UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

 

WASHINGTON, D.C. 20549

 

FORM 10-Q

 

Quarterly Report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the Quarterly Period Ended September 30, 2012

 

Commission File Number 001-15877

 

German American Bancorp, Inc.

(Exact name of registrant as specified in its charter)

 

Indiana   35-1547518
(State or other jurisdiction of   (I.R.S. Employer
incorporation or organization)   Identification No.)

 

711 Main Street, Jasper, Indiana 47546

(Address of Principal Executive Offices and Zip Code)

 

Registrant’s telephone number, including area code: (812) 482-1314

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

 

YES x   NO ¨

 

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 during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

 

YES x   NO ¨

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company:

 

Large accelerated filer ¨ Accelerated filer x Non-accelerated filer ¨ 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 ¨  NO x

 

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

 

Class   Outstanding at November 1, 2012
Common Shares, no par value   12,630,646

 

 
 

 

CAUTION REGARDING FORWARD-LOOKING STATEMENTS AND ASSOCIATED RISKS

 

Information included in or incorporated by reference in this Quarterly Report on Form 10-Q, our other filings with the Securities and Exchange Commission (the “SEC”) and our press releases or other public statements, contains or may contain “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. Please refer to the discussions of our forward-looking statements and associated risks in our annual report on Form 10-K for the year ended December 31, 2011, in Item 1, “Business – Forward-Looking Statements and Associated Risks” and our discussion of risk factors in Item 1A, “Risk Factors” of that annual report on Form 10-K, as updated from time to time in our subsequent SEC filings, including by Item 2 of Part I of this Report (“Management’s Discussion and Analysis of Financial Condition and Results of Operations”) at the conclusion of that Item 2 under the heading “Forward-Looking Statements and Associated Risks.”

 

2
 

 

 

*****

  

INDEX

 

PART I. FINANCIAL INFORMATION 4
     
Item 1. Financial Statements 4
     
  Consolidated Balance Sheets – September 30, 2012 and December 31, 2011 4
     
  Consolidated Statements of Income and Comprehensive Income -  
  Three Months Ended September 30, 2012 and 2011 5
     
  Consolidated Statements of Income and Comprehensive Income -  
  Nine Months Ended September 30, 2012 and 2011 6
     
  Consolidated Statements of Cash Flows – Nine Months Ended  
  September 30, 2012 and 2011 7
     
  Notes to Consolidated Financial Statements – September 30, 2012 8-28
     
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations 29-40
     
Item 3. Quantitative and Qualitative Disclosures About Market Risk 40-41
     
Item 4.  Controls and Procedures 41
     
PART II. OTHER INFORMATION 42
     
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 42
     
Item 6. Exhibits 43
     
SIGNATURES 43
   
INDEX OF EXHIBITS 44

 

3
 

 

PART I.FINANCIAL INFORMATION
Item 1.Financial Statements

 

GERMAN AMERICAN BANCORP, INC.

CONSOLIDATED BALANCE SHEETS

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

 

   September 30,   December 31, 
   2012   2011 
         
ASSETS          
Cash and Due from Banks  $33,960   $28,366 
Federal Funds Sold and Other Short-term Investments   29,828    32,737 
Cash and Cash Equivalents   63,788    61,103 
           
Interest-bearing Time Deposits with Banks   2,715    5,986 
Securities Available-for-Sale, at Fair Value    612,396    516,844 
Securities Held-to-Maturity, at Cost (Fair value of $351 and $697 on September 30, 2012 and December 31, 2011, respectively)   346    690 
           
Loans Held-for-Sale, at Fair Value   18,993    21,485 
           
Loans    1,168,146    1,123,549 
Less: Unearned Income   (3,012)   (2,556)
 Allowance for Loan Losses   (15,922)   (15,312)
Loans, Net   1,149,212    1,105,681 
           
Stock in FHLB of Indianapolis and Other Restricted Stock, at Cost   8,340    8,340 
Premises, Furniture and Equipment, Net   36,730    37,706 
Other Real Estate   1,610    2,343 
Goodwill   18,865    18,865 
Intangible Assets   3,077    4,346 
Company Owned Life Insurance   29,975    29,263 
Accrued Interest Receivable and Other Assets   16,251    61,115 
TOTAL ASSETS  $1,962,298   $1,873,767 
           
LIABILITIES          
Non-interest-bearing Demand Deposits  $327,450   $282,335 
Interest-bearing Demand, Savings, and Money Market Accounts   933,561    899,584 
Time Deposits   358,026    374,279 
Total Deposits   1,619,037    1,556,198 
           
FHLB Advances and Other Borrowings   141,074    130,993 
Accrued Interest Payable and Other Liabilities   19,218    18,966 
TOTAL LIABILITIES   1,779,329    1,706,157 
           
SHAREHOLDERS’ EQUITY          
Preferred Stock, no par value; 500,000   shares authorized, no shares issued        
Common Stock, no par value, $1 stated value;  30,000,000 shares authorized   12,631    12,594 
Additional Paid-in Capital   95,434    95,039 
Retained Earnings   61,996    49,434 
Accumulated Other Comprehensive Income   12,908    10,543 
           
TOTAL SHAREHOLDERS’ EQUITY   182,969    167,610 
           
TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY  $1,962,298   $1,873,767 
           
End of period shares issued and outstanding   12,630,646    12,594,258 

 

See accompanying notes to consolidated financial statements.

 

4
 

 

GERMAN AMERICAN BANCORP, INC.

CONSOLIDATED STATEMENTS OF INCOME

AND COMPREHENSIVE INCOME

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

 

   Three Months Ended 
   September 30, 
   2012   2011 
INTEREST INCOME        
Interest and Fees on Loans  $15,082   $15,933 
Interest on Federal Funds Sold and Other Short-term Investments   11    48 
Interest and Dividends on Securities:          
Taxable   3,235    3,645 
Non-taxable   625    479 
TOTAL INTEREST INCOME   18,953    20,105 
           
INTEREST EXPENSE          
Interest on Deposits   1,622    2,823 
Interest on FHLB Advances and Other Borrowings   938    1,079 
TOTAL INTEREST EXPENSE   2,560    3,902 
           
NET INTEREST INCOME   16,393    16,203 
Provision for Loan Losses   640    1,300 
NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES   15,753    14,903 
           
NON-INTEREST INCOME          
Trust and Investment Product Fees   659    602 
Service Charges on Deposit Accounts   1,049    1,120 
Insurance Revenues   1,469    1,261 
Company Owned Life Insurance   213    233 
Interchange Fee Income   418    395 
Other Operating Income   811    86 
Net Gains on Sales of Loans   941    863 
Net Gains on Securities   598     
TOTAL NON-INTEREST INCOME   6,158    4,560 
           
NON-INTEREST EXPENSE          
Salaries and Employee Benefits   7,261    6,687 
Occupancy Expense   1,066    1,142 
Furniture and Equipment Expense   650    621 
FDIC Premiums   271    295 
Data Processing Fees   311    321 
Professional Fees   585    526 
Advertising and Promotion   439    383 
Intangible Amortization   405    480 
Other Operating Expenses   1,740    1,550 
TOTAL NON-INTEREST EXPENSE   12,728    12,005 
           
Income before Income Taxes   9,183    7,458 
Income Tax Expense   2,891    2,291 
NET INCOME  $6,292   $5,167 
           
Other Comprehensive Income:          
Changes in Unrealized Gain on Securities Available-for-Sale, Net   1,186    3,427 
Total Other Comprehensive Income  $1,186   $3,427 
           
COMPREHENSIVE INCOME  $7,478   $8,594 
           
Basic Earnings Per Share  $0.50   $0.41 
Diluted Earnings Per Share  $0.50   $0.41 
           
Dividends Per Share  $0.14   $0.14 

 

See accompanying notes to consolidated financial statements.

 

5
 

 

GERMAN AMERICAN BANCORP, INC.

CONSOLIDATED STATEMENTS OF INCOME

AND COMPREHENSIVE INCOME

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

 

   Nine  Months Ended 
   September 30, 
   2012   2011 
INTEREST INCOME          
Interest and Fees on Loans  $46,380   $48,620 
Interest on Federal Funds Sold and Other Short-term Investments   84    179 
Interest and Dividends on Securities:          
Taxable   9,982    10,075 
Non-taxable   1,797    1,271 
TOTAL INTEREST INCOME   58,243    60,145 
           
INTEREST EXPENSE          
Interest on Deposits   5,523    9,464 
Interest on FHLB Advances and Other Borrowings   3,066    3,107 
TOTAL INTEREST EXPENSE   8,589    12,571 
           
NET INTEREST INCOME   49,654    47,574 
Provision for Loan Losses   1,721    3,900 
NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES   47,933    43,674 
           
NON-INTEREST INCOME          
Trust and Investment Product Fees   2,019    1,561 
Service Charges on Deposit Accounts   3,001    3,135 
Insurance Revenues   4,218    4,600 
Company Owned Life Insurance   723    836 
Interchange Fee Income   1,309    1,126 
Other Operating Income   1,500    982 
Net Gains on Sales of Loans   2,330    1,651 
Net Gains on Securities   692    1,045 
TOTAL NON-INTEREST INCOME   15,792    14,936 
           
NON-INTEREST EXPENSE          
Salaries and Employee Benefits   21,409    20,810 
Occupancy Expense   3,219    3,216 
Furniture and Equipment Expense   2,054    2,243 
FDIC Premiums   851    1,191 
Data Processing Fees   746    1,821 
Professional Fees   1,777    1,630 
Advertising and Promotion   1,208    1,000 
Intangible Amortization   1,269    1,495 
Other Operating Expenses   5,211    4,740 
TOTAL NON-INTEREST EXPENSE   37,744    38,146 
           
Income before Income Taxes   25,981    20,464 
Income Tax Expense   8,120    5,788 
NET INCOME  $17,861   $14,676 
           
Other Comprehensive Income:          
Changes in Unrealized Gain on Securities Available-for-Sale, Net   2,365    9,097 
Total Other Comprehensive Income  $2,365   $9,097 
           
COMPREHENSIVE INCOME  $20,226   $23,773 
           
Basic Earnings Per Share  $1.42   $1.17 
Diluted Earnings Per Share  $1.41   $1.17 
           
Dividends Per Share  $0.42   $0.42 

 

See accompanying notes to consolidated financial statements.

 

6
 

 

GERMAN AMERICAN BANCORP, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(unaudited, dollars in thousands)

 

   Nine Months Ended 
   September 30, 
   2012   2011 
CASH FLOWS FROM OPERATING ACTIVITIES          
Net Income  $17,861   $14,676 
Adjustments to Reconcile Net Income to Net Cash from Operating Activities:          
Net Amortization on Securities   3,419    1,491 
Depreciation and Amortization   3,584    3,902 
Loans Originated for Sale   (125,770)   (71,166)
Proceeds from Sales of Loans Held-for-Sale   130,375    74,658 
Loss in Investment in Limited Partnership       20 
Provision for Loan Losses   1,721    3,900 
Gain on Sale of Loans, net   (2,330)   (1,651)
Gain on Securities, net   (692)   (1,045)
Loss (Gain) on Sales of Other Real Estate and Repossessed Assets   (232)   191 
Loss (Gain) on Disposition and Impairment of Premises and Equipment   (1)   17 
Increase in Cash Surrender Value of Company Owned Life Insurance   (712)   (840)
Equity Based Compensation   463    465 
Change in Assets and Liabilities:          
Interest Receivable and Other Assets   3,716    4,068 
Interest Payable and Other Liabilities   (1,048)   (2,339)
Net Cash from Operating Activities   30,354    26,347 
           
CASH FLOWS FROM INVESTING ACTIVITIES          
Proceeds from Maturity of Other Short-term Investments   3,236    5,475 
Proceeds from Maturities, Calls, Redemptions of Securities Available-for-Sale   100,964    71,619 
Redemption of Federal Reserve Bank Stock       694 
Proceeds from Sales of Securities Available-for-Sale   92,344     
Purchase of Securities Available-for-Sale   (244,755)   (267,696)
Proceeds from Maturities of Securities Held-to-Maturity   344    815 
Proceeds from Redemption of Federal Home Loan Bank Stock       1,523 
Proceeds from Sales of Loans   7,560    1,364 
Loans Made to Customers, net of Payments Received   (55,676)   16,777 
Proceeds from Sales of Other Real Estate   3,827    3,461 
Property and Equipment Expenditures   (3,091)   (2,377)
Proceeds from Sales of Property and Equipment   1    12 
Acquire Capitalized Lease       (6)
Acquisition of American Community Bancorp, Inc.       55,780 
Net Cash from Investing Activities   (95,246)   (112,559)
           
CASH FLOWS FROM FINANCING ACTIVITIES          
Change in Deposits   62,876     163,950 
Change in Short-term Borrowings   30,090    (34,112)
Repayments of Long-term Debt   (20,059)   (5,045)
Issuance of Common Stock   35    12 
Employee Stock Purchase Plan   (66)   (25)
Dividends Paid   (5,299)   (5,284)
Net Cash from Financing Activities   67,577    119,496 
           
Net Change in Cash and Cash Equivalents   2,685    33,284 
Cash and Cash Equivalents at Beginning of Year   61,103    19,271 
Cash and Cash Equivalents at End of Period  $63,788   $52,555 
Cash Paid During the Period for          
Interest  $9,411   $13,317 
Income Taxes   6,484    5,156 
           
Supplemental Non Cash Disclosures          
Loans Transferred to Other Real Estate  $2,862   $3,409 
Accounts Receivable Transferred to Securities   (43,167)    

 

See accompanying notes to consolidated financial statements.

 

7
 

 

GERMAN AMERICAN BANCORP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2012

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

 

Note 1 – Basis of Presentation

 

German American Bancorp, Inc. operates primarily in the banking industry. The accounting and reporting policies of German American Bancorp, Inc. and its subsidiaries conform to U.S. generally accepted accounting principles. Certain information and footnote disclosures normally included in financial statements prepared in accordance with U.S. generally accepted accounting principles have been condensed or omitted. All adjustments which are, in the opinion of management, necessary for a fair presentation of the results for the periods reported have been included in the accompanying unaudited consolidated financial statements, and all such adjustments are of a normal recurring nature. Certain prior year amounts have been reclassified to conform with current year classifications. It is suggested that these consolidated financial statements and notes be read in conjunction with the financial statements and notes thereto in the German American Bancorp, Inc. December 31, 2011 Annual Report on Form 10-K.

 

Note 2 – Per Share Data

 

The computations of Basic Earnings per Share and Diluted Earnings per Share are as follows:

 

   Three Months Ended 
   September 30, 
  2012   2011 
Basic Earnings per Share:          
Net Income  $6,292   $5,167 
Weighted Average Shares Outstanding   12,628,335    12,593,521 
Basic Earnings per Share  $0.50   $0.41 
           
Diluted Earnings per Share:          
Net Income  $6,292   $5,167 
           
Weighted Average Shares Outstanding   12,628,335    12,593,521 
Potentially Dilutive Shares, Net   20,589    4,691 
Diluted Weighted Average Shares Outstanding   12,648,924    12,598,212 
Diluted Earnings per Share  $0.50   $0.41 

 

Stock options for 99,275 shares of common stock were not considered in computing diluted earnings per share for the quarter ended September 30, 2011 because they were anti-dilutive. There were no anti-dilutive shares for the quarter ended September 30, 2012.

 

The computations of Basic Earnings per Share and Diluted Earnings per Share are as follows:

 

   Nine Months Ended 
   September 30, 
   2012   2011 
Basic Earnings per Share:        
Net Income  $17,861   $14,676 
Weighted Average Shares Outstanding   12,618,863    12,577,558 
Basic Earnings per Share  $1.42   $1.17 
           
Diluted Earnings per Share:          
Net Income  $17,861   $14,676 
           
Weighted Average Shares Outstanding   12,618,863    12,577,558 
Potentially Dilutive Shares, Net   15,009    5,719 
Diluted Weighted Average Shares Outstanding   12,633,872    12,583,277 
Diluted Earnings per Share  $1.41   $1.17 

 

Stock options for 89,275 shares of common stock were not considered in computing diluted earnings per share for the nine months ended September 30, 2011 because they were anti-dilutive. There were no anti-dilutive shares for the nine months ended September 30, 2012.

 

8
 

 

GERMAN AMERICAN BANCORP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2012

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

 

Note 3 – Securities

 

The amortized cost, unrealized gross gains and losses recognized in accumulated other comprehensive income (loss), and fair value of Securities Available-for-Sale at September 30, 2012 and December 31, 2011, were as follows:

 

       Gross   Gross     
   Amortized   Unrealized   Unrealized   Fair 
   Cost   Gains   Losses   Value 
Securities Available-for-Sale:                    
September 30, 2012                    
U.S. Treasury and Agency Securities  $3,578   $47   $   $3,625 
Obligations of State and Political Subdivisions   69,630    5,223        74,853 
Mortgage-backed Securities - Residential   518,123    15,147    (58)   533,212 
Equity Securities   684    22        706 
Total  $592,015   $20,439   $(58)  $612,396 
                     
December 31, 2011                    
U.S. Treasury and Agency Securities  $6,340   $82   $   $6,422 
Corporate Securities   1,003    2        1,005 
Obligations of State and Political Subdivisions   60,606    4,195   (2)   64,799 
Mortgage-backed Securities - Residential   431,495    12,529    (90)   443,934 
Equity Securities   684            684 
Total  $500,128   $16,808   $(92)  $516,844 

 

Equity securities that do not have readily determinable fair values are included in the above totals, are carried at historical cost and are evaluated for impairment on a periodic basis. All mortgage-backed securities in the above table are residential mortgage-backed securities and guaranteed by government sponsored entities.

 

The carrying amount, unrecognized gains and losses and fair value of Securities Held-to-Maturity at September 30, 2012 and December 31, 2011, were as follows:

 

       Gross   Gross     
   Carrying   Unrecognized   Unrecognized   Fair 
   Amount   Gains   Losses   Value 
Securities Held-to-Maturity:                    
September 30, 2012                    
Obligations of State and Political Subdivisions  $346   $5   $   $351 
                     
December 31, 2011                    
Obligations of State and Political Subdivisions  $690   $7   $   $697 

 

The amortized cost and fair value of Securities at September 30, 2012 by contractual maturity are shown below. Expected maturities may differ from contractual maturities because some issuers have the right to call or prepay certain obligations with or without call or prepayment penalties. Mortgage-backed and Equity Securities are not due at a single maturity date and are shown separately.

 

   Amortized   Fair 
   Cost   Value 
Securities Available-for-Sale:          
Due in one year or less  $2,372   $2,385 
Due after one year through five years   14,817    15,273 
Due after five years through ten years   26,967    29,072 
Due after ten years   29,052    31,748 
Mortgage-backed Securities - Residential   518,123    533,212 
Equity Securities   684    706 
Totals  $592,015   $612,396 

 

9
 

 

GERMAN AMERICAN BANCORP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2012

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

 

Note 3 – Securities (continued)

 

   Carrying   Fair 
   Amount   Value 
Securities Held-to-Maturity:          
Due in one year or less  $   $ 
Due after one year through five years   346    351 
Due after five years through ten years        
Due after ten years        
Totals  $346   $351 

 

Below is a summary of securities with unrealized losses as of September 30, 2012 and December 31, 2011, presented by length of time the securities have been in a continuous unrealized loss position:

 

   Less than 12 Months   12 Months or More   Total 
   Fair   Unrealized   Fair   Unrealized   Fair   Unrealized 
   Value   Loss   Value   Loss   Value   Loss 
At September 30, 2012:                              
U.S. Treasury and Agency Securities  $   $   $   $   $   $ 
Corporate Securities                        
Obligations of State and Political Subdivisions                        
Mortgage-backed Securities - Residential   5,992    (58)           5,992    (58)
Equity Securities                        
Total  $5,992   $(58)  $   $   $5,992   $(58)

 

   Less than 12 Months   12 Months or More   Total 
   Fair   Unrealized   Fair   Unrealized   Fair   Unrealized 
   Value   Loss   Value   Loss   Value   Loss 
At December 31, 2011:                              
U.S. Treasury and Agency Securities  $   $   $   $   $   $ 
Corporate Securities                        
Obligations of State and Political Subdivisions   203    (2)           203    (2)
Mortgage-backed Securities - Residential   39,947    (90)           39,947    (90)
Equity Securities                        
Total  $40,150   $(92)  $   $   $40,150   $(92)

 

Securities are written down to fair value when a decline in fair value is not considered temporary. In estimating other-than-temporary losses, management considers many factors, including: (1) the length of time and the extent to which the fair value has been less than cost, (2) the financial condition and near-term prospects of the issuer, (3) whether the market decline was affected by macroeconomic conditions, and (4) whether the Company has the intent to sell the debt security or more likely than not will be required to sell the debt security before its anticipated recovery. The Company does not intend to sell or expect to be required to sell these securities, and the decline in fair value is largely due to changes in market interest rates, therefore, the Company does not consider these securities to be other-than-temporarily impaired. All mortgage-backed securities in the Company’s portfolio are guaranteed by government sponsored entities, are investment grade, and are performing as expected.

 

The Company held a minority interest in American Community Bancorp, Inc., prior to the acquisition on January 1, 2011. For the nine months ended September 30, 2011, the Company recognized a gain of $1.045 million on the stock held of American Community Bancorp, Inc. as a result of the acquisition.

 

Note 4 – Derivatives

 

The Company executes interest rate swaps with commercial banking customers to facilitate their respective risk management strategies. Those interest rate swaps are simultaneously hedged by offsetting interest rate swaps that the Company executes with a third party, such that the Company minimizes its net risk exposure resulting from such transactions. The agreements are considered stand alone derivatives and changes in the fair value of derivatives are reported in earnings as non-interest income. The notional amount of these interest rate swaps was $6.1million at September 30, 2012. The fair value of these contracts combined was $6 as associated gains and losses nearly offset.

 

10
 

 

GERMAN AMERICAN BANCORP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2012

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

 

Note 5 – Loans

 

Loans were comprised of the following classifications at September 30, 2012 and December 31, 2011:

 

   September 30,   December 31, 
   2012   2011 
Commercial:          
Commercial and Industrial Loans and Leases  $328,058   $293,172 
Commercial Real Estate Loans   467,666    452,071 
Agricultural Loans   165,198    167,693 
Retail:          
Home Equity Loans   73,828    77,070 
Consumer Loans   42,652    47,409 
Residential Mortgage Loans   90,744    86,134 
Subtotal   1,168,146    1,123,549 
Less: Unearned Income   (3,012)   (2,556)
Allowance for Loan Losses   (15,922)   (15,312)
Loans, Net  $1,149,212   $1,105,681 

 

The following table presents the activity in the allowance for loan losses by portfolio class for the three months ending September 30, 2012 and 2011:

 

    Commercial                                            
    and                                            
    Industrial     Commercial           Home           Residential              
    Loans and     Real Estate     Agricultural     Equity     Consumer     Mortgage              
    Leases     Loans     Loans     Loans     Loans     Loans     Unallocated     Total  
September 30, 2012                                                                
Beginning Balance   $ 4,707     $ 8,732     $ 890     $ 181     $ 227     $ 391     $ 564     $ 15,692  
Provision for Loan Losses     193       376       21       21       12       (12     29       640  
Recoveries     8       62                   35       2             107  
Loans Charged-off     (54 )     (351 )           (7 )     (63 )     (42 )           (517 )
Ending Balance   $ 4,854     $ 8,819     $ 911     $ 195     $ 211     $ 339     $ 593     $ 15,922  

 

   Commercial                             
   and                             
   Industrial   Commercial       Home       Residential         
   Loans and   Real Estate   Agricultural   Equity   Consumer   Mortgage         
   Leases   Loans   Loans   Loans   Loans   Loans   Unallocated   Total 
September 30, 2011                                        
Beginning Balance  $4,292   $7,697   $733   $213   $400   $746   $699   $14,780 
Provision for Loan Losses   90    1,120   (5)   108    54    57    (124)   1,300 
Recoveries   90    28        2    37            157 
Loans Charged-off   (82)   (714)       (29)   (85)   (161)       (1,071)
Ending Balance  $4,390   $8,131   $728   $294   $406   $642   $575   $15,166 

 

11
 

 

GERMAN AMERICAN BANCORP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2012

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

 

NOTE 5 – Loans (continued)

 

The following table presents the activity in the allowance for loan losses by portfolio class for the nine months ending September 30, 2012 and 2011:

 

   Commercial                             
   and                             
   Industrial   Commercial       Home       Residential         
   Loans and   Real Estate   Agricultural   Equity   Consumer   Mortgage         
   Leases   Loans   Loans   Loans   Loans   Loans   Unallocated   Total 
September 30, 2012                                        
Beginning Balance  $3,493   $9,297   $926   $258   $190   $402   $746   $15,312 
Provision for Loan Losses   1,466    232   (15   (9)   141    59    (153)   1,721 
Recoveries   57    88        1    99    11        256 
Loans Charged-off   (162)   (798)       (55)   (219)   (133)       (1,367)
Ending Balance  $4,854   $8,819   $911   $195   $211   $339   $593   $15,922 

  

   Commercial                             
   and                             
   Industrial   Commercial       Home       Residential         
   Loans and   Real Estate   Agricultural   Equity   Consumer   Mortgage         
   Leases   Loans   Loans   Loans   Loans   Loans   Unallocated   Total 
September 30, 2011                                        
Beginning Balance  $3,713   $7,497   $750   $220   $362   $543   $232   $13,317 
Provision for Loan Losses   845    2,007    (22)   194    138    395    343    3,900 
Recoveries   96    131        5    96    15        343 
Loans Charged-off   (264)   (1,504)       (125)   (190)   (311)       (2,394)
Ending Balance  $4,390   $8,131   $728   $294   $406   $642   $575   $15,166 

  

The following table presents the balance in the allowance for loan losses and the recorded investment in loans by portfolio class and based on impairment method as of September 30, 2012 and December 31, 2011:

 

       Commercial                         
       and                         
       Industrial   Commercial       Home       Residential     
       Loans and   Real Estate   Agricultural   Equity   Consumer   Mortgage     
   Total   Leases   Loans   Loans   Loans   Loans   Loans   Unallocated 
September 30, 2012                                        
Allowance for Loan Losses:                                        
Ending Allowance Balance                                        
Attributable to Loans:                                        
Individually Evaluated for Impairment  $5,433   $1,281   $4,152   $      $       
Collectively Evaluated for Impairment   10,392    3,497    4,646    911    195    211    339    593 
Acquired with Deteriorated Credit Quality   97    76    21                     
Total Ending Allowance Balance  $15,922   $4,854   $8,819   $911   $195   $211   $339   $593 
Loans:                                        
Loans Individually Evaluated for Impairment  $11,817   $2,669   $9,148      $   $   $   $ 
Loans Collectively Evaluated for Impairment   1,149,752    323,974    450,332    167,851    74,068    42,630    90,897     
Loans Acquired with Deteriorated Credit Quality   11,940    2,324    9,313            152    151     
Total Ending Loans Balance (1)  $1,173,509   $328,967   $468,793   $167,851   $74,068   $42,782   $91,048   $ 

 

(1) Total recorded investment in loans includes $5,363 in accrued interest.

 

12
 

 

GERMAN AMERICAN BANCORP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2012

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

 

NOTE 5 – Loans (continued)

  

       Commercial                         
       and                         
       Industrial   Commercial       Home       Residential     
       Loans and   Real Estate   Agricultural   Equity   Consumer   Mortgage     
   Total   Leases   Loans   Loans   Loans   Loans   Loans   Unallocated 
December 31, 2011                                        
Allowance for Loan Losses:                                        
Ending Allowance Balance                                        
Attributable to Loans:                                        
Individually Evaluated for Impairment  $4,834   $466   $4,368   $   $   $   $   $ 
Collectively Evaluated for Impairment   10,401    3,027    4,852    926    258    190    402    746 
Acquired with Deteriorated Credit Quality   77        77                     
Total Ending Allowance Balance  $15,312   $3,493   $9,297   $926   $258   $190   $402   $746 
                                         
Loans:                                        
Loans Individually Evaluated for Impairment  $16,613   $3,567   $13,046   $   $   $   $   $ 
Loans Collectively Evaluated for Impairment   1,096,571    287,924    427,063    170,513    77,323    47,431    86,317     
Loans Acquired with Deteriorated Credit Quality   16,121    2,596    13,209            164    152     
Total Ending Loans Balance (1)  $1,129,305   $294,087   $453,318   $170,513   $77,323   $47,595   $86,469   $ 

  

(1) Total recorded investment in loans includes $5,756 in accrued interest.

 

The following table presents loans individually evaluated for impairment by class of loans including purchase credit impaired loans that subsequently result in additional allowance for loan losses as of September 30, 2012 and December 31, 2011:

 

   Unpaid       Allowance for 
   Principal   Recorded   Loan Losses 
   Balance   Investment   Allocated 
September 30, 2012               
With No Related Allowance Recorded:               
Commercial and Industrial Loans and Leases  $116   $95   $ 
Commercial Real Estate Loans   2,116    2,066     
Agricultural Loans            
                
With An Allowance Recorded:               
Commercial and Industrial Loans and Leases   2,696    2,683    1,357 
Commercial Real Estate Loans   7,123    7,110    4,173 
Agricultural Loans            
Total  $12,051   $11,954   $5,530 

 

13
 

 

GERMAN AMERICAN BANCORP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2012

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

NOTE 5 – Loans (continued)

 

   Unpaid       Allowance for 
   Principal   Recorded   Loan Losses 
   Balance   Investment   Allocated 
December 31, 2011               
With No Related Allowance Recorded:               
Commercial and Industrial Loans and Leases  $1,084   $1,066   $ 
Commercial Real Estate Loans   5,959    5,894     
Agricultural Loans            
                
With An Allowance Recorded:               
Commercial and Industrial Loans and Leases   2,502    2,501    466 
Commercial Real Estate Loans   7,400    7,230    4,445 
Agricultural Loans            
Total  $16,945   $16,691   $4,911 

 

The following table presents loans individually evaluated for impairment by class of loans including purchase credit impaired loans that subsequently result in additional allowance for loan losses for the three month period ended September 30, 2012 and 2011:

 

   Average   Interest   Cash 
   Recorded   Income   Basis 
   Investment   Recognized   Recognized 
September 30, 2012               
With No Related Allowance Recorded:               
Commercial and Industrial Loans and Leases  $139   $1   $1 
Commercial Real Estate Loans   3,353    12    12 
Agricultural Loans            
                
With An Allowance Recorded:               
Commercial and Industrial Loans and Leases   2,749    4    3 
Commercial Real Estate Loans   7,179    6    5 
Agricultural Loans            
Total  $13,420   $23   $21 

 

   Average   Interest   Cash 
   Recorded   Income   Basis 
   Investment   Recognized   Recognized 
September 30, 2011               
With No Related Allowance Recorded:               
Commercial and Industrial Loans and Leases  $105   $6   $6 
Commercial Real Estate Loans   4,362    14    14 
Agricultural Loans            
                
With An Allowance Recorded:               
Commercial and Industrial Loans and Leases   3,467    3    3 
Commercial Real Estate Loans   7,777    14    13 
Agricultural Loans            
Total  $15,711   $37   $36 

 

14
 

 

GERMAN AMERICAN BANCORP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2012

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

 

NOTE 5 – Loans (continued)

 

The following table presents loans individually evaluated for impairment by class of loans including purchase credit impaired loans that subsequently result in additional allowance for loan losses for the nine month period ended September 30, 2012 and 2011:

 

   Average   Interest   Cash 
   Recorded   Income   Basis 
   Investment   Recognized   Recognized 
September 30, 2012               
With No Related Allowance Recorded:               
Commercial and Industrial Loans and Leases  $298   $3   $3 
Commercial Real Estate Loans   5,023    17    17 
Agricultural Loans   49    2    2 
                
With An Allowance Recorded:               
Commercial and Industrial Loans and Leases   2,795    7    6 
Commercial Real Estate Loans   7,003    17    14 
Agricultural Loans            
Total  $15,168   $46   $42 

 

   Average   Interest   Cash 
   Recorded   Income   Basis 
   Investment   Recognized   Recognized 
September 30, 2011               
With No Related Allowance Recorded:               
Commercial and Industrial Loans and Leases  $345   $9   $9 
Commercial Real Estate Loans   3,603    46    46 
Agricultural Loans   25    6    6 
                
With An Allowance Recorded:               
Commercial and Industrial Loans and Leases   4,009    9    9 
Commercial Real Estate Loans   10,046    50    47 
Agricultural Loans            
Total  $18,028   $120   $117 

 

The following tables present the recorded investment in non-accrual loans and loans past due 90 days or more still on accrual by class of loans as of September 30, 2012 and December 31, 2011:

 

           Loans Past Due 
           90 Days or More 
   Non-Accrual   & Still Accruing 
   2012   2011   2012   2011 
                 
Commercial and Industrial Loans and Leases  $2,596   $3,471   $   $ 
Commercial Real Estate Loans   8,847    13,289         
Agricultural Loans                
Home Equity Loans   111    90         
Consumer Loans   168    259         
Residential Mortgage Loans   422    748         
Total  $12,144   $17,857   $   $ 

 

Non-accrual loans and loans past due 90 days or more still on accrual include both smaller balance homogeneous loans that are collectively evaluated for impairment and individually classified impaired loans.

 

15
 

 

GERMAN AMERICAN BANCORP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2012

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

 

NOTE 5 – Loans (continued)

 

The following table presents the aging of the recorded investment in past due loans by class of loans as of September 30, 2012 and December 31, 2011:

 

               90 Days         
       30-59 Days   60-89 Days   or More   Total   Loans Not 
   Total   Past Due   Past Due   Past Due   Past Due   Past Due 
September 30, 2012                              
Commercial and Industrial Loans and Leases  $328,967   $415   $6   $447   $868   $328,099 
Commercial Real Estate Loans   468,793    145        3,237    3,382    465,411 
Agricultural Loans   167,851    20    99        119    167,732 
Home Equity Loans   74,068    497    160    110    767    73,301 
Consumer Loans   42,782    218    56    8    282    42,500 
Residential Mortgage Loans   91,048    2,496    507    421    3,424    87,624 
Total (1)  $1,173,509   $3,791   $828   $4,223   $8,842   $1,164,667 

 

(1) Total recorded investment in loans includes $5,363 in accrued interest.

 

              90 Days         
      30-59 Days   60-89 Days   or More   Total   Loans Not 
   Total   Past Due   Past Due   Past Due   Past Due   Past Due 
December 31, 2011                              
Commercial and Industrial Loans and Leases  $294,087   $220   $   $1,141   $1,361   $292,726 
Commercial Real Estate Loans   453,318    381    148    5,920    6,449    446,869 
Agricultural Loans   170,513    10            10    170,503 
Home Equity Loans   77,323    176    6    90    272    77,051 
Consumer Loans   47,595    287    117    221    625    46,970 
Residential Mortgage Loans   86,469    2,752    893    748    4,393    82,076 
Total (1)  $1,129,305   $3,826   $1,164   $8,120   $13,110   $1,116,195 

 

(1) Total recorded investment in loans includes $5,756 in accrued interest.

 

Troubled Debt Restructurings:

 

The Company has allocated $195 of specific reserves on $375 in principal to customers whose loan terms have been modified in troubled debt restructurings as of September 30, 2012. The Company had allocated $198 of specific reserves on $409 in principal to customers whose loan terms have been modified in troubled debt restructurings as of December 31, 2011. The Company has not committed to lending any additional amounts as of September 30, 2012 and December 31, 2011 to customers with outstanding loans that are classified as troubled debt restructurings.

 

For the three and nine months ended September 30, 2012, no troubled debt restructurings occurred. For the three months ended September 30, 2011, no troubled debt restructurings occurred. For the nine months ended September 30, 2011, one troubled debt restructuring occurred. Pre-modification and post-modification outstanding recorded investment for this loan totaled $284 and $50, respectively. The modification of the terms of this loan included one or a combination of the following: a reduction of the stated interest rate of the loan; an extension of the maturity date at a stated rate of interest lower than the current market rate for new debt with similar risk; or a permanent reduction of the recorded investment in the loan.

 

The troubled debt restructurings resulted in no charge-offs for the three and nine months ended September 30, 2012. The troubled debt restructuring resulted in no charge-offs for the three months ended September 30, 2011 and $145 during the nine months ended September 30, 2011.

 

For the three and nine months ended September 30, 2012 and 2011, there were no payment defaults within the twelve months following modification for troubled debt restructurings.

 

16
 

 

GERMAN AMERICAN BANCORP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2012

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

 

NOTE 5 – Loans (continued)

 

A loan is considered to be in payment default once it is 30 days contractually past due under the modified terms. In order to determine whether a borrower is experiencing financial difficulty, an evaluation is performed of the probability that the borrower will be in payment default on any of its debt in the foreseeable future without modification. This evaluation is performed under the Company’s internal underwriting policy.

 

Credit Quality Indicators:

 

The Company categorizes loans into risk categories based on relevant information about the ability of borrowers to service their debt such as: current financial information, historical payment experience, credit documentation, public information, and current economic trends, among other factors. The Company classifies loans as to credit risk by individually analyzing loans. This analysis includes commercial and industrial loans, commercial real estate loans, and agricultural loans with an outstanding balance greater than $100. This analysis is typically performed on at least an annual basis. The Company uses the following definitions for risk ratings:

 

Special Mention. Loans classified as special mention have a potential weakness that deserves management’s close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the loan or of the institution’s credit position at some future date.

 

Substandard. Loans classified as substandard are inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any. Loans so classified have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. They are characterized by the distinct possibility that the institution will sustain some loss if the deficiencies are not corrected.

 

Doubtful. Loans classified as doubtful have all the weaknesses inherent in those classified as substandard, with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions, and values, highly questionable and improbable.

 

Loans not meeting the criteria above that are analyzed individually as part of the above described process are considered to be pass rated loans. Loans listed as not rated are either less than $100 or are included in groups of homogeneous loans. Based on the most recent analysis performed, the risk category of loans by class of loans is as follows:

 

      Special             
   Pass   Mention   Substandard   Doubtful   Total 
September 30, 2012                         
Commercial and Industrial Loans and Leases  $297,257   $13,247   $18,463   $   $328,967 
Commercial Real Estate Loans   425,660    20,082    23,051        468,793 
Agricultural Loans   162,916    2,562    2,373        167,851 
Total  $885,833   $35,891   $43,887   $   $965,611 

 

      Special             
   Pass   Mention   Substandard   Doubtful   Total 
December 31, 2011                         
Commercial and Industrial Loans and Leases  $264,037   $16,188   $13,862   $   $294,087 
Commercial Real Estate Loans   396,057    28,272    28,989        453,318 
Agricultural Loans   165,153    2,744    2,616        170,513 
Total  $825,247   $47,204   $45,467   $   $917,918 

 

17
 

 

GERMAN AMERICAN BANCORP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2012

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

 

NOTE 5 – Loans (continued)

 

The Company considers the performance of the loan portfolio and its impact on the allowance for loan losses. For home equity, consumer and residential mortgage loan classes, the Company also evaluates credit quality based on the aging status of the loan, which was previously presented, and by payment activity. The following table presents the recorded investment in home equity, consumer and residential mortgage loans based on payment activity as of September 30, 2012 and December 31, 2011:

 

   Home Equity   Consumer   Residential 
   Loans   Loans   Mortgage Loans 
September 30, 2012               
Performing  $73,957   $42,614   $90,626 
Nonperforming   111    168    422 
Total  $74,068   $42,782   $91,048 

 

   Home Equity   Consumer   Residential 
   Loans   Loans   Mortgage Loans 
December 31, 2011               
Performing  $77,233   $47,336   $85,721 
Nonperforming   90    259    748 
Total  $77,323   $47,595   $86,469 

 

The Company has purchased loans, for which there was, at acquisition, evidence of deterioration of credit quality since origination and it was probable, at acquisition, that all contractually required payments would not be collected. The recorded investment of those loans is as follows:

 

   September 30, 2012 
     
Commercial and Industrial Loans  $2,324 
Commercial Real Estate Loans   9,313 
Home Equity Loans    
Consumer Loans   152 
Residential Mortgage Loans   151 
Total  $11,940 
      
Carrying amount, Net of Allowance  $11,843 

 

   December 31, 2011 
     
Commercial and Industrial Loans  $2,596 
Commercial Real Estate Loans   13,209 
Home Equity Loans    
Consumer Loans   164 
Residential Mortgage Loans   152 
Total  $16,121 
      
Carrying amount, Net of Allowance  $16,044 

 

Accretable yield, or income expected to be collected, is as follows:

 

   September  30, 2012   September  30, 2011 
         
Balance at July 1  $389   $1,478 
New Loans Purchased        
Accretion of Income   (223)   (359)
Reclassifications from Non-accretable Difference   262    129 
Charge-off of Accretable Yield       (74)
Balance at September 30  $428   $1,174 

 

18
 

 

GERMAN AMERICAN BANCORP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2012

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

 

NOTE 5 – Loans (continued)

 

   September 30, 2012   September  30, 2011 
         
Balance at January 1  $967   $ 
New Loans Purchased       2,042 
Accretion of Income   (1,007)   (923)
Reclassifications from Non-accretable Difference   468    129 
Charge-off of Accretable Yield       (74)
Balance at September 30  $428   $1,174 

 

For those purchased loans disclosed above, the Company did not increase the allowance for loan losses during the three and nine months ended September 30, 2012. For those purchased loans disclosed above, the Company increased the allowance for loan losses by $96 and $171 during the three and nine months ended September 30, 2011. No allowances for loan losses were reversed during the same periods.

 

Note 6 – Segment Information

 

The Company’s operations include three primary segments: core banking, trust and investment advisory services, and insurance operations. The core banking segment involves attracting deposits from the general public and using such funds to originate consumer, commercial and agricultural, commercial and agricultural real estate, and residential mortgage loans, primarily in the Company’s local markets. The core banking segment also involves the sale of residential mortgage loans in the secondary market. The trust and investment advisory services segment involves providing trust, investment advisory, and brokerage services to customers. The insurance segment offers a full range of personal and corporate property and casualty insurance products, primarily in the Company’s banking subsidiary’s local markets.

 

The core banking segment is comprised by the Company’s banking subsidiary, German American Bancorp, which operated through 35 banking offices at September 30, 2012. Net interest income from loans and investments funded by deposits and borrowings is the primary revenue for the core-banking segment. The trust and investment advisory services segment’s revenues are comprised primarily of fees generated by German American Financial Advisors & Trust Company. These fees are derived by providing trust, investment advisory, and brokerage services to its customers. The insurance segment primarily consists of German American Insurance, Inc., which provides a full line of personal and corporate insurance products. Commissions derived from the sale of insurance products are the primary source of revenue for the insurance segment.

 

The following segment financial information has been derived from the internal financial statements of German American Bancorp, Inc., which are used by management to monitor and manage the financial performance of the Company. The accounting policies of the three segments are the same as those of the Company. The evaluation process for segments does not include holding company income and expense. Holding company amounts are the primary differences between segment amounts and consolidated totals, and are reflected in the column labeled “Other” below, along with amounts to eliminate transactions between segments.

 

       Trust and             
       Investment             
   Core   Advisory           Consolidated 
   Banking   Services   Insurance   Other   Totals 
Three Months Ended September 30, 2012                         
Net Interest Income  $16,909   $6   $9   $(531)  $16,393 
Net Gains on Sales of Loans   941                941 
Net Gains on Securities   598                598 
Trust and Investment Product Fees       659            659 
Insurance Revenues   3    5    1,461        1,469 
Noncash Items:                         
Provision for Loan Losses   640                640 
Depreciation and Amortization   941    6    101    37    1,085 
Income Tax Expense (Benefit)   3,186    (45)   70    (320)   2,891 
Segment Profit (Loss)   6,578    (71)   100    (315)   6,292 
Segment Assets at September 30, 2012   1,964,276    11,724    7,914    (21,616)   1,962,298 

 

19
 

 

GERMAN AMERICAN BANCORP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2012

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

 

NOTE 6 – Segment Information (continued)

 

       Trust and             
       Investment             
   Core   Advisory           Consolidated 
   Banking   Services   Insurance   Other   Totals 
Three Months Ended September 30, 2011                         
Net Interest Income  $16,726   $7   $6   $(536)  $16,203 
Net Gains on Sales of Loans   863                863 
Net Gains on Securities                    
Trust and Investment Product Fees       603        (1)  602
Insurance Revenues   16    7    1,238        1,261 
Noncash Items:                         
Provision for Loan Losses   1,300                1,300 
Depreciation and Amortization   1,072    4    103    38    1,217 
Income Tax Expense (Benefit)   2,717    (100)   (11)   (315)   2,291 
Segment Profit (Loss)   5,595    (151)   (21)   (256)   5,167 
Segment Assets at December 31, 2011   1,875,417    11,801    7,948    (21,399)   1,873,767 

  

       Trust and             
       Investment             
   Core   Advisory           Consolidated 
   Banking   Services   Insurance   Other   Totals 
Nine Months Ended September 30, 2012                         
Net Interest Income  $51,213   $16   $26   $(1,601)  $49,654 
Net Gains on Sales of Loans   2,330                2,330 
Net Gains on Securities   692                692 
Trust and Investment Product Fees   3    2,018         (2)  2,019
Insurance Revenues   19    32    4,167        4,218 
Noncash Items:                         
Provision for Loan Losses   1,721                1,721 
Depreciation and Amortization   3,145    16    311    112    3,584 
Income Tax Expense (Benefit)   9,041    (103)   176    (994)   8,120 
Segment Profit (Loss)   18,737    (168)   245    (953)   17,861 
Segment Assets at September 30, 2012   1,964,276    11,724    7,914    (21,616)   1,962,298 

 

       Trust and             
       Investment             
   Core   Advisory           Consolidated 
   Banking   Services   Insurance   Other   Totals 
Nine Months Ended September 30, 2011                         
Net Interest Income  $49,155   $14   $19   $(1,614)  $47,574 
Net Gains on Sales of Loans   1,651                1,651 
Net Gains on Securities               1,045    1,045 
Trust and Investment Product Fees   2    1,562        (3)  1,561
Insurance Revenues   56    9    4,551   (16)   4,600 
Noncash Items:                         
Provision for Loan Losses   3,900                3,900 
Depreciation and Amortization   3,392    21    376    113    3,902 
Income Tax Expense (Benefit)   6,712    (247)   319    (996)   5,788 
Segment Profit (Loss)   14,559    (374)   418    73    14,676 
Segment Assets at December 31, 2011   1,875,417    11,801    7,948    (21,399)   1,873,767 

 

20
 

 

GERMAN AMERICAN BANCORP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2012

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

 

Note 7 – Stock Repurchase Plan

 

On April 26, 2001 the Company announced that its Board of Directors approved a stock repurchase program for up to 607,754 (as adjusted for subsequent stock dividends) of the outstanding Common Shares of the Company. Shares may be purchased from time to time in the open market and in large block privately negotiated transactions. The Company is not obligated to purchase any shares under the program, and the program may be discontinued at any time before the maximum number of shares specified by the program is purchased. As of September 30, 2012, the Company had purchased 334,965 (as adjusted for subsequent stock dividends) shares under the program. No shares were purchased under the program during the nine months ended September 30, 2012 and 2011.

 

Note 8 – Equity Plans and Equity Based Compensation

 

The Company maintains three equity incentive plans under which stock options, restricted stock, and other equity incentive awards can be granted. At September 30, 2012, the Company has reserved 611,548 shares of Common Stock (as adjusted for subsequent stock dividends and subject to further customary anti-dilution adjustments) for the purpose of issuance pursuant to outstanding and future grants of options, restricted stock, and other equity awards to officers, directors and other employees of the Company.

 

For the nine months ended September 30, 2012 and 2011, the Company granted no options, and accordingly, recorded no stock option expense related to option grants during the three and nine months ended September 30, 2012 and 2011. The Company recorded no other stock compensation expense applicable to options during the quarter and nine months ended September 30, 2012 and 2011 because all outstanding options were fully vested prior to 2007. In addition, there was no unrecognized option expense as all outstanding options were fully vested prior to September 30, 2012 and 2011.

 

During the periods presented, awards of long-term incentives were granted in the form of restricted stock, granted in tandem with cash credit entitlements. The incentive awards will typically be in the form of 50% restricted stock grants and 50% cash credit entitlements. The restricted stock grants and tandem cash credit entitlements are subject to forfeiture in the event that the recipient of the grant does not continue employment with the Company through December 5 of the year of grant, at which time they generally vest 100 percent. For measuring compensation costs, restricted stock awards are valued based upon the market value of the common shares on the date of grant. During the quarter ended September 30, 2012, the Company granted awards of 118 shares of restricted stock. During the nine months ended September 30, 2012, the Company granted awards of 30,137 shares of restricted stock. During the three and nine months ended September 30, 2011, the Company granted awards of 302 and 37,769 shares of restricted stock, respectively.

 

The following table presents expense recorded for restricted stock and cash entitlements as well as the related tax effect for the periods presented:

 

   Three Months Ended 
   September 30, 
   2012   2011 
Restricted Stock Expense  $155   $158 
Cash Entitlement Expense   147    138 
Tax Effect   (122)   (120)
Net of Tax  $180   $176 

 

   Nine Months Ended 
   September 30, 
   2012   2011 
Restricted Stock Expense  $463   $466 
Cash Entitlement Expense   440    413 
Tax Effect   (365)   (356)
Net of Tax  $538   $523 

 

Unrecognized expense associated with the restricted stock grants and cash entitlements totaled $304 and $296 as of September 30, 2012 and 2011, respectively.

 

21
 

 

GERMAN AMERICAN BANCORP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2012

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

 

Note 8 – Equity Plans and Equity Based Compensation (continued)

 

The Company maintains an Employee Stock Purchase Plan whereby eligible employees have the option to purchase the Company’s common stock at a discount. The purchase price of the shares under this Plan has been set at 95% of the fair market value of the Company’s common stock as of the last day of the plan year. The plan provides for the purchase of up to 500,000 shares of common stock, which the Company may obtain by purchases on the open market or from private sources, or by issuing authorized but unissued common shares. Funding for the purchase of common stock is from employee and Company contributions.

 

The Employee Stock Purchase Plan is not considered compensatory. There was no expense recorded for the employee stock purchase plan during the three and nine months ended September 30, 2012 and 2011, nor was there any unrecognized compensation expense as of September 30, 2012 and 2011 for the Employee Stock Purchase Plan.

 

Note 9 – Fair Value

 

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. There are three levels of inputs that may be used to measure fair values:

 

Level 1: Quoted prices (unadjusted) for identical assets or liabilities in active markets that the entity has the ability to access as of the measurement date.

 

Level 2: Significant other observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data.

 

Level 3: Significant unobservable inputs that reflect a reporting entity’s own assumptions about the assumptions that market participants would use in pricing an asset or liability.

 

The Company used the following methods and significant assumptions to estimate the fair value of each type of financial instrument:

 

Investment Securities: The fair values for investment securities are determined by quoted market prices, if available (Level 1). For securities where quoted prices are not available, fair values are calculated based on market prices of similar securities (Level 2). For securities where quoted prices or market prices of similar securities are not available, fair values are calculated using discounted cash flows or other market indicators (Level 3). Level 3 pricing is obtained from a third-party based upon similar trades that are not traded frequently without adjustment by the Company. At September 30, 2012, the Company held $12.2 million in Level 3 securities which consist of $11.8 million of non-rated Obligations of State and Political Subdivisions and $353 thousand of equity securities that are not actively traded. Absent the credit rating, significant assumptions must be made such that the credit risk input becomes an unobservable input and thus these securities are reported by the Company in a Level 3 classification.

 

Derivatives: The fair values of derivatives are based on valuation models using observable market data as of the measurement date (Level 2).

 

Impaired Loans: Fair values for impaired collateral dependent loans are generally based on appraisals obtained from licensed real estate appraisers and in certain circumstances consideration of offers obtained to purchase properties prior to foreclosure. Appraisals for commercial real estate generally use three methods to derive value: cost, sales or market comparison and income approach. The cost method bases value in the cost to replace the current property. Value of market comparison approach evaluates the sales price of similar properties in the same market area. The income approach considers net operating income generated by the property and an investors required return. Adjustments are routinely made in the appraisal process by the independent appraisers to adjust for differences between the comparable sales and income data available. Comparable sales adjustments are based on known sales prices of similar type and similar use properties and duration of time that the property has been on the market to sell. Such adjustments made in the appraisal process are typically significant and result in a Level 3 classification of the inputs for determining fair value.

 

22
 

 

 

 

GERMAN AMERICAN BANCORP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2012

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

 

Note 9 – Fair Value (continued)

 

Appraisals for both collateral-dependent impaired loans and other real estate owned are performed by certified general appraisers (for commercial properties) or certified residential appraisers (for residential properties) whose qualifications and licenses have been reviewed and verified by the Company. Once received, a member of the Company’s Risk Management Area reviews the assumptions and approaches utilized in the appraisal. In determining the value of impaired collateral dependent loans and other real estate owned, significant unobservable inputs may be used which include: physical condition of comparable properties sold, net operating income generated by the property and investor rates of return.

 

Other Real Estate: Nonrecurring adjustments to certain commercial and residential real estate properties classified as other real estate (ORE) are measured at the lower of carrying amount or fair value, less costs to sell. Fair values are generally based on third party appraisals of the property utilizing similar techniques as discussed above for Impaired Loans, resulting in a Level 3 classification. In cases where the carrying amount exceeds the fair value, less costs to sell, impairment loss is recognized.

 

Loans Held-for-Sale: The fair values of loans held for sale are determined by using quoted prices for similar assets, adjusted for specific attributes of that loan resulting in a Level 2 classification.

 

Assets and Liabilities Measured on a Recurring Basis

 

Assets and liabilities measured at fair value on a recurring basis, including financial assets and liabilities for which the Company has elected the fair value option, are summarized below:

 

   Fair Value Measurements at September 30, 2012 Using 
   Quoted Prices in             
   Active Markets for   Significant Other   Significant     
   Identical Assets   Observable Inputs   Unobservable Inputs     
   (Level 1)   (Level 2)   (Level 3)   Total 
Assets:                    
U.S. Treasury and Agency Securities  $   $3,625   $   $3,625 
Corporate Securities                
Obligations of State and Political Subdivisions       63,053    11,800    74,853 
Mortgage-backed Securities-Residential       533,212        533,212 
Equity Securities   353        353    706 
Total Securities  $353   $599,890   $12,153   $612,396 
                     
Loans Held-for-Sale  $   $18,993   $   $18,993 
                     
Derivatives  $   $209   $   $209 
                     
Financial Liabilities Derivatives  $   $214   $   $214 

 

23
 

 

GERMAN AMERICAN BANCORP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2012

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

 

Note 9 – Fair Value (continued)

 

   Fair Value Measurements at December 31, 2011 Using 
   Quoted Prices in             
   Active Markets for   Significant Other   Significant     
   Identical Assets   Observable Inputs   Unobservable Inputs     
   (Level 1)   (Level 2)   (Level 3)   Total 
Assets:                    
U.S. Treasury and Agency Securities  $   $6,422   $   $6,422 
Corporate Securities           1,005    1,005 
Obligations of State and Political Subdivisions       60,027    4,772    64,799 
Mortgage-backed Securities-Residential       443,934        443,934 
Equity Securities   331        353    684 
Total Securities  $331   $510,383   $6,130   $516,844 
                     
Loans Held-for-Sale  $   $21,485   $   $21,485 

 

There were no transfers between Level 1 and Level 2 for the periods ended September 30, 2012 and December 31, 2011.

 

At September 30, 2012, the aggregate fair value of the Loans Held-for-Sale was $18,993, aggregate contractual principal balance was $18,784 with a difference of $209. At December 31, 2011, the aggregate fair value of the Loans Held-for-Sale was $21,485 and the aggregate contractual principle balance was $21,225 with a difference of $260.

 

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 three and nine months ended September 30, 2012 and 2011:

 

   Obligations of State                 
   and Political                 
   Subdivisions   Equity Securities   Corporate Securities 
   2012   2011   2012   2011   2012   2011 
                         
Balance of Recurring Level 3 Assets at
June 30
  $11,791   $4,772   $353   $353   $   $1,005 
Total Gains or Losses (realized/unrealized) Included in Earnings   9                     
Purchases                        
Balance of Recurring Level 3 Assets at September 30  $11,800   $4,772   $353   $353   $   $1,005 

 

   Obligations of State                 
   and Political                 
   Subdivisions   Equity Securities   Corporate Securities 
   2012   2011   2012   2011   2012   2011 
                         
Balance of Recurring Level 3 Assets at
January 1
  $4,772   $   $353   $353   $1,005   $ 
Total Gains or Losses (realized/unrealized) Included in Earnings   60                     
Maturities / Calls   (697)               (1,005)   
Purchases   7,665    4,772                1,005 
Balance of Recurring Level 3 Assets at September 30  $11,800   $4,772   $353   $353   $   $1,005 

 

24
 

 

GERMAN AMERICAN BANCORP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2012

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

 

Note 9 – Fair Value (continued)

 

Assets and Liabilities Measured on a Non-Recurring Basis

 

Assets and liabilities measured at fair value on a non-recurring basis are summarized below:

 

   Fair Value Measurements at September 30, 2012 Using 
   Quoted Prices in             
   Active Markets for   Significant Other   Significant     
   Identical Assets   Observable Inputs   Unobservable Inputs     
   (Level 1)   (Level 2)   (Level 3)   Total 
Assets:                    
Impaired Loans with Specific Allocations                    
Commercial and Industrial Loans  $   $   $1,326   $1,326 
Commercial Real Estate Loans           2,930    2,930 
Other Real Estate                    
Commercial Real Estate           150    150 
Residential                

 

   Fair Value Measurements at December 31, 2011 Using 
   Quoted Prices in             
   Active Markets for   Significant Other   Significant     
   Identical Assets   Observable Inputs   Unobservable Inputs     
   (Level 1)   (Level 2)   (Level 3)   Total 
Assets:                    
Impaired Loans with Specific Allocations                    
Commercial and Industrial Loans  $   $   $2,035   $2,035 
Commercial Real Estate Loans           2,783    2,783 
Other Real Estate                    
Commercial Real Estate           250    250 
Residential                

 

Impaired loans, which are measured for impairment using the fair value of the collateral for collateral dependent loans, had a carrying amount of $9,786 with a valuation allowance of $5,530, resulting in an additional provision for loan losses of $393 for the three months ended September 30, 2012 and an additional provision for loan losses of $1,023 for the nine months ended September 30, 2012. Impaired loans, which are measured for impairment using the fair value of the collateral for collateral dependent loans, had a carrying amount of $9,729 with a valuation allowance of $4,911, resulting in an additional provision for loan losses of $4,226 for the year ended December 31, 2011.

 

Other Real Estate which is measured at the lower of carrying or fair value less costs to sell had a carrying value of $150 at September 30, 2012. A charge to earnings through Other Operating Income of $100 was included in the three and nine months ended September 30, 2012. A charge to earnings through Other Operating Income of $230 was included in the three and nine months ended September 30, 2011. Other Real Estate, which is measured at the lower of carrying or fair value less costs to sell, had a carrying amount of $250 at December 31, 2011.

 

25
 

 

GERMAN AMERICAN BANCORP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2012

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

 

Note 9 – Fair Value (continued)

 

The following table presents quantitative information about Level 3 fair value measurements for financial instruments measured at fair value on a non-recurring basis at September 30, 2012:

 

             Range
       Valuation     (Weighted
   Fair Value   Technique(s)  Unobservable Input(s)  Average)
Impaired Loans - Commercial and Industrial Loans  $1,298   Sales comparison approach  Adjustment for differences between the comparable sales  4%-58%
(8%)
               
Impaired Loans - Commercial Real Estate Loans  $2,930   Sales comparison approach
Income approach
Cost approach
  Adjustment for physical condition of comparable properties sold  20%-78%
(46%)
          Adjustment for net operating income  generated by the property   
          Adjustment for investor rates of return   

 

The carrying amounts and estimated fair values of the Company’s financial instruments not previously presented are provided in the table below for the periods ending September 30, 2012 and December 31, 2011. Not all of the Company’s assets and liabilities are considered financial instruments, and therefore are not included in the table. Because no active market exists for a significant portion of the Company’s financial instruments, fair value estimates were based on subjective judgments, and therefore cannot be determined with precision.

 

       Fair Value Measurements at     
       September 30, 2012 Using     
   Carrying Value   Level 1   Level 2   Level 3   Total 
Financial Assets:                         
Cash and Short-term Investments  $66,503   $33,960   $32,543   $   $66,503 
Securities Held-to-Maturity   346        351        351 
FHLB Stock and Other Restricted Stock   8,340    N/A    N/A    N/A    N/A 
Loans, Net   1,144,984            1,152,329    1,152,329 
Accrued Interest Receivable   7,746        1,972    5,774    7,746 
Financial Liabilities:                         
Demand, Savings, and Money Market Deposits   (1,261,011)   (1,261,011)           (1,261,011)
Time Deposits   (358,026)       (362,656)       (362,656)
Short-term Borrowings   (70,109)       (70,109)       (70,109)
Long-term Debt   (70,965)       (48,480)   (26,919)   (75,399)
Accrued Interest Payable   (1,062)       (973)   (89)   (1,062)
Unrecognized Financial Instruments:                         
Commitments to Extend Credit                    
Standby Letters of Credit                    
Commitments to Sell Loans                    

 

26
 

 

GERMAN AMERICAN BANCORP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2012

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

 

Note 9 – Fair Value (continued)

 

   December 31, 2011 
   Carrying   Fair 
   Value   Value 
Financial Assets:          
Cash and Short-term Investments  $67,089   $67,089 
Securities Held-to-Maturity   690    697 
FHLB Stock and Other Restricted Stock   8,340    N/A 
Loans, Net   1,100,863    1,111,532 
Accrued Interest Receivable   7,793    7,793 
Financial Liabilities:          
Demand, Savings, and Money Market Deposits   (1,181,919)   (1,181,919)
Time Deposits   (374,279)   (380,584)
Short-term Borrowings   (40,019)   (40,019)
Long-term Debt   (90,974)   (96,047)
Accrued Interest Payable   (1,884)   (1,884)
Unrecognized Financial Instruments:          
Commitments to Extend Credit        
Standby Letters of Credit        
Commitments to Sell Loans        

 

Cash and Short-Term Investments:

The carrying amount of cash and short-term investments approximate fair values and are classified as Level 1 or Level 2.

 

Securities Held-to-Maturity:

The fair values for investment securities are determined by quoted market prices, if available (Level 1). For securities where quoted prices are not available, fair values are calculated based on market prices of similar securities (Level 2).

 

FHLB Stock and Other Restricted Stock:

It is not practical to determine the fair values of FHLB stock and other restricted stock due to restrictions placed on their transferability.

 

Loans:

Fair values of loans, excluding loans held for sale and collateral dependent impaired loans having a specific allowance allocation, 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 as described previously. The methods utilized to estimate fair value of loans do not necessarily represent an exit price.

 

Accrued Interest Receivable:

The carrying amount of accrued interest approximates fair value resulting in a Level 2 or Level 3 classification consistent with the asset they are associated with.

 

Deposits:

The fair values disclosed for demand deposits (e.g., interest and non-interest checking, savings and certain types of money market accounts) are, by definition, equal to the amount payable on demand at the reporting date (i.e., their carrying amount) resulting in a Level 1 classification. Fair values for fixed rate time 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.

 

27
 

 

GERMAN AMERICAN BANCORP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2012

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

 

Note 9 – Fair Value (continued)

 

Short-term Borrowings:

The carrying amounts of federal funds purchased, borrowings under repurchase agreements, and other short-term borrowings, generally maturing within ninety days, approximate their fair values resulting in a Level 2 classification.

 

Long-Term Debt:

The fair values of the Company’s long-term borrowings are estimated using discounted cash flow analyses based on the current borrowing rates for similar types of borrowing arrangements resulting in a Level 2 classification.

 

The fair values of the Company’s 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.

 

Accrued Interest Payable:

The carrying amount of accrued interest approximates fair value resulting in a Level 2 or Level 3 classification consistent with the liability they are associated with.

 

Off-balance Sheet Instruments:

Commitments to extend credit and standby letters of credit are generally short-term or variable rate with minimal fees charged. These instruments have no carrying value, and the fair value is not material. The fair value of commitments to sell loans is the cost or benefit of settling the commitments with the counter-party at the reporting date. At September 30, 2012 and December 31, 2011, none of the Company’s commitments to sell loans were mandatory, and there is no cost or benefit to settle these commitments.

 

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

GERMAN AMERICAN BANCORP, INC.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

German American Bancorp, Inc. is a financial services holding company based in Jasper, Indiana. The Company’s Common Stock is traded on NASDAQ’s Global Select Market, under the symbol GABC. The principal subsidiary of German American Bancorp, Inc. is its banking subsidiary, German American Bancorp, which operates through 35 banking offices in thirteen Southern Indiana counties. German American Bancorp owns a trust, brokerage, and financial planning subsidiary, which operates from its banking offices, and a full line property and casualty insurance agency with seven insurance agency offices throughout its market area.

 

Throughout this Management’s Discussion and Analysis, as elsewhere in this report, when we use the term “Company,” we will usually be referring to the business and affairs (financial and otherwise) of the Company and its subsidiaries and affiliates as a whole. Occasionally, we will refer to the term “parent company” or “holding company” when we mean to refer to only German American Bancorp, Inc.

 

This section presents an analysis of the consolidated financial condition of the Company as of September 30, 2012 and December 31, 2011 and the consolidated results of operations for the three and nine months ended September 30, 2012 and 2011. This discussion should be read in conjunction with the consolidated financial statements and other financial data presented elsewhere herein and with the financial statements and other financial data, as well as the Management’s Discussion and Analysis of Financial Condition and Results of Operations, included in the Company’s December 31, 2011 Annual Report on Form 10-K.

 

MANAGEMENT OVERVIEW

 

This updated discussion should be read in conjunction with the Management Overview that was included in our Management’s Discussion and Analysis of Financial Condition and Results of Operations in the Company’s December 31, 2011 Annual Report on Form 10-K and in the Company’s Quarterly Report on Form 10-Q for the quarters ended March 31, 2012 and June 30, 2012.

 

During the third quarter and first nine months of 2012, the Company achieved record levels of earnings. The Company’s third quarter net income totaled $6,292,000, or $0.50 per share, representing an increase of approximately 22% on a per share basis, from the $5,167,000, or $0.41 per share, recorded during the same quarter last year. On a year-to-date basis, 2012 earnings improved to $17,861,000 or $1.41 per share, as compared to $14,676,000, or $1.17 per share for the first nine months of 2011 representing an increase of approximately 21% on a per share basis.

 

The Company’s third quarter and first nine months of 2012 earnings were positively impacted by a $190,000 or 1% and $2,080,000, or 4%, increase in the level of net interest income as compared to the same periods of 2011. The current year net interest income improvement was largely the result of a higher level of earning assets. Also contributing to the improved level of earnings in the third quarter of 2012 and the first nine months of 2012 was a lower level of loan loss provision compared with the same periods of 2011.

 

The Company’s third quarter of 2012 and year-to-date 2012 earnings as compared with the third quarter of 2011 and year-to-date 2011 were also positively impacted by an increased level of non-interest income. The key drivers in the increased level of quarterly non-interest income was primarily a higher level of insurance revenues, increased levels of gains related to the liquidation of other real estate, and increased gains from sales of securities. The key drivers in the increased level of year-to-date non-interest income was higher trust and investment product fees, increased levels of gains related to the liquidation of other real estate, and higher levels of gains on sales of residential mortgage loans.

 

The Company’s first nine months of 2012 earnings as compared with the first nine months of 2011 were also positively impacted by a lower level of operating expenses. This reduction was largely related to an elevated level of expenses in the first half of 2011 related to the acquisition of American Community Bancorp, Inc. effective January 1, 2011. The Company’s third quarter of 2012 operating costs were higher than the third quarter of 2011 primarily as a result of an increased level of salaries and benefit costs.

 

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

 

The financial condition and results of operations for German American Bancorp, Inc. presented in the Consolidated Financial Statements, accompanying Notes to the Consolidated Financial Statements, and selected financial data appearing elsewhere within this Report, are, to a large degree, dependent upon the Company’s accounting policies. The selection of and application of these policies involve estimates, judgments, and uncertainties that are subject to change. The critical accounting policies and estimates that the Company has determined to be the most susceptible to change in the near term relate to the determination of the allowance for loan losses, the valuation of securities available for sale, and the valuation allowance on deferred tax assets.

 

29
 

 

Allowance for Loan Losses

 

The Company maintains an allowance for loan losses to cover probable incurred credit losses at the balance sheet date. 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. Allocations of the allowance may be made for specific loans, but the entire allowance is available for any loan that, in management’s judgment, should be charged-off. A provision for loan losses is charged to operations based on management’s periodic evaluation of the necessary allowance balance. Evaluations are conducted at least quarterly and more often if deemed necessary. The ultimate recovery of all loans is susceptible to future market factors beyond the Company’s control.

 

The Company has an established process to determine the adequacy of the allowance for loan losses. The determination of the allowance is inherently subjective, as it requires significant estimates, including the amounts and timing of expected future cash flows on impaired loans, estimated losses on other classified loans and pools of homogeneous loans, and consideration of 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, all of which may be susceptible to significant change. The allowance consists of two components of allocations, specific and general. These two components represent the total allowance for loan losses deemed adequate to cover losses inherent in the loan portfolio.

 

Commercial and agricultural loans are subject to a standardized grading process administered by an internal loan review function. The need for specific reserves is considered for credits when graded substandard or when: (a) the customer’s cash flow or net worth appears insufficient to repay the loan; (b) the loan has been criticized in a regulatory examination; (c) the loan is on non-accrual; or, (d) other reasons where the ultimate collectibility of the loan is in question, or the loan characteristics require special monitoring. Specific allowances are established in cases where management has identified significant conditions or circumstances related to an individual credit that we believe indicates the loan is impaired. Specific allocations on impaired loans are determined by comparing the loan balance to the present value of expected cash flows or expected collateral proceeds. Allocations are also applied to categories of loans not considered individually impaired but for which the rate of loss is expected to be greater than historical averages, including those graded substandard and non-performing consumer or residential real estate loans. Such allocations are based on past loss experience and information about specific borrower situations and estimated collateral values.

 

General allocations are made for other pools of loans, including non-classified loans, homogeneous portfolios of consumer and residential real estate loans, and loans within certain industry categories believed to present unique risk of loss. General allocations of the allowance are primarily made based on a one-year historical average for loan losses for these portfolios, judgmentally adjusted for economic factors and portfolio trends.

 

Due to the imprecise nature of estimating the allowance for loan losses, the Company’s allowance for loan losses includes a minor unallocated component. The unallocated component of the allowance for loan losses incorporates the Company’s judgmental determination of inherent losses that may not be fully reflected in other allocations, including factors such as economic uncertainties, lending staff quality, industry trends impacting specific portfolio segments, and broad portfolio quality trends. Therefore, the ratio of allocated to unallocated components within the total allowance may fluctuate from period to period.

 

Securities Valuation

 

Securities available-for-sale are carried at fair value, with unrealized holding gains and losses reported separately in accumulated other comprehensive income (loss), net of tax. The Company obtains market values from a third party on a monthly basis in order to adjust the securities to fair value. Equity securities that do not have readily determinable fair values are carried at cost. Additionally, when securities are deemed to be other than temporarily impaired, a charge will be recorded through earnings; therefore, future changes in the fair value of securities could have a significant impact on the Company’s operating results. In determining whether a market value decline is other than temporary, management considers the reason for the decline, the extent of the decline, the duration of the decline and whether the Company intends to sell or believes it will be required to sell the securities prior to recovery. As of September 30, 2012, gross unrealized losses on the securities available-for-sale portfolio totaled approximately $58,000 and gross unrealized gains totaled approximately $20,439,000. As of September 30, 2012, held-to-maturity securities had a gross unrecognized gain of approximately $5,000.

 

30
 

 

Income Tax Expense

 

Income tax expense involves estimates related to the valuation allowance on deferred tax assets and loss contingencies related to exposure from tax examinations.

 

A valuation allowance reduces deferred tax assets to the amount management believes is more likely than not to be realized. In evaluating the realization of deferred tax assets, management considers the likelihood that sufficient taxable income of appropriate character will be generated within carryback and carryforward periods, including consideration of available tax planning strategies. Tax related loss contingencies, including assessments arising from tax examinations and tax strategies, are recorded as liabilities when the likelihood of loss is probable and an amount or range of loss can be reasonably estimated. In considering the likelihood of loss, management considers the nature of the contingency, the progress of any examination or related protest or appeal, the views of legal counsel and other advisors, experience of the Company or other enterprises in similar matters, if any, and management’s intended response to any assessment.

 

RESULTS OF OPERATIONS

 

Net Income:

 

Net income for the quarter ended September 30, 2012 totaled $6,292,000, or $0.50 per share, an increase of $1,125,000 or 22% from the quarter ended September 30, 2011 net income of $5,167,000, or $0.41 per share.

 

Net income for the nine months ended September 30, 2012 totaled $17,861,000, or $1.41 per share, an increase of $3,185,000 or 22% from the nine months ended September 30, 2011 net income of $14,676,000, or $1.17 per share. The improvement in the first nine months of 2012 earnings compared to the first nine months of 2011 earnings represented an increase of approximately 21% on a per share basis.

 

Net Interest Income:

 

Net interest income is the Company’s single largest source of earnings, and represents the difference between interest and fees realized on earning assets, less interest paid on deposits and borrowed funds. Several factors contribute to the determination of net interest income and net interest margin, including the volume and mix of earning assets, interest rates, and income taxes. Many factors affecting net interest income are subject to control by management policies and actions. Factors beyond the control of management include the general level of credit and deposit demand, Federal Reserve Board monetary policy, and changes in tax laws.

 

31
 

 

The following table summarizes net interest income (on a tax-equivalent basis). For tax-equivalent adjustments, an effective tax rate of 35% was used for all periods presented (1).

 

   Average Balance Sheet 
   (Tax-equivalent basis / dollars in thousands) 
   Three Months Ended   Three Months Ended 
   September 30, 2012   September 30, 2011 
   Principal   Income /   Yield /   Principal   Income /   Yield / 
   Balance   Expense   Rate   Balance   Expense   Rate 
Assets                              
Federal Funds Sold and Other Short-term Investments  $31,575   $11    0.14%  $82,010   $48    0.23%
Securities:                              
Taxable   558,942    3,235    2.32%   473,399    3,645    3.08%
Non-taxable   75,663    962    5.09%   51,463    737    5.73%
Total Loans and Leases (2)   1,161,325    15,148    5.19%   1,110,637    15,993    5.72%
Total Interest Earning Assets   1,827,505    19,356    4.22%   1,717,509    20,423    4.73%
Other Assets   134,646              135,178           
Less: Allowance for Loan Losses   (16,298)             (15,242)          
Total Assets  $1,945,853             $1,837,445           
                               
Liabilities and Shareholders’ Equity                              
Interest-bearing Demand, Savings and Money Market Deposits  $943,035   $387    0.16%  $879,435   $989    0.45%
Time Deposits   358,477    1,235    1.37%   393,693    1,834    1.85%
FHLB Advances and Other Borrowings   121,340    938    3.08%   128,356    1,079    3.34%
Total Interest-bearing Liabilities   1,422,852    2,560    0.72%   1,401,484    3,902    1.10%
Demand Deposit Accounts   322,003              256,764           
Other Liabilities   20,817              16,998           
Total Liabilities   1,765,672              1,675,246           
Shareholders’ Equity   180,181              162,199           
Total Liabilities and Shareholders’ Equity  $1,945,853             $1,837,445           
                               
Cost of Funds             0.56%             0.90%
Net Interest Income       $16,796             $16,521      
Net Interest Margin             3.66%             3.83%

 

(1)Effective tax rates were determined as though interest earned on the Company’s investments in municipal bonds and loans was fully taxable.

(2)Loans held-for-sale and non-accruing loans have been included in average loans.

 

Net interest income increased $190,000 or 1% (an increase of $275,000 or 2% on a tax-equivalent basis) for the quarter ended September 30, 2012 compared with the same quarter of 2011. The increased net interest income during the third quarter of 2012 compared with the third quarter of 2011 was driven by a higher level of earning assets including both average loan growth and growth in the securities portfolio which resulted from growth of the Company’s deposit base.

 

Average earning assets increased by approximately $110.0 million for the three months ended September 30, 2012 compared with the same period of 2011. Average loans outstanding increased $50.7 million during the three months ended September 30, 2012 compared with the third quarter of 2011. Average federal funds sold and other short-term investments decreased by $50.4 million during the third quarter of 2012 compared with the same quarter of 2011. The average securities portfolio increased approximately $109.7 million, or 21%, in the three months ended September 30, 2012 compared with the third quarter of 2011. The key driver of the increased securities portfolio was the decline in the federal funds sold position and an increased level of average core deposits (core deposits defined as demand deposits - both interest and non-interest bearing, savings, money market and time deposits in denominations of less than $100,000). The increase in average core deposits totaled $100.0 million, or approximately 7%, during the third quarter of 2012 compared with the third quarter of 2011.

 

The net interest margin represents tax-equivalent net interest income expressed as a percentage of average earning assets. The tax equivalent net interest margin was 3.66% for the third quarter of 2012 compared to 3.83% during the third quarter of 2011. The yield on earning assets totaled 4.22% during the quarter ended September 30, 2012 compared to 4.73% in the same period of 2011 while the cost of funds (expressed as a percentage of average earning assets) totaled 0.56% during the quarter ended September 30, 2012 compared to 0.90% in the same period of 2011.

 

32
 

 

The decline in the net interest margin in the third quarter of 2012 compared with the third quarter of 2011 was largely attributable to the continued downward pressure on earning asset yields being driven by a historically low market interest rate environment and a very competitive marketplace for lending opportunities. Accretion of loan discounts on certain acquired loans contributed approximately 6 basis points on an annualized basis to the net interest margin in the quarter ended September 30, 2012 compared to approximately 9 basis points during the third quarter of 2011. The decline in the Company’s cost of funds by approximately 34 basis points during the third quarter of 2012 compared to the third quarter 2011 was driven by a continued decline in deposit rates.

 

The following table summarizes net interest income (on a tax-equivalent basis). For tax-equivalent adjustments, an effective tax rate of 35% was used for all periods presented (1).

 

   Average Balance Sheet 
   (Tax-equivalent basis / dollars in thousands) 
   Nine Months Ended   Nine Months Ended 
   September 30, 2012   September 30, 2011 
   Principal   Income /   Yield /   Principal   Income /   Yield / 
   Balance   Expense   Rate   Balance   Expense   Rate 
Assets                              
Federal Funds Sold and Other Short-term Investments  $52,415   $84    0.21%  $92,872   $179    0.26%
Securities:                              
Taxable   545,464    9,982    2.44%   424,410    10,075    3.17%
Non-taxable   70,126    2,765    5.26%   45,149    1,956    5.78%
Total Loans and Leases (2)   1,132,352    46,574    5.49%   1,110,640    48,801    5.87%
Total Interest Earning Assets   1,800,357    59,405    4.40%   1,673,071    61,011    4.87%
Other Assets   137,012              138,757           
Less: Allowance for Loan Losses   (16,188)             (14,571)          
Total Assets  $1,921,181             $1,797,257           
                               
Liabilities and Shareholders’ Equity                              
Interest-bearing Demand, Savings and Money Market Deposits  $941,179   $1,370    0.19%  $855,717   $3,495    0.55%
Time Deposits   362,459    4,153    1.53%   395,094    5,969    2.02%
FHLB Advances and Other Borrowings   118,428    3,066    3.46%   124,532    3,107    3.34%
Total Interest-bearing Liabilities   1,422,066    8,589    0.81%   1,375,343    12,571    1.22%
Demand Deposit Accounts   304,214              249,529           
Other Liabilities   19,922              14,887           
Total Liabilities   1,746,202              1,639,759           
Shareholders’ Equity   174,979              157,498           
Total Liabilities and Shareholders’ Equity  $1,921,181             $1,797,257           
                               
Cost of Funds             0.63%             1.00%
Net Interest Income       $50,816             $48,440      
Net Interest Margin             3.77%             3.87%

 

(1)Effective tax rates were determined as though interest earned on the Company’s investments in municipal bonds and loans was fully taxable.

(2)Loans held-for-sale and non-accruing loans have been included in average loans.

 

Net interest income increased $2,080,000 or 4% (an increase of $2,376,000 or 5% on a tax-equivalent basis) for the nine months ended September 30, 2012 compared with the same period of 2011. The increased net interest income during the first nine months of 2012 compared with the first nine months of 2011 was driven by a higher level of earning assets including both modest average loan growth and growth in the securities portfolio which resulted from growth of the Company’s deposit base.

 

Average earning assets increased by approximately $127.3 million for the nine months ended September 30, 2012 compared with the same period of 2011. Average loans outstanding increased $21.7 million during the nine months ended September 30, 2012 compared with the same period of 2011. Average federal funds sold and other short-term investments decreased by $40.5 million during the nine months ended September 30, 2012 compared with the same period of 2011. The average securities portfolio increased approximately $146.0 million, or 31%, in the nine months ended September 30, 2012 compared with the first nine months of 2011. The key driver of the increased securities portfolio was the decline in the federal funds sold position and an increased level of average core deposits. The increase in average core deposits totaled $113.3 million, or approximately 8%, during the first nine months of 2012 compared with the same period of 2011.

 

The tax equivalent net interest margin was 3.77% for the nine months ended September 30, 2012 compared to 3.87% during the same period of 2011. The yield on earning assets totaled 4.40% during the nine months ended September 30, 2012 compared to 4.87% in the same period of 2011 while the cost of funds (expressed as a percentage of average earning assets) totaled 0.63% during the nine months ended September 30, 2012 compared to 1.00% in the same period of 2011.

 

33
 

 

As was the case in the quarterly comparison, the decline in the net interest margin in the first nine months of 2012 compared with the first nine months of 2011 was largely attributable to the continued downward pressure on earning asset yields being driven by a historically low market interest rate environment and a very competitive marketplace for lending opportunities. Accretion of loan discounts on certain acquired loans contributed approximately 14 basis points on an annualized basis to the net interest margin in the nine months ended September 30, 2012 compared to approximately 17 basis points during the same period of 2011. The decline in the Company’s cost of funds by 37 basis points during the first nine months of 2012 compared to the first nine months of 2011 was driven by a continued decline in deposit rates.

 

Provision for Loan Losses:

 

The Company provides for loan losses through regular provisions to the allowance for loan losses. The provision is affected by net charge-offs on loans and changes in specific and general allocations of the allowance. The provision for loan losses totaled $640,000 during the quarter ended September 30, 2012, a decrease of $660,000 or 51% compared to the provision of $1,300,000 during the quarter ended September 30, 2011. The provision for loan losses totaled $1,721,000 for the nine months ended September 30, 2012, a decrease of $2,179,000 or 56% compared to the provision of $3,900,000 during the nine months ended September 30, 2011. The decline in the provision for loan losses in the three and nine month periods ended September 30, 2012 compared with the same periods of 2011 was attributable to a reduced level of net charge-offs and lower levels of non-performing loans.

 

During the third quarter of 2012, the annualized provision for loan losses represented 0.22% of average loans outstanding compared with 0.47% on an annualized basis of average loans outstanding during the third quarter of 2011. Net charge-offs totaled $410,000 or 0.14% on an annualized basis of average loans outstanding during the three months ended September 30, 2012, compared with $914,000 or 0.33% on an annualized basis of average loans outstanding during the same period of 2011.

 

During the nine months ended September 30, 2012, the annualized provision for loan losses represented 0.20% of average loans outstanding compared with 0.47% on an annualized basis of average loans outstanding during the first nine months of 2011. Net charge-offs totaled $1,111,000 or 0.13% on an annualized basis of average loans outstanding during the nine months ended September 30, 2012, compared with $2,051,000 or 0.25% on an annualized basis of average loans outstanding during the same period of 2011.

 

The provision for loan losses made during the three and nine months ended September 30, 2012 was made at a level deemed necessary by management to absorb estimated, probable incurred losses in the loan portfolio. A detailed evaluation of the adequacy of the allowance for loan losses is completed quarterly by management, the results of which are used to determine provision for loan losses. Management estimates 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.

 

Non-interest Income:

 

During the quarter ended September 30, 2012, non-interest income totaled $6,158,000, an increase of $1,598,000 or 35% compared with the third quarter of 2011.

 

       Change from 
  Three Months   Prior Period 
Non-interest Income  Ended September 30,   Amount   Percent 
(dollars in thousands)  2012   2011   Change   Change 
Trust and Investment Product Fees  $659   $602   $57    9%
Service Charges on Deposit Accounts   1,049    1,120    (71)   (6)
Insurance Revenues   1,469    1,261    208    16 
Company Owned Life Insurance   213    233    (20)   (9)
Interchange Fee Income   418    395    23    6 
Other Operating Income   811    86    725    843 
Subtotal   4,619    3,697    922    25 
Net Gains on Sales of Loans   941    863    78    9 
Net Gains on Securities   598        598    n/m 
Total Non-interest Income  $6,158   $4,560   $1,598    35 

 

n/m = not meaningful

 

34
 

 

Insurance revenues increased $208,000, or 16%, during the quarter ended September 30, 2012, compared with the third quarter of 2011. The increase was largely attributable to higher level of commercial related insurance revenues. Other operating income increased $725,000, or 843%, during the quarter ended September 30, 2012 compared with the third quarter of 2011. The increase in the third quarter of 2012 compared to the third quarter of 2011 was largely related to the net gain on sales of other real estate which totaled approximately $301,000 during the third quarter of 2012 compared with a net loss on sales and write-down of other real estate of $294,000 during the third quarter of 2011.

 

Net gains on sales of loans totaled $941,000 during the quarter ended September 30, 2012, an increase of $78,000, or 9%, compared with the third quarter of 2011. Loan sales totaled $37.8 million during the third quarter of 2012, compared with $25.0 million during the third quarter of 2011. During the third quarter of 2012, the Company realized a net gain on the sale of securities of $598,000 related to the sale of approximately $40.4 million of securities. There were no securities sales during the third quarter of 2011.

 

During the nine months ended September 30, 2012, non-interest income totaled $15,792,000, an increase of $856,000 or 6% compared with the first nine months of 2011.

 

       Change from 
   Nine Months   Prior Period 
Non-interest Income  Ended September 30,   Amount   Percent 
(dollars in thousands)  2012   2011   Change   Change 
Trust and Investment Product Fees  $2,019   $1,561   $458    29%
Service Charges on Deposit Accounts   3,001    3,135    (134)   (4)
Insurance Revenues   4,218    4,600    (382)   (8)
Company Owned Life Insurance   723    836    (113)   (14)
Interchange Fee Income   1,309    1,126    183    16 
Other Operating Income   1,500    982    518    53 
Subtotal   12,770    12,240    530    4 
Net Gains on Sales of Loans   2,330    1,651    679    41 
Net Gains on Securities   692    1,045    (353)   (34)
Total Non-interest Income  $15,792   $14,936   $856    6 

 

Trust and investment product fees increased 29% during the nine months ended September 30, 2012 compared with the same period of 2011. The increase was primarily attributable to increased trust revenues supplemented by increased retail brokerage revenues. Insurance revenues decreased approximately 8% during the nine months ended September 30, 2012 as compared to the first nine months of 2011 as a result of lower contingency revenue. Contingency revenue totaled $88,000 during the nine months ended September 30, 2012 compared with contingency revenue of $872,000 in the first nine months of 2011. The fluctuation in contingency revenue during 2012 and 2011 is a normal course of business type of variance and is reflective of claims and loss experience with insurance carriers that the Company represents through its property and casualty insurance agency. The decline in contingency revenue was partially offset by an increased level of commercial insurance revenues during 2012 compared with 2011.

 

Net interchange revenues related to debit cards increased approximately 16% during the first nine months of 2012 compared with the nine months ended September 30, 2011 primarily due to increased customer utilization. Other operating income increased 53% during the nine months ended September 30, 2012 compared with the same period of 2011. The increase was primarily related to a net gain on sales of other real estate during the nine months ended September 30, 2012 compared with a net loss on sales and write-downs of other real estate during first nine months of 2011.

 

Net gains on sales of loans increased $679,000, or 41%, during the nine months ended September 30, 2012 compared with the same period of 2011. Loan sales totaled $128.2 million during the nine months ended September 30, 2012 compared with $78.4 million during the same period of 2011. The net gain on securities declined $353,000, or 34%, during the first nine months of 2012 compared with the first nine months of 2011. During the first nine months of 2012, the Company realized net gains on the sale of securities of $692,000 related to the sale of approximately $49.5 million of securities. The Company realized a net gain on securities of $1,045,000 during 2011 related to the acquisition accounting treatment of the existing equity ownership position the Company held in American Community at the time of acquisition.

 

35
 

 

Non-interest Expense:

 

During the quarter ended September 30, 2012, non-interest expense totaled $12,728,000, an increase of $723,000 or 6% compared with the third quarter of 2011.

 

       Change from 
   Three Months   Prior Period 
Non-interest Expense  Ended September 30,   Amount   Percent 
(dollars in thousands)  2012   2011   Change   Change 
Salaries and Employee Benefits  $7,261   $6,687   $574    9%
Occupancy, Furniture and Equipment                    
Expense   1,716    1,763    (47)   (3)
FDIC Premiums   271    295    (24)   (8)
Data Processing Fees   311    321    (10)   (3)
Professional Fees   585    526    59    11 
Advertising and Promotion   439    383    56    15 
Intangible Amortization   405    480    (75)   (16)
Other Operating Expenses   1,740    1,550    190    12 
Total Non-interest Expense  $12,728   $12,005   $723    6 

 

Salaries and employee benefits increased 9% during the quarter ended September 30, 2012 compared with the third quarter of 2011. The increase in salaries and benefits during the third quarter of 2012 compared with the third quarter of 2011 was primarily the result of an increased number of full-time equivalent employees, increased costs related to the Company’s partially self-insured health insurance plan and increased commission payout related to higher levels of mortgage loan sales revenues in the secondary market and increased insurance revenues.

 

During the nine months ended September 30, 2012, non-interest expense totaled $37,744,000, a decrease of $402,000 or 1% compared with the first nine months of 2011.

          Change from 
   Nine Months          Prior Period
Non-interest Expense  Ended September 30,     Amount   Percent 
(dollars in thousands)  2012   2011   Change   Change 
Salaries and Employee Benefits  $21,409   $20,810   $599    3%
Occupancy, Furniture and Equipment                    
Expense   5,273    5,459    (186)   (3)
FDIC Premiums   851    1,191    (340)   (29)
Data Processing Fees   746    1,821    (1,075)   (59)
Professional Fees   1,777    1,630    147    9 
Advertising and Promotion   1,208    1,000    208    21 
Intangible Amortization   1,269    1,495    (226)   (15)
Other Operating Expenses   5,211    4,740    471    10