River Valley Bancorp. 10-Q 2010
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
Commission file number: 0-21765
RIVER VALLEY BANCORP
(Exact name of registrant as specified in its charter)
(Registrant’s telephone number, including area code)
(Former name, former address and former fiscal year, if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes x No ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
Yes ¨ No ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check One):
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes ¨ No x
The number of shares of the Registrant’s common stock, without par value, outstanding as of November 12, 2010 was 1,514,472.
RIVER VALLEY BANCORP
RIVER VALLEY BANCORP
Consolidated Condensed Balance Sheets
See Notes to Consolidated Condensed Financial Statements.
RIVER VALLEY BANCORP
Consolidated Condensed Statements of Income
See Notes to Consolidated Condensed Financial Statements.
RIVER VALLEY BANCORP
Consolidated Condensed Statements of Comprehensive Income
See Notes to Consolidated Condensed Financial Statements.
RIVER VALLEY BANCORP
Consolidated Condensed Statements of Cash Flows
See Notes to Consolidated Condensed Financial Statements.
RIVER VALLEY BANCORP
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
River Valley Bancorp (the “Corporation” or the “Company”) is a unitary savings and loan holding company whose activities are primarily limited to holding the stock of River Valley Financial Bank (“River Valley” or the “Bank”). The Bank conducts a general banking business in southeastern Indiana and Carroll County, Kentucky which consists of attracting deposits from the general public and applying those funds to the origination of loans for consumer, residential and commercial purposes. River Valley’s profitability is significantly dependent on net interest income, which is the difference between interest income generated from interest-earning assets (i.e. loans and investments) and the interest expense paid on interest-bearing liabilities (i.e. customer deposits and borrowed funds). Net interest income is affected by the relative amount of interest-earning assets and interest-bearing liabilities and the interest received or paid on these balances. The level of interest rates paid or received by the Bank can be significantly influenced by a number of competitive factors, such as governmental monetary policy, that are outside of management’s control.
NOTE 1: BASIS OF PRESENTATION
The accompanying consolidated condensed financial statements were prepared in accordance with instructions for Form 10-Q and, therefore, do not include information or footnotes necessary for a complete presentation of financial position, results of operations, and cash flows in conformity with generally accepted accounting principles. Accordingly, these financial statements should be read in conjunction with the consolidated financial statements and notes thereto of the Corporation included in the Annual Report on Form 10-K for the year ended December 31, 2009. However, in the opinion of management, all adjustments (consisting of only normal recurring accruals) which are necessary for a fair presentation of the financial statements have been included. The results of operations for the three-month and nine-month periods ended September 30, 2010, are not necessarily indicative of the results which may be expected for the entire year. The consolidated condensed balance sheet of the Corporation as of December 31, 2009 has been derived from the audited consolidated balance sheet of the Corporation as of that date.
NOTE 2: PRINCIPLES OF CONSOLIDATION
The consolidated condensed financial statements include the accounts of the Corporation and its subsidiary, the Bank. The Bank currently owns four subsidiaries. Madison 1st Service Corporation, which was incorporated under the laws of the State of Indiana on July 3, 1973, currently holds land and cash but does not otherwise engage in significant business activities. RVFB Investments, Inc., RVFB Holdings, Inc., and RVFB Portfolio, LLC were established in Nevada the latter part of 2005. They hold and manage a significant portion of the Bank’s investment portfolio. All significant inter-company balances and transactions have been eliminated in the accompanying consolidated condensed financial statements.
NOTE 3: EARNINGS PER SHARE
Earnings per share have been computed based upon the weighted average common shares outstanding.
Net income for the three-month period ending September 30, 2010 of $291,000 was reduced by $90,000 for dividends on preferred stock in the same period, to arrive at income available to common stockholders of $201,000. Net income for the nine-month period ending September 30, 2010 of $1,726,000 was reduced by $272,000 for dividends on preferred stock in the same period, to arrive at income available to common stockholders of $1,454,000. The Corporation issued the preferred stock in the fourth quarter of 2009; therefore, no similar adjustment was necessary for the three-month or nine-month periods ended September 30, 2009.
Options to purchase 5,000 shares of common stock at an exercise price of $22.25 per share were outstanding for the three-month and nine-month periods ending September 30, 2010 and September 30, 2009. Options to purchase 19,000 shares of common stock at $14.56 per share and 8,400 shares at $13.25 per share were outstanding for the three- and nine-month periods ending September 30, 2009. These groups of options were not included in the computation of diluted earnings per share for each period because the option price was greater than the average market price of the common shares.
In addition, options to purchase 15,000 shares and 27,400 shares of common stock at exercise prices ranging from $5.38 to $14.56 were outstanding at September 30, 2009 and September 30, 2010, respectively. These options were included in the diluted shares outstanding for the three-month and nine-month periods ended September 30, 2009 and September 30, 2010.
NOTE 4: DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS
The Corporation recognizes fair values in accordance with Financial Accounting Standards Codification (ASC) Topic 820. ASC Topic 820 defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. ASC Topic 820 also establishes a fair value hierarchy which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The standard describes three levels of inputs that may be used to measure fair value:
Following is a description of the valuation methodologies used for instruments measured at fair value on a recurring basis and recognized in the accompanying balance sheet, as well as the general classification of such instruments pursuant to the valuation hierarchy.
Where quoted market prices are available in an active market, securities are classified within Level 1 of the valuation hierarchy. The Corporation does not currently hold any Level 1 securities. If quoted market prices are not available, then fair values are estimated by using pricing models which utilize certain market information or quoted prices of securities with similar characteristics (Level 2). For securities where quoted prices, market prices of similar securities or pricing models which utilize observable inputs are not available, fair values are calculated using discounted cash flows or other market indicators (Level 3). Discounted cash flows are calculated using spread to swap and LIBOR curves that are updated to incorporate loss severities, volatility, credit spread and optionality. Rating agency industry research reports as well as defaults and deferrals on individual securities are reviewed and incorporated into calculations. Level 2 securities include residential mortgage-backed agency securities, federal agency securities and certain municipal securities. Securities classified within Level 3 of the hierarchy include pooled trust preferred securities which are less liquid securities.
The following tables present the fair value measurements of assets and liabilities recognized in the accompanying balance sheets measured at fair value on a recurring basis and the level within the ASC Topic 820 fair value hierarchy in which the fair value measurements fall at September 30, 2010 and December 31, 2009, respectively (in thousands).
The following is a reconciliation of the beginning and ending balances of recurring fair value measurements recognized in the accompanying balance sheet using significant unobservable (Level 3) inputs for the three-month and nine-month periods ended September 30, 2010 and September 30, 2009:
There were no realized or unrealized gains or losses included in net income for the three-month and nine-month periods ended September 30, 2010 and September 30, 2009.
At September 30, 2009, Level 3 securities included two pooled trust preferred securities. The fair value on these securities is calculated using a combination of observable and unobservable assumptions as a quoted market price is not readily available. Both securities remain in Level 3 at September 30, 2010. For the past two fiscal years, trading of these types of securities has only been conducted on a distress sale or forced liquidation basis. As a result, the Corporation is now measuring the fair values using discounted cash flow projections and has included the securities in Level 3.
Following is a description of the valuation methodologies used for instruments measured at fair values on a non-recurring basis and recognized in the accompanying balance sheet, as well as the general classification of such instruments pursuant to the valuation hierarchy.
The following tables present the fair value measurements of assets and liabilities recognized in the accompanying balance sheet measured at fair value on a non-recurring basis and the level within the ASC Topic 820 fair value hierarchy in which the fair value measurements fall at September 30, 2010 and December 31, 2009, respectively (in thousands).
Impaired Loans (Collateral Dependent)
Loans for which it is probable that the Corporation will not collect all principal and interest due according to contractual terms are measured for impairment. Allowable methods for determining the amount of impairment include estimating fair value using the fair value of the collateral for collateral dependent loans.
If the impaired loan is identified as collateral dependent, then the fair value method of measuring the amount of impairment is utilized. This method requires obtaining a current independent appraisal of the collateral and applying a discount factor to the value.
Impaired loans that are collateral dependent are classified within Level 3 of the fair value hierarchy when impairment is determined using the fair value method.
Mortgage Servicing Rights
Mortgage servicing rights are initially recorded at fair value and are subsequently reported at amortized cost and periodically evaluated for impairment. New mortgage servicing rights recorded during the current accounting period are recorded at fair value and are disclosed as a nonrecurring measurement.
Mortgage servicing rights recorded as an asset and into income during the nine months ended September 30, 2010 and the year ended December 31, 2009 totaled $124,000 and $443,000, respectively. For the nine months ended September 30, 2010, impairment on prior period mortgage servicing rights was recovered and included in income in the amount of $14,000. This compares to impairment recorded against income for the year ended December 31, 2009 of $38,000. Mortgage servicing rights do not trade in an active, open market with readily observable prices. Accordingly, fair values of new mortgage servicing rights are estimated using discounted cash flow models. Due to the nature of the valuation inputs, recording initial mortgage servicing rights are classified within Level 3 of the hierarchy.
The following methods and assumptions were used to estimate the fair value of each class of financial instrument:
Cash and Cash Equivalents - The fair value of cash and cash equivalents approximates carrying value.
Loans Held for Sale - Fair values are based on quoted market prices.
Loans> - The fair value for loans is estimated using discounted cash flow analyses, using interest rates currently being offered for loans with similar terms to borrowers of similar credit quality.
Interest Receivable/Payable - The fair values of interest receivable/payable approximate carrying values.
Deposits> - The fair values of noninterest-bearing, interest-bearing demand and savings accounts are equal to the amount payable on demand at the balance sheet date. The carrying amounts for variable rate, fixed-term certificates of deposit approximate their fair values at the balance sheet date. Fair values for fixed-rate certificates of deposit are estimated using a discounted cash flow calculation that applies interest rates currently being offered on certificates to a schedule of aggregated expected monthly maturities on such time deposits.
Federal Home Loan Bank Advances> - The fair value of these borrowings are estimated using a discounted cash flow calculation, based on current rates for similar debt.
Borrowings> - The fair value of these borrowings are estimated using a discounted cash flow calculation, based on current rates for similar debt or as applicable, based on quoted market prices for the identical liability when traded as an asset.
Advance Payment by Borrowers for Taxes and Insurance - The fair value approximates carrying value.
Off-Balance Sheet Commitments> - Commitments include commitments to originate mortgage and consumer loans and standby letters of credit and are generally of a short-term nature. The fair value of such commitments are based on fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the counterparties’ credit standing. The carrying amounts of these commitments, which are immaterial, are reasonable estimates of the fair value of these financial instruments.
The estimated fair values of the Corporation’s financial instruments are as follows:
NOTE 5: INVESTMENT SECURITIES
The amortized cost and approximate fair values of securities as of September 30, 2010 and December 31, 2009 are as follows:
The amortized cost and fair value of available-for-sale securities at September 30, 2010, by contractual maturity, are shown below. Expected maturities will differ from contractual maturities because issuers may have the right to call or prepay obligations with or without call or prepayment penalties.
The carrying value of securities pledged as collateral, to secure public deposits, borrowings and for other purposes, was $16,425,000 and $23,136,000 at September 30, 2010 and December 31, 2009, respectively.
Proceeds from sales of securities available for sale during the nine-month period ended September 30, 2010 and September 30, 2009 were $9,637,000 and $1,620,000, respectively. Gross gains of $309,000 and losses of $3,000 resulting from sales and calls of available-for-sale securities were realized during the nine-month period ended September 30, 2010. Comparatively, gross gains of $97,000 and no losses were realized for the nine-month period ended September 30, 2009.
Proceeds from sales of securities available for sale during the three-month period ended September 30, 2010 and September 30, 2009 were $2,271,000 and $0, respectively. Gross gains of $175,000 and losses of $0 resulting from sales and calls of available-for-sale securities were realized during the three-month period ended September 30, 2010. Comparatively, there were no gains or losses realized for the three-month period ended September 30, 2009.
Certain investments in debt securities are reported in the financial statements at an amount less than their historical cost. Total fair value of these investments at September 30, 2010 was $1,704,000, which is approximately 2.2% of the Corporation’s investment portfolio. The fair value of these investments at December 31, 2009 was $21,210,000, which represented 26.7% of the Corporation’s investment portfolio. Management has the ability and intent to hold securities with unrealized losses to recovery, which may be maturity. Based on evaluation of available evidence, including recent changes in market interest rates, management believes that any declines in fair values for these securities are temporary.
Should the impairment of any of these securities become other than temporary, the cost basis of the investment will be reduced and the resulting credit portion of the loss recognized in net income and the non-credit portion of the loss would be recognized in accumulated other comprehensive income in the period the other-than-temporary impairment is identified.
The following table shows the Corporation’s investments’ gross unrealized losses and fair value, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position at September 30, 2010 and December 31, 2009:
The unrealized losses on the Corporation’s investments in direct obligations of U.S. government agencies were primarily caused by interest rate changes. The contractual terms of those investments do not permit the issuer to settle the securities at a price less than the amortized cost bases of the investments. Because the Corporation does not intend to sell the investments and it is not more likely than not that the Corporation will be required to sell the investments before recovery of their amortized cost bases, which may be maturity, the Corporation did not consider those investments to be other-than-temporarily impaired at September 30, 2009. There are no U.S. government agency investments in a continuous loss position as of September 30, 2010.
Residential Mortgage-Backed Agency Securities
The unrealized losses on the Corporation’s investment in residential mortgage-backed agency securities were primarily caused by interest rate changes. The Corporation expects to recover the amortized cost basis over the term of the securities. Because the decline in market value is attributable to changes in interest rates and not credit quality, and because the Corporation does not intend to sell the investments and it is not more likely than not that the Corporation will be required to sell the investments before recovery of their amortized cost bases, which may be maturity, the Corporation does not consider those investments to be other-than-temporarily impaired at September 30, 2010.
State and Municipal
The unrealized losses on the Corporation’s investments in securities of state and political subdivisions were primarily caused by interest rate changes. The contractual terms of those investments do not permit the issuer to settle the securities at a price less than the amortized cost bases of the investments. Because the Corporation does not intend to sell the investments and it is not more likely than not that the Corporation will be required to sell the investments before recovery of their amortized cost bases, which may be maturity, the Corporation does not consider those investments to be other-than-temporarily impaired at September 30, 2010.
The unrealized losses on the Corporation’s investment in corporate securities were due primarily to losses on two pooled trust preferred issues held by the Corporation. The two, ALESCO 9A and PRETSL XXVII Ltd, had unrealized losses at September 30, 2010 of $530,000 and $297,000, respectively. At December 31, 2009, the unrealized losses on these two investments were $655,000 and $274,000, respectively. These two securities are rated Ba1 and A3, respectively, by Moody’s indicating these securities are considered of moderate investment quality and credit risk. One issue is in the highest tranche and the second issue is in the second highest tranche of the total issue, providing good collateral coverage at those tranche levels, thus providing protection for the Corporation. The Corporation has reviewed the pricing reports for these investments and has determined that the decline in the market price is not other than temporary and indicates thin trading activity rather than a true decline in the value of the investment. Factors considered in reaching this determination included the class or “tranche” held by the Corporation, the collateral position of the tranches, projected cash flows and the credit ratings. The Corporation does not intend to sell the investments and it is not more likely than not that the Corporation will be required to sell the investments before recovery of their amortized cost bases, which may be maturity, and expects to receive all contractual cash flows related to these investments. Based upon these factors, the Corporation has determined these securities are not other-than-temporarily impaired at September 30, 2010.
NOTE 6: ALLOWANCE FOR LOAN LOSSES
The following tables analyze the changes in the allowance during the three-month and nine-month periods ended September 30, 2010 and September 30, 2009 respectively.
Information on impaired loans is summarized below.
At September 30, 2010 and December 31, 2009, the Corporation had non-accruing loans totaling $6,862,000 and $7,199,000, respectively. At September 30, 2010 and December 31, 2009, there were no accruing loans delinquent 90 days or more.
NOTE 7: BUSINESS ACQUISITION
In the second quarter of 2010, the Corporation acquired a commercial bank branch in New Albany, Indiana. The Corporation purchased premises and equipment and customer deposits. Net cash proceeds of $582,000 were received in the transaction. Goodwill recognized in the transaction was $48,000 and is expected to be fully deductible for tax purposes.
NOTE 8: RECENT ACCOUNTING PRONOUNCEMENTS
In January 2010, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2010-06, “Improving Disclosures About Fair Value Measurements,” which added disclosure requirements about transfers in and out of Levels 1 and 2, clarified existing fair value disclosure requirements about the appropriate level of disaggregation, and clarified that a description of valuation techniques and inputs used to measure fair value was required for recurring and nonrecurring Level 2 and 3 fair value measurements. Management has determined the adoption of these provisions of this ASU only affected the disclosure requirements for fair value measurements and as a result did not have a material effect on the Corporation’s financial position or results of operations. This ASU also requires that Level 3 activity about purchases, sales, issuances, and settlements be presented on a gross basis rather than as a net number as currently permitted. This provision of the ASU is effective for the Corporation’s reporting period ending March 31, 2011. Management has determined the adoption of this guidance will not have a material effect on the Corporation’s financial position or results of operations.
In July 2010, the Financial Accounting Standards Board issued Accounting Standards Update (“ASU”) No. 2010-20, “Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses,” which added disclosure requirements about an entity’s allowance for loan losses and the credit quality of its financing receivables. The required disclosures include a roll forward of the allowance for credit losses on a portfolio segment basis and information about modified, impaired, non-accrual and past due loan and credit quality indicators. ASU 2010-20 will be effective for the Corporation’s reporting period ending December 31, 2010, as it relates to disclosures required as of the end of a reporting period. Management has determined the adoption of this guidance will not have a material effect on the Corporation’s financial position or results of operations.
NOTE 9: RECLASSIFICATIONS
Certain reclassifications have been made to the 2009 consolidated condensed financial statements to conform to the September 30, 2010 presentation.
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
FORWARD LOOKING STATEMENTS
This Quarterly Report on Form 10-Q (“Form 10-Q”) contains statements which constitute forward looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These statements appear in a number of places in this Form 10-Q and include statements regarding the intent, belief, outlook, estimate or expectations of the Corporation (as defined in the notes to the consolidated condensed financial statements), its directors or its officers primarily with respect to future events and the future financial performance of the Corporation. Readers of this Form 10-Q are cautioned that any such forward looking statements are not guarantees of future events or performance and involve risks and uncertainties, and that actual results may differ materially from those in the forward looking statements as a result of various factors. The accompanying information contained in this Form 10-Q identifies important factors that could cause such differences. These factors include changes in interest rates; loss of deposits and loan demand to other financial institutions; substantial changes in financial markets; changes in real estate values and the real estate market; regulatory changes; or turmoil and governmental intervention in the financial services industry.
EFFECT OF CURRENT EVENTS
The global and U.S. economies have been experiencing significantly reduced business activity as a result of, among other factors, disruptions in the financial system for a prolonged period. Dramatic declines in the housing market, with falling home prices and increasing foreclosures and unemployment, have resulted in significant write-downs of asset values by financial institutions, including government-sponsored entities and major commercial and investment banks. These write-downs, initially of mortgage-backed securities but spreading to credit default swaps and other derivative securities, have caused many financial institutions to seek additional capital, to merge with larger and stronger institutions and, in some cases, to fail.
Reflecting concern about the stability of the financial markets generally and the strength of counterparties, many lenders and institutional investors have reduced, and in some cases, ceased to provide funding to borrowers, including other financial institutions. The availability of credit, confidence in the financial sector, and level of volatility in the financial markets have been significantly adversely affected as a result. The volatility and disruption in the capital and credit markets has reached unprecedented levels. In some cases, the markets have produced downward pressure on stock prices and credit capacity for certain issuers without regard to those issuers’ underlying financial strength.
Further adverse effects on the U.S. banking and financial industries, as well as on the broader U.S. and global economies, could have an adverse effect on the Corporation and its business.
The level of turmoil in the financial services industry continues to present unusual risks and challenges for the Corporation, as described below:
The Current Economic Environment Poses Challenges For Us and Could Adversely Affect Our Financial Condition and Results of Operations.> We are operating in a challenging and uncertain economic environment, including generally uncertain national conditions and local conditions in our markets. The capital and credit markets have been experiencing volatility and disruption for more than two years. The risks associated with our business become more acute in periods of a slowing economy or slow growth. Financial institutions continue to be affected by sharp declines in the real estate market and constrained financial markets. While we are taking steps to decrease and limit our exposure to problem loans, we nonetheless retain direct exposure to the residential and commercial real estate markets, and we are affected by these events.
Our loan portfolio includes commercial real estate loans, residential mortgage loans, and construction and land development loans. Continued declines in real estate values, home sales volumes and financial stress on borrowers as a result of the uncertain economic environment, including job losses, could have an adverse effect on our borrowers or their customers, which could adversely affect our financial condition and results of operations. In addition, deterioration in local economic conditions in our markets could drive losses beyond that which is provided for in our allowance for loan losses and result in the following other consequences: increases in loan delinquencies, problem assets and foreclosures may increase; demand for our products and services may decline; deposits may decrease, which would adversely impact our liquidity position; and collateral for our loans, especially real estate, may decline in value, in turn reducing customers’ borrowing power, and reducing the value of assets and collateral associated with our existing loans.
Impact of Recent and Future Legislation.> In response to the financial crises affecting the banking system and financial markets and going concern threats to investment banks and other financial institutions, the government has responded with a number of new and amended regulatory provisions. Many of these provisions directly or indirectly impact the Corporation, including the Emergency Economic Stabilization Act of 2008 (“EESA”), the Troubled Asset Relief Program (“TARP”), and the American Recovery and Reinvestment Act of 2009 (“ARRA”).
In addition, on July 21, 2010, President Obama signed into law the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”), which significantly changes the regulation of financial institutions and the financial services industry. The Dodd-Frank Act includes provisions affecting large and small financial institutions alike, including several provisions that will profoundly affect how community banks, thrifts, and small bank and thrift holding companies, such as the Corporation, will be regulated in the future. Among other things, these provisions abolish the Office of Thrift Supervision and transfer its functions to the other federal banking agencies, relax rules regarding interstate branching, allow financial institutions to pay interest on business checking accounts, change the scope of federal deposit insurance coverage, and impose new capital requirements on bank and thrift holding companies. The Dodd-Frank Act also establishes the Bureau of Consumer Financial Protection as an independent entity within the Federal Reserve, which will be given the authority to promulgate consumer protection regulations applicable to all entities offering consumer financial services or products, including banks. Additionally, the Dodd-Frank Act includes a series of provisions covering mortgage loan origination standards affecting, among other things, originator compensation, minimum repayment standards, and pre-payments. The Dodd-Frank Act contains numerous other provisions affecting financial institutions of all types, many of which may have an impact on the operating environment of the Corporation in substantial and unpredictable ways. Consequently, the Dodd-Frank Act is likely to affect our cost of doing business, it may limit or expand our permissible activities, and it may affect the competitive balance within our industry and market areas. The nature and extent of future legislative and regulatory changes affecting financial institutions, including as a result of the Dodd-Frank Act, is very unpredictable at this time. The Corporation’s management is actively reviewing the provisions of the Dodd-Frank Act and assessing its probable impact on the business, financial condition, and results of operations of the Corporation. However, the ultimate effect of the Dodd-Frank Act on the financial services industry in general, and the Corporation in particular, is uncertain at this time.
The failure of such measures to help stabilize the financial markets, and a continuation or worsening of current financial market conditions, could materially and adversely affect our business, financial condition, results of operations, access to credit or the trading price of our common stock.
Further, federal and state governments could pass additional legislation responsive to current credit conditions. As an example, the Bank could experience higher credit losses because of federal or state legislation or regulatory action that reduces the amount the Bank’s borrowers are otherwise contractually required to pay under existing loan contracts. Also, the Bank could experience higher credit losses because of federal or state legislation or regulatory action that limits its ability to foreclose on property or other collateral or makes foreclosure less economically feasible.
At this time, we cannot determine the specific impact that any new legislation, and the rules and regulations to be adopted to implement that legislation, will have on the Corporation or the Bank.
Additional Increases in Insurance Premiums. >The FDIC insures the Bank’s deposits up to certain limits. The FDIC charges us premiums to maintain the Deposit Insurance Fund. The Bank elected to participate in the FDIC’s Temporary Liquidity Guarantee Program, which increased its insurance premiums during 2009 by 10 basis points per annum and will cause increased insurance premiums during 2010 as well. Current economic conditions have increased expectations for bank failures. The FDIC takes control of failed banks and ensures payment of deposits up to insured limits using the resources of the Deposit Insurance Fund. The FDIC has designated the Deposit Insurance Fund long-term target reserve ratio at 1.25 percent of insured deposits. Due to recent bank failures, the FDIC insurance fund reserve ratio has fallen below 1.15 percent, the statutory minimum. The FDIC has implemented a restoration plan beginning January 1, 2009, that is intended to return the reserve ratio to an acceptable level over 8 years. The restoration plan has uniformly increased insurance assessments by 7 basis points (annualized) and will increase them again by 3 basis points (annualized) effective January 1, 2011. Further increases in premium assessments are also possible and would increase the Corporation’s expenses. Also, in addition to the 5 basis point special assessment of $178,000 that the Corporation paid in September 2009, the FDIC required us to pay on December 30, 2009, actual and estimated third and fourth quarter 2009 assessments, totaling $230,000, plus a prepayment of all estimated 2010, 2011 and 2012 assessments totaling $1.6 million.
Increased assessment rates and special assessments have had a material impact on the Corporation’s results of operations and could continue to do so.
The Soundness of Other Financial Institutions Could Adversely Affect Us.> Financial services institutions are interrelated as a result of trading, clearing, counterparty, or other relationships. We have exposure to many different industries and counterparties, and we routinely execute transactions with counterparties in the financial services industry, including brokers and dealers, commercial banks, investment banks, mutual and hedge funds, and other institutional clients. Many of these transactions expose us to credit risk in the event of default by our counterparty or client. In addition, our credit risk may be exacerbated when the collateral held by us cannot be realized or is liquidated at prices not sufficient to recover the full amount of the loan or derivative exposure due us. There is no assurance that any such losses would not materially and adversely affect our results of operations or earnings.
Future Reduction in Liquidity in the Banking System.> The Federal Reserve Bank has been providing vast amounts of liquidity in to the banking system to compensate for weaknesses in short-term borrowing markets and other capital markets. A reduction in the Federal Reserve’s activities or capacity could reduce liquidity in the markets, thereby increasing funding costs to the Bank or reducing the availability of funds to the Bank to finance its existing operations.
Difficult Market Conditions Have Adversely Affected Our Industry>. We are particularly exposed to downturns in the U.S. housing market. Dramatic declines in the housing market over the past year, with falling home prices and increasing foreclosures, unemployment and under-employment, have negatively impacted the credit performance of mortgage loans and securities and resulted in significant write-downs of asset values by financial institutions, including government-sponsored entities, major commercial and investment banks, and regional financial institutions. Reflecting concern about the stability of the financial markets generally and the strength of counterparties, many lenders and institutional investors have reduced or ceased providing funding to borrowers, including to other financial institutions. This market turmoil and tightening of credit have led to an increased level of commercial and consumer delinquencies, lack of consumer confidence, increased market volatility and widespread reduction of business activity generally. The resulting economic pressure on consumers and lack of confidence in the financial markets could adversely affect our business, financial condition and results of operations. We do not expect that the difficult conditions in the financial markets are likely to improve in the near future. A worsening of these conditions would likely exacerbate the adverse effects of these difficult market conditions on the financial institutions industry. In particular, we may face the following risks in connection with these events:
Concentrations of Real Estate Loans Could Subject the Corporation to Increased Risks in the Event of a Real Estate Recession or Natural Disaster>. A significant portion of the Corporation’s loan portfolio is secured by real estate. The real estate collateral in each case provides an alternate source of repayment in the event of default by the borrower and may deteriorate in value during the time the credit is extended. A weakening of the real estate market in our primary market area could result in an increase in the number of borrowers who default on their loans and a reduction in the value of the collateral securing their loans, which in turn could have an adverse effect on our profitability and asset quality. If we are required to liquidate the collateral securing a loan to satisfy the debt during a period of reduced real estate values, our earnings and capital could be adversely affected. Historically, Indiana and Kentucky have experienced, on occasion, significant natural disasters, including tornadoes and floods. The availability of insurance for losses for such catastrophes is limited. Our operations could also be interrupted by such natural disasters. Acts of nature, including tornadoes and floods, which may cause uninsured damage and other loss of value to real estate that secures our loans or interruption in our business operations, may also negatively impact our operating results or financial condition.
CRITICAL ACCOUNTING POLICIES
Note 1 to the consolidated financial statements presented on pages 65 through 69 of the Annual Report on Form 10-K for the year ended December 31, 2009 contains a summary of the Corporation’s significant accounting policies. Certain of these policies are important to the portrayal of the Corporation’s financial condition, since they require management to make difficult, complex or subjective judgments, some of which may relate to matters that are inherently uncertain. Management believes that its critical accounting policies include determining the allowance for loan losses and the valuation of mortgage servicing rights.
Allowance for Loan Losses
The allowance for loan losses is a significant estimate that can and does change based on management’s assumptions about specific borrowers and current general economic and business conditions, among other factors. Management reviews the adequacy of the allowance for loan losses on at least a quarterly basis. The evaluation by management includes consideration of past loss experience, changes in the composition of the loan portfolio, the current condition and amount of loans outstanding, identified problem loans and the probability of collecting all amounts due.
The allowance for loan losses represents management’s estimate of probable losses inherent in the Corporation’s loan portfolios. In determining the appropriate amount of the allowance for loan losses, management makes numerous assumptions, estimates and assessments.
The Corporation’s strategy for credit risk management includes conservative, centralized credit policies, and uniform underwriting criteria for all loans as well as an overall credit limit for each customer significantly below legal lending limits. The strategy also emphasizes diversification on a geographic, industry and customer level, regular credit quality reviews and quarterly management reviews of large credit exposures and loans experiencing deterioration of credit quality.
The Corporation’s allowance consists of three components: probable losses estimated from individual reviews of specific loans, probable losses estimated from historical loss rates, and probable losses resulting from economic or other deterioration above and beyond what is reflected in the first two components of the allowance.
Larger commercial loans that exhibit probable or observed credit weaknesses are subject to individual review. Where appropriate, reserves are allocated to individual loans based on management’s estimate of the borrower’s ability to repay the loan given the availability of collateral, other sources of cash flow and legal options available to the Corporation. Included in the review of individual loans are those that are considered impaired. A loan is considered impaired when, based on current information and events, it is probable that the Corporation will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record and the amount of the shortfall in relation to the principal and interest owed. Impairment is measured on a loan-by-loan basis for commercial and construction loans by either the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s obtainable market price or the fair value of the collateral if the loan is collateral dependent. Any allowances for impaired loans are measured based on the present value of expected future cash flows discounted at the loan’s effective interest rate or fair value of the underlying collateral. The Corporation evaluates the collectibility of both principal and interest when assessing the need for a loss accrual. Historical loss rates are applied to other commercial loans not subject to specific reserve allocations.
Homogenous loans, such as consumer installment and residential mortgage loans are not individually risk graded. Rather, standard credit scoring systems are used to assess credit risks. Reserves are established for each pool of loans based on the expected net charge-offs for one year. Loss rates are based on the average net charge-off history by loan category.
Historical loss rates for loans may be adjusted for significant factors that, in management’s judgment, reflect the impact of any current conditions on loss recognition. Factors which management considers in the analysis include the effects of the national and local economies, trends in the nature and volume of loans (delinquencies, charge-offs and non-accrual loans), changes in mix, asset quality trends, risk management and loan administration, changes in the internal lending policies and credit standards, collection practices and examination results from bank regulatory agencies and the Corporation’s internal loan review. The portion of the allowance that is related to certain qualitative factors not specifically related to any one loan type is considered the unallocated portion of the reserve.
Allowances on individual loans and historical loss rates are reviewed quarterly and adjusted as necessary based on changing borrower and/or collateral conditions and actual collection and charge-off experience.
The Corporation’s primary market area for lending is Clark, Floyd and Jefferson counties in southeastern Indiana and portions of northeastern Kentucky adjacent to that market. When evaluating the adequacy of allowance, consideration is given to this regional geographic concentration and the closely associated effect changing economic conditions have on the Corporation’s customers.
In compliance with regulatory guidance and in reaction to the economic factors at work during 2009, management reviewed and revised the methodolgy for evaluating the adequacy of its allowance for loan and lease losses during the fourth quarter of 2009. Management made the following changes to the methodology:
Valuation of Mortgage Servicing Rights
The Corporation recognizes the rights to service mortgage loans as separate assets in the consolidated balance sheet. The total cost of loans, when sold, is allocated between loans and mortgage servicing rights based on the relative fair values of each. Mortgage servicing rights are subsequently carried at the lower of the initial carrying value, adjusted for amortization, or fair value. Mortgage servicing rights are evaluated for impairment based on the fair value of those rights. Factors included in the calculation of fair value of the mortgage servicing rights include, estimating the present value of future net cash flows, market loan prepayment speeds for similar loans, discount rates, servicing costs, and other economic factors. Servicing rights are amortized over the estimated period of net servicing revenue. It is likely that these economic factors will change over the life of the mortgage servicing rights, resulting in different valuations of the mortgage servicing rights. The differing valuations will affect the carrying value of the mortgage servicing rights on the consolidated balance sheet as well as the income recorded from loan servicing in the consolidated income statement. As of September 30, 2010, and December 31, 2009, mortgage servicing rights had carrying values of $537,000 and $505,000 respectively.
At September 30, 2010, the Corporation’s consolidated assets totaled $382.3 million, a decrease of $13.9 million, or 3.5%, from December 31, 2009. Highlights for the period included the acquisition of a branch location in New Albany, Indiana, the purchase of an additional $1.0 million of Bank-owned life insurance, the repayment of $21.0 million in Federal Home Loan Bank advances, deposit growth and an increase in the allowance for loan losses.
The branch acquisition included $1.2 million in demand and maturity deposits; building and fixtures valued at $502,000; and goodwill and core deposit intangibles of $48,000 and $28,000 respectively. Net cash received in this transaction totaled $582,000.
Interest-bearing demand deposits held by the Corporation decreased by $3.6 million to $5.9 million at September 30, 2010. This compared to $9.5 million at December 31, 2009. During the period, the Corporation also experienced a reduction in net loans of $9.5 million, and a $2.5 million reduction in the investment portfolio. The decrease in the loan portfolio year-to-date was the result of conventional 1-4 family portfolio mortgages being refinanced and sold into the secondary market, certain non-performing loans being reduced by short sales and write downs, and a reduced demand for lending in general. Certain available-for-sale investments were sold in 2010 for liquidity and to take advantage of gain positions.
The Corporation’s consolidated allowance for loan losses totaled $3.5 million at September 30, 2010 as compared to $2.6 million at December 31, 2009. The increase reflects a year-to-date 2010 provision expense of $1.9 million and net charge-off activity of $1.0 million. In addition to those net charge-offs, specific reserves were established during the period for three loan relationships, totaling $780,000. Of those reserves, $467,000 was for one loan collateralized by a piece of property that was valued at $1.4 million in February of 2009 and decreased in value by 51.4%, to $695,000 as of September, 2010. Funding for the allowance represented 1.29% and .94% of total loans for September 30, 2010 and December 31, 2009, respectively. Classified loans are reviewed quarterly and reserves or write down of principal are taken as needed. The Corporation treats specific reserves as charge-offs in calculating the historical charge-off rates for the analysis of the allowance for loan losses.
Delinquency 30 or more days past due as of September 30, 2010 was $12.3 million, or 4.54% of total loans, as compared to $10.2 million, or 3.69%, at December 31, 2009. The increase included a single loan of $1.3 million well collateralized by a commercial building in New Albany, Indiana.
Non-performing loans (defined as loans delinquent greater than 90 days and loans on non-accrual status) as of September 30, 2010 were $6.9 million, compared to $10.0 million at the same date in 2009 and $7.2 million at December 31, 2009, decreasing in September from both prior periods as work-outs and foreclosures were completed. Non-performing loans as a percent of total loans were 2.54%, 3.58% and 2.59%, respectively, for those periods. The expense for the provision for loan losses was $1.9 million for the nine months ended September 30, 2010, as compared to $2.6 million for the same period in 2009. The 2009 provision reflected specific reserves taken for certain large relationships, which were subsequently written off as partial charge-offs at December 31, 2009. Net charge-offs for the nine-month period ended September 30, 2010 were $1.0 million as compared to net charge-offs of $163,000 for the same period in 2009. The increase was primarily due to charge-offs taken on two loans.
Although management believes that its allowance for loan losses at September 30, 2010, was appropriate based upon the available facts and circumstances, there can be no assurance that additions to such allowance will not be necessary in future periods, which could negatively affect the Corporation’s results of operations. Management is diligent in monitoring delinquent loans and in the analysis of the factors affecting the allowance. In December 2009, the Corporation modified its methodology for analysis of the allowance, reducing the historical look-back period to three years, from five, and incorporating greater stratification of loan types and concentrations.
Other changes in the asset mix of the Corporation occurred with varying impact on the financial statements. Reflective of the economic environment, real estate held for sale increased by $317,000, from $253,000 as of December 31, 2009 to $570,000 as of September 30, 2010. Other assets, primarily comprised of prepaid assets and mortgage servicing rights declined by $607,000 primarily due to declines in prepaid assets. The decrease in prepaid assets was due primarily to a reduction period to period, in prepaid FDIC assessment, $325,000 expensed, and prepaid insurance and retirement assets of $308,000. Interest receivable decreased 7.1% over the nine-month period from $2.2 million as of December 31, 2009 to $2.1 million as of September 30, 2010, as yields and average balances both dropped. Loans held for sale to the Federal Home Loan Mortgage Corporation (FHLMC) increased from $175,000 at December 31, 2009 to $638,000 at September 30, 2010 due to the increase in refinancing activity.
Deposits totaled $281.1 million at September 30, 2010, an increase of $4.5 million, or 1.6%, compared to total deposits at December 31, 2009 of $276.6 million. During the nine-month period ended September 30, 2010, noninterest-bearing transactional deposit accounts increased slightly by 4.8%, or $1.1 million, and interest-bearing accounts, primarily money market demand deposit accounts and certificate of deposit accounts, increased 1.3%, or $3.4 million. Deposit growth for the period has been consistently strong and these slight increase figures are not indicative of the overall growth in deposits for the year as a single depositor withdrew $10.0 million in September of 2010 in connection with a large commercial construction project.
Borrowings totaled $65.2 million at September 30, 2010 versus $86.2 million at December 31, 2009, a drop of $21.0 million, or 24.4%, period to period, as the Corporation used portions of excess liquidity to pay down advances. Of total borrowings, $58.0 million and $79.0 million, respectively, represented Federal Home Loan Bank (FHLB) advances with average rates of 3.84% and 4.56% at the respective dates. These balances and average rates on advances from the FHLB compare to $80.0 million and 4.55% at September 30, 2009. In August, the Corporation took advantage of a program with the FHLB, restructuring a portion of existing advances to lower rates, with similar terms. Advances of $19.0 million, averaging a cost of 5.38%, were restructured to an average cost of 3.28% and an average term of 4.5 years. The restructuring will result in savings of approximately $33,000 per month. Borrowing costs of $2.5 million for the nine months ended September 30, 2010 compared to $3.2 million for the same period in 2009, reflecting lower average balances on borrowings and the savings from restructuring. The Corporation primarily utilizes bullet advances from the Federal Home Loan Bank. Bullet advances have steep penalties for prepayment and therefore the Corporation typically only repays these borrowings at maturity.
Other liabilities increased by $1.0 million from $1.7 million at December 31, 2009 to $2.7 million at September 30, 2010, primarily due to a $640,000 increase, period to period, in the deferred tax liability for unrealized gains on available-for-sale securities.
Stockholders’ equity totaled $32.5 million at September 30, 2010, an increase of $1.7 million, or 5.7%, from the $30.7 million at December 31, 2009. The increase was primarily due to the change in the unrealized gains on available-for-sale investments, at a gain position of $1.6 million at September 30, 2010, as compared to $453,000 at December 31, 2009, and year-to-date net income of $1.7 million. The Corporation paid dividends totaling $1.2 million to preferred and common shareholders during the period, with dividends to common shareholders of $.63 per share.
The Bank is required to maintain minimum regulatory capital pursuant to federal regulations. At September 30, 2010, the Bank’s regulatory capital exceeded all applicable regulatory capital requirements.
COMPARISON OF OPERATING RESULTS FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2010 AND 2009
The Corporation’s net income for the nine months ended September 30, 2010 totaled $1.7 million, an increase of $796,000 from the $930,000 reported for the period ended September 30, 2009. The increase was fueled by significant decreases in the cost of funds, period to period, as deposit and borrowing cost of funds dropped from 2.47% at September 30, 2009 to 1.80% at September 30, 2010. This drop translated to a $1.3 million, or 18.7%, decrease in interest expense period to period. This compared to a slight decrease in income from interest-earning assets of $195,000, or 1.4%, for the same period, with the yield on loans changing only negligibly from 5.96% at September 30, 2009 to 6.00% a year later, and average balances for the loan portfolio declining. Yields on investments dropped from 4.01% at September 30, 2009 to 3.49% at September 30, 2010. However, income from investments increased from September 30, 2009 to September 30, 2010 on a more than $5.8 million increase in investments held. That increase was comprised roughly of a $3.1 million increase in municipal securities plus an $8.8 million increase in residential mortgage-backed collateralized mortgage obligation securities. Corporate investments dropped by $3.0 million over the same period as did federal agency investments by $2.3 million. Also contributing significantly to the increase, provision expense declined $658,000 from the nine months ended September 30, 2009 to the same point in 2010. Gain on loan sales to the secondary market, a significant contributor to net income in 2009, decreased dramatically in the first nine months of 2010, with income for the nine-month period ended September 30, 2010 at $385,000 as compared to $927,000 for the same period in 2009, a decrease of $542,000.
Other items affecting net income included increased income from debit card interchange fees, a decrease in service charges for overdrawn accounts, increased expenses relative to staffing and overhead as the New Albany branch was opened in 2010, and a decrease in the Federal Deposit Insurance Corporation (FDIC) premium assessment. Expense for FDIC insurance for the nine-month period ended September 30, 2010 was $351,000, significantly less than the expense for the nine-month period ended September 30, 2009 of $665,000. FDIC expense for the 2009 period included a special assessment of FDIC premiums. In 2010, there has not been a special assessment of FDIC premiums. Also contributing to net income for the period were net gains on the sale of available-for-sale securities, sold for liquidity and to take advantage of strong gain positions.
Net Interest Income
Total interest income for the nine months ended September 30, 2010 was $14.1 million compared to the $14.3 million recorded at September 30, 2009. As discussed earlier, loan yields remained nearly flat, period to period, with the yield at September 30, 2010 at 6.00% as compared to 5.96% at the same point a year earlier. Investment income remained constant as yields dropped, but the average balance of investments increased.
Total interest expense for the same period decreased by $1.3 million, or 18.7%, from the $7.0 million reported at September 30, 2009 to $5.7 million at September 30, 2010. For the nine months ended September 30, 2010 interest expense from deposits totaled $3.2 million while interest expense from borrowings totaled $2.5 million, as compared to $3.8 million and $3.2 million for the same period in 2009. Of the overall decrease in interest expense, $619,000 was attributable to interest expense on deposits, primarily fixed-maturity deposits, as certificates matured and re-priced at the lower rates in effect since the Federal Reserve cuts in 2008, and the spread between interest-earning assets and interest-bearing liabilities widened. Over the same period, the Corporation experienced a decrease of $698,000, or 21.7%, on interest expense for borrowings as advances were repaid. The average rate paid on those borrowings decreased from 4.55% at September 30, 2009 to 3.84% at September 30, 2010. The decrease in the average cost of borrowings was primarily due to the restructuring of FHLB advances to take advantage of lower rates, and to the repayment of $22.0 million in advances during the period of September 30, 2009 to September 30 2010. Total advances outstanding as of September 30, 2010 were $58.0 million as compared to $80.0 million at the same point in 2009.
Net interest income was $8.4 million for the nine months ended September 30, 2010, compared to $7.3 million for the same period in 2009, with the increase period to period of $1.1 million, or 15.4%. This reflects the increasing spread between interest-earning assets and interest-bearing liabilities, combined with changes in the mix of the underlying assets and liabilities.
Provision for Losses on Loans
A provision for losses on loans is charged to income to bring the total allowance for loan losses to a level considered appropriate by management based upon historical experience, the volume and type of lending conducted by the Corporation, the status of past due principal and interest, general economic conditions, particularly as such conditions relate to the Corporation’s market area, and other factors related to the collectibility of the Corporation’s loan portfolio. As a result of such analysis, management recorded a $1.9 million provision for losses on loans for the nine months ended September 30, 2010, as compared to $2.6 million for the same period in 2009. The 2009 provision, atypical to previous expenses, was the result of specific reserves established primarily for two large loan relationships. Subsequently, at December 31, 2009, these specific reserves were recorded as partial write downs of the principal balances. The 2010 provision expense was impacted by the devaluation of collateral on a single loan, valued at $1.4 million in February of 2009 and subsequently valued at $695,000 as of September, 2010. A reserve for this loan was established at September 30, 2010, with total specific reserves recorded for three relationships of $780,000. Specific reserves established as of September 30, 2009 were $3.0 million. The majority of these specific reserves were established in the second quarter of 2009 and subsequently charged off in the fourth quarter of 2009. Net charge-offs for the nine months ended September 30, 2010 were $1.0 million as compared to $163,000 for the same nine months in 2009. Outside of those specific reserves in 2009, the decrease in the provision expense year-to-year has been predicated primarily on declining levels of loan activity and shrinkage in the loan portfolio, estimated losses on non-performing loans, of which the majority have already been reduced by partial charge-offs or short sales of the underlying collateral, and some consistency in delinquencies, particularly those more than 90 days past due.
Non-performing loans as of September 30, 2010 were $6.9 million, a decrease of $3.1 million, from the $10.0 million at the same point in 2009, as work-out and foreclosure activity effects were seen. Delinquency for loans 30-89 days past due as of September 30, 2010 totaled $5.4 million as compared to $1.8 million at the same point in 2009, with total delinquency at $12.3 million at September 30, 2010 as compared to $11.8 million at September 30, 2009. While management believes that the allowance for losses on loans is appropriate at September 30, 2010, based upon the available facts and circumstances, there can be no assurance that the loan loss allowance will be adequate to cover losses on non-performing assets in the future.
Other income decreased by $435,000 during the nine months ended September 30, 2010 to $2.8 million, as compared to the $3.2 million reported for the same period in 2009. The decrease was due primarily to the decrease in loan sales into the secondary market, period to period. Gains on sales to the FHLMC (Freddie Mac) for the nine months ending September 30, 2010 totaled $385,000, a decrease of $542,000 from the $927,000 recorded for the same period ended September 30, 2009. Service fees and charges, which includes income from overdrawn deposit accounts (NSF fees), decreased $163,000 as customers appeared to be more frugal in their spending habits. Offsetting those decreases were losses on foreclosed real estate owned, which were less for the nine-month period ended September 30, 2010, at $10,000, as compared to net losses of $41,000 at the same point in 2009. Interchange fee income, from the use of debit cards, increased for the period by $47,000, or 20.7% from $227,000 for the nine-month period ended September 30, 2009 to $274,000 for the same period in 2010. Gains on the sale of available