Consumers Bancorp, Inc.
Annual Report 2011

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C M Y CM MY CY CMY K Financial Highlights Dollar amounts in thousands, except per share data ASSETS Total cash and cash equivalents Certificates of deposit in financial institutions Securities, available-for-sale Federal bank and other restricted stocks, at cost Total loans Less allowance for loan losses Net loans Other assets Total assets LIABILITIES Deposits: Non-interest bearing demand Interest bearing demand Savings Time Total deposits Short-term borrowings Federal Home Loan Bank advances Other liabilities Total liabilities SHAREHOLDERS’ EQUITY Total shareholders’ equity Total liabilities and shareholders’ equity June 30, 2011 June 30, 2010 $ 13,828 4,900 91,889 1,186 177,551 (2,101) 175,450 12,887 $ 300,140 $ 64,657 14,829 79,816 88,944 248,246 17,012 7,535 2,023 274,816 $ 13,806 980 64,262 1,186 174,283 (2,276) 172,007 11,152 $ 263,393 $ 47,659 13,687 63,704 91,264 216,314 13,086 8,297 1,980 239,677 25,324 $ 300,140 23,716 $ 263,393 Cash dividends paid per share Weighted average number of shares outstanding $ 0.41 2,042,874 $ 0.40 2,032,588 NET INCOME Interest income Interest expense Net interest income Provision for loan losses Net interest income after provision for loan losses Other income Other expense Income before income taxes Income taxes Net income $ 12,784 1,916 10,868 435 10,433 2,011 9,575 2,869 621 $ 2,248 $ 12,610 2,560 10,050 544 9,506 2,148 9,048 2,606 567 $ 2,039 Basic earnings per share $ 1.10 $ 1.00 Please refer to the annual report on Form 10-K for additional financial information. AnnualReportCoverSpread.indd 1 9/12/2011 3:05:34 PM Dear Fellow Shareholders, The term “community bank” is frequently tossed about by politicians and the media, but judging from the questions I receive the meaning of the term remains unclear. I believe community banking is defined by attitude; not size. It is a business philosophy that permeates all aspects of an organization; one that combines talented people, local commitment, thoughtful investment and superior technology into an unbeatable package that, when done well, yields superior financial performance. Community banks meet the collective needs of their employees, customers, investors and communities. In short, they are the banks that strengthen their communities. Let me elaborate on my definition of a community bank and why I believe Consumers Bancorp stands out as one of the best. I believe community banking is defined by attitude; not size. It is a business philosophy that permeates all aspects of an organization … Community banks have people at all levels of an organization who have a stake in the communities they serve. Consumers Bancorp has 100% local board representation and local executive and senior managers making decisions that affect the region. We have seven commercial lenders working in specific markets and industries; many in their home or adopted towns. People cannot just be local; they must be talented and committed to their customers. I assure you that the Consumers’ staff and leadership in each department define both ideas. In community banks, the people make the biggest difference. Community bank managers make decisions with the long-term interest of the bank and customer at heart. While most retail and commercial customers have been affected by this economy, those with practical banking solutions and sincere banking partnerships will survive. This long-term outlook has allowed the best community banks to flourish during the prolonged economic downturn. Strong credit and investment quality stemming from years of consistent decisions continue to have a positive impact on Consumers Bancorp. Our lenders continue to work with manufacturers, farmers and organizations to ensure their future competitiveness and sustainability. The strong income and asset quality results achieved over the past three years and documented in these pages are testament to the appropriateness of this long- term thinking. institutions their employees’ the organizations and local leadership Community banks provide involvement by supporting in that are important to the long-term viability and vibrancy of the region. Invariably, community banks enthusiastically provide financial support to the same organizations. Again, Consumers National Bank defines this concept. You will find Consumers National Bank and its directors and employees offering support to schools, hospitals, Text.indd 1 9/12/2011 3:17:48 PM libraries, Habitat for Humanity, YMCAs, 4-H, Junior Achievement, bands, athletics, chambers of commerce, service organizations and economic development the community is a mission we take very seriously. Strengthening groups. Community banks have a local focus. Each dollar deposited in Consumers National Bank is available for investment in local individuals, farms, businesses and organizations. Funds are not diverted to far-flung businesses or exotic investment vehicles. Over the past three years, Consumers National Bank has made $105 million in loans primarily in Stark, Columbiana and Carroll counties. These investments spur economic growth and generate the income used to support our 119 local employees, fund our commitment to local organizations, pay local taxes and provide a return to our 950 local shareholders. In addition, we fulfill our business needs through local small businesses that participate in the same cycle. As the cover of this report portrays, your bank contributes to all phases of the local economy. Each dollar deposited in Consumers National Bank is available for individuals, investment farms, businesses and organizations. local in to long-time commitment Knowing that successful community banks and their customers need technology to compete in today’s world, they complement the community bank philosophy with leading edge technology. this Consumers’ strategy remains strong. We have long embraced internet, mobile and text banking, as well as image solutions and on- merchant capture, line account opening. This fiscal year we have provided our customers with Intuit’s internet banking and personal financial management (FinanceWorks) solutions, Purchase Rewards programs, new personal payment systems as well as smart phone and tablet banking applications. We have expanded cash management capabilities and payroll services. We look forward to internet bill pay advances, an upgraded investment services platform and more insurance initiatives. We also look toward efficiencies through expanded use of wireless, “cloud” computing, web and electronic marketing and social media applications. We will continue to upgrade our customers’ experiences and accessibility without compromising the community bank model. Community banks are profitable. The mega banks’ focus on short-term profits and their subsequent near catastrophic collapse is well-chronicled. Similarly, the headline-capturing failures of community banks often follow a similar, albeit less dramatic, reach for growth and profit. Community banks that hold to the above principles generally outperform those who stray. Consumers’ model held and its financial performance over the last several years is proof that the model remains viable. Asset growth continued with 2011 earnings increasing more than ten percent over 2010 and ii Text.indd 2 9/12/2011 3:17:49 PM been created over the last three years. This is the message we took to the new Hartville market and the answer I give when asked about community banking. It is a compelling response that I am proud to deliver. Please join me in spreading the message. Your support is vital and appreciated. I look forward to personally thanking you for your support at the Annual Shareholders Meeting at noon on October 26 at the Quarry Golf Club. Sincerely, Sincerely, Ralph J. Lober, II President and CEO Consumers Bancorp being included in US Bankers list of the top 200 community banks in the country for the second straight year. Community banks are resilient. The industry has survived interstate banking, regulation, deregulation, numerous economic catastrophes and even more regulation by adhering to its guiding principles. Much has been written about the new round of regulatory pressure and requirements being pushed to banks of all sizes. While the government response is significant and uneven, the best community banks will adjust resources where necessary, work for change where possible and, most importantly, continue to profitably serve our communities. Consumers National Bank has the infrastructure, talent, leadership and discipline to operate in the new regulatory environment. We look to leverage our credit, risk, finance, technology and marketing infrastructure to benefit from reasonable market opportunities. Our people will again differentiate us. Over the last three years shareholders’ equity has increased $5.75 million, or 29% while the corporation paid out $2.46 million in quarterly dividends. Finally, community banks have local shareholders who care about the future of their “Main Street.” The best banks reward the long-term vision of their shareholders with strong equity growth and consistent dividends. Again, Consumers Bancorp meets the test. Consumers Bancorp remains independent with approximately 950 shareholders including approximately 41 employee shareholders. Over the last three years shareholders’ equity has increased $5.75 million, or 29% while the corporation paid out $2.46 million in quarterly dividends. The quarterly per share dividend amount increased by 10 percent in the fourth fiscal quarter of 2011 after remaining stable throughout the banking crisis. In total, $8.2 million in shareholder value has Text.indd 3 iii 9/12/2011 3:17:51 PM Investing In Your Local Economy “It’s often been said if you really want to know what’s going on, just follow the money.” This is the opening line in a recent radio commercial Consumers National Bank aired to promote how our bank contributes to the local economy. “ You open a checking account with us, then a local businessman needs a loan—he hires employees who need clothes and food…” continues the commercial explaining in concrete terms how Consumers transforms customer deposits into business loans that support the economic cycle every step of the way. In this year’s annual report, we are highlighting some of our customers to illustrate how Consumers is deeply involved with and invested in the economic health of the communities we serve. Small Business and Agriculture to According the U.S. Small Business Administration, small firms represent 99.7 percent of all employer firms, employ just over half of all private sector employees, pay 44 percent of total U.S. private payroll, and have generated 64 percent of net new jobs over the past 15 years. Agricultural trade also provides significant contributions to both the agricultural and non-agricultural sectors of the U.S. economy, supporting $280.5 billion in economic output and 1.6 million jobs in 2009, according to the Agricultural & Applied Economics Association. Clearly small business and agriculture are significant drivers of our local economy. lending capabilities are boosted by Our relationships with the U.S. Small Business Administration—Consumers an SBA Preferred Lender that ranked in the top 10 of all banks in the northern region of Ohio—local chambers of commerce and development entities, and various state and federal lending programs. is We can begin our review of the bank’s roll in the local economic chain by looking at one of our long-time agriculture customers in the dairy industry—Sandy Hill Dairy Farm in Columbiana Dairy cows at Sandy Hill Farm in Winona County. Bruce and Jennine Woolf and their son Brad run a successful dairy operation on a 1,200 acre farm that includes 325 dairy cows. They generate approximately 700,000 pounds of milk per month and several local jobs. The Woolf ’s sell their dairy product to local businesses for processing which generates income for Sandy Hill Dairy Farm and provides raw materials for the dairy industry in Columbiana and surrounding counties. Consumers is proud to have assisted the Woolf ’s with financing of the operation and expansion of their business. Consumers provides financial support to several types of local agriculture operations, from crops to poultry and from beef to dairy. We have one of the area’s only locally-based commercial lenders who is dedicated to agriculture lending. He works with agriculture customers to finance real estate and farm equipment purchases, as well as building construction. Consumers participates with the Farm Service Agency (FSA), State of Ohio AgLink Program, USDA Loan Programs, and others to bring all the available resources to the table to facilitate lending to the area’s agriculture industry. Agriculture loans accounted for 13.8% of total loans in 2011. Consumers is an active lender in both small business and agriculture and is fortunate that our markets provide a unique blend of manufacturing and lending business is strong—over the past three years, farming. Our iv Text.indd 4 9/12/2011 3:17:53 PM Consumers has made $105 million in loans in and around Stark, Columbiana and Carroll counties—very good performance during a slow economy. We offer a wide variety of loan options to assist our commercial customers, including C & I loans, lines of credit, real estate, working capital, and more. The Manufacturing Link Much of the farm products produced locally is processed locally as well. We can look at another customer of Consumers to see how our agricultural customers link to local manufacturers. One of the oldest dairies in our area is Minerva Dairy in Stark County. Minerva Dairy has been producing butter, Batch churned butter at Minerva Dairy a wide variety of cheeses including Kosher and their Award-winning Lacey Swiss since 1894. Under the guidance of owner Phil Mueller and his son Adam, Minerva Dairy makes 12 million pounds of cheese and 3 million pounds of batch churned butter annually. They employ 60 people which directly supports the local economy. As it says on their website, “Minerva Dairy is an extension of our 90 local family-owned dairy farm suppliers. We believe in the value of our relationships with our dairy owners/operators.” As a local community bank, Consumers is a perfect fit for companies like Minerva Dairy that are dedicated to working with local farmers and to providing the best products to the community. Text.indd 5 Consumers has the accounts and services that businesses of all sizes need to run their operations effectively and efficiently. We expanded our cash management services enabling companies to more efficiently manage their money online. Payroll services have been enhanced to make it easier for businesses to pay their employees in a variety of ways. We added a Business Account Specialist to work exclusively with business customers to ensure that they are getting the most from their banking partnership and because person-to-person relationships are still important to us. The Wheels of the Cycle Whether it is hauling raw milk from farm to dairy, cheese and butter from dairy to grocery stores, or steel from mills to manufacturers, transportation plays an important role in the economic cycle. Consumers is involved in the transportation chain including through several trucking customers, Green Lines Transportation, Inc., a privately owned business in Carroll County that was established in 1980. Today, with financial assistance and support from Consumers, owner Roger Bettis has grown Green Lines into an ISO 9001:2008 certified company with 120 trucks that ship more than 1.4 Green Lines hauls 1.4 billion pounds of freight annually. billion pounds of heavy general commodities in over 39,000 truckloads a year. While Green Lines operates in several surrounding states as well as locally, it generates local jobs and tax revenues that support our local economy and makes our region strong. v 9/12/2011 3:17:55 PM People Throughout the Cycle In the final phase of the economic cycle, people make purchases to meet their daily needs. Consumers is present in the final step of the process as well. First, we support store owners as in the case of our customer Horizon Management, Inc. in Mahoning County, which operates more than a dozen Save-A-Lot Food Stores in many of the communities we serve. Through their neighborhood stores, co-owners John Kawecki and Henry Nemenz, Jr. provide residents of small towns with more grocery store choices. When the big grocery chains close their doors on small neighborhoods, they leave residents with fewer shopping options. John and Henry open Save-A-Lot stores to offer service to local communities at affordable prices. Their story Customers begin and end the economic cycle. is reminiscent of Consumers’ story of opening a brand new banking facility in East Canton after the town’s only bank closed in 1999. Both Horizon Management and Consumers fulfill the needs of small communities that are not met by large national or regional companies. Consumers is present in retail stores every time a customer writes a check to pay for groceries, charges gas with a Visa debit card, or pays a bill through our online banking service. We facilitate the flow of money through the economic cycle by giving people a variety of payment methods to choose from and by giving businesses a variety of ways to accept payments from customers. Through services such as e-Courier remote check deposit, our customers can deposit checks into their accounts without leaving their place of business. For customers with large cash receipts, our new e-Vault enables them to receive immediate credit for cash deposited at their location. All these services make it easier for businesses and customers to do business with each other. People are also the beginning of the economic cycle. Their individual deposits in checking accounts, savings accounts, and certificates of deposit supply the core of the money that Consumers lends to all of our business customers in the form of commercial loans and lines of credit. Consumers is the engine in the local economy that converts your deposits into loans for local individuals and businesses. As we say in our radio commercial, “When you bank with us you are empowering our community in a major way.” We are committed to providing customers with new technology that makes managing their money easier. As customers depend more on access to account information over the internet, on smart phones, through iPads and other wireless devices, Consumers is meeting their growing demands. FinanceWorks account aggregation facilitates personal financial management by presenting customers with an online snapshot of all their accounts and tracks their expenses, making it easier to create—and stick to—a budget. Text message banking enables customers to check their accounts and receive alerts about balances and payments. Our mobile app connects customers directly to online banking where they can view all their accounts, pay bills, transfer funds and much more. Our person-to- person PoP Money service will let customers transfer funds to anyone by email or text. vi Text.indd 6 9/12/2011 3:17:57 PM Board of Directors Back row from left: Ralph Lober, II, Harry Schmuck, Jr., David Johnson, James Kiko, Sr., John Tonti Front row from left: Laurie McClellan (Chairman of the Board), John Furey, Brad Goris, James Hanna, Thomas Kishman (cid:40)(cid:91)(cid:72)(cid:70)(cid:88)(cid:87)(cid:76)(cid:89)(cid:72)(cid:3)(cid:48)(cid:68)(cid:81)(cid:68)(cid:74)(cid:72)(cid:80)(cid:72)(cid:81)(cid:87) 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(cid:53)(cid:72)(cid:81)(cid:72)(cid:72)(cid:3)(cid:58)(cid:82)(cid:82)(cid:71)(cid:15)(cid:3)(cid:54)(cid:72)(cid:81)(cid:76)(cid:82)(cid:85)(cid:3)(cid:57)(cid:76)(cid:70)(cid:72)(cid:3)(cid:51)(cid:85)(cid:72)(cid:86)(cid:76)(cid:71)(cid:72)(cid:81)(cid:87)(cid:18)(cid:38)(cid:75)(cid:76)(cid:72)(cid:73)(cid:3)(cid:41)(cid:76)(cid:81)(cid:68)(cid:81)(cid:70)(cid:76)(cid:68)(cid:79)(cid:3)(cid:50)(cid:73)(cid:191)(cid:70)(cid:72)(cid:85) Text.indd 7 vii 9/12/2011 3:18:01 PM UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-K (Mark one) ⌧ Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the fiscal year ended June 30, 2011 OR (cid:133) Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the transition period from to Commission File No. 033-79130 CONSUMERS BANCORP, INC. (Exact name of registrant as specified in its charter) OHIO (State or other jurisdiction of incorporation or organization) 34-1771400 (I.R.S. Employer Identification No.) 614 East Lincoln Way, P.O. Box 256, Minerva, Ohio 44657 (330) 868-7701 (Address, including zip code, and telephone number, including area code, of registrant’s principal executive offices) Securities registered pursuant Section 12(b) of the Act: None Securities registered pursuant Section 12(g) of the Act: Common Shares, no par value Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes (cid:133) No ⌧ Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes (cid:133) No ⌧ 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 ⌧ No (cid:133) Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 229.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes (cid:133) No (cid:133) Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§ 229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. (cid:133) 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): Large accelerated filer (cid:133) Accelerated filer (cid:133) Non-accelerated filer (cid:133) Smaller reporting company ⌧ (Do not check if small reporting company) Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes (cid:133) No ⌧ Based on the closing sales price on December 31, 2010, the aggregate market value of the voting stock held by non-affiliates of the Registrant was approximately $16,279,068. The number of shares outstanding of the Registrant’s common stock, without par value was 2,049,873 at September 1, 2011. DOCUMENTS INCORPORATED BY REFERENCE Certain specifically designated portions of Consumers Bancorp, Inc.’s definitive Proxy Statement dated September 16, 2011 for its 2011 Annual Meeting of Shareholders are incorporated by reference into Part III of this Form 10-K. TABLE OF CONTENTS PART I ITEM 1—BUSINESS...............................................................................................................................................................................3 ITEM 1A—RISK FACTORS...................................................................................................................................................................6 ITEM 1B—UNRESOLVED STAFF COMMENTS ................................................................................................................................6 ITEM 2—PROPERTIES ..........................................................................................................................................................................7 ITEM 3—LEGAL PROCEEDINGS ........................................................................................................................................................7 ITEM 4—REMOVED AND RESERVED...............................................................................................................................................7 PART II ITEM 5—MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED SHAREHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES.......................................................................................................................................8 ITEM 6—SELECTED FINANCIAL DATA ...........................................................................................................................................8 ITEM 7—MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS ..................................................................................................................................................................................9 ITEM 7A—QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK....................................................20 ITEM 8—FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.......................................................................................21 ITEM 9—CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE ................................................................................................................................................................................50 ITEM 9A—CONTROLS AND PROCEDURES ...................................................................................................................................50 ITEM 9B—OTHER INFORMATION...................................................................................................................................................50 PART III ITEM 10—DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE .............................................................51 ITEM 11—EXECUTIVE COMPENSATION .......................................................................................................................................51 ITEM 12—SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED SHAREHOLDER MATTERS ........................................................................................................................................................51 ITEM 13—CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE ..................51 ITEM 14—PRINCIPAL ACCOUNTANT FEES AND SERVICES .....................................................................................................51 ITEM 15—EXHIBITS AND FINANCIAL STATEMENT SCHEDULES...........................................................................................51 PART I ITEM 1—BUSINESS Business Consumers Bancorp, Inc. (Corporation), is a bank holding company under the Bank Holding Company Act of 1956, as amended and is a registered bank holding company, incorporated under the laws of the State of Ohio. In February 1995, the Corporation acquired all the issued and outstanding capital stock of Consumers National Bank (Bank), a bank chartered under the laws of the United States of America. The Corporation’s activities have been limited primarily to holding the common stock of the Bank. Since 1965, the Bank’s main office has been serving the Minerva, Ohio area from its location at 614 East Lincoln Way, Minerva, Ohio. The Bank’s business involves attracting deposits from businesses and individual customers and using such deposits to originate commercial, mortgage and consumer loans in its market area, consisting primarily of Stark, Columbiana, Carroll and contiguous counties in Ohio. The Bank also invests in securities consisting primarily of obligations of U.S. government sponsored entities, municipal obligations and mortgage-backed securities issued by Fannie Mae, Freddie Mac and Ginnie Mae. Supervision and Regulation The Corporation is supervised by the Board of Governors of the Federal Reserve System (Federal Reserve Board) and the Bank is subject to supervision, regulation and periodic examination by the Office of the Comptroller of the Currency (OCC). Earnings of the Corporation are affected by state and federal laws and regulations and by policies of various regulatory authorities. Changes in applicable law or in the policies of various regulatory authorities could affect materially the business and prospects of the Corporation and the Bank. The following discussion of supervision and regulation is qualified in its entirety by reference to the statutory and regulatory provisions discussed. Regulation of the Corporation: The Bank Holding Company Act: As a bank holding company, the Corporation is subject to regulation under the Bank Holding Company Act of 1956, as amended (BHCA) and the examination and reporting requirements of the Board of Governors of the Federal Reserve System (Federal Reserve Board). Under the BHCA, the Corporation is subject to periodic examination by the Federal Reserve Board and required to file periodic reports regarding its operations and any additional information that the Federal Reserve Board may require. The BHCA generally limits the activities of a bank holding company to banking, managing or controlling banks, furnishing services to or performing services for its subsidiaries and engaging in any other activities that the Federal Reserve Board has determined to be so closely related to banking or to managing or controlling banks as to be a proper incident to those activities. In addition, the BHCA requires every bank holding company to obtain the approval of the Federal Reserve Board prior to acquiring substantially all the assets of any bank, acquiring direct or indirect ownership or control of more than 5% of the voting shares of a bank or merging or consolidating with another bank holding company. Privacy Provisions of Gramm-Leach-Bliley Act: The Gramm-Leach-Bliley Act of 1999 contains extensive provisions on a customer’s right to privacy of non-public personal information. Under these provisions, a financial institution must provide to its customers the institution’s policies and procedures regarding the handling of customers’ non-public personal information. Except in certain cases, an institution may not provide personal information to unaffiliated third parties unless the institution discloses that such information may be disclosed and the customer is given the opportunity to opt out of such disclosure. The Corporation and the Bank are also subject to certain state laws that deal with the use and distribution of non- public personal information. Sarbanes-Oxley Act: The Sarbanes-Oxley Act of 2002 contains important requirements for public companies in the area of financial disclosure and corporate governance. In accordance with section 302(a) of the Sarbanes-Oxley Act, written certifications by the Corporation’s Chief Executive Officer and Chief Financial Officer are required. These certifications attest that the Corporation’s quarterly and annual reports filed with the SEC do not contain any untrue statement of a material fact or omit to state a material fact. 3 Regulation of the Bank: As a national bank, Consumers National Bank is subject to regulation, supervision and examination by the OCC and by the Federal Deposit Insurance Corporation (FDIC). These examinations are designed primarily for the protection of the depositors of the Bank. Dividend Restrictions: Dividends from the Bank are the primary source of funds for payment of dividends to our shareholders. However, there are statutory limits on the amount of dividends the Bank can pay without regulatory approval. Under regulations promulgated by the OCC, the Bank may not declare a dividend in excess of its undivided profits. Additionally, the Bank may not declare a dividend if the total amount of all dividends, including the proposed dividend, declared by the Bank in any calendar year exceeds the total of its retained net income of that year to date, combined with its retained net income of the two preceding years, unless the dividend is approved by the OCC. The Bank may not declare or pay any dividend if, after making the dividend, the Bank would be “undercapitalized,” as defined in the federal regulations. FDIC: The FDIC is an independent federal agency, which insures the deposits of federally insured banks and savings associations up to certain prescribed limits and safeguards the safety and soundness of financial institutions. The deposits of the Bank are subject to the deposit insurance assessments of the Bank Insurance Fund of the FDIC. Under the FDIC’s deposit insurance assessment system, the assessment rate for any insured institutions varies according to regulatory capital levels of the institution and other factors such as supervisory evaluations. The FDIC is authorized to prohibit any insured institution from engaging in any activity that poses a serious threat to the insurance fund and may initiate enforcement actions against banks, after first giving the institution’s primary regulatory authority and opportunity to take such action. The FDIC may also terminate the deposit insurance of any institution that has engaged in or is engaging in unsafe or unsound practices, is in an unsafe or unsound condition to continue operations or has violated any applicable law, order or condition imposed by the FDIC. FHLB: The Bank is also a member of the Federal Home Loan Bank of Cincinnati (FHLB), which is a privately capitalized, government sponsored enterprise that expands housing and economic development opportunities throughout the nation by providing loans and other banking services to community-based financial institutions. Risk-Based Capital Requirements: The Federal Reserve Board and the OCC employ similar risk-based capital guidelines in their examination and regulation of bank holding companies and national banks. As of the fiscal year-end 2010, the Corporation met the definition of a Small Bank Holding Company and, therefore was exempt from consolidated risk-based and coverage capital adequacy guidelines for bank holding companies. The guidelines involve a process of assigning various risk weights to different classes of assets, then evaluating the sum of the risk-weighted balance sheet structure against the capital base. If capital falls below the minimum levels established by the guidelines, the bank holding company or bank may be denied approval to acquire or establish additional banks or non-bank businesses or to open new facilities. In addition, failure to satisfy capital guidelines could subject a banking institution to a variety of enforcement actions by federal bank regulatory authorities, including the termination of deposit insurance by the FDIC and a prohibition on the acceptance of “brokered deposits.” Under regulations adopted under these provisions, for an institution to be well capitalized it must have a total risk-based capital ratio of at least 10%, a Tier I risk-based capital ratio of at least 6% and a Tier I leverage ratio of at least 5% and not be subject to any specific capital order or directive. The OCC and the FDIC may take various corrective actions against any undercapitalized bank and any bank that fails to submit an acceptable capital restoration plan or fails to implement a plan accepted by the OCC or the FDIC. These powers include, but are not limited to, requiring the institution to be recapitalized, prohibiting asset growth, restricting interest rates paid, requiring prior approval of capital distributions by any bank holding company that controls the institution, requiring divestiture by the institution of its subsidiaries or by the holding company of the institution itself, requiring new election of directors, and requiring the dismissal of directors and officers. The OCC’s final supervisory judgment concerning an institution’s capital adequacy could differ significantly from the conclusions that might be derived from the absolute level of an institution’s risk-based capital ratios. Therefore, institutions generally are expected to maintain risk-based capital ratios that exceed the minimum ratios. At June 30, 2011, the Bank was in compliance with all regulatory capital requirements. 4 Interstate Banking and Branching: The Interstate Banking and Branch Efficiency Act of 1995 has eased restrictions on interstate expansion and consolidation of banking operations by, among other things: (i) permitting interstate bank acquisitions regardless of host state laws, (ii) permitting interstate merger of banks unless specific states have opted out of this provision and (iii) permitting banks to establish new branches outside the state provided the law of the host state specifically allows interstate bank branching. Community Reinvestment Act: The Community Reinvestment Act requires depository institutions to assist in meeting the credit needs of their market areas, including low and moderate-income areas, consistent with safe and sound banking practices. Under this Act, each institution is required to adopt a statement for each of its market areas describing the depository institution’s efforts to assist in its community’s credit needs. Depository institutions are periodically examined for compliance and assigned ratings. Banking regulators consider these ratings when considering approval of a proposed transaction by an institution. USA Patriot Act: In 2001, Congress enacted the Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism (USA Patriot Act) Act of 2001 (Patriot Act). The Patriot Act is designed to deny terrorists and criminals the ability to obtain access to the United States’ financial system and has significant implications for depository institutions, brokers, dealers, and other businesses involved in the transfer of money. The Patriot Act mandates financial services companies to implement additional policies and procedures with respect to additional measures designed to address any or all of the following matters: money laundering, terrorist financing, identifying and reporting suspicious activities and currency transactions, and currency crimes. Recent Legislation Impacting the Financial Services Industry: Dodd-Frank Act: On July 21, 2010, sweeping financial regulatory reform legislation entitled the “Dodd-Frank Wall Street Reform and Consumer Protection Act” (Dodd-Frank Act) was signed into law. The Dodd-Frank Act implements far- reaching changes across the financial regulatory landscape, including provisions that, among other things, will: • Centralize responsibility for consumer financial protection by creating a new agency, the Consumer Financial Protection Bureau, responsible for implementing, examining and enforcing compliance with federal consumer financial laws. • Require the Office of the Comptroller of the Currency to seek to make its capital requirements for national banks, countercyclical so that capital requirements increase in times of economic expansion and decrease in times of economic contraction. • Change the assessment base for federal deposit insurance from the amount of insured deposits to consolidated assets less tangible capital, eliminate the ceiling of the Deposit Insurance Fund (DIF) and increase the floor of the DIF, which generally will reduce the level of assessments for institutions with assets below $10 billion and increase the level of assessments for institutions with assets in excess of $10 billion. • Implement corporate governance revisions, including with regard to executive compensation and proxy access by shareholders, which apply to all public companies, not just financial institutions. • Make permanent the $250 thousand limit for federal deposit insurance and increase the cash limit of Securities Investor Protection Corporation protection from $100 thousand to $250 thousand and provide unlimited federal deposit insurance until January 1, 2013 for non-interest bearing demand transaction accounts at all insured depository institutions. • Repeal the federal prohibitions on the payment of interest on demand deposits, thereby permitting depository institutions to pay interest on business transaction and other accounts effective one year after the bill was signed into law. • Amend the Electronic Fund Transfer Act (EFTA) to, among other things, give the Federal Reserve the authority to establish rules regarding interchange fees charged for electronic debit transactions by payment card issuers having assets over $10 billion and to enforce a new statutory requirement that such fees be reasonable and proportional to the actual cost of a transaction to the issuer. • Make permanent SOX 404 (B) exemption regarding auditor attestation requirements for companies with less than $75 million in market capitalization. Many aspects of the Dodd-Frank Act are subject to rulemaking and will take effect over several years, making it difficult to anticipate the overall financial impact on the Corporation, its customers or the financial industry more generally. Provisions in the legislation that affect deposit insurance assessments, payment of interest on demand deposits and interchange fees could 5 increase the costs associated with deposits as well as place limitations on certain revenues those deposits may generate. We will continue to monitor legislative developments and assess their potential impact on our business. Employees As of June 30, 2011, the Bank employed 96 full-time and 18 part-time employees. None of the employees are represented by a collective bargaining group. Management considers its relations with employees to be good. Statistical Disclosure The following statistical information is included on the indicated pages of this Report: Average Consolidated Balance Sheet And Net Interest Margin ................................................................. Interest Rates and Interest Differential ....................................................................................................... Carrying Values Of Securities .................................................................................................................... Maturities And Weighted-Average Yield Of Securities ............................................................................. Loan Types ................................................................................................................................................. Selected Loan Maturities And Interest Sensitivity...................................................................................... Non-accrual, Past Due And Restructured Loans And Other Nonperforming Assets.................................. Potential Problem Loans ............................................................................................................................. Summary Of Loan Loss Experience ........................................................................................................... Allocation Of Allowance For Loan Losses................................................................................................. Average Amount And Average Rate Paid On Deposits.............................................................................. Time Deposits Of $100 Thousand Or More................................................................................................ Short-Term Borrowings .............................................................................................................................. Selected Consolidated Financial Data......................................................................................................... 10 11 13 14 14 15 15 16 16 16 17 17 17 and 42 8 Available Information The Corporation files annual, quarterly, and current reports, proxy statements, and other information with the SEC. These filings are available to the public over the Internet at the SEC’s web site at www.sec.gov. Shareholders may also read and copy any document that the Corporation files at the SEC’s public reference room located at 100 F Street, NE, Washington, DC 20549. Shareholders may call the SEC at 1-800-SEC-0330 for further information on the public reference room. Shareholders may request a copy of any of the Corporation’s filings at no cost by writing or e-mailing the Corporation at the following address or e-mail address: Consumers Bancorp, Inc., Attn: Theresa J. Linder, 614 East Lincoln Way, Minerva, Ohio 44657 or e-mail to shareholderrelations@consumersbank.com. The Corporation’s Code of Ethics Policy, which is applicable to all directors, officers and employees of the corporation, and its Code of Ethics for Principal Financial Officers, which is applicable to the principal executive officer and the principal financial officer, are each available on the Investor Relations section under Corporate Governance of the Corporation’s website (www.consumersbank.com). Copies of either of the Code of Ethics Policies are also available in print to shareholders upon request, addressed to the Corporate Secretary at Consumers Bancorp, Inc., 614 East Lincoln Way, Minerva, Ohio 44657. The Corporation intends to post amendments to or waivers from its Code of Ethics on its website. ITEM 1A—RISK FACTORS Not applicable for Smaller Reporting Companies. ITEM 1B—UNRESOLVED STAFF COMMENTS None. 6 ITEM 2—PROPERTIES The Bank owns and maintains the premises in which eight of the eleven banking facilities are located, and leases offices in Carrollton, Alliance and Malvern. The location of each of the currently operating offices is as follows: Minerva Office: Salem Office: Waynesburg Office: Hanoverton Office: Carrollton Office: Alliance Office: Lisbon Office: Louisville Office: East Canton Office: Malvern Office: Hartville Office: 614 E. Lincoln Way, P.O. Box 256, Minerva, Ohio, 44657 141 S. Ellsworth Ave., P.O. Box 798, Salem, Ohio, 44460 8607 Waynesburg Dr. SE, P.O. Box 746, Waynesburg, Ohio, 44423 30034 Canal St., P.O. Box 178, Hanoverton, Ohio, 44423 1017 Canton Rd. NW, Carrollton, Ohio, 44615 610 West State St., Alliance, Ohio, 44601 7985 Dickey Dr., Lisbon, Ohio 44432 1111 N. Chapel St., Louisville, Ohio 44641 440 W. Noble, East Canton, Ohio, 44730 4070 Alliance Rd., Malvern, Ohio 44644 1215 W. Maple Street, Hartville, OH 44632 In the opinion of management, the properties listed above are adequate for their present uses and the Bank’s business requirements and are adequately covered by insurance. ITEM 3—LEGAL PROCEEDINGS The Corporation is not a party to any pending material legal or administrative proceedings, other than ordinary routine litigation incidental to the business of the Corporation. Further, there are no material legal proceedings in which any director, executive officer, principal shareholder or affiliate of the Corporation is a party or has a material interest that is adverse to the Corporation. No routine litigation in which the Corporation is involved is expected to have a material adverse impact on the financial position or results of operations of the Corporation. ITEM 4—REMOVED AND RESERVED 7 PART II ITEM 5—MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED SHAREHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES The Corporation had 2,049,873 common shares outstanding on June 30, 2011 with 693 shareholders of record and an estimated 236 additional beneficial holders whose stock was held in nominee name. The common shares of Consumers Bancorp, Inc. are traded on the over-the-counter bulletin board. The following quoted market prices reflect inter-dealer prices, without adjustments for retail markups, markdowns, or commissions and may not represent actual transactions. The market prices represent highs and lows reported during the quarterly period. Quarter Ended High............................................................... Low ............................................................... Cash dividends paid per share ....................... Quarter Ended High............................................................... Low ............................................................... Cash dividends paid per share ....................... September 30, 2010 $ 13.25 10.75 0.10 September 30, 2009 $ 12.70 10.10 0.10 December 31, 2010 $ 13.85 11.25 0.10 December 31, 2009 $ 12.25 9.51 0.10 March 31, 2011 $ 12.50 11.55 0.10 March 31, 2010 $ 12.00 10.65 0.10 June 30, 2011 $ 13.25 11.85 0.11 June 30, 2010 $ 11.90 11.10 0.10 Management does not have knowledge of the prices paid in all transactions and has not verified the accuracy of those prices that have been reported. Because of the lack of an established market for the Corporation’s common shares, these prices may not reflect the prices at which the common shares would trade in an active market. The Corporation’s principal source of funds for dividend payment is dividends received from the Bank. Banking regulations limit the amount of dividends that may be paid without prior approval of regulatory agencies. Under these regulations, the amount of dividends that may be paid in any calendar year is limited to the current year’s net profits, combined with the retained net profits of the preceding two years, subject to the capital requirements described above. See Note 1 and Note 11 to the Consolidated Financial Statements for dividend restrictions. The Corporation has no compensation plans under which equity securities are authorized for issuance. There were no repurchases of the Corporation’s securities during the 2011 fiscal year. ITEM 6—SELECTED FINANCIAL DATA Not applicable for Smaller Reporting Companies. 8 ITEM 7—MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Dollars in thousands, except per share data) General The following is management’s analysis of the Corporation’s financial condition and results of operations as of and for the years ended June 30, 2011 and 2010. This discussion is designed to provide a more comprehensive review of the operating results and financial position than could be obtained from an examination of the financial statements alone. This analysis should be read in conjunction with the consolidated financial statements and related footnotes and the selected financial data included elsewhere in this report. Overview Consumers Bancorp, Inc., a bank holding company incorporated under the laws of the State of Ohio, owns all of the issued and outstanding capital stock of Consumers National Bank, a bank chartered under the laws of the United States of America. The Corporation’s activities have been limited primarily to holding the common stock of the Bank. The Bank’s business involves attracting deposits from businesses and individual customers and using such deposits to originate commercial, mortgage and consumer loans in its market area, consisting primarily of Stark, Columbiana, Carroll and contiguous counties in Ohio. The Bank also invests in securities consisting primarily of U.S. government sponsored entities, municipal obligations, mortgage-backed and collateralized mortgage obligations issued by Fannie Mae and Freddie Mac. Comparison of Results of Operations for the Years Ended June 30, 2011 and June 30, 2010 Net Income. Net income increased by $209, or 10.3%, from 2010 to 2011. The increase was mainly the result of an $818, or 8.1%, increase in net interest income that was partially offset by an increase in other expenses of $527, or 5.8%, from the previous year. Net Interest Income. Net interest income, the difference between interest income earned on interest-earning assets and interest expense incurred on interest-bearing liabilities, is the largest component of the Corporation’s earnings. Net interest income is affected by changes in the volumes, rates and composition of interest-earning assets and interest-bearing liabilities. Net interest margin is calculated by dividing net interest income on a fully tax equivalent basis (FTE) by total interest-earning assets. FTE income includes tax-exempt income, restated to a pre-tax equivalent, based on the statutory federal income tax rate. All average balances are daily average balances. Non-accruing loans are included in average loan balances. Net Interest Income Year ended June 30, Net interest income............................................................................................. Taxable equivalent adjustments to net interest ................................................... Net interest income, fully taxable equivalent ..................................................... Net interest margin ............................................................................................. Taxable equivalent adjustment ........................................................................... Net interest margin, fully taxable equivalent...................................................... 2011 $ 10,868 445 $ 11,313 4.05% 0.17 4.22% 2010 $ 10,050 388 $ 10,438 4.13% 0.15 4.28% Net interest income for the year of 2011 was $10,868, an increase of $818, or 8.1%, from $10,050 in the year of 2010. The Corporation’s tax equivalent net interest margin for the year ended June 30, 2011 was 4.22%, a decrease of 6 basis points from 2010. Interest income for the year of 2011 was $12,784, an increase of $174, or 1.4%, from $12,610 in the year of 2010. The increase in interest income was primarily the result of an increase of $25,336, or 10.4%, in average interest-earning assets, which was partially offset by lower market rates affecting the yield on all interest earning assets. Interest expense for the year of 2011 was $1,916, a decrease of $644, or 25.2%, from $2,560 in the year of 2010. This decrease was mainly the result of lower market rates affecting the rates paid on all interest-bearing deposit accounts and borrowings. 9 Average Balance Sheet and Net Interest Margin Average Balance 2011 Interest Yield/ Rate Average Balance 2010 Interest Yield/ Rate Interest earning assets: Taxable securities ................................................ $ 54,861 $ 1,624 1,314 Nontaxable Securities (1)..................................... 10,237 Loans receivable (1) ............................................ Interest bearing deposits and federal funds sold .. 22,463 176,034 15,599 3.02% $ 46,133 $ 1,827 4.03% 1,143 5.98 5.85 9,967 5.96 5.82 61 0.54 54 0.35 19,144 167,142 11,202 Total interest earning assets................................. Non-interest earning assets .................................. 268,957 12,659 13,229 4.94% 243,621 11,969 12,998 5.35% Total assets .......................................................... $ 281,616 $ 255,590 Interest bearing liabilities: NOW.................................................................... $ 14,102 $ Savings................................................................. Time deposits....................................................... Short-term borrowings......................................... FHLB advances ................................................... 71,968 90,863 14,892 7,940 19 151 1,447 45 254 0.13% $ 13,387 $ 0.21 1.59 0.30 3.20 59,873 90,297 12,977 8,883 27 0.20% 184 0.31 2,006 2.22 50 0.39 293 3.30 Total interest bearing liabilities ........................... 199,765 1,916 0.96% 185,417 2,560 1.38% Non-interest bearing liabilities............................. 57,452 Total liabilities ..................................................... Shareholders’ equity ............................................ 257,217 24,399 Total liabilities and shareholders’ equity ............. $ 281,616 47,389 232,806 22,784 $ 255,590 Net interest income, interest rate spread (1) ........ $ 11,313 3.98% $ 10,438 3.97% Net interest margin (net interest as a percent of average interest earning assets) (1) ................. Federal tax exemption on non-taxable securities and loans included in interest income Average interest earning assets to interest bearing liabilities............................................. (1) Calculated on a fully taxable equivalent basis 4.22% 4.28% $ 445 $ 388 134.64% 131.39% 10 The following table presents the changes in the Corporation’s interest income and interest expense resulting from changes in interest rates and changes in the volume of interest-earning assets and interest-bearing liabilities. Changes attributable to both rate and volume that cannot be segregated have been allocated in proportion to the changes due to rate and volume. INTEREST RATES AND INTEREST DIFFERENTIAL 2011 Compared to 2010 Increase / (Decrease) Change due to Volume Change due to Rate Total Change 2010 Compared to 2009 Increase / (Decrease) Change due to Volume Change due to Rate Total Change (In thousands) (508) $ (359) $ (26) (251) (26) 27 (126) (17) (475) Interest earning assets: Taxable securities ................................................................. $ (203) $ Nontaxable securities (1) ...................................................... Loans receivable (2) ............................................................. Federal funds sold................................................................. 171 270 (7) $ 305 197 521 19 Total interest income ............................................................ Interest bearing liabilities: NOW accounts...................................................................... Savings deposits ................................................................... Time deposits........................................................................ Short-term borrowings.......................................................... FHLB advances .................................................................... Total interest expense ........................................................... 231 1,042 (811) (8) (33) (559) (5) (39) (644) 1 33 12 7 (30) 23 (9) (66) (571) (12) (9) (667) Net interest income ............................................................... $ 875 $ 1,019 $ (144) $ (22) (135) (639) (162) (35) (993) 518 $ (19) $ 47 643 10 (340) (20) (769) (27) 681 (1,156) 6 27 175 (18) (29) 161 520 (28) (162) (814) (144) (6) (1,154) $ (2) (1) Nontaxable income is adjusted to a fully tax equivalent basis utilizing a 34% tax rate. (2) Non-accrual loan balances are included for purposes of computing the rate and volume effects although interest on these balances has been excluded. Provision for Loan Losses. The provision for loan losses represents the charge to income necessary to adjust the allowance for loan losses to an amount that represents management’s assessment of the estimated probable credit losses in the Corporation’s loan portfolio that have been incurred at each balance sheet date. The provision for loan losses was $435 in fiscal year 2011 compared to $544 in fiscal year 2010. For 2011, net charge-offs were $610, or 0.34% of total loans compared with $260, or 0.15% of total loans, for the same period last year. Despite incurring a higher level of net charge-offs in the current year period, the provision for loan losses decreased compared to the prior year period mainly due to a decline in the level of non-performing loans and a resulting reduction in the amount of specific allowance allocations. A total of $204 of the 2011 net charge-offs within in the commercial real estate and 1-4 family residential real estate loan portfolios were related to loans that had been specifically allocated for within the allowance for loan losses in a prior period when the probable loss had been identified. Also, general reserves declined as unemployment rates in the Corporation’s primary market area of Stark, Columbiana and Carroll counties in Ohio have improved over the past 12 months. Non-performing loans were $1,760 as of June 30, 2011 and represented 0.99% of total loans. This compared with $2,342, or 1.34%, at June 30, 2010. The allowance for loan losses to total non-performing loans at June 30, 2011 was 119.38% compared with 97.18% at June 30, 2010. Non- performing loans have been considered in management’s analysis of the appropriateness of the allowance for loan losses. Management and the Board of Directors closely monitor these loans and believe the prospect for recovery of principal, less identified specific reserves, are favorable. Other Income. Total other income was $2,011 for fiscal year 2011, compared to $2,148 for the same period last year. Adjusted for security gains, a security impairment charge, and gains or losses from the sale of other real estate owned (OREO), other income totaled $2,308 for the 2011 fiscal year, compared with $2,393 for the same period last year. Service charges on deposit accounts decreased by $248, or 16.1%, in 2011 to $1,292 from $1,540 mainly from a decline in overdraft account fee income due to a new rule issued by the Federal Reserve Board that became effective in August 2010 11 that prohibits financial institutions from charging consumers fees for paying overdrafts on automated teller machine and debit card transactions, unless a consumer consents to the overdraft service for those types of transactions. Debit card interchange income increased in 2011 to $644 from $524 from the previous fiscal year due to higher volume as a result of increased customer usage and an increase in the number of debit cards issued. On July 21, 2010, the Dodd-Frank Act amended the Electronic Fund Transfer Act to, among other things, give the Federal Reserve the authority to establish rules regarding interchange fees charged for electronic debit transactions by payment card issuers having assets over $10 billion and to enforce a new statutory requirement that such fees be reasonable and proportional to the actual cost of a transaction to the issuer. Because of the uncertainty as to any future rulemaking by the Federal Reserve, the Corporation cannot provide any assurance as to the ultimate impact of the Dodd-Frank Act on the amount of interchange income from debit card transactions reported in future periods. Bank owned life insurance income increased by $6, or 3.4%, in 2011 to $182 from $176 mainly as a result of an increase in the cash surrender value of life insurance. In February 2011, $431 of single-premium life insurance was purchased following the conversion of a term life insurance policy. Gains recognized on the sale of securities totaled $71 during 2011 and $218 during the same period last year. During fiscal year 2011, the Corporation sold callable agency securities that were projected to be called within a short period of time and recognized gains totaling $98. These gains were partially offset by a $27 loss from the sale of a collateralized mortgage obligation that was underperforming. An other-than-temporary impairment loss of $370 related to a trust preferred security was recognized during the 2011 fiscal year and a $410 impairment charge related to the same security was recognized during the 2010 fiscal year. As of June 30, 2011, the adjusted amortized cost of this trust preferred security was $202. A discussion of the impairment loss is included on the following pages under the heading “Financial Condition.” Other Expenses. Total other expenses were $9,575 for the year ended June 30, 2011; an increase of $527, or 5.8% from $9,048 for the year ended June 30, 2010. Salaries and employee benefit expenses increased $393, or 8.9%, during the fiscal year ended June 30, 2011 mainly due to staff added in fiscal year 2010 in the lending and credit administration functions and due to normal merit increases that went into effect on July 1, 2010, following the removal of a salary freeze that was in place during the preceding eighteen months. Occupancy and equipment expenses decreased by $50, or 4.7%, mainly due to the renegotiation of miscellaneous equipment and service contracts and lower depreciation expense. Occupancy expenses are expected to increase in fiscal year 2012 as a result of the opening of the Hartville, Ohio branch location. Federal Deposit Insurance Corporation (FDIC) assessments decreased by $26, or 8.3%, compared to the same period last year mainly due to an industry wide change in the way FDIC insurance assessments are calculated. On April 1, 2011, the deposit insurance assessment base changed from total domestic deposits to average total assets minus average tangible equity, pursuant to a rule issued by the FDIC as required by the Dodd-Frank Act. Marketing and advertising expenses increased by $78, or 52.0%, compared to the same period last year mainly due to an increase in marketing efforts as a result of the opening of the Hartville, Ohio branch location. The amortization of the intangible is directly related to the core deposit purchase premium of the Lisbon, Ohio branch that was purchased in January 2000. Debit card processing expenses increased by $47, or 15.9%, during the 2011 fiscal year mainly due to increased debit card usage by our customers. Other expense totaled $1,217 for the year ended June 30, 2011, an increase of $141, or 13.1%, from $1,076 for the year ended June 30, 2010. The increase was mainly due to one-time security expenses following robberies at two of the Corporation’s branch locations and additional costs from a new vendor providing enhanced webhosting services and from the conversion to a new internet banking provider. Income Tax Expense. The provision for income taxes totaled $621 and $567 for the years ended June 30, 2011 and 2010, respectively. The effective tax rates were 21.6% and 21.8%, respectively. The effective tax rate differed from the federal statutory rate principally as a result of tax-exempt income from obligations of states and political subdivisions, loans and earnings on bank owned life insurance. 12 Financial Condition Total assets at June 30, 2011 were $300,140 compared to $263,393 at June 30, 2010, an increase of $36,747, or 14.0%. The increase in total assets is mainly attributed to an increase in securities of $27,627 and an increase in loans of $3,268. These increases were primarily funded by an increase of $31,932, or 14.8%, in total deposits. Securities. Available-for-sale securities increased by $27,627 from $64,262 at June 30, 2010 to $91,889 at June 30, 2011. The securities portfolio is mainly comprised of residential mortgage-backed securities and collateralized mortgage obligations issued by Fannie Mae, Freddie Mac and Ginnie Mae, obligations of government sponsored enterprises and state and political subdivisions. Within the securities portfolio, the Corporation owns a trust preferred security, which represents collateralized debt obligations (CDOs) issued by other financial and insurance companies. The security is part of a pool of issuers that support a more senior tranche of securities. Due to the illiquidity in the market, it is unlikely the Corporation would be able to recover its investment in this security if the Corporation sold the security at this time. Due to an increase in principal and/or interest deferrals by the issuers of the underlying securities, the cash interest payments for the trust preferred security are being deferred. On June 30, 2011, the lowest credit rating on this security was Fitch’s rating of C, which is defined as highly speculative. The issuers in this security are primarily banks, bank holding companies and a limited number of insurance companies. The investment security is evaluated using a model to compare the present value of expected cash flows to prior periods expected cash flows to determine if there has been an adverse change in cash flows during the period. The discount rate used to calculate the cash flows is the coupon rate of the security, based on the forward LIBOR curve. The other-than-temporary impairment (OTTI) model considers the structure and term of the CDO and the financial condition of the underlying issuers. Specifically, the model details interest rates, principal balances of note classes and underlying issuers, the timing and amount of interest and principal payments of the underlying issuers, and the allocation of the payments to the note classes. The current estimate of expected cash flows is based on the most recent trustee reports and any other relevant market information including announcements of interest payment deferrals or defaults of underlying trust preferred securities. Assumptions used in the model include expected future default rates and prepayments. We assume no recoveries on defaults and all interest payment deferrals are treated as defaults with an assumed recovery rate of 15% on deferrals. In addition we use the model to “stress” the CDO, or make assumptions more severe than expected activity, to determine the degree to which assumptions could deteriorate before the CDO could no longer fully support repayment of the Corporation’s note class. According to the June 30, 2011 analysis, the expected cash flows were below the recorded amortized cost of the trust preferred security. Therefore, management determined it was appropriate to record an other-than-temporary impairment loss of $370 and $410 for the fiscal year-to-date periods ended June 30, 2011 and 2010. The accumulated other- than-temporary impairment loss recognized in earnings was $780 at June 30, 2011 and $410 at June 30, 2010. Management has reviewed this security and these conclusions with an independent third party. If there is further deterioration in the underlying collateral of this security, other-than-temporary impairments may also occur in future periods. The following table sets forth certain information regarding the amortized cost and fair value of the Corporation’s securities at the dates indicated. Amortized Cost Gross Unrealized Gains Gross Unrealized Losses June 30, 2011 Obligations of government sponsored entities........................................... Obligations of state and political subdivisions .......................................... Mortgage-backed securities - residential ................................................... Collateralized mortgage obligations ......................................................... Trust preferred security.............................................................................. $ $ 16,185 24,725 29,424 19,856 202 Total securities........................................................................................... $ 90,392 $ June 30, 2010 Obligations of government sponsored entities........................................... Obligations of state and political subdivisions .......................................... Mortgage-backed securities - residential ................................................... Collateralized mortgage obligations ......................................................... Trust preferred security.............................................................................. $ $ 10,771 20,073 24,333 7,094 572 Total securities........................................................................................... $ 62,843 $ 98 $ 584 1,172 74 — 1,928 $ 236 $ 392 1,279 34 — 1,941 $ (23) (211) — (62) (135) (431) (3) (218) — (151) (150) (522) Fair Value $ 16,260 25,098 30,596 19,868 67 $ 91,889 $ 11,004 20,247 25,612 6,977 422 $ 64,262 13 The following tables summarize the amounts and distribution of the Corporation’s securities held and the weighted average yields as of June 30, 2011: Amortized Cost Fair Value Average Yield / Cost AVAILABLE-FOR-SALE Obligations of government sponsored entities: 3 months or less ..................................................................................................................... $ Over 3 months through 1 year ............................................................................................... Over 1 year through 5 years................................................................................................... Total obligations of government sponsored entities.......................................................... Obligations of state and political subdivisions: Over 1 year through 5 years................................................................................................... Over 5 years through 10 years ............................................................................................... Over 10 years......................................................................................................................... Total obligations of state and political subdivisions ......................................................... Mortgage-backed securities - residential: Over 1 year through 5 years................................................................................................... Over 5 years through 10 years ............................................................................................... Total mortgage-backed securities....................................................................................... Collateralized mortgage obligations: 3 months or less ..................................................................................................................... $ Over 3 months through 1 year ............................................................................................... Over 1 year through 5 years................................................................................................... Total collateralized mortgage obligations.......................................................................... Trust preferred security...................................................................................................... Total securities ..................................................................................................................... $ 2,504 2,525 11,156 16,185 1,045 5,818 17,862 24,725 27,983 1,441 29,424 1 575 19,280 19,856 202 90,392 $ 2,507 2,554 11,199 16,260 1,091 6,020 17,987 25,098 29,079 1,517 30,596 1.69% 2.10 1.76 1.80 4.86 5.37 6.12 5.89 3.63 4.38 3.67 $ 1 578 19,289 19,868 67 $ 91,889 (0.39) 1.09 2.53 2.49 — 3.64% The weighted average interest rates are based on coupon rates for securities purchased at par value and on effective interest rates considering amortization or accretion if the securities were purchased at a premium or discount. The weighted average yield on tax-exempt obligations has been calculated on a tax equivalent basis. Average yields are based on amortized cost balances. The negative 0.39% yield on the collateralized mortgage obligations with a term of 3 months or less was a result of unexpectedly high prepayment speeds increasing the premium amortization due to the prolonged historically low mortgage rates. The yield on the trust preferred security is zero since the cash interest payments for this security are being deferred. At June 30, 2011, there were no holdings of securities of any one issuer, other than the U.S. government and its agencies and corporations, with an aggregate book value which exceeds 10% of shareholders’ equity. Loans. Loan receivables increased by $3,268 to $177,551 at June 30, 2011 compared to $174,283 at June 30, 2010. Loan demand, particularly in the commercial real estate area and advances on established commercial lines of credit, has been lower than previous years due to the current economic conditions. Major classifications of loans, net of deferred loan fees and costs, were as follows as of June 30: Commercial ........................................................................ Commercial real estate: Construction .................................................................... Other ................................................................................ 1-4 Family residential real estate: Owner occupied............................................................... Non-owner occupied........................................................ Construction .................................................................... Consumer loans .................................................................. Total loans .......................................................................... $ 177,551 14 2011 $ 19,297 2010 $ 14,559 1,049 97,199 34,517 19,047 596 5,846 2,916 99,462 34,448 16,750 328 5,820 $ 174,283 The following is a schedule of contractual maturities and repayments of 1-4 family residential real estate construction, commercial and commercial real estate loans, as of June 30, 2011: Due in one year or less ............................................................................................................. Due after one year but within five years .................................................................................. Due after five years .................................................................................................................. Total ......................................................................................................................................... $ 11,230 15,795 91,116 $ 118,141 The following is a schedule of fixed and variable rate 1-4 family residential real estate construction, commercial and commercial real estate loans due after one year (variable rate loans are those loans with floating or adjustable interest rates) as of June 30, 2011: Fixed Interest Rates Variable Interest Rates Total 1-4 family residential real estate construction, commercial and commercial real estate loans due after one year.......................................................................... $44,599 $62,312 Foreign Outstandings—there were no foreign outstandings during the periods presented. There are no concentrations of loans greater than 10% of total loans, which are not otherwise disclosed as a category of loans. Allowance for Loan Losses. The allowance for loan losses balance and the provision charged to expense are judgmentally determined by management based upon a periodic review of the loan portfolio, an analysis of impaired loans, past loan loss experience, current economic conditions, collateral value assumptions for collateral-dependent loans and various other circumstances which are subject to change over time. Probable losses are estimated by stratifying the total loan portfolio into pools of homogenous loans by ownership, collateral type and loan purpose and applying the Bank’s three year historical loss ratio, increased for more recent trends in loss experience, to each loan pool. Also, the local unemployment rate is monitored and additional reserves are applied to all loans that are not assigned a specific reserve if there is an increase in the local unemployment rate. Specific reserves are determined by management’s review of delinquent loans, impaired loans, non-accrual loans, loans classified as substandard, watch list loans, loans to industries experiencing economic difficulties and other selected large loans. The collectability of these loans is evaluated after considering the current financial position of the borrower, the estimated market value of the collateral, guarantees and the Corporation’s collateral position versus other creditors. Judgments, which are necessarily subjective, as to the probability of loss and the amount of such loss, are formed on these loans, as well as other loans in the aggregate. Failure to receive principal and interest payments when due on any loan results in efforts to restore such loan to a current status. Loans are classified as non-accrual when, in the opinion of management, full collection of principal and accrued interest is not expected. The loans must be brought and kept current for six sustained payments before being considered for removal from non-accrual status. Commercial and commercial real estate loans are classified as impaired if management determines that full collection of principal and interest, in accordance with the terms of the loan documents, is not probable. If a loan is impaired, a portion of the allowance is allocated so the loan is reported, net, at the present value of estimated future cash flows using the loan’s existing rate or at the fair value of collateral if repayment is expected from the collateral. Loans are evaluated for impairment when payments are delayed, typically 90 days or more, or when it is probable that not all principal and interest amounts will be collected according to the original terms of the loan. As of June 30, 2011, impaired loans totaled $2,536, of which $1,745 are included in non-accrual loans. Continued unsuccessful collection efforts generally lead to initiation of foreclosure or other legal proceedings. The following schedule summarizes non-accrual, past due, impaired and restructured loans for the years ended June 30: 2011 2010 Non-accrual loans ..................................................................................... $ 1,760 $ 2,342 Accruing loans past due 90 days or more ................................................. — Total non-performing loans ...................................................................... $ 1,760 $ 2,342 25 Other real estate owned............................................................................. Total non-performing assets...................................................................... $ 1,836 $ 2,367 Impaired loans........................................................................................... $ 2,536 $ 2,635 335 Accruing restructured loans ...................................................................... $ — 791 $ 76 15 The non-performing loans are either in the process of foreclosure or efforts are being made to work with the borrower to bring the loan current. Properties acquired by the Corporation as a result of foreclosure, or by deed in lieu of foreclosure, are classified as “other real estate owned” until such time as they are sold or otherwise disposed. As of June 30, 2011, there was $76, or three individual properties, classified as other real estate owned. Potential Problem Loans. There were no loans, not otherwise identified above, included on management’s watch or troubled loan lists that management has serious doubts as to the ability of such borrowers to comply with the loan repayment terms. Management’s watch and troubled loan lists includes loans which management has some doubt as to the borrowers’ ability to comply with the present repayment terms, loans which management is actively monitoring due to changes in the borrowers financial condition and other loans which management wants to more closely monitor due to special circumstances. These loans and their potential loss exposure have been considered in management’s analysis of the adequacy of the allowance for loan losses. The following table summarizes the Corporation’s loan loss experience, and provides a breakdown of the charge-off, recovery and other activity for the years ended June 30: Allowance for loan losses at beginning of year ........................................ Loans charged off: Commercial .............................................................................................. Commercial real estate ............................................................................. 1-4 Family residential real estate .............................................................. 1-4 Family real estate construction........................................................... Consumer loans ........................................................................................ Total charge offs....................................................................................... Recoveries: Commercial .............................................................................................. Commercial real estate ............................................................................. 1-4 Family residential real estate .............................................................. 1-4 Family real estate construction........................................................... Consumer loans ........................................................................................ Total recoveries ........................................................................................ Net charge offs.......................................................................................... Provision for loan losses charged to operations........................................ Allowance for loan losses at end of year .................................................. 2011 2010 $ 2,276 $ 1,992 — 182 62 — 117 361 — 6 1 — 94 101 9 510 62 — 116 697 2 19 — — 66 87 610 435 260 544 $ 2,101 $ 2,276 The following schedule is a breakdown of the allowance for loan losses allocated by type of loan and related ratios: Allocation of the Allowance for Loan Losses Allowance Amount % of Loan Type to Total Loans Allowance Amount % of Loan Type to Total Loans June 30, 2011 June 30, 2010 Commercial ........................................................................................ Commercial real estate loans .............................................................. 1-4 Family residential real estate ........................................................ Consumer loans .................................................................................. Total.................................................................................................... $ 179 882 947 93 $ 2,101 10.9 % 55.3 30.5 3.3 100.0 % $ 183 1,337 653 103 $ 2,276 8.4 % 58.7 29.5 3.4 100.0 % While management’s periodic analysis of the adequacy of the allowance for loan loss may allocate portions of the allowance for specific problem loan situations, the entire allowance is available for any loan charge-off that may occur. Cash Surrender Value of Life Insurance. The cash surrender value of life insurance increased by $613 from June 30, 2010, to $5,411 as of June 30, 2011. The increase was mainly due to the purchase of $431 of single-premium life insurance following the conversion of a term life insurance policy that was originally purchased as a cost recovery component with a salary continuation agreement that was entered into with an executive officer in August 2008. 16 Funding Sources. Total deposits increased $31,932, or 14.8%, from $216,314 at June 30, 2010 to $248,246 at June 30, 2011. Non-interest bearing deposits increased $16,998, or 35.7%, savings deposits increased $16,112, or 25.3%, and interest- bearing checking balances increased $1,142, or 8.3%, from June 30, 2010 to June 30, 2011. The increase in deposits reflects a current trend in the industry where customers are turning to the safety of insured deposits during these uncertain economic times. The following is a schedule of average deposit amounts and average rates paid on each category for the periods included: Years Ended June 30, 2011 Amount 55,499 Non-interest bearing demand deposit .................... $ 14,102 Interest bearing demand deposit ............................ 71,968 Savings .................................................................. 90,863 Certificates and other time deposits....................... Total ...................................................................... $ 232,432 Rate — 0.13% 0.21 1.59 0.70% 2010 Amount $ 45,582 13,387 59,873 90,297 $ 209,139 Rate — 0.20% 0.31 2.22 1.06% The following table summarizes time deposits issued in amounts of $100 thousand or more as of June 30, 2011 by time remaining until maturity: Maturing in: 3,599 Under 3 months ....................................................................................................................... $ 11,672 Over 3 to 6 months .................................................................................................................. 6,956 Over 6 to 12 months ................................................................................................................ Over 12 months ....................................................................................................................... 12,480 Total ........................................................................................................................................ $ 34,707 See Note 7—Short-Term Borrowings to the Consolidated Financial Statements, for information concerning short-term borrowings. Shareholders’ Equity. Total shareholders’ equity increased by $1,608 from $23,716 at June 30, 2010 to $25,324 at June 30, 2011. The increase was primarily due to net income of $2,248 for the current fiscal year and cash of $146 received from the dividend reinvestment and stock purchase program. These increases were partially offset by cash dividends paid of $837. Liquidity Management considers the asset position of the Bank to be sufficiently liquid to meet normal operating needs and conditions. The Bank’s earning assets are divided primarily between loans and available-for-sale securities, with any excess funds placed in federal funds sold or interest-bearing deposit accounts with other financial institutions on a daily basis. Net cash inflow from operating activities for the 2011 fiscal year were $4,163 and net cash inflow from financing activities was $34,405. Net cash outflow from investing activities was $38,546. The major sources of cash were $31,932 net increase in deposits, $21,112 net increase from sales, maturities or principal pay downs on available-for-sale securities. The major uses of cash were the $49,803 purchase of securities and a $3,954 net increase in loans. Total cash and cash equivalents were $13,828 as of June 30, 2011 compared to $13,806 at June 30, 2010. The Bank groups its loan portfolio into four major categories: commercial loans; commercial real estate loans; 1-4 family residential real estate loans; and consumer loans. The Bank’s 1-4 family residential real estate loan portfolio consists of three basic segments: mortgage loans having fixed rates for terms not longer than fifteen years, variable rate home equity line of credit loans and fixed rate loans having maturity or renewal dates that are less than the scheduled amortization period. Commercial and commercial real estate loans are comprised of both variable rate notes subject to interest rate changes based on the prime rate or T-bill and fixed rate notes having maturities of generally not greater than five years. Consumer loans offered by the Bank are generally written for periods of up to five years, based on the nature of the collateral. These may be either installment loans having regular monthly payments or demand type loans for short periods of time. 17 Funds not allocated to the Bank’s loan portfolio are invested in various securities having diverse maturity schedules. The majority of the Bank’s securities are held in obligations of U.S. Government sponsored entities, mortgage-backed securities, and investments in tax free municipal bonds. The Bank offers several forms of deposit products to its customers. The rates offered by the Bank and the fees charged for them are competitive with others available currently in the market area. While the Bank continues to be under competitive pressures in the Bank’s market area as financial institutions attempt to attract and keep new deposits, we believe many commercial and retail customers have been turning to community banks in these uncertain times. Time deposit interest rates continued to decline in the 2011 fiscal year. Compared to our peers, the Corporation’s core deposits consist of a large percentage of non-interest bearing demand deposits resulting in the cost of funds remaining at a low level of 0.96%. Jumbo time deposits (those with balances of $100 thousand and over) increased from $33,763 at June 30, 2010 to $34,707 at June 30, 2011. These deposits are monitored closely by the Bank and typically priced on an individual basis. When these deposits are from a municipality, certain bank-owned securities are pledged to guarantee the safety of these public fund deposits as required by Ohio law. The Corporation has the option to use a fee paid broker to obtain deposits from outside its normal service area as an additional source of funding. However, these deposits are not relied upon as a primary source of funding and the Bank can foresee no dependence on these types of deposits in the near term. The net interest margin is monitored on a monthly basis. It is the Bank’s goal to maintain the net interest margin at 4.0% or greater. The net interest margin on a tax equivalent basis for 2011 was 4.22% as compared to 4.28% for 2010. Capital Resources At June 30, 2011, management believes the Bank complied with all regulatory capital requirements. Based on the Bank’s computed regulatory capital ratios, the OCC has determined the Bank to be well capitalized under the Federal Deposit Insurance Act as of its latest exam date. The Bank’s actual and required capital amounts are disclosed in Note 11 of the Consolidated Financial Statements. Management is not aware of any matters occurring subsequent to that exam that would cause the Bank’s capital category to change. Impact of Inflation and Changing Prices The financial statements and related data presented herein have been prepared in accordance with U.S. generally accepted accounting principles, which require the measurement of financial position and results of operations primarily in terms of historical dollars without considering changes in the relative purchasing power of money over time due to inflation. Unlike most industrial companies, virtually all of the assets and liabilities of the Corporation are monetary in nature. Therefore, interest rates have a more significant impact on a financial institution’s performance than the effects of general levels of inflation. Interest rates do not necessarily move in the same direction or in the same magnitude as the prices of goods and services. The liquidity, maturity structure and quality of the Corporation’s assets and liabilities are critical to the maintenance of acceptable performance levels. Critical Accounting Policies and Use of Significant Estimates The financial condition and results of operations for the Corporation presented in the Consolidated Financial Statements, accompanying notes to the Consolidated Financial Statements and management’s discussion and analysis are, to a large degree, dependent upon the Corporation’s accounting policies. The selection and application of these accounting policies involve judgments, estimates and uncertainties that are susceptible to change. Presented below is a discussion of the accounting policy that management believes is the most important to the portrayal and understanding of the Corporation’s financial condition and results of operations. This policy requires management’s most difficult, subjective and complex judgments about matters that are inherently uncertain. In the event that different assumptions or conditions were to prevail, and depending upon the severity of such changes, the possibility of materially different financial condition or results of operations is a reasonable likelihood. Also, see Note 1 of the Consolidated Financial Statements for additional information related to significant accounting policies. Allowance for Loan Losses. Management periodically reviews the loan portfolio in order to establish an estimated allowance for loan losses (allowance) that are probable as of the respective reporting date. Additions to the allowance are charged against earnings for the period as a provision for loan losses. Actual loan losses are charged against the allowance when management believes that the collection of principal will not occur. Unpaid interest for loans that are placed on non- accrual status is reversed against current interest income. 18 The allowance is regularly reviewed by management to determine whether or not the amount is considered adequate to absorb probable incurred losses. If not, an additional provision is made to increase the allowance. This evaluation includes specific loss estimates on certain individually reviewed loans, loss estimates for loan groups or pools that are based on historical loss experience and general loss estimates that are based upon the size, quality, and concentration characteristics of the various loan portfolios, adverse situations that may affect a borrower’s ability to repay, and current economic and industry conditions, among other things. The allowance is also subject to periodic examination by regulators whose review includes a determination as to its adequacy to absorb probable incurred losses. Those judgments and assumptions that are most critical to the application of this accounting policy are the initial and on- going credit-worthiness of the borrower, the amount and timing of future cash flows of the borrower that are available for repayment of the loan, the sufficiency of underlying collateral, the enforceability of third-party guarantees, the frequency and subjectivity of loan reviews and risk grading, emerging or changing trends that might not be fully captured in the historical loss experience, and charges against the allowance for actual losses that are greater than previously estimated. These judgments and assumptions are dependent upon or can be influenced by a variety of factors including the breadth and depth of experience of lending officers, credit administration and the loan review staff that periodically review the status of the loan, changing economic and industry conditions, changes in the financial condition of the borrower, and changes in the value and availability of the underlying collateral and guarantees. While the Corporation strives to reflect all known risk factors in its evaluations, judgment errors may occur. If different assumptions or conditions were to prevail, the amount and timing of interest income and loan losses could be materially different. These factors are most pronounced during economic downturns. Since, as described above, so many factors can affect the amount and timing of losses on loans it is difficult to predict, with any degree of certainty, the affect on income if different conditions or assumptions were to prevail. Valuation of Securities and Other-Than-Temporary Impairment (OTTI). The fair value of available-for-sale securities is estimated using relevant market information and other assumptions. Fair value measurements are classified within one of three levels in a valuation hierarchy based upon the transparency of inputs to the valuation of an asset or liability as of the measurement date. Fair value estimates involve uncertainties and matters of significant judgment regarding interest rates, credit risk, discounted cash flows, prepayments, and other factors, especially in the absence of broad markets for particular items. Changes in assumptions or in market conditions could significantly affect the estimates. Securities are reviewed at least quarterly for indicators of other-than-temporary impairment. This determination requires significant judgment. In estimating other-than-temporary impairment, management evaluates: the length of time and extent the fair value has been less than cost, the expected cash flows of the security, the financial condition and near term prospects of the issuer, and whether the Corporation has the intent to sell the security or the likelihood the Corporation will be required to sell the security at an unrealized loss position prior to any anticipated recovery in fair value, which may be maturity. A decline in value that is considered to be credit-related other-than-temporary is recorded as a loss within other income in the consolidated statements of income. Contractual Obligations, Commitments and Contingent Liabilities The following table presents, as of June 30, 2011, the Corporation’s significant fixed and determinable contractual obligations by payment date. The payment amounts represent those amounts contractually due to the recipient and do not include any unamortized premiums or discounts. Further discussion of the nature of each obligation is included in the referenced note to the consolidated financial statements. Certificates of deposit .................... Short-term borrowings................... Federal Home Loan Advances....... Salary continuation plan ................ Operating leases............................. Deposits without maturity.............. Note Reference 6 7 8 9 4 2012 $ 49,051 17,012 596 22 115 — 2013 $24,386 — 579 22 105 — 2014 $ 5,987 — 69 22 91 — 2015 $4,248 — 57 22 78 — 2016 $4,504 — 559 22 19 — Thereafter 768 $ — 5,675 1,053 — — Total $ 88,944 17,012 7,535 1,163 408 159,302 Note 12 to the Consolidated Financial Statements discusses in greater detail other commitments and contingencies and the various obligations that exist under those agreements. These commitments and contingencies consist primarily of commitments to extend credit to borrowers under lines of credit. 19 Off-Balance Sheet Arrangements At June 30, 2011, the Corporation had no unconsolidated, related special purpose entities, nor did the Corporation engage in derivatives and hedging contracts, such as interest rate swaps, which may expose the Corporation to liabilities greater than the amounts recorded on the consolidated balance sheet. The Corporation’s investment policy prohibits engaging in derivative contracts for speculative trading purposes; however, in the future, the Corporation may pursue certain contracts, such as interest rate swaps, in an effort to execute a sound and defensive interest rate risk management policy. Forward-Looking Statements All statements set forth in this discussion or future filings by the Corporation with the Securities and Exchange Commission, or other public or shareholder communications, or in oral statements made with the approval of an authorized executive officer, that are not historical in nature, including words or phrases “will likely result,” “are expected to,” “will continue,” “is anticipated,” “estimate,” “project,” “believe” or similar expressions are intended to identify “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. These forward-looking statements may involve risks and uncertainties that are difficult to predict, may be beyond our control, and could cause actual results to differ materially from those described in such statements. Any such forward-looking statements are made only as of the date of this report or the respective dates of the relevant incorporated documents, as the case may be, and, except as required by law, we undertake no obligation to update these forward-looking statements to reflect subsequent events or circumstances. Factors that could cause actual results for future periods to differ materially from those anticipated or projected include, but are not limited to: • regional and national economic conditions becoming less favorable than expected, resulting in, among other things, a deterioration in credit quality of assets and the underlying value of collateral could prove to be less valuable than otherwise assumed; the nature, extent, and timing of government and regulatory actions; • • material unforeseen changes in the financial condition or results of the Bank’s customers; • • • changes in levels of market interest rates which could reduce anticipated or actual margins; competitive pressures on product pricing and services; and a continued deterioration in market conditions causing debtors to be unable to meet their obligations. The risks and uncertainties identified above are not the only risks we face. Additional risks and uncertainties not presently known to us or that we currently believe to be immaterial also may adversely affect us. Should any known or unknown risks and uncertainties develop into actual events, those developments could have material adverse effects on our business, financial condition and results of operations. ITEM 7A—QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Not applicable for Smaller Reporting Companies. 20 ITEM 8—FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA REPORT OF MANAGEMENT ON THE CORPORATION`S INTERNAL CONTROL OVER FINANCIAL REPORTING Management of Consumers Bancorp, Inc. is responsible for establishing and maintaining adequate internal control over financial reporting. Internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with U. S. generally accepted accounting principles. Internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of assets; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures are made only in accordance with authorizations of management and directors; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, have been detected. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies and procedures may deteriorate. Management of Consumers Bancorp, Inc., including the Chief Executive Officer and the Chief Financial Officer, has assessed the Corporation’s internal control over financial reporting as of June 30, 2011, based on criteria for effective internal control over financial reporting described in “Internal Control — Integrated Framework” issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this assessment, management has concluded that the Corporation’s internal control over financial reporting was effective as of June 30, 2011, based on the specified criteria. This annual report does not include an attestation report of the Corporation’s independent registered public accounting firm regarding internal control over financial reporting because management’s report was not subject to attestation by the Corporation’s registered public accounting firm pursuant to rules of the Securities and Exchange Commission that permit the Corporation to provide only management’s report. Ralph J. Lober, II Chief Executive Officer Renee K. Wood Chief Financial Officer & Treasurer 21 REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM Board of Directors and Shareholders Consumers Bancorp, Inc. Minerva, Ohio We have audited the accompanying consolidated balance sheets of Consumers Bancorp, Inc. as of June 30, 2011 and 2010 and the related consolidated statements of income, comprehensive income, changes in shareholders’ equity, and cash flows for the years then ended. These financial statements are the responsibility of the Corporation’s management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. The Corporation is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Corporation’s internal control over financial reporting. Accordingly, we express no such opinion. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall consolidated financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Consumers Bancorp, Inc. as of June 30, 2011 and 2010 and the results of its operations and its cash flows for the years then ended, in conformity with U. S. generally accepted accounting principles. Crowe Horwath LLP Cleveland, Ohio September 16, 2011 22 CONSOLIDATED BALANCE SHEETS As of June 30, 2011 and 2010 (Dollar amounts in thousands, except per share data) ASSETS: Cash on hand and noninterest-bearing deposits in financial institutions ........................................................ Federal funds sold and interest-bearing deposits in financial institutions………………………………….. Total cash and cash equivalents ................................................................................................................ Certificate of deposits in financial institutions ............................................................................................... Securities, available-for-sale........................................................................................................................... Federal bank and other restricted stocks, at cost............................................................................................. Total loans ...................................................................................................................................................... Less allowance for loan losses........................................................................................................................ Net loans ................................................................................................................................................... Cash surrender value of life insurance............................................................................................................ Premises and equipment, net .......................................................................................................................... Intangible assets, net....................................................................................................................................... Other real estate owned .................................................................................................................................. Accrued interest receivable and other assets................................................................................................... 2011 2010 $ $ 5,944 7,884 5,973 7,833 13,828 4,900 91,889 1,186 177,551 (2,101) 175,450 5,411 4,776 89 76 2,535 13,806 980 64,262 1,186 174,283 (2,276) 172,007 4,798 3,581 250 25 2,498 Total assets................................................................................................................................................ $ 300,140 $ 263,393 LIABILITIES: Deposits: Non-interest bearing demand.......................................................................................................................... Interest bearing demand.................................................................................................................................. Savings ........................................................................................................................................................... Time................................................................................................................................................................ Total deposits ............................................................................................................................................ Short-term borrowings.................................................................................................................................... Federal Home Loan Bank advances ............................................................................................................... Accrued interest payable and other liabilities ................................................................................................. $ 64,657 14,829 79,816 88,944 248,246 17,012 7,535 2,023 $ 47,659 13,687 63,704 91,264 216,314 13,086 8,297 1,980 Total liabilities .......................................................................................................................................... Commitments and contingent liabilities ......................................................................................................... 274,816 — 239,677 — SHAREHOLDERS’ EQUITY: Preferred stock, no par value; 350,000 shares authorized .............................................................................. Common shares, no par value; 3,500,000 shares authorized; 2,180,315 and 2,168,329 shares issued as of June 30, 2011 and 2010, respectively .................................................................................................... Retained earnings ........................................................................................................................................... Treasury stock, at cost (130,442 common shares at June 30, 2011 and 2010) ............................................... Accumulated other comprehensive income .................................................................................................... Total shareholders’ equity......................................................................................................................... — — 5,114 20,881 (1,659) 988 25,324 4,968 19,470 (1,659) 937 23,716 Total liabilities and shareholders’ equity .................................................................................................. $ 300,140 $ 263,393 See accompanying notes to consolidated financial statements. 23 CONSOLIDATED STATEMENTS OF INCOME Years Ended June 30, 2011 and 2010 (Dollar amounts in thousands, except per share data) 2011 2010 Interest income: Loans, including fees ..................................................................................................... $ 10,212 Federal funds sold and interest-bearing deposits in financial institutions...................... 54 Securities: Taxable................................................................................................................. Tax-exempt .......................................................................................................... Total interest income .................................................................................. 1,624 894 12,784 Interest expense: Deposits ......................................................................................................................... Short-term borrowings................................................................................................... Federal Home Loan Bank advances............................................................................... Total interest expense ................................................................................. Net interest income.................................................................................................................. Provision for loan losses.......................................................................................................... Net interest income after provision for loan losses ................................................................. Other income: Service charges on deposit accounts.............................................................................. Debit card interchange income ...................................................................................... Bank owned life insurance income ................................................................................ Securities gains, net ....................................................................................................... Other-than-temporary loss Total impairment loss .................................................................................................... Loss recognized in other comprehensive income .......................................................... Net impairment loss recognized in earnings .......................................................... Gain (loss) on disposition or direct write-down of other real estate owned................... Other .............................................................................................................................. Total other income ...................................................................................... 1,617 45 254 1,916 10,868 435 10,433 1,292 644 182 71 (370) — (370) 2 190 2,011 Other expenses: 4,827 Salaries and employee benefits...................................................................................... 1,019 Occupancy and equipment............................................................................................. 553 Data processing expenses .............................................................................................. 346 Professional and director fees ........................................................................................ 287 Federal Deposit Insurance Corporation assessments ..................................................... 242 Franchise taxes............................................................................................................... 228 Marketing and advertising ............................................................................................. 121 Loan and collection expenses ........................................................................................ 161 Amortization of intangible............................................................................................. 231 Telephone and communications .................................................................................... 343 Debit card processing expenses ..................................................................................... 1,217 Other .............................................................................................................................. 9,575 Total other expenses ................................................................................... 2,869 Income before income taxes.................................................................................................... 621 Income tax expense ................................................................................................................. Net income.............................................................................................................................. $ 2,248 1.10 Basic earnings per share ....................................................................................................... $ See accompanying notes to consolidated financial statements. 24 $ 9,939 61 1,827 783 12,610 2,217 50 293 2,560 10,050 544 9,506 1,540 524 176 218 (410) — (410) (53) 153 2,148 4,434 1,069 534 370 313 223 150 189 161 233 296 1,076 9,048 2,606 567 $ 2,039 1.00 $ CONSOLIDATED STATEMENTS OF CHANGES IN COMPREHENSIVE INCOME Years Ended June 30, 2011 and 2010 (Dollar amounts in thousands, except per share data) 2011 2010 Net Income .............................................................................................................................. $ 2,248 $ 2,039 Other comprehensive income (loss), net of tax: Net change in unrealized gains (losses): Other-than-temporarily impaired securities: Unrealized gains (loss) on other-than-temporarily impaired securities ......................... Reclassification adjustment for losses included in income............................................ Net unrealized gain ........................................................................................................ Income tax effect ........................................................................................................... Available-for-sale securities which are not other-than-temporarily impaired: Unrealized gains arising during the period .................................................................... Reclassification adjustment for gains included in income ............................................. Net unrealized gain ....................................................................................................... Income tax effect ........................................................................................................... (355) 370 15 5 10 134 (71) 63 22 41 66 410 476 162 314 1,151 (218 ) 933 317 616 51 Other comprehensive income .................................................................................................. Total comprehensive income................................................................................................... $ 2,299 930 $ 2,969 See accompanying notes to consolidated financial statements. 25 CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY Years Ended June 30, 2011 and 2010 (Dollar amounts in thousands, except per share data) Balance, June 30, 2009............................................... Comprehensive Income: Net income................................................................... Other comprehensive income ...................................... Total comprehensive income ....................................... Issuance of 8,329 shares for dividend reinvestment and stock purchase plan .......................................... Cash dividends declared ($0.40 per share) .................. Balance, June 30, 2010............................................... Comprehensive Income: Net income................................................................... Other comprehensive income ...................................... Total comprehensive income ....................................... Issuance of 11,986 shares for dividend reinvestment and stock purchase plan .......................................... Cash dividends declared ($0.41 per share) .................. Balance, June 30, 2011............................................... $ 5,114 Accumulated Other Comprehensive Income 7 $ 930 Common Shares $ 4,869 Retained Earnings $ 18,244 Treasury Stock $ (1,659) 2,039 99 (813) 4,968 19,470 (1,659) 937 2,248 51 146 (837) $ 20,881 $ (1,659) $ 988 Total Shareholders’ Equity $ 21,461 2,039 930 2,969 99 (813) 23,716 2,248 51 2,299 146 (837) $ 25,324 See accompanying notes to consolidated financial statements. 26 CONSOLIDATED STATEMENTS OF CASH FLOWS Years Ended June 30, 2011 and 2010 (Dollar amounts in thousands, except per share data) Cash flows from operating activities: Net income ......................................................................................................................... Adjustments to reconcile net income to net cash flows from operating activities: Depreciation ....................................................................................................................... Securities amortization and accretion, net .......................................................................... Provision for loan losses..................................................................................................... (Gain) loss on disposition or direct write-down of other real estate owned ....................... Deferred income taxes........................................................................................................ Gain on sale of securities.................................................................................................... Impairment loss on securities ............................................................................................. Intangible amortization....................................................................................................... Increase in cash surrender value of life insurance .............................................................. Change in: Accrued interest receivable ................................................................................................ Accrued interest payable .................................................................................................... Other assets and other liabilities......................................................................................... Net cash flows from operating activities ............................................................................ Cash flows from investing activities: Securities available-for-sale Purchases............................................................................................................................ Maturities, calls and principal pay downs .......................................................................... Proceeds from sales of available for sale securities............................................................ Net (increase)/decrease in certificates of deposit with other financial institutions............. Net increase in loans........................................................................................................... Purchase of Bank owned life insurance.............................................................................. Acquisition of premises and equipment ............................................................................. Proceeds from sale of other real estate owned.................................................................... Net cash flows from investing activities............................................................................. Cash flows from financing activities: Net increase in deposit accounts......................................................................................... Proceeds from FHLB advances .......................................................................................... Repayments of FHLB advances ......................................................................................... Change in short-term borrowings ....................................................................................... Proceeds from dividend reinvestment and stock purchase plan ......................................... Dividends paid.................................................................................................................... Net cash flows from financing activities ............................................................................ Increase (decrease) in cash and cash equivalents ............................................................... Cash and cash equivalents, beginning of year .................................................................... Cash and cash equivalents, end of year .......................................................................... 2011 2010 $ 2,248 $ 2,039 382 843 435 (2) 81 (71) 370 161 (182) (37) (40) (25) 4,163 (49,803) 15,989 5,123 (3,920) (3,954) (431) (1,577) 27 (38,546) 430 431 544 53 (316) (218) 410 161 (176) 95 (62) (776) 2,615 (27,330) 16,956 7,672 1,032 (14,622) — (235) 323 (16,204) 31,932 1,000 (1,762) 3,926 146 (837) 34,405 22 13,806 $ 13,828 12,263 — (1,076) (1,969) 99 (813) 8,504 (5,085) 18,891 $ 13,806 Supplemental noncash disclosures: Transfers from loans to repossessed assets......................................................................... $ 76 $ 220 See accompanying notes to consolidated financial statements. 27 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS June 30, 2011 and 2010 (Dollar amounts in thousands, except per share data) NOTE 1—SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Unless otherwise indicated, dollar amounts are in thousands, except per share data. Principles of Consolidation: The consolidated financial statements include the accounts of Consumers Bancorp, Inc. (Corporation) and its wholly owned subsidiary, Consumers National Bank (Bank), together referred to as the Corporation. All significant intercompany transactions have been eliminated in the consolidation. Nature of Operations: Consumers Bancorp, Inc. is a bank holding company headquartered in Minerva, Ohio that provides, through its banking subsidiary, a broad array of products and services throughout its primary market area of Stark, Columbiana, Carroll and contiguous counties in Ohio. The Bank’s business involves attracting deposits from businesses and individual customers and using such deposits to originate commercial, mortgage and consumer loans in its primary market area. Business Segment Information: Consumers Bancorp, Inc. is a bank holding company engaged in the business of commercial and retail banking, which accounts for substantially all of its revenues, operating income, and assets. Accordingly, all of its operations are reported in one segment, banking. Use of Estimates: To prepare financial statements in conformity with U. S. generally accepted accounting principles, management makes estimates and assumptions based on available information. These estimates and assumptions affect the amounts reported in the financial statements and the disclosures provided, and actual results could differ. The allowance for loan losses, fair values of financial instruments, and determination of other-than-temporary impairment of securities are particularly subject to change. Cash Flows: Cash and cash equivalents include cash, deposits with other financial institutions with original maturities of less than 90 days and federal funds sold. Net cash flows are reported for customer loan and deposit transactions, interest bearing deposits in other financial institutions and short-term borrowings. Cash paid for interest was $1,956 and $2,622 for the years ending June 30, 2011 and 2010, respectively. Cash paid for income taxes was $830 and $785 for the years ending June 30, 2011 and 2010, respectively. Interest–Bearing Deposits in Other Financial Institutions: Interest-bearing deposits in other financial institutions mature within one year and are carried at cost. Cash Reserves: The Bank is required to maintain cash on hand and non-interest bearing balances on deposit with the Federal Reserve Bank to meet regulatory reserve and clearing requirements. The required reserve balance at June 30, 2011 and 2010 was $3,075 and $1,768, respectively. Securities: Securities are generally classified into either held-to-maturity or available-for-sale categories. Held-to- maturity securities are carried at amortized cost and are those that the Corporation has the positive intent and ability to hold to maturity. Available-for-sale securities are those that the Corporation may decide to sell before maturity if needed for liquidity, asset-liability management, or other reasons. Available-for-sale securities are reported at fair value, with unrealized gains or losses included in other comprehensive income as a separate component of equity, net of tax. Federal bank and other restricted stocks, such as Federal Home Loan Bank stock, are carried at cost. Interest income includes amortization of purchase premiums and accretion of discounts. Premiums and discounts on securities are amortized on the level-yield method without anticipating prepayments, except for mortgage-backed securities where prepayments are anticipated. Gains and losses on sales are recorded on the trade date and determined using the specific identification method. Management evaluates securities for OTTI at least on a quarterly basis and more frequently when economic or market conditions warrant such an evaluation. For securities in an unrealized loss position, management considers the extent and duration of the unrealized loss, and the financial condition and near-term prospects of the issuer. Management also assesses whether it intends to sell, or it is more likely than not that it will be required to sell, a security in an unrealized loss position before recovery of its amortized cost basis. If either of these criteria is met, the entire difference between amortized cost and fair value is recognized as impairment through earnings. For securities that do not meet the aforementioned criteria, the amount of impairment is split into two components as follows: 1) OTTI related to credit loss, which must be recognized in the income 28 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS statement and 2) OTTI related to other factors, which is recognized in other comprehensive income. The credit loss is defined as the difference between the present value of the cash flows expected to be collected and the amortized cost basis. Federal Home Loan Bank (FHLB) stock: The Bank is a member of the FHLB system. Members are required to own a certain amount of stock based on the level of borrowings and other factors, and may invest in additional amounts. FHLB stock, included with Federal bank and other restricted stocks in the Consolidated Balance Sheet, is carried at cost, classified as a restricted security and periodically evaluated for impairment based on ultimate recovery of par value. Since this stock is viewed as a long-term investment, impairment is based on ultimate recovery of par value. Both cash and stock dividends are reported as income. Loans: Loans that management has the intent and ability to hold for the foreseeable future or until maturity or payoff are reported at the principal balance outstanding, deferred loan fees and costs, and an allowance for loan losses. Interest income is accrued on the unpaid principal balance. Loan origination fees, net of certain direct origination costs, are deferred and recognized in interest income using the level-yield method without anticipating prepayments. The recorded investment in loans includes accrued interest receivable. Interest income is reported on the interest method and includes amortization of net deferred loan fees and costs over the loan term. Interest income on mortgage and commercial loans is discontinued at the time the loan is 90 days delinquent unless the loan is well-secured and in the process of collection. Consumer loans are typically charged off no later than 90 days past due. Past due status is determined by the contractual terms of the loan. In all cases, loans are placed on non-accrual or charged- off at an earlier date if collection of principal or interest is considered doubtful. All interest accrued but not received on loans placed on non-accrual is reversed against interest income. Interest received on such loans is accounted for on the cash-basis or cost-recovery method, until qualifying for return to accrual. Loans are returned to accrual status when the customer has exhibited the ability to repay and demonstrated this ability over a consecutive six month period and future payments are reasonably assured. Loan Commitments and Related Financial Instruments: Financial instruments include off-balance sheet credit instruments, such as commitments to make loans and commercial letters of credit, issued to meet customer financing needs. The face amount for these items represents the exposure to loss, before considering customer collateral or ability to repay. Such financial instruments are recorded when funded. Concentrations of Credit Risk: The Bank grants consumer, real estate and commercial loans primarily to borrowers in Stark, Columbiana and Carroll counties. Therefore, the Corporation’s exposure to credit risk is significantly affected by changes in the economy in this tri-county area. Automobiles and other consumer assets, business assets and residential and commercial real estate secure most loans. Allowance for Loan Losses: The allowance for loan losses is a valuation allowance for probable incurred credit losses. Loan losses are charged against the allowance when management believes the uncollectability of a loan balance is confirmed. Subsequent recoveries, if any, are credited to the allowance. Management estimates the allowance balance required based on past loan loss experience, the nature and volume of the portfolio, information about specific borrower situations and estimated collateral values, economic conditions and other factors. Allocations of the allowance may be made for specific loans, but the entire allowance is available for any loan that, in management’s judgment, should be charged-off. The allowance consists of specific and general components. The specific component relates to loans that are individually classified as impaired. The general component covers non-classified loans and is based on historical loss experience adjusted for current factors. A loan is considered impaired when, based on current information and events, it is probable that the Corporation will be unable to collect all amounts due according to the contractual terms of the loan agreement. Loans, for which the terms have been modified resulting in a concession, and for which the borrower is experiencing financial difficulties, are considered trouble debt restructurings and classified as impaired. 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. 29 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Impairment is evaluated in total for smaller-balance loans of similar nature such as residential mortgage, consumer loans and on an individual loan basis for other loans. If a loan is impaired, a portion of the allowance is allocated so the loan is reported, net, at the present value of estimated future cash flows using the loan’s existing rate or at the fair value of collateral if repayment is expected from the collateral. Loans are evaluated for impairment when payments are delayed, typically 90 days or more, or when it is probable that not all principal and interest amounts will be collected according to the original terms of the loan. Troubled debt restructurings are separately identified for impairment disclosures and are measured at the present value of estimated future cash flows using the loan’s effective interest rate at inception. If a troubled debt restructuring is considered to be a collateral dependent loan, the loan is reported, net, at the fair value of the collateral. For troubled debt restructurings that subsequently default, the Corporation determines the amount of reserve in accordance with the accounting policy for the allowance for loan losses. The general component covers non-impaired loans and is based on historical loss experience adjusted for current factors. The historical loss experience is determined by portfolio segment and is based on the actual loss history experienced by the Corporation over the most recent three year period. This actual loss experience is supplemented with other economic factors based on the risks present for each portfolio segment. These economic factors include consideration of the following: levels of and trends in volume and terms of loans; effects of any changes in risk selection and underwriting standards; other changes in lending policies, procedures and practices; experience, ability and depth of lending management and other relevant staff; national and local economic trends and conditions; industry conditions; and effects of changes in credit concentrations. The following portfolio segments have been identified: Commercial Loans: Commercial loans are made for a wide variety of general business purposes, including financing for equipment, inventories and accounts receivable. The term of each commercial loan varies by its purpose. Commercial loans are underwritten after evaluating and understanding the borrower’s ability to operate profitably and prudently expand its business. Current and projected cash flows are evaluated to determine the ability of the borrower to repay their obligations as agreed. Commercial loans are primarily made based on the identified cash flows of the borrower and secondarily on the underlying collateral provided by the borrower. The cash flows of borrowers, however, may not be as expected and the collateral securing these loans may fluctuate in value. Most commercial loans are secured by the assets being financed or other business assets such as accounts receivable or inventory and usually incorporate a personal guarantee; however, some short-term loans may be made on an unsecured basis. In the case of loans secured by accounts receivable, the availability of funds for the repayment of these loans may be substantially dependent on the ability of the borrower to collect amounts due from its customers. The commercial loan portfolio includes loans to a wide variety of corporations and businesses across many industrial classifications in the areas where the Bank operates. Commercial Real Estate: Commercial real estate loans include mortgage loans to farmers, multi-family investment properties, developers and owners of commercial real estate. Commercial real estate lending typically involves higher loan principal amounts and the repayment of these loans is generally largely dependent on the successful operation of the property securing the loan or the business conducted on the property securing the loan. Commercial real estate loans may be more adversely affected by conditions in the real estate markets or in the general economy. The properties securing the Corporation’s commercial real estate portfolio are diverse in terms of type and geographic location. This diversity helps reduce the Corporation’s exposure to adverse economic events that affect any single market or industry. Management monitors and evaluates commercial real estate loans based on collateral, geography and risk grade criteria. In addition, management tracks the level of owner-occupied commercial real estate loans versus non-owner occupied loans. Residential real estate: Residential real estate loans are secured by one to four family residential properties and include both owner occupied, non-owner occupied and home equity loans. Credit approval for residential real estate loans requires demonstration of sufficient income to repay the principal and interest and the real estate taxes and insurance, stability of employment, an established credit record and an appropriately appraised value of the real estate securing the loan that generally requires that the residential real estate loan amount be no more than 80% of the purchase price or the appraised value of the real estate securing the loan. Underwriting standards for home equity loans are heavily influenced by statutory requirements, which include, but are not limited to, a maximum loan-to-value percentage of 80%, collection remedies, the number of such loans a borrower can have at one time and documentation requirements. Consumer Loans: The Corporation originates direct and indirect consumer loans, primarily automobile loans, personal lines of credit, and unsecured consumer loans in its primary market areas. Credit approval for consumer loans requires income sufficient to repay principal and interest due, stability of employment, an established credit record and sufficient collateral for secured loans. Consumer loans typically have shorter terms and lower balances with higher yields as compared to real estate mortgage loans, but generally carry higher risks of default. Consumer loan collections are dependent on the borrower’s continuing financial stability, and thus are more likely to be affected by adverse personal circumstances. 30 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Other Real Estate Owned: Real estate properties acquired through, or in lieu of, loan foreclosure are initially recorded at fair value less costs to sell at the date of acquisition, establishing a new cost basis. Any reduction to fair value from the carrying value of the related loan at the time of acquisition is accounted for as a loan loss. These assets are subsequently accounted for at lower of cost or fair value less estimated costs to sell. If the fair value declines after acquisition, a valuation allowance is recorded as a charge to income. Operating costs after acquisition are expensed. Gains and losses on disposition are reported as a charge to income. Premises and Equipment: Land is carried at cost. Premises and equipment are stated at cost less accumulated depreciation. Depreciation is computed primarily using the straight-line method over the estimated useful life of the owned asset and, for leasehold improvements, generally over the lesser of the remaining term of the lease facility or the estimated economic life of the improvement. Useful lives range from three years for software to thirty-nine and one-half years for buildings. Cash Surrender Value of Life Insurance: The Bank has purchased single-premium life insurance policies to insure the lives of current and former participants in the salary continuation plan. As of June 30, 2011, the Bank had policies with total death benefits of $11,944 and total cash surrender values of $5,411. As of June 30, 2010, the Bank had policies with total death benefits of $10,328 and total cash surrender values of $4,798. Bank owned life insurance is recorded at the amount that can be realized under the insurance contract at the balance sheet date, which is the cash surrender value adjusted for other changes or other amounts due that are probable at settlement. Tax-exempt income is recognized from the periodic increases in cash surrender value of these policies. The amount included in income (net of policy commissions and mortality costs) was $182, and $176 for the years ended June 30, 2011 and 2010, respectively. Intangible Assets: Core deposit intangible is recorded at cost and is amortized over an estimated life of 12 years on a straight line method. Intangibles are assessed annually for impairment and written down as necessary. Long-term Assets: Premises and equipment, core deposit and other intangible assets and other long-term assets are reviewed for impairment when events indicate their carrying amount may not be recoverable from future undiscounted cash flows. If impaired, the assets are recorded at fair value. Repurchase Agreements: Substantially all repurchase agreement liabilities, which are classified as short-term borrowings, represent amounts advanced by various customers. Securities are pledged to cover these liabilities, which are not covered by federal deposit insurance. Profit Sharing Plan: The Bank maintains a 401(k) profit sharing plan covering all eligible employees. Matching contributions are made and expensed annually. Income Taxes: The Corporation files a consolidated federal income tax return. Income tax expense is the sum of the current-year income tax due or refundable and the change in deferred tax assets and liabilities. Deferred tax assets and liabilities are the expected future tax consequences of temporary differences between the carrying amounts and tax basis of assets and liabilities, computed using enacted tax rates. A valuation allowance, if needed, reduces deferred tax assets to the amount expected to be realized. The Corporation applies a more likely than not recognition threshold for all tax uncertainties in accordance with U. S. generally accepted accounting principles. A tax position is recognized as a benefit only if it is more likely than not the position would be sustained in a tax examination, with a tax examination being presumed to occur. The amount recognized is the largest amount of tax benefit greater than 50% likely of being realized on examination. The Corporation recognizes interest and/or penalties related to income tax matters in income tax expense. Earnings per Common Share: Earnings per common share is net income divided by the weighted average common shares outstanding during the period. The weighted average number of common shares outstanding was 2,042,874 and 2,032,588 for the years ended June 30, 2011 and 2010, respectively. The Corporation’s capital structure contains no dilutive securities. Comprehensive Income: Comprehensive income consists of net income and other comprehensive income. Other comprehensive income includes unrealized gains and losses on securities available-for-sale, which are also recognized as a separate component of equity, net of tax. 31 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Loss Contingencies: Loss contingencies, including claims and legal actions arising in the ordinary course of business, are recorded as liabilities when the likelihood of loss is probable and an amount or range of loss can be reasonably estimated. Management does not believe there are such matters that will have a material effect on the financial statements. Fair Value of Financial Instruments: Fair values of financial instruments are estimated using relevant market information and other assumptions, as more fully disclosed in a separate note. Fair value estimates involve uncertainties and matters of significant judgment regarding interest rates, credit risk, discounted cash flows, prepayments, and other factors, especially in the absence of broad markets for particular items. Changes in assumptions or in market conditions could significantly affect the estimates. Dividend Restrictions: Banking regulations require maintaining certain capital levels and may limit the dividends paid by the Bank to the holding company or by the holding company to shareholders. As of June 30, 2011 the Bank could, without prior approval, declare a dividend of approximately $3,519. Newly Issued But Not Yet Effective Accounting Standards: In April 2011, the Financial Accounting Standards Board (FASB) amended existing guidance for assisting a creditor in determining whether a restructuring is a troubled debt restructuring. The amendments clarify the guidance for a creditor’s evaluation of whether it has granted a concession and whether a debtor is experiencing financial difficulties. With regard to determining whether a concession has been granted, the Accounting Standards Update (ASU) clarifies that creditors are precluded from using the effective interest method to determine whether a concession has been granted. In the absence of using the effective interest method, a creditor must now focus on other considerations such as the value of the underlying collateral, evaluation of other collateral or guarantees, the debtor’s ability to access other funds at market rates, interest rate increases and whether the restructuring results in a delay in payment that is insignificant. This guidance is effective for interim and annual reporting periods beginning after June 15, 2011, and should be applied retrospectively to the beginning of the annual period of adoption. For purposes of measuring impairment on newly identified troubled debt restructurings, the amendments should be applied prospectively for the first interim or annual period beginning on or after June 15, 2011. Management is currently reviewing this guidance to determine the impact, if any, to the Corporation’s consolidated financial statements. In May 2011, the FASB issued ASU No. 2011-04, “Fair Value Measurement (Topic 820) — Amendments to Achieve Common Fair Value Measurements and Disclosure Requirements in U.S. GAAP and IFRSs.” ASU 2011-04 amends Topic 820, “Fair Value Measurements and Disclosures”; to converge the fair value measurement guidance in U.S. generally accepted accounting principles and International Financial Reporting Standards. ASU 2011-04 clarifies the application of existing fair value measurement requirements, changes certain principles in Topic 820 and requires additional fair value disclosures. ASU 2011-04 is effective for annual periods beginning after December 15, 2011, and is not expected to have a significant impact on the Corporation’s financial statements. In June 2011, the FASB issued No. ASU 2011-05, “Comprehensive Income (Topic 220) — Presentation of Comprehensive Income.” ASU 2011-05 amends Topic 220, “Comprehensive Income”, to require that all nonowner changes in stockholders’ equity be presented in either a single continuous statement of comprehensive income or in two separate but consecutive statements. Additionally, ASU 2011-05 requires entities to present, on the face of the financial statements, reclassification adjustments for items that are reclassified from other comprehensive income to net income in the statement or statements where the components of net income and the components of other comprehensive income are presented. The option to present components of other comprehensive income as part of the statement of changes in stockholders’ equity was eliminated. ASU 2011-05 is effective for annual periods beginning after December 15, 2011, and is not expected to have a significant impact on the Corporation’s financial statements. Reclassifications: Certain reclassifications have been made to the June 30, 2010 financial statements to be comparable to the June 30, 2011 presentation. 32 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 2—SECURITIES The following table sets forth certain information regarding the amortized cost and fair value of the Corporation’s available-for-sale securities at the dates indicated. Description of Securities June 30, 2011 Obligations of U.S. government-sponsored entities and agencies ........................... $ 16,185 24,725 Obligations of state and political subdivisions ........................................................ 29,424 Mortgage-backed securities - residential ................................................................. 19,856 Collateralized mortgage obligations ........................................................................ 202 Trust preferred security............................................................................................ Total securities......................................................................................................... $ 90,392 Amortized Cost Gross Unrealized Gains Gross Unrealized Losses Fair Value $ 98 584 1,172 74 — $1,928 $ $ — (23) $ 16,260 (211) 25,098 30,596 (62) 19,868 (135) 67 (431) $ 91,889 Amortized Cost Gross Unrealized Gains Gross Unrealized Losses Fair Value r $ $ (3) $ 11,004 (218) 20,247 — 25,612 (151) 6,977 (150) 422 (522) $ 64,262 June 30, 2010 Obligations of U.S. government sponsored entities and agencies ........................... $ 10,771 20,073 Obligations of state and political subdivisions ........................................................ 24,333 Mortgage-backed securities - residential ................................................................. 7,094 Collateralized mortgage obligations ........................................................................ 572 Trust preferred security............................................................................................ Total securities......................................................................................................... $ 62,843 $ 236 392 1,279 34 — $1,941 Proceeds from sales of debt securities during 2011 and 2010 were as follows: Proceeds from sales Gross realized gains Gross realized gains from calls Gross realized losses 2011 $ 5,123 77 21 27 2010 $ 7,672 219 — 1 The amortized cost and fair values of available-for-sale securities at June 30, 2011 by expected maturity are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. Securities not due at a single maturity date, primarily mortgage- backed securities, collateralized mortgage obligations and the trust preferred security are shown separately. Amortized Cost Due in one year or less............................................................................................................ $ 5,029 12,201 Due after one year through five years..................................................................................... 5,818 Due after five years through ten years .................................................................................... 17,862 Due after ten years .................................................................................................................. Total........................................................................................................................................ Mortgage-backed securities – residential................................................................................ Collateralized mortgage obligations ....................................................................................... Trust preferred security........................................................................................................... 40,910 29,424 19,856 202 Total........................................................................................................................................ $ 90,392 Fair Value $ 5,061 12,290 6,020 17,987 41,358 30,596 19,868 67 $ 91,889 33 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Securities with a carrying value of approximately $43,262 and $40,901 were pledged at June 30, 2011 and 2010, respectively, to secure public deposits and commitments as required or permitted by law. At June 30, 2011 and 2010, there were no holdings of securities of any one issuer, other than the U.S. government and its agencies, with an aggregate book value greater than 10% of shareholders’ equity. The following table summarizes the securities with unrealized losses at June 30, 2011 and 2010, aggregated by investment category and length of time the individual securities have been in a continuous unrealized loss position: Description of Securities June 30, 2011 Obligations of U.S. government-sponsored entities ... $ Obligations of states and political subdivisions.......... Collateralized mortgage obligations ........................... Trust preferred security............................................... Less than 12 Months Unrealized Fair Loss Value 12 Months or more Total Fair Value Unrealized Loss Fair Value Unrealized Loss 3,088 $ 3,656 9,665 — (23) $ (81) (62) — — $ 1,221 — 67 — $ (130) — (135) 3,088 $ 4,877 9,665 67 (23) (211) (62) (135) (431) Total temporarily impaired ......................................... $ 16,409 $ (166) $ 1,288 $ (265) $ 17,697 $ Less than 12 Months Unrealized Fair Loss Value 12 Months or more Total Fair Value Unrealized Loss Fair Value Unrealized Loss June 30, 2010 Obligations of government-sponsored entities ........... $ Obligations of states and political subdivisions.......... Collateralized mortgage obligations ........................... Trust preferred security............................................... 764 $ (3) $ 5,331 4,763 — (179) (151) — — $ 649 — 422 — $ (39) — (150) 764 $ 5,980 4,763 422 Total temporarily impaired ......................................... $ 10,858 $ (333) $ 1,071 $ (189) $ 11,929 $ (3) (218) (151) (150) (522) Management evaluates securities for other-than-temporary impairment (OTTI) on a quarterly basis, and more frequently when economic or market conditions warrant such an evaluation. The securities portfolio is evaluated for OTTI by segregating the portfolio into two general segments and applying the appropriate OTTI model. Investment securities are generally evaluated for OTTI under FASB ASC Topic 320, Accounting for Certain Investments in Debt and Equity Securities. However, the trust preferred security is evaluated using the model outlined in FASB ASC Topic 325, Recognition of Interest Income and Impairment on Purchased Beneficial Interests and Beneficial Interests that Continue to be Held by a Transfer in Securitized Financial Assets. In determining OTTI under the ASC Topic 320 model, management considers many factors, including: (1) the length of time and the extent to which the fair value has been less than cost, (2) the financial condition and near-term prospects of the issuer, (3) whether the market decline was affected by macroeconomic conditions, and (4) whether the entity has the intent to sell the debt security or more likely than not will be required to sell the debt security before its anticipated recovery. The assessment of whether an other-than-temporary decline exists involves a high degree of subjectivity and judgment and is based on the information available to management at a point in time. The second segment of the portfolio uses the OTTI guidance provided by ASC Topic 325. Under the ASC Topic 325 model, the present value of the remaining cash flows as estimated at the preceding evaluation date are compared to the current expected remaining cash flows. An OTTI is deemed to have occurred if there has been an adverse change in the remaining expected future cash flows. The analysis of the trust preferred security falls within the scope of ASC Topic 325. As of June 30, 2011, the Corporation’s security portfolio consisted of $91,889, of which $17,697 were in an unrealized loss position. The unrealized losses are related to the Corporation’s U.S. government-sponsored entities, obligations of states and political subdivisions, collateralized mortgage obligations and the trust preferred security, as discussed below: Collateralized Mortgage Obligations: At June 30, 2011, all of the collateralized mortgage obligations held by the Corporation were issued by U.S. government-sponsored entities and agencies, primarily Fannie Mae, Freddie Mac and Ginnie Mae, institutions which the government has affirmed its commitment to support. Because the decline in fair value is attributable 34 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS to changes in interest rates and illiquidity, and not credit quality, and because the Corporation does not have the intent to sell nor is it likely that it will be required to sell the securities before their anticipated recovery, the Corporation does not consider these securities to be other-than-temporarily impaired at June 30, 2011. Obligations of States and Political Subdivisions: At June 30, 2011, approximately 91.1% of the obligations of states and political subdivisions held by the Corporation were general obligation bonds and 8.9% were revenue bonds. The decline in fair value of these securities is mainly attributable to temporary illiquidity and the turmoil within the municipal bond insurance industry, not credit quality. The recent credit concerns within the municipal bond insurance industry have reduced the liquidity of these securities and, as a result, have caused a decline in the value for some municipal securities. The Corporation owns general obligation warrants issued by Tallapoosa County, Alabama with an amortized cost of $985 and fair value of $865 that have been in a continuous unrealized loss position for more than 12 months. Standard & Poor’s assigned a credit rating of A with a stable outlook. An A credit rating is defined as having a strong capacity to meet its financial commitments, but somewhat susceptible to adverse economic conditions and changes in circumstances. Standard & Poor assigned its rating to reflect the county’s stable economic base with employment opportunities across the manufacturing, education and healthcare sectors, strong financial position and low overall debt levels. Tallapoosa County, Alabama has a low debt to assessed ratio of 2.36% and a low per capita debt of $370. Management monitors the financial data of the individual municipalities to ensure they meet minimum credit standards. Since the Corporation does not intend to sell these securities and it is not likely the Corporation will be required to sell these securities at an unrealized loss position prior to any anticipated recovery in fair value, which may be maturity, management does not believe there is any other-than-temporary impairment related to these securities at June 30, 2011. Trust Preferred Security: The Corporation owns a trust preferred security, which represents collateralized debt obligations (CDOs) issued by other financial and insurance companies. The following table summarizes the relevant characteristics of the pooled-trust-preferred security at June 30, 2011. The security is part of a pool of issuers that support a more senior tranche of securities. Due to the illiquidity in the market, it is unlikely the Corporation would be able to recover its investment in this security if the Corporation sold the security at this time. Par Value Deal Name Pre Tsl XXII (1) $ 982 Book Value Fair Value Unrealized Loss # of Issuers Currently Performing/ Remaining Actual Deferrals and Defaults as a % of Original Collateral Expected Defaults as a % of Remaining Collateral Excess Subordination (2) $ 202 $ 67 $ 135 59/95 32.7% 17.0% — (1) Security was determined to have other-than-temporary impairment. As such, the book value is net of recorded credit impairment. (2) Excess subordination percentage represents the additional defaults in excess of both current and projected defaults that the security can absorb before the bond experiences credit impairment. Excess subordinated percentage is calculated by: (a) determining what percentage of defaults a deal can experience before the bond has credit impairment, and (b) subtracting from this default breakage percentage both total current and expected future default percentages. Due to an increase in principal and/or interest deferrals by the issuers of the underlying securities, the cash interest payments for the trust preferred security are being deferred. On June 30, 2011, the lowest credit rating on this security was Fitch’s rating of C, which is defined as highly speculative. The issuers in this security are primarily banks, bank holding companies and a limited number of insurance companies. The investment security is evaluated using a model to compare the present value of expected cash flows to prior periods expected cash flows to determine if there has been an adverse change in cash flows during the period. The discount rate used to calculate the cash flows is the coupon rate of the security, based on the forward LIBOR curve. The OTTI model considers the structure and term of the CDO and the financial condition of the underlying issuers. Specifically, the model details interest rates, principal balances of note classes and underlying issuers, the timing and amount of interest and principal payments of the underlying issuers, and the allocation of the payments to the note classes. The current estimate of expected cash flows is based on the most recent trustee reports and any other relevant market information including announcements of interest payment deferrals or defaults of underlying trust preferred securities. Assumptions used in the model include expected future default rates and prepayments. We assume no recoveries on defaults and all interest payment deferrals are treated as defaults with an assumed recovery rate of 15% on deferrals. In addition we use the model to “stress” the CDO, or make assumptions more severe than expected activity, to determine the degree to which assumptions could deteriorate before the CDO could no longer fully support repayment of the Corporation’s note class. 35 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS According to the June 30, 2011 analysis, the expected cash flows were below the recorded amortized cost of the trust preferred security. Therefore, management determined it was appropriate to record an other-than-temporary impairment loss of $370 and $410 for the fiscal year-to-date periods ended June 30, 2011 and 2010. The accumulated other-than-temporary impairment loss recognized in earnings was $780 at June 30, 2011 and $410 at June 30, 2010. No other-than-temporary impairment was recorded in prior years. Management has reviewed this security and these conclusions with an independent third party. If there is further deterioration in the underlying collateral of this security, other-than-temporary impairments may also occur in future periods. NOTE 3—LOANS Major classifications of loans were as follows as of June 30: Commercial..................................................................................................................... Commercial real estate: Construction............................................................................................................. Other ........................................................................................................................ 1 – 4 Family residential real estate: Owner occupied ....................................................................................................... Non-owner occupied................................................................................................ Construction............................................................................................................. Consumer ........................................................................................................................ Subtotal Less: Deferred loan fees and costs .................................................................................. Allowance for loan losses ............................................................................................... Net loans ......................................................................................................................... 2011 $ 19,297 2010 $ 14,559 1,057 97,403 2,916 99,761 34,488 19,098 597 5,874 177,814 (263) (2,101) $ 175,450 34,428 16,738 328 5,824 174,554 (271) (2,276) $ 172,007 The following table presents the activity in the allowance for loan losses by portfolio segment for the year ending June 30, 2011: Allowance for loan losses: Beginning balance Provision for loan losses Loans charged-off Recoveries Commercial $ 183 3 (9) 2 Commercial Real Estate 1-4 Family Residential Real Estate Consumer Total $ 1,337 36 (510) 19 $ 653 356 (62) — $ 103 40 (116) 66 $ 2,276 435 (697) 87 Total ending allowance balance $ 179 $ 882 $ 947 $ 93 $ 2,101 The change in the allowance for loan losses consists of the following for the year ended June 30, 2010: Balance at beginning of year ............................................................................ Provision for loan losses .................................................................................. Loans charged-off ............................................................................................ Recoveries ........................................................................................................ Balance at end of year ...................................................................................... 2010 $ 1,992 544 (361) 101 $ 2,276 36 I S T N E M E T A T S L A C N A N I F D E T A D I L O S N O C O T S E T O N s a d o h t e m t n e m r i a p m i n o d e s a b d n a t n e m g e s o i l o f t r o p y b s n a o l n i t n e m t s e v n i d e d r o c e r e h t d n a s e s s o l n a o l r o f e c n a w o l l a e h t n i e c n a l a b e h t s t n e s e r p e l b a t g n i w o l l o f e h T . e l b a v i e c e r t s e r e t n i d e u r c c a f o 2 7 4 $ d n a s e e f n a o l d e r r e f e d t e n f o ) 3 6 2 ( $ s i s n a o l n i t n e m t s e v n i d e d r o c e r e h t n i d e d u l c n I . 1 1 0 2 , 0 3 e n u J f o 2 3 4 9 6 6 , 1 1 0 1 , 2 9 2 5 , 2 4 9 4 , 5 7 1 $ $ $ 3 2 0 , 8 7 1 $ — 3 9 3 9 — 8 6 8 , 5 8 6 8 , 5 $ $ $ $ l a t o T r e m u s n o C y l i m a F 4 - 1 l a i t n e d i s e R l a e R e t a t s E l a i c r e m m o C l a e R e t a t s E 3 9 2 4 5 6 7 4 9 $ $ 6 2 1 6 5 7 2 8 8 2 4 0 , 1 9 7 2 , 3 5 $ 5 0 4 , 1 3 9 0 , 7 9 1 2 3 , 4 5 $ 8 9 4 , 8 9 $ $ $ $ l a i c r e m m o C 3 1 6 6 1 9 7 1 2 8 4 5 2 , 9 1 6 3 3 , 9 1 $ $ $ $ 7 3 : s n a o l o t e l b a t u b i r t t a e c n a l a b e c n a w o l l a g n i d n E t n e m r i a p m i r o f d e t a u l a v e y l l a u d i v i d n I : s e s s o l n a o l r o f e c n a w o l l A t n e m r i a p m i r o f d e t a u l a v e y l e v i t c e l l o C e c n a l a b e c n a w o l l a g n i d n e l a t o T t n e m r i a p m i r o f d e t a u l a v e y l l a u d i v i d n i t n e m r i a p m i r o f d e t a u l a v e y l e v i t c e l l o c s n a o L s n a o L : s n a o l n i t n e m t s e v n i d e d r o c e R e c n a l a b s n a o l g n i d n e l a t o T I S T N E M E T A T S L A C N A N I F D E T A D I L O S N O C O T S E T O N s i s a B h s a C t s e r e t n I d e z i n g o c e R t s e r e t n I e m o c n I d e z i n g o c e R e g a r e v A d e d r o c e R t n e m t s e v n I r o f e c n a w o l l A s e s s o L n a o L d e t a c o l l A d e d r o c e R t n e m t s e v n I d i a p n U l a p i c n i r P e c n a l a B — — — 8 1 — — 8 1 $ $ — — — 3 2 6 — 9 2 $ $ 0 2 2 0 5 1 6 8 3 2 , 1 2 0 3 8 3 7 1 6 8 , 2 $ $ — — 3 1 6 2 1 3 0 9 2 2 3 4 $ $ 8 1 2 1 4 4 6 3 9 9 9 1 3 3 2 7 9 2 5 , 2 $ 8 1 3 1 4 4 6 7 9 9 0 2 3 4 2 7 $ . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . : e t a t s e l a e r l a i c r e m m o C l a i c r e m m o C . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . r e h t O : d e d r o c e r e c n a w o l l a d e t a l e r o n h t i W . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . : e t a t s e l a e r l a i c r e m m o C l a i c r e m m o C . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . d e i p u c c o r e n w O . . . . . . . . . . . . . . . . . . . . . . . . . . . . . d e i p u c c o r e n w o - 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h s a C 8 3 : 1 1 0 2 , 0 3 e n u J d e d n e r a e y e h t r o f d n a f o s a s n a o l f o s s a l c y b t n e m r i a p m i r o f d e t a u l a v e y l l a u d i v i d n i s n a o l o t d e t a l e r n o i t a m r o f n i s t n e s e r p e l b a t g n i w o l l o f e h T NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The following table presents the recorded investment in non-accrual and loans past due over 90 days still on accrual by class of loans as of June 30, 2011: Commercial Commercial real estate: Other 1 – 4 Family residential: Owner occupied Non-owner occupied Consumer Total Non-accrual 64 $ 754 219 723 — 1,760 $ Loans Past Due Over 90 Days Still Accruing — $ — — — — — $ The following table presents non-accrual and loans past due over 90 days still on accrual as of June 30, 2010: 2010 Loans on non-accrual........................................................................................................ $ 2,342 — Loans past due over 90 days and still accruing................................................................. Non-accrual loans and loans past due 90 days still on accrual include both smaller balance homogeneous loans that are collectively evaluated for impairment and individually classified impaired loans. The following table presents the aging of the recorded investment in past due loans as of June 30, 2011 by class of loans: Commercial Commercial real estate: Construction Other 1-4 Family residential: Owner occupied Non-owner occupied Construction Consumer Total Days Past Due 30 - 59 Days 60 - 89 Days $ — $ 1 90 Days or Greater & Non-accrual — $ Total Past Due 1 $ Loans Not Past Due 19,335 $ Total $ 19,336 — — — — — 26 26 $ — 242 167 44 — — 454 $ — 412 23 175 — — 610 — 654 1,053 96,791 1,053 97,445 190 219 — 26 $ 1,090 34,438 18,877 597 5,842 $ 176,933 34,628 19,096 597 5,868 $ 178,023 $ The above table of past due loans includes the recorded investment in non-accrual loans of $410 in the 60-89 days past due category and $740 in the loans not past due category. Troubled Debt Restructurings: The Corporation allocated $229 and $3 of specific reserves to customers whose loan terms have been modified in troubled debt restructurings as of June 30, 2011 and 2010. As of June 30, 2011 and 2010, the Corporation had not committed to lend any additional amounts to customers with outstanding loans that are classified as troubled debt restructurings. Credit Quality Indicators: The Corporation categorizes loans into risk categories based on relevant information about the ability of borrowers to service their debt such as: current financial information, historical payment experience, credit documentation, public information, and current economic trends, among other factors. The Corporation analyzes loans individually by classifying the loans as to credit risk. This analysis includes loans with a total outstanding loan relationship greater than $100 thousand and non-homogeneous loans, such as commercial and commercial real estate loans. This analysis is performed on a monthly basis. The Corporation uses the following definitions for risk ratings: 39 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Special Mention. Loans classified as special mention have a potential weakness that deserves management's close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the loan or of the institution's credit position at some future date. Substandard. Loans classified as substandard are inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any. Loans so classified have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. They are characterized by the distinct possibility that the institution will sustain some loss if the deficiencies are not corrected. Doubtful. Loans classified as doubtful have all the weaknesses inherent in those classified as substandard, with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions, and values, highly questionable and improbable. Loans not meeting the criteria above that are analyzed individually as part of the above described process are considered to be pass rated loans. Loans listed as not rated are either less than $100,000 or are included in groups of homogeneous loans. As of June 30, 2011, and based on the most recent analysis performed, the recorded investment by risk category of loans by class of loans is as follows: Commercial Commercial real estate: Construction Other 1-4 Family residential real estate: Owner occupied Non-owner occupied Construction Consumer Total Pass 17,469 $ Special Mention $ 743 Substandard Doubtful 82 $ 884 $ 868 87,857 5,526 14,549 28 — $ 126,297 $ 76 5,624 305 1,976 — — 8,724 $ 109 2,055 372 1,657 — — 5,077 $ — 1,405 319 723 — — 2,529 Not Rated 158 $ — 504 28,106 191 569 5,868 $ 35,396 The Bank has granted loans to certain of its executive officers, directors and their affiliates. A summary of activity during the year ended June 30, 2011 of related party loans were as follows: Principal balance at beginning of year ....................................................................................... $ New loans................................................................................................................................... Repayments ................................................................................................................................ Principal balance at end of year ................................................................................................. $ 2010 1,446 103 (376) 1,173 40 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 4—PREMISES AND EQUIPMENT Major classifications of premises and equipment were as follows as of June 30: Land ...................................................................................................................................... Land improvements .............................................................................................................. Building and leasehold improvements .................................................................................. Furniture, fixture and equipment........................................................................................... $ Total premises and equipment .............................................................................................. Accumulated depreciation and amortization......................................................................... Premises and equipment, net................................................................................................. $ 2011 2010 1,174 368 4,174 4,278 9,994 (5,218) 4,776 $ $ 953 327 3,433 5,076 9,789 (6,208) 3,581 Depreciation expense was $382 and $430 for the years ended June 30, 2011 and 2010, respectively. The Corporation is obligated under non-cancelable operating leases for facilities and equipment. The approximate minimum annual rentals and commitments under these non-cancelable agreements and leases with remaining terms in excess of one year are as follows: 2012.............................................................................................................................................. 2013.............................................................................................................................................. 2014.............................................................................................................................................. 2015.............................................................................................................................................. 2016.............................................................................................................................................. Thereafter ..................................................................................................................................... 115 105 91 78 19 — $ 408 Rent expense incurred was $111 and $99 during the years ended June 30, 2011 and 2010, respectively. NOTE 5—INTANGIBLE ASSETS The following summarizes the original balance and accumulated amortization of core deposit intangible assets at June 30, 2011 and 2010: Original balance .................................................................................................... Less: accumulated amortization ............................................................................ Net balance, June 30.............................................................................................. 2011 $ 1,927 1,838 89 $ 2010 $ 1,927 1,677 $ 250 Amortization expense for the years ended June 30, 2011 and 2010 was $161 for each year. Amortization expense is estimated to be $89 for the year ending June 30, 2012. 41 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 6—DEPOSITS The aggregate amount of time deposits, each with a minimum denomination of $100 thousand was $34,707 and $33,763 as of June 30, 2011 and 2010, respectively. Scheduled maturities of time deposits at June 30, 2011 were as follows: 2012........................................................................................................................................ 2013........................................................................................................................................ 2014........................................................................................................................................ 2015........................................................................................................................................ 2016........................................................................................................................................ Thereafter ............................................................................................................................... $ 49,051 24,386 5,987 4,248 4,504 768 $ 88,944 Related party deposits totaled $4,178 as of June 30, 2011 and $4,088 as of June 30, 2010. NOTE 7—SHORT-TERM BORROWINGS Short-term borrowings consisted of repurchase agreements. Repurchase agreements are financing arrangements. Physical control is maintained for all securities pledged to secure repurchase agreements. Information concerning all short-term borrowings at June 30, maturing in less than one year is summarized as follows: Balance at June 30 ........................................................................................ Average balance during the year................................................................... Maximum month-end balance ...................................................................... Average interest rate during the year ............................................................ Weighted average rate June 30 ..................................................................... 2011 $ 17,012 14,892 18,169 0.30% 0.27% 2010 $ 13,086 12,977 14,267 0.39% 0.38% Repurchase agreements mature daily. The Bank has pledged obligations of government-sponsored entities and mortgage- backed securities with a carrying value of $18,055 and $14,823 at June 30, 2011 and 2010, respectively, as collateral for the repurchase agreements. Total interest expense on short-term borrowings was $45 and $50 for the years ended June 30, 2011 and 2010, respectively. NOTE 8—FEDERAL HOME LOAN BANK ADVANCES A summary of Federal Home Loan Bank (FHLB) advances were as follows: Advance Type Maturity Term Interest Rate Balance June 30, 2011 Balance June 30, 2010 Principal and interest, mortgage matched Principal and interest, mortgage matched Principal and interest, mortgage matched Interest-only, single maturity Interest-only, single maturity Interest-only, single maturity Interest-only, single maturity Interest-only, single maturity Principal and interest, mortgage matched Interest-only, single maturity Interest-only, single maturity Interest-only, putable Principal and interest, mortgage matched 07/01/2010 10/01/2010 12/01/2010 01/18/2011 01/24/2011 07/22/2011 01/24/2012 07/24/2012 04/01/2014 10/09/2015 10/12/2017 12/07/2017 04/01/2019 Fixed Fixed Fixed Fixed Fixed Fixed Fixed Fixed Fixed Fixed Fixed Fixed Fixed 42 6.90% 7.00 6.10 3.14 3.09 3.24 3.37 3.50 2.54 1.43 2.07 3.24 4.30 — $ — — — — — 500 500 84 500 500 5,000 451 $ 7,535 $ 1 3 28 625 500 500 500 500 141 — — 5,000 499 $ 8,297 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Each fixed rate advance has a prepayment penalty equal to the present value of 100% of the lost cash flow based upon the difference between the contract rate on the advance and the current rate on the new advance. The $5 million putable advance with the maturity date of December 7, 2017 can be called quarterly until maturity at the option of the FHLB. The following table is a summary of the scheduled principal payments for all advances: Twelve Months Ending June 30 2012........................................................................................................................................... 2013........................................................................................................................................... 2014........................................................................................................................................... 2015........................................................................................................................................... 2016........................................................................................................................................... Thereafter .................................................................................................................................. Principal Payments $ 596 579 69 57 559 5,675 $ 7,535 During fiscal year 2011, the Corporation prepaid two $500 thousand fixed rate single maturity advances and replaced them with two $500 thousand fixed rate single maturity advances with lower rates. Because the present value of the cash flows of the new debt including the prepayment penalty was not more than 10% different than the old debt, the transaction is considered to be an exchange rather than an extinguishment of debt. As such, prepayment penalties totaling $16 were capitalized and are being amortized over the life of the new debt. Unamortized capitalized prepayment penalties totaled $13 at June 30, 2011. Pursuant to collateral agreements with the FHLB, advances are secured by all the stock invested in the FHLB and certain qualifying first mortgage loans. The advances were collateralized by $39,180 and $36,211 of first mortgage loans under a blanket lien arrangement at June 30, 2011 and 2010, respectively. Based on this collateral and the Corporation’s holdings of FHLB stock, the Bank is eligible to borrow up to a total of $19,027 in advances at June 30, 2011. NOTE 9—EMPLOYEE BENEFIT PLANS The Bank has a 401(k) savings and retirement plan available for substantially all eligible employees. Under the plan, the Bank is required to match each participant’s voluntary contribution to the plan but not to exceed 4% of the individual’s compensation. Amounts charged to operations were $115 and $109, for the years ended June 30, 2011 and 2010, respectively. The Bank has adopted a Salary Continuation Plan (the Plan) to encourage Bank executives to remain employees of the Bank. The Plan provides such executives (and, in the event of the executive’s death, surviving beneficiary) with 180 months of salary continuation payments equal to a certain percentage of an executive’s average compensation, as defined within each agreement, for the three full calendar years prior to Normal Retirement Age. For purposes of the Plan, “Normal Retirement Age” means the executive’s 65th birthday. Vesting under the Plan commences at age 50 and is prorated until age 65. If an executive dies during active service, the executive’s beneficiary is entitled to the Normal Retirement Benefit. The executive can become fully vested in the Accrual Balance upon termination of employment following a disability or a change in control of the Bank. For purposes of the Plan, “Accrual Balance” means the liability that should be accrued by the Corporation for the Corporation’s obligation to the executive under the Plan. For purposes of calculating the Accrual Balance, the discount rate in effect at June 30, 2011 was 5.25%. The accrued liability for the salary continuation plan was $1,163 as of June 30, 2011 and $1,002 as of June 30, 2010. For the years ended June 30, 2011 and 2010, approximately $183 and $166, respectively, have been charged to expense in connection with the Plan. Distributions to participants were $22 for both of the years ending June 30, 2011 and 2010, respectively. NOTE 10—INCOME TAXES The provision for income taxes consists of the following for the years ended June 30: Current income taxes................................................................................ Deferred income taxes (benefits) ............................................................. 2011 2010 $ $ 540 $ 81 621 $ 883 (316) 567 43 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The net deferred income tax asset consists of the following components at June 30: Deferred tax assets: Allowance for loan losses ................................................................................... $ Deferred compensation ....................................................................................... Recognized loss on impairment of security ........................................................ Intangibles........................................................................................................... OREO deferred gain ........................................................................................... OREO valuation allowance................................................................................. Nonaccrual loan interest income......................................................................... Gross deferred tax asset........................................................................................... Deferred tax liabilities: Depreciation........................................................................................................ Loan fees............................................................................................................. Prepaid expenses................................................................................................. FHLB stock dividends ........................................................................................ Net unrealized securities gain ............................................................................. 2011 2010 520 $ 413 265 122 18 — 47 1,385 610 354 139 111 19 6 49 1,288 (270) (202) (113) (165) (509) (135) (184) (88) (165) (483) Gross deferred tax liabilities.................................................................................... (1,259) (1,055) Net deferred asset .................................................................................................... $ 126 $ 233 The difference between the provision for income taxes and amounts computed by applying the statutory income tax rate of 34% to statutory income before taxes consists of the following for the years ended June 30: Income taxes computed at the statutory rate on pretax income................................ Tax exempt income .................................................................................................. Cash surrender value income ................................................................................... Other ........................................................................................................................ 2011 $ 975 (304) (62) 12 $ 621 2010 $ 886 (270) (60) 11 $ 567 At June 30, 2011 and June 30, 2010, the Corporation had no unrecognized tax benefits recorded. The Corporation does not expect the total amount of unrecognized tax benefits to significantly increase within the next twelve months. There were no interest or penalties recorded for the years ended June 30, 2011 and 2010 and there were no amounts accrued for interest and penalties at June 30, 2011 and 2010. The Corporation and the Bank are subject to U.S. federal income tax as an income-based tax and a capital-based franchise tax in the state of Ohio. The Corporation and the Bank are no longer subject to examination by taxing authorities for years before 2007. NOTE 11—REGULATORY MATTERS The Bank is subject to regulatory capital requirements administered by federal banking agencies. Capital adequacy guidelines and prompt corrective-action regulations involve quantitative measures of assets, liabilities, and certain off-balance- sheet items calculated under regulatory accounting practices. Capital amounts and classifications are also subject to qualitative judgments by regulators about components, risk weightings, and other factors and the regulators can lower classifications in certain cases. Failure to meet various capital requirements can initiate regulatory action that could have a direct material effect on the financial statements. Management believes as of June 30, 2011, the Bank has met all capital adequacy requirements to which it is subject. The prompt corrective action regulations provide five classifications, including well capitalized, adequately capitalized, under-capitalized, significantly undercapitalized, and critically undercapitalized, although these terms are not used to represent overall financial condition. If adequately capitalized, regulatory approval is required to accept brokered deposits. If 44 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS undercapitalized, capital distributions are limited, as is asset growth and expansion, and plans for capital restoration are required. As of fiscal year-end 2011, the Corporation met the definition of a small bank holding company and, therefore, was exempt from consolidated risk-based and leverage capital adequacy guidelines for bank holding companies. At year-end 2011 and 2010, actual Bank capital levels (in millions) and minimum required levels were as follows: Actual Amount Ratio Minimum Required For Capital Adequacy Purposes Ratio Amount Minimum Required To Be Well Capitalized Under Prompt Corrective Action Regulations Ratio Amount June 30, 2011 Total capital (to risk weighted assets) Bank..................................................................................... Tier 1 capital (to risk weighted assets) Bank..................................................................................... Tier 1 capital (to average assets) Bank..................................................................................... June 30, 2010 Total capital (to risk weighted assets) Bank..................................................................................... Tier 1 capital (to risk weighted assets) Bank..................................................................................... Tier 1 capital (to average assets) Bank..................................................................................... $ 26.3 14.0% $ 15.0 8.0% $ 18.8 10.0% 22.2 11.8 22.2 7.5 7.5 11.8 4.0 4.0 11.3 14.8 6.0 5.0 $ 24.7 13.4% $ 14.8 8.0% $ 18.5 10.0% 20.4 11.1 20.4 7.8 7.4 10.5 4.0 4.0 11.1 13.1 6.0 5.0 As of the latest regulatory examination, the Bank was categorized as well capitalized. There are no conditions or events since that examination that management believes may have changed the Bank’s category. The Corporation’s principal source of funds for dividend payment is dividends received from the Bank. Banking regulations limit the amount of dividends that may be paid without prior approval of regulatory agencies. Under these regulations, the amount of dividends that may be paid in any calendar year is limited to the current year’s net profits, combined with the retained net profits of the preceding two years, subject to the capital requirements described above. As of June 30, 2011 the Bank could, without prior approval, declare a dividend of approximately $3,519. NOTE 12—COMMITMENTS WITH OFF-BALANCE SHEET RISK The Bank is a party to commitments to extend credit in the normal course of business to meet the financing needs of its customers. Commitments are agreements to lend to customers providing there are no violations of any condition established in the contract. Commitments to extend credit have a fixed expiration date or other termination clause. These instruments involve elements of credit and interest rate risk more than the amount recognized in the statements of financial position. The Bank uses the same credit policies in making commitments to extend credit as it does for on-balance sheet instruments. The Bank evaluates each customer’s credit on a case by case basis. The amount of collateral obtained is based on management’s credit evaluation of the customer. The amount of commitments to extend credit and the exposure to credit loss for non-performance by the customer was $27,528 and $23,435 as of June 30, 2011 and 2010, respectively. Of the June 30, 2011 commitments, $25,119 carried variable rates of interest ranging from 2.00% to 7.25% and $2,409 carried fixed rates of interest ranging from 2.75% to 7.75%. Of the June 30, 2010 commitments, $22,690 carried variable rates of interest ranging from 2.00% to 10.00% and $745 carried fixed rates of interest ranging from 2.25% to 8.12%. Financial standby letters of credit were $579 and $477 as of June 30, 2011 and 2010, respectively. In addition, commitments to extend credit of $7,759 and $6,333 as of June 30, 2011 and 2010, respectively, were available to checking account customers related to the overdraft protection program. Since some loan commitments expire without being used, the amount does not necessarily represent future cash commitments. 45 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 13—FAIR VALUE Fair value is the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. There are three levels of inputs that may be used to measure fair values: Level 1: Quoted prices (unadjusted) for identical assets or liabilities in active markets that the entity has the ability to access as of the measurement date. Level 2: Significant other observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data. Level 3: Significant unobservable inputs that reflect a company’s own assumptions about the assumptions that market participants would use in pricing an asset or liability. Valuation techniques include use of discounted cash flow models and similar techniques. The Corporation used the following methods and significant assumptions to estimate the fair value of items: Securities: When available, the fair values of available-for-sale securities are determined by obtaining quoted prices on nationally recognized securities exchanges (Level 1 inputs). For securities where quoted market prices are not available, fair values are calculated based on market prices of similar securities (Level 2 inputs). For securities where quoted prices or market prices of similar securities are not available, fair values are calculated using discounted cash flows or other market indicators (Level 3 inputs). Discounted cash flows are calculated using spread to the swap and LIBOR curves. Rating agency and industry research reports as well as defaults and deferrals on individual securities are reviewed and incorporated into the calculations. Federal bank and other restricted stocks includes stock acquired for regulatory purposes, such as Federal Home Loan Bank stock and Federal Reserve Bank stock that are accounted for at cost due to restrictions placed on their transferability; and therefore, are not subject to the fair value disclosure requirements. Impaired Loans: The fair value of impaired loans with specific allocations of the allowance for loan losses is generally based on recent real estate appraisals. These appraisals may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach. Adjustments are routinely made in the appraisal process by the appraisers to adjust for differences between the comparable sales and income data available. Such adjustments are usually significant and typically result in a Level 3 classification of the inputs for determining fair value. Other Real Estate Owned: Nonrecurring adjustments to certain commercial and residential real estate properties classified as other real estate owned (OREO) are measured at the lower of carrying amount or fair value, less costs to sell. Fair values are generally based on third party appraisals of the property. These appraisals may use a single valuation approach or a combination of approaches including comparable sales and the income approach. Adjustments are routinely made in the appraisal process by the independent appraisers to adjust for differences between the comparable sales and income data available. Such adjustments are usually significant and typically result in a Level 3 classification of the inputs for determining fair value. Assets and liabilities measured at fair value on a recurring basis are summarized below: Assets: Obligations of government-sponsored entities Obligations of states and political subdivisions Mortgage-backed securities - residential Collateralized mortgage obligations Trust preferred security Fair Value Measurements at June 30, 2011 Using Balance at June 30, 2011 Level 1 Level 2 Level 3 $ — — — — — $ 16,260 25,098 30,596 19,868 — $ — — — — 67 $ 16,260 25,098 30,596 19,868 67 46 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Assets: Obligations of government sponsored entities Obligations of states and political subdivisions Mortgage-backed securities - residential Collateralized mortgage obligations Trust preferred security Fair Value Measurements at June 30, 2010 Using Level 1 Level 2 Level 3 $ — — — — — $ 11,004 20,247 25,612 6,977 — $ — — — — 422 Balance at June 30, 2010 $ 11,004 20,247 25,612 6,977 422 The following table presents a reconciliation of assets measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the years ended June 30, 2011 and 2010: Beginning balance Realized losses included in other income Change in fair value included in other comprehensive income Ending balance, June 30 Trust Preferred Security 2011 $ 422 (370) 15 $ 67 2010 $ 356 (410) 476 $ 422 Assets and liabilities measured at fair value on a non-recurring basis are summarized below: Impaired loans: Commercial Commercial real estate: Other 1-4 Family: Owner occupied Non-owner occupied Assets: Impaired loans Other real estate owned, net Fair Value Measurements at June 30, 2011 Using Balance at June 30, 2011 Level 1 Level 2 Level 3 $ 51 $ — $ — $ 51 871 317 434 — — — — — — 871 317 434 Fair Value Measurements at June 30, 2010 Using Balance at June 30, 2010 Level 1 Level 2 Level 3 $ 1,375 5 $ — — $ — — $ 1,375 5 Impaired loans, which are generally measured for impairment using the fair value of the collateral for collateral dependent loans, had a principal balance of $2,105, with a valuation allowance of $432 at June 30, 2011, resulting in an additional provision for loan losses of $272 being recorded for the twelve month period ended June 30, 2011. As of June 30, 2010, impaired loans with a principal balance of $1,918, with a valuation allowance of $543, resulting in an additional provision for loan losses of $344 being recorded for the twelve month period ended June 30, 2010. There were no other real estate owned being carried at fair value as of June 30, 2011. Other real estate owned which is measured at the lower of carrying or fair value less costs to sell, had a net carrying amount of $5, which was made up of the outstanding balance of $22, net of a valuation allowance of $17 at June 30, 2010, resulting in a write-down of $17 for the year ended June 30, 2010. 47 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Fair Value of Financial Instruments The following table shows the estimated fair value at June 30, 2011 and 2010, and the related carrying value of financial instruments: Financial Assets: Cash and cash equivalents .................................................................. Certificates of deposits in other financial institutions......................... Securities available-for-sale................................................................ Loans, net ........................................................................................... Accrued interest receivable................................................................. Financial Liabilities: Demand and savings deposits ............................................................. Time deposits...................................................................................... Short-term borrowings........................................................................ Federal Home Loan Bank advances ................................................... Accrued interest payable..................................................................... 2011 2010 Carrying Amount $ 13,828 4,900 91,889 175,450 980 (159,302) (88,944) (17,012) (7,535) (82) Estimated Fair Value $ 13,828 4,900 91,889 174,182 980 (159,302) (89,725) (17,012) (7,884) (82) Carrying Amount $ 13,806 980 64,262 172,007 943 (125,050) (91,264) (13,086) (8,297) (122) Estimated Fair Value $ 13,806 980 64,262 167,577 943 (125,050) (91,926) (13,086) (8,681) (122) For purposes of the above disclosures of estimated fair value, the following assumptions were used. Estimated fair value for cash and cash equivalents, certificates of deposits in other financial institutions, accrued interest receivable and payable, demand and savings deposits and short-term borrowings were considered to approximate carrying value for instruments that reprice frequently and fully. Fair value for loans was estimated for portfolios of loans with similar financial characteristics. For adjustable rate loans that reprice at least annually and for fixed rate commercial loans with maturities of six months or less which possess normal risk characteristics, carrying value was determined to be fair value. Fair value of other types of loans (including adjustable rate loans which reprice less frequently than annually and fixed rate term loans or loans which possess higher risk characteristics) was estimated by discounting future cash flows using the current rates at which similar loans would be made to borrowers with similar credit ratings and for similar anticipated maturities. Fair value for impaired loans was based on recent appraisals of the collateral or, if appropriate, using estimated discounted cash flows. The Corporation has not considered market illiquidity in estimating the fair value of loans due to uncertain and inconsistent market pricing being experienced on June 30, 2011. Fair value of core deposits, including demand deposits, savings accounts and certain money market deposits, was the amount payable on demand. Fair value of fixed-maturity certificates of deposit was estimated using the rates offered at June 30, 2011 and 2010, for deposits of similar remaining maturities. Estimated fair value does not include the benefit that result from low-cost funding provided by the deposit liabilities compared to the cost of borrowing funds in the market. Fair value of short- term borrowings and accrued interest was determined to be the carrying amounts since these financial instruments generally represent obligations that are due on demand. Fair value of Federal Home Loan Bank advances was estimated using current rates at June 30, 2011 and 2010 for similar financing. The fair value of unrecorded commitments at June 30, 2011 and 2010 was not material. 48 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 14—PARENT COMPANY FINANCIAL STATEMENTS Condensed financial information of Consumers Bancorp. Inc. (parent company only) follows: June 30, 2011 June 30, 2010 Condensed Balance Sheets Assets 25 Cash ........................................................................................................................................... $ 2,000 Subordinated debenture receivable from subsidiary .................................................................. 92 Other assets................................................................................................................................ 23,254 Investment in subsidiary ............................................................................................................ Total assets ................................................................................................................................ $ 25,371 Liabilities 47 Other liabilities .......................................................................................................................... $ 25,324 Shareholders’ equity .................................................................................................................. Total liabilities & shareholders’ equity...................................................................................... $ 25,371 $ 114 2,000 94 21,577 $ 23,785 $ 69 23,716 $ 23,785 Condensed Statements of Income Cash dividends from subsidiary.................................................................................. Other income .............................................................................................................. Other expense ............................................................................................................. Income before income taxes and equity in undistributed net income of subsidiary ... Income tax benefit ...................................................................................................... Income before equity in undistributed net income of subsidiary................................ Equity in undistributed net income of subsidiary ....................................................... Net income.................................................................................................................. Condensed Statements of Cash Flows Cash flows from operating activities Net income ................................................................................................................. Equity in undistributed net income of Bank subsidiary ............................................. Change in other assets and liabilities ......................................................................... Net cash flows from operating activities ................................................................. Cash flows from financing activities Dividend paid............................................................................................................. Proceeds from dividend reinvestment and stock purchase plan ................................. Net cash flows from financing activities ................................................................. Change in cash and cash equivalents ......................................................................... Beginning cash and cash equivalents ......................................................................... Ending cash and cash equivalents .............................................................................. Year Ended June 30, 2011 Year Ended June 30, 2010 $ 650 160 197 613 (9) 622 1,626 $ 2,248 $ 700 160 188 672 (5) 677 1,362 $ 2,039 Year Ended June 30, 2011 Year Ended June 30, 2010 $ 2,248 (1,626 ) (20 ) 602 (837 ) 146 (691 ) (89 ) 114 25 $ $ 2,039 (1,362 ) 25 702 (813 ) 99 (714 ) (12 ) 126 $ 114 49 ITEM 9—CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None. ITEM 9A—CONTROLS AND PROCEDURES The management of the Corporation is responsible for establishing and maintaining effective disclosure controls and procedures, as defined under Rule 13a-15(e) of the Securities Exchange Act of 1934 (Act). As of June 30, 2011, an evaluation was performed under the supervision and with the participation of management, including the Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Corporation’s disclosure controls and procedures. Based on that evaluation, management concluded that the Corporation’s disclosure controls and procedures as of June 30, 2011 were effective in ensuring that information required to be disclosed by the Corporation in the reports that it files or submits under the Act were recorded, processed, summarized and reported within the time period required by the Securities and Exchange Commission’s rules and forms and that such information is accumulated and communicated to the management, including the Chief Executive Officer and the Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure. There were no changes in the Corporation’s internal controls over financial reporting that occurred during the fourth quarter of fiscal year 2011 that have materially affected, or are reasonably likely to materially affect the Corporation’s internal controls over financial reporting. The Report of Management on the Company’s Internal Controls Over Financial Reporting appears on page 21. ITEM 9B—OTHER INFORMATION None. 50 PART III ITEM 10—DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE The information required by this item is set forth in the Corporation’s Proxy Statement dated September 16, 2011 under the captions “Election of Directors,” “Directors and Executive Officers,” “The Board of Directors and its Committees,” “Section 16(a) Beneficial Ownership Reporting Compliance,” and “Certain Transactions and Relationships,” and is incorporated herein by reference. The Corporation’s Code of Ethics Policy, which is applicable to all directors, officers and employees of the Corporation, and its Code of Ethics for Principal Financial Officers, which is applicable to the principal executive officer and the principal financial officer, are each available on the Investor Relations section under Corporate Governance of the Corporation’s website (www.consumersbank.com). Copies of either of the Code of Ethics Policies are also available in print to share owners upon request, addressed to the Corporate Secretary at Consumers Bancorp, Inc., 614 East Lincoln Way, Minerva, Ohio 44657. The Corporation intends to post amendments to or waivers from its Code of Ethics on its website. ITEM 11—EXECUTIVE COMPENSATION The information required by this item is set forth in the Corporation’s Proxy Statement dated September 16, 2011 under the captions “Director Compensation,” “Executive Compensation,” “Defined Contribution Plan,” “Salary Continuation Program,” “Noncompetition Agreement,” “Compensation Committee Report,” and “Compensation Committee Interlock and Insider Participation,” and is incorporated herein by reference. ITEM 12—SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED SHAREHOLDER MATTERS The information required by this item is set forth in the Corporation’s Proxy Statement dated September 16, 2011 under the caption “Security Ownership of Certain Beneficial Owners and Management,” and is incorporated herein by reference. ITEM 13—CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE The information required by this item is set forth in the Corporation’s Proxy Statement dated September 16, 2011 under the caption “Certain Transactions and Relationships,” and is incorporated herein by reference. ITEM 14—PRINCIPAL ACCOUNTANT FEES AND SERVICES The information required by this item is set forth in the Corporation’s Proxy Statement dated September 16, 2011 under the caption “Principal Accountant Fees and Services,” and is incorporated herein by reference. ITEM 15—EXHIBITS AND FINANCIAL STATEMENT SCHEDULES PART IV (a) The following documents are filed as part of this report: (1) The report of independent registered accounting firm and the consolidated financial statements appearing in Item 8. (2) Financial statement schedules are omitted as they are not required or are not applicable, or the required information is included in the financial statements. (3) The exhibits required by this item are listed in the Exhibit Index of this Form 10-K. (b) The exhibits to this Form 10-K begin on page 53 of this report. (c) See Item 15(a)(2) above. 51 Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. SIGNATURES Date: September 16, 2011 CONSUMERS BANCORP, INC. By: By: /s/ Ralph J. Lober, II President and Chief Executive Officer /s/ Renee K. Wood Chief Financial Officer and Treasurer Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities indicated on September 16, 2011. Signatures Signatures /s/ Laurie L. McClellan Laurie L. McClellan Chairman of the Board of Directors /s/ Ralph J. Lober, II Ralph J. Lober, II President, Chief Executive Officer and Director /s/ John P. Furey John P. Furey Director /s/ Bradley Goris Bradley Goris Director /s/ James R. Kiko, Sr. James R. Kiko, Sr. Director /s/ Harry W. Schmuck, Jr. Harry W. Schmuck, Jr. Director /s/ James V. Hanna James V. Hanna Director /s/ David W. Johnson David W. Johnson Director /s/ Thomas M. Kishman Thomas M. Kishman Director /s/ John E. Tonti John E. Tonti Director 52 Exhibit Number 3.1 Description of Document Amended and Restated Articles of Incorporation of the Corporation. Reference is made to Form 10-K of the Corporation filed September 22, 2010, which is incorporated herein by reference. EXHIBIT INDEX 3.2 4 10.3 10.6 10.7 11 21 23 31.1 31.2 32.1 Amended and Restated Code of Regulations of the Corporation. Reference is made to Form 10-K of the Corporation filed September 15, 2008, which is incorporated herein by reference. Form of Certificate of Common Shares. Reference is made to Form 10-KSB of the Corporation filed September 26, 2002, which is incorporated herein by reference. Lease Agreement entered into between Furey Holdings, LLC and Consumers National Bank on December 23, 2005. Reference is made to Form 10-Q of the Corporation filed February 14, 2006, which is incorporated herein by reference. 2011 Amendment and Restatement of Salary Continuation agreement entered into with Mr. Lober on February 11, 2011. Reference is made to Form 10-Q of the Corporation filed February 11, 2011, which is incorporated herein by reference. Form Noncompetition agreement entered into with Ms. Wood on February 11, 2011. Reference is made to Form 10-Q of the Corporation filed February 11, 2011, which is incorporated herein by reference. Computation of Earnings per Share. Reference is made to this Annual Report on Form 10-K Note 1 to the Consolidated Financial Statements, which is incorporated herein by reference. Subsidiaries of Consumers Bancorp, Inc. Filed with this Annual Report on Form 10-K. Consent of Crowe Horwath LLP Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. Certification of Chief Financial Officer and Treasurer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. Certification of Chief Executive Officer and Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. 53 General Information External Independent Certified Public Accountants Crowe Horwath LLP 600 Superior Avenue, Ste. 902 Cleveland, Ohio 44114 General Counsel Squire, Sanders & Dempsey LLP 4900 Key Tower 127 Public Square Cleveland, Ohio 44114 Stock Transfer Agent and Registrar Registrar and Transfer Company 10 Commerce Drive Cranford, New Jersey 07016-3572 1-800-368-5948 Market Makers Greig McDonald Community Banc Investments, Inc. 26 East Main Street New Concord, Ohio 43762 740-826-7601 800-224-1013 Thomas L. Dooley Boenning & Scattergood 9916 Brewster Lane Powell, Ohio 43065 614-203-2996 866-326-8113 Robert S. McCulloch Hunter Associates 194 East State Street P.O. Box 1300 Salem, Ohio 44460 800-203-6593 Common Stock Listing Consumers Bancorp, Inc. common stock trades on the OTC Bulletin Board under the symbol CBKM.OB. The CUSIP is 210509105. As of June 30, 2011, there were 2,049,873 shares outstanding with 693 shareholders of record and an estimated 236 additional beneficial holders whose stock was held in nominee name. Dividend Reinvestment and Stock Purchase Plan Existing holders of common stock may elect to have all or a portion of cash dividends automatically invested in additional shares of common stock without payment of any brokerage or service charge. Additionally, shareholders may elect to purchase shares of common stock with optional cash payments of $100 to $5,000 per quarter without payment of any brokerage commission or service charge. Shareholders should contact Registrar and Transfer Company to execute these convenient options at www.rtco.com or 800-368-5948. Dividend Payments Subject to the approval of the Board of Directors, quarterly cash dividends are typically paid on or about the 15th day of September, December, March, and June. Direct Deposit of Cash Dividends Shareholders may elect to have their cash dividends deposited directly into their savings or checking account. Shareholders should contact Registrar and Transfer Company to execute this convenient option at www.rtco.com or 800-368-5948. Shareholder Relations shareholderrelations@consumersbank.com Website www.consumersbancorp.com Annual Meeting The 2011 annual meeting of shareholders will be held on Wednesday, October 26, 2011, at 12:00 p.m. at The Quarry Golf Club, 5650 Quarry Lake Drive, Canton, Ohio, 44730. Annual Report on Form 10-K A copy of the Company’s Annual Report on Form 10-K for the fiscal year ended June 30, 2011, as filed with the Securities and Exchange Commission, will be furnished without charge to shareholders upon written request to Theresa J. Linder, Corporate Secretary. An electronic version is also available on our website at www.consumersbancorp.com. Directors Emeriti Homer Unkefer Walter Young Our 2011 annual report was printed and shipped by our customer Davis Graphic Communication Solutions in Summit County, Ohio. AnnualReportCoverSpread.indd 2 9/12/2011 3:05:35 PM C M Y CM MY CY CMY K

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