Unassociated Document
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 June 30, 2009

OR
¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For transition period from ________ to ________

Commission File Number 0-33203

LANDMARK BANCORP, INC.
(Exact name of Registrant as specified in its charter)

Delaware
          
43-1930755
(State or other jurisdiction of incorporation or organization)
 
(I.R.S. Employer Identification Number)

701 Poyntz Avenue, Manhattan, Kansas       66502
(Address of principal executive offices)                              (Zip Code)

(785) 565-2000
(Registrant's telephone number, including area code)

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 Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes ¨  No ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company.  See 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
(Do not check if a smaller reporting company)

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

Indicate the number of shares outstanding of each of the Registrant's classes of common stock as of the latest practicable date: as of July 31, 2009, the Registrant had outstanding 2,371,450 shares of its common stock, $.01 par value per share.

 
 

 

LANDMARK BANCORP, INC.
Form 10-Q Quarterly Report

Table of Contents

   
Page Number
PART I
     
Item 1.
Financial Statements and Related Notes
2 - 19
Item 2.
Management's Discussion and Analysis of Financial Condition and Results of Operations
20 - 29
Item 3.
Quantitative and Qualitative Disclosures about Market Risk
29 - 30 
Item 4.
Controls and Procedures
30
     
PART II
     
Item 1.
Legal Proceedings
31
Item 1A.
Risk Factors
31
     
Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds
31
Item 3.
Defaults Upon Senior Securities
31
Item 4.
Submission of Matters to a Vote of Security Holders
32
Item 5.
Other Information
32
Item 6.
Exhibits
32
     
Form 10-Q Signature Page
33

 
1

 

ITEM 1.  FINANCIAL STATEMENTS AND RELATED NOTES

LANDMARK BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
(Unaudited)

(Dollars in thousands)
 
June 30,
   
December 31,
 
   
2009
   
2008
 
Assets
           
Cash and cash equivalents
  $ 18,853     $ 13,788  
Investment securities:
               
Available for sale, at fair value
    170,062       162,245  
Other securities
    7,909       9,052  
Loans, net
    355,306       365,772  
Loans held for sale
    7,544       1,487  
Premises and equipment, net
    16,614       13,956  
Goodwill
    12,894       12,894  
Other intangible assets, net
    2,609       2,407  
Bank owned life insurance
    12,242       11,996  
Accrued interest and other assets
    9,107       8,617  
Total assets
  $ 613,140     $ 602,214  
                 
Liabilities and Stockholders’ Equity
               
Liabilities:
               
Deposits:
               
Non-interest bearing demand
  $ 57,290     $ 49,823  
Money market and NOW
    154,635       150,116  
Savings
    28,926       26,203  
Time, $100,000 and greater
    61,461       49,965  
Time, other
    159,266       163,439  
Total deposits
    461,578       439,546  
                 
Federal Home Loan Bank borrowings
    61,117       77,319  
Other borrowings
    28,855       27,047  
Accrued expenses, taxes and other liabilities
    9,041       6,896  
Total liabilities
    560,591       550,808  
                 
Stockholders' equity:
               
Preferred stock, $0.01 par, 200,000 shares authorized, none issued
    -       -  
Common stock, $0.01 par, 7,500,000 shares authorized, 2,411,412 shares issued, at June 30, 2009 and December 31, 2008
    24       24  
Additional paid-in capital
    23,951       23,873  
Retained earnings
    28,939       27,819  
Treasury stock, at cost; 39,962 and 39,162 shares at June 30, 2009 and December 31, 2008, respectively
    (947 )     (935 )
Accumulated other comprehensive income
    582       625  
Total stockholders' equity
    52,549       51,406  
                 
Total liabilities and stockholders' equity
  $ 613,140     $ 602,214  

See accompanying notes to condensed consolidated financial statements.

 
2

 

LANDMARK BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF EARNINGS
(Unaudited)

(Dollars in thousands, except per share data)
 
Three months ended June 30,
   
Six months ended June 30,
 
   
2009
   
2008
   
2009
   
2008
 
Interest income:
                       
Loans:
                       
Taxable
  $ 5,170     $ 6,113     $ 10,303     $ 12,727  
Tax-exempt
    64       56       113       99  
Investment securities:
                               
Taxable
    1,069       1,198       2,185       2,421  
Tax-exempt
    621       599       1,230       1,195  
Other
    4       19       7       37  
Total interest income
    6,928       7,985       13,838       16,479  
                                 
Interest expense:
                               
Deposits
    1,558       2,615       3,197       5,737  
Borrowed funds
    811       897       1,690       1,808  
Total interest expense
    2,369       3,512       4,887       7,545  
Net interest income
    4,559       4,473       8,951       8,934  
Provision for loan losses
    800       300       1,100       900  
Net interest income after provision for loan losses
    3,759       4,173       7,851       8,034  
                                 
Non-interest income:
                               
Fees and service charges
    1,142       1,115       2,098       2,081  
Gains on sale of loans
    1,199       394       1,907       739  
Gain on prepayment of FHLB borrowings
    -       -       -       246  
Bank owned life insurance
    124       118       247       234  
Other
    174       136       287       278  
Total non-interest income
    2,639       1,763       4,539       3,578  
                                 
Investment securities gains (losses), net:
                               
Impairment losses on investment securities
    (60 )     -       (910 )     -  
Less noncredit-related losses
    (189 )     -       334       -  
Net impairment losses
    (249 )     -       (576 )     -  
Gains on sales of investment securities
    -       497       -       497  
Investment securities gains (losses), net
    (249 )     497       (576 )     497  
                                 
Non-interest expense:
                               
Compensation and benefits
    2,203       2,097       4,379       4,225  
Occupancy and equipment
    663       673       1,314       1,434  
Federal deposit insurance premiums
    447       13       480       26  
Data processing
    204       206       394       403  
Amortization of intangibles
    191       205       378       409  
Professional fees
    192       121       364       233  
Advertising
    119       89       240       177  
Other
    926       859       1,851       1,645  
Total non-interest expense
    4,945       4,263       9,400       8,552  
Earnings before income taxes
    1,204       2,170       2,414       3,557  
Income tax expense
    192       594       393       914  
Net earnings
  $ 1,012     $ 1,576     $ 2,021     $ 2,643  
Earnings per share:
                               
Basic
  $ 0.43     $ 0.66     $ 0.85     $ 1.09  
Diluted
  $ 0.43     $ 0.66     $ 0.85     $ 1.08  
Dividends per share
  $ 0.19     $ 0.18     $ 0.38     $ 0.36  

See accompanying notes to condensed consolidated financial statements.

 
3

 

 LANDMARK BANCORP, INC. AND SUBSIDIARY
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)

(Dollars in thousands)
 
Six months ended June 30,
 
   
2009
   
2008
 
Net cash used in operating activities
  $ (712 )   $ (1,220 )
                 
Cash flows from investing activities:
               
Net decrease (increase) in loans
    12,247       (2,241 )
Maturities and prepayments of investment securities
    29,101       7,097  
Purchase of investment securities
    (37,707 )     (25,901 )
Proceeds from sales of investment securities
    1,210       10,407  
Proceeds from sales of premises and equipment and foreclosed assets
    1,095       668  
Purchases of premises and equipment, net
    (552 )     (472 )
Net cash paid in branch acquisition
    (130 )     -  
Net cash provided by (used in) investing activities
    5,264       (10,442 )
                 
Cash flows from financing activities:
               
Net increase (decrease) in deposits
    15,636       (4,855 )
Federal Home Loan Bank advance borrowings
    -       35,000  
Federal Home Loan Bank advance repayments
    (10,018 )     (13,518 )
Federal Home Loan Bank line of credit, net
    (6,000 )     (6,400 )
Other borrowings, net
    1,808       3,903  
Purchase of treasury stock
    (12 )     (3,296 )
Proceeds from issuance of stock under stock option plans
    -       30  
Excess tax benefit related to stock option plans
    -       5  
Payment of dividends
    (901 )     (887 )
Net cash provided by financing activities
    513       9,982  
                 
Net increase (decrease) in cash and cash equivalents
    5,065       (1,680 )
Cash and cash equivalents at beginning of period
    13,788       14,739  
Cash and cash equivalents at end of period
  $ 18,853     $ 13,059  
                 
Supplemental disclosure of cash flow information:
               
Cash paid during period for interest
  $ 4,832     $ 7,776  
Cash paid during period for taxes, net
    312       213  
                 
Supplemental schedule of non-cash investing and financing activities:
               
Transfer of loans to real estate owned
  $ 1,140     $ 1,346  
Branch acquisition:
               
Fair value of liabilities assumed
    6,650       -  
Fair value of assets acquired
    6,520       -  

See accompanying notes to condensed consolidated financial statements.

 
4

 

LANDMARK BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF EQUITY AND COMPREHENSIVE INCOME
(Unaudited)

(Dollars in thousands, except per share data)
 
Common
stock
   
Additional
paid-in
capital
   
Retained
earnings
   
Treasury
stock
   
Accumulated
other
comprehensive
income
   
Total
 
                                     
Balance at December 31, 2007
  $ 24     $ 24,304     $ 27,493     $ (206 )   $ 680     $ 52,295  
Comprehensive income:
                                            -  
Net earnings
    -       -       2,643       -       -       2,643  
Change in fair value of investment securities available-for-sale, net of tax
    -       -       -       -       (931 )     (931 )
Total comprehensive income
    -       -       2,643       -       (931 )     1,712  
Dividends paid ($0.36 per share)
    -       -       (887 )     -       -       (887 )
Stock-based compensation
    -       57       -       -       -       57  
Exercise of stock options, 1,882 shares, including tax benefit of $5,010
    -       35       -       -       -       35  
Purchase of 134,385 treasury shares
    -       -       -       (3,296 )     -       (3,296 )
Adoption of EITF 06-4
    -       -       (335 )     -       -       (335 )
Balance June 30, 2008
  $ 24     $ 24,396     $ 28,914     $ (3,502 )   $ (251 )   $ 49,581  
                                                 
Balance at December 31, 2008
  $ 24     $ 23,873     $ 27,819     $ (935 )   $ 625     $ 51,406  
Comprehensive income:
                                               
Net earnings
    -       -       2,021       -       -       2,021  
Change in fair value of investment securities available-for-sale for which a portion of an other than temporary impairment has been recorded in net earnings, net of tax
    -       -       -       -       246       246  
Change in fair value of all other investment securities available-for-sale, net of tax
    -       -       -       -       (289 )     (289 )
Total comprehensive income
    -       -       2,021       -       (43 )     1,978  
Dividends paid ($0.38 per share)
    -       -       (901 )     -       -       (901 )
Stock-based compensation
    -       78       -       -       -       78  
Purchase of 800 shares treasury shares
    -       -       -       (12 )     -       (12 )
Balance at June 30, 2009
  $ 24     $ 23,951     $ 28,939     $ (947 )   $ 582     $ 52,549  

 See accompanying notes to condensed consolidated financial statements.

 
5

 

LANDMARK BANCORP, INC. AND SUBSIDIARY
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

1. 
Interim Financial Statements

The condensed consolidated financial statements of Landmark Bancorp, Inc. (the “Company”) and subsidiary have been prepared in accordance with the instructions to Form 10-Q.  To the extent that information and footnotes required by U.S. generally accepted accounting principles for complete financial statements are contained in or consistent with the consolidated audited financial statements incorporated by reference in the Company’s Form 10-K for the year ended December 31, 2008, such information and footnotes have not been duplicated herein.  In the opinion of management, all adjustments, consisting of normal recurring accruals, considered necessary for a fair presentation of financial statements have been reflected herein.  The December 31, 2008, condensed consolidated balance sheet has been derived from the audited consolidated balance sheet as of that date.  The results of the interim period ended June 30, 2009 are not necessarily indicative of the results expected for the year ending December 31, 2009.  Subsequent events have been evaluated for potential recognition or disclosure through the time of the filing on August 13, 2009, which represents the date the consolidated financial statements were issued.

2. 
Goodwill and Other Intangible Assets

The Company tests goodwill for impairment annually or more frequently if circumstances warrant.  During 2009, the decline in the Company’s stock price coupled with current market conditions in the financial services industry, constituted a triggering event which required an impairment test to be performed.  The Company performed an impairment test as of March 31, 2009 by comparing the fair value of the Company’s single reporting unit to its carrying value.  Fair value was determined using observable market data including the Company’s market capitalization and valuation multiples compared to recent financial industry acquisition multiples to estimate the fair value of the Company’s single reporting unit.  Based on the results of the March 31, 2009 impairment testing which indicated no impairment, along with the Company’s conclusion that no triggering events occurred during the second quarter of 2009, the Company concluded its goodwill was not impaired as of June 30, 2009.

On May 8, 2009, the Company’s subsidiary, Landmark National Bank, assumed approximately $6.4 million in deposits in connection with a branch acquisition.  As part of the transaction, Landmark National Bank agreed to pay a deposit premium of 1.75 percent on the core deposit balance as of 270 days after the close of the transaction.  As of May 8, 2009 the core deposit premium, based on the acquired core deposit balances, was $86,000.  The following is an analysis of changes in the core deposit intangible assets:

   
Three months ended June 30,
 
  (Dollars in thousands)
 
2009
   
2008
 
   
Fair value at
acquisition
   
Accumulated
Amortization
   
Fair value at
acquisition
   
Accumulated
Amortization
 
Balance at beginning of period
  $ 5,396     $ (3,314 )   $ 5,396     $ (2,641 )
Additions
    86       -       -       -  
Amortization
    -       (153 )     -       (177 )
Balance at end of period
  $ 5,482     $ (3,467 )   $ 5,396     $ (2,818 )
 
   
Six months ended June 30,
 
  (Dollars in thousands)
 
2009
   
2008
 
   
Fair value at
acquisition
   
Accumulated
Amortization
   
Fair value at
acquisition
   
Accumulated
Amortization
 
Balance at beginning of period
  $ 5,396     $ (3,159 )   $ 5,396     $ (2,462 )
Additions
    86       -       -       -  
Amortization
    -       (308 )     -       (356 )
Balance at end of period
  $ 5,482     $ (3,467 )   $ 5,396     $ (2,818 )

 
6

 

The following is an analysis of changes in the mortgage servicing rights:

   
Three months ended June 30,
 
  (Dollars in thousands)
 
2009
   
2008
 
   
Cost
   
Accumulated
Amortization
   
Cost
   
Accumulated
Amortization
 
Balance at beginning of period
  $ 893     $ (600 )   $ 771     $ (572 )
Additions
    339       -       19       -  
Prepayments/maturities
    (21 )     21       (19 )     19  
Amortization
    -       (38 )     -       (28 )
Balance at end of period
  $ 1,211     $ (617 )   $ 771     $ (581 )
 
   
Six months ended June 30,
 
  (Dollars in thousands)
 
2009
   
2008
 
   
Cost
   
Accumulated
Amortization
   
Cost
   
Accumulated
Amortization
 
Balance at beginning of period
  $ 772     $ (602 )   $ 770     $ (560 )
Additions
    494       -       33       -  
Prepayments/maturities
    (55 )     55       (32 )     32  
Amortization
    -       (70 )     -       (53 )
Balance at end of period
  $ 1,211     $ (617 )   $ 771     $ (581 )
 
The mortgage servicing rights correspond to loans serviced by the Company for unrelated third parties with outstanding principal balances of $120.5 million and $82.0 million at June 30, 2009 and December 31, 2008, respectively.  Gross service fee income related to such loans was $63,000 and $56,000 for the quarters ended June 30, 2009 and 2008, respectively, which is included in fees and service charges in the condensed consolidated statements of earnings.  Gross service fee income for the six months ended June 30, 2009 and 2008 was $114,000 and $113,000, respectively.

Aggregate amortization expense for the quarters ended June 30, 2009 and 2008, was $191,000 and $205,000, respectively and $378,000 and $409,000 for the six months ended June 30, 2009 and 2008, respectively.  The following depicts estimated amortization expense for all intangible assets for the remainder of 2009 and in successive years ending December 31:

Year
    
Amount (in thousands)
 
Remainder of 2009
  $ 376  
2010
    667  
2011
    567  
2012
    471  
2013
    297  
Thereafter
    231  

 
7

 

3. 
Investments

A summary of investment securities available-for-sale is as follows:

   
As of June 30, 2009
 
         
Gross
   
Gross
       
   
Amortized
   
unrealized
   
unrealized
   
Estimated
 
  (Dollars in thousands)
 
cost
   
gains
   
losses
   
fair value
 
                         
U. S. federal agency obligations
  $ 26,652     $ 626     $ (1 )   $ 27,277  
Municipal obligations
    67,096       1,028       (631 )     67,493  
Mortgage-backed securities
    62,514       1,400       (3 )     63,911  
Pooled trust preferred securities
    1,914       -       (1,595 )     319  
Common stocks
    693       112       (17 )     788  
Certificates of deposit
    10,274       -       -       10,274  
Total
  $ 169,143     $ 3,166     $ (2,247 )   $ 170,062  

   
As of December 31, 2008
 
         
Gross
   
Gross
       
   
Amortized
   
unrealized
   
unrealized
   
Estimated
 
  (Dollars in thousands)
 
cost
   
gains
   
losses
   
fair value
 
                         
U. S. federal agency obligations
  $ 28,566     $ 950     $ (2 )   $ 29,514  
Municipal obligations
    63,711       1,532       (934 )     64,309  
Mortgage-backed securities
    55,752       934       (104 )     56,582  
Pooled trust preferred securities
    2,488             (1,748 )     740  
Common stocks
    693       389       (8 )     1,074  
Certificates of deposit
    10,026                   10,026  
Total
  $ 161,236     $ 3,805     $ (2,796 )   $ 162,245  

Included in the June 30, 2009 gross unrealized losses above, are noncredit-related losses of $334,000, recorded in accumulated other comprehensive income, related to a $1.0 million par investment in a pool of trust preferred securities, which was determined to be other than temporarily impaired.  The amortized cost of the other than temporarily impaired investment, after recognition of $576,000 of impairment losses, was $424,000 at June 30, 2009.  The fair value of this security was $90,000 at June 30, 2009 compared to $275,000 at December 31, 2008, while the unrealized losses included in accumulated other comprehensive were $334,000 at June 30, 2009 and $725,000 at December 31, 2008.

 
8

 

The summary of available-for-sale investment securities shows that some of the securities in the available-for-sale investment portfolio had unrealized losses, or were temporarily impaired, as of June 30, 2009 and December 31, 2008.  This temporary impairment represents the estimated amount of loss that would be realized if the securities were sold on the valuation date.  Securities which were temporarily impaired are shown below, along with the length of the impairment period.

(Dollars in thousands)
       
As of June 30, 2009
 
   
Number
   
Less than 12 months
   
12 months or longer
   
Total
 
   
of
   
Fair
   
Unrealized
   
Fair
   
Unrealized
   
Fair
   
Unrealized
 
   
securities
   
value
   
losses
   
value
   
losses
   
value
   
losses
 
U. S. federal agency obligations
 
3
    $ 160     $ (1 )     -       -     $ 160     $ (1 )
Municipal obligations
 
51
      16,184       (417 )     3,073       (214 )     19,257       (631 )
Mortgage-backed securities
 
6
      3,840       (3 )     69       -       3,909       (3 )
Pooled trust preferred securities
 
3
      -       -       319       (1,595 )     319       (1,595 )
Common stocks
 
5
      75       (17 )     -       -       75       (17 )
Total
 
68
    $ 20,259     $ (438 )   $ 3,461     $ (1,809 )   $ 23,720     $ (2,247 )


(Dollars in thousands)
       
As of December 31, 2008
 
   
Number
   
Less than 12 months
   
12 months or longer
   
Total
 
   
of
   
Fair
   
Unrealized
   
Fair
   
Unrealized
   
Fair
   
Unrealized
 
   
securities
   
value
   
losses
   
value
   
losses
   
value
   
losses
 
U. S. federal agency obligations
 
3
    $ 64     $ -     $ 133     $ (2 )   $ 197     $ (2 )
Municipal obligations
 
56
      13,282       (466 )     8,542       (468 )     21,824       (934 )
Mortgage-backed securities
 
80
      12,219       (78 )     3,400       (26 )     15,619       (104 )
Pooled trust preferred securities
 
3
      -       -       740       (1,748 )     740       (1,748 )
Common stocks
 
3
      13       (2 )     18       (6 )     31       (8 )
Total
 
145
    $ 25,578     $ (546 )   $ 12,834     $ (2,250 )   $ 38,412     $ (2,796 )

The Company’s assessment of other than temporary impairment is based on its reasonable judgment of the specific facts and circumstances impacting each individual security at the time such assessments are made.  The Company reviews and considers factual information, including expected cash flows, the structure of the security, the credit quality of the underlying assets and the current and anticipated market conditions.  As of January 1, 2009, the Company early adopted Financial Accounting Standards Board (“FASB”) Staff Position (“FSP”) No. FAS 115-2 and FAS 124-2, “Recognition and Presentation of Other Than Temporary Impairments,” which changed the accounting for other than temporary impairments of debt securities and separates the impairment into credit-related and other factors.

The receipt of principal, at par, and interest on mortgage-backed securities is guaranteed by the respective government-sponsored agency guarantor, such that the Company believes that its mortgage-backed securities do not expose the Company to credit related losses.  Based on these factors, along with the Company’s intent to not sell the security and that it is more likely than not that the Company will not be required to sell the security before recovery of its cost basis, the Company believes that the mortgage-backed securities identified in the tables above were temporarily depressed as of June 30, 2009 and December 31, 2008.  The Company’s mortgage-backed securities portfolio consisted of securities predominantly underwritten to the standards of and guaranteed by the government-sponsored agencies of FHLMC, FNMA and GNMA.

The Company believes that the decline in the value of certain municipal obligations was primarily related to an overall widening of market spreads for many types of fixed income products during 2008 and 2009, reflecting, among other things, reduced liquidity and the downgrades on the underlying credit default insurance providers.  At June 30, 2009, the Company does not intend to sell and it is more likely than not that the Company will not be required to sell until the recovery of its cost, its municipal obligations in an unrealized loss position.  Due to the issuers’ continued satisfaction of the securities’ obligations in accordance with their contractual terms and the expectation that they will continue to do so as well as the evaluation of the fundamentals of the issuers’ financial condition and other objective evidence, management’s intention not to sell and belief that it is more likely than not that the Company will not have to sell such securities prior to recovery of the Company’s amortized cost, and therefore the Company believes that the municipal obligations identified in the tables above were temporarily depressed as of June 30, 2009 and December 31, 2008.
 
9


At June 30, 2009, the Company owned three pooled trust preferred securities with an original cost basis of $2.5 million, which represent investments in pools of debt obligations issued by financial institutions and insurance companies.  The market for these securities is considered to be inactive according to the guidance issued in FSP No. FAS 157-4, “Determining Fair Value When the Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly,” which the Company early adopted as of January 1, 2009.  The Company used a discounted cash flow model to determine the estimated fair value of its pooled trust preferred securities and to assess if the present value of the cash flows expected to be collected was less than the amortized cost, which would result in an other than temporary impairment.  The assumptions used in preparing the discounted cash flow model include the following: estimated discount rates (using yields of comparable traded instruments adjusted for illiquidity and other risk factors), estimated deferral and default rates on collateral, and estimated cash flows.  The discounted cash flow analysis included a review of all issuers within the collateral pool and incorporated higher deferral and default rates, as compared to historical rates, in the cash flow projections through maturity.  The Company also reviewed a stress test of these securities to determine the additional estimated deferrals or defaults in the collateral pool in excess of what the Company believes is likely, before the payments on the individual securities are negatively impacted.

At June 30, 2009, the analysis of two of the Company’s three investments in pooled trust preferred securities indicated that the unrealized loss was temporary and that it is more likely than not that the Company would be able to recover the cost basis of these securities.  However, the Company determined that a portion of the unrealized loss on the third investment in a $1.0 million pooled trust preferred security was other than temporary.  The amount of actual and projected deferrals and/or defaults by the financial institutions underlying this pooled trust preferred security, increased significantly since the beginning of 2009, primarily when a large number of deferrals occurred in this pool during April and July of 2009.  The percentage of the pool that was not performing according to the contractual terms of the agreements increased from 9% at December 31, 2008, to 28% at March 31, 2009 and 41% at June 30, 2009.  The increase in nonperforming collateral resulted in an other than temporary impairment of this security.  The Company follows the provisions of FSP No. FAS 115-2 and FAS 124-2 in determining the amount of the other than temporary impairment recorded to earnings.  The Company performed a discounted cash flow analysis, using the factors noted above to determine the amount of the other than temporary impairment that was applicable to either credit losses or other factors.  The amount associated with credit losses, $576,000, was then realized through a charge to earnings for the six months ended June 30, 2009 as an impairment loss, while the $334,000 change in the unrealized loss associated with other factors was recorded in other comprehensive income.

The following table reconciles the changes in the Company’s credit losses recognized in earnings.

   
Three months
ending
   
Six months
ending
 
(Dollars in thousands)
 
June 30, 2009
   
June 30, 2009
 
Beginning balance
  $ 327     $ -  
Additional credit losses:
               
Securities with no previous other than temporary impairment
    -       576  
Securities with previous other than temporary impairments
    249       -  
Ending balance
  $ 576     $ 576  

It is reasonably possible that the fair values of the Company’s investment securities could decline in the future if the overall economy and the financial condition of some of the issuers continue to deteriorate and the liquidity of these securities remains low.  As a result, there is a risk that additional other than temporary impairments may occur in the future and any such amounts could be material to the Company’s consolidated statements of earnings.

Maturities of investment securities at June 30, 2009 are as follows:

(Dollars in thousands)
 
Amortized
cost
   
Estimated
fair value
 
Due in less than one year
  $ 27,749     $ 26,262  
Due after one year but within five years
    25,349       25,984  
Due after five years
    52,837       53,115  
Mortgage-backed securities and common stock
    63,208       64,700  
Total
  $ 169,143     $ 170,062  

10

 
For mortgage-backed securities, actual maturities will differ from contractual maturities because borrowers have the right to prepay obligations with or without prepayment penalties.

Other investment securities include investments in Federal Home Loan Bank (“FHLB”) and Federal Reserve Bank (“FRB”) stock.  The carrying value of the FHLB stock at June 30, 2009 and December 31, 2008 was $6.2 million and $7.3 million, respectively, and the carrying value of the FRB stock at June 30, 2009 and December 31, 2008 was $1.7 million.  These securities are not readily marketable and are required for regulatory purposes and borrowing availability.  Since there are no available observable market values, these securities are carried at cost.  Redemption of these investments is at the option of the FHLB or FRB.  We have assessed the ultimate recoverability of these stocks and believe that no impairment has occurred.

4. 
Loans

Loans consisted of the following:

(Dollars in thousands)
 
June 30,
 2009
   
Percent of
total
   
December 31,
2008
   
Percent of
total
 
Real estate loans:
                       
One-to-four family residential
  $ 104,342       29.0 %   $ 112,815       30.5 %
Commercial
    127,824       35.6 %     126,977       34.4 %
Construction
    12,709       3.5 %     19,618       5.3 %
Commercial loans
    107,140       29.8 %     101,976       27.6 %
Consumer loans
    7,545       2.1 %     7,937       2.2 %
Total
    359,560       100.0 %     369,323       100.0 %
                                 
Less:  Deferred loan fees/costs and loans in process
    (571 )             (320 )        
Less:  Allowance for loan losses
    4,827               3,871          
Loans, net
  $ 355,306             $ 365,772          

A summary of the activity in the allowance for loan losses is as follows:

   
Three months ended June 30,
   
Six months ended June 30,
 
 (Dollars in thousands)
 
2009
   
2008
   
2009
   
2008
 
Beginning balance
  $ 4,307     $ 3,288     $ 3,871     $ 4,172  
Provision for loan losses
    800       300       1,100       900  
Charge-offs
    (298 )     (277 )     (380 )     (1,780 )
Recoveries
    18       15       236       34  
Ending balance
  $ 4,827     $ 3,326     $ 4,827     $ 3,326  

During the six months ended June 30, 2009 we had a net loan charge-off of $144,000 compared to $1.7 million of net loan charge-offs for the comparable period of 2008.

 
11

 

A summary of the non-accrual loans is as follows:

(Dollars in thousands)
 
June 30,
2009
   
December 31,
2008
 
Real estate loans:
           
One-to-four family residential
  $ 742     $ 1,358  
Commercial
    1,867       2,041  
Construction
    5,254       759  
Commercial loans
    5,679       1,537  
Consumer loans
    26       53  
Total non-accrual loans
  $ 13,568     $ 5,748  

A summary of the nonperforming assets is as follows:

(Dollars in thousands)
 
June 30,
2009
   
December 31,
2008
 
Total non-accrual loans
  $ 13,568     $ 5,748  
Accruing loans over 90 days past due
    -       -  
Other real estate owned
    1,916       1,934  
Total nonperforming assets
  $ 15,484     $ 7,682  
                 
Total nonperforming loans to total loans, net
    3.8%       1.6%  
Total nonperforming assets to total assets
    2.5%       1.3%  
Allowance for loan losses to gross loans outstanding
    1.3%       1.0%  
Allowance for loan losses to total nonperforming loans
    35.6%       67.3%  

Loans past due more than a month totaled $15.6 million at June 30, 2009, compared to $9.4 million at December 31, 2008.  At June 30, 2009, $13.6 million in loans were on non-accrual status, or 3.8% of net loans, compared to a balance of $5.7 million in loans on non-accrual status, or 1.6% of net loans, at December 31, 2008.  Non-accrual loans consist primarily of loans greater than ninety days past due and which are also included in the past due loan balances.  There were no loans 90 days delinquent and still accruing interest at June 30, 2009 or December 31, 2008.  The increase in non-accrual and past due loans was primarily driven by a $4.2 million construction loan relationship and a $3.7 million commercial agriculture loan that were classified as non-accrual and past due during the first six months of 2009.

A summary of the impaired loans is as follows:
 
(Dollars in thousands)
 
June 30,
2009
   
December 31,
2008
 
Impaired loans for which an allowance has been provided
  $ 10,999     $ 1,867  
Impaired loans for which no allowance has been provided
    2,709       5,192  
Total impaired loans
    13,708       7,059  
Allowance related to impaired loans
  $ 2,215     $ 705  

Our impaired loans increased primarily because of the same two loans impacting the non-accrual and past due loan balances.  Our analysis of the two nonperforming loans mentioned above concluded that the potential exists that the updated collateral values or sources of repayment may not be sufficient to fully cover the outstanding loan balances at June 30, 2009.

 
12

 

5. 
Fair Value Measurements

  On January 1, 2008, the Company adopted the provisions of SFAS No. 157, which defines fair value, establishes a framework for measuring fair value and expands the disclosures about fair value measurements.  SFAS No. 157 requires the use of a hierarchy of fair value techniques based upon whether the inputs to those fair values reflect assumptions other market participants would use based upon market data obtained from independent sources or reflect the Company’s own assumptions of market participant valuation.  Effective January 1, 2009, the Company adopted SFAS No. 157 on certain nonfinancial assets and liabilities, which include foreclosed real estate, long-lived assets, goodwill, and core deposit premium, which are recorded at fair value only upon impairment.  In accordance with SFAS No. 157, the fair value hierarchy is as follows:

• Level 1: 
Unadjusted quoted prices in active markets that are accessible at the measurement date for identical, unrestricted assets or liabilities.
• Level 2: 
Quoted prices for similar assets in active markets, quoted prices in markets that are not active or quoted prices that contain observable inputs such as yield curves, volatilities, prepayment speeds and other inputs derived from market data.
• Level 3: 
Quoted prices or valuation techniques that require inputs that are both significant to the fair value measurement and unobservable.

Valuation methods for instruments measured at fair value on a recurring basis

  The Company’s investment securities classified as available-for-sale include agency securities, municipal obligations, mortgage-backed securities, pooled trust preferred securities, certificates of deposits and common stocks.  Quoted exchange prices are available for the common stock investments, which are classified as Level 1.  Agency securities and mortgage-backed obligations are priced utilizing industry-standard models that consider various assumptions, including time value, yield curves, volatility factors, prepayment speeds, default rates, loss severity, current market and contractual prices for the underlying financial instruments, as well as other relevant economic measures.  Substantially all of these assumptions are observable in the marketplace, can be derived from observable data, or are supported by observable levels at which transactions are executed in the marketplace and are classified as Level 2.  Municipal securities are valued using a type of matrix, or grid, pricing in which securities are benchmarked against the treasury rate based on credit rating.  These model and matrix measurements are classified as Level 2 in the fair value hierarchy.  The Company’s investments in fixed rate certificates of deposits are valued using a net present value model that discounts the future cash flows at the current market rates and are classified as Level 2.

The Company classifies its pooled trust preferred securities as Level 3.  The portfolio consists of three investments in pooled trust preferred securities issued by financial companies.  The Company has determined that the observable market data associated with these assets do not represent orderly transactions in accordance with FSP No. FAS 157-4 and reflect forced liquidations or distressed sales.  Based on the lack of observable market data, the Company estimated fair value based on the observable data available and reasonable unobservable market data.  The Company estimated fair value based on a discounted cash flow model which used appropriately adjusted discount rates reflecting credit and liquidity risks.

  The following table represents the Company’s investment securities that are measured at fair value on a recurring basis at June 30, 2009 and December 31, 2008 allocated to the appropriate fair value hierarchy:

         
As of June 30, 2009
 
         
Fair value hierarchy
 
  (Dollars in thousands)
 
Total
   
Level 1
   
Level 2
   
Level 3
 
Assets:
                       
Available-for-sale securities
  $ 170,062     $ 728     $ 169,015     $ 319  
Liabilities:
                               
Derivative financial instruments
    34       -       -       34  

         
As of December 31, 2008
 
         
Fair value hierarchy
 
  (Dollars in thousands)
 
Total
   
Level 1
   
Level 2
   
Level 3
 
Assets:
                       
Available-for-sale securities
  $ 162,245     $ 1,014     $ 160,490     $ 740  
Derivative financial instruments
    18       -       -       18  
 
13

 
The following table reconciles the changes in the Company’s Level 3 instruments during the first six months of 2009.

         
Derivative
 
   
Available-for
   
financial
 
(Dollars in thousands)
 
sale-securities
   
instruments
 
Level 3 fair value at December 31, 2008
  $ 740     $ 18  
Transfers into Level 3
    -          
Total gains (losses)
               
Included in earnings
    (576 )     (52 )
Included in other comprehensive income
    (155 )     -  
Level 3 asset (liability) fair value at June 30, 2009
  $ 319     $ (34 )

Changes in the fair value of available-for-sale securities are included in other comprehensive income to the extent the changes are not considered other than temporary impairments.  Other than temporary impairment tests are performed on a quarterly basis and any decline in the fair value of an individual security below its cost that is deemed to be other than temporary results in a write-down of that security’s cost basis.  During the first six months of 2009 the Company recorded a $576,000 impairment loss on one of its pooled trust preferred securities.

The Company’s derivative financial instruments consist solely of interest rate lock commitments and corresponding forward sales contracts on mortgage loans held for sale and are not designated as hedging instruments.  The fair values of these derivatives are based on quoted prices for similar loans in the secondary market.  The market prices are adjusted by a factor, based on the Company’s historical data and its judgment about future economic trends, which considers the likelihood that a commitment will ultimately result in a closed loan.  These instruments are classified as Level 3 based on the unobservable nature of these assumptions.  The amounts are included in other assets or other liabilities on the consolidated balance sheets and gains on sale of loans in the consolidated statements of earnings.

Valuation methods for instruments measured at fair value on a nonrecurring basis

The Company’s other investment securities include investments in Federal Home Loan Bank of Topeka (“FHLB”) and Federal Reserve Bank (“FRB”) stock, which are held for regulatory purposes.  These investments generally have restrictions on the sale and/or liquidation of stock and the carrying value is approximately equal to fair value.  Fair value measurements for these securities are classified as Level 3 based on the undeliverable nature and related credit risk.

The Company does not value its loan portfolio at fair value, however adjustments are recorded on certain loans to reflect the impaired value on the underlying collateral.  Collateral values are generally reviewed on a loan-by-loan basis through independent appraisals.  Appraised values may be discounted based on management’s historical knowledge, changes in market conditions and/or management’s expertise and knowledge of the client and the client’s business.  Because many of these inputs are unobservable the valuations are classified as Level 3.  The carrying value of the Company’s impaired loans was $13.7 million, before an allocated allowance of $2.2 million at June 30, 2009, compared to a carrying value of $7.1 million and allocated allowance of $705,000 at December 31, 2008.

Mortgage loans originated and intended for sale in the secondary market are carried at the lower of cost or estimated fair value, determined on an aggregate basis.  The mortgage loan valuations are based on quoted secondary market prices for similar loans and are classified as Level 2.

The Company’s measure of its goodwill is based on market based valuation techniques, including reviewing the Company’s stock price and valuation multiples as compared to recent financial industry acquisition multiples to estimate the fair value of the Company’s single reporting unit.  The fair value measurements are classified as Level 3.

Core deposit intangibles are recognized at the time core deposits are acquired, using valuation techniques which calculate the present value of the estimated net cost savings relative to the Company’s alternative costs of funds over the expected remaining economic life of the deposits.  Subsequent evaluations are made when facts or circumstances indicate potential impairment may have occurred.  The models incorporate market discount rates, estimated average core deposit lives and alternative funding rates.  The fair value measurements are classified as Level 3.
 
14


The Company measures its mortgage servicing rights at the lower of cost or fair value, and amortizes them over the period equal to estimated net servicing income.  Periodic impairment assessments are performed based on fair value estimates at the reporting date.  The fair value of mortgage servicing rights are estimated based on a valuation model which calculates the present value of estimated future cash flows associated with servicing the underlying loans.  The model incorporates assumptions that market participants use in estimating future net servicing income, including estimated prepayment speeds, market discount rates, cost to service, and other servicing income, including late fees.  The fair value measurements are classified as Level 3.

Other real estate owned include assets acquired through, or in lieu of, foreclosure are initially recorded at the date of foreclosure at fair value of collateral less estimates selling costs.  Subsequent to foreclosure, valuations are updated periodically and are based upon appraisals, third party price opinions or internal pricing models and are classified as Level 3.   During the first six months of 2009 the Company recorded an impairment charge of $100,000 on a single property with a fair value of $170,000.

The following table represents the Company’s assets that are measured at fair value on a nonrecurring basis at June 30, 2009 allocated to the appropriate fair value hierarchy:

(Dollars in thousands)
       
Fair value hierarchy
   
Total gains
 
Assets:
 
Total
   
Level 1
   
Level 2
   
Level 3
   
(losses)
 
Other investment securities
  $ 7,909     $ -     $ -     $ 7,909     $ -  
Impaired loans
    11,492       -       -       11,492       (1,510 )
Loans held for sale
    7,603       -       7,603       -       -  
Other real estate owned
    1,916       -       -       1,916       (100 )

6. 
Fair Value of Financial Instruments

Fair value estimates of the Company’s financial instruments as of June 30, 2009 and December 31, 2008, including methods and assumptions utilized, are set forth below:

   
As of June 30, 2009
   
As of December 31, 2008
 
   
(Dollars in thousands)
 
   
Carrying
   
Estimated
   
Carrying
   
Estimated
 
   
amount
   
fair value
   
amount
   
fair value
 
Cash and cash equivalents
  $ 18,853