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OVBC > SEC Filings for OVBC > Form 10-Q on 10-May-2013All 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


10-May-2013

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, taxes, the effects of implementation of the Budget Control Act of 2011 and the American Taxpayer Relief Act of 2012 and the continuing economic uncertainty in various parts of the world; 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, 2012. 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 provide RALs to its customers.

For the three months ended March 31, 2013, the Company's net income increased by $601, or 22.9%, as compared to the same period in 2012, to finish at $3,223. The Company's earnings per share for the first quarter of 2013 increased by $.14, or 21.5%, compared to the same period in 2012, to finish at $.79 per share. The annualized net income to average asset ratio, or return on assets (ROA), improved to 1.56% at March 31, 2013, as compared to 1.20% at March 31, 2012. The Company's net income to average equity ratio, or return on equity (ROE), improved to 17.13% at March 31, 2013, as compared to 14.60% at March 31, 2012.


The largest contributor to the Company's higher 2013 first quarter net income was a $1,285, or 97.6%, decrease in loan loss provision expense. This decrease was the result of lower net charge-offs during the first quarter of 2013, which decreased $1,549, or 85.4%, as compared to the first quarter of 2012. The decrease in net charge-offs was primarily due to additional partial charge-offs of $1,118 taken on various residential real estate and commercial real estate loans in March 2012. The partial charge-offs required a corresponding impairment charge to provision expense due to a continued deterioration of collateral values. In addition, the partial charge-offs taken on these residential real estate and commercial real estate loan balances in March 2012 contributed to an increase in general allocations associated with the average historical loan loss factor within the allowance for loan losses.

Further impacting net income results during the three months ended March 31, 2013 was an increase in the Company's noninterest income of $461, or 13.3%, over the same period in 2012. The growth in noninterest income was largely due to net life insurance proceeds collected in the first quarter of 2013, as well as increased transaction volume related to the Company's ERC/ERD fees, debit and credit card interchange income, and mortgage banking revenue.

Partially offsetting the benefits of lower provision expense and higher noninterest income during the first quarter of 2013 was lower net interest income combined with higher noninterest expenses. The Company's net interest income decreased $491, or 5.5%, during the first quarter of 2013 as compared to the first quarter of 2012. The decrease was impacted mostly from lower average earning assets of $786,219 at March 31, 2013 as compared to $823,271 at March 31, 2012, largely from loans. The Company's noninterest expense increased $616, or 8.4%, during the first quarter of 2013 as compared to the first quarter of 2012. Higher noninterest expense was impacted by increases in foreclosed asset costs related to the liquidation of real estate in process of foreclosure, as well as salaries and employee benefits due to annual merit increases and retirement benefit costs. Further impacting noninterest expense during the first quarter of 2013 was a fee of $212 associated with the redemption of $5,000 in trust preferred securities classified as subordinated debentures in March 2013. While this contributed to the growth in overhead expenses during the first quarter of 2013, the $5,000 redemption in trust preferred securities is anticipated to have a favorable impact on future earnings due to the elimination of $530 in annual interest expense.

The consolidated total assets of the Company increased $65,685, or 8.5%, during the first three months of 2013 as compared to year-end 2012, to finish at $834,908. This change in assets was led by an increase in the Company's interest-bearing deposits with banks, which increased $70,496 from year-end 2012, largely from short-term investments in the Company's Federal Reserve Bank clearing account. During the first quarter of 2013, the Company experienced an 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 its Federal Reserve Bank clearing account, which increased $70,511 from year-end 2012. Asset balances were further increased by growth in the Company's investment securities, which increased $4,535, or 3.8%, from year-end 2012. The Company has invested a portion of its excess funds from investment security prepayments and maturity proceeds into long-term U.S. Government sponsored entity ("GSE") securities during the first quarter of 2013, which increased $8,002 from year-end 2012.

The first three months of 2013 saw the Company's loan portfolio decrease $7,014, or 1.3%, from year-end 2012. This change in loan balances came primarily from the commercial real estate loan portfolio, which decreased $2,745, or 1.6%, from year-end 2012, largely due to increases in loan payoffs recorded during the first quarter of 2013. Further decreasing the Company's loan portfolio were consumer and residential real estate loans, which decreased $2,745 and $2,470, respectively, from year-end 2012. The decreases in consumer loans were largely due to lower auto loan balances, while lower residential real estate loan balances were impacted mostly in longer-term, fixed-rate loans.

While the demand for loans was down during the first three months of 2013, the Company was able to benefit from growth in its total deposit liabilities of $67,308 from year-end 2012. The majority of this growth came from the Company's core noninterest-bearing deposit balances increasing $73,181 from year-end 2012, as a result of an increased level of ERC/ERD transactions being processed during the first quarter of 2013. Interest-bearing deposit liabilities continued to shift into more core


deposit sources from year-end 2012, such as the Company's NOW and savings account balances while experiencing a larger shift away from non-core deposit sources such as retail and wholesale time deposits. The Company's core interest-bearing deposit balances were up $10,520 from year-end 2012, while its non-core time deposit balances were down $16,393 from year-end 2012. While other borrowed funds remained relatively the same from year-end 2012, the Company's subordinated debentures decreased $5,000 during the same period, which was due to the redemption of $5,000 in trust preferred securities on March 7, 2013. The redemption supports the Company's continued emphasis on lowering funding costs to strengthen the net interest margin as average earning assets continue to decline. The Company anticipates an annual interest expense savings of $530, most of which will be recognized in 2013.

The retained portion of excess liquidity created by seasonal growth in total deposits will be available to fund potential earning asset growth during the remainder of 2013.

Comparison of Financial Condition at March 31, 2013 and December 31, 2012

The following discussion focuses, in more detail, on the consolidated financial condition of the Company at March 31, 2013 compared to December 31, 2012. 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 March 31, 2013, cash and cash equivalents had increased $69,721, or 152.7%, to $115,372, as compared to $45,651 at December 31, 2012. The increase in cash and cash equivalents was largely due to deposit liability growth combined with increased loan payoffs from year-end 2012. The rise in deposit liability balances was mostly from seasonal increases in ERC/ERD transactions that facilitate within the Company's noninterest-bearing deposit accounts. 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 utilizes its Federal Reserve Bank clearing account to manage both investment security purchases and maturities, as well as to fund maturities of retail and wholesale 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, which currently is 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. The Company's focus will be to continue to re-invest these liquid funds in longer-term, higher-yielding assets, such as loans and investment securities, 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 $4,535, or 3.8%, as compared to year-end 2012. The Company's investment securities portfolio consists of GSE investment securities, U.S. Government agency ("Agency") mortgage-backed securities and obligations of states and political subdivisions. During the first quarter of 2013, the Company continued to experience increased cash flows from monthly principal repayments of its agency mortgage-backed securities. The Company invested a portion of these excess funds into new long-term GSE securities, which increased $8,002 from year-end 2012. The Company's investment in new GSE securities increased diversification within the investment securities portfolio, which was comprised mostly of agency mortgage-backed securities, totaling 73.6% of total investment securities at March 31, 2013.


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 $8,340 from January 1, 2013 through March 31, 2013. As a result of increasing principal repayments and reinvestments into GSE securities, the Company's agency mortgage-backed securities decreased $3,454, or 3.7%, from year-end 2012.

For the remainder of 2013, 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 three months of 2013, total loan balances decreased from year-end 2012 by $7,014, or 1.3%. 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 $2,745, or 1.6%, from year-end 2012. 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 2013, which decreased $2,726, or 2.6%, from year-end 2012. This decrease was mostly due to a payoff totaling $1,063 on one owner-occupied commercial real estate loan. 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 decreased $1,913, or 3.6%, from year-end 2012 in large part due to the larger loan payoffs of three nonowner-occupied loans totaling $2,109. 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 increased $1,894, or 10.9%, from year-end 2012, 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 March 31, 2013, the Company's commercial and industrial loan portfolio was up from year-end 2012 by $946, or 1.7%. 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 half of the Company's total commercial loan portfolio, including participation loans, consists of rental property loans (28.3% of portfolio), hotel and motel loans (6.9% of portfolio), government & education loans (6.3% of portfolio), church loans (5.4% of portfolio) and construction & remodeling loans (5.4% of portfolio). At March 31, 2013, 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 78.5% of total originations. The growing West Virginia markets also accounted for 19.3% 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.


Lower loan balances during 2013 were also influenced by the Company's total consumer loans, which decreased $2,745, or 2.7%, from year-end 2012. 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 $1,095, or 2.7%, from year-end 2012. The automobile lending component comprises the largest portion of the Company's consumer loan portfolio, representing 41.2% of total consumer loans at March 31, 2013. In recent years, growing economic factors have weakened the economy and have limited consumer spending. 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. The decreasing trend of auto loan balances should continue during 2013.

The remaining consumer loan products not discussed above declined $1,650, or 2.8%, which included general decreases in loan balances from recreational vehicles, mobile homes, home equity lines of credit and unsecured loans.

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 quarter of 2013, total residential real estate loan balances decreased $2,470, or 1.1%, from year-end 2012. The decrease was mostly from the Company's fixed-rate loans, which declined $6,077, or 4.5%, from year-end 2012. 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. Originating long-term fixed-rate real estate loans at such low rates presents 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. 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 2013 versus 2012. During the first three months of 2013, a total of 40 loans totaling $4,972 were sold, compared to 37 loans sold totaling $4,717 during the first three months of 2012. The remaining real estate loan portfolio balances increased $3,607, or 4.0%. 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 $6,184, or 18.3%, from year-end 2012. 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.

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 continued challenges to its attempt to grow its loan portfolio in 2013.

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 Company is faced with the ongoing decision of whether to foreclose on these troubled loans and take possession of the collateral or to work with the borrower to modify the original terms of the loan. A successful loan modification not only avoids costly foreclosure proceedings but, more importantly, could result in the full repayment of the loan principal amount. The Company continues to monitor and make loan modifications to certain troubled loans that would ease payment pressures on the borrower. Most generally, the modification "period" of the original terms of the loan is only temporary (i.e. 12 months), after which the loan would resume under the original contractual terms of the loan. GAAP and regulatory guidance identifies certain loan modifications that would be classified as TDR's, which, in general, is when a bank, for reasons related to a borrower's financial difficulties, grants a concession to the borrower that the bank would not otherwise consider. One such qualification would be if the bank modified the original terms of the loan for the remaining original life of the debt. Modifications of the original terms would include temporarily adjusting the contractual interest rate of the loan or converting the payment method from principal and interest amortization payments to interest-only for a temporary period of time.

During the first three months of 2013, the Company's allowance for loan losses decreased $233, or 3.4%, to finish at $6,672 as compared to $6,905 at year-end 2012. This decrease in reserves was largely due to a reduction in general allocations related to economic risk trends, lower net charge-offs and lower loan balances. Management has focused on improving asset quality and lowering credit risk while working to maintain its relationships with its borrowers. As part of the Company's quarterly analysis of the allowance for loan losses, an improving trend has been identified within its economic risk allocation, which, among other things, accounts for unemployment rates and classified/criticized asset levels. Since year-end 2012, unemployment rates within the Company's lending markets have decreased, while classified and criticized asset balances have also decreased. The Company has also continued to experience improving trends in lower loan losses associated with net charge-offs during the past 36 months, which have contributed to less required general allocations of the allowance for loan losses. At March 31, 2013, the Company's annualized ratio of net charge-offs to average loans decreased to 0.19%, as compared to 1.23% at March 31, 2012 and 2.65% at March 31, 2011, primarily within the commercial real estate loan portfolio. In addition, the Company's total loan portfolio balance decreased $7,014 from year-end 2012, having a direct impact on lower general allocations of the allowance. As a result, these factors contributed to a $238, or 5.0%, decrease in the Company's total general allocation from year-end 2012.

The Company's impaired loans decreased $482 from year-end 2012 in large part due to the payoff of one commercial real estate loan totaling $300 and a large principal paydown of $422 on another commercial real estate loan. The portions of impaired loans for which there are specific allocations reflect losses that the Company expects to incur, as they will not likely be able to collect all amounts due according to the contractual terms of the loan. At March 31, 2013, . . .

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