Form 10-Q
Table of Contents

 
 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-Q
     
þ   Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
     
    for the quarterly period ended June 30, 2011.
or
     
o   Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
     
    for the transition period from                      to                     .
Commission File Number: 0-7617
UNIVEST CORPORATION OF PENNSYLVANIA
(Exact name of registrant as specified in its charter)
     
Pennsylvania   23-1886144
(State or other jurisdiction of incorporation of organization)   (IRS Employer Identification No.)
14 North Main Street, Souderton, Pennsylvania 18964
(Address of principal executive offices)(Zip Code)
Registrant’s telephone number, including area code: (215) 721-2400
Not applicable
(Former name, former address and former fiscal year, if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. þ Yes o No
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
þ Yes o 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.
             
Large accelerated filer o   Accelerated filer þ   Non-accelerated filer o   Smaller reporting company o
        (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).
o Yes þ No
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.
     
Common Stock, $5 par value   16,777,382
(Title of Class)   (Number of shares outstanding at July 29, 2011)
 
 

 

 


 

UNIVEST CORPORATION OF PENNSYLVANIA AND SUBSIDIARIES
INDEX
         
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    53  
 
       
 Exhibit 31.1
 Exhibit 31.2
 Exhibit 32.1
 Exhibit 32.2
 EX-101 INSTANCE DOCUMENT
 EX-101 SCHEMA DOCUMENT
 EX-101 CALCULATION LINKBASE DOCUMENT
 EX-101 LABELS LINKBASE DOCUMENT
 EX-101 PRESENTATION LINKBASE DOCUMENT
 EX-101 DEFINITION LINKBASE DOCUMENT

 

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Table of Contents

PART I. FINANCIAL INFORMATION
Item 1.  
Financial Statements
UNIVEST CORPORATION OF PENNSYLVANIA
CONSOLIDATED BALANCE SHEETS
                 
    (UNAUDITED)     (SEE NOTE)  
(Dollars in thousands, except per share data)   At June 30, 2011     At December 31, 2010  
 
               
ASSETS
               
Cash and due from banks
  $ 32,433     $ 11,624  
Interest-earning deposits with other banks
    6,781       17,563  
Investment securities held-to-maturity (fair value $18 and $32 at June 30, 2011 and December 31, 2010, respectively)
    18       32  
Investment securities available-for-sale
    418,002       466,992  
Loans held for sale
    2,102       4,178  
Loans and leases
    1,438,707       1,471,186  
Less: Reserve for loan and lease losses
    (32,601 )     (30,898 )
 
           
Net loans and leases
    1,406,106       1,440,288  
 
           
Premises and equipment, net
    34,166       34,605  
Goodwill
    51,320       51,320  
Other intangibles, net of accumulated amortization and fair value adjustments of $9,420 and $9,495 at June 30, 2011 and December 31, 2010, respectively
    5,456       5,477  
Bank owned life insurance
    48,622       48,010  
Accrued interest and other assets
    53,371       53,804  
 
           
Total assets
  $ 2,058,377     $ 2,133,893  
 
           
 
               
LIABILITIES
               
Demand deposits, noninterest-bearing
  $ 277,515     $ 271,125  
Demand deposits, interest-bearing
    480,888       529,884  
Savings deposits
    486,666       467,511  
Time deposits
    376,225       417,750  
 
           
Total deposits
    1,621,294       1,686,270  
 
           
Securities sold under agreements to repurchase
    99,070       90,271  
Other short-term borrowings
          24,600  
Accrued expenses and other liabilities
    36,372       37,534  
Long-term debt
    5,000       5,000  
Subordinated notes
    3,000       3,375  
Company-obligated mandatorily redeemable preferred securities of subsidiary trusts holding junior subordinated debentures of Univest (Trust Preferred Securities)
    20,619       20,619  
 
           
Total liabilities
    1,785,355       1,867,669  
 
           
SHAREHOLDERS’ EQUITY
               
Common stock, $5 par value: 48,000,000 shares authorized at June 30, 2011 and December 31, 2010; 18,266,404 shares issued at June 30, 2011 and December 31, 2010; 16,777,379 and 16,648,303 shares outstanding at June 30, 2011 and December 31, 2010, respectively
    91,332       91,332  
Additional paid-in capital
    58,326       59,080  
Retained earnings
    153,728       151,978  
Accumulated other comprehensive loss, net of taxes
    (3,099 )     (6,766 )
Treasury stock, at cost; 1,489,025 shares and 1,618,101 shares at June 30, 2011 and December 31, 2010, respectively
    (27,265 )     (29,400 )
 
           
Total shareholders’ equity
    273,022       266,224  
 
           
Total liabilities and shareholders’ equity
  $ 2,058,377     $ 2,133,893  
 
           
     
Note:  
The consolidated balance sheet at December 31, 2010 has been derived from the audited financial statements at that date but does not include all of the information and footnotes required by U. S. generally accepted accounting principles for complete financial statements. Certain amounts have been reclassified to conform to the current-year presentation. See accompanying notes to the unaudited consolidated financial statements.

 

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Table of Contents

UNIVEST CORPORATION OF PENNSYLVANIA
CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
                                 
    Three Months Ended June 30,     Six Months Ended June 30,  
    2011     2010     2011     2010  
    (Dollars in thousands, except per share data)  
Interest income
                               
Interest and fees on loans and leases:
                               
Taxable
  $ 17,367     $ 17,770     $ 34,574     $ 35,376  
Exempt from federal income taxes
    1,047       1,062       2,178       2,039  
 
                       
Total interest and fees on loans and leases
    18,414       18,832       36,752       37,415  
 
                       
Interest and dividends on investment securities:
                               
Taxable
    2,166       2,855       4,412       5,616  
Exempt from federal income taxes
    1,112       1,172       2,231       2,302  
Other interest income
    12       19       15       30  
 
                       
Total interest income
    21,704       22,878       43,410       45,363  
 
                       
Interest expense
                               
Interest on deposits
    2,290       3,588       4,756       7,808  
Interest on short-term borrowings
    80       653       160       1,455  
Interest on long-term borrowings
    353       361       704       719  
 
                       
Total interest expense
    2,723       4,602       5,620       9,982  
 
                       
Net interest income
    18,981       18,276       37,790       35,381  
Provision for loan and lease losses
    5,556       4,865       10,690       9,760  
 
                       
Net interest income after provision for loan and lease losses
    13,425       13,411       27,100       25,621  
 
                       
Noninterest income
                               
Trust fee income
    1,625       1,500       3,250       3,000  
Service charges on deposit accounts
    1,356       1,812       2,692       3,594  
Investment advisory commission and fee income
    1,194       1,152       2,356       2,208  
Insurance commission and fee income
    2,072       1,896       4,272       4,139  
Other service fee income
    1,437       1,475       2,792       2,384  
Bank owned life insurance income
    268       202       612       534  
Other-than-temporary impairment on equity securities
    (3 )     (42 )     (10 )     (47 )
Net gain on sales of securities
    569       38       569       87  
Net gain on mortgage banking activities
    328       475       303       935  
Net loss on interest rate swap
          (516 )           (826 )
Net loss on dispositions of fixed assets
    (9 )     (5 )     (9 )     (11 )
Net loss on sales and write-downs of other real estate owned
    (265 )     (16 )     (617 )     (363 )
Other
    124       88       245       632  
 
                       
Total noninterest income
    8,696       8,059       16,455       16,266  
 
                       
Noninterest expense
                               
Salaries and benefits
    9,634       9,469       18,617       19,280  
Net occupancy
    1,361       1,309       2,911       2,663  
Equipment
    965       900       1,942       1,838  
Marketing and advertising
    393       917       982       1,601  
Deposit insurance premiums
    427       663       1,140       1,260  
Other
    3,626       3,651       7,560       7,346  
 
                       
Total noninterest expense
    16,406       16,909       33,152       33,988  
 
                       
Income before income taxes
    5,715       4,561       10,403       7,899  
Applicable income taxes
    1,199       831       2,025       1,199  
 
                       
Net income
  $ 4,516     $ 3,730     $ 8,378     $ 6,700  
 
                       
Net income per share:
                               
Basic
  $ .27     $ .23     $ .50     $ .40  
Diluted
    .27       .23       .50       .40  
Dividends declared
    .20       .20       .40       .40  
     
Note:  
Certain amounts have been reclassified to conform to the current-year presentation. See accompanying notes to the unaudited consolidated financial statements.

 

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UNIVEST CORPORATION OF PENNSYLVANIA
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY
(Unaudited)
                                                         
            Accumulated                                  
    Common     Other             Additional                    
    Shares     Comprehensive     Common     Paid-in     Retained     Treasury        
(Dollars in thousands, except per share data)   Outstanding     (Loss) Income     Stock     Capital     Earnings     Stock     Total  
 
                                                       
For the Six Months Ended June 30, 2011
                                                       
 
                                                       
Balance at December 31, 2010:
    16,648,303     $ (6,766 )   $ 91,332     $ 59,080     $ 151,978     $ (29,400 )   $ 266,224  
Comprehensive income:
                                                       
Net income
                            8,378             8,378  
Other comprehensive income, net of income tax:
                                                       
Unrealized gain on investment securities available for sale
          3,744                               3,744  
Unrealized loss on swap
          (242 )                             (242 )
Unrecognized pension benefits
          165                               165  
 
                                                     
Total comprehensive income
                                        12,045  
 
                                                     
Cash dividends declared ($0.40 per share)
                            (6,688 )           (6,688 )
Stock issued under dividend reinvestment and employee stock purchase plans and other employee benefit programs
    73,345                   62       13       1,215       1,290  
Purchases of treasury stock
    (3,005 )                             (52 )     (52 )
Restricted stock awards granted
    58,736                   (1,019 )     47       972        
Vesting of restricted stock awards
                      203                   203  
 
                                         
Balance at June 30, 2011
    16,777,379     $ (3,099 )   $ 91,332     $ 58,326     $ 153,728     $ (27,265 )   $ 273,022  
 
                                         
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY
                                                         
            Accumulated                                  
    Common     Other             Additional                    
    Shares     Comprehensive     Common     Paid-in     Retained     Treasury        
(Dollars in thousands, except per share data)   Outstanding     (Loss) Income     Stock     Capital     Earnings     Stock     Total  
 
                                                       
For the Six Months Ended June 30, 2010
                                                       
 
                                                       
Balance at December 31, 2009:
    16,465,083     $ (524 )   $ 91,332     $ 60,126     $ 150,507     $ (33,634 )   $ 267,807  
Comprehensive income:
                                                       
Net income
                            6,700             6,700  
Other comprehensive income, net of income tax:
                                                       
Unrealized gain on investment securities available for sale
          1,471                               1,471  
Unrealized loss on swap
          (1,047 )                             (1,047 )
Unrecognized pension benefits
          149                               149  
 
                                                     
Total comprehensive income
                                        7,273  
 
                                                     
Cash dividends declared ($0.40 per share)
                            (6,631 )           (6,631 )
Stock issued under dividend reinvestment and employee stock purchase plans and other employee benefit programs
    57,970                         (321 )     1,351       1,030  
Purchases of treasury stock
    (325 )                             (6 )     (6 )
Restricted stock awards granted
    67,982                   (1,197 )     (396 )     1,593        
Vesting of restricted stock awards
                      51                   51  
 
                                         
Balance at June 30, 2010
    16,590,710     $ 49     $ 91,332     $ 58,980     $ 149,859     $ (30,696 )   $ 269,524  
 
                                         
     
Note:  
Certain amounts have been reclassified to conform to the current-year presentation. See accompanying notes to the unaudited consolidated financial statements.

 

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UNIVEST CORPORATION OF PENNSYLVANIA
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
                 
    For the Six Months Ended  
    June 30,  
(Dollars in thousands)   2011     2010  
 
               
Cash flows from operating activities:
               
Net income
  $ 8,378     $ 6,700  
Adjustments to reconcile net income to net cash provided by operating activities:
               
Provision for loan and lease losses
    10,690       9,760  
Depreciation of premises and equipment
    1,287       1,260  
Other-than-temporary impairment on equity securities
    10       47  
Net gain on sales of investment securities
    (569 )     (87 )
Net gain on mortgage banking activities
    (303 )     (935 )
Net loss on interest rate swap
          826  
Net loss on dispositions of fixed assets
    9       11  
Net loss on sales and write-downs of other real estate owned
    617       363  
Bank owned life insurance income
    (612 )     (534 )
Other adjustments to reconcile net income to cash provided by operating activities
    1,829       2,795  
Originations of loans held for sale
    (71,240 )     (53,994 )
Proceeds from the sale of loans held for sale
    74,087       53,840  
Increase in interest receivable and other assets
    (1,595 )     (1,894 )
Decrease in accrued expenses and other liabilities
    (730 )     (2,331 )
 
           
Net cash provided by operating activities
    21,858       15,827  
 
           
Cash flows from investing activities:
               
Net cash paid due to acquisitions, net of cash acquired
          (2 )
Net capital expenditures
    (857 )     (1,809 )
Proceeds from maturities of securities held-to-maturity
    15       37  
Proceeds from maturities and calls of securities available-for-sale
    105,018       151,516  
Proceeds from sales of securities available-for-sale
    5,928       3,616  
Purchases of investment securities available-for-sale
    (55,827 )     (166,286 )
Purchases of lease financings
          (4,816 )
Net decrease (increase) in loans and leases
    19,079       (23,137 )
Net decrease in interest-bearing deposits
    10,782       28,385  
Proceeds from sales of other real estate owned
    1,390       1,425  
 
           
Net cash provided by (used in) investing activities
    85,528       (11,071 )
 
           
Cash flows from financing activities:
               
Net (decrease) increase in deposits
    (64,976 )     45,515  
Net decrease in short-term borrowings
    (15,801 )     (41,721 )
Repayment of subordinated debt
    (375 )     (375 )
Purchases of treasury stock
    (52 )     (6 )
Stock issued under dividend reinvestment and employee stock purchase plans and other employee benefit programs
    1,290       1,030  
Cash dividends paid
    (6,663 )     (6,607 )
 
           
Net cash used in financing activities
    (86,577 )     (2,164 )
 
           
Net increase in cash and due from banks
    20,809       2,592  
Cash and due from banks at beginning of year
    11,624       20,535  
 
           
Cash and due from banks at end of period
  $ 32,433     $ 23,127  
 
           
 
               
Supplemental disclosures of cash flow information
               
Cash paid during the year for:
               
Interest
  $ 5,923     $ 12,069  
Income taxes, net of refunds received
    3,606       129  
Noncash transfer of loans to other real estate owned
  $ 4,413     $ 162  
     
Note:  
Certain amounts have been reclassified to conform to the current-year presentation. See accompanying notes to the unaudited consolidated financial statements.

 

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UNIVEST CORPORATION OF PENNSYLVANIA AND SUBSIDIARIES
Notes to the Unaudited Consolidated Financial Statements
Note 1. Summary of Significant Accounting Policies
Principles of Consolidation and Basis of Presentation
The accompanying unaudited consolidated financial statements include the accounts of Univest Corporation of Pennsylvania (the Corporation) and its wholly owned subsidiaries; the Corporation’s primary subsidiary is Univest Bank and Trust Co. (the Bank). All significant intercompany balances and transactions have been eliminated in consolidation. The unaudited interim consolidated financial statements included herein have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission (the SEC). Certain information and footnote disclosures normally included in financial statements prepared in accordance with U.S. generally accepted accounting principles (U.S. GAAP) have been condensed or omitted pursuant to such rules and regulations for interim financial information. The accompanying unaudited consolidated financial statements reflect all adjustments which are of a normal recurring nature and are, in the opinion of management, necessary for a fair presentation of the financial statements for the interim periods presented. Certain prior period amounts have been reclassified to conform to the current-year presentation. Operating results for the six-month period ended June 30, 2011 are not necessarily indicative of the results that may be expected for the year ending December 31, 2011. It is suggested that these unaudited consolidated financial statements be read in conjunction with the audited financial statements and the notes thereto included in the registrant’s Annual Report on Form 10-K for the year ended December 31, 2010, which was filed with the SEC on March 4, 2011.
Use of Estimates
The preparation of the unaudited consolidated financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates. Material estimates that are particularly susceptible to significant changes include fair value measurement of investment securities available for sale and assessment for impairment of certain investment securities, reserve for loan and lease losses, valuation of goodwill and other intangible assets, mortgage servicing rights, deferred tax assets and liabilities, benefit plans and stock-based compensation expense.
Recent Accounting Pronouncements
In June 2011, the Financial Accounting Standards Board (FASB) issued an Accounting Standards Update (ASU) regarding the presentation of comprehensive income and to increase the prominence of items reported in other comprehensive income. The guidance requires entities to report the total of comprehensive income, the components of net income and the components of other comprehensive income either in a single continuous financial statement or in two separate but consecutive financial statements. This update is effective for fiscal years and interim periods within those years, beginning after December 15, 2011, or March 31, 2012 for the Corporation, and is to be applied retrospectively. The Corporation does not expect the guidance will have a material impact on its financial statements but will result in a revised format for the presentation of comprehensive income and the components of other comprehensive income.
In May 2011, the FASB issued an ASU regarding fair value measurements which establishes a global standard in U.S. GAAP and International Financial Reporting Standards for applying fair value measurements and disclosures. Consequently, the amendments in this update change the wording to describe many of the requirements for measuring fair value and for disclosing information about fair value measurements. The amendments do not require additional fair value measurements and most of the amendments are not intended to result in a change of the application of fair value measurement requirements. Additional disclosures required include 1) for fair value measurements categorized within Level 3 of the fair value hierarchy: a) the valuation processes used by the reporting entity b) the sensitivity of the fair value measurement to changes in unobservable inputs and the interrelationships between those unobservable inputs, if any and 2) the categorization by level of the fair value hierarchy for items that are not measured at fair value in the statement of financial position but for which the fair value is required to be disclosed. This amendment is effective for fiscal years and interim periods within those years, beginning after December 15, 2011, or March 31, 2012 for the Corporation, and is to be applied prospectively. The Corporation does not anticipate the guidance will have a material impact on its financial statements but will result in revised and expanded disclosures.

 

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In April 2011, the FASB issued an ASU regarding a creditor’s determination of whether a restructuring is a troubled debt restructuring. In evaluating whether a restructuring constitutes a troubled debt restructuring, a creditor must separately conclude that the restructuring constitutes both a concession and the borrower is experiencing financial difficulties under the guidance provided by this update. In addition, the amendments clarify that a creditor is precluded from using the effective interest rate test in the borrower’s guidance on restructuring of payables when evaluating whether a restructuring constitutes a troubled debt restructuring. The guidance on identifying and disclosing troubled debt restructurings is effective for interim and annual periods beginning on or after June 15, 2011, or September 30, 2011 for the Corporation, and applies retrospectively to restructurings occurring on or after the beginning of the year or January 1, 2011 for the Corporation. The guidance on measuring the impairment of a receivable restructured in a troubled debt restructuring is effective on a prospective basis. The Corporation is in the process of evaluating the impact of the adoption of this troubled debt restructuring guidance on its financial statements.
In July 2010, the FASB issued an ASU for improving disclosures about the credit quality of financing receivables and the allowance for credit losses. Disclosures must be disaggregated by portfolio segment, the level at which an entity develops and documents a systematic method for determining its allowance for credit losses, and class of financing receivable. The required disclosures include, among other things, a rollforward of the allowance for credit losses as well as information about modified, impaired, nonaccrual and past due loans and credit quality indicators. For disclosures required as of the end of a reporting period, the update was effective and implemented commencing as of December 31, 2010 for the Corporation’s financial statements. Disclosures that relate to activity during a reporting period were required for financial statements that include periods beginning on or after January 1, 2011, or March 31, 2011 for the Corporation. The application of the provisions of these standards did not have a material impact on the Corporation’s financial statements although it resulted in expanded disclosures effective March 31, 2011, which are included under Note 4, “Credit Quality of Loans and Leases and the Reserve for Loans and Lease Losses.” The guidance related to troubled debt restructurings is effective for interim and annual periods beginning after June 15, 2011, or September, 30, 2011 for the Corporation, in order to be concurrent with the effective date of guidance under the Accounting Standards Update issued in April 2011 regarding a creditor’s determination of whether a restructuring is a troubled debt restructuring. The guidance applies retrospectively to troubled debt restructurings occurring on or after January 1, 2011.

 

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Note 2. Investment Securities
The following table shows the amortized cost and the approximate fair value of the held-to-maturity securities and available-for-sale securities at June 30, 2011 and December 31, 2010 by maturity within each type.
                                                                 
    June 30, 2011     December 31, 2010  
            Gross     Gross                     Gross     Gross        
    Amortized     Unrealized     Unrealized     Fair     Amortized     Unrealized     Unrealized     Fair  
(Dollars in thousands)   Cost     Gains     Losses     Value     Cost     Gains     Losses     Value  
 
                                                               
Securities Held-to-Maturity
                                                               
Residential mortgage-backed securities:
                                                               
Within 1 year
  $     $     $     $     $ 15     $     $     $ 15  
 
                                               
 
                            15                   15  
 
                                               
Other securities:
                                                               
Within 1 year
    18                   18       17                   17  
 
                                               
 
    18                   18       17                   17  
 
                                               
Total
  $ 18     $     $     $ 18     $ 32     $     $     $ 32  
 
                                               
Securities Available-for-Sale
                                                               
U.S. government corporations and agencies:
                                                               
Within 1 year
  $ 5,000     $ 35     $     $ 5,035     $ 7,000     $     $     $ 7,000  
After 1 year to 5 years
    132,511       615       (458 )     132,668       182,585       515       (2,000 )     181,100  
 
                                               
 
    137,511       650       (458 )     137,703       189,585       515       (2,000 )     188,100  
 
                                               
State and political subdivisions:
                                                               
Within 1 year
    755       11             766       451                   451  
After 1 year to 5 years
    9,406       352             9,758       8,801       281             9,082  
After 5 years to 10 years
    11,692       370       (57 )     12,005       14,042       281       (69 )     14,254  
Over 10 years
    88,065       2,057       (380 )     89,742       86,315       639       (2,693 )     84,261  
 
                                               
 
    109,918       2,790       (437 )     112,271       109,609       1,201       (2,762 )     108,048  
 
                                               
Residential mortgage-backed securities:
                                                               
After 5 years to 10 years
    12,488       793             13,281       14,709       743             15,452  
Over 10 years
    71,931       3,069       (481 )     74,519       66,919       3,222       (492 )     69,649  
 
                                               
 
    84,419       3,862       (481 )     87,800       81,628       3,965       (492 )     85,101  
 
                                               
Commercial mortgage obligations:
                                                               
After 5 years to 10 years
    7,013       219             7,232       8,855       252             9,107  
Over 10 years
    61,113       905       (380 )     61,638       63,827       1,321       (1,164 )     63,984  
 
                                               
 
    68,126       1,124       (380 )     68,870       72,682       1,573       (1,164 )     73,091  
 
                                               
Other securities:
                                                               
Within 1 year
    3,548                   3,548       4,692       30             4,722  
After 1 year to 5 years
    4,990       5             4,995       4,988             (43 )     4,945  
 
                                               
 
    8,538       5             8,543       9,680       30       (43 )     9,667  
 
                                               
Equity securities:
                                                               
No stated maturity
    2,369       662       (216 )     2,815       2,447       680       (142 )     2,985  
 
                                               
 
    2,369       662       (216 )     2,815       2,447       680       (142 )     2,985  
 
                                               
Total
  $ 410,881     $ 9,093     $ (1,972 )   $ 418,002     $ 465,631     $ 7,964     $ (6,603 )   $ 466,992  
 
                                               
Expected maturities may differ from contractual maturities because debt issuers may have the right to call or prepay obligations without call or prepayment penalties.
Securities with a fair value of $299.4 million and $347.3 million at June 30, 2011 and December 31, 2010, respectively, were pledged to secure public deposits and for other purposes as required by law.
During the six months ended June 30, 2011 and 2010, available-for-sale securities with a fair value at the date of sale of $5.9 million and $3.6 million, respectively, were sold. Gross realized gains on such sales totaled $569 thousand in 2011 and $108 thousand in 2010. Gross realized losses on sales were $0 thousand in 2011 and $21 thousand in 2010. Tax expense related to net realized gains from the sales of investment securities for the six months ended June 30, 2011 and 2010 was $199 thousand and $30 thousand, respectively. Accumulated other comprehensive income related to securities of $4.6 million and $884 thousand, net of taxes, has been included in shareholders’ equity at June 30, 2011 and December 31, 2010, respectively. Unrealized losses in investment securities at June 30, 2011 and December 31, 2010 do not represent other-than-temporary impairments.

 

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The Corporation realized other-than-temporary impairment charges to noninterest income of $10 thousand and $47 thousand, respectively, on its equity portfolio during the six months ended June 30, 2011 and 2010. The Corporation determined that it was probable that certain equity securities would not regain market value equivalent to the Corporation’s cost basis within a reasonable period of time due to a decline in the financial stability of the underlying companies. The Corporation carefully monitors all of its equity securities and has not taken impairment losses on certain other equity securities in an unrealized loss position, at this time, as the financial performance of the underlying companies is not indicative of the market deterioration of their stock and it is probable that the market value of the equity securities will recover to the Corporation’s cost basis in the individual securities in a reasonable amount of time. The equity securities within the following table consist of common stocks of other financial institutions, which have experienced recent declines in value consistent with the industry as a whole. Management evaluated the near-term prospects of the issuers in relation to the severity and duration of the impairment. The Corporation has the positive intent to hold these securities and believes it is more likely than not, that it will not have to sell these securities until recovery to the Corporation’s cost basis occurs. The Corporation does not consider these investments to be other-than-temporarily impaired at June 30, 2011 and December 31, 2010.
Management evaluates debt securities, which are comprised of U. S. Government, Government Sponsored Agencies, municipalities and other issuers, for other-than-temporary impairment and considers the current economic conditions, the length of time and the extent to which the fair value has been less than cost, interest rates and the bond rating of each security. All of the debt securities are rated as investment grade and management believes that it will not incur any losses. The unrealized losses on the Corporation’s investments in debt securities are temporary in nature since they are primarily related to market interest rates and are not related to the underlying credit quality of the issuers within our investment portfolio. The Corporation does not have the intent to sell the debt securities and believes it is more likely than not, that it will not have to sell the securities before recovery of their cost basis. The Corporation has not recognized any other-than-temporary impairment charges on debt securities for the six months ended June 30, 2011 and 2010.
At June 30, 2011 and December 31, 2010, there were no investments in any single non-federal issuer representing more than 10% of shareholders’ equity.
The following table shows the amount of securities that were in an unrealized loss position at June 30, 2011 and December 31, 2010:
                                                 
    At June 30, 2011  
    Less than Twelve Months     Twelve Months or Longer     Total  
            Unrealized             Unrealized             Unrealized  
(Dollars in thousands)   Fair Value     Losses     Fair Value     Losses     Fair Value     Losses  
 
                                               
U.S. government corporations and agencies
  $ 59,466     $ (458 )   $     $     $ 59,466     $ (458 )
State and political subdivisions
    14,920       (290 )     2,654       (147 )     17,574       (437 )
Residential mortgage-backed securities
                3,906       (481 )     3,906       (481 )
Commercial mortgage obligations
    19,537       (380 )                 19,537       (380 )
Equity securities
    873       (216 )                 873       (216 )
 
                                   
Total
  $ 94,796     $ (1,344 )   $ 6,560     $ (628 )   $ 101,356     $ (1,972 )
 
                                   
                                                 
    At December 31, 2010  
    Less than Twelve Months     Twelve Months or Longer     Total  
            Unrealized             Unrealized             Unrealized  
(Dollars in thousands)   Fair Value     Losses     Fair Value     Losses     Fair Value     Losses  
 
                                               
U.S. government corporations and agencies
  $ 107,978     $ (2,000 )   $     $     $ 107,978     $ (2,000 )
State and political subdivisions
    52,531       (2,589 )     1,589       (173 )     54,120       (2,762 )
Residential mortgage-backed securities
    10,096       (38 )     4,419       (454 )     14,515       (492 )
Commercial mortgage obligations
    19,322       (1,164 )                 19,322       (1,164 )
Other securities
    4,945       (43 )                 4,945       (43 )
Equity securities
    951       (140 )     17       (2 )     968       (142 )
 
                                   
Total
  $ 195,823     $ (5,974 )   $ 6,025     $ (629 )   $ 201,848     $ (6,603 )
 
                                   

 

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Note 3. Loans and Leases
The following is a summary of the major loan and lease categories:
                 
    At June 30,     At December 31,  
(Dollars in thousands)   2011     2010  
 
               
Commercial, financial and agricultural
  $ 479,670     $ 463,518  
Real estate-commercial
    511,162       516,546  
Real estate-construction
    84,857       119,769  
Real estate-residential secured for business purpose
    32,717       42,459  
Real estate-residential secured for personal purpose
    132,554       121,876  
Real estate-home equity secured for personal purpose
    80,230       80,875  
Loans to individuals
    42,577       44,087  
Lease financings
    84,777       92,617  
 
           
Total gross loans and leases
    1,448,544       1,481,747  
Less: Unearned income
    (9,837 )     (10,561 )
 
           
Total loans and leases, net of unearned income
  $ 1,438,707     $ 1,471,186  
 
           
Note 4. Credit Quality of Loans and Leases and the Reserve for Loan and Lease Losses
Age Analysis of Past Due Loans and Leases
The following presents, by class of loans and leases, an aging of past due loans and leases, loans and leases which are current and the recorded investment in loans and leases greater than 90 days past due which are accruing interest at June 30, 2011 and December 31, 2010:
                                                         
                                                    Recorded  
                                                    Investment  
                                                    Greater than  
                    Greater                             90 Days  
                    Than                             Past Due  
    30-59 Days     60-89 Days     90 Days     Total             Total Loans     and Accruing  
(Dollars in thousands)   Past Due*     Past Due*     Past Due*     Past Due*     Current*     and Leases     Interest*  
 
                                                       
At June 30, 2011
                                                       
 
                                                       
Commercial, financial and agricultural
  $ 153     $ 214     $ 4     $ 371     $ 473,312     $ 479,670     $ 4  
Real estate-commercial real estate and construction:
                                                       
Commercial real estate
    828             468       1,296       477,615       511,162       468  
Construction
                            75,959       84,857        
Real estate-residential and home equity:
                                                       
Residential secured for business purpose
    100       52             152       32,347       32,717        
Residential secured for personal purpose
    55                   55       132,280       132,554        
Home equity secured for personal purpose
    356       69       44       469       79,730       80,230       44  
Loans to individuals
    306       173       133       612       41,913       42,577       133  
Lease financings
    894       399       10       1,303       72,752       74,940       10  
 
                                         
Total
  $ 2,692     $ 907     $ 659     $ 4,258     $ 1,385,908     $ 1,438,707     $ 659  
 
                                         
     
*  
Excludes impaired loans and leases.

 

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                                                    Recorded  
                                                    Investment  
                                                    Greater than  
                    Greater                             90 Days  
                    Than                             Past Due  
    30-59 Days     60-89 Days     90 Days     Total             Total Loans     and Accruing  
(Dollars in thousands)   Past Due*     Past Due*     Past Due*     Past Due*     Current*     and Leases     Interest*  
 
                                                       
At December 31, 2010
                                                       
 
                                                       
Commercial, financial and agricultural
  $ 924     $     $     $ 924     $ 454,792     $ 463,518     $  
Real estate-commercial real estate and construction:
                                                       
Commercial real estate
    3,836                   3,836       484,527       516,546        
Construction
    156                   156       112,739       119,769        
Real estate-residential and home equity:
                                                       
Residential secured for business purpose
                            42,008       42,459        
Residential secured for personal purpose
    92             270       362       120,250       121,876       270  
Home equity secured for personal purpose
    118       74       44       236       80,639       80,875       44  
Loans to individuals
    537       153       382       1,072       42,934       44,087       382  
Lease financings
    1,071       421             1,492       79,437       82,056        
 
                                         
Total
  $ 6,734     $ 648     $ 696     $ 8,078     $ 1,417,326     $ 1,471,186     $ 696  
 
                                         
     
*  
Excludes impaired loans and leases.
Nonaccrual and Troubled Debt Restructured Loans and Leases
The following presents, by class of loans and leases, nonaccrual loans and leases (including nonaccrual troubled debt restructured loans and leases) and accruing troubled debt restructured loans and leases at June 30, 2011 and December 31, 2010. Troubled debt restructured loans and leases include concessions primarily related to extensions of interest-only payment periods and an occasional payment modification. These modifications typically are on a short-term basis up to one year.
                                                 
    At June 30, 2011     At December 31, 2010  
            Accruing                     Accruing        
            Troubled     Total             Troubled     Total  
            Debt     Impaired             Debt     Impaired  
    Nonaccrual     Restructured     Loans     Nonaccrual     Restructured     Loans  
    Loans and     Loans and     and     Loans and     Loans and     and  
(Dollars in thousands)   Leases*     Leases     Leases     Leases*     Leases     Leases  
 
                                               
Commercial, financial and agricultural
  $ 5,979     $ 8     $ 5,987     $ 7,627     $ 175     $ 7,802  
Real estate-commercial real estate and construction:
                                               
Commercial real estate
    29,797       2,454       32,251       28,183             28,183  
Construction
    6,831       2,067       8,898       6,874             6,874  
Real estate-residential and home equity:
                                               
Residential secured for business purpose
    109       109       218       361       90       451  
Residential secured for personal purpose
    61       158       219       1,264             1,264  
Home equity secured for personal purpose
          31       31                    
Loans to individuals
          52       52       21       60       81  
Lease financings
    736       149       885       902       225       1,127  
 
                                   
Total
  $ 43,513     $ 5,028     $ 48,541     $ 45,232     $ 550     $ 45,782  
 
                                   
     
*  
Includes non-accrual troubled debt restructured loans and leases of $2.8 million and $1.2 million at June 30, 2011 and December, 31, 2010, respectively.
Credit Quality Indicators
The following tables present by class, the recorded investment in loans and leases by credit quality indicator at June 30, 2011 and December 31, 2010.

 

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The Corporation employs a ten (10) grade risk rating system related to the credit quality of commercial loans and residential real estate loans secured for a business purpose of which the first six categories are pass categories (credits not adversely rated). The following is a description of the internal risk ratings and the likelihood of loss related to each risk rating. Loans with risk ratings of one through five are reviewed based on the relationship dollar amount with the borrower: loans with a relationship total of $2.5 million or greater are reviewed quarterly; loans with a relationship balance of less than $2.5 million but greater than $500 thousand are reviewed annually based on the borrower’s fiscal year; loans with a relationship balance of less than $500 thousand are reviewed only if the loan becomes 60 days or more past due. Loans with risk ratings of six are also reviewed based on the relationship dollar amount with the borrower: loans with a relationship balance of $2.0 million or greater are reviewed quarterly; loans with a relationship balance of less than $2.0 million but greater than $500 thousand are reviewed annually; loans with a relationship balance of less than $500 thousand are reviewed only if the loan becomes 60 days or more past due. Loans with risk ratings of seven are reviewed at least quarterly, and as often as monthly, at management’s discretion. Loans with risk ratings of eight through ten are reviewed monthly.
  1.  
Cash Secured — No credit risk
  2.  
Fully Secured — Negligible credit risk
  3.  
Strong — Minimal credit risk
  4.  
Satisfactory — Nominal credit risk
  5.  
Acceptable — Moderate credit risk
  6.  
Pre-Watch — Marginal, but stable credit risk
  7.  
Special Mention — Potential weakness
  8.  
Substandard — Well-defined weakness
  9.  
Doubtful — Collection in-full improbable
  10.  
Loss — Considered uncollectible
Commercial Credit Exposure Credit Risk by Internally Assigned Grades
                                                                 
                                                    Real Estate-Residential  
    Commercial, Financial                                     Secured for  
    and Agricultural     Real Estate-Commercial     Real Estate-Construction     Business Purpose  
    At June 30,     At December 31,     At June 30,     At December 31,     At June 30,     At December 31,     At June 30,     At December 31,  
(Dollars in thousands)   2011     2010     2011     2010     2011     2010     2011     2010  
 
                                                               
Grade:
                                                               
1. Cash secured/ 2. Fully secured
  $ 1,160     $ 2,714     $     $     $     $     $     $  
3. Strong
    5,275       16,350       10,024       11,542       1,284       2,674             28  
4. Satisfactory
    34,315       71,258       30,591       47,755       1,634       12,217       1,386       1,836  
5. Acceptable
    291,171       254,422       278,855       261,520       42,235       78,116       19,761       24,987  
6. Pre-watch
    87,861       70,259       116,331       109,493       22,511       11,296       8,530       6,322  
7. Special Mention
    16,133       8,476       22,580       17,596       5,701       684       741       700  
8. Substandard
    40,692       36,933       51,788       67,379       11,492       14,782       2,299       8,586  
9. Doubtful
    3,063       3,106       993       1,261                          
10. Loss
                                               
 
                                               
Total
  $ 479,670     $ 463,518     $ 511,162     $ 516,546     $ 84,857     $ 119,769     $ 32,717     $ 42,459  
 
                                               
The Corporation monitors the credit risk profile by payment activity for the following classifications of loans and leases: residential real estate loans secured for a personal purpose, home equity loans secured for a personal purpose, loans to individuals and lease financings by payment activity. Nonperforming loans and leases are loans past due 90 days or more and loans and leases on non-accrual of interest as well as troubled debt restructured loans. Performing loans and leases are reviewed only if the loan becomes 60 days or more past due. Nonperforming loans and leases are reviewed monthly. Performing loans and leases have a nominal to moderate risk of loss. Nonperforming loans and leases are loans with a well-defined weakness as well as loans where collection in-full is improbable.

 

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Credit Exposure — Real Estate-Residential Secured for Personal Purpose, Real Estate-Home Equity Secured for Personal Purpose, Loans to individuals, Lease Financing Credit Risk Profile by Payment Activity
                                                                 
    Real Estate-Residential     Real Estate-Home Equity              
    Secured for     Secured for              
    Personal Purpose     Personal Purpose     Loans to individuals     Lease Financing  
    At June 30,     At December 31,     At June 30,     At December 31,     At June 30,     At December 31,     At June 30,     At December 31,  
(Dollars in thousands)   2011     2010     2011     2010     2011     2010     2011     2010  
 
                                                               
Performing
  $ 132,336     $ 120,342     $ 80,155     $ 80,831     $ 42,392     $ 43,624     $ 74,045     $ 80,929  
Nonperforming
    218       1,534       75       44       185       463       895       1,127  
 
                                               
Total
  $ 132,554     $ 121,876     $ 80,230     $ 80,875     $ 42,577     $ 44,087     $ 74,940     $ 82,056  
 
                                               
Risks associated with lending activities include, among other things, the impact of changes in interest rates and economic conditions, which may adversely impact the ability of borrowers to repay outstanding loans, and impact the value of the associated collateral.
Commercial, financial and agricultural loans, commercial real estate loans, construction loans and residential real estate loans with a business purpose are generally perceived as having more risk of default than residential real estate loans with a personal purpose and consumer loans. These types of loans involve larger loan balances to a single borrower or groups of related borrowers. Commercial real estate loans may be affected to a greater extent than residential loans by adverse conditions in real estate markets or the economy because commercial real estate borrowers’ ability to repay their loans depends on successful development of their properties, as well as the factors affecting residential real estate borrowers.
Commercial, financial and agricultural business loans are typically based on the borrowers’ ability to repay the loans from the cash flow of their businesses. These loans may involve greater risk because the availability of funds to repay each loan depends substantially on the success of the business itself. In addition, the collateral securing the loans often depreciates over time, is difficult to appraise and liquidate and fluctuates in value based on the success of the business.
Risk of loss on a construction loan depends largely upon whether our initial estimate of the property’s value at completion of construction equals or exceeds the cost of the property construction (including interest). During the construction phase, a number of factors can result in delays and cost overruns. If estimates of value are inaccurate or if actual construction costs exceed estimates, the value of the property securing the loan may be insufficient to ensure full repayment when completed through a permanent loan or by seizure of collateral. Included in real estate-construction is track development financing. Risk factors related to track development financing include the demand for residential housing and the real estate valuation market. When projects move slower than anticipated, the properties may have significantly lower values than when the original underwriting was completed, resulting in lower collateral values to support the loan. Extended time frames also cause the interest carrying cost for a project to be higher than the builder projected, negatively impacting the builder’s profit and cash flow and, therefore, their ability to make principal and interest payments.
Commercial real estate loans and residential real estate loans with a business purpose secured by owner-occupied properties are dependent upon the successful operation of the borrower’s business. If the operating company suffers difficulties in terms of sales volume and/or profitability, the borrower’s ability to repay the loan may be impaired. Loans secured by properties where repayment is dependent upon payment of rent by third party tenants or the sale of the property may be impacted by loss of tenants, lower lease rates needed to attract new tenants or the inability to sell a completed project in a timely fashion and at a profit.
Commercial, financial and agricultural loans, commercial real estate loans, construction loans and residential real estate loans secured for a business purpose are more susceptible to a risk of loss during a downturn in the business cycle. The Corporation has strict underwriting, review, and monitoring procedures in place, however, these procedures cannot eliminate all of the risks related to these loans.

 

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The Corporation focuses on both assessing the borrower’s capacity and willingness to repay and on obtaining sufficient collateral. Commercial, financial and agricultural loans are generally secured by the borrower’s assets and by personal guarantees. Commercial real estate and residential real estate loans secured for a business purpose are originated primarily within the Eastern Pennsylvania market area at conservative loan-to-value ratios and often by a guarantee of the borrowers. Management closely monitors the composition and quality of the total commercial loan portfolio to ensure that any credit concentrations by borrower or industry are closely monitored.
The Corporation originates fixed-rate and adjustable-rate real estate-residential mortgage loans that are secured by the underlying 1- to 4-family residential properties for personal purposes. Credit risk exposure in this area of lending is minimized by the evaluation of the credit worthiness of the borrower, including debt-to-equity ratios, credit scores and adherence to underwriting policies that emphasize conservative loan-to-value ratios of generally no more than 80%. Residential mortgage loans granted in excess of the 80% loan-to-value ratio criterion are generally insured by private mortgage insurance.
In the real estate-home equity loan portfolio secured for a personal purpose, combined loan-to-value ratios at origination are generally limited to 80%. Other credit considerations may warrant higher combined loan-to-value ratios and are generally insured by private mortgage insurance.
Credit risk in the loans to individuals portfolio, which includes, direct consumer loans and credit cards, is controlled by strict adherence to conservative underwriting standards that consider debt-to-income levels and the creditworthiness of the borrower and, if secured, collateral values.
The primary risks that are involved with lease financing receivables are credit underwriting and borrower industry concentrations. The Corporation has strict underwriting, review, and monitoring procedures in place to mitigate this risk. Risk also lies in the residual value of the underlying equipment. Residual values are subject to judgments as to the value of the underlying equipment that can be affected by changes in economic and market conditions and the financial viability of the residual guarantors and insurers. To the extent not guaranteed or assumed by a third party, or otherwise insured against, the Corporation bears the risk of ownership of the leased assets. This includes the risk that the actual value of the leased assets at the end of the lease term will be less than the residual value. The Corporation greatly reduces this risk by using $1.00 buyout leases, in which the entire cost of the leased equipment is included in the contractual payments, leaving no residual payment at the end of the lease terms.

 

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Reserve for Loan and Lease Losses and Recorded Investment in Loans and Leases
The following presents, by portfolio segment, a summary of the activity in the reserve for loan and lease losses, the balance in the reserve for loan and lease losses disaggregated on the basis of impairment method and the recorded investment in loans and leases disaggregated on the basis of impairment method for the three and six months ended June 30, 2011 and 2010:
                                                                 
                            Real Estate-                          
                            Residential                          
                    Real Estate-     and                          
    Commercial,     Real Estate-     Residential     Home Equity                          
    Financial     Commercial     Secured for     Secured for     Loans                    
    and     and     Business     Personal     to     Lease              
(Dollars in thousands)   Agricultural     Construction     Purpose     Purpose     Individuals     Financings     Unallocated     Total  
 
                                                               
For the Three Months Ended June 30, 2011
                                                               
 
                                                               
Reserve for loan and lease losses:
                                                               
Beginning balance
  $ 11,098     $ 16,464     $ 995     $ 594     $ 701     $ 1,946     $ 1,006     $ 32,804  
Charge-offs
    (1,644 )     (3,375 )     (136 )     (35 )     (396 )     (391 )             (5,977 )
Recoveries
    49       17       3       1       34       114               218  
Provision (recovery of provision)
    1,374       2,986       157       136       356       243       304       5,556  
 
                                               
Ending balance
  $ 10,877     $ 16,092     $ 1,019     $ 696     $ 695     $ 1,912     $ 1,310     $ 32,601  
 
                                               
 
                                                               
For the Three Months Ended June 30, 2010
                                                               
 
                                                               
Reserve for loan and lease losses:
                                                               
Beginning balance
  $ 14,088     $ 8,311     $ 860     $ 486     $ 822     $ 1,499     $ 999     $ 27,065  
Charge-offs
    (1,180 )     (1,638 )     (5 )           (194 )     (603 )           (3,620 )
Recoveries
    43       485       9             66       196             799  
Provision (recovery of provision)
    (420 )     4,170       (10 )     (4 )     111       931       87       4,865  
 
                                               
Ending balance
  $ 12,531     $ 11,328     $ 854     $ 482     $ 805     $ 2,023     $ 1,086     $ 29,109  
 
                                               
                                                                 
                            Real Estate-                          
                            Residential                          
                    Real Estate-     and                          
    Commercial,     Real Estate-     Residential     Home Equity                          
    Financial     Commercial     Secured for     Secured for     Loans                    
    and     and     Business     Personal     to     Lease              
(Dollars in thousands)   Agricultural     Construction     Purpose     Purpose     Individuals     Financings     Unallocated     Total  
 
                                                               
For the Six Months Ended June 30, 2011
                                                               
 
                                                               
Reserve for loan and lease losses:
                                                               
Beginning balance
  $ 9,630     $ 15,288     $ 1,333     $ 544     $ 734     $ 1,950     $ 1,419     $ 30,898  
Charge-offs
    (2,774 )     (5,063 )     (194 )     (38 )     (597 )     (859 )           (9,525 )
Recoveries
    181       80       6       3       78       190             538  
Provision (recovery of provision)
    3,840       5,787       (126 )     187       480       631       (109 )     10,690  
 
                                               
Ending balance
  $ 10,877     $ 16,092     $ 1,019     $ 696     $ 695     $ 1,912     $ 1,310     $ 32,601  
 
                                               
 
                                                               
For the Six Months Ended June 30, 2010
                                                               
 
                                                               
Reserve for loan and lease losses:
                                                               
Beginning balance
  $ 12,148     $ 7,975     $ 1,058     $ 501     $ 887     $ 1,175     $ 1,054     $ 24,798  
Charge-offs
    (2,348 )     (2,438 )     (5 )           (479 )     (1,192 )           (6,462 )
Recoveries
    68       489       10             142       304             1,013  
Provision (recovery of provision)
    2,663       5,302       (209 )     (19 )     255       1,736       32       9,760  
 
                                               
Ending balance
  $ 12,531     $ 11,328     $ 854     $ 482     $ 805     $ 2,023     $ 1,086     $ 29,109  
 
                                               

 

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                            Real Estate-                          
                            Residential                          
                    Real Estate-     and                          
    Commercial,     Real Estate-     Residential     Home Equity                          
    Financial     Commercial     Secured for     Secured for     Loans                    
    and     and     Business     Personal     to     Lease              
(Dollars in thousands)   Agricultural     Construction     Purpose     Purpose     Individuals     Financings     Unallocated     Total  
 
                                                               
As of June 30, 2011
                                                               
 
                                                               
Reserve for loan and lease losses:
                                                               
Ending balance: individually evaluated for impairment
  $ 372     $ 933     $     $     $     $     $ N/A     $ 1,305  
Ending balance: collectively evaluated for impairment
    10,505       15,159       1,019       696       695       1,912       1,310       31,296  
 
                                               
Total ending balance
  $ 10,877     $ 16,092     $ 1,019     $ 696     $ 695     $ 1,912     $ 1,310     $ 32,601  
 
                                               
 
                                                               
Loans and leases:
                                                               
Ending balance: individually evaluated for impairment
  $ 5,987     $ 41,149     $ 218     $ 250     $ 52     $ 885             $ 48,541  
Ending balance: collectively evaluated for impairment
    473,683       554,870       32,499       212,534       42,525       74,055               1,390,166  
 
                                                 
Total ending balance
  $ 479,670     $ 596,019     $ 32,717     $ 212,784     $ 42,577     $ 74,940             $ 1,438,707  
 
                                                 
 
                                                               
As of June 30, 2010
                                                               
Reserve for loan and lease losses:
                                                               
Ending balance: individually evaluated for impairment
  $ 668     $ 3,395     $ 65     $     $     $     $ N/A     $ 4,128  
Ending balance: collectively evaluated for impairment
    11,863       7,933       789       482       805       2,023       1,086       24,981  
 
                                               
Total ending balance
  $ 12,531     $ 11,328     $ 854     $ 482     $ 805     $ 2,023     $ 1,086     $ 29,109  
 
                                               
 
                                                               
Loans and leases:
                                                               
Ending balance: individually evaluated for impairment
  $ 2,253     $ 25,741     $ 661     $ 1,338     $ 62     $ 985             $ 31,040  
Ending balance: collectively evaluated for impairment
    461,489       571,219       43,178       209,425       44,906       87,890               1,418,107  
 
                                                 
Total ending balance
  $ 463,742     $ 596,960     $ 43,839     $ 210,763     $ 44,968     $ 88,875             $ 1,449,147  
 
                                                 

 

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Impaired Loans and Leases
The following presents, by class of loans and leases, the recorded investment and unpaid principal balance of impaired loans and leases, the amounts of the impaired loans and leases for which there is not an allowance for credit losses and the amounts for which there is an allowance for credit losses at June 30, 2011 and December 31, 2010:
                                                 
    At June 30, 2011     At December 31, 2010  
            Unpaid                     Unpaid        
    Recorded     Principal     Related     Recorded     Principal     Related  
(Dollars in thousands)   Investment     Balance     Allowance     Investment     Balance     Allowance  
 
                                               
Impaired loans and leases with no related allowance recorded:
                                               
Commercial, financial and agricultural
  $ 5,143     $ 6,028             $ 4,761     $ 5,074          
Real estate-commercial real estate
    25,011       28,869               21,403       23,094          
Real estate-construction
    7,469       9,453               6,225       8,025          
Real estate-residential secured for business purpose
    218       729               361       730          
Real estate-residential secured for personal purpose
    219       219               632       632          
Real estate-home equity secured for personal purpose
    31       31                              
Loans to individuals
    52       52               81       81          
Lease financings
    885       885               1,127       1,127          
 
                                       
Total impaired loans and leases with no related allowance recorded:
  $ 39,028     $ 46,266             $ 34,590     $ 38,763          
 
                                       
 
                                               
Impaired loans and leases with an allowance recorded:
                                               
Commercial, financial and agricultural
  $ 844     $ 867     $ 372     $ 3,041     $ 3,058     $ 650  
Real estate-commercial real estate
    7,240       7,676       860       6,780       8,321       909  
Real estate-construction
    1,429       1,444       73       649       649       33  
Real estate-residential secured for business purpose
                      90       90       29  
Real estate-residential secured for personal purpose
                      632       632       2  
 
                                   
Total impaired loans and leases with an allowance recorded
  $ 9,513     $ 9,987     $ 1,305     $ 11,192     $ 12,750     $ 1,623  
 
                                   
 
                                               
Total impaired loans and leases:
                                               
Commercial, financial and agricultural
  $ 5,987     $ 6,895     $ 372     $ 7,802     $ 8,132     $ 650  
Real estate-commercial real estate
    32,251       36,545       860       28,183       31,415       909  
Real estate-construction
    8,898       10,897       73       6,874       8,674       33  
Real estate-residential secured for business purpose
    218       729             451       820       29  
Real estate-residential secured for personal purpose
    219       219             1,264       1,264       2  
Real estate-home equity secured for personal purpose
    31       31                          
Loans to individuals
    52       52             81       81        
Lease financings
    885       885             1,127       1,127        
 
                                   
Total impaired loans and leases:
  $ 48,541     $ 56,253     $ 1,305     $ 45,782     $ 51,513     $ 1,623  
 
                                   

 

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The following presents by class of loans and leases, the average recorded investment in impaired loans and leases and an analysis of interest on impaired loans and leases:
                                                 
    Three Months Ended June 30, 2011     Three Months Ended June 30, 2010  
                    Interest                     Interest  
                    Income That                     Income That  
                    Would Have                     Would Have  
                    Been                     Been  
                    Recognized                     Recognized  
    Average     Interest     Under     Average     Interest     Under  
    Recorded     Income     Original     Recorded     Income     Original  
(Dollars in thousands)   Investment     Recognized*     Terms     Investment     Recognized*     Terms  
 
                                               
Commercial, financial and agricultural
  $ 6,387     $ 12     $ 105     $ 2,461     $ 3     $ 35  
Real estate-commercial real estate
    26,802       48       452       17,841       36       270  
Real estate-construction
    9,093       28       88       9,159             96  
Real estate-residential secured for business purpose
    327       1       3       879       9       7  
Real estate-residential secured for personal purpose
    544       2       5       1,122             18  
Real estate-home equity secured for personal purpose
    23                   249             3  
Loans to individuals
    58       2             62       2        
Lease financings
    972                   990              
 
                                   
Total
  $ 44,206     $ 93     $ 653     $ 32,763     $ 50     $ 429  
 
                                   
     
*  
Includes interest income recognized on accruing troubled debt restructured loans of $73 thousand and $26 thousand for the three months ended June 30, 2011 and 2010, respectively.
                                                 
    Six Months Ended June 30, 2011     Six Months Ended June 30, 2010  
                    Interest                     Interest  
                    Income That                     Income That  
                    Would Have                     Would Have  
                    Been                     Been  
                    Recognized                     Recognized  
    Average     Interest     Under     Average     Interest     Under  
    Recorded     Income     Original     Recorded     Income     Original  
(Dollars in thousands)   Investment     Recognized*     Terms     Investment     Recognized*     Terms  
 
                                               
Commercial, financial and agricultural
  $ 6,753     $ 14     $ 193     $ 2,937     $ 6     $ 89  
Real estate-commercial real estate
    26,225       52       844       17,016       58       520  
Real estate-construction
    8,141       28       175       11,607             289  
Real estate-residential secured for business purpose
    380       3       9       869       18       13  
Real estate-residential secured for personal purpose
    750       19       20       1,182       13       23  
Real estate-home equity secured for personal purpose
    13                   249             5  
Loans to individuals
    62       3       1       63       3        
Lease financings
    1,034                   949              
 
                                   
Total
  $ 43,358     $ 119     $ 1,242     $ 34,872     $ 98     $ 939  
 
                                   
     
*  
Includes interest income recognized on accruing troubled debt restructured loans of $79 thousand and $74 thousand for the six months ended June 30, 2011 and 2010, respectively.

 

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Note 5. Mortgage Servicing Rights
The Corporation has originated mortgage servicing rights which are included in other intangible assets on the consolidated balance sheets. Mortgage servicing rights are amortized in proportion to, and over the period of, estimated net servicing income on a basis similar to the interest method using an accelerated amortization method and are subject to periodic impairment testing. The aggregate fair value of these rights was $3.4 million and $2.9 million at June 30, 2011 and December 31, 2010. The fair value of mortgage servicing rights was determined using discount rates ranging from 3.50% to 7.32% for the six months ended June 30, 2011.
Changes in the mortgage servicing rights balance are summarized as follows:
                                 
    Three Months Ended     Six Months Ended  
    June 30,     June 30,  
    2011     2010     2011     2010  
    (Dollars in thousands)  
 
                               
Beginning of period
  $ 2,772     $ 1,620     $ 2,441     $ 1,437  
Servicing rights capitalized
    236       258       688       508  
Amortization of servicing rights
    (112 )     (75 )     (189 )     (140 )
Changes in valuation
    (18 )     (4 )     (62 )     (6 )
 
                       
End of period
  $ 2,878     $ 1,799     $ 2,878     $ 1,799  
 
                       
Mortgage loans serviced for others
  $ 355,356     $ 216,760     $ 355,356     $ 216,760  
 
                       
Activity in the valuation allowance for mortgage servicing rights was as follows:
                                 
    Three Months Ended     Six Months Ended  
    June 30,     June 30,  
    2011     2010     2011     2010  
    (Dollars in thousands)  
 
                               
Valuation allowance, beginning of period
  $ (245 )   $ (252 )   $ (201 )   $ (250 )
Additions
    (18 )     (4 )     (62 )     (6 )
Reductions
                       
Direct write-downs
                       
 
                       
Valuation allowance, end of period
  $ (263 )   $ (256 )   $ (263 )   $ (256 )
 
                       
The estimated amortization expense of mortgage servicing rights for each of the five succeeding fiscal years is as follows:
         
Year (Dollars in thousands)   Amount  
2011
  $ 246  
2012
    433  
2013
    372  
2014
    322  
2015
    277  
Thereafter
    1,228  
Note 6. Income Taxes
As of June 30, 2011 and December 31, 2010, the Corporation had no material unrecognized tax benefits, accrued interest or penalties. Penalties are recorded in non-interest expense in the year they are assessed and are treated as a non-deductible expense for tax purposes. Interest is recorded in non-interest expense in the year it is assessed and is treated as a deductible expense for tax purposes. As of June 30, 2011, the Corporation’s 2007 federal tax return was examined and tax years 2007 through 2010 remain subject to federal examination as well as examination by state taxing jurisdictions.

 

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Note 7. Retirement Plans and Other Postretirement Benefits
Substantially all employees who were hired before December 8, 2009 are covered by a noncontributory retirement plan. Effective December 31, 2009, the benefits under the noncontributory retirement plan, in its current form, were frozen and the plan was amended and converted to a cash balance plan, with participants not losing any pension benefits already earned in the plan. Prior to the cash balance plan conversion effective December 31, 2009, the plan provided benefits based on a formula of each participant’s final average pay. Future benefits under the cash balance plan accrue by crediting participants annually with an amount equal to a percentage of earnings in that year based on years of credited service as defined in the plan. Additionally, employees hired on or after December 8, 2009 are not eligible to participate in the noncontributory retirement plan. The Corporation also provides supplemental executive retirement benefits, a portion of which is in excess of limits imposed on qualified plans by federal tax law. These plans are non-qualified benefit plans. Information on these plans are aggregated and reported under “Retirement Plans” within this footnote.
The Corporation also provides certain postretirement healthcare and life insurance benefits for retired employees. Information on these benefits is reported under “Other Postretirement Benefits” within this footnote.
The Corporation sponsors a Supplemental Non-Qualified Pension Plan (SNQPP) which was established in 1981 for employees who have served for several years, with ability and distinction, in one of the primary policy-making senior level positions, with the understanding that the future growth and continued success of the Corporation’s business may well reflect the continued services to be rendered by these employees and the Corporation’s desire to be reasonably assured that these employees will continue to serve and realizing that if these employees would enter into competition with the Corporation, it would suffer severe financial loss. The SNQPP was established prior to the existence of a 401(k) Deferred Savings Plan, the Employee Stock Purchase Plan and the Long-Term Incentive Plans and therefore is not actively offered to new participants.
Information with respect to the Retirement and Supplemental Retirement Plans and Other Postretirement Benefits follows:
Components of net periodic benefit cost were as follows:
                                 
    For the Three Months Ended June 30,  
    2011     2010     2011     2010  
                    Other Post Retirement  
(Dollars in thousands)   Retirement Plans     Benefits  
 
                               
Service cost
  $ 184     $ 81     $ 17     $ 18  
Interest cost
    433       427       30       27  
Expected return on plan assets
    (476 )     (404 )            
Amortization of net loss
    176       168             (3 )
Amortization (accretion) of prior service cost
    12       (6 )     (5 )     (5 )
Accretion of transition asset
    (70 )     (71 )            
 
                       
Net periodic cost
  $ 259     $ 195     $ 42     $ 37  
 
                       
                                 
    For the Six Months Ended June 30,  
    2011     2010     2011     2010  
                    Other Post Retirement  
(Dollars in thousands)   Retirement Plans     Benefits  
 
                               
Service cost
  $ 278     $ 182     $ 33     $ 38  
Interest cost
    863       856       59       53  
Expected return on plan assets
    (948 )     (835 )            
Amortization of net loss
    364       337       17       7  
Amortization (accretion) of prior service cost
    24       24       (10 )     (10 )
Accretion of transition asset
    (141 )     (142 )            
 
                       
Net periodic cost
  $ 440     $ 422     $ 99     $ 88  
 
                       

 

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The Corporation previously disclosed in its financial statements for the year ended December 31, 2010, that it expected to make contributions of $54 thousand to its qualified and non-qualified retirement plans and $97 thousand to its other postretirement benefit plans in 2011. During the six months ended June 30, 2011, the Corporation contributed $20 thousand and $40 thousand to its qualified and non-qualified retirement plans and other postretirement plans, respectively. As of June 30, 2011, $726 thousand has been paid to participants from the qualified and non-qualified retirement plans and $40 thousand has been paid to participants from the other postretirement plans.
Note 8. Earnings Per Share
The following table sets forth the computation of basic and diluted earnings per share:
                                 
    Three Months Ended     Six Months Ended  
    June 30,     June 30,  
(Dollars and shares in thousands, except per share data)   2011     2010     2011     2010  
 
                               
Numerator:
                               
Numerator for basic and diluted earnings per share — Income available to common shareholders
  $ 4,516     $ 3,730     $ 8,378     $ 6,700  
 
                       
Denominator:
                               
Denominator for basic earnings per share — weighted-average shares outstanding
    16,772       16,590       16,742       16,563  
Effect of dilutive securities:
                               
Employee stock options
                       
 
                       
Denominator for diluted earnings per share — adjusted weighted-average shares outstanding
    16,772       16,590       16,742       16,563  
 
                       
Basic earnings per share
  $ 0.27     $ 0.23     $ 0.50     $ 0.40  
 
                       
Diluted earnings per share
  $ 0.27     $ 0.23     $ 0.50     $ 0.40  
 
                       
Anti-dilutive options have been excluded in the computation of diluted earnings per share because the options’ exercise prices were greater than the average market price of the common stock. For the three months ended June 30, 2011 and 2010, there were 518,032 and 403,032 average anti-dilutive options at an average exercise price of $22.06 and $23.41, per share, respectively. For the six months ended June 30, 2011 and 2010, there were 503,115 and 403,032 average anti-dilutive options at an average exercise price of $22.20 and $23.41, per share, respectively.

 

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Note 9. Comprehensive Income and Accumulated Other Comprehensive (Loss) Income
The following table shows the components of comprehensive income, net of income taxes, for the periods presented:
                                 
    Three Months Ended     Six Months Ended  
    June 30,     June 30,  
    2011     2010     2011     2010  
    (Dollars in thousands)  
 
                               
Net income
  $ 4,516     $ 3,730     $ 8,378     $ 6,700  
 
                               
Net unrealized gains on available-for-sale investment securities:
                               
Net unrealized gains arising during the period
    3,355       1,506       4,107       1,497  
Less: reclassification adjustment for net gains (losses) on sales realized in net income
    370       25       370       57  
Less: reclassification adjustment for other-than-temporary impairment on equity securities realized in net income
    (2 )     (28 )     (7 )     (31 )
 
                       
Total net unrealized gains on available-for-sale investment securities
    2,987       1,509       3,744       1,471  
Net change in fair value of derivatives used for cash flow hedges
    (391 )     (828 )     (242 )     (1,047 )
Defined benefit pension plans:
                               
Less: amortization of net loss included in net periodic pension costs
    (115 )     (116 )     (248 )     (232 )
Less: accretion (amortization) of prior service cost included in net periodic pension costs
    (4 )     7       (9 )     (9 )
Less: accretion of transition asset included in net periodic pension costs
    46       46       92       92  
 
                       
Total defined benefit pension plans
    73       63       165       149  
 
                       
Total comprehensive income, net of tax
  $ 7,185     $ 4,474     $ 12,045     $ 7,273  
 
                       
The following table shows the components of accumulated other comprehensive (loss) income, net of taxes, for the periods presented:
                                 
    Net Unrealized     Net Change              
    Gains on     in Fair Value     Net Change     Accumulated  
    Available for     of Derivative     Related to     Other  
    Sale Investment     Used for Cash     Defined Benefit     Comprehensive  
(Dollars in thousands)   Securities     Flow Hedges     Pension Plan     (Loss) Income  
 
                               
Balance, December 31, 2009
  $ 5,373     $ 1,150     $ (7,047 )   $ (524 )
Net Change
    1,471       (1,047 )     149       573  
 
                       
Balance, June 30, 2010
  $ 6,844     $ 103     $ (6,898 )   $ 49  
 
                       
 
                               
Balance, December 31, 2010
  $ 884     $ 320     $ (7,970 )   $ (6,766 )
Net Change
    3,744       (242 )     165       3,667  
 
                       
Balance, June 30, 2011
  $ 4,628     $ 78     $ (7,805 )   $ (3,099 )
 
                       
Note 10. Derivative Instruments and Hedging Activities
The Corporation may use interest-rate swap agreements to modify the interest rate characteristics from variable to fixed or fixed to floating in order to reduce the impact of interest rate changes on future net interest income. The Corporation accounts for its interest-rate swap contracts in cash flow and fair value hedging relationships by establishing and documenting the effectiveness of the instrument in offsetting the change in cash flows or fair value of assets or liabilities that are being hedged. To determine effectiveness, the Corporation performs an analysis to identify if changes in fair value or cash flow of the derivative correlate to the equivalent changes in the forecasted interest receipts related to a specified hedged item. Recorded amounts related to interest-rate swaps are included in other assets or liabilities. The change in fair value of the ineffective part of the instrument would need to be charged to the statement of operations, potentially causing material fluctuations in reported earnings in the period of the change relative to comparable periods.

 

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The Corporation’s credit exposure on interest rate swaps includes fair value and any collateral that is held by a third party. Changes in the fair value of derivative instruments designated as hedges of future cash flows are recognized in equity until the underlying forecasted transactions occur, at which time the deferred gains and losses are recognized in income. For a qualifying fair value hedge, the gain or loss on the hedging relationship is recognized in earnings, and the change in fair value on the hedged item to the extent attributable to the hedged risk adjusts the carrying amount of the hedged item and is recognized in earnings.
Derivative loan commitments represent agreements for delayed delivery of financial instruments in which the buyer agrees to purchase and the seller agrees to deliver, at a specified future date, a specified instrument at a specified price or yield. The Corporation’s derivative loan commitments are commitments to sell loans secured by 1-to-4 family residential properties whose predominant risk characteristic is interest rate risk. The fair values of these derivative loan commitments are based upon the estimated amount the Corporation would receive or pay to terminate the contracts or agreements, taking into account current interest rates and, when appropriate, the current creditworthiness of the counterparties. Loans held for sale are included as forward loan commitments. At June 30, 2011, the notional amounts of interest rate locks with customers and forward loan commitments were $18.9 million and $21.0 million, respectively, with fair values of a positive $299 thousand and $33 thousand, respectively. At December 31, 2010, the notional amounts of interest rate locks with customers and forward loan commitments were $37.7 million and $41.8 million, respectively, with positive fair values of $530 thousand and $269 thousand, respectively. For the interest rate locks with customers, the Corporation recognized fair value adjustments which resulted in gains of $29 thousand and $562 thousand for the three months ended June 30, 2011 and 2010, respectively and losses of $533 thousand and gains of $723 thousand for the six months ended June 30, 2011 and 2010, respectively. For the forward loan commitments, the Corporation recognized fair value adjustments which resulted in gains of $116 thousand and losses of $365 thousand for the three months ended June 30, 2011 and 2010, respectively and gains of $65 thousand and losses of $426 thousand for the six months ended June 30, 2011 and 2010, respectively. The fair value gains and losses related to interest rate locks and forward loan commitments are classified as a component of net gain on mortgage banking activities in the Corporation’s consolidated statements of income.
On March 24, 2009, the Corporation entered into a $22.0 million notional interest rate swap, which had been classified as a fair value hedge on a real estate-commercial loan. Under the terms of the swap agreement, the Corporation paid a fixed rate of 6.49% and received a floating rate which was based on the one month U.S. London Interbank Borrowing Rate (LIBOR) with a 357 basis point spread and a maturity date of April 1, 2019. The Corporation performed an assessment of the hedge at inception and at re-designation. During the fourth quarter of 2009, the Corporation participated $5.0 million of the hedged real estate-commercial loan and de-designated the hedge relationship. During the first quarter of 2010, the Corporation re-designated $17.0 million of the interest rate swap. Upon re-designation, $17.0 million of the swap had some ineffectiveness and the $5.0 million remained undesignated. During the third quarter of 2010, the Corporation terminated the swap. The underlying commercial loan had a positive fair value adjustment on the termination date of $859 thousand which is being amortized through a reduction of interest income over the remaining life. For this interest rate swap, the Corporation recognized fair value adjustments which resulted in losses of $516 thousand and $826 thousand for the three and six months ended June 30, 2010. The fair value gains and losses related to this interest rate swap are classified as a component of net (loss) gain on interest rate swap in the Corporation’s consolidated statements of income.

 

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On December 23, 2008, the Corporation entered into a cash flow hedge with a notional amount of $20.0 million that had the effect of converting the variable rates on trust preferred securities to a fixed rate. Under the terms of the swap agreement, the Corporation pays a fixed rate of 2.65% and receives a floating rate based on the three month LIBOR with a maturity date of January 7, 2019. The Corporation has performed an assessment of the hedge at inception and determined that this derivative is highly effective in offsetting the changes in the cash flows of the hedged item. At June 30, 2011, the interest rate swap had a positive fair value of $120 thousand, which was classified on the balance sheet as a component of other assets, and was determined to be highly effective in offsetting the changes in the cash flows of the hedged item. The fair value of the interest rate swap, net of taxes, of $78 thousand was recorded as a component of accumulated other comprehensive loss on the balance sheet. At December 31, 2010, the interest rate swap had a positive fair value of $492 thousand, which was classified on the balance sheet as a component of other assets, and was determined to be highly effective in offsetting the changes in the cash flows of the hedged item. The fair value of the interest rate swap, net of taxes, of $320 thousand was recorded as a component of accumulated other comprehensive loss on the balance sheet. The cash payments on the interest rate swap of $120 thousand and $119 thousand during the three months ended June 30, 2011 and 2010, respectively, and $237 thousand and $239 thousand during the six months ended June 30, 2011 and 2010, respectively, were recorded as a component of interest expense on the income statement. The Corporation expects that approximately $467 thousand of the net gain in accumulated other comprehensive loss will be reclassified as a reduction of interest expense within the next twelve months.
Note 11. Fair Value Disclosures
Fair value is the price that would be received to sell an asset or paid to transfer a liability (an exit price) in an orderly transaction between market participants on the measurement date. The Corporation determines the fair value of its financial instruments based on the fair value hierarchy. The Corporation maximizes the use of observable inputs and minimizes the use of unobservable inputs when measuring fair value. Observable inputs are inputs that market participants would use in pricing the asset or liability developed based on market data obtained from sources independent of the Corporation. Unobservable inputs are inputs that reflect the Corporation’s assumptions that the market participants would use in pricing the asset or liability based on the best information available in the circumstances. Three levels of inputs are used to measure fair value. A financial instrument’s level within the fair value hierarchy is based on the lowest level of input significant to the fair value measurement.
   
Level 1—Valuations are based on quoted prices in active markets for identical assets or liabilities that the Corporation has the ability to access. Since valuations are based on quoted prices that are readily and regularly available in an active market, valuation of these products does not entail a significant degree of judgment. Assets and liabilities utilizing Level 1 inputs include: Exchange-traded equity and most U.S. treasury securities.
   
Level 2—Valuations are based on quoted prices in markets that are not active or for which all significant inputs are observable, either directly or indirectly. Assets and liabilities generally utilizing Level 2 inputs include: most U.S. Government agency mortgage-backed debt securities (MBS), corporate debt securities, corporate and municipal bonds, residential mortgage loans held for sale, certain commercial loans, certain equity securities, mortgage servicing rights and derivative financial instruments.
   
Level 3—Valuations are based on inputs that are unobservable and significant to the overall fair value measurement. Assets and liabilities utilizing Level 3 inputs include: financial instruments whose value is determined using pricing models, discounted cash-flow methodologies, or similar techniques, as well as instruments for which the fair value calculation requires significant management judgment or estimation. These assets and liabilities include: certain commercial mortgage obligations (CMO’s) securities.
Following is a description of the valuation methodologies used for instruments measured at fair value, as well as the general classification of such instruments pursuant to the valuation hierarchy.

 

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Investment Securities
Where quoted prices are available in an active market for identical instruments, investment securities are classified within Level 1 of the valuation hierarchy. Level 1 investment securities include highly liquid U.S. Treasury securities and most equity securities. If quoted market prices are not available, then fair values are estimated by using pricing models, quoted prices of securities with similar characteristics or discounted cash flows. Examples of instruments, which would generally be classified within Level 2 of the valuation hierarchy, include U.S. Government sponsored enterprises, certain MBS, CMOs, and municipal bonds and certain equity securities. In cases where there is limited activity or less transparency around inputs to the valuation, investment securities are classified within Level 3 of the valuation hierarchy. Investment securities classified within Level 3 include certain CMO securities.
Derivative Financial Instruments
The fair values of derivative financial instruments are based upon the estimated amount the Corporation would receive or pay to terminate the contracts or agreements, taking into account current interest rates and, when appropriate, the current creditworthiness of the counterparties. Derivative financial instruments are classified within Level 2 of the valuation hierarchy.
The following table presents the assets and liabilities measured at fair value on a recurring basis as of June 30, 2011 and December 31, 2010, classified using the fair value hierarchy:
                                 
    At June 30, 2011  
                            Assets/  
                            Liabilities at  
(Dollars in thousands)   Level 1     Level 2     Level 3     Fair Value  
 
                               
Assets:
                               
Available-for-sale securities:
                               
U.S government corporations and agencies
  $     $ 137,703     $     $ 137,703  
State and political subdivisions
          112,271             112,271  
Mortgage-backed securities
          87,800             87,800  
Commercial mortgage obligations
          68,870             68,870  
Other securities
          8,543             8,543  
Equity securities
    2,815                   2,815  
 
                       
Total available-for-sale securities
    2,815       415,187             418,002  
 
Interest rate swap
          120             120  
Interest rate locks with customers
          299             299  
Forward loan commitments
          33             33  
 
                       
Total assets
  $ 2,815     $ 415,639     $     $ 418,454  
 
                       
Liabilities:
                               
Liabilities
  $     $     $     $  
 
                       
Total liabilities
  $     $     $     $  
 
                       
                                 
    At December 31, 2010  
                            Assets/  
                            Liabilities at  
(Dollars in thousands)   Level 1     Level 2     Level 3     Fair Value  
 
                               
Assets:
                               
Available-for-sale securities:
                               
U.S government corporations and agencies
  $     $ 188,100     $     $ 188,100  
State and political subdivisions
          108,048             108,048  
Mortgage-backed securities
          85,101             85,101  
Commercial mortgage obligations
          68,760       4,331       73,091  
Other securities
          9,667             9,667  
Equity securities
    2,985                   2,985  
 
                       
Total available-for-sale securities
    2,985       459,676       4,331       466,992  
 
                               
Interest rate swaps
          492             492  
Interest rate locks with customers
          530             530  
Forward loan commitments
          269             269  
 
                       
Total assets
  $ 2,985     $ 460,967     $ 4,331     $ 468,283  
 
                       
Liabilities:
                               
Liabilities
  $     $     $     $  
 
                       
Total liabilities
  $     $     $     $  
 
                       

 

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The following table presents a reconciliation for all assets measured at fair value on a recurring basis and for which the Corporation utilized Level 3 inputs to determine fair value for the three months ended June 30, 2010. There was no activity to report for the three months ended June 30, 2011.
                                         
    Three Months Ended June 30, 2010  
            Total     Total                
    Balance at     Unrealized     Realized             Balance at  
    March 31,     Gains or     Gains or             June 30,  
(Dollars in thousands)   2010     (Losses)     (Losses)     Paydowns     2010  
 
                                       
Available-for-sale securities:
                                       
Commercial mortgage obligations
  $ 5,051     $ 24     $     $ (323 )   $ 4,752  
Asset-backed securities
    438       (3 )           (134 )     301  
 
                             
Total Level 3 assets
  $ 5,489     $ 21     $     $ (457 )   $ 5,053  
 
                             
The following table presents a reconciliation for all assets measured at fair value on a recurring basis and for which the Corporation utilized Level 3 inputs to determine fair value for the six months ended June 30, 2011 and 2010.
                                                 
    Six Months Ended June 30, 2011  
            Total     Total                        
    Balance at     Unrealized     Realized                     Balance at  
    December 31,     Gains or     Gains or             Transfers     June 30,  
(Dollars in thousands)   2010     (Losses)     (Losses)     Paydowns     to Level 2     2011  
 
                                               
Available-for-sale securities:
                                               
Commercial mortgage obligations
  $ 4,331     $ (26 )   $     $ (135 )   $ (4,170 )   $  
 
                                   
Total Level 3 assets
  $ 4,331     $ (26 )   $     $ (135 )   $ (4,170 )   $  
 
                                   
                                         
    Six Months Ended June 30, 2010  
            Total     Total                
    Balance at     Unrealized     Realized             Balance at  
    December 31,     Gains or     Gains or             June 30,  
(Dollars in thousands)   2009     (Losses)     (Losses)     Paydowns     2010  
 
                                       
Available-for-sale securities:
                                       
Commercial mortgage obligations
  $ 5,172     $ 146     $     $ (566 )   $ 4,752  
Asset-backed securities
    573       (8 )           (264 )     301  
 
                             
Total Level 3 assets
  $ 5,745     $ 138     $     $ (830 )   $ 5,053  
 
                             
Realized gains or losses are recognized in the consolidated statements of income. There were no realized gains or losses recognized on Level 3 assets during the three or six month periods ended June 30, 2011 or 2010. The CMO security which was previously classified at Level 3 at June 30, 2010 and December 31, 2010 was transferred to Level 2 at March 31, 2011 as the CMO market for these types of securities are again being actively traded in the market and quoted prices are again observable at June 30, 2011.

 

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The following table represents assets measured at fair value on a non-recurring basis as of June 30, 2011 and December 31, 2010.
                                 
    At June 30, 2011  
                            Assets/Liabilities  
(Dollars in thousands)   Level 1     Level 2     Level 3     at Fair Value  
 
                               
Real estate-commercial loan
  $     $ 17,427     $     $ 17,427  
Impaired loans and leases
                47,236       47,236  
Mortgage servicing rights
          2,878             2,878  
 
                       
Total
  $     $ 20,305     $ 47,236     $ 67,541  
 
                       
                                 
    At December 31, 2010  
                            Assets/Liabilities  
(Dollars in thousands)   Level 1     Level 2     Level 3     at Fair Value  
 
                               
Loans held for sale
  $     $ 4,178     $     $ 4,178  
Real estate-commercial loan
          17,650             17,650  
Impaired loans and leases
                44,159       44,159  
Mortgage servicing rights
          2,441             2,441  
 
                       
Total
  $     $ 24,269     $ 44,159     $ 68,428  
 
                       
The fair value of the Corporation’s loans held for sale are generally determined using a pricing model based on current market information obtained from external sources, including, interest rates, and bids or indications provided by market participants on specific loans that are actively marketed for sale. The Corporation’s loans held for sale are primarily residential mortgage loans and are generally classified in Level 2 due to the observable pricing data. Loans held for sale at June 30, 2011 were carried at the lower of cost or estimated fair value.
The fair value of the hedged real estate-commercial loan (as discussed in Note 10) was based on a discounted cash flow model which takes into consideration the changes in market value due to changes in LIBOR. Commercial loans are classified within Level 2 of the valuation hierarchy. During the fourth quarter of 2009, the Corporation participated $5.0 million of the hedged real estate-commercial loan and at that time the remaining $17.0 million loan was marked to fair value due to the de-designation of the fair value hedge. During the first quarter of 2010, the swap was re-designated and the hedged loan was being marked to fair value on a recurring basis. During the third quarter of 2010 the swap was terminated and the loan was marked to fair value. The fair value is being amortized to par value over the remaining life of the loan using the level-yield method.
Impaired loans and leases include those collateral-dependent loans and leases for which the practical expedient was applied, resulting in a fair-value adjustment to the loan or lease. Impaired loans and leases are evaluated and valued at the time the loan and lease is identified as impaired, at the lower of cost or fair value. Fair value is measured based on the value of the collateral securing these loans and leases less cost to sell and is classified at a Level 3 in the fair value hierarchy. The fair value of collateral is based on appraisals performed by qualified licensed appraisers hired by the Corporation. At June 30, 2011, impaired loans and leases had a carrying amount of $48.5 million with a valuation allowance of $1.3 million. At December 31, 2010, impaired loans and leases had a carrying amount of $45.8 million with a valuation allowance of $1.6 million.
The Corporation estimates the fair value of mortgage servicing rights using discounted cash flow models that calculate the present value of estimated future net servicing income. The model uses readily available prepayment speed assumptions for the current interest rates of the portfolios serviced. Mortgage servicing rights are classified within Level 2 of the valuation hierarchy. The Corporation reviews the mortgage servicing rights portfolio on a quarterly basis for impairment and the mortgage servicing rights are carried at the lower of amortized cost or estimated fair value.
Certain non-financial assets subject to measurement at fair value on a non-recurring basis include goodwill and other intangible assets. During the six months ended June 30, 2011, there were no triggering events to fair value goodwill and other intangible assets.

 

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The following table represents the estimates of fair value of financial instruments:
                                 
    At June 30, 2011     At December 31, 2010  
    Carrying,             Carrying,        
    Notional or             Notional or        
    Contract             Contract        
(Dollars in thousands)   Amount     Fair Value     Amount     Fair Value  
 
Assets:
                               
Cash and short-term interest-earning assets
  $ 39,214     $ 39,214     $ 29,187     $ 29,187  
Investment securities
    418,020       418,020       467,024       467,024  
Loans held for sale
    2,102       2,127       4,178       4,178  
Net loans and leases
    1,406,106       1,467,908       1,440,288       1,499,065  
Interest rate swaps
    20,000       120       20,000       492  
Interest rate locks with customers
    18,926       299       37,691       530  
Forward loan commitments
    21,015       33       41,842       269  
Liabilities:
                               
Deposits
    1,621,294       1,574,419       1,686,270       1,666,566  
Short-term borrowings
    99,070       95,023       114,871       114,908  
Long-term borrowings
    28,619       28,885       28,994       29,363  
Off-Balance-Sheet:
                               
Commitments to extend credit
          (1,187 )           (1,069 )
The following methods and assumptions were used by the Corporation in estimating its fair value disclosures for financial instruments:
Cash and short-term interest-earning assets: The carrying amounts reported in the balance sheets for cash and due from banks, interest-earning deposits with other banks, and federal funds sold and other short-term investments approximates those assets’ fair values.
Investment securities: Fair values for the held-to-maturity and available-for-sale investment securities are based on quoted market prices that are available in an active market for identical instruments. If quoted market prices are not available, then fair values are estimated by using pricing models, quoted prices of securities with similar characteristics or discounted cash flows.
Loans held for sale: The fair value of the Corporation’s loans held for sale are generally determined using a pricing model based on current market information obtained from external sources, including, interest rates, and bids or indications provided by market participants on specific loans that are actively marketed for sale. The Corporation’s loans held for sale are primarily residential mortgage loans. Loans held for sale are carried at the lower of cost or estimated fair value.
Loans and leases: The fair values for loans are estimated using discounted cash flow analyses, using a discount rate consisting of an appropriate risk free rate, as well as components for credit risk, operating expense and embedded prepayment options. As permitted, the fair value of the loans and leases are not based on the exit price concept as discussed in the first paragraph of this note.
Derivative Financial Instruments: The fair values of derivative financial instruments are based upon the estimated amount the Corporation would receive or pay to terminate the contracts or agreements, taking into account current interest rates and, when appropriate, the current creditworthiness of the counterparties.
Deposit liabilities: The fair values for deposits with fixed maturities are estimated by discounting the final maturity. At June 30, 2011, the fair values for non-maturing deposits are established based on expected cash flows and repricing characteristics for the instruments and incorporates Corporation developed, market-based assumptions regarding the impact of changing interest rates on these financial instruments. At December 31, 2010, the fair value for non-maturing deposits were established using a decay factor estimate of cash flows based upon industry-accepted assumptions with the discount rate consisting of an appropriate risk free rate and including components for operating expense.

 

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Short-term borrowings: The carrying amounts of securities sold under repurchase agreements, and fed funds purchased approximate their fair values. Short-term FHLB advances with embedded options are estimated using a discounted cash flow analysis using a discount rate consisting of an appropriate risk free rate, as well as operating expense, and embedded prepayment options
Long-term borrowings: The fair values of the Corporation’s long-term borrowings (other than deposits) are estimated using a discounted cash flow analysis using a discount rate consisting of an appropriate risk free rate, as well as components for credit risk, operating expense, and embedded prepayment options.
Off-balance-sheet instruments: Fair values for the Corporation’s off-balance-sheet instruments are based on the fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the counterparties’ credit standing.

 

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Item 2.  
Management’s Discussion and Analysis of Financial Condition and Results of Operations
(All dollar amounts presented within tables are in thousands, except per share data. “N/M” equates to “not meaningful”; “—” equates to “zero” or “doesn’t round to a reportable number”; and “N/A” equates to “not applicable.” Certain amounts have been reclassified to conform to the current-year presentation.)
Forward-Looking Statements
The information contained in this report may contain forward-looking statements. When used or incorporated by reference in disclosure documents, the words “believe,” “anticipate,” “estimate,” “expect,” “project,” “target,” “goal” and similar expressions are intended to identify forward-looking statements within the meaning of section 27A of the Securities Act of 1933. Such forward-looking statements are subject to certain risks, uncertainties and assumptions, including those set forth below:
   
Operating, legal and regulatory risks
   
Economic, political and competitive forces impacting various lines of business
   
The risk that our analysis of these risks and forces could be incorrect and/or that the strategies developed to address them could be unsuccessful
   
Volatility in interest rates
   
Other risks and uncertainties, including those occurring in the U.S. and world financial systems
Should one or more of these risks or uncertainties materialize, or should underlying assumptions prove incorrect, actual results may vary materially from those anticipated, estimated, expected or projected. These forward-looking statements speak only as of the date of the report. The Corporation expressly disclaims any obligation to publicly release any updates or revisions to reflect any change in the Corporation’s expectations with regard to any change in events, conditions or circumstances on which any such statement is based.
Critical Accounting Policies
Management, in order to prepare the Corporation’s financial statements in conformity with U.S. generally accepted accounting principles, is required to make estimates and assumptions that affect the amounts reported in the Corporation’s financial statements. There are uncertainties inherent in making these estimates and assumptions. Certain critical accounting policies, discussed below, could materially affect the results of operations and financial position of the Corporation should changes in circumstances require a change in related estimates or assumptions. The Corporation has identified the fair value measurement of investment securities available for sale and assessment for impairment of certain investment securities, reserve for loan and lease losses, valuation of goodwill and other intangible assets, mortgage servicing rights, deferred tax assets and liabilities, benefit plans and stock-based compensation as areas with critical accounting policies. For more information on these critical accounting policies, please refer to the Corporation’s 2010 Annual Report on Form 10-K.
General
Univest Corporation of Pennsylvania, (the Corporation), is a Bank Holding Company. It owns all of the capital stock of Univest Bank and Trust Co. (the Bank), Univest Delaware, Inc., and Univest Reinsurance Corporation.
Effective as of the close of the business on June 29, 2011 and following receipt of required regulatory approvals, Univest National Bank and Trust Co. converted from a national bank to a Pennsylvania state-chartered bank and trust company, as authorized by the National Bank Act and Pennsylvania law. As a result of the conversion, the bank opened on June 30, 2011 as an FDIC-insured Pennsylvania bank and trust company operating under the name, “Univest Bank and Trust Co.” The Corporation believes that the charter conversion will allow greater flexibility to execute its strategy as a community bank and remain competitive in the markets it chooses to serve. As a state-chartered member bank of the Federal Reserve System, the Bank will be regulated primarily by the Pennsylvania Department of Banking and the Federal Reserve Bank of Philadelphia. The conversion to a state charter will not have any significant financial or regulatory impact or affect the Corporation’s current activities or customers.

 

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The Bank is engaged in the general commercial banking business and provides a full range of banking services and trust services to its customers. The Bank is the parent company of Delview, Inc., which is the parent company of Univest Insurance, Inc., an independent insurance agency, and Univest Investments, Inc., a full-service broker-dealer and investment advisory firm. The Bank is also the parent company of Univest Capital, Inc., a small ticket commercial finance business, and TCG Investment Advisory, a registered investment advisor which provides discretionary investment consulting and management services. Through its wholly-owned subsidiaries, the Bank provides a variety of financial services to individuals, municipalities and businesses throughout its markets of operation.
Executive Overview
The Corporation reported net income for the three months ended June 30, 2011 of $4.5 million or $0.27 diluted earnings per share compared to net income of $3.7 million or $0.23 diluted earnings per share for the three months ended June 30, 2010. Net income for the six months ended June 30, 2011 was $8.4 million or $0.50 diluted earnings per share compared to net income of $6.7 million or $0.40 diluted earnings per share for the same period in the prior year.
Net interest income on a tax-equivalent basis for the three months ended June 30, 2011 was up $805 thousand, or 4.1% compared to the same period in 2010. The second quarter 2011 net interest margin was 4.24%, level with 4.24% for the first quarter of 2011 and an improvement of 13 basis points over the 4.11% level for the second quarter of 2010. Net interest income on a tax-equivalent basis for the six months ended June 30, 2011 was up $2.7 million, or 7.1% compared to the same period in 2010. The tax equivalent net interest margin for the first six months of 2011 was 4.24% compared to 4.05% for the first six months of 2010. The increase in net interest income and the net interest margin for the three and six months ended June 30, 2011 was mainly attributable to declines in the cost of interest-bearing liabilities, primarily time deposits as well as regular savings accounts, and declines in the volume of Federal Home Loan Bank of Pittsburgh (FHLB) borrowings, exceeding the declines in yields on total interest-earning assets. The Corporation repaid its maturing FHLB advances in 2010, reducing FHLB advances from $54.0 million at June 30, 2010 to $5.0 million at December 31, 2010. FHLB advances at June 30, 2011 remained at $5.0 million.
The provision for loan and lease losses increased by $691 thousand for the three months ended June 30, 2011 compared to the same period in 2010 and by $930 thousand for the six months ended June 30, 2011 from the comparable period in 2010.
Non-interest income increased $637 thousand, or 7.9% during the three months ended June 30, 2011 compared to the same period in 2010 and $189 thousand or 1.2% for the six months ended June 30, 2011 compared to the same period in the prior year primarily due to increased income from trust fees and insurance commissions and fees and a net gain on sales of securities of $569 thousand. Additionally, the three and six months ended June 30, 2010 were impacted by a net loss on the ineffective portion of a fair value swap of $516 thousand and $826 thousand, respectively, which was terminated in the third quarter of 2010. These favorable variances were partially offset by a decline in service charges on deposit accounts for the three and six months of 2011 compared to the same periods in 2010 of $456 thousand and $902 thousand, respectively, mostly due to amendments to Regulation E which were implemented in August 2010. In addition, the six months ended June 30, 2011 compared to 2010 was impacted by a decrease of $632 thousand in the net gain on mortgage banking activities, as a result of negative fair value adjustments on the mortgage pipeline as mortgage demand has softened due to a continued slow purchase market for housing, and a decrease in other income mainly due to a litigation settlement in the first quarter of 2010 and increased servicing fee income.

 

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Non-interest expense decreased $503 thousand, or 3.0% for the three months ended June 30, 2011 compared to the same period in 2010 and $836 thousand, or 2.5% for the six months ended June 30, 2011 compared to the same period in 2010. Marketing and advertising expense decreased $524 thousand and $619 thousand for the three and six months ended June 30, 2011, compared to the same periods in 2010, respectively, mainly due to higher advertising in 2010 to support a major brand campaign. Deposit insurance premiums decreased $236 thousand during the second quarter of 2011 from the comparable quarter in the prior year mainly due to the change in the assessment calculation requirement through the FDIC rule implemented April 1, 2011. The payment was formerly based on deposits whereas the rule change now bases the payment on average consolidated total assets less average tangible equity. Additionally, salaries and benefit expense decreased $663 thousand for the six months ended June 30, 2011 compared to the same period in 2010 mainly due to increased deferred loan origination costs on loan credits partially offset by higher commissions expense, restricted stock expense and salaries and benefits expense to grow the mortgage banking business. Occupancy expenses increased by $248 thousand for the six months ended June 30, 2011 from the same period in 2010.
Nonperforming loans and leases were $49.2 million at June 30, 2011 compared to $44.3 million at March 31, 2011, $46.5 million at December 31, 2010 and $32.3 million at June 30, 2010. The increase in non-accrual loans at June 30, 2011 compared to March 31, 2011 was primarily due to the migration of one large Shared National Credit to a theatre to non-accrual status. This commercial real estate loan relationship represented $11.3 million in the aggregate of which $2.6 million was charged-off during the second quarter of 2011 and the remaining $8.7 million was moved to non-accrual with sufficient estimated collateral at June 30, 2011. Nonperforming loans and leases as a percentage of total loans and leases were 3.42% at June 30, 2011 compared to 3.16% at December 31, 2010 and 2.23% at June 30, 2010. Net charge-offs for the three months ended June 30, 2011 were $5.8 million compared to $2.8 million for the three months ended June 30, 2010. Net charge-offs for the six months ended June 30, 2011 were $9.0 million compared to $5.4 million for the same period in the prior year. The increase in loan and lease charge-offs was mainly due to deterioration of underlying collateral and economic factors. The increase occurred primarily in the commercial real estate category, mostly due to the aforementioned Shared National Credit to a theatre. Charge-offs also occurred in the commercial, financial and agricultural and lease financing categories.
The Corporation earns its revenues primarily from the margins and fees it generates from loans and leases and depository services it provides as well as from trust fees and insurance and investment commissions. The Corporation seeks to achieve adequate and reliable earnings by growing its business while maintaining adequate levels of capital and liquidity and limiting its exposure to credit and interest rate risk to Board of Directors approved levels. As interest rates increase, fixed-rate assets that banks hold will tend to decrease in value; conversely, as interest rates decline, fixed-rate assets that banks hold will tend to increase in value. The Corporation is in a more asset sensitive position; although interest rates are expected to remain low for the foreseeable future, it anticipates increasing interest rates over the longer term, which it expects would benefit its net interest margin.
The Corporation seeks to establish itself as the financial provider of choice in the markets it serves. It plans to achieve this goal by offering a broad range of high quality financial products and services and by increasing market awareness of its brand and the benefits that can be derived from its products. The Corporation operates in an attractive market for financial services but also is in intense competition with domestic and international banking organizations and other insurance and investment providers for the financial services business. The Corporation has taken initiatives to achieve its business objectives by acquiring banks and other financial service providers in strategic markets, through marketing, public relations and advertising, by establishing standards of service excellence for its customers, and by using technology to ensure that the needs of its customers are understood and satisfied.

 

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Results of Operations
The Corporation’s consolidated net income and earnings per share for the three and six months ended June 30, 2011 and 2010 were as follows:
                                                                 
    For the Three Months                     For the Six Months        
(Dollars in thousands,   Ended June 30,     Change     Ended June 30,     Change  
except per share data)   2011     2010     Amount     Percent     2011     2010     Amount     Percent  
 
                                                               
Net income
  $ 4,516     $ 3,730     $ 786       21.1 %   $ 8,378     $ 6,700     $ 1,678       25.0 %
Net income per share:
                                                               
Basic
  $ 0.27     $ 0.23     $ 0.04       17.4 %   $ 0.50     $ 0.40     $ 0.10       25.0 %
Diluted
    0.27       0.23       0.04       17.4       0.50       0.40       0.10       25.0  
Return on average shareholders’ equity was 6.64% and return on average assets was 0.86% for the three months ended June 30, 2011, compared to 5.54% and 0.72%, respectively, for the same period in 2010. Return on average shareholders’ equity was 6.24% and return on average assets was 0.80% for the six months ended June 30, 2011, compared to 5.01% and 0.65%, respectively, for the same period in 2010.
Net Interest Income
Net interest income is the difference between interest earned on loans and leases, investments and other interest-earning assets and interest paid on deposits and other interest-bearing liabilities. Net interest income is the principal source of the Corporation’s revenue. Table 1 presents a summary of the Corporation’s average balances, the tax-equivalent yields earned on average assets, and the cost of average liabilities, and shareholders’ equity on a tax-equivalent basis for the three and six months ended June 30, 2011 and 2010. The tax-equivalent net interest margin is tax-equivalent net interest income as a percentage of average interest-earning assets. The tax-equivalent net interest spread represents the difference between the weighted average tax-equivalent yield on interest-earning assets and the weighted average cost of interest-bearing liabilities. The effect of net interest free funding sources represents the effect on the net interest margin of net funding provided by noninterest-earning assets, noninterest-bearing liabilities and shareholders’ equity. Table 2 analyzes the changes in the tax-equivalent net interest income for the periods broken down by their rate and volume components. Sensitivities associated with the mix of assets and liabilities are numerous and complex. The Investment Asset/Liability Management Committee works to maintain an adequate and stable net interest margin for the Corporation.
Net interest income on a tax-equivalent basis for the three months ended June 30, 2011 increased $805 thousand, or 4.1% compared to the same period in 2010. The tax-equivalent net interest margin for the three months ended June 30, 2011 increased 13 basis points to 4.24% from 4.11% for the three-months ended June 30, 2010. Net interest income on a tax-equivalent basis increased $2.7 million, or 7.1% for the six months ended June 30, 2011 compared to the same period in 2010. The tax-equivalent net interest margin for the six months ended June 30, 2011 increased 19 basis points to 4.24% from 4.05% for the first six months of 2010. The increase in net interest income and the net interest margin for the three and six months ended June 30, 2011 was mainly attributable to declines in the cost of interest-bearing liabilities, primarily time deposits as well as regular savings accounts, and a decline in the volume of FHLB borrowings, exceeding the declines in yields on total interest-earning assets. The Corporation repaid its maturing FHLB advances in 2010, reducing FHLB advances from $54.0 million at June 30, 2010 to $5.0 million at December 31, 2010. FHLB advances remained at $5.0 million at June 30, 2011.

 

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Table 1 — Average Balances and Interest Rates — Tax-Equivalent Basis
                                                 
    For the Three Months Ended June 30,  
    2011     2010  
    Average     Income/     Average     Average     Income/     Average  
(Dollars in thousands)   Balance     Expense     Rate     Balance     Expense     Rate  
 
                                               
Assets:
                                               
Interest-earning deposits with other banks
  $ 19,401     $ 12       0.25 %   $ 26,700     $ 19       0.29 %
U.S. Government obligations
    153,239       639       1.67       158,505       922       2.33  
Obligations of states and political subdivisions
    110,187       1,712       6.23       108,820       1,803       6.65  
Other debt and equity securities
    176,180       1,527       3.48       175,577       1,933       4.42  
 
                                   
Total interest-earning deposits and investments
    459,007       3,890       3.40       469,602       4,677       3.99  
 
                                   
Commercial, financial and agricultural loans
    431,427       4,947       4.60       415,943       4,892       4.72  
Real estate-commercial and construction loans
    541,862       7,399       5.48       523,306       7,752       5.94  
Real estate-residential loans
    245,996       2,757       4.50       256,296       2,785       4.36  
Loans to individuals
    41,924       597       5.71       46,185       599       5.20  
Municipal loans and leases
    128,799       1,680       5.23       104,720       1,564       5.99  
Lease financings
    61,068       1,667       10.95       78,828       1,742       8.86  
 
                                   
Gross loans and leases
    1,451,076       19,047       5.26       1,425,278       19,334       5.44  
 
                                   
Total interest-earning assets
    1,910,083       22,937       4.82       1,894,880       24,011       5.08  
 
                                   
Cash and due from banks
    29,706                       37,510                  
Reserve for loan and lease losses
    (33,995 )                     (28,864 )                
Premises and equipment, net
    34,302                       35,002                  
Other assets
    156,077                       152,402                  
 
                                           
Total assets
  $ 2,096,173                     $ 2,090,930                  
 
                                           
Liabilities:
                                               
Interest-bearing checking deposits
  $ 210,487       59       0.11     $ 182,156       62       0.14  
Money market savings
    277,420       174       0.25       293,697       277       0.38  
Regular savings
    481,312       374       0.31       445,781       661       0.59  
Time deposits
    405,829       1,683       1.66       435,969       2,588       2.38  
 
                                   
Total time and interest-bearing deposits
    1,375,048       2,290       0.67       1,357,603       3,588       1.06  
 
                                   
Securities sold under agreements to repurchase
    101,093       78       0.31       98,802       111       0.45  
Other short-term borrowings
    3,498       2       0.23       51,936       542       4.19  
Long-term debt
    5,000       47       3.77       5,717       48       3.37  
Subordinated notes and capital securities
    23,619       306       5.20       25,119       313       5.00  
 
                                   
Total borrowings
    133,210       433       1.30       181,574       1,014       2.24  
 
                                   
Total interest-bearing liabilities
    1,508,258       2,723       0.72       1,539,177       4,602       1.20  
 
                                   
Demand deposits, non-interest bearing
    280,764                       249,018                  
Accrued expenses and other liabilities
    34,199                       32,833                  
 
                                           
Total liabilities
    1,823,221                       1,821,028                  
 
                                           
Shareholders’ Equity:
                                               
Common stock
    91,332                       91,332                  
Additional paid-in capital
    61,469                       61,420                  
Retained earnings and other equity
    120,151                       117,150                  
 
                                           
Total shareholders’ equity
    272,952                       269,902                  
 
                                           
Total liabilities and shareholders’ equity
  $ 2,096,173                     $ 2,090,930                  
 
                                           
Net interest income
          $ 20,214                     $ 19,409          
 
                                           
Net interest spread
                    4.10                       3.88  
Effect of net interest-free funding sources
                    0.14                       0.23  
 
                                           
Net interest margin
                    4.24 %                     4.11 %
 
                                           
Ratio of average interest-earning assets to average interest-bearing liabilities
    126.64 %                     123.11 %                
 
                                           

 

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    For the Six Months Ended June 30,  
    2011     2010  
    Average     Income/     Average     Average     Income/     Average  
(Dollars in thousands)   Balance     Expense     Rate     Balance     Expense     Rate  
 
                                               
Assets:
                                               
Interest-earning deposits with other banks
  $ 12,876     $ 15       0.23 %   $ 20,531     $ 30       0.29 %
U.S. Government obligations
    161,900       1,356       1.69       136,457       1,663       2.46  
Obligations of states and political subdivisions
    109,610       3,433       6.32       107,733       3,543       6.63  
Other debt and equity securities
    170,610       3,056       3.61       181,948       3,953       4.38  
 
                                   
Total interest-earning deposits and investments
    454,996       7,860       3.48       446,669       9,189       4.15  
 
                                   
Commercial, financial and agricultural loans
    430,039       10,118       4.74       412,820       9,557       4.67  
Real estate-commercial and construction loans
    550,038       14,650       5.37       523,693       15,314       5.90  
Real estate-residential loans
    245,155       5,398       4.44       258,615       5,643       4.40  
Loans to individuals
    42,464       1,223       5.81       46,843       1,397       6.01  
Municipal loans and leases
    125,656       3,411       5.47       101,104       2,989       5.96  
Lease financings
    62,677       3,185       10.25       79,991       3,465       8.74  
 
                                   
Gross loans and leases
    1,456,029       37,985       5.26       1,423,066       38,365       5.44  
 
                                   
Total interest-earning assets
    1,911,025       45,845       4.84       1,869,735       47,554       5.13  
 
                                   
Cash and due from banks
    32,886                       34,582                  
Reserve for loan and lease losses
    (33,203 )                     (27,728 )                
Premises and equipment, net
    34,462                       34,931                  
Other assets
    155,904                       153,450                  
 
                                           
Total assets
  $ 2,101,074                     $ 2,064,970                  
 
                                           
Liabilities:
                                               
Interest-bearing checking deposits
  $ 201,630       123       0.12     $ 177,095       119       0.14  
Money market savings
    293,022       375       0.26       286,843       593       0.42  
Regular savings
    481,358       837       0.35       430,940       1,442       0.67  
Time deposits
    408,416       3,421       1.69       435,072       5,654       2.62  
 
                                   
Total time and interest-bearing deposits
    1,384,426       4,756       0.69       1,329,950       7,808       1.18  
 
                                   
Securities sold under agreements to repurchase
    98,782       149       0.30       97,330       228       0.47  
Other short-term borrowings
    6,865       11       0.32       61,547       1,227       4.02  
Long-term debt
    5,000       94       3.79       5,732       94       3.31  
Subordinated notes and capital securities
    23,805       610       5.17       25,305       625       4.98  
 
                                   
Total borrowings
    134,452       864       1.30       189,914       2,174       2.31  
 
                                   
Total interest-bearing liabilities
    1,518,878       5,620       0.75       1,519,864       9,982       1.32  
 
                                   
Demand deposits, non-interest bearing
    278,473                       242,388                  
Accrued expenses and other liabilities
    33,062                       33,249                  
 
                                           
Total liabilities
    1,830,413                       1,795,501                  
 
                                           
Shareholders’ Equity:
                                               
Common stock
    91,332                       91,332                  
Additional paid-in capital
    61,441                       61,420                  
Retained earnings and other equity
    117,888                       116,717                  
 
                                           
Total shareholders’ equity
    270,661                       269,469                  
 
                                           
Total liabilities and shareholders’ equity
  $ 2,101,074                     $ 2,064,970                  
 
                                           
Net interest income
          $ 40,225                     $ 37,572          
 
                                           
Net interest spread
                    4.09                       3.81  
Effect of net interest-free funding sources
                    0.15                       0.24  
 
                                           
Net interest margin
                    4.24 %                     4.05 %
 
                                           
Ratio of average interest-earning assets to average interest-bearing liabilities
    125.82 %                     123.02 %                
 
                                           
Notes:   For rate calculation purposes, average loan and lease categories include unearned discount.
 
Nonaccrual loans and leases have been included in the average loan and lease balances.
 
Loans held for sale have been included in the average loan balances.
 
Tax-equivalent amounts for the three and six months ended June 30, 2011 and 2010 have been calculated using the Corporation’s federal applicable rate of 35.0%.

 

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Table 2 — Analysis of Changes in Net Interest Income
The rate-volume variance analysis set forth in the table below compares changes in tax-equivalent net interest income for the periods indicated by their rate and volume components. The change in interest income/expense due to both volume and rate has been allocated proportionately.
                                                 
    Three Months Ended June 30,     Six Months Ended June 30,  
    2011 Versus 2010     2011 Versus 2010  
    Volume     Rate             Volume     Rate        
    Change     Change     Total     Change     Change     Total  
    (Dollars in thousands)  
Interest income:
                                               
Interest-earning deposits with other banks
  $ (4 )   $ (3 )   $ (7 )   $ (10 )   $ (5 )   $ (15 )
U.S. Government obligations
    (30 )     (253 )     (283 )     274       (581 )     (307 )
Obligations of states and political subdivisions
    23       (114 )     (91 )     60       (170 )     (110 )
Other debt and equity securities
    7       (413 )     (406 )     (234 )     (663 )     (897 )
 
                                   
Interest on deposits, investments and federal funds sold
    (4 )     (783 )     (787 )     90       (1,419 )     (1,329 )
 
                                   
Commercial, financial and agricultural loans and leases
    180       (125 )     55       413       148       561  
Real estate-commercial and construction loans
    266       (619 )     (353 )     750       (1,414 )     (664 )
Real estate-residential loans
    (115 )     87       (28 )     (296 )     51       (245 )
Loans to individuals
    (58 )     56       (2 )     (129 )     (45 )     (174 )
Municipal loans and leases
    330       (214 )     116       683       (261 )     422  
Lease financings
    (438 )     363       (75 )     (822 )     542       (280 )
 
                                   
Interest and fees on loans and leases
    165       (452 )     (287 )     599       (979 )     (380 )
 
                                   
Total interest income
    161       (1,235 )     (1,074 )     689       (2,398 )     (1,709 )
 
                                   
Interest expense:
                                               
Interest-bearing checking deposits
    10       (13 )     (3 )     19       (15 )     4  
Money market savings
    (14 )     (89 )     (103 )     13       (231 )     (218 )
Regular savings
    48       (335 )     (287 )     150       (755 )     (605 )
Time deposits
    (168 )     (737 )     (905 )     (328 )     (1,905 )     (2,233 )
 
                                   
Interest on time and interest-bearing deposits
    (124 )     (1,174 )     (1,298 )     (146 )     (2,906 )     (3,052 )
 
                                   
Securities sold under agreement to repurchase
    3       (36 )     (33 )     3       (82 )     (79 )
Other short-term borrowings
    (268 )     (272 )     (540 )     (597 )     (619 )     (1,216 )
Long-term debt
    (7 )     6       (1 )                  
Subordinated notes and capital securities
    (20 )     13       (7 )     (38 )     23       (15 )
 
                                   
Interest on borrowings
    (292 )     (289 )     (581 )     (632 )     (678 )     (1,310 )
 
                                   
Total interest expense
    (416 )     (1,463 )     (1,879 )     (778 )     (3,584 )     (4,362 )
 
                                   
Net interest income
  $ 577     $ 228     $ 805     $ 1,467     $ 1,186     $ 2,653  
 
                                   
     
Notes:  
For rate calculation purposes, average loan and lease categories include unearned discount.
 
   
Nonaccrual loans and leases have been included in the average loan and lease balances.
 
   
Loans held for sale have been included in the average loan balances.
 
   
Tax-equivalent amounts for the three and six months ended June 30, 2011 and 2010 have been calculated using the Corporation’s federal applicable rate of 35.0%.
Interest Income
Three months ended June 30, 2011 versus 2010
Interest income on a tax-equivalent basis for the three months ended June 30, 2011 decreased $1.1 million, or 4.5% from the same period in 2010. This decrease was mainly due to a 59 basis point decrease in the average rate earned on investment securities and deposits at other banks as well as an 18 basis point decrease in the average rate earned on loans partially offset by a $25.8 million increase in average loan volume. The decline in interest income on investment securities and deposits at other banks of $787 thousand for the three months ended June 30, 2011 compared to the same period in 2010 was mostly due to maturities, pay-downs and calls of investment securities and replacement with lower yielding investments due to the lower interest rate environment. Interest and fees on loans and leases declined by $287 thousand during the three months ended June 30, 2011 compared to the same period in 2010. The Corporation experienced decreases in the average rates on commercial real estate and construction loans as well as decreases in average volume for lease financings and residential real estate loans. These decreases were mostly attributable to the lower interest rate environment and increased refinancing activity as well as reduced leasing origination volume. These unfavorable variances were partially offset by growth of commercial business loans as well as growth in commercial real estate and construction loans and municipal loans and leases.

 

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Six months ended June 30, 2011 versus 2010
Interest income on a tax-equivalent basis for the six months ended June 30, 2011 decreased $1.7 million, or 3.6% from the same period in 2010. This decrease was mainly due to a 67 basis point decrease in the average rate earned on investment securities and deposits at other banks as well as an 18 basis point decrease in the average rate earned on loans partially offset by a $33.0 million increase in average loan volume. The decline in interest income on investment securities and deposits at other banks of $1.3 million for the six months ended June 30, 2011 compared to the same period in 2010 was mostly due to maturities, pay-downs and calls of investment securities and replacement with lower yielding investments due to the lower interest rate environment. Interest and fees on loans and leases declined by $380 thousand during the six months ended June 30, 2011 compared to the same period in 2010. The Corporation experienced decreases in the average rates on commercial real estate and construction loans as well as decreases in average volume for lease financings and residential real estate loans. These decreases were mostly attributable to the lower interest rate environment and increased refinancing activity as well as reduced leasing origination volume. These unfavorable variances were partially offset by growth of commercial business loans as well as growth in commercial real estate and construction loans and municipal loans and leases.
Interest Expense
Three months ended June 30, 2011 versus 2010
Interest expense on a tax-equivalent basis for the three months ended June 30, 2011 decreased $1.9 million, or 40.8% from the comparable period in 2010. This decrease was mainly due to a 39 basis point decrease in the Corporation’s average cost of deposits as well as a $48.4 million decrease in average borrowings and a 94 basis point decrease in the average borrowing rate. The decrease in the Corporation’s cost of deposits was largely attributable to re-pricing of time deposit accounts as well as regular savings accounts. For the three months ended June 30, 2011, interest expense on time deposits decreased $905 thousand and interest expense on savings accounts decreased by $287 thousand. For the three months ended June 30, 2011, average deposits increased by $17.4 million with increases in average regular savings of $35.5 million, interest-bearing checking of $28.3 million partially offset by decreases in average money market savings of $16.3 million and average time deposits of $30.1 million. The Corporation’s focus on growing low cost core deposits and the lower interest rate environment has resulted in a shift in customer deposits from time deposits to savings accounts. Interest on other short-term borrowings mainly includes interest paid on federal funds purchased and short-term FHLB borrowings. In addition, the Bank offers an automated cash management checking account that sweeps funds daily into a repurchase agreement account. Interest expense on other short-term borrowings decreased $540 thousand for the three months ended June 30, 2011 compared to the same period in 2010 primarily due to a decrease in average volume of $48.4 million and a reduction in average rate of 396 basis points. The decreases in average rate and volume were due to maturities of FHLB advances.
Six months ended June 30, 2011 versus 2010
Interest expense on a tax-equivalent basis for the six months ended June 30, 2011 decreased $4.4 million, or 43.7% from the comparable period in 2010. This decrease was mainly due to a 49 basis point decrease in the Corporation’s average cost of deposits as well as a $55.5 million decrease in average borrowings and a 101 basis point decrease in the average borrowing rate. The decrease in the Corporation’s cost of deposits was largely attributable to re-pricing of time deposit accounts as well as regular savings accounts. For the six months ended June 30, 2011, interest expense on time deposits decreased $2.2 million and interest expense on savings accounts decreased by $605 thousand. For the six months ended June 30, 2011, average deposits increased by $54.5 million with increases in average regular savings of $50.4 million, interest-bearing checking of $24.5 million and money market savings of $6.2 million partially offset by a decrease in average time deposits of $26.7 million. The Corporation’s focus on growing low cost core deposits and the lower interest rate environment has resulted in a shift in customer deposits from time deposits to savings accounts. Interest expense on other short-term borrowings decreased $1.2 million for the six months ended June 30, 2011 compared to the same period in 2010 primarily due to a decrease in average volume of $54.7 million and a reduction in average rate of 370 basis points. The decreases in average rate and volume were due to maturities of FHLB advances.

 

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Provision for Loan and Lease Losses
The reserve for loan and lease losses is determined through a periodic evaluation that takes into consideration the growth of the loan and lease portfolio, the status of past-due loans and leases, current economic conditions, various types of lending activity, policies, real estate and other loan commitments, and significant changes in charged-off activity. Loans and leases are also reviewed for impairment based on discounted cash flows using the loans’ and leases’ initial effective interest rates or the fair value of the collateral for certain collateral dependent loans and leases. Any of the above criteria may cause the reserve to fluctuate. The provision for the three months ended June 30, 2011 and 2010 was $5.6 million and $4.9 million, respectively. The provision for the six months ended June 30, 2011 and 2010 was $10.7 million and $9.8 million, respectively.
Noninterest Income
Noninterest income consists of trust department fee income, service charges on deposit accounts, commission income, net gains (losses) on sales of securities and loans, net gains (losses) on mortgage banking activities, net gains (losses) on interest rate swaps, net gains (losses) on sales and write-downs of other real estate owned and other miscellaneous types of income. Other service fee income primarily consists of fees from credit card companies for a portion of merchant charges paid to the credit card companies for the Bank’s customer debit card usage (Mastermoney fees), non-customer debit card fees, other merchant fees, mortgage servicing income and mortgage placement income. Bank owned life insurance income represents changes in the cash surrender value of bank-owned life insurance policies, which is affected by the market value of the underlying assets, and also includes any excess proceeds from death benefit claims. Other non-interest income includes gains (losses) on investments in partnerships, gains (losses) on sales of other real estate owned, reinsurance income and other miscellaneous income.
The following table presents noninterest income for the periods indicated:
                                                                 
    Three Months Ended                     Six Months Ended        
    June 30,     Change     June 30,     Change  
    2011     2010     Amount     Percent     2011     2010     Amount     Percent  
    (Dollars in thousands)  
 
                                                               
Trust fee income
  $ 1,625     $ 1,500     $ 125       8.3 %   $ 3,250     $ 3,000     $ 250       8.3 %
Service charges on deposit accounts
    1,356       1,812       (456 )     (25.2 )     2,692       3,594       (902 )     (25.1 )
Investment advisory commission and fee income
    1,194       1,152       42       3.6       2,356       2,208       148       6.7  
Insurance commission and fee income
    2,072       1,896       176       9.3       4,272       4,139       133       3.2  
Other service fee income
    1,437       1,475       (38 )     (2.6 )     2,792       2,384       408       17.1  
Bank owned life insurance income
    268       202       66       32.7       612       534       78       14.6  
Other-than-temporary impairment on equity securities
    (3 )     (42 )     39       92.9       (10 )     (47 )     37       78.7  
Net gain on sales of securities
    569       38       531       N/M       569       87       482       N/M  
Net gain on mortgage banking activities
    328       475       (147 )     (30.9 )     303       935       (632 )     (67.6 )
Net loss on interest rate swap
          (516 )     516       N/M             (826 )     826       N/M  
Net loss on dispositions of fixed assets
    (9 )     (5 )     (4 )     (80.0 )     (9 )     (11 )     2       18.2  
Net loss on sales and write-downs of other real estate owned
    (265 )     (16 )     (249 )     N/M       (617 )     (363 )     (254 )     (70.0 )
Other
    124       88       36       40.9       245       632       (387 )     (61.2 )
 
                                                   
Total noninterest income
  $ 8,696     $ 8,059     $ 637       7.9     $ 16,455     $ 16,266     $ 189       1.2  
 
                                                   

 

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Three months ended June 30, 2011 versus 2010
Total non-interest income increased $637 thousand, or 7.9% during the three months ended June 30, 2011 compared to the same period in 2010 primarily due to increased income from trust fees and insurance commissions and fees and an increase in net gain on sales of securities. Additionally, the three months ended June 30, 2010 was impacted by a net loss on the ineffective portion of a fair value swap of $516 thousand which was terminated in the third quarter of 2010. These favorable variances were partially offset by a decline in service charges on deposit accounts mostly due to Regulation E and a negative valuation adjustment on other real estate owned.
Trust fee income increased by $125 thousand and insurance commission and fee income increased by $176 thousand during the three months ended June 30, 2011 from the comparable period in 2010 primarily related to increases in the market values of trust assets and increased insurance volume.
Service charges on deposit accounts decreased $456 thousand during the three months ended June 30, 2011 from the comparable period in 2010 primarily due to decreased levels of insufficient fund charges. In November 2009, the Federal Reserve Board issued a final rule that, effective July 1, 2010, in accordance with Regulation E, prohibits financial institutions from charging consumers fees for paying overdrafts on automated teller machine and one-time debit card transactions, unless a consumer consents, or opts in, to the overdraft service for those types of transactions. The Corporation implemented the provisions of Regulation E in the third quarter of 2010.
During the three months ended June 30, 2011, the Corporation sold $5.9 million in available for sale securities that resulted in a net gain of $569 thousand primarily from the sale of mortgage-backed securities. During the three months ended June 30, 2010, the Corporation sold $3.5 million in available for sale securities that resulted in a net gain of $38 thousand. The Corporation did not realize any significant other-than-temporary impairment charges on its equity portfolio during the three months ended June 30, 2011 and 2010. The Corporation carefully monitors all of its equity securities and has not taken impairment losses on certain other securities in an unrealized loss position, at this time, as the financial performance and near-term prospects of the underlying companies are not indicative of the market deterioration of their stock. The Corporation has the positive intent and ability to hold these securities and believes it is more likely than not, that it will not have to sell these securities until recovery to the Corporation’s cost basis occurs.
For the three months ended June 30, 2011, the Corporation recognized a net gain on mortgage banking activities of $328 thousand compared to a net gain of $475 thousand for the same period in 2010. The net gain consists of gains on sales of mortgages held for sale and fair value adjustments on interest-rate locks and forward loan commitments. The decrease in the net gain on mortgage banking activities during the second quarter of 2011 resulted mainly from a decreased volume of sales and a net decrease in the fair market value adjustments on the interest rate locks.
For the three months ended June 30, 2010, the Corporation recognized a loss of $516 thousand on the ineffective portion of a fair value interest rate swap for a commercial real estate loan due to the decline in interest rates during the quarter. This interest rate swap was terminated in the third quarter of 2010 due to the forecasted low interest rate environment. The underlying commercial loan had a positive fair value adjustment at the termination date of $859 thousand which is being amortized through a reduction of interest income over the remaining life of the loan.
For the three months ended June 30, 2011, the Corporation recognized a net loss on sales and write-downs of other real estate owned of $265 thousand compared to a net loss of $16 thousand for the same period in 2010. During the second quarter of 2011, the Corporation recognized a negative valuation adjustment on a commercial property of $260 thousand based on the updated fair value.

 

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Six months ended June 30, 2011 versus 2010
Total non-interest income increased by $189 thousand, or 1.2% during the six months ended June 30, 2011 compared to the same period in 2010. The Corporation experienced increases in income from trust fees, investment advisory commissions and fees, insurance commission and fees and other service fees and an increase in net gain on sales of securities. Additionally, the six months ended June 30, 2010 was impacted by a net loss on the ineffective portion of a fair value swap of $826 thousand which was terminated in the third quarter of 2010. These favorable variances were partially offset by a decline in service charges on deposit accounts mostly due to Regulation E, a decrease in the net gain on mortgage banking activities, an increase in the net loss on sales and write-downs of other real estate owned and a reduction in other income mainly due to a litigation settlement during the first quarter of 2010.
Trust fee income increased by $250 thousand and investment advisory commission and fee income increased by $148 thousand during the six months ended June 30, 2011 from the comparable period in 2010 primarily related to increases in the market values of the assets and increased volume. Insurance commission and fee income increased $133 thousand during the six months ended June 30, 2011 mainly attributable to increased volume. Other service fee income increased $408 thousand for the six months ended June 30, 2011 primarily attributable to increases in Mastermoney interchange fees, mortgage servicing fee income and check charges.
Service charges on deposit accounts decreased $902 thousand during the six months ended June 30, 2011 from the comparable period in 2010 primarily due to decreased levels of insufficient fund charges. In November 2009, the Federal Reserve Board issued a final rule that, effective July 1, 2010, in accordance with Regulation E, prohibits financial institutions from charging consumers fees for paying overdrafts on automated teller machine and one-time debit card transactions, unless a consumer consents, or opts in, to the overdraft service for those types of transactions. The Corporation implemented the provisions of Regulation E in the third quarter of 2010.
During the six months ended June 30, 2011, the Corporation sold $5.9 million in available for sale securities, primarily from the mortgage-backed securities portfolio, which resulted in a net gain of $569 thousand. During the six months ended June 30, 2010, the Corporation sold $3.6 million in available for sale securities, mainly from the municipal securities portfolio, which resulted in a net gain of $87 thousand
For the six months ended June 30, 2011, the Corporation recognized a net gain on mortgage banking activities of $303 thousand compared to a net gain of $935 thousand for the same period in 2010. The net gain consists of gains on sales of mortgages held for sale and fair value adjustments on interest-rate locks and forward loan commitments. The decrease in the net gain on mortgage banking activities during the six months of 2011 resulted mainly from a net decrease in the fair market value adjustments on the interest rate locks.
For the six months ended June 30, 2010, the Corporation recognized a loss of $826 thousand on the ineffective portion of a fair value interest rate swap for a commercial real estate loan mainly related to re-designation of the swap during the first quarter of 2010 and a decline in interest rates. This interest rate swap was terminated in the third quarter of 2010 due to the forecasted low interest rate environment. The underlying commercial loan had a positive fair value adjustment at the termination date of $859 thousand which is being amortized through a reduction of interest income over the remaining life of the loan.
For the six months ended June 30, 2011, the Corporation recognized a net loss on sales and write-downs of other real estate owned of $617 thousand compared to a net loss of $363 thousand for the same period in 2010. The net losses were mainly due to the recognition of negative valuation adjustments on three commercial properties in 2011 and one commercial property in 2010 based on the updated fair values.
Other income for the six months ended June 30, 2011 decreased $387 thousand from the same period in the prior year mainly due to income received from a litigation settlement during the first quarter of 2010.
Noninterest Expense
The operating costs of the Corporation are known as non-interest expense, and include, but are not limited to, salaries and benefits, equipment expense, and occupancy costs. Expense control is very important to the management of the Corporation, and every effort is made to contain and minimize the growth of operating expenses, and to provide technological innovation whenever practical, as operations change or expand.

 

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The following table presents noninterest expense for the periods indicated:
                                                                 
    Three Months Ended                     Six Months Ended        
    June 30,     Change     June 30,     Change  
    2011     2010     Amount     Percent     2011     2010     Amount     Percent  
    (Dollars in thousands)  
 
                                                               
Salaries and benefits
  $ 9,634     $ 9,469     $ 165       1.7 %   $ 18,617     $ 19,280     $ (663 )     (3.4 )%
Net occupancy
    1,361       1,309       52       4.0       2,911       2,663       248       9.3  
Equipment
    965       900       65       7.2       1,942       1,838       104       5.7  
Marketing and advertising
    393       917       (524 )     (57.1 )     982       1,601       (619 )     (38.7 )
Deposit insurance premiums
    427       663       (236 )     (35.6 )     1,140       1,260       (120 )     (9.5 )
Other
    3,626       3,651       (25 )     (0.7 )     7,560       7,346       214       2.9  
 
                                                   
Total noninterest expense
  $ 16,406     $ 16,909     $ (503 )     (3.0 )   $ 33,152     $ 33,988     $ (836 )     (2.5 )
 
                                                   
Three months ended June 30, 2011 versus 2010
Total non-interest expense decreased $503 thousand, or 3.0% for the three months ended June 30, 2011 compared to the same period in 2010 primarily due to decreases in advertising expense and deposit insurance premiums partially offset by a slight increase in salaries and benefit expense. Marketing and advertising expense decreased $524 thousand for the three months ended June 30, 2011 mostly due to higher advertising expense in 2010 to support a major brand campaign. Deposit insurance premiums decreased $236 thousand for the three months ended June 30, 2011 mainly due to the change in the assessment calculation requirement through the FDIC rule implemented April 1, 2011. The payment was formerly based on the amount of deposits whereas the rule change now bases the payment on average consolidated total assets less average tangible equity.
Six months ended June 30, 2011 versus 2010
Total non-interest expense decreased $836 thousand, or 2.5% for the six months ended June 30, 2011 compared to the same period in 2010. Salaries and benefit expense decreased $663 thousand during the six months ended June 30, 2011 compared to the same period in 2010 mainly due to increased deferred loan origination costs on loan credits partially offset by higher commissions expense, restricted stock expense and salaries and benefits expense to grow the mortgage banking business. The Corporation implemented higher deferred loan origination costs on loan credits, commencing during the fourth quarter of 2010, based upon an in-depth study performed which incorporated management’s additional review time spent as a result of increased scrutiny of loan credits. Additionally, as more loan approvals are currently being approved at the Committee level as opposed to individual relationship managers and as the Corporation proactively manages its credit risk given the current economic environment, increased costs for each loan credit are being incurred in connection with the loan approval process; and as a result, a higher level of costs are being deferred. Marketing and advertising expense decreased $619 thousand for the six months ended June 30, 2011 mostly due to higher advertising expense in 2010 to support a major brand campaign. Occupancy expense increased $248 thousand for the six months ended June 30, 2011 primarily due to increased rent, taxes and other occupancy costs related to a branch relocation and branch improvements. Other expenses increased $214 thousand primarily due to increased loan processing expenses and bank shares tax.
Tax Provision
The provision for income taxes for the three months ended June 30, 2011 and 2010 was $1.2 million and $831 thousand, at effective rates of 20.98% and 18.22%, respectively. The provision for income taxes for the six months ended June 30, 2011 and 2010 was $2.0 million and $1.2 million, at effective rates of 19.47% and 15.18%, respectively. The effective tax rates reflect the benefits of tax-exempt income from investments in municipal securities and loans and bank-owned life insurance. The increase in the effective tax rate between the three-month and six-month periods is primarily due to a smaller percentage of tax-exempt income to pre-tax income.

 

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Financial Condition
Assets
Total assets decreased $75.5 million since December 31, 2010 primarily due to a decrease in loans and leases and investment securities. The following table presents the assets for the periods indicated:
                                 
    At June 30,     At December 31,     Change  
(Dollars in thousands)   2011     2010     Amount     Percent  
 
                               
Cash, interest-earning deposits and federal funds sold
  $ 39,214     $ 29,187     $ 10,027       34.4 %
Investment securities
    418,020       467,024       (49,004 )     (10.5 )
Loans held for sale
    2,102       4,178       (2,076 )     (49.7 )
Total loans and leases
    1,438,707       1,471,186       (32,479 )     (2.2 )
Reserve for loan and lease losses
    (32,601 )     (30,898 )     (1,703 )     (5.5 )
Premises and equipment, net
    34,166       34,605       (439 )     (1.3 )
Goodwill and other intangibles, net
    56,776       56,797       (21 )      
Bank owned life insurance
    48,622       48,010       612       1.3  
Accrued interest and other assets
    53,371       53,804       (433 )     (0.8 )
 
                         
Total assets
  $ 2,058,377     $ 2,133,893     $ (75,516 )     (3.5 )
 
                         
Cash, Interest-earning Deposits and Federal Funds Sold
Cash, interest-earning deposits and federal funds sold increased as of June 30, 2011 as compared to December 31, 2010 primarily due to an increase in cash maintained at the Federal Reserve Bank.
Investment Securities
The investment portfolio is managed as part of the overall asset and liability management process to optimize income and market performance over an entire interest rate cycle while mitigating risk. Activity in this portfolio is undertaken primarily to manage liquidity and interest rate risk, to take advantage of market conditions that create more economically attractive returns on these investments, and to collateralize public funds deposits. The securities portfolio consists primarily of U.S. Government agency, residential mortgage-backed and municipal securities.
Total investments decreased by $49.0 million at June 30, 2011 compared to December 31, 2010. Maturities and paydowns of $34.4 million, calls of $67.1 million, and sales of $9.4 million were partially offset by purchases of $55.8 million.
Loans and Leases
Total gross loans and leases decreased by $32.5 million at June 30, 2011 as compared to December 31, 2010 mainly due to continued light credit demand and utilization of lines by both business and consumers as a result of the prolonged challenging and uncertain economic environment. Declines occurred in construction loans of $34.9 million, commercial real estate of $5.4 million, residential mortgages secured for business purposes of $9.7 million, lease financings of $7.1 million and consumer loans of $1.5 million while commercial, financial and agricultural loans increased by $16.2 million and residential loans secured for personal purposes increased by $10.7 million.
Asset Quality
Performance of the entire loan and lease portfolio is reviewed on a regular basis by bank management and loan officers. A number of factors regarding the borrower, such as overall financial strength, collateral values and repayment ability, are considered in deciding what actions should be taken when determining the collectability of interest for accrual purposes.

 

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When a loan or lease, including a loan or lease that is impaired, is classified as nonaccrual, the accrual of interest on such a loan or lease is discontinued. A loan or lease is classified as nonaccrual when the contractual payment of principal or interest has become 90 days past due or management has serious doubts about the further collectability of principal or interest, even though the loan or lease is currently performing. A loan or lease may remain on accrual status if it is in the process of collection and is either guaranteed or well secured. When a loan or lease is placed on nonaccrual status, unpaid interest credited to income is reversed. Interest received on nonaccrual loans and leases is either applied against principal or reported as interest income, according to management’s judgment as to the collectability of principal.
Loans or leases are usually restored to accrual status when the obligation is brought current, has performed in accordance with the contractual terms for a reasonable period of time, and the ultimate collectability of the total contractual principal and interest is no longer in doubt.
Total cash basis, troubled debt restructured and nonaccrual loans and leases totaled $48.5 million at June 30, 2011, $45.8 million at December 31, 2010, and $31.0 million at June 30, 2010; the balance at June 30, 2011 primarily consisted of commercial real estate, construction and commercial, financial and agricultural loans. For the six months ended June 30, 2011 and 2010, impaired loans and leases resulted in lost interest income of $1.2 million and $939 thousand, respectively. The Corporation’s ratio of nonperforming assets to total loans and leases and other real estate owned was 3.75% as of June 30, 2011, compared to 3.32% as of December 31, 2010 and 2.35% as of June 30, 2010. The ratio of nonperforming assets to total assets was 2.63% at June 30, 2011, 2.29% at December 31, 2010 and 1.63% at June 30, 2010.
At June 30, 2011, the recorded investment in loans and leases that were considered to be impaired was $48.5 million, all of which were on a nonaccrual basis or accruing trouble debt restructured. The related reserve for loan and lease losses for those loans was $1.3 million. At December 31, 2010, the recorded investment in loans and leases that were considered to be impaired was $45.8 million, all of which were on a nonaccrual basis or accruing trouble debt restructured. The related reserve for loan and lease losses for those loans was $1.6 million. The amount of the specific reserve needed for these credits could change in future periods subject to changes in facts and judgments related to these credits. Specific reserves have been established based on current facts and management’s judgments about the ultimate outcome of these credits. The increase in impaired loans and leases at June 30, 2011 compared to December 31, 2010 was mainly due to the migration of one large Shared National Credit to a theatre to non-accrual status. This commercial real estate loan relationship represented $11.3 million in aggregate of which $2.6 million was charged-off during the second quarter of 2011 and the remaining $8.7 million was moved to non-accrual and is secured with sufficient estimated collateral at June 30, 2011; therefore, there is no specific reserve on this credit at June 30, 2011. The theatre continues to be open and operating. In addition, two large real estate construction loan relationships were transferred to accruing troubled debt restructured status totaling $2.8 million during the first quarter of 2011. Due to the stagnant real estate market, these borrowers’ properties have not been selling or are selling slowly, and therefore, the maturity dates on these construction loans have been extended. There is no specific reserve related to these loans. Partially offsetting these increases were the foreclosures on four commercial loan relationships and one consumer relationship and transfers of the collateral to other real estate owned during the first six months of 2011 of $4.4 million. Impaired loans at June 30, 2011 also included several large commercial real estate, construction, and commercial business credits which migrated to non-accrual status during the fourth quarter of 2010 and were not concentrated in any one industry consisting of hotel/office space; investment commercial real estate; a construction company; and a manufacturing company. In addition, impaired loans at June 30, 2011 included one large credit which went on non-accrual during the third quarter of 2009 and is for four separate facilities to a local commercial real estate developer/home builder, aggregating to $14.5 million at June 30, 2011. There is a specific allowance on this credit of $66 thousand at June 30, 2011 to cover deficiencies in the underlying real estate value under current market conditions. The borrower does not have the resources to develop these properties; therefore, the properties must be sold. The Corporation will continue to closely monitor this credit relationship and may have to provide additional reserve in future quarters related to this credit. The Corporation will continue to closely monitor the impaired loans and may have to provide additional reserves in future quarters related to these credits. At June 30, 2010, the recorded investment in loans and leases that were considered to be impaired was $31.0 million, all of which were on a nonaccrual basis or accruing trouble debt restructured. The related reserve for loan and lease losses for those loans was $4.1 million.

 

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The other real estate owned balance increased from $2.4 million at December 31, 2010 to $5.0 million at June 30, 2011 and consisted of six commercial properties and one residential property. During the first half of 2011, six properties were acquired, one property was sold, and three properties had negative valuation adjustments totaling $612 thousand based on the updated fair value.
Table 3 — Nonaccrual, Past Due and Troubled Debt Restructured Loans and Leases, and Other Real Estate Owned
The following table details the aggregate principal balance of loans and leases classified as nonaccrual (including nonaccrual trouble debt restructured loans and leases), past due loans and leases and accruing troubled debt restructured loans and leases as well as other real estate owned as of the dates indicated:
                         
    At June 30,     At December 31,     At June 30,  
(Dollars in thousands)   2011     2010     2010  
 
                       
Nonaccruing loans and leases, including nonaccrual troubled debt restructured loans and leases*:
                       
Commercial, financial and agricultural
  $ 5,979     $ 7,627     $ 2,064  
Real estate — commercial
    29,797       28,183       17,683  
Real estate — construction
    6,831       6,874       7,236  
Real estate — residential
    170       1,625       1,741  
Loans to individuals
          21        
Leases financings
    736       902       817  
 
                 
Total nonaccruing loans and leases, including nonaccrual troubled debt restructured loans and leases*
    43,513       45,232       29,541  
Accruing troubled debt restructured loans and leases, not included above
    5,028       550       1,499  
 
                 
Total impaired loans and leases
  $ 48,541     $ 45,782     $ 31,040  
 
                 
 
                       
Accruing loans and leases 90 days or more past due:
                       
Commercial, financial and agricultural
  $ 4     $     $ 596  
Real estate — commercial
    468              
Real estate — residential
    44       314       542  
Loans to individuals
    133       382       138  
Lease financings
    10              
 
                 
Total accruing loans and leases, 90 days or more past due
  $ 659     $ 696     $ 1,276  
 
                 
Total non-performing loans and leases
  $ 49,200     $ 46,478     $ 32,316  
 
                 
Other real estate owned
  $ 4,952     $ 2,438     $ 1,827  
 
                 
Total non-performing assets
  $ 54,152     $ 48,916     $ 34,143  
 
                 
     
*  
Includes non-accrual troubled debt restructured loans and leases of $2.8 million, $1.2 million and $1.1 million at June 30, 2011, December, 31, 2010 and June 30, 2010, respectively.
Reserve for Loan and Lease Losses
Management believes the reserve for loan and lease losses is maintained at a level that is adequate as of June 30, 2011 to absorb probable losses in the loan and lease portfolio. Management’s methodology to determine the adequacy of and the provisions to the reserve considers specific credit reviews, past loan and lease loss experience, current economic conditions and trends, and the volume, growth, and composition of the portfolio.
The reserve for loan and lease losses is determined through a monthly evaluation of reserve adequacy. This analysis takes into consideration the growth of the loan and lease portfolio, the status of past-due loans and leases, current economic conditions, various types of lending activity, policies, real estate and other loan commitments, and significant changes in charge-off activity. Non-accrual loans and leases, and those which are troubled debt restructured, are evaluated individually. All other loans and leases are evaluated as pools. Based on historical loss experience, loss factors are determined giving consideration to the areas noted in the preceding paragraph and applied to the pooled loan and lease categories to develop the general or allocated portion of the reserve. Loans are also reviewed for impairment based on discounted cash flows using the loans’ initial effective interest rate or the fair value of the collateral for certain collateral-dependent loans. Management also reviews the activity within the reserve to determine what actions, if any, should be taken to address differences between estimated and actual losses. Any of the above factors may cause the provision to fluctuate.

 

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Wholesale leasing portfolios are purchased by the Bank’s subsidiary, Univest Capital, Inc. Credit losses on these purchased portfolios are largely the responsibility of the seller up to pre-set dollar amounts initially equal to 10 to 20 percent of the portfolio purchase amount. The dollar amount of recourse for purchased portfolios is inclusive of cash holdbacks and purchase discounts. Purchased wholesale leasing portfolios outstanding equaled $5.1 million at June 30, 2011 and $9.4 million at December 31, 2010.
The reserve for loan and lease losses is based on management’s evaluation of the loan and lease portfolio under current economic conditions and such other factors, which deserve recognition in estimating loan and lease losses. This evaluation is inherently subjective, as it requires estimates including the amounts and timing of future cash flows expected to be received on impaired loans that may be susceptible to significant change. Additions to the reserve arise from the provision for loan and lease losses charged to operations or from the recovery of amounts previously charged off. Loan and lease charge-offs reduce the reserve. Loans and leases are charged off when there has been permanent impairment or when in the opinion of management the full amount of the loan or lease, in the case of non-collateral dependent borrowings, will not be realized. Certain impaired loans and leases are reported at the present value of expected future cash flows using the loan’s initial effective interest rate, or at the loan’s observable market price or the fair value of the collateral if the loan is collateral dependent.
The reserve for loan and lease losses consists of an allocated reserve and unallocated reserve categories. The allocated reserve is comprised of reserves established on specific loans and leases, and class reserves based on historical loan and lease loss experience, current trends, and management assessments. The unallocated reserve is based on both general economic conditions and other risk factors in the Corporation’s individual markets and portfolios.
The specific reserve element is based on a regular analysis of impaired commercial and real estate loans. For these loans, the specific reserve established is based on an analysis of related collateral value, cash flow considerations and, if applicable, guarantor capacity.
The class reserve element is determined by an internal loan and lease grading process in conjunction with associated allowance factors. The Corporation revises the class allowance factors whenever necessary, but no less than quarterly, in order to address improving or deteriorating credit quality trends or specific risks associated with a given loan or lease pool classification.
The Corporation maintains a reserve in other liabilities for off-balance sheet credit exposures that currently are unfunded in categories with historical loss experience.
The reserve for loan and lease losses increased $1.7 million from December 31, 2010 to June 30, 2011, primarily due to deterioration of underlying collateral and economic factors. As a result of the provision exceeding net-charge-offs combined with the decline in outstanding loans during the year, the ratio of the reserve for loan and lease losses to total loans and leases increased to 2.27% at June 30, 2011 from 2.10% at December 31, 2010 and 2.01% at June 30, 2010. Management believes that, as of June 30, 2011, the reserve is maintained at a level that is adequate to absorb losses in the loan and lease portfolio.
Goodwill and Other Intangible Assets
Goodwill and other intangible assets have been recorded on the books of the Corporation in connection with acquisitions. The Corporation has covenants not to compete, intangible assets due to branch acquisitions, core deposit intangibles, customer-related intangibles and mortgage servicing rights, which are not deemed to have an indefinite life and therefore will continue to be amortized over their useful life using the present value of projected cash flows. The amortization of intangible assets was $358 thousand and $342 thousand for the three months ended June 30, 2011 and 2010, respectively and $707 thousand and $704 thousand for the six months ended June 30, 2011 and 2010, respectively. The Corporation also has goodwill with a net carrying amount of $51.3 million at June 30, 2011 and December 31, 2010, which is deemed to be an indefinite intangible asset and is not amortized.

 

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Goodwill and other identifiable intangibles are reviewed for potential impairment on an annual basis, or more often, if events or circumstances indicate there may be impairment. Goodwill is tested for impairment at the reporting unit level and an impairment loss is recorded to the extent that the carrying amount of goodwill exceeds its implied fair value. The Corporation completed an annual impairment test for the intangible asset category during 2010 and there were no impairments recorded in 2010. There can be no assurance that future impairment tests will not result in a charge to earnings. Since the last annual impairment date, there were no circumstances to indicate impairment.
Other Assets
At June 30, 2011 and December 31, 2010, the Bank held $3.3 million in Federal Reserve Bank stock as required by member banks of the Federal Reserve System. The Bank is also required to hold stock in the FHLB in relation to the level of outstanding FHLB borrowings by the Bank. The Bank held FHLB stock of $6.4 million and $7.1 million as of June 30, 2011 and December 31, 2010, respectively. On December 23, 2008, the FHLB announced that it would be suspending the payment of its dividends and the repurchase of excess capital stock in order to rebuild its capital levels. This is due to the other-than-temporary impairment write down required on the FHLB’s private-label mortgage portfolio which could reduce their capital below required levels. Additionally, the FHLB might require its members to increase its capital stock requirement. During the fourth quarter of 2010 and the first and second quarters of 2011, the FHLB repurchased a limited amount of excess capital stock. The FHLB will make decisions on future repurchases of excess capital stock on a quarterly basis. Effective February 28, 2011, the FHLB entered into a Joint Capital Enhancement Agreement with the other 11 Federal Home Loan Banks (collectively, the FHLBanks). The agreement calls for a plan for each FHLBank to build additional retained earnings and enhance capital. This will commence later in 2011, upon completion of the FHLBank’s currently required Resolution Funding Corporation assessment. Under the plan, each FHLBank will, on a quarterly basis, allocate at least 20 percent of its net income to a separate restricted retained earnings account until the balance of the account equals one percent of that FHLBank’s balance of outstanding obligations. Based on current information from the FHLB, management believes that if there is any impairment in the FHLB stock it is temporary. Therefore, as of June 30, 2011 and December 31, 2010, the FHLB stock is recorded at cost.
Liabilities
Total liabilities decreased since December 31, 2010 primarily due to decreases in deposits and short-term borrowings. The following table presents the liabilities for the periods indicated:
                                 
    At June 30,     At December 31,     Change  
(Dollars in thousands)   2011     2010     Amount     Percent  
 
                               
Deposits
  $ 1,621,294     $ 1,686,270     $ (64,976 )     (3.9 )%
Short-term borrowings
    99,070       114,871       (15,801 )     (13.8 )
Long-term borrowings
    28,619       28,994       (375 )     (1.3 )
Accrued expenses and other liabilities
    36,372       37,534       (1,162 )     (3.1 )
 
                         
Total liabilities
  $ 1,785,355     $ 1,867,669     $ (82,314 )     (4.4 )
 
                         
Deposits
Total deposits decreased by $65.0 million primarily the result of a decline of public fund balances of approximately $49.2 million, due to anticipated seasonal runoff of tax deposits. The decreases in public fund balances consisted of $19.6 million of time deposits and $29.6 million of core deposits.
Interest-bearing demand deposits decreased $49.0 million and time deposits decreased $41.5 million. These decreases were partially offset by increases in regular savings of $19.2 million and noninterest-bearing demand deposits of $6.4 million. The lower interest rate environment has resulted in a shift in customer deposits from time deposits to savings accounts.

 

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Borrowings
Long-term borrowings at June 30, 2011, included $3.0 million in Subordinated Capital Notes, $20.6 million of Trust Preferred Securities and $5.0 million in long-term borrowings from the FHLB. Short-term borrowings typically include securities sold under agreement to repurchase, federal funds purchased, Federal Reserve Bank discount window borrowings and short-term FHLB borrowings. Short-term borrowings decreased mainly due to a decrease in federal funds purchased of $24.6 million partially offset by an increase in securities sold under agreements to repurchase.
Shareholders’ Equity
Total shareholders’ equity at June 30, 2011 increased $6.8 million since December 31, 2010. This increase was primarily due to the issuance of stock under the dividend reinvestment and employee stock purchase plans, reductions in unrealized losses on the investment portfolio, and net income exceeding dividends declared.
The following table presents the shareholders’ equity for the periods indicated:
                                 
    At June 30,     At December 31,     Change  
(Dollars in thousands)   2011     2010     Amount     Percent  
 
                               
Common stock
  $ 91,332     $ 91,332     $       %
Additional paid-in capital
    58,326       59,080       (754 )     (1.3 )
Retained earnings
    153,728       151,978       1,750       1.2  
Accumulated other comprehensive loss
    (3,099 )     (6,766 )     3,667       54.2  
Treasury stock
    (27,265 )     (29,400 )     2,135       7.3  
 
                         
Total shareholders’ equity
  $ 273,022     $ 266,224     $ 6,798       2.6  
 
                         
Retained earnings at June 30, 2011 were impacted by the six months of net income of $8.4 million offset by cash dividends of $6.7 million declared during the first six months of 2011. Additional paid-in capital decreased mainly due to shares issued for restricted stock awards. The decrease in accumulated other comprehensive loss was mainly a result of increases in the fair values of municipal bonds and U.S. government agency securities. Treasury stock decreased primarily due to shares issued for the employee stock purchase plan, the dividend reinvestment plan and restricted stock awards.
Capital Adequacy
The Corporation and the Bank are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Corporation’s and the Bank’s financial statements. Capital adequacy guidelines, and additionally for the Bank the prompt corrective action regulations, involve quantitative measures of assets, liabilities, and certain off-balance-sheet items calculated under regulatory accounting practices. Capital amounts and classifications are also subject to qualitative judgments by regulators about components, risk weighting and other factors.
Quantitative measures established by regulation to ensure capital adequacy require the Corporation and the Bank to maintain minimum amounts and ratios (set forth in the following table) of total and Tier 1 capital (as defined in the regulations) to risk-weighted assets (as defined), and of Tier 1 capital (as defined) to average assets (as defined).

 

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Table 4 — Regulatory Capital
                                                 
                                    To Be Well-  
                                    Capitalized Under  
                    For Capital     Prompt Corrective  
    Actual     Adequacy Purposes     Action Provisions  
(Dollars in thousands)   Amount     Ratio     Amount     Ratio     Amount     Ratio  
 
                                               
As of June 30, 2011:
                                               
Total Capital (to Risk-Weighted Assets):
                                               
Corporation
  $ 262,804       16.25 %   $ 129,373       8.00 %   $ 161,717       10.00 %
Bank
    246,108       15.45       127,409       8.00       159,262       10.00  
Tier 1 Capital (to Risk-Weighted Assets):
                                               
Corporation
    241,934       14.96       64,687       4.00       97,030       6.00  
Bank
    226,041       14.19       63,705       4.00       95,557       6.00  
Tier 1 Capital (to Average Assets):
                                               
Corporation
    241,934       11.87       81,511       4.00       101,889       5.00  
Bank
    226,041       11.19       80,834       4.00       101,042       5.00  
 
                                               
As of December 31, 2010:
                                               
Total Capital (to Risk-Weighted Assets):
                                               
Corporation
  $ 260,244       15.47 %   $ 134,623       8.00 %   $ 168,279       10.00 %
Bank
    243,908       14.71       132,674       8.00       165,842       10.00  
Tier 1 Capital (to Risk-Weighted Assets):
                                               
Corporation
    238,393       14.17       67,312       4.00       100,968       6.00  
Bank
    223,050       13.45       66,337       4.00       99,505       6.00  
Tier 1 Capital (to Average Assets):
                                               
Corporation
    238,393       11.45       82,649       4.00       103,311       5.00  
Bank
    223,050       10.89       81,911       4.00       102,389       5.00  
As of June 30, 2011 and December 31, 2010, management believes that the Corporation and the Bank met all capital adequacy requirements to which they are subject. The Corporation, like other bank holding companies, currently is required to maintain Tier 1 Capital and Total Capital (the sum of Tier 1, Tier 2 and Tier 3 capital) equal to at least 4.0% and 8.0%, respectively, of its total risk-weighted assets (including various off-balance-sheet items, such as standby letters of credit). The Bank, like other depository institutions, is required to maintain similar capital levels under capital adequacy guidelines. For a depository institution to be considered “well capitalized” under the regulatory framework for prompt corrective action, its Tier 1 and Total Capital ratios must be at least 6.0% and 10.0% on a risk-adjusted basis, respectively. As of June 30, 2011, the Bank is categorized as “well capitalized” under the regulatory framework for prompt corrective action. There are no conditions or events since that notification that management believes have changed the Bank’s category.
Asset/Liability Management
The primary functions of Asset/Liability Management are to assure adequate earnings, capital and liquidity while maintaining an appropriate balance between interest-earning assets and interest-bearing liabilities. Liquidity management involves the ability to meet cash flow requirements of customers and corporate needs. Interest-rate sensitivity management seeks to avoid fluctuating net interest margins and to enhance consistent growth of net interest income through periods of changing rates.
The Corporation uses both interest-sensitivity gap analysis and simulation techniques to quantify its exposure to interest rate risk. The Corporation uses the gap analysis to identify and monitor long-term rate exposure and uses a simulation model to measure the short-term rate exposures. The Corporation runs various earnings simulation scenarios to quantify the effect of declining or rising interest rates on the net interest margin over a one-year horizon. The simulation uses existing portfolio rate and repricing information, combined with assumptions regarding future loan and deposit growth, future spreads, prepayments on residential mortgages, and the discretionary pricing of non-maturity assets and liabilities.

 

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Liquidity
The Corporation, in its role as a financial intermediary, is exposed to certain liquidity risks. Liquidity refers to the Corporation’s ability to ensure that sufficient cash flow and liquid assets are available to satisfy demand for loans and deposit withdrawals. The Corporation manages its liquidity risk by measuring and monitoring its liquidity sources and estimated funding needs. The Corporation has a contingency funding plan in place to address liquidity needs in the event of an institution-specific or a systemic financial crisis.
Sources of Funds
Core deposits and cash management repurchase agreements (Repos) have historically been the most significant funding sources for the Corporation. These deposits and Repos are generated from a base of consumer, business and public customers primarily located in Bucks and Montgomery counties, Pennsylvania. The Corporation faces increased competition for these deposits from a large array of financial market participants, including banks, thrifts, mutual funds, security dealers and others.
The Corporation supplements its core funding with money market funds it holds for the benefit of various trust accounts. These funds are fully collateralized by the Bank’s investment portfolio and are at current money market mutual fund rates. This funding source is subject to changes in the asset allocations of the trust accounts.
The Corporation, through the Bank, has short-term and long-term credit facilities with the FHLB with a maximum borrowing capacity of approximately $361.6 million. At June 30, 2011 and December 31, 2010, total outstanding short-term and long-term borrowings with the FHLB totaled $5.0 million. The maximum borrowing capacity with the FHLB changes as a function of qualifying collateral assets as well as the FHLB’s internal credit rating of the Bank and the amount of funds received may be reduced by additional required purchases of FHLB stock.
The Corporation maintains federal fund lines with several correspondent banks totaling $82.0 million at June 30, 2011 and December 31, 2010. Future availability under these lines is subject to the prerogatives of the granting banks and may be withdrawn at will.
The Corporation, through the Bank, has an available line of credit at the Federal Reserve Bank of Philadelphia, the amount of which is dependent upon the balance of loans and securities pledged as collateral. At June 30, 2011 and December 31, 2010, the Corporation had no outstanding borrowings under this line.
Cash Requirements
The Corporation has cash requirements for various financial obligations, including contractual obligations and commitments that require cash payments. The most significant contractual obligation, in both the under and over one year time period, is for the Bank to repay its certificates of deposit. Short-term borrowings consisting of securities sold under agreement to repurchase constitute the next largest payment obligation. The Bank anticipates meeting these obligations by continuing to provide convenient depository and cash management services through its branch network, thereby replacing these contractual obligations with similar fund sources at rates that are competitive in our market.
Commitments to extend credit are the Bank’s most significant commitment in both the under and over one year time periods. These commitments do not necessarily represent future cash requirements in that these commitments often expire without being drawn upon.
Recent Accounting Pronouncements
For information regarding recent accounting pronouncements, refer to Footnote 1, “Summary of Significant Accounting Policies” of this Form 10-Q.

 

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Item 3.  
Quantitative and Qualitative Disclosures About Market Risk
No material changes in the Corporation’s market risk or market strategy occurred during the current period. A detailed discussion of market risk is provided in the Registrant’s Annual Report on Form 10-K for the period ended December 31, 2010.
Item 4.  
Controls and Procedures
Evaluation of Disclosure Controls and Procedures
Management is responsible for the disclosure controls and procedures of the Corporation. Disclosure controls and procedures are controls and other procedures of an issuer that are designed to ensure that information required to be disclosed by the issuer in the reports that it files or submits under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods required by the SEC’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be so disclosed by an issuer is accumulated and communicated to the issuer’s management, including its principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure. As of the end of the period covered by this report, an evaluation was performed under the supervision and with the participation of the Corporation’s management, including the Chief Executive Officer (Principal Executive Officer) and Chief Financial Officer (Principal Financial and Accounting Officer), of the effectiveness of the design and operation of the Corporation’s disclosure controls and procedures. Based on that evaluation, the Corporation’s Chief Executive Officer and Chief Financial Officer concluded that the disclosure controls and procedures were effective as of June 30, 2011.
Changes in Internal Control over Financial Reporting
There were no changes in the Corporation’s internal control over financial reporting (as defined in Rule 13a-15(f)) during the quarter ended June 30, 2011 that materially affected, or are reasonably likely to materially affect, the Corporation’s internal control over financial reporting.
PART II. OTHER INFORMATION
Item 1.  
Legal Proceedings
Management is not aware of any litigation that would have a material adverse effect on the consolidated financial position of the Corporation. There are no proceedings pending other than the ordinary routine litigation incident to the business of the Corporation. In addition, there are no material proceedings pending or known to be threatened or contemplated against the Corporation or the Bank by government authorities.
Item 1A.  
Risk Factors
There were no material changes from the risk factors previously disclosed in the Registrant’s Form 10-K, Part 1, Item 1A, for the Year Ended December 31, 2010 as filed with the Securities and Exchange Commission on March 4, 2011.

 

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Item 2.  
Unregistered Sales of Equity Securities and Use of Proceeds
The following table provides information on repurchases by the Corporation of its common stock during the three months ended June 30, 2011.
 
ISSUER PURCHASES OF EQUITY SECURITIES
 
                    Total Number of     Maximum Number of  
                    Shares Purchased     Shares that May Yet  
    Total Number     Average     as Part of Publicly     Be Purchased Under  
    of Shares     Price Paid     Announced Plans or     the Plans or  
Period   Purchased     per Share     Programs     Programs  
April 1 — 30, 2011
                      643,782  
May 1 — 31, 2011
                      643,782  
June 1 — 30, 2011
                      643,782  
 
                           
Total
                           
 
                           
     
1.  
Transactions are reported as of settlement dates.
 
2.  
The Corporation’s current stock repurchase program was approved by its Board of Directors and announced on August 22, 2007. The repurchased shares limit is net of normal Treasury activity such as purchases to fund the Dividend Reinvestment Program, Employee Stock Purchase Program and the equity compensation plan.
 
3.  
The number of shares approved for repurchase under the Corporation’s stock repurchase program is 643,782.
 
4.  
The Corporation’s current stock repurchase program does not have an expiration date.
 
5.  
No stock repurchase plan or program of the Corporation expired during the period covered by the table.
 
6.  
The Corporation has no stock repurchase plan or program that it has determined to terminate prior to expiration or under which it does not intend to make further purchases. The plans are restricted during certain blackout periods in conformance with the Corporation’s Insider Trading Policy.
Item 3.  
Defaults Upon Senior Securities
None
Item 4.  
Removed and Reserved
Item 5.  
Other Information
None
Item 6.  
Exhibits
  a.  
Exhibits
     
Exhibit 3.1  
Amended and Restated Articles of Incorporation are incorporated by reference to Appendix A of Form DEF14A, filed with the Securities and Exchange Commission (the SEC) on March 9, 2006.
   
 
Exhibit 3.2  
Amended By-Laws dated September 26, 2007 are incorporated by reference to Exhibit 3.2 of Form 8-K, filed with the SEC on September 27, 2007.
   
 
Exhibit 31.1  
Certification of William S. Aichele, Chairman, President and Chief Executive Officer of the Corporation, pursuant to Rule 13a-14(a) of the Exchange Act, as enacted by Section 302 of the Sarbanes-Oxley Act of 2002.
   
 
Exhibit 31.2  
Certification of Jeffrey M. Schweitzer, Senior Executive Vice President and Chief Financial Officer, pursuant to Rule 13a-14(a) of the Exchange Act, as enacted by Section 302 of the Sarbanes-Oxley Act of 2002.
   
 
Exhibit 32.1  
Certification of William S. Aichele, Chief Executive Officer of the Corporation, pursuant to 18 United States Code Section 1350, as enacted by Section 906 of the Sarbanes-Oxley Act of 2002.

 

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Exhibit 32.2  
Certification of Jeffrey M. Schweitzer, Chief Financial Officer of the Corporation, pursuant to 18 United States Code Section 1350, as enacted by Section 906 of the Sarbanes-Oxley Act of 2002.
   
 
Exhibit 101.INS  
XBRL Instance Document
   
 
Exhibit 101.SCH  
XBRL Taxonomy Extension Schema Document
   
 
Exhibit 101.CAL  
XBRL Taxonomy Extension Calculation Linkbase Document
   
 
Exhibit 101.LAB  
XBRL Taxonomy Extension Label Linkbase Document
   
 
Exhibit 101.PRE  
XBRL Taxonomy Extension Presentation Linkbase Document
   
 
Exhibit 101.DEF  
XBRL Taxonomy Extension Definitions Linkbase Document

 

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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
         
  Univest Corporation of Pennsylvania
(Registrant)
 
 
Date: August 8, 2011  /s/ William S. Aichele    
  William S. Aichele, Chairman, President and   
  Chief Executive Officer (Principal Executive Officer)   
 
Date: August 8, 2011  /s/ Jeffrey M. Schweitzer    
  Jeffrey M. Schweitzer, Senior Executive Vice President,  
  and Chief Financial Officer
(Principal Financial and Accounting Officer)
 
 

 

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