• Borrower’s business exhibits a deteriorating market position in the industry.

• Borrower’s management lacks depth and succession.

• Business is unable to withstand temporary setbacks without affecting repayment capability.

• Borrower is not financeable by another bank but possibly by a finance company or specialized lender.

 

Risk Rating 7             Substandard

 

A substandard asset is inadequately protected by the current sound worth and paying capacity of the obligor or of the collateral pledged, if any. Assets so classified must have a well-defined weakness, or weaknesses, that jeopardize the liquidation of the debt. They are characterized by the distinct possibility that the Corporation will sustain some loss if the deficiencies are not corrected.

 

General Characteristics:

• The primary source of borrower’s repayment no longer provides satisfactory support and repayment is dependent on secondary sources.

• A substandard loan is inadequately protected by the current sound worth and paying capacity of the obligor or by the collateral pledged, if any.

• Normal repayment from the borrower is impaired although no loss of principal is envisioned.

• A partial loss of interest or principal will occur if the borrower’s deficiencies are not corrected.

• Borrower’s cash flow is generally not sufficient to fund anticipated cash needs.

• Borrower’s financeable assets may not be sufficient to protect the Corporation’s position.

• Adverse trends in borrower’s operations that jeopardized debt repayment may require the borrower to undertake a significant reorganization of financing or the business.

• Borrower shows poor liquidity and high leverage impairing the repayment of the debt in accordance with agreed upon terms.

• Borrower’s management lacks depth and succession; may be inexperienced or of questionable character.

• Borrower’s market position in the industry is deteriorating.

• Borrower is not financeable by another bank or finance company.

 

 

 

 

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Risk Rating 8       Doubtful

 

An asset classified as doubtful has all the weaknesses inherent in one classified substandard with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions, and values, highly questionable and improbable.

 

General Characteristics:

• Inadequate primary source of repayment.  Assumes a less than satisfactory secondary source of repayment on a most-likely case basis.  There may be adequate secondary source of repayment on a best-case basis.

• Borrower has the same weaknesses found in Substandard borrowers.

• Loss probability is extremely high but because of certain important and reasonably specific factors that may work to strengthen the loan, its classification as an estimated loss is deferred until a more exact status may be determined.

• Pending factors may include a proposed merger or acquisition; liquidation procedures; capital injections; perfecting liens on additional collateral; and refinancing plans.

• Borrower’s cash flow is insufficient to fund cash needs.

• Borrower’s financeable assets are insufficient to protect the Corporation’s position.

• Borrower’s source of debt repayment is dependent on liquidation of assets with a probable loss.

• Borrower may no longer be a going concern, or may not exist as a going concern for the foreseeable future.

• No alternative financing sources exist for borrower.

 

The following tables present risk grades and classified loans by class of commercial loan in the Corporation’s portfolios as of March 31, 2014 and December 31, 2013 (dollars in thousands):

 

 

 

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March 31, 2014
Commercial Loan Portfolio:  Credit risk profile by internally assigned grade	Commercial & Industrial		Non-Farm, Non-Residential Real Estate Loans		Construction & Development		Commercial Loans Secured by Residential R/E		All Other Commercial Loans			Commercial Loan Totals
Pass	$	87,146	$	166,383	$	40,428	$	31,328	$	23,451		$	348,736
Special Mention	811		3,944		-		-		177			4,932
Substandard	1,287		5,689		391		411		-			7,778
Doubtful	1,075		-		-		-		1,210			2,285
TOTALS	$	90,319	$	176,016	$	40,819	$	31,739	$	24,838		$	363,731
Retail Loan Portfolio:  Credit risk profiles based on delinquency status classification	Consumer Loans		Single-Family Residential**		All Other Retail Loans		Retail Loan Totals
Performing	$	10,149	$	215,284	$	28,367	$	253,800
Non-performing*	22		2,899		5		2,926
TOTALS	$	10,171	$	218,183	$	28,372	$	256,726
*Loans are classified as non-performing loans and are automatically placed on non-accrual status once they reach 90 days past due.  For the purposes of this calculation, all loans rated at or below Substandard  (RR7) are classified as non-performing.
**Single-family residential loans includes first mortgages, closed-end second mortgages, residential construction loans, and home equity lines of credit (HELOC's).
December 31, 2013
Commercial Loan Portfolio:  Credit risk profile by internally assigned grade	Commercial & Industrial		Non-Farm, Non-Residential Real Estate Loans		Construction & Development		Commercial Loans Secured by Residential R/E		All Other Commercial Loans			Commercial Loan Totals
Pass	$	92,155	$	170,585	$	29,463	$	26,516	$		24,131	$		342,850
Special Mention	836		3,883		-		-		179			4,898
Substandard	635		1,745		475		424		1,023			4,302
Doubtful	1,076		-		-		-		1,249			2,325
TOTALS	$	94,702	$	176,213	$	29,938	$	26,940	$		26,582	$		354,375
Retail Loan Portfolio:  Credit risk profiles based on delinquency status classification	Consumer Loans		Single-Family Residential**		All Other Retail Loans		Retail Loan Totals
Performing	$	10,936	$	212,096	$	27,643	$	250,675
Non-performing*	21		1,667		28		1,716
TOTALS	$	10,957	$	213,763	$	27,671	$	252,391
*Loans are classified as non-performing loans and are automatically placed on non-accrual status once they reach 90 days past due.  For the purposes of this calculation, all loans rated at or below Substandard (RR7) are classified as non-performing.
**Single-family residential loans includes first mortgages, closed-end second mortgages, residential construction loans, and home equity lines of credit (HELOC's).

 

 

Allowance for Loan and Lease Losses. The ALLL is a reserve established through a provision for loan losses charged to expense, which represents management’s best estimate of probable losses that have been incurred within the existing portfolio of loans. The allowance, in the judgment of management, is necessary to reserve for estimated loan losses and risks inherent in the loan portfolio. The Corporation’s ALLL methodology includes allowance allocations calculated in accordance with ASC Topic 310, “Receivables” (“ASC Topic 310”), and allowance allocations calculated in accordance with ASC Topic 450, “Contingencies” (“ASC Topic 450”).  Accordingly, the methodology is based on historical loss experience by type of credit and internal risk grade, specific homogeneous risk pools and specific loss allocations, with adjustments for current events and conditions. The Corporation’s process for determining the appropriate level of the ALLL is designed to account for credit deterioration as it occurs. The provision for loan losses reflects loan quality trends, including the levels of and trends related to non-accrual loans, past due loans, potential problem loans, criticized loans and net charge-offs or recoveries, among other factors. The provision for loan losses also reflects the totality of actions taken on all loans for a particular period.  Therefore, the amount of the provision reflects not only the necessary increases in the ALLL related to newly identified criticized loans, but it also reflects actions taken related to other loans including, among other things, any necessary increases or decreases in required allowances for specific loans or loan pools. 

 

The level of the allowance reflects management’s continuing evaluation of industry concentrations, specific credit risks, loan loss experience, current loan portfolio quality, present economic, political and regulatory conditions and unidentified losses inherent in the current loan portfolio. Portions of the allowance may be allocated for specific credits; however, the entire allowance is available for any credit that, in management’s judgment, should be charged off. While management utilizes its best judgment and information available, the ultimate adequacy of the allowance is dependent upon a variety of factors beyond the Corporation’s control, including, among other things, the performance of the Corporation’s loan portfolio, the economy, and changes in interest.

 

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The Corporation’s ALLL consists of three elements: (i) specific valuation allowances determined in accordance with ASC Topic 310 based on probable losses on specific loans; (ii) historical valuation allowances determined in accordance with ASC Topic 450 based on historical loan loss experience for loans with similar characteristics and trends, adjusted, as necessary, to reflect the impact of current conditions; and (iii) general valuation allowances determined in accordance with ASC Topic 450 based on general economic conditions and other qualitative risk factors both internal and external to the Corporation. 

 

The allowances established for probable losses on specific loans are based on a regular analysis and evaluation of problem loans. Loans are classified based on an internal credit risk grading process that evaluates, among other things: (i) the obligor’s ability to repay; (ii) the underlying collateral, if any; and (iii) the economic environment and industry in which the borrower operates. This analysis is performed at the relationship manager level for all commercial loans. When

a loan has an assigned risk rating of 8 (Doubtful) or higher, a special assets officer analyzes the loan to determine whether the loan is impaired and, if impaired, the need to specifically allocate a portion of the ALLL to the loan. Specific valuation allowances are determined by analyzing the borrower’s ability to repay amounts owed, collateral deficiencies, the relative risk grade of the loan and economic conditions affecting the borrower’s industry, among other things.

 

Historical valuation allowances are calculated based on the historical loss experience of specific types of loans and the internal risk grade of such loans at the time they were charged-off. The Corporation calculates historical loss ratios for pools of similar loans with similar characteristics based on the proportion of actual charge-offs experienced to the total population of loans in the pool. The historical loss ratios are updated quarterly based on actual charge-off experience.  A historical valuation allowance is established for each pool of similar loans based upon the product of the historical loss ratio and average balance of the loans in the pool. The Corporation’s pools of similar loans include similarly risk-graded groups of commercial and industrial loans, commercial real estate loans, consumer real estate loans and consumer and other loans.

           

The components of the general valuation allowance include (i) the additional reserves allocated to specific loan portfolio segments as a result of applying an environmental risk adjustment factor to the base historical loss allocation and (ii) the additional reserves that are not allocated to specific loan portfolio segments including allocations for groups of similar loans with risk characteristics that exceed certain concentration limits established by management.

 

There is an inherent imprecision in calculating the specific portion of the ALLL.  Therefore, a factor has been added to the allocation of each of the identified segments of the loan portfolio to account for the imprecision.

 

            Included in the general valuation allowances are allocations for groups of similar loans with risk characteristics that exceed certain concentration limits established by management. Concentration risk limits have been established, among other things, for certain industry concentrations, large balance and highly leveraged credit relationships that exceed specified risk grades, and loans originated with policy exceptions that exceed specified risk grades.

 

The ALLL is maintained at a level considered adequate to provide for the losses that can be reasonably anticipated.  Management’s periodic evaluation of the adequacy of the allowance is based on the Corporation’s past loan loss experience, known and inherent risks in the portfolio, adverse situations that may affect the borrower’s ability to repay, the estimated value of any underlying collateral, composition of the loan portfolio, current economic conditions and other relevant factors.  This evaluation is inherently subjective as it requires material estimates that may be susceptible to change. 

 

 

 

 

 

 

 

 

 

 

 

 

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The following tables summarize the allocation in the ALLL by loan segment for the three months ended March 31, 2014 and March 31, 2013 and the year ended December 31, 2013 (dollars in thousands): 

 

			Residential		Consumer and
	Commercial		Real Estate		Other Retail		Totals
Beginning ALLL balance - 12/31/13	$	7,359	$	1,084	$	152	$	8,595
Less: Charge-offs	-		-		-		-
Add: Recoveries	14		1		11		26
Add: Provisions	-		-		-		-
Ending ALLL balance - 3/31/14	$	7,373	$	1,085	$	163	$	8,621
			Residential		Consumer and
	Commercial		Real Estate		Other Retail		Totals
Beginning ALLL balance - 12/31/12	$	7,528	$	1,109	$	172	$	8,809
Less: Charge-offs	(144)		(12)		(14)		(170)
Add: Recoveries	10		-		8		18
Add: Provisions	(54)		46		8		-
Ending ALLL balance - 3/31/13	$	7,340	$	1,143	$	174	$	8,657
			Residential		Consumer and
	Commercial		Real Estate		Other Retail		Totals
Beginning ALLL balance - 1/1/13	$	7,528	$	1,109	$	172	$	8,809
Less: Charge-offs	(222)		(27)		(49)		(298)
Add: Recoveries	53		2		29		84
Add: Provisions	-		-		-		-
Ending ALLL balance - 12/31/13	$	7,359	$	1,084	$	152	$	8,595

 

The following tables detail the amount of the ALLL allocated to each portfolio segment as of March 31, 2014, December 31, 2013 and March 31, 2013, disaggregated on the basis of the Corporation’s impairment methodology (dollars in thousands):

			Residential		Consumer and
March 31, 2014	Commercial		Real Estate		Other Retail		Totals
Loans individually evaluated for impairment	$	1,407	$	194	$	-	$	1,601
Loans collectively evaluated for impairment	5,966		891		163		7,020
Total	$	7,373	$	1,085	$	163	$	8,621
			Residential		Consumer and
December 31, 2013	Commercial		Real Estate		Other Retail		Totals
Loans individually evaluated for impairment	$	342	$	118	$	11	$	471
Loans collectively evaluated for impairment	7,017		966		141		8,124
Total	$	7,359	$	1,084	$	152	$	8,595
			Residential		Consumer and
March 31, 2013	Commercial		Real Estate		Other Retail		Totals
Loans individually evaluated for impairment	$	267	$	227	$	-	$	494
Loans collectively evaluated for impairment	7,073		916		174		8,163
Total	7,340		1,143		174		8,657

 

 

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The following tables show loans related to each balance in the ALLL by portfolio segment and disaggregated on the basis of the Corporation’s impairment methodology (dollars in thousands):

 

			Residential		Consumer and
March 31, 2014	Commercial		Real Estate		Other Retail		Totals
Loans individually evaluated for impairment	$	11,442	$	1,473	$	-	$	12,915
Loans collectively evaluated for impairment	352,289		216,710		38,543		607,542
Ending Balance	$	363,731	$	218,183	$	38,543	$	620,457
`			Residential		Consumer and
December 31, 2013	Commercial		Real Estate		Other Retail		Totals
Loans individually evaluated for impairment	$	8,227	$	987	$	11	$	9,225
Loans collectively evaluated for impairment	346,148		212,776		38,617		597,541
Ending Balance	$	354,375	$	213,763	$	38,628	$	606,766
			Residential		Consumer and
March 31, 2013	Commercial		Real Estate		Other Retail		Totals
Loans individually evaluated for impairment	$	8,756	$	1,744	$	-	$	10,500
Loans collectively evaluated for impairment	335,012		212,907		15,144		563,063
Ending Balance	$	343,768	$	214,651	$	15,144	$	573,563

 

 

NOTE 6 – BORROWED FUNDS

 

The Corporation has a Cash Management Advance Line of Credit Agreement (the “CMA”), dated June 21, 2010, with the FHLB.  The CMA is a component of the Blanket Agreement.  The purpose of the CMA is to assist with short-term liquidity management.  Under the terms of the CMA, the Corporation may borrow a maximum of $40 million, selecting a variable rate of interest for up to 90 days or a fixed rate for a maximum of 30 days.  There were no borrowings outstanding under the CMA as of March 31, 2014 or December 31, 2013.

 

NOTE 7 – POST-RETIREMENT BENEFIT PLAN

(dollars in thousands)	Three months ended
	March 31, 2014		March 31, 2013
Service cost	$	8	$	35
Interest cost	28		73
Amortization of net gain	47		(47)
Net periodic pension cost	$	83	$	61

 

 

The Corporation contributed $37 and $107 to the plan for the three month periods ending March 31, 2014 and 2013, respectively.

 

NOTE 8 – RECENT ACCOUNTING PRONOUNCEMENTS

 

ASU 2014-04, “Troubled Debt Restructurings by Creditors (Topic 310).” ASU 2014-04 applies to all creditors who obtain physical possession (resulting from an in substance repossession or foreclosure) of residential real estate property collateralizing a consumer mortgage loan in satisfaction of a receivable. The update requires interim and annual disclosure of both (1) the amount of foreclosed residential real estate property held by the creditor and (2) the recorded investment in consumer mortgage loans collateralized by residential real estate property that are in the process of foreclosure according to local requirements of the applicable jurisdiction.  ASU 2014-04 is effective for public business entities for annual periods, and interim periods within those annual periods, beginning after December 15, 2014 and is not expected to have a significant impact on the Corporation’s financial statements. 

 

 

 

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ASU 2014-08, “Presentation of Financial Statements (Topic 205) and Property, Plant, and Equipment (Topic 360):  Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity.”  The amendments in the Update affect an entity that has either of the following:  (1) a component of an entity that either is disposed of or meets the criteria in paragraph 205-20-45-1E to be classified as held for sale or (2) a business or nonprofit activity that, on acquisition, meets the criteria in paragraph 205-20-45-1E to be classified as held for sale.  ASU 2014-08 is effective in the first quarter of 2015 for public companies with calendar year ends and is not expected to have a significant impact on the Corporation’s financial statements.

 

 

 

 

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