Under
the Agreement, the board must also ensure that the Banks internal ratings of
credit relationships are timely, accurate, and consistent with the regulatory
credit classification criteria set forth in the Comptrollers Handbook and
related authority. The board must also ensure that any loan relationship with a
high probability of payment default or other well-defined weakness is rated no
better than substandard, regardless of the existence of certain other
mitigating factors that could reduce credit risk.
In
2010, the internal loan review staff, and the scope of their reviews, was expanded. Considerable progress was
achieved in meeting the expanded loan review scope and evaluating and verifying internal loan ratings in
a timely basis consistent with credit classification criteria set forth in the Comptroller’s Handbook.
Loan review grading methodology was refined to ensure that loans with a probability of payment default or well defined weaknesses
are graded substandard regardless of mitigating controls which might reduce credit risk. The
Director’s Loan Committee monitored this process with bi-monthly meetings and reviewed loan review reports to ensure compliance with the terms
of the Agreement.
In
March of 2011, the risk management departments loan review function was
restructured, and the majority of the loan review responsibilities were
out-sourced to a loan review risk advisory firm. The external loan review
services will begin in April of 2011 and are structured to cover 75% of the
loan portfolio (excluding residential and consumer loans). The
external loan review will be managed by the Loan Review Officer within the risk
management department with reports made independently to the Directors Loan
Committee. The Directors Loan Committee then reports results to the Banks
Board of Directors. The outsourcing of the loan review function will assist
management in ensuring the Banks internal ratings of commercial credit
relationships are timely, accurate and consistent with regulatory credit
classification criteria, as well as assist in the identification of trends and
the assessment of the overall quality of the loan portfolio.
In
the fourth quarter of 2010, the Corporation filled a newly created role of
Chief Credit Officer and established a credit administration division to
oversee the development, maintenance and monitoring of loan policies and
procedures. Responsibilities of the credit administration division that have
been created in the fourth quarter of 2010 and the first quarter of 2011
include credit analysis, credit risk management, loan servicing and
administration, collections and the special assets group, as well as loan
portfolio analysis and the maintenance of the allowance for loan losses. The
functions of the special assets group include loss mitigation and workout of
non-performing loans, liquidation of non-performing assets and other
responsibilities to accelerate and maximize loan recoveries. As part of
establishing the new credit administration division and improving internal
controls, the Banks Chief Credit Officer has identified and engaged
experienced personnel to fill key roles within credit administration.
In
addition to the special assets group, credit risk analytics was created and
staffed to facilitate allowance for loan losses calculations, loan portfolio
monitoring, migration analysis, concentration analysis and other credit risk
analysis. In conjunction with the special assets group, the credit risk
analytics position is responsible for ensuring that loan level detail is
appropriately maintained relative to problem loan reporting, including current
appraisal documentation and the identification of non-accrual loans and loans subject
to classification as troubled debt restructurings.
On
January 24, 2011, the Corporation notified the U.S. Treasury that it will defer
regularly scheduled payments on the Corporations 25,083 shares in Series B
Preferred Stock. As of March 31, 2011, dividends in arrears on the preferred
stock, which must be paid prior to the payment of dividends on common shares,
total approximately $314,000.
In
April 2011, the Corporation received a Sale Agreement concerning an industrial
development property located in the Corporations northern region, the carrying
value of which represents over 40% of the balance of other real estate owned as
of March 31, 2011. The closing of this other real estate owned sale is expected
to occur in the third quarter of 2011.
RESULTS OF OPERATIONS
Net income available to common
stockholders was $1,728,000 for the first quarter of 2011 compared to net loss
available to common stockholders of ($62,000) for the first quarter of 2010.
Basic and diluted earnings per common share available to common stockholders
for the first quarter of 2011 was $0.52 compared to basic and diluted loss per
share of $0.02 for the first quarter of 2010. This represents an increase of
$1,790,000 (2,887%) or $0.54 per basic and diluted common share. The higher net
income figure is attributable to a decrease in the provision for loan losses,
resulting from the stabilization in the rate of deterioration in the loan
portfolio. The annualized return on average assets and return on average equity
increased to 0.64% and 12.16%, respectively, for the first quarter of 2011,
compared with 0.09% and 1.38% for the first quarter of 2010.
Net
interest income before the provision for loan losses was $9,357,000 for the
first quarter of 2011, compared to $9,483,000 for the first quarter of 2010 (a
decrease of only $126,000 or 1.3%). The net yield on interest-earning assets
(on a fully taxable equivalent basis) increased by 0.52% to 4.42% in the first
quarter of 2011 from 3.90% in the first quarter of 2010. This large increase in
the net yield on average interest-earning assets was driven
by a reduction in the cost of interest-bearing liabilities, primarily time
deposits, which decreased from 1.59% for the first quarter of 2010 to 0.88% for
the first quarter of 2011.
31
The
Corporations provision for loan loss expense recorded each quarter is
determined by managements evaluation of the risk characteristics of the loan
portfolio. Net charge-offs increased during the first quarter of 2011 to
$1,694,000, compared to net charge-offs of $1,318,000 for the first quarter of
2010. The Corporation recorded a loan loss provision of $1,875,000 in the first
quarter of 2011 compared to a provision of $3,925,000 in the first quarter of
2010. The allowance for loan losses is discussed more fully below.
Non-interest
income totaled $3,600,000 for the first quarter of 2011, compared to $3,192,000
in the first quarter of 2010, an increase of $408,000 or 12.8%. This increase
was primarily due to the realization of gains on securities sold of $442,000
for the first quarter of 2011. During the first quarter of 2010, $316,000 in
income was recognized with the adoption of ASC 310 regarding deferred loan
fees, and gains on securities sold were recognized of $640,000. The categories
of service charges on deposits and trust and farm management fees experienced
increases of $52,000 (5.8%) and $26,000 (9.8.%), respectively, due to an
increase in overdraft fee income and higher fees received from estate
settlement projects. Annualized non-interest income as a percentage of total
average assets increased to 1.32% for the first three months of 2011, from
1.06% for the same period in 2010.
Total
non-interest expense for the first quarter of 2011 was $9,435,000, an increase
of $149,000 (or 1.6%) from $9,286,000 in the first quarter of 2010. The largest
differences between the first quarters of 2011 and 2010 was an increase in
salaries and employee benefits costs of $203,000, an increase of 4.6%, due to
the addition of personnel, primarily in the Credit Administration department.
Also, the category of other operating expense increased $170,000 (or 15.8%) due
primarily to an increase in insurance premium expenses. Annualized non-interest
expense as a percentage of total average assets decreased to 3.45% for the
first three months of 2011, compared to 3.09% for the same period in 2010.
INCOME
TAXES
The
Corporation recorded an income tax benefit of $88,000 for the first quarter of
2011, as compared to an income tax benefit of $795,000 for the first quarter of
2010. The effective tax rate was (5.3%) for the three-month period ended March
31, 2011 and (148.5%) for the three-month period ended March 31, 2010. The
income tax benefit recognized as of March 31, 2011 is due to the periods
pre-tax income coupled with the effect of tax-exempt investment interest
income. The Corporation also recorded a tax benefit of approximately $328,000
to reflect the impact of first quarter 2011 changes in state income tax rates
on the deferred tax assets. For more information on the Corporations income
taxes see Note 10
Income Taxes in the Notes to condensed Consolidated Financial Statements.
FDIC
On
September 29, 2009, the Board of Directors of the FDIC adopted a Notice of
Proposed Rulemaking (NPR) that would require insured institutions to prepay
their estimated quarterly risk-based assessments for the fourth quarter of 2009
and for all of 2010, 2011 and 2012. The FDIC estimated that the total prepaid
assessments collected would be approximately $45 billion. The FDIC Board also
voted to adopt a uniform three-basis point increase in assessment rates
effective on January 1, 2011, and extend the restoration period from seven to
eight years.
Under
GAAP accounting rules, unlike special assessments, prepaid assessments do not
immediately affect bank earnings. Each institution recorded the entire amount
of its assessment related to future periods as a prepaid expense (an asset) as
of December 31, 2009, the date the payment was made. The Corporation paid an
assessment of $6,763,000 for the fourth quarter of 2009 and for all of 2010,
2011 and 2012.
Beginning
January 1, 2010, and each quarter thereafter, each institution would record an
expense (charge to earnings) for its regular quarterly assessment and an
offsetting credit to the prepaid assessment until the asset is exhausted. At
March 31, 2011, the Corporation had a remaining prepaid assessment of
$3,733,000. This amount is reflected in the category of Other Assets in the
condensed Consolidated Balance Sheets. The Corporation recorded $534,000 of
federal insurance assessment expense for the first quarter of 2011 and $603,000
for the first quarter of 2010.
32
ANALYSIS OF FINANCIAL CONDITION
Total
assets at March 31, 2011 decreased to $1,080,734,000 from $1,096,471,000 at
December 31, 2010 (a decrease
of $15.7 million or 1.5%). Total loan balances decreased by $15.8 million
during the three month period to $688.3 million due to seasonal pay downs in
the agricultural portfolio and general decline in the overall demand for new
low-risk credit. Investment balances totaled $253,877,000 at March 31, 2011,
compared to $260,940,000 at December 31, 2010 (a decrease of $7.1 million, or
2.7%), as part of managements overall asset liability management strategy to
reduce higher cost deposit relationships while maintaining stable liquidity.
Total deposits decreased to $950,667,000 at March 31, 2011 from $962,961,000 at
December 31, 2010 (a decrease of $12.3 million or 1.3%). Comparing categories
of deposits at March 31, 2011 to December 31, 2010, time deposits decreased
$13.7 million (or 3.7%), interest-bearing demand deposits decreased $3.5
million (or 0.9%), savings deposits increased $8.4 million (or 11.2%) and
demand deposits decreased $3.5 million (or 2.5%). Borrowings, consisting of
customer repurchase agreements, treasury, tax, and loan (TT&L) deposits,
and Federal Home Loan Bank (FHLB) advances, decreased from $71,559,000 at December
31, 2010 to $66,730,000 at March 31, 2011 (a decrease of $4.8 million or 6.7%).
This decrease was primarily due to the maturity and repayment of a $4,000,000
FHLB advance in the first quarter of 2011.
CAPITAL
PURCHASE PROGRAM
On
January 23, 2009, the Corporation received $25,083,000 of equity capital by
issuing to the United States Department of Treasury 25,083 shares of the
Corporations 5.00% Series B Non-voting Cumulative Preferred Stock, par value
$0.01 per share with a liquidation preference of $1,000 per share and a
ten-year warrant to purchase up to 155,025 shares of the Corporations common
stock, par value $5.00 per share, at an exercise price of $24.27 per share. The
proceeds received were allocated to the preferred stock and additional paid-in
capital based on their relative fair values. The resulting discount on the
preferred stock is amortized against retained earnings and is reflected in the
Corporations consolidated statement of income as Dividends on preferred
shares, resulting in additional dilution to the Corporations earnings per
share. The warrants are exercisable, in whole or in part, over a term of 10
years. The warrants were included in the Corporations diluted average common
shares outstanding (subject to anti-dilution). Both the preferred securities
and warrants were accounted for as additions to the Corporations regulatory
Tier 1 and total capital.
The
Series B Preferred Stock is not mandatorily redeemable and will pay cumulative
dividends at a rate of 5% per year for the first five years and 9% per year
thereafter. The Corporation can redeem the preferred securities at any time
with Federal Reserve approval. The Series B Preferred Stock ranks on equal
priority with the Corporations currently authorized Series A Preferred stock.
A
company that participates must adopt certain standards for executive
compensation, including (a) prohibiting golden parachute payments as defined
in the Emergency Economic Stabilization Act of 2008 (EESA) to senior Executive
Officers; (b) requiring recovery of any compensation paid to senior Executive
Officers based on criteria that is later proven to be materially inaccurate;
(c) prohibiting incentive compensation that encourages unnecessary and
excessive risks that threaten the value of the financial institution; and (d)
accepting restrictions on the payment of dividends and the repurchase of common
stock.
On
January 24, 2011, the Corporation notified the U.S. Treasury that it will defer
regularly scheduled payments on the Corporations 25,083 shares in Series B
Preferred Stock. As of March 31, 2011, dividends in arrears on the preferred
stock, which must be paid prior to the payment of dividends on common shares,
total approximately $314,000.
33
LOANS
The
Corporations loan portfolio largely reflects the profile of the communities in
which it operates. The Corporation essentially offers four types of loans:
commercial, agricultural, real estate and consumer installment. The Corporation
has no foreign loans. The following table summarizes the Corporations loan
portfolio:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
March
31,
2011
|
|
December
31,
2010
|
|
March
31,
2010
|
|
|
|
Amount
|
|
% of
Total
|
|
Amount
|
|
% of
Total
|
|
Amount
|
|
% of
Total
|
|
Commercial
|
|
$
|
143,009
|
|
|
20.8
|
%
|
$
|
138,325
|
|
|
19.6
|
%
|
$
|
151,806
|
|
|
21.6
|
%
|
Agricultural
|
|
|
66,427
|
|
|
9.7
|
|
|
78,086
|
|
|
11.1
|
|
|
74,797
|
|
|
10.6
|
|
Agricultural real estate
|
|
|
46,791
|
|
|
6.8
|
|
|
46,361
|
|
|
6.6
|
|
|
45,912
|
|
|
6.5
|
|
Commercial real estate
|
|
|
205,134
|
|
|
29.8
|
|
|
205,301
|
|
|
29.2
|
|
|
225,309
|
|
|
32.0
|
|
Commercial real estate development
|
|
|
85,758
|
|
|
12.5
|
|
|
88,402
|
|
|
12.6
|
|
|
97,017
|
|
|
13.8
|
|
Residential real estate
|
|
|
87,989
|
|
|
12.8
|
|
|
90,869
|
|
|
12.9
|
|
|
99,725
|
|
|
14.2
|
|
Total Real Estate
|
|
|
425,672
|
|
|
61.8
|
|
|
430,933
|
|
|
61.2
|
|
|
467,963
|
|
|
66.5
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Consumer
|
|
|
53,205
|
|
|
7.7
|
|
|
56,730
|
|
|
8.1
|
|
|
62,259
|
|
|
8.8
|
|
Total loans
|
|
$
|
688,313
|
|
|
100.0
|
%
|
$
|
704,074
|
|
|
100.0
|
%
|
$
|
756,825
|
|
|
100.0
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total assets
|
|
$
|
1,080,734
|
|
|
|
|
$
|
1,096,471
|
|
|
|
|
$
|
1,200,474
|
|
|
|
|
Loans to total assets
|
|
|
63.7
|
%
|
|
|
|
|
64.2
|
%
|
|
|
|
|
63.0
|
%
|
|
|
|
Total
loans decreased $15,761 (or 2.2%) in the first three months of 2011. There were
no acquisitions in the first quarter of 2011 or in 2010. The decrease reflects
the Corporations 2011 capital management objectives, as well as the continued
dual effects of the present economic environment in which business and consumer
borrowers have reduced demand and capacity for new indebtedness and borrower
financial deterioration resulting in a higher level of loans charged off and
transferred to other real estate owned.
Commercial
loans increased $4,684 (or 3.4%) in the first three months of 2011. The small
increase is due to some expansion in the competitive environment for commercial
loans as economic circumstances begin to show slight improvement.
Loans
to agricultural operations decreased $11,659 (or 17.6%) in the first three
months of 2011. Short-term agricultural loans are seasonal in nature with
paydown from grain sales occurring near the beginning and end of each year.
Rapid growth in the bio-fuels industry (primarily ethanol) and rising worldwide
food demand have dramatically influenced corn prices since the latter part of
2006. Rising corn prices have influenced soybean prices as the two commodities
compete for planted acreage. Corn and soybeans are the two primary crops of the
Corporations market area. As in 2010, selling prices remain historically
strong in 2011, resulting in another year of high profitability for most of the
Corporations agricultural customers. The balance sheet of local agriculture
remains strong, both in terms of equity and liquidity. Agriculture remains the
largest single loan industry concentration of the Corporation. The highly
experienced agricultural staff continues to effectively manage risk and seek
opportunities in this portfolio. Agricultural loans as a percentage of total
loans were 9.7% at March 31, 2011, compared to 11.1% at year-end 2010.
Total
real estate loans decreased $5,261 (or 1.2%) in the first three months of 2011.
Residential real estate loans with fixed rates of more than 5 years are
generally sold into the secondary market. The Corporation retains the servicing
of sold loans, maintaining the local relationship with customers and generating
servicing fee income. With home mortgage rates in 2010 and the first quarter of
2011 at their lowest level in over 50 years, many borrowers refinanced
adjustable rate loans into fixed rate loans that were sold. Total home mortgage
closings were $130,000 in 2010, $45,000 below the record level of $175,000 in
2009.
Consumer
installment loans decreased $3,525 (or 6.2%) in the first three months of 2011.
Home equity lending, which continues to reflect reduced consumer demand,
comprises over two thirds of the installment portfolio.
Although
the risk of non-payment for any reason exists with respect to all loans,
certain other more specific risks are associated with each type of loan. The
primary risks associated with commercial loans are quality of the borrowers
management and the impact of national economic factors. Development and
construction loans have primary risks associated with demand for housing and
other construction projects. As these businesses are capital intensive, when demand
for product weakens, revenues are reduced while fixed costs such as debt
service remain. With respect to agricultural loans, the primary risks are
weather and, like commercial loans, the quality of the borrowers management.
Risks associated with real estate loans include concentrations of loans in a
loan type, such as commercial or agricultural, and fluctuating land values.
Non-owner occupied commercial real estate loans have risks related to occupancy
and lease rates during economic downturns. Installment loans also have risks
associated with concentrations of loans in a single type of loan. Installment
loans additionally carry the risk of a borrowers unemployment as a result of
deteriorating economic conditions. With the exception of agricultural lending,
the current economic environment has increased the risk level in the subsidiary
banks loan portfolio.
34
The
Corporations strategy with respect to addressing and managing these types of
risks, whether loan demand is weak or strong, is for the subsidiary bank to
follow its loan policies and sound underwriting practices, which include: (i)
granting loans on a sound and collectible basis, (ii) investing funds
profitably for the benefit of the stockholders and the protection of depositors,
(iii) serving the legitimate needs of the community and the subsidiary banks
general market area while obtaining a balance between maximum yield and minimum
risk, (iv) ensuring that primary and secondary sources of repayment are
adequate in relation to the amount of the loan, (v) administering loan policies
through a Directors Loan Committee, an Executive Loan Committee and Officer
approvals, (vi) developing and maintaining adequate diversification of the loan
portfolio as a whole and of the loans within each loan category and (vii)
ensuring that each loan is properly documented and, if appropriate, secured or
guaranteed by government agencies, and that insurance coverage is adequate,
especially with respect to certain agricultural loans because of the risk of
poor weather. In the present difficult economic environment, bank officers and
staff actively work with borrowers to achieve the best resolutions possible.
NON-PERFORMING LOANS AND OTHER REAL ESTATE OWNED
Non-performing
loans consist of non-accrual loans, loans past due 90 days on which interest is
still accruing and loans modified in troubled debt restructurings (restructured
loans). Non-performing loans amounted to 15.16% of total loans at March 31,
2011 compared to 13.83% at December 31, 2010. The increase reflects a higher
level of stress in the commercial real estate industry. The primary components
of the non-accrual total are in two industries. One is the commercial real
estate development industry, primarily in the Corporations northern and
eastern market areas. Non-performing commercial real estate development loans
comprise approximately 43.3% of the Corporations total non-performing loans as
of March 31, 2011. Due to dramatic declines in residential real estate sales
activity, certain builders and developers have encountered difficulty in
servicing their debt, eventually leading to non-performing status. The other
primary component of non-performing loans is commercial real estate loans,
which comprise approximately 33.8% of the non-performing total as of March 31,
2011. These are comprised of owner-occupied facilities and leased facilities
and are located throughout the Corporations market area. The balance of
non-performing loans is comprised primarily of residential real estate and home
equity credits. The Corporation has been proactive in obtaining updated
appraisals for non-performing loans secured by real estate. The continued
downward pressure on real estate values, particularly development properties,
has prompted charge-offs and the recording of specific reserves for potential
loss on loans secured by real estate. Management believes this situation peaked
in 2010.
Restructured
loans at March 31, 2011 were $23,685 compared to $23,386 at December 31, 2010.
These are loans to borrowers that are experiencing varying levels of financial
stress but are expected to recover. To assist the borrowers, the Corporation
has provided some concession in loan terms, most commonly extending the loan
amortization or adjusting the interest rate. In the present economic
environment, the vast majority of non-performing loans are secured by real
estate. At the time a loan is restructured, the Corporation considers the
repayment history of the loan and the value of the collateral. If the principal
or interest is due and has remained unpaid for 90 days of more and the loan is
not well-secured, the loan is placed on nonaccrual status. If the principal and
interest payments are current and the loan is well-secured, the restructured
loan continues to accrue interest. Once a loan is placed on nonaccrual status,
the borrower is required to make current principal and interest payments based
on the modified terms for a period of at least 6 months before returning the
loan to accrual status.
As
of March 31, 2011 and December 31, 2010, $12,991 and $14,368, respectively, in
restructured loans were in accrual status. When the loan is restructured, the
Loan Officer is required to document the basis for the restructure, obtain current
and complete credit and cash flow information and identify a specific repayment
plan that would retire the debt. This information is provided to the Credit
Analysis department which prepares a thorough credit presentation. The credit
presentation includes the modified terms of the loan, a collateral analysis and
a cash flow analysis based on the modified terms of the loan. The credit
presentation is presented to the Directors Loan Committee for approval.
35
Problem
credits are closely monitored by the lending staff, credit administration
division and special assets group, which was newly formed in 2010. In addition,
beginning in April 2011, external loan review performed by representatives
of a loan review risk advisory firm will provide further assistance in
identifying problem situations. Loans over 90 days past due are normally either
charged off or placed on a non-accrual status. Problem credits have a life
cycle. They either improve or they move through a workout/liquidation process.
The workout process often includes reclassification to non-accrual status,
unless the loan is well secured and in the process of collection. Collateral
securing non-accrual real estate loans that are not resolved by borrowers
becomes other real estate owned via foreclosure or receipt of a deed in lieu of
foreclosure. The Corporation actively markets other real estate owned
properties for sale.
The
Corporation formed a special assets group in 2010 to focus on the management of
the other real estate owned workout process. Total other real estate owned as
of March 31, 2011 was $20,572. The Corporation had $20,652 in other real estate
owned as of December 31, 2010. Over 40% of the March 31, 2011 total is one
industrial development property located in the Corporations northern region.
The Corporation is actively marketing the property by parcel or as a bulk sale.
Most of all improvements are complete on the property. Two distribution centers
are presently located in the industrial park. Additional roadways may be built
depending on how end users choose parcel configuration. A third distribution
center is under construction as of March 31, 2011 on a portion of the parcel
that was sold in 2010. The selling price per acre was significantly above the
Corporations carrying value of the property. In April 2011, the Corporation
received a Sale Agreement concerning the remaining acres for this industrial
development property. The closing of this particular other real owned sale is
expected to occur in the third quarter of 2011.
As
with non-performing loans, the Corporation is proactive in obtaining appraisals
to support the carrying value of other real estate owned property on the
condensed Consolidated Balance Sheets. The following table provides information
on the Corporations non-performing loans and other real estate owned as of the
periods indicated:
|
|
|
|
|
|
|
|
|
|
|
|
|
March 31,
2011
|
|
December 31,
2010
|
|
March 31,
2010
|
|
Non-accrual
|
|
$
|
78,086
|
|
$
|
72,404
|
|
$
|
53,448
|
|
90 days past due and
accruing
|
|
|
2,562
|
|
|
1,561
|
|
|
22
|
|
Restructured
|
|
|
23,685
|
|
|
23,386
|
|
|
13,821
|
|
|
|
|
|
|
|
|
|
|
|
|
Total non-performing loans
|
|
$
|
104,333
|
|
$
|
97,351
|
|
$
|
67,291
|
|
|
|
|
|
|
|
|
|
|
|
|
Other real estate owned
|
|
|
20,572
|
|
|
20,652
|
|
|
20,145
|
|
Total non-performing assets
|
|
$
|
124,905
|
|
$
|
118,003
|
|
$
|
87,436
|
|
|
|
|
|
|
|
|
|
|
|
|
Non-performing loans to total loans (net of unearned interest)
|
|
|
15.16
|
%
|
|
13.83
|
%
|
|
9.08
|
%
|
Non-performing assets to
total assets
|
|
|
11.56
|
%
|
|
10.76
|
%
|
|
7.28
|
%
|
Non-performing
loans consist of non-accrual loans, loans past due 90 days on which interest is
still accruing and restructured loans. Impaired loans of $110,578,
included in the impaired loans table in Note 8 - “Loans and the Allowance for
Loan Losses” in the Notes to Condensed Consolidated Financial Statements, include
$6,245 in impaired loans which are performing as of March 31, 2011, and
therefore are not included in non-performing loans. Performing impaired loans
consist of loans for which management has concern regarding the ultimate
collectability of full principal and interest under the original terms of the
loan agreement due to issues such as borrower payment capacity or
collateral coverage. There were no performing impaired loans as of December 31,
2010.
36
Of
the $104,333 in impaired loans at March 31, 2011, the Corporation relied on
third party appraisals for $101,344 of the impaired loans. Approximately,
$85,857 or 82.3% of the impaired loans had current third party appraisals which
were relied upon. These appraisals were completed within 12 months of March 31,
2011. The appraisals for the remaining $15,472 in impaired loans in which third
party appraisals were obtained had not been updated as the fair value in the
last appraisal received and the current estimated value were in significant
excess of the outstanding debt for $2,434 of these loans.New appraisals for the
remaining impaired loan balances without updated appraisals have been
ordered during the first quarter and the bank will receive the new
appraisals during the second quarter. The average loan to fair value for the
$15,472 was approximately 73.8%. Collateral values which are not based on
current appraisals are discounted 10% to 20% in the collateral evaluation in
addition to the already required
10% discount. The initial 10% discount is due to the anticipated selling costs
of the collateral. The additional discount is based on several factors. These
factors include the Loan Officers review of the collateral and its current
condition, the Corporations knowledge of the current economic environment in
the collaterals market, and the Corporations past experience with real estate
in the area. The date of the appraisal is also considered in conjunction with
the economic environment and the decline in the real estate market since the appraisal
was obtained. The increase in the general reserve portion of the allowance for
loan losses, which was significantly impacted by the increased level of fourth
quarter 2010 loan losses, is adequate to provide for the potential exposure on
loans with non-current appraisals.
The
following table provides a loan-to-value ratio distribution for the $15,472 in
impaired loans with appraisals over twelve months old as of March 31, 2011:
|
|
|
|
|
|
|
Loan-to-Value
|
|
Amount
|
|
|
0 - 50%
|
|
$
|
1,316
|
|
|
50 - 60%
|
|
$
|
1,118
|
|
|
60 - 70%
|
|
$
|
-0-
|
|
|
70 - 80%
|
|
$
|
2,957
|
|
|
80 - 90%
|
|
$
|
1,188
|
|
|
90% +
|
|
$
|
8,893
|
|
Once
a loan is deemed an impaired loan, the Loan Officer or Special Assets officer
in conjunction with the credit analysis department in credit administration,
completes a Problem Asset Workout Summary, which includes a detailed review of
the collateral. If the estimated current collateral value is in significant
excess of the outstanding debt or the appraisal is less than twelve months old,
a new appraisal is not ordered. If the collateral value is not in significant
excess of the outstanding debt or the appraisal is over twelve months old, the
Loan Officer or Special Assets officer with concurrence of the Chief Credit
Officer will determine if a new appraisal should be ordered based on their
knowledge of the current market in the collaterals area. If the Corporation
determines that full collection of the principal of the debt owed is not
likely, a new appraisal is ordered. If the estimated fair value represented in
the new appraisal is less than the outstanding debt, a charge-off is recorded
equal to the difference between the discounted collateral value and the
outstanding debt.
The
determination of a specific allowance or charge-off is reviewed by the
Corporation on a monthly basis. During the three months ended March 31, 2011,
the Corporation recorded partial charge-offs totaling $1,267 on the impaired
loans with an outstanding balance of $3,066. The charge-offs were considered
warranted as the loans were considered collateral dependent and the discounted
collateral value was not sufficient to cover the outstanding debt.
The
Corporation requires appraisals on real estate if the loan is over $250,000 or
if the collateral is commercial real estate at the time of origination of the
loan. If the appraisal is not within one year of the reporting period, the loan
officer provides an additional discount on the collateral based on the Loan
Officers review of the collateral and its current condition, the Corporations
knowledge of the current economic environment in the collaterals market and
the Corporations past experience with real estate in the area. The date of the
appraisal is also considered in conjunction with the economic environment and
the decline in the real estate market since the appraisal was obtained. This
additional discount is usually 10% to 20%. If the loan is below $250,000 and is
not commercial real estate, an internal valuation of the collateral may be
used, but must be completed by a staff member who has no involvement in the
credit decision. Underlying collateral consisting of vehicles, equipment or
other assets is valued using information provided by the borrower. The Loan
Officer must confirm the existence of the assets and provide adequate discounts
on the value of the collateral when determining its adequacy to cover the loan.
Problem Asset Workout Summaries are reviewed by the Risk Management department
and utilized in the preparation of the allowance for loan losses calculation.
Summaries include a collateral analysis detailing a description of the
collateral, the date of the appraisal and the discounts on the collateral. If
the discounted collateral is sufficient to cover the outstanding loan balance,
no specific valuation allowance is placed on the loan.
37
ALLOWANCE FOR POSSIBLE LOAN LOSSES
The
allowance shown in the following table represents the allowance available to
absorb losses within the entire portfolio:
|
|
|
|
|
|
|
|
|
|
|
|
|
March
31,
2011
|
|
December
31,
2010
|
|
March
31,
2010
|
|
Amount of loans outstanding at end of period (net of unearned
interest)
|
|
$
|
688,313
|
|
$
|
704,074
|
|
$
|
756,836
|
|
Average amount of loans outstanding for the period (net of unearned
interest)
|
|
$
|
696,574
|
|
$
|
687,177
|
|
$
|
778,162
|
|
Allowance for loan losses at beginning of year
|
|
$
|
29,726
|
|
$
|
12,075
|
|
$
|
12,075
|
|
Charge-offs:
|
|
|
|
|
|
|
|
|
|
|
Agricultural
|
|
|
24
|
|
|
68
|
|
|
-0-
|
|
Commercial
|
|
|
1,203
|
|
|
19,525
|
|
|
981
|
|
Real estate-mortgage
|
|
|
354
|
|
|
2,266
|
|
|
362
|
|
Installment
|
|
|
186
|
|
|
1,307
|
|
|
74
|
|
Total charge-offs
|
|
|
1,767
|
|
|
23,166
|
|
|
1,417
|
|
|
Recoveries:
|
|
|
|
|
|
|
|
|
|
|
Agricultural
|
|
|
-0-
|
|
|
-0-
|
|
|
-0-
|
|
Commercial
|
|
|
28
|
|
|
45
|
|
|
96
|
|
Real estate-mortgage
|
|
|
-0-
|
|
|
-0-
|
|
|
-0-
|
|
Installment
|
|
|
45
|
|
|
222
|
|
|
3
|
|
Total recoveries
|
|
|
73
|
|
|
267
|
|
|
99
|
|
Net loans charged off
|
|
|
1,694
|
|
|
22,899
|
|
|
1,318
|
|
Provision for loan losses
|
|
|
1,875
|
|
|
40,550
|
|
|
3,925
|
|
|
Allowance for loan losses at end of period
|
|
$
|
29,907
|
|
$
|
29,726
|
|
$
|
14,682
|
|
|
Net loans charged off to average loans
|
|
|
0.97
|
%
|
|
3.33
|
%
|
|
0.69
|
%
|
Allowance for loan losses to non-performing loans
|
|
|
28.66
|
%
|
|
30.53
|
%
|
|
21.82
|
%
|
Allowance for loan losses to total loans at end of period (net of
unearned interest)
|
|
|
4.34
|
%
|
|
4.22
|
%
|
|
1.94
|
%
|
The
allowance for loan losses is considered by management to be a critical
accounting policy. The allowance for loan losses is increased by provisions
charged to operating expense and decreased by charge-offs, net of recoveries.
The allowance is based on factors that include the overall composition of the
loan portfolio, types of loans, past loss experience, loan delinquencies,
potential substandard and doubtful loans, and such other factors that, in
managements best judgment, deserve evaluation in estimating possible loan
losses. The adequacy of the allowance for possible loan losses is monitored
monthly during the ongoing, systematic review of the loan portfolio by the
Credit Risk Analytics staff in Credit Administration, Senior Lending Officers,
Chief Credit Officer, Chief Operating Officer, Chief Financial Officer and
Chief Executive Officer of the subsidiary bank. The results of these reviews
are reported to the Board of Directors of the subsidiary bank on a monthly
basis. Monitoring and addressing problem loan situations are primarily the
responsibility of the subsidiary banks staff, management and its Board of
Directors.
More
specifically, the Corporation calculates the appropriate level of the allowance
for loan losses on a monthly basis using base charge-offs for each loan type,
substandard loans and potential losses with respect to specific loans. In
addition to managements assessment of the portfolio, the Corporation and the
subsidiary bank are examined periodically by regulatory agencies. Although the
regulatory agencies do not determine whether the subsidiary banks allowance
for loan losses is adequate, such agencies do review the procedures and
policies followed by management of the subsidiary bank in establishing the
allowance.
38
Given
the current state of the economy, management has assessed the impact of the
recession on each category of loans and adjusted historical loss factors for
more recent economic trends. Management utilizes a twelve quarter history as
one component in assessing the probability of inherent future losses, while
including additional weighting of the most recent historical data. Given the decline in
economic conditions over the past year, management has also increased its
allocation to various loan categories for economic factors. Some of the
economic factors include the potential for reduced cash flow for commercial
operating loans from reduction in sales or increased operating costs, decreased
occupancy rates for commercial buildings, reduced levels of home sales for
commercial and land developments, reduced values in real estate or other
collateral, the decline in and uncertainty regarding grain prices and increased
operating costs for farmers, and increased levels of unemployment and
bankruptcy impacting consumers ability to pay. Each of these economic
uncertainties was taken into consideration in developing the appropriate level
of reserve.
The
Corporations allowance for loan losses has two components. The first component
is based upon individual review of nonperforming, substandard or other loans
identified as a risk for loss and deemed impaired. This includes our
nonperforming loans, which consist of nonaccrual loans, loans past due over 90
days and troubled debt restructurings, loans designated as impaired as defined
by accounting and regulatory guidance and loans evaluated for potential loss on
an individual basis.
The second
component is based upon expected, but unidentified, losses inherent in our loan
portfolio. The second component is determined utilizing the Corporations most
recent twelve quarter net charge-off history which is then adjusted for
qualitative and quantitative factors. These reserve percentages are reviewed on
a quarterly basis by an Allowance Review Committee which is comprised of
members of management, including lending, accounting and credit administration.
The qualitative and quantitative factors considered include economic
conditions, changes in underwriting practices, changes in the value of
collateral, changes in the portfolio volume, staff experience, past due and
nonaccrual loans, loan review oversight, concentrations of loans and
competition.
The
allowance for loan losses of $29,907 and $29,726, respectively, was 4.34% and
4.22% of total loans as of March 31, 2011 and December 31, 2010. The
Corporations net losses as a percentage of loans was 0.97% and 3.33% for the
three months ended March 31, 2011 and year ended December 31, 2010,
respectively. The Corporations net losses experienced and the level of the
required allowance for loan losses have grown slightly and remain high due to
the continued deterioration in the economic environment, especially relative to
commercial real estate and commercial real estate development loans in its
northern and eastern markets in Grundy, Kane and DuPage counties, but the
growth trend in losses and provision appears to be diminishing as signs of
economic stabilization begin to appear in the commercial real estate market.
During the
first quarter of 2011, $1,694 in loan charge-offs were recorded due to the
receipt of updated appraisals reflecting the current deterioration in the
collateral value of commercial real estate and commercial real estate
development properties primarily in the northern and eastern markets. In
estimating the adequacy of the allowance for loan losses, management utilizes a
twelve-quarter loan loss history as one component in assessing the probability
of inherent future losses, while including higher weighting of the most recent
data.
In the
fourth quarter of 2010, loan charge-offs increased the historical losses
contained in the twelve quarter loan loss history and significantly increased
the general reserve portion of the allowance for loan losses. These
charge-offs, combined with the continued credit deterioration in the northern
and eastern markets, resulted in the large fourth quarter provision for loan
losses, resulting in a total of $40,550 provision for loan losses for 2010. In
conjunction with recorded charge-offs and recoveries for 2010, this resulted in
an increase in the ratio of the allowance for loan losses to loans net of
unearned interest as of December 31, 2010 to 4.22% compared to 1.51% as of
December 31, 2009.
The
allowance for loan losses as a percentage of non-performing loans has decreased
to 28.7% as of March 31, 2011 from 30.5% as of December 31, 2010. The allowance
for loan losses calculation takes into consideration continuing economic
declines and resulting increases in non-performing loans in the quantitative
and qualitative factors used to adjust the reserve percentages on loans not
specifically reserved for in the calculation.
39
There were
$19,594 in specific loan loss reserves for the non-performing loans as of March
31, 2011, compared to $12,245 as of December 31, 2010. Although non-performing
loans have increased, the balance is comprised of loans that management
believes will not result in significant additional losses not reserved in the
allowance for loan losses as of March 31, 2011. Management considers the
allowance for loan losses adequate to meet probable losses as of March 31,
2011.
CAPITAL RESOURCES
Federal
regulations require all financial institutions to evaluate capital adequacy by
the risk-based capital method, which makes capital requirements more sensitive
to the levels of risk inherent in different assets. At March 31, 2011, total
risk-based capital of PNBC was 10.01%, compared to 9.68% at December 31, 2010.
The Tier 1 capital ratio increased from 5.93% at December 31, 2010, to 6.19% at
March 31, 2011. Total stockholders equity to total assets at March 31, 2011
increased to 5.31% from 5.19% at December 31, 2010.
LIQUIDITY
Liquidity
is measured by a financial institutions ability to raise funds through
deposits, borrowed funds, capital, or the sale of assets. Additional sources of
liquidity include cash flow from the repayment of loans and the maturity and
principal prepayment of amortizing investment securities. Major uses of cash
include the origination of loans and purchase of investment securities. Cash
flows provided by investing and operating activities, offset by those used in
financing activities, resulted in a net increase in cash and cash equivalents
of $12.3 million from December 31, 2010 to March 31, 2011. This increase was
primarily the result of a net decrease in loans. For more detailed information,
see the Corporations condensed Consolidated Statements of Cash Flows.
FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET
RISK
The
Corporation generates agribusiness, commercial, mortgage and consumer loans to
customers located primarily in North Central Illinois. The Corporations loans
are generally secured by specific items of collateral including real property,
consumer assets and business assets. Although the Corporation has a diversified
loan portfolio, a substantial portion of its debtors ability to honor their
contracts is dependent upon economic conditions in the agricultural industry.
In the
normal course of business to meet the financing needs of its customers, the
subsidiary bank is party to financial instruments with off-balance sheet risk.
These financial instruments include commitments to extend credit and standby
letters of credit. These instruments involve, to varying degrees, elements of
credit and interest rate risk in excess of the amount recognized in the
consolidated balance sheets. The contract amounts of those instruments reflect
the extent of involvement the subsidiary bank has in particular classes of
financial instruments.
The
subsidiary banks exposure to credit loss in the event of non-performance by
the other party to the financial instrument for commitments to extend credit
and standby letters of credit is represented by the contractual notional amount
of those instruments. The subsidiary bank uses the same credit policies in
making commitments and conditional obligations as they do for on-balance-sheet
instruments. At March 31, 2011, commitments to extend credit and standby
letters of credit were approximately $111.0 million and $1.5 million
respectively.
Commitments
to extend credit are agreements to lend to a customer as long as there is no
violation of any condition established in the contract. Commitments generally
have fixed expiration dates or other termination clauses and may require
payment of a fee. Since many of the commitments are expected to expire without
being drawn upon, the total commitment amounts do not necessarily represent
future cash requirements. The subsidiary bank evaluates each customers
creditworthiness on a case-by-case basis. The amount of collateral obtained, if
deemed necessary, by the subsidiary bank upon extension of credit is based on
managements credit evaluation of the counterparty. Collateral held varies, but
may include real estate, accounts receivable, inventory, property, plant and
equipment, and income-producing properties.
40
Standby
letters of credit are conditional commitments issued by the subsidiary bank to
guarantee the performance of a customer to a third party. The credit risk
involved in issuing standby letters of credit is essentially the same as that
involved in extending loan facilities to customers. The subsidiary bank secures
the standby letters of credit with the same collateral used to secure the loan.
The maximum amount of credit that would be extended under standby letters of
credit is equal to the off-balance sheet contract amount. The standby letters
of credit have terms that expire in one year or less.
LAND HELD FOR SALE
The
Corporation owns separate lots in Elburn, Aurora and Somonauk, Illinois that
have been removed from the land balance and are now shown on the Corporations
balance sheet as land held-for-sale, at the lower of cost or market. The land
in Elburn, approximately 2 acres, was purchased in 2003 in anticipation of the
construction of a branch facility and has a cost basis of $820,000 at March 31,
2011. The land in Aurora, consisting of two lots remaining from the original
purchase of fourteen acres in 2004 which was used to construct a branch
facility, has a cost basis of $1,344,000. The land in Somonauk, acquired in
2005 during the acquisition of FSB Bancorp, Inc., consists of approximately two
acres with a cost basis of $80,000.
LEGAL PROCEEDINGS
There are
various claims pending against the Corporations subsidiary bank, arising in
the normal course of business. Management believes, based upon consultation
with counsel, that liabilities arising from these proceedings, if any, will not
be material to the Corporations financial position or results of operation.
QUANTITATIVE AND QUALITATIVE DISCLOSURES
ABOUT MARKET RISK
As a
smaller reporting company under the SECs scaled reporting requirements, the
Corporation is not required to include the information required by this item.
Accordingly, the information is omitted from this 10-Q filing.
EFFECTS OF INFLATION
The
condensed Consolidated Financial Statements and related condensed consolidated
financial data presented herein have been prepared in accordance with
accounting principles generally accepted in the United States of America and
practices within the banking industry which require the measurement of
financial condition and operating results in terms of historical dollars,
without considering the changes in the relative purchasing power of money over
time due to inflation. Unlike most industrial companies, virtually all the
assets and liabilities of a financial institution are monetary in nature. As a
result, interest rates have a more significant impact on a financial
institutions performance than the effects of general levels of inflation.
41
PRINCETON NATIONAL BANCORP,
INC. AND SUBSIDIARY
The
following table sets forth (in thousands) details of average balances, interest
income and expense, and resulting annualized yields/costs for the Corporation
for the periods indicated, reported on a fully taxable equivalent basis, using
a tax rate of 34%.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended, March 31, 2011
|
|
Three Months Ended, March 31, 2010
|
|
|
|
Average
Balance
|
|
Interest
|
|
Yield/
Cost
|
|
Average
Balance
|
|
Interest
|
|
Yield/
Cost
|
|
Average Interest-Earning Assets
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest-bearing
deposits
|
|
$
|
38,932
|
|
$
|
21
|
|
|
0.22
|
%
|
$
|
61,316
|
|
$
|
32
|
|
|
0.21
|
%
|
Taxable
investment securities
|
|
|
159,371
|
|
|
1,516
|
|
|
3.86
|
%
|
|
148,478
|
|
|
1,491
|
|
|
4.07
|
%
|
Tax-exempt
investment securities
|
|
|
92,167
|
|
|
1,361
|
|
|
5.99
|
%
|
|
126,315
|
|
|
2,049
|
|
|
6.58
|
%
|
Federal
funds sold
|
|
|
0
|
|
|
0
|
|
|
0.00
|
%
|
|
145
|
|
|
0
|
|
|
0.00
|
%
|
Net
loans
|
|
|
613,884
|
|
|
8,896
|
|
|
5.88
|
%
|
|
725,573
|
|
|
10,621
|
|
|
5.94
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total interest-earning assets
|
|
|
904,354
|
|
|
11,794
|
|
|
5.29
|
%
|
|
1,061,828
|
|
|
14,193
|
|
|
5.42
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Average
non-interest earning assets
|
|
|
190,127
|
|
|
|
|
|
|
|
|
158,716
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total average assets
|
|
$
|
1,094,481
|
|
|
|
|
|
|
|
$
|
1,220,543
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Average Interest-Bearing Liabilities
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest-bearing
demand deposits
|
|
$
|
388,883
|
|
|
611
|
|
|
0.64
|
%
|
$
|
378,885
|
|
|
1,143
|
|
|
1.22
|
%
|
Savings
deposits
|
|
|
78,393
|
|
|
15
|
|
|
0.08
|
%
|
|
70,155
|
|
|
16
|
|
|
0.09
|
%
|
Time
deposits
|
|
|
356,015
|
|
|
1,112
|
|
|
1.27
|
%
|
|
471,757
|
|
|
2,214
|
|
|
1.90
|
%
|
Interest-bearing demand notes issued to the
U.S. Treasury
|
|
|
1,090
|
|
|
0
|
|
|
0.03
|
%
|
|
930
|
|
|
0
|
|
|
0.04
|
%
|
Federal funds purchased and customer
repurchase agreements
|
|
|
37,586
|
|
|
61
|
|
|
0.66
|
%
|
|
42,008
|
|
|
96
|
|
|
0.93
|
%
|
Advances
from Federal Home Loan Bank
|
|
|
8,511
|
|
|
23
|
|
|
1.10
|
%
|
|
27,644
|
|
|
153
|
|
|
2.24
|
%
|
Trust
preferred securities
|
|
|
25,000
|
|
|
115
|
|
|
1.87
|
%
|
|
25,000
|
|
|
355
|
|
|
5.76
|
%
|
Note
payable
|
|
|
0
|
|
|
0
|
|
|
0.00
|
%
|
|
0
|
|
|
0
|
|
|
0.00
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total interest-bearing liabilities
|
|
|
895,478
|
|
|
1,937
|
|
|
0.88
|
%
|
|
1,016,378
|
|
|
3,977
|
|
|
1.59
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
yield on average interest-earning assets
|
|
|
|
|
$
|
9,857
|
|
|
4.42
|
%
|
|
|
|
$
|
10,216
|
|
|
3.90
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Average
non-interest-bearing liabilities
|
|
|
141,379
|
|
|
|
|
|
|
|
|
127,843
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Average
stockholders equity
|
|
|
57,624
|
|
|
|
|
|
|
|
|
76,322
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total average liabilities and stockholders
equity
|
|
$
|
1,094,481
|
|
|
|
|
|
|
|
$
|
1,220,543
|
|
|
|
|
|
|
|
The following table reconciles tax-equivalent net interest income (as shown
above) to net interest income as reported on the Consolidated Statements of
Income.
|
|
|
|
|
|
|
|
|
|
For the Three Months Ended
March 31,
|
|
|
|
2011
|
|
2010
|
|
Net
interest income as stated
|
|
$
|
9,357
|
|
$
|
9,483
|
|
Tax equivalent adjustment-investments
|
|
|
463
|
|
|
697
|
|
Tax equivalent adjustment-loans
|
|
|
37
|
|
|
36
|
|
|
|
|
|
|
|
|
|
Tax
equivalent net interest income
|
|
$
|
9,857
|
|
$
|
10,216
|
|
42
Schedule 7
Controls and Procedures
|
|
(a)
|
Disclosure controls and procedures. We
evaluated the effectiveness of the design and operation of our disclosure
controls and procedures as of March 31, 2011. Our disclosure controls and
procedures are the controls and other procedures that we designed to ensure
that we record, process, summarize and report in a timely manner the
information we must disclose in reports that we file with or submit to the
SEC. Thomas D. Ogaard, President and Chief Executive Officer, and Rodney D.
Stickle, Senior Vice President and Chief Financial Officer, reviewed and
participated in this evaluation. Based on this evaluation, management
concluded that, as of the date of their evaluation, our disclosure controls
were effective.
|
|
|
(b)
|
Internal controls. There have been
significant changes in our internal accounting controls or in other factors
during the quarter ended March 31, 2011 that strengthened those controls as
described below.
|
During the
audit of the financial statements as of December 31, 2010, BKD, LLP, the
Corporations external public accounting firm, identified a control deficiency
that was determined to be a material weakness. A material weakness is a
deficiency, or a combination of deficiencies, in internal control over
financial reporting, such that there is a reasonable possibility that a material
misstatement of the Companys annual or interim financial statements will not
be prevented or detected on a timely basis. The material weaknesses noted was
in collateral valuation analysis. Management has taken remediation actions to
address this internal control matter and has remediated this material weakness
as of March 31, 2011. A more complete discussion of managements actions is
detailed below.
Management has evaluated the procedures for monitoring asset quality
and evaluating appraisals on classified and collateral dependent loans. The
following processes have been implemented to specifically mitigate the control
weakness identified:
|
|
|
|
1)
|
Problem Asset Workout Summaries
(PAWS), which are detailed analyses prepared quarterly in the evaluation of
each non-performing loan relationship, are reviewed with more frequency prior
to quarter end by management and staff of the Credit Administration
Department with oversight now provided by the Directors Loan Committee to
ensure that collateral valuations are appropriately obtained, and updated,
where applicable, in a timely fashion.
|
|
|
|
|
2)
|
In situations involving classified and
collateral-dependent loans where appraisals are dated more than twelve months
prior and updated appraisals are pending completion or are in the process of
review, management evaluates the need for recognition of additional
adjustment or discount to the existing appraised value of the collateral to
assure that recorded reserves are appropriate.
|
|
|
|
|
3)
|
Management maintains a heightened sense
of awareness of the need to fully evaluate all PAWS and ensure that all
documentation is complete, appraisals are timely, reviewed and appropriately
discounted, and all review procedures appropriately completed.
|
|
|
|
|
4)
|
The Corporation filled a newly created role of Chief Credit Officer
and established a Credit Administration Department to oversee the
development, maintenance, and monitoring of loan policies and procedures.
Responsibilities of the Credit Administration Department include credit
analysis, credit risk management, loan servicing and administration,
collections, and the special assets group, as well as loan portfolio analysis
and the maintenance of the allowance for loan losses. The functions of the
special assets group include loss mitigation and workout of non-performing
loans, liquidation of non-performing assets, and other responsibilities to
accelerate and maximize loan recoveries. As part of establishing the new
Credit Administration Department, the Banks Chief Credit Officer has
identified and engaged experienced personnel to fill key roles within credit
administration in continuing to address the Corporations identified material
weakness.
|
|
|
|
|
5)
|
A credit risk analytics group, within the Credit Administration
Department, was created and staffed to facilitate the timely and appropriate
preparation of allowance for loan losses evaluation, loan portfolio
monitoring, migration analysis, concentration analysis, and other credit risk
analysis. In conjunction with the special assets group, the credit risk
analytics group is responsible for ensuring that loan level detail is
appropriately maintained relative to problem loan reporting, including
current appraisal documentation, and the identification of non-accrual loans
and loans subject to classification as troubled debt restructurings.
|
43
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