UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 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 June 30, 2010
| ¨ | TRANSITION REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the transition period from to
Commission File Number 0-24958
POTOMAC BANCSHARES, INC.
(Exact Name of Registrant as Specified in Its Charter)
| West Virginia | 55-0732247 | |
| (State or Other Jurisdiction of Incorporation or Organization) |
(I.R.S. Employer Identification No.) | |
| 111 East Washington Street PO Box 906, Charles Town WV |
25414-0906 | |
| (Address of Principal Executive Offices) | (Zip Code) | |
Registrant’s telephone number, including area code 304-725-8431
Indicate by check mark whether the registrant: (l) 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 (§ 232.405 of this Chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). 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 definition of “accelerated filer”, “large accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
| Large Accelerated Filer ¨ | Accelerated Filer ¨ | |||
| Non-Accelerated Filer ¨ | Smaller Reporting Company x | |||
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x
APPLICABLE ONLY TO CORPORATE REGISTRANTS
Indicate the number of shares outstanding of each of the registrant’s classes of common stock, as of the latest practicable date.
3,390,178 as of August 7, 2010
POTOMAC BANCSHARES, INC. AND SUBSIDIARY
FORM 10-Q
June 30, 2010
INDEX
| PAGE | ||||
| PART I. |
FINANCIAL INFORMATION | 3 | ||
| Item 1. |
Financial Statements. | 3 | ||
| Consolidated Balance Sheets as of June 30, 2010 (Unaudited) and December 31, 2009 (Audited) | 3 | |||
| 4 | ||||
| 5 | ||||
| Consolidated Statements of Cash Flows (Unaudited) for the Six Months Ended June 30, 2010 and 2009 | 6 | |||
| Notes to Consolidated Financial Statements June 30, 2010 (Unaudited) and December 31, 2009 (Audited) | 7 - 16 | |||
| Item 2. | Management’s Discussion and Analysis of Financial Condition and Results of Operations. | 16 - 20 | ||
| Item 4. | Controls and Procedures. | 21 | ||
| Part II. | OTHER INFORMATION | 21 | ||
| Item 1. | Legal Proceedings. | 21 | ||
| Item 2. | Unregistered Sales of Equity Securities and Use of Proceeds. | 21 | ||
| Item 4. | (Removed and Reserved). | 21 | ||
| Item 5. | Other Information. | 21 | ||
| Item 6. | Exhibits. | 22 | ||
| Signatures | 23 | |||
FORWARD-LOOKING STATEMENTS
The Private Securities Litigation Reform Act of 1995 evidences Congress’ determination that the disclosure of forward-looking information is desirable for investors and encourages such disclosure by providing a safe harbor for forward-looking statements by corporate management. This Form 10-Q, including Management’s Discussion and Analysis of Financial Condition and Results of Operations, contains forward-looking statements that involve risk and uncertainty. “Forward-looking statements” are easily identified by the use of words such as “could,” “anticipate,” “estimate,” “believe,” “confident,” and similar words that refer to a future outlook. To comply with the terms of the safe harbor, the company notes that a variety of factors could cause the company’s actual results and experiences to differ materially from the anticipated results or other expectations expressed in the company’s forward-looking statements.
The risks and uncertainties that may affect the operations, performance, development and results of the company’s business include, but are not limited to, the growth of the economy, unemployment, pricing in the real estate market, interest rate movements, the impact of competitive products, services and pricing, customer business requirements, the current economic environment posing significant challenges and affecting our financial condition and results of operations, the possibility of future FDIC assessments, Congressional legislation and similar matters (including changes as a result of rules and regulations adopted under the Dodd-Frank Wall Street Reform and Consumer Protection Act). We caution readers of this report not to place undue reliance on forward-looking statements which are subject to influence by unanticipated future events. Actual results, accordingly, may differ materially from management expectations.
2
| Item 1. | Financial Statements |
POTOMAC BANCSHARES, INC. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)
(Unaudited)
| June 30 | December 31 | |||||||
| 2010 | 2009 | |||||||
| Assets: |
||||||||
| Cash and due from banks |
$ | 13,278 | $ | 6,620 | ||||
| Interest-bearing deposits in other financial institutions |
— | 53 | ||||||
| Federal funds sold |
1,875 | 5,950 | ||||||
| Securities available for sale, at fair value |
39,680 | 34,313 | ||||||
| Loans held for sale |
— | 97 | ||||||
| Loans, net of allowance for loan losses of $5,577 and $5,718, respectively |
221,460 | 228,993 | ||||||
| Premises and equipment, net |
8,485 | 8,726 | ||||||
| Other real estate owned, net of valuation allowance of $258 and $303, respectively |
6,647 | 5,632 | ||||||
| Accrued interest receivable |
991 | 952 | ||||||
| Federal Home Loan Bank of Pittsburgh stock |
805 | 805 | ||||||
| Other assets |
10,703 | 11,048 | ||||||
| Total Assets |
$ | 303,924 | $ | 303,189 | ||||
| Liabilities and Stockholders’ Equity: |
||||||||
| Liabilities: |
||||||||
| Deposits |
||||||||
| Noninterest-bearing |
$ | 27,650 | $ | 27,953 | ||||
| Interest-bearing |
235,427 | 236,514 | ||||||
| Total Deposits |
263,077 | 264,467 | ||||||
| Securities sold under agreements to repurchase |
7,609 | 7,340 | ||||||
| Federal Home Loan Bank advances |
3,307 | 3,856 | ||||||
| Accrued interest payable |
393 | 405 | ||||||
| Other liabilities |
3,011 | 1,549 | ||||||
| Total Liabilities |
$ | 277,397 | $ | 277,617 | ||||
| Stockholders’ Equity: |
||||||||
| Common stock, $1 per share par value; 5,000,000 shares authorized; 3,671,691 shares issued and outstanding |
$ | 3,672 | $ | 3,672 | ||||
| Surplus |
3,915 | 3,898 | ||||||
| Undivided profits |
22,791 | 21,931 | ||||||
| Accumulated other comprehensive (loss), net |
(985 | ) | (1,063 | ) | ||||
| $ | 29,393 | $ | 28,438 | |||||
| Less cost of shares acquired for the treasury, 281,513 shares |
2,866 | 2,866 | ||||||
| Total Stockholders’ Equity |
$ | 26,527 | $ | 25,572 | ||||
| Total Liabilities and Stockholders’ Equity |
$ | 303,924 | $ | 303,189 | ||||
See Notes to Consolidated Financial Statements.
3
POTOMAC BANCSHARES, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands except per share data)
(Unaudited)
| For the Three
Months Ended June 30 |
For the Six Months Ended June 30 |
|||||||||||||
| 2010 | 2009 | 2010 | 2009 | |||||||||||
| Interest and Dividend Income: |
||||||||||||||
| Interest and fees on loans |
$ | 3,269 | $ | 3,509 | $ | 6,546 | $ | 7,031 | ||||||
| Interest on securities available for sale – taxable |
216 | 254 | 412 | 497 | ||||||||||
| Interest on securities available for sale – nontaxable |
49 | 37 | 98 | 71 | ||||||||||
| Interest on federal funds sold |
1 | 1 | 2 | 3 | ||||||||||
| Other interest and dividends |
4 | 4 | 7 | 13 | ||||||||||
| Total Interest and Dividend Income |
$ | 3,539 | $ | 3,805 | $ | 7,065 | $ | 7,615 | ||||||
| Interest Expense: |
||||||||||||||
| Interest on deposits |
$ | 1,023 | $ | 1,210 | $ | 2,101 | $ | 2,503 | ||||||
| Interest on securities sold under agreements to repurchase and federal funds purchased |
20 | 38 | 40 | 76 | ||||||||||
| Federal Home Loan Bank advances |
15 | 52 | 61 | 106 | ||||||||||
| Total Interest Expense |
$ | 1,058 | $ | 1,300 | $ | 2,202 | $ | 2,685 | ||||||
| Net Interest Income |
$ | 2,481 | $ | 2,505 | $ | 4,863 | $ | 4,930 | ||||||
| Provision for Loan Losses |
461 | 1,560 | 771 | 3,137 | ||||||||||
| Net Interest Income after Provision for Loan Losses |
$ | 2,020 | $ | 945 | $ | 4,092 | $ | 1,793 | ||||||
| Noninterest Income: |
||||||||||||||
| Trust and financial services |
$ | 227 | $ | 189 | $ | 437 | $ | 364 | ||||||
| Service charges on deposit accounts |
478 | 539 | 914 | 1,034 | ||||||||||
| Fee income on secondary market loans |
18 | 56 | 24 | 108 | ||||||||||
| Gain (loss) on sale of other real estate |
30 | (18 | ) | 142 | 36 | |||||||||
| Visa/MC Fees |
178 | 140 | 329 | 267 | ||||||||||
| Cash surrender value of life insurance |
59 | 60 | 118 | 118 | ||||||||||
| Other operating income |
103 | 81 | 181 | 142 | ||||||||||
| Total Noninterest Income |
$ | 1,093 | $ | 1,047 | $ | 2,145 | $ | 2,069 | ||||||
| Noninterest Expenses: |
||||||||||||||
| Salaries and employee benefits |
$ | 1,142 | $ | 1,293 | $ | 2,402 | $ | 2,544 | ||||||
| Net occupancy expense of premises |
144 | 141 | 334 | 273 | ||||||||||
| Furniture and equipment expenses |
227 | 247 | 437 | 467 | ||||||||||
| Impairment loss on CFSI stock |
— | — | — | 117 | ||||||||||
| FDIC assessment |
154 | 190 | 274 | 234 | ||||||||||
| Printing, stationery and supplies |
67 | 45 | 102 | 120 | ||||||||||
| ATM and check card expenses |
71 | 89 | 135 | 184 | ||||||||||
| Foreclosed property expense |
110 | 539 | 291 | 718 | ||||||||||
| Other operating expenses |
546 | 590 | 995 | 1,103 | ||||||||||
| Total Noninterest Expenses |
$ | 2,461 | $ | 3,134 | $ | 4,970 | $ | 5,760 | ||||||
| Income (Loss) before Income Tax Expense (Benefit) |
$ | 652 | $ | (1,142 | ) | $ | 1,267 | $ | (1,898 | ) | ||||
| Income Tax Expense (Benefit) |
214 | (508 | ) | 407 | (846 | ) | ||||||||
| Net Income (Loss) |
$ | 438 | $ | (634 | ) | $ | 860 | $ | (1,052 | ) | ||||
| Earnings (Loss) Per Share, basic and diluted |
$ | .13 | $ | (.19 | ) | $ | .25 | $ | (.31 | ) | ||||
See Notes to Consolidated Financial Statements.
4
POTOMAC BANCSHARES, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY
FOR THE SIX MONTHS ENDED JUNE 30, 2010 AND 2009
(in thousands, except share and per share data)
(Unaudited)
| Common Stock |
Surplus | Undivided Profits |
Treasury Stock |
Accumulated Other Comprehensive (Loss) |
Comprehensive Income/(Loss) |
Total | ||||||||||||||||||||
| Balances, December 31, 2008 |
$ | 3,672 | $ | 3,851 | $ | 25,070 | $ | (2,837 | ) | $ | (1,952 | ) | $ | 27,804 | ||||||||||||
| Comprehensive (loss) |
||||||||||||||||||||||||||
| Net (loss) |
— | — | (1,052 | ) | — | — | $ | (1,052 | ) | (1,052 | ) | |||||||||||||||
| Other comprehensive (loss): unrealized holding (losses) arising during the period (net of tax, $59) |
— | — | — | — | (115 | ) | (115 | ) | (115 | ) | ||||||||||||||||
| Total comprehensive (loss) |
$ | (1,167 | ) | |||||||||||||||||||||||
| Purchase of treasury shares: |
— | — | — | (29 | ) | — | (29 | ) | ||||||||||||||||||
| Stock-based compensation expense |
— | 24 | — | — | — | 24 | ||||||||||||||||||||
| Cash dividends ($.24 per share) |
— | — | (797 | ) | — | — | (797 | ) | ||||||||||||||||||
| Balances, June 30, 2009 |
$ | 3,672 | $ | 3,875 | $ | 23,221 | $ | (2,866 | ) | $ | (2,067 | ) | $ | 25,835 | ||||||||||||
| Balances, December 31, 2009 |
$ | 3,672 | $ | 3,898 | $ | 21,931 | $ | (2,866 | ) | $ | (1,063 | ) | $ | 25,572 | ||||||||||||
| Comprehensive income |
||||||||||||||||||||||||||
| Net income |
— | — | 860 | — | — | $ | 860 | 860 | ||||||||||||||||||
| Other comprehensive income: |
— | — | — | — | 78 | 78 | 78 | |||||||||||||||||||
| Total comprehensive income |
$ | 938 | ||||||||||||||||||||||||
| Stock-based compensation expense |
— | 17 | — | — | — | 17 | ||||||||||||||||||||
| Balances, June 30, 2010 |
$ | 3,672 | $ | 3,915 | $ | 22,791 | $ | (2,866 | ) | $ | (985 | ) | $ | 26,527 | ||||||||||||
See Notes to Consolidated Financial Statement
5
POTOMAC BANCSHARES, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(Unaudited)
| For the Six Months Ended |
||||||||
| June 30 2010 |
June 30 2009 |
|||||||
| CASH FLOWS FROM OPERATING ACTIVITIES |
||||||||
| Net income (loss) |
$ | 860 | $ | (1,052 | ) | |||
| Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities: |
||||||||
| Provision for loan losses |
771 | 3,137 | ||||||
| Depreciation |
282 | 272 | ||||||
| Valuation allowance for other real estate |
16 | — | ||||||
| Discount accretion and premium amortization on securities, net |
82 | 61 | ||||||
| Gain on sale of other real estate |
(142 | ) | (36 | ) | ||||
| Loss on disposal of fixed assets |
2 | 5 | ||||||
| Stock compensation expense |
17 | 24 | ||||||
| Proceeds from sale of loans |
1,091 | 4,932 | ||||||
| Origination of loans for sale |
(994 | ) | (5,603 | ) | ||||
| Changes in assets and liabilities: |
||||||||
| (Increase) decrease in accrued interest receivable |
(39 | ) | 109 | |||||
| Decrease (increase) in other assets |
303 | (132 | ) | |||||
| Decrease in accrued interest payable |
(12 | ) | (7 | ) | ||||
| Increase (decrease) in other liabilities |
1,462 | (1,896 | ) | |||||
| Net cash provided by (used in) operating activities |
$ | 3,699 | $ | (186 | ) | |||
| CASH FLOWS FROM INVESTING ACTIVITIES |
||||||||
| Proceeds from maturity of securities available for sale |
$ | — | $ | 4,500 | ||||
| Proceeds from call of securities available for sale |
19,545 | 8,000 | ||||||
| Purchase of securities available for sale |
(24,875 | ) | (23,487 | ) | ||||
| Net decrease (increase) in loans |
4,520 | (196 | ) | |||||
| Purchases of premises and equipment |
(42 | ) | (1,026 | ) | ||||
| Proceeds from sale of other real estate |
1,353 | 2,426 | ||||||
| Net cash provided by (used in) investing activities |
$ | 501 | $ | (9,783 | ) | |||
| CASH FLOWS FROM FINANCING ACTIVITIES |
||||||||
| Net (decrease) increase in noninterest-bearing deposits |
$ | (303 | ) | $ | 2,198 | |||
| Net (decrease) increase in interest-bearing deposits |
(1,087 | ) | 4,328 | |||||
| Net purchase of securities sold under agreements to repurchase and federal funds purchased |
269 | 1,503 | ||||||
| Net repayment of Federal Home Loan Bank advances |
(549 | ) | (455 | ) | ||||
| Purchase of treasury shares |
— | (29 | ) | |||||
| Cash dividends |
— | (797 | ) | |||||
| Net cash (used in) provided by financing activities |
$ | (1,670 | ) | $ | 6,748 | |||
| Increase (decrease) in cash and cash equivalents |
$ | 2,530 | $ | (3,221 | ) | |||
| CASH AND CASH EQUIVALENTS |
||||||||
| Beginning |
12,623 | 8,349 | ||||||
| Ending |
$ | 15,153 | $ | 5,128 | ||||
| SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION |
||||||||
| Cash payments for: |
||||||||
| Interest |
$ | 2,214 | $ | 2,692 | ||||
| Income taxes |
$ | — | $ | 41 | ||||
| SUPPLEMENTAL SCHEDULE OF NON-CASH INVESTING AND FINANCING ACTIVITIES |
||||||||
| Unrealized gain (loss) on securities available for sale |
$ | 118 | $ | (174 | ) | |||
| Loans transferred to other real estate owned |
$ | 2,226 | $ | 6,013 | ||||
| Loans made on sale of other real estate |
$ | 298 | $ | 448 | ||||
See Notes to Consolidated Financial Statements.
6
POTOMAC BANCSHARES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2010 (UNAUDITED) AND DECEMBER 31, 2009
| 1. | In the opinion of management, the accompanying financial statements contain all adjustments (consisting of only normal recurring accruals) necessary to present fairly the financial position as of June 30, 2010 and December 31, 2009, the results of operations for the three months and six months ended June 30, 2010 and 2009, and cash flows and statements of changes in stockholders’ equity for the six months ended June 30, 2010 and 2009. The statements should be read in conjunction with Notes to Consolidated Financial Statements included in the Potomac Bancshares, Inc. annual report for the year ended December 31, 2009. The results of operations for the three month and six month periods ended June 30, 2010 and 2009 are not necessarily indicative of the results to be expected for the full year. |
The consolidated financial statements of Potomac Bancshares, Inc. (the “company”) and its wholly-owned subsidiary, Bank of Charles Town (the “bank”), include the accounts of both companies. All material inter-company balances and transactions have been eliminated in consolidation.
Certain reclassifications have been made to prior period amounts to conform to the current year presentation.
In preparing these financial statements the company has evaluated events and transactions for potential recognition or disclosure through the date the financial statements were issued.
| 2. | Stock-Based Compensation |
The 2003 Stock Incentive Plan was approved by stockholders on May 13, 2003, which authorized up to 183,600 shares of common stock to be used in the granting of incentive options to employees and directors. On April 24, 2007, the stockholders approved an additional 250,000 shares of common stock to be used in the granting of incentive options to employees and directors. This is the first and only stock incentive plan adopted by the company. Under the plan, the option price cannot be less than the fair market value of the stock on the date granted. An option’s maximum term is ten years from the date of grant. Options granted under the plan may be subject to a graded vesting schedule.
Incremental stock-based compensation expense recognized for the six month periods ending June 30, 2010 and 2009 was $17 thousand and $24 thousand, respectively.
Stock option compensation expense is the estimated fair value of options granted amortized on a straight-line basis over the requisite service period for each separately vesting portion of the award. Fair value is estimated using the Black-Scholes option-pricing model. There were no options granted during the first six months of 2010 and 2009.
Stock option plan activity for the six months ended June 30, 2010 is summarized below:
| Shares | Weighted Average Exercise Price |
Weighted Average Remaining Contractual Life (in years) |
Aggregate Intrinsic Value | |||||||
| Options outstanding, January 1, 2010 |
126,224 | $ | 14.75 | |||||||
| Granted |
— | — | ||||||||
| Exercised |
— | — | ||||||||
| Canceled or expired |
— | — | ||||||||
| Options outstanding, June 30, 2010 |
126,224 | 14.75 | 5 | $ | — | |||||
| Options exercisable, June 30, 2010 |
113,399 | 14.59 | 5 | $ | — | |||||
The aggregate intrinsic value of a stock option in the table above represents the total pre-tax intrinsic value (the amount by which the current market value of the underlying stock exceeds the exercise price of the option) that would have been received by the option holders had all option holders exercised their options on June 30, 2010. The amount changes based on changes in the market value of the company’s stock.
As of June 30, 2010 there was $33 thousand of total unrecognized compensation expense related to nonvested stock options, which will be recognized over the remaining five year average service period.
7
| 3. | Securities |
The amortized cost and fair value of securities available for sale as of June 30, 2010 and December 31, 2009 (in thousands) are as follows:
| June 30, 2010 | |||||||||||||
| Amortized Cost |
Gross Unrealized Gains |
Gross Unrealized (Losses) |
Fair Value | ||||||||||
| Obligations of U. S. Government agencies |
$ | 33,153 | $ | 328 | $ | (1 | ) | $ | 33,480 | ||||
| State and municipal obligations |
5,043 | 76 | (19 | ) | 5,100 | ||||||||
| Equity securities |
1,100 | — | — | 1,100 | |||||||||
| $ | 39,296 | $ | 404 | $ | (20 | ) | $ | 39,680 | |||||
| December 31, 2009 | |||||||||||||
| Amortized Cost |
Gross Unrealized Gains |
Gross Unrealized (Losses) |
Fair Value | ||||||||||
| Obligations of U. S. Government agencies |
$ | 28,159 | $ | 279 | $ | (15 | ) | $ | 28,423 | ||||
| State and municipal obligations |
4,789 | 56 | (55 | ) | 4,790 | ||||||||
| Equity securities |
1,100 | — | — | 1,100 | |||||||||
| $ | 34,048 | $ | 335 | $ | (70 | ) | $ | 34,313 | |||||
The primary purpose of the investment portfolio is to generate income and meet liquidity needs of the company through readily saleable financial instruments. The portfolio is made up of fixed rate bonds, whose prices move inversely with rates. At the end of any accounting period, the investment portfolio has unrealized gains and losses. The company monitors the portfolio, which is subject to liquidity needs, market rate changes and credit risk changes, to see if adjustments are needed. The primary concern in a loss situation is the credit quality of the business behind the instrument. The primary cause of impairments is the decline in the prices of the bonds as rates have risen. There are 5 accounts in the consolidated portfolio that have losses at June 30, 2010. The primary cause of the temporary impairments in the company’s investments in debt securities was fluctuations in interest rates. Because the company intends to hold these investments in debt securities to maturity and it is more likely than not that the company will not be required to sell these investments before a recovery of unrealized losses, the company does not consider these investments to be other-than-temporarily impaired at June 30, 2010 and no impairment has been recognized.
The following table summarizes the fair value and gross unrealized losses for securities aggregated by investment category and length of time that individual securities have been in a continuous gross unrealized loss position as of June 30, 2010 and December 31, 2009 (in thousands).
| June 30, 2010 | ||||||||||||||||||||
| Less than 12 months | More than 12 months | Total | ||||||||||||||||||
| Fair Value |
Gross Unrealized Losses |
Fair Value |
Gross Unrealized Losses |
Fair Value |
Gross Unrealized Losses |
|||||||||||||||
| Obligations of U.S. Government agencies |
$ | 1,017 | $ | (1 | ) | $ | — | $ | — | $ | 1,017 | $ | (1 | ) | ||||||
| State and municipal obligations |
1,951 | (19 | ) | — | — | 1,951 | (19 | ) | ||||||||||||
| Total |
$ | 2,968 | $ | (20 | ) | $ | — | $ | — | $ | 2,968 | $ | (20 | ) | ||||||
8
| 3. | Securities (Continued) |
| December 31, 2009 | ||||||||||||||||||||
| Less than 12 months | More than 12 months | Total | ||||||||||||||||||
| Fair Value | Gross Unrealized Losses |
Fair Value | Gross Unrealized Losses |
Fair Value | Gross Unrealized Losses |
|||||||||||||||
| Obligations of U.S. Government agencies |
$ | 4,987 | $ | (15 | ) | $ | — | $ | — | $ | 4,987 | $ | (15 | ) | ||||||
| State and municipal obligations |
2,746 | (55 | ) | — | — | 2,746 | (55 | ) | ||||||||||||
| Total |
$ | 7,733 | $ | (70 | ) | $ | — | $ | — | $ | 7,733 | $ | (70 | ) | ||||||
The company investment in Federal Home loan Bank (“FHLB”) stock totaled $805 thousand at June 30, 2010. FHLB stock is generally viewed as a long term investment and as a restricted investment security, which is carried at cost, because there is no market for the stock, other than the FHLBs or member institutions. Therefore, when evaluating FHLB stock for impairment, its value is based on ultimate recoverability of the par value rather than by recognizing temporary declines in value. Despite the FHLBs temporary suspension of repurchases of excess capital stock in 2009, the company does not consider this investment to be other-than-temporarily impaired at June 30, 2010 and no impairment has been recognized. FHLB stock is shown as a separate line item on the balance sheet and is not a part of the available for sale securities portfolio.
| 4. | Loans |
The loan portfolio, stated at face amount, is composed of the following:
| June 30, 2010 |
December 31, 2009 | |||||
| (in thousands) | ||||||
| Mortgage loans on real estate: |
||||||
| Construction, land development and other land loans |
$ | 29,573 | $ | 38,083 | ||
| Secured by farmland |
871 | 1,419 | ||||
| Secured by 1-4 family residential |
98,283 | 102,290 | ||||
| Secured by multifamily residential |
2,037 | 2,070 | ||||
| Secured by nonfarm nonresidential |
80,119 | 71,916 | ||||
| Commercial and industrial loans (except those secured by real estate) |
7,531 | 9,700 | ||||
| Consumer loans |
7,703 | 9,011 | ||||
| All other loans |
920 | 222 | ||||
| Total loans |
$ | 227,037 | $ | 234,711 | ||
| Less: allowance for loan losses |
5,577 | 5,718 | ||||
| $ | 221,460 | $ | 228,993 | |||
| 5. | Allowance for Loan Losses |
The following is a summary of transactions (in thousands) in the allowance for loan losses:
| June 30, 2010 |
December 31, 2009 |
June 30, 2009 |
||||||||||
| Balance at beginning of period |
$ | 5,718 | $ | 4,079 | $ | 4,079 | ||||||
| Provision charged to operating expense |
771 | 6,690 | 3,137 | |||||||||
| Recoveries added to the allowance |
122 | 232 | 127 | |||||||||
| Loan losses charged to the allowance |
(1,034 | ) | (5,283 | ) | (3,524 | ) | ||||||
| Balance at end of period |
$ | 5,577 | $ | 5,718 | $ | 3,819 | ||||||
9
| 5. | Allowance for Loan Losses (Continued) |
The following is a summary of information pertaining to impaired loans at June 30, 2010 and December 31, 2009 (in thousands):
| June 30, 2010 |
December 31, 2009 | |||||
| Impaired loans without a valuation allowance |
$ | 11,284 | $ | 12,397 | ||
| Impaired loans with a valuation allowance |
14,145 | 14,985 | ||||
| Total impaired loans |
$ | 25,429 | $ | 27,382 | ||
| Valuation allowance related to impaired loans |
$ | 3,556 | $ | 3,799 | ||
| Total nonaccrual loans |
$ | 3,094 | $ | 3,819 | ||
| Average investment in impaired loans |
$ | 22,222 | $ | 16,262 | ||
| Interest income recognized on impaired loans |
$ | 617 | $ | 1,233 | ||
| Interest income recognized on a cash basis on impaired loans |
$ | 0 | $ | 68 | ||
No additional funds are committed to be advanced in connection with impaired loans.
Impaired loans are evaluated in relation to the ability of the customer to meet the agreed upon terms of the loan and are evaluated by the value of collateral pledged to secure the loan. Impaired loans without a valuation allowance have sufficient collateral value to cover the outstanding balance of the loan.
Total nonaccrual loans as reported in the above table include impaired and non-impaired loans. Nonaccrual loans excluded from the above impaired loan disclosure at June 30, 2010 and December 31, 2009 totaled $1.1 million and $1.3 million, respectively. If interest had been accrued on the nonaccrual loans excluded from the impaired loan disclosure, such income would have approximated $34 thousand for the first half of 2010 and $58 thousand in 2009.
| 6. | Employee Benefit Plans |
Components of net periodic benefit cost for the pension and postretirement benefit plans are shown below:
| Pension Benefits | Other Postretirement Benefits | |||||||||||||
| Six Months Ended | Six Months Ended | |||||||||||||
| June 30 2010 |
June 30 2009 |
June 30 2010 |
June 30 2009 | |||||||||||
| (in thousands) | (in thousands) | |||||||||||||
| Components of Net Periodic Benefit Cost |
||||||||||||||
| Service cost |
$ | — | $ | 151 | $ | 6 | $ | 6 | ||||||
| Interest cost |
207 | 205 | 17 | 15 | ||||||||||
| Expected return on plan assets |
(230 | ) | (157 | ) | — | — | ||||||||
| Amortization of net obligation at transition |
— | — | 9 | 9 | ||||||||||
| Recognized net actuarial loss |
48 | 36 | — | — | ||||||||||
| Net periodic benefit cost |
$ | 25 | $ | 235 | $ | 32 | $ | 30 | ||||||
The company’s defined benefit pension plan was frozen as of October 31, 2009. Benefits of all existing participants stopped accruing and no new participants could be admitted to the plan after that date. The results of the freeze can be seen in the changes in service cost and net periodic benefit cost of the pension plan between the periods ending June 30, 2009 and June 30, 2010.
10
| 6. | Employee Benefit Plans (continued) |
Employer Contribution
The company anticipates the 2010 contribution for the pension plan will approximate $345 thousand. The company has made payments of $316 thousand as of June 30, 2010. The company has made payments of $10 thousand for the other postretirement benefit plans for the first six months of 2010 and anticipates remaining payments for 2010 to total $12 thousand.
| 7. | Weighted Average Number of Shares Outstanding and Earnings Per Share |
The following shows the weighted average number of shares used in computing earnings per share and the effect on weighted average number of shares of diluted potential common stock. Potential diluted common stock had no effect on June 30, 2010 and June 30, 2009 earnings per share.
| Six Months Ended June 30, 2010 |
Six Months Ended June 30, 2009 |
||||||||||
| Average Shares | Per Share Amount | Average Shares | Per Share Amount | ||||||||
| Basic earnings per share |
3,390,178 | $ | .25 | 3,390,860 | $ | (.31 | ) | ||||
| Effect of dilutive securities: |
|||||||||||
| Stock options |
— | — | |||||||||
| Diluted earnings per share |
3,390,178 | $ | .25 | 3,390,860 | $ | (.31 | ) | ||||
For the six months ended June 30, 2010, stock options representing 126,224 shares and for the six months ended June 30, 2009, stock options representing 131,474 shares were not included in the calculation of earnings per share as their effect would have been anti-dilutive.
| 8. | Recent Accounting Pronouncements |
In June 2009, the FASB issued new guidance relating to the accounting for transfers of financial assets. The new guidance, which was issued as SFAS No. 166, “Accounting for Transfers of Financial Assets, an amendment to SFAS No. 140”, was adopted into Codification in December 2009 through the issuance of Accounting Standards Update (“ASU”) 2009-16. The new standard provides guidance to improve the relevance, representational faithfulness, and comparability of the information that an entity provides in its financial statements about a transfer of financial assets; the effects of a transfer on its financial position, financial performance and cash flows; and a transferor’s continuing involvement, if any, in transferred financial assets. The adoption of the new guidance did not have a material impact on the company’s consolidated financial statements.
In June 2009, the FASB issued new guidance relating to the variable interest entities. The new guidance, which was issued as SFAS No. 167, “Amendments to FASB Interpretation No. 46(R)”, was adopted into Codification in December 2009. The objective of the guidance is to improve financial reporting by enterprises involved with variable interest entities and to provide more relevant and reliable information to users of financial statements. SFAS No. 167 is effective as of January 1, 2010. The adoption of the new guidance did not have a material impact on the company’s consolidated financial statements.
In January 2010, the FASB issued ASU 2010-04, “Accounting for Various Topics – Technical Corrections to SEC Paragraphs”. ASU 2010-04 makes technical corrections to existing SEC guidance including the following topics: accounting for subsequent investments, termination of an interest rate swap, issuance of financial statements – subsequent events, use of residual method to value acquired assets other than goodwill, adjustments in assets and liabilities for holding gains and losses, and selections of discount rate used for measuring defined benefit obligation. The adoption of the new guidance did not have a material impact on the company’s consolidated financial statements.
11
| 8. | Recent Accounting Pronouncements (Continued) |
In January 2010, the FASB issued Accounting Standards Update No. 2010-06, “Fair Value Measurements and Disclosures (Topic 820): Improving Disclosures about Fair Value Measurements”. ASU 2010-06 amends Subtopic 820-10 to clarify existing disclosures, require new disclosures, and includes conforming amendments to guidance on employers’ disclosures about postretirement benefit plan assets. ASU 2010-06 is effective for interim and annual periods beginning after December 15, 2009, except for 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. The adoption of the new guidance did not have a material impact on the company’s consolidated financial statements.
In February 2010, the FASB issued Accounting Standards Update No. 2010-09, “Subsequent Events (Topic 855): Amendments to Certain Recognition and Disclosure Requirements”. ASU 2010-09 addresses both the interaction of the requirements of Topic 855 with the SEC’s reporting requirements and the intended breadth of the reissuance disclosures provisions related to subsequent events. An entity that is an SEC filer is not required to disclose the date through which subsequent events have been evaluated. ASU 2010-09 is effective immediately. The adoption of the new guidance did not have a material impact on the company’s consolidated financial statements.
In July 2010, the FASB issued ASU 2010-20, “Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses.” The new disclosure guidance will significantly expand the existing requirements and will lead to greater transparency into a company’s exposure to credit losses from lending arrangements. The extensive new disclosures of information as of the end of a reporting period will become effective for both interim and annual reporting periods ending after December 15, 2010. Specific items regarding activity that occurred before the issuance of the ASU, such as the allowance roll forward and modification disclosures, will be required for periods beginning after December 15, 2010. The company is currently assessing the impact that ASU 2010-20 will have on its consolidated financial statements.
| 9. | Fair Value Measurements |
Determination of Fair Value
The company uses fair value measurements to record fair value adjustments to certain assets and liabilities and to determine fair value disclosures. In accordance with the Fair Value Measurements and Disclosures topic of FASB ASC, the fair value of a financial instrument is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Fair value is best determined based upon quoted market prices. However, in many instances, there are no quoted market prices for the company’s various financial instruments. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. Accordingly, the fair value estimates may not be realized in an immediate settlement of the instrument.
The recent fair value guidance provides a consistent definition of fair value, which focuses on exit price in an orderly transaction (that is, not a forced liquidation or distressed sale) between market participants at the measurement date under current market conditions. If there has been a significant decrease in the volume and level of activity for the asset or liability, a change in valuation technique or the use of multiple valuation techniques may be appropriate. In such instances, determining the price at which willing market participants would transact at the measurement date under current market conditions depends on the facts and circumstances and requires the use of significant judgment. The fair value is a reasonable point within the range that is most representative of fair value under current market conditions.
Fair Value Hierarchy
In accordance with this guidance, the company groups its financial assets and financial liabilities generally measured at fair value in three levels, based on the markets in which the assets and liabilities are traded and the reliability of the assumptions used to determine fair value.
12
| 9. | Fair Value Measurements (Continued) |
Level 1 – Valuation is based on quoted prices in active markets for identical assets or liabilities that the reporting entity has the ability to access at the measurement date. Level 1 assets and liabilities generally include debt and equity securities that are traded in an active exchange market. Valuations are obtained from readily available pricing sources for market transactions involving identical assets or liabilities.
Level 2 – Valuation is based on inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly. The valuation may be based on quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the asset or liability.
Level 3 – Valuation is based on unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. Level 3 assets and liabilities include financial instruments whose value is determined using pricing models, discounted cash flow methodologies, or similar techniques, as well as instruments for which determination of fair value requires significant management judgment or estimation.
A financial instrument’s categorization within the valuation hierarchy is based upon the lowest level of input that is significant to the fair value measurement.
The following methods and assumptions were used by the company in estimating fair value disclosures for financial instruments:
Cash and Short-Term Investments
The carrying amounts of cash and short-term instruments approximate fair values based on the short-term nature of the assets.
Securities
Securities available for sale are recorded at fair value on a recurring basis. Fair value measurement is based upon quoted market prices, when available (Level 1). If quoted market prices are not available, fair values are measured utilizing independent valuation techniques of identical or similar securities for which significant assumptions are derived primarily from or corroborated by observable market data. Third party vendors compile prices from various sources and may determine the fair value of identical or similar securities by using pricing models that consider observable market data (Level 2).
Loans
For variable rate loans that reprice frequently and with no significant change in credit risk, fair values are based on carrying values. Fair values for other loans were estimated using discounted cash flow analyses, using interest rates currently being offered.
Deposit Liabilities
The fair value of demand deposits, savings accounts, and certain money market deposits is the amount payable on demand at the reporting date. The fair value of fixed-maturity fixed rate certificates of deposit is estimated using the rates currently offered for deposits of similar remaining maturities.
Short-Term Borrowings
The carrying amounts of borrowings under repurchase agreements and federal funds purchased approximate fair value.
FHLB Advances
The fair values of the company’s FHLB advances are estimated using discounted cash flow analysis based on the company’s incremental borrowing rates for similar types of borrowing arrangements.
13
| 9. | Fair Value Measurements (Continued) |
Accrued Interest
The carrying amounts of accrued interest approximate fair value.
Off-Balance Sheet Financial Instruments
The fair value of commitments 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 value of letters of credit is based on fees currently charged for similar agreements or on the estimated cost to terminate them or otherwise settle the obligations with the counterparties at the reporting date.
At June 30, 2010 and December 31, 2009, the fair value of loan commitments and standby-letters of credit was immaterial. Therefore, they have not been included in the following table.
The carrying amounts and estimated fair values of the company’s financial instruments are as follows:
| June 30, 2010 | December 31, 2009 | |||||||||||
| Carrying Amount |
Fair Value |
Carrying Amount |
Fair Value | |||||||||
| (in thousands) | (in thousands) | |||||||||||
| Financial assets: |
||||||||||||
| Cash |
$ | 13,278 | $ | 13,278 | $ | 6,673 | $ | 6,673 | ||||
| Federal funds sold |
1,875 | 1,875 | 5,950 | 5,950 | ||||||||
| Securities available for sale |
39,680 | 39,680 | 34,313 | 34,313 | ||||||||
| Loans, net |
221,460 | 219,010 | 228,993 | 236,838 | ||||||||
| Loans held for sale |
— | — | 97 | 97 | ||||||||
| Accrued interest receivable |
991 | 991 | 952 | 952 | ||||||||
| Financial liabilities: |
||||||||||||
| Deposits |
263,077 | 263,181 | 264,467 | 260,915 | ||||||||
| Securities sold under agreements to repurchase |
7,609 | 7,609 | 7,340 | 7,340 | ||||||||
| FHLB advances |
3,307 | 3,318 | 3,856 | 4,012 | ||||||||
| Accrued interest payable |
393 | 393 | 405 | 405 | ||||||||
Assets and Liabilities Measured at Fair Value on a Recurring Basis
The following describes the valuation techniques used by the company to measure certain financial assets and liabilities recorded at fair value on a recurring basis in the financial statements.
14
| 9. | Fair Value Measurements (Continued) |
The following table presents the balances (in thousands) of financial assets measured at fair value on a recurring basis as of June 30, 2010 and December 31, 2009:
| Fair Value Measurements at June 30, 2010 Using | ||||||||||||
| Description |
Balance as of June 30, 2010 |
Quoted Prices in Active Markets for Identical Assets (Level 1) |
Significant Other Observable Inputs (Level 2) |
Significant Unobservable Inputs (Level 3) | ||||||||
| Available for sale securities |
$ | 39,680 | $ | — | $ | 39,680 | $ | — | ||||
| Fair Value Measurements at December 31, 2009 Using | ||||||||||||
| Description |
Balance as of December 31, 2009 |
Quoted Prices in Active Markets for Identical Assets (Level 1) |
Significant Other Observable Inputs (Level 2) |
Significant Unobservable Inputs (Level 3) | ||||||||
| Available for sale securities |
$ | 34,313 | $ | — | $ | 34,313 | $ | — | ||||
Assets and Liabilities Measured at Fair Value on a Nonrecurring Basis
Certain assets are measured at fair value on a nonrecurring basis in accordance with generally accepted accounting principles. Adjustments to the fair value of these assets usually result from the application of lower-of-cost-or-market accounting or write-downs of individual assets.
The following describes the valuation techniques used by the company to measure certain assets recorded at fair value on a nonrecurring basis in the financial statements:
Loans held for sale: Loans held for sale are carried at the lower of cost or market value. These loans currently consist of one-to-four family residential loans originated for sale in the secondary market. Fair value is based on the price secondary markets are currently offering for similar loans using observable market data which is not materially different than cost due to the short duration between origination and sale (Level 2). As such, the company records any fair value adjustments on a nonrecurring basis. No nonrecurring fair value adjustments were recorded on loans held for sale during the periods ended June 30, 2010 and December 31, 2009. Gains and losses on the sale of loans are recorded within other operating income on the consolidated statements of operations.
Impaired Loans: Loans are designated as impaired when, in the judgment of management based on current information and events, it is probable that all amounts due according to the contractual terms of the loan agreement will not be collected. The measurement of loss associated with impaired loans can be based on either the observable market price of the loan or the fair value of the collateral. Fair value is measured based on the value of the collateral securing the loans. Collateral may be in the form of real estate or business assets including equipment, inventory, and accounts receivable. The vast majority of the collateral is real estate. The value of real estate collateral is determined utilizing an income or market valuation approach based on an appraisal conducted by an independent, licensed appraiser outside of the company using observable market data (Level 2). However, if the collateral is a house or building in the process of construction or if an appraisal of the real estate property is over two years old, then the fair value is considered Level 3. The value of business equipment is based upon an outside appraisal if deemed significant, or the net book value on the applicable business’ financial statements if not considered significant using observable market data. Likewise, values for inventory and accounts receivable are based on financial statement balances or aging reports (Level 3). Impaired loans allocated to the Allowance for Loan Losses are measured at fair value on a nonrecurring basis. Any fair value adjustments are recorded in the period incurred as provision for loan losses on the consolidated statements of operations.
Other Real Estate Owned: Certain assets such as other real estate owned (OREO) are measured at fair value less cost to sell.
15
| 9. | Fair Value Measurements (Continued) |
The following table summarizes the company’s financial assets that were measured at fair value (in thousands) on a nonrecurring basis as of June 30, 2010 and December 31, 2009.
| Carrying Value at June 30, 2010 | ||||||||||||
| Description |
Balance as of June 30, 2010 |
Quoted Prices in Active Markets for Identical Assets (Level 1) |
Significant Other Observable Input (Level 2) |
Significant Unobservable Input (Level 3) | ||||||||
| Assets |
||||||||||||
| Impaired Loans |
$ | 10,589 | $ | — | $ | 9,783 | $ | 806 | ||||
| OREO |
6,647 | — | 6,647 | — | ||||||||
| Carrying Value at December 31, 2009 | ||||||||||||
| Description |
Balance as of December 31, 2009 |
Quoted Prices in Active Markets for Identical Assets (Level 1) |
Significant Other Observable Input (Level 2) |
Significant Unobservable Input (Level 3) | ||||||||
| Assets |
||||||||||||
| Impaired Loans |
$ | 11,186 | $ | — | $ | 3,311 | $ | 7,875 | ||||
| OREO |
5,632 | — | 5,632 | — | ||||||||
| Item 2. | Management’s Discussion and Analysis of Financial Condition and Results of Operations |
CRITICAL ACCOUNTING POLICIES
General
The company’s financial statements are prepared in accordance with accounting principles generally accepted in the United States of America (GAAP). The financial information contained within our statements is, to a significant extent, financial information that is based on measures of the financial effects of transactions and events that have already occurred. A variety of factors could affect the ultimate value that is obtained either when earning income, recognizing an expense, recovering an asset or relieving a liability. We use historical loss factors as one factor in determining the inherent loss that may be present in our loan portfolio. Actual losses could differ significantly from the historical factors that we use. In addition, GAAP itself may change from one previously acceptable method to another method. Although the economics of our transactions would be the same, the timing of events that would impact our transactions could change.
Allowance for Loan Losses
The allowance for loan losses is an estimate of the losses that may be sustained in our loan portfolio. The allowance is based on two basic principles of accounting: (1) losses be accrued when they are probable of occurring and are capable of estimation and (2) losses be accrued based on the differences between the value of collateral, present value of future cash flows or values that are observable in the secondary market and the loan balance.
The allowance consists of specific, general and unallocated components. The specific component relates to loans that are classified as doubtful or substandard. For such loans that are also classified as impaired, an allowance is established when the discounted cash flows (or collateral value or observable market price) of the impaired loan is lower than the carrying value of that loan. The general component covers non-classified loans and is based on historical loss experience adjusted for qualitative factors. An unallocated component is maintained to cover uncertainties that could affect management’s estimate of probable losses. The unallocated component of the allowance reflects that margin of imprecision inherent in the underlying assumptions used in the methodologies for estimating specific and general losses in the portfolio.
16
FINANCIAL OVERVIEW
The outlook for the economy continues to be somewhat of a moving target. Each day seems to bring economic news that contradicts the news of the previous day. Management keeps abreast of the latest economic data and how it might affect our local economy. The overall view is still that the economic recovery will be slow and, at times, painful.
The strategies adopted by management and the board of directors and discussed in the March 31, 2010 Form 10-Q are producing the intended results. We are once again increasing capital and income. Although gross income is lower than the previous year we have increased net income through cost cutting measures such as lowering interest rates on deposits and encouraging employees to cut costs whenever reasonably possible. This strategy has produced three consecutive quarters of net income and each quarter has been slightly more profitable than the previous quarter.
Total assets have increased $.7 million or .2% from the December 2009 total of $303.2 million to $303.9 million at June 30, 2010. Cash and due from banks increased $6.7 million from December 31, 2009 and $5.6 million from March 31, 2010. Cash and due from banks increased because of liquidity needs and the added fact of keeping funds at the Federal Reserve. Currently the Federal Reserve is paying slightly higher rates than our correspondents are paying for federal funds. Federal funds sold decreased $4.1 million from December 31, 2009 compared to June 30, 2010. Securities have increased $5.4 million from December 31, 2009 and have decreased $3.5 million from March 31, 2010. Securities have been somewhat volatile due to the call of many higher yielding securities and the timing of replacing the called securities. Loans have decreased $7.5 million since December 31, 2009 and $5.6 million since March 31, 2010. The decrease in loans has been a combination of payoffs and defaults. Other real estate owned has increased $1.0 million from December 31, 2009 and $0.8 million from March 31, 2010. Other real estate owned has increased due to continuing defaults by customers on residential and commercial properties as well as the continued slow pace of the real estate market.
Total deposits have decreased $.4 million or .5% at June 30, 2010 compared to December 31, 2009. Noninterest-bearing deposits have decreased 1.1% and interest-bearing deposits have decreased 0.5% during the first six months of 2010. Overall, core deposits actually increased slightly. The largest contributor to the decrease in total deposits was the maturity of $1.5 million in brokered deposits.
The June 30, 2010 annualized return (loss) on average assets is .56% compared to (.74)% at December 31, 2009. At June 30, 2010 the annualized return (loss) on average equity is 6.56 % compared to (8.53)% at December 31, 2009. The Tier 1 capital to average assets ratio (leverage capital ratio) is 8.99% at June 30, 2010 compared to 8.75% at December 31, 2009. The Tier 1 capital to total risk weighted assets ratio is 12.37% at June 30, 2010 compared to 11.65% at December 31, 2009. The total capital to risk weighted assets ratio is 13.64% at June 30, 2010 compared to 12.92% at December 31, 2009. All capital ratios are within the regulatory guidelines for “well capitalized”.
17
The following table is an analysis of the company’s allowance for loan losses with amounts shown in thousands. Management monitors the loan portfolio on a continual basis with procedures that allow for problem loans and potentially problem loans to be highlighted and watched. Written reports are prepared on a monthly basis for all loans and information on commercial loans graded below a certain level and are reported to the Board of Directors on a monthly basis. Based on experience, these loan policies and the bank’s grading and review system, management believes the loan loss allowance is adequate.
| June 30 2010 |
December 31 2009 |
June 30 2009 |
||||||||||
| Balance at beginning of period |
$ | 5,718 | $ | 4,079 | $ | 4,079 | ||||||
| Charge-offs: |
||||||||||||
| Commercial, financial and agricultural |
— | 23 | 23 | |||||||||
| Real estate – construction |
406 | 3,957 | 2,945 | |||||||||
| Real estate – mortgage |
487 | 920 | 376 | |||||||||
| Consumer |
141 | 383 | 180 | |||||||||
| Total charge-offs |
1,034 | 5,283 | 3,524 | |||||||||
| Recoveries: |
||||||||||||
| Commercial, financial and agricultural |
— | 5 | 5 | |||||||||
| Real estate – construction |
— | — | — | |||||||||
| Real estate – mortgage |
8 | 2 | 2 | |||||||||
| Consumer |
114 | 225 | 120 | |||||||||
| Total recoveries |
122 | 232 | 127 | |||||||||
| Net charge-offs |
912 | 5,051 | 3,397 | |||||||||
| Provision charged to operations |
771 | 6,690 | 3,137 | |||||||||
| Balance at end of period |
$ | 5,577 | $ | 5,718 | $ | 3,819 | ||||||
| Ratio of net charge-offs during the period to average loans outstanding during the period |
.40 | % | 2.11 | % | 1.39 | % | ||||||
Loans are placed on nonaccrual status when principal or interest is delinquent for 90 days or more. Interest income generally is not recognized on specific impaired loans unless the likelihood of further loss is remote. Interest income on other nonaccrual loans is recognized only to the extent of interest payments received. The majority of the current nonaccrual loans as shown in the chart below are in the process of collection.
Following is a table showing the risk elements in the loan portfolio with amounts in thousands.
| June 30 2010 |
December 31 2009 |
June 30 2009 |
||||||||||
| Nonaccrual loans |
$ | 3,094 | $ | 3,819 | $ | 2,707 | ||||||
| Restructured loans |
— | — | — | |||||||||
| Foreclosed properties |
6,647 | 5,632 | 5,566 | |||||||||
| Total nonperforming assets |
$ | 9,741 | $ | 9,451 | $ | 8,273 | ||||||
| Loans past due 90 days accruing interest |
$ | — | $ | — | $ | 558 | ||||||
| Allowance for loan losses to period end loans |
2.46 | % | 2.44 | % | 1.61 | % | ||||||
| Nonperforming assets to period end loans and foreclosed properties |
4.17 | % | 3.93 | % | 3.41 | % | ||||||
At June 30, 2010, other potential problem loans total $6.4 million. Loans are viewed as potential problem loans according to the ability of such borrowers to comply with current repayment terms. These loans are subject to constant management attention, and their status is reviewed on a regular basis.
18
The details of the income statements for the six months ended June 30, 2010 and 2009 are highlighted below.
| • | Net income in 2010 is $860 thousand compared to the net loss in 2009 of $1.1 million. The greatest factors contributing to this increase are the decrease in interest rates on deposits, an overall decrease in most expense categories and a large decrease in the provision for loan losses. |
| • | At June 30, 2010, total interest and dividend income is down 7.2% compared to June 30, 2009 due to decreased interest rates on a reduced loan portfolio and the replacement of called securities with lower yielding securities. |
| • | At June 30, 2010, interest expense was 18.0% below 2009 expense for the same time period. The decrease in expense is due to the decrease in interest rates including the FHLB advance that was refinanced at the end of the first quarter of 2010. |
| • | Net interest margin at June 30, 2010 is 3.53%, equal to the December 31, 2009 figure of 3.53% and down slightly from the June 30, 2009 figure of 3.55%. During the first six months of 2010, the overall average rate on loans dropped slightly from 5.78% at December 31, 2009 to 5.73% at June 30, 2010. The overall rate on loans at June 30, 2009 was 5.83%. During this same period the overall average rate being paid on deposits decreased to 1.77% from 2.03% at December 31, 2009 and 2.16% at June 30, 2009. |
Noninterest income increased 3.7% for the six months ended June 30, 2010 compared to June 30, 2009. Some significant income items are listed here.
| • | Income from fiduciary activities has increased 20.1% in 2010 over the same period in 2009. Both trust and investment income has increased over 2009. The majority of the increase in trust income was the closing of estates where the fees were greater than the original accruals for the income. When an estate account is established the trust department creates an estimate of expected fee income from the account. A monthly accrual is booked based on the estimate. When the estate closes the income is adjusted for the difference between the estimate and the actual fee earned. |
| • | Gains on the sale of other real estate have increased 294% over the 2009 amount. This increase is due to more properties being sold in 2010. Another factor is the continuing stabilization of the housing market which has slightly increased real estate values, although not to pre-recession levels. |
| • | Visa and MasterCard fees have increased 23.2% over 2009. The increase is still due to the continued popularity of the Smart Checking account which requires twelve debit card transactions each statement cycle to earn the higher interest rate. |
| • | Other income has increased 27.5% over the same period in 2009. The increase is due to increases in a number of other income categories. |
| • | Service charges on deposit accounts have decreased 11.6% in 2010 from 2009. The bulk of this change is decrease in income from overdraft fees and return check charges. It appears that customers are paying more attention to their spending and incurring fewer fees. These fees may decrease even more based on proposed legislation that would affect the amount the bank can charge customers for these fees. |
| • | Fee income on secondary loans has decreased 77.8% as of June 30, 2010 compared to June 30, 2009. Although the housing market is showing some stabilization, it has not resulted in an increase in mortgage activity. |
Noninterest expense decreased about 13.7% for the six months ended June 30, 2010 compared to June 30, 2009. Some details are listed below.
| • | The FDIC assessment has increased 17.1%. This is the result of increases in the calculation of the assessment. The FDIC was forced to increase the assessment to recoup the costs of the many bank failures in the past few years. |
| • | Occupancy expense has increased 22.3 % over 2009. A significant factor in the increase is the depreciation of the costs of the Smith Building addition and second floor renovations, all at the main office. These projects were not complete as of June 30, 2009. |
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| • | Printing, stationery and supplies expense decreased 15%. This is due to management emphasis on cutting costs. There are many more expense categories that have decreased, to a lesser extent, for the same reason. This expense category increased 91.4% in the quarter ended June 30, 2010 over the quarter ended March 31, 2010. The increase is the result of expenses related to notifying customers of the legislation requiring customers to opt in to the overdraft protection feature on deposit accounts. |
| • | ATM and check card expenses have decreased 26.6% in the first six months of 2010 compared to the same time period in 2009. The expense in 2009 included the cost of reissuing quantities of cards that were compromised due to the nationwide “Heartland payment systems” fraud. The expense is down in 2010 based on not having that additional expense. |
| • | Foreclosed property expenses are 59.5% lower as of June 2010 compared to June 2009. The number of new foreclosures has decreased. In addition, the foreclosures have required less expense to prepare them for sale. |
| • | Other noninterest expenses have decreased 9.8% at June 30, 2010 compared to June 30, 2009. There are few significant changes, but slight decreases in many expenses. Most of the decreases are due to the aforementioned management emphasis on controlling costs. The few significant changes are detailed below. |
| • | External audit expense decreased 56.5% in 2010 compared to 2009. The majority of the decrease is due to the cost of an out-sourced loan review in 2009. The review will not be performed in 2010. |
| • | Legal fees have increased 48.5% over the same period in 2009. The increase is due to more legal fees related to foreclosure and bankruptcy proceedings during the first half of 2010 as compared to the same period in 2009. |
LIQUIDITY
Liquid assets of the company include cash and due from banks, securities purchased under agreements to resell, federal funds sold, securities available for sale, and loans and investments maturing within one year. The company’s statement of cash flows details this liquidity since January 1, 2010.
Operating Activities. The company’s net income provides cash from the bank’s operating activities. The net income figure is adjusted for certain noncash transactions, such as depreciation expense, that reduce net income but do not require a cash outlay. Through June 30, 2010 net income as adjusted has provided cash of $3.7 million. Interest income earned on loans and investments is the company’s major income source.
Investing Activities. Customer deposits and company borrowings provide the funds used to invest in loans and securities. In addition, the principal portion of loan payments and loan payoffs and funds from maturing investments provide cash flow. Purchases of bank premises and equipment are an investing activity. The net amount of cash provided by investing activities through June 30, 2010 is $.5 million.
Financing Activities. Customer deposits and company borrowings provide the financing for the investing activities as stated above. If the company has an excess of funds on any given day, the bank will sell these funds to make additional interest income to fund activities. Likewise, if the company has a shortage of funds on any given day it will purchase funds and pay interest for the use of these funds. Financing activities also include payment of dividends, purchase of shares of the company’s common stock for the treasury and repayment of any borrowed or purchased funds. The net amount of cash used in financing activities as of June 30, 2010 is $1.7 million.
Borrowing capabilities provide additional liquidity. The bank has unused credit lines in the approximate amount of $16 million at multiple institutions including the Federal Home Loan Bank of Pittsburgh.
OFF BALANCE SHEET ARRANGEMENTS
No material changes to off balance sheet arrangement have occurred since the filing of the 2009 Form 10-K.
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| Item 4. | Controls and Procedures |
Under the supervision and with the participation of our management, including our principal executive officer and principal financial officer, we have evaluated the effectiveness of the design and operation of our disclosure controls and procedures as of the date of this quarterly report. Based on that evaluation, our principal executive officer and principal financial officer have concluded that these controls and procedures are effective. There were no significant changes in our internal controls or in other factors that could significantly affect these controls subsequent to the date of their evaluation.
Disclosure controls and procedures are our controls and other procedures that are designed to ensure that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is accumulated and communicated to our management, including our principal executive officer and principal financial officer, as appropriate, to allow timely decisions regarding required disclosure.
| Item 1. | Legal Proceedings. |
There are no material legal proceedings to which the Registrant or its subsidiary, directors or officers is a party or by which they, or any of them, are threatened. All legal proceedings presently pending or threatened against Potomac Bancshares, Inc. and its subsidiary involve routine litigation incidental to the business of the company or the subsidiary and are either not material in respect to the amount in controversy or fully covered by insurance.
| Item 2. | Unregistered Sales of Equity Securities and Use of Proceeds. |
ISSUER PURCHASES OF EQUITY SECURITIES
| Period |
(a) Total Number of Shares Purchased |
(b) Average Price Paid Per Share |
(c) Total Number of Shares Purchased as Part of Publicly Announced Programs |
(d) Maximum Number of Shares that May Yet be Purchased Under the Program | ||||
| April 1 through April 30 |
NONE | — | 283 553 | 62 515 | ||||
| May 1 through May 31 |
NONE | — | 283 553 | 62 515 | ||||
| June 1 through June 30 |
NONE | — | 283 553 | 62 515 |
On February 12, 2002, the company’s board of directors originally authorized the repurchase program. The program authorized the repurchase of up to 10% of the company’s stock over the next twelve months. The stock may be purchased in the open market and/or in privately negotiated transactions as management and the board of directors determine prudent. The program has been extended on an annual basis at Potomac’s reorganization meeting.
| Item 4. | (Removed and Reserved). |
| Item 5. | Other Information |
(b) There have been changes to the procedures by which security holders may recommend nominees to the registrant’s board of directors. The details of the change were provided on Form 8-K filing on June 25, 2010. A complete copy of the amended and restated bylaws are included in Exhibit 3.2 in this Form 10-Q.
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| Item 6. | Exhibits |
| 3.2 | Amended and restated bylaws of Potomac Bancshares, Inc. | |
| 31.1 | Certification Under Exchange Act Rule 13a-14, Chief Executive Officer (and Section 302 of Sarbanes-Oxley Act of 2002) | |
| 31.2 | Certification Under Exchange Act Rule 13a-14, Chief Financial Officer (and Section 302 of Sarbanes-Oxley Act of 2002) | |
| 32 | Certification Pursuant to 18 U.S.C. Section 1350, Chief Executive Officer and Chief Financial Officer (pursuant to Section 906 of Sarbanes-Oxley Act of 2002) | |
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In accordance with the requirements of the Exchange Act, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
| POTOMAC BANCSHARES, INC. | ||||||
| Date: August 16, 2010 |
/s/ Robert F. Baronner, Jr. |
|||||
| Robert F. Baronner, Jr. | ||||||
| President & CEO | ||||||
| Date: August 16, 2010 |
/s/ Gayle Marshall Johnson |
|||||
| Gayle Marshall Johnson | ||||||
| Sr. Vice President and Chief Financial Officer | ||||||
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