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 December 31, 2012
(cid:1) (cid:1) (cid:1) (cid:1) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
OR
Commission file number: 001-33033
PORTER BANCORP, INC.
(Exact name of registrant as specified in its charter)
Kentucky
(State or other jurisdiction of
incorporation or organization)
61-1142247
(I.R.S. Employer Identification No.)
2500 Eastpoint Parkway, Louisville, Kentucky
(Address of principal executive offices)
40223
(Zip Code)
Registrant’s telephone number, including area code: (502) 499-4800
Securities registered pursuant to Section 12(b) of the Act:
Title of each class
Common Stock, no par value
Name of each exchange on which registered
NASDAQ Global Market
Securities registered pursuant to Section 12(g) of the Act:
None
Indicate by check mark if the registrant is a well-known seasoned issuer (as defined in Rule 405 of the Securities Act). Yes (cid:1) 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:1) 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 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:1)
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data
File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 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 No (cid:1)
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K 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:1)
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 definition of “accelerated filer”, “large accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
(Check one):
Large accelerated filer (cid:1) Accelerated filer (cid:1) Non-accelerated filer (cid:1) Smaller reporting company
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes (cid:1) No
The aggregate market value of the voting common equity held by non-affiliates computed by reference to the price at which the common equity
was last sold as of the close of business on June 30, 2012, was $8,654,366 based upon the last sales price reported for such date on the
NASDAQ Global Market.
The number of shares outstanding of the registrant’s Common Stock, no par value, as of January 31, 2013, was 12,144,989.
Portions of the registrant’s Proxy Statement for the Annual Meeting of Shareholders to be held May 22, 2013 are incorporated by reference into
Part III of this Form 10-K.
DOCUMENTS INCORPORATED BY REFERENCE
TABLE OF CONTENTS
PART I
Item 1. Business
Item 1A.
Item 1B.
Item 2.
Item 3.
Item 4.
Risk Factors
Unresolved Staff Comments
Properties
Legal Proceedings
Mine Safety Disclosures
PART II
Item 5.
Item 6.
Item 7.
Item 7A.
Item 8.
Item 9.
Item 9A.
Item 9B.
PART III
Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity
Securities
Selected Financial Data
Management’s Discussion and Analysis of Financial Condition and Results of Operation
Quantitative and Qualitative Disclosures About Market Risk
Financial Statements and Supplementary Data
Changes in and Disagreements With Accountants on Accounting and Financial Disclosure
Controls and Procedures
Other Information
Item 10.
Item 11.
Item 12.
Item 13.
Item 14.
Directors, Executive Officers and Corporate Governance
Executive Compensation
Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
Certain Relationships and Related Transactions, and Director Independence
Principal Accounting Fees and Services
PART IV
Item 15.
Exhibits and Financial Statement Schedules
Signatures
Index to Exhibits
Page No.
1
1
11
22
22
22
22
23
23
25
26
55
57
100
100
101
101
101
101
102
102
102
103
103
104
105
Preliminary Note Concerning Forward-Looking Statements
PART I
This report contains statements about the future expectations, activities and events that constitute forward-looking statements. Forward-looking
statements express our beliefs, assumptions and expectations of our future financial and operating performance and growth plans, taking into
account information currently available to us. These statements are not statements of historical fact. The words “believe,” “may,” “should,”
“anticipate,” “estimate,” “expect,” “intend,” “objective,” “seek,” “plan,” “strive” or similar words, or the negatives of these words, identify
forward-looking statements.
Forward-looking statements involve risks and uncertainties that may cause our actual results to differ materially from the expectations of future
results we expressed or implied in any forward-looking statements. These risks and uncertainties can be difficult to predict and may be out of
our control. Factors that could contribute to differences in our results include, but are not limited to deterioration in the financial condition of
borrowers resulting in significant increases in loan losses and provisions for those losses; changes in the interest rate environment, which may
reduce our margins or impact the value of securities, loans, deposits and other financial instruments; changes in loan underwriting, credit
review or loss reserve policies associated with economic conditions, examination conclusions, or regulatory developments; general economic
or business conditions, either nationally, regionally or locally in the communities we serve, may be worse than expected, resulting in, among
other things, a deterioration in credit quality or a reduced demand for credit; the results of regulatory examinations; any matter that would cause
us to conclude that there was impairment of any asset, including intangible assets; the continued service of key management personnel; our
ability to attract, motivate and retain qualified employees; factors that increase the competitive pressure among depository and other financial
institutions, including product and pricing pressures; the ability of our competitors with greater financial resources to develop and introduce
products and services that enable them to compete more successfully than us; the impact of governmental restrictions on entities participating
in the Capital Purchase Program of the U.S. Department of the Treasury; inability to comply with regulatory capital requirements and to secure
any required regulatory approvals for capital actions; legislative or regulatory developments, including changes in laws concerning taxes,
banking, securities, insurance and other aspects of the financial services industry; and fiscal and governmental policies of the United States
federal government.
Other risks are detailed in Item 1A. “Risk Factors” of this Form 10-K all of which are difficult to predict and many of which are beyond our
control.
Forward-looking statements are not guarantees of performance or results. A forward-looking statement may include the assumptions or bases
underlying the forward-looking statement. We have made our assumptions and bases in good faith and believe they are reasonable. We caution
you however, that estimates based on such assumptions or bases frequently differ from actual results, and the differences can be material. The
forward-looking statements included in this report speak only as of the date of the report. We do not intend to update these statements unless
applicable laws require us to do so.
Item 1.
Business
Overview
We are a bank holding company headquartered in Louisville, Kentucky. We are the eighth largest independent banking organization domiciled
in the state of Kentucky based on total assets. Through our wholly-owned subsidiary PBI Bank, we operate 18 full-service banking offices in
twelve counties in Kentucky. Our markets include metropolitan Louisville in Jefferson County and the surrounding counties of Henry and
Bullitt, and extend south along the Interstate 65 corridor to Tennessee. We serve south central Kentucky and southern Kentucky from banking
offices in Butler, Green, Hart, Edmonson, Barren, Warren, Ohio, and Daviess Counties. We also have an office in Lexington, the second
largest city in Kentucky. PBI Bank is both a traditional community bank with a wide range of commercial and personal banking products,
including wealth management and trust services, and an on-line bank which delivers competitive deposit products and services through an on-
line banking division operating under the name of Ascencia. As of December 31, 2012, we had total assets of $1.2 billion, total loans of $899.1
million, total deposits of $1.1 billion and stockholders’ equity of $47.2 million.
History
We were organized in 1988, and historically conducted our banking business through separate community banks under the common control of
J. Chester Porter, our chairman emeritus, and Maria L. Bouvette, our chairman and chief executive officer. In 2005, we completed a
reorganization in which we consolidated our subsidiary banks into a single bank. On December 31, 2005, we renamed our consolidated
subsidiary PBI Bank to create a single brand name for our banking operations throughout our market area. We completed our initial public
offering in September 2006.
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On November 21, 2008, we issued to the U.S. Treasury, in exchange for cash consideration of $35.0 million, (i) 35,000 shares of Fixed Rate
Cumulative Perpetual Preferred Stock, Series A, with a liquidation preference of $1,000 per share (the “Series A Preferred Stock”), and (ii) a
warrant to purchase up to 330,561 shares of our common stock for $15.88 per share.
In 2010, we completed a $32.0 million private placement to accredited investors. Following completion of the transactions involved, Porter
Bancorp had issued (i) 2,465,569 shares of common stock, (ii) 317,042 shares of Non−Voting Cumulative Mandatorily Convertible Perpetual
Preferred Shares, Series C (“Series C Preferred Stock”) and (iii) warrants to purchase 1,163,045 shares of non-voting common stock at a price
of $11.50 per share. See Item 7., Management’s Discussion and Analysis of Financial Condition and Results of Operation – Capital.
On June 24, 2011, PBI Bank entered into a consent order with the Federal Deposit Insurance Corporation (“FDIC”) and the Kentucky
Department of Financial Institutions (“KDFI”). The consent order requires the Bank to improve its asset quality, reduce its loan concentrations,
and maintain a minimum Tier 1 leverage ratio of 9% and a minimum total risk based capital ratio of 12%.
On September 21, 2011, Porter Bancorp entered into a written agreement with the Federal Reserve Bank of St. Louis. Porter Bancorp made
formal commitments to use its resources to serve as a source of strength for PBI Bank, to assist the Bank in addressing weaknesses identified
by the FDIC and the KDFI, to pay no dividends without prior written approval, to pay no interest on subordinated debentures or principal on
trust preferred securities without written approval, and to submit a plan to maintain sufficient capital.
In October 2012, the Bank entered into a new Consent Order with the FDIC and KDFI again agreeing to maintain a minimum Tier 1 leverage
ratio of 9% and a minimum total risk based capital ratio of 12%. The Bank also agreed that if it should be unable to reach the required capital
levels, and if directed in writing by the FDIC, then the Bank would within 30 days develop, adopt and implement a written plan to sell or merge
itself into another federally insured financial institution or otherwise immediately obtain a sufficient capital investment into the Bank to fully
meet the capital requirements. The new Consent Order also requires the Bank to continue to adhere to the plans implemented in response to the
June 2011 Consent Order, and includes the substantive provisions of the June 2011 Consent Order.
Our Markets
We operate in markets that include the four largest cities in Kentucky – Louisville, Lexington, Owensboro and Bowling Green – and in other
communities along the I-65 corridor.
(cid:4) Louisville/Jefferson, Bullitt and Henry Counties: Our headquarters are in Louisville, the largest city in Kentucky and the
twenty-seventh largest city in the United States. The Louisville metropolitan area includes the consolidated Louisville/Jefferson
County and 12 surrounding Kentucky and Southern Indiana counties with an estimated 1.3 million residents in 2011. We also
have banking offices in Bullitt County, south of Louisville, and Henry County, east of Louisville. Our six banking offices in these
counties also serve the contiguous counties of Spencer, Shelby and Oldham to the east and northeast of Louisville. The area’s
employers are diversified across many industries and include the air hub for United Parcel Service (“UPS”), two Ford assembly
plants, General Electric’s Consumer and Industrial division, Humana, Norton Healthcare, Brown-Forman and YUM! Brands.
(cid:4) Lexington/Fayette County: Lexington, located in Fayette County, is the second largest city in Kentucky with an estimated
countywide population of over 302,000 in 2011. Lexington is the financial, educational, retail, healthcare and cultural hub for
Central and Eastern Kentucky. It is known worldwide for its Bluegrass horse farms and Keeneland Race Track, and proudly
boasts of itself as “The Horse Capital of the World.” It is also the home of the University of Kentucky and Transylvania
University. The area’s employers include Toyota, Lexmark, IBM Global Services and Valvoline.
(cid:4) Southern Kentucky: This market includes Bowling Green, the third largest city in Kentucky, located about 60 miles north of
Nashville, Tennessee. Bowling Green, located in Warren County, is the home of Western Kentucky University and is the
economic hub of the area. This market also includes thriving communities in the contiguous Barren County, including the city of
Glasgow. The combined population of Warren and Barren counties was approximately 158,000 in 2011. Major employers in
Barren and Warren Counties include GM’s Corvette plant and several other automotive facilities and R.R. Donnelley’s regional
printing facility.
(cid:4) Owensboro/Daviess County: Owensboro, located on the banks of the Ohio River, is Kentucky’s fourth largest city. Daviess
County had an estimated countywide population of approximately 97,000 in 2011. The city is called a festival city, with over 20
annual community celebrations that attract visitors from around the world, including its world famous Bar-B-Q Festival which
attracts over 80,000 visitors giving Owensboro recognition as “The Bar-B-Q Capital of the World”. It is an industrial, medical,
retail and cultural hub for Western Kentucky and the area employers include Owensboro Medical System, Texas Gas, US Bank
Home Mortgage and Toyotetsu.
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(cid:4) South Central Kentucky: South of the Louisville metropolitan area, we have banking offices in Butler, Edmonson, Green, Hart,
and Ohio Counties, which had a combined population of approximately 78,000 in 2011. This region includes stable community
markets comprised primarily of agricultural and service-based businesses. Each of our banking offices in these markets has a
stable customer and core deposit base.
Our Products and Services
We meet our customers’ banking needs with a broad range of financial products and services. Our lending services include real estate,
commercial, mortgage and consumer loans to small to medium-sized businesses, the owners and employees of those businesses, and other
executives and professionals. We complement our lending operations with an array of retail and commercial deposit products. In addition, we
offer our customers drive-through banking facilities, automatic teller machines, night depository, personalized checks, credit cards, debit cards,
internet banking, electronic funds transfers through ACH services, domestic and foreign wire transfers, travelers’ checks, cash management,
vault services, loan and deposit sweep accounts and lock box services . Through our trust division, we offer personal trust services, employer
retirement plan services and personal financial and retirement planning services.
Employees
At December 31, 2012, the Company had 278 full-time equivalent employees. Our employees are not subject to a collective bargaining
agreement, and management considers the Company’s relationship with employees to be good.
Competition
The banking business is highly competitive, and we experience competition in our market from many other financial institutions. Competition
among financial institutions is based upon interest rates offered on deposit accounts, interest rates charged on loans, other credit and service
charges relating to loans, the quality and scope of the services offered, the convenience of banking facilities and, in the case of loans to
commercial borrowers, relative lending limits. We compete with commercial banks, credit unions, savings and loan associations, mortgage
banking firms, consumer finance companies, securities brokerage firms, insurance companies, money market funds and other mutual funds, as
well as super-regional, national and international financial institutions that operate offices within our market area and beyond.
There are a number of banks that offer services exclusively over the internet and other banks market their internet services to their customers
nationwide. Many of the larger banks have greater market presence and greater financial resources to market their internet banking services.
Additionally, new competitors and competitive factors are likely to emerge, particularly in view of the rapid development of internet
commerce. On the other hand, we believe that many customers prefer to be able to conduct their banking transactions at local banking offices.
We believe that these findings support our strategic decision to complement our traditional community bank with our uniquely branded online
bank to offer customers the benefits of both traditional and internet banking services.
Supervision and Regulation
Consent Order and Formal Written Agreement. On June 24, 2011, PBI Bank entered into a Consent Order with the FDIC and the Kentucky
Department of Financial Institutions. PBI Bank agreed to obtain the written consent of both agencies before declaring or paying any future
dividends. As a practical matter, PBI Bank will not be able to pay dividends to Porter Bancorp for the foreseeable future . The consent order
also establishes benchmarks for the Bank to improve its asset quality, reduce its loan concentrations, and maintain a minimum Tier 1 leverage
ratio of 9% and a minimum total risk based capital ratio of 12%. At December 31, 2012, the Bank’s Tier 1 leverage ratio declined to 5.4% and
its total risk-based capital ratio declined to 9.8%, which are below the minimums of 9.0% and 12.0% required by the Bank’s Consent Order. At
December 31, 2012, Porter Bancorp’s leverage ratio was 4.5% and its total risk-based capital ratio was 9.8%. We are continuing our efforts to
strengthen our capital levels and comply with the Consent Order as outlined in the written capital plan submitted by the Bank to its regulators
in December 2012.
On September 21, 2011, we entered into a formal written agreement with the Federal Bank of St. Louis. Porter Bancorp made formal
commitments in the agreement to use its financial and management resources to serve as a source of strength for the Bank and to assist the
Bank in addressing weaknesses identified by the FDIC and the KDFI, to pay no dividends without prior written approval, to pay no interest or
principal on subordinated debentures or trust preferred securities without written approval, and to submit an acceptable plan to maintain
sufficient capital.
In October 2012, the Bank entered into a new Consent Order with the FDIC and KDFI again agreeing to maintain a minimum Tier 1 leverage
ratio of 9% and a minimum total risk based capital ratio of 12%. The Bank also agreed that if it should be unable to reach the required capital
levels, and if directed in writing by the FDIC, then the Bank would within 30 days develop, adopt and implement a written plan to sell or merge
itself into another federally insured financial institution or otherwise obtain a capital investment into the Bank sufficient to fully meet the
capital requirements.
3
We expect to continue to work with our regulators toward capital ratio compliance as outlined in the written capital plan previously submitted
by the Bank. The new Consent Order also requires the Bank to continue to adhere to the plans implemented in response to the June 2011
Consent Order, and includes the substantive provisions of the June 2011 Consent Order. As of December 31, 2012, the capital ratios required
by the Consent Order were not met.
Bank and Holding Company Laws, Rules and Regulations. The following is a summary description of the relevant laws, rules and
regulations governing banks and bank holding companies. The descriptions of, and references to, the statutes and regulations below are brief
summaries and do not purport to be complete. The descriptions are qualified in their entirety by reference to the specific statutes and
regulations discussed.
The Dodd-Frank Act. On July 21, 2010, the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (“Dodd-Frank Act”) was
signed into law. The Dodd-Frank Act imposes new restrictions and an expanded framework of regulatory oversight for financial institutions,
including depository institutions. Because the Dodd-Frank Act requires various federal agencies to adopt a broad range of regulations with
significant discretion, many of the details of the new law and the effects it will have on the Company are not known at this time.
The Dodd-Frank Act represents a comprehensive overhaul of the financial services industry within the United States. There are a number of
reform provisions that are likely to significantly impact the ways in which banks and bank holding companies, including the Company, do
business. For example, the Dodd-Frank Act changes the assessment base for federal deposit insurance premiums by modifying the deposit
insurance assessment base calculation to be based on a depository institution’s consolidated assets less tangible capital instead of deposits,
permanently increases the standard maximum amount of deposit insurance per customer to $250,000 and extends the unlimited deposit
insurance on non-interest bearing transaction accounts through January 1, 2013. The Dodd-Frank Act also imposes more stringent capital
requirements on bank holding companies by, among other things, imposing leverage ratios on bank holding companies and prohibiting new
trust preferred security issuances from counting as Tier I capital. The Dodd-Frank Act also repeals the federal prohibition on the payment of
interest on demand deposits, thereby permitting depository institutions to pay interest on business transaction and other accounts. The Act
codifies and expands the Federal Reserve’s source of strength doctrine, which requires that all bank holding companies serve as a source of
financial strength for its subsidiary banks. Other provisions of the Dodd-Frank Act include, but are not limited to: (i) the creation of a new
financial consumer protection agency that is empowered to promulgate new consumer protection regulations and revise existing regulations in
many areas of consumer protection; (ii) enhanced regulation of financial markets, including derivatives and securitization markets; (iii) reform
related to the regulation of credit rating agencies; (iv) the elimination of certain trading activities by banks; and (v) new disclosure and other
requirements relating to executive compensation and corporate governance.
Many provisions of the Dodd-Frank Act will not be implemented immediately and will require interpretation and rule- making by federal
agencies. The Company is monitoring all relevant sections of the Dodd-Frank Act to ensure continued compliance with laws and regulations.
While the ultimate effect of the Dodd-Frank Act on the Company cannot currently be determined, the law is likely to result in increased
compliance costs and fees paid to regulators, along with possible restrictions on the Company’s operations.
Porter Bancorp. Porter Bancorp is registered as a bank holding company under the Bank Holding Company Act of 1956, as amended, and is
subject to supervision and regulation by the Board of Governors of the Federal Reserve System. As such, we must file with the Federal Reserve
Board annual and quarterly reports and other information regarding our business operations and the business operations of our subsidiaries. We
are also subject to examination by the Federal Reserve Board and to operational guidelines established by the Federal Reserve Board. We are
subject to the Bank Holding Company Act and other federal laws on the types of activities in which we may engage, and to other supervisory
requirements, including regulatory enforcement actions for violations of laws and regulations.
Acquisitions. A bank holding company must obtain Federal Reserve Board approval before acquiring, directly or indirectly, ownership or
control of more than 5% of the voting stock or all or substantially all of the assets of a bank, merging or consolidating with any other bank
holding company and before engaging, or acquiring a company that is not a bank but is engaged in certain non-banking activities. Federal law
also prohibits a person or group of persons from acquiring “control” of a bank holding company without notifying the Federal Reserve Board
in advance, and then only if the Federal Reserve Board does not object to the proposed transaction. The Federal Reserve Board has established
a rebuttable presumptive standard that the acquisition of 10% or more of the voting stock of a bank holding company would constitute an
acquisition of control of the bank holding company. In addition, any company is required to obtain the approval of the Federal Reserve Board
before acquiring 25% (5% in the case of an acquirer that is a bank holding company) or more of any class of a bank holding company’s voting
securities, or otherwise obtaining control or a “controlling influence” over a bank holding company.
4
Permissible Activities. A bank holding company is generally permitted under the Bank Holding Company Act to engage in or acquire direct or
indirect control of more than 5% of the voting shares of any bank, bank holding company or company engaged in any activity that the Federal
Reserve Board determines to be so closely related to banking as to be a proper incident to the business of banking.
Under current federal law, a bank holding company may elect to become a financial holding company, which enables the holding company to
conduct activities that are “financial in nature.” Activities that are “financial in nature” include securities underwriting, dealing and market
making; sponsoring mutual funds and investment companies; insurance underwriting and agency; merchant banking activities; and activities
that the Federal Reserve Board has determined to be closely related to banking. No regulatory approval will be required for a financial holding
company to acquire a company, other than a bank or savings association, engaged in activities that are financial in nature or incidental to
activities that are financial in nature, as determined by the Federal Reserve Board. We have not filed an election to become a financial holding
company.
U.S. Treasury Capital Purchase Program . On November 21, 2008, pursuant to the U.S. Department of the Treasury’s (the “U.S. Treasury”)
Capital Purchase Program (the “CPP”), established under the Emergency Economic Stabilization Act of 2008 (“EESA”), Porter Bancorp issued
and sold to the U.S. Treasury in an offering exempt from registration under the Securities Act of 1933, (i) 35,000 shares of Porter Bancorp’s
Fixed Rate Cumulative Perpetual Preferred Stock, Series A, no par value and liquidation preference $1,000 per share ($35 million aggregate
liquidation preference) (the “Series A Preferred Stock”) and (ii) a warrant (the “Warrant”) to purchase 330,561 shares (adjusted for stock
dividends) of Porter Bancorp’s common stock, at an exercise price of $15.88 per share (adjusted for stock dividends), subject to certain anti-
dilution and other adjustments for an aggregate purchase price of $35 million in cash. The securities purchase agreement, dated November 21,
2008, pursuant to which the securities issued to the U.S. Treasury under the CPP were sold, limits the payment of dividends on Porter
Bancorp’s common stock to the quarterly dividend level at the time of the transaction without prior approval of the U.S. Treasury, limits Porter
Bancorp’s ability to repurchase shares of its common stock (with certain exceptions, including the repurchase of our common stock to offset
share dilution from equity-based compensation awards) and grants registration rights to the holders of the Series A Preferred Stock, the
Warrant and the common stock of Porter Bancorp to be issued upon any exercise of the Warrant. The U.S. Treasury has notified us that it
intends to sell at auction the shares of Series A Preferred Stock issued by the Company. We do not know, at this time, the U.S. Treasury’s
timeline for such a sale.
The American Recovery and Reinvestment Act (“ARRA”) was enacted on February 17, 2009. ARRA imposes certain executive compensation
and corporate governance obligations on all current and future CPP recipients, including Porter Bancorp, until the institution has redeemed the
preferred stock. On June 15, 2009, under the authority granted to it under EESA and ARRA, the U. S. Treasury issued an interim final rule
under Section 111 of EESA, as amended by ARRA, regarding compensation and corporate governance restrictions that would be imposed on
CPP recipients, effective June 15, 2009. As a CPP recipient with currently outstanding CPP obligations, we are subject to the compensation and
corporate governance restrictions and requirements set forth in the interim final rule. The restrictions and requirements provided for in the
implementing regulations are generally as follows: (1) required us to establish an independent compensation committee, (2) required us to
adopt a corporate policy on luxury or excessive expenditures; (3) requires our compensation committee to conduct semi-annual risk
assessments to assure that our compensation arrangements do not encourage “unnecessary and excessive risks” or the manipulation of earnings
to increase compensation; (4) requires us to recoup or “clawback” any bonus, retention award or incentive compensation paid by us to a senior
executive officer or any of our next 20 most highly compensated employees, if the payment was based on financial statements or other
performance criteria that are later found to be materially inaccurate; (5) prohibits us from making severance payments or “golden parachutes”
to any of our senior executive officers or next five most highly compensated employees; (6) prohibits us from paying or accruing bonuses,
retention awards or incentive compensation, except for certain long-term stock awards, to our five most highly compensated employees;
(7) prohibits us from providing tax gross-ups to any of our senior executive officers or next 20 most highly compensated employees;
(8) requires us to provide enhanced disclosure of perquisites to the FDIC and the U.S. Treasury; (9) requires us to disclose to the FDIC and the
U.S. Treasury the use and role of compensation consultants; (10) requires our chief executive officer and chief financial officer to provide
period certifications about our compensation practices and compliance with the interim final rule; and (11) requires us to provide an annual
non-binding shareholder vote, or “say-on-pay” proposal, to approve the compensation of our named executives, consistent with regulations
promulgated by the Securities and Exchange Commission. On January 12, 2010, the SEC adopted final regulations setting forth the parameters
for such say-on pay proposals for public company CPP participants. The U.S. Treasury has notified us that it intends to sell at auction the
shares of Series A Preferred Stock issued by the Company. We do not know the U.S. Treasury’s timeline for that sale. If the U.S. Treasury
completes such a sale, most of the compensation restrictions described above will no longer apply to the Company and the Bank.
5
Capital Adequacy Requirements. The Federal Reserve Board has adopted a system using risk-based capital guidelines to evaluate the capital
adequacy of bank holding companies. Under the guidelines, specific categories of assets are assigned different risk weights, based generally on
the perceived credit risk of the asset. These risk weights are multiplied by corresponding asset balances to determine a “risk-weighted” asset
base. The guidelines require a minimum total risk-based capital ratio of 8.0%. At least half of the total capital must be composed of common
equity, retained earnings, senior perpetual preferred stock issued to the U. S. Treasury under the CPP and qualifying perpetual preferred stock
and certain hybrid capital instruments, less certain intangible assets (“Tier 1 capital”). The remainder may consist of certain subordinated debt,
certain hybrid capital instruments, qualifying preferred stock and a limited amount of the allowance for loan losses (“Tier 2 capital”). Total
capital is the sum of Tier 1 and Tier 2 capital. To be considered well-capitalized under the risk-based capital guidelines, an institution must
maintain a total capital to total risk-weighted assets ratio of at least 10% and a Tier 1 capital to total risk-weighted assets ratio of 6% or greater.
We are under a Consent Order with our primary regulators as previously discussed. Please see “Supervision and Regulation” above for our
capital requirements.
In addition to the risk-based capital guidelines, the Federal Reserve Board uses a leverage ratio as an additional tool to evaluate the capital
adequacy of bank holding companies. The leverage ratio is a company’s Tier 1 capital divided by its average total consolidated assets. Certain
highly rated bank holding companies may maintain a minimum leverage ratio of 3.0%, but other bank holding companies may be required to
maintain a leverage ratio of 4.0%.
The federal banking agencies’ risk-based and leverage ratios are minimum supervisory ratios generally applicable to banking organizations that
meet certain specified criteria, assuming that they have the highest regulatory rating. Banking organizations not meeting these criteria are
expected to operate with capital positions well above the minimum ratios. The federal bank regulatory agencies may set capital requirements
for a particular banking organization that are higher than the minimum ratios when circumstances warrant. Federal Reserve Board guidelines
also provide that banking organizations experiencing internal growth or making acquisitions will be expected to maintain strong capital
positions substantially above the minimum supervisory levels, without significant reliance on intangible assets.
Dividends. Under Federal Reserve policy, bank holding companies should pay cash dividends on common stock only out of income available
over the past year and only if prospective earnings retention is consistent with the organization’s expected future needs and financial condition.
The policy provides that bank holding companies should not declare a level of cash dividends that undermines the bank holding company’s
ability to serve as a source of strength to its banking subsidiaries.
Porter Bancorp is a legal entity separate and distinct from PBI Bank. The majority of our revenue is from dividends paid to us by PBI Bank.
PBI Bank is subject to laws and regulations that limit the amount of dividends it can pay. If, in the opinion of a federal regulatory agency, an
institution under its jurisdiction is engaged in or is about to engage in an unsafe or unsound practice, the agency may require, after notice and
hearing, that the institution cease such practice. The federal banking agencies have indicated that paying dividends that deplete an institution’s
capital base to an inadequate level would be an unsafe and unsound banking practice. Under the Federal Deposit Insurance Corporation
Improvement Act (FDICIA), an insured institution may not pay any dividend if payment would cause it to become undercapitalized or if it
already is undercapitalized. Moreover, the Federal Reserve and the FDIC have issued policy statements providing that bank holding companies
and banks should generally pay dividends only out of current operating earnings. A bank holding company may still declare and pay a dividend
if it does not have current operating earnings if the bank holding company expects profits for the entire year and the bank holding company
obtains the prior consent of the Federal Reserve. Porter Bancorp and PBI Bank must obtain the prior written consent of each of their primary
regulators prior to declaring or paying any future dividends.
Under Kentucky law, dividends by Kentucky banks may be paid only from current or retained net profits. Before any dividend may be declared
for any period (other than with respect to preferred stock), a bank must increase its capital surplus by at least 10% of the net profits of the bank
for the period until the bank’s capital surplus equals the amount of its stated capital attributable to its common stock. Moreover, the Kentucky
Department of Financial Institutions must approve the declaration of dividends if the total dividends to be declared by a bank for any calendar
year would exceed the bank’s total net profits for such year combined with its retained net profits for the preceding two years, less any required
transfers to surplus or a fund for the retirement of preferred stock or debt. We are also subject to the Kentucky Business Corporation Act, which
generally prohibits dividends to the extent they result in the insolvency of the corporation from a balance sheet perspective or in the corporation
becoming unable to pay its debts as they come due. PBI Bank did not pay any dividends in 2012.
Prior to November 21, 2011, unless Porter Bancorp redeemed all of the Series A Preferred Stock issued to the U.S. Treasury on November 21,
2008 or unless the U.S. Treasury transferred all the preferred securities to a third party, the consent of the U.S. Treasury was required for Porter
Bancorp to declare or pay any dividend or make any distribution on common stock other than (i) regular quarterly cash dividends of not more
than the per share dividend amount at the time of the issuance of the Series A Preferred Stock, as adjusted for any stock split, stock dividend,
reverse stock split, reclassification or similar transaction, (ii) dividends payable solely in shares of common stock and (iii) dividends or
distributions of rights or junior stock in connection with a shareholders’ rights plan.
6
Imposition of Liability for Undercapitalized Subsidiaries. Bank regulators are required to take “prompt corrective action” to resolve problems
associated with insured depository institutions whose capital declines below certain levels. In the event an institution becomes
“undercapitalized,” it must submit a capital restoration plan. The capital restoration plan will not be accepted by the regulators unless each
company having control of the undercapitalized institution guarantees the subsidiary’s compliance with the capital restoration plan up to a
certain specified amount. Any such guarantee from a depository institution’s holding company is entitled to a priority of payment in
bankruptcy.
The aggregate liability of the holding company of an undercapitalized bank is limited to the lesser of 5% of the institution’s assets at the time it
became undercapitalized or the amount necessary to cause the institution to be “adequately capitalized.” The bank regulators have greater
power in situations where an institution becomes “significantly” or “critically” undercapitalized or fails to submit a capital restoration plan. For
example, a bank holding company controlling such an institution can be required to obtain prior Federal Reserve Board approval of proposed
dividends, or might be required to consent to a consolidation or to divest the troubled institution or other affiliates.
Source of Financial Strength. Under Federal Reserve policy, a bank holding company is expected to act as a source of financial strength to, and
to commit resources to support, its bank subsidiaries. This support may be required at times when, absent such a policy, the bank holding
company may not be inclined to provide it. In addition, any capital loans by the bank holding company to its bank subsidiaries are subordinate
in right of payment to deposits and to certain other indebtedness of the bank subsidiary. In the event of a bank holding company’s bankruptcy,
any commitment by the bank holding company to a federal bank regulatory agency to maintain the capital of subsidiary banks will be assumed
by the bankruptcy trustee and entitled to a priority of payment. The Federal Reserve’s “Source of Financial Strength” policy was codified in the
Dodd-Frank Act.
PBI Bank. PBI Bank, a Kentucky chartered commercial bank, is subject to regular bank examinations and other supervision and regulation by
both the FDIC and the Kentucky Department of Financial Institutions (“KDFI”). Kentucky’s banking statutes contain a “super-parity”
provision that permits a well-rated Kentucky banking corporation to engage in any banking activity which could be engaged in by a national
bank operating in any state; a state bank, a thrift or savings bank operating in any other state; or a federal chartered thrift or federal savings
association meeting the qualified thrift lender test and operating in any state could engage, provided the Kentucky bank first obtains a legal
opinion specifying the statutory or regulatory provisions that permit the activity.
Capital Requirements. Similar to the Federal Reserve Board’s requirements for bank holding companies, the FDIC has adopted risk-based
capital requirements for assessing state non-member banks’ capital adequacy. The FDIC’s risk-based capital guidelines require that all banks
maintain a minimum ratio of total capital to total risk-weighted assets of 8.0% and a minimum ratio of Tier 1 capital to total risk-weighted
assets of 4.0%. To be well-capitalized, a bank must have a ratio of total capital to total risk-weighted assets of at least 10.0% and a ratio of Tier
1 capital to total risk-weighted assets of 6.0%.
PBI Bank has agreed with its primary regulators to maintain a ratio of total capital to total risk-weighted assets of at least 12.0% and a ratio of
Tier 1 capital to total assets of 9%. As of December 31, 2012, PBI Bank’s ratio of total capital to total risk-weighted assets was 9.8% and its
ratio of Tier 1 capital to total assets was 5.4%, both under the ratios required by the Consent Order.
The FDIC also requires a minimum leverage ratio of 3.0% of Tier 1 capital to total assets for the highest rated banks and an additional cushion
of approximately 100-200 basis points for all other banks. The leverage ratio operates in tandem with the FDIC’s risk-based capital guidelines
and places a limit on the amount of leverage a bank can undertake by requiring a minimum level of capital to total assets.
Prompt Corrective Action. Pursuant to the Federal Deposit Insurance Act (“FDIA”), the FDIC must take prompt corrective action to resolve the
problems of undercapitalized institutions. FDIC regulations define the levels at which an insured institution would be considered “well
capitalized,” “adequately capitalized,” “undercapitalized,” “significantly undercapitalized” and “critically undercapitalized.” A “well-
capitalized” bank has a total risk-based capital ratio of 10.0% or higher; a Tier 1 risk- based capital ratio of 6.0% or higher; a leverage ratio of
5.0% or higher; and is not subject to any written agreement, order or directive requiring it to maintain a specific capital level for any capital
measure. An “adequately capitalized” bank has a total risk-based capital ratio of 8.0% or higher; a Tier 1 risk-based capital ratio of 4.0% or
higher; a leverage ratio of 4.0% or higher (3.0% or higher if the bank was rated a composite 1 in its most recent examination report and is not
experiencing significant growth); and does not meet the criteria for a well-capitalized bank. A bank is “undercapitalized” if it fails to meet any
one of the ratios required to be adequately capitalized. A depository institution may be deemed to be in a capitalization category that is lower
than is indicated by its actual capital position if it receives an unsatisfactory examination rating. The degree of regulatory scrutiny increases and
the permissible activities of a bank decreases, as the bank moves downward through the capital categories. Depending on a bank’s level of
capital, the FDIC’s corrective powers include:
7
•
requiring a capital restoration plan;
• placing limits on asset growth and restriction on activities;
•
requiring the bank to issue additional voting or other capital stock or to be acquired;
• placing restrictions on transactions with affiliates;
•
restricting the interest rate the bank may pay on deposits;
• ordering a new election of the bank’s board of directors;
•
requiring that certain senior executive officers or directors be dismissed;
• prohibiting the bank from accepting deposits from correspondent banks;
•
requiring the bank to divest certain subsidiaries;
• prohibiting the payment of principal or interest on subordinated debt; and
• ultimately, appointing a receiver for the bank.
In the event an institution is required to submit a capital restoration plan, the institution’s holding company must guaranty the subsidiary’s
compliance with the capital restoration plan up to a certain specified amount. Any such guarantee from a depository institution’s holding
company is entitled to a priority of payment in bankruptcy. The aggregate liability of the holding company of an undercapitalized bank is
limited to the lesser of 5% of the institution’s assets at the time it became undercapitalized or the amount necessary to cause the institution to be
“adequately capitalized.” The bank regulators have greater power in situations where an institution becomes “significantly” or “critically”
undercapitalized or fails to submit a capital restoration plan. For example, a bank holding company controlling such an institution can be
required to obtain prior Federal Reserve Board approval of proposed dividends, or might be required to consent to a consolidation or to divest
the troubled institution or other affiliates.
Deposit Insurance Assessments. The deposits of PBI Bank are insured by the Deposit Insurance Fund (DIF) of the FDIC up to the limits set
forth under applicable law and are subject to the deposit insurance premium assessments of the DIF. The FDIC imposes a risk-based deposit
premium assessment system, which was amended pursuant to the Federal Deposit Insurance Reform Act of 2005 (the “Reform Act”). Under
this system, as amended, the assessment rates for an insured depository institution vary according to the level of risk incurred in its activities.
To arrive at an assessment rate for a banking institution, the FDIC places it in one of four risk categories determined by reference to its capital
levels and supervisory ratings. The assessment rate schedule can change from time to time, at the discretion of the FDIC, subject to certain
limits.
On November 12, 2009, the FDIC amended the final rule adopted on May 22, 2009 to restore losses to the DIF. The new rule required insured
institutions to prepay on December 30, 2009, an estimated quarterly risk-based assessment for the fourth quarter of 2009 and for all 2010, 2011,
and 2012. An institution’s assessment is calculated by taking the institution’s actual September 30, 2009 assessment and adjusting it quarterly
by an estimated 5% annual growth rate through the end of 2012. Further, the FDIC incorporated a uniform 3 basis point increase effective
January 1, 2011. On December 30, 2009, PBI Bank prepaid $7.9 million of FDIC insurance premiums for 2010 through 2012. The entire
amount of the prepaid assessment was recorded as a prepaid expense. As of December 31, 2009, and each quarter thereafter, each institution is
to record an expense, or a charge to earnings, for its quarterly assessment invoiced on its quarterly statement and an offsetting credit to the
prepaid assessment until the asset is exhausted. At December 31, 2012, our prepaid assessment was exhausted.
The Dodd-Frank Act imposes additional assessments and costs with respect to deposits. Under the Dodd-Frank Act, the FDIC is directed to
impose deposit insurance assessments based on total assets rather than total deposits, as well as making permanent the increase of deposit
insurance to $250,000 and providing for full insurance of non-interest bearing transaction accounts beginning December 31, 2010, for two
years. In February 2011, the FDIC adopted a final rule on the deposit insurance assessment system. The rule is effective as of April 1, 2011,
and revises the assessment system to comply with Dodd-Frank and also includes a revised assessment rate process with the goal of
differentiating insured depository institutions who pose greater risk to the DIF. The first assessments under the new rule were payable in the
third quarter of 2011.
Safety and Soundness Standards. The FDIA requires the federal bank regulatory agencies to prescribe standards, by regulations or
guidelines, relating to internal controls, information systems and internal audit systems, loan documentation, credit underwriting, interest rate
risk exposure, asset growth, asset quality, earnings, stock valuation and compensation, fees and benefits, and such other operational and
managerial standards as the agencies deem appropriate. Guidelines adopted by the federal bank regulatory agencies establish general standards
relating to internal controls and information systems, internal audit systems, loan documentation, credit underwriting, interest rate exposure,
asset growth and compensation, fees and benefits. In general, the guidelines require, among other things, appropriate systems and practices to
identify and manage the risk and exposures specified in the guidelines. The guidelines prohibit excessive compensation as an unsafe and
unsound practice and describe compensation as excessive when the amounts paid are unreasonable or disproportionate to the services
performed by an executive officer, employee, director or principal stockholder. In addition, the agencies adopted regulations that authorize, but
do not require, an agency to order an institution that has been given notice by an agency that it is not satisfying any of such safety and
soundness standards to submit a compliance plan. If, after being so notified, an institution fails to submit an acceptable compliance plan or fails
in any material respect to implement an acceptable compliance plan, the agency must issue an order directing action to correct the deficiency
and may issue an order directing other actions of the types to which an undercapitalized institution is subject under the “prompt corrective
action” provisions of FDIA. See “Prompt Corrective Actions” above. If an institution fails to comply with such an order, the agency may seek
to enforce such order in judicial proceedings and to impose civil money penalties.
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Branching. Kentucky law permits Kentucky chartered banks to establish a banking office in any county in Kentucky. A Kentucky bank may
also establish a banking office outside of Kentucky. Well capitalized Kentucky banks that have been in operation at least three years and that
satisfy certain criteria relating to, among other things, their composite and management ratings, may establish a banking office in Kentucky
without the approval of the KDFI upon notice to the KDFI and any other state bank with its main office located in the county where the new
banking office will be located. Branching by all other banks requires the approval of the KDFI, who must ascertain and determine that the
public convenience and advantage will be served and promoted and that there is reasonable probability of the successful operation of the
banking office.
The transaction must also be approved by the FDIC, which considers a number of factors, including financial history, capital adequacy,
earnings prospects, character of management, needs of the community and consistency with corporate powers.
Historically, an out-of-state bank was permitted to establish banking offices in Kentucky only by merging with a Kentucky bank. De novo
branching into Kentucky by an out-of-state bank was not permitted. This difficulty for out-of-state banks to branch in Kentucky limited the
ability of a Kentucky bank to branch into many states, as several states have reciprocity requirements for interstate branching. The Dodd-Frank
Act permits de novo interstate branching by national banks and insured state banks by amending the state “opt-in” election. Applications for
out-of-state de novo branches would be approved if, under the law of the state in which the branch is to be located, a state bank chartered by
such state would be permitted to establish the branch.
Insider Credit Transactions. The restrictions on loans to directors, executive officers, principal shareholders and their related interests
(collectively referred to herein as “insiders”) contained in the Federal Reserve Act and Regulation O apply to all insured depository institutions
and their subsidiaries. These restrictions include limits on loans to one borrower and conditions that must be met before such a loan can be
made. There is also an aggregate limitation on all loans to insiders and their related interests. These loans cannot exceed the institution’s total
unimpaired capital and surplus.
Automated Overdraft Payment Regulation. The Federal Reserve and FDIC have recently enacted consumer protection regulations related to
automated overdraft payment programs offered by financial institutions. In November 2009, the Federal Reserve amended its Regulation E to
prohibit financial institutions from charging consumers fees for paying overdrafts on automated teller machine and one-time debit card
transactions, unless a consumer consents, or opts in, to the overdraft service for those types of transactions. The Regulation E amendments also
require financial institutions to provide consumers with a notice that explains the financial institution’s overdraft services, including the fees
associated with the service and the consumer’s choices.
In November 2010, the FDIC supplemented the Regulation E amendments by requiring FDIC-supervised institutions to implement additional
changes relating to automated overdraft payment programs by July 1, 2011. The most significant of these changes require financial institutions
to monitor overdraft payment programs for “excessive or chronic” customer use and undertake “meaningful and effective” follow-up action
with customers that overdraw their accounts more than six times during a rolling 12-month period. The additional guidance also imposes daily
limits on overdraft charges, requires institutions to review and modify check-clearing procedures, prominently distinguish account balances
from available overdraft coverage amounts and requires increased board and management oversight regarding overdraft payment programs.
Consumer Protection Laws. PBI Bank is subject to consumer laws and regulations that are designed to protect consumers in transactions with
banks. While the list set forth herein is not exhaustive, these laws and regulations include the Truth in Lending Act, the Truth in Savings Act,
the Electronic Funds Transfer Act, the Expedited Funds Availability Act, the Equal Credit Opportunity Act, the Fair Housing Act, the Real
Estate Settlement and Procedures Act, the Fair Credit Reporting Act, and the Federal Trade Commission Act, among others. References to or
summaries of these laws is subject to the full text and implementation of such laws. These laws and regulations mandate certain disclosure
requirements and regulate the manner in which financial institutions must deal with customers when taking deposits or making loans to such
customers.
9
Privacy. Federal law currently contains extensive customer privacy protection provisions. Under these provisions, a financial institution must
provide to its customers, at the inception of the customer relationship and annually thereafter, the institution’s policies and procedures
regarding the handling of customers’ nonpublic personal financial information. These provisions also provide that, except for certain limited
exceptions, an institution may not provide such personal information to unaffiliated third parties unless the institution discloses to the customer
that such information may be so provided and the customer is given the opportunity to opt out of such disclosure. Federal law makes it a
criminal offense, except in limited circumstances, to obtain or attempt to obtain customer information of a financial nature by fraudulent or
deceptive means.
Community Reinvestment Act. The Community Reinvestment Act (“CRA”) requires the FDIC to assess our record in meeting the credit needs
of the communities we serve, including low- and moderate-income neighborhoods and persons. The FDIC’s assessment of our record is made
available to the public. The assessment also is part of the Federal Reserve Board’s consideration of applications to acquire, merge or
consolidate with another banking institution or its holding company, to establish a new banking office or to relocate an office.
Bank Secrecy Act. The Bank Secrecy Act of 1970 (“BSA”) was enacted to deter money laundering, establish regulatory reporting standards for
currency transactions and improve detection and investigation of criminal, tax and other regulatory violations. BSA and subsequent laws and
regulations require us to take steps to prevent the use of PBI Bank in the flow of illegal or illicit money, including, without limitation, ensuring
effective management oversight, establishing sound policies and procedures, developing effective monitoring and reporting capabilities,
ensuring adequate training and establishing a comprehensive internal audit of BSA compliance activities. In recent years, federal regulators
have increased the attention paid to compliance with the provisions of BSA and related laws, with particular attention paid to “Know Your
Customer” practices. Banks have been encouraged by regulators to enhance their identification procedures prior to accepting new customers in
order to deter criminal elements from using the banking system to move and hide illegal and illicit activities.
USA Patriot Act. The USA Patriot Act of 2001 (the “Patriot Act”) contains anti-money laundering measures affecting insured depository
institutions, broker-dealers and certain other financial institutions. The Patriot Act requires financial institutions to implement policies and
procedures to combat money laundering and the financing of terrorism, including standards for verifying customer identification at account
opening, and rules to promote cooperation among financial institutions, regulators and law enforcement entities in identifying parties that may
be involved in terrorism or money laundering, and grants the Secretary of the Treasury broad authority to establish regulations and to impose
requirements and restrictions on financial institutions’ operations. In addition, the Patriot Act requires the federal bank regulatory agencies to
consider the effectiveness of a financial institution’s anti-money laundering activities when reviewing bank mergers and bank holding company
acquisitions.
Temporary Liquidity Guarantee Program. Under the FDIC’s Temporary Liquidity Guarantee Program (TLGP), the FDIC guaranteed U.S.
depository institutions’ transaction accounts and certain qualifying senior unsecured debt. We participated in the TLGP’s Transaction Account
Guarantee Program (TAGP), which provided that all non-interest bearing transaction accounts maintained at PBI Bank were insured in full by
the FDIC, regardless of the standard maximum deposit insurance amounts. Although the guarantee of non-interest bearing transaction account
deposits under the TLGP ended on June 30, 2010, the Dodd-Frank Act provided for unlimited FDIC deposit insurance coverage on non-interest
bearing transaction accounts at all insured institutions, regardless of participation in the TLGP, until January 1, 2013.
Effect on Economic Environment. The policies of regulatory authorities, including the monetary policy of the Federal Reserve Board, have
a significant effect on the operating results of bank holding companies and their subsidiaries. Among the means available to the Federal
Reserve Board to affect the money supply are open market operations in U.S. government securities, changes in the discount rate on member
bank borrowings and changes in reserve requirements against member bank deposits. These means are used in varying combinations to
influence overall growth and distribution of bank loans, investments and deposits, and their use may affect interest rates charged on loans or
paid for deposits.
Federal Reserve Board monetary policies have materially affected the operating results of commercial banks in the past and are expected to
continue to do so in the future. The nature of future monetary policies and the effect of such policies on our business and earnings and those of
our subsidiaries cannot be predicted.
Recently Enacted and Future Legislation. Various laws, regulations and governmental programs affecting financial institutions and the
financial industry are from time to time introduced in Congress or otherwise promulgated by regulatory agencies. Such measures may change
the operating environment of Porter Bancorp and its subsidiaries in substantial and unpredictable ways. The nature and extent of future
legislative, regulatory or other changes affecting financial institutions is very unpredictable at this time.
10
We cannot predict what other legislation or economic policies of the various regulatory authorities might be enacted or adopted or what other
regulations might be adopted or the effects thereof. Future legislation and policies and the effects thereof might have a significant influence on
overall growth and distribution of loans, investments and deposits and affect interest rates charged on loans or paid on time and savings
deposits. Such legislation and policies have had a significant effect on the operating results of commercial banks in the past and are expected to
continue to do so in the future.
Available Information
We file reports with the SEC including our annual report on Form 10-K, quarterly reports on Form 10-Q, current event reports on Form 8-K
and proxy statements, as well as any amendments to those reports. The public may read and copy any materials we file with the SEC at the
SEC’s Public Reference Room at 100 F Street, NE, Washington, DC 20549. The public may obtain information on the operation of the Public
Reference Room by calling the SEC at 1-800-SEC-0330. The SEC maintains an internet site that contains reports, proxy and information
statements and other information regarding issuers that file electronically with the SEC at http://www.sec.gov . Our annual report on Form 10-
K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports filed or furnished pursuant to section 13(a)
or 15(d) of the Exchange Act are accessible at no cost on our web site at http://www.pbibank.com , under the Investors Relations section, once
they are electronically filed with or furnished to the SEC. A shareholder may also request a copy of our Annual Report on Form 10-K free of
charge upon written request to: Chief Financial Officer, Porter Bancorp, Inc., 2500 Eastpoint Parkway, Louisville, Kentucky 40223.
Item 1A. Risk Factors
An investment in our common stock involves a number of risks. Realization of any of the risks described below could have a material adverse
effect on our business, financial condition, results of operations, cash flow and/or future prospects.
We are subject to a Consent Order with the FDIC and the KDFI and a formal agreement with the Federal Reserve that restrict the
conduct of our operations and may have a material adverse effect on our business.
Our good standing with bank regulatory agencies is of fundamental importance to the continuation of our businesses. In June 2011, PBI Bank
agreed to a Consent Order with the FDIC and KDFI in which the Bank agreed, among other things, to improve asset quality, reduce loan
concentrations, and maintain a minimum Tier 1 leverage ratio of 9% and a minimum total risk based capital ratio of 12%. The Consent Order
was included in our Current Report on 8-K filed on June 30, 2011.
On September 21, 2011, we entered into a Written Agreement with the Federal Reserve Bank of St. Louis. Pursuant to the Agreement, we
made formal commitments to, among other things, use our financial and management resources to serve as a source of strength for the Bank
and to assist the Bank in addressing weaknesses identified by the FDIC and the KDFI, to pay no dividends without prior written approval, to
pay no interest or principal on subordinated debentures or trust preferred securities without prior written approval, and to submit an acceptable
plan to maintain sufficient capital.
In October 2012, the Bank entered into a new Consent Order with the FDIC and KDFI again agreeing to maintain a minimum Tier 1 leverage
ratio of 9% and a minimum total risk based capital ratio of 12%. The Bank also agreed that if it should be unable to reach the required capital
levels, and if directed in writing by the FDIC, then the Bank would within 30 days develop, adopt and implement a written plan to sell or merge
itself into another federally insured financial institution or otherwise immediately obtain a sufficient capital investment into the Bank to fully
meet the capital requirements. The new Consent Order also requires the Bank to continue to adhere to the plans implemented in response to the
June 2011 Consent Order, and includes the substantive provisions of the June 2011 Consent Order. We did not meet the capital ratios required
by the Consent Order as of December 31, 2012.
Bank regulatory agencies can exercise discretion when an institution does not meet minimum regulatory capital levels and the other terms of a
consent order. The agencies may initiate changes in management, issue mandatory directives, impose monetary penalties or refrain from
formal sanctions, depending on individual circumstances. Any action taken by bank regulatory agencies could damage our reputation and have
a material adverse effect on our business. Compliance with the Consent Order also increases our operating expense, and adversely affects our
financial performance.
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We have made commitments to the banking regulators to raise additional capital. Our inability to increase our capital to the levels
required by our bank regulatory agreements could have a material adverse effect on our business.
We recorded a net loss to common shareholders of $33.4 million in 2012. The net loss for 2012 was due in part to provision for loan losses of
$40.3 million, and $10.5 million of expense related to other real estate owned.
Our losses, driven by asset impairments, nonperforming loan costs, and other real estate owned expenses, have reduced our capital below the
levels agreed upon with our banking regulators. While we believe we have recognized the probable losses in our portfolio, the continuing
weakness in the real estate market makes it difficult to determine the degree to which additional performing loans will deteriorate to weakened
credit status. Further credit deterioration could result in additional losses and a reduction in capital levels.
In its consent order with the FDIC and the KDFI, PBI Bank has agreed to maintain a ratio of total capital to total risk-weighted assets of at least
12.0% and a ratio of Tier 1 capital to total assets of 9%. As of December 31, 2012, PBI Bank’s ratio of total capital to total risk-weighted assets
was 9.8% and its ratio of Tier 1 capital to total assets was 5.4%, both below the ratios required by the consent order.
We have agreed with and submitted to the FDIC, the KDFI and the Federal Reserve Bank of St. Louis a plan to restore our capital ratios to
levels that comply with our regulatory agreements. We are evaluating various specific initiatives to increase our regulatory capital and reduce
our total assets. Strategic alternatives include divesting of branch offices, selling loans and raising capital by selling stock.
Our ability to raise additional capital will depend on, among other things, conditions in the capital markets at that time, which are outside of our
control, and our financial performance, including the management of our revenue, expenses, levels of average assets, credit quality, and levels
of other real estate owned. We may not have access to capital on acceptable terms or at all. Our inability to raise additional capital on
acceptable terms when needed could have a material adverse effect on our businesses, financial condition and results of operations. In addition,
if we are unable to comply with our regulatory capital requirements, it could result in more stringent enforcement actions by the bank
regulatory agencies, which could damage our reputation and have a material adverse effect on our business.
Our ability to pay cash dividends on our common and preferred stock and pay interest on the junior subordinated debentures that
relate to our trust preferred securities is currently restricted. Our inability to resume paying dividends and distributions on these
securities may adversely affect our common shareholders.
We historically paid quarterly cash dividends on our common stock until we suspended dividend payments in October 2011. Effective with the
fourth quarter of 2011, we began deferring cash dividends on the Series A Preferred Stock held by the U.S. Treasury and interest payments on
the junior subordinated notes relating to our trust preferred securities. Deferring interest payments on the junior subordinated notes resulted in
a deferral of distributions on our trust preferred securities. We will be prohibited from paying cash dividends on our common stock until such
time as we have paid all deferred dividends on our Series A Preferred Stock and all deferred distributions on our trust preferred securities.
If we defer interest payments on our trust preferred securities for 20 consecutive quarters, we must pay all deferred interest and resume
quarterly interest payments or we will be in default. If we miss six quarterly dividend payments on the Series A preferred stock, whether or
not consecutive, the U.S. Treasury will have the right to appoint two directors to our board of directors until all accrued but unpaid dividends
have been paid. Dividends on the Series A preferred stock and deferred distributions on our trust preferred securities are cumulative and
therefore unpaid dividends and distributions will accrue and compound on each subsequent payment date. If we become subject to any
liquidation, dissolution or winding up of affairs, holders of the trust preferred securities and then holders of the preferred stock will be entitled
to receive the liquidation amounts to which they are entitled including the amount of any accrued and unpaid distributions and dividends,
before any distribution to the holders of common stock.
Our business has been and may continue to be adversely affected by current conditions in the financial markets and by economic
conditions generally.
Although the economic slowdown that the United States has experienced since 2008 has begun to reverse and the markets have generally
improved, businesses across a wide range of industries continue to face serious difficulties due to the lack of consumer spending and the lack of
liquidity in the global credit markets. Ongoing weakness in business and economic conditions generally or specifically in our markets has had,
and could continue to have one or more of the following adverse effects on our business:
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● A decrease in the demand for loans and other products and services offered by us;
● A decrease in the value of collateral securing our loans;
● An impairment of certain intangible assets, such as core deposit intangibles; and
● An increase in the number of customers who become delinquent, file for protection under bankruptcy laws or default on their
loans.
The general business environment has had an adverse effect on our business during the past four years. Although the general business
environment has shown some improvement, there can be no assurance that such improvement can be sustained. In addition, the improvement
of certain economic indicators, such as real estate asset values and rents and unemployment, may vary between geographic markets and may
continue to lag behind improvement in the overall economy. These economic indicators typically affect the real estate and financial services
industries, in which we have a significant number of customers, more significantly than other economic sectors. Furthermore, we have a
substantial lending business that depends upon the ability of borrowers to make debt service payments on loans. Should unemployment or real
estate asset values fail to recover for an extended period of time, or if economic conditions worsen or remain volatile, our business, financial
condition or results of operations could be adversely affected.
A large percentage of our loans are collateralized by real estate, and prolonged weakness in the real estate market may result in losses
and adversely affect our profitability.
Approximately 89.3% of our loan portfolio as of December 31, 2012, was comprised of commercial and residential loans collateralized by real
estate. Adverse economic conditions since 2008 have decreased demand for real estate which has depressed real estate values in our markets.
Persistent weakness in the real estate market could continue to significantly impair the value of our collateral and our ability to sell the
collateral upon foreclosure. The real estate collateral in each case provides an alternate source of repayment in the event of default by the
borrower and may deteriorate in value during the time the credit is extended. If real estate values decline further, it will become more likely that
we would be required to increase our allowance for loan losses. If during a period of reduced real estate values, we are required to liquidate the
collateral securing a loan to satisfy the debt or to increase our allowance for loan losses, it could materially reduce our profitability and
adversely affect our financial condition.
We have a significant percentage of real estate construction and development loans, which carry a higher degree of risk. Persistent
weakness in the residential construction and commercial development real estate markets has increased the non-performing assets in
our loan portfolio and our provision expense for losses on loans. These impacts have had, and could continue to have a material
adverse effect on our capital, financial condition and results of operations.
Approximately 7.8% of our loan portfolio as of December 31, 2012, consisted of real estate construction and development loans. These loans
generally carry a higher degree of risk than long-term financing of existing properties because repayment depends on the ultimate completion
of the project and usually on the sale of the property. If we are forced to foreclose on a project prior to its completion, we may not be able to
recover the entire unpaid portion of the loan or we may be required to fund additional money to complete the project or hold the property for an
indeterminate period of time. Any of these outcomes may result in losses and adversely affect our profitability.
Residential construction and commercial development real estate activity in our markets continues to be affected by challenging economic
conditions. Prolonged weakness in these sectors may lead to additional valuation adjustments on our loan portfolios and real estate owned as
we continue to reassess the fair value of our non-performing assets, the loss severity of loans in default and the fair value of real estate owned.
We also may realize additional losses in connection with our disposition of non-performing assets. A weak real estate market could further
reduce demand for residential housing, which, in turn, could adversely affect real estate development and construction activities. Consequently,
the longer the current economic conditions persist, the more likely they are to adversely affect the ability of residential real estate developer
borrowers to repay these loans and the value of property used as collateral for such loans. These economic conditions and market factors have
negatively affected some of our larger loans, causing our total net-charge offs to increase and requiring us to significantly increase our
allowance for loan losses. If adverse economic conditions persist, these trends could continue to worsen. Any further increase in our non-
performing assets and related increases in our provision expense for losses on loans could negatively affect our business and could have a
material adverse effect on our capital, financial condition and results of operations.
Our decisions regarding credit risk may not be accurate, and our allowance for loan losses may not be sufficient to cover actual losses,
which could adversely affect our business, financial condition and results of operations.
We maintain an allowance for loan losses at a level we believe is adequate to absorb probable incurred losses in our loan portfolio based on
historical loan loss experience, specific problem loans, value of underlying collateral and other relevant factors. If our assessment of these
factors is ultimately inaccurate, the allowance may not be sufficient to cover actual future loan losses, which would adversely affect our
operating results. Our estimates are subjective, and their accuracy depends on the outcome of future events. Changes in economic, operating
and other conditions that are generally beyond our control could cause actual loan losses to increase significantly. In addition, bank regulatory
agencies, as an integral part of their supervisory functions, periodically review the adequacy of our allowance for loan losses. Regulatory
agencies have from time to time required us to increase our provision for loan losses or to recognize additional loan charge-offs when their
judgment has differed from ours. Any of these events could have a material negative impact on our operating results.
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Our levels of additional classified loans and non-performing assets may increase in the foreseeable future if economic conditions remain weak
and cause more borrowers to default. Further, the value of the collateral underlying a given loan, and the realizable value of such collateral in a
foreclosure sale, are likely to decline if the real estate markets remain weak, making us less likely to realize a full recovery if a borrower
defaults on a loan. Any additional increases in the level of our non-performing assets, loan charge-offs or provision for loan losses, or our
inability to realize the full value of underlying collateral in the event of a loan default, could negatively affect our business, financial condition,
and results of operations and the trading price of our securities.
We have had difficulty maintaining effective internal controls over loan grading.
As of December 31, 2011, management determined that our controls regarding the determination of loan grades were not operating effectively.
Specifically, our internal control process surrounding loan grades, which consists of a combination of internal and external loan review
activities, identified and corrected the grades for the majority of loans that were not initially graded correctly. However, we determined that
such loan review did not sufficiently cover all loans subject to potential grading error during 2011. We expanded the scope of our controls to
cover the remainder of the portfolio and adjusted our allowance for loan losses as of December 31, 2011 to take the additional findings into
consideration. Although the Company has determined as of December 31, 2012 that this weakness has been remediated, it is possible that we
could have additional internal control weakness in this area in future periods.
If we experience greater credit losses than anticipated, our operating results may be adversely affected.
As a lender, we are exposed to the risk that our customers will be unable to repay their loans according to their terms and that any collateral
securing the payment of their loans may not be sufficient to assure repayment. Credit losses are inherent in the business of making loans and
could have a material adverse effect on our operating results. Our credit risk with respect to our real estate and construction loan portfolio will
relate principally to the creditworthiness of borrowers and the value of the real estate serving as security for the repayment of loans. Our credit
risk with respect to our commercial and consumer loan portfolio will relate principally to the general creditworthiness of businesses and
individuals within our local markets.
We make various assumptions and judgments about the collectability of our loan portfolio and provide an allowance for estimated credit losses
based on a number of factors. We believe that our allowance for credit losses is adequate. However, if our assumptions or judgments are
wrong, our allowance for credit losses may not be sufficient to cover our actual credit losses. We may have to increase our allowance in the
future in response to the request of one of our primary banking regulators, to adjust for changing conditions and assumptions, or as a result of
any deterioration in the quality of our loan portfolio. The actual amount of future provisions for credit losses cannot be determined at this time
and may vary from the amounts of past provisions.
We continue to hold and acquire a significant amount of OREO properties, which could increase operating expenses and result in
future losses to the Company.
During recent years, we have acquired a significant amount of real estate as a result of foreclosure or by deed in lieu of foreclosure that is listed
on our balance sheet as other real estate owned (OREO). This increase in our OREO portfolio has increased the expenses we have incurred to
manage and dispose of these properties, which sometimes includes funding construction required to facilitate sale. We expect that our operating
results in 2013 will continue to be adversely affected by expenses associated with OREO, including insurance and taxes, completion and repair
costs, as well as by the funding costs associated with assets that are tied up in OREO.
Properties in our OREO portfolio are recorded at the lower of the recorded investment in the loans for which the properties previously served
as collateral or “fair value,” which represents the estimated sales price of the properties on the date acquired less estimated selling costs.
Generally, in determining “fair value” an orderly disposition of the property is assumed, except where a different disposition strategy is
expected. Significant judgment is required in estimating the fair value of OREO, and the period of time within which such estimates can be
considered current may change during periods of market volatility, such as we have experienced since 2008.
Any further decreases in market prices of real estate in our market areas may lead to additional OREO write downs, with a corresponding
expense in our income statement. We evaluate OREO property values periodically and write down the carrying value of the properties if and
when the results of our evaluations require it.
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In response to market conditions and other economic factors, we may utilize alternative sale strategies other than orderly disposition as part of
our OREO disposition strategy, such as bulk sales. In this event, as a result of the significant judgments required in estimating fair value and
the variables involved in different methods of disposition, the net proceeds realized from such sales transactions could differ significantly from
appraisals, comparable sales, and other estimates used to determine the fair value of our OREO properties. In addition, our disposition of
OREO through alternative sales strategies could impact the fair value of comparable OREO properties remaining in our portfolio.
Our profitability depends significantly on local economic conditions.
Because most of our business activities are conducted in central Kentucky and most of our credit exposure is in that region, we are at risk from
adverse economic or business developments affecting this area, including declining regional and local business and employment activity, a
downturn in real estate values and agricultural activities and natural disasters. To the extent the central Kentucky economy remains weak, the
rates of delinquencies, foreclosures, bankruptcies and losses in our loan portfolio will likely increase. Moreover, the value of real estate or other
collateral that secures our loans could be adversely affected by the economic downturn or a localized natural disaster. The economic downturn
has had a negative impact on our financial results and may continue to have a negative impact on our business, financial condition, results of
operations and future prospects.
Our small to medium-sized business portfolio may have fewer resources to weather the downturn in the economy.
Our portfolio includes loans to small and medium-sized businesses and other commercial enterprises. Small and medium-sized businesses
frequently have smaller market shares than their competitors, may be more vulnerable to economic downturns, often need substantial additional
capital to expand or compete and may experience substantial variations in operating results, any of which may impair a borrower’s ability to
repay a loan. In addition, the success of a small or medium-sized business often depends on the management talents and efforts of one or two
persons or a small group of persons, and the death, disability or resignation of one or more of these persons could have a material adverse
impact on the business and its ability to repay our loan. A continued economic downturn could have a more pronounced negative impact on our
target market, which could cause us to incur substantial credit losses that could materially harm our operating results.
Our profitability is vulnerable to fluctuations in interest rates.
Changes in interest rates could harm our financial condition or results of operations. Our results of operations depend substantially on net
interest income, the difference between interest earned on interest-earning assets (such as investments and loans) and interest paid on interest-
bearing liabilities (such as deposits and borrowings). Interest rates are highly sensitive to many factors, including governmental monetary
policies and domestic and international economic and political conditions. Factors beyond our control, such as inflation, recession,
unemployment and money supply may also affect interest rates. If our interest-earning assets mature or reprice more quickly than our interest-
bearing liabilities in a given period as a result of decreasing interest rates, our net interest income may decrease. Likewise, our net interest
income may decrease if interest-bearing liabilities mature or reprice more quickly than interest-earning assets in a given period as a result of
increasing interest rates.
Fixed-rate loans increase our exposure to interest rate risk in a rising rate environment because interest-bearing liabilities would be subject to
repricing before assets become subject to repricing. Adjustable-rate loans decrease the risk associated with changes in interest rates but involve
other risks, such as the inability of borrowers to make higher payments in an increasing interest rate environment. At the same time, for secured
loans, the marketability of the underlying collateral may be adversely affected by higher interest rates. In a declining interest rate environment,
there may be an increase in prepayments on loans as the borrowers refinance their loans at lower interest rates, which could reduce net interest
income and harm our results of operations.
If we cannot obtain adequate funding, we may not be able to meet the cash flow requirements of our depositors and borrowers, or meet
the operating cash needs of the Company to fund corporate expansion or other activities.
Our liquidity policies and limits are established by the Board of Directors of PBI Bank, with operating limits set by the Asset Liability
Committee (“ALCO”), based upon analyses of the ratio of loans to deposits and the percentage of assets funded with non-core or wholesale
funding. The ALCO regularly monitors the overall liquidity position of PBI Bank and the Company to ensure that various alternative strategies
exist to cover unanticipated events that could affect liquidity. Liquidity is the ability to meet cash flow needs on a timely basis at a reasonable
cost. If our liquidity policies and strategies don’t work as well as intended, then we may be unable to make loans and to repay deposit liabilities
as they become due or are demanded by customers. The ALCO follows established board approved policies and monitors guidelines to
diversify our wholesale funding sources to avoid concentrations in any one-market source. Wholesale funding sources include Federal funds
purchased, securities sold under repurchase agreements, non-core brokered deposits, and Federal Home Loan Bank (“FHLB”) advances that are
collateralized with mortgage-related assets.
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We maintain a portfolio of securities that can be used as a secondary source of liquidity. There are other available sources of liquidity,
including additional collateralized borrowings such as FHLB advances, the issuance of debt securities, and the issuance of preferred or
common securities in public or private transactions. If we were unable to access any of these funding sources when needed, we might not be
able to meet the needs of our customers, which could adversely impact our financial condition, our results of operations, cash flows and our
level of regulatory-qualifying capital.
We may need to raise additional capital in the future by selling capital stock. Future sales or other dilution of our equity may adversely
affect the market price of our common stock.
We are not restricted from issuing additional common stock, including securities that are convertible into or exchangeable for, or that represent
the right to receive, common stock. The issuance of additional shares of common stock or the issuance of convertible securities would dilute
the ownership interest of our existing common shareholders. The market price of our common stock could decline as a result of such an
offering as well as other sales of a large block of shares of our common stock or similar securities in the market after such an offering, or the
perception that such sales could occur.
Our stock has traded from time-to-time at a price below our book value per share. Accordingly, a sale of common shares at or below our stock
price would be dilutive to current shareholders.
As a bank holding company, we depend on dividends and distributions paid by our banking subsidiary.
Porter Bancorp is a legal entity separate and distinct from PBI Banks and our other subsidiaries. Our principal source of cash flow, from which
we would fund any dividends paid to our shareholders, has historically been dividends Porter Bancorp receives from PBI Bank. Regulations of
the FDIC and the KDFI govern the ability of PBI Bank to pay dividends and other distributions to us, and regulations of the Federal Reserve
govern our ability to pay dividends or make other distributions to our shareholders. In its consent order with the FDIC and the KDFI, PBI Bank
agreed not to pay dividends to us without the prior consent of those regulators. During 2011, Porter Bancorp contributed $13.1 million to PBI
Bank. The contribution, which was made to strengthen PBI Bank’s capital in an effort to help it comply with its capital ratio requirements
under the consent order, also substantially decreased the liquid assets of Porter Bancorp. Liquid assets decreased from $20.3 million at
December 31, 2010, to $4.9 million at December 31, 2011, and to $3.5 million at December 31, 2012. Since PBI Bank is unlikely to be in a
position to pay dividends to Porter Bancorp for the foreseeable future, cash inflows for Porter Bancorp are limited to earnings on investment
securities, sales of investment securities, and interest on its deposits held at PBI Bank. These cash inflows, along with the liquid assets held at
December 31, 2012, are needed to cover ongoing operating expenses of Porter Bancorp, which have been reduced and are budgeted at $1.1
million for 2013. Parent company liquidity could be improved by raising capital. See the “Supervision-Porter Bancorp-Dividends” section of
Item 1. “Business” and the “Dividends” section of Item 5. “Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer
Purchases of Equity Securities” of this Annual Report on Form 10-K.
We may not pay dividends on your common stock and we have agreed with the Federal Reserve to obtain its written consent before
declaring or paying any future dividends.
Holders of shares of our common stock are only entitled to receive such dividends as our board of directors may declare from funds legally
available for such payments. Although we have historically declared cash dividends on our common stock, we currently do not pay a cash
dividend and we are not required to do so. Also, because we have issued preferred stock to the U.S. Treasury under its Capital Purchase
Program (“CPP”), our ability to increase our dividend or to repurchase our common stock is limited for so long as any securities issued under
such program remain outstanding, as discussed in greater detail in the “Dividends” section of Item 5. “Market for Registrant’s Common Equity,
Related Stockholder Matters and Issuer Purchases of Equity Securities” of this Annual Report on Form 10-K. There can be no assurance that
we will pay dividends to our shareholders in the future, or if dividends are paid, that we will increase our dividend to historical levels or
otherwise. Our ability to pay dividends to our shareholders is not only subject to limitations imposed by the terms of the CPP, but also by
limitations and guidance issued by the Federal Reserve. For example, under Federal Reserve guidance, bank holding companies generally are
advised to consult in advance with the Federal Reserve before declaring dividends, and to strongly consider reducing, deferring or eliminating
dividends, in certain situations, such as when declaring or paying a dividend that would exceed earnings for the fiscal quarter for which the
dividend is being paid, or when declaring or paying a dividend that could result in a material adverse change to the organization’s capital
structure. In addition, Porter Bancorp has agreed with the Federal Reserve to obtain its written consent prior to declaring or paying any future
dividends. As a practical matter, Porter Bancorp cannot pay dividends for the foreseeable future.
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We may not be able to realize the value of our tax losses and deductions.
Due to our losses, we have a net operating loss carry-forward of $15.0 million, credit loss carry-forwards of $692,000, and other net deferred
tax assets of $28.2 million. In order to realize the benefit of these tax losses, credits and deductions, we will need to generate substantial taxable
income in future periods. We established a 100% valuation allowance for all deferred tax assets in 2011. Should the Company issue new shares
to raise additional capital, a change in control could be triggered, as defined by Section 382 of the Internal Revenue Code, which could
negatively impact or limit the ability to utilize our net operating loss carry-forwards, credit loss carry-forwards, and other net deferred tax
assets.
Our issuance of securities to the U.S. Department of the Treasury may limit our ability to return capital to our shareholders and is
dilutive to our common shares. In addition, the dividend rate increases substantially after five years if we do not redeem the shares by
that time.
On November 21, 2008, we sold $35 million of senior preferred stock to the U.S. Treasury as part of the Capital Purchase Program established
under the Emergency Economic Stabilization Act of 2008. Unless we are able to redeem the preferred stock by November 21, 2013, the
dividends on this capital will increase substantially at that point, from 5% (approximately $1.75 million annually) to 9% (approximately $3.15
million annually). Depending on market conditions and our financial performance at the time, this increase in dividends could significantly
impact our capital, liquidity and earnings available to common shareholders.
The terms of the transaction with the U.S. Treasury limit our ability to pay dividends and repurchase our shares. We will not be able to pay any
dividends on our common stock unless and until we are current on our dividend payments on the preferred shares. Effective with the fourth
quarter of 2011, we began deferring the payment of regular quarterly cash dividends on this preferred stock. These restrictions may have an
adverse effect on the market price of our common stock.
The U.S. Treasury has the unilateral ability to change some of the restrictions imposed on us by virtue of our sale of securities to it.
In addition to the restrictions our ability to pay dividends or repurchase our stock, our preferred stock purchase agreement with the U.S.
Treasury authorizes the U.S. Treasury to unilaterally amend the agreement to the extent required to comply with any future changes in federal
statutes. Following our November 21, 2008 issuance of senior preferred stock to the U.S. Treasury, the agreement was amended to impose
restrictions on the conduct of our business, including restrictions on the compensation we can pay to executive officers and corporate
governance requirements. These restrictions could have an adverse impact on the conduct of our business, as could any additional amendments
in the future that impose further requirements or amend existing requirements.
Our chairman and chairman emeritus together have sufficient voting power to elect or remove our directors, to determine the vote on
any matter that requires shareholder approval, and otherwise control our company. In exercising their voting power, they may act
according to their own interests, which may be adverse to your interests.
As of December 31, 2012, J. Chester Porter and Maria L. Bouvette together beneficially owned approximately 6,072,216 shares, or 50.6% of
our outstanding common stock. Mr. Porter has made arrangements that provide for Ms. Bouvette to retain voting control of his common stock
in the event of death or incapacity. Ms. Bouvette has made similar arrangements that provide for a committee including Mr. Porter and two of
her siblings to retain voting control of her common stock in the event of death or incapacity. Accordingly, Mr. Porter and Ms. Bouvette
currently have the power to exercise control over our business and affairs and to determine the outcome of any matter submitted to a vote of
our shareholders, including the election and removal of a majority of our board of directors, any amendment of our articles of incorporation
(including any amendment that changes the rights of our common stock) and any merger, consolidation or sale of all or substantially all of our
assets. Mr. Porter and Ms. Bouvette could take actions or make decisions in their self-interest that are opposed to your best interests. They
could remove directors who take actions or make decisions they oppose but are favored by our other shareholders. They may be less receptive
to the desires communicated by shareholders. Neither our articles of incorporation, our bylaws, nor Kentucky law requires the vote of more
than a simple majority of our outstanding shares of common stock to approve a matter submitted for shareholder approval, subject to the
general statutory requirement that any transaction in which one or more directors have a direct or indirect interest (other than as a shareholder)
must be “fair” to the corporation. Mr. Porter and Ms. Bouvette have a level of concentrated control that could discourage others from initiating
any potential merger, takeover or other change of control transaction that may otherwise give you the opportunity to realize a premium over the
then-prevailing market price of our common stock. As a result, the market price of our common stock could be adversely affected.
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We are a “controlled company” within the meaning of the NASDAQ corporate governance rules because J. Chester Porter and Maria
L. Bouvette together own more than 50% of our sole class of voting stock. As a controlled company, our controlling shareholders have
greater power to make decisions in their own self-interest and against the interests of other shareholders, and investors and other
shareholders will have fewer procedural and substantive protections against the exercise of this power.
A “controlled company” may elect not to comply with the following NASDAQ corporate governance rules, which require that:
● a majority of its board of directors consists of “independent directors,” which the NASDAQ rules define as persons who are not
either officers or employees of the company and have no relationships that, in the opinion of the board of directors, would interfere
with the exercise of independent judgment in carrying out their responsibilities as directors;
● decisions regarding the compensation paid to executive officers are made either by a compensation committee composed entirely of
independent directors or by a majority of the independent directors; and
● nominations for election to the board of directors are made either by a nominating committee composed entirely of independent
directors with a written charter addressing the committee’s purpose and responsibilities or by a majority of the independent directors.
Although a majority of our directors are independent directors, Mr. Porter and Ms. Bouvette, together have the voting power to remove
directors who oppose actions or decisions they favor. Mr. Porter and Ms. Bouvette also have the power to elect a majority of directors who are
not independent directors. Our board may elect to dispense with the nominating and governance committee at any time without shareholder
consent. Accordingly, our shareholders have fewer procedural and substantive protections than shareholders of companies subject to all of the
NASDAQ corporate governance requirements.
Higher FDIC deposit insurance premiums and assessments could significantly increase our non-interest expense.
Our deposits are insured by the FDIC up to legal limits and, accordingly, we are subject to FDIC deposit insurance assessments. High levels of
bank failures over the past three years and increases in the statutory deposit insurance limits have increased resolution costs to the FDIC and
put pressure on the DIF. In order to maintain a strong funding position and restore the reserve ratios of the DIF, the FDIC increased assessment
rates on insured institutions, charged a special assessment to all insured institutions as of June 30, 2009 and required banks to prepay three
years’ worth of premiums on December 30, 2009. If there are additional financial institution failures, we may be required to pay even higher
FDIC premiums than the recently increased levels, or the FDIC may charge additional special assessments. Further, the FDIC recently
increased the DIF’s target reserve ratio to 2.0 percent of insured deposits following the Dodd-Frank Act’s elimination of the 1.5 percent cap on
the DIF’s reserve ratio. Additional increases in our assessment rate may be required in the future to achieve this targeted reserve ratio. These
recent increases in deposit assessments and any future increases, required prepayments or special assessments of FDIC insurance premiums
may adversely affect our business, financial condition or results of operations.
Additionally, pursuant to the Dodd-Frank Act, the FDIC amended its regulations regarding assessment for federal deposit insurance to base
such assessments on the average total consolidated assets of the insured institution during the assessment period, less the average tangible
equity of the institution during the assessment period. Prior to this change, we were assessed only on deposit balances. The FDIC adopted a rule
implementing this change, as well as adopting a revised risk-based assessment calculation in February 2011. The FDIC has also proposed a rule
tying assessment rates of FDIC-insured institutions to the institution’s employee compensation programs. The exact nature and cumulative
effect of these recent changes are not yet known, but they are expected to increase the amount of premiums we must pay for FDIC insurance.
Any such increase may adversely affect our business, financial condition or results of operations.
We face strong competition from other financial institutions and financial service companies, which could adversely affect our results
of operations and financial condition.
We compete with other financial institutions in attracting deposits and making loans. Our competition in attracting deposits comes principally
from other commercial banks, credit unions, savings and loan associations, securities brokerage firms, insurance companies, money market
funds and other mutual funds. Our competition in making loans comes principally from other commercial banks, credit unions, savings and
loan associations, mortgage banking firms and consumer finance companies. In addition, competition for business in the Louisville
metropolitan area has grown in recent years as changes in banking law have allowed several banks to enter the market by establishing new
branches. Likewise, competition is increasing in the other growing markets we have targeted, which may adversely affect our ability to execute
our plans for expansion. Moreover, our advantage from having operated a nationally recognized online banking division since 1999 may
diminish, as nearly all of our competitors now offer online banking and may become more successful in attracting online business over time as
they become more experienced.
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Competition in the banking industry may also limit our ability to attract and retain banking clients. We maintain smaller staffs of associates and
have fewer financial and other resources than larger institutions with which we compete. Financial institutions that have far greater resources
and greater efficiencies than we do may have several marketplace advantages resulting from their ability to:
● offer higher interest rates on deposits and lower interest rates on loans than we can;
● offer a broader range of services than we do;
● maintain more branch locations than we do; and
● mount extensive promotional and advertising campaigns.
In addition, banks and other financial institutions with larger capitalization and other financial intermediaries may not be subject to the same
regulatory restrictions as we are and may have larger lending limits than we do. Some of our current commercial banking clients may seek
alternative banking sources as they develop needs for credit facilities larger than we can accommodate. If we are unable to attract and retain
customers, we may not be able to maintain growth and our results of operations and financial condition may otherwise be negatively impacted.
We depend on our senior management team, and the unexpected loss of one or more of our senior executives could impair our
relationship with customers and adversely affect our business and financial results.
Our future success significantly depends on the continued services and performance of our key management personnel. Our future performance
will depend on our ability to motivate and retain these and other key officers. The Dodd-Frank Act, legislation governing participants in the
U.S. Treasury’s CPP program and the policies of bank regulatory agencies have placed restrictions on our executive compensation practices.
Such restrictions and standards may further impact our company’s ability to compete for talent with other businesses and financial institutions
that are not subject to the same limitations as we are. The loss of the services of members of our senior management or other key officers or
our inability to attract additional qualified personnel as needed could materially harm our business.
Our reported financial results depend on management’s selection of accounting methods and certain assumptions and estimates.
Our accounting policies and assumptions are fundamental to our reported financial condition and results of operations. Our management must
exercise judgment in selecting and applying many of these accounting policies and methods so they comply with generally accepted accounting
principles and reflect management’s judgment of the most appropriate manner to report our financial condition and results. In some cases,
management must select the accounting policy or method to apply from two or more alternatives, any of which may be reasonable under the
circumstances, yet may result in our reporting materially different results than would have been reported under a different alternative.
Certain accounting policies are critical to presenting our reported financial condition and results. They require management to make difficult,
subjective or complex judgments about matters that are uncertain. Materially different amounts could be reported under different conditions or
using different assumptions or estimates. These critical accounting policies include the allowance for credit losses, intangible assets, and
income taxes. Because of the uncertainty of estimates involved in these matters, we may be required to do one or more of the following:
significantly increase the allowance for credit losses and/or sustain credit losses that are significantly higher than the reserve provided;
recognize significant impairment on our other intangible assets or significantly increase our accrued income taxes.
While management continually monitors and improves our system of internal controls, data processing systems, and corporate wide
processes and procedures, we may suffer losses from operational risk in the future.
Management maintains internal operational controls, and we have invested in technology to help us process large volumes of transactions.
However, we may not be able to continue processing at the same or higher levels of transactions. If our systems of internal controls should fail
to work as expected, if our systems were to be used in an unauthorized manner, or if employees were to subvert the system of internal controls,
significant losses could occur.
We process large volumes of transactions on a daily basis and are exposed to numerous types of operational risk, which could cause us to incur
substantial losses. Operational risk resulting from inadequate or failed internal processes, people, and systems includes the risk of fraud by
employees or persons outside of our company, the execution of unauthorized transactions by employees, errors relating to transaction
processing and systems, and breaches of the internal control system and compliance requirements. This risk of loss also includes potential legal
actions that could arise as a result of the operational deficiency or as a result of noncompliance with applicable regulatory standards.
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We establish and maintain systems of internal operational controls that provide management with timely and accurate information about our
level of operational risk. While not foolproof, these systems have been designed to manage operational risk at appropriate, cost effective levels.
We have also established procedures that are designed to ensure that policies relating to conduct, ethics and business practices are followed.
Nevertheless, we experience loss from operational risk from time to time, including the effects of operational errors, and these losses may be
substantial.
Our information systems may experience an interruption or security breach.
Failure in or breach of our operational or security systems or infrastructure, or those of our third party vendors and other service providers,
including as a result of cyber attacks, could disrupt our businesses, result in the disclosure or misuse of confidential or proprietary information,
damage our reputation, increase our costs and cause losses. As a large financial institution, we depend on our ability to process, record and
monitor a large number of customer transactions on a continuous basis. As customer, public and regulatory expectations regarding operational
and information security have increased, our operational systems and infrastructure must continue to be safeguarded and monitored for
potential failures, disruptions and breakdowns. Our business, financial, accounting, data processing systems or other operating systems and
facilities may stop operating properly or become disabled or damaged as a result of a number of factors including events that are wholly or
partially beyond our control. For example, there could be sudden increases in customer transaction volume; electrical or telecommunications
outages; natural disasters such as earthquakes, tornadoes, and hurricanes; disease pandemics; events arising from local or larger scale political
or social matters, including terrorist acts; and, as described below, cyber attacks. Although we have business continuity plans and other
safeguards in place, our business operations may be adversely affected by significant and widespread disruption to our physical infrastructure
or operating systems that support our businesses and customers.
Information security risks for financial institutions have generally increased in recent years in part because of the proliferation of new
technologies, the use of the Internet and telecommunications technologies to conduct financial transactions, and the increased sophistication
and activities of organized crime, hackers, terrorists, activists, and other external parties. As noted above, our operations rely on the secure
processing, transmission and storage of confidential information in our computer systems and networks. In addition, to access our products and
services, our customers may use personal smartphones, tablet PC’s, and other mobile devices that are beyond our control systems. Although we
believe we have robust information security procedures and controls, our technologies, systems, networks, and our customers’ devices may
become the target of cyber attacks or information security breaches that could result in the unauthorized release, gathering, monitoring, misuse,
loss or destruction of our customers’ confidential, proprietary and other information or that of our customers, or otherwise disrupt the business
operations of ourselves, our customers or other third parties.
Third parties with which we do business or that facilitate our business activities, could also be sources of operational and information security
risk to us, including from breakdowns or failures of their own systems or capacity constraints. Although to date we have not experienced any
material losses relating to cyber attacks or other information security breaches, there can be no assurance that we will not suffer such losses in
the future. Our risk and exposure to these matters remains heightened because of, among other things, the evolving nature of these threats and
the prevalence of Internet and mobile banking. As cyber threats continue to evolve, we may be required to expend significant additional
resources to continue to modify or enhance our protective measures or to investigate and remediate any information security vulnerabilities.
Disruptions or failures in the physical infrastructure or operating systems that support our businesses and customers, or cyber attacks or
security breaches of the networks, systems or devices that our customers use to access our products and services could result in customer
attrition, regulatory fines, penalties or intervention, reputational damage, reimbursement or other compensation costs, and/or additional
compliance costs, any of which could materially adversely affect our business, results of operations or financial condition.
We operate in a highly regulated environment and, as a result, are subject to extensive regulation and supervision that could adversely
affect our financial performance and our ability to implement our growth and operating strategies.
We are subject to examination, supervision and comprehensive regulation by federal and state regulatory agencies, which is described under
“Item 1 – Business—Supervision and Regulation.” Regulatory oversight of banks is primarily intended to protect depositors, the federal deposit
insurance funds, and the banking system as a whole, not our shareholders. Compliance with these regulations is costly and may make it more
difficult to operate profitably.
20
Federal and state banking laws and regulations govern numerous matters including the payment of dividends, the acquisition of other banks and
the establishment of new banking offices. We must also meet specific regulatory capital requirements. Our failure to comply with these laws,
regulations and policies or to maintain our capital requirements could affect our ability to pay dividends on common stock, our ability to grow
through the development of new offices and our ability to make acquisitions. These limitations may prevent us from successfully implementing
our growth and operating strategies.
In addition, the laws and regulations applicable to banks could change at any time, which could significantly impact our business and
profitability. For example, new legislation or regulation could limit the manner in which we may conduct our business, including our ability to
attract deposits and make loans. Events that may not have a direct impact on us, such as the bankruptcy or insolvency of a prominent U.S.
corporation, can cause legislators and banking regulators and other agencies such as the Financial Accounting Standards Board, the SEC, the
Public Company Accounting Oversight Board and various taxing authorities to respond by adopting and or proposing substantive revisions to
laws, regulations, rules, standards, policies and interpretations. The nature, extent, and timing of the adoption of significant new laws and
regulations, or changes in or repeal of existing laws and regulations may have a material impact on our business and results of operations.
Changes in regulation may cause us to devote substantial additional financial resources and management time to compliance, which may
negatively affect our operating results.
Changes in banking laws could have a material adverse effect on us.
We are subject to changes in federal and state laws as well as changes in banking and credit regulations, and governmental economic and
monetary policies. We cannot predict whether any of these changes may adversely and materially affect us. The current regulatory environment
for financial institutions entails significant potential increases in compliance requirements and associated costs. Federal and state banking
regulators also possess broad powers to take supervisory actions as they deem appropriate. These supervisory actions may result in higher
capital requirements, higher insurance premiums and limitations on our activities that could have a material adverse effect on our business and
profitability.
Recent legislation regarding the financial services industry may have a significant adverse effect on our operations.
The Dodd-Frank Act was signed into law on July 21, 2010. The Dodd-Frank Act will implement significant changes to the U.S. financial
system, including among others:
● new requirements on banking, derivative and investment activities, including the repeal of the prohibition on the payment of interest
●
on business demand accounts, and debit card interchange fee requirements;
the creation of a new Consumer Financial Protection Bureau (“CFPB”) with supervisory authority, including the power to conduct
examinations and take enforcement actions with respect to financial institutions with assets of $10 billion or more and implement
regulations that will affect all financial institutions;
● provisions affecting corporate governance and executive compensation of all companies subject to the reporting requirements of the
Securities and Exchange Act of 1934, as amended; and
● a provision that would require bank regulators to set minimum capital levels for bank holding companies that are as strong as those
required for their insured depository subsidiaries, subject to a grandfather clause for holding companies with less than $15 billion in
assets as of December 31, 2009.
Many provisions in the Dodd-Frank Act remain subject to regulatory rule-making and implementation, the effects of which are not yet known.
As a result, it is difficult to gauge the ultimate impact of certain provisions of the Dodd-Frank Act because the implementation of many
concepts is left to regulatory agencies. For example, the CFPB is given the power to adopt new regulations to protect consumers and is given
control over existing consumer protection regulations adopted by federal banking regulators. The CFPB has begun the rule-making process but
it is not known at this time when any rules will be finalized and implemented.
The provisions of the Dodd-Frank Act and any rules adopted to implement those provisions as well as any additional legislative or regulatory
changes may impact the profitability of our business activities and costs of operations, require that we change certain of our business practices,
materially affect our business model or affect retention of key personnel, require us to raise additional regulatory capital, including additional
Tier 1 capital, and could expose us to additional costs (including increased compliance costs). These and other changes may also require us to
invest significant management attention and resources to make any necessary changes and may adversely affect our ability to conduct our
business as previously conducted or our results of operations or financial condition.
21
Item 1B. Unresolved Staff Comments
Not applicable.
Item 2.
Properties
PBI Bank has 18 full-service banking offices. The following table shows the location, square footage and ownership of each property. We
believe that each of these locations is adequately insured. Data processing and support operations are located in the Main office in Louisville
and the Glasgow office building on Columbia Avenue. Trust services and operations are located in the Campbell Lane office in Bowling
Green.
Markets
Louisville/Jefferson, Bullitt and Henry Counties
Main Office: 2500 Eastpoint Parkway, Louisville
Eminence Office: 645 Elm Street, Eminence
Hillview Office: 11998 Preston Highway, Hillview
Pleasureville Office: 5440 Castle Highway, Pleasureville
Shepherdsville Office: 340 South Buckman Street, Shepherdsville
Conestoga Office: 155 Conestoga Parkway, Shepherdsville
Lexington/Fayette County
Lexington Office: 2424 Harrodsburg Road, Suite 100, Lexington
South Central Kentucky
Brownsville Office: 113 East Main, Brownsville
Greensburg Office: 202-04 North Main Street, Greensburg
Horse Cave Office: 210 East Main Street, Horse Cave
Morgantown Office: 112 West Logan Street, Morgantown
Munfordville Office: 949 South Dixie Highway, Munfordville
Northside Office: 1300 North Main Street, Beaver Dam
Wal-Mart Office: 1701 North Main Street, Beaver Dam
Owensboro/Daviess County
Owensboro Office: 1819 Frederica Street, Owensboro
Southern Kentucky
Fairview Office: 1042 Fairview Avenue, Suite A, Bowling Green
Campbell Lane Office: 751 Campbell Lane, Bowling Green
Glasgow Office: 1006 West Main Street, Glasgow
Other Properties
Office Building: 701 Columbia Avenue, Glasgow
Item 3.
Legal Proceedings
Square Footage Owned/Leased
30,000
1,500
3,500
10,000
10,000
3,900
Owned
Owned
Owned
Owned
Owned
Owned
8,500
Leased
8,500
11,000
5,000
7,500
9,000
3,200
500
Owned
Owned
Owned
Owned
Owned
Owned
Leased
3,000
Owned
3,000
7,500
12,000
Leased
Owned
Owned
19,000
Owned
In the normal course of operations, we are defendants in various legal proceedings. We record contingent liabilities resulting from claims
against us when a loss is assessed to be probable and the amount of the loss is reasonably estimable. Assessing probability of loss and
estimating probable losses requires analysis of multiple factors, including in some cases judgments about the potential actions of third party
claimants and courts. Recorded contingent liabilities are based on the best information available and actual losses in any future period are
inherently uncertain. In the opinion of management, there is no known legal proceeding pending which an adverse decision would be expected
to result in a material adverse change in our business or consolidated financial position. See Footnote 24, “Contingencies” in the Notes to our
consolidated financial statements for additional detail regarding ongoing legal proceedings and other matters.
Item 4.
Mine Safety Disclosures
Not applicable.
22
PART II
Item 5.
Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Market Information
Our common stock is traded on the NASDAQ Global Market under the ticker symbol “PBIB”. The following table presents the high and low
sales prices for our common stock reported on the NASDAQ Global Market for the periods indicated. Market prices and dividends paid have
been restated to reflect stock dividends.
Quarter Ended
Fourth Quarter
Third Quarter
Second Quarter
First Quarter
Quarter Ended
Fourth Quarter
Third Quarter
Second Quarter
First Quarter
$
$
2012
Market Value
High
Low
Dividend
1.99 $
2.25
2.40
3.05
0.70 $
1.48
1.50
1.69
0.00
0.00
0.00
0.00
2011
Market Value
High
Low
Dividend
3.50 $
5.01
8.17
10.72
1.95 $
2.96
4.72
7.89
0.00
0.00
0.01
0.01
As of January 31, 2013, we had approximately 1,021 shareholders, including 361 shareholders of record and approximately 660 beneficial
owners whose shares are held in “street” name by securities broker-dealers or other nominees.
23
Dividends
We will not be able to pay dividends on our common stock for the foreseeable future. We historically paid quarterly cash dividends on our
common stock until we suspended dividend payments in October 2011.
As a bank holding company, Porter Bancorp’s ability to declare and pay dividends depends on certain federal regulatory considerations,
including the guidelines of the Federal Reserve regarding capital adequacy and dividends. Porter Bancorp has agreed with the Federal Reserve
to obtain its written consent prior to declaring or paying any future dividends.
Our principal source of revenue with which to pay dividends on our common stock is the dividends that PBI Bank may declare and pay to us
out of funds legally available for payment of dividends. PBI Bank must obtain the prior written consent of its primary regulators prior to
declaring or paying any future dividends. In addition to this current restriction, various laws applicable to PBI Bank also limit its payment of
dividends to us. A Kentucky chartered bank may declare a dividend of an amount of the bank’s net profits as the board deems appropriate. The
approval of the KDFI is required if the total of all dividends declared by the bank in any calendar year exceeds the total of its net profits for that
year combined with its retained net profits for the preceding two years, less any required transfers to surplus or a fund for the retirement of
preferred stock or debt. As a practical matter, PBI Bank will not be able to pay dividends to us for the foreseeable future.
Effective with the fourth quarter of 2011, we began deferring cash dividends on our Series A preferred stock held by the U.S. Treasury and
interest payments on the junior subordinated notes relating to our trust preferred securities. Deferring interest payments on the junior
subordinated notes resulted in the deferral of distributions on our trust preferred securities. We will not be able to pay cash dividends on our
common stock in the future until we have paid all accrued and unpaid dividends on our Series A preferred stock and all deferred distributions
on our trust preferred securities. Dividends on the Series A preferred stock and deferred distributions on our trust preferred securities are
cumulative and therefore unpaid dividends and distributions will accrue and compound on each subsequent payment date. If we become subject
to any liquidation, dissolution or winding up of affairs, holders of the trust preferred securities and then holders of the preferred stock will be
entitled to receive the liquidation amounts to which they are entitled including the amount of any accrued and unpaid distributions and
dividends, before any distribution can be made to the holders of our common stock.
Purchase of Equity Securities by Issuer
The Company did not repurchase any shares in 2012.
24
Item 6.
Selected Financial Data
The following table summarizes our selected historical consolidated financial data from 2008 to 2012. You should read this information in
conjunction with Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and Item 8. “Financial
Statements and Supplementary Data.”
Selected Consolidated Financial Data
(Dollars in thousands except per share data)
2012
As of and for the Years Ended December 31,
2010
2011
2009
Income Statement Data:
Interest income
Interest expense
Net interest income
Provision for loan losses
Non-interest income
Non-interest expense
Income (loss) before income taxes
Income tax expense (benefit)
Net income (loss)
Less:
Dividends on preferred stock
Accretion on Series A preferred stock
(Earnings) loss allocated to participating securities
Net income (loss) available to common
Common Share Data (1):
Basic earnings (loss) per common share
Diluted earnings (loss) per common share
Cash dividends declared per common share
Book value per common share
Tangible book value per common share
Balance Sheet Data (at period end):
Total assets
Debt obligations:
FHLB advances
Junior subordinated debentures
Subordinated capital note
Average Balance Data:
Average assets
Average loans
Average deposits
Average FHLB advances
Average junior subordinated debentures
Average subordinated capital note
Average stockholders’ equity
$
$
$
57,729 $
15,774
41,955
40,250
9,590
44,292
(32,997 )
(65 )
(32,932 )
(1,750 )
(179 )
1,429
(33,432 ) $
73,554 $
22,039
51,515
62,600
7,833
104,273
(107,525 )
(218 )
(107,307 )
(1,750 )
(177 )
4,080
(105,154 ) $
(2.85 ) $
(2.85 )
0.00
0.74
0.58
(8.98 ) $
(8.98 )
0.02
3.74
3.54
86,407 $
28,841
57,566
30,100
11,582
46,478
(7,430 )
(3,046 )
(4,384 )
(1,810 )
(177 )
184
(6,187 ) $
(0.60 ) $
(0.60 )
0.49
12.76
10.33
94,466 $
40,412
54,054
14,200
7,094
30,456
16,492
5,424
11,068
(1,750 )
(176 )
(97 )
9,045 $
1.00 $
1.00
0.76
14.61
11.44
2008
100,107
52,881
47,226
5,400
6,868
27,757
20,937
6,927
14,010
(194 )
(20 )
(94 )
13,702
1.51
1.51
0.73
14.14
11.18
$
1,162,631 $
1,455,424 $
1,723,952 $
1,835,090 $
1,647,857
5,604
25,000
6,975
7,116
25,000
7,650
15,022
25,000
8,550
82,980
25,000
9,000
142,776
25,000
9,000
$
1,341,565 $
1,033,320
1,217,083
6,325
25,000
7,309
75,679
1,659,959 $
1,243,474
1,434,462
15,315
25,000
8,208
159,434
1,747,648 $
1,353,295
1,459,041
47,800
25,000
8,941
188,015
1,714,131 $
1,371,034
1,385,572
106,259
25,000
9,000
168,752
1,572,599
1,324,658
1,250,614
138,954
25,000
4,525
131,706
______________________
(1) Common share data has been adjusted to reflect 5% stock dividends effective December 14, 2010, November 19, 2009 and November
10, 2008 .
25
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operation
Management’s discussion and analysis of financial condition and results of operations analyzes the consolidated financial condition and results
of operations of Porter Bancorp, Inc. and its wholly owned subsidiary, PBI Bank. Porter Bancorp, Inc. is a Louisville, Kentucky-based bank
holding company which operates 18 full-service banking offices in twelve counties through its wholly-owned subsidiary, PBI Bank. Our
markets include metropolitan Louisville in Jefferson County and the surrounding counties of Henry and Bullitt, and extend south along the
Interstate 65 corridor to Tennessee. We serve south central Kentucky and southern Kentucky from banking offices in Butler, Green, Hart,
Edmonson, Barren, Warren, Ohio, and Daviess Counties. We also have an office in Lexington, the second largest city in Kentucky. The Bank
is both a traditional community bank with a wide range of commercial and personal banking products and an online bank which delivers
competitive deposit products and services through an on-line banking division operating under the name of Ascencia.
Historically, we have focused on commercial and commercial real estate lending, both in markets where we have banking offices and other
growing markets in our region. Commercial, commercial real estate and real estate construction loans accounted for 58.6% of our total loan
portfolio as of December 31, 2012, and 60.5% as of December 31, 2011. Commercial lending generally produces higher yields than residential
lending, but involves greater risk and requires more rigorous underwriting standards and credit quality monitoring.
Overview
The following discussion should be read in conjunction with our consolidated financial statements and accompanying notes and other schedules
presented elsewhere in the report.
For the year ended December 31, 2012, we reported a net loss of $32.9 million compared with net loss of $107.3 million for the year ended
December 31, 2011. After deductions for dividends on preferred stock, accretion on preferred stock, and allocating losses to participating
securities, the net loss to common shareholders was $33.4 million for the year ended December 31, 2012, compared with net loss to common
shareholders of $105.2 million for the year ended December 31, 2011. Basic and diluted loss per common share were $(2.85) for the year
ended December 31, 2012, compared with loss per common share of $(8.98) for 2011.
Our financial performance in 2012 continued to be negatively impacted by the Bank’s high level of nonperforming loans and other real estate
owned. Asset quality remediation, capital restoration, and lowering the risk profile of the Company are our major objectives for 2013.
Non-performing loans were 10.52% of total loans, and nonperforming assets stood at 11.89% of total assets at December 31, 2012. We remain
diligent in the management of our portfolio and are striving to improve credit quality by working throughout our markets with our clients to
balance selective new customer acquisition, customer service for our existing clients and prudent risk management.
Significant developments for the year ended December 31, 2012 were:
● John T. Taylor joined the management team in July as President of Porter Bancorp and CEO of PBI Bank. Mr. Taylor is a seasoned
banking veteran with deep and broad experience in our Kentucky markets, community banking, and problem asset
resolution. Additionally, John R. Davis joined the management team in August and was appointed Chief Credit Officer of PBI Bank
with responsibility for establishing and executing the credit quality policies and overseeing credit administration for the organization.
●
●
In October 2012, PBI Bank entered into a new Consent Order with the FDIC and KDFI. Under the new order, the Bank agreed to
maintain the capital levels required by the June 2011 order and also agreed should the capital levels not be reached, and if directed in
writing by the FDIC, the Bank would develop a plan to immediately raise sufficient capital, or to sell or merge itself into another
FDIC insured institution. The new Consent Order also requires the Bank to continue to adhere to the plans implemented in response to
the June 2011 Consent Order, and includes the substantive provisions of the June 2011 order.
In order to comply with the capital requirements of the Consent Order, management and the Board of Directors are evaluating
appropriate strategies for increasing the Company’s capital. These include, among other things, a possible public offering or private
placement of common stock to new and existing shareholders. We have engaged Sandler O’Neill & Partners, LP to act as our
financial advisor and to assist our Board in this evaluation and to assist in evaluating our options for the redemption of our Series A
preferred stock issued to the US Treasury in 2008 under the Capital Purchase Program.
26
● Total assets decreased 20.1% to $1.2 billion at December 31, 2012 compared with $1.5 billion at the 2011 year-end.
● Loans decreased 20.9% to $899.1 million compared with $1.1 billion at December 31, 2011.
● Deposits declined 19.5% to $1.1 billion compared with $1.3 billion at December 31, 2011. Certificate of deposit balances declined
$263.8 million to $760.6 million at December 31, 2012, from $1.0 billion at December 31, 2011. Loan proceeds received from the
repayment of our commercial real estate and construction and development loans were used primarily to redeem maturing certificates
of deposit during the year. Demand deposits increased 2.9% to $114.3 million during 2012 compared with $111.1 million at
December 31, 2011.
● Net interest margin decreased to 3.31% for 2012 compared with 3.40% for 2011. The decrease in margin between periods was due
primarily to a reduction in interest earning assets, primarily loans, coupled with lower rates on those assets and elevated non-accrual
loan levels. Average loans decreased 16.9% to $1.0 billion in 2012 compared with $1.2 billion in 2011.
● Non-performing loans increased $1.2 million to $94.6 million at December 31, 2012, compared with $93.4 million at December 31,
2011. The increase was primarily in the commercial real estate segment of our portfolio, partially offset by decreases in the
construction and development, and 1-4 family residential real estate segments. Non-performing assets increased from $134.8 million
at December 31, 2011, to $138.3 million at December 31, 2012.
● Provision for loan losses decreased $22.4 million in 2012 compared with 2011 as the result of shrinking the loan portfolio and lower
net loan charge-offs of $36.1 million, or 3.50% of average loans for 2012, compared with $44.3 million, or 3.56% of average loans for
2011. Although lower than the prior year, our provision for loan losses was elevated in 2012 by a strategy change during the third
quarter of 2012 related to classified loans which we expect to more quickly remediate by litigation or foreclosure. For loans subject to
this expectation, we applied an additional fair value discount ranging from 10% to 33% to the underlying collateral in our impairment
analysis estimates as resolution of this nature generally results in receiving lower values for real estate collateral in a more aggressive
sales environment. This resulted in a provision for loan loss of approximately $5.1 million related to these loans. Additionally, the
provision for loan losses was negatively impacted by the high level of loan charge-offs in our historical loss experience factors, which
we use to estimate the general component of our allowance for loan losses as well as additional downgrades within the loan portfolio.
● We continue to execute on our strategy to reduce our commercial real estate and construction and development loans. We reduced
construction and development loans by $31.2 million to $70.3 million, or 82% of total risk-based capital, at December 31, 2012
compared with $101.5 million, or 85% of total risk-based capital, at December 31, 2011. Non-owner occupied commercial real estate
loans, construction and development loans, and multi-family residential real estate loans as a group were reduced by $103.5 million to
$311.1 million, or 362% of total risk-based capital, at December 31, 2012 compared with $414.6 million, or 349% of total risk-based
capital, at December 31, 2011.
● Loans past due 30-59 days increased from $17.3 million at December 31, 2011 to $38.2 million at December 31, 2012 and loans past
due 60-89 days increased from $3.9 million at December 31, 2011, to $20.3 million at December 31, 2012. These increases were
primarily in the commercial real estate, construction and development, and multi-family residential real estate segments of our
portfolio.
● Foreclosed properties were $43.7 million at December 31, 2012, compared with $41.4 million at December 31, 2011. The Company
acquired $33.5 million of OREO and sold $24.2 million of OREO during 2012. In addition, fair value write-downs of $7.7 million
were recorded during 2012 to reflect declining values as evidenced by new appraisals and reduced marketing prices in connection with
our sales strategies. Our ratio of non-performing assets to total assets increased to 11.9% at December 31, 2012, compared with 9.3%
at December 31, 2011.
These items are discussed in further detail throughout this “Management’s Discussion and Analysis of Financial Condition and Results of
Operations” Section.
Going Concern Considerations and Future Plans
The consolidated financial statements have been prepared on a going concern basis, which contemplates the realization of assets and the
satisfaction of liabilities in the normal course of business for the foreseeable future. However, the events and circumstances described in this
discussion create an uncertainty about the Company’s ability to continue as a going concern.
27
For the year ended December 31, 2012, we reported net loss to common shareholders of $33.4 million. This loss was attributable primarily to
$40.3 million of provision for loan losses expense due to continued decline in credit trends in our portfolio that resulted in net charge-offs of
$36.1 million, OREO expense of $10.5 million resulting from fair value write-downs driven by new appraisals and reduced marketing prices,
net loss on sales, and ongoing operating expense. We also had lower net interest margin due to lower average loans outstanding, loans re-
pricing at lower rates, and the level of non-performing loans in our portfolio. Net loss to common shareholders of $33.4 million, for the year
ended December 31, 2012, compares with net loss to common shareholders of $105.2 million for year ended December 31, 2011.
During the year ended December 31, 2011, we recorded a net loss to common shareholders of $105.2 million. This loss was attributable to a
$23.8 million goodwill impairment charge, the establishment of a $31.7 million valuation allowance on our deferred tax assets, OREO expense
of $47.5 million related to valuation adjustments reflecting our change in strategy related to certain OREO properties, fair value write-downs
related to new appraisals received for properties in the portfolio during 2011, net loss on the sale of OREO properties, and increase in carrying
costs associated with carrying these higher levels of assets. We also recorded a provision for loan losses expense of $62.6 million due to the
continued decline in credit trends within our portfolio.
In June 2011, the Bank entered into a Consent Order with the FDIC and KDFI in which the Bank agreed, among other things, to improve asset
quality, reduce loan concentrations, and maintain a minimum Tier 1 leverage ratio of 9% and a minimum total risk based capital ratio of 12%.
The Consent Order was included in our Current Report on 8-K filed on June 30, 2011. In October 2012, the Bank entered into a new Consent
Order with the FDIC and KDFI, again agreeing to maintain a minimum Tier 1 leverage ratio of 9% and a minimum total risk based capital ratio
of 12%. The Bank also agreed that if it should be unable to reach the required capital levels, and if directed in writing by the FDIC, then the
Bank would within 30 days develop, adopt and implement a written plan to sell or merge itself into another federally insured financial
institution or otherwise immediately obtain a sufficient capital investment into the Bank to fully meet the capital requirements.
We expect to continue to work with our regulators toward capital ratio compliance as outlined in the written capital plan submitted by the Bank
in December 2012. The new Consent Order also requires the Bank to continue to adhere to the plans implemented in response to the June 2011
Consent Order, and includes the substantive provisions of the June 2011 Consent Order. The new Consent Order was included in our Current
Report on 8-K filed on September 19, 2012. As of December 31, 2012, the capital ratios required by the Consent Order were not met.
In order to meet these capital requirements, the Board of Directors and management are continuing to evaluate strategies to achieve the
following objectives:
●
Increasing capital through a possible public offering or private placement of common stock to new and existing shareholders. We
have engaged Sandler O’Neill & Partners, LP to act as our financial advisor and to assist our Board in this evaluation and to assist in
evaluating our options for the redemption of our Series A preferred stock issued to the US Treasury in 2008 under the Capital
Purchase Program.
● Continuing to operate the Company and Bank in a safe and sound manner. This strategy will require us to reduce our lending
concentrations, remediate non-performing loans, and reduce other noninterest expense through the disposition of OREO.
● Continuing with succession planning and adding resources to the management team. John T. Taylor was named President and CEO
for PBI Bank and appointed to our board of directors in July 2012. Additionally, John R. Davis was appointed Chief Credit Officer
of PBI Bank in August 2012, with responsibility for establishing and executing the credit quality policies and overseeing credit
administration for the organization.
● Evaluating our internal processes and procedures, distribution of labor, and work-flow to ensure we have adequately and appropriately
deployed resources in an efficient manner in the current environment. To this end, we believe the opportunity exists for the
centralization of key processes which will lead to improved execution and cost savings.
● Executing on our commitment to improve credit quality and reduce loan concentrations and balance sheet risk.
o We have reduced the size of our loan portfolio significantly from $1.3 billion at December 31, 2010 to $1.1 billion at
December 31, 2011, and $899.1 million at December 31, 2012. We have significantly improved our staffing in the
commercial lending area which is now led by John R. Davis, who joined the management team in August 2012 and now
serves as Chief Credit Officer.
28
o Our Consent Order calls for us to reduce our construction and development loans to not more than 75% of total risk-based
capital. We were not in compliance at December 31, 2012 with construction and development loans representing 82% of total
risk-based capital. These loans totaled $70.3 million, or 82% of total risk-based capital, at December 31, 2012 and $101.5
million, or 85% of total risk-based capital, at December 31, 2011.
o Our Consent Order also requires us to reduce non-owner occupied commercial real estate loans, construction and
development loans, and multi-family residential real estate loans as a group, to not more than 250% of total risk-based
capital. While we have made significant improvements over the last year, we were not in compliance with this concentration
limit at December 31, 2012. These loans totaled $311.1 million, or 362% of total risk-based capital, at December 31, 2012
compared with $414.6 million, or 349% of total risk-based capital, at December 31, 2011.
o We are working to reduce non-owner occupied commercial real estate loans, construction and development loans, and multi-
family residential real estate loans by curtailing new construction and development lending and new non-owner occupied
commercial real estate lending. We are also receiving principal reductions from amortizing credits and pay-downs from our
customers who sell properties built for resale. We have reduced the construction loan portfolio from $199.5 million at
December 31, 2010 to $70.3 million at December 31, 2012. Our non-owner occupied commercial real estate loans declined
from $293.3 million at December 31, 2010 to $189.8 million at December 31, 2012.
● Executing on our commitment to sell other real estate owned and reinvest in quality income producing assets.
o The remediation process for loans secured by real estate has led the Bank to acquire significant levels of OREO in 2012,
2011, and 2010. The Bank acquired $33.5 million, $41.9 million, and $90.8 million of OREO during 2012, 2011, and 2010,
respectively.
o We have incurred significant losses in disposing of OREO. We incurred losses totaling $9.3 million, $42.8 million, and
$13.9 million in 2012, 2011, and 2010, respectively, from sales and fair value write-downs attributable to declining
valuations as evidenced by new appraisals and from changes in our sales strategies.
o To ensure that we maximize the value we receive upon the sale of OREO, we continue to evaluate sales opportunities and
channels. We are targeting multiple sales opportunities and channels through internal marketing and the use of brokers,
auctions, and technology sales platforms. Proceeds from the sale of OREO totaled $22.5 million during 2012, $26.0 in 2011,
and $25.0 million in 2010.
o At December 31, 2011, the OREO portfolio consisted of 75% construction, development, and land assets. At December 31,
2012, this concentration had declined to 51%. This is consistent with our reduction of construction, development and other
land loans, which have declined to $70.3 million at December 31, 2012, compared to $101.5 million at December 31,
2011. Over the past year, the composition of our OREO portfolio has shifted to be more heavily weighted towards
commercial real estate properties with a cash flow opportunity and 1-4 family residential properties, which we have found to
be more liquid than construction, development, and land assets. Commercial real estate properties represent 35% of the
OREO portfolio at December 31, 2012, compared with 15% at December 31, 2011. 1-4 family residential properties
represent 12% of the OREO portfolio at December 31, 2012, compared with 7% at December 31, 2011.
● Evaluating other strategic alternatives, such as the sale of assets or branches.
Bank regulatory agencies can exercise discretion when an institution does not meet the terms of a consent order. Based on individual
circumstances, the agencies may issue mandatory directives, impose monetary penalties, initiate changes in management, or take more serious
adverse actions.
These financial statements do not include any adjustments that may result should the Company be unable to continue as a going concern.
29
Application of Critical Accounting Policies
Our accounting and reporting policies comply with GAAP and conform to general practices within the banking industry. We believe that of our
significant accounting policies, the following may involve a higher degree of management assumptions and judgments that could result in
materially different amounts to be reported if conditions or underlying circumstances were to change.
Allowance for Loan Losses – PBI Bank maintains an allowance for loan losses believed to be sufficient to absorb probable incurred credit
losses existing in the loan portfolio, and the board of directors evaluates the adequacy of the allowance for loan losses on a quarterly basis. We
evaluate the adequacy of the allowance using, among other things, historical loan loss experience, known and inherent risks in the portfolio,
adverse situations that may affect the borrower’s ability to repay, estimated value of the underlying collateral and current economic conditions
and trends. The allowance may be allocated for specific loans or loan categories, 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 is based on historical loss experience adjusted for environmental
factors. We develop allowance estimates based on actual loss experience adjusted for current economic conditions and trends. Allowance
estimates are a prudent measurement of the risk in the loan portfolio which we apply to individual loans based on loan type. If the mix and
amount of future charge-off percentages differ significantly from those assumptions used by management in making its determination, we may
be required to materially increase our allowance for loan losses and provision for loan losses, which could adversely affect our results.
Other Real Estate Owned – Other real estate owned (OREO) is real estate acquired as a result of foreclosure or by deed in lieu of
foreclosure. It is classified as real estate owned until such time as it is sold. When property is acquired as a result of foreclosure or by deed in
lieu of foreclosure, it is recorded at its fair market value less estimated cost to sell. Any write-down of the property at the time of acquisition is
charged to the allowance for loan losses. Subsequent reductions in fair value are recorded as non-interest expense. To determine the fair value
of OREO for smaller dollar single family homes, we consult with internal real estate sales staff and external realtors, investors, and appraisers.
If the internally evaluated market price is below our underlying investment in the property, appropriate write-downs are recorded. For larger
dollar commercial real estate properties, we obtain a new appraisal of the subject property in connection with the transfer to other real estate
owned. We do not obtain updated appraisals on a quarterly basis after the receipt of the initial appraisal. Rather, we internally review the fair
value of the other real estate owned in our portfolio on a quarterly basis to determine if a new appraisal is warranted based on the specific
circumstances of each property. We obtain updated appraisals each year on the anniversary of ownership unless a sale is imminent.
Goodwill and Intangible Assets – We evaluate goodwill and intangible assets that have indefinite useful lives for impairment at least annually
and more frequently if circumstances indicate their value may not be recoverable. We evaluate goodwill for impairment by comparing the fair
value of the reporting unit to the book value of the reporting unit. If the fair value, net of goodwill, exceeds book value, then goodwill is not
considered to be impaired. We evaluated goodwill for impairment during the second quarter of 2011 because our common stock, which trades
publicly on the NASDAQ, experienced a significant drop in value throughout the months of May and June 2011. Our stock trended downward
during the first quarter of 2011 and continued downward throughout the months of May and June 2011. The stock closed on June 30, 2011 at
$4.98 per share and has regularly traded at a market price less than book value per common share since the second quarter of 2010.
We evaluated the potential negative impact on the value of our common stock from being removed from the Russell 3000 Index during June
2011, the trend of lower earnings in 2011 compared to historical performance due to the continuing impact on earnings from loan loss
provisions, non-performing loans, and foreclosed properties, and recent regulatory agreements entered into by the Company. Our goodwill
impairment testing completed during the fourth quarter of 2010 included, among other things, future projections of earnings at levels exceeding
actual results for 2011. The level of loan loss provisions and the cost of foreclosed properties continue to exceed our prior expectations as we
work through issues with our non-performing loan levels and other real estate owned portfolio.
The fair value of our goodwill was determined utilizing our market capitalization based upon recent common stock price levels. We also
considered market comparison transactions and control premiums for institutions of a similar size and performance. Based on this analysis, we
determined that our goodwill was impaired and recorded an impairment charge of $23.8 million in the quarter ended June 30, 2011. The
impairment charge had no impact on the Company’s liquidity, cash flows, or regulatory capital ratios.
Intangible assets that are not amortized are evaluated for impairment at least annually by comparing the fair values of those assets to their
carrying values. Other identifiable intangible assets that are subject to amortization are amortized on an accelerated basis over the years
expected to be benefited, which we believe is 10 years. We review these amortizable intangible assets for impairment if circumstances indicate
their value may not be recoverable based on a comparison of fair value to carrying value. Based on our annual review, management does not
believe our intangible assets are impaired at December 31, 2012.
30
Stock-based Compensation – Compensation cost is recognized for stock options and restricted stock awards issued to employees, based on
the fair value of these awards at the date of grant. We utilize a Black-Scholes model, which requires the input of highly subjective assumptions,
such as volatility, risk-free interest rates and dividend pay-out rates, to estimate the fair value of stock options, while the market price of the
Company’s common stock at the date of grant is used for restricted stock awards. Compensation cost is recognized over the required service
period, generally defined as the vesting period. For awards with graded vesting, compensation cost is recognized on a straight-line basis over
the requisite service period for the entire award.
Valuation of Deferred Tax Asset – We evaluate deferred tax assets for impairment on a quarterly basis. We established a 100% deferred tax
valuation allowance of $31.7 million in December 2011 based upon the analysis of our past performance and our expected future performance.
We considered all evidence currently available, both positive and negative, in determining, based on the weight of that evidence, the
likelihood that the deferred tax asset would be realized. During that review, we determined that the level of our recent historical losses, the
level of our non-performing assets, our inability to meet our forecasted levels of earnings in 2011, our intent to defer payment of dividends on
our subordinated debentures and Series A Preferred Stock, and our non-compliance with the capital requirements of our Consent Order
outweighed our forecasted taxable earnings levels for the near and long term. As such, we established a 100% deferred tax valuation
allowance. When evaluating our deferred tax assets for realizability during 2012, we concluded that a full valuation allowance was still
necessary at December 31, 2012, due to the additional losses incurred during the year. A return to profitability would enable us to reduce the
valuation allowance and thereby offset income tax expense that would otherwise be recognized. Examinations of our income tax returns or
changes in tax law may impact our deferred tax assets and liabilities as well as our provision for income taxes.
Contingencies – In the normal course of operations, we are defendants in various legal proceedings. We record contingent liabilities resulting
from claims against us when a loss is assessed to be probable and the amount of the loss is reasonably estimable. Assessing probability of loss
and estimating probable losses requires analysis of multiple factors, including in some cases judgments about the potential actions of third party
claimants and courts. Recorded contingent liabilities are based on the best information available and actual losses in any future period are
inherently uncertain.
Results of Operations
The following table summarizes components of income and expense and the change in those components for 2012 compared with 2011:
Gross interest income
Gross interest expense
Net interest income
Provision for credit losses
Non-interest income
Gains on sale of securities, net
Other than temporary impairment on securities
Non-interest expense
Net income (loss) before taxes
Income tax expense (benefit)
Net income (loss)
Dividends on preferred stock
Accretion on Series A preferred stock
Earnings allocated to participating securities
Net income (loss) available to common shareholders
For the
Years Ended December 31, Change from Prior Period
2012
2011
Amount
(dollars in thousands)
Percent
$
57,729 $
15,774
41,955
40,250
6,354
3,236
—
44,292
(32,997 )
(65 )
(32,932 )
(1,750 )
(179 )
1,429
(33,432 )
73,554 $
22,039
51,515
62,600
6,766
1,108
(41 )
104,273
(107,525 )
(218 )
(107,307 )
(1,750 )
(177 )
4,080
(105,154 )
(15,825 )
(6,265 )
(9,560 )
(22,350 )
(412 )
2,128
41
(59,981 )
74,528
153
74,375
—
(2 )
(2,651 )
71,722
(21.5 )%
(28.4 )
(18.6 )
(35.7 )
(6.1 )
192.1
(100.0 )
(57.5 )
(69.3 )
(70.2 )
(69.3 )
—
1.1
(65.0 )
(68.2 )
Net loss of $32.9 million for the year ended December 31, 2012, decreased $74.4 million from net loss of $107.3 million for 2011. Net loss to
common shareholders of $33.4 million for the year ended December 31, 2012, decreased $71.7 million from net loss to common shareholders
of $105.2 million for 2011. This decrease in net loss was attributable primarily to lower provision for loan losses expense, decreased non-
interest expense associated with our OREO, and higher net gain on sales of securities, partially offset by lower net interest income. In addition,
the 2011 results included a one-time goodwill impairment charge of $23.8 million.
31
The following table summarizes components of income and expense and the change in those components for 2011 compared with 2010:
Gross interest income
Gross interest expense
Net interest income
Provision for credit losses
Non-interest income
Gains on sale of securities, net
Other than temporary impairment on securities
Non-interest expense
Net income (loss) before taxes
Income tax expense (benefit)
Net income (loss)
Dividends on preferred stock
Accretion on Series A preferred stock
Earnings allocated to participating securities
Net income (loss) available to common shareholders
For the
Years Ended December 31, Change from Prior Period
2011
2010
Amount
(dollars in thousands)
Percent
$
73,554 $
22,039
51,515
62,600
6,766
1,108
(41 )
104,273
(107,525 )
(218 )
(107,307 )
(1,750 )
(177 )
4,080
(105,154 )
86,407 $
28,841
57,566
30,100
7,027
5,152
(597 )
46,478
(7,430 )
(3,046 )
(4,384 )
(1,810 )
(177 )
184
(6,187 )
(12,853 )
(6,802 )
(6,051 )
32,500
(261 )
(4,044 )
556
57,795
(100,095 )
2,828
(102,923 )
60
—
3,896
(98,967 )
(14.9 )%
(23.6 )
(10.5 )
108.0
(3.7 )
(78.5 )
(93.1 )
124.3
1347.2
(92.8 )
2347.7
(3.3 )
—
2117.4
1599.6
Net loss of $107.3 million for the year ended December 31, 2011, increased $102.9 million from net loss of $4.4 million for 2010. Net loss to
common shareholders of $105.2 million for the year ended December 31, 2011, increased $99.0 million from net loss to common shareholders
of $6.2 million for 2010. This decrease in earnings was attributable primarily to a one-time goodwill impairment charge of $23.8 million,
establishment of a deferred tax asset valuation allowance of $31.7 million, increased provision for loan losses expense, and non-interest
expenses associated with our OREO.
Goodwill was determined to be impaired during the second quarter of 2011 as the result of operating losses and a significant drop in value of
our common stock which trades on NASDAQ. The deferred tax asset is dependent on future levels of income. Given our net loss for the past
two years, and evaluation of other positive and negative evidence, we established a 100% valuation allowance for our deferred tax asset in the
fourth quarter of 2011. Provision for loan losses expense increased $32.5 million, or 108.0%, in comparison with 2010 as a result of an increase
in non-performing loans, and an increase in net loan charge-offs to $44.3 million, or 3.56% of average loans for 2011, compared with
$22.2 million, or 1.64% of average loans for 2010. Non-interest income decreased $261,000, or 3.7%, in comparison with 2010 primarily as a
result of decreased service charges on deposit accounts. Gains on sales of investment securities decreased $4.0 million, or 78.5% in
comparison with 2010 due to fewer sales of securities during the year.
Non-interest expense increased $57.8 million, or 124.3%, in comparison with 2010 primarily as a result of a one-time goodwill impairment
charge of $23.8 million, increased expense related to other real estate owned, increased loan collection expense, and borrowing prepayment
fees. Income tax benefit decreased $2.8 million, or 92.8%, as the result of the establishment of the $31.7 million deferred tax valuation
allowance.
Net Interest Income – Our net interest income was $42.0 million for the year ended December 31, 2012, a decrease of $9.6 million, or 18.6%,
compared with $51.5 million for the same period in 2011. Net interest spread and margin were 3.16% and 3.31%, respectively, for 2012,
compared with 3.24% and 3.40%, respectively, for 2011. Average nonaccrual loans were $90.8 million and $67.4 million in 2012 and 2011,
respectively. The decrease in net interest income was primarily the result of lower average earning assets coupled with lower rates on those
assets. In addition, net interest income and net interest margin were adversely affected by $4.9 million and $4.0 million of interest lost on non-
accrual loans during 2012 and 2011, respectively.
Our average interest-earning assets were $1.28 billion for 2012, compared with $1.53 billion for 2011, a 16.5% decrease, primarily attributable
to lower average loans and interest bearing deposits with financial institutions, partially offset by higher average investment
securities. Average loans were $1.03 billion for 2012, compared with $1.24 billion for 2011, a 16.9% decrease. Average interest bearing
deposits with financial institutions were $62.1 million in 2012, compared with $127.1 million in 2011, a 51.1% decrease. Average investment
securities were $173.1 million for 2012, compared with $148.5 million for 2011, a 16.6% increase. Our total interest income decreased 21.5%
to $57.7 million for 2012, compared with $73.6 million for 2011. The change was due primarily to lower interest rates on and lower volume of
loans and interest bearing deposits with financial institutions, and lower interest rates on investment securities.
32
Our average interest-bearing liabilities decreased by 17.5% to $1.14 billion for 2012, compared with $1.39 billion for 2011. Our total interest
expense decreased by 28.4% to $15.8 million for 2012, compared with $22.0 million during 2011, due primarily to lower interest rates paid on
and lower volume of certificates of deposit, NOW and money market deposits. Our average volume of certificates of deposit decreased 18.6%
to $912.1 million for 2012, compared with $1.12 billion for 2011. The average interest rate paid on certificates of deposit decreased to 1.52%
for 2012, compared with 1.65% for 2011, as the result of continued re-pricing of certificates of deposit at maturity to lower interest rates. Our
average volume of NOW and money market deposit accounts decreased 10.5% to $153.0 million for 2012, compared with $171.0 million for
2011. The average interest rate paid on NOW and money market deposit accounts decreased to 0.42% for 2012, compared with 0.85% for
2011.
Our net interest income was $51.5 million for the year ended December 31, 2011, a decrease of $6.1 million, or 10.5%, compared with $57.6
million for the same period in 2010. Net interest spread and margin were 3.24% and 3.40%, respectively, for 2011, compared with 3.38% and
3.59%, respectively, for 2010. Average nonaccrual loans were $67.4 million and $54.0 million in 2011 and 2010, respectively. The decrease in
net interest income was primarily the result of lower average earning assets. In addition, net interest income and net interest margin were
adversely affected by $4.0 million and $2.7 million of interest lost on non-accrual loans during 2011 and 2010, respectively. Also, average
interest bearing liabilities as a percentage of interest earning assets increased from 89.6% in 2010 to 90.3% in 2011 due to lower capital.
Nonaccrual loans increased significantly in the fourth quarter of 2011.
Our average interest-earning assets were $1.53 billion for 2011, compared with $1.62 billion for 2010, a 5.2% decrease, primarily attributable
to lower average loans and investment securities. Average loans were $1.24 billion for 2011, compared with $1.35 billion for 2010, an 8.1%
decrease. Average investment securities were $148.5 million for 2011, compared with $159.9 million for 2010, a 7.1% decrease. Our total
interest income decreased 14.9% to $73.6 million for 2011, compared with $86.4 million for 2010. The change was due primarily to lower
interest rates on and lower volume of loans and investment securities.
Our average interest-bearing liabilities decreased by 4.4% to $1.39 billion for 2011, compared with $1.45 billion for 2010. Our total interest
expense decreased by 23.6% to $22.0 million for 2011, compared with $28.8 million during 2010, due primarily to lower interest rates paid on
certificates of deposit, and a lower volume of FHLB advances. Our average volume of certificates of deposit decreased 3.2% to $1.12 billion
for 2011, compared with $1.16 billion for 2010. The average interest rate paid on certificates of deposit decreased to 1.65% for 2011, compared
with 2.02% for 2010. Our average volume of FHLB advances decreased 68.0% to $15.3 million for 2011, compared with $47.8 million for
2010. The average interest rate paid on FHLB advances decreased to 3.51% for 2011, compared with 4.22% for 2010. The decrease in cost of
funds was the result of the continued re-pricing of certificates of deposit at maturity at lower interest rates.
33
Average Balance Sheets
The following table sets forth the average daily balances, the interest earned or paid on such amounts, and the weighted average yield on
interest-earning assets and weighted average cost of interest-bearing liabilities for the periods indicated. Dividing income or expense by the
average daily balance of assets or liabilities, respectively, derives such yields and costs for the periods presented.
For the Years Ended December 31,
Average
Balance
2012
Interest
Earned/Paid
Average
Yield/Cost
Average
Balance
(dollars in thousands)
2011
Interest
Earned/Paid
Average
Yield/Cost
ASSETS
Interest-earning assets:
Loans receivables (1)(2)
Real estate
Commercial
Consumer
Agriculture
Other
U.S. Treasury and agencies
Mortgage-backed securities
State and political subdivision
securities (3)
State and political subdivision
securities
Corporate bonds
FHLB stock
Other debt securities
Other equity securities
Federal funds sold
Interest-bearing deposits in other
financial institutions
Total interest-earning
$
921,314 $
64,252
22,720
24,196
838
6,588
111,637
46,179
3,510
1,903
1,304
22
199
1,986
26,631
887
17,363
8,957
10,072
572
1,359
3,109
62,127
563
482
447
46
57
2
142
57,729
assets
Less: Allowance for loan losses
Non-interest-earning assets
Total assets
1,281,735
(53,484 )
113,314
$ 1,341,565
LIABILITIES AND
STOCKHOLDERS’ EQUITY
Interest-bearing liabilities
Certificates of deposit and other
5.01 % $ 1,111,136 $
77,098
5.46
29,140
8.38
25,175
5.39
925
2.63
10,173
3.02
96,221
1.78
59,450
4,362
2,428
1,407
32
322
2,967
5.12
3.24
5.38
4.44
8.04
4.19
0.06
0.23
29,506
1,123
3,178
7,466
10,072
572
1,397
5,729
127,087
172
452
428
46
49
3
313
5.35 %
5.66
8.33
5.59
3.46
3.17
3.08
5.86
5.41
6.05
4.25
8.04
3.51
0.05
0.25
4.54 %
1,534,875
(37,762 )
162,846
$ 1,659,959
73,554
4.83 %
time deposits
$
912,061 $
13,828
1.52 % $ 1,120,154 $
18,468
1.65 %
NOW and money market
deposits
Savings accounts
Federal funds purchased and
repurchase agreements
FHLB advances
Junior subordinated debentures
Total interest-bearing
153,032
38,665
2,088
6,325
32,309
641
154
7
207
937
0.42
0.40
0.34
3.27
2.90
171,028
36,511
1,451
228
10,524
15,315
33,208
440
537
915
0.85
0.62
4.18
3.51
2.76
liabilities
1,144,480
15,774
1.38 %
1,386,740
22,039
1.59 %
Non-interest-bearing liabilities
Non-interest-bearing deposits
Other liabilities
Total liabilities
Stockholders’ equity
Total liabilities and
113,325
8,081
1,265,886
75,679
stockholders’
equity
$ 1,341,565
106,769
7,016
1,500,525
159,434
$ 1,659,959
Net interest income
Net interest spread
$
41,955
$
51,515
3.16 %
3.24 %
Net interest margin
Ratio of average interest-earning
assets to average interest-bearing
liabilities
3.31 %
111.99 %
3.40 %
110.68 %
__________________________
(1)
Includes loan fees in both interest income and the calculation of yield on loans.
(2) Calculations include non-accruing loans in average loan amounts outstanding.
(3) Taxable equivalent yields are calculated assuming a 35% federal income tax rate.
34
For the Years Ended December 31,
Average
Balance
2011
Interest
Earned/Paid
Average
Yield/Cost
Average
Balance
(dollars in thousands)
2010
Interest
Earned/Paid
Average
Yield/Cost
ASSETS
Interest-earning assets:
Loans receivables (1)(2)
Real estate
Commercial
Consumer
Agriculture
Other
U.S. Treasury and agencies
Mortgage-backed securities
State and political subdivision
securities (3)
State and political subdivision
securities
Corporate bonds
FHLB stock
Other debt securities
Other equity securities
Federal funds sold
Interest-bearing deposits in other
financial institutions
Total interest-earning
$ 1,111,136 $
77,098
29,140
25,175
925
10,173
96,221
59,450
4,362
2,428
1,407
32
322
2,967
29,506
1,123
3,178
7,466
10,072
572
1,397
5,729
127,087
172
452
428
46
49
3
313
73,554
assets
Less: Allowance for loan losses
Non-interest-earning assets
Total assets
1,534,875
(37,762 )
162,846
$ 1,659,959
LIABILITIES AND
STOCKHOLDERS’ EQUITY
Interest-bearing liabilities
Certificates of deposit and other
5.35 % $ 1,209,125 $
84,847
5.66
34,346
8.33
23,877
5.59
1,100
3.46
9,674
3.17
110,718
3.08
67,960
5,131
2,944
1,483
41
362
5,846
5.86
5.41
6.05
4.25
8.04
3.51
0.05
0.25
21,331
854
2,947
12,906
10,072
694
1,623
12,633
82,648
161
875
441
46
48
16
199
5.62 %
6.05
8.57
6.21
3.73
3.74
5.28
6.16
5.46
6.78
4.38
6.63
2.96
0.13
0.24
4.83 %
1,618,541
(27,836 )
156,943
$ 1,747,648
86,407
5.37 %
time deposits
$ 1,120,154 $
18,468
1.65 % $ 1,156,724 $
23,415
2.02 %
NOW and money market
deposits
Savings accounts
Federal funds purchased and
repurchase agreements
FHLB advances
Junior subordinated debentures
Total interest-bearing
171,028
36,511
1,451
228
10,524
15,315
33,208
440
537
915
0.85
0.62
4.18
3.51
2.76
164,541
35,393
11,734
47,800
33,941
1,716
261
484
2,015
950
1.04
0.74
4.12
4.22
2.80
liabilities
1,386,740
22,039
1.59 %
1,450,133
28,841
1.99 %
Non-interest-bearing liabilities
Non-interest-bearing deposits
Other liabilities
Total liabilities
Stockholders’ equity
Total liabilities and
106,769
7,016
1,500,525
159,434
stockholders’
equity
$ 1,659,959
102,383
7,117
1,559,633
188,015
$ 1,747,648
Net interest income
Net interest spread
Net interest margin
Ratio of average interest-earning
assets to average interest-bearing
$
51,515
$
57,566
3.24 %
3.40 %
3.38 %
3.59 %
liabilities
110.68 %
111.61 %
__________________________
(1)
Includes loan fees in both interest income and the calculation of yield on loans.
(2) Calculations include non-accruing loans in average loan amounts outstanding.
(3) Taxable equivalent yields are calculated assuming a 35% federal income tax rate.
35
Rate/Volume Analysis
The table below sets forth information regarding changes in interest income and interest expense for the periods indicated. For each category of
interest-earning assets and interest-bearing liabilities, information is provided on changes attributable to (1) changes in rate (changes in rate
multiplied by old volume); (2) changes in volume (changes in volume multiplied by old rate); and (3) changes in rate-volume (change in rate
multiplied by change in volume). Changes in rate-volume are proportionately allocated between rate and volume variance.
Year Ended December 31, 2012 vs. 2011
Year Ended December 31, 2011 vs. 2010
Increase (decrease)
due to change in
Increase (decrease)
due to change in
Rate
Volume
Net
Change
Rate
Volume
Net
Change
(in thousands)
$
(3,824 ) $
(14 )
(1,401 )
(10,937 ) $
(109 )
420
(14,761 ) $
(123 )
(981 )
(3,782 ) $
(58 )
(2,190 )
(6,098 ) $
18
(689 )
(9,880 )
(40 )
(2,879 )
(243 )
(54 )
19
—
9
—
398
84
—
—
(1 )
(1 )
155
30
19
—
8
(1 )
(55 )
(86 )
(13 )
9
8
(6 )
335
(337 )
—
(9 )
(7 )
(7 )
(21 )
(150 )
(171 )
5
109
280
(423 )
(13 )
—
1
(13 )
114
(5,529 )
(10,296 )
(15,825 )
(6,168 )
(6,685 )
(12,853 )
Interest-earning assets:
Loan receivables
U.S. Treasury and agencies
Mortgage-backed securities
State and political subdivision
securities
Corporate bonds
FHLB stock
Other debt securities
Other equity securities
Federal funds sold
Interest-bearing deposits in other
financial institutions
Total increase (decrease) in interest
income
Interest-bearing liabilities:
Certificates of deposit and
other time deposits
NOW and money market accounts
Savings accounts
Federal funds purchased and
repurchase agreements
FHLB advances
Junior subordinated debentures
Total increase (decrease) in interest
expense
Increase (decrease) in net interest
(1,402 )
(670 )
(86 )
(231 )
(34 )
46
(3,238 )
(140 )
12
(202 )
(296 )
(24 )
(4,640 )
(810 )
(74 )
(433 )
(330 )
22
(4,238 )
(324 )
(41 )
7
(293 )
(15 )
(709 )
59
8
(51 )
(1,185 )
(20 )
(4,947 )
(265 )
(33 )
(44 )
(1,478 )
(35 )
(2,377 )
(3,888 )
(6,265 )
(4,904 )
(1,898 )
(6,802 )
income
$
(3,152 ) $
(6,408 ) $
(9,560 ) $
(1,264 ) $
(4,787 ) $
(6,051 )
36
Non-Interest Income – The following table presents for the periods indicated the major categories of non-interest income:
Service charges on deposit accounts
Income from fiduciary activities
Bank card interchange fees
Other real estate owned rental income
Secondary market brokerage fees
Gain on sales of loans originated for sale
Gain on sales of investment securities, net
Other-than-temporary impairment on securities
Other
Total non-interest income
2012
For the Years Ended
December 31,
2011
(in thousands)
2010
2,239 $
1,177
727
420
94
338
3,236
—
1,359
9,590 $
2,609 $
993
668
200
219
713
1,108
(41 )
1,364
7,833 $
2,984
987
606
121
327
554
5,152
(597 )
1,448
11,582
$
$
Non-interest income increased by $1.8 million to $9.6 million for 2012 compared with $7.8 million for 2011. This was due primarily to
increased gain on sales of investment securities of $2.1 million, or 192.1%, due to higher volume of sales. This increase was offset partially by
decreased service charges on deposit accounts of $370,000, or 14.2%, and decreased gain on sales of loans originated for sale of $375,000, or
52.6%. Fewer service charges on deposit account fees were the result of lower transaction volume. Lower gains on sales of loans originated for
sale were the result of fewer loans originated for sale during the year in the USDA and SBA programs.
Non-interest income decreased by $3.7 million to $7.8 million for 2011 compared with $11.6 million for 2010. This was due primarily to lower
gain on sales of investment securities of $4.0 million, or 78.5%, due to fewer sales. Our non-interest income was also lower due to decreased
service charges on deposit accounts of $375,000, or 12.6%, and decreased secondary market brokerage fees of $108,000, or 33.0%. Fewer
service charges on deposit account fees were the result of lower transaction volume. These decreases were offset partially by increased gains on
sales of loans originated for sale of $159,000, or 28.7%, and lower other-than-temporary impairment charges of $556,000, or 93.1%.
Non-interest Expense – The following table presents the major categories of non-interest expense:
Salary and employee benefits
Occupancy and equipment
Goodwill impairment charge
Other real estate owned expense
FDIC insurance
Loan collection expense
State franchise tax
Professional fees
Communications
Borrowing prepayment fees
Postage and delivery
Office supplies
Advertising
Other
Total non-interest expense
2012
For the Years Ended
December 31,
2011
(in thousands)
2010
$
$
16,648 $
3,642
—
10,549
2,835
2,442
2,174
1,985
710
—
454
357
154
2,342
44,292 $
15,218 $
3,729
23,794
47,525
3,470
2,509
2,228
1,392
678
486
485
352
314
2,093
104,273 $
14,903
4,095
—
16,254
2,971
908
2,172
1,067
737
—
722
388
408
1,853
46,478
Non-interest expense for the year ended December 31, 2012, of $44.3 million represented a 57.5% decrease from $104.3 million for the same
period last year. The decrease in non-interest expense was attributable primarily to decreased other real estate owned expense due to lower loss
on sales of OREO, lower valuation write-downs, and lower property maintenance expenses. Expenses related to other real estate owned
include:
37
Net loss on sales
Provision to allowance for sales strategy change
Provision to allowance for declining market values
Operating expense
Total
2012
2011
(in thousands)
1,672 $
—
7,154
1,723
10,549 $
8,889
25,613
9,261
3,762
47,525
$
$
During 2012, we recorded approximately $7.2 million of provision to allowance for declining market values related to new appraisals received
for properties in the portfolio during the year. This compares with $9.3 million of provision related to new appraisals received for properties in
the portfolio during 2011.
In 2011, the Company sold, in a single transaction, 54 finished condominium property units from condominium developments held in our
OREO portfolio with a carrying value of approximately $11.0 million, for $5.2 million, resulting in a pre-tax loss of $5.8 million. No similar
transaction occurred in 2012.
Although we were carrying our OREO at fair market value less estimated cost to sell in 2011, we subsequently adjusted our valuations for land
development and residential development properties held in OREO that were similar to the properties we sold in 2011. We recorded an
allowance totaling approximately $25.6 million to reflect our intent to market these properties more aggressively to retail and bulk buyers. No
similar change in sales strategy was implemented during 2012.
FDIC insurance assessments decreased $635,000, or 18.3%, to $2.8 million in 2012 from $3.5 million in 2011 due to decreased deposit levels.
Borrowing prepayment fees decreased $486,000 as no such fees were incurred during 2012. Additionally, non-interest expense for 2011
included a non-recurring 100% goodwill impairment charge of $23.8 million.
These improvements were offset partially by higher salaries and employee benefits expense of $1.4 million, or 9.4%, due primarily to additions
to staff in our credit administration and workout divisions, and higher professional fees of $593,000, or 42.6%, due primarily to increased audit
and accounting fees, and loan review fees.
Non-interest Expense Comparison – 2011 to 2010
Non-interest expense for the year ended December 31, 2011, of $104.3 million represented a 124.3% increase from $46.5 million for the same
period last year. The increase in non-interest expense was attributable primarily to an increase in other real estate owned expense from
increased losses on sales of OREO, OREO write-downs to reflect declining market values and the impact of our sales strategy change in regard
to certain OREO properties, and OREO maintenance expenses. Expenses related to other real estate owned include:
Net loss on sales
Provision to allowance for sales strategy change
Provision to allowance for declining market values
Operating expense
Total
2011
2010
(in thousands)
8,889 $
25,613
9,261
3,762
47,525 $
565
—
14,062
1,627
16,254
$
$
In 2011, management determined, with the concurrence of the Board of Directors, that certain properties held in OREO were not likely to be
successfully disposed of in an acceptable time-frame using routine marketing efforts. It became apparent due to weakness in the economy and
softness in demand for housing that certain land development and residential condominium projects would require extended holding periods to
sell the properties at recent appraised values. Accordingly, in June of 2011, the Company sold, in a single transaction, 54 finished
condominium property units from condominium developments held in our OREO portfolio with a carrying value of approximately
$11.0 million, for $5.2 million, resulting in a pre-tax loss of $5.8 million.
Although we were carrying our OREO at fair market value less estimated cost to sell, we subsequently adjusted our valuations for land
development and residential development properties held in OREO similar to the properties we sold in 2011. We recorded an allowance
totaling approximately $25.6 million to reflect our intent to market these properties more aggressively to retail and bulk buyers. Additionally,
we recorded approximately $9.3 million of fair value write-downs related to new appraisals received for properties in the portfolio during 2011.
38
Loan collection expense increased $1.6 million, or 176.3%, to $2.5 million in 2011 from $908,000 in 2010 due to settlements of certain legal
matters and increased volume of foreclosures. In June 2011, we settled this litigation for less than the $1,058,000 minimum amount of
compensatory and punitive damages awarded in a jury verdict against PBI Bank, which we recorded in the second quarter as loan collection
expense. We also recorded approximately $300,000 of loan collection expense in 2011 related to a Jefferson County, Kentucky court ruling to
uphold a contested mechanics lien on a property for which we took a deed in lieu of foreclosure.
FDIC insurance assessments increased $499,000, or 16.8%, to $3.5 million in 2011 from $3.0 million in 2010 as a result of our non-performing
asset levels. Salaries and employee benefits expense increased $315,000, or 2.1%, to $15.2 million in 2011 from $14.9 million in 2010 due to
merit raises and increases in staff primarily in the credit and problem asset workout areas. Professional fees increased $325,000, or 30.5%, to
$1.4 million in 2011 from $1.1 million in 2010 due to increased accounting and evaluation services related to goodwill impairment and
deferred tax assets, and increased staff recruitment services and management evaluation services. We incurred borrowing prepayment fees of
$312,000 on the retirement of a $10 million repurchase agreement prior to maturity and $174,000 on the prepayment of $5.5 million of FHLB
advances prior to maturity. We elected to redeem these higher cost borrowings in connection with our asset/liability planning and to lower our
cost of funds in future periods. No similar transactions occurred in 2010.
These increases were offset partially by a decrease in occupancy and equipment expense of $366,000, or 8.9%, due to reduced depreciation on
equipment expense, and decreased postage and delivery expense of $237,000, or 32.8%, due to our decision to replace certain third-party
courier services with in-house personnel.
Goodwill Impairment
The Company evaluates goodwill for impairment annually in the fourth quarter unless events or changes in circumstances indicate potential
impairment may have occurred between annual assessments. Goodwill was reviewed for impairment during the second quarter of 2011 because
the market price of our common stock on NASDAQ declined. Our stock trended downward during the first quarter of 2011 to a low of $7.89
per share and continued downward through May and June 2011. The stock closed on June 30, 2011 at $4.98 per share and has traded at a
market price less than book value per common share since the second quarter of 2010. Our market value to book value ratios are noted below.
The ratio at June 30, 2011 is reflected on a pre-goodwill impairment charge basis.
Market Value to Book Value Ratio:
Book Value
Per Share
Market
Price Per
Share
Market to
Book
Ratio
12/31/2010 $
3/31/2011 $
6/30/2011 $
12.76 $
12.79 $
9.47 $
10.31
7.89
4.98
81 %
62 %
53 %
We evaluated the potential negative impact of several factors on the value of our common stock, including, being removed from the Russell
3000 Index during June 2011; the trend of lower earnings in 2011 compared to historical performance due to the continuing impact of loan loss
provisions, non-performing loans, and foreclosed properties; and our agreements with regulators. Our goodwill impairment testing completed
during the fourth quarter of 2010 included, among other things, future projections of earnings at levels exceeding actual results for 2011. The
level of loan loss provisions and the cost of foreclosed properties continue to exceed our prior expectations as we work through issues with our
non-performing loan levels and other real estate owned portfolio.
We determined the fair value utilizing our market capitalization based upon recent common stock price levels. We also considered market
comparison transactions and control premiums for institutions of a similar size and performance. Based on this analysis, we determined that
our goodwill was impaired and recorded an impairment charge of $23.8 million in the quarter ended June 30, 2011. The impairment charge had
no impact on the Company’s liquidity, cash flows, or regulatory ratios.
Income Tax Expense – Income tax benefit was $65,000 for 2012 compared with $218,000 for 2011. The 2011 income tax benefit was affected
significantly by the establishment of a 100% valuation allowance for our deferred tax asset of $31.7 million. Our deferred tax valuation
allowance increased to $43.9 million at December 31, 2012. Our statutory federal tax rate was 35% in both 2012 and 2011. The effective tax
rate for 2012 and 2011 is not meaningful due to the reduction of income tax benefit as the result of the establishment of the deferred tax
valuation allowance.
39
The valuation allowance for our deferred tax assets does not have any impact on our liquidity, nor does it preclude us from using the tax losses,
tax credits or other timing differences in the future. To the extent we generate taxable income in a given quarter, the valuation allowance may
be reduced to offset fully or partially the corresponding income tax expense. Any remaining deferred tax asset valuation allowance may be
reversed through income tax expense once we can demonstrate a sustainable return to profitability and conclude it is more likely than not the
deferred tax asset will be utilized.
See Note 14, “Income Taxes”, for additional discussion of our income taxes.
Income tax benefit was $218,000 for 2011 compared with $3.0 million for 2010. The 2011 income tax benefit was affected significantly by the
establishment of a 100% valuation allowance for our deferred tax asset of $31.7 million. Our statutory federal tax rate was 35% in both 2011
and 2010. Our effective federal tax rate was 41.0% in 2010. The effective tax rate for 2011 is not meaningful due to the reduction of income tax
benefit as the result of the establishment of the deferred tax valuation allowance.
Analysis of Financial Condition
Total assets at December 31, 2012 were $1.2 billion compared with $1.5 billion at December 31, 2011, a decrease of $292.8 million or 20.1%.
This decrease was attributable primarily to a decrease of $236.9 million in loans. The decrease in loans was attributable to principal reductions
by customers outpacing loan originations and advances, as well as $37.5 million in loan charge-offs and the transfer of loan balances totaling
$33.5 million to OREO.
PBI Bank’s total risk-based capital was $85.8 million at December 31, 2012. PBI Bank’s consent order with its primary regulators required its
Board of Directors to adopt and implement a plan to reduce its construction and development loans to not more than 75% of total risk-based
capital. These loans totaled $70.3 million, or 82% of total risk-based capital, at December 31, 2012. It also required a plan to reduce non-
owner occupied commercial real estate loans, construction and development loans, and multifamily residential real estate loans as a group, to
not more than 250% of total risk based capital. These loans totaled $311.1 million, or 362% of total risk-based capital, at December 31, 2012.
While we have not yet reduced our balances in these categories to the percentages established in our plan, the largest decrease in loans was in
our construction loan portfolio, which declined from $101.5 million at December 31, 2011 to $70.3 million at December 31, 2012. Our non-
owner occupied commercial real estate loans declined from $252.7 million at December 31, 2011 to $189.8 million at December 31, 2012.
Total assets at December 31, 2011 were $1.5 billion compared with $1.7 billion at December 31, 2010, a decrease of $268.5 million or
15.6%. This decrease was attributable primarily to a decrease of $166.6 million in loans. The decrease in loans was attributable to principal
reductions by customers outpacing loan originations and advances, as well as $44.6 million in loan charge-offs and the transfer of loan balances
totaling $41.9 million to OREO.
Loans Receivable – Loans receivable decreased $236.9 million, or 20.9%, during the year ended December 31, 2012, to $899.1 million. Our
commercial, commercial real estate and real estate construction portfolios decreased by an aggregate of $161.1 million, or 23.4%, during 2012
and comprised 58.6% of the total loan portfolio at December 31, 2012.
Loans receivable decreased $166.6 million, or 12.8%, to $1.1 billion at December 31, 2011, compared with $1.3 billion at December 31, 2010.
Our commercial, commercial real estate and real estate construction portfolios decreased $129.7 million, or 15.9%, to $687.5 million at
December 31, 2011. At December 31, 2011, these loans comprised 60.5% of the total loan portfolio compared with 62.7% of the loan portfolio
at December 31, 2010.
Loan Portfolio Composition – The following table presents a summary of the loan portfolio at the dates indicated, net of deferred loan fees,
by type. There are no foreign loans in our portfolio and other than the categories noted, there is no concentration of loans in any industry
exceeding 10% of total loans.
Commercial
Commercial Real Estate:
Construction
Farmland
Other
Residential Real Estate:
Multi-family
1-4 Family
Consumer
Agriculture
Other
Total loans
As of December 31,
2012
2011
Amount
Percent Amount
Percent
(dollars in thousands)
$
52,567
5.85 % $
71,216
6.27 %
70,284
80,825
322,687
50,986
278,273
20,383
22,317
770
899,092
7.82
8.99
35.89
101,471
90,958
423,844
5.67
30.95
2.27
2.48
0.08
60,410
337,350
26,011
23,770
993
100.00 % $ 1,136,023
8.93
8.01
37.31
5.31
29.70
2.29
2.09
0.09
100.00 %
$
40
2010
Amount
Percent
As of December 31,
2009
Amount
Percent
(dollars in thousands)
2008
Amount
Percent
$
90,290
6.93 % $
89,903
6.36 % $
90,978
6.74 %
199,524
85,523
441,844
15.32
6.56
33.92
304,230
83,898
451,945
21.53
5.94
31.99
371,301
77,504
377,130
74,919
353,418
31,913
24,177
1,060
$ 1,302,668
5.75
27.13
2.45
1.86
0.08
65,043
354,358
36,989
25,064
1,488
100.00 % $ 1,412,918
4.60
25.08
2.62
1.77
0.11
56,350
319,734
37,783
16,181
3,145
100.00 % $ 1,350,106
27.50
5.74
27.94
4.17
23.68
2.80
1.20
0.23
100.00 %
Commercial
Commercial Real Estate:
Construction
Farmland
Other
Residential Real Estate:
Multi-family
1-4 Family
Consumer
Agriculture
Other
Total loans
Our lending activities are subject to a variety of lending limits imposed by state and federal law. PBI Bank’s secured legal lending limit to a
single borrower was approximately $20.7 million at December 31, 2012.
At December 31, 2012, we had eight loan relationships each with aggregate extensions of credit in excess of $10 million. Five of the eight
relationships include loans that have been classified as substandard by the Bank’s internal loan review process. In 2011, we had thirteen loan
relationships each with aggregate extensions of credit in excess of $10 million. For further discussion of classified loans refer to the asset
quality discussion in our “Allowance for Loan Losses” section.
Our real estate construction portfolio declined approximately $31.2 million from 2011 to 2012 as the result of construction projects being
completed and sold to end users or refinanced under permanent financing arrangements, and also loans in this category being transferred to
OREO through the normal progression of collection, workout, and ultimate disposition. We continue to actively work to reduce the size of our
real estate construction portfolio.
As of December 31, 2012, we had $9.4 million of participations in real estate loans purchased from, and $61.9 million of participations in real
estate loans sold to, other banks. As of December 31, 2011, we had $16.4 million of participations in real estate loans purchased from, and
$82.7 million of participations in real estate loans sold to, other banks.
Our loan participation totals include participations in real estate loans purchased from and sold to two affiliate banks, The Peoples Bank, Mt.
Washington and The Peoples Bank, Taylorsville. Our chairman emeritus, J. Chester Porter and his brother and our director, William G. Porter,
each own a 50% interest in Lake Valley Bancorp, Inc., the parent holding company of The Peoples Bank, Taylorsville, Kentucky. J. Chester
Porter, William G. Porter and our chairman and chief executive officer, Maria L. Bouvette, serve as directors of The Peoples Bank,
Taylorsville. Our chairman emeritus owns an interest of approximately 36.0% and his brother and our director owns an interest of
approximately 3.0% in Crossroads Bancorp, Inc., the parent holding company of The Peoples Bank, Mount Washington, Kentucky. J. Chester
Porter and Maria L. Bouvette, serve as directors of The Peoples Bank, Mount Washington. During 2012, 2011, and 2010, we entered into
management services agreements with each of these banks. Each agreement provides that our executives and employees provide management
and accounting services to the subject bank, including overall responsibility for establishing and implementing policy and strategic planning.
These entities are not consolidated in the financial statements of the Company. Maria Bouvette also serves as chief financial officer of each of
the banks. We received a $4,000 monthly fee from The Peoples Bank, Taylorsville and a $2,000 monthly fee from The Peoples Bank, Mount
Washington for these services. Beginning in 2013, these management services agreements were not renewed.
41
As of December 31, 2012, we had $2.7 million of participations in real estate loans purchased from, and $6.5 million of participations in real
estate loans sold, to these affiliate banks. As of December 31, 2011, we had $4.1 million of participations in real estate loans purchased from,
and $13.2 million of participations in real estate loans sold to, these affiliate banks. At December 31, 2012, $1.4 million and $943,000 of loan
participations sold to Peoples Bank, Taylorsville, and Peoples Bank, Mt. Washington, respectively, were on non-accrual.
We have analyzed our relationship with these affiliates and determined that we do not have the power to direct the activities of the affiliates in
a manner that would significantly impact their economic performance nor do we govern their absorption of losses or the use of their economic
resources. As such, these entities are not consolidated in our financial statements.
Loan Maturity Schedule – The following table sets forth information at December 31, 2012, regarding the dollar amount of loans, net of
deferred loan fees, maturing in the loan portfolio based on their contractual terms to maturity:
Loans with fixed rates:
Commercial
Commercial Real Estate:
Construction
Farmland
Other
Residential Real Estate:
Multi-family
1-4 Family
Consumer
Agriculture
Other
Total fixed rate loans
Loans with floating rates:
Commercial
Commercial Real Estate:
Construction
Farmland
Other
Residential Real Estate:
Multi-family
1-4 Family
Consumer
Agriculture
Other
Total floating rate loans
Maturing
Within
One Year
As of December 31, 2012
Maturing
1 through
5 Years
Maturing
Over 5
Years
(dollars in thousands)
Total
Loans
$
11,176 $
13,616 $
2,201 $
26,993
13,383
11,654
99,897
9,923
53,511
4,442
3,014
219
207,219 $
10,684
22,442
114,421
31,596
98,419
12,879
1,420
—
305,477 $
1,289
6,089
8,808
2,857
67,452
1,826
129
—
90,651 $
25,356
40,185
223,126
44,376
219,382
19,147
4,563
219
603,347
$
$
14,725 $
6,330 $
4,519 $
25,574
22,222
8,685
26,714
579
10,716
613
11,774
—
96,028 $
13,748
4,685
35,326
1,290
14,192
401
5,332
524
81,828 $
8,958
27,270
37,521
4,741
33,983
222
648
27
117,889 $
44,928
40,640
99,561
6,610
58,891
1,236
17,754
551
295,745
$
Non-Performing Assets – Non-performing assets consist of certain restructured loans for which interest rate or other terms have been
renegotiated, loans past due 90 days or more still on accrual, loans on which interest is no longer accrued, real estate acquired through
foreclosure and repossessed assets. Loans, including impaired loans, are placed on non-accrual status when they become past due 90 days or
more as to principal or interest, unless they are adequately secured and in the process of collection. Loans are considered impaired if full
principal or interest payments are not anticipated in accordance with the contractual loan terms. Impaired loans are carried at the present value
of expected future cash flows discounted at the loan’s effective interest rate or at the fair value of the collateral less cost to sell if the loan is
collateral dependent. Loans are reviewed on a regular basis and normal collection procedures are implemented when a borrower fails to make a
required payment on a loan. If the delinquency on a mortgage loan exceeds 90 days and is not cured through normal collection procedures or an
acceptable arrangement is not worked out with the borrower, we institute measures to remedy the default, including commencing a foreclosure
action. Consumer loans generally are charged off when a loan is deemed uncollectible by management and any available collateral has been
disposed. Commercial business and real estate loan delinquencies are handled on an individual basis by management with the advice of legal
counsel.
42
Interest income on loans is recognized on the accrual basis except for those loans placed on non-accrual status. The accrual of interest on
impaired loans is discontinued when management believes, after consideration of economic and business conditions and collection efforts, that
the borrowers’ financial condition is such that collection of interest is doubtful, which typically occurs after the loan becomes 90 days
delinquent. When interest accrual is discontinued, existing accrued interest is reversed and interest income is subsequently recognized only to
the extent cash payments are received on well-secured loans.
Real estate acquired as a result of foreclosure or by deed in lieu of foreclosure is classified as real estate owned until such time as it is sold.
New and used automobiles and other motor vehicles acquired as a result of foreclosure are classified as repossessed assets until they are sold.
When such property is acquired it is recorded at its fair market value less cost to sell. Any write-down of the property at the time of acquisition
is charged to the allowance for loan losses. Subsequent gains and losses are included in non-interest expense.
The following table sets forth information with respect to non-performing assets as of the dates indicated:
Past due 90 days or more still on accrual
Loans on non-accrual status
Total non-performing loans
Real estate acquired through foreclosure
Other repossessed assets
Total non-performing assets
Non-performing loans to total loans
Non-performing assets to total assets
Allowance for non-performing loans
Allowance for non-performing loans to non-performing
loans
2012
2011
As of December 31,
2010
(dollars in thousands)
2009
2008
86 $
94,517
94,603
43,671
—
138,274 $
1,350 $
92,020
93,370
41,449
5
134,824 $
594 $
59,799
60,393
67,635
52
128,080 $
5,968 $
78,888
84,856
14,548
80
99,484 $
11,598
9,725
21,323
7,839
96
29,258
10.52 %
11.89 %
13,250 $
8.22 %
9.26 %
11,382 $
4.63 %
7.43 %
7,977 $
6.00 %
5.42 %
7,266 $
1.58 %
1.78 %
2,363
14.0 %
12.2 %
13.2 %
8.6 %
11.1 %
$
$
$
A troubled debt restructuring (TDR) is where the Company has agreed to a loan modification in the form of a concession for a borrower who is
experiencing financial difficulty. The majority of the Company’s TDRs involve a reduction in interest rate, a deferral of principal for a stated
period of time, or an interest only period. All TDRs are considered impaired, and the Company has allocated reserves for these loans to reflect
the present value of the concessionary terms granted to the customer. If the loan is considered collateral dependent, it is reported net of
allocated reserves, at the fair value of the collateral less cost to sell.
We do not have a formal loan modification program. Rather, we work with individual borrower on a case-by-case basis to facilitate the orderly
collection of our principal and interest before a loan becomes a non-performing loan. If a borrower is unable to make contractual payments, we
review the particular circumstances of that borrower’s situation and negotiate a revised payment stream. In other words, we identify performing
borrowers experiencing financial difficulties, and through negotiations, we lower their interest rate, most typically on a short-term basis for
three to six months. Our goal when restructuring a credit is to afford the borrower a reasonable period of time to remedy the issue causing cash
flow constraints within their business so that they can return to performing status over time.
Our loan modifications have taken the form of reduction in interest rate and/or curtailment of scheduled principal payments for a short-term
period, usually three to six months, but in some cases until maturity of the loan. In some circumstances we restructure real estate secured loans
in a bifurcated fashion whereby we have a fully amortizing “A” loan at a market interest rate and an interest-only “B” loan at a reduced interest
rate. Our restructured loans are all collateral secured loans. If a customer fails to perform under the modified terms, we place the loan(s) on
non-accrual status and begin the process of working with the customer to liquidate the underlying collateral to satisfy the debt.
At December 31, 2012, we had 123 restructured loans totaling $117.8 million with borrowers who experienced deterioration in financial
condition compared with 114 loans totaling $113.7 million at December 31, 2011. In general, these loans were granted interest rate reductions
to provide cash flow relief to borrowers experiencing cash flow difficulties. Of these restructured loans for 2012, five loans totaling
approximately $5.2 million were also granted principal payment deferrals until maturity. There were no concessions made to forgive principal
relative to these loans, although we have recorded partial charge-offs for certain restructured loans. In general, these loans are secured by first
liens on 1-4 residential or commercial real estate properties, or farmland. Restructured loans also included $3.8 million of commercial loans
for 2012. At December 31, 2012, $77.3 million of TDRs were performing according to their modified terms.
43
In accordance with current guidance, we continue to report restructured loans as restructured until such time as the loan is paid in full,
otherwise settled, sold, or charged-off. If the borrower fails to perform, we place the loan on non-accrual status and seek to liquidate the
underlying collateral for these loans. Our non-accrual policy for restructured loans is identical to our non-accrual policy for all loans. Our
policy calls for a loan to be reported as non-accrual if it is maintained on a cash basis because of deterioration in the financial condition of the
borrower, payment in full of principal and interest is not expected, or principal or interest has been in default for a period of 90 days or more
unless the assets are both well secured and in the process of collection. Changes in value for impairment, including the amount attributed to the
passage of time, are recorded entirely within the provision for loan losses.
We consider any loan that is restructured for a borrower experiencing financial difficulties due to a borrower’s potential inability to pay in
accordance with contractual terms of the loan to be a troubled debt restructure. Specifically, we consider a concession involving a modification
of the loan terms, such as (i) a reduction of the stated interest rate, (ii) reduction or deferral of principal, or (iii) reduction or deferral of accrued
interest at a stated interest rate lower than the current market rate for new debt with similar risk all to be troubled debt restructurings. When a
modification of terms is made for a competitive reason, we do not consider that to be a troubled debt restructuring. A primary example of a
competitive modification would be an interest rate reduction for a performing customer’s loan to a market rate as the result of a market decline
in rates.
See Footnote 4, “Loans”, to the financial statements for additional disclosure related to troubled debt restructuring.
Interest income that would have been earned on non-performing loans was $4.9 million, $4.0 million, and $2.7 million for the years ended
December 31, 2012, 2011, and 2010, respectively. Interest income recognized on accruing non-performing loans was $460,000, $611,000, and
$222,000 for the years ended December 31, 2012, 2011, and 2010, respectively.
Loans more than 90 days past due decreased $1.3 million, and non-accrual loans increased $2.5 million, respectively, from December 31, 2011
to December 31, 2012. The $94.6 million in nonperforming loans at December 31, 2012, and $93.4 million at December 31, 2011, were
primarily construction, land development, other land, commercial real estate, and residential real estate loans. The protracted slowdown in
housing unit sales and loss of tenants or inability to lease vacant office and retail space has placed inordinate stress on these customers and their
ability to repay according to the contractual terms of the loans. As such, we have placed these credits on non-accrual and have begun the
appropriate collection actions to resolve them. Management believes it has established adequate loan loss reserves for these credits.
Loans past due 30-59 days increased from $17.3 million at December 31, 2011 to $38.2 million at December 31, 2012. Loans past due 60-89
days increased from $3.9 million at December 31, 2011 to $20.3 million at December 31, 2012. This represents a $37.2 million increase from
December 31, 2011 to December 31, 2012, in loans past due 30-89 days. These increases were primarily in the construction and residential
real estate segments of the portfolio. We considered this trend in delinquency levels during the evaluation of qualitative trends in the portfolio
when establishing the general component of our allowance for loan losses. Subsequent to December 31, 2012, loans to two significant
borrowing relationships, which at December 31, 2012 were past due 30-59 days totaling $23.5 million and past due 60-89 days totaling $12.7
million, were placed on non-accrual. These loans were classified as impaired and allocated reserves of $4.9 million at December 31, 2012.
Foreclosed Properties – Foreclosed properties at December 31, 2012 were $43.7 million compared with $41.4 million at December 31,
2011. See Footnote 6, “Other Real Estate Owned”, to the financial statements. During 2012, we acquired $33.5 million of OREO properties
and sold properties totaling approximately $24.2 million. We value foreclosed properties at fair value less estimated costs to sell when acquired
and expect to liquidate these properties to recover our investment in the due course of business.
Other real estate owned (OREO) is recorded at fair market value less estimated cost to sell at time of acquisition. Any write-down of the
property at the time of acquisition is charged to the allowance for loan losses. Subsequent reductions in fair value are recorded as non-interest
expense. To determine the fair value of OREO for smaller dollar, single family homes, we consult with internal real estate sales staff and
external realtors, investors, and appraisers. If the internally evaluated market price is below our underlying investment in the property, we
record an appropriate write-down.
For larger dollar commercial real estate properties, we obtain a new appraisal of the subject property in connection with the transfer to OREO.
In some of these circumstances, an appraisal is in process at quarter end and we must make our best estimate of the fair value of the underlying
collateral based on our internal evaluation of the property, our review of the most recent appraisal, and discussions with the currently engaged
appraiser. We obtain updated appraisals on the anniversary date of ownership unless a sale is imminent.
44
The following table presents the major categories of OREO at the year-ends indicated:
Commercial Real Estate:
Construction
Farmland
Other
Residential Real Estate:
Multi-family
1-4 Family
Net activity relating to other real estate owned during the years indicated is as follows:
OREO Activity
OREO as of January 1
Real estate acquired
Valuation adjustments for sales strategy change
Valuation adjustments for declining market values
Improvements
Loss on sale
Proceeds from sale of properties
OREO as of December 31
2012
2011
(in thousands)
22,323 $
602
15,175
195
5,376
43,671 $
31,280
715
6,364
—
3,090
41,449
2012
2011
(in thousands)
41,449 $
33,528
—
(7,154 )
1
(1,672 )
(22,481 )
43,671 $
67,635
41,917
(25,613 )
(9,261 )
1,650
(8,889 )
(25,990 )
41,449
$
$
$
$
Net loss on sales, write-downs, and operating expenses for OREO totaled $10.5 million for the year ended December 31, 2012, compared with
$47.5 million for the same period of 2011. The 2011 results were impacted significantly by our determination in the 2011 second quarter that
certain properties held in other real estate were not likely to be successfully disposed of in an acceptable time-frame using routine marketing
efforts. It became apparent that certain condominium projects were going to require extended holding periods to sell the properties at their
most recent appraised values. Accordingly, during June 2011, the Company sold, in a single transaction, 54 finished condominium property
units from several condominium developments in our OREO portfolio, with a carrying value of approximately $11.0 million for $5.2 million,
resulting in a pre-tax loss of $5.8 million. In addition, management adjusted its valuations for similar condominium and residential
development properties held in other real estate through provision of an allowance of $10.6 million on other real estate held, with the objective
of marketing these properties more aggressively.
Although we were carrying our OREO at fair market value less estimated cost to sell, we subsequently adjusted our valuations for land
development and residential development properties held in OREO similar to the properties we sold in 2011. We recorded an allowance
totaling approximately $25.6 million during 2011 to reflect our intent to market these properties more aggressively to retail and bulk buyers.
No similar change in sales strategy was implemented during 2012.
We recorded approximately $7.7 million and $8.3 million of fair value write-downs related to new appraisals received for properties in the
OREO portfolio during 2012 and 2011 respectively. We were successful in selling OREO totaling $24.2 million and $34.9 million during
2012 and 2011, respectively.
Allowance for Loan Losses – The allowance for loan losses is based on management’s continuing review and evaluation of individual loans,
loss experience, current economic conditions, risk characteristics of various categories of loans and such other factors that, in management’s
judgment, require current recognition in estimating loan losses.
45
The following table sets forth an analysis of loan loss experience as of and for the periods indicated:
Balances at beginning of period
$
52,579 $
34,285 $
2012
2011
As of December 31,
2010
(dollars in thousands)
26,392 $
2009
2008
19,652 $
16,342
Loans charged-off:
Real estate
Commercial
Consumer
Agriculture
Total charge-offs
Recoveries:
Real estate
Commercial
Consumer
Agriculture
Total recoveries
Net charge-offs
Provision for loan losses
Balance acquired in bank acquisition
Balance at end of period
31,437
3,784
1,130
1,164
37,515
38,538
4,197
1,070
841
44,646
19,261
2,675
496
29
22,461
6,519
301
875
36
7,731
1,040
129
125
72
1,366
36,149
40,250
—
56,680 $
184
69
87
—
340
44,306
62,600
—
52,579 $
114
28
104
8
254
22,207
30,100
—
34,285 $
133
55
76
7
271
7,460
14,200
—
26,392 $
$
2,711
347
749
27
3,834
145
85
85
8
323
3,511
5,400
1,421
19,652
Allowance for loan losses to period-end loans
Net charge-offs to average loans
Allowance for loan losses to non-performing loans
6.30 %
3.50 %
59.91 %
4.63 %
3.56 %
56.31 %
2.63 %
1.64 %
56.77 %
1.87 %
0.54 %
31.10 %
1.46 %
0.27 %
92.16 %
Our allowance for loan losses is a reserve established through charges to earnings in the form of a provision for loan losses. The allowance for
loan losses is comprised of specific reserves and general reserves. Generally, all loans that have been identified as impaired are reviewed on a
quarterly basis in order to determine whether a specific allowance is required. A loan is considered impaired when based on current
information;, it is probable that we will not receive all amounts due in accordance with the contractual terms of the loan agreement. Once a loan
has been identified as impaired, management measures impairment in accordance with ASC 310.10, “Impairment of a Loan.” When
management’s measured value of the impaired loan is less than the recorded investment in the loan, the amount of the impairment is recorded
as a specific reserve. These specific reserves are determined on an individual loan basis based on management’s current evaluation of our loss
exposure for each credit given the payment status, financial condition of the borrower and value of any underlying collateral. Loans for which
specific reserves have been provided are excluded from the general reserve calculations described below. Changes in specific reserves from
period to period are the result of changes in the circumstances of individual loans such as charge-offs, pay-offs, changes in collateral values or
other factors.
The allowance for loan losses represents management’s estimate of the amount necessary to provide for known and inherent losses in the loan
portfolio in the normal course of business. Due to the uncertainty of risks in the loan portfolio, management’s judgment of the amount of the
allowance necessary to absorb loan losses is approximate. The allowance for loan losses is also subject to regulatory examinations and may be
adjusted in response to a determination by the regulatory agencies as to its adequacy in comparison with peer institutions.
We make specific allowances for each impaired loan based on its type and classification as discussed above. At year-end 2012, our allowance
for loan losses to total non-performing loans increased to 59.9% from 56.3% at year-end 2011. We have assessed these loans for collectability
and considered, among other things, the borrower’s ability to repay, the value of the underlying collateral, and other market conditions to
ensure that the allowance for loan losses is adequate to absorb probable incurred losses. We also maintain a general reserve for each loan type
in the loan portfolio. In determining the amount of the general reserve portion of our allowance for loan losses, management considers factors
such as our historical loan loss experience, the growth, composition and diversification of our loan portfolio, current delinquency levels, the
results of recent regulatory examinations and general economic conditions. Based on these factors, we apply estimated percentages to the
various categories of loans, not including any loan that has a specific allowance allocated to it, based on our historical experience, portfolio
trends and economic and industry trends. This information is used by management to set the general reserve portion of the allowance for loan
losses at a level it deems prudent.
Our portfolio is comprised primarily of loans secured by real estate. A decline in the value of the real estate serving as collateral for our loans
may impact our ability to collect those loans. In general, we obtain updated appraisals on property securing our loans when circumstances are
warranted such as at the time of renewal or when market conditions have significantly changed. We use qualified licensed appraisers approved
by our Board of Directors. These appraisers possess prerequisite certifications and knowledge of the local and regional marketplace.
46
Based on an evaluation of the loan portfolio, management presents a quarterly review of the allowance for loan losses to our Board of
Directors, indicating any change in the allowance for loan losses since the last review and any recommendations as to adjustments in the
allowance for loan losses.
This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes
available or as events change. We increased the allowance for loan losses as a percentage of loans outstanding to 6.30% at December 31, 2012
from 4.63% at December 31, 2011. The level of the allowance is based on estimates and the ultimate losses may vary from these estimates.
We follow a loan grading program designed to evaluate the credit risk in our loan portfolio. Through this loan grading process, we maintain an
internally classified watch list which helps management assess the overall quality of the loan portfolio and the adequacy of the allowance for
loan losses. Loans categorized as watch list loans show warning elements where the present status exhibits one or more deficiencies that require
attention in the short-term or where pertinent ratios of the loan account have weakened to a point where more frequent monitoring is warranted.
These loans do not have all of the characteristics of a classified loan (substandard or doubtful) but do show weakened elements as compared
with those of a satisfactory credit. We review these loans to assist in assessing the adequacy of the allowance for loan losses.
In establishing the appropriate classification for specific assets, management considers, among other factors, the estimated value of the
underlying collateral, the borrower’s ability to repay, the borrower’s repayment history and the current delinquent status. As a result of this
process, loans are categorized as special mention, substandard or doubtful.
Loans classified as “special mention” do not have all of the characteristics of substandard or doubtful loans. They have one or more
deficiencies which warrant special attention and which corrective action, such as accelerated collection practices, may remedy.
Loans classified as “substandard” are those loans with clear and defined weaknesses such as a highly leveraged position, unfavorable financial
ratios, uncertain repayment sources or poor financial condition which may jeopardize the repayment of the debt as contractually agreed. They
are characterized by the distinct possibility that we will sustain some losses if the deficiencies are not corrected.
Loans classified as “doubtful” are those loans which have characteristics similar to substandard loans but with an increased risk that collection
or liquidation in full is highly questionable and improbable.
Once a loan is deemed impaired or uncollectible as contractually agreed, the loan is charged-off either partially or in-full against the allowance
for loan losses, based upon the expected future cash flows discounted at the loan’s effective interest rate, or the fair value of collateral less
estimated cost to sell with respect to collateral-based loans.
As of December 31, 2012, we had $248.7 million of loans classified as substandard, $396,000 classified as doubtful, $34.7 million classified as
special mention and none classified as loss. This compares with $229.6 million of loans classified as substandard, $391,000 classified as
doubtful, $48.9 million classified as special mention and none classified as loss as of December 31, 2011. The $19.1 million increase in loans
classified as substandard was primarily concentrated in the commercial real estate portfolio. As of December 31, 2012, we had allocations of
$34.0 million in the allowance for loan losses related to these classified loans. This compares to allocations of $30.2 million in the allowance
for loan losses related to classified loans at December 31, 2011.
We recorded a provision for loan losses of $40.3 million for the year ended December 31, 2012, compared with $62.6 million for 2011 and
$30.1 million for 2010. The total allowance for loan losses was $56.7 million or 6.30% of total loans, at December 31, 2012, compared with
$52.6 million or 4.63% of total loans at December 31, 2011, and $34.3 million or 2.63% of total loans at December 31, 2010. The increased
allowance is consistent with the increase in our classified loans of $39.0 million from December 31, 2011 to December 31, 2012, loan charge-
off trends, and other trends within the portfolio, in particular the protracted slowdown in housing unit sales and continued weakness in demand
for residential land in our markets. Net charge-offs were $36.1 million for the year ended December 31, 2012, compared with $44.3 million for
2011 and $22.2 million for 2010. Charge-offs for 2012 were concentrated in the loans secured by real estate category of the portfolio. Real
estate charge-offs represents 84% of our net charge-offs for 2012. These net charge-offs consisted of $18.3 million of commercial real estate
loans, $8.9 million of residential real estate loans, and $3.2 million of construction and land development loans. The continued weakness in the
real estate sector of the market continued to exert downward pressure on the value of real estate securing our loans. We continue to closely
monitor real estate values for property that secures our loans to ensure our allowance is adequate.
The following table depicts management’s allocation of the allowance for loan losses by loan type. Allowance funding and allocation is based
on management’s current evaluation of risk in each category, economic conditions, past loss experience, loan volume, past due history and
other factors. Since these factors and management’s assumptions are subject to change, the allocation is not necessarily predictive of future
portfolio performance. The allocation is made by analytical purposes and is not necessarily indicative of the categories in which future losses
may occur. The total allowance is available to absorb losses from any segment of loans.
47
As of December 31,
2012
2011
Amount of
Allowance
Percent of
Loans to
Total
Loans
(dollars in thousands)
Amount of
Allowance
Percent of
Loans to
Total
Loans
$
4,402
5.85 % $
4,207
6.27 %
5,989
2,600
26,179
2,464
13,771
857
403
15
56,680
7.82
8.99
35.89
5.67
30.95
2.27
2.48
0.08
100.00 % $
13,920
2,023
17,081
1,797
12,420
792
325
14
52,579
8.93
8.01
37.31
5.31
29.70
2.29
2.09
0.09
100.00 %
$
2010
Amount of
Allowance
Percent of
Loans to
Total
Loans
As of December 31,
2009
Percent of
Loans to
Total
Loans
(dollars in thousands)
Amount of
Allowance
2008
Amount of
Allowance
Percent of
Loans to
Total
Loans
$
2,147
6.93 % $
2,040
6.36 % $
1,623
6.74 %
11,164
702
12,209
517
6,707
701
134
4
—
34,285
15.32
6.56
33.92
5.75
27.13
2.45
1.86
0.08
—
100.00 % $
8,215
643
9,266
578
4,662
538
163
5
282
26,392
21.53
5.94
31.99
4.60
25.08
2.62
1.77
0.11
—
100.00 % $
5,907
882
6,770
590
2,271
603
238
26
742
19,652
27.50
5.74
27.94
4.17
23.68
2.80
1.20
0.23
—
100.00 %
$
Commercial
Commercial Real Estate:
Construction
Farmland
Other
Residential Real Estate:
Multi-family
1-4 Family
Consumer
Agriculture
Other
Total
Commercial
Commercial Real Estate:
Construction
Farmland
Other
Residential Real Estate:
Multi-family
1-4 Family
Consumer
Agriculture
Other
Unallocated
Total
Investment Securities – The securities portfolio serves as a source of liquidity and earnings and contributes to the management of interest rate
risk. We have the authority to invest in various types of liquid assets, including short-term United States Treasury obligations and securities of
various federal agencies, obligations of states and political subdivisions, corporate bonds, certificates of deposit at insured savings and loans
and banks, bankers’ acceptances and federal funds. We may also invest a portion of our assets in certain commercial paper and corporate debt
securities. We are also authorized to invest in mutual funds and stocks whose assets conform to the investments that we are authorized to make
directly. The investment portfolio increased by $19.6 million, or 12.4%, to $178.5 million at December 31, 2012, compared with $158.9
million at December 31, 2011.
48
The following table sets forth the carrying value of our securities portfolio at the dates indicated. There were no securities classified as held-to-
maturity at either period end.
December 31, 2012
Gross
Gross
Unrealized
Unrealized
Gains
Losses
Amortized
Cost
Fair
Value
Amortized
Cost
December 31, 2011
Gross
Gross
Unrealized
Unrealized
Gains
Losses
Fair
Value
(dollars in thousands)
Securities available-for-sale
U.S. Treasury and agencies
$
Agency mortgage-backed: residential
State and municipal
Corporate
Other debt
Equity
5,603 $
94,298
52,485
18,851
572
1,359
$ 173,168 $
Total
530 $
1,141
2,335
1,150
46
487
5,689 $
— $ 6,133 $
(257 ) 95,182
(87 ) 54,733
(37 ) 19,964
618
—
1,846
—
10,494 $
97,286
35,456
7,259
572
1,359
(381 ) $ 178,476 $ 152,426 $
1,149 $
2,211
2,610
315
34
356
6,675 $
— $ 11,643
(22 ) 99,475
(4 ) 38,062
7,332
606
1,715
(268 ) $ 158,833
(242 )
—
—
The following table sets forth the contractual maturities, fair values and weighted-average yields for our securities held at December 31, 2012:
After Five
Years
But Within
Ten Years
Amount Yield Amount Yield Amount Yield Amount Yield Amount Yield
$ — —% $ 3,525 2.59 % $ 2,608 3.39 % $
After One Year
But Within
Five Years
Due Within
One Year
— —% $ 6,133 2.92 %
After Ten
Years
Total
828 4.76
— —
802 5.17 93,552 1.60 95,182 1.65
930 6.51 3,004 5.62 22,729 3.90 28,070 3.75 54,733 3.96
— — 7,235 6.21 1,123 5.14 11,606 2.33 19,964 3.77
618 6.50
— —
— —
930 6.51 % $ 14,592 5.08 % $ 27,262 3.94 % $ 133,846 2.12 % $ 176,630 2.65 %
618 6.50
— —
$
1,846
$ 178,476
U.S. Treasury and agencies
Agency mortgage-backed
State and municipal
Corporate bonds
Other debt
Total
Equity
Total
________________________________
Average yields in the table above were calculated on a tax equivalent basis using a federal income tax rate of 35%. Mortgage-backed securities
are securities that have been developed by pooling a number of real estate mortgages. These securities are issued by federal agencies such as
Government National Mortgage Association (“Ginnie Mae”), Fannie Mae and Freddie Mac, as well as non-agency company issuers. These
securities are deemed to have high credit ratings, and minimum regular monthly cash flows of principal and interest. Cash flows from agency
backed mortgage-backed securities are guaranteed by the issuing agencies.
Unlike U.S. Treasury and U.S. government agency securities, which have a lump sum payment at maturity, mortgage-backed securities provide
cash flows from regular principal and interest payments and principal prepayments throughout the lives of the securities. Mortgage-backed
securities that are purchased at a premium will generally suffer decreasing net yields as interest rates drop because home owners tend to
refinance their mortgages. Thus, the premium paid must be amortized over a shorter period. Therefore, those securities purchased at a discount
will obtain higher net yields in a decreasing interest rate environment. As interest rates rise, the opposite will generally be true. During a period
of increasing interest rates, fixed rate mortgage-backed securities do not tend to experience heavy prepayments of principal and consequently,
the average life of this security will not be shortened. If interest rates begin to fall, prepayments will increase. Non-agency issuer mortgage-
backed securities do not carry a government guarantee. We limit our purchases of these securities to bank qualified issues with high credit
ratings. We regularly monitor the performance and credit ratings of these securities and evaluate these securities, as we do all of our securities,
for other-than-temporary impairment on a quarterly basis. At December 31, 2012, 98.4% of the agency mortgage-backed securities we held had
contractual final maturities of more than ten years with a weighted average life of 24.9 years.
In December 2011, based upon relevant market information, we determined that our basis in twelve equity securities with an unrealized loss
position for more the 12 months was not recoverable in the near term. Therefore, during 2011, we recorded an other-than-temporary
impairment charge totaling $41,000 for these securities which had an adjusted cost basis of $206,000.
The Company held 40 equity securities at December 31, 2012. Management monitors the underlying financial condition of the issuers and
current market pricing for these equity securities monthly. At December 31, 2012, we had one equity securities in our portfolio with an
unrealized loss of less than $500.
Deposits – We attract both short-term and long-term deposits from the general public by offering a wide range of deposit accounts and interest
rates. In recent years, we have been required by market conditions to rely increasingly on short to mid-term certificate accounts and other
deposit alternatives, including brokered and wholesale deposits, which are more responsive to market interest rates. We use forecasts based on
interest rate risk simulations to assist management in monitoring our use of certificates of deposit and other deposit products as funding sources
and the impact of their use on interest income and net interest margin in various rate environments. At December 31, 2012, brokered deposits
totaled $15.0 million. We are currently restricted from accepting, renewing, or rolling-over brokered deposits without the prior receipt of a
waiver on a case-by-case basis from our regulators.
49
We primarily rely on our banking office network to attract and retain deposits in our local markets and leverage our online Ascencia division to
attract out-of-market deposits. Market interest rates and rates on deposit products offered by competing financial institutions can significantly
affect our ability to attract and retain deposits. During 2012, total deposits decreased $258.7 million compared with 2011. During 2011, total
deposits decreased $143.9 million compared with 2010. The decrease in deposits for 2012 and 2011 was primarily in certificates of deposit
balances and money market accounts.
To evaluate our funding needs in light of deposit trends resulting from continually changing conditions, management and board committees
evaluate simulated performance reports that forecast changes in margins along with other pertinent economic data. We continue to offer
attractively priced deposit products along our product line to allow us to retain deposit customers and reduce interest rate risk during various
rising and falling interest rate cycles.
We offer savings accounts, NOW accounts, money market accounts and fixed rate certificates with varying maturities. The flow of deposits is
influenced significantly by general economic conditions, changes in interest rates and competition. Our management adjusts interest rates,
maturity terms, service fees and withdrawal penalties on our deposit products periodically. The variety of deposit products allows us to
compete more effectively in obtaining funds and to respond with more flexibility to the flow of funds away from depository institutions into
outside investment alternatives. However, our ability to attract and maintain deposits and the costs of these funds has been, and will continue to
be, significantly affected by market conditions.
The following table sets forth the average daily balances and weighted average rates paid for our deposits for the periods indicated:
2012
Average
Balance
Average
Rate
For the Years Ended December 31,
2011
Average
Average
Balance
Rate
(dollars in thousands)
2010
Average
Balance
Average
Rate
$
113,325
89,820
63,212
38,665
912,061
$ 1,217,083
$
0.37 %
0.49
0.40
1.52
106,769
89,103
81,925
36,511
1,120,154
$ 1,434,462
1.20 %
$
0.74 %
0.96
0.62
1.65
102,383
83,111
81,430
35,393
1,156,724
$ 1,459,041
1.40 %
0.85 %
1.24
0.74
2.02
1.74 %
Demand
Interest Checking
Money Market
Savings
Certificates of Deposit
Total Deposits
Weighted Average Rate
The following table sets forth the average daily balances and weighted average rates paid for our certificates of deposit for the periods
indicated:
2012
Average
Balance
Average
Rate
For the Years Ended December 31,
2011
Average
Average
Balance
Rate
(dollars in thousands)
2010
Average
Balance
Average
Rate
$
$
478,502
433,559
912,061
569,667
1.40 % $
1.64
550,487
1.52 % $ 1,120,154
579,978
1.59 % $
1.71
576,746
1.65 % $ 1,156,724
2.00 %
2.05
2.02 %
Certificates of Deposit
Less than $100,000
$100,000 or more
Total
The following table shows at December 31, 2012 the amount of our time deposits of $100,000 or more by time remaining until maturity:
Maturity Period
Three months or less
Three months through six months
Six months through twelve months
Over twelve months
Total
Retail
Brokered
Total
(in thousands)
$
$
40,770 $
38,900
64,762
160,095
304,527 $
— $
15,000
—
—
15,000 $
40,770
53,900
64,762
160,095
319,527
50
We strive to maintain competitive pricing on our deposit products which we believe allows us to retain a substantial percentage of our
customers when their time deposits mature.
Borrowing – Deposits are the primary source of funds for our lending and investment activities and for our general business purposes. We can
also use advances (borrowings) from the FHLB of Cincinnati to supplement our pool of lendable funds, meet deposit withdrawal requirements
and manage the terms of our liabilities. Advances from the FHLB are secured by our stock in the FHLB, certain commercial real estate loans
and substantially all of our first mortgage residential loans. At December 31, 2012, we had $5.6 million in advances outstanding from the
FHLB and the capacity to increase our borrowings an additional $23.0 million. The FHLB of Cincinnati functions as a central reserve bank
providing credit for savings banks and other member financial institutions. As a member, we are required to own capital stock in the FHLB and
are authorized to apply for advances on the security of such stock and certain of our home mortgages and other assets (principally, securities
which are obligations of, or guaranteed by, the United States) provided that we meet certain standards related to creditworthiness.
The following table sets forth information about our FHLB advances as of and for the periods indicated:
Average balance outstanding
Maximum amount outstanding at any month-end during the period
End of period balance
Weighted average interest rate:
At end of period
During the period
$
2012
December 31,
2011
(dollars in thousands)
15,315 $
38,937
7,116
6,325 $
7,015
5,604
2010
47,800
110,763
15,022
3.21 %
3.27 %
3.31 %
3.51 %
3.87 %
4.22 %
Subordinated Capital Note – At December 31, 2012, our bank subsidiary, PBI Bank, had a subordinated capital note outstanding in the
amount of $7.0 million. The note is unsecured, bears interest at the BBA three-month LIBOR floating rate plus 300 basis points, and qualifies
as Tier 2 capital. Interest only was due quarterly through September 30, 2010, at which time quarterly principal payments of $225,000 plus
interest commenced. The note is due July 1, 2020. At December 31, 2012, the interest rate on this note was 3.36%.
Junior Subordinated Debentures – At December 31, 2012, we had four issues of junior subordinated debentures outstanding totaling $25.0
million as shown in the table below.
Liquidation
Amount
Trust
Preferred
Securities
Issuance Date
Optional
Prepayment
Date (2)
(dollars in thousands)
Junior
Subordinated
Debt and
Investment
in Trust
(dollars in thousands)
Interest Rate (1)
Maturity Date
$
5,000
2/13/2004
3/17/2009
3-month LIBOR + 2.85%
$
5,155
2/13/2034
3,000
4/15/2004
6/17/2009
3-month LIBOR + 2.79%
3,093
4/15/2034
14,000
12/14/2006
3/1/2012
3-month LIBOR + 1.67%
14,434
3/1/2037
$
3,000
25,000
2/13/2004
3/17/2009
3-month LIBOR + 2.85%
$
3,093
25,775
2/13/2034
Description
Porter Statutory
Trust II
Porter Statutory
Trust III
Porter Statutory
Trust IV
Asencia Statutory
Trust I
(1) As of December 31, 2012, the 3-month LIBOR was 0.31%.
(2) The debentures are callable on or after the optional prepayment date at their principal amount plus accrued interest.
The trust preferred securities are subject to mandatory redemption, in whole or in part, upon repayment of the subordinated debentures at
maturity or their earlier redemption at the liquidation preference. The subordinated debentures, which mature February 13, 2034, April 15,
2034, and March 1, 2037, are redeemable before the maturity date at our option on or after March 17, 2009, June 17, 2009, and March 1, 2012,
respectively, at their principal amount plus accrued interest. We have the option to defer interest payments on the subordinated debentures from
time to time for a period not to exceed 20 consecutive quarters. After such period, we must pay all deferred interest and resume quarterly
interest payments or we will be in default. Effective with the fourth quarter of 2011, we began deferring interest payments on our junior
subordinated debentures.
51
Deferring interest payments on our junior subordinated notes resulted in the deferral of distributions on our trust preferred securities. We will
be prohibited from paying cash dividends on our common stock until such time as we have paid all deferred distributions on our trust preferred
securities.
The trust preferred securities issued by our subsidiary trusts are currently included in our Tier 1 capital for regulatory purposes. On March 1,
2005, the Federal Reserve Board adopted final rules that continue to allow trust preferred securities to be included in Tier 1 capital, subject to
stricter quantitative and qualitative limits. Currently, no more than 25% of our Tier 1 capital can consist of trust preferred securities and
qualifying perpetual preferred stock. To the extent the amount of our trust preferred securities exceeds the 25% limit, the excess would be
includable in Tier 2 capital. The new quantitative limits were effective March 31, 2011. As of December 31, 2012, Porter Bancorp’s trust
preferred securities totaled 25% of its Tier 1 capital and 37% of its Tier 2 capital.
Each of the trusts issuing the trust preferred securities holds junior subordinated debentures we issued with a 30 year maturity. The final rules
provide that in the last five years before the junior subordinated debentures mature, the associated trust preferred securities will be excluded
from Tier 1 capital and included in Tier 2 capital. In addition, the trust preferred securities during this five-year period would be amortized out
of Tier 2 capital by one-fifth each year and excluded from Tier 2 capital completely during the year before maturity.
Liquidity
Liquidity risk arises from the possibility we may not be able to satisfy current or future financial commitments, or may become unduly reliant
on alternative funding sources. The objective of liquidity risk management is to ensure that we meet the cash flow requirements of depositors
and borrowers, as well as our operating cash needs, taking into account all on- and off-balance sheet funding demands. Liquidity risk
management also involves ensuring that we meet our cash flow needs at a reasonable cost. We maintain an investment and funds management
policy, which identifies the primary sources of liquidity, establishes procedures for monitoring and measuring liquidity, and establishes
minimum liquidity requirements in compliance with regulatory guidance. Our Asset Liability Committee continually monitors and reviews our
liquidity position.
Funds are available from a number of sources, including the sale of securities in the available-for-sale portion of the investment portfolio,
principal pay-downs on loans and mortgage-backed securities, customer deposit inflows, brokered deposits and other wholesale funding.
During 2012 and 2011, we utilized brokered deposits to supplement our funding strategy. At December 31, 2012, these deposits totaled $15.0
million compared with $118.4 million at December 31, 2011. We are currently restricted from accepting, renewing, or rolling-over brokered
deposits without the prior receipt of a waiver on a case-by-case basis from our regulators. The following table shows at December 31, 2012, the
amount of our brokered certificates of deposit by time remaining to maturity (in thousands):
Three months or less
Three months through six months
Six months through twelve months
Over twelve months
Total
$
$
—
15,000
—
—
15,000
Traditionally, we have borrowed from the FHLB to supplement our funding requirements. At December 31, 2012, we had an unused borrowing
capacity with the FHLB of $23.0 million.
After December 31, 2011, as a result of our recent financial results, the FHLB changed our collateral arrangements from a blanket pledge of
residential mortgage loans to a detailed loan listing requirement. Our borrowing capacity under the detailed loan listing requirement is based
on the market value of the underlying pledged loans rather than the unpaid principal balance of the pledged loans. The listing requirement also
increases the level of collateral required for borrowings.
We also secured federal funds borrowing lines from correspondent banks totaling $5.0 million on a secured basis. Management believes our
sources of liquidity are adequate to meet expected cash needs for the foreseeable future, however, the availability of these lines could be
affected by our financial position. We are also subject to FDIC interest rate restrictions for deposits. As such, we are permitted to offer up to the
“national rate” plus 75 basis points as published weekly by the FDIC.
52
We use cash to pay dividends on common stock, if and when declared by the Board of Directors, and to service debt. The main sources of
funding include dividends paid by PBI Bank, management fees received from PBI Bank and affiliated banks and financing obtained in the
capital markets. During 2011, Porter Bancorp contributed $13.1 million to its subsidiary, PBI Bank, which substantially decreased its liquid
assets. The contribution was made to strengthen the Bank’s capital in an effort to help it comply with its capital ratio requirements under the
consent order. Liquid assets decreased from $20.3 million at December 31, 2010, to $4.9 million at December 31, 2011, and to $3.5 million at
December 31, 2012. Since the Bank is unlikely to be in a position to pay dividends to the parent company for the foreseeable future, cash
inflows for the parent are limited to earnings on investment securities, sales of investment securities, and interest on deposits with the Bank.
These cash inflows along with the liquid assets held at December 31, 2012, are needed to cover ongoing operating expenses of the parent
company which have been reduced and are budgeted at $1.1 million for 2013. Parent company liquidity could be improved if a capital raise
was accomplished. See the “Supervision-Porter Bancorp-Dividends” section of Item 1. “Business” and the “Dividends” section of Item 5.
“Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities” of this Annual Report on
Form 10-K.
Capital
In the fourth quarter of 2011, we began deferring the payment of regular quarterly cash dividends on our Series A Preferred Stock issued to the
U.S. Treasury. If we defer dividend payments for six quarters, the holder of our Series A Preferred Stock (currently the U.S. Treasury) would
then have the right to appoint representatives to our Board of Directors. We will continue to accrue any deferred dividends, which will be
deducted from income to common shareholders for financial statement purposes.
In addition, effective with the fourth quarter of 2011, we began deferring interest payments on our junior subordinated notes with resulted in a
deferral of distributions on our trust preferred securities, Therefore, we will not be able to pay cash dividends on our common stock until such
time that we have paid all deferred distributions on our trust preferred securities.
Stockholders’ equity decreased $35.3 million to $47.2 million at December 31, 2012, compared with $83.8 million at December 31, 2011. The
decrease was due to the 2012 net loss and to dividends accrued on our Series A Preferred Stock.
In 2010, we completed a $32 million private placement to accredited investors. Following completion of the transactions involved, Porter
Bancorp had issued (i) 2,465,569 shares of common stock, (ii) 317,042 shares of Series C Preferred Stock and (iii) warrants to purchase to
purchase 1,163,045 shares of non-voting common stock at a price of $11.50 per share.
The Series C Preferred Stock has no voting rights (except when required by law), has a liquidation preference over our common stock, and
dividend rights equivalent to our common stock. Each share of Series C Preferred Stock automatically converts into 1.05 shares of common
stock at such time as, after giving effect to the automatic conversion, the holder of the Series C Preferred Stock (together with its affiliates and
any other persons with which it is acting in concert or whose holdings would otherwise be required to be aggregated for purposes of federal
banking law) beneficially holds, directly or indirectly, less than 9.9% of the number of shares of common stock then issued and outstanding.
The warrants are exercisable into non-voting common stock until they expire on September 16, 2015. The non-voting common stock has no
voting rights (except when required by law), but otherwise has the same dividend and other rights as our common stock. Upon issuance, each
share of non-voting common stock automatically converts into 1.05 shares of common stock at such time as, after giving effect to the automatic
conversion, the holder of the non-voting common stock (together with its affiliates and any other persons with which it is acting in concert or
whose holdings would otherwise be required to be aggregated for purposes of federal banking law) holds, directly or indirectly, beneficially
less than 9.9% of the number of shares of common stock then issued and outstanding.
On November 21, 2008, we issued to the U.S. Treasury, in exchange for aggregate consideration of $35.0 million, 35,000 shares of our Series
A Preferred Stock and a warrant to purchase up to 330,561 shares of our common stock for $15.88 per share. The warrant is immediately
exercisable and has a 10-year term. The Series A Preferred Stock qualifies as Tier 1 capital and pays cumulative cash dividends quarterly at an
annual rate of 5% for the first five years, and 9% thereafter. The Series A Preferred Stock is non-voting (except when required by law) and
after issuance may be redeemed by the Company at $1,000 per share plus accrued unpaid dividends. Dividends accrued and unpaid on our
Series A Preferred Stock, and interest accrued and unpaid on those dividends, totaled $2.5 million at December 31, 2012.
Kentucky banking laws limit the amount of dividends that may be paid to a holding company by its subsidiary banks without prior approval.
These laws limit the amount of dividends that may be paid in any calendar year to current year’s net income, as defined in the laws, combined
with the retained net income of the preceding two years, less any dividends declared during those periods. During 2013, the amount available to
be paid by PBI Bank to Porter Bancorp would be 2013 earnings to date. However, PBI Bank has agreed with its primary regulators to obtain
their written consent prior to declaring or paying any future dividends.
53
Each of the federal bank regulatory agencies has established risk-based capital requirements for banking organizations. See Item 1. Business –
Supervision and Regulation – Porter Bancorp – Capital Adequacy Requirements and PBI Bank – Capital Requirements. In addition, PBI Bank
has agreed with its primary regulators to maintain a ratio of total capital to total risk-weighted assets (“total risk-based capital ratio”) of at least
12.0%, and a ratio of Tier 1 capital to total assets (“leverage ratio”) of 9.0%.
The following table shows the ratios of Tier 1 capital and total capital to risk-adjusted assets and the leverage ratios for Porter Bancorp and PBI
Bank at December 31, 2012:
Regulatory
Minimums
Well-
Capitalized
Minimums
Minimum
Capital
Ratios
Under
Consent
Order
Porter
Bancorp
PBI
Bank
Tier 1 Capital
Total risk-based capital
Tier 1 leverage ratio
4.0 %
8.0
4.0
6.0 %
10.0
5.0
N/A
12.0 %
9.0
6.46 %
9.81
4.50
7.71 %
9.82
5.37
At December 31, 2012, PBI Bank’s Tier 1 leverage ratio declined to 5.37% which is below the 9% minimum capital ratio required by the
Consent Order and its total risk-based capital ratio declined to 9.82% which is below the 12% minimum capital ratio required by the Consent
Order. Bank regulatory agencies can exercise discretion when an institution does not maintain minimum capital levels or meet the other terms
of a consent order. The agencies may initiate changes in management, issue mandatory directives, impose monetary penalties or refrain from
formal sanctions, depending on individual circumstances. Any action taken by bank regulatory agencies could damage our reputation and have
a material adverse effect on our business.
See Footnote 2, “Going Concern Considerations and Future Plans”, to the financial statements for additional information.
Off Balance Sheet Arrangements
In the normal course of business, we enter into various transactions, which, in accordance with GAAP, are not included in our consolidated
balance sheets. We enter into these transactions to meet the financing needs of our customers. These transactions include commitments to
extend credit and standby letters of credit, which involve, to varying degrees, elements of credit risk and interest rate risk in excess of the
amounts recognized in the consolidated balance sheets.
Our commitments associated with outstanding standby letters of credit and commitments to extend credit as of December 31, 2012 are
summarized below. Since commitments associated with letters of credit and commitments to extend credit may expire unused, the amounts
shown do not necessarily reflect our actual future cash funding requirements:
Commitments to extend credit
Standby letters of credit
Total
$
$
25,418 $
2,261
27,679 $
One year
or less
More than 1
year but less
than 3 years
3 years or
more but less
than 5 years
(dollars in thousands)
1,993 $
—
1,993 $
11,356 $
—
11,356 $
5 years
or more
Total
14,104 $
—
14,104 $
52,871
2,261
55,132
Standby Letters of Credit – Standby letters of credit are written conditional commitments we issue to guarantee the performance of a
borrower to a third party. If the borrower does not perform in accordance with the terms of the agreement with the third party, we would be
required to fund the commitment. The maximum potential amount of future payments we could be required to make is represented by the
contractual amount of the commitment. If the commitment is funded, we would be entitled to seek recovery from the borrower. Our policies
generally require that standby letter of credit arrangements contain security and debt covenants similar to those contained in loan agreements.
Commitments to Extend Credit – We enter into contractual commitments to extend credit, normally with fixed expiration dates or
termination clauses, at specified rates and for specific purposes. Substantially all of our commitments to extend credit are contingent upon
borrowers maintaining specific credit standards at the time of loan funding. We minimize our exposure to loss under these commitments by
subjecting them to credit approval and monitoring procedures.
54
Contractual Obligations
The following table summarizes our contractual obligations and other commitments to make future payments as of December 31, 2012:
Time deposits
FHLB borrowing (1)
Subordinated capital note
Junior subordinated debentures
Total
One year
or less
More than 1
year but less
than 3 years
3 years or
more but less
than 5 years
5 years or
more
Total
$
$
409,593 $
1,125
900
—
411,618 $
(dollars in thousands)
24,868 $
1,184
1,800
—
27,852 $
326,027 $
1,398
1,800
—
329,225 $
85 $
1,897
2,475
25,000
29,457 $
760,573
5,604
6,975
25,000
798,152
(1) Fixed rate mortgage-matched borrowings with rates ranging from 0% to 5.25%, and maturities ranging from 2013 through 2033,
averaging 3.21%.
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 operating results in historical dollars without considering changes in the
relative purchasing power of money over time due to inflation.
We have an asset and liability structure that is essentially monetary in nature. As a result, interest rates have a more significant impact on our
performance than the effects of general levels of inflation. Periods of high inflation are often accompanied by relatively higher interest rates,
and periods of low inflation are accompanied by relatively lower interest rates. As market interest rates rise or fall in relation to the rates earned
on our loans and investments, the value of these assets decreases or increases respectively.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
To minimize the volatility of net interest income and exposure to economic loss that may result from fluctuating interest rates, we manage our
exposure to adverse changes in interest rates through asset and liability management activities within guidelines established by our Asset
Liability Committee (“ALCO”). The ALCO, which is comprised of senior management representatives, has the responsibility for approving
and ensuring compliance with asset/liability management policies. Interest rate risk is the exposure to adverse changes in the net interest
income as a result of market fluctuations in interest rates. The ALCO, on an ongoing basis, monitors interest rate and liquidity risk in order to
implement appropriate funding and balance sheet strategies. Management considers interest rate risk to be our most significant market risk.
We utilize an earnings simulation model to analyze net interest income sensitivity. We then evaluate potential changes in market interest rates
and their subsequent effects on net interest income. The model projects the effect of instantaneous movements in interest rates of both 100 and
200 basis points that are sustained for one year. Assumptions based on the historical behavior of our deposit rates and balances in relation to
changes in interest rates are also incorporated into the model. These assumptions are inherently uncertain and, as a result, the model cannot
precisely measure future net interest income or precisely predict the impact of fluctuations in market interest rates on net interest income.
Actual results will differ from the model’s simulated results due to timing, magnitude and frequency of interest rate changes as well as changes
in market conditions and the application and timing of various management strategies.
Our interest sensitivity profile was asset sensitive at December 31, 2012 and December 31, 2011. Given an instantaneous 100 basis point
increase in interest rates our base net interest income would increase by an estimated 4.0% at December 31, 2012 compared with an increase of
5.8% at December 31, 2011.
The following table indicates the estimated impact on net interest income under various interest rate scenarios for the year ended December 31,
2012, as calculated using the static shock model approach:
Change in Interest Rates
+ 200 basis points
+ 100 basis points
Change in Future
Net Interest Income
Dollar Change Percentage Change
(dollars in thousands)
$
2,883
1,460
8.11 %
4.11
We did not run a model simulation for declining interest rates as of December 31, 2012, because the Federal Reserve effectively lowered the
federal funds target rate between 0.00% to 0.25% in December 2008. Therefore, further short-term rate reductions are not practical. As we
implement strategies to mitigate the risk of rising interest rates in the future, these strategies will lessen our forecasted “base case” net interest
income in the event of no interest rate changes.
55
Our interest sensitivity at any point in time will be affected by a number of factors. These factors include the mix of interest sensitive assets and
liabilities as well as their relative pricing schedules. It is also influenced by market interest rates, deposit growth, loan growth, decay rates and
prepayment speed assumptions.
The following table sets forth the amounts of our interest-earning assets and interest-bearing liabilities outstanding at December 31, 2012,
which we anticipate, based upon certain assumptions, to reprice or mature in each of the future time periods shown. The projected repricing of
assets and liabilities anticipates prepayments and scheduled rate adjustments, as well as contractual maturities under an interest rate unchanged
scenario within the selected time intervals. While we believe such assumptions are reasonable, we cannot assure you that assumed repricing
rates will approximate our actual future activity.
Volume Subject to Repricing Within
0 – 90
Days
91 – 181
Days
182 – 365
Days
1 – 5
Years
(dollars in thousands)
Over 5
Years
Non-
Interest
Sensitive Total
Assets:
Federal funds sold and short-term
investments
Investment securities
FHLB stock
Loans held for sale
Loans, net of allowance
Fixed and other assets
Total assets
$
—
41,161 $
7,647
23,607
—
10,072
—
507
94,144
334,552
—
—
$ 409,899 $ 101,791
$
—
11,291
—
—
120,496
—
$ 131,787
$
—
56,537
—
—
246,679
—
$ 303,216
$
— $
65,459
—
—
103,221
—
$ 168,680 $
41,161
— $
178,476
13,935
10,072
—
507
—
842,412
(56,680 )
90,003
90,003
47,258 $ 1,162,631
Liabilities and Stockholders’
Equity
Interest-bearing checking,
savings, and money market
accounts
Certificates of deposit
Borrowed funds
Other liabilities
Stockholders’ equity
Total liabilities and
stockholders’ equity
Period gap
Cumulative gap
Period gap to total assets
Cumulative gap to total assets
Cumulative interest-earning
assets to cumulative
interest-bearing liabilities
$
$ 190,176 $
113,009
34,897
—
—
—
128,822
273
—
—
$
$
—
164,875
459
—
—
—
352,434
3,062
—
—
— $
1,433
1,522
—
—
— $ 190,176
760,573
—
40,213
—
124,479
124,479
47,190
47,190
$ 338,082 $ 129,095
(27,304 )
$
44,513
$
$
71,817
71,817 $
$ 165,334
$
$
(33,547 ) $
$
10,966
(52,280 ) $ 165,725
(41,314 ) $ 124,411
$ 355,496
$
2,955 $ 171,669 $ 1,162,631
6.18 %
6.18 %
(2.35 %)
3.83 %
(2.89 %)
0.94 %
(4.50 %)
(3.55 %)
14.25 %
10.40 %
121.24 %
109.53 %
101.73 %
95.82 %
112.55 %
Our one-year cumulative gap position as of December 31, 2012 was positive $11.0 million or 0.9% of assets. This is a one-day position that is
continually changing and is not necessarily indicative of our position at any other time. Any gap analysis has inherent shortcomings because
certain assets and liabilities may not move proportionally as interest rates change.
56
Item 8.
Financial Statements and Supplementary Data
The following consolidated financial statements and reports are included in this section:
Management’s Report on Internal Control Over Financial Reporting
Report of Independent Registered Public Accounting Firm
Consolidated Balance Sheets as of December 31, 2012 and 2011
Consolidated Statements of Operations for the Years Ended December 31, 2012, 2011, and 2010
Consolidated Statements of Comprehensive Loss for the Years Ended December 31, 2012, 2011, and 2010
Consolidated Statements of Change in Stockholders’ Equity for the Years Ended
December 31, 2012, 2011, and 2010
Consolidated Statements of Cash Flows for the Years Ended December 31, 2012, 2011, and 2010
Notes to Consolidated Financial Statements
57
MANAGEMENT’S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING
The Management of Porter Bancorp, Inc. (the “Company”) is responsible for the preparation, integrity, and fair presentation of the Company’s
annual consolidated financial statements. All information has been prepared in accordance with U.S. generally accepted accounting principles
and, as such, includes certain amounts that are based on Management’s best estimates and judgments.
Management is responsible for establishing and maintaining adequate internal control over financial reporting presented in conformity 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 the assets of the
Company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in
accordance with U.S. generally accepted accounting principles, and that receipts and expenditures of the Company are being made only in
accordance with authorizations of management and directors of the Company; and (3) provide reasonable assurance regarding prevention or
timely detection of unauthorized acquisition, use, or disposition of the Company’s assets that could have a material effect on the financial
statements.
Two of the objectives of internal control are to provide reasonable assurance to Management and the Board of Directors that transactions are
properly authorized and recorded in our financial records, and that the preparation of the Company’s financial statements and other financial
reporting is done in accordance with U.S. generally accepted accounting principles.
Management has made its own assessment of the effectiveness of the Company’s internal control over financial reporting as of December 31,
2012, in relation to the criteria described in the report, Internal Control — Integrated Framework, issued by the Committee of Sponsoring
Organizations of the Treadway Commission (“COSO”). Based on our assessment, Management concludes that as of December 31, 2012, the
Company’s internal control over financial reporting is effective based on those criteria.
There are inherent limitations in the effectiveness of internal control, including the possibility of human error and the circumvention or
overriding of controls. Accordingly, even effective internal control can provide only reasonable assurance with respect to reliability of financial
statements. Furthermore, the effectiveness of internal control can vary with changes in circumstances. Based on its assessment, Management
believes that as of December 31, 2012, the Company’s internal control was effective in achieving the objectives stated above.
/s/ Maria L. Bouvette
Maria L. Bouvette
Chairman and
Chief Executive Officer
February 28, 2013
/s/ Phillip W. Barnhouse
Phillip W. Barnhouse
Chief Financial Officer
58
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Porter Bancorp, Inc.
Louisville, Kentucky
We have audited the accompanying consolidated balance sheets of Porter Bancorp, Inc. as of December 31, 2012 and 2011, and the related
consolidated statements of operations, changes in stockholders’ equity and comprehensive income, and cash flows for each of the three years in
the period ended December 31, 2012. These consolidated financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these consolidated 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 financial statements are free of material
misstatement. The Company 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 Company’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 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 Porter
Bancorp, Inc. as of December 31, 2012 and 2011, and the results of its operations and its cash flows for each of the three years in the period
ended December 31, 2012, in conformity with U.S. generally accepted accounting principles.
The accompanying consolidated financial statements have been prepared assuming the Company will continue as a going concern. As
discussed in Note 2 to the consolidated financial statements, the Company has incurred substantial losses in 2012, 2011 and 2010, largely as a
result of asset impairments. In addition, the Company’s bank subsidiary is not in compliance with a regulatory enforcement order issued by its
primary federal regulator requiring, among other things, increased minimum regulatory capital ratios. Additional significant asset impairments
or continued failure to comply with the regulatory enforcement order may result in additional adverse regulatory action. These events raise
substantial doubt about the Company’s ability to continue as a going concern. Management’s plans with regard to these matters are also
discussed in Note 2 to the consolidated financial statements. The consolidated financial statements do not include any adjustments that might
result from the outcome of this uncertainty.
Crowe Horwath, LLP
Louisville, Kentucky
February 28, 2013
59
PORTER BANCORP, INC.
CONSOLIDATED BALANCE SHEETS
December 31,
(Dollar amounts in thousands except share data)
Assets
Cash and due from financial institutions
Federal funds sold
Cash and cash equivalents
Securities available for sale
Mortgage loans held for sale
Loans, net of allowance of $56,680 and $52,579, respectively
Premises and equipment
Other real estate owned
Federal Home Loan Bank stock
Bank owned life insurance
Accrued interest receivable and other assets
Total assets
Liabilities and Stockholders’ Equity
Deposits
Non-interest bearing
Interest bearing
Total deposits
Repurchase agreements
Federal Home Loan Bank advances
Accrued interest payable and other liabilities
Subordinated capital note
Junior subordinated debentures
Total liabilities
Commitments and contingent liabilities (Note 18)
Stockholders’ equity
Preferred stock, no par, 1,000,000 shares authorized
Series A - 35,000 issued and outstanding; Liquidation preference of
$35 million at December 31, 2012
Series C – 317,042 issued and outstanding; Liquidation preference of
$3.6 million at December 31, 2012
Common stock, no par, 86,000,000 shares authorized, 12,002,421 and
11,824,472 shares issued and outstanding, respectively
Additional paid-in capital
Retained deficit
Accumulated other comprehensive income
Total stockholders' equity
Total liabilities and stockholders’ equity
See accompanying notes.
60
$
$
$
2012
2011
46,512 $
3,060
49,572
178,476
507
842,412
20,805
43,671
10,072
8,398
8,718
1,162,631 $
104,680
1,282
105,962
158,833
694
1,083,444
21,541
41,449
10,072
8,106
25,323
1,455,424
114,310 $
950,749
1,065,059
2,634
5,604
10,169
6,975
25,000
1,115,441
—
111,118
1,212,645
1,323,763
1,738
7,116
7,628
7,650
25,000
1,372,895
—
34,840
34,661
3,283
3,283
112,236
20,283
(126,517 )
3,065
47,190
1,162,631 $
112,236
19,841
(91,656 )
4,164
82,529
1,455,424
$
PORTER BANCORP, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
Years Ended December 31,
(Dollar amounts in thousands except per share data)
2012
2011
2010
Interest income
Loans, including fees
Taxable securities
Tax exempt securities
Federal funds sold and other
Interest expense
Deposits
Federal Home Loan Bank advances
Junior subordinated debentures
Subordinated capital note
Federal funds purchased and other
Net interest income
Provision for loan losses
Net interest income (loss) after provision for loan losses
Non-interest income
Service charges on deposit accounts
Income from fiduciary activities
Bank card interchange fees
Other real estate owned rental income
Secondary market brokerage fees
Net gain on sales of loans originated for sale
Net gain on sales of securities
Other-than-temporary impairment loss
Total impairment loss
Loss recognized in other comprehensive income
Net impairment loss recognized in earnings
Other
Non-interest expense
Salaries and employee benefits
Occupancy and equipment
Goodwill impairment
Other real estate owned expense
FDIC insurance
Loan collection expense
State franchise tax
Professional fees
Communications
Borrowing prepayment fees
Postage and delivery
Advertising
Other
Loss before income taxes
Income tax expense (benefit)
Net loss
Less:
Dividends on preferred stock
Accretion on Series A preferred stock
(Earnings) loss allocated to participating securities
Net loss attributable to common shareholders
Basic loss per common share
Diluted loss per common share
$
52,918 $
3,333
887
591
57,729
14,623
207
671
266
7
15,774
41,955
40,250
1,705
2,239
1,177
727
420
94
338
3,236
—
—
—
1,359
9,590
16,648
3,642
—
10,549
2,835
2,442
2,174
1,985
710
—
454
154
2,699
44,292
(32,997 )
(65 )
(32,932 )
67,679 $
4,008
1,123
744
73,554
20,147
537
632
283
440
22,039
51,515
62,600
(11,085 )
2,609
993
668
200
219
713
1,108
(41 )
—
(41 )
1,364
7,833
15,218
3,729
23,794
47,525
3,470
2,509
2,228
1,392
678
486
485
314
2,445
104,273
(107,525 )
(218 )
(107,307 )
(1,750 )
(179 )
1,429
(33,432 ) $
(2.85 ) $
(2.85 ) $
(1,750 )
(177 )
4,080
(105,154 ) $
(8.98 ) $
(8.98 ) $
$
$
$
77,559
7,338
854
656
86,407
25,392
2,015
639
311
484
28,841
57,566
30,100
27,466
2,984
987
606
121
327
554
5,152
(597 )
—
(597 )
1,448
11,582
14,903
4,095
—
16,254
2,971
908
2,172
1,067
737
—
722
408
2,241
46,478
(7,430 )
(3,046 )
(4,384 )
(1,810 )
(177 )
184
(6,187 )
(0.60 )
(0.60 )
See accompanying notes.
61
PORTER BANCORP, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS
Years Ended December 31,
(in thousands)
Net loss
Other comprehensive income (loss):
Unrealized gain (loss) on securities:
Unrealized gain (loss) arising during the period
Reclassification of other than temporary impairment
Reclassification of amount realized through sales
Included in net loss
Tax effect
Net of tax
Comprehensive loss
2012
$
(32,932 ) $
2011
(107,307 ) $
2010
(4,384 )
1,545
—
(3,236 )
(1,691 )
592
(1,099 )
(34,031 ) $
4,162
41
(1,108 )
3,095
(1,083 )
2,012
(105,295 ) $
4,553
597
(5,152 )
(2 )
1
(1 )
(4,385 )
$
See accompanying notes.
62
PORTER BANCORP, INC.
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY
Years Ended December 31,
(Dollar amounts in thousands except share and per share data)
Shares
Amount
Common
Series A
Preferred
Series B
Preferred
Series C
Preferred Common
Series A
Preferred
Series B
Preferred
Series C
Preferred
Additional
Paid-In
Capital
Retained
(Deficit)
Accumulated
Other
Comprehensive
Income (Loss) Total
8,756,440
35,000
—
— $
83,104
$ 34,307 $
—
$
—
$
14,959
$ 34,811 $
2,153
$ 169,334
1,820,531
— 597,000 365,080
17,429
—
6,182
3,780
3,149
—
— 30,540
597,000
— (597,000 )
—
6,182
—
(6,182 )
—
—
—
—
—
48,038
—
—
(48,038 )
497
—
—
(497 )
—
—
—
—
69,182
(9,566 )
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
482
—
—
(4,384 )
—
—
482
(4,384 )
—
—
—
—
—
—
—
—
—
—
(1 )
(1 )
—
—
—
—
—
—
—
—
—
(1,750 )
—
(1,750 )
—
—
—
—
—
—
—
—
—
(60 )
—
(60 )
—
—
—
—
—
—
—
—
—
(40 )
—
(40 )
—
—
—
—
—
177
—
—
—
(177 )
—
—
—
564,482
—
—
—
—
—
—
—
5,024
—
—
—
—
—
—
(4,706 )
—
(4,706 )
—
848
(5,872 )
—
—
Balances,
January 1,
2010
Issuance of stock
and warrants
in private
placement
Conversion of
Series B
preferred to
common
Conversion of
Series C
preferred to
common
Issuance of
unvested
stock
Forfeited unvested
stock
Stock-based
compensation
expense
Net loss
Changes in
accumulated
other
comprehensive
income, net
of taxes
Dividends 5% on
Series A
preferred
stock
Dividends on
Series B
preferred
stock ($0.10
per share)
Dividends on
Series C
preferred
stock ($0.10
per share)
Accretion of Series
A preferred
stock
discount
Cash dividends
declared
($0.49 per
share)
5% stock dividend
declared
Balances,
December 31,
2010
Issuance of
11,846,107
35,000
— 317,042 112,236 34,484
—
3,283
19,438 17,822
2,152 189,415
unvested
stock
Forfeited unvested
stock
Stock-based
compensation
expense
Net loss
Changes in
accumulated
other
2,800
(24,435 )
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
403
— (107,307 )
403
—
— (107,307 )
comprehensive
income, net
of taxes
Dividends 5% on
Series A
preferred
stock
Dividends on
Series C
preferred
stock ($0.02
per share)
Accretion of Series
A preferred
stock
discount
Cash dividends
declared
($0.02 per
share)
Balances,
—
—
—
—
—
—
—
—
—
—
2,012
2,012
—
—
—
—
—
—
—
—
—
(1,750 )
—
(1,750 )
—
—
—
—
—
—
—
—
—
(7 )
—
(7 )
—
—
—
—
—
177
—
—
—
(177 )
—
—
—
—
—
—
—
—
—
—
—
(237 )
—
(237 )
December 31,
2011
Issuance of
11,824,472
35,000
— 317,042 112,236 34,661
—
3,283
19,841 (91,656 )
4,164 82,529
unvested
stock
Forfeited unvested
stock
Stock-based
compensation
expense
Net loss
Changes in
accumulated
other
comprehensive
income, net
of taxes
Dividends 5% on
Series A
preferred
stock
Accretion of Series
A preferred
stock
discount
Balances,
191,140
(13,191 )
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
442
—
— (32,932 )
—
442
— (32,932 )
—
—
—
—
—
—
—
—
—
—
(1,099 )
(1,099 )
—
—
—
—
—
—
—
—
—
(1,750 )
—
(1,750 )
—
—
—
—
—
179
—
—
—
(179 )
—
—
December 31,
2012
12,002,421
35,000
— 317,042 $ 112,236 $ 34,840 $
— $
3,283 $
20,283 $ (126,517 ) $
3,065 $ 47,190
See accompanying notes.
63
PORTER BANCORP, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended December 31,
(in thousands)
Cash flows from operating activities
Net loss
Adjustments to reconcile net loss to net cash from operating activities
2012
2011
2010
$
(32,932 ) $
(107,307 ) $
(4,384 )
Depreciation and amortization
Provision for loan losses
Net amortization (accretion) on securities
Goodwill impairment charge
Stock-based compensation expense
Deferred income taxes (benefit)
Net gain on sales of loans originated for sale
Loans originated for sale
Proceeds from sales of loans originated for sale
Net loss on sales of other real estate owned
Net write-down of other real estate owned
Net realized gain on sales of investment securities
Earnings on bank owned life insurance
Net change in accrued interest receivable and other assets
Net change in accrued interest payable and other liabilities
Net cash from operating activities
Cash flows from investing activities
Purchases of available-for-sale securities
Sales of available-for-sale securities
Maturities and prepayments of available-for-sale securities
Proceeds from sale of other real estate owned
Improvements to other real estate owned
Loan originations and payments, net
Purchases of premises and equipment, net
Net cash from investing activities
Cash flows from financing activities
Net change in deposits
Net change in repurchase agreements
Repayment of Federal Home Loan Bank advances
Advances from Federal Home Loan Bank
Repayment of subordinated capital note
Issuance of preferred stock and warrants, net
Issuance of common stock and warrants, net
Cash dividends paid on preferred stock
Cash dividends paid on common stock
Net cash from financing activities
Net change in cash and cash equivalents
Beginning cash and cash equivalents
Ending cash and cash equivalents
Supplemental cash flow information:
Interest paid
Income taxes paid (refunded)
Supplemental non-cash disclosure:
Transfer from loans to other real estate
Financed sales of other real estate owned
5% Stock dividend
2,288
40,250
3,335
—
442
—
(338 )
(16,365 )
16,827
1,672
7,154
(3,236 )
(292 )
16,150
791
35,746
(162,840 )
93,199
48,800
21,940
(1 )
167,272
(511 )
167,859
(258,704 )
896
(1,512 )
—
(675 )
—
—
—
—
(259,995 )
(56,390 )
105,962
49,572 $
15,402 $
(12,726 )
33,528 $
541
—
2,389
62,600
1,552
23,794
436
12,958
(713 )
(24,881 )
24,649
8,889
34,874
(1,067 )
(301 )
(7,062 )
(575 )
30,235
(123,609 )
50,318
23,378
14,142
(1,650 )
92,190
(332 )
54,437
(143,905 )
(9,878 )
(32,906 )
25,000
(900 )
—
—
(1,319 )
(237 )
(164,145 )
(79,473 )
185,435
105,962 $
22,218 $
2,000
41,917 $
11,848
—
2,926
30,100
(9 )
—
467
(7,898 )
(554 )
(28,165 )
28,467
565
14,062
(4,555 )
(296 )
3,667
(485 )
33,908
(55,750 )
96,808
25,917
15,284
(1,947 )
6,160
(368 )
86,104
(62,428 )
99
(307,958 )
240,000
(450 )
11,064
19,476
(1,847 )
(4,706 )
(106,750 )
13,262
172,173
185,435
29,637
4,850
90,787
9,736
5,872
$
$
$
See accompanying notes .
64
PORTER BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2012, 2011 and 2010
NOTE 1 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Nature of Operations and Principles of Consolidation – The consolidated financial statements include Porter Bancorp, Inc. (Company or
PBI) and its subsidiary, PBI Bank (Bank). The Company owns a 100% interest in the Bank.
The Company provides financial services through its offices in Central Kentucky and Louisville. Its primary deposit products are checking,
savings, and term certificate accounts, and its primary lending products are residential mortgage, commercial, and real estate loans.
Substantially all loans are collateralized by specific items of collateral including business assets, commercial real estate, and residential real
estate. Commercial loans are expected to be repaid from cash flow from operations of businesses. There are no significant concentrations of
loans to any one industry or customer. However, customers’ ability to repay their loans is dependent on the real estate and general economic
conditions in the area. Other financial instruments which potentially represent concentrations of credit risk include deposit accounts in other
financial institutions and federal funds sold. The Company also provides trust services.
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 future results could differ. The allowance for loan losses, goodwill and other intangible assets, fair
value of other real estate owned, stock compensation, deferred tax assets, and fair values of financial instruments are particularly subject to
change.
Cash Flows – Cash and cash equivalents include cash, deposits with other financial institutions under 90 days, and federal funds sold. Net cash
flows are reported for customer and loan deposit transactions, interest-bearing deposits in other financial institutions, and federal funds
purchased and repurchase agreements.
Securities – Debt securities are classified as available-for-sale when they might be sold before maturity. Equity securities with readily
determined fair values are classified as available-for-sale. Securities available for sale are carried at fair value, with unrealized holding gains
and losses reported in other comprehensive income.
Interest income includes amortization of purchase premium or discount. Premiums and discounts on securities are amortized on the level-yield
method anticipating prepayments on mortgage backed securities. Gains and losses on sales are recorded on the trade date and determined using
the specific identification method.
Management evaluates securities for other-than-temporary impairment (“OTTI”) on at least 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 the criteria regarding intent or requirement to sell is met, the entire difference between amortized cost and fair value is
recognized as impairment through earnings. For debt 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 statement and 2) other-than-temporary
impairment (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. For equity securities, the entire amount of
impairment is recognized through earnings.
Loans Held for Sale – Mortgage loans originated and intended for sale in the secondary market are carried at the lower of aggregate cost or
fair value, as determined by outstanding commitments from investors. Net unrealized losses, if any, are recorded as a valuation allowance and
charged to earnings.
Mortgage loans held for sale are generally sold with servicing rights released. If sold with servicing retained, the carrying value of mortgage
loans sold is reduced by the amount allocated to the servicing right. Gains and losses on sales of mortgage loans are based on the difference
between the selling price and the carrying value of the related loan sold.
Mortgage banking derivatives used in the ordinary course of business consist of mandatory forward sales contracts and rate lock loan
commitments. Forward contracts represent future commitments to deliver loans at a specified price and date and are used to manage interest
rate risk on loan commitments and mortgage loans held for sale. Rate lock commitments represent commitments to fund loans at a specific rate.
These derivatives involve underlying items, such as interest rates, and are designed to transfer risk. Substantially all of these instruments expire
within 60 days from the date of issuance. Notional amounts are amounts on which calculations and payments are based, but which do not
represent credit exposure, as credit exposure is limited to the amounts required to be received or paid.
65
We adopted FASB ASC topic 815, “Derivative and Hedging” during the first quarter of 2009. Our commitments to deliver loans and our rate
lock loan commitments were insignificant at year end.
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, net of 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 the outstanding principal balance and unamortized
deferred origination costs and fees.
Interest income on mortgage and commercial loans is discontinued at the time the loan is 90 days delinquent unless the loan is well
collateralized and in process of collection. Consumer and credit card loans are typically charged off no later than 90 days past due. Past due
status is based on 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 for 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 all the
principal and interest amounts contractually due are brought current and future payments are reasonably assured.
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 uncollectibility of a loan balance is confirmed. Subsequent recoveries, if any,
are credited to the allowance. We estimate the allowance balance required using 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 our 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. A loan is impaired when, based on current information and events, it is probable that the Company 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 troubled debt restructurings and classified as
impaired.
Factors considered 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. We determine the significance of payment delays and payment shortfalls on 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.
If a loan is impaired, a portion of the allowance is allocated so that 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 solely from the collateral. Large groups of smaller
balance homogeneous loans, such as consumer and residential real estate loans, are collectively evaluated for impairment, and accordingly,
they are not separately identified for impairment disclosures. 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 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, we determine 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 our actual loss history experienced over the most recent three years with
weighting towards the most recent periods. 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 delinquencies and impaired
loans; levels of and trends in charge-offs and recoveries; 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. At
year-end 2010, we increased our emphasis on historical loss experience and the qualitative factors discussed above that we believe are essential
to assessing the general component of the reserve. We believe this added emphasis serves to ensure our estimates affecting the general
component of the reserve most effectively parallel changing risks in the market in a timely fashion.
66
A portfolio segment is defined as the level at which an entity develops and documents a systematic methodology to determine its allowance for
loan losses. We identified the following portfolio segments: commercial, commercial real estate, residential real estate, consumer, agricultural,
and other.
● Commercial loans are dependent on the strength of the industries of the related borrowers and the success of their businesses.
Commercial loans are advances for equipment purchases, or to provide working capital, or to meet other financing needs of business
enterprises. These loans may be secured by accounts receivable, inventory, equipment or other business assets. Financial information
is obtained from the borrowers to evaluate their ability to repay the loans.
● Commercial real estate loans are affected by the local commercial real estate market and the local economy. Commercial real estate
loans include loans on properties occupied by the borrowers and on properties for commercial purposes. Construction and
development loans are a component of this segment. These loans are generally secured by land under development or homes and
commercial buildings under construction. Appraisals are obtained to support the loan amount. Financial information is obtained from
the borrowers and/or the individual project to evaluate cash flows sufficiency to service the debt.
● Residential real estate loans are affected by the local residential real estate market, local economy, and, for variable rate mortgages,
movement in indices tied to these loans. For owner occupied residential loans, the borrowers’ repayment ability is evaluated through a
review of credit scores and debt to income ratios. For non-owner occupied residential loans, such as rental real estate, financial
information is obtained from the borrowers and/or the individual project to evaluate cash flows sufficiency to service the debt.
Appraisals are obtained to support the loan amount.
● Consumer loans are dependent on local economies. Consumer loans are generally secured by consumer assets, but may be unsecured.
We evaluate the borrowers’ repayment ability through a review of credit scores and an evaluation of debt to income ratios.
● Agriculture loans are dependent on the industries tied to these loans and are generally secured by livestock, crops, and/or equipment,
but may be unsecured. We evaluate the borrowers’ repayment ability through a review of credit scores and an evaluation of debt to
income ratios.
● Other loans include loans to municipalities, loans secured by stock, and overdrafts. For municipal loans, we evaluate the borrowers’
revenue streams as well as ability to repay form general funds. For loans secured by stock, we evaluate the market value of the stock
securing the loan in relation to the loan amount. Overdrafts are funded based on pre-established criteria related to the deposit account
relationship.
We analyze all relevant risk characteristics for each portfolio segment and have determined that loans in each segment possess similar general
risk characteristics that are analyzed in connection with our loan underwriting processes and procedures. In determining the allocated
allowance, we utilize weighted average loss rates for the past three years most heavily weighting the current year. Commercial real estate loans
are our largest segment and had the highest level of qualitative adjustments due to trends in our markets for underlying collateral values and
risks related to tenant rents and for economic factors such as decreased sales demand, elevated inventory levels, and declining collateral
values. Residential real estate loan considerations include macro factors such as unemployment rates, trends in vacancy rates, and home value
trends. The commercial portfolio qualitative adjustments are related to industry concentrations and geographical market. Our agricultural,
consumer, and other portfolios are less significant in terms of size and risk is assessed based on the smaller dollar size of these loans and the
more geographical areas where the collateral is located.
Transfers of Financial Assets – Transfers of financial assets are accounted for as sales, when control over the assets has been
relinquished. Control over transferred assets is deemed to be surrendered when the assets have been isolated from the Company, the transferee
obtains the right (free of conditions that constrain it from taking advantage of that right) to pledge or exchange the transferred assets, and the
Company does not maintain effective control over the transferred assets through an agreement to repurchase them before their maturity.
Other Real Estate Owned – Assets acquired through or instead of loan foreclosure are initially recorded at fair value less estimated costs to
sell when acquired, establishing a new cost basis. These assets are subsequently accounted for at the lower of cost or fair value, less estimated
costs to sell. If fair value declines subsequent to foreclosure, a valuation allowance is recorded through expense. Costs after acquisition are
expensed.
Premises and Equipment – Land is carried at cost. Premises and equipment are stated at cost less accumulated depreciation. Buildings and
related components are depreciated using the straight-line method with useful lives ranging from 5 to 33 years. Furniture, fixtures and
equipment are depreciated using the straight-line or accelerated method with useful lives ranging from 3 to 7 years.
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 is carried at cost, classified as a
restricted security, and periodically evaluated for impairment. Because this stock is viewed as long term investment, impairment is based on
ultimate recovery of par value. Both cash and stock dividends are reported as income.
67
Goodwill and Intangible Assets – Goodwill resulting from business combinations prior to January 1, 2009, represents the excess of the
purchase price over the fair value of the net assets of businesses acquired. Goodwill resulting from business combinations after January 1,
2009, is generally determined as the excess of the fair value of the consideration transferred, plus the fair value of any non-controlling interests
in the acquiree, over the fair value of the net assets acquired and liabilities assumed as of the acquisition date. Goodwill and intangible assets
acquired in a purchase business combination and determined to have an indefinite useful life are not amortized, but tested for impairment at
least annually. Intangible assets with definite useful lives are amortized over their estimated useful lives to their estimated residual values.
Intangible assets on our balance sheet, other than goodwill, have defined useful lives. The Company has selected November 30th as the date to
perform the annual impairment test on goodwill unless events or changes in circumstances indicate potential impairment may have occurred
between annual assessments. We assessed our goodwill for impairment during the second quarter of 2011 because our stock, which trades
publicly on the NASDAQ, experienced a significant drop in value throughout the months of May and June 2011. Based on this analysis, we
determined that our Goodwill was impaired and recorded an impairment charge of $23.8 million in the quarter ended June 30, 2011. The
impairment charge had no impact on the Company’s liquidity, cash flows, or regulatory capital ratios. (See Note 7 for more specific
disclosure.)
Other intangible assets consist of core deposit and trust account intangible assets arising from whole bank and branch acquisitions. They are
initially measured at fair value and then are amortized on an accelerated or straight-line basis over their estimated useful lives, which range
from 7 to 10 years.
Bank Owned Life Insurance – The Bank has purchased life insurance policies on certain key executives. Company 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 charges or other amounts due that are probable at settlement.
Long-Term Assets – Premises and equipment, 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 represent amounts advanced by various customers. Securities are
pledged to cover these liabilities, which are not covered by federal deposit insurance.
Benefit Plans – Employee 401(k) and profit sharing plan expense is the amount of matching contributions. Deferred compensation and
supplemental retirement plan expense allocates the benefits over years of service.
Stock-Based Compensation – Compensation cost is recognized for stock options and unvested stock awards issued to employees, based on
the fair value of these awards at the date of grant. A Black-Scholes model is utilized to estimate the fair value of stock options, while the
market price of the Corporation’s common stock at the date of grant is used for restricted stock awards. Compensation cost is recognized over
the required service period, generally defined as the vesting period. For awards with graded vesting, compensation cost is recognized on a
straight-line basis over the requisite service period for the entire award.
Income Taxes – Income tax expense is the total 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 amounts for the temporary differences between carrying amounts and
tax bases 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.
A tax position is recognized as a benefit only if it is "more likely than not" that the tax 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 that is greater than 50% likely of being
realized on examination. For tax positions not meeting the "more likely than not" test, no tax benefit is recorded. The Company recognizes
interest and/or penalties related to income tax matters in income tax expense.
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 they
are funded.
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.
68
Equity – Stock dividends in excess of 20% are reported by transferring the par value of the stock issued from retained earnings to common
stock. Stock dividends for 20% or less are reported by transferring the fair value, as of the ex-dividend date, of the stock issued from retained
earnings to common stock and additional paid-in capital. Fractional share amounts are paid in cash with a reduction in retained earnings.
Preferred Stock – Series A Preferred stock was issued in 2008 and is outstanding under the United States Department of the Treasury’s
Capital Purchase Program. Issued in conjunction with the Preferred Stock were common stock warrants. See Note 16 for a discussion of the
terms and conditions of that transaction. The proceeds received in the offering were allocated on a pro rata basis to the Preferred Stock and the
Warrants based on relative fair values. In estimating the fair value of the Warrants, the Company utilized the Black-Scholes model which
includes assumptions regarding the Company’s common stock prices, stock price volatility, dividend yield, the risk free interest rate and the
estimated life of the Warrant. The fair value of the Preferred Stock was determined using a discounted cash flow methodology. The value
assigned to the Preferred Stock will be amortized up to the $35.0 million liquidation value of such preferred stock, with the cost of such
amortization being reported as additional preferred stock dividends. Dividends are accrued quarterly. Quarterly cash payment of dividends was
deferred effective with the fourth quarter of 2011. (See Note 16 for more specific disclosure.)
Series B and C Preferred stock were issued in 2010 and Series C Preferred stock remains outstanding. See Note 16 for a discussion of the
terms and conditions of this transaction.
Earnings Per Common Share – Basic earnings per common share are net income available to common shareholders divided by the weighted
average number of common shares outstanding during the period. Diluted earnings per common share include the dilutive effect of additional
potential common shares issuable under stock options and warrants. Earnings and dividends per share are restated for all stock splits and
dividends through the date of issue of the financial statements.
Earnings (Loss) Allocated to Participating Securities – Our issued and outstanding Series C Preferred Stock is automatically convertible into
common stock at such time as the holder together with its affiliates beneficially own less than 9.9% of the then outstanding common shares of
the company. We also have issued and outstanding unvested common shares to employees and directors through our stock incentive
plan. Earnings (loss) are allocated to these participating securities based on their percentage of total issued and outstanding shares.
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 now are such matters that will have a material effect on the financial statements.
Dividend Restriction – Banking regulations require maintaining certain capital levels and may limit the dividends paid by the Bank to the
Company or by the Company to shareholders. (See Note 17 for more specific disclosure.)
Fair Value of Financial Instruments – Fair values of financial instruments are estimated using relevant market information and other
assumptions, as more fully disclosed in Note 19. Fair value estimates involve uncertainties and matters of significant judgment regarding
interest rates, credit risk, 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.
Reclassifications – Some items in the prior year financial statements were reclassified to conform to the current presentation. Reclassifications
had no effect on prior year net loss or shareholders’ equity.
NOTE 2 – GOING CONCERN CONSIDERATIONS AND FUTURE PLANS
The consolidated financial statements have been prepared on a going concern basis, which contemplates the realization of assets and the
satisfaction of liabilities in the normal course of business for the foreseeable future. However, the events and circumstances described in this
Note create an uncertainty about the Company’s ability to continue as a going concern.
For the year ended December 31, 2012, we reported net loss to common shareholders of $33.4 million. This loss was attributable primarily to
$40.3 million of provision for loan losses expense due to continued decline in credit trends in our portfolio that resulted in net charge-offs of
$36.1 million, OREO expense of $10.5 million resulting from fair value write-downs driven by new appraisals and reduced marketing prices,
net loss on sales, and ongoing operating expense. We also had lower net interest margin due to lower average loans outstanding, loans re-
pricing at lower rates, and the level of non-performing loans in our portfolio. Net loss to common shareholders of $33.4 million, for the year
ended December 31, 2012, compares with net loss to common shareholders of $105.2 million for year ended December 31, 2011.
69
During the year ended December 31, 2011, we recorded a net loss to common shareholders of $105.2 million. This loss was attributable to a
$23.8 million goodwill impairment charge, the establishment of a $31.7 million valuation allowance on our deferred tax assets, OREO expense
of $47.5 million related to valuation adjustments for our change in strategy related to certain properties, fair value write-downs related to new
appraisals received for properties in the portfolio during 2011, net loss on the sale of OREO properties, and increase in carrying costs
associated with carrying these higher levels of assets. We also recorded a provision for loan losses expense of $62.6 million due to the
continued decline in credit trends within our portfolio.
In June 2011, the Bank entered into a Consent Order with the FDIC and KDFI in which the Bank agreed, among other things, to improve asset
quality, reduce loan concentrations, and maintain a minimum Tier 1 leverage ratio of 9% and a minimum total risk based capital ratio of 12%.
The Consent Order was included in our Current Report on 8-K filed on June 30, 2011. In October 2012, the Bank entered into a new Consent
Order with the FDIC and KDFI again agreeing to maintain a minimum Tier 1 leverage ratio of 9% and a minimum total risk based capital ratio
of 12%. The Bank also agreed that if it should be unable to reach the required capital levels, and if directed in writing by the FDIC, then the
Bank would within 30 days develop, adopt and implement a written plan to sell or merge itself into another federally insured financial
institution or otherwise immediately obtain a sufficient capital investment into the Bank to fully meet the capital requirements.
We expect to continue to work with our regulators toward capital ratio compliance as outlined in the written capital plan submitted by the Bank
in December 2012. The new Consent Order also requires the Bank to continue to adhere to the plans implemented in response to the June 2011
Consent Order, and includes the substantive provisions of the June 2011 Consent Order. The new Consent Order was included in our Current
Report on 8-K filed on September 19, 2012. As of December 31, 2012, the capital ratios required by the Consent Order were not met.
In order to meet these capital requirements, the Board of Directors and management are continuing to evaluate strategies to achieve the
following objectives:
●
Increasing capital through a possible public offering or private placement of common stock to new and existing shareholders. We
have engaged Sandler O’Neill & Partners, LP to act as our financial advisor and to assist our Board in this evaluation and to assist in
evaluating our options for the redemption of our Series A preferred stock issued to the US Treasury in 2008 under the Capital
Purchase Program.
● Continuing to operate the Company and Bank in a safe and sound manner. This strategy will require us to reduce our lending
concentrations, remediate non-performing loans, and reduce other noninterest expense through the disposition of OREO.
● Continuing with succession planning and adding resources to the management team. John T. Taylor was named President and CEO
for PBI Bank and appointed to the board of directors in July 2012. Additionally, John R. Davis was appointed Chief Credit Officer of
PBI Bank in August 2012, with responsibility for establishing and executing the credit quality policies and overseeing credit
administration for the organization.
● Evaluating our internal processes and procedures, distribution of labor, and work-flow to ensure we have adequately and appropriately
deployed resources in an efficient manner in the current environment. To this end, we believe the opportunity exists for the
centralization of key processes which will lead to improved execution and cost savings.
● Executing on our commitment to improve credit quality and reduce loan concentrations and balance sheet risk.
o We have reduced the size of our loan portfolio significantly from $1.3 billion at December 31, 2010 to $1.1 billion at
December 31, 2011, and $899.1 million at December 31, 2012. We have significantly improved our staffing in the
commercial lending area which is now led by John R. Davis, who joined the management team in August 2012 and now
serves as Chief Credit Officer.
o Our Consent Order calls for us to reduce our construction and development loans to not more than 75% of total risk-based
capital. We were not in compliance at December 31, 2012 with construction and development loans representing 82% of total
risk-based capital. These loans totaled $70.3 million, or 82% of total risk-based capital, at December 31, 2012 and $101.5
million, or 85% of total risk-based capital, at December 31, 2011.
70
o Our Consent Order also requires us to reduce non-owner occupied commercial real estate loans, construction and
development loans, and multi-family residential real estate loans as a group, to not more than 250% of total risk-based
capital. While we have made significant improvements over the last year, we were not in compliance with this concentration
limit at December 31, 2012. These loans totaled $311.1 million, or 362% of total risk-based capital, at December 31, 2012
compared with $414.6 million, or 349% of total risk-based capital, at December 31, 2011.
o We are working to reduce non-owner occupied commercial real estate loans, construction and development loans, and multi-
family residential real estate loans by curtailing new construction and development lending and new non-owner occupied
commercial real estate lending. We are also receiving principal reductions from amortizing credits and pay-downs from our
customers who sell properties built for resale. We have reduced the construction loan portfolio from $199.5 million at
December 31, 2010 to $70.3 million at December 31, 2012. Our non-owner occupied commercial real estate loans declined
from $293.3 million at December 31, 2010 to $189.8 million at December 31, 2012.
● Executing on our commitment to sell other real estate owned and reinvest in quality income producing assets.
o The remediation process for loans secured by real estate has led the Bank to acquire significant levels of OREO in 2012,
2011, and 2010. The Bank acquired $33.5 million, $41.9 million, and $90.8 million of OREO during 2012, 2011, and 2010,
respectively.
o We have incurred significant losses in disposing of OREO. We incurred losses totaling $9.3 million, $42.8 million, and $13.9
million in 2012, 2011, and 2010, respectively, from sales and fair value write-downs attributable to declining valuations as
evidenced by new appraisals and from changes in our sales strategies.
o To ensure that we maximize the value we receive upon the sale of OREO, we continue to evaluate sales opportunities and
channels. We are targeting multiple sales opportunities and channels through internal marketing and the use of brokers,
auctions, and technology sales platforms. Proceeds from the sale of OREO totaled $22.5 million during 2012, $26.0 in 2011,
and $25.0 million in 2010.
o At December 31, 2011, the OREO portfolio consisted of 75% construction, development, and land assets. At December 31,
2012, this concentration had declined to 51%. This is consistent with our reduction of construction, development and other
land loans, which have declined to $70.3 million at December 31, 2012, compared to $101.5 million at December 31,
2011. Over the past year, the composition of our OREO portfolio has shifted to be more heavily weighted towards
commercial real estate properties with a cash flow opportunity and 1-4 family residential properties, which we have found to
be more liquid than construction, development, and land assets. Commercial real estate properties represents 35% of the
OREO portfolio at December 31, 2012 compared with 15% at December 31, 2011. 1-4 family residential properties represent
12% of the OREO portfolio at December 31, 2012 compared with 7% at December 31, 2011.
● Evaluating other strategic alternatives, such as the sale of assets or branches.
Bank regulatory agencies can exercise discretion when an institution does not meet the terms of a consent order. Based on individual
circumstances, the agencies may issue mandatory directives, impose monetary penalties, initiate changes in management, or take more serious
adverse actions.
These financial statements do not include any adjustments that may result should the Company be unable to continue as a going concern.
71
NOTE 3 – SECURITIES
The fair value of available for sale securities and the related gross unrealized gains and losses recognized in accumulated other comprehensive
income (loss) were as follows:
December 31, 2012
U.S. Government and federal agency
Agency mortgage-backed: residential
State and municipal
Corporate bonds
Other debt securities
Total debt securities
Equity
Total
December 31, 2011
U.S. Government and federal agency
Agency mortgage-backed: residential
State and municipal
Corporate bonds
Other debt securities
Total debt securities
Equity
Total
Amortized
Cost
Gross
Unrealized
Gains
Gross
Unrealized
Losses
(in thousands)
Fair Value
$
$
$
$
5,603 $
94,298
52,485
18,851
572
171,809
1,359
173,168 $
10,494 $
97,286
35,456
7,259
572
151,067
1,359
152,426 $
530 $
1,141
2,335
1,150
46
5,202
487
5,689 $
1,149 $
2,211
2,610
315
34
6,319
356
6,675 $
— $
(257 )
(87 )
(37 )
—
(381 )
—
(381 ) $
— $
(22 )
(4 )
(242 )
—
(268 )
—
(268 ) $
6,133
95,182
54,733
19,964
618
176,630
1,846
178,476
11,643
99,475
38,062
7,332
606
157,118
1,715
158,833
Sales and calls of available for sale securities were as follows:
Proceeds
Gross gains
Gross losses
$
2012
2011
(in thousands)
2010
93,199 $
3,543
307
50,318 $
1,108
—
96,808
6,079
927
The tax provision related to these net gains and losses realized on sales were $1.1 million, $388,000, and $1.8 million, respectively.
The amortized cost and fair value of our debt securities are shown by contractual maturity. Expected maturities may differ from actual
maturities if borrowers have the right to call or prepay obligations with or without call or prepayment penalties. Securities not due at a single
maturity date, mortgage-backed, are shown separately.
Maturity
Available-for-sale
Within one year
One to five years
Five to ten years
Beyond ten years
Agency mortgage-backed: residential
Total
December 31, 2012
Fair
Value
Amortized
Cost
(in thousands)
$
$
12,656 $
14,582
41,119
9,154
94,298
171,809 $
12,713
16,102
43,112
9,521
95,182
176,630
Securities pledged at year-end 2012 and 2011 had carrying values of approximately $76.4 million and $57.7 million, respectively, and were
pledged to secure public deposits and repurchase agreements.
At year-end 2012 and 2011, there were no holdings of securities of any one issuer, other than the U.S. Government and its agencies, in an
amount greater than 10% of stockholders’ equity.
72
Securities with unrealized losses at year-end 2012 and 2011, aggregated by investment category and length of time that individual securities
have been in a continuous unrealized loss position, are as follows:
Description of Securities
2012
Agency mortgage-backed: residential
State and municipal
Corporate bonds
Equity securities
$
Total temporarily impaired
$
2011
Agency mortgage-backed: residential
State and municipal
Corporate bonds
$
Total temporarily impaired
$
Less than 12 Months
Fair
Value
Unrealized
Loss
12 Months or More
Fair
Value
Unrealized
Loss
(in thousands)
Total
Fair
Value
Unrealized
Loss
23,375 $
7,961
3,777
2
35,115 $
2,159 $
508
2,805
5,472 $
(257 ) $
(87 )
(37 )
—
(381 ) $
(22 ) $
(4 )
(242 )
(268 ) $
— $
—
—
—
— $
— $
—
—
— $
— $
—
—
—
— $
— $
—
—
— $
23,375 $
7,961
3,777
2
35,115 $
2,159 $
508
2,805
5,472 $
(257 )
(87 )
(37 )
—
(381 )
(22 )
(4 )
(242 )
(268 )
The Company evaluates securities for other-than-temporary impairment at least on a quarterly basis, and more frequently when economic or
market concerns warrant such evaluation. Consideration is given to the length of time and the extent to which the fair value has been less than
cost, the financial condition and near-term prospects of the issuer, underlying credit quality of the issuer, and the intent and ability of the
Company to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value. In analyzing an
issuer’s financial condition, the Company may consider whether the securities are issued by the federal government or its agencies, whether
downgrades by bond rating agencies have occurred, the sector or industry trends and cycles affecting the issuer, and the results of reviews of
the issuer’s financial condition. In December 2011, we recorded an other-than-temporary impairment charge totaling $41,000 for equity
securities held in our portfolio with an adjusted cost basis of $206,000. The market prices of the stocks had been below our adjusted basis for
more than twelve months and after consideration of the companies financial conditions and the likelihood the market value would recover to
our cost basis in a reasonable period of time, the investment was written down to fair value. As of December 31, 2012, management does not
believe any securities in our portfolio with unrealized losses should be classified as other than temporarily impaired at this time. Management
currently intends to hold all securities with unrealized losses until recovery, which for fixed income securities may be at maturity.
NOTE 4 – LOANS
Loans at year-end by class were as follows:
Commercial
Commercial Real Estate:
Construction
Farmland
Other
Residential Real Estate:
Multi-family
1-4 Family
Consumer
Agriculture
Other
Subtotal
Less: Allowance for loan losses
Loans, net
73
2012
2011
$
(in thousands)
52,567 $
71,216
70,284
80,825
322,687
101,471
90,958
423,844
50,986
278,273
20,383
22,317
770
899,092
(56,680 )
842,412 $
60,410
337,350
26,011
23,770
993
1,136,023
(52,579 )
1,083,444
$
Activity in the allowance for loan losses for the years indicated was as follows:
Beginning balance
Provision for loan losses
Loans charged-off
Loan recoveries
Ending balance
2012
2011
(in thousands)
2010
$
$
52,579 $
40,250
(37,515 )
1,366
56,680 $
34,285 $
62,600
(44,646 )
340
52,579 $
26,392
30,100
(22,461 )
254
34,285
The following table presents the activity in the allowance for loan losses by portfolio segment for the year ended December 31, 2012:
Commercial
Consumer Agriculture Other Total
Commercial
Real Estate
Residential
Real
Estate
Beginning balance
Provision for loan losses
Loans charged off
Recoveries
Ending balance
$
$
4,207 $
3,850
(3,784 )
129
4,402 $
33,024 $
23,275
(22,366 )
835
34,768 $
(in thousands)
14,217 $
10,884
(9,071 )
205
16,235 $
792 $
1,070
(1,130 )
125
857 $
325 $
1,170
(1,164 )
72
403 $
14 $ 52,579
40,250
(37,515 )
1,366
15 $ 56,680
1
–
–
The following table presents the activity in the allowance for loan losses by portfolio segment for the year ended December 31, 2011:
Commercial
Consumer Agriculture Other Total
Commercial
Real Estate
Residential
Real
Estate
Beginning balance
Provision for loan losses
Loans charged off
Recoveries
Ending balance
$
$
2,147 $
6,188
(4,197 )
69
4,207 $
24,075 $
34,043
(25,243 )
149
33,024 $
7,224 $
20,253
(13,295 )
35
14,217 $
701 $
1,074
(1,070 )
87
792 $
134 $
1,032
(841 )
–
325 $
10
–
–
4 $ 34,285
62,600
(44,646 )
340
14 $ 52,579
(in thousands)
The following table presents the balance in the allowance for loan losses and the recorded investment in loans by portfolio segment and based
on the impairment method as of December 31, 2012:
Commercial
Consumer Agriculture Other Total
Commercial
Real Estate
Residential
Real
Estate
Allowance for loan losses:
Ending allowance balance attributable
to loans:
(in thousands)
Individually evaluated for impairment $
Collectively evaluated for impairment
$
Total ending allowance balance
263 $
4,139
4,402 $
16,046 $
18,722
34,768 $
4,641 $
11,594
16,235 $
68 $
789
857 $
5 $
398
403 $
11 $ 21,034
35,646
15 $ 56,680
4
Loans:
Loans individually evaluated for
impairment
$
5,296 $
125,922 $
56,799 $
212 $
55 $
524 $ 188,808
Loans collectively evaluated for
impairment
Total ending loans balance
$
47,271
52,567 $
347,874
20,171
272,460
473,796 $ 329,259 $ 20,383 $
22,262
22,317 $
246 710,284
770 $ 899,092
74
The following table presents the balance in the allowance for loan losses and the recorded investment in loans by portfolio segment and based
on the impairment method as of December 31, 2011:
Commercial
Consumer Agriculture Other Total
Commercial
Real Estate
Residential
Real
Estate
Allowance for loan losses:
Ending allowance balance attributable
to loans:
(in thousands)
Individually evaluated for impairment $
Collectively evaluated for impairment
$
Total ending allowance balance
554 $
3,653
4,207 $
9,580 $
23,444
33,024 $
2,172 $
12,045
14,217 $
— $
792
792 $
— $
325
325 $
8 $ 12,314
40,265
6
14 $ 52,579
Loans:
Loans individually evaluated for
impairment
$
5,032 $
116,676 $
27,848 $
— $
631 $
540 $ 150,727
Loans collectively evaluated for
impairment
Total ending loans balance
$
66,184
71,216 $
499,598
26,011
369,911
616,274 $ 397,759 $ 26,011 $
23,139
23,770 $
453 985,296
993 $ 1,136,023
Impaired Loans
Impaired loans include restructured loans and commercial, construction, agriculture, and commercial real estate loans on non-accrual or
classified as doubtful, whereby collection of the total amount is improbable, or loss, whereby all or a portion of the loan has been written off or
a specific allowance for loss had been provided.
Average of impaired loans during the year
Interest income recognized during impairment
Cash basis interest income recognized
2012
2011
(in thousands)
2010
$ 175,828 $
3,976
355
95,331 $
2,594
412
69,167
1,358
115
The following table presents information related to loans individually evaluated for impairment by class of loan as of and for the year ended
December 31, 2012:
Unpaid
Principal
Balance
Recorded
Investment
Allowance
For Loan
Losses
Allocated
(in thousands)
Average
Recorded
Investment
Interest
Income
Recognized
Cash
Basis
Income
Recognized
With No Related Allowance Recorded:
Commercial
Commercial real estate:
Construction
Farmland
Other
Residential real estate:
Multi-family
1-4 Family
Consumer
Agriculture
Other
With An Allowance Recorded:
Commercial
Commercial real estate:
Construction
Farmland
Other
Residential real estate:
Multi-family
1-4 Family
Consumer
$
1,460 $
1,234 $
— $
1,637 $
5 $
1,155
4,448
2,134
1,109
4,448
1,892
643
13,539
70
45
—
643
13,158
70
45
—
—
—
—
—
—
—
—
—
1,745
4,706
3,436
910
11,291
219
366
—
2
57
3
—
56
8
2
—
4,108
4,062
263
3,964
169
26,645
8,557
97,699
25,455
6,456
86,562
1,543
734
13,769
19,514
5,794
83,087
348
43
2,011
14,906
31,021
142
14,906
28,092
142
1,643
2,998
68
11,187
27,404
29
468
787
—
4
2
57
3
—
56
5
—
—
27
5
2
185
—
9
—
Agriculture
Other
Total
10
524
6
533
$ 207,106 $ 188,808 $ 21,034 $ 175,828 $
10
524
5
11
—
17
3,976 $
—
—
355
75
The following table presents information related to loans individually evaluated for impairment by class of loan as of and for the year ended
December 31, 2011:
Unpaid
Principal
Balance
Recorded
Investment
Allowance
For Loan
Losses
Allocated
(in thousands)
Average
Recorded
Investment
Interest
Income
Recognized
Cash
Basis
Income
Recognized
With No Related Allowance
Recorded:
Commercial
Commercial real estate:
Construction
Farmland
Other
Residential real estate:
Multi-family
1-4 Family
Consumer
Agriculture
Other
With An Allowance Recorded:
Commercial
Commercial real estate:
Construction
Farmland
Other
Residential real estate:
Multi-family
1-4 Family
Consumer
Agriculture
Other
Total
$
1,868 $
1,825 $
— $
1,984 $
26 $
1,121
3,302
6,039
—
—
—
637
—
1,193
3,218
5,640
—
—
—
631
—
—
—
—
—
—
—
—
—
7,584
2,218
12,114
—
1,351
—
253
—
7
36
169
—
34
—
5
—
3,207
3,207
554
2,630
189
23,175
7,303
85,535
20,174
6,862
79,859
4,795
26,225
—
—
540
163,747 $
4,316
23,262
—
—
540
150,727 $
4,275
574
4,731
558
1,614
—
—
8
12,314 $
6,090
6,487
36,583
2,824
15,105
—
—
108
95,331 $
143
322
899
150
614
—
—
—
2,594 $
$
26
5
36
99
—
—
—
5
—
90
—
—
148
—
3
—
—
—
412
Troubled Debt Restructuring
A troubled debt restructuring (TDR) is where the Company has agreed to a loan modification in the form of a concession for a borrower who is
experiencing financial difficulty. The majority of the Company’s TDRs involve a reduction in interest rate, a deferral of principal for a stated
period of time, or an interest only period. All TDRs are considered impaired and the Company has allocated reserves for these loans to reflect
the present value of the concessionary terms granted to the customer.
76
The following table presents the types of TDR loan modifications by portfolio segment outstanding as of December 31, 2012 and 2011:
TDRs
Performing to
Modified Terms
TDRs Not
Performing to
Modified Terms
(in thousands)
Total
TDRs
December 31, 2012
Commercial
Rate reduction
Principal deferral
Interest only payments
Commercial Real Estate:
Construction
Rate reduction
Farmland
Rate reduction
Principal deferral
Other
Rate reduction
Principal deferral
Interest only payments
Residential Real Estate:
Multi-family
Rate reduction
Interest only payments
1-4 Family
Rate reduction
Consumer
Rate reduction
Other
Rate reduction
Total TDRs
December 31, 2011
Commercial
Rate reduction
Principal deferral
Commercial Real Estate:
Construction
Rate reduction
Interest only payments
Farmland
Rate reduction
Principal deferral
Other
Rate reduction
Interest only payments
Residential Real Estate:
Multi-family
Rate reduction
Interest only payments
1-4 Family
Rate reduction
Principal deferral
Other
Rate reduction
Total TDRs
$
$
$
$
1,972 $
887
—
4,834
150
725
36,515
1,195
2,466
13,087
652
— $
—
958
4,459
—
2,438
22,631
—
2,107
—
—
14,323
7,871
14
—
1,972
887
958
9,293
150
3,163
59,146
1,195
4,573
13,087
652
22,194
14
524
77,344 $
—
40,464 $
524
117,808
1,231 $
898
11,155
—
182
746
42,946
1,288
2,247
656
12,255
—
540
74,144 $
— $
—
3,767
1,404
—
5,101
20,446
—
1,413
—
7,176
247
—
39,554 $
1,231
898
14,922
1,404
182
5,847
63,392
1,288
3,660
656
19,431
247
540
113,698
At December 31, 2012 and 2011, 66% and 65%, respectively, of the Company’s TDRs were performing according to their modified
terms. The Company allocated $15.1 million and $10.6 million as of December 31, 2012 and 2011, respectively, in reserves to customers
whose loan terms have been modified in TDRs. The Company has committed to lend additional amounts totaling $259,000 and $317,000 as of
December 31, 2012 and 2011, respectively, to customers with outstanding loans that are classified as TDRs.
77
The following table presents a summary of the types of TDR loan modifications by portfolio type that occurred during the twelve months ended
December 31, 2012 and 2011:
TDRs
Performing to
Modified Terms
TDRs Not
Performing to
Modified Terms
Total
TDRs
(in thousands)
December 31, 2012
Commercial
Rate reduction
Interest only payments
Commercial Real Estate:
Construction
Rate reduction
Farmland
Rate reduction
Other
Rate reduction
Principal deferral
Interest only payments
Residential Real Estate:
Multi-family
Rate reduction
1-4 Family
Rate reduction
Consumer
Rate reduction
Total TDRs
December 31, 2011
Commercial
Rate reduction
Commercial Real Estate:
Construction
Rate reduction
Interest only payments
Farmland
Rate reduction
Principal deferral
Other
Rate reduction
Residential Real Estate:
Multi-family
Rate reduction
Interest only payments
1-4 Family
Rate reduction
Principal deferral
Other
Rate reduction
Total TDRs
$
1,972 $
—
—
150
16,468
1,194
2,466
12,805
7,514
14
42,583 $
— $
958
831
—
1,089
—
2,107
—
—
—
4,985 $
1,972
958
831
150
17,557
1,194
4,573
12,805
7,514
14
47,568
$
$
$
1,231 $
— $
1,231
11,155
—
182
746
3,367
1,404
—
—
14,522
1,404
182
746
41,682
20,446
62,128
2,247
656
7,968
—
540
66,407 $
—
—
1,651
247
—
27,115 $
2,247
656
9,619
247
540
93,522
As of December 31, 2012 and 2011, 90% and 71%, respectively, of the Company’s TDRs that occurred during 2012 and 2011, respectively,
were performing in accordance with their modified terms. The Company has allocated $4.8 million and $3.8 million, respectively, in reserves
to customers whose loan terms have been modified during 2012 and 2011, respectively. For modifications occurring during the twelve months
ended December 31, 2012 and 2011, the post-modification balances approximate the pre-modification balances.
During 2012 and 2011, approximately $12.0 million and $33.2 million of TDRs, respectively, defaulted on their restructured loan and the
default occurred within the 12 month period following the loan modification. These defaults consisted of $6.6 million in commercial real estate
loans, $3.2 million in construction loans, $1.2 million in 1-4 family residential real estate loans, and $958,000 in commercial loans. A default is
considered to have occurred once the TDR is past due 90 days or more or it has been placed on nonaccrual.
78
Nonperforming Loans
Nonperforming loans include impaired loans and smaller balance homogeneous loans, such as residential mortgage and consumer loans, that
are collectively evaluated for impairment.
The following table presents the recorded investment in nonaccrual and loans past due 90 days and still on accrual by class of loan as of
December 31, 2012 and 2011:
Commercial
Commercial Real Estate:
Construction
Farmland
Other
Residential Real Estate:
Multi-family
1-4 Family
Consumer
Agriculture
Other
Total
Nonaccrual
Loans Past
Due 90 Days
And Over Still
Accruing
2012
2011
2012
2011
(in thousands)
$
2,437 $
2,903 $
36 $
7,808
10,030
46,036
1,516
26,501
135
54
—
94,517 $
13,564
9,152
35,154
2,921
27,375
320
631
—
92,020 $
$
—
—
—
—
50
—
—
—
86 $
109
—
26
918
—
265
—
32
—
1,350
Subsequent to December 31, 2012, loans to two significant borrowing relationships included in the following table of past due loans, which
were past due 30-59 days totaling $23.5 million and loans past due 60-89 days totaling $12.7 million, were placed on non-accrual. These loans
were classified as impaired at December 31, 2012.
The following table presents the aging of the recorded investment in past due loans by class as of December 31, 2012 and 2011:
December 31, 2012
Commercial
Commercial Real Estate:
Construction
Farmland
Other
Residential Real Estate:
Multi-family
1-4 Family
Consumer
Agriculture
Other
Total
30 – 59
Days
60 – 89
Days
Past Due
Past Due
90 Days
And Over
Past Due
Non-accrual
Total
Past Due
And
Non-accrual
$
1,279 $
90 $
36 $
2,437 $
3,842
(in thousands)
5,815
58
13,037
—
1,221
75
7
—
20,303 $
—
—
—
—
50
—
—
—
86 $
7,808
10,030
46,036
1,516
26,501
135
54
—
94,517 $
24,133
11,010
64,211
10,278
38,917
520
214
—
153,125
10,510
922
5,138
8,762
11,145
310
153
—
38,219 $
79
$
December 31, 2011
Commercial
Commercial Real Estate:
Construction
Farmland
Other
Residential Real Estate:
Multi-family
1-4 Family
Consumer
Agriculture
Other
Total
30 – 59
Days
60 – 89
Days
Past Due
Past Due
90 Days
And Over
Past Due
Non-accrual
Total
Past Due
And
Non-accrual
(in thousands)
$
2,792 $
91 $
109 $
2,903 $
5,895
20
1,353
4,555
442
7,568
593
23
—
17,346 $
—
305
756
135
2,511
149
—
—
3,947 $
—
26
918
—
265
—
32
—
1,350 $
13,564
9,152
35,154
2,921
27,375
320
631
—
92,020 $
13,584
10,836
41,383
3,498
37,719
1,062
686
—
114,663
$
Credit Quality Indicators – We categorize loans into risk categories at origination based upon original underwriting. Subsequent to
origination, we categorized 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. Loans are analyzed individually by classifying the loans as to credit risk. This analysis includes loans with an outstanding
balance greater than $500,000 and non-homogeneous loans, such as commercial and commercial real estate loans. This analysis is performed
on a quarterly basis. We do not have any non-rated loans. The following definitions are used for risk ratings:
Watch – Loans classified as watch are those loans which have experienced a potentially adverse development which necessitates increased
monitoring.
Special Mention – Loans classified as special mention do not have all of the characteristics of substandard or doubtful loans. They have one or
more deficiencies which warrant special attention and which corrective action, such as accelerated collection practices, may remedy.
Substandard – Loans classified as substandard are those loans with clear and defined weaknesses such as a highly leveraged position,
unfavorable financial ratios, uncertain repayment sources or poor financial condition which may jeopardize the repayment of the debt as
contractually agreed. They are characterized by the distinct possibility that we will sustain some losses if the deficiencies are not corrected.
Doubtful – Loans classified as doubtful are those loans which have characteristics similar to substandard loans but with an increased risk that
collection or liquidation in full is 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. As of December 31, 2012 and 2011, and based on the most recent analysis performed, the risk category of loans by class of loans is as
follows:
Pass
Watch
Special
Mention
Substandard Doubtful
Total
(in thousands)
$
27,085 $
10,153 $
6,495 $
8,772 $
62 $
52,567
26,085
47,017
122,603
18,387
159,975
17,232
19,256
246
437,886 $
21,713
13,461
66,223
14,637
47,030
2,211
1,467
524
177,419 $
3,647
3,532
14,955
—
5,167
35
869
—
34,700 $
18,839
16,815
118,635
17,962
66,101
842
725
—
248,691 $
$
—
—
271
—
—
63
—
—
396 $
70,284
80,825
322,687
50,986
278,273
20,383
22,317
770
899,092
December 31, 2012
Commercial
Commercial Real Estate:
Construction
Farmland
Other
Residential Real Estate:
Multi-family
1-4 Family
Consumer
Agriculture
Other
Total
80
Pass
Watch
Special
Mention
Substandard Doubtful
Total
(in thousands)
$
53,223 $
9,357 $
3,237 $
5,300 $
99 $
71,216
45,407
69,880
213,406
37,807
247,423
23,721
22,502
453
713,822 $
13,132
4,955
80,149
4,619
28,734
1,418
343
540
143,247 $
7,777
2,688
30,787
2,100
2,276
43
14
—
48,922 $
35,155
13,236
99,502
15,884
58,891
762
911
—
229,641 $
$
—
199
—
—
26
67
—
—
391 $
101,471
90,958
423,844
60,410
337,350
26,011
23,770
993
1,136,023
December 31, 2011
Commercial
Commercial Real Estate:
Construction
Farmland
Other
Residential Real Estate:
Multi-family
1-4 Family
Consumer
Agriculture
Other
Total
NOTE 5 – PREMISES AND EQUIPMENT
Year-end premises and equipment were as follows:
Land and buildings
Furniture and equipment
Accumulated depreciation
2012
2011
(in thousands)
24,860 $
18,074
42,934
(22,129 )
20,805 $
23,493
19,086
42,579
(21,038 )
21,541
$
$
Depreciation expense was $1,165,000, $1,205,000 and $1,450,000 for 2012, 2011 and 2010, respectively.
NOTE 6 – OTHER REAL ESTATE OWNED
Other real estate owned (OREO) is real estate acquired as a result of foreclosure or by deed in lieu of foreclosure. It is classified as real estate
owned until such time as it is sold. When property is acquired as a result of foreclosure or by deed in lieu of foreclosure, it is recorded at its
fair market value less cost to sell. Any write-down of the property at the time of acquisition is charged to the allowance for loan losses.
Subsequent reductions in fair value are recorded as non-interest expense. To determine the fair value of OREO for smaller dollar single family
homes, we consult with internal real estate sales staff and external realtors, investors, and appraisers. If the internally evaluated market price is
below our underlying investment in the property, appropriate write-downs are taken.
For larger dollar residential and commercial real estate properties, we obtain a new appraisal of the subject property in connection with the
transfer to other real estate owned. We obtain updated appraisals each year on the anniversary date of ownership unless a sale is imminent.
We continue to explore opportunities to sell OREO properties in bulk. In 2011, as a result of adopting a strategy to more aggressively market
our OREO properties, we determined that we would be willing to sell certain OREO properties at an amount below their individual appraised
values. Accordingly, we adjusted our valuations for these properties downward by increasing their valuation allowances to reflect our more
aggressive disposition strategy. These properties are primarily single and multi-family residential land development properties. The following
table presents the major categories of OREO at the period-ends indicated:
Commercial Real Estate:
Construction
Farmland
Other
Residential Real Estate:
Multi-family
1-4 Family
Valuation allowance
2012
2011
(in thousands)
$
$
22,912 $
618
15,577
200
5,518
44,825
(1,154 )
43,671 $
32,538
744
6,620
—
3,214
43,116
(1,667 )
41,449
81
OREO Valuation Allowance Activity:
Beginning balance
Provision to allowance
Write-downs
Ending balance
Activity relating to other real estate owned during the years indicated is as follows:
OREO Activity
OREO as of January 1
Real estate acquired
Valuation adjustments for sales strategy change
Valuation adjustments for declining market values
Improvements
Loss on sale
Proceeds from sale of properties
OREO as of December 31
Expenses related to other real estate owned include:
Net loss on sales
Provision to allowance
Operating expense
Total
NOTE 7 – GOODWILL AND INTANGIBLE ASSETS
Goodwill
The change in balance of goodwill during the years indicated was as follows:
Beginning of year
Acquired goodwill
Impairment
End of year
2012
2011
(in thousands)
1,667 $
7,154
(7,667 )
1,154 $
700
34,874
(33,907 )
1,667
2012
2011
(in thousands)
43,116 $
33,528
—
(7,667 )
1
(1,672 )
(22,481 )
44,825 $
68,335
41,917
(25,613 )
(8,294 )
1,650
(8,889 )
(25,990 )
43,116
$
$
$
$
2012
2011
(in thousands)
2010
$
$
1,672 $
7,154
1,723
10,549 $
8,889 $
34,874
3,762
47,525 $
565
14,062
1,627
16,254
2012
2011
(in thousands)
— $
—
—
— $
23,794
—
(23,794 )
—
$
$
The Company evaluated goodwill for impairment annually in the fourth quarter unless events or changes in circumstances indicate potential
impairment may have occurred between annual assessments. Goodwill was reviewed for impairment during the second quarter of 2011 because
our common stock, which trades publicly on the NASDAQ, experienced a significant drop in value throughout the months of May and June
2011. Our stock trended downward during the first quarter of 2011 and continued downward throughout the months of May and June
2011. The stock closed on June 30, 2011 at $4.98 per share and has traded at a market price less than book value per common share since the
second quarter of 2010.
We evaluated the potential negative impact on the value of our common stock from being removed from the Russell 3000 Index during June
2011, the trend of lower earnings in 2011 compared to historical performance due to the continuing impact on earnings from loan loss
provisions, non-performing loans, and foreclosed properties, and recent regulatory agreements entered into by the company. Our goodwill
impairment testing completed during the fourth quarter of 2010 included, among other things, future projections of earnings at levels exceeding
actual results for 2011. The level of loan loss provisions and the cost of foreclosed properties continue to exceed our prior expectations as we
work through issues with our non-performing loan levels and other real estate owned portfolio.
82
The fair value was determined utilizing our market capitalization based upon recent common stock price levels. We also considered market
comparison transactions and control premiums for institutions of a similar size and performance. Based on this analysis, we determined that
our Goodwill was impaired and recorded an impairment charge of $23.8 million in the quarter ended June 30, 2011. The impairment charge
had no impact on the Company’s liquidity, cash flows, or regulatory ratios.
Acquired Intangible Assets
Acquired intangible assets were as follows as of year-end:
Amortized intangible assets:
Core deposit intangibles
Trust account intangibles
2012
2011
Gross
Carrying
Amount
Accumulated
Amortization
Gross
Carrying
Amount
Accumulated
Amortization
(in thousands)
$
4,183 $
100
2,581 $
53
4,183 $
100
2,124
43
Aggregate amortization expense was $467,000, $468,000 and $464,000 for 2012, 2011 and 2010, respectively.
Estimated aggregate amortization expense for intangible assets for each of the next five years is as follows (in thousands):
2013
2014
2015
2016
2017
NOTE 8 – DEPOSITS
The following table shows deposits by category:
Non-interest bearing
Interest checking
Money market
Savings
Certificates of deposit
Total
$
437
407
345
344
117
December
31,
2012
December
31,
2011
(in thousands)
114,310 $
87,234
63,715
39,227
760,573
1,065,059 $
111,118
87,653
64,302
36,357
1,024,333
1,323,763
$
$
Time deposits of $100,000 or more were approximately $319,527,000 and $493,344,000 at year-end 2012 and 2011, respectively.
Scheduled maturities of total time deposits for each of the next five years are as follows (in thousands):
2013
2014
2015
2016
2017
Thereafter
Retail
Brokered
Total
$
$
394,593 $
173,311
152,716
13,974
10,894
85
745,573 $
15,000 $
—
—
—
—
—
15,000 $
409,593
173,311
152,716
13,974
10,894
85
760,573
Historically, the Bank has utilized brokered and wholesale deposits to supplement its funding strategy. At December 31, 2012, and 2011, these
deposits totaled $15.0 million and $118.4 million, respectively. As stipulated in the Consent Order, PBI Bank is currently restricted from
accepting, renewing, or rolling-over brokered deposits without the prior receipt of a waiver on a case-by-case basis from our regulators.
83
NOTE 9 – SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE
Securities sold under agreements to repurchase are financing arrangements that mature within two years. At maturity, the securities underlying
the agreements are returned to the Company. Securities sold under agreements to repurchase are secured by agency, mortgage-backed, and
municipal securities. Information concerning securities sold under agreements to repurchase is summarized as follows:
2012
2011
Balance at year-end
Average daily balance during the year
Average interest rate during the year
Maximum month-end balance during the year
Weighted average interest rate at year-end
Fair value of securities sold under agreements to repurchase at year-end
$
$
$
$
(in thousands)
2,634 $
2,088 $
0.35 %
2,634 $
0.23 %
2,634 $
1,738
10,451
4.20 %
11,672
2.26 %
1,738
During 2011, we retired a $10 million repurchase agreement prior to maturity and incurred a prepayment penalty of $312,000.
NOTE 10 – ADVANCES FROM FEDERAL HOME LOAN BANK
At year-end, advances from the Federal Home Loan Bank were as follows:
2012
2011
(in thousands)
Monthly amortizing advances with fixed rates from 0.00% to 5.25% and maturities ranging from 2013 through
2033, averaging 3.21% for 2012
Total
$
$
5,604 $
5,604 $
7,116
7,116
Each advance is payable per terms on agreement, with a prepayment penalty. During 2011, we incurred prepayment penalties of $174,000 on
the prepayments of advances totaling $5.5 million. No similar penalty was incurred during 2012. The advances were collateralized by
approximately $163.3 million and $411.5 million of first mortgage loans, under a blanket lien arrangement at year-end 2012 and 2011,
respectively. Our borrowing capacity is based on the market value of the underlying pledged loans rather than the unpaid principal balance of
the pledged loans. The availability of our borrowing capacity could be affected by our financial position and the FHLB could require additional
collateral or, among other things, exercise its rights to deny a funding request, at its discretion. Additionally, any new advances are limited to a
one year maturity or less. At December 31, 2012, our additional borrowing capacity with the FHLB was $23.0 million.
Scheduled principal payments on the above during the next five years (in thousands):
2013
2014
2015
2016
2017
Thereafter
Advances
1,125
$
729
669
634
550
1,897
5,604
$
At year-end 2012, the Company had approximately $5.0 million of federal funds lines of credit available from correspondent institutions;
however, the availability of these lines could be affected by our financial position.
NOTE 11 – SUBORDINATED CAPITAL NOTE
The subordinated capital note issued by PBI Bank totaled $7.0 million at December 31, 2012. The note is unsecured, bears interest at the BBA
three-month LIBOR floating rate plus 300 basis points, and qualifies as Tier 2 capital. Interest only was due quarterly through September 30,
2010, at which time quarterly principal payments of $225,000 plus interest commenced. Scheduled principal payments of $900,000 per year
are due each of the next five years with $2,475,000 due thereafter. The note matures July 1, 2020. At December 31, 2012, the interest rate on
this note was 3.36%.
84
NOTE 12 – JUNIOR SUBORDINATED DEBENTURES
The junior subordinated debentures are redeemable at par prior to the maturity dates of February 13, 2034, April 15, 2034, and March 1, 2037,
at the option of the Company as defined within the trust indenture. The Company has the option to defer interest payments on the junior
subordinated debentures from time to time for a period not to exceed twenty (20) consecutive quarters. If payments are deferred, the Company
is prohibited from paying dividends to its common stockholders. Effective with the fourth quarter of 2011, we began deferring interest
payments on the junior subordinated notes which resulted in a deferral of distributions on our trust preferred securities. Therefore, future cash
dividends on our common stock are subject to the prior payment of all deferred distributions on our trust preferred securities. Dividends
accrued and unpaid on our junior subordinated debentures totaled $871,000 at December 31, 2012. A summary of the junior subordinated
debentures is as follows:
Description
Porter Statutory Trust II
Porter Statutory Trust III
Porter Statutory Trust IV
Asencia Statutory Trust I
Issuance
Date
Optional
Prepayment
Date (2)
02-13-2004 03-17-2009
04-15-2004 06-17-2009
12-14-2006 03-01-2012
02-13-2004 03-17-2009
Interest Rate (1)
3-month LIBOR + 2.85%
3-month LIBOR + 2.79%
3-month LIBOR + 1.67%
3-month LIBOR + 2.85%
Junior
Subordinated
Debt Owed
to
Trust
5,000,000 02-13-2034
3,000,000 04-15-2034
14,000,000 03-01-2037
3,000,000 02-13-2034
Maturity
Date
$
$ 25,000,000
(1) As of December 31, 2012 the 3-month LIBOR was 0.31%.
(2) The debentures are callable on or after the optional prepayment date at their principal amount plus accrued interest.
NOTE 13 – OTHER BENEFIT PLANS
401(K) Plan – The Company 401(k) Savings Plan allows employees to contribute up to 15% of their compensation, which is matched equal to
50% of the first 4% of compensation contributed. The Company, at its discretion, may make an additional contribution. Total contributions
made by the Company to the plan amounted to approximately $148,000, $131,000 and $188,000 in 2012, 2011 and 2010, respectively.
Supplemental Executive Retirement Plan – During 2004, the Company created a supplemental executive retirement plan covering certain
executive officers. Under the plan, the Company pays each participant, or their beneficiary, a specific defined benefit amount over 10 years,
beginning with the individual’s retirement or early termination of service for reasons other than cause. A liability is accrued for the obligation
under these plans. The expense incurred for the plan was $151,000, $49,000 and $264,000 for the years ended December 31, 2012, 2011 and
2010, respectively. The related liability was $1,338,000, $1,208,000 and $1,161,000 at December 31, 2012, 2011 and 2010, respectively, and is
included in other liabilities on the balance sheets.
The Company purchased life insurance on the participants to fund the benefits of these plans. The cash surrender value of all insurance policies
was $8,398,000 and $8,106,000 at December 31, 2012 and 2011, respectively. Income earned from the cash surrender value of life insurance
totaled $292,000, $301,000 and $296,000 for the years ended December 31, 2012, 2011 and 2010, respectively. The income is recorded as
other non-interest income.
NOTE 14 – INCOME TAXES
Income tax expense (benefit) was as follows:
Current
Deferred
Net operating loss
Establishment of valuation allowance
Change in valuation allowance
2012
2011
(in thousands)
2010
$
$
(65 ) $
754
(12,581 )
—
11,827
(65 ) $
(12,093 ) $
(17,403 )
(2,439 )
31,717
—
(218 ) $
4,852
(7,898 )
—
—
—
(3,046 )
85
Effective tax rates differ from federal statutory rate of 35% applied to income (loss) before income taxes due to the following.
Federal statutory rate times financial statement income (loss)
Effect of:
Establishment of valuation allowance
Change in valuation allowance
Goodwill impairment charge
Tax-exempt income
Nontaxable life insurance income
Federal tax credits
Other, net
Total
Year-end deferred tax assets and liabilities were due to the following.
2012
2011
(in thousands)
2010
$
(11,549 ) $
(37,634 ) $
(2,600 )
—
11,827
—
(314 )
(102 )
—
73
(65 ) $
31,717
—
6,169
(392 )
(105 )
(45 )
72
(218 ) $
—
—
—
(302 )
(104 )
(45 )
5
(3,046 )
$
Deferred tax assets:
Allowance for loan losses
Other real estate owned write-down
Net operating loss carry-forward
New market tax credit carry-forward
Alternative minimum tax credit carry-forward
Net assets from acquisitions
Other than temporary impairment on securities
Amortization of non-compete agreements
Other
Deferred tax liabilities:
Fixed assets
Net unrealized gain on securities available for sale
FHLB stock dividends
Originated mortgage servicing rights
Other
Net deferred tax asset before valuation allowance
Valuation allowance
Net deferred tax asset
2012
2011
(in thousands)
$
$
19,838 $
10,408
15,051
208
692
592
374
19
936
48,118
409
1,858
1,276
98
549
4,190
43,928
(43,928 )
— $
18,403
12,905
2,470
208
685
543
374
27
827
36,442
445
2,242
1,276
103
659
4,725
31,717
(31,717 )
—
Our estimate of the realizability of the deferred tax asset is dependent on our estimate of projected future levels of taxable income as all
carryback ability was fully absorbed by our tax loss of $40.1 million for 2011. In analyzing future taxable income levels, we considered all
evidence currently available, both positive and negative. Based on our analysis, we established a valuation allowance for all deferred tax assets
as of December 31, 2011.
The Company does not have any beginning and ending unrecognized tax benefits. The Company does not expect the total amount of
unrecognized tax benefits to significantly increase or decrease in the next twelve months. There were no interest and penalties recorded in the
income statement or accrued for the year ended December 31, 2012 related to unrecognized tax benefits.
The Company and its subsidiaries are subject to U.S. federal income tax and the Company is subject to income tax in the state of
Kentucky. The Company is no longer subject to examination by taxing authorities for years before 2009.
86
NOTE 15 – RELATED PARTY TRANSACTIONS
Loans to principal officers, directors, and their affiliates in 2012 were as follows (in thousands):
Beginning balance
New loans
Repayments
Ending balance
$
$
1,376
30
(173 )
1,233
Deposits from principal officers, directors, and their affiliates at year-end 2012 and 2011 were $1.4 million and $2.5 million, respectively.
Our loan participation totals include participations in real estate loans purchased from and sold to two affiliate banks, The Peoples Bank, Mt.
Washington and The Peoples Bank, Taylorsville. Our chairman emeritus, J. Chester Porter and his brother and our director, William G. Porter,
each own a 50% interest in Lake Valley Bancorp, Inc., the parent holding company of The Peoples Bank, Taylorsville, Kentucky. J. Chester
Porter, William G. Porter and our chairman and chief executive officer, Maria L. Bouvette, serve as directors of The Peoples Bank,
Taylorsville. Our chairman emeritus, J. Chester Porter owns an interest of approximately 36.0% and his brother and our director, William G.
Porter, owns an interest of approximately 3.0% in Crossroads Bancorp, Inc., the parent holding company of The Peoples Bank, Mount
Washington, Kentucky. J. Chester Porter and Maria L. Bouvette, serve as directors of The Peoples Bank, Mount Washington. We have entered
into management services agreements with each of these banks. Each agreement provides that our executives and employees provide
management and accounting services to the subject bank, including overall responsibility for establishing and implementing policy and
strategic planning. Maria Bouvette also serves as chief financial officer of each of the banks. We received a $4,000 monthly fee from The
Peoples Bank, Taylorsville and a $2,000 monthly fee from The Peoples Bank, Mount Washington for these services. Beginning in 2013, these
management services agreements were not renewed.
As of December 31, 2012, we had $2.7 million of participations in real estate loans purchased from, and $6.5 million of participations in real
estate loans sold, to these affiliate banks. As of December 31, 2011, we had $4.1 million of participations in real estate loans purchased from,
and $13.2 million of participations in real estate loans sold to, these affiliate banks. At December 31, 2012, $1.4 million of loan participations
sold to Peoples Bank, Taylorsville, and $943,000 sold to Peoples Bank, Mt. Washington were on non-accrual.
NOTE 16 – PREFERRED STOCK AND STOCK PURCHASE WARRANTS
In 2010, we completed a $32 million private placement to accredited investors. Following completion of the transactions involved, Porter
Bancorp had issued (i) 2,465,569 shares of common stock, (ii) 317,042 shares of Series C Preferred Stock and (iii) warrants to purchase
1,163,045 shares of non-voting common stock at a price of $11.50 per share.
The Series C Preferred Stock has no voting rights (except when required by law), has a liquidation preference over our common stock, dividend
rights equivalent to our common stock. Each share of Series C Preferred Stock automatically converts into 1.05 shares of common stock at such
time as, after giving effect to the automatic conversion, the holder of such Series C Preferred Stock (together with its affiliates and any other
persons with which it is acting in concert or whose holdings would otherwise be required to be aggregated for purposes of federal banking law)
beneficially holds, directly or indirectly, less than 9.9% of the number of shares of common stock then issued and outstanding.
The warrants are exercisable into non-voting common stock until they expire on September 16, 2015. The non-voting common stock has no
voting rights (except when required by law), but otherwise has substantially the same rights as our common stock. Upon issuance, each share of
non-voting common stock automatically converts into 1.05 shares of common stock at such time as, after giving effect to the automatic
conversion, the holder of non-voting common stock (together with its affiliates and any other persons with which it is acting in concert or
whose holdings would otherwise be required to be aggregated for purposes of federal banking law) holds, directly or indirectly, beneficially
less than 9.9% of the number of shares of common stock then issued and outstanding.
On November 21, 2008, we issued to the U.S. Treasury, in exchange for aggregate consideration of $35.0 million, 35,000 shares of our Series
A Preferred Stock and a warrant to purchase up to 330,561 shares of our common stock for $15.88 per share. The warrant is immediately
exercisable and has a 10-year term. The Series A Preferred Stock qualifies as Tier 1 capital and pays cumulative cash dividends quarterly at an
annual rate of 5% for the first five years, and 9% thereafter. The Series A Preferred Stock is non-voting (except when required by law) and,
beginning on February 15, 2012, may be redeemed by the Company at $1,000 per share plus accrued unpaid dividends.
In the fourth quarter of 2011, we began deferring the payment of regular quarterly cash dividends on our Series A Preferred Stock issued to the
U.S. Treasury. If we defer dividend payments for six quarters, the holder of our Series A Preferred Stock (currently the U.S. Treasury) would
then have the right to appoint representatives to our Board of Directors. We will continue to accrue any deferred dividends, which will be
deducted from income to common shareholders for financial statement purposes. Dividends accrued and unpaid on our Series A Preferred
Stock, and interest accrued and unpaid on those dividends, totaled $2.5 million at December 31, 2012.
87
NOTE 17 – CAPITAL REQUIREMENTS AND RESTRICTIONS ON RETAINED EARNINGS
Banks and bank holding companies are subject to regulatory capital requirements administered by federal banking agencies. Capital adequacy
guidelines and, additionally for banks, 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. Failure to meet capital requirements can initiate regulatory action.
On June 24, 2011, PBI Bank entered into a Consent Order with the FDIC and the Kentucky Department of Financial Institutions. The consent
order requires the Bank to complete a management study, to maintain Tier 1 capital as a percentage of total assets of at least 9% and a total risk
based capital ratio of at least 12%, to develop a plan to reduce our risk position in each substandard asset in excess of $1 million, to complete
board review of the adequacy of the allowance for loan losses prior to quarterly Call Report submissions, to adopt procedures which strengthen
the loan review function and ensure timely and accurate grading of credit relationships, to charge-off all assets classified as loss, to develop a
plan to reduce concentrations of construction and development loans to not more than 75% of total risk based capital and non-owner occupied
commercial real estate loans to not more than 250% of total risk based capital, to limit asset growth to no more than 5% in any quarter or 10%
annually, to not extend additional credit to any borrower classified substandard unless the board of directors adopts prior to the extension a
detailed statement giving reasons why the extension is in the best interest of the bank, and to not declare or pay any dividend without the prior
consent of our regulators. We are also restricted from accepting, renewing, or rolling-over brokered deposits without the prior receipt of a
waiver on a case-by-case basis from our regulators.
On September 21, 2011, we entered into a Written Agreement with the Federal Reserve Bank of St. Louis. Pursuant to the Agreement, we
made formal commitments to use our financial and management resources to serve as a source of strength for the Bank and to assist the Bank
in addressing weaknesses identified by the FDIC and the KDFI, to pay no dividends without prior written approval, to pay no interest or
principal on subordinated debentures or trust preferred securities without prior written approval, and to submit an acceptable plan to maintain
sufficient capital.
In October 2012, the Bank entered into a new Consent Order with the FDIC and KDFI again agreeing to maintain a minimum Tier 1 leverage
ratio of 9% and a minimum total risk based capital ratio of 12%. The Bank cannot be considered well-capitalized while under the Consent
Order. The Bank also agreed that if it should be unable to reach the required capital levels, and if directed in writing by the FDIC, then the
Bank would within 30 days develop, adopt and implement a written plan to sell or merge itself into another federally insured financial
institution or otherwise immediately obtain a sufficient capital investment into the Bank to fully meet the capital requirements.
The new Consent Order also requires the Bank to continue to adhere to the plans implemented in response to the June 2011 Consent Order, and
includes the substantive provisions of the June 2011 Consent Order. As of December 31, 2012, the capital ratios required by the Consent Order
were not met.
The following table shows the ratios of Tier 1 capital and total capital to risk-adjusted assets and the leverage ratios for Porter Bancorp, Inc.
and PBI Bank at the dates indicated:
Regulatory
Minimums
Well-
Capitalized
Minimums
Minimum
Capital
Ratios
Under
Consent
Order
December 31, 2012
December 31, 2011
Porter
Bancorp
PBI
Bank
Porter
Bancorp
PBI
Bank
Tier 1 Capital
Total risk-based capital
Tier 1 leverage ratio
4.0 %
8.0
4.0
6.0 %
10.0
5.0
N/A
12.0 %
9.0
6.46 %
9.81
4.50
7.71 %
9.82
5.37
9.23 %
11.22
6.53
8.86 %
10.86
6.23
At December 31, 2012, PBI Bank’s Tier 1 leverage ratio declined to 5.37% which is below the 9% minimum capital ratio required by the
Consent Order and its total risk-based capital ratio declined to 9.82% which is below the 12% minimum capital ratio required by the Consent
Order. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators
that, if undertaken, could have a materially adverse effect on our financial condition.
88
Kentucky banking laws limit the amount of dividends that may be paid to a holding company by its subsidiary banks without prior approval.
These laws limit the amount of dividends that may be paid in any calendar year to current year’s net income, as defined in the laws, combined
with the retained net income of the preceding two years, less any dividends declared during those periods. PBI Bank has agreed with its
primary regulators to obtain their written consent prior to declaring or paying any future dividends. As a practical matter, PBI Bank cannot pay
dividends for the foreseeable future.
NOTE 18 – LOAN COMMITMENTS AND OTHER RELATED ACTIVITIES
Some financial instruments, such as loan commitments, lines of credit and letters of credit are issued to meet customer-financing needs. These
are agreements to provide credit or to support the credit of others, as long as conditions established in the contract are met, and usually have
expiration dates. Commitments may expire without being used. Off-balance-sheet risk to credit loss exists up to the face amount of these
instruments, although material losses are not anticipated. The same credit policies are used to make such commitments as are used for loans,
including obtaining collateral at exercise of the commitment.
The Company holds instruments, in the normal course of business, with clients that are considered financial guarantees. Standby letters of
credit guarantees are issued in connection with agreements made by clients to counterparties. Standby letters of credit are contingent upon
failure of the client to perform the terms of the underlying contract. The Company evaluates each credit request of its customers in accordance
with established lending policies. Based on these evaluations and the underlying policies, the amount of required collateral (if any) is
established. Collateral held varies but may include negotiable instruments, accounts receivable, inventory, property, plant and equipment,
income producing properties, residential real estate, and vehicles. The Company’s access to these collateral items is generally established
through the maintenance of recorded liens or, in the case of negotiable instruments, possession. No liability is currently established for the
standby letters of credit.
The contractual amounts of financial instruments with off-balance-sheet risk at year end were as follows:
Commitments to make loans
Unused lines of credit
Standby letters of credit
2012
2011
Fixed
Rate
Variable
Rate
Fixed
Rate
Variable
Rate
$
2,490 $
11,910
1,085
(in thousands)
3,546 $
34,925
1,176
4,413 $
13,485
746
9,458
49,312
2,707
Commitments to make loans are generally made for periods of one year or less.
NOTE 19 – FAIR VALUES
Fair value is the exchange price that would be received for an asset or paid to transfer a liability (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. We use various
valuation techniques to determine fair value, including market, income and cost approaches. 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 an entity has the ability to access as of the
measurement date, or observable inputs.
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, and other inputs that are observable or can be corroborated by observable market data.
Level 3: Significant unobservable inputs that reflect an entity’s own assumptions about the assumptions that market participants
would use in pricing an asset or liability.
In certain cases, the inputs used to measure fair value may fall into different levels of the fair value hierarchy. When that occurs, we classify
the fair value hierarchy on the lowest level of input that is significant to the fair value measurement. We used the following methods and
significant assumptions to estimate fair value.
Securities: The fair values of securities available for sale are determined by obtaining quoted prices on nationally recognized
securities exchanges, if available. This valuation method is classified as Level 1 in the fair value hierarchy. For securities where
quoted prices are not available, fair values are calculated on market prices of similar securities, or matrix pricing, which is a
mathematical technique used widely in the industry to value debt securities without relying exclusively on quoted prices for the
specific securities but rather by relying on the securities’ relationship to other benchmark quoted securities. Matrix pricing relies on
the securities’ relationship to similarly traded securities, benchmark curves, and the benchmarking of like securities. Matrix pricing
utilizes observable market inputs such as benchmark yields, reported trades, broker/dealer quotes, issuer spreads, two-sided markets,
benchmark securities, bids, offers, reference data, and industry and economic events. In instances where broker quotes are used, these
quotes are obtained from market makers or broker-dealers recognized to be market participants. This valuation method is classified as
Level 2 in the fair value hierarchy. 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. This valuation method is classified as Level 3 in the fair
value hierarchy. Discounted cash flows are calculated using spread to swap and LIBOR curves that are updated to incorporate loss
severities, volatility, credit spread and optionality. During times when trading is more liquid, broker quotes are used (if available) to
validate the model. Rating agency and industry research reports as well as defaults and deferrals on individual securities are reviewed
and incorporated into the calculations.
89
Impaired Loans: An impaired loan is evaluated at the time the loan is identified as impaired and is recorded at fair value less costs to
sell. Fair value is measured based on the value of the collateral securing the loan and is classified as Level 3 in the fair value
hierarchy. Fair value is determined using several methods. Generally, the fair value of real estate is determined based on appraisals by
qualified licensed appraisers. 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. These routine adjustments are made to adjust the value of a specific property relative to comparable properties
for variations in qualities such as location, size, and income production capacity relative to the subject property of the appraisal. Such
adjustments are typically significant and result in a Level 3 classification of the inputs for determining fair value.
We routinely apply an internal discount to the value of appraisals used in the fair value evaluation of our impaired loans. The
deductions to the appraisal take into account changing business factors and market conditions, as well as potential value impairment in
cases where our appraisal date predates a likely change in market conditions. These deductions range from 10% for routine real
estate collateral to 25% for real estate that is determined (1) to have a thin trading market or (2) to be specialized collateral. This is in
addition to estimated discounts for cost to sell of six to ten percent.
We also apply discounts to the expected fair value of collateral for impaired loans where the likely resolution involves litigation or
foreclosure. Resolution of this nature generally results in receiving lower values for real estate collateral in a more aggressive sales
environment. We have utilized discounts ranging from 10% to 33% in our impairment evaluations when applicable.
Impaired loans are evaluated quarterly for additional impairment. We obtain updated appraisals on properties securing our loans when
circumstances are warranted such as at the time of renewal or when market conditions have significantly changed. This determination
is made on a property-by-property basis in light of circumstances in the broader economic climate and our assessment of deterioration
of real estate values in the market in which the property is located. The first stage of our assessment involves management’s
inspection of the property in question. Management also engages in conversations with local real estate professionals, investors, and
market makers to determine the likely marketing time and value range for the property. The second stage involves an assessment of
current trends in the regional market. After thorough consideration of these factors, management will either internally evaluate fair
value or order a new appraisal.
Other Real Estate Owned (OREO) : OREO is evaluated at the time of acquisition and recorded at fair value as determined by
independent appraisal or internal market evaluation less cost to sell. Our quarterly evaluations of OREO for impairment are driven by
property type. For smaller dollar single family homes, we consult with internal real estate sales staff and external realtors, investors,
and appraisers. Based on these consultations, we determine asking prices for OREO properties we are marketing for sale. If the
internally evaluated fair value is below our recorded investment in the property, appropriate write-downs are taken.
For larger dollar commercial real estate properties, we obtain a new appraisal of the subject property in connection with the transfer to
other real estate owned. In some of these circumstances, an appraisal is in process at quarter end, and we must make our best estimate
of the fair value of the underlying collateral based on our internal evaluation of the property, review of the most recent appraisal, and
discussions with the currently engaged appraiser. We obtain updated appraisals on the anniversary date of ownership unless a sale is
imminent.
90
We routinely apply an internal discount to the value of appraisals used in the fair value evaluation of our OREO. The deductions to the
appraisal take into account changing business factors and market conditions, as well as potential value impairment in cases where our
appraisal date predates a likely change in market conditions. These deductions range from 10% for routine real estate collateral to
25% for real estate that is determined (1) to have a thin trading market or (2) to be specialized collateral. This is in addition to
estimated discounts for cost to sell of six to ten percent.
In 2011, management, with concurrence of the Board of Directors, determined that certain properties held in other real estate were not
likely to be successfully disposed of in an acceptable time-frame using routine marketing efforts. It became apparent that certain
properties were going to require extended holding periods to sell the properties at recent appraised values. These properties are
primarily single and multi-family residential loan development properties. Given our change in strategy to reduce non-performing
assets in an accelerated manner, management adjusted downward the valuations for single and multi-family residential loan
development properties in our OREO portfolio to amounts below their individual appraised values.
Financial assets measured at fair value on a non-recurring basis are summarized below:
Fair Value Measurements at December 31, 2012 Using
(in thousands)
Quoted Prices In
Active Markets
for
Identical Assets
(Level 1)
Significant Other
Observable
Inputs
(Level 2)
Significant
Unobservable
Inputs
(Level 3)
Carrying
Value
6,133 $
95,182
54,733
19,964
618
1,846
178,476 $
— $
—
—
—
—
1,846
1,846 $
6,133 $
95,182
54,733
19,964
—
—
176,012 $
—
—
—
—
618
—
618
Fair Value Measurements at December 31, 2011 Using
(in thousands)
Quoted Prices In
Active Markets
for
Identical Assets
(Level 1)
Significant Other
Observable
Inputs
(Level 2)
Significant
Unobservable
Inputs
(Level 3)
Carrying
Value
11,643 $
99,475
38,062
7,332
606
1,715
158,833 $
— $
—
—
—
—
1,715
1,715 $
11,643 $
99,475
36,889
7,332
—
—
155,339 $
—
—
1,173
—
606
—
1,779
$
$
$
$
Description
Available-for-sale securities
U.S. Government and
federal agency
Agency mortgage-backed: residential
State and municipal
Corporate bonds
Other debt securities
Equity securities
Total
Description
Available-for-sale securities
U.S. Government and
federal agency
Agency mortgage-backed: residential
State and municipal
Corporate bonds
Other debt securities
Equity securities
Total
There were no transfers between Level 1 and Level 2 during 2012 or 2011.
91
The table below presents a reconciliation of all assets measured at fair value on a recurring basis using significant unobservable inputs (Level
3) for the periods ended December 31, 2012 and 2011:
State and Municipal
Securities
2012
2011
Other Debt
Securities
2012
2011
Balances of recurring Level 3 assets at January 1
$
1,173 $
(in thousands)
— $
Total gain (loss) for the period:
Included in other comprehensive income (loss)
Transfers into Level 3
Sales
Balance of recurring Level 3 assets at September 30
$
—
—
(1,173 )
— $
—
1,173
—
1,173 $
606 $
12
—
—
618 $
572
34
—
—
606
The fair value for five municipal securities with fair values of $1.2 million as of December 31, 2011 were transferred out of Level 2 and into
Level 3 because of a lack of observable market data for these investments due to a decrease in market activity for these securities. Our policy is
to recognize transfers as of the end of the reporting period. As a result, the fair value for these municipal securities was transferred on
December 31, 2011.
Level 3 state and municipal securities valuations are supported by analysis prepared by an independent third party. Their approach to
determining fair value involves using recently executed transactions for similar securities and market quotations for similar securities. As
securities of this type are not rated by the rating agencies and trading volumes are thin, it was determined that these were valued using Level 3
inputs. We sold our Level 3 municipal securities in the second quarter of 2012 and had no securities of this nature at December 31, 2012.
Our other debt security valuation is determined internally by calculating discounted cash flows using the security’s coupon rate of 6.5% and an
estimated current market rate of 10.0% based upon the current yield curve plus spreads that adjust for volatility, credit risk, and
optionality. We also consider the issuer(s) publicly filed financial information as well as assumptions regarding the likelihood of deferrals and
defaults.
Financial assets measured at fair value on a non-recurring basis are summarized below:
Description
Impaired loans:
Commercial
Commercial real estate:
Construction
Farmland
Other
Residential real estate:
Multi-family
1-4 Family
Consumer
Agriculture
Other
Other real estate owned, net:
Commercial real estate:
Construction
Farmland
Other
Residential real estate:
Multi-family
1-4 Family
Fair Value Measurements at December 31,
2012 Using
(in thousands)
Quoted
Prices In
Active
Markets for
Identical
Assets
(Level 1)
Significant
Other
Observable
Inputs
(Level 2)
Significant
Unobservable
Inputs
(Level 3)
Carrying
Value
$
3,799 $
— $
— $
3,799
23,912
5,722
72,793
13,263
25,094
74
5
513
22,323
602
15,175
195
5,376
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
23,912
5,722
72,793
13,263
25,094
74
5
513
22,323
602
15,175
195
5,376
92
Fair Value Measurements at December 31,
2011 Using
(in thousands)
Quoted
Prices In
Active
Markets for
Identical
Assets
(Level 1)
Significant
Other
Observable
Inputs
(Level 2)
Significant
Unobservable
Inputs
(Level 3)
Carrying
Value
$
2,653 $
— $
— $
2,653
15,899
6,288
75,128
3,758
21,648
532
31,280
715
6,364
3,090
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
15,899
6,288
75,128
3,758
21,648
532
31,280
715
6,364
—
3,090
Description
Impaired loans:
Commercial
Commercial real estate:
Construction
Farmland
Other
Residential real estate:
Multi-family
1-4 Family
Other
Other real estate owned, net:
Commercial real estate:
Construction
Farmland
Other
Residential real estate:
1-4 Family
Impaired loans, which are measured for impairment using the fair value of the collateral for collateral dependent loans, had a carrying amount
of $152.2 million, with a valuation allowance of $20.0 million, at December 31, 2012, resulting in an additional provision for loan losses of
$13.1 million for the year ended December 31, 2012. At December 31, 2011, impaired loans had a carrying amount of $138.2 million, with a
valuation allowance of $12.3 million, resulting in an additional provision for loan losses of $10.1 million for the year ended December 31,
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 $43.7 million as
of December 31, 2012, compared with $41.4 million at December 31, 2011. Write-downs of $7.2 million and $34.9 million were recorded on
other real estate owned for the years ended December 31, 2012 and 2011, respectively.
The following table presents qualitative information about level 3 fair value measurements for financial instruments measured at fair value on a
non-recurring basis at December 31, 2012:
Fair Value
(in thousands)
Valuation
Technique(s)
Unobservable Input(s)
Range (Weighted
Average)
Impaired loans – C ommercial
$
3,799 Market value approach
Adjustment for receivables and
16% - 32% (24%)
inventory discounts
Impaired loans – Commercial real
$
estate
89,461 Sales comparison approach
Adjustment for differences
between the comparable
sales
Impaired loans – Residential real
$
estate
38,357 Sales comparison approach Adjustment for differences
between the comparable
sales
0% - 69% (19%)
0% - 38% (15%)
Other real estate owned –
Commercial real estate
Other real estate owned –
Residential real estate
$
$
38,100 Sales comparison approach
Income approach
Adjustment for differences
between the comparable
sales
3% - 50% (18%)
9% - 16% (12%)
Discount or capitalization rate
5,571 Sales comparison approach
Adjustment for differences
between the comparable
sales
0% - 30% (9%)
93
Carrying amount and estimated fair values of financial instruments were as follows at year-end 2012:
Financial assets
Cash and cash equivalents
Securities available for sale
Federal Home Loan Bank stock
Mortgage loans held for sale
Loans, net
Accrued interest receivable
Financial liabilities
Deposits
Securities sold under agreements to repurchase
Federal Home Loan Bank advances
Subordinated capital notes
Junior subordinated debentures
Accrued interest payable
Carrying
Amount
Fair Value Measurements at December 31, 2012 Using
Level 1
Level 2
(in thousands)
Level 3
Total
$
$
49,572 $
178,476
10,072
507
842,412
5,138
1,065,059 $
2,634
5,604
6,975
25,000
2,104
41,938 $
1,846
N/A
—
—
—
114,310 $
—
—
—
—
—
7,634 $
176,012
N/A
507
—
1,150
955,216 $
2,634
5,607
—
—
1,173
— $
618
N/A
—
853,996
3,988
49,572
178,476
N/A
507
853,996
5,138
— $
—
—
6,599
13,821
931
1,069,526
2,634
5,607
6,599
13,821
2,104
Carrying amount and estimated fair values of financial instruments were as follows at year-end 2011:
Financial assets
Cash and cash equivalents
Securities available for sale
Federal Home Loan Bank stock
Mortgage loans held for sale
Loans, net
Accrued interest receivable
Financial liabilities
Deposits
Securities sold under agreements to repurchase
Federal Home Loan Bank advances
Subordinated capital notes
Junior subordinated debentures
Accrued interest payable
Carrying
Amount
Fair Value Measurements at December 31, 2011 Using
Level 1
Level 2
(in thousands)
Level 3
Total
$
$
105,962 $
158,833
10,072
694
1,083,444
6,682
1,323,763 $
1,738
7,116
7,650
25,000
1,732
93,877 $
1,715
N/A
—
—
—
12,085 $
155,339
N/A
694
—
970
— $
1,779
N/A
—
1,093,456
5,712
111,118 $
—
—
—
—
—
1,221,015 $
1,738
7,015
—
—
1,510
— $
—
—
7,110
19,765
222
105,962
158,833
N/A
694
1,093,456
6,682
1,332,133
1,738
7,015
7,110
19,765
1,732
The methods and assumptions used to estimate fair value are described as follows:
(a) Cash and Cash Equivalents
The carrying amounts of cash and short-term instruments approximate fair values and are classified as either Level 1 or Level 2.
Noninterest bearing deposits are Level 1 whereas interest bearing due from bank accounts and fed funds sold are Level 2.
(b) FHLB Stock
It is not practical to determine the fair value of FHLB stock due to restrictions placed on its transferability.
94
(c) Loans, Net
Fair values of loans, excluding loans held for sale, are estimated as follows: For variable rate loans that reprice frequently and with no
significant change in credit risk, fair values are based on carrying values resulting in a Level 3 classification. Fair values for other loans are
estimated using discounted cash flow analyses, using interest rates currently being offered for loans with similar terms to borrowers of
similar credit quality resulting in a Level 3 classification. Impaired loans are valued at the lower of cost or fair value as described
previously. The methods utilized to estimate the fair value of loans do not necessarily represent an exit price.
(d) Mortgage Loans Held for Sale
The fair value of loans held for sale is estimated based upon binding contracts and quotes from third party investors resulting in a Level 2
classification.
(e) Deposits
The fair values disclosed for non-interest bearing deposits are, by definition, equal to the amount payable on demand at the reporting date
resulting in a Level 1 classification. The carrying amounts of variable rate interest bearing deposits approximate their fair values at the
reporting date resulting in a Level 2 classification. Fair values for fixed rate interest bearing deposits are estimated using a discounted cash
flows calculation that applies interest rates currently being offered on certificates to a schedule of aggregated expected monthly maturities
on time deposits resulting in a Level 2 classification.
(f) Securities Sold Under Agreements to Repurchase
The carrying amounts of borrowings under repurchase agreements approximate their fair values resulting in a Level 2 classification.
( g) Other Borrowings
The fair values of the Company’s FHLB advances are estimated using discounted cash flow analyses based on the current borrowing rates
resulting in a Level 2 classification.
The fair values of the Company’s subordinated capital notes and junior subordinated debentures are estimated using discounted cash flow
analyses based on the current borrowing rates for similar types of borrowing arrangements resulting in a Level 3 classification.
(h) Accrued Interest Receivable/Payable
The carrying amounts of accrued interest approximate fair value resulting in a Level 2 or Level 3 classification based on the level of the
asset or liability with which the accrual is associated.
NOTE 20 – STOCK PLANS AND STOCK BASED COMPENSATION
The Company has a stock option plan and a stock incentive plan. On February 23, 2006, the Company adopted the Porter Bancorp, Inc. 2006
Stock Incentive Plan. The 2006 Plan permits the issuance of up to 400,000 shares of the Company’s common stock upon the exercise of stock
options or upon the grant of stock awards. As of December 31, 2012, the Company had granted 153,316 unvested shares net of forfeitures and
vesting under the stock incentive plan. Shares issued under the plan vest annually on the anniversary date of the grant over two to ten years.
The Company has 142,663 shares remaining available for issue under the plan. All shares issued under the above mentioned plans came from
authorized and unissued shares.
On May 15, 2006, the Board of Directors approved the Porter Bancorp, Inc. 2006 Non-Employee Directors Stock Ownership Incentive Plan,
which was approved by holders of the Company’s voting common stock on June 8, 2006. On May 22, 2008, shareholders voted to amend the
plan to change the form of incentive award from stock options to unvested shares. Under the terms of the plan, 100,000 shares are reserved for
issuance to non-employee directors upon the exercise of stock options or upon the grant of unvested stock awards granted under the plan. Prior
to the amendment, options were granted automatically under the plan at fair market value on the date of grant. The options vest over a three-
year period and have a five year term. Unvested shares are granted automatically under the plan at fair market value on the date of grant and
vest semi-annually on the anniversary date of the grant over three years.
On May 16, 2012, holders of the Company’s voting common stock voted to further amend the 2006 Non-Employee Directors Stock Ownership
Incentive Plan to award restricted shares having a fair market value of $25,000 annually to each non-employee director, and to increase the
number of shares issuable under the Directors’ Plan from 100,000 shares to 400,000 shares. Shares issued under the amended plan vest semi-
annually on the anniversary date of the grant over three years.
95
To date, the Company has issued 80,078 unvested shares to non-employee directors. At December 31, 2012, 295,712 shares remain available
for issuance under this plan.
The fair value of the 2012 unvested shares issued to certain employees was $169,000, or $1.74 per weighted-average share. The fair value of
the 2012 unvested shares issued to non-employee directors was $155,000, or $1.65 per share. The Company recorded $442,000 and $436,000
of stock-based compensation during 2012 and 2011, respectively, to salaries and employee benefits. There was no significant impact on
compensation expense resulting from forfeited or expiring shares. We expect substantially all of the unvested shares outstanding at the end of
the period will vest according to the vesting schedule. A deferred tax benefit of $0 and $153,000, respectively, was recognized related to this
expense.
The following table summarizes unvested share activity as of and for the year indicated:
Outstanding, beginning
Granted
Vested
Forfeited
Outstanding, ending
December 31, 2012
Weighted
Average
Grant
Price
13.21
1.69
8.89
15.22
4.49
Unvested
Shares
100,226 $
191,140
(44,781 )
(13,191 )
233,394 $
As of December 31, 2012, all stock options issued to non-employee directors had expired and none were exercised during their grant term.
When granted, stock options have an exercise price that is equal to or greater than the fair market value of the Company’s stock on the date the
options were granted. Options granted generally become fully exercisable at the end of three years of continued employment. Options have a
life of five years.
The following table summarizes stock option activity as of and for the year indicated:
Outstanding, beginning
Forfeited
Expired
Outstanding, ending
December 31, 2012
Weighted
Average
Exercise
Price
Options
29,530 $
—
(29,530 )
— $
19.88
—
19.88
—
No options were exercised during 2012. The Company recorded no stock option compensation expense during the year ended December 31,
2012. No options were modified during the period. As of December 31, 2012, no stock options issued by the Company had been exercised,
and all granted options had expired.
Unrecognized stock based compensation expense related to unvested shares for 2013 and beyond is estimated as follows (in thousands):
2013
2014
2015
2016
2017 & thereafter
$
400
300
157
57
22
96
NOTE 21 – EARNINGS (LOSS) PER SHARE
The factors used in the basic and diluted earnings per share computation follow:
Net loss
Less:
Preferred stock dividends
Accretion of Series A preferred stock discount
Loss attributable to unvested shares
Loss attributable to Series C preferred
Net loss attributable to common shareholders, basic and diluted
$
Basic
Weighted average common shares including unvested common shares and Series C
2012
2011
(in thousands, except share and per share data)
(4,384 )
$
(107,307 ) $
(32,932 ) $
2010
(1,750 )
(179 )
482
947
(33,432 ) $
(1,750 )
(177 )
1,092
2,988
(105,154 ) $
(1,810 )
(177 )
81
103
(6,187 )
Preferred outstanding
Less: Weighted average unvested common shares
Less: Weighted average Series C preferred shares
Weighted average common shares outstanding
Basic loss per common share
Diluted
Add: Dilutive effects of assumed exercises of common and Preferred Series C stock
warrants
Weighted average common shares and potential common shares
Diluted loss per common share
(169,323 )
(332,894 )
12,248,936 12,169,987 10,640,872
(135,757 )
(171,616 )
11,746,719 11,715,461 10,333,499
(0.60 )
$
(121,632 )
(332,894 )
(2.85 ) $
(8.98 ) $
—
—
11,746,719 11,715,461 10,333,499
(0.60 )
$
(2.85 ) $
(8.98 ) $
—
Stock options for 29,530 shares of common stock for 2011, and 86,469 shares of common stock for 2010, were not considered in computing
diluted earnings per common share because they were anti-dilutive. The Company had no outstanding stock options at December 31, 2012.
Additionally, a warrant for the purchase of 330,561 shares of the Company’s common stock at an exercise price of $15.88 was outstanding at
December 31, 2012, 2011 and 2010 but was not included in the diluted earnings per share computation as inclusion would have been anti-
dilutive. Finally, warrants for the purchase of 1,380,437 shares of non-voting common stock at an exercise price of $11.50 per share were
outstanding at December 31, 2012, 2011, and 2010, but were not included in the diluted earnings per share computation as inclusion would
have been anti-dilutive.
NOTE 22 – PARENT COMPANY ONLY CONDENSED FINANCIAL INFORMATION
Condensed financial information of Porter Bancorp Inc. is presented as follows:
CONDENSED BALANCE SHEETS
December 31,
ASSETS
Cash and cash equivalents
Securities available-for-sale
Investment in banking subsidiary
Investment in and advances to other subsidiaries
Other assets
Total assets
LIABILITIES AND SHAREHOLDERS’ EQUITY
Debt
Accrued expenses and other liabilities
Shareholders’ equity
Total liabilities and shareholders’ equity
97
2012
2011
(in thousands)
995 $
2,464
71,711
776
535
76,481 $
2,564
2,321
103,083
776
550
109,294
25,775 $
3,516
47,190
76,481 $
25,775
990
82,529
109,294
$
$
$
$
CONDENSED STATEMENTS OF OPERATIONS
Years ended December 31,
Interest income
Dividends from subsidiaries
Other income
Interest expense
Other expense
Income (loss) before income tax and undistributed subsidiary income
Income tax expense (benefit)
Equity in undistributed subsidiary income (loss)
Net income (loss)
CONDENSED STATEMENTS OF CASH FLOWS
Years ended December 31,
Cash flows from operating activities
Net income (loss)
Adjustments:
Equity in undistributed subsidiary (income) loss
Income tax valuation allowance
Loss on sale of assets
Change in other assets
Change in other liabilities
Other
Net cash (used in) from operating activities
Cash flows from investing activities
Investments in subsidiaries
Purchase of securities
Sales of securities
Net cash used in investing activities
Cash flows from financing activities
Proceeds from sale of preferred stock, net
Proceeds from sale of common stock, net
Repurchase of common stock, net
Dividends paid on preferred stock
Dividends paid on common stock
Net cash from (used in) financing activities
Net change in cash and cash equivalents
Beginning cash and cash equivalents
Ending cash and cash equivalents
2012
2011
(in thousands)
2010
$
$
114 $
21
72
(692 )
(1,453 )
(1,938 )
864
(30,130 )
(32,932 ) $
215 $
20
1,272
(652 )
(3,614 )
(2,759 )
468
(104,080 )
(107,307 ) $
609
20
1,787
(659 )
(3,420 )
(1,663 )
(592 )
(3,313 )
(4,384 )
2012
2011
(in thousands)
2010
$
(32,932 ) $
(107,307 ) $
(4,384 )
30,130
—
—
(21 )
776
478
(1,569 )
104,080
1,095
—
157
(273 )
1,404
(844 )
3,313
—
84
(219 )
225
445
(536 )
—
—
—
—
—
—
—
—
—
—
(13,100 )
—
—
(13,100 )
(21,000 )
(514 )
6,117
(15,397 )
—
—
—
(1,319 )
(237 )
(1,556 )
11,064
19,476
—
(1,847 )
(4,706 )
23,987
8,054
10,010
18,064
(1,569 )
2,564
995 $
(15,500 )
18,064
2,564 $
$
98
NOTE 23 – QUARTERLY FINANCIAL DATA (UNAUDITED)
Interest
Income
Net Interest
Income
Provision
For
Loan Losses
Net
Income
(Loss)
(in thousands, except per share data)
OREO
Expense
2012
First quarter
Second quarter
Third quarter
Fourth quarter
2011
First quarter
Second quarter
Third quarter
Fourth quarter
$
$
15,755 $
14,812
13,987
13,175
11,454 $
10,795
10,132
9,574
3,750 $
4,000
25,500
7,000
1,257 $
1,205
5,204
2,883
$
1,502
151
(27,732 ) (1)
(6,853 )
19,616 $
19,198
18,103
16,637
13,768 $
13,441
12,655
11,651
5,100 $
13,700
8,000
35,800
1,367 $
22,109
17,029
7,020
$
799
(39,989 ) (2)
(12,162 ) (3)
(55,955 ) (4)
Earnings (Loss)
Per Common Share
Basic
Diluted
0.08 $
(0.03 )
(2.29 )
(0.59 )
0.03 $
(3.33 )
(1.04 )
(4.64 )
0.08
(0.03 )
(2.29 )
(0.59 )
0.03
(3.33 )
(1.04 )
(4.64 )
(1) Third quarter net income was lower than the previous quarter due to increased provision for loan losses expense during the quarter as a
result of the continued decline in credit trends in our portfolio. The provision was also negatively impacted by a strategy change related to
classified loans which we expected to more quickly remediate by litigation or foreclosure.
(2) Second quarter net income was lower than the previous quarter due to increased provision for loan losses expense during the quarter, higher
fair value write-down adjustments on OREO, and a goodwill impairment charge of $23.8 million.
(3) Third quarter net income was affected by OREO write-downs to prepare for a bulk sale of OREO.
(4) Fourth quarter net income was lower than previous quarters due to increased provision for loan losses expense during the quarter and the
establishment of a deferred tax asset valuation allowance of $31.7 million.
NOTE 24 – CONTINGENCIES
In 2010, the Company sold common shares, convertible preferred shares and warrants to purchase common shares to accredited investors for
$32 million in a private placement. In the placement, SBAV LP, an affiliate of Clinton Group, Inc. (“CGI”) purchased 456,524 common shares
and warrants to purchase 228,262 common shares for $10.93 per share for $5,000,016. The numbers of shares and the warrant exercise price
have been adjusted to reflect the Company’s 5% stock dividend in November 2010.
On July 11, 2011, CGI sent a letter to the Company, which was also attached as an exhibit to a Schedule 13D CGI filed with the Securities and
Exchange Commission on the same date. In its letter CGI set forth concerns about the Company’s executive leadership team and its ability to
properly manage the Bank's operations, compliance with GAAP, financial disclosures and relationships with regulators, referencing the consent
order PBI Bank entered into with the FDIC and the KDFI on June 24, 2011. CGI listed a number of steps it believed the Company must take to
maximize shareholder value and comply with the consent order. In addition, CGI alleged “that it is likely that a number of representations and
warranties made when the CGI affiliate entered into an agreement to purchase shares were false,” and demanded that the Company take
immediate steps to “redress such breaches and make CGI and the other purchasers whole.”
On July 20, 2011, the Company’s board of directors established a new Risk Policy and Oversight Committee comprised of independent
directors, to lead the Board’s oversight of the assessment and management of the risks of Porter Bancorp and PBI Bank. During the third
quarter, the Oversight Committee undertook an investigation of the allegations raised in the CGI 13D to evaluate their merit and to ascertain
the reasonableness of the Bank’s allowance for loan losses and OREO valuations at the time of Clinton’s investment.
The Oversight Committee reported its conclusions to the Company’s board of directors in October 2011. While recognizing opportunities for
procedural improvements existed in the Bank’s lending and non-performing asset administration, the Oversight Committee concluded that this
did not rise to a level that would result in the financial statements, or representations and warranties with respect to the financial statements,
being misleading to investors in the 2010 private placement offering of the Company’s stock. The Oversight Committee further concluded that
investors were afforded ample opportunity and access to information for their due diligence, including documentation involving asset valuation
estimates, on-site management discussions and additional inquiries during visits to the Company headquarters, and access to loan files of their
choosing and the appraisals contained therein, and that the Company’s disclosures were adequate in all material respects.
99
On January 30, 2012, CGI delivered a demand to inspect the Company’s records pursuant to the Kentucky Business Corporation Act. The
Company provided records to CGI in accordance with Kentucky law.
On December 17, 2012, SBAV LP filed a lawsuit against Porter Bancorp, PBI Bank, J. Chester Porter and Maria L. Bouvette in New York
state court. The proceeding was removed to New York federal district court on January 16, 2013. SBAV LP v. Porter Bancorp, et. al ., Civ.
Action 13 Civ. 0372 (S.D.N.Y). The complaint alleges violation of the Kentucky Securities Act, negligent misrepresentation and, against
defendants Porter Bancorp and Bouvette, breach of contract. The plaintiff seeks damages in an amount in excess of $4,500,000, or the
difference between the $5,000,016 purchase price and the value of the securities when sold by the plaintiff, plus interest at the applicable
statutory rate, costs and reasonable attorneys’ fees. The defendants have filed motions to dismiss the suit or, in the alternative, to transfer it to
federal district court in Kentucky. We dispute the material factual allegations made in the complaint and intend to defend the plaintiff’s claims
vigorously. We have not accrued liability related to this matter as we believe we have meritorious defenses.
On June 18, 2010, three real estate development companies filed suit in Kentucky state court against PBI Bank and Managed Assets of
Kentucky (“MAKY”). Signature Point Condominiums LLC, et al. v. PBI Bank, et al ., Jefferson Circuit Court, Case No 10-CI-04295. The
plaintiffs had borrowed funds from PBI Bank to finance a real estate development project in Jefferson County, Kentucky. In March 2010, PBI
agreed to release the plaintiffs and the guarantors on the loans related to the project, and in exchange the plaintiffs conveyed the real estate
securing the loans to PBI Bank. PBI Bank also granted the plaintiffs a right of first refusal to repurchase a +/- 30 acre tract of land within the
project. In May 2010, PBI Bank submitted to plaintiffs the required notice of its intent to sell the land subject to the right of first refusal. After
plaintiffs declined to exercise their right of first refusal, PBI Bank sold the land to MAKY in June 2010 for $3.8 million.
Plaintiffs filed suit shortly before the closing of the sale and recorded a lis pendens claiming an interest in the land, effectively preventing
MAKY from taking clear title. Plaintiffs have asserted claims of fraud, breach of fiduciary duty, breach of the duty of good faith and fair
dealing, tortuous interference with prospective business advantage and conspiracy to commit fraud, negligence, and conspiracy against PBI
Bank and MAKY. Plaintiffs are seeking to rescind the agreement conveying the project to PBI Bank, but only with respect to the +/- 30 acre
tract of land. PBI has filed a counterclaim against the plaintiffs and a third party complaint against the guarantors, asserting claims of fraud.
MAKY has asserted claims against the plaintiffs for slander of title and interference with business opportunities. PBI’s position is that if the
conveyance agreement is rescinded, then PBI’s notes, mortgages, and guarantees as well as the obligations of the plaintiffs and guarantors
under the loans, which total more than $26 million, would all be reinstated. PBI would then seek to enforce its rights under such
instruments. The matter is scheduled for trial in July 2013. The preliminary motions on procedural matters have been submitted and ruled
on. We have not accrued liability related to this matter as we believe we have meritorious claims and defenses.
In the normal course of operations, we are defendants in various legal proceedings. We record contingent liabilities resulting from claims
against us when a loss is assessed to be probable and the amount of the loss is reasonably estimable. Assessing probability of loss and
estimating probable losses requires analysis of multiple factors, including in some cases judgments about the potential actions of third party
claimants and courts. Recorded contingent liabilities are based on the best information available and actual losses in any future period are
inherently uncertain. Currently, we do not believe that any of our pending legal proceedings or claims will have a material impact on our
financial position or results of operations.
Item 9 . Changes in and Disagreements With Accountants on Accounting and Financial Disclosure
None
Item 9A . Controls and Procedures
Management is responsible for establishing and maintaining effective disclosure controls and procedures, as defined under Rules 13a-15(e) and
15d-15(e) of the Securities Exchange Act of 1934. As of December 31, 2012, 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 our disclosure controls and procedures.
As a result of regulatory examination and audit processes applied to our loan grading activities shortly before and after year end 2011, we
determined that our internal process for assigning loan grades did not always establish an accurate grade for credit risk. Our internal control
processes surrounding loan grades, which consist of a combination of internal and external loan review activities, identified and corrected
grades for the majority of loans that were not initially graded correctly. However, our loan review had not sufficiently covered all loans subject
to potential grading error throughout the 2011 fiscal year. In preparing our annual report on Form 10-K, we identified the extent to which our
loan review controls did not operate and expanded the scope to cover the remainder of the portfolio and adjusted our allowance for loan losses
to take the additional findings into consideration. Accordingly, we determined the controls regarding the determination of loan grades were not
operating effectively as of December 31, 2011. Our management, overseen by the Audit Committee, worked throughout 2012 to implement
steps to remediate the control weaknesses for loan grading discovered in the closing process for the year and quarter ended December 31, 2011.
100
These enhanced procedures and process improvements include:
● Completion of additional independent internal and external loan reviews of the portfolio to ensure accurate grading from
March 2012 through December 2012.
● Review of the portfolio by assigned loan officer for proper grading.
● Analytical review of the portfolio by management based upon payment performance.
● Retention of John R. Davis to serve as Chief Credit Officer overseeing credit administration and credit quality policy and
●
procedures.
Implementation of a centralized loan administration and analysis team within the credit department to ensure more timely and
regular review of grading, performance metrics, financial information, and collateral.
In addition to those procedures, management implemented the following controls to ensure the accuracy, consistency, and timeliness of loan
grades:
Implemented reporting on risk rating changes to the Bank’s loan committee weekly and to the Board of Directors monthly.
●
● Ensured the risk rating assessment is a common discussion during the adjudication of any committee level loan request.
● Grade changes arising from specific file reviews or those recommended by the loan officer are routed to the loan review
department manager to ensure accurate, consistent, and timely update.
During 2012, we took steps to resolve the material weakness by changing our procedures for loan grading, as discussed above. Based on our
evaluation, management, including our Chief Executive Officer and our Chief Financial Officer, concluded that our disclosure controls and
procedures were effective as of the end of the period covered by this report. There were no other changes in our internal control over financial
reporting that occurred during the year ended December 31, 2012 that have materially affected, or are reasonably likely to materially affect, our
internal control over financial reporting.
Item 9B . Other Information
None
Item 10 . Directors, Executive Officers and Corporate Governance.
PART III
We have adopted a code of ethics applicable to our Chief Executive Officer and our senior financial officers, which is posted on our website at
http://www.pbibank.com . If we amend or waive any of the provisions of the Code of Ethics applicable to our Chief Executive Officer or senior
financial officers, we intend to disclose the amendment or waiver on our website. We will provide to any person without charge, upon request,
a copy of this Code of Ethics. You can request a copy by contacting Porter Bancorp, Inc., Chief Financial Officer, 2500 Eastpoint Parkway,
Louisville, Kentucky, 40223, (telephone) 502-499-4800.
Additional information required by this Item 10 is omitted because we are filing a definitive proxy statement pursuant to Regulation 14A on or
before April 30, 2013, which includes the required information. The required information contained in our proxy statement is incorporated
herein by reference.
Item 11 . Executive Compensation.
The information required by this Item 11 is omitted because we are filing a definitive proxy statement pursuant to Regulation 14A on or before
April 30, 2013, which includes the required information. The required information contained in our proxy statement is incorporated herein by
reference.
101
Item 12 . Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
The information required by this Item 12 is omitted because we are filing a definitive proxy statement pursuant to Regulation 14A on or before
April 30, 2013, which includes the required information. The required information contained in our proxy statement is incorporated herein by
reference.
Item 13 . Certain Relationships and Related Transactions, and Director Independence.
The information required by this Item 13 is omitted because we are filing a definitive proxy statement pursuant to Regulation 14A on or before
April 30, 2013, which includes the required information. The required information contained in our proxy statement is incorporated herein by
reference.
Item 14 . Principal Accounting Fees and Services.
The information required by this Item 14 is omitted because we are filing a definitive proxy statement pursuant to Regulation 14A on or before
April 30, 2013, which includes the required information. The required information contained in our proxy statement is incorporated herein by
reference.
102
Item 15 . Exhibits and Financial Statement Schedules
(a) 1. The following financial statements are included in this Form 10-K:
PART IV
Consolidated Balance Sheets as of December 31, 2012 and 2011
Consolidated Statements of Operations for the Years Ended December 31, 2012, 2011, and 2010
Consolidated Statements of Comprehensive Loss for the Years Ended December 31, 2012, 2011 and 2010
Consolidated Statements of Change in Stockholders’ Equity for the Years Ended December 31, 2012, 2011, and 2010
Consolidated Statements of Cash Flows for the Years Ended December 31, 2012, 2011, and 2010
Notes to Consolidated Financial Statements
Report of Independent Registered Public Accounting Firm
(a) 2. List of Financial Statement Schedules
Financial statement schedules are omitted because the information is not applicable.
(a) 3. List of Exhibits
The Exhibit Index of this report is incorporated by reference. The compensatory plans or arrangement required to be filed as exhibits to
this Form 10-K pursuant to Item 15(c) are noted with an asterisk in the Exhibit Index.
103
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Company has duly caused this report to be
signed on its behalf by the undersigned, thereunto duly authorized.
SIGNATURES
February 28, 2013
PORTER BANCORP, INC.
By: /s/ Maria L. Bouvette
Maria L. Bouvette
Chairman & Chief Executive Officer
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.
/s/ Maria L. Bouvette
Maria L. Bouvette
/s/ John T. Taylor
John T. Taylor
/s/ Phillip W. Barnhouse
Phillip W. Barnhouse
/s/ David L. Hawkins
David L. Hawkins
/s/ W. Glenn Hogan
W. Glenn Hogan
/s/ Sidney L. Monroe
Sidney L. Monroe
/s/ William G. Porter
William G. Porter
/s/ Stephen A. Williams
Stephen A. Williams
/s/ W. Kirk Wycoff
W. Kirk Wycoff
Chairman and Chief Executive Officer
February 28, 2013
President
February 28, 2013
Chief Financial Officer
February 28, 2013
Director
Director
Director
Director
Director
Director
104
February 28, 2013
February 28, 2013
February 28, 2013
February 28, 2013
February 28, 2013
February 28, 2013
EXHIBIT INDEX
Exhibit No. (1) Description
3.1
Amended and Restated Articles of Incorporation of Registrant, dated December 7, 2005. Exhibit 3.1 to Form S-1
Registration Statement (Reg. No. 333-133198) filed April 11, 2006 is hereby incorporated by reference.
3.2
Articles of Amendment to the Amended and Restated Articles of Incorporation, dated November 18, 2008. Exhibit 3.1 to
Form 8-K filed November 24, 2008 is hereby incorporated by reference.
3.3
3.4
3.5
3.6
Articles of Amendment to the Amended and Restated Articles of Incorporation, dated June 29, 2010. Exhibit 3.1 to the
Registrant’s Current Report on Form 8-K filed with the SEC on July 7, 2010 is hereby incorporated by reference.
Articles of Amendment to the Amended and Restated Articles of Incorporation, dated June 30, 2010. Exhibit 3.2 to the
Registrant’s Current Report on Form 8-K filed with the SEC on July 7, 2010 is hereby incorporated by reference.
Articles of Amendment to the Amended and Restated Articles of Incorporation, dated October 22, 2010. Exhibit 4.8 to
Form S-3 Registration Statement (Reg. No. 333-170678) filed November 18, 2010 is hereby incorporated by reference.
Bylaws of the Registrant, dated November 30, 2005. Exhibit 3.2 to Form S-1 Registration Statement (Reg. No. 333-133198)
filed April 11, 2006 is hereby incorporated by reference.
4.1
Warrant to purchase up to 299,829 shares. Exhibit 4.1 to Form 8-K filed November 24, 2008 is hereby incorporated by
reference.
4.2
4.3
4.4
10.1+
10.2+
10.3+
10.4+
Securities Purchase Agreement between the Registrant and the Purchasers thereto, dated as of June 30, 2010. Exhibit 10.1 to
the Registrant’s Current Report on Form 8-K filed with the SEC on July 7, 2010 is hereby incorporated by reference.
Registration Rights Agreement between the Registrant and the Purchasers thereto, dated as of June 30, 2010. Exhibit 10.2 to
the Registrant’s Current Report on Form 8-K filed with the SEC on July 7, 2010 is hereby incorporated by reference.
Letter Agreement between the Registrant and SBAV LP, dated as of July 23, 2010. Exhibit 10 to the Registrant’s Current
Report on Form 8-K filed with the SEC on July 29, 2010 is hereby incorporated by reference.
Porter Bancorp, Inc. Amended and Restated 2006 Stock Incentive Plan. Exhibit 10.2 to Form S-1 Registration Statement
(Reg. No. 333-133198) filed April 11, 2006 is hereby incorporated by reference.
Form of Porter Bancorp, Inc. Stock Option Award Agreement. Exhibit 10.3 to Form S-1 Registration Statement (Reg.
No. 333-133198) filed April 11, 2006 is hereby incorporated by reference.
Form of Porter Bancorp, Inc. Restricted Stock Award Agreement. Exhibit 10.4 to Form S-1 Registration Statement (Reg.
No. 333-133198) filed April 11, 2006 is hereby incorporated by reference.
Form of Ascencia Bank (now known as PBI Bank) Supplemental Executive Retirement Plan. Exhibit 10.5 to Form S-1
Registration Statement (Reg. No. 333-133198) filed April 11, 2006 is hereby incorporated by reference.
10.5+
Form of Amendment to PBI Bank Supplemental Executive Retirement Plan.
10.6+
10.7+
10.8
Porter Bancorp, Inc. 2006 Non-Employee Directors Stock Ownership Incentive Plan, as amended May 22, 2008. Annex A
Definitive Proxy Statement filed April 17, 2008 is hereby incorporated by reference.
Amendment to Porter Bancorp, Inc. 2006 Non-Employee Directors Stock Ownership Incentive Plan, as amended May 22,
2008.
Promissory Installment Note of Maria L. Bouvette and J. Chester Porter, as borrowers, to David L. Hawkins, as lender.
Exhibit 10.7 to Form S-1/A Registration Statement (Reg. No. 333-133198) filed May 24, 2006 is hereby incorporated by
reference.
10.9
Letter Agreement, dated November 21, 2008 including the Securities Purchase Agreement – Standard Terms incorporated by
reference therein, between the Company and the U.S. Treasury. Exhibit 10.1 to Form 8-K filed November 24, 2008 is
hereby incorporated by reference.
105
Exhibit No. (1)
Description
10.10
10.11+
Form of Waiver of Senior Executive Officers. Exhibit 10.2 to Form 8-K filed November 24, 2008 is hereby incorporated by
reference.
Porter Bancorp, Inc. 2011 Incentive Compensation Bonus Plan (incorporated by reference to Exhibit 10.14 to 2011 Form
10K).
10.12
Consent with Federal Deposit Insurance Corporation and Kentucky Department of Financial Institutions dated June 24,
2011. Exhibit 99.1 to Form 8-K filed June 30, 2011.
21.1
23.1
31.1
31.2
32.1
32.2
99.1
List of Subsidiaries of Porter Bancorp, Inc.
Consent of Crowe Horwath LLP, Independent Registered Public Accounting Firm
Certification of Chief Executive Officer pursuant to Exchange Act Rules 13a-14 or 15d-14
Certification of Chief Financial Officer pursuant to Exchange Act Rules 13a-14 or 15d-14
Certification of Chief Executive Officer pursuant to Exchange Act Rules 13a-14(b) or 15d-14(b) and 18 U.S.C. Section 1350
Certification of Chief Financial Officer pursuant to Exchange Act Rules 13a-14(b) or 15d-14(b) and U.S.C. Section 1350
Certification of Principal Executive Officer pursuant to Section 30.15 of the U.S. Treasury’s Interim Final Rule on TARP
Standards for Compensation and Corporate Governance.
99.2
Certification of Principal Executive Officer pursuant to Section 30.15 of the U.S. Treasury’s Interim Final Rule on TARP
Standards for Compensation and Corporate Governance.
101
The following financial statements from the Company’s Annual Report on Form 10K for the year ended December 31, 2012,
formatted in XBRL: (i) Consolidated Balance Sheets, (ii) Consolidated Statements of Operations, (iii) Consolidated
Statements of Comprehensive Income, (iv) Consolidated Statements of Changes in Stockholders’ Equity, (v) Consolidated
Statements of Cash Flows, (vi) Notes to Consolidated Financial Statements.
_________________________
+ Management contract or compensatory plan or arrangement.
(1) The Company has other long-term debt agreements that meet the exclusion set forth in Section 601(b)(4)(iii)(A) of Regulation S-K. The
Company hereby agrees to furnish a copy of such agreements to the Securities and Exchange Commission upon request.
106
Exhibit 21.1
Direct Subsidiary
PBI Bank
Asencia Statutory Trust I
Porter Statutory Trust II
Porter Statutory Trust III
Porter Statutory Trust IV
PBIB Corporation, Inc.
Indirect Subsidiary
PBI Title Services, LLC
Durham-Mudd Insurance
Agency, Inc.
SUBSIDIARIES OF PORTER BANCORP, INC.
Jurisdiction of Organization
Does Business As
Kentucky
Connecticut
Connecticut
Connecticut
Connecticut
Kentucky
PBI Bank
Asencia Statutory Trust I
Porter Statutory Trust II
Porter Statutory Trust III
Porter Statutory Trust IV
PBIB Corporation, Inc.
Jurisdiction of Organization
Does Business As
Parent Entity
Kentucky
Kentucky
PBI Title Services, LLC
Durham-Mudd Insurance
PBI Bank
PBI Bank
Agency, Inc.
CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Exhibit 23.1
We consent to the incorporation by reference in Registration Statement Nos. 333-143676 and 333-143678 on Form S-8 and Registration
Statement No. 333-156281 and 333-170678 on Form S-3 of Porter Bancorp, Inc. of our report dated February 28, 2013 with respect to the
consolidated financial statements of Porter Bancorp, Inc., which report appears in this Annual Report on Form 10-K of Porter Bancorp, Inc. for
the year ended December 31, 2012.
Louisville, Kentucky
February 28, 2013
Crowe Horwath LLP
Exhibit 31.1
PORTER BANCORP, INC .
RULE 13A-14(A) CERTIFICATION OF CHIEF EXECUTIVE OFFICER
I, Maria L. Bouvette, Chief Executive Officer of Porter Bancorp, Inc. (the “Company”), certify that:
1. I have reviewed this Annual Report on Form 10-K of the Company;
2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period
covered by this report;
3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material
respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;
4. The registrant’s other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-
15(f) and 15d-15(f)) for the registrant and have:
(a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our
supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others
within those entities, particularly during the period in which this report is being prepared;
(b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed
under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial
statements for external purposes in accordance with generally accepted accounting principles;
(c) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about
the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and
(d) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's
most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably
likely to materially affect, the registrant's internal control over financial reporting; and
5. The registrant's other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial
reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent
functions):
(a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which
are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and
(b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's
internal control over financial reporting.
Dated: February 28, 2013
/s/ Maria L. Bouvette
Maria L.
Bouvette
Chief Executive Officer
Exhibit 31.2
PORTER BANCORP, INC .
RULE 13A-14(A) CERTIFICATION OF CHIEF FINANCIAL OFFICER
I, Phillip W. Barnhouse, Chief Financial Officer of Porter Bancorp, Inc. (the “Company”), certify that:
1. I have reviewed this Annual Report on Form 10-K of the Company;
2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period
covered by this report;
3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material
respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;
4. The registrant’s other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-
15(f) and 15d-15(f)) for the registrant and have:
(a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our
supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others
within those entities, particularly during the period in which this report is being prepared;
(b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed
under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial
statements for external purposes in accordance with generally accepted accounting principles;
(c) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about
the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and
(d) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's
most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably
likely to materially affect, the registrant's internal control over financial reporting; and
5. The registrant's other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial
reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent
functions):
(a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which
are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and
(b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's
internal control over financial reporting.
Dated: February 28, 2013
/s/ Phillip W. Barnhouse
Phillip W.
Barnhouse
Chief Financial Officer
SECTION 906 CERTIFICATION
Exhibit 32.1
In connection with the Annual Report on Form 10-K of Porter Bancorp, Inc. (the “Company”) for the annual period ended December 31,
2012, as filed with the Securities and Exchange Commission on the date hereof (the “Report”), I, Maria L. Bouvette, Chief Executive Officer
of the Company, do hereby certify, in accordance with 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act
of 2002, that:
(1) The Report fully complies with the requirements of Section 13(a) or 15(d), as applicable, of the Securities Exchange Act of 1934,
as amended; and
(2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of
the Company.
Dated: February 28, 2013
PORTER BANCORP, INC.
By: /s/ Maria L. Bouvette
Maria L. Bouvette
Chief Executive Officer
SECTION 906 CERTIFICATION
Exhibit 32.2
In connection with the Annual Report on Form 10-K of Porter Bancorp, Inc. (the “Company”) for the annual period ended December 31,
2012, as filed with the Securities and Exchange Commission on the date hereof (the “Report”), I, Phillip W. Barnhouse, Chief Financial Officer
of the Company, do hereby certify, in accordance with 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act
of 2002, that:
(1) The Report fully complies with the requirements of Section 13(a) or 15(d), as applicable, of the Securities Exchange Act of 1934,
as amended; and
(2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of
the Company.
Dated: February 28, 2013
PORTER BANCORP, INC.
By: /s/ Phillip W. Barnhouse
Phillip W. Barnhouse
Chief Financial Officer
PORTER BANCORP, INC .
TARP CERTIFICATION OF CHIEF EXECUTIVE OFFICER
Exhibit 99.1
I, Maria L. Bouvette, Chief Executive Officer of Porter Bancorp, Inc. (the “Company”), certify that:
(1) The compensation committee (the “Compensation Committee”) of the Board of Directors (the “Board”) of the Company has met at least
every six months during the prior fiscal year with the senior risk officers of the Company to discuss and evaluate senior executive officer
compensation plans and employee compensation plans and the risks these plans pose to the Company;
(2) The Compensation Committee has identified and limited the features in the senior executive officer compensation plans that could lead
senior executive officers to take unnecessary and excessive risks that could threaten the value of the Company, has identified any features in
the employee compensation plans that pose risks to the Company, and has limited those features to ensure that the Company is not
unnecessarily exposed to risks;
(3) The Compensation Committee has reviewed at least every six months the terms of each employee compensation plan and identified and
limited the features in the plan that could encourage the manipulation of reported earnings of the Company to enhance the compensation of an
employee;
(4) The Compensation Committee will certify to these reviews;
(5) The Compensation Committee will provide a narrative description of how it limited the features in (i) senior executive officer compensation
plans that could lead senior executive officers to take unnecessary and excessive risks that could threaten the value of the Company, (ii)
employee compensation plans to ensure that the Company is not unnecessarily exposed to risks, and (iii) employee compensation plans that
could encourage the manipulation of reported earnings of the Company to enhance the compensation of an employee;
(6) The Company has required that all bonuses, retention awards, and incentive compensation of the senior executive officers and next twenty
most highly compensated employees be subject to a provision for recovery or “clawback” by the Company if the payments were based on
materially inaccurate financial statements or any other materially inaccurate performance metric criteria;
(7) The Company has prohibited any golden parachute payment to the senior executive officers and the next five most highly compensated
employees. For this purpose, a golden parachute payment is any payment triggered by involuntary termination with or without cause;
bankruptcy, insolvency or receivership of the Company; or a change in control of the Company;
(8) The Company has limited bonuses, retention awards, and incentive compensation paid to or accrued by employees to whom the bonus
payment limitation applies;
(9) The Company will permit a non-binding shareholder resolution on the senior executive officer compensation disclosures provided under the
Federal securities laws in accordance with any guidance, rules, and regulations promulgated by the SEC;
(10) The Company and its employees have complied with the excessive or luxury expenditures policy, as defined in the regulations and
guidance established under section 111 of EESA; and any expenses that, pursuant to the policy, required approval of the Board of Directors, a
committee of the Board of Directors, a senior executive officer, or an executive officer with a similar level of responsibility were properly
approved;
(11) The Company will disclose the amount, nature, and justification for the offering of any perquisites whose total value exceeds $25,000 for
each of the employees subject to the bonus payment limitations;
(12) The Company will disclose whether the Company, the Board, or the Compensation Committee has engaged a compensation consultant,
and the services the compensation consultant or any affiliate provided;
(13) The Company has prohibited any tax gross-ups on compensation to the senior executive officers and the next twenty most highly
compensated employees;
(14) The Company has substantially complied with any compensation requirements set forth in the agreement between the Company and the
Treasury, as may have been amended;
(15) The Company has submitted to Treasury a complete and accurate list of the senior executive officers and the twenty next most highly
compensated employees for the current fiscal year with the non-senior executive officers ranked in descending order of level of annual
compensation, and with the name, title, and employer of each senior executive officer and most highly compensated employee identified; and,
(16) The officer certifying understands that a knowing and willful false or fraudulent statement made in connection with the certification may
be punished by fine, imprisonment or both.
Dated: February 28, 2013
By: /s/ Maria L. Bouvette
Maria L. Bouvette
Chief Executive Officer
Exhibit 99.2
PORTER BANCORP, INC .
TARP CERTIFICATION OF CHIEF FINANCIAL OFFICER
I, Phillip W. Barnhouse, Chief Financial Officer of Porter Bancorp, Inc. (the “Company”), certify that:
(1) The compensation committee (the “Compensation Committee”) of the Board of Directors (the “Board”) of the Company has met at least
every six months during the prior fiscal year with the senior risk officers of the Company to discuss and evaluate senior executive officer
compensation plans and employee compensation plans and the risks these plans pose to the Company;
(2) The Compensation Committee has identified and limited the features in the senior executive officer compensation plans that could lead
senior executive officers to take unnecessary and excessive risks that could threaten the value of the Company, has identified any features in
the employee compensation plans that pose risks to the Company, and has limited those features to ensure that the Company is not
unnecessarily exposed to risks;
(3) The Compensation Committee has reviewed at least every six months the terms of each employee compensation plan and identified and
limited the features in the plan that could encourage the manipulation of reported earnings of the Company to enhance the compensation of an
employee;
(4) The Compensation Committee will certify to these reviews;
(5) The Compensation Committee will provide a narrative description of how it limited the features in (i) senior executive officer compensation
plans that could lead senior executive officers to take unnecessary and excessive risks that could threaten the value of the Company, (ii)
employee compensation plans to ensure that the Company is not unnecessarily exposed to risks, and (iii) employee compensation plans that
could encourage the manipulation of reported earnings of the Company to enhance the compensation of an employee;
(6) The Company has required that all bonuses, retention awards, and incentive compensation of the senior executive officers and next twenty
most highly compensated employees be subject to a provision for recovery or “clawback” by the Company if the payments were based on
materially inaccurate financial statements or any other materially inaccurate performance metric criteria;
(7) The Company has prohibited any golden parachute payment to the senior executive officers and the next five most highly compensated
employees. For this purpose, a golden parachute payment is any payment triggered by involuntary termination with or without cause;
bankruptcy, insolvency or receivership of the Company; or a change in control of the Company;
(8) The Company has limited bonuses, retention awards, and incentive compensation paid to or accrued by employees to whom the bonus
payment limitation applies;
(9) The Company will permit a non-binding shareholder resolution on the senior executive officer compensation disclosures provided under the
Federal securities laws in accordance with any guidance, rules, and regulations promulgated by the SEC;
(10) The Company and its employees have complied with the excessive or luxury expenditures policy, as defined in the regulations and
guidance established under section 111 of EESA; and any expenses that, pursuant to the policy, required approval of the Board of Directors, a
committee of the Board of Directors, a senior executive officer, or an executive officer with a similar level of responsibility were properly
approved;
(11) The Company will disclose the amount, nature, and justification for the offering of any perquisites whose total value exceeds $25,000 for
each of the employees subject to the bonus payment limitations;
(12) The Company will disclose whether the Company, the Board, or the Compensation Committee has engaged a compensation consultant,
and the services the compensation consultant or any affiliate provided;
(13) The Company has prohibited any tax gross-ups on compensation to the senior executive officers and the next twenty most highly
compensated employees;
(14) The Company has substantially complied with any compensation requirements set forth in the agreement between the Company and the
Treasury, as may have been amended;
(15) The Company has submitted to Treasury a complete and accurate list of the senior executive officers and the twenty next most highly
compensated employees for the current fiscal year, with the non-senior executive officers ranked in descending order of level of annual
compensation, and with the name, title, and employer of each senior executive officer and most highly compensated employee identified; and,
(16) The officer certifying understands that a knowing and willful false or fraudulent statement made in connection with the certification may
be punished by fine, imprisonment or both.
Dated: February 28, 2013
By: /s/Phillip W. Barnhouse
Phillip W. Barnhouse
Chief Financial Officer