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OVBC > SEC Filings for OVBC > Form 10-Q on 9-Nov-2012All Recent SEC Filings

Show all filings for OHIO VALLEY BANC CORP | Request a Trial to NEW EDGAR Online Pro

Form 10-Q for OHIO VALLEY BANC CORP


9-Nov-2012

Quarterly Report


ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

(dollars in thousands, except share and per share data)

Forward Looking Statements

Except for the historical statements and discussions contained herein, statements contained in this report constitute "forward looking statements" within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Act of 1934 and as defined in the Private Securities Litigation Reform Act of 1995. Such statements are often, but not always, identified by the use of such words as "believes," "anticipates," "expects," and similar expressions. Such statements involve various important assumptions, risks, uncertainties, and other factors, many of which are beyond our control that could cause actual results to differ materially from those expressed in such forward looking statements. These factors include, but are not limited to:
changes in political, economic or other factors such as inflation rates, recessionary or expansive trends, and taxes; competitive pressures; fluctuations in interest rates; the level of defaults and prepayment on loans made by the Company; unanticipated litigation, claims, or assessments; fluctuations in the cost of obtaining funds to make loans; and regulatory changes. Additional detailed information concerning a number of important factors which could cause actual results to differ materially from the forward-looking statements contained in management's discussion and analysis is available in the Company's filings with the Securities and Exchange Commission, under the Securities Exchange Act of 1934, including the disclosure under the heading "Item 1A. Risk Factors" of Part 1 of the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2011. Readers are cautioned not to place undue reliance on such forward looking statements, which speak only as of the date hereof. The Company undertakes no obligation and disclaims any intention to republish revised or updated forward looking statements, whether as a result of new information, unanticipated future events or otherwise.

Financial Overview

The Company is primarily engaged in commercial and retail banking, offering a blend of commercial and consumer banking services within southeastern Ohio as well as western West Virginia. The banking services offered by the Bank include the acceptance of deposits in checking, savings, time and money market accounts; the making and servicing of personal, commercial, floor plan and student loans; the making of construction and real estate loans; and credit card services. The Bank also offers individual retirement accounts, safe deposit boxes, wire transfers and other standard banking products and services. In addition, the Bank is one of a limited number of financial institutions which facilitates the payment of tax refunds through a third-party tax software provider. The Bank has facilitated the payment of these tax refunds through electronic refund check/deposit ("ERC/ERD") transactions. ERC/ERD transactions involve the issuing of a tax refund to the taxpayer after the Bank has received the refund from the federal/state government. ERC/ERD transactions occur primarily during the tax refund loan season, typically during the first quarter of each year. Prior to 2012, the Bank also offered refund anticipation loans ("RALs") through the same third-party tax software provider. RALs are short-term cash advances


against a customer's anticipated income tax refund. The Bank ceased offering RALs effective April 19, 2011, although it still provides ERC/ERD transactions. Loan Central continues to offer RALs.

For the three months ended September 30, 2012, net income increased by $221, or 24.9%, to finish at $1,107, compared to the same period in 2011. Earnings per share for the third quarter of 2012 also increased by $.05, or 22.7%, compared to the same period in 2011, to finish at $.27 per share. For the nine months ended September 30, 2012, net income increased by $974, or 21.8%, to finish at $5,448, compared to the same period in 2011. Earnings per share during the first nine months of 2012 also increased by $.23, or 20.5%, to finish at $1.35 per share compared to the same period in 2011. The annualized net income to average asset ratio, or return on assets (ROA), improved to 0.87% at September 30, 2012, as compared to 0.68% at September 30, 2011. The Company's net income to average equity ratio, or return on equity (ROE), improved to 9.89% at September 30, 2012, as compared to 8.60% at September 30, 2011.

The largest contributor to the Company's growth in net income for 2012 has been lower provision expense. While provision expense was limited to a minimal increase of $31 during the three months ended September 30, 2012, provision expense has remained below the previous year-to-date results, decreasing $1,832, or 37.7%, during the nine months ended September 30, 2012, compared to the same periods in 2011. Lower provision expense during the nine months ended September 30, 2012 was impacted mostly by lower net charge-offs, which were down $5,548 when compared to the same period in 2011. This was primarily the result of higher net charge-offs taken on certain impaired loans during the first and second quarters of 2011, resulting in higher general allocations of the allowance for loan losses associated with the Company's average historical loan loss factor. A large portion of these higher net charge-offs during 2011 was related to $3,839 in partial charge-offs taken on one impaired commercial loan relationship during the first quarter of 2011. While $2,906 had already been allocated within the allowance for loan losses for this charge-off, an additional impairment charge to provision expense of $933 was recognized due to a continued deterioration of collateral values. The partial charge-offs from this commercial relationship also contributed to the increase in general allocations during the first nine months of 2011.

Partially offsetting the reduction in provision expense for the nine months ended September 30, 2012 was a decrease in the Company's net interest income of $317 and $709 for the three and nine months ended September 30, 2012, as compared to the same periods in 2011. Contributing to the overall decrease in net interest income were lower average earning assets, which decreased $29,199 during the third quarter of 2012, and $43,736 during the first nine months of 2012, compared to the same periods in 2011, largely from loans. Also contributing to lower net interest income was the elimination of the Bank's RAL product. After the 2011 tax season, the Bank ceased offering RALs as recommended by the FDIC and, as a result, did not record any RAL fee income during the nine months ended September 30, 2012, as compared to $561 in RAL fees during the nine months ended September 30, 2011.

Further impacting the net income results were changes in the Company's noninterest income and noninterest expenses during the three and nine months ended September 30, 2012. When compared to the three and nine months ended September 30, 2011, the Company's noninterest income during the three and nine months ended September 30, 2012 increased $616 and $723, respectively, while noninterest expense decreased $44 and increased $371, respectively. Noninterest income was largely impacted by increases in the Company's gains of other real estate owned, debit and credit card interchange income, and mortgage banking revenue. A decrease in the Company's ERC/ERD fees partially offset the growth in noninterest income during the year-to-date period ended September 30, 2012, decreasing $254, or 10.0%, as compared to the same period in 2011. ERC/ERD fees are discussed further under the caption "Noninterest Income" in this Management's Discussion and Analysis. Higher noninterest expense was impacted by increased salaries and employee benefits related to higher healthcare and retirement benefit costs.

The consolidated total assets of the Company decreased $8,223, or 1.0%, during the first nine months of 2012 as compared to year-end 2011, to finish at $795,954. This change in assets was mostly due to a decrease in the Company's earning assets of $8,133 from year-end 2011, resulting from lower loans partially offset by increases in both interest-bearing deposits with banks and investment securities. The first nine months of 2012 saw the Company's loan portfolio decrease $35,773, or 6.0%, from year-end 2011. This change in loan balances came primarily from the commercial real estate loan portfolio, which


decreased $22,088, or 10.6%, from year-end 2011, largely due to increases in loan payoffs as well as additional charge-offs recorded during the first nine months of 2012. Further decreasing the Company's loan portfolio were residential real estate and consumer loans, which decreased $8,741 and $6,973, respectively, from year-end 2011. The decrease in residential real estate loans came mostly from longer-term, fixed-rate loans, while lower consumer loan balances were largely due to auto loans.

Interest-bearing deposits with banks increased $8,991 from year-end 2011. Interest-bearing deposits with banks largely consist of short-term investments in the Company's Federal Reserve Bank clearing account, which earns 0.25%. During the first quarter of 2012, the Company experienced a significant increase in tax refund volume related to its ERC/ERD business. These short-term tax refunds, facilitating through several of the Company's noninterest-bearing checking accounts, were invested with the Federal Reserve Bank clearing account. As the tax season ended during the second quarter of 2012, the short-term tax refund deposits had disbursed out of the Federal Reserve Bank clearing account, leaving a portion of excess funds retained in the account. With loan demand being challenged and payments and payoffs increasing at a faster pace than new loan balances, a portion of the retained excess funds from the Company's Federal Reserve Bank clearing account were used to fund investment security purchases as well as to satisfy increased maturities within the Company's time deposit portfolio. The Company's investment securities increased $18,649, or 17.2%, from year-end 2011, mostly from purchases of long-term U.S. Government agency ("Agency") mortgage-backed securities.

The Company continues to place more emphasis on growing its core deposit sources, such as noninterest-bearing demand accounts as well as interest-bearing NOW, money market and savings account balances. This emphasis has contributed to a larger balance shift away from its noncore deposit sources such as retail and wholesale time deposits. As a result, during the first nine months of 2012, the Company experienced a $28,162 decrease in its noncore time deposit balances from year-end 2011. This is compared to increases in the Company's interest- and noninterest-bearing core deposit balances, which were up $16,926 and $49, respectively, from year-end 2011. Interest-bearing deposits benefited from increased NOW and savings account balances while noninterest-bearing balances were largely impacted by excess funds retained from the ERC/ERD transactions that had processed during the tax season of 2012, as well as increased balances within the Company's rewards checking products.

The Company will continue to utilize its excess liquidity to fund potential earning asset growth during the fourth quarter of 2012.

Comparison of Financial Condition at September 30, 2012 and December 31, 2011

The following discussion focuses, in more detail, on the consolidated financial condition of the Company at September 30, 2012 compared to December 31, 2011. This discussion should be read in conjunction with the interim consolidated financial statements and the footnotes included in this Form 10-Q.

Cash and Cash Equivalents

The Company's cash and cash equivalents consist of cash, as well as interest- and non-interest bearing balances due from banks. The amounts of cash and cash equivalents fluctuate on a daily basis due to customer activity and liquidity needs. At September 30, 2012, cash and cash equivalents had increased $10,217, or 19.8%, to $61,847, as compared to $51,630 at December 31, 2011. The change in cash and cash equivalents was largely affected by the Company's increase in interest-bearing Federal Reserve Bank clearing account balances caused by increased liquidity from seasonal tax deposits, increased loan payoffs and growth in core deposits from year-end 2011. The Company will generally experience higher levels of excess funds during the first quarter than any other part of the year due to increased tax refund deposits from its ERC/ERD tax business. Liquidity levels normalize during the second quarter as these short-term tax refund deposits are fully disbursed from its Federal Reserve Bank clearing account, leaving a portion of retained excess funds. The Company continues to utilize its interest-bearing Federal Reserve Bank clearing account to maintain these excess funds while loan demand remains challenged. In addition, the Company


will utilize its Federal Reserve Bank clearing account to manage both investment security purchases and maturities, as well as to fund continued maturities of retail and wholesale certificates of deposit ("CD's"). The interest rate paid on both the required and excess reserve balances is based on the targeted federal funds rate established by the Federal Open Market Committee. As of the filing date of this report, the interest rate calculated by the Federal Reserve continues to be 0.25%. This interest rate is similar to what the Company would have received from its investments in federal funds sold, currently in a range of less than 0.25%. Furthermore, Federal Reserve Bank balances are 100% secured.

As liquidity levels vary continuously based on consumer activities, amounts of cash and cash equivalents can vary widely at any given point in time. The Company's focus will be to continue to re-invest these liquid funds back into longer-term, higher-yielding assets, such as loans and investment securities, during 2012 when the opportunities arise. Further information regarding the Company's liquidity can be found under the caption "Liquidity" in this Management's Discussion and Analysis.

Securities

The balance of total securities increased $18,649, or 17.2%, as compared to year-end 2011. The Company's investment securities portfolio has consisted of U.S. Treasury securities, U.S. Government sponsored entity ("GSE") securities, Agency mortgage-backed securities and obligations of states and political subdivisions. During the first nine months of 2012, the Company experienced an increase in its liquidity position impacted by retained excesss funds from seasonal tax clearing activities and increased loan payments and payoffs. As a result, the Company invested a portion of its excess funds into new long-term Agency mortgage-backed securities, which increased $24,870, or 32.0%, from year-end 2011. Typically, the primary advantage of Agency mortgage-backed securities has been the increased cash flows due to the more rapid monthly repayment of principal as compared to other types of investment securities, which deliver proceeds upon maturity or call date. However, with the current low interest rate environment and loan balances at a declining pace, the cash flow that is being collected is being reinvested at lower rates. Principal repayments from Agency mortgage-backed securities totaled $17,721 from January 1, 2012 through September 30, 2012.

While security growth has been evident within the Agency mortgage-backed securities portfolio, the Company saw its U.S. Treasury and GSE securities balances decrease $7,056, or 87.4%, collectively, from year-end 2011. In addition to helping achieve diversification within the Company's investment securities portfolio, U.S. Treasury and GSE securities have been used to satisfy pledging requirements for repurchase agreements. However, during the third quarter of 2011, newly enacted legislation permitted business checking accounts to earn interest on their deposits. This legislation prompted all of the Company's repurchase agreement accounts to reinvest into either interest-bearing demand accounts subject to normal FDIC insurance coverage or noninterest-bearing demand accounts with unlimited FDIC insurance coverage until the end of 2012. As a result, the Company's repurchase agreement balances were $0 at December 31, 2011, eliminating the need to secure these balances with U.S. Treasury and GSE investment securities. For the remainder of 2012, the Company's focus will be to generate interest revenue primarily through loan growth, as loans generate the highest yields of total earning assets.

Loans

The loan portfolio represents the Company's largest asset category and is its most significant source of interest income. During the first nine months of 2012, total loan balances decreased from year-end 2011 by $35,773, or 6.0%. Lower loan balances were mostly influenced by the commercial loan portfolio, which includes both commercial real estate and commercial and industrial loans. While commercial loans were down, management continues to place emphasis on its commercial lending, which generally yields a higher return on investment as compared to other types of loans.

Commercial real estate, the Company's largest segment of commercial loans, decreased $22,088, or 10.6%, from year-end 2011. Commercial real estate consists of owner-occupied, nonowner-occupied and construction loans. Commercial real estate also includes loan participations with other banks outside the Company's primary market area. Although the Company is not actively seeking to participate in loans


originated outside its primary market area, it has taken advantage of the relationships it has with certain lenders in those areas where the Company believes it can profitably participate with an acceptable level of risk. Commercial real estate loans were down largely from its owner-occupied portfolio during 2012, which decreased $23,580, or 18.2%, from year-end 2011. This decrease was mostly due to large loan payoffs during the first quarter of 2012 totaling $16,537 on various owner-occupied commercial real estate loans with two borrowers. Owner-occupied loans consist of nonfarm, nonresidential properties. A commercial owner-occupied loan is a borrower purchased building or space for which the repayment of principal is dependent upon cash flows from the ongoing operations conducted by the party, or an affiliate of the party, who owns the property. Owner-occupied loans of the Company include loans secured by hospitals, churches, and hardware and convenience stores. Nonowner-occupied loans increased $1,800, or 3.2%, from year-end 2011 in large part due to one commercial loan relationship that transitioned from the construction/land development phase of its borrowing arrangement during the third quarter of 2012. Nonowner-occupied loans are property loans for which the repayment of principal is dependent upon rental income associated with the property or the subsequent sale of the property, such as apartment buildings, condominiums, hotels and motels. These loans are primarily impacted by local economic conditions, which dictate occupancy rates and the amount of rent charged. Commercial construction loans, which decreased $308, or 1.4%, from year-end 2011, are extended to individuals as well as corporations for the construction of an individual property or multiple properties and are secured by raw land and the subsequent improvements.

At September 30, 2012, the Company's commercial and industrial loan portfolio was up from year-end 2011 by $2,029, or 4.5%. Commercial and industrial loans consist of loans to corporate borrowers primarily in small to mid-sized industrial and commercial companies that include service, retail and wholesale merchants. Collateral securing these loans includes equipment, inventory, and stock.

Over sixty-five percent of the Company's total commercial loan portfolio, including participation loans, consists of rental property loans (29.6% of portfolio), construction and land development loans (10.2% of portfolio), medical industry loans (6.9% of portfolio), hotel and motel loans (6.8% of portfolio), government and education loans (6.4% of portfolio), and church loans (5.3% of portfolio). At September 30, 2012, the primary market areas for the Company's commercial loan originations, excluding loan participations, were in the areas of Gallia, Jackson and Pike counties of Ohio, which accounted for 47.1% of total originations. The growing West Virginia markets also accounted for 37.3% of total originations for the same time period. While management believes lending opportunities exist in the Company's markets, future commercial lending activities will depend upon economic and related conditions, such as general demand for loans in the Company's primary markets, interest rates offered by the Company, the effects of competitive pressure and normal underwriting considerations.

Generating residential real estate loans remains a significant focus of the Company's lending efforts. Residential real estate loan balances comprise the largest portion of the Company's loan portfolio and consist primarily of one- to four-family residential mortgages and carry many of the same customer and industry risks as the commercial loan portfolio. During the first nine months of 2012, total residential real estate loan balances decreased $8,741, or 3.7%, from year-end 2011. The decrease was mostly from the Company's 15-, 20- and 30-year fixed-rate loans, which declined $18,549, or 11.3%, from year-end 2011. Long-term interest rates continue to remain at historic low levels and have prompted periods of increased refinancing demand for long-term, fixed-rate real estate loans in recent years. Management has determined that originating 100% of the demand for long-term fixed-rate real estate loans at such low rates would present an unacceptable level of interest rate risk. Therefore, to help manage interest rate risk while also satisfying the demand for long-term, fixed-rate real estate loans, the Company has strategically chosen to originate and sell most of its fixed-rate mortgage loans to the secondary market, which allowed its customers to take advantage of low rates and reduce their monthly costs. The Company maintains its relationship with the customer by servicing the loan. The customer must qualify to take advantage of a secondary market loan based on various criteria which could limit volume growth. The Company has experienced an increase in refinancing volume, which has led to higher secondary market sales in 2012 versus 2011. During the first nine months of 2012, a total of 153 loans totaling $19,798 were sold, compared to 70 loans sold totaling $7,839 during the first nine months of 2011. The remaining real estate loan portfolio balances increased $9,808, or 13.2%. This increase came primarily from the Company's


other variable-rate loan products being offered to its customers as alternative financing options. A customer that may not qualify for a long-term, secondary market loan may choose from one of the Company's other adjustable-rate mortgage products. This has contributed to higher balances of five-year, adjustable-rate mortgages, which were up $11,263 or 67.9%, from year-end 2011. The Company believes it has limited its interest rate risk exposure due to its practice of promoting and selling residential mortgage loans to the secondary market. The Company will continue to follow this secondary market strategy until long-term interest rates increase back to a range that falls within an acceptable level of interest rate risk.

Lower loan balances during 2012 were also influenced by the Company's total consumer loans, which decreased $6,973, or 6.5%, from year-end 2011. The Company's consumer loans are primarily secured by automobiles, mobile homes, recreational vehicles and other personal property. Personal loans and unsecured credit card receivables are also included as consumer loans. The decrease in consumer loans came mostly from the Company's automobile lending portfolio, which decreased $4,194, or 9.2%, from year-end 2011. The automobile lending component comprises the largest portion of the Company's consumer loan portfolio, representing 41.4% of total consumer loans at September 30, 2012. In recent years, growing economic factors have weakened the economy and have limited consumer spending. During this time of economic challenge, the Company continues to maintain a strict loan underwriting process on its consumer auto loan offerings to limit future loss exposure. The Company's interest rates offered on indirect automobile opportunities have struggled to compete with the more aggressive lending practices of local banks and alternative methods of financing, such as captive finance companies offering loans at below-market interest rates related to this segment. The decreasing trend of auto loan balances should continue during the fourth quarter 2012, as the larger institutions and captive finance companies will continue to aggressively compete for a larger share of the market.

The remaining consumer loan products not discussed above declined $2,779, or 4.5%, which include general decreases in loan balances from recreational vehicles, mobile homes, home equity lines of credit and unsecured loans. Management will continue to place more emphasis on other loan portfolios (i.e. commercial and, to a smaller extent, residential real estate) that will promote increased profitable loan growth and higher returns. Indirect automobile loans bear additional costs from dealers that partially offset interest revenue and lower the rate of return.

The Company continues to monitor the pace of its loan volume. The well-documented housing market crisis and other disruptions within the economy have negatively impacted consumer spending, which has continued to limit the lending opportunities within the Company's market locations. Declines in the housing market since 2007, with falling home prices and increasing foreclosures and unemployment, have continued to result in significant write-downs of asset values by financial institutions. To combat this ongoing potential for loan loss, the Company will remain consistent in its approach to sound underwriting practices and a focus on asset quality. The Company anticipates its overall loan growth in 2012 to remain challenged.

Allowance for Loan Losses

Management evaluates the adequacy of the allowance for loan losses quarterly based on several factors, including, but not limited to, general economic conditions, loan portfolio composition, prior loan loss experience, and management's estimate of probable incurred losses. Management continually monitors the loan portfolio to identify potential portfolio risks and to detect potential credit deterioration in the early stages, and then establishes reserves based upon its evaluation of these inherent risks. Actual losses on loans are reflected as reductions in the reserve and are referred to as charge-offs. The amount of the provision for loan losses charged to operating expenses is the amount necessary, in management's opinion, to maintain the allowance for loan losses at an adequate level that is reflective of probable and inherent loss. The allowance required is primarily a function of the relative quality of the loans in the loan portfolio, the mix of loans in the portfolio and the rate of growth of outstanding loans. Impaired loans, which include loans classified as troubled debt restructurings ("TDR's"), are considered in the determination of the overall adequacy of the allowance for loan losses.

The struggles of our U.S. economy in recent years have had a direct impact on the Company's borrowers,


as they continue to experience financial difficulties and liquidity strains. The . . .

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