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 March 31, 2010

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 ¨  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 May 13, 2010, the Registrant had outstanding 2,504,265 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 - 17
Item 2.
Management's Discussion and Analysis of Financial Condition and Results of Operations
18 – 25
Item 3.
Quantitative and Qualitative Disclosures about Market Risk
25 - 26
Item 4.
Controls and Procedures
27
     
PART II
 
     
Item 1.
Legal Proceedings
27
Item 1A.
Risk Factors
27
Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds
27
Item 3.
Defaults Upon Senior Securities
27
Item 4.
Reserved
27
Item 5.
Other Information
27
Item 6.
Exhibits
27
     
Form 10-Q Signature Page
28

 
1

 

ITEM 1.  FINANCIAL STATEMENTS AND RELATED NOTES

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

(Dollars in thousands)
 
March 31,
   
December 31,
 
   
2010
   
2009
 
Assets
           
Cash and cash equivalents
  $ 10,338     $ 12,379  
Investment securities:
               
Available-for-sale, at fair value
    160,673       161,628  
Other securities
    8,031       7,991  
Loans, net
    343,978       342,738  
Loans held for sale
    6,064       4,703  
Premises and equipment, net
    15,658       15,877  
Goodwill
    12,894       12,894  
Other intangible assets, net
    2,328       2,481  
Bank owned life insurance
    12,670       12,548  
Real estate owned
    3,083       1,129  
Accrued interest and other assets
    10,332       9,799  
Total assets
  $ 586,049     $ 584,167  
                 
Liabilities and Stockholders’ Equity
               
Liabilities:
               
Deposits:
               
Non-interest bearing demand
  $ 56,089     $ 54,799  
Money market and NOW
    168,791       162,449  
Savings
    31,609       29,010  
Time, $100,000 and greater
    50,446       48,422  
Time, other
    139,647       143,915  
Total deposits
    446,582       438,595  
                 
Federal Home Loan Bank borrowings
    50,947       56,004  
Other borrowings
    26,684       26,179  
Accrued interest, taxes, and other liabilities
    7,372       9,494  
Total liabilities
    531,585       530,272  
                 
Commitments and contingencies
               
                 
Stockholders’ equity:
               
Preferred stock, $0.01 par, 200,000 shares authorized; none issued
    -       -  
Common stock, $0.01 par, 7,500,000 shares authorized; 2,504,265 and 2,489,779 shares issued at March 31, 2010 and December 31, 2009, respectively
    25       25  
Additional paid-in capital
    25,057       24,844  
Retained earnings
    28,191       27,523  
Accumulated other comprehensive income
    1,191       1,503  
Total stockholders’ equity
    54,464       53,895  
                 
Total liabilities and stockholders’ equity
  $ 586,049     $ 584,167  

See accompanying notes to consolidated financial statements.

 
2

 

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

(Dollars in thousands, except per share amounts)
 
Three months ended March 31,
 
   
2010
   
2009
 
Interest income:
           
Loans:
           
Taxable
  $ 4,792     $ 5,133  
Tax-exempt
    78       49  
Investment securities:
               
Taxable
    794       1,116  
Tax-exempt
    627       609  
Other
    1       3  
Total interest income
    6,292       6,910  
Interest expense:
               
Deposits
    1,039       1,639  
Borrowings
    685       879  
Total interest expense
    1,724       2,518  
Net interest income
    4,568       4,392  
Provision for loan losses
    700       300  
Net interest income after provision for loan losses
    3,868       4,092  
Non-interest income:
               
Fees and service charges
    1,005       956  
Gains on sales of loans, net
    511       708  
Bank owned life insurance
    124       123  
Other
    125       113  
Total non-interest income
    1,765       1,900  
                 
Investment securities gains (losses), net:
               
Impairment losses on investment securities
    -       (850 )
Less noncredit-related losses
    -       523  
Net impairment losses
    -       (327 )
Gains on sales of investment securities
    563       -  
Investment securities gains (losses), net
    563       (327 )
                 
Non-interest expense:
               
Compensation and benefits
    2,324       2,177  
Occupancy and equipment
    719       651  
Federal deposit insurance premiums
    179       33  
Data processing
    208       190  
Amortization of intangibles
    179       187  
Professional fees
    134       172  
Advertising
    118       121  
Other
    947       924  
Total non-interest expense
    4,808       4,455  
Earnings before income taxes
    1,388       1,210  
Income tax expense
    245       201  
Net earnings
  $ 1,143     $ 1,009  
Earnings per share:
               
Basic
  $ 0.46     $ 0.40  
Diluted
  $ 0.46     $ 0.40  
Dividends per share
  $ 0.19     $ 0.18  

See accompanying notes to consolidated financial statements.

 
3

 

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

(Dollars in thousands)
 
Three months ended March 31,
 
   
2010
   
2009
 
             
Net cash used in operating activities
  $ (2,013 )   $ (8,164 )
                 
Cash flows from investing activities:
               
Net (increase) decrease in loans
    (4,154 )     9,811  
Maturities and prepayments of investment securities
    8,789       13,087  
Purchases of investment securities
    (18,058 )     (25,919 )
Proceeds from sale of investment securities
    10,097       -  
Proceeds from sales of foreclosed assets
    142       2  
Purchases of premises and equipment, net
    (26 )     (78 )
Net cash used in investing activities
    (3,210 )     (3,097 )
Cash flows from financing activities:
               
Net increase in deposits
    7,987       17,667  
Federal Home Loan Bank advance repayments
    (5,009 )     (9 )
Change in Federal Home Loan Bank line of credit, net
    -       (6,000 )
Other borrowings, net
    505       632  
Proceeds from issuance of common stock under stock option plans
    143       -  
Excess tax benefit related to stock option plans
    31       -  
Payment of dividends
    (475 )     (451 )
Purchase of treasury stock
    -       (12 )
Net cash provided by financing activities
    3,182       11,827  
Net (decrease) increase in cash and cash equivalents
    (2,041 )     566  
Cash and cash equivalents at beginning of year
    12,379       13,788  
Cash and cash equivalents at end of year
  $ 10,338     $ 14,354  
Supplemental disclosure of cash flow information:
               
Cash paid during the year for income taxes
  $ 450     $ (13 )
Cash paid during the year for interest
    1,838       2,498  
Supplemental schedule of noncash investing and financing activities:
               
Transfer of loans to real estate owned
  $ 2,095     $ 486  

See accompanying notes to consolidated financial statements.

 
4

 

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

(Dollars in thousands, except per share amounts)
 
Common
stock
   
Additional
paid-in
capital
   
Retained
earnings
   
Treasury
stock
   
Accumulated other
comprehensive
income
   
Total
 
Balance at December 31, 2008
  $ 24     $ 23,873     $ 27,819     $ (935 )   $ 625     $ 51,406  
Comprehensive income:
                                               
Net earnings
    -       -       1,009       -       -       1,009  
Change in fair value of investment securities available-for-sale, net of tax
    -       -       -       -       (180 )     (180 )
Total comprehensive income
                                            829  
Dividends paid ($0.18 per share)
    -       -       (451 )     -       -       (451 )
Stock based compensation
    -       39       -       -       -       39  
Purchase of 800 treasury shares
    -       -       -       (12 )     -       (12 )
Balance at March 31, 2009
  $ 24     $ 23,912     $ 28,377     $ (947 )   $ 445     $ 51,811  
                                                 
Balance at December 31, 2009
  $ 25     $ 24,844     $ 27,523     $ -     $ 1,503     $ 53,895  
Comprehensive income:
                                               
Net earnings
    -       -       1,143       -       -       1,143  
Change in fair value of investment securities available-for-sale, net of tax
    -       -       -       -       (312 )     (312 )
Total comprehensive income
                                            831  
Dividends paid ($0.19 per share)
    -       -       (475 )     -       -       (475 )
Stock based compensation
    -       39       -       -       -       39  
Exercise of stock options, 14,486 shares, including excess tax benefit of $31
    -       174       -       -       -       174  
Balance at March 31, 2010
  $ 25     $ 25,057     $ 28,191     $ -     $ 1,191     $ 54,464  

See accompanying notes to 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 (“GAAP”) 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, 2009, 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, 2009 consolidated balance sheet has been derived from the audited consolidated balance sheet as of that date.  The results of the interim period ended March 31, 2010 are not necessarily indicative of the results expected for the year ending December 31, 2010.  The Company evaluates subsequent events and transactions that occur after the balance sheet date up to the date that financial statements are filed for potential recognition or disclosure.

2.
Goodwill and Other Intangible Assets

The Company tests goodwill for impairment annually or more frequently if circumstances warrant.  The Company’s annual impairment test as of December 31, 2009 concluded that its goodwill was not impaired, however the Company can make no assurances that future impairment tests will not result in goodwill impairments.  The Company concluded there were no triggering events during the first quarter of 2010 that required an interim goodwill impairment test.

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.  The core deposit premium, based on the acquired core deposit balances, was $86,000.  The final core deposit premium, measured on February 2, 2010, was $49,000.  The following is an analysis of changes in the core deposit intangible assets:

   
Three months ended March 31,
 
  (Dollars in thousands)
 
2010
   
2009
 
   
Fair value at
acquisition
   
Accumulated
Amortization
   
Fair value at
acquisition
   
Accumulated
Amortization
 
Balance at beginning of period
  $ 5,482     $ (3,767 )   $ 5,396     $ (3,159 )
Additions
    -       -       -       -  
Adjustments to prior estimates
    (37 )     -       -       -  
Amortization
    -       (129 )     -       (155 )
Balance at end of period
  $ 5,445     $ (3,896 )   $ 5,396     $ (3,314 )

Mortgage servicing rights are related to loans serviced by the Company for unrelated third parties.  The outstanding principal balances of such loans was $140.3 million and $138.4 million at March 31, 2010 and December 31, 2009, respectively.  Gross service fee income related to such loans was $87,000 and $52,000 for the quarters ended March 31, 2010 and 2009, respectively, which is included in fees and service charges in the consolidated statements of earnings.  The following is an analysis of changes in the mortgage servicing rights:

   
Three months ended March 31,
 
  (Dollars in thousands)
 
2010
   
2009
 
   
Cost
   
Accumulated
Amortization
   
Cost
   
Accumulated
Amortization
 
Balance at beginning of period
  $ 1,447     $ (681 )   $ 772     $ (602 )
Additions
    63       -       155       -  
Prepayments/maturities
    (14 )     14       (34 )     34  
Amortization
    -       (50 )     -       (32 )
Balance at end of period
  $ 1,496     $ (717 )   $ 893     $ (600 )

 
6

 

Aggregate core deposit and mortgage servicing rights amortization expense for the quarters ended March 31, 2010 and 2009, was $179,000 and $187,000, respectively.  The following depicts estimated amortization expense for all intangible assets for the remainder of 2010 and in successive years ending December 31:

Year
 
Amount (in thousands)
 
Remainder of 2010
  $ 526  
2011
    610  
2012
    514  
2013
    430  
2014
    173  
Thereafter
    75  

3.
Investments

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

   
As of March 31, 2010
 
         
Gross
   
Gross
       
   
Amortized
   
unrealized
   
unrealized
   
Estimated
 
(Dollars in thousands)
 
cost
   
gains
   
losses
   
fair value
 
                         
U. S. federal agency obligations
  $ 25,616     $ 270     $ (20 )   $ 25,866  
Municipal obligations, tax exempt
    66,274       1,800       (215 )     67,859  
Municipal obligations, taxable
    1,366       -       (9 )     1,357  
Mortgage-backed securities
    51,256       1,043       (58 )     52,241  
Common stocks
    762       287       (10 )     1,039  
Pooled trust preferred securities
    1,524       -       (1,210 )     314  
Certificates of deposit
    11,997       -       -       11,997  
Total
  $ 158,795     $ 3,400     $ (1,522 )   $ 160,673  
                                 
   
As of December 31, 2009
 
           
Gross
   
Gross
         
   
Amortized
   
unrealized
   
unrealized
   
Estimated
 
(Dollars in thousands)
 
cost
   
gains
   
losses
   
fair value
 
                                 
U. S. federal agency obligations
  $ 18,734     $ 356     $ -     $ 19,090  
Municipal obligations, tax exempt
    67,149       1,938       (228 )     68,859  
Municipal obligations, taxable
    1,366       -       (23 )     1,343  
Mortgage-backed securities
    63,265       1,532       (102 )     64,695  
Common stocks
    693       191       (19 )     865  
Pooled trust preferred securities
    1,528       -       (1,267 )     261  
Certificates of deposit
    6,515       -       -       6,515  
Total
  $ 159,250     $ 4,017     $ (1,639 )   $ 161,628  

Included in the gross unrealized losses at March 31, 2010, are noncredit-related losses of $1.2 million, recorded in accumulated other comprehensive income, related to three investments, totaling $2.5 million in par, in pools of trust preferred securities, which were determined to be other-than-temporarily impaired.  The amortized cost of the portfolio of pooled trust preferred securities, after recognition of $961,000 of credit related impairment losses during 2009, was $1.5 million at both March 31, 2010 and December 31, 2009.  The fair value of these three securities totaled $314,000 at March 31, 2010 compared to $261,000 at December 31, 2009, while the unrealized losses included in accumulated other comprehensive income were $1.2 million at March 31, 2010 and $1.3 million at December 31, 2009.

 
7

 

The summary of available-for-sale investment securities shows that some of the securities had unrealized losses, or were temporarily impaired, as of March 31, 2010 and December 31, 2009.  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.

         
As of March 31, 2010
 
(Dollars in thousands)
       
Less than 12 months
   
12 months or longer
   
Total
 
   
No. of
   
Fair
   
Unrealized
   
Fair
   
Unrealized
   
Fair
   
Unrealized
 
   
securities
   
value
   
losses
   
value
   
losses
   
value
   
losses
 
U.S. federal agency obligations
    6     $ 10,415     $ (20 )   $ -     $ -     $ 10,415     $ (20 )
Municipal obligations, tax exempt
    26       7,980       (156 )     721       (59 )     8,701       (215 )
Municipal obligations, taxable
    1       996       (9 )     -       -       996       (9 )
Mortgage-backed securities
    7       8,134       (58 )     -       -       8,134       (58 )
Common stocks
    3       25       (2 )     1       (8 )     26       (10 )
Pooled trust preferred securities
    2       -       -       314       (1,210 )     314       (1,210 )
Total
    45     $ 27,550     $ (245 )   $ 1,036     $ (1,277 )   $ 28,586     $ (1,522 )
                                                         
           
As of December 31, 2009
 
(Dollars in thousands)
         
Less than 12 months
   
12 months or longer
   
Total
 
   
No. of
   
Fair
   
Unrealized
   
Fair
   
Unrealized
   
Fair
   
Unrealized
 
   
securities
   
value
   
losses
   
value
   
losses
   
value
   
losses
 
Municipal obligations, tax exempt
    24     $ 7,765     $ (167 )   $ 780     $ (61 )   $ 8,545     $ (228 )
Municipal obligations, taxable
    2       1,233       (23 )     -       -       1,233       (23 )
Mortgage-backed securities
    6       8,140       (101 )     44       (1 )     8,184       (102 )
Common stocks
    4       59       (19 )     -       -       59       (19 )
Pooled trust preferred securities
    3       -       -       261       (1,267 )     261       (1,267 )
Total
    39     $ 17,197     $ (310 )   $ 1,085     $ (1,329 )   $ 18,282     $ (1,639 )

The Company performs quarterly reviews of the investment portfolio to determine if investment securities have any declines in fair value which might be considered other-than-temporary.  The initial review begins with all securities in an unrealized loss position.  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 all available information, including expected cash flows, the structure of the security, the credit quality of the underlying assets and the current and anticipated market conditions.  Any credit-related impairments on debt securities are realized through a charge to earnings.  If an equity security is determined to be other-than-temporarily impaired, the entire impairment is realized through a charge to earnings.

As of March 31, 2010, the Company does not intend to sell and it is more likely than not that the Company will not be required to sell its municipal obligations in an unrealized loss position until the recovery of its cost.  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, the evaluation of the fundamentals of the issuers’ financial condition and other objective evidence, the Company believes that the municipal obligations identified in the tables above were temporarily impaired as of March 31, 2010 and December 31, 2009.

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 impaired as of March 31, 2010 and December 31, 2009.  The Company’s mortgage-backed securities portfolio consists of securities underwritten to the standards of and guaranteed by the government-sponsored agencies of FHLMC, FNMA and GNMA.

 
8

 

As of March 31, 2010, the Company owned three pooled trust preferred securities with an original cost basis of $2.5 million, which represent investments in pools of collateralized debt obligations issued by financial institutions and insurance companies.  The market for these securities is considered to be inactive.   The Company used discounted cash flow models 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 associated with the credit of the underlying collateral.  The assumptions used in preparing the discounted cash flow models include the following: estimated discount rates, estimated deferral and default rates on collateral, assumed recoveries, and estimated cash flows including all information available through the date of issuance of the financial statements.  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.

As of March 31, 2010, the analysis of the Company’s three investments in pooled trust preferred securities indicated that the unrealized losses on the securities were not credit related.  The Company did not record any credit related impairments in the first quarter of 2010.  In the first quarter of 2009, the analysis indicated that a portion of the unrealized loss was other-than-temporary on one of the pooled trust preferred securities.  The increase in nonperforming collateral on a $1.0 million par pooled trust preferred investment resulted in a credit related other-than-temporary impairment of $327,000 during the quarter ended March 31, 2009.  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.  As of December 31, 2009, the Company had recorded credit losses on all three pooled trust preferred securities totaling $961,000 through a charge to earnings for the year ended December 31, 2009.

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

  
 
Three months ending March 31,
 
  (Dollars in thousands)
 
2010
   
2009
 
Beginning balance
  $ 961     $ -  
Additional credit losses:
               
Securities with no previous other than temporary impairment
    -       327  
Securities with previous other than temporary impairments
    -       -  
Ending balance
  $ 961     $ 327  

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 financial statements.  The fair value of the Company’s investment securities may also decline from an increase in market interest rates, as the market prices of these investments move inversely to their market yields.

Maturities of investment securities at March 31, 2010 are as follows:

(Dollars in thousands)
 
Amortized
   
Estimated
 
   
cost
   
fair value
 
Due in less than one year
  $ 27,831     $ 25,804  
Due after one year but within five years
    31,026       31,713  
Due after five years
    47,920       49,876  
Mortgage-backed securities and common stocks
    52,018       53,280  
Total
  $ 158,795     $ 160,673  

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

Gross realized gains and losses on sales of available-for-sale securities are as follows:

(Dollars in thousands)
 
Three months ended March 31,
 
   
2010
   
2009
 
Realized gains
  $ 563     $ -  
Realized losses
    -       -  
Total
  $ 563     $ -  

 
9

 

Other investment securities include restricted investments in Federal Home Loan Bank (“FHLB”) and Federal Reserve Bank (“FRB”) stock.  The carrying value of the FHLB stock at March 31, 2010 and December 31, 2009 was $6.3 million and $6.2 million, respectively and the carrying value of the FRB stock at March 31, 2010 and December 31, 2009 was $1.8 million.  These securities are not readily marketable and are required for regulatory purposes and borrowing availability.  Since there is no available market values these securities are carried at cost.  Redemption of these investments at par value is at the option of the FHLB or FRB.  We have assessed the ultimate recoverability of these investments and believe that no impairment has occurred.

4.
Loans and Allowance for Loan Losses

Loans consisted of the following as of:

(Dollars in thousands)
 
March 31,
   
December 31,
 
   
2010
   
2009
 
Real estate loans:
           
One-to-four family residential
  $ 97,762     $ 98,333  
Commercial
    105,963       106,470  
Construction and land
    34,190       36,864  
Commercial loans
    104,439       98,213  
Consumer loans
    7,261       7,884  
Total gross loans
    349,615       347,764  
Deferred loan fees/(costs) and loans in process
    400       442  
Allowance for loan losses
    (6,037 )     (5,468 )
Loans, net
  $ 343,978     $ 342,738  
                 
Percent of total
               
Real estate loans:
               
One-to-four family residential
    27.9 %     28.3 %
Commercial
    30.3 %     30.6 %
Construction and land
    9.8 %     10.6 %
Commercial loans
    29.9 %     28.2 %
Consumer loans
    2.1 %     2.3 %
Total gross loans
    100.0 %     100.0 %

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

(Dollars in thousands)
 
Three months ended March 31,
 
   
2010
   
2009
 
Beginning balance
  $ 5,468     $ 3,871  
Provision for loan losses
    700       300  
Charge-offs
    (147 )     (82 )
Recoveries
    16       218  
Ending balance
  $ 6,037     $ 4,307  

 
10

 

At March 31, 2010, $11.8 million in loans were on non-accrual status, or 3.4% of net loans, compared to a balance of $11.8 million, or 3.5% of net loans, at December 31, 2009.  Non-accrual loans consist primarily of loans greater than ninety days past due.  There were no loans 90 days delinquent and still accruing interest at March 31, 2010 or December 31, 2009.

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

(Dollars in thousands)
 
March 31
   
December 31,
 
   
2010
   
2009
 
Real estate loans:
           
One-to-four family residential
  $ 970     $ 1,146  
Commercial
    2,706       1,475  
Construction and land
    5,241       6,402  
Commercial loans
    2,822       2,785  
Consumer loans
    36       22  
Total non-accrual loans
  $ 11,775     $ 11,830  

A summary of the nonperforming assets is as follows:
   
March 31,
   
December 31,
 
(Dollars in thousands)
 
2010
   
2009
 
             
Total non-accrual loans
  $ 11,775     $ 11,830  
Accruing loans over 90 days past due
    -       -  
Nonperforming investments, at fair value
    314       261  
Real estate owned
    3,083       1,129  
Total nonperforming assets
  $ 15,172     $ 13,220  
                 
Total nonperforming loans to total loans, net
    3.4 %     3.5 %
Total nonperforming assets to total assets
    2.6 %     2.3 %
Allowance for loan losses to gross loans outstanding
    1.7 %     1.6 %
Allowance for loan losses to nonperforming loans
    51.3 %     46.2 %

The $2.0 increase in other real estate owned was primarily the result of the foreclosure on a $1.3 million residential subdivision development as the Company took possession of the real estate after the development slowed and the borrower was unable to comply with the contractual terms of the loan.  The remaining increase in other real estate owned was from foreclosures on residential properties.
 
A summary of the impaired loans is as follows:
 
(Dollars in thousands)
 
March 31,
   
December 31,
 
   
2010
   
2009
 
Real estate loans:
           
One-to-four family residential
  $ 970     $ 1,146  
Commercial
    2,706       1,475  
Construction and land
    5,241       6,402  
Commercial loans
    2,822       2,785  
Consumer loans
    36       22  
Total impaired loans
  $ 11,775     $ 11,830  
                 
Impaired loans for which an allowance has been provided
  $ 9,046     $ 10,620  
Impaired loans for which no allowance has been provided
    2,729       1,210  
Allowance related to impaired loans
  $ 3,430     $ 2,770  

 
11

 

5.
Earnings per Share

Basic earnings per share have been computed based upon the weighted average number of common shares outstanding during each period.  Diluted earnings per share includes the effect of all potential common shares outstanding during each period.  The shares used in the calculation of basic and diluted earnings per share are shown below:

(Dollars in thousands, except per share amounts)
 
Three months ended March 31,
 
   
2010
   
2009
 
Net earnings available to common shareholders
  $ 1,143     $ 1,009  
                 
Weighted average common shares outstanding - basic
    2,489,779       2,490,564  
Assumed exercise of stock options
    2,163       5,352  
Weighted average common shares outstanding - diluted
    2,491,942       2,495,916  
Earnings per share (1):
               
Basic
  $ 0.46     $ 0.40  
Diluted
  $ 0.46     $ 0.40  

(1) All per share amounts have been adjusted to give effect to the 5% stock dividend paid during December 2009.

6.
Comprehensive Income

The Company’s other comprehensive income consists of the unrealized holding gains and losses on available for sale securities as shown below.

(Dollars in thousands)
 
Three months ended March 31,
 
   
2010
   
2009
 
Net earnings
  $ 1,143     $ 1,009  
Unrealized holding gains (losses) on available-for-sale securities for which a portion of an other-than-temporary impairment has been recorded in earnings
    57       (125 )
Net unrealized holding gains (losses) on all other available-for-sale securities
    6       (513 )
Less reclassification adjustment for (gains) losses included in earnings
    (563 )     327  
Net unrealized losses
    (500 )     (311 )
Income tax benefit
    (188 )     (131 )
Total comprehensive income
  $ 831     $ 829  

7.
Fair Value of Financial Instruments and Fair Value Measurements

The Company follows FASB ASC 820 “Fair Value Measurements and Disclosures,” which defines fair value, establishes a framework for measuring fair value and expands the disclosures about fair value measurements.  ASC Topic 820-10-55 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 began applying FASB ASC 820 to 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.  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.

 
12

 

Fair value estimates of the Company’s financial instruments as of March 31, 2010 and December 31, 2009, including methods and assumptions utilized, are set forth below:

(Dollars in thousands)
 
March 31, 2010
   
December 31, 2009
 
   
Carrying
   
Estimated
   
Carrying
   
Estimated
 
   
amount
   
fair value
   
amount
   
fair value
 
Financial assets:
                       
Cash and cash equivalents
  $ 10,338     $ 10,338     $ 12,379     $ 12,379  
Investment securities:
                               
Available-for-sale
    160,673       160,673       161,628       161,628  
Other securities
    8,031       8,031       7,991       7,991  
Loans, net
    343,978       345,806       342,738       343,671  
Loans held for sale
    6,064       6,189       4,703       4,718  
Mortgage servicing rights
    779       2,362       766       2,188  
Accrued interest receivable
  $ 2,893     $ 2,893     $ 2,702     $ 2,702  
                                 
Financial liabilities:
                               
Non-maturity deposits
  $ 256,489     $ 256,489     $ 246,258     $ 246,258  
Time deposits
    190,093       191,264       192,337       193,707  
FHLB borrowings
    50,947       53,086       56,004       58,174  
Other borrowings
    26,684       25,025       26,179       24,537  
Derivative financial instruments
    23       23       84       84  
Accrued interest payable
  $ 914     $ 914     $ 1,028     $ 1,028  

Methods and Assumptions Utilized

The carrying amount of cash, cash equivalents, repurchase agreements and federal funds sold are considered to approximate fair value.

The Company’s investment securities classified as available-for-sale include U.S. federal agency securities, municipal obligations, mortgage-backed securities, pooled trust preferred securities, certificates of deposits and common stocks.  Quoted exchange prices are available for the Company’s 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 FDIC insured, 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 various financial companies.  These securities are valued based on a matrix pricing in which the securities are benchmarked against single issuer trust preferred securities based on credit rating.  The pooled trust preferred market is inactive so single issuer trading is used as the benchmark, with additional adjustments made for credit and liquidity risk.

The Company’s other investment securities include investments in FHLB and 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 estimated fair value of the Company’s loan portfolio is based on the segregation of loans by collateral type, interest terms, and maturities.  The fair value is estimated based on discounting scheduled and estimated cash flows through maturity using an appropriate risk-adjusted yield curve to approximate current interest rates for each category.  No adjustment was made to the interest rates for changes in credit risk of performing loans where there are no known credit concerns.  Management segregates loans in appropriate risk categories.  Management believes that the risk factor embedded in the interest rates along with the allowance for loan losses applicable to the performing loan portfolio results in a fair valuation of such loans.  This method of estimating fair value does not incorporate the exit-price concept of fair value prescribed by ASC Topic 820.  The fair values of impaired loans are generally based on market prices for similar assets determined through independent appraisals or discounted values of independent appraisals and brokers’ opinions of value.

 
13

 

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 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.

The Company measures its mortgage servicing rights at the lower of amortized cost or fair value.  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.

The carrying amount of accrued interest receivable and payable are considered to approximate fair value.

The estimated fair value of deposits with no stated maturity, such as non-interest bearing demand deposits, savings, money market accounts, and NOW accounts, is equal to the amount payable on demand.  The fair value of interest bearing time deposits is based on the discounted value of contractual cash flows of such deposits.  The discount rate is estimated using the rates currently offered for deposits of similar remaining maturities.  These fair values do not incorporate the value of core deposit intangibles which may be associated with the deposit base.

The fair value of advances from the FHLB and other borrowings is estimated using current rates offered for similar borrowings adjusted for the Company’s current credit spread if applicable.

Off-Balance Sheet Financial Instruments

The fair value of letters of credit and commitments to extend credit is based on the fees currently charged to enter into similar agreements.  The aggregate of these fees is not material.  These instruments are also discussed in Item 2 Management’s Discussion and Analysis of Financial Condition.

Limitations

Fair value estimates are made at a specific point in time based on relevant market information and information about the financial instruments.  These estimates do not reflect any premium or discount that could result from offering for sale at one time the Company’s entire holdings of a particular financial instrument.  Because no market exists for a significant portion of the Company’s financial instruments, fair value estimates are based on judgments regarding future loss experience, current economic conditions, risk characteristics of various financial instruments, and other factors.  These estimates are subjective in nature and involve uncertainties and matters of significant judgment, and, therefore, cannot be determined with precision.  Changes in assumptions could significantly affect the estimates.  Fair value estimates are based on existing balance sheet financial instruments without attempting to estimate the value of anticipated future business and the value of assets and liabilities that are not considered financial instruments.

 
14

 

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

The following table represents the Company’s financial instruments that are measured at fair value on a recurring basis at March 31, 2010 and December 31, 2009 allocated to the appropriate fair value hierarchy:

(Dollars in thousands)
       
As of March 31, 2010
 
         
Fair value hierarchy
 
   
Total
   
Level 1
   
Level 2
   
Level 3
 
Assets:
                       
Cash and cash equivalents
  $ 10,338     $ 10,338     $ -     $ -  
Available-for-sale securities
                               
U. S. federal agency obligations
    25,866       -       25,866       -  
Municipal obligations, tax exempt
    67,859       -       67,859       -  
Municipal obligations, taxable
    1,357       -       1,357       -  
Mortgage-backed securities
    52,241       -       52,241       -  
Common stocks
    1,039       979       60       -  
Pooled trust preferred securities
    314       -       -       314  
Certificates of deposit
    11,997       -       11,997       -  
Liabilities:
                               
Derivative financial instruments
  $ 23     $ -     $ -     $ 23  
                                 
           
As of December 31, 2009
 
           
Fair value hierarchy
 
   
Total
   
Level 1
   
Level 2
   
Level 3
 
Assets:
                               
Cash and cash equivalents
  $ 12,379     $ 12,379     $ -     $ -  
Available-for-sale securities
                               
U. S. federal agency obligations
    19,090       -       19,090       -  
Municipal obligations, tax exempt
    68,859       -       68,859       -  
Municipal obligations, taxable
    1,343       -       1,343       -  
Mortgage-backed securities
    64,695       -       64,695       -  
Common stocks
    865       805       60       -  
Pooled trust preferred securities
    261       -       -       261  
Certificates of deposit
    6,515       -       6,515       -  
Liabilities:
                               
Derivative financial instruments
  $ 84     $ -     $ -     $ 84  

The following table reconciles the changes in the Company’s Level 3 financial instruments during the first quarter of 2010:
(Dollars in thousands)
       
Derivative
 
   
Available-for
   
financial
 
   
sale-securities
   
instruments
 
Level 3 asset (liability) fair value at December 31, 2009
  $ 261     $ (84 )
Transfers into Level 3
    -       -  
Payments applied to reduce carrying value
    (4 )     -  
Total gains (losses):
               
Included in earnings
    -       61  
Included in other comprehensive income
    57       -  
Level 3 asset (liability) fair value at March 31, 2010
  $ 314     $ (23 )

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.

 
15

 

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

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 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 $11.8 at both March 31, 2010 and December 31, 2009, with allocated allowances of $3.4 million and $2.8 million,  respectively.

The Company’s measure of its goodwill is based on market based valuation techniques, including reviewing the Company’s market capitalization with appropriate control premiums and valuation multiples as compared to recent similar 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.

Other real estate owned includes assets acquired through, or in lieu of, foreclosure are initially recorded at the date of foreclosure at the fair value of the collateral less estimated selling costs.  Subsequent to foreclosure, valuations are updated periodically and are based upon independent appraisals, third party price opinions or internal pricing models and are classified as Level 3.

The following table represents the Company’s financial instruments that are measured at fair value on a non-recurring basis at March 31, 2010 and December 31, 2009 allocated to the appropriate fair value hierarchy:

(Dollars in thousands)
       
As of March 31 ,2010
       
         
Fair value hierarchy
   
Total gains
 
   
Total
   
Level 1
   
Level 2
   
Level 3
   
/ (losses)
 
Assets:
                             
Other investment securities
  $ 8,031     $ -     $ -     $ 8,031     $ -  
Impaired loans
    8,345       -       -       8,345       (698 )
Loans held for sale
    6,189       -       6,189       -       -  
Mortgage servicing rights
    2,362       -       -       2,362       -  
Other real estate owned
  $ 3,083     $ -     $ -     $ 3,083     $ -  
                                         
(Dollars in thousands)
         
As of December 31 ,2009