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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
Quarterly Report Under Section 13 or 15(d) of the
Securities Exchange Act of 1934
For the Quarterly period ended June 30, 2011
Commission file number 0-12055
FARMERS NATIONAL BANC CORP.
(Exact name of registrant as specified in its charter)
     
OHIO   34-1371693
     
(State or other jurisdiction of incorporation or organization)   (I.R.S. Employer Identification No)
20 South Broad Street
     
Canfield, OH   44406
     
(Address of principal executive offices)   (Zip Code)
(330) 533-3341
(Registrant’s telephone number, including area code)
Not applicable
(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 þ No o
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 þ No o
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 o   Accelerated filer þ   Non-accelerated filer o   Smaller reporting company o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No þ
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.
     
Class   Outstanding at July 31, 2011
     
Common Stock, No Par Value   18,700,453 shares
 
 

 


 

         
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10-Q Certifications
       
 
       
Section 906 Certifications
       
 
       
 Exhibit 3.2
 Exhibit 31.a
 Exhibit 31.b
 Exhibit 32.a
 Exhibit 32.b
 EX-101 INSTANCE DOCUMENT
 EX-101 SCHEMA DOCUMENT
 EX-101 CALCULATION LINKBASE DOCUMENT
 EX-101 LABELS LINKBASE DOCUMENT
 EX-101 PRESENTATION LINKBASE DOCUMENT

 


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CONSOLIDATED BALANCE SHEETS
FARMERS NATIONAL BANC CORP. AND SUBSIDIARIES
(Unaudited)
                 
    (In Thousands of Dollars)  
    June 30,     December 31,  
    2011     2010  
 
               
ASSETS
               
Cash and due from banks
  $ 28,170     $ 30,772  
Federal funds sold
    16,969       6,533  
 
           
TOTAL CASH AND CASH EQUIVALENTS
    45,139       37,305  
 
           
 
               
Securities available for sale
    358,335       314,347  
 
               
Loans
    568,704       590,367  
Less allowance for loan losses
    10,876       9,307  
 
           
NET LOANS
    557,828       581,060  
 
           
 
               
Premises and equipment, net
    14,599       13,944  
Bank owned life insurance
    14,699       11,529  
Goodwill
    3,709       3,709  
Other intangibles
    2,956       3,211  
Other assets
    16,956       17,646  
 
           
TOTAL ASSETS
  $ 1,014,221     $ 982,751  
 
           
 
               
LIABILITIES AND STOCKHOLDERS’ EQUITY
               
Deposits:
               
Noninterest-bearing
  $ 81,550     $ 77,728  
Interest-bearing
    688,513       683,322  
 
           
TOTAL DEPOSITS
    770,063       761,050  
 
           
 
               
Short-term borrowings
    108,720       105,634  
Long-term borrowings
    23,572       24,733  
Other liabilities
    3,290       3,286  
 
           
TOTAL LIABILITIES
    905,645       894,703  
 
           
 
               
Commitments and contingent liabilities
               
 
               
Stockholders’ Equity:
               
Common Stock — Authorized 25,000,000 shares; issued 18,700,466 in 2011 and 15,699,184 in 2010
    104,012       96,142  
Retained (deficit) earnings
    (2,155 )     14,502  
Accumulated other comprehensive income
    6,719       2,907  
Treasury stock, at cost; 13 shares in 2011 and 2,053,149 in 2010
    0       (25,503 )
 
           
TOTAL STOCKHOLDERS’ EQUITY
    108,576       88,048  
 
           
TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY
  $ 1,014,221     $ 982,751  
 
           
See accompanying notes

 

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CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME
FARMERS NATIONAL BANC CORP. AND SUBSIDIARIES
(Unaudited)
                                 
    (In Thousands except Per Share Data)  
    For the Three Months Ended     For the Six Months Ended  
    June 30,     June 30,     June 30,     June 30,  
    2011     2010     2011     2010  
 
                               
INTEREST AND DIVIDEND INCOME
                               
Loans, including fees
  $ 8,354     $ 9,192     $ 16,820     $ 18,424  
Taxable securities
    2,048       2,261       3,917       4,502  
Tax exempt securities
    729       584       1,468       1,175  
Dividends
    53       47       99       100  
Federal funds sold
    10       15       19       24  
 
                       
TOTAL INTEREST AND DIVIDEND INCOME
    11,194       12,099       22,323       24,225  
 
                       
 
                               
INTEREST EXPENSE
                               
Deposits
    1,684       2,420       3,382       5,165  
Short-term borrowings
    104       234       201       519  
Long-term borrowings
    249       269       500       551  
 
                       
TOTAL INTEREST EXPENSE
    2,037       2,923       4,083       6,235  
 
                       
NET INTEREST INCOME
    9,157       9,176       18,240       17,990  
Provision for loan losses
    1,075       1,600       2,950       4,378  
 
                       
NET INTEREST INCOME AFTER
                               
PROVISION FOR LOAN LOSSES
    8,082       7,576       15,290       13,612  
 
                       
 
                               
NONINTEREST INCOME
                               
Service charges on deposit accounts
    500       497       973       975  
Bank owned life insurance income, including death benefits
    119       131       278       257  
Trust fees
    1,365       1,197       2,703       2,429  
Security gains (losses)
    0       (3 )     0       (3 )
Insurance agency commissions
    28       110       92       172  
Investment commissions
    263       129       454       240  
Other operating income
    419       660       811       987  
 
                       
TOTAL NONINTEREST INCOME
    2,694       2,721       5,311       5,057  
 
                       
 
                               
NONINTEREST EXPENSES
                               
Salaries and employee benefits
    4,483       4,099       8,671       8,076  
Occupancy and equipment
    922       892       1,838       1,817  
State and local taxes
    238       224       485       456  
Professional fees
    267       381       503       690  
Advertising
    211       147       356       277  
FDIC insurance
    244       317       592       620  
Intangible amortization
    112       145       255       290  
Core processing charges
    245       237       490       476  
Other operating expenses
    1,370       1,203       2,716       2,475  
 
                       
TOTAL NONINTEREST EXPENSES
    8,092       7,645       15,906       15,177  
 
                       
INCOME BEFORE INCOME TAXES
    2,684       2,652       4,695       3,492  
INCOME TAXES
    567       618       888       611  
 
                       
NET INCOME
  $ 2,117     $ 2,034     $ 3,807     $ 2,881  
 
                               
OTHER COMPREHENSIVE INCOME, NET OF TAX:
                               
Change in net unrealized gains on securities, net of reclassifications
    3,769       2,988       3,812       4,055  
 
                       
COMPREHENSIVE INCOME
  $ 5,886     $ 5,022     $ 7,619     $ 6,936  
 
                       
 
                               
NET INCOME PER SHARE — basic and diluted
  $ 0.11     $ 0.15     $ 0.21     $ 0.21  
 
                       
 
                               
DIVIDENDS PER SHARE
  $ 0.03     $ 0.03     $ 0.06     $ 0.06  
 
                       
See accompanying notes

 

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CONSOLIDATED STATEMENTS OF CASH FLOWS
FARMERS NATIONAL BANC CORP. AND SUBSIDIARIES
(Unaudited)
                 
    (In Thousands of Dollars)  
    Six Months Ended  
    June 30,     June 30,  
    2011     2010  
 
               
CASH FLOWS FROM OPERATING ACTIVITIES
               
Net income
  $ 3,807     $ 2,881  
Adjustments to reconcile net income to net cash from operating activities:
               
Provision for loan losses
    2,950       4,378  
Depreciation and amortization
    829       861  
Net amortization of securities
    2,540       504  
Security (gains) losses
    0       3  
Loss on sale of other real estate owned
    29       48  
Income on bank owned life insurance
    (278 )     (257 )
Net change in other assets and liabilities
    (1,139 )     863  
 
           
NET CASH FROM OPERATING ACTIVITIES
    8,738       9,281  
 
               
CASH FLOWS FROM INVESTING ACTIVITIES
               
Proceeds from maturities and repayments of securities available for sale
    19,251       27,489  
Proceeds from sales of securities available for sale
    3,361       1,896  
Purchases of securities available for sale
    (63,277 )     (39,014 )
Loan originations and payments, net
    19,845       (7,560 )
Proceeds from sale of other real estate owned
    141       354  
Purchase of bank owned life insurance
    (3,000 )     0  
Proceeds from BOLI death benefit
    108       0  
Additions to premises and equipment
    (1,179 )     (632 )
 
           
NET CASH FROM INVESTING ACTIVITIES
    (24,750 )     (17,467 )
 
               
CASH FLOWS FROM FINANCING ACTIVITIES
               
Net change in deposits
    9,013       (16,873 )
Net change in short-term borrowings
    3,086       11,999  
Repayment of Federal Home Loan Bank borrowings and other debt
    (1,161 )     (1,889 )
Cash dividends paid
    (1,119 )     (813 )
Proceeds from dividend reinvestment
    255       240  
Net proceeds from issuance of common shares
    13,772       0  
 
           
NET CASH FROM FINANCING ACTIVITIES
    23,846       (7,336 )
 
           
NET CHANGE IN CASH AND CASH EQUIVALENTS
    7,834       (15,522 )
 
               
Beginning cash and cash equivalents
    37,305       51,160  
 
           
Ending cash and cash equivalents
  $ 45,139     $ 35,638  
 
           
 
               
Supplemental cash flow information:
               
Interest paid
  $ 4,108     $ 6,435  
Income taxes paid
  $ 2,085     $ 50  
 
               
Supplemental noncash disclosures:
               
Transfer of loans to other real estate
  $ 437     $ 173  
See accompanying notes

 

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NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
Principles of Consolidation:
Farmers National Banc Corp. (the “Company”) is a multi-bank holding company registered under the Bank Holding Company Act of 1956, as amended. The Company provides full banking services through its nationally chartered subsidiary, The Farmers National Bank of Canfield (the “Bank”). The Company provides trust services through its subsidiary, Farmers Trust Company (the “Trust”), and insurance services through the Bank’s subsidiary, Farmers National Insurance. The consolidated financial statements include the accounts of the Company, the Bank, the Trust and Farmers National Insurance. All significant intercompany balances and transactions have been eliminated in the consolidation.
Basis of Presentation:
The unaudited condensed consolidated financial statements have been prepared in conformity with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by U.S. generally accepted accounting principles (“U.S. GAAP”) for complete financial statements. The financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in the Company’s 2010 Annual Report to Shareholders included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2010. The interim consolidated financial statements include all adjustments (consisting of only normal recurring items) that, in the opinion of management, are necessary for a fair presentation of the financial position and results of operations for the periods presented. The results of operations for the interim periods disclosed herein are not necessarily indicative of the results that may be expected for a full year.
Estimates:
To prepare financial statements in conformity with U.S. GAAP, management makes estimates and assumptions based on available information. These estimates and assumptions affect the amounts reported in the financial statements and the disclosures provided, and future results could differ. The allowance for loan losses, deferred tax assets, carrying amount of goodwill and fair values of financial instruments are particularly subject to change.
Segments:
The Company provides a broad range of financial services to individuals and companies in northeastern Ohio. While the Company’s chief decision makers monitor the revenue streams of the various products and services, operations are managed and financial performance is primarily aggregated and reported in two lines of business, the Bank segment and the Trust segment.
Shareholders’ Equity:
The Company successfully completed a rights and public offering of 5,000,000 common shares in January 2011. As part of this rights offering the Company issued 2,946,864 shares of authorized but unissued shares and reissued 2,053,136 shares of treasury stock. Total proceeds from the offering net of offering costs of $1.2 million were $13.8 million. Since the Company’s cost basis of the treasury shares was greater than the price paid for stock issued in the rights offering, the difference of $19.3 million was recorded as a reduction to retained earnings. Other changes to retained earnings for the six months ended June 30, 2011 were net income of $3.8 million and partially offset by dividends paid to shareholders of $1.1 million. In addition to the rights and public offering, common stock increased by $255 thousand during the six months ended June 30, 2011 due to the issuance of 54,418 shares of stock through the Company’s dividend reinvestment program. Accumulated other comprehensive income increased $3,8 million from December 31, 2010 to June 30, 2011 due to the after tax impact of increases in fair value of securities available for sale during that period.

 

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Securities:
The following table summarizes the amortized cost and fair value of the available-for-sale investment securities portfolio at June 30, 2011 and December 31, 2010 and the corresponding amounts of unrealized gains and losses recognized in accumulated other comprehensive income were as follows:
                                 
            Gross     Gross        
(In Thousands of Dollars)   Amortized     Unrealized     Unrealized     Fair  
June 30, 2011   Cost     Gains     Losses     Value  
U.S. Treasury and U.S. government sponsored entities
  $ 87,200     $ 3,750     $ (15 )   $ 90,935  
State and political subdivisions
    80,045       2,456       (691 )     81,810  
Mortgage-backed securities — residential
    157,505       4,620       (395 )     161,730  
Collateralized mortgage obligations
    22,850       238       0       23,088  
Equity securities
    149       373       (16 )     506  
Other securities
    250       16       0       266  
 
                       
 
                               
Totals
  $ 347,999     $ 11,453     $ (1,117 )   $ 358,335  
 
                       
 
                               
(In Thousands of Dollars)
December 31, 2010
                               
U.S. Treasury and U.S. government sponsored entities
  $ 67,376     $ 2,768     $ (166 )   $ 69,978  
State and political subdivisions
    81,397       1,215       (2,146 )     80,466  
Mortgage-backed securities — residential
    140,681       4,099       (1,003 )     143,777  
Collateralized mortgage obligations
    20,021       1       (362 )     19,660  
Equity securities
    149       66       (16 )     199  
Other securities
    250       17       0       267  
 
                       
 
                               
Totals
  $ 309,874     $ 8,166     $ (3,693 )   $ 314,347  
 
                       
There was one security sale during the three and six month periods ended June 30, 2011. Proceeds from the sale were $3.4 million with no gain or loss recognized. Proceeds from sales of securities were $1.9 million for the three and six month periods ended June 30, 2010. Gross losses of $3 thousand were realized on these sales, during the second quarter of 2010.
The amortized cost and fair value of the debt securities portfolio are shown by expected maturity. Expected maturities may differ from contractual maturities if issuers have the right to call or prepay obligations with or without call or prepayment penalties. Mortgage backed securities are not due at a single maturity date and are shown separately.
                 
    June 30, 2011  
    Amortized     Fair  
(In Thousands of Dollars)   Cost     Value  
Maturity
               
Within one year
  $ 4,300     $ 4,385  
One to five years
    98,306       102,048  
Five to ten years
    40,161       40,699  
Beyond ten years
    24,728       25,879  
Mortgage-backed and CMO securities
    180,355       184,818  
 
           
Total
  $ 347,850     $ 357,829  
 
           

 

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The following table summarizes the investment securities with unrealized losses at June 30, 2011 and December 31, 2010, aggregated by major security type and length of time in a continuous unrealized loss position:
                                                 
    Less Than 12 Months     12 Months or Longer     Total  
(In Thousands of Dollars)   Fair     Unrealized     Fair     Unrealized     Fair     Unrealized  
June 30, 2011   Value     Losses     Value     Losses     Value     Losses  
Available-for-sale
                                               
U.S. Treasury and U.S. government-sponsored entities
  $ 4,976     $ (10 )   $ 288     $ (5 )   $ 5,264     $ (15 )
State and political subdivisions
    22,234       (580 )     851       (111 )     23,085       (691 )
Mortgage-backed securities — residential
    43,337       (395 )     25       (0 )     43,362       (395 )
Equity securities
    0       0       7       (16 )     7       (16 )
 
                                   
 
                                               
Total
  $ 70,547     $ (985 )   $ 1,171     $ (132 )   $ 71,718     $ (1,117 )
 
                                   
                                                 
    Less Than 12 Months     12 Months or Longer     Total  
(In Thousands of Dollars)   Fair     Unrealized     Fair     Unrealized     Fair     Unrealized  
December 31, 2010   Value     Losses     Value     Losses     Value     Losses  
Available-for-sale
                                               
U.S. Treasury and U.S. government-sponsored entities
  $ 8,458     $ (160 )   $ 313     $ (6 )   $ 8,771     $ (166 )
State and political subdivisions
    36,118       (1,981 )     790       (165 )     36,908       (2,146 )
Mortgage-backed securities — residential
    45,567       (1,002 )     26       (1 )     45,593       (1,003 )
Collateralized mortgage obligations
    19,594       (362 )     0       0       19,594       (362 )
Equity securities
    0       0       8       (16 )     8       (16 )
 
                                   
 
                                               
Total
  $ 109,737     $ (3,505 )   $ 1,137     $ (188 )   $ 110,874     $ (3,693 )
 
                                   
Other-Than-Temporary-Impairment
Management evaluates securities for other-than-temporary impairment (“OTTI”) at least on a quarterly basis, and more frequently when economic or market conditions warrant such an evaluation. Investment securities are generally evaluated for OTTI under Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 320, Investments — Debt and Equity Securities. Consideration is given to the length of time and the extent to which the fair value has been less than cost, the financial condition and near-term prospects of the issuer, whether the market decline was affected by macroeconomic conditions and whether the Company has the intent to sell the debt security or more likely than not will be required to sell the debt security before its anticipated recovery. In analyzing an issuer’s financial condition, the Company may consider whether the securities are issued by the federal government or its agencies, or U.S. government sponsored enterprises, whether downgrades by bond rating agencies have occurred, and the results of reviews of the issuer’s financial condition. The assessment of whether an other-than-temporary decline exists involves a high degree of subjectivity and judgment and is based on the information available to management at a point in time.

 

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When OTTI occurs, the amount of the OTTI recognized in earnings depends on whether an entity intends to sell the security or it is more likely than not it will be required to sell the security before recovery of its amortized cost basis. If an entity intends to sell or it is more likely than not it will be required to sell the security before recovery of its amortized cost basis, the OTTI shall be recognized in earnings equal to the entire difference between the investment’s amortized cost basis and its fair value at the balance sheet date. The previous amortized cost basis less the OTTI recognized in earnings becomes the new amortized cost basis of the investment. For debt securities that do not meet the aforementioned criteria, the amount of impairment is split into two components as follows: 1) OTTI related to credit loss, which must be recognized in the income statement and 2) OTTI related to other factors, which is recognized in other comprehensive income or loss. The credit loss is defined as the difference between the present value of the cash flows expected to be collected and the amortized cost basis. For equity securities, the entire amount of impairment is recognized through earnings.
As of June 30, 2011, the Company’s security portfolio consisted of 414 securities, 53 of which were in an unrealized loss position. The majority of the unrealized losses on the Company’s securities are related to its holdings of U.S. government-sponsored entities, state and political subdivisions, and mortgage-backed securities as discussed below.
Unrealized losses on debt securities issued by U.S. government-sponsored entities have not been recognized into income because the securities are of high credit quality, management does not have the intent to sell these securities before their anticipated recovery and the decline in fair value is largely due to fluctuations in market interest rates and not credit quality. Consequently, the fair value of such debt securities is expected to recover as the securities approach their maturity date.
Unrealized losses on debt securities at June 30, 2011 relative to obligations of state and political subdivisions have not been recognized into income. Generally, these debt securities have maintained their investment grade ratings and management does not have the intent to sell these securities before their anticipated recovery, which may be at maturity.
All of the Company’s holdings of mortgage-backed securities were issued by U.S. government sponsored enterprises. Unrealized losses on mortgage-backed securities have not been recognized into income. Because the decline in fair value is attributable to changes in interest rates and illiquidity, and not credit quality, and because the Company does not have the intent to sell these mortgage-backed securities and it is likely that it will not be required to sell the securities before their anticipated recovery, the Company does not consider these securities to be OTTI.
Loans:
Loan balances were as follows:
                 
    June 30,     December 31,  
(In Thousands of Dollars)   2011     2010  
Commercial real estate
               
Owner occupied
  $ 105,743     $ 111,261  
Non-owner occupied
    74,464       76,592  
Other
    15,696       16,582  
Commercial
    74,800       76,635  
Residential real estate
               
1-4 family residential
    147,318       154,132  
Home equity lines of credit
    22,658       23,624  
Consumer
               
Indirect
    113,386       116,999  
Direct
    11,507       11,302  
Other
    1,464       1,485  
 
           
Subtotal
    567,036       588,612  
Net deferred loan (fees) costs
    1,668       1,755  
Allowance for loan losses
    (10,876 )     (9,307 )
 
           
Net loans
  $ 557,828     $ 581,060  
 
           

 

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The following tables present the activity in the allowance for loan losses by portfolio segment for the three and six months ending June 30, 2011.
Three Months Ended June 30, 2011
                                                 
    Commercial             Residential                    
(In Thousands of Dollars)   Real Estate     Commercial     Real Estate     Consumer     Unallocated     Total  
Allowance for loan losses
                                               
Beginning balance, April 1, 2011
  $ 6,020     $ 1,878     $ 1,261     $ 842     $ 136     $ 10,137  
Provision for loan losses
    582       51       34       272       136       1,075  
Recoveries
    6       12       402       279             699  
Loans charged off
    (555 )     (55 )     (155 )     (270 )           (1,035 )
 
                                   
Ending balance, June 30, 2011
  $ 6,053     $ 1,886     $ 1,542     $ 1,123     $ 272     $ 10,876  
 
                                   
Six Months Ended June 30, 2011
                                                 
    Commercial             Residential                    
(In Thousands of Dollars)   Real Estate     Commercial     Real Estate     Consumer     Unallocated     Total  
Allowance for loan losses
                                               
Beginning balance, January 1, 2011
  $ 5,780     $ 1,707     $ 881     $ 875     $ 64     $ 9,307  
Provision for loan losses
    905       334       1,154       349       208       2,950  
Recoveries
    8       34       403       468             913  
Loans charged off
    (640 )     (189 )     (896 )     (569 )           (2,294 )
 
                                   
Ending balance, June 30, 2011
  $ 6,053     $ 1,886     $ 1,542     $ 1,123     $ 272     $ 10,876  
 
                                   
The following table presents the activity in the allowance for loan losses for the three and six months ending June 30, 2010.
                 
    Three Months Ended     Six Months Ended  
(In Thousands of Dollars)   June 30, 2010     June 30, 2010  
Allowance for loan losses
               
Beginning balance
  $ 8,220     $ 7,400  
Provision for loan losses
    1,600       4,378  
Recoveries
    125       272  
Loans charged off
    (1,690 )     (3,795 )
 
           
Ending balance
  $ 8,255     $ 8,225  
 
           

 

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The following tables present the balance in the allowance for loan losses and the recorded investment in loans by portfolio segment and based on impairment method as of June 30, 2011 and December 31, 2010. The recorded investment in loans includes the unpaid principal balance and unamortized loan origination fees and costs but excludes accrued interest receivable, which is not considered to be material:
June 30, 2011
                                                 
    Commercial             Residential                    
(In Thousands of Dollars)   Real Estate     Commercial     Real Estate     Consumer     Unallocated     Total  
Ending allowance balance attributable to loans:
                                               
Individually evaluated for impairment
  $ 348     $ 252     $     $     $     $ 600  
Collectively evaluated for impairment
    5,705       1,634       1,542       1,123       272       10,276  
 
                                   
Total ending allowance balance
  $ 6,053     $ 1,886     $ 1,542     $ 1,123     $ 272     $ 10,876  
 
                                   
 
Loans:
                                               
Loans individually evaluated for impairment
  $ 5,152     $ 1,049     $     $     $     $ 6,201  
Loans collectively evaluated for impairment
    190,226       73,751       169,303       129,223             562,503  
 
                                   
Total ending loans balance
  $ 195,378     $ 74,800     $ 169,303     $ 129,223     $     $ 568,704  
 
                                   
December 31, 2010
                                                 
    Commercial             Residential                    
(In Thousands of Dollars)   Real Estate     Commercial     Real Estate     Consumer     Unallocated     Total  
Ending allowance balance attributable to loans:
                                               
Individually evaluated for impairment
  $ 572     $ 33     $     $     $     $ 605  
Collectively evaluated for impairment
    5,208       1,674       881       875       64       8,702  
 
                                   
Total ending allowance balance
  $ 5,780     $ 1,707     $ 881     $ 875     $ 64     $ 9,307  
 
                                   
 
                                               
Loans:
                                               
Loans individually evaluated for impairment
  $ 6,045     $ 1,015     $     $     $     $ 7,060  
Loans collectively evaluated for impairment
    197,849       75,620       177,067       132,771             583,307  
 
                                   
Total ending loans balance
  $ 203,894     $ 76,635     $ 177,067     $ 132,771     $     $ 590,367  
 
                                   
Interest income recognized during impairment for the three and six months ending June 30, 2011 and June 30, 2010 was immaterial.

 

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The following tables present loans individually evaluated for impairment by class of loans as of June 30, 2011 and December 31, 2010 and the average recorded investment by class for the six months ended June 30, 2011:
(In Thousands of Dollars)
                                         
                                    Three  
                            Six Months     Months  
                    Allowance     Ended     Ended  
    Unpaid             for Loan     Average     Average  
    Principal     Recorded     Losses     Recorded     Recorded  
June 30, 2011   Balance     Investment     Allocated     Investment     Investment  
With no related allowance recorded:
                                       
Commercial real estate
                                       
Owner occupied
  $ 1,203     $ 1,208     $     $ 1,236     $ 1,211  
Non-owner occupied
                             
Other
                             
Commercial
    641       641             671       655  
Residential real estate
                                       
1-4 family residential
                             
Home equity lines of credit
                             
Consumer
                                       
Indirect
                             
Direct
                             
Other
                             
With an allowance recorded:
                                       
Commercial real estate
                                       
Owner occupied
    2,286       2,288       99       2,405       2,375  
Non-owner occupied
    823       825       143       894       833  
Other
    830       831       106       812       802  
Commercial
    405       408       252       459       445  
Residential real estate
                                       
1-4 family residential
                             
Home equity lines of credit
                             
Consumer
                                       
Indirect
                             
Direct
                             
Other
                             
 
                             
Total
  $ 6,188     $ 6,201     $ 600     $ 6,477     $ 6,321  
 
                             

 

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(In Thousands of Dollars)
                         
                    Allowance for  
    Unpaid Principal     Recorded     Loan Losses  
December 31, 2010   Balance     Investment     Allocated  
With no related allowance recorded:
                       
Commercial real estate
                       
Owner occupied
  $ 821     $ 818     $  
Non-owner occupied
    466       465        
Other
    365       364        
Commercial
    800       798        
Residential real estate
                       
1-4 family residential
                 
Home equity lines of credit
                 
Consumer
                       
Indirect
                 
Direct
                 
Other
                 
With an allowance recorded:
                       
Commercial real estate
                       
Owner occupied
    3,147       3,141       134  
Non-owner occupied
    167       167       3  
Other
    1,097       1,090       435  
Commercial
    219       217       33  
Residential real estate
                       
1-4 family residential
                 
Home equity lines of credit
                 
Consumer
                       
Indirect
                 
Direct
                 
Other
                 
 
                 
Total
  $ 7,082     $ 7,060     $ 605  
 
                 
The following table presents the recorded investment in nonaccrual and loans past due over 90 days still on accrual by class of loans as of June 30, 2011 and December 31, 2010:
                                 
    June 30, 2011     December 31, 2010  
            Loans Past             Loans Past  
            Due over 90             Due over 90  
            Days Still             Days Still  
(In Thousands of Dollars)   Nonaccrual     Accruing     Nonaccrual     Accruing  
Commercial real estate
                               
Owner occupied
  $ 1,365     $     $ 1,960     $  
Non-owner occupied
    421             550        
Other
    885             1,462        
Commercial
    408             400        
Residential real estate
                               
1-4 family residential
    3,726       29       3,362       190  
Home equity lines of credit
    931       20       815       10  
Consumer
                               
Indirect
    14       51       27       53  
Direct
          38             48  
Other
                      24  
 
                       
Total
  $ 7,750     $ 138     $ 8,576     $ 325  
 
                       
Nonaccrual loans and loans past due 90 days still on accrual included both smaller balance homogeneous loans that are collectively evaluated for impairment and individually classified impaired loans.

 

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The following table presents the aging of the recorded investment in past due loans as of June 30, 2011 and December 31, 2010 by class of loans:
June 30, 2011
                                                 
                    Greater                    
    30-59     60-89     than 90                    
    Days Past     Days Past     Days Past     Total Past     Loans Not        
(In Thousands of Dollars)   Due     Due     Due     Due     Past Due     Total  
Commercial real estate
                                               
Owner occupied
  $ 114     $     $ 1,365     $ 1,479     $ 103,980     $ 105,459  
Non-owner occupied
    15             421       436       73,828       74,264  
Other
                885       885       14,770       15,655  
Commercial
    261       35       408       704       74,096       74,800  
Residential real estate
                                               
1-4 family residential
    1,209       185       3,755       5,149       141,497       146,646  
Home equity lines of credit
    111       147       951       1,209       21,449       22,658  
Consumer
                                               
Indirect
    1,221       352       65       1,638       114,613       116,251  
Direct
    113       18       38       169       11,338       11,507  
Other
    12       1             13       1,451       1,464  
 
                                   
Total
  $ 3,056     $ 738     $ 7,888     $ 11,682     $ 557,022     $ 568,704  
 
                                   
December 31, 2010
                                                 
                    Greater                    
    30-59     60-89     than 90                    
    Days Past     Days Past     Days Past     Total Past     Loans Not        
(In Thousands of Dollars)   Due     Due     Due     Due     Past Due     Total  
Commercial real estate
                                               
Owner occupied
  $ 407     $ 91     $ 1,960     $ 2,458     $ 108,509     $ 110,967  
Non-owner occupied
    499       59       550       1,108       75,281       76,389  
Other
                1,462       1,462       15,076       16,538  
Commercial
    286       275       400       961       75,674       76,635  
Residential real estate
                                               
1-4 family residential
    2,981       435       3,552       6,968       146,475       153,443  
Home equity lines of credit
    334       16       825       1,175       22,449       23,624  
Consumer
                                               
Indirect
    1,668       519       80       2,267       117,716       119,983  
Direct
    253       91       48       392       10,911       11,303  
Other
    9       1       24       34       1,451       1,485  
 
                                   
Total
  $ 6,437     $ 1,487     $ 8,901     $ 16,825     $ 573,542     $ 590,367  
 
                                   
Troubled Debt Restructurings:
Included in loans individually impaired are loans with balances of $3.4 million and $3.0 million for which the Company has modified the repayment terms at June 30, 2011 and December 31, 2010. The Company has allocated $40 thousand of specific reserves to customers whose loan terms have been modified in troubled debt restructurings as of June 30, 2011 and December 31, 2010. There are no commitments to lend additional amounts to borrowers with loans that are classified as troubled debt restructurings at June 30, 2011 and December 31, 2010.
Credit Quality Indicators:
The Company categorizes loans into risk categories based on relevant information about the ability of borrowers to service their debt such as: current financial information, historical payment experience, credit documentation, public information, and current economic trends, among other factors. The Company analyzes loans individually by classifying the loans as to credit risk. This analysis is performed on a monthly basis. The Company uses the following definitions for risk ratings:
Special Mention. Loans classified as special mention have a potential weakness that deserves management’s close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the loan or of 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.

 

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Substandard. Loans classified as substandard are inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any. Loans so classified have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. Substandard loans are characterized by the distinct possibility that the institution will sustain some loss if the deficiencies are not corrected.
Doubtful. Loans classified as doubtful have all the weaknesses inherent in those classified as 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.
Loans not meeting the criteria above that are analyzed individually as part of the above described process are considered to be pass rated loans. As of June 30, 2011 and December 31, 2010, and based on the most recent analysis performed, the risk category of loans by class of loans is as follows:
June 30, 2011
                                                 
            Special     Sub-                    
(In Thousands of Dollars)   Pass     Mention     standard     Doubtful     Not Rated     Total  
Commercial real estate
                                               
Owner occupied
  $ 87,297     $ 5,902     $ 12,260     $     $     $ 105,459  
Non-owner occupied
    62,191       1,162       10,911                   74,264  
Other
    12,639       597       2,419                   15,655  
Commercial
    66,646       4,302       3,852                   74,800  
 
                                   
Total
  $ 228,773     $ 11,963     $ 29,442     $     $     $ 270,178  
 
                                   
December 31, 2010
                                                 
            Special     Sub-                    
(In Thousands of Dollars)   Pass     Mention     standard     Doubtful     Not Rated     Total  
Commercial real estate
                                               
Owner occupied
  $ 91,976     $ 3,893     $ 15,098     $     $     $ 110,967  
Non-owner occupied
    63,502       1,075       11,812                   76,389  
Other
    12,005       786       3,747                   16,538  
Commercial
    65,358       4,076       7,201                   76,635  
 
                                   
Total
  $ 232,841     $ 9,830     $ 37,858     $     $     $ 280,529  
 
                                   
The Company considers the performance of the loan portfolio and its impact on the allowance for loan losses. For residential, consumer and indirect loan classes, the Company also evaluates credit quality based on the aging status of the loan, which was previously presented, and by payment activity. The following table presents the recorded investment in residential, consumer and indirect auto loans based on payment activity as of June 30, 2011 and December 31, 2010. Nonperforming loans are loans past due 90 days and still accruing interest and nonaccrual loans.
June 30, 2011
                                         
    Residential Real Estate     Consumer  
            Home Equity                    
    1-4 Family     Lines of                    
(In Thousands of Dollars)   Residential     Credit     Indirect     Direct     Other  
 
                                       
Performing
  $ 142,891     $ 21,707     $ 116,186     $ 11,469     $ 1,465  
Nonperforming
    3,755       951       65       38        
 
                             
Total
  $ 146,646     $ 22,658     $ 116,251     $ 11,507     $ 1,465  
 
                             

 

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December 31, 2010
                                         
    Residential Real Estate     Consumer  
            Home Equity                    
    1-4 Family     Lines of                    
(In Thousands of Dollars)   Residential     Credit     Indirect     Direct     Other  
 
                                       
Performing
  $ 149,891     $ 22,799     $ 119,903     $ 11,255     $ 1,461  
Nonperforming
    3,552       825       80       48       24  
 
                             
Total
  $ 153,443     $ 23,624     $ 119,983     $ 11,303     $ 1,485  
 
                             
Earnings Per Share:
The computation of basic and diluted earnings per share is shown in the following table:
                                 
    Three Months Ended     Six Months Ended  
(In Thousands, except Share and   June 30,     June 30,  
Per Share Data)   2011     2010     2011     2010  
Basic EPS computation
                               
Numerator — Net income
  $ 2,117     $ 2,034     $ 3,807     $ 2,881  
Denominator — Weighted average shares outstanding
    18,674,213       13,546,569       17,820,254       13,533,302  
Basic earnings per share
  $ .11     $ .15     $ .21     $ .21  
 
                       
 
                               
Diluted EPS computation
                               
Numerator — Net income
  $ 2,117     $ 2,034     $ 3,807     $ 2,881  
Denominator — Weighted average shares outstanding for basic earnings per share
    18,674,213       13,546,569       17,820,254       13,533,302  
Effect of Stock Options
    0       0       0       0  
 
                       
Weighted averages shares for diluted earnings per share
    18,674,213       13,546,569       17,820,254       13,533,302  
 
                         
Diluted earnings per share
  $ .11     $ .15     $ .21     $ .21  
 
                       
Stock options for 28,500 and 34,000 shares were not considered in the computing of diluted earnings per share for 2011 and 2010, respectively, because they were antidilutive.
Stock Based Compensation:
The Company’s Stock Option Plan (the “Plan”), permitted the grant of share options to its directors, officers and employees. Under the terms of the Plan no additional shares can be issued. Option awards were granted with an exercise price equal to the market price of the Company’s common shares at the date of grant, with a vesting period of 5 years and have 10-year contractual terms. At June 30, 2011 there were 28,500 outstanding options of which 25,500 were fully vested and are exercisable.
The fair value of each option award is estimated on the date of grant using a Black-Scholes model. Total compensation cost charged against income for the stock option plan for the six month period ended June 30, 2011 was not material. No related income tax benefit was recorded.
Comprehensive Income:
Comprehensive income consists of net income and other comprehensive income or loss. Other comprehensive income or loss consists solely of the change in net unrealized gains and losses on securities available for sale, net of reclassification for gains or losses recognized in income.

 

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Recent Accounting Pronouncements
ASU No. 2010-20, “Receivables (Topic 310) — Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses.” ASU 2010-20 requires entities to provide disclosures designed to facilitate financial statement users’ evaluation of (i) the nature of credit risk inherent in the entity’s portfolio of financing receivables, (ii) how that risk is analyzed and assessed in arriving at the allowance for credit losses and (iii) the changes and reasons for those changes in the allowance for credit losses. Disclosures must be disaggregated by portfolio segment, the level at which an entity develops and documents a systematic method for determining its allowance for credit losses, and class of financing receivable, which is generally a disaggregation of portfolio segments. The required disclosures include, among other things, a rollforward of the allowance for credit losses as well as information about modified, impaired, non-accrual and past due loans and credit quality indicators. ASU 2010-20 became effective for the Company’s consolidated financial statements as of December 31, 2010, as it relates to disclosures required as of the end of a reporting period. Disclosures that relate to activity during a reporting period became effective for the Company’s consolidated financial statements beginning on January 1, 2011. ASU 2011-01, “Receivables (Topic 310) — Deferral of the Effective Date of Disclosures about Troubled Debt Restructurings in Update No. 2010-20,” temporarily deferred the effective date for disclosures related to troubled debt restructurings to coincide with the effective date of the then proposed ASU 2011-02, “Receivables (Topic 310) — A Creditor’s Determination of Whether a Restructuring Is a Troubled Debt Restructuring,” which is further discussed below.
ASU No. 2010-28, “Intangibles — Goodwill and Other (Topic 350) — When to Perform Step 2 of the Goodwill Impairment Test for Reporting Units with Zero or Negative Carrying Amounts.” ASU 2010-28 modifies Step 1 of the goodwill impairment test for reporting units with zero or negative carrying amounts. For those reporting units, an entity is required to perform Step 2 of the goodwill impairment test if it is more likely than not that a goodwill impairment exists. In determining whether it is more likely than not that a goodwill impairment exists, an entity should consider whether there are any adverse qualitative factors indicating that an impairment may exist such as if an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying amount. ASU 2010-28 became effective for the Company on January 1, 2011 and did not have a significant impact on the Company’s consolidated financial statements.
ASU No. 2011-02, “Receivables (Topic 310) — A Creditor’s Determination of Whether a Restructuring Is a Troubled Debt Restructuring.” ASU 2011-02 clarifies which loan modifications constitute troubled debt restructurings and is intended to assist creditors in determining whether a modification of the terms of a receivable meets the criteria to be considered a troubled debt restructuring, both for purposes of recording an impairment loss and for disclosure of troubled debt restructurings. In evaluating whether a restructuring constitutes a troubled debt restructuring, a creditor must separately conclude, under the guidance clarified by ASU 2011-02, that both of the following exist: (a) the restructuring constitutes a concession; and (b) the debtor is experiencing financial difficulties. ASU 2011-02 will be effective for the Company on July 1, 2011, and applies retrospectively to restructurings occurring on or after January 1, 2011. Adoption of ASU 2011-02 is not expected have a significant impact on the Company’s consolidated financial statements.
Fair Value
Fair value is the exchange price that would be received for an asset or paid to transfer a liability (exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. There are three levels of inputs that may be used to measure fair values:
Level 1 — Quoted prices (unadjusted) for identical assets or liabilities in active markets that the entity has the ability to access as of the measurement date.

 

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Level 2 — Significant other observable inputs other than Level 1 prices such as 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.
Level 3 — Significant unobservable inputs that reflect a reporting entity’s own assumptions about the assumptions that market participants would use in pricing an asset or liability.
The Company used the following methods and significant assumptions to estimate the fair value of each type of financial instrument:
Investment Securities: The fair values for investment securities are determined by quoted market prices, if available (Level 1). For securities where quoted prices are not available, fair values are calculated based on market prices of similar securities (Level 2). For securities where quoted prices or market prices of similar securities are not available, fair values are calculated using discounted cash flows or other market indicators (Level 3).
Impaired Loans: The fair value of impaired loans with specific allocations of the allowance for loan losses is generally based on recent real estate appraisals. These appraisals may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach. Adjustments are routinely made in the appraisal process by the appraisers to adjust for differences between the comparable sales and income data available. Such adjustments are usually significant and typically result in a Level 3 classification of the inputs for determining fair value.
Assets Measured on a Recurring Basis
Assets measured at fair value on a recurring basis are summarized below:
                                 
            Fair Value Measurements at  
            June 30, 2011 Using:  
            Quoted Prices in              
            Active Markets     Significant Other     Significant  
            for Identical     Observable     Unobservable  
    Carrying     Assets     Inputs     Inputs  
(In Thousands of Dollars)   Value     (Level 1)     (Level 2)     (Level 3)  
Financial Assets
                               
Investment securities available-for sale
                               
U.S. Treasury and U.S. government sponsored entities
  $ 90,935     $ 0     $ 90,935     $ 0  
State and political subdivisions
    81,810       0       81,810       0  
Mortgage-backed securities-residential
    161,730       0       161,718       12  
Collateralized mortgage obligations
    23,088       0       23,088       0  
Equity securities
    506       506       0       0  
Other securities
    266       0       266       0  
 
                       
Total investment securities
  $ 358,335     $ 506     $ 357,817     $ 12  
 
                       

 

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            Fair Value Measurements at  
            December 31, 2010 Using:  
            Quoted Prices in              
            Active Markets     Significant Other     Significant  
            for Identical     Observable     Unobservable  
    Carrying     Assets     Inputs     Inputs  
(In Thousands of Dollars)   Value     (Level 1)     (Level 2)     (Level 3)  
Financial Assets
                               
Investment securities available-for sale
                               
U.S. Treasury and U.S. government sponsored entities
  $ 69,978     $ 0     $ 69,978     $ 0  
State and political subdivisions
    80,466       0       80,466       0  
Mortgage-backed securities-residential
    143,777       0       143,765       12  
Collateralized mortgage obligations
    19,660       0       19,660       0  
Equity securities
    199       199       0       0  
Other securities
    267       0       267       0  
 
                       
Total investment securities
  $ 314,347     $ 199     $ 314,136     $ 12  
 
                       
There were no significant transfers between level 1 and level 2 during the three and six month periods ending June 30, 2011.
The table below presents a reconciliation and income statement classification of gains and losses for all assets measured at fair value on a recurring basis:
                                 
    Investment Securities  
    Available-for-sale  
    (Level 3)  
    Three Months Ended June 30,     Six Months Ended June 30,  
(In Thousands of Dollars)   2011     2010     2011     2010  
Beginning balance
  $ 12     $ 13     $ 12     $ 13  
Total unrealized gains or losses:
                               
Included in other comprehensive income or loss
    0       0       0       0  
Purchases, sales, issuances and settlements, net
    0       0       0       0  
Transfer in and/or out
    0       0       0       0  
 
                       
Ending balance
  $ 12     $ 13     $ 12     $ 13  
 
                       
Assets Measured on a Non-Recurring Basis
Assets measured at fair value on a non-recurring basis are summarized below:
                                 
    Fair Value Measurements  
    at June 30, 2011 Using:  
            Quoted Prices     Significant        
            in Active     Other     Significant  
            Markets for     Observable     Unobservable  
            Identical Assets     Inputs     Inputs  
(In Thousands of Dollars)   Carrying Value     (Level 1)     (Level 2)     (Level 3)  
Financial assets:
                               
Impaired loans
                               
Commercial real estate
                               
Owner occupied
  $ 441     $ 0     $ 0     $ 441  
Non-owner occupied
    680       0       0       680  
Other
    724       0       0       724  
Commercial
    153       0       0       153  

 

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    Fair Value Measurements  
    at December 31, 2010 Using:  
            Quoted Prices     Significant        
            in Active     Other     Significant  
            Markets for     Observable     Unobservable  
            Identical Assets     Inputs     Inputs  
(In Thousands of Dollars)   Carrying Value     (Level 1)     (Level 2)     (Level 3)  
Financial assets:
                               
Impaired loans
                               
Commercial real estate
                               
Owner occupied
  $ 1,239     $ 0     $ 0     $ 1,239  
Non-owner occupied
    164       0       0       164  
Other
    662       0       0       662  
Commercial
    186       0       0       186  
Impaired loans, which are measured for impairment using the fair value of the collateral for collateral dependent loans, had a principal balance of $2.6 million with a valuation allowance of $561 thousand, resulting in an additional provision for loan loss of $66 thousand and $397 thousand for the three and six month periods ending June 30, 2011. At December 31, 2010, impaired loans had a principal balance of $2.8 million, with a valuation allowance of $565 thousand. Excluded from the fair value of impaired loans, at June 30, 2011 and December 31, 2010, discussed above are $1.8 million of loans classified as troubled debt restructurings, which are not carried at fair value.
The carrying amounts and estimated fair values of financial instruments, at June 30, 2011 and December 31, 2010 are as follows:
                 
(In Thousands of Dollars)            
June 30, 2011   Carrying Amount     Fair Value  
Financial assets
               
Cash and cash equivalents
  $ 45,139     $ 45,139  
Securities available-for-sale
    358,335       358,335  
Restricted stock
    4,224       n/a  
Loans, net
    557,828       574,353  
Accrued interest receivable
    4,086       4,086  
 
               
Financial liabilities
               
Deposits
    770,063       774,535  
Short-term borrowings
    108,720       108,720  
Long-term borrowings
    23,572       26,068  
Accrued interest payable
    678       678  
                 
(In Thousands of Dollars)            
December 31, 2010   Carrying Amount     Fair Value  
Financial assets
               
Cash and cash equivalents
  $ 37,305     $ 37,305  
Securities available-for-sale
    314,347       314,347  
Restricted stock
    3,977       n/a  
Loans, net
    581,060       590,331  
Accrued interest receivable
    4,125       4,125  
 
               
Financial liabilities
               
Deposits
    761,050       764,170  
Short-term borrowings
    105,634       105,634  
Long-term borrowings
    24,733       27,080  
Accrued interest payable
    703       703  

 

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The methods and assumptions used to estimate fair value are described as follows:
Carrying amount is the estimated fair value for cash and cash equivalents, accrued interest receivable and payable, demand deposits, short-term debt, and variable rate loans or deposits that reprice frequently and fully. The methods for determining the fair values for securities were described previously. For fixed rate loans or deposits and for variable rate loans or deposits with infrequent repricing or repricing limits, fair value is based on discounted cash flows using current market rates applied to the estimated life and credit risk. Fair value of debt is based on current rates for similar financing. It was not practicable to determine the fair value of restricted stock due to restrictions placed on its transferability. The fair value of off-balance-sheet items is not considered material.
Segment Information
The reportable segments are determined by the products and services offered, primarily distinguished between banking and trust operations. They are also distinguished by the level of information provided to the chief operating decision makers in the Company, who use such information to review performance of various components of the business, which are then aggregated. Loans, investments, and deposits provide the revenues in the banking operation, and trust service fees provide the revenue in trust operations. All operations are domestic.
Significant segment totals are reconciled to the financial statements as follows:
                                 
(In Thousands of Dollars)   Trust     Bank             Consolidated  
June 30, 2011   Segment     Segment     Others     Totals  
 
                               
Assets
                               
Cash and due from banks
  $ 2,019     $ 43,147     $ (27 )   $ 45,139  
Securities available for sale
    2,387       355,821       127       358,335  
Net loans
    0       557,828       0       557,828  
Premises and equipment, net
    109       14,490       0       14,599  
Goodwill and other intangibles
    6,665       0       0       6,665  
Other assets
    545       30,759       351       31,655  
 
                       
Total Assets
  $ 11,725     $ 1,002,045     $ 451     $ 1,014,221  
 
                       
 
                               
Liabilities and Stockholders’ Equity
                               
Deposits, borrowings and other liabilities
  $ 613     $ 910,132     $ (5,100 )   $ 905,645  
Stockholders’ equity
    11,112       91,913       5,551       108,576  
 
                       
Total Liabilities and Stockholders’ Equity
  $ 11,725     $ 1,002,045     $ 451     $ 1,014,221  
 
                       
                                 
(In Thousands of Dollars)   Trust     Bank             Consolidated  
December 31, 2010   Segment     Segment     Others     Totals  
 
                               
Assets
                               
Cash and due from banks
  $ 1,122     $ 36,343     $ (160 )   $ 37,305  
Securities available for sale
    2,627       311,601       119       314,347  
Net loans
    0       581,060       0       581,060  
Premises and equipment, net
    113       13,831       0       13,944  
Goodwill and other intangibles
    6,920       0       0       6,920  
Other assets
    425       28,336       414       29,175  
 
                       
Total Assets
  $ 11,207     $ 971,171     $ 373     $ 982,751  
 
                       
 
                               
Liabilities and Stockholders’ Equity
                               
Deposits, borrowings and other liabilities
  $ 368     $ 894,052     $ 283     $ 894,703  
Stockholders’ equity
    10,839       77,119       90       88,048  
 
                       
Total Liabilities and Stockholders’ Equity
  $ 11,207     $ 971,171     $ 373     $ 982,751  
 
                       

 

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(In Thousands of Dollars)                          
For the Three Months Ended   Trust     Bank             Consolidated  
June 30, 2011   Segment     Segment     Others     Totals  
Net interest income
  $ 11     $ 9,158     $ (12 )   $ 9,157  
Provision for loan losses
    0       1,075       0       1,075  
Service fees, security gains and other noninterest income
    1,377       1,356       (39 )     2,694  
Noninterest expense
    1,149       6,743       200       8,092  
 
                       
Income before taxes
    239       2,696       (251 )     2,684  
Income taxes
    82       570       (85 )     567  
 
                       
Net Income
  $ 157     $ 2,126     $ (166 )   $ 2,117  
 
                       
                                 
(In Thousands of Dollars)                          
For the Six Months Ended   Trust     Bank             Consolidated  
June 30, 2011   Segment     Segment     Others     Totals  
Net interest income
  $ 22     $ 18,243     $ (25 )   $ 18,240  
Provision for loan losses
    0       2,950       0       2,950  
Service fees, security gains and other noninterest income
    2,727       2,661       (77 )     5,311  
Noninterest expense
    2,349       13,255       302       15,906  
 
                       
Income before taxes
    400       4,699       (404 )     4,695  
Income taxes
    137       888       (137 )     888  
 
                       
Net Income
  $ 263     $ 3,811     $ (267 )   $ 3,807  
 
                       
                                 
(In Thousands of Dollars)                          
For the Three Months Ended   Trust     Bank             Consolidated  
June 30, 2010   Segment     Segment     Others     Totals  
Net interest income
  $ 20     $ 9,168     $ (12 )   $ 9,176  
Provision for loan losses
    0       1,600       0       1,600  
Service fees, security gains and other noninterest income
    1,254       1,158       309       2,721  
Noninterest expense
    1,115       6,365       165       7,645  
 
                       
Income before taxes
    159       2,361       132       2,652  
Income taxes
    55       518       45       618  
 
                       
Net Income
  $ 104     $ 1,843     $ 87     $ 2,034  
 
                       
                                 
(In Thousands of Dollars)                          
For the Six Months Ended   Trust     Bank             Consolidated  
June 30, 2010   Segment     Segment     Others     Totals  
Net interest income
  $ 39     $ 17,971     $ (20 )   $ 17,990  
Provision for loan losses
    0       4,378       0       4,378  
Service fees, security gains and other noninterest income
    2,486       2,226       345       5,057  
Noninterest expense
    2,257       12,711       209       15,177  
 
                       
Income before taxes
    268       3,108       116       3,492  
Income taxes
    93       479       39       611  
 
                       
Net Income
  $ 175     $ 2,629     $ 77     $ 2,881  
 
                       

 

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Item 2.   Management’s Discussion and Analysis of Financial Condition and Results of Operations
Forward Looking Statements
Discussions in this report that are not statements of historical fact (including statements that include terms such as “will,” “may,” “should,” “believe,” “expect,” “anticipate,” “estimate,” “project,” intend,” and “plan”) are forward-looking statements that involve risks and uncertainties. Any forward-looking statement is not a guarantee of future performance and actual future results could differ materially from those contained in forward-looking information. Factors that could cause or contribute to such differences include, without limitation, risks and uncertainties detailed from time to time in the Company’s filings with the Securities and Exchange Commission, including without limitation the risk factors disclosed in Item 1A, “Risk Factors,” of in the Company’s Annual Report on Form 10-K for the year ended December 31, 2010.
Many of these factors are beyond the Company’s ability to control or predict, and readers are cautioned not to put undue reliance on those forward-looking statements. The following list, which is not intended to be an all-encompassing list of risks and uncertainties affecting the Company, summarizes several factors that could cause the Company’s actual results to differ materially from those anticipated or expected in these forward-looking statements:
    general economic conditions in market areas where we conduct business, which could materially impact credit quality trends;
    business conditions in the banking industry;
    the regulatory environment;
    fluctuations in interest rates;
    demand for loans in the market areas where we conduct business;
    rapidly changing technology and evolving banking industry standards;
    competitive factors, including increased competition with regional and national financial institutions;
    new service and product offerings by competitors and price pressures; and other like items.
Other factors not currently anticipated may also materially and adversely affect the Company’s results of operations, cash flows and financial position. There can be no assurance that future results will meet expectations. While the Company believes that the forward-looking statements in this report are reasonable, the reader should not place undue reliance on any forward-looking statement. In addition, these statements speak only as of the date made. The Company does not undertake, and expressly disclaims, any obligation to update or alter any statements whether as a result of new information, future events or otherwise, except as may be required by applicable law.
Overview
For the three months ended June 30, 2011, the Company reported net income of $2.1 million, compared to $2.0 million for the second quarter of 2010. Net income for the six months ended June 30, 2011 was $3.8 million compared to $2.9 million for the same six month period in 2010, representing a 32% increase. Income from trust fees and investment commissions increased 18% during the same six month period. The increases reflect the continued benefit from the strategy to diversify income streams. On a per share basis, net income was $0.11 per diluted share compared $0.15 for the second quarter ended June 30, 2010. The tangible common equity ratio increased to 10.11% at June 30, 2011 as compared to 7.92% at June 30, 2010, mainly as a result of the successful common share offering completed in the first quarter of 2011. The provision for loan losses decreased from $4.4 million for the six month period ending June 30, 2010 to $3.0 million for the six months ended June 30, 2011. This 33% decrease is a result of improved credit quality, as net charge-offs have declined from $3.5 million for the first six months of 2010 to $1.4 million for the same period in 2011. There has also been a decline in 30-89 day delinquencies, from $5.7 million at June 30, 2010 to $3.8 million at June 30, 2011.

 

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The Company’s total assets reported at June 30, 2011 were $1.01 billion, which remains unchanged compared to $1.01 billion in total assets recorded at June 30, 2010. Net loans were reported at $557.8 million at June 30, 2011, versus $605.0 million at the same time in 2010, a decrease of $47.2 million, or 7.8%. The decline in loans, particularly in the first quarter of 2011, is related to seasonality in the retail lending portfolio and slow economic growth. The decline in loan balances resulted in a lower level of loan income for the current quarter. Over this same period, deposits increased $9.4 million, or 1.2%, from $760.7 million at June 30, 2010 to $770.1 million at June 30, 2011.
Stockholders’ equity totaled $108.6 million, or 10.7% of total assets, at June 30, 2011, an increase of $21.6 million, or 24.8%, compared to $87.0 million at June 30, 2010. The increase in equity was primarily the result of the successful common share offering completed in the first quarter of 2011, adding approximately $14 million in capital. The increase is also the result of net income, offset by mark to market adjustments in the Company’s investment securities and cash dividends paid to shareholders during the past twelve months. Shareholders received a $0.03 per share cash dividend on June 30, 2011 and a total of $0.12 per share cash dividends paid in the past four quarters. Book value per share decreased 9.4% from $6.41 per share at June 30, 2010 to $5.81 per share at June 30, 2011. This decrease is mainly the result of the increase in shares outstanding, which includes the 5 million shares issued in the first quarter 2011 common share offering, which were offered at $3.00 per share. The Company’s tangible book value per share also decreased 7.3% from $5.88 per share at June 30, 2010 to $5.45 per share at June 30, 2011.
Results of Operations
The following is a comparison of selected financial ratios and other results at or for the three-month and six month periods ending June 30, 2011 and 2010:
                                 
    At or for the Three Months     At or for the Six Months  
    Ended June 30,     Ended June 30,  
(In Thousands, except Per Share Data)   2011     2010     2011     2010  
Total Assets
  $ 1,014,221     $ 1,014,804     $ 1,014,221     $ 1,014,804  
Net Income
  $ 2,117     $ 2,034     $ 3,807     $ 2,881  
Basic and Diluted Earnings Per Share
  $ .11     $ .15     $ .21     $ .21  
Return on Average Assets (Annualized)
    .83 %     .79 %     .76 %     .57 %
Return on Average Equity (Annualized)
    8.05 %     9.78 %     7.69 %     6.89 %
Efficiency Ratio (tax equivalent basis)
    64.42 %     62.15 %     63.50 %     62.93 %
Equity to Asset Ratio
    10.71 %     8.57 %     10.71 %     8.57 %
Tangible Common Equity Ratio *
    10.11 %     7.92 %     10.11 %     7.92 %
Dividends to Net Income
    26.45 %     19.96 %     29.39 %     28.18 %
Net Loans to Assets
    55.00 %     59.62 %     55.00 %     59.62 %
Loans to Deposits
    73.85 %     80.62 %     73.85 %     80.62 %
     
*   The tangible common equity ratio is calculated by dividing total common stockholders’ equity by total assets, after reducing both amounts by intangible assets. The tangible common equity ratio is not required by U.S. GAAP or by applicable bank regulatory requirements, but is a metric used by management to evaluate the adequacy of the Company’s capital levels. Since there is no authoritative requirement to calculate the tangible common equity ratio, the Company’s tangible common equity ratio is not necessarily comparable to similar capital measures disclosed or

 

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    used by other companies in the financial services industry. Tangible common equity and tangible assets are non-U.S. GAAP financial measures and should be considered in addition to, not as a substitute for or superior to, financial measures determined in accordance with U.S. GAAP. With respect to the calculation of the actual unaudited tangible common equity ratio as of June 30, 2011 and 2010, reconciliations of tangible common equity to U.S. GAAP total common stockholders’ equity and tangible assets to U.S. GAAP total assets are set forth below:
                 
(In Thousands of Dollars)   June 30, 2011     June 30, 2010  
Reconciliation of Common Stockholders’ Equity to Tangible Common Equity
               
Stockholders’ Equity
  $ 108,576     $ 86,991  
Less Goodwill and other intangibles
    6,665       7,210  
 
           
Tangible Common Equity
  $ 101,911     $ 79,781  
 
           
                 
(In Thousands of Dollars)   June 30, 2011     June 30, 2010  
Reconciliation of Total Assets to Tangible Assets
               
Total Assets
  $ 1,014,221     $ 1,014,804  
Less Goodwill and other intangibles
    6,665       7,210  
 
           
Tangible Assets
  $ 1,007,556     $ 1,007,594  
 
           
Net Interest Income. The following schedules detail the various components of net interest income for the periods indicated. All asset yields are calculated on a tax-equivalent basis where applicable. Security yields are based on amortized cost.

 

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Average Balance Sheets and Related Yields and Rates
(Dollar Amounts in Thousands)
                                                 
    Three Months Ended     Three Months Ended  
    June 30, 2011     June 30, 2010  
    AVERAGE                     AVERAGE              
    BALANCE     INTEREST     RATE (1)     BALANCE     INTEREST     RATE (1)  
EARNING ASSETS
                                               
 
                                               
Loans (3) (5) (6)
  $ 562,446     $ 8,444       6.02 %   $ 599,884     $ 9,286       6.21 %
Taxable securities (4)
    269,339       2,048       3.05       255,423       2,261       3.55  
Tax-exempt securities (4) (6)
    76,049       1,111       5.86       58,103       875       6.04  
Equity Securities (2) (6)
    4,343       53       4.89       4,126       47       4.57  
Federal funds sold
    40,287       10       0.10       36,325       15       0.17  
 
                                   
Total earning assets
    952,464       11,666       4.91       953,861       12,484       5.25  
 
                                               
NONEARNING ASSETS
                                               
 
                                               
Cash and due from banks
    18,820                       22,933                  
Premises and equipment
    13,794                       14,405                  
Allowance for Loan Losses
    (10,563 )                     (8,048 )                
Unrealized gains (losses) on securities
    6,073                       8,245                  
Other assets (3)
    43,244                       41,877                  
 
                                           
Total Assets
  $ 1,023,832                     $ 1,033,273                  
 
                                           
 
                                               
INTEREST-BEARING LIABILITIES
                                               
 
                                               
Time deposits
  $ 248,816     $ 1,280       2.06 %   $ 300,567     $ 1,912       2.55 %
Savings deposits
    332,426       385       0.46       295,564       471       0.64  
Demand deposits
    109,679       19       0.07       107,979       37       0.14  
Short term borrowings
    117,610       104       0.35       146,094       234       0.64  
Long term borrowings
    23,643       249       4.22       25,357       269       4.26  
 
                                   
Total Interest-Bearing Liabilities
    832,174       2,037       0.98       875,561       2,923       1.34  
 
                                               
NONINTEREST-BEARING LIABILITIES AND STOCKHOLDERS’ EQUITY
                                               
 
                                               
Demand deposits
    82,715                       70,528                  
Other Liabilities
    3,399                       3,733                  
Stockholders’ equity
    105,544                       83,451                  
 
                                           
Total Liabilities and Stockholders’ Equity
  $ 1,023,832                     $ 1,033,273                  
 
                                   
 
                                               
Net interest income and interest rate spread
          $ 9,629       3.93 %           $ 9,561       3.91 %
 
                                       
 
                                               
Net interest margin
                    4.05 %                     4.02 %
     
(1)   Rates are calculated on an annualized basis.
 
(2)   Equity securities include restricted stock, which is included in other assets on the consolidated balance sheets.
 
(3)   Non-accrual loans and overdraft deposits are included in other assets.
 
(4)   Includes unamortized discounts and premiums. Average balance and yield are computed using the average historical amortized cost.
 
(5)   Interest on loans includes fee income of $401 thousand and $564 thousand for 2011 and 2010 respectively and is reduced by amortization of $441 thousand and $448 thousand for 2011 and 2010 respectively.
 
(6)   For 2011, adjustments of $90 thousand and $382 thousand respectively are made to tax equate income on tax exempt loans and tax exempt securities. For 2010, adjustments of $94 thousand and $291 thousand respectively are made to tax equate income on tax exempt loans and tax exempt securities. These adjustments are based on a marginal federal income tax rate of 35%, less disallowances.

 

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Average Balance Sheets and Related Yields and Rates
(Dollar Amounts in Thousands)
                                                 
    Six Months Ended     Six Months Ended  
    June 30, 2011     June 30, 2010  
    AVERAGE                     AVERAGE              
    BALANCE     INTEREST     RATE (1)     BALANCE     INTEREST     RATE (1)  
EARNING ASSETS
                                               
Loans (3) (5) (6)
  $ 567,849     $ 16,998       6.04 %   $ 600,034     $ 18,612       6.26 %
Taxable securities (4)
    252,588       3,917       3.13       248,726       4,502       3.65  
Tax-exempt securities (4) (6)
    76,557       2,235       5.89       58,449       1,760       6.07  
Equity Securities (2) (6)
    4,235       99       4.71       4,126       100       4.89  
Federal funds sold
    34,920       19       0.11       31,063       24       0.16  
 
                                   
Total earning assets
    936,149       23,268       5.01       942,398       24,998       5.35  
 
                                               
NONEARNING ASSETS
                                               
 
                                               
Cash and due from banks
    22,943                       22,705                  
Premises and equipment
    13,840                       14,394                  
Allowance for Loan Losses
    (10,064 )                     (7,565 )                
Unrealized gains (losses) on securities
    4,851                       7,383                  
Other assets (3)
    42,412                       41,941                  
 
                                           
Total Assets
  $ 1,010,131                     $ 1,021,256                  
 
                                           
 
                                               
INTEREST-BEARING LIABILITIES
                                               
 
                                               
Time deposits
  $ 250,811     $ 2,588       2.08 %   $ 310,383     $ 4,080       2.65 %
Savings deposits
    328,139       757       0.47       288,020       1,000       0.70  
Demand deposits
    110,469       37       0.07       106,474       85       0.16  
Short term borrowings
    111,586       201       0.36       134,673       519       0.78  
Long term borrowings
    23,819       500       4.23       25,999       551       4.27  
 
                                   
Total Interest-Bearing Liabilities
    824,824       4,083       1.00       865,549       6,235       1.45  
 
                                               
NONINTEREST-BEARING LIABILITIES AND STOCKHOLDERS’ EQUITY
                                               
 
                                               
Demand deposits
    82,074                       69,194                  
Other Liabilities
    3,356                       2,252                  
Stockholders’ equity
    99,877                       84,261                  
 
                                           
Total Liabilities and Stockholders’ Equity
  $ 1,010,131                     $ 1,021,256                  
 
                                   
 
                                               
Net interest income and interest rate spread
          $ 19,185       4.01 %           $ 18,763       3.90 %
 
                                       
 
                                               
Net interest margin
                    4.14 %                     4.02 %
     
(1)   Rates are calculated on an annualized basis.
 
(2)   Equity securities include restricted stock, which is included in other assets on the consolidated balance sheets.
 
(3)   Non-accrual loans and overdraft deposits are included in other assets.
 
(4)   Includes unamortized discounts and premiums. Average balance and yield are computed using the average historical amortized cost.
 
(5)   Interest on loans includes fee income of $837 thousand and $994 thousand for 2011 and 2010 respectively and is reduced by amortization of $888 thousand and $882 thousand for 2011 and 2010 respectively.
 
(6)   For 2011, adjustments of $178 thousand and $767 thousand respectively are made to tax equate income on tax exempt loans and tax exempt securities. For 2010, adjustments of $188 thousand and $585 thousand respectively are made to tax equate income on tax exempt loans and tax exempt securities. These adjustments are based on a marginal federal income tax rate of 35%, less disallowances.

 

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Net interest income. Net interest income was $9.2 million for the second quarter of 2011, which compares to $9.2 million in the second quarter of 2010. The net interest margin to average earning assets on a fully taxable equivalent basis improved 3 basis points to 4.05% for the three months ended June 30, 2011, compared to 4.02% for the same period in the prior year. In comparing the quarters ending June 30, 2011 and 2010, yields on earning assets decreased 34 basis points, while the cost of interest bearing liabilities decreased 36 basis points.
On a year-to-date basis, net interest income improved to $18.2 million for the six month period ended June 30, 2011, compared to $18.0 million in the same period in 2010. The annualized net interest margin to average earning assets on a fully taxable equivalent basis was 4.14% for the six months ended June 30, 2011, compared to 4.02% for the same period in the prior year.
Noninterest Income. Noninterest income was $2.7 million for the second quarter of 2011, which compares to $2.7 million for the same quarter of 2010. Trust fees were $1.4 million for the quarter ended June 30, 2011, an increase of $168 thousand, or 14.0%, compared to the same quarter in 2010. Investment commissions also increased for the quarter ended June 30, 2011 to $263 thousand compared to $129 thousand in the same quarter in 2010. The increase in both the trust fees and investment commissions can be attributed to equity market appreciation during the current quarter, as most of the fee income is based on fair market values of invested securities.
Noninterest income for the six months ended June 30, 2011 was $5.3 million, compared to $5.1 million for the same period in 2009. The increase in noninterest income is primarily due to increases in trust fee income and investment commissions in 2011 of $274 thousand and $214 thousand, respectively. As with the current quarter, the six month increase in trust and investment commissions is related to the equity markets’ appreciation.
Noninterest Expense. Noninterest expense totaled $8.1 million for the second quarter of 2011, which is $447 thousand more than the $7.6 million in the same quarter in 2010. Most of this increase is a result of a $384 thousand increase in salaries and employee benefits, resulting from a higher number of employees in the current period.
Noninterest expenses for the six months ended June 30, 2011 was $15.9 million, compared to $15.2 million for the same period in 2010, representing an increase of $729 thousand, or 4.8%. The increase is mainly the result of a $595 thousand increase in salaries and employee benefits. Salaries and benefits increased as a result of added employees in the new loan production office and an accrual of salary expense from the separation agreement with a key employee.
The following is a detail of non-interest expense line items classified between the Trust and the other entities in the Company for the three month and six month periods ending June 30, 2011 and 2010:
                                                 
    For the Three Months Ended  
    June 30, 2011     June 30, 2010  
    Trust     Bank and     Total     Trust     Bank and     Total  
(In Thousands of Dollars)   Company     Others     Company     Company     Others     Company  
Noninterest expense
                                               
Salaries and employee benefits
  $ 704     $ 3,779     $ 4,483     $ 630     $ 3,469     $ 4,099  
Occupancy and equipment
    130       792       922       124       768       892  
State and local taxes
    24       214       238       29       195       224  
Professional fees
    12       255       267       15       366       381  
Advertising
    3       208       211       0       147       147  
FDIC insurance
    0       244       244       0       317       317  
Intangible amortization
    112       0       112       145       0       145  
Core processing charges
    0       245       245       0       237       237  
Other operating expenses
    164       1,206       1,370       172       1,031       1,203  
 
                                   
Total noninterest expense
  $ 1,149     $ 6,943     $ 8,092     $ 1,115     $ 6,530     $ 7,645  
 
                                   

 

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    For the Six Months Ended  
    June 30, 2011     June 30, 2010  
    Trust     Bank and     Total     Trust     Bank and     Total  
(In Thousands of Dollars)   Company     Others     Company     Company     Others     Company  
Noninterest expense
                                               
Salaries and employee benefits
  $ 1,416     $ 7,255     $ 8,671     $ 1,280     $ 6,796     $ 8,076  
Occupancy and equipment
    269       1,569       1,838       248       1,569       1,817  
State and local taxes
    49       436       485       59       397       456  
Professional fees
    23       480       503       30       660       690  
Advertising
    3       353       356       2       275       277  
FDIC insurance
    0       592       592       0       620       620  
Intangible amortization
    255       0       255       290       0       290  
Core processing charges
    0       490       490       0       476       476  
Other operating expenses
    334       2,382       2,716       348       2,127       2,475  
 
                                   
Total noninterest expense
  $ 2,349     $ 13,557     $ 15,906     $ 2,257     $ 12,920     $ 15,177  
 
                                   
The Company’s tax equivalent efficiency ratio for the three month period ended June 30, 2011 was 64.42% compared to 62.15% for the same period in 2010. The decline in the efficiency ratio was the result of the $46 thousand decrease in net interest income and noninterest income, and a $447 thousand increase in noninterest expense.
The Company’s tax equivalent efficiency ratio for the six month period ended June 30, 2011 was 63.50% compared to 62.93% in the prior year’s same six month period. The decline in the efficiency ratio was the result of the $729 thousand increase in noninterest expense.
Income Taxes. Income tax expense totaled $567 thousand for the quarter ended June 30, 2011 and $618 thousand tax expense for the quarter ended June 30, 2010. The decrease in the current quarter can be attributed to the $145 thousand increase in tax exempt income from state and local government securities.
Income tax expense was $888 thousand for the first six months of 2011 and $611 thousand for the first six months of 2010. The effective tax rate for the first six months of 2011 was 18.91%, compared to 17.50% for the same period in 2010. The effective tax rate increase over the same period in 2010 was due to the recognition of tax benefits related to the arbitration and subsequent settlement surrounding the acquisition of the Trust company during the first six months of 2010.
Other Comprehensive Income. For the quarter ended June 30, 2011, the change in net unrealized gains on securities, net of reclassifications, resulted in an unrealized gain, net of tax, of $3.8 million, compared to an unrealized gain of $3.0 million for the same period in 2010. Management believes the increases in fair value for the three month periods ending June 30 in 2011 and 2010 are the result of the continued low interest rate environment that exists in the debt securities market.
For the first six months of 2011, the change in net unrealized gains on securities, net of reclassifications, resulted in an unrealized gain, net of tax, of $3.8 million, compared to an unrealized gain of $4.1 million for the same period in 2010. Management believes the increase in fair value for the periods in 2011 and 2010 is largely due to lower market interest rates.

 

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Financial Condition
Cash and cash equivalents. Cash and cash equivalents increased $7.8 million during the first six months of 2011. The Company expects these levels to remain steady over the next few months. The increase is a result of management’s effort to keep a larger balance in federal funds sold for unforeseen liquidity purposes
Securities. Securities available-for-sale increased by $44.0 million since December 31, 2010. Securities were purchased in an effort to increase returns on some of the cash available from the additional core deposit account balances and repurchase agreements sold during the period. There was a $5.9 million increase in the net unrealized gains on securities during the first six months of 2011.
Loans. Gross loans decreased $21.7 million, or 3.67%, since December 31, 2010. The commercial real estate loan and residential real estate loan portfolios decreased $8.5 million and $7.8 million, respectively, accounting for the majority of the decrease in gross loans during the first six months of 2011. The decline in loans is related to seasonality in the retail lending portfolio and slow economic growth in the Mahoning Valley. The decline in loan balances resulted in a lower level of loan income for the current quarter. On a fully tax equivalent basis, loans contributed 73.05% of total interest income for the six months ended June 30, 2011 and 74.45% for the same period in 2010.
Allowance for Loan Losses. The following table indicates key asset quality ratios that management evaluates on an ongoing basis. The unpaid principal balance of non-performing loans and non-performing assets was used in the calculation of amounts and ratios on the table below.
Asset Quality History
(In Thousands of Dollars)
                                         
    6/30/11     3/31/11     12/31/10     9/30/10     6/30/10  
 
                                       
Nonperforming loans
  $ 7,865     $ 11,011     $ 8,901     $ 9,207     $ 9,954  
 
                                       
Nonperforming loans as a % of total loans
    1.38 %     1.91 %     1.51 %     1.52 %     1.62 %
 
                                       
Loans delinquent 30-89 days
    3,758       3,392       7,924       5,888       5,652  
Loans delinquent 30-89 days as a % of total loans
    .66 %     .59 %     1.34 %     .97 %     .92 %
 
                                       
Allowance for loan losses
  $ 10,876     $ 10,137     $ 9,307     $ 7,785     $ 8,255  
 
                                       
Allowance for loan losses as a % of loans
    1.91 %     1.76 %     1.58 %     1.28 %     1.35 %
Allowance for loan losses as a % of nonperforming loans
    138.28 %     92.06 %     104.56 %     84.56 %     82.93 %
Annualized net charge-offs to average net loans outstanding
    .24 %     .74 %     .46 %     1.31 %     1.04 %
 
                                       
Non-performing assets
    8,664       11,867       9,433       9,533       10,099  
Non-performing assets as a % of total assets
    0.85 %     1.17 %     .96 %     .90 %     1.00 %
 
                                       
Net charge-offs for the quarter
    336       1,045       677       1,970       1,565  
For six months ended June 30, 2011, management provided $3.0 million to the allowance for loan losses, a decrease of $1.4 million over the same six month period in the prior year. This 32% decrease is a result of improved credit quality, as net charge-offs have declined from $3.5 million for the first six months of 2010 to $1.4 million for the same period in 2011. There has also been a decline in the 30-89 day delinquencies, from $5.7 million at June 30, 2010 to $3.8 million at June 30, 2011. The ratio of nonperforming loans to total loans decreased from 1.62% at June 30, 2010 to 1.38% at June 30, 2011. Non-performing loans totaled $7.9 million at June 30, 2011, a decrease of $2.1 million, compared to June 30, 2010. The decrease compared to the prior period is primarily related to lower levels of non-performing commercial and commercial real estate loans. On June 30, 2011, the ratio of the allowance for loan losses (ALLL) to non-performing loans was 138%, compared to 83% at June 30, 2010. At June 30, 2011, the ALLL/total loan ratio was 1.91% compared to 1.35% at June 30, 2010. This ALLL/total loan ratio’s increase over the past twelve months is mainly the result of loan balances declining from $613.3 million at June 30, 2010 to $568.7 million at June 30, 2011. The residential and consumer portfolios have experienced some deterioration during the six month period ending June 30, 2011. In addition, real estate values have continued to depreciate, causing management to provide more to the ALLL.

 

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For the three months ended June 30, 2011, management provided $1.1 million to the allowance for loan losses, a decrease of $800 thousand from the preceding quarter and a decrease of $525 thousand over the same three month period in the prior year. Net charge-offs for the quarter ending June 30, 2011 were $336 thousand compared to $1.0 million and $1.6 million for the first quarter of 2011 and the second quarter of 2010, respectively. The provision for loan losses exceeded net charge-offs for the three month period ended June 30, 2011 which is mainly due to an unusually high amount of recoveries during quarter ending June 30, 2011. Recoveries for the three month period ending June 30, 2011 were $699 thousand compared to $214 thousand and $125 thousand for the quarters ending March 31, 2011 and June 30, 2010, respectively.
Based on the evaluation of the adequacy of the allowance for loan losses, management believes that the allowance for loan losses at June 30, 2011 to be adequate and reflects probable incurred losses in the portfolio. The provision for loan losses is based on management’s judgment after taking into consideration all factors connected with the collectability of the existing loan portfolio. Management evaluates the loan portfolio in light of economic conditions, changes in the nature and volume of the loan portfolio, industry standards and other relevant factors. Specific factors considered by management in determining the amounts charged to operating expenses include previous credit loss experience, the status of past due interest and principal payments, the quality of financial information supplied by loan customers and the general condition of the industries in the community to which loans have been made.
Deposits. Total deposits increased $9.0 million, or 1.18%, since December 31, 2010. Balances in the Company’s non-interest bearing deposits increased $3.8 million, or 4.92%, between December 31, 2010 and June 30, 2011. Money market accounts also increased $8.4 million between December 31, 2010 and June 30, 2011. Time deposit accounts decreased $6.4 million, or 2.51%, during the six month period, as customers continued to move deposit dollars from time deposits seeking liquidity. The Company’s focus is on core deposit growth and the Company will continue to price deposit rates to remain competitive within the market and to retain customers. At June 30, 2011, core deposits — savings and money market accounts, time deposits less than $100,000 and demand deposits — represented approximately 85% of total deposits.
Borrowings. Total borrowings increased $1.9 million, or 1.48%, since December 31, 2010. The increase in borrowings is the result of an increase in securities sold under repurchase agreements offset by a decrease in Federal Home Loan Bank (“FHLB”) advances. Repurchase agreements increased $3.1 million while federal home loan advances decreased $1.1 million during the first six months of 2011. The increase in repurchase agreements is due to an increase in public funds deposits and the decrease in FHLB advances is the result of normal pay down of the advances.
Capital Resources. Total stockholders’ equity increased from $88.0 million at December 31, 2010 to $108.6 million at June 30, 2011. The increase is a result of the successful completion by the Company of a 5,000,000 common share offering during January 2011, which injected approximately $14 million into the Company. The increase is also the result of net income and mark to market adjustments in the Company’s investment securities partially offset by cash dividends paid to shareholders during the past twelve months. Shareholders received a $0.03 per share cash dividend on June 30, 2011 and a total of $0.06 per share cash dividends paid in the past two quarters. Book value per share decreased 9.9% from $6.45 per share at December 31, 2010 to $5.81 per share at June 30, 2011. This decrease is mainly the result of the sale of stock at less than book value.
The capital management function is a regular process that consists of providing capital for both the current financial position and the anticipated future growth of the Company. As of June 30, 2011 the Company’s total risk-based capital ratio stood at 16.94%, and the Tier I risk-based capital ratio and Tier I leverage ratio were at 15.65% and 9.41%, respectively. Management believes that the Company and the Bank meet all capital adequacy requirements to which they are subject, as of June 30, 2011.

 

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Due to the continuing growth in Farmers Bank’s business and the increase in its allowance for loan losses associated with current economic conditions, senior management and the Board have determined that higher levels of capital are appropriate. The OCC concurred in the Board’s view that additional capital would be beneficial in supporting its continued growth and operations. As a result, effective February 2, 2010, the OCC proposed and Farmers Bank accepted the following individual minimum capital requirements for Farmers Bank: Tier I Capital to Adjusted Total Assets of 7.20% and Total Capital to Risk-Weighted Assets of 11.00%. At June 30, 2011, the Bank is in compliance with these minimum capital requirements.
Critical Accounting Policies
The Company follows financial accounting and reporting policies that are in accordance with U.S. GAAP. These policies are presented in Note 1 of the consolidated audited financial statements in the Company’s Annual Report to Shareholders included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2010. Critical accounting policies are those policies that require management’s most difficult, subjective or complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain. The Company has identified two accounting policies that are critical accounting policies and an understanding of these policies is necessary to understand the Company’s financial statements. These policies relate to determining the adequacy of the allowance for loan losses and other-than-temporary impairment of securities. Additional information regarding these policies is included in the notes to the aforementioned 2010 consolidated financial statements, Note 1 (Summary of Significant Accounting Policies), Note 2 (Securities), Note 3 (Loans), and the sections captioned “Loan Portfolio” and “Investment Securities”.
Management believes that the accounting for goodwill and other intangible assets also involves a higher degree of judgment than most other significant accounting policies. U.S. GAAP establishes standards for the amortization of acquired intangible assets and the impairment assessment of goodwill. Goodwill arising from business combinations represents the value attributable to unidentifiable intangible assets in the business acquired. The Company’s goodwill relates to the value inherent in the banking industry and that value is dependent upon the ability of the Company’s trust subsidiary to provide quality, cost-effective trust services in a competitive marketplace. The goodwill value is supported by revenue that is in part driven by the volume of business transacted. A decrease in earnings resulting from a decline in the customer base or the inability to deliver cost-effective services over sustained periods can lead to impairment of goodwill that could adversely impact earnings in future periods. U.S. GAAP requires an annual evaluation of goodwill for impairment, or more frequently if events or changes in circumstances indicate that the asset might be impaired. The fair value of the goodwill, which resides on the books of the Trust, is estimated by reviewing the past and projected operating results for the subsidiary and trust banking industry comparable information.
Liquidity
The Company maintains, in the opinion of management, liquidity sufficient to satisfy depositors’ requirements and meet the credit needs of customers. The Company depends on its ability to maintain its market share of deposits as well as acquiring new funds. The Company’s ability to attract deposits and borrow funds depends in large measure on its profitability, capitalization and overall financial condition. The Company’s objective in liquidity management is to maintain the ability to meet loan commitments, purchase securities or to repay deposits and other liabilities in accordance with their terms without an adverse impact on current or future earnings. Principal sources of liquidity for the Company include assets considered relatively liquid, such as federal funds sold, cash and due from banks, as well as cash flows from maturities and repayments of loans, and securities.

 

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Along with its liquid assets, the Bank has additional sources of liquidity available which help to insure that adequate funds are available as needed. These other sources include, but are not limited to, loan repayments, the ability to obtain deposits through the adjustment of interest rates and the purchasing of federal funds and borrowings on an approved line of credit at a major domestic bank. At June 30, 2011, this line of credited totaled $15.0 million and the Bank had not borrowed against this line. In addition, the Company has a $1.5 million revolving line of credit with a correspondent bank. The outstanding balance at June 30, 2011 was $1.1 million. Management feels that its liquidity position is adequate and continues to monitor the position on a monthly basis. As of June 30, 2011, the Bank had outstanding balances with the FHLB of Cincinnati of $23.4 million with additional borrowing capacity of approximately $77.6 million with the FHLB as well as access to the Federal Reserve Discount Window, which provides an additional source of funds. The Bank views its membership in the FHLB as a solid source of liquidity.
The primary investing activities of the Company are originating loans and purchasing securities. During the first six months of 2011, net cash used by investing activities amounted to $24.7 million, compared to $17.5 million used in investing activities for the same period in 2010. Purchases of securities amounted to $63.3 million used during the first six months of 2011 compared to $39.0 million used during the same period in 2010. $19.8 million in net cash provided by loan originations and payments during the first six months of 2011, compared to $7.6 million used in loan originations and payments during the same period in 2010, accounted for a majority of the $7.3 million change in cash provided by investing activities. The cash provided by lending activities during this year’s first six month period can be attributed to a reduction to the activity in the indirect, consumer real estate, and the commercial loan portfolios.
The primary financing activities of the Company are obtaining deposits, repurchase agreements and other borrowings. Net cash provided by financing activities amounted to $23.8 million for the first six months of 2011, compared to $7.3 million used by financing activities for the same period in 2010. $13.8 million of this change is a result of the issuance of the Company’s common and treasury shares during the public offering during the first quarter of 2011. A smaller increase of $8.9 million in the short term borrowings category, compared to prior year, along with $9.0 million in cash provided by deposits in 2011 compared to $16.9 million in cash used for deposits in 2010 accounted for the remaining differences in financing activities.
Off-Balance Sheet Arrangements
In the normal course of business, to meet the financial needs of our customers, we are a party to financial instruments with off-balance sheet risk. These financial instruments generally include commitments to originate mortgage, commercial and consumer loans, and involve to varying degrees, elements of credit and interest rate risk in excess of amounts recognized in the Consolidated Balance Sheets. The Bank’s maximum exposure to credit loss in the event of nonperformance by the borrower is represented by the contractual amount of those instruments. Because some commitments may expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The same credit policies are used in making commitments as are used for on-balance sheet instruments. Collateral is required in instances where deemed necessary. Undisbursed balances of loans closed include funds not disbursed but committed for construction projects. Unused lines of credit include funds not disbursed, but committed for, home equity, commercial and consumer lines of credit. Financial standby letters of credit are conditional commitments issued to guarantee the performance of a customer to a third party. Those guarantees are primarily used to support public and private borrowing arrangements. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. Total unused commitments were $82.8 million at June 30, 2011 and $68.3 million at December 31, 2010.

 

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Recent Market and Regulatory Developments
In response to the current national and international economic recession, and in an effort to stabilize and strengthen the financial markets and banking industries, the United States Congress and governmental agencies have taken a number of significant actions over the past several years, including the passage of legislation and the implementation of a number of programs. The most recent of these actions was the passage into law, on July 21, 2010, of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”). The Dodd-Frank Act is the most comprehensive change to banking laws and the financial regulatory environment since the Great Depression of the 1930s. The Dodd-Frank Act affects almost every aspect of the nation’s financial services industry and mandates change in several key areas, including regulation and compliance, securities regulation, executive compensation, regulation of derivatives, corporate governance, and consumer protection. While these changes in the law will have a major impact on large financial institutions, even relatively smaller institutions such as the Company will be affected.
For example, state consumer financial protection laws historically have been preempted in their application to national banking associations by the National Bank Act and rules and interpretations adopted by the Office of the Comptroller of the Currency (“OCC”) under that statute. Federal preemption of these laws will be diminished under the new regulatory regime. As Congress has authorized states to enact their own substantive protections and to allow state attorneys general to initiate civil actions to enforce federal consumer protections. In this respect, the Company will be subject to regulation by the new Bureau of Consumer Financial Protection (the “Bureau”) under the Board of Governors of the Federal Reserve System (the “Federal Reserve Board”). The Bureau will consolidate enforcement currently undertaken by myriad financial regulatory agencies, and will have substantial power to define the rights of consumers and responsibilities of providers, including the Company.
In addition, and among many other legislative changes that the Company will assess, the Company will: (1) experience a new assessment model from the FDIC based on assets, not deposits; (2) be subject to enhanced executive compensation and corporate governance requirements; and (3) be able, for the first time (and perhaps competitively compelled) to offer interest on business transaction and other accounts.
The extent to which the Dodd-Frank Act and initiatives thereunder will succeed in addressing the credit markets or otherwise result in an improvement in the national economy is uncertain. In addition, because most aspects of this legislation will be subject to intensive agency rulemaking and subsequent public comment prior to implementation over the next several months, it is difficult to predict at this time the ultimate effect of the Dodd-Frank Act on the Company. It is likely, however, that the Company’s expenses will increase as a result of new compliance requirements.
Various legislation affecting financial institutions and the financial industry will likely continue to be introduced in Congress, and such legislation may further change banking statutes and the operating environment of the Company in substantial and unpredictable ways, and could increase or decrease the cost of doing business, limit or expand permissible activities or affect the competitive balance depending upon whether any of this potential legislation will be enacted, and if enacted, the effect that it or any implementing regulations, would have on the financial condition or results of operations of the Company or any of its subsidiaries. With the enactment of the Dodd-Frank Act, the nature and extent of future legislative and regulatory changes affecting financial institutions remains very unpredictable at this time.
To the extent that the previous information describes statutory and regulatory provisions applicable to the Company, it is qualified in its entirety by reference to the full text of those provisions or agreement. Also, such statutes, regulations and policies are continually under review by Congress and state legislatures and federal and state regulatory agencies and are subject to change at any time, particularly in the current economic and regulatory environment. Any such change in statutes, regulations or regulatory policies applicable to the Company could have a material effect on the business of the Company.

 

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Item 3.   Quantitative and Qualitative Disclosures About Market Risk
The Company’s ability to maximize net income is dependent, in part, on management’s ability to plan and control net interest income through management of the pricing and mix of assets and liabilities. Because a large portion of assets and liabilities of the Company are monetary in nature, changes in interest rates and monetary or fiscal policy affect its financial condition and can have significant impact on the net income of the Company. Additionally, the Company’s balance sheet is currently liability sensitive and in the low interest rate environment that exists today, the Company’s net interest margin should maintain current levels throughout the near future.
The Company considers the primary market exposure to be interest rate risk. Simulation analysis is used to monitor the Company’s exposure to changes in interest rates, and the effect of the change to net interest income. The following table shows the effect on net interest income and the net present value of equity in the event of a sudden and sustained 200 basis point increase or decrease in market interest rates:
             
Changes In Interest Rate   June 30, 2011   December 31, 2010   ALCO
(basis points)   Result   Result   Guidelines
Net Interest Income Change
           
+200
  -3.11%   -3.54%   15.00%
-200
  -4.37%   -3.10%   15.00%
Net Present Value
           
Of Equity Change
           
+200
  .89%   -2.24%   20.00%
-200
  -34.87%   -32.08%   20.00%
The results of the simulation indicate that in an environment where interest rates rise or fall 100 and 200 basis points over a 12 month period, using June 30, 2011 amounts as a base case, and considering the increase in deposit liabilities, and the volatile financial markets. It should be noted that the change in the net present value of equity exceeded policy when the simulation model assumed a sudden decrease in rates of 200 basis points (2%). This was primarily because the positive impact on the fair value of assets would not be as great as the negative impact on the fair value of certain liabilities. Specifically, because core deposits typically bear relatively low interest rates, their fair value would be negatively impacted as the rates could not be adjusted by the full extent of the sudden decrease in rates. Management does not believe that a 200 basis rate decline is realistic in the current interest rate environment. The remaining results of this analysis comply with internal limits established by the Company. A report on interest rate risk is presented to the Board of Directors and the Asset/Liability Committee on a quarterly basis. The Company has no market risk sensitive instruments held for trading purposes, nor does it hold derivative financial instruments, and does not plan to purchase these instruments in the near future.
Item 4.   Controls and Procedures
Based on their evaluation, as of the end of the period covered by this Quarterly Report on Form 10-Q, the Company’s Chief Executive Officer and Chief Financial Officer have concluded the Company’s disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934) are effective. There were no changes in the Company’s internal controls over financial reporting (as defined in Rule 13a — 15(f) under the Exchange Act) that occurred during the fiscal quarter ended June 30, 2011, that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

 

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PART II — OTHER INFORMATION
Item 1.   Legal Proceedings
In the opinion of management there are no outstanding legal actions that will have a material adverse effect on the Company’s financial condition or results of operations.
Item 1A.   Risk Factors
There have been no material changes to the Company’s risk factors from those disclosed in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2010.
Item 2.   Unregistered Sales of Equity Securities and Use of Proceeds Purchases of equity securities by the issuer.
On July 14, 2009, the Company announced the adoption of a stock repurchase program that authorizes the repurchase of up to 4.9% or approximately 657 thousand shares of its outstanding common stock in the open market or in privately negotiated transactions. This program expired in July 2010 and as of this filing had not been renewed.
There was no treasury stock purchased by the issuer during the second quarter of 2011.
Item 3.   Defaults Upon Senior Securities
Not applicable.
Item 4.   (Removed and Reserved).
Item 5.   Other Information
Not applicable.
Item 6.   Exhibits
The following exhibits are filed or incorporated by reference as part of this report:
         
  3.1    
Articles of Incorporation of Farmers National Banc Corp., as amended (incorporated by reference from Exhibit 4.1 to the Company’s Registration Statement on Form S-3 filed with the SEC on October 3, 2001 (File No. 333-70806).
       
 
  3.2    
Amended Code of Regulations of Farmers National Banc Corp. (filed herewith).
       
 
  10.1    
Farmers National Banc Corp. Form of Indemnification Agreement (incorporated by reference from Exhibit 10.1 to the Company’s Current Report on Form 8-K filed with the SEC on April 29, 2011).
       
 
  10.2    
Farmers National Banc Corp. Cash Incentive Plan (incorporated by reference from Exhibit 10.1 to the Company’s Current Report on Form 8-K filed with the SEC on June 24, 2011).
       
 
  10.3    
Farmers National Banc Corp. Long-Term Incentive Plan (incorporated by reference from Exhibit 10.1 to the Company’s Current Report on Form 8-K filed with the SEC on June 29, 2011).

 

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  10.4    
Retirement Agreement by and between Farmers National Banc Corp., the Farmers National Bank of Canfield and Frank L. Paden (incorporated by reference from Exhibit 10.2 to the Company’s Current Report on Form 8-K filed with the SEC on June 29, 2011).
       
 
  31.1    
Rule 13a-14(a)/15d-14(a) Certification of John S. Gulas, President and Chief Executive Officer of the Company (filed herewith).
       
 
  31.2    
Rule 13a-14(a)/15d-14(a) Certification of Carl D. Culp, Executive Vice President, Chief Financial Officer and Treasurer of the Company (filed herewith).
       
 
  32.1    
Certification pursuant to 18 U.S.C. Section 1350 of John S. Gulas, President and Chief Executive Officer of the Company (filed herewith).
       
 
  32.2    
Certification pursuant to 18 U.S.C. Section 1350 of Carl D. Culp, Executive Vice President, Chief Financial Officer and Treasurer of the Company (filed herewith).
       
 
  101 *  
The following materials from the Company’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2011, formatted in XBRL (Extensible Business Reporting Language): (i) the Consolidated Balance Sheets; (ii) the Consolidated Statements of Income and Comprehensive Income; (iii) the Consolidated Statements of Cash Flows; and (iv) Notes to Consolidated Financial Statements, tagged as blocks of text.
     
*   As provided in Rule 406T of Regulation S-T, this information shall not be deemed “filed” for purposes of Section 11 and 12 of the Securities Act of 1933 and Section 18 of the Securities Exchange Act of 1934 or otherwise subject to liability under those sections.

 

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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
     
     FARMERS NATIONAL BANC CORP.
   
 
   
Dated: August 9, 2011
   
 
   
/s/John S. Gulas
 
John S. Gulas
   
President and Chief Executive Officer
   
 
   
Dated: August 9, 2011
   
 
   
/s/Carl D. Culp
 
Carl D. Culp
   
Executive Vice President and Treasurer
   

 

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