f10q_093011-0343.htm

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q

[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the quarterly period ended: September 30, 2011.
or
[   ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from ____________ to ____________

Commission File No. 000-51338

PARKE BANCORP, INC.
(Exact name of registrant as specified in its charter)
 
New Jersey
  
65-1241959
(State or other jurisdiction of incorporation or organization)
  
(IRS Employer Identification No.)
     
601 Delsea Drive, Washington Township, New Jersey
  
08080
(Address of principal executive offices)
  
(Zip Code)
  
856-256-2500
(Registrant's telephone number, including area code)

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

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes [X]                No [  ]
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§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 [X]                No [  ]
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.   See the definitions of "large accelerated filer”, “accelerated filer", and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
 
Large accelerated filer [  ]             Accelerated filer [  ]            Non-accelerated filer [  ]          Smaller reporting company [X]
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes [  ]                No [X]

As of November 14, 2011, there were issued and outstanding 4,886,178 shares of the registrant's common stock.
 

 
 
 

PARKE BANCORP, INC.
 

 
FORM 10-Q
 

 
FOR THE QUARTER ENDED SEPTEMBER 30, 2011

INDEX
 
   
Page
Part I
FINANCIAL INFORMATION
  
     
Item 1.
Financial Statements
1
Item 2.
Management's Discussion and Analysis of Financial Condition and Results of Operations
39
Item 3.
Quantitative and Qualitative Disclosures About Market Risk
50
Item 4.
Controls and Procedures
50
     
Part II
OTHER INFORMATION
  
     
Item 1.
Legal Proceedings
50
Item 1A.
Risk Factors
50
Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds
50
Item 3.
Defaults Upon Senior Securities
50
Item 4.
Reserved
51
Item 5.
Other Information
51
Item 6.
Exhibits
51
  
SIGNATURES

EXHIBITS and CERTIFICATIONS



 
 
 

PART I. FINANCIAL INFORMATION
Item 1. Financial Statements

Parke Bancorp Inc. and Subsidiaries
  
CONSOLIDATED BALANCE SHEETS
  
(unaudited)
  
   
September 30,
    
December 31,
  
   
2011
    
2010
  
   
(in thousands except share data)
  
ASSETS
            
Cash  and due from financial institutions
   $ 69,301     $ 57,628  
Investment securities available for sale, at fair value
     24,401       27,730  
Investment securities held to maturity (fair value of $2,021 at September
       30, 2011 and $2,048 at December 31, 2010)
     2,024       1,999  
Total investment securities
     26,425       29,729  
Loans held for sale
     1,110       11,454  
Loans, net of unearned income
     638,197       626,739  
Less: Allowance for loan losses
     16,472       14,789  
Net loans and leases
     621,725       611,950  
Accrued interest receivable
     2,905       3,273  
Premises and equipment, net
     4,167       4,279  
Other real estate owned (OREO)
     18,190       16,701  
Restricted stock, at cost
     3,117       3,040  
Bank owned life insurance (BOLI)
     5,496       5,362  
Other assets
     14,611       13,437  
Total Assets
   $ 767,047     $ 756,853  
                 
LIABILITIES AND EQUITY
                
Liabilities
                
Deposits
                
Noninterest-bearing deposits
   $ 23,395     $ 23,168  
Interest-bearing deposits
     598,634       581,554  
Total deposits
     622,029       604,722  
FHLB borrowings
     40,646       40,759  
Other borrowed funds
     10,000       21,454  
Subordinated debentures
     13,403       13,403  
Accrued interest payable
     656       828  
Other liabilities
     3,996       4,955  
Total liabilities
     690,730       686,121  
Equity
                
Preferred stock, $1,000 liquidation value per share; authorized
    1,000,000 shares; Issued: 16,288 shares at September 30, 2011 and
    December 31, 2010
     15,821       15,683  
Common stock, $.10 par value; authorized 10,000,000 shares; Issued:
    5,097,078 shares at September 30, 2011 and 4,653,133 shares at
    December 31, 2010
     510       465  
Additional paid-in capital
     45,844       41,931  
Retained earnings
     16,793       15,494  
Accumulated other comprehensive loss
     (539 )     (693 )
Treasury stock, 210,900 shares at September 30, 2011 and December
    31, 2010, at cost
     (2,180 )     (2,180 )
Total shareholders’ equity
     76,249       70,700  
Noncontrolling (minority) interest in consolidated subsidiaries
     68       32  
Total equity
     76,317       70,732  
Total liabilities and  equity
   $ 767,047     $ 756,853  
                 
See accompanying notes to consolidated financial statements
  

 
 
1
 

 
Parke Bancorp Inc. and Subsidiaries
  
CONSOLIDATED STATEMENTS OF INCOME
  
(unaudited)
  
 
For the nine months ended September 30,
    
For the three months ended September 30,
  
 
2011
    
2010
    
2011
    
2010
  
     
Interest income:
                        
Interest and fees on loans
   $ 29,802     $ 29,621     $ 9,912     $ 10,044  
Interest and dividends on investments
     1,033       1,290       329       428  
Interest on cash equivalents
     75       16       31       11  
Total interest income
     30,910       30,927       10,272       10,483  
Interest expense:
                                
Interest on deposits
     5,965       7,241       1,960       2,376  
Interest on borrowings
     1,066       1,330       352       444  
Total interest expense
     7,031       8,571       2,312       2,820  
Net interest income
     23,879       22,340       7,960       7,652  
Provision for loan losses
     6,850       6,401       2,350       2,100  
Net interest income after provision for loan losses
     17,029       15,939       5,610       5,552  
Noninterest income:
                                
Loan fees
     185       109       20       28  
Net income from BOLI
     133       132       45       43  
Service fees on deposit accounts
     166       191       58       62  
Gain on sale of SBA loans
     3,892       1,311       751       635  
Other than temporary impairment losses
     (132 )     (115 )     (48 )     (71 )
Portion of loss recognized in other 
    comprehensive income (OCI) (before taxes)
     47       49       20       23  
Net impairment losses recognized in earnings
     (85 )     (66 )     (28 )     (48 )
(Loss) gain on sale and write-down of real estate owned
     (525 )     39       (577 )     (7 )
Other
     173       176       56       121  
Total noninterest income
     3,939       1,892       325       834  
Noninterest expense:
                                
Compensation and benefits
     4,227       3,641       1,406       1,163  
Professional services
     966       873       321       291  
Occupancy and equipment
     751       691       248       253  
Data processing
     316       250       92       88  
FDIC insurance
     877       653       192       216  
Other operating expense
     2,371       2,144       793       1,265  
Total noninterest expense
     9,508       8,252       3,052       3,276  
Income before income tax expense
     11,460       9,595       2,883       3,121  
Income tax expense
     4,605       3,802       1,161       1,180  
Net income attributable to Company and noncontrolling (minority) interest
     6,855       5,793       1,722       1,941  
Net income attributable to noncontrolling (minority) interest
     (848 )     (168 )     (152 )     (113 )
Net income attributable to Company
     6,007       5,625       1,570       1,828  
Preferred stock dividend and discount accretion
     749       740       251       247  
Net income available to common shareholders
   $ 5,258     $ 4,885     $ 1,319     $ 1,581  
                                 
Earnings per common share
                                
Basic
   $ 1.08     $ 1.00     $ 0.27     $ 0.32  
Diluted
   $ 1.05     $ 0.98     $ 0.27     $ 0.32  
Weighted average shares outstanding
                                
Basic
     4,886,178       4,860,956       4,886,178       4,881,610  
Diluted
     4,987,961       4,975,535       4,937,242       4,900,332  
See accompanying notes to consolidated financial statements
  

 
2
 


 
Parke Bancorp, Inc. and Subsidiaries
CONSOLIDATED STATEMENTS OF CHANGE IN TOTAL EQUITY
(unaudited)
 
 Preferred
Stock
  
 Common
Stock
  
 
Additional
Paid-In
Capital
  
 
Retained Earnings
  
Accumulated
Other Comprehensive
Loss
  
 
 Treasury
Stock
  
 
Total Shareholders' Equity
  
Non-Controlling (Minority) Interest
  
Total Equity
(in thousands)
Balance, December 31, 2009
$
15,508
  
$
421
  
$
37,020
  
$
14,071
  
$
(2,867
 ) 
$
(2,180
 ) 
$
61,973
  
$
—
  
$
61,973 
Stock options  exercised
              
22
                      
22
          
22 
Capital contribution by noncontrolling
(minority) interest
                                            
196
    
196 
Capital withdrawals by noncontrolling
(minority) interest
                                            
(186
 
) 
 
(186)
10% common stock dividend
        
44
    
4,879
    
(4,929
 )               
(6
 )         
(6)
Comprehensive income:
                                                    
Net income
                    
5,625
                
5,625
    
168
    
5,793 
Non-credit unrealized losses on debt
    securities with OTTI, net of taxes
                          
85
          
85
          
85 
Net unrealized gains on available for sale securities without OTTI, net of taxes
                          
1,921
          
1,921
          
1,921 
Pension liability adjustments, net of tax
                          
32
          
32
          
32 
Total comprehensive income
                                      
7,663
    
168
    
7,831 
Dividend on preferred stock (5% annually)
                    
(610
 )               
(610
 )         
(610)
Accretion of discount on preferred stock
  
130
                
(130
 )               
—
          
— 
Balance, September 30, 2010
$
15,638
  
$
465
  
$
41,921
  
$
14,027
  
$
(829
 ) 
$
(2,180
 ) 
$
69,042
  
$
178
  
$
69,220 
                                                     
                                                     
                                                     
Balance, December 31, 2010
$
15,683
  
$
465
  
$
41,931
  
$
15,494
  
$
(693
 ) 
$
(2,180
 ) 
$
70,700
  
$
32
  
$
70,732 
Capital withdrawals by noncontrolling
(minority) interest
                                            
(812
 
) 
 
(812)
10% common stock dividend
        
45
    
3,913
    
(3,959
 )               
(1
 )         
(1)
Comprehensive income:
                                                    
Net income
                    
6,007
                
6,007
    
848
    
6,855 
Non-credit unrealized losses on debt
    securities with OTTI, net of taxes
                          
(47
 
) 
       
(47
 
) 
       
(47)
Net unrealized gains on available for sale securities without OTTI, net of taxes
                          
171
          
171
          
171 
Pension liability adjustments, net of taxes
                          
30
          
30
          
30 
Total comprehensive income
                                      
6,161
    
848
    
7,009 
Dividend on preferred stock (5% annually)
                    
(611
 )               
(611
 )         
(611)
Accretion of discount on preferred stock
  
138
                
(138
 )               
—
          
— 
Balance, September 30, 2011
$
15,821
  
$
510
  
$
45,844
  
$
16,793
  
$
(539
 ) 
$
(2,180
 ) 
$
76,249
  
$
68
  
$
76,317 
                                                     
See accompanying notes to consolidated financial statements
            

 
3
 


 
Parke Bancorp Inc. and Subsidiaries
  
CONSOLIDATED STATEMENTS OF CASH FLOWS
  
(unaudited)
  
   
For the nine months ended September 30,
  
   
2011
    
2010
  
   
(in thousands)
  
Cash Flows from Operating Activities
            
Net income
   $ 6,855     $ 5,793  
Adjustments to reconcile net income to net cash provided by operating activities:
                
Depreciation and amortization
     273       247  
Provision for loan losses
     6,850       6,401  
Bank owned life insurance income
     (133 )     (132 )
Supplemental executive retirement plan expense
     286       333  
Gain on sale of SBA loans
     (3,892 )     (1,311 )
SBA loans originated for sale
     (21,993 )     (12,593 )
Proceeds from sale of SBA loans originated for sale
     24,455       13,904  
Gain (loss) and writedown on sale of other real estate owned
     525       (39 )
Other than temporary impairment of investments
     85       66  
Net accretion of purchase premiums and discounts on securities
     (59 )     (59 )
Changes in operating assets and liabilities:
                
Increase in accrued interest receivable and other assets
     (908 )     (848 )
 (Decrease) increase in accrued interest payable and other accrued liabilities
     (1,047 )     1,107  
Net cash provided by operating activities
     11,297       8,525  
Cash Flows from Investing Activities
                
Purchases of investment securities available for sale
     —       (1,794 )
(Purchases) redemptions of restricted stock
     (77 )     7  
Proceeds from sale of securities available for sale
     500       —  
Proceeds from maturities and principal payments on mortgage-backed securities
     2,983       7,171  
Proceeds from the sale of REO property
     3,175       453  
Advances for other real estate owned
     (4,387 )     —  
Net increase in loans
     (17,427 )     (45,407 )
Purchases of bank premises and equipment
     (161 )     (1,724 )
Net cash used in investing activities
     (15,394 )     (41,294 )
Cash Flows from Financing Activities
                
Payment of dividend on preferred stock
     (611 )     (610 )
Cash payment of fractional shares on 10% stock dividend
     (1 )     (6 )
Proceeds from exercise of stock options and warrants
     —       22  
Net decrease in Federal Home Loan Bank short term borrowings
     —       2,319  
Minority interest capital withdrawal
     (812 )     —  
Payments of Federal Home Loan Bank advances
     (113 )     (607 )
Net increase in noninterest-bearing deposits
     227       1,194  
Net increase in interest-bearing deposits
     17,080       77,473  
Net cash provided by financing activities
     15,770       79,785  
Increase in cash and cash equivalents
     11,673       47,016  
Cash and Cash Equivalents, beginning of period
     57,628       4,154  
Cash and Cash Equivalents, end of period
   $ 69,301     $ 51,170  
Supplemental Disclosure of Cash Flow Information:
                
Cash paid for:
                
Interest on deposits and borrowed funds
 
   $ 7,219     $ 8,527  
Income taxes
   $ 5,601     $ 6,200  
Supplemental Schedule of Noncash Activities:
                
Real estate acquired in settlement of loans
   $ 802     $ 13,273  
Transfer of loans in settlement of secured borrowings
   $ 11,454       —  
See accompanying notes to consolidated financial statements
                
                 

 
4
 

Notes to Consolidated Financial Statements (Unaudited)

NOTE 1.  ORGANIZATION

Parke Bancorp, Inc. ("Parke Bancorp” or the "Company") is a bank holding company incorporated under the laws of the State of New Jersey in January 2005 for the sole purpose of becoming the holding company of Parke Bank (the "Bank").

The Bank is a commercial bank which commenced operations on January 28, 1999. The Bank is chartered by the New Jersey Department of Banking and insured by the Federal Deposit Insurance Corporation ("FDIC"). Parke Bancorp and the Bank maintain their principal offices at 601 Delsea Drive, Washington Township, New Jersey. The Bank also conducts business through branches in Galloway Township, Northfield and Washington Township, New Jersey and Philadelphia, Pennsylvania.

The Bank competes with other banking and financial institutions in its primary market areas. Commercial banks, savings banks, savings and loan associations, credit unions and money market funds actively compete for savings and time certificates of deposit and all types of loans. Such institutions, as well as consumer financial and insurance companies, may be considered competitors of the Bank with respect to one or more of the services it renders.

The Bank is subject to the regulations of certain state and federal agencies, and accordingly, the Bank is periodically examined by such regulatory authorities. As a consequence of the regulation of commercial banking activities, the Bank’s business is particularly susceptible to future state and federal legislation and regulations.


NOTE 2.  SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Basis of Financial Statement Presentation: The accounting and reporting policies of the Bank conform to accounting principles generally accepted in the United States of America (“GAAP”) and predominant practices within the banking industry.

The accompanying consolidated financial statements include the accounts of Parke Bancorp, Inc. and its wholly-owned subsidiaries Parke Bank, Parke Capital Markets, Farm Folly, Inc. and Taylors Glen LLC. Also included are the accounts of 44 Business Capital Partners LLC, a joint venture formed in 2009 to originate and service SBA loans. Parke Bank has a 51% ownership interest in the joint venture. Parke Capital Trust I, Parke Capital Trust II and Parke Capital Trust III are wholly-owned subsidiaries but are not consolidated because they do not meet the requirements for consolidation under applicable accounting guidance.  All significant inter-company balances and transactions have been eliminated.

The accompanying interim financial statements should be read in conjunction with the annual financial statements and notes thereto included in Parke Bancorp Inc.’s Annual Report on Form 10-K for the year ended December 31, 2010 since they do not include all of the information and footnotes required by GAAP. The accompanying interim financial statements for the three and nine months ended September 30, 2011 and 2010 are unaudited. The balance sheet as of December 31, 2010, was derived from the audited financial statements. In the opinion of management, these financial statements include all normal and recurring adjustments necessary for a fair statement of the results for such interim periods. Results of operations for the three months and nine months ended September 30, 2011 are not necessarily indicative of the results for the full year.
 
 
5
 
 
Use of Estimates: In preparing the interim financial statements, management makes estimates and assumptions based on available information that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities as of the date of the balance sheet and reported amounts of expenses and revenues. Actual results could differ from such estimates. The allowance for loan losses, deferred taxes, evaluation of investment securities for other-than-temporary impairment and fair values of financial instruments and other real estate owned (“OREO”) are significant estimates and particularly subject to change.

Recently Issued Accounting Pronouncements:

On July 1, 2009, the Accounting Standards Codification (“ASC”) became the Financial Accounting Standards Board’s (“FASB”) officially recognized source of authoritative GAAP applicable to all public and non-public non-governmental entities, superseding existing FASB, AICPA, EITF and related literature. Rules and interpretive releases of the SEC under the authority of federal securities laws are also sources of authoritative GAAP for SEC registrants. All other accounting literature is considered non-authoritative. The switch to the ASC affects the way companies refer to GAAP in financial statements and accounting policies. Citing particular content in the ASC involves specifying the unique numeric path to the content through the Topic, Subtopic, Section and Paragraph structure.

New authoritative accounting guidance (Accounting Standards Update No. 2011-01) under ASC Topic 310, "Receivables", temporarily delayed the effective date of the disclosures about troubled debt restructurings in Update 2010-20. The delay was intended to allow the Board time to complete its deliberations on what constituted a troubled debt restructuring. In April 2011, new authoritative guidance (Accounting Standards Update No. 2011-02) under ASC Topic 310 was released to assist creditors in determining whether a restructuring is a troubled debt restructuring. This update clarifies the guidance on a whether a creditor has made a concession and whether a debtor is experiencing financial difficulties. In addition, the disclosures that were deferred under ASU 2011-01 will now be required. ASU 2011-02 is effective for the first interim or annual period beginning after June 15, 2011. The expanded new disclosures are incorporated in Note 4, “Loans”, and did not have a material impact on the Company’s financial condition or results of operation.

In April 2011, the FASB issued (ASU) 2011-02 which provides additional guidance related to determining whether a creditor has granted a concession, include factors and examples for creditors to consider in evaluating whether a restructuring results in a delay in payment that is insignificant. The guidance prohibits creditors from using the borrower’s effective rate test to evaluate whether a concession has been granted to the borrower and adds factors for creditors to use in determining whether a borrower is experiencing financial difficulties. A provision in ASU 2011-02 also ends the FASB’s deferral of the additional disclosures about troubled debt restructurings as required by ASU 2010-20. There was no significant impact to amounts reported in the consolidated financial position or results of operations from the adoption of ASU 2011-02.

In June 2011, the FASB issued guidance to improve the comparability, consistency and transparency of financial reporting and to increase the prominence of items reported in other comprehensive income. The amendments require that all non-owner changes in stockholders’ equity be presented either in a single continuous statement of comprehensive income or in two separate but consecutive statements. The amendments do not change the items that must be reported in other comprehensive income or when an item of other comprehensive income must be reclassified to net income. The amendments are effective for interim and annual periods beginning after December 15, 2011 with retrospective application. The Company will adopt the accounting standard during 2012, as required, with no material impact on its results of operations or financial position.

 
6
 


NOTE 3.  INVESTMENT SECURITIES
 

The following is a summary of the Company's investments in available-for-sale and held-to-maturity securities as of September 30, 2011 and December 31, 2010: 

 As of September 30, 2011
  
Amortized
cost
  
Gross
unrealized
gains
  
Gross
unrealized
losses
  
Other-than-
temporary
impairments
in OCI
  
Fair value
  
 Available-for-sale:
(amounts in thousands)
  
             
U.S. Government sponsored entities
$
3,006
  
$
11
  
$
—
  
$
—
  
$
3,017
  
Corporate debt obligations
  
1,500
    
14
    
24
    
—
    
1,490
  
    Residential mortgage-backed securities
13,329
  
821
  
—
  
—
  
14,150
  
Collateralized mortgage obligations
1,624
  
100
  
—
  
20
  
1,704
  
Collateralized debt obligations
5,556
  
—
  
1,014
  
502
  
4,040
  
Total available-for-sale
$
25,015
  
$
946
  
$
1,038
  
$
522
  
$
24,401
  
                     
 Held to maturity:
                    
States and political subdivisions
$
2,024
  
$
65
  
$
68
  
$
—
  
$
2,021
  
 
 
 
 As of December 31, 2010
  
Amortized
cost
  
Gross
unrealized
gains
  
Gross
unrealized
losses
  
Other-than-
temporary
impairments
in OCI
  
Fair value
  
 Available-for-sale:
(amounts in thousands)
  
             
U.S. Government sponsored entities
$
3,006
  
$
14
  
$
95
  
$
—
  
$
2,925
  
Corporate debt obligations
  
2,000
    
94
    
—
    
—
    
2,094
  
    Residential mortgage-backed securities
15,938
  
645
  
24
  
—
  
16,559
  
Collateralized mortgage obligations
2,045
  
107
  
—
  
—
  
2,152
  
Collateralized debt obligations
5,562
  
—
  
1,014
  
548
  
4,000
  
Total available-for-sale
$
28,551
  
$
860
  
$
1,133
  
$
548
  
$
27,730
  
                     
 Held to maturity:
                    
States and political subdivisions
$
1,999
  
$
60
  
$
11
  
$
—
  
$
2,048
  
 
 

 

 
7
 

The amortized cost and fair value of debt securities classified as available-for-sale and held-to-maturity, by contractual maturity as of September 30, 2011 are as follows:
 
 
Amortized
Cost
  
Fair
Value
 
(amounts in thousands)
Available-for-sale:
  
Due within one year
$
—
  
$
—
Due after one year through five years
  
1,000
    
1,009
Due after five years through ten years
  
2,000
    
2,002
Due after ten years
  
7,062
    
5,536
Residential mortgage-backed securities and collateralized 
  mortgage obligations
  
14,953
    
15,854
Total  available-for-sale
$
25,015
  
$
24,401

 
Held-to-maturity:
  
Due within one year
$
—
  
$
—
Due after one year through five years
  
—
    
—
Due after five years through ten years
  
—
    
—
Due after ten years
  
2,024
    
2,021
Total held-to-maturity
$
2,024
  
$
2,021

Expected maturities will differ from contractual maturities for mortgage related securities because the issuers of certain debt securities do have the right to call or prepay their obligations without any penalty.
 
As of September 30, 2011, securities with a carrying value of $10.1 million, and fair value of $10.5 million, are pledged as collateral for borrowed funds. In addition, securities with a carrying value of $8.9 million and fair value of $9.4 million were pledged to secure public deposits.
 

 
8
 

The following tables show the gross unrealized losses and fair value of the Company's investments with unrealized losses that are not deemed to be other-than-temporarily impaired, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, at September 30, 2011:
 

 
    
Less Than 12 Months
  
12 Months or Greater
  
Total
Description of Securities
Fair
Value
  
Unrealized
Losses
  
Fair
Value
  
Unrealized
Losses
  
Fair
Value
  
Unrealized
Losses
 
(amounts in thousands)
Available-for-sale:
                                  
Corporate debt obligations
$
476
  
$
24
  
$
—
  
$
—
  
$
476
  
$
24
Collateralized debt obligations
  
—  
   
—  
   
3,736
    
1,014
    
3,736
    
1,014
Total available-for-sale
$
476    
 
$
24  
 
$
3,736
  
$
1,014
  
$
4,212
  
$
1,038
                                   
Held-to-maturity:
                                  
States and political subdivisions
$
720  
 
$
68  
 
$
—
  
$
—
  
$
720
  
$
68

 
Corporate Debt Obligations: The unrealized loss on the Company’s investment in corporate debt obligations relates to one security. The loss was caused by movement in interest rates. Because the Company does not intend to sell the investment and it is not more likely than not that the Company will be required to sell the investment before recovery of its amortized cost basis, which may be maturity, it does not consider the investment in this security to be other-than-temporarily impaired at September 30, 2011.
 
Collateralized Debt Obligations:  The Company’s unrealized loss on investments in collateralized debt obligations (“CDOs”) relates to three securities  issued by financial institutions, totaling $3.7 million. CDOs are pooled securities primarily secured by trust preferred securities (“TruPS”), subordinated debt and surplus notes issued by small and mid-sized banks and insurance companies. These securities are generally floating rate instruments with 30-year maturities, and are callable at par by the issuer after five years. The current economic downturn has had a significant adverse impact on the financial services industry, consequently, TruPS CDOs do not have an active trading market. With the assistance of competent third-party valuation specialists, the Company utilized the following methodology to determine the fair value:
 
Cash flows were developed based on the estimated speeds at which the trust preferred securities are expected to prepay, the estimated rates at which the trust preferred securities are expected to defer payments, the estimated rates at which the trust preferred securities are expected to default, and the severity of the losses on securities which default. Trust preferred securities generally allow for prepayment by the issuer without a prepayment penalty any time after five years. Due to the lack of new trust preferred issuances and the relatively poor conditions of the financial institution industry, a relatively modest rate of prepayment was assumed going forward. Estimates for conditional default rates (“CDR”) are based on the payment characteristics of the trust preferred securities themselves (e.g. current, deferred, or defaulted) as well as the financial condition of the trust preferred issuers in the pool. Estimates for the near-term rates of deferral and CDR are based on key financial ratios relating to the financial institutions’ capitalization, asset quality, profitability and liquidity. Finally, we consider whether or not the financial
 
9
 
 
institution has received TARP funding, and if it has, the amount. Longer-term rates of deferral and defaults are based on historical averages. The fair value of each bond was assessed by discounting its projected cash flows by a discount rate.  The discount rates were based on the yields of publicly traded TruPS and preferred stock issued by comparably rated banks.  The fair value for previous reporting periods was based on indicative market bids and resulted in much lower values due to the inactive trading market.
 
The underlying issuers have been analyzed, and projections have been made regarding the future performance, considering factors including defaults and interest deferrals.  The analysis indicates that the Company should expect to receive all contractual cash flows.  Because the Company does not intend to sell the investments and it is not more likely than not that the Company will be required to sell the investments before recovery of its amortized cost basis, which may be maturity, it does not consider these investments to be other-than-temporarily impaired at September 30, 2011 or December 31, 2010.
 
 
10
 
Other-Than-Temporarily Impaired Debt Securities
 

We assess whether we intend to sell or it is more likely than not that we will be required to sell a security before recovery of its amortized cost basis less any current-period credit losses. For debt securities that are considered other-than-temporarily impaired (“OTTI”) and that we do not intend to sell and will not be required to sell prior to recovery of our amortized cost basis, we separate the amount of the impairment into the amount that is credit related (credit loss component) and the amount due to all other factors. The credit loss component is recognized in earnings and is the difference between the security’s amortized cost basis and the present value of its expected future cash flows. The remaining difference between the security’s fair value and the present value of future expected cash flows is due to factors that are not credit related and is recognized in other comprehensive income.

The present value of expected future cash flows is determined using the best estimate of cash flows discounted at the effective interest rate implicit to the security at the date of purchase or the current yield to accrete an asset-backed or floating rate security. The methodology and assumptions for establishing the best estimate cash flows vary depending on the type of security. The asset-backed securities cash flow estimates are based on bond specific facts and circumstances that may include collateral characteristics, expectations of delinquency and default rates, loss severity and prepayment speeds and structural support, including subordination and guarantees. The corporate bond cash flow estimates are derived from scenario-based outcomes of expected corporate restructurings or the disposition of assets using bond specific facts and circumstances including timing, security interests and loss severity.

We have a process in place to identify debt securities that could potentially have a credit impairment that is other than temporary.  This process involves monitoring late payments, pricing levels, downgrades by rating agencies, key financial ratios, financial statements, revenue forecasts and cash flow projections as indicators of credit issues.  On a quarterly basis, we review all securities to determine whether an other-than-temporary decline in value exists and whether losses should be recognized. We consider relevant facts and circumstances in evaluating whether a credit or interest rate-related impairment of a security is other than temporary. Relevant facts and circumstances considered include: (1) the extent and length of time the fair value has been below cost; (2) the reasons for the decline in value; (3) the financial position and access to capital of the issuer, including the current and future impact of any specific events and (4) for fixed maturity securities, our intent to sell a security or whether it is more likely than not we will be required to sell the security before the recovery of its amortized cost which, in some cases, may extend to maturity and for equity securities, our ability and intent to hold the security for a period of time that allows for the recovery in value.
 
The following table presents a roll-forward of the credit loss component of the amortized cost of debt securities that we have written down for OTTI and the credit component of the loss that is recognized in earnings. OTTI recognized in earnings for credit-impaired debt securities is presented as additions in two components based upon whether the current period is the first time the debt security was credit-impaired (initial credit impairment) or is not the first time the debt security was credit impaired (subsequent credit impairments). The credit loss component is reduced if we sell, intend to sell or believe we will be required to sell previously credit-impaired debt securities. Additionally, the credit loss component is reduced if we receive cash flows in excess of what we expected to receive over the remaining life of the credit-impaired debt security, the security matures or is fully written down. Changes in the credit loss component of credit-impaired debt securities were as follows for the periods ended September 30, 2011 and 2010.

 
11
 



   
For the Nine Months Ended
September 30,
  
   
2011
    
2010
  
             
   
(amounts in thousands)
  
Beginning balance
   $ 2,657     $ 4,008  
Initial credit impairment
     —       —  
Subsequent credit impairments
     85       66  
Reductions for amounts recognized in earnings due to intent or requirement to sell
     —       —  
Reductions for securities sold
     —       —  
Reductions for securities deemed worthless
     524       1,384  
Reductions for increases in cash flows expected to be collected
     —       —  
Ending balance
   $ 2,218     $ 2,690  
 
 
   
For the Three Months Ended
September 30,
  
   
2011
    
2010
  
             
   
(amounts in thousands)
  
Beginning balance
   $ 2,398     $ 2,808  
Initial credit impairment
     —       —  
Subsequent credit impairments
     28       48  
Reductions for amounts recognized in earnings due to intent or requirement to sell
     —       —  
Reductions for securities sold
     —       —  
Reductions for securities deemed worthless
     208       166  
Reductions for increases in cash flows expected to be collected
     —       —  
Ending balance
   $ 2,218     $ 2,690  

A summary of investment gains and losses recognized in income during the nine month and three month periods ended September 30, 2011 and 2010 are as follows:

   
For the Nine Months Ended
September 30,
  
   
2011
    
2010
  
             
   
(amounts in thousands)
  
Available-for-sale securities:
            
        Realized gains
   $ —     $ —  
        Realized (losses)
     —       —  
        Other than temporary impairment
     (85 )     (66 )
Total available-for-sale securities
   $ (85 )   $ (66 )
                 
Held-to-maturity securities:
                
        Realized gains
   $ —     $ —  
        Realized (losses)
     —       —  
        Other than temporary impairment
     —       —  
Total held-to-maturity securities
   $ —     $ —  

 
12
 

   
For the Three Months Ended
September 30,
  
   
2011
    
2010
  
             
   
(amounts in thousands)
  
Available-for-sale securities:
            
        Realized gains
   $ —     $ —  
        Realized (losses)
     —       —  
        Other than temporary impairment
     (28 )     (48 )
Total available-for-sale securities
   $ (28 )   $ (48 )
                 
Held-to-maturity securities:
                
        Realized gains
   $ —     $ —  
        Realized (losses)
     —       —  
        Other than temporary impairment
     —       —  
Total held-to-maturity securities
   $ —     $ —  

During the first nine months of 2011, the Company recognized $85,000 of other-than-temporary impairment losses on available-for-sale securities, attributable to impairment charges recognized on a privately issued CMO.

The impairment charges for the CMO were recognized in light of significant deterioration of housing values in the residential real estate market, the significant rise in delinquencies and charge-offs of the underlying mortgage loans and resulting decline in the market value of the securities.

With the assistance of competent third-party valuation specialists, the Company utilized the following methodologies to quantify the OTTI. The underlying mortgage collateral was analyzed in order to project future cash flows and to calculate the credit component of the OTTI. Four major assumptions were utilized; prepayment (CPR), conditional default rate (CDR), loss severity and risk adjusted discount rate. The methodologies for the four assumptions are:

CPR assumptions were based on an evaluation of the lifetime conditional prepayment rates; 3 month CPR over the most recent period, past 6 months and past 12 months; estimated prepayment rates provided by the Securities Industry & Financial Markets Association (SIFMA), forecasts from other industry experts, and judgment given recent deterioration in credit conditions and declines in property values. The CPR assumptions utilized ranged from 7.73% to 8.51%.

CDR estimates were based on the status of the loans – current, 30-59 days delinquent, 60-89 days delinquent, 90+ days delinquent, foreclosure or REO – and proprietary loss migration models (i.e. percentage of 30 day delinquents that will ultimately migrate to default, percentage of 60 day delinquents that will ultimately migrate to default, etc.). The model assumes that the 60 day plus population will move to repossession inventory subject to the loss migration assumptions and liquidate over the next 36 months. Defaults vector from month 37 to month 48 to the month 49 CDR value and ultimately vector to zero over an extended period of time of at least 15 years. The CDR assumption utilized started at a range of 5.58% to 6.23%, and ramped down to a range of 1.80% to 4.14% by month 49.

Loss severity estimates are based on the initial loan to value ratio, the loan’s lien position, private mortgage insurance proceeds available (if any), and the estimated change in the price of the property since origination.  The loss severity assumption is static for twelve months at 50.9% then decreases monthly based on future market appreciation to a floor of 23%.
 
 
13
 

 
The risk adjusted discount rate of 15% was derived based on the spread from the most recent active market indication for either the instrument in question or a proxy of the instrument. The resulting spread was then used in conjunction with the swap curve to discount the expected cash flow stream.

NOTE 4.  LOANS
 
The portfolio of the loans outstanding consists of:
 
   
September 30, 2011
    
December 31, 2010
  
   
Amount
    
Percentage
of Total
Loans
    
Amount
    
Percentage
of Total
Loans
  
   
(amounts in thousands)
  
Commercial and industrial
   $ 23,931       3.7 %   $ 24,782       4.0 %
Real estate construction:
                                
Residential
     21,525       3.4       38,810       6.2  
Commercial
     56,826       8.9       57,086       9.1  
Real estate mortgage:
                                
Commercial – owner occupied
     145,351       22.8       141,035       22.5  
Commercial – non owner occupied
     207,231       32.5       178,755       28.6  
Residential – 1 to 4 family
     147,272       23.1       141,315       22.5  
Residential - Multifamily
     17,514       2.7       27,841       4.4  
Consumer
     18,547       2.9       17,115       2.7  
Total Loans
   $ 638,197       100.0 %   $ 626,739       100.0 %
                                 

 
The Company maintains interest reserves for the purpose of making periodic and timely interest payments for borrowers that qualify.  Total loans with interest reserves were $29.0 million and $65.6 million at September 30, 2011 and December 31, 2010 respectively. On a monthly basis management reviews loans with interest reserves to assess current and projected performance.

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

Commercial loans are underwritten after evaluating and understanding the borrower's ability to operate profitably and prudently expand its business. Underwriting standards are designed to promote relationship banking rather than transactional banking. Once it is determined that the borrower's management possesses sound ethics and solid business acumen, the Company's management examines current and projected cash flows to determine the ability of the borrower to repay its obligations as agreed. Commercial loans are primarily made based on the identified cash flows of the borrower and secondarily on the underlying collateral provided by the borrower. The cash flows of borrowers, however, may not be as expected and the collateral securing these loans may fluctuate in value. Most commercial loans are secured by the assets being financed or other business assets such as accounts receivable or inventory and
 
 
14
 
 
almost always will incorporate a personal guarantee. In the case of loans secured by accounts receivable, the availability of funds for the repayment of these loans may be substantially dependent on the ability of the borrower to collect amounts due from its customers.

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

Commercial real estate loans are subject to underwriting standards and processes similar to commercial loans, in addition to those of real estate loans. These loans are viewed primarily as cash flow loans and secondarily as loans secured by real estate. Commercial real estate lending typically involves higher loan principal amounts and the repayment of these loans is generally largely dependent on the successful operation of the property securing the loan or the business conducted on the property securing the loan. Commercial real estate loans may be more adversely affected by conditions in the real estate markets or in the general economy. The properties securing the Company’s commercial real estate portfolio are diverse in terms of type and geographic location within our market area. This diversity helps reduce the Company's exposure to adverse economic events that affect any single market or industry. Management monitors and evaluates commercial real estate loans based on collateral, geography and risk grade criteria. The Company also monitors economic conditions and trends affecting market areas it serves. In addition, management tracks the level of owner-occupied commercial real estate loans versus non-owner occupied loans. At September 30, 2011, approximately 41.4% of the outstanding principal balance of the Company’s commercial real estate loans were secured by owner-occupied properties.

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

The Company maintains an outsourced independent loan review program that reviews and validates the credit risk program on a periodic basis. Results of these reviews are presented to management. The loan review process complements and reinforces the risk identification and assessment decisions made by lenders and credit personnel, as well as the Company's policies and procedures.

Nonaccrual and Past Due Loans:  Loans are considered past due if the required principal and interest payments have not been received as of the date such payments were due. Loans are placed on non-accrual status when, in management's opinion, the borrower may be unable to meet payment obligations as they become due, as well as when a loan is 90 days past due, unless the loan is well secured and in the process of collection, as required by regulatory provision. Loans may be placed on non-accrual status regardless
 
 
15
 
 
of whether or not such loans are considered past due. When interest accrual is discontinued, all unpaid accrued interest is reversed. Interest income is subsequently recognized only to the extent cash payments are received in excess of principal due. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured.

An age analysis of past due loans by class follows:
 
As of September 30, 2011
30-59 Days
Past Due
  
60-89 Days
Past Due
  
Greater than
90 Days and Accruing
  
Greater than
90 Days and
Not
Accruing
  
Total
Past Due
    
Current
  
Total
Loans
 
(Amounts in thousands)
Commercial and industrial
$
594
  
$
—
  
$
—
  
$
—
  
$
594
  
$
23,337
  
$
23,931
Real estate construction:
                                        
        Residential
  
—
    
—
    
—
    
4,557
    
4,557
    
16,968
    
21,525
        Commercial
  
—
    
1,698
    
—
    
7,597
    
9,295
    
47,531
    
56,826
Real estate mortgage:
                                        
        Commercial – owner occupied
  
165
    
—
    
—
    
4,878
    
5,043
    
140,308
    
145,351
        Commercial – non owner occupied
  
1,510
    
—
    
—
    
10,686
    
12,196
    
195,035
    
207,231
        Residential – 1 to 4 family
  
524
    
—
    
—
    
10,294
    
10,818
    
136,454
    
147,272
        Residential - Multifamily
  
—
    
—
    
—
    
585
    
585
    
16,929
    
17,514
Consumer
  
—
    
—
    
—
    
169
    
169
    
18,378
    
18,547
Total Loans
$
2,793
  
$
1,698
  
$
—
  
$
38,766
  
$
43,257
  
$
594,940
  
$
638,197
 
As of December 31, 2010
30-59 Days
Past Due
  
60-89 Days
Past Due
  
Greater than
90 Days and Accruing
  
Greater than
90 Days and
Not
Accruing
  
Total
Past Due
    
Current
  
Total
Loans
 
(Amounts in thousands)
Commercial and industrial
$
21
  
$
98
  
$
—
  
$
—
  
$
119
  
$
24,663
  
$
24,782
Real estate construction:
                                        
        Residential
  
1,657
    
—
    
—
    
8,546
    
10,203
    
28,607
    
38,810
        Commercial
  
266
    
—
    
—
    
6,701
    
6,967
    
50,119
    
57,086
Real estate mortgage:
                                        
        Commercial – owner occupied
  
4,157
    
—
    
—
    
546
    
4,703
    
136,332
    
141,035
        Commercial – non owner occupied
  
406
    
5,670
    
—
    
826
    
6,902
    
171,853
    
178,755
        Residential – 1 to 4 family
  
1,334
    
2,161
    
—
    
9,415
    
12,910
    
128,405
    
141,315
        Residential - Multifamily
  
75
    
—
    
—
    
1,350
    
1,425
    
26,416
    
27,841
Consumer
  
—
    
—
    
—
    
61
    
61
    
17,054
    
17,115
Total Loans
$
7,916
  
$
7,929
  
$
—
  
$
27,445
  
$
43,290
  
$
583,449
  
$
626,739


 
16
 

Impaired Loans:  Loans with a risk rating of substandard or worse are deemed impaired. In addition, Troubled Debt Restructurings are also deemed impaired.

All impaired loans have an independent third-party full appraisal to determine the net realizable value (“NRV”) based on the fair value of the underlying collateral, less cost to sell and other costs, such as unpaid real estate taxes, that have been identified, or the present value of discounted cash flows in the case of certain impaired loans that are not collateral dependent. The appraisal will be based on an "as-is" valuation and will follow a reasonable valuation method that addresses the direct sales comparison, income, and cost approaches to market value, reconciles those approaches, and explains the elimination of each approach not used. Appraisals are updated every 12 months or sooner if we have identified possible further deterioration in value. Prior to receiving the updated appraisal, we will establish a specific reserve for any estimated deterioration, based upon our assessment of market conditions, adjusted for estimated costs to sell and other identified costs. If the NRV is greater than the loan amount, then no impairment loss exists. If the NRV is less than the loan amount, the shortfall is recognized by a specific reserve. If the borrower fails to pledge additional collateral in the ninety day period, a charge-off equal to the difference between the loan carrying value and NRV will occur. In certain circumstances, however, a direct charge-off may be taken at the time that the NRV calculation reveals a shortfall. All impaired loans are evaluated based on the criteria stated above on a quarterly basis and any change in the reserve requirements are recorded in the period identified. All partially charged-off loans remain on nonaccrual status until they are brought current as to both principal and interest and have at least nine months of payment history and future collectability of principal and interest is assured.


 
17
 

Impaired loans are set forth in the following tables.

 As of September 30, 2011
  
Recorded
Investment
    
Unpaid
Principal
Balance
    
Related
Allowance
    
Average
Recorded Investment
    
Interest
Income
Recognized1
  
 
  
(Amounts in thousands)
  
With no related allowance recorded:
                              
        Commercial and industrial
   $ 594     $ 594     $ —     $ 594     $ 18  
        Real estate construction:
                                        
                Residential
     4,149       4,341       —       5,877       160  
                Commercial
     14,324       14,545       —       14,455       331  
        Real estate mortgage:
                                        
                Commercial – owner occupied
     7,043       7,043       —       7,097       135  
                Commercial – non owner occupied
     43,024       43,024       —       46,163       2,228  
                Residential – 1 to 4 family
     12,090       14,689       —       14,557       169  
                Residential - Multifamily
     585       655       —       626       29  
        Consumer
     169       169       —       171       8  
      81,978       85,060       —       89,540       3,078  
                                         
With an allowance recorded:
                                        
        Commercial and industrial
     —       —       —       —       —  
        Real estate construction:
                                        
                Residential
     5,772       7,010       1,391       6,737       176  
                Commercial
     1,645       1,645       166       1,564       55  
        Real estate mortgage:
                                        
                Commercial – owner occupied
     592       592       24       593       34  
                Commercial – non owner occupied
     12,244       12,364       643       11,358       305  
                Residential – 1 to 4 family
     1,976       1,976       43       1,806       64  
                Residential - Multifamily
     3,426       3,426       2       4,136       218  
        Consumer
     —       —       —       —       —  
      25,655       27,013       2,269       26,194       852  
                                         
Total:
                                        
        Commercial and industrial
     594       594       —       594       18  
        Real estate construction:
                                        
                Residential
     9,921       11,351       1,391       12,614       336  
                Commercial
     15,969       16,190       166       16,019       386  
        Real estate mortgage:
                                        
                Commercial – owner occupied
     7,635       7,635       24       7,690       169  
                Commercial – non owner occupied
     55,268       55,388       643       57,521       2,533  
                Residential – 1 to 4 family
     14,066       16,665       43       16,363       233  
                Residential - Multifamily
     4,011       4,081       2       4,762       247  
        Consumer
     169       169       —       171       8  
Total
   $ 107,633     $ 112,073     $ 2,269     $ 115,734     $ 3,930  

1Reflects the interest income recognized on impaired loans, which includes performing troubled debt restructurings accruing interest, during the nine month period ending September 30, 2011. Interest income recognized on a cash basis subsequent to a loan being placed on nonaccrual was $162,000 during the period.


 
18
 


 As of December 31, 2010
  
Recorded
Investment
    
Unpaid
Principal
Balance
    
Related
Allowance
    
Average
Recorded Investment
    
Interest
Income
Recognized1
  
 
  
(Amounts in thousands)
  
With no related allowance recorded:
                              
        Commercial and industrial
   $ 785     $ 785     $ —     $ 509     $ 11  
        Real estate construction:
                                        
                Residential
     13,180       14,147       —       12,789       106  
                Commercial
     18,181       18,770       —       7,845       214  
        Real estate mortgage:
                                        
                Commercial – owner occupied
     9,022       9,022       —       5,209       395  
                Commercial – non owner occupied
     33,281       33,282       —       10,994       1,167  
                Residential – 1 to 4 family
     6,185       6,211       —       6,203       153  
                Residential - Multifamily
     2,355       2,425       —       1,676       77  
        Consumer
     61       61       —       31       —  
      83,050       84,703       —       45,256       2,123  
                                         
With an allowance recorded:
                                        
        Commercial and industrial
     —       —       —       —       —  
        Real estate construction:
                                        
                Residential
     6,599       7,820       2,091       6,576       70  
                Commercial
     —       —       —       —       —  
        Real estate mortgage: