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[April 28, 2014]
FARMERS & MERCHANTS BANCORP INC - 10-Q - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(Edgar Glimpses Via Acquire Media NewsEdge) INTRODUCTION Farmers & Merchants Bancorp, Inc. (Company) is a bank holding company incorporated under the laws of Ohio in 1985. Our primary subsidiary, The Farmers & Merchants State Bank (Bank) is a community bank operating in Northwest Ohio since 1897. We report our financial condition and net income on a consolidated basis and we report only one segment.
Our executive offices are located at 307 North Defiance Street, Archbold, Ohio 43502, and our telephone number is (419)446-2501.
For a discussion of the general development of the Company's business throughout 2014, please see the portion of Management's Discussion and Analysis of Financial Condition and Results of Operations captioned "2014 in Review".
27-------------------------------------------------------------------------------- ITEM 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS NATURE OF ACTIVITIES The Bank's primary service area, Northwest Ohio and Northeast Indiana, continue to experience a higher level of unemployment as compared to the national average. However, both local and national averages are showing a slight downward trend. The agricultural industry continued its strong performance in 2013 as evidenced by strengthened financial statements. The automotive sector showed improvement with car dealers in our marketing area ending with more profitable numbers than in recent years. Overall, business profits are improving. Loan growth occurred during the fourth quarter of 2013 and first quarter 2014 and the Bank finally surpassed the loan balances of yearend 2012 along with first quarter 2013 and yearend 2013. New 1-4 family residential and construction remain weak and refinancing activity is also below the level of same period 2013.
The Bank acquired its 21st office during the fourth quarter of 2013. The office is located in Custar, Ohio and was a natural extension of the Bank's market area. The office provides the full range of services discussed below.
The Farmers & Merchants State Bank engages in general commercial banking and savings business including commercial, agricultural and residential mortgage, consumer and credit card lending activities. Because the Bank's offices are located in Northwest Ohio and Northeast Indiana, a substantial amount of the loan portfolio is comprised of loans made to customers in the farming industry for such things as farm land, farm equipment, livestock and operating loans for seed, fertilizer, and feed. Other types of lending activities include loans for home improvements, and loans for the purchase of autos, trucks, recreational vehicles, motorcycles, and other consumer goods.
The Bank also provides checking account services, as well as savings and time deposit services such as certificates of deposits. In addition ATMs (Automated Teller Machines) are provided at most branch locations along with other independent locations such as major employers and hospitals in the market area.
The Bank has custodial services for IRAs (Individual Retirement Accounts) and HSAs (Health Savings Accounts). The Bank provides on-line banking access for consumer and business customers. For consumers, this includes bill-pay, on-line statement opportunities and mobile banking. For business customers, it provides the option of electronic transaction origination such as wire and ACH file transmittal. In addition, the Bank offers remote deposit capture or electronic deposit processing and merchant credit card services. Mobile banking was added in 2012 and has been widely accepted and used by consumers.
The Bank has established underwriting policies and procedures which facilitate operating in a safe and sound manner in accordance with supervisory and regulatory guidance. Within this sphere of safety and soundness, the Bank's practice has been not to promote innovative, unproven credit products which will not be in the best interest of the Bank or its customers. The Bank does offer a hybrid mortgage loan. Hybrid loans are loans that start out as a fixed rate mortgage but after a set number of years automatically adjust to an adjustable rate mortgage. The Bank offers a three year fixed rate mortgage after which the interest rate will adjust annually. The majority of the Bank's adjustable rate mortgages are of this type. In order to offer longer term fixed rate mortgages, the Bank does participate in the Freddie Mac, Farmer Mac and Small Business Lending programs. The Bank also normally retains the servicing rights on these partially or 100% sold loans. In order for the customer to participate in these programs they must meet the requirements established by these agencies. In addition, the Bank does sell some of its longer term fixed rate agricultural mortgages into the secondary market with the aid of a broker.
The Bank does not have a program to fund sub-prime loans. Sub-prime loans are characterized as a lending program or strategy that targets borrowers who pose a significantly higher risk of default than traditional retail banking customers.
Following are the characteristics and underwriting criteria for each major type of loan the Bank offers: Commercial Real Estate - Construction, purchase, and refinance of business purpose real estate. Risks include loan amount in relation to construction delays and overruns, vacancies, collateral value subject to market value fluctuations, interest rate, market demands, borrower's ability to repay in orderly fashion, and others. The Bank does employ stress testing on higher balance loans to mitigate risk by ensuring the customer's ability to repay in a changing rate environment before granting loan approval.
28-------------------------------------------------------------------------------- ITEM 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS NATURE OF ACTIVITIES (Continued) Agricultural Real Estate - Purchase of farm real estate or for permanent improvements to the farm real estate. Cash flow from the farm operation is the repayment source and is therefore subject to the financial success of the farm operation.
Consumer Real Estate - Purchase, refinance, or equity financing of one to four family owner occupied dwelling. Success in repayment is subject to borrower's income, debt level, character in fulfilling payment obligations, employment, and others.
Commercial and Industrial - Loans to proprietorships, partnerships, or corporations to provide temporary working capital and seasonal loans as well as long term loans for capital asset acquisition. Risks include adequacy of cash flow, reasonableness of profit projections, financial leverage, economic trends, management ability, and others. The Bank does employ stress testing on higher balance loans to mitigate risk by ensuring the customer's ability to repay in a changing rate environment before granting loan approval.
Agricultural - Loans for the production and housing of crops, fruits, vegetables, and livestock or to fund the purchase or re-finance of capital assets such as machinery and equipment and livestock. The production of crops and livestock is especially vulnerable to commodity prices and weather. The vulnerability to commodity prices is offset by the farmer's ability to hedge their position by the use of the future contracts. The risk related to weather is often mitigated by requiring federal crop insurance.
Consumer - Funding for individual and family purposes. Success in repayment is subject to borrower's income, debt level, character in fulfilling payment obligations, employment, and others.
Industrial Development Bonds - Funds for public improvements in the Bank's service area. Repayment ability is based on the continuance of the taxation revenue as the source of repayment.
All loan requests are reviewed as to credit worthiness and are subject to the Bank's underwriting guidelines as to secured versus unsecured credit. Secured loans are in turn subject to loan to value (LTV) requirements based on collateral types as set forth in the Bank's Loan Policy. In addition, credit scores of principal borrowers are reviewed and an approved exception from an additional officer is required should a credit score not meet the Bank's Loan Policy guidelines.
Consumer Loans: Maximum loan to value (LTV) for cars, trucks and light trucks vary from 90% to 110% depending on whether direct or indirect.
Loans above 100% are generally due to additional charges for extended warranties and/or insurance coverage periods of wage or death.
Boats, campers, motorcycles, RV's and Motor Coaches range from 80%-90% based on age of vehicle.
1st or 2nd mortgages on 1-4 family homes range from 75%-90% with "in-house" first real estate mortgages requiring private mortgage insurance on those exceeding 80% LTV.
The Bank will only make Qualified Mortgages as defined by the Truth in Lending Act and Regulation Z.
Raw land LTV maximum ranges from 65%-75% depending on whether or not the property has been improved.
Commercial/Agriculture/Real Estate: Maximum LTVs range from 70%-80% depending on type.
Accounts Receivable: Up to 80% LTV.
29 -------------------------------------------------------------------------------- ITEM 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS NATURE OF ACTIVITIES (Continued) Inventory: Agriculture: Livestock and grain up to 80% LTV, crops (insured) up to 75% and Warehouse Receipts up to 87%.
Commercial: Maximum LTV of 50% on raw and finished goods.
Used vehicles, new recreational vehicles and manufactured homes not to exceed (NTE) 80% LTV.
Equipment: New not to exceed 80% of invoice, used NTE 50% of listed book or 75% of appraised value.
Restaurant equipment up to 35% of market value.
Heavy trucks, titled trailers up to NTE 75% LTV and aircraft up to 75% of appraised value.
We also provide checking account services, as well as savings and time deposit services such as certificates of deposits. In addition, ATMs are provided at all of our Ohio and Indiana banking offices. Two ATM's are located at Sauder Woodworking Co., Inc., a major employer in Archbold. Additional locations in Ohio are at Northwest State Community College, Archbold; Community Hospitals of Williams County, Bryan; Fairlawn Haven Wyse Commons, Archbold; R&H Restaurant, Fayette; Delta Eagles, Sauder Village, Archbold; Fulton County Health Center, Wauseon; downtown Defiance; and a mobile trailer ATM. In Indiana, four additional remote ATM's are located in the town of St. Joe; at Kaiser's Supermarket and Therma-Tru in Butler; and at DeKalb Memorial Hospital in Auburn.
F&M Investment Services, the brokerage department of the Bank, opened for business in April, 1999. Securities are offered through Raymond James Financial Services, Inc.
The Company is a bank holding company within the meaning of the Bank Holding Company Act of 1956. Our subsidiary bank is in turn regulated and examined by the Ohio Division of Financial Institutions, and the Federal Deposit Insurance Corporation. The activities of our bank subsidiary are also subject to other federal and state laws and regulations.
The Bank's primary market includes smaller communities located in the Ohio counties of Defiance, Fulton, Henry, Lucas, Williams and Wood and in the Indiana counties of DeKalb and Steuben. The commercial banking business in this market is highly competitive with approximately 17 other depository institutions currently doing business in the Bank's primary market. In our banking activities, we compete directly with other commercial banks, credit unions and farm credit services and savings and loan institutions in each of their operating localities. In a number of locations, we compete against entities which are much larger than us. The primary factors in competing for loans and deposits are the rates charged as well as location and quality of service provided. On December 31, 2007, the Bank acquired the Knisely Bank of Indiana, expanding its market with the addition of offices in Butler and Auburn, Indiana, both located in DeKalb County. An additional office was opened in the summer of 2008 in Angola, Indiana, located in Steuben County. On July 9, 2010 the Bank purchased a branch office in Hicksville, Ohio shortening the distance between our Ohio and Indiana offices. The Bank opened an office in Waterville, Lucas County, Ohio in second quarter 2013 providing growth opportunity and extension of the market area. An additional office in Wood County was opened in fourth quarter 2013. The office was added through a single office acquisition and is located in Custar, Ohio.
At March 31, 2014, we had 248 full time equivalent employees. The employees are not represented by a collective bargaining unit. We provide our employees with a comprehensive benefit program, some of which are contributory. We consider our employee relations to be excellent.
FIRST Q 2014 IN REVIEW Loan growth continued in the first quarter of 2014 even with the expected pay down of seasonal borrowings after yearend. This loan growth was preceded by a strong fourth quarter which included an office acquisition and increased borrowings in the commercial and agricultural real estate portfolios. This growth is important to the Company as a step in the right direction to improve its net interest income and margin.
30-------------------------------------------------------------------------------- ITEM 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS FIRST Q 2014 IN REVIEW (Continued) Net interest income improved during the first quarter of 2014 as compared to the first quarter of 2013 by $746 thousand. This was accomplished due to increased loan balances and lower borrowing levels for the quarter. Loan income was up $598 thousand and total interest expense down $289 thousand.
Offsetting the improvement in net interest income was a decrease in noninterest income. Loan sales in both the agricultural and 1-4 family portfolios decreased significantly in comparison to previous year, down almost $21 million. Net gain on sales of loans was therefore also down $391 thousand. In fact, in comparing first quarter 2014 to first quarter 2013, 2013 outperformed 2014 in all areas of noninterest income, ending the quarter with a total difference of $698 thousand.
This was not an unexpected turn of events and is why loan growth is so vital to the Company going forward.
Total allowance provision for loan losses was $261 thousand higher than 2013.
Loan growth and charge-offs warranted additional provision expense be taken in the first quarter. Impaired loans decreased $381 thousand from December 31, 2013 levels and down $2.1 million from March 31, 2013. The same comparison applied for nonaccrual loans, showing an improvement in lower balances by $714 thousand than December 31, 2013. Past due loans increased by $827 thousand in comparing March 31, 2014 to December 31, 2013 balances, with the majority in the first past due bucket of 30-59 days. Overall past dues remain at extremely low levels.
In 2014, the Company continues to work on the collection of these loans and looks forward to maintaining the low exposure during 2014.
All rates remain low and are expected to remain low throughout 2014. This has enabled the Company to continue to sell investment securities and recognize a gain without compromising the yield. In 2013, the transactions had modestly extended the duration of the investment portfolio. Sales in 2014 have so far been used to fund loan growth and reinvestment into securities has not been necessary. For all of 2013, the recognized gain was $775 thousand, of which $221 thousand was recognized in the first quarter. For first quarter 2014, the Company has recognized gains of $122 thousand. Most of the securities sold were agencies maturing in a short time period. The Bank was able to continue to capitalize on the steepness of the yield curve and the unrealized market gain position the last three years. Additional sales throughout 2014 may be executed as needed to fund loan growth, which management expects to continue. The market value of the security portfolio has declined as evidenced by the high other comprehensive loss reported on the income statement and statement of comprehensive income. Additional opportunity to se1l investment securities for a gain may be limited for the remainder of 2014.
The majority of the Bank's commercial borrowers have experienced slight improvement, although a few still lag. As the economic recovery remains fragile and consumer confidence still remains at lower levels, consumer sensitive industries and the retail sector may continue to experience pressures as well.
The Company has seen improvement in unemployment levels throughout its market area. Announcement of employment expansions by local businesses have also improved the outlook for 2014.
Agriculture remained strong in 2013 and farmers have begun to protect their revenues for 2014 through hedges and the purchase of crop insurance. Prices have come down in commodities and farmers work to structure inputs to offset.
Overall, profitability in the first quarter of 2014 was down as compared to the same quarter last year. In comparisons, net income is down 9% or $194 thousand.
Net interest income was up 11.5% over the same period 2013. The Company has done an exceptional job of growing loans while keeping past dues low. The Company remains strong, stable, and well capitalized and has the capacity to continue to cover the increased costs of doing business in a tough economy while seeking good loans to improve profitability. The Company continues to look for new opportunities to generate and protect revenue and provide additional channels through which to serve our customers and maintain our high level of customer satisfaction.
The Bank has been attentive to the significant final mortgage rules and additional guidance issued by the Consumer Financial Protection Bureau to implement the Dodd-Frank Wall Street Reform and Consumer Protection Act provisions. Effective in January 2014, these rules are a game-changer which impacts the entire mortgage lending industry, as well as the Bank's perspective on its mortgage lending business. The Bank continues to work toward fulfillment of applicable requirements for these new mortgage rules, as it gains further understanding of the complexities and inter-related nature of these rules, makes strategic decisions, and addresses key considerations 31-------------------------------------------------------------------------------- ITEM 1 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS FIRST Q 2014 IN REVIEW (Continued) necessary for implementation of each rule. The Company is also preparing for the implementation of Basel III capital rules which will begin phase in for the Company on January 1, 2015. These rules may impact the ability of some financial institutions to pay dividends, though the Company believes itself to be able to maintain its strong capital position and not be limited in that regard. Larger institutions, which the rule was designed for, were required to begin reporting as of January 1, 2014.
CRITICAL ACCOUNTING POLICY AND ESTIMATES The Company's consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States of America, and the Company follows general practices within the financial services industry in which it operates. At times the application of these principles requires management to make assumptions, estimates and judgments that affect the amounts reported in the financial statements and accompanying notes.
These assumptions, estimates and judgments are based on information available as of the date of the financial statements. As this information changes, the financial statements could reflect different assumptions, estimates and judgments. Certain policies inherently have a greater reliance on assumptions, estimates and judgments and as such have a greater possibility of producing results that could be materially different than originally reported. Examples of critical assumptions, estimates and judgments are when assets and liabilities are required to be recorded at fair value, when a decline in the value of an asset not required to be recorded at fair value warrants an impairment write-down or valuation reserve to be established, or when an asset or liability must be recorded contingent upon a future event.
These policies, along with the disclosures presented in the notes to the condensed consolidated financial statements and in the management discussion and analysis of the financial condition and results of operations, provide information on how significant assets and liabilities are valued and how those values are determined for the financial statements. Based on the valuation techniques used and the sensitivity of financial statement amounts to assumptions, estimates, and judgments underlying those amounts, management has identified the determination of the Allowance for Loan and Lease Losses (ALLL) and the valuation of its Mortgage Servicing Rights and Other Real Estate Owned (OREO) as the accounting areas that require the most subjective or complex judgments, and as such could be the most subject to revision as new information becomes available.
Assets acquired through, or in lieu of, loan foreclosure are held for sale and are initially recorded at fair value at the date of foreclosure. Subsequent to foreclosure, valuations are periodically performed by management and the assets are carried at the lower of carrying amount or fair value less cost to sell.
Foreclosed real estate for sale is carried at the lower of fair value minus estimated costs to sell, or cost. Costs of holding foreclosed real estate are charged to expense in the current period, except for significant property improvements, which are capitalized. Valuations are periodically performed by management and a write-down is recorded by a charge to non-interest expense if the carrying value exceeds the fair value minus estimated costs to sell.
Foreclosed real estate is classified as other real estate owned. The net income from operations of foreclosed real estate held for sale is reported in non-interest income. At March 31, 2014, holdings were $1.8 million and were $2.1 million as of December 31, 2013 and $2.2 million as of March 31, 2013.
The ALLL represents management's estimate of probable credit losses inherent in the Bank's loan portfolio, unfunded loan commitments, and letters of credit at the report date. The ALLL methodology is regularly reviewed for its appropriateness and is approved annually by the Board of Directors. This written methodology is consistent with Generally Accepted Accounting Principles which provides for a consistently applied analysis.
The Bank's methodology provides an estimate of the probable credit losses either by calculating a specific loss per credit or by applying a composite of historical factors over a relevant period of time with current internal and external factors which may affect credit collectability. Such factors which may influence estimated losses are the conditions of the local and national economy, local unemployment trends, abilities of lending staff, valuation trends of fixed assets, and trends in credit delinquency, classified credits, and credit losses.
Inherent in most estimates is an imprecision. The Bank's ALLL provides a margin for imprecision with an unallocated amount.
32-------------------------------------------------------------------------------- ITEM 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS CRITICAL ACCOUNTING POLICY AND ESTIMATES (Continued) Bank regulatory agencies and external auditors periodically review the Bank's methodology and adequacy of the ALLL. Any required changes in the ALLL or loan charge-offs by these agencies or auditors may have a material effect on the ALLL.
The Company is required to estimate the value of its Mortgage Servicing Rights.
The Company recognizes as separate assets rights to service fixed rate single-family mortgage loans that it has sold without recourse but services for others for a fee. Mortgage servicing assets are initially recorded at cost, based upon pricing multiples as determined by the purchaser, when the loans are sold. Mortgage servicing assets are carried at the lower of the initial carrying value, adjusted for amortization, or estimated fair value. Amortization is determined in proportion to and over the period of estimated net servicing income using the level yield method. For purposes of determining impairment, the mortgage servicing assets are stratified into like groups based on loan type, term, new versus seasoned and interest rate. The valuation is completed by an independent third party.
The expected and actual rates of mortgage loan prepayments are the most significant factors driving the potential for the impairment of the value of mortgage servicing assets. Increases in mortgage loan prepayments reduce estimated future net servicing cash flows because the life of the underlying loan is reduced.
The Company's mortgage servicing rights relating to loans serviced for others represent an asset of the company. This asset is initially capitalized and included in other assets on the Company's consolidated balance sheet. The mortgage servicing rights are then amortized against noninterest income in proportion to, and over the period of the estimated future net servicing income of the underlying mortgage servicing rights. There are a number of factors, however, that can effect the ultimate value of the mortgage servicing rights to the Company, including the estimated prepayment speed of the loan and the discount rate used to present value the servicing right. For example, if the mortgage loan is prepaid, the Company will receive fewer servicing fees, meaning that the present value of the mortgage servicing rights is less than the carrying value of those rights on the Company's balance sheet. Therefore, in an attempt to reflect an accurate expected value to the Company of the mortgage servicing rights, the Company receives a valuation of its mortgage servicing rights from an independent third party. The independent third party's valuation of the mortgage servicing rights is based on relevant characteristics of the Company's loan servicing portfolio, such as loan terms, interest rates and recent national prepayment experience, as well as current national market interest rate levels, market forecasts and other economic conditions.
Management, with the advice from its third party valuation firm, reviewed the assumptions related to prepayment speeds, discount rates, and capitalized mortgage servicing income on a quarterly basis. Changes are reflected in the following quarter's analysis related to the mortgage servicing asset. In addition, based upon the independent third party's valuation of the Company's mortgage servicing rights, management then establishes a valuation allowance by each strata, if necessary, to quantify the likely impairment of the value of the mortgage servicing rights to the Company. The estimates of prepayment speeds and discount rates are inherently uncertain, and different estimates could have a material impact on the Company's net income and results of operations. The valuation allowance is evaluated and adjusted quarterly by management to reflect changes in the fair value of the underlying mortgage servicing rights based on market conditions. The accuracy of these estimates and assumptions by management and its third party valuation specialist can be directly tied back to the fact that management has only been required to record minor valuation allowances through its income statement over time based upon the valuation of each stratum of servicing rights. For more information regarding the estimates and calculations used to establish the ALLL and the value of Mortgage Servicing Rights, please see Note 1 to the consolidated financial statements provided herewith.
MATERIAL CHANGES IN FINANCIAL CONDITION, LIQUIDITY AND CAPITAL RESOURCES In comparing the balance sheet of March 31, 2014 to that of December 31, 2013, the cash equivalent liquidity of the Bank has increased by approximately $8.3 million and still remains strong. The increase in liquidity was facilitated by the office acquisition in the fourth quarter of 2013 of which deposits account for $29.5 million and loans only $11.4 million. During the three months of 2014, net loans have increased $6.6 million even with a $10 million decrease stemming from the repayment on a line of credit by a single borrowing relationship which was expected and which happens each year at this time. The fact that loan levels increased in light of the anticipated yearly reduction is a positive factor towards future improvement to profitability.
33-------------------------------------------------------------------------------- ITEM 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS MATERIAL CHANGES IN FINANCIAL CONDITION, LIQUIDITY AND CAPITAL RESOURCES (Continued) The Company's decrease in total assets of just $1.3 million was due to lower balances within securities on the asset side of $17.3 million and FHLB borrowings of $4.5 million. The Company has an unsecured borrowing capacity of $105.3 million through correspondent banks and over $76.6 million of unpledged securities which may be sold or used as collateral. The strength of the security portfolio is shown in the tables to follow. With the exception of stock, all of the Bank's security portfolio is categorized as available for sale and as such is recorded at market value.
A large fluctuation in the market value of the securities occurred during the first quarter causing the unrealized gain position to decrease significantly.
Management recognized the change in the market early and was quick to capture a portion of the gain before it fluctuated to an unrealized loss position.
Management feels confident that liquidity needs can easily be funded from an orderly runoff of the investment portfolio, along with other sources of funding.
As previously stated, net loans show an increase for the three months ended March 31, 2014, which reverses the trend in declining loan balances which the Bank had experienced all throughout fiscal year 2012 and up through the second quarter 2013. Growth came within commercial and agricultural real estate portfolios with the remaining portfolios showing decreases as comparing to yearend 2013. The balance of the decrease in the other loan portfolios was due to the pay down, payoff or refinancing of loans. Loan sales into the secondary market have also impacted the consumer and agricultural real estate portfolios though on a much smaller basis than in 2013. Year to date, the Bank has sold approximately $6.7 million of loans into the secondary market, while originating only $4.7 million of the loans during the same three-month period as demonstrated in the cash flow statement for the period. The majority of the activity stemmed from within the 1-4 family portfolio. The trend of decreasing loan balances is not unique to this year as the chart to follow shows the decreasing 2012-2013 trend and shows a large uptick for March 2014 as compared to March 2013. The Bank is also starting to generate a positive trend of increasing loan balances after our first quarter activity when comparing to yearend. The Bank's pipeline of loans has increased, driven by opportunities for new relationships as business activity begins to reflect a more optimistic opinion of the economy and large financial institutions downsize certain portfolios.
The chart below shows the breakdown of the loan portfolio by category as of March 31 for the last three years.
(In Thousands) March-14 March-13 March-12 Amount Amount Amount Commercial Real Estate $ 261,634 $ 209,601 $ 200,865 Agricultural Real Estate 49,629 35,898 31,814 Consumer Real Estate 91,368 77,160 79,716 Commercial and Industrial 90,024 89,779 103,915 Agricultural 64,859 51,896 54,084 Consumer, Overdrafts and other loans 21,322 19,292 21,652 Industrial Development Bonds 4,334 1,202 1,196 Total Loans $ 583,170 $ 484,828 $ 493,242 On a year to year comparison basis, the Commercial real estate portfolio shows the largest increase of $52.0 million in balance as of March 31, 2014 compared to March 31, 2013. Agricultural real estate shows an increase of $13.7 million.
Consumer real estate showed the largest improvement in the consumer balances of $14.2 million. Overall, all categories of loans increased. Loans increased $98.3 million as compared to the same period last year and increased $89.9 million as compared to March 31, 2012.
Overall, total assets of the Company remained equivalent decreasing just $1.3 million from December 31, 2013 to March 31, 2014.
34-------------------------------------------------------------------------------- ITEM 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS MATERIAL CHANGES IN FINANCIAL CONDITION, LIQUIDITY AND CAPITAL RESOURCES (Continued) Deposits increased $13.8 million with the largest increase in the deposit portfolio of $12.1 million in the interest-bearing transaction portfolio due to the continuing popularity of the KASASA program. The largest decrease of $9.3 million was in the time deposits. The mix of the portfolio continued to transition to a higher level of core deposits as a result primarily of the Bank's offering of a high interest bearing transaction account along with an increase in health savings accounts.
The Certificate of Deposit (COD) portfolio has decreased $9.3 million during the first three months of 2014, which is part of the reason why the Bank continues to decrease the cost of funds. Through its pricing, the Bank has limited its attractiveness to short-term rate shoppers and foresees continuing this strategy through the 2014. This is demonstrated below in the section of this MD&A captioned "MATERIAL CHANGES IN RESULTS OF OPERATIONS - Interest Expense".
The Bank paid off $4.5 million in FHLB advances which had matured during 2014.
This too should lower the cost of funds. Securities sold under agreement to repurchase decreased $11.0 million during the first three months of 2014 as compared to yearend.
Capital increased a modest $222 thousand from year-end during the three months of 2014. Positive earnings offset by a decrease in accumulated other comprehensive income and a dividend declaration are the factors behind the capital remaining basically equal to yearend. Comprehensive loss decreased $675 thousand which encompassed the shift of $122 thousand from unrealized gain to realized gain with the sale of securities. Dividends paid year-to-date were $36 thousand higher than the same period last year with a one cent increase per share being the reason.
The Company continues to be well-capitalized in accordance with Federal regulatory capital requirements as the capital ratios below show: Primary Ratio 11.28 % Tier I Leverage Ratio 10.78 % Risk Based Capital Tier I 15.59 % Total Risk Based Capital 16.42 % Stockholders' Equity/Total Assets 11.25 % MATERIAL CHANGES IN RESULTS OF OPERATIONS Comparison of Results of Operation for three month periods ended March 31, 2014 and 2013.
Improvement in net interest income for the first quarter 2014 was not high enough to offset the loss of noninterest income. As a result, net income was $194 thousand lower than 2013's first quarter. The $598 thousand higher balance in interest and fees from loans was generated from the increase loan balances of fourth quarter 2013 and first quarter 2014. Noninterest income for 2014 was impacted in all areas driven primarily by (i) a decrease in the gain on sale of securities of $99 thousand, (ii) a $391 thousand decrease on gain of sale of loans and (iii) lower levels of collection of customer service fees and charges by $185 thousand.
Net interest income after the provision for loan expense for the quarter ended March 31, 2014 was up $485 thousand from the three-month period ended March 31, 2013. The increase in total interest income for the comparison of the two periods was $457 thousand and the decrease in total interest expense was $289 thousand, making it the principal driver behind the overall increase. The provision for loan loss expense was approximately $261 thousand higher than same period 2013. The provision was needed for loan growth and replacement for the net charge-offs of $297 thousand that occurred during the period and was based on Management's quarterly analysis of the adequacy of the allowance for loan losses.
Noninterest expense was higher by $39 thousand in comparison largely due to the addition of the Waterville and Custar offices. The number of full time equivalent employees was 246 as of March 31, 2013 compared to 248 as of March 31, 2014.
35 -------------------------------------------------------------------------------- ITEM 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS MATERIAL CHANGES IN RESULTS OF OPERATIONS (Continued) The low balances in past dues, nonaccruals, OREO and troubled loans, all contributed to lower levels of expense in legal fees as relate to collections along with appraisal expense. A change to the calculation of Ohio state tax was also favorable for the Company in 2014.
Overall, the performance for the year-to-date comparison had lower bottom line income of $194 thousand caused by the reduced level of noninterest income generation.
The Company predicted the lower noninterest income position and is focused on continuing to strengthen our core earnings through loan growth and improvement to the net interest margin. New products and services will be introduced in 2014 to create additional revenue opportunities.
Interest Income Annualized interest income and yield on earning assets is up 13 basis points in 2014 as compared to March 31, 2013. While the average total earning assets were only higher by less than 1% or $7.3 million than the prior year, the increase in interest income resulted primarily from the increased growth of the Company's earning assets. As the table that follows confirms, the increase in the amount of the interest earning portfolios from investments to loans caused a higher March 2014 earnings in loans and securities thereby and caused higher combined yields. The increased volume in the loan portfolio did offset the loss in interest income due to rate changes. The security portfolio will continue to be utilized to fund loan growth. Prepayment speeds remain high on mortgage-backed securities, though these may slow as the Bank's refinancing activity has and long term rates inch higher.
Rates on the loan portfolio are lower as compared to the previous year due to the change in the composition of the overall portfolio. An emphasis on building spreads and margins on existing loans remains intact. Funding the loans with excess security holdings has been beneficial in the first quarter of 2014.
Overall loans are up in average $84.5 million and the security portfolio down $42.0 million on average from the previous year. Deposit generation in the two new offices are the factors behind the discrepancy of balances.
The yields on tax-exempt securities and the portion of tax-exempt IDB loans included in loans have been tax adjusted based on a 34% tax rate in the charts to follow.
(In Thousands) March 31, 2014 Yield/Rate Average Balance Interest/Dividends March 31, 2014 March 31, 2013 Interest Earning Assets: Loans $ 569,081 $ 6,676 4.69 % 5.02 % Taxable Investment Securities 247,097 1,017 1.65 % 1.56 % Tax-exempt Investment Securities 69,000 463 4.07 % 4.39 % Fed Funds Sold & Interest Bearing Deposits 8,841 3 0.14 % 0.17 % Total Interest Earning Assets $ 894,019 $ 8,159 3.76 % 3.63 % Change in March 31, 2014 Interest Income Compared to March 31, 2013 Change Due to Volume Due to Rate Interest Earning Assets: Loans $ 598 $ 1,996 $ (1,398 ) Taxable Investment Securities (133 ) (389 ) 256 Tax-exempt Investment Securities 3 111 (108 ) Fed Funds Sold & Interest Bearing Deposits (11 ) (17 ) 6 Total Interest Earning Assets $ 457 $ 1,701 $ (1,244 ) 36 -------------------------------------------------------------------------------- ITEM 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS MATERIAL CHANGES IN RESULTS OF OPERATIONS (Continued) Interest Expense Interest expense continued to be lower than the comparable three months of 2013.
Interest expense related to deposits was down $249 thousand while the average interest-bearing deposit balance decreased by $1.5 million in comparing the balances of each three month period. Time deposits continue to reprice down and the Bank continues to try and lengthen the duration of the portfolio with specials offered in terms longer than thirty-six months. However, depositors continue to place more funds in shorter term deposits while they wait for rates to rise or move funds elsewhere. KASASA Cash and Saver along with HSA's helped to increase the savings average deposit balances by $37.3 million.
Interest on borrowed funds was $42 thousand lower for the three month period ended March 31, 2014 than 2013. More borrowings from Federal Home Loan Bank were paid off during 2013 and 2014, making the average balance in other borrowed money considerably lower by $7.2 million in 2014 in comparison. Thus the largest decrease in cost of funds for other borrowed money was due to the decreased volume which also impacted the rate of the remaining borrowings portfolio.
During the first quarter of 2014, all borrowings from the FHLB were paid off.
Fed Funds Purchased and Securities Sold under Agreement to Repurchase had a larger average balance in 2014 of $7.8 million of whose cost was offset by lower rates making the fluctuation cost a minimal $2 thousand.
Asset yield increased 13 basis points while cost of funds decreased 16 basis points. The main focus is to continue to increase asset yield by using excess cash and the liquidation of lower yielding investments to fund loan growth.
(In Thousands) March 31, 2014 Yield/Rate Average Balance Interest/Dividends March 31, 2014 March 31, 2013 Interest Bearing Liabilities: Savings Deposits $ 432,927 $ 349 0.32 % 0.39 % Other Time Deposits 229,734 529 0.92 % 1.11 % Other Borrowed Money 581 4 2.75 % 2.37 % Fed Funds Purchased & Securities Sold under Agreement to Repurch. 59,738 62 0.42 % 0.46 % Total Interest Bearing Liabilities $ 722,980 $ 944 0.52 % 0.68 % Change in March 31, 2014 Interest Expense Compared to March 31, 2013 Change Due to Volume Due to Rate Interest Bearing Liabilities: Savings Deposits $ (41 ) $ 60 $ (101 ) Other Time Deposits (208 ) (165 ) (43 ) Other Borrowed Money (42 ) (99 ) 57 Fed Funds Purchased & Securities Sold under Agreement to Repurch. 2 16 (14 ) Total Interest Bearing Liabilities $ (289 ) $ (188 ) $ (101 ) Net Interest Income Net interest income is higher in the three month comparison, which is the opposite position as yearend 2013's comparison to yearend 2012. The issue of earning less per earning asset dollar was reversed as evidenced by a 27 basis point higher net interest margin ratio when comparing year-to-date 2014 to 2013.
The tables above demonstrate that the improvements in net interest income is primarily a result of a continued shift in balance sheet composition with the benefits hampered by the extended low rate environment.
Management expects the current interest rate environment to continue to further hamper the Company's progress on improving interest margins throughout the remainder of the fiscal year. As a result, interest income, in comparison 37-------------------------------------------------------------------------------- ITEM 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS MATERIAL CHANGES IN RESULTS OF OPERATIONS (Continued) to 2013 should increase throughout the year with a higher level of loan growth.
The Bank continues to attempt to add spread on renewing loans while loan growth is needed to improve the overall numbers. Interest expense on time deposits may start to show an increase as depositors begin to transition back into longer-term deposits. The portfolio has very limited potential for large fluctuations in rates due to the duration of this low rate environment. Should rates begin to rise; the challenge will be to delay the upward pricing of deposits in order to allow the Bank to generate a greater spread from the increased yield on its earning assets.
Provision Expense Provision for loan loss was $261 thousand higher for the three months ended March 31, 2014 as compared to the same 2013 period. A higher net charge-off position in 2014 than in 2013 along with fourth quarter 2013 and 2014 first quarter loan growth warranted the increased provision to the loan loss reserve.
The balance in nonaccrual loans decreased $714 thousand along with a decrease of $381 thousand in impaired loan balances as of March 31, 2014 as compared to the balances as of December 31, 2013. In comparing to March 31, 2013, nonaccrual balances decreased $2.0 million and impaired loan balances decreased $2.1 million. Provision expense related to those increased balances was recognized in the later time periods of 2012. The overall loan portfolio was also $98.1 million higher as of March 31, 2014 compared to March 31, 2013. The Bank continues to focus on the commercial and commercial real estate portfolios for both asset quality and growth. As the charts further below will show for 2013 and 2012, a large portion of the provision was also to replace the reserve balance depleted from the net charge-offs during the period and 2014 had a larger net charge-off position than 2013.
Should the recovery stop or continue to slow even further, it is more likely additional credits may encounter cash flow problems and the Bank remains diligent in providing funds to offset future losses. In the immediate future, the Bank would expect to fund the loan loss reserve for any loan growth that may occur.
The Bank uses the following guidelines as stated in policy to determine when to realize a charge-off, whether a partial or full loan balance. A charge down in whole or in part is realized when unsecured consumer loans, credit card credits and overdraft lines of credit reach 90 days delinquency. At 120 days delinquent, secured consumer loans are charged down to the value of the collateral, if repossession of the collateral is assured and/or in the process of repossession.
Consumer mortgage loan deficiencies are charged down upon the sale of the collateral or sooner upon the recognition of collateral deficiency. Commercial and agricultural credits are charged down at 120 days delinquency, unless an established and approved work-out plan is in place or litigation of the credit will likely result in recovery of the loan balance. Upon notification of bankruptcy, unsecured debt is charged off. Additional charge-off may be realized as further unsecured positions are recognized.
The Bank has recognized a significant decrease in the overall balance of impaired loans when looking at March 2014 compared to March 2013. A positive factor can also be seen in the decrease in the current average balance for the quarter during 2014 as compared to first and fourth quarter 2013. This is due mainly to the collection of principal from the sale of collateral from borrowers and continual collection of payments on these borrowers classified as impaired.
The Bank had $974 thousand of its impaired loans classified as troubled debt restructured "TDR" as of March 31, 2014. One new TDR impaired relationship was added during the first quarter however, when combined with pay downs, the change resulted in $381 thousand less in impaired balances and the specific allocation balance was decreased by $255 thousand.
In determining the allocation for impaired loans the Bank applies the observable market price of the collateral securing the asset, reduced by applying a discount for estimated costs of collateral liquidation. In some instances where the discounted market value is less than the loan amount, a specific impairment allocation is assigned, which may be reduced or eliminated by the write down of the credit's active principal outstanding balance.
For the majority of the Bank's impaired loans, the Bank will apply the observable market price methodology. However, the Bank may also utilize a measurement incorporating the present value of expected future cash flows discounted at the loan's effective rate of interest. To determine observable market price, collateral asset values securing an impaired loan are periodically evaluated. Maximum time of re-evaluation is every 12 months for chattels 38-------------------------------------------------------------------------------- ITEM 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS MATERIAL CHANGES IN RESULTS OF OPERATIONS (Continued) and titled vehicles and every two years for real estate. In this process, third party evaluations are obtained and heavily relied upon. Until such time that updated appraisals are received, the Bank may discount the collateral value used.
The ALLL has a direct impact on the provision expense. The increase in the ALLL is funded through recoveries and provision expense. The following tables both deal with the allowance for credit losses. The first table breaks down the activity within ALLL for each loan portfolio segment and shows the contribution provided by both the recoveries and the provision along with the reduction of the allowance caused by charge-offs. The second table discloses how much of the ALLL is attributed to each segment of the loan portfolio, as well as the percent that each particular segment of the loan portfolio represents to the entire loan portfolio in the aggregate. Commercial real estate loans accounted for the largest component of charge-offs and consumer loan activity has accounted for the largest component of recoveries in first quarter 2014 as compared to 2013.
As was mentioned in previous discussion, the commercial real estate portfolio is currently having a major impact on the ALLL, both through charge-off activity and due to growth of balances.
The following table presents activities for the allowance for loan losses by loan type for three months ended March 31, 2014, 2013, and 2012.
(In Thousands) Three Three Three Months Months Months Ended Ended Ended March-14 March-13 March-12 Loans $ 582,872 $ 484,828 $ 493,242 Daily average of outstanding loans $ 569,081 $ 484,590 $ 491,969 Allowance for Loan Losses - January 1 $ 5,194 $ 5,224 $ 5,091 Loans Charged off: Commercial Real Estate 201 20 - Agricultural Real Estate - - - Consumer Real Estate 64 10 40 Commercial and Industrial - - - Agricultural - - - Consumer & other loans 101 86 86 366 116 126 Loan Recoveries Commercial Real Estate 2 - 4 Agricultural Real Estate - - - Consumer Real Estate 10 4 3 Commercial and Industrial 5 15 15 Agricultural 1 1 7 Consumer & other loans 51 49 30 69 69 59 Net Charge Offs 297 47 67 Provision for loan loss 428 167 128 Acquisition provision for loan loss - - - Allowance for Loan & Lease Losses - March 31 $ 5,325 $ 5,344 $ 5,152 Allowance for Unfunded Loan Commitments & Letters of Credit - March 31 180 172 140 Total Allowance for Credit Losses - March 31 $ 5,505 $ 5,516 $ 5,292 Ratio of net charge-offs to average Loans outstanding 0.05 % 0.01 % 0.01 % Ratio of Allowance for Loan Loss to Nonperforming Loans 203.68 % 128.42 % 170.43 % 39 -------------------------------------------------------------------------------- ITEM 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS MATERIAL CHANGES IN RESULTS OF OPERATIONS (Continued) The following table presents the balances for allowance of loan losses by loan type for three months ended March 31, 2014 and March 31, 2013.
(In Thousands (In Thousands) March-2014 March-2013 % of % of Amount Porfolio Amount Porfolio Balance at End of Period Applicable To: Commercial Real Estate $ 1,958 44.89 $ 1,566 43.24 Agricultural Real Estate 131 8.51 105 7.40 Consumer Real Estate 402 15.68 463 15.91 Commercial and Industrial 1,330 15.44 1,972 18.52 Agricultural 324 11.13 260 10.70 Consumer, Overdrafts and other loans 270 3.61 256 3.98 Unallocated 910 0.74 722 0.25 Allowance for Loan & Lease Losses 5,325 5,344 Off Balance Sheet Commitments 180 172 Total Allowance for Credit Losses $ 5,505 $ 5,516 The percentage of delinquent loans has trended downward since the beginning of 2010 from a high of 2.85% of total loans in January to .25% as of the end of December 2013. March 2014 increased slightly to .39% though any percentage under 1% is considered low. These percentages do not include nonaccrual loans which are not past due. This level of delinquency is due in part to an adherence to sound underwriting practices over the course of time, an improvement in the financial status of companies to which the Bank extends credit, continued financial stability in the agricultural loan portfolio, and the write down of uncollectable credits in a timely manner.
Non-interest Income Overall, noninterest income for first quarter 2014 was $698 thousand below the same time period of 2013. As has been expected, revenue from gains on sales of loans, investment securities and other assets owned diminished compared to prior periods. The Bank was able to capitalize on those opportunities; however, current increases in the long term market rates has slowed the progress. All categories of noninterest income decreased as compared to first quarter 2013.
The Bank does not expect a significant change in the opportunity for gains for the remainder of 2014.
$9 million in sales of investment securities were conducted in first quarter 2014 to fund loan growth and capture some additional revenue. The sales resulted in a gain of $122 thousand. First quarter 2013 had sales of $35 million resulting in gains of $221 thousand. The difference between 2014 and 2013 sales was the utilization of the funds. 2014 went to fund loan growth while 2013 was reinvested in securities.
This does not mean that some avenues were not available for improvement. With the percentage of core deposits, specifically checking accounts, increasing throughout the Bank's market area, debit card usage was higher. Corresponding interchange income increased to over $500 thousand for the quarter, outperforming first quarter 2013 by $55 thousand. The same held true for credit card fees which had increased revenue of $22.5 thousand.
Overdraft and return check fees were lower by $55.9 thousand in comparing the quarters, even though the number of accounts increased by almost 2 thousand.
The Bank is in the early stages of designing new (while revamping older) products and services to capture additional revenue. More importantly, to also add value to our customer experience and meet new service demands.
40-------------------------------------------------------------------------------- ITEM 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS MATERIAL CHANGES IN RESULTS OF OPERATIONS (Continued) The impact of mortgage servicing rights, both to income and expense, is shown in the following table which reconciles the value of mortgage servicing rights. The capitalization runs through non-interest income while the amortization thereof is included in non-interest expense. A slight impairment in the valuation of the thirty year segment occurred in the fourth quarter of 2012 and was reversed in the second quarter of 2013, eliminating all impairment. Therefore, first quarter 2013 includes a slight valuation allowance of which there is not any in 2014.
For 2014, mortgage servicing rights caused $36 thousand more in expense than for first quarter 2013.
(In Thousands) 2014 2013 Beginning Balance, January 1 $ 2,066 $ 2,063 Capitalized Additions 41 132 Amortization (82 ) (137 ) Ending Balance, March 31 2,025 2,058 Valuation Allowance - (16 ) Mortgage Servicing Rights, net March 31 $ 2,025 $ 2,042 Loss on sale of other assets owned was higher by $23 thousand as of first quarter end 2014 as compared to same period 2013. This represents an additional expense or a decrease in non-interest income for the period. This line item includes losses from sales of assets, losses from write-downs to the Bank's Other Real Estate Owned (ORE) and losses resulting from the loss or disposal of fixed assets, though the fixed asset sales are inconsequential. Holdings in ORE decreased to $1.8 million as of March 31, 2014 compared to holdings of $2.2 million as of March 31. 2013. Activity on sales of ORE has increased in 2014 with four sales compared to only one sale in first quarter 2013 and the Bank expects this to continue throughout the remainder of 2014. The Bank also wrote down the value on four properties due to updated appraisals and expects holdings to decrease even further.
The movement of income from comprehensive income to realized gain on sale of securities is disclosed in the table to follow. Since the Bank classifies its entire investment portfolio, with the exception of stock, as available for sale, the majority of any gain/loss on the sale is a direct shift of funds from unrealized gain to realized gain. Since the purchase of additional or replacement securities occurs at the same time, those new securities immediately impact the other comprehensive loss.
(In Thousands) Three Months Ended Three Months Ended March 31, 2014 March 31, 2013 Net Unrealized gain (loss) on available-for-sale securities $ (901 ) $ (916 ) Less reclassification adjustment for gain on sale of available-for-sale securities 122 221 Net unrealized losses (1,023 ) (1,137 ) Tax Effect 348 387 Other comprehensive loss $ (675 ) $ (750 ) Non-Interest Expense Non-interest expense for the three months ended March 31, 2014 was only $39 thousand higher than for the same period of 2013. Salaries and wages were almost equal to 2013, being $3 thousand less than the same three month time frame. The number of full time equivalent employees increased from 246 as of March 31, 2013 to 248 as of March 31, 2014. This occurred even with the addition of two offices in 2014's numbers.
41 -------------------------------------------------------------------------------- ITEM 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS MATERIAL CHANGES IN RESULTS OF OPERATIONS (Continued) Non-Interest Expense (Continued) Medical costs show a $93 thousand decrease in comparing year-to-date 2014 to 2013. The Bank instituted a change to how a HSA contribution per employee was given. Instead of depositing all at once at the start of the year as was done in 2013, the contribution is distributed through the year. The Bank also switched medical providers at yearend 2013, which resulted in claims which would have normally been covered in 2014 being expensed in 2013. Health insurance costs have increased for the Bank in 2014, though it is not clearly evident in looking at the line items.
An incentive accrual is also lower in 2014 than in 2013 by $72 thousand. This is due to the lower net income of the Bank for the period on which the incentive is calculated. The Bank continues to reward employees for performance and the accrual reflects this.
A decrease occurred of $55 thousand in the amortization expense of mortgage servicing rights. When a mortgage is refinanced, any unamortized servicing right is fully expensed and therefore, drives the amortization expense higher within that period. Of the sales and originations shown in the cash flow, $4.5 million were originated and $4.9 million sold from the 1-4 family portfolio which had mortgage servicing rights attached. These were down from $16.0 million in originations and $18.1 million in sales from the same portfolio as of first quarter 2013. Therefore, amortization expense from refinancing activity would be expected to be lower, which it is.
Other general and administrative expenses were higher during the three months for 2014 by $121 thousand; as compared to the same three months 2013. The amortization expense of the core deposit intangible was $14.8 thousand higher in 2014 than in 2013 due to the Custar office acquisition in December 2013. General legal fees were $37 thousand higher in first quarter 2014 as compared to same time frame of 2013. Legal fees as related to collection of problem loans were down $38.5 thousand in the same comparison. Improvement in past dues, nonaccruals, OREO and troubled loans were behind the lower expense. Other expenses related to these areas were also down $85.5 thousand form the previous year.
Additional decreases in general and administrative noninterest expense were lower taxes for the State of Ohio as a revised tax code became effective in 2014, resulting in a Company savings of $59.8 thousand for the first quarter on a consolidated basis. An adjustment for force placed property insurance that was over expensed resulted in a one-time decrease for general insurance expense in 2014.
The second largest increase in the line item general and administrative expense is in NSF checks and other losses stemming from the Bank's deposit accounts. In comparing the first quarter of 2014 to 2013, the increase amounted to $45.6 thousand more expense in 2014. This represents an area of great concern to the Bank as the failures of other organizations to protect customer's information hurts the Bank's bottom line. This exposure to risk continues to increase as our society adopts and utilizes more technology than ever before.
Overall non-interest expense was just $39 thousand higher in 2014 than in 2013.
The Company continues to monitor costs to safeguard profitability.
Net Income Overall, net income was down $194 thousand for the three months ended March 31, 2014, compared to the same period of 2013. The improvement in asset quality that has occurred over the last two years along with lower loan balances enabled the Company to have low levels of provision expense until third quarter 2013.
Provision was increased during the quarter due to charge-offs and loan growth and was $261 thousand higher than 2013 on a comparable year-to-date. This coupled with the decreases in gain/loss on sale of other assets owned, gain on sale of investments, and gain on sales of loans are the largest factors behind the decrease.
The importance of a higher loan to asset percentage was evidenced by the improvement in interest income and yield. With the decrease in noninterest income, it becomes essential that the Bank continue to build on the growth in loans of the last two quarters. The ability to fund that loan growth with a growth in core deposits is another strength of the Company which should continue with the addition of new offices.
42-------------------------------------------------------------------------------- ITEM 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS MATERIAL CHANGES IN RESULTS OF OPERATIONS (Continued) The Bank also has the ability to borrow funds or sell securities and best of all, the option to choose which source correlates to be the most profitable.
The effective tax rate for the Bank increased during the first quarter as stock was redeemed by the Federal Home Loan Bank for the first time. Stock dividends, that were previously tax deferred, were currently taxed. This resulted in additional provision of $100 thousand for 2014 as compared to 2013. Offsetting this tax effect is the holdings of tax exempt municipal securities at the holding company level.
The Company is positioned for improvement in the net interest margin while rates remain low, provided there is an increase in loan demand. It will be a challenge to maintain the margin once short term rates begin to rise. However, the Bank remains focused on improving the asset yield through improved asset quality and added spread to prime on variable and adjustable rate loans. As with the rest of the banking industry, the Company is also limited from achieving higher profitability by the cost of increased regulatory requirements such as Regulation E, Dodd-Frank Wall Street Reform and Consumer Protection Act and any other additional regulations that may be enacted during 2014 and their corresponding cost of compliance. The Company will continue to seek to enhance existing products and services to increase revenue, improve efficiency and increase customer satisfaction.
Overall, the Bank is working to offset the probable loss of noninterest income streaming from sales by increasing the loan balances. Possible improvement in the net interest margin appears attainable with the loan increases shown in the quarterly comparisons.
FORWARD LOOKING STATEMENTS Statements contained in this portion of the Company's report may be forward-looking statements, as that term is defined in the Private Securities Litigation Reform Act of 1995. Forward-looking statements may be identified by the use of words such as "intend," "believe," "expect," "anticipate," "should," "planned," "estimated," and "potential." Such forward-looking statements are based on current expectations, but may differ materially from those currently anticipated due to a number of factors, which include, but are not limited to, factors discussed in documents filed by the Company with the Securities and Exchange Commission from time to time. Other factors which could have a material adverse effect on the operations of the Company and its subsidiaries which include, but are not limited to, changes in interest rates, general economic conditions, legislative and regulatory changes, monetary and fiscal policies of the U.S. Government, including policies of the U.S. Treasury and the Federal Reserve Board, the quality and composition of the loan or investment portfolios, demand for loan products, deposit flows, competition, demand for financial services in the Bank's market area, changes in relevant accounting principles and guidelines and other factors over which management has no control. The forward-looking statements are made as of the date of this report, and the Company assumes no obligation to update the forward-looking statements or to update the reasons why actual results differ from those projected in the forward-looking statements.
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