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OVBC > SEC Filings for OVBC > Form 10-Q on 12-Nov-2013All Recent SEC Filings

Show all filings for OHIO VALLEY BANC CORP

Form 10-Q for OHIO VALLEY BANC CORP


12-Nov-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 season, typically during the first quarter of each year. Loan Central also provides refund anticipation loans ("RALs") to its customers. RALs are short-term cash advances against a customer's anticipated income tax refund.

For the three months ended September 30, 2013, the Company's net income decreased by $46, or 4.2%, as compared to the same period in 2012, to finish at $1,061. Earnings per share for the third quarter of 2013 also decreased by $.01, or 3.7%, compared to the same period in 2012, to finish at $.26 per share. For the nine months ended September 30, 2013, net income increased by $778, or 14.3%, to finish at $6,226, compared to the same period in 2012. Earnings per share for the first nine months of 2013 also increased by $.18, or 13.3%, compared to the same period in 2012, to finish at $1.53 per share. The annualized net income to average asset ratio, or return on assets ("ROA"), improved to 1.05% at September 30, 2013, as compared to .87% at September 30, 2012. The Company's net income to average equity ratio, or return on equity ("ROE"), improved to 10.72% at September 30, 2013, as compared to 9.89% at September 30, 2012.

The largest contributor to the Company's comparable net income results during the third quarter of 2013 and successful year-to-date growth through September 30, 2013 was lower provision expense, which decreased $350 during the three months ended September 30, 2013, and decreased $2,348 during the nine months ended September 30, 2013, as compared to the same periods in 2012. The decreases in provision expense in 2013 were impacted mostly by lower levels of net charge-offs and improved asset quality factors when compared to the previous year of 2012. During the three months ended September 30, 2013, net charge-offs were reduced to $35, a decrease of $490 from the same period in 2012, due to higher charge-offs recognized during the third quarter of 2012. During the nine months ended September 30, 2013, net charge-offs totaled $314, a decrease of $1,868 from the same period in 2012. The ratio of nonperforming loans to total loans was 0.84% at September 30, 2013 compared to 1.27% at September 30, 2012. With the continued improvement in asset quality trends, the historical loan loss factors that impact the general allocations of the allowance for loan losses have decreased. As a result, the required general reserves have decreased, which contributed to lower provision expense for both the three and nine months ended September 30, 2013 when compared to the same periods in 2012.


Further impacting the net income results were changes in the Company's noninterest income during 2013. Noninterest income finished at $1,574 during the three months ended September 30, 2013, representing a decrease of 6.0% when compared to $1,674 of noninterest income recognized during the same period in 2012. This $100 quarterly decrease was largely due to lower revenue from mortgage banking income and higher losses recognized on other real estate owned. Noninterest income during the nine months ended September 30, 2013 improved to $7,479, an increase of $352 when compared to the same period in 2012. Noninterest income during 2013 has been largely impacted by net life insurance proceeds, as well as increased transaction volume related to the Company's ERC/ERD fees and debit and credit card interchange income. Bank owned life insurance proceeds of $452 were collected in the first quarter of 2013 in conjunction with the Company's investment in various benefit plans for its directors and key employees. Also, during the nine months ended September 30, 2013, ERC/ERD fees increased $253 from the same period in 2012, due to an increase in the number of tax refund items processed. This revenue source has accounted for 34 percent of the Company's noninterest income for the first nine months of 2013. Further contributing to revenue growth during 2013 was the increase in interchange fees earned on debit and credit card transactions. By continuing to offer incentives to customers to utilize the bank's debit and credit card for purchases, interchange income increased $209 during the nine months ended September 30, 2013 as compared to the same period in 2012.

Partially offsetting the benefits of lower provision expense and noninterest income improvement during 2013 were changes in net interest income and noninterest expense. The Company's net interest income during the three months ended September 30, 2013 improved by $63 to finish at $7,930, as compared to the same period in 2012. The contributing factor to net interest income growth was a higher net interest margin resulting from a decline in lower yielding asset balances with the Federal Reserve Bank. During the third quarter of 2013, the average balance of the Company's Federal Reserve Bank clearing account, earning 25 basis points, decreased $37,358 when compared to the average balance during the third quarter of 2012, which had a positive effect on the net interest margin. This, combined with the continued decrease in funding costs, improved the third quarter 2013 net interest margin to 4.57%, as compared to 4.23% during the third quarter of 2012. While the Company's net interest income improved during 2013's third quarter, year-to-date net interest income during the nine months ended September 30, 2013 decreased $640 as compared to the same period in 2012. The decrease was impacted mostly from lower average earning assets of $740,518 at September 30, 2013, as compared to $782,491 at September 30, 2012. The decline in average loan balances contributed most to lower net interest income and is reflective of the continued stagnant economic environment, which has reduced the amount of lending opportunities within the Company's market areas.

The Company's noninterest expenses during the three and nine months ended September 30, 2013 increased $363 and $1,134, respectively, as compared to the same periods in 2012. Higher noninterest expense was impacted by increases in salaries and employee benefits of $208 and $561 during the three and nine months ended September 30, 2013, respectively, as compared to the same periods in 2012. The increases were largely due to annual merit increases and retirement benefit costs. The Company also recognized higher incentive costs on customer relationship accounts, which increased overhead expense by $53 during the three months ended September 30, 2013, and $178 during the nine months ended September 30, 2013, as compared to the same periods in 2012. Noninterest expense was also impacted by fluctuations in foreclosed asset costs, which were down $18 during the three months ended September 30, 2013, but increased $146 during the nine months ended September 30, 2013, as compared to the same periods in 2012. Foreclosed asset costs are related to the liquidation of real estate assets in process of foreclosure. Further impacting noninterest expense 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 specifically during the nine months ended September 30, 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 decreased $21,717, or 2.8%, during the first nine months of 2013, as compared to year-end 2012, to finish at $747,506. This change in assets was due to a decrease in the Company's earning assets of $18,966 from year-end 2012, mostly from lower interest-bearing deposits with banks and investment securities. The Company's interest-bearing deposits with banks decreased $12,087 from year-end 2012, largely from short-term investments in the Company's Federal Reserve Bank clearing account. The Company used its Federal Reserve Bank clearing account to fund increased maturities within the Company's time deposit portfolio, which contributed to lower interest-bearing deposit balances at September 30, 2013.

The Company's investment securities also decreased $6,299, or 5.3%, during the first nine months of 2013 as compared to year-end 2012. This change was impacted mostly by a $13,963, or 14.9%, decrease in the Company's U.S. Government agency ("Agency") mortgage-backed securities portfolio, which continue to experience increased cash flows from monthly principal repayments. A portion of the mortgage-backed security proceeds were used to invest in new, long-term U.S. Government sponsored entity ("GSE") securities, which increased $7,843 from year-end 2012, providing added diversification within the Company's investment securities portfolio at September 30, 2013.

Further impacting lower assets was the Company's loan portfolio, which decreased $2,075, or 0.4%, from year-end 2012. This change in loan balances came primarily from the residential real estate loan portfolio, which decreased $10,021, or 4.4%, from year-end 2012, largely due to a decline in loan demand of long-term, fixed-rate mortgages. This decrease was partially offset by a $7,946 increase in the Company's commercial and consumer loan portfolios, collectively, during the nine months ended September 30, 2013, as compared to year-end 2012. Increases came from both commercial real estate and commercial and industrial loan balances within the commercial loan portfolio and consumer real estate balances within the consumer loan portfolio.

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 2013, the Company experienced a $37,598 decrease in its noncore time deposit balances from year-end 2012. This is compared to an increase in the Company's interest-bearing core deposit balances, which were up $17,482 from year-end 2012. Interest-bearing deposits benefited from increased NOW and savings account balances. The Company's noninterest-bearing core deposit balances decreased $6,115 from year-end 2012 primarily from lower business checking account balances.

Comparison of Financial Condition at September 30, 2013 and December 31, 2012

The following discussion focuses, in more detail, on the consolidated financial condition of the Company at September 30, 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 September 30, 2013, cash and cash equivalents had decreased $12,754, or 27.9%, to finish at $32,897, as compared to $45,651 at December 31, 2012. The decrease in cash and cash equivalents was largely affected by the Company's use of excess funds retained from seasonal tax deposits during the first half of 2013. 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 and third quarters 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. With loan demand continuing to decline during the third quarter of 2013, the Company used its Federal Reserve Bank clearing account deposits to help fund a net reduction in deposits of $26,231, primarily related to 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. Carrying excess cash has a negative impact on interest income since the Company currently only earns 0.25% on its deposits with the Federal Reserve. As a result, the Company's focus will be to continue to re-invest these excess funds back into longer-term, higher-yielding assets, such as loans and investment securities, during 2013 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 decreased $6,299, or 5.3%, as compared to year-end 2012. The Company's investment securities portfolio consists of GSE investment securities, agency mortgage-backed securities and obligations of states and political subdivisions. During the first nine months of 2013, the Company continued to experience increased cash flows from monthly principal repayments of its agency mortgage-backed securities. Typically, the monthly repayment of principal has been the primary advantage of agency mortgage-backed securities 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 $20,703 from January 1, 2013 through September 30, 2013. As a result of increasing principal repayments, the Company's agency mortgage-backed securities decreased $13,963, or 14.9%, from year-end 2012.

The Company invested a portion of the excess funds from its agency mortage-backed securities into new long-term GSE securities, which increased $7,843 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 71.3% of total investment securities at September 30, 2013.

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 nine months of 2013, total loan balances decreased from year-end 2012 by $2,075, or 0.4%. Lower loan balances were mostly influenced by the residential real estate loan portfolio. 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 2013, total residential real estate loan balances decreased $10,021, or 4.4%, from year-end 2012. The decrease was mostly from the Company's fixed-rate loans, which declined $20,479, or 15.0%, 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 long-term 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. In 2012, the Company experienced an increase in refinancing volume for long-term fixed-rate real estate loans, particularly during the second half of 2012. As a result, during the first nine months of 2013, refinancing volume that led to secondary market sales has trended down, with 99 loans sold totaling $12,143 as compared to 153 loans sold totaling $19,798 during the first nine months of 2012.

The remaining real estate loan portfolio balances increased $10,458, or 11.7%, from year-end 2012. 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 does 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 $15,821, or 46.8%, from year-end 2012. The Company will continue to follow its secondary market strategy until long-term interest rates increase back to a range that falls within an acceptable level of interest rate risk.

The decrease in residential real estate loan balances during 2013 was partially offset by increases in the Company's commercial loan portfolio, which includes both commercial real estate and commercial and industrial loan balances. Commercial real estate, the Company's largest segment of commercial loans, increased $2,583, or 1.5%, 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 loan balances increased largely from its construction loans, which increased $6,793, or 39.1%, from year-end 2012. Construction loans 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. The Company's nonowner-occupied loans increased $2,703, or 5.1%, from year-end 2012 due to increases in originations. 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. The Company's owner-occupied loan portfolio decreased during 2013 by $6,913, or 6.6%, from year-end 2012. This change was in large part due to the larger loan payoffs and paydowns of seven owner-occupied loans totaling $4,947. 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.

At September 30, 2013, the Company's commercial and industrial loan portfolio was up from year-end 2012 by $4,283, or 7.5%, largely from the origination of two larger loans during the second and third quarters of 2013. 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 (27.8% of portfolio), hotel and motel loans (6.9% of portfolio), government & education loans (6.2% of portfolio), church loans (5.4% of portfolio) and construction and remodeling loans (5.3% of portfolio). At September 30, 2013, the primary market areas for the Company's commercial loan originations, excluding loan participations, continued to be in the areas of Gallia, Jackson and Pike counties of Ohio, which accounted for 37.9% of total originations. The West Virginia markets also accounted for 22.7% of total originations during 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. Management will continue to place emphasis on its commercial lending, which generally yields a higher return on investment as compared to other types of loans.


The Company's total loans were also impacted by consumer loans, which increased $1,080, or 1.1%, 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 limited growth in consumer loans has been mostly affected by the Company's automobile lending portfolio, which decreased $874, or 2.1%, from year-end 2012. The automobile lending component comprises the largest portion of the Company's consumer loan portfolio, representing 39.9% of total consumer loans at September 30, 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 is expected to continue during the remainder of 2013.

The remaining consumer loan products not discussed above increased $1,954, or 3.3%, from year-end 2012, which include changes in loan balances from consumer real estate, recreational vehicles, mobile homes, home equity lines of credit and unsecured loans.

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.

Allowance for Loan Losses

Assessing the adequacy of the allowance for loan losses is a process that requires considerable judgment. 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 . . .

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