News Column

FIRST GUARANTY BANCSHARES, INC. - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations

May 15, 2014

The following management discussion and analysis is intended to highlight the significant factors affecting the Company's financial condition and results of operations presented in the consolidated financial statements included in this Form 10-Q. This discussion is designed to provide readers with a more comprehensive view of the operating results and financial position than would be obtained from reading the consolidated financial statements alone. Reference should be made to those statements for an understanding of the following review and analysis. The financial data at March 31, 2014 and for the three months ended March 31, 2014 and 2013 have been derived from unaudited consolidated financial statements and include, in the opinion of management, all adjustments (consisting of normal recurring accruals and provisions) necessary to present fairly the Company's financial position and results of operations for such periods. First Guaranty Bancshares, Inc. is a bank holding company headquartered in Hammond, LA with one wholly owned subsidiary, First Guaranty Bank. First Guaranty Bank is a Louisiana state chartered commercial bank with 21 banking facilities including one drive-up only facility, located throughout Southeast, Southwest and North Louisiana. The Company emphasizes personal relationships and localized decision making to ensure that products and services are matched to customer needs. The Company competes for business principally on the basis of personal service to customers, customer access to officers and directors and competitive interest rates and fees.



Special Note Regarding Forward-Looking Statements

Congress passed the Private Securities Litigation Act of 1995 in an effort to encourage corporations to provide information about a Company's anticipated future financial performance. This act provides a safe harbor for such disclosure, which protects us from unwarranted litigation, if actual results are different from Management expectations. This discussion and analysis contains forward-looking statements and reflects Management's current views and estimates of future economic circumstances, industry conditions, company performance and financial results. The words "may," "should," "expect," "anticipate," "intend," "plan," "continue," "believe," "seek," "estimate" and similar expressions are intended to identify forward-looking statements. These forward-looking statements are subject to a number of factors and uncertainties, including, changes in general economic conditions, either nationally or in our market areas, that are worse than expected; competition among depository and other financial institutions; inflation and changes in the interest rate environment that reduce our margins or reduce the fair value of financial instruments; adverse changes in the securities markets; changes in laws or government regulations or policies affecting financial institutions, including changes in regulatory fees and capital requirements; our ability to enter new markets successfully and capitalize on growth opportunities; our ability to successfully integrate acquired entities, if any; changes in consumer spending, borrowing and savings habits; changes in accounting policies and practices, as may be adopted by the bank regulatory agencies, the Financial Accounting Standards Board, the Securities and Exchange Commission and the Public Company Accounting Oversight Board; changes in our organization, compensation and benefit plans; changes in our financial condition or results of operations that reduce capital available to pay dividends; and changes in the financial condition or future prospects of issuers of securities that we own, which could cause our actual results and experience to differ from the anticipated results and expectations, expressed in such forward-looking statements. 24



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First Quarter 2014 Financial Overview

Financial highlights for the three month periods of 2014 and 2013 are as follows:

? Net income for the first quarter of 2014 and 2013 was $2.8 million and $2.1

million, respectively. Net income to common shareholders after preferred stock

dividends was $2.7 million and $1.8 million for the first quarter of 2014 and

2013, with earnings per common share of $0.43 and $0.29, respectively.

The increase in net income for the first quarter of 2014 when compared to the

first quarter of 2013 was primarily the result of an increase in loan interest

income, a decrease in interest expense, and a decrease in provision for loan

losses.

? Net interest income for the first quarter of 2014 and 2013 was $10.5 million

and $9.6 million, respectively. The net interest margin was 2.98% for the

first quarter 2014 and 2.85% for the same period in 2013.

? The provision for loan losses for the first quarter of 2014 was $0.3 million

compared to $0.9 million for the first quarter of 2013.

? Total assets at March 31, 2014 were $1.44 billion; a increase of $5.4 million

or 0.4% from December 31, 2013. The increase in assets was primarily from an

increase in loans.

? Investment securities totaled $619.7 million at March 31, 2014, a decrease of

$14.8 million when compared to $634.5 million at December 31, 2013. At March

31, 2014, available for sale securities, at fair value, totaled $473.1 million; a decrease of $11.1 million when compared to $484.2 million at December 31, 2013. At March 31, 2014, held to maturity securities, at amortized cost, totaled $146.6 million; a decrease of $3.7 million when compared to $150.3 million at December 31, 2013.



? The weighted average life of the securities portfolio at March 31, 2014 was

5.6 years a decline of 0.1 years when compared to the average life of 5.7

years at December 31, 2013.

? The net loan portfolio at March 31, 2014 totaled $700.3 million, a net

increase of $7.5 million from the December 31, 2013 net loan portfolio of

$692.8 million. Loans are reduced by the allowance for loan losses which

totaled $9.6 million for March 31, 2014 and $10.4 million for December 31,

2013.

? Total impaired loans decreased $2.6 million at March 31, 2014 to $27.3 million

compared to $29.9 million at December 31, 2013.

? Loans classified as Troubled Debt Restructurings ("TDRs") stayed at the same

level of $3.2 million for March 31, 2014 and December 31, 2013.

? Total deposits decreased $6.3 million or 0.5% at March 31, 2014 compared to

December 31, 2013. This decrease is from seasonal fluctuation of public fund

deposits.

? Return on average assets for the three months ended March 31, 2014 and March

31, 2013 was 0.78% and 0.60%, respectively. Return on average common

shareholders' equity, adjusted for preferred stock dividends, for the three

months ended March 31, 2014 and March 31, 2013 was 12.27% and 7.69%,

respectively. Return on average assets is calculated by dividing annualized

net income before preferred dividends by average assets. Return on common

shareholders' equity is calculated by dividing net earnings applicable to

common shareholders by average common shareholders' equity.

? The Company's Board of Directors declared a cash dividend of $0.16 per common

share in the first quarters of 2014 and 2013.

? Other real estate decreased $0.7 million to $2.7 million at March 31, 2014

from $3.4 million at December 31, 2013.

? Book value per common share was $14.31 as of March 31, 2014 compared to $13.35

as of December 31, 2013. The increase in book value per share is a result of

the decrease in the unrealized loss on available for sale securities and due

to an increase in retained earnings..

? Preferred stock dividends from participation in the U.S. Treasury's Small

Business Lending Fund ("SBLF") decreased $0.2 million to $0.1 million for the

first quarter of 2014 compared to $0.3 million for the same period in 2013.

The reduction was due to the increase in qualified small business loans.

The

Company is at the contractual minimum rate of 1.0% on the SBLF preferred stock. 25



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Financial Condition

Changes in Financial Condition from December 31, 2013 to March 31, 2014

General.

Total assets as of March 31, 2014 were $1.44 billion; a increase $5.4 million or 0.4% from December 31, 2013. The increase in assets represents an increase in loans. Investment Securities. Investment securities at March 31, 2014 totaled $619.7 million, a decrease of $14.8 million compared to $634.5 million at December 31, 2013. The decrease is attributed to the sale of corporate securities and a reduction in short term Treasury bills used for seasonal public funds pledging. The investment portfolio consisted of available for sale securities at their fair market value total of $473.1 million and held to maturity securities at amortized cost total of $146.6 million. The securities portfolio consisted principally of U.S. Government agency securities, agency backed mortgage backed securities, corporate debt securities and municipal bonds. The securities portfolio provides the Company with a relatively stable source of income and provides a balance to credit risk when compared to other categories of assets. Management monitors the securities portfolio for both credit and interest rate risk. The Company generally limits the purchase of corporate securities to individual issuers to manage concentration and credit risk. Corporate securities generally have a maturity of 10 years or less. Government agency securities generally have maturities of 15 years or less. Corporate securities held at fair value totaled $134.6 million at March 31, 2014. U.S. Government Agency securities that were held at fair value totaled $291.5 million at March 31, 2014. Agency securities that were held for maturity and carried at amortized cost totaled $84.5 million at March 31, 2014. The fair value of held to maturity agency securities was $80.2 million at March 31, 2014. Mortgage backed securities that were held for maturity and carried at amortized cost totaled $62.1 million at March 31, 2014. The fair value of held to maturity mortgage backed securities was $60.2 million at March 31, 2014. At March 31, 2014, $40.0 million or 6.4% of the securities portfolio was scheduled to mature in less than one year. Securities with contractual maturity dates over 10 years totaled $39.6 million or 6.3% of the total portfolio. Mortgage backed securities totaled $62.1 million or 9.9% of the investment portfolio. The weighted average contractual maturity of the securities portfolio was 5.6 years at March 31, 2014 compared to 5.7 years at December 31, 2013. The average maturity of the securities portfolio is affected by call options that may be exercised by the issuer of the securities and are influenced by market interest rates. Average securities as a percentage of average interest-earning assets were 45.5% for the three month period ended March 31, 2014 and 47.9% for the same period in 2013. At March 31, 2014, the U.S Government agency securities and municipal bonds qualified as securities pledgeable to collateralize repurchase agreements and public funds. Securities pledged totaled $493.8 million at March 31, 2014 and $503.1 million at December 31, 2013. See Note 3 of the Notes to Consolidated Financial Statements for more information on investment securities.



Loans.

Average loans as a percentage of average interest-earning assets were 49.8% for the three month period ended March 31, 2014 and 46.2% for the same period in 2013. Net loans increased $7.5 million or 1.1% from $692.8 million at December 31, 2013. As we have increased our loans to qualified small businesses, as a part of the SBLF program, our preferred dividend on our SBLF capital has decreased to $0.1 million for the first quarter of 2014 from $0.3 million for the same period in 2013. There are no significant concentrations of credit to any individual borrower. As of March 31, 2014, 72.5% of our loan portfolio was secured primarily or secondarily by real estate. The largest portion of our loan portfolio, at 47.0%, is non-farm non-residential loans secured by real estate. Net loans are reduced by the allowance for loan losses which totaled $9.6 million for March 31, 2014 and $10.4 million for December 31, 2013. Loan charge offs totaled $1.1 million during the first three months of 2014, compared to $1.9 million during the same period of 2013. Recoveries totaled $0.1 million during the first three months of 2014 and $0.1 million during the first three months of 2013. See Note 4 of the Notes to Consolidated Financial Statements for more information on loans and Note 5 for information on the allowance for loan losses. 26

-------------------------------------------------------------------------------- Nonperforming Assets. Nonperforming assets consist of loans on which interest is no longer accrued and real estate acquired through foreclosure (other real estate). The accrual of interest is discontinued on loans when management believes there is reasonable uncertainty about the full collection of principal and interest or when the loan is contractually past due 90 days or more and not fully secured. If the principal amount of the loan is adequately secured, then interest income on such loans is recognized only in periods in which actual payments are received. The table below sets forth the amounts and categories of our non-performing assets and restructured loans where the interest rate or other terms have been renegotiated at the dates indicated. December 31, (in thousands) March 31, 2014 2013 Nonaccrual loans: Real Estate: Construction and land development $ 117 $ 73 Farmland 95 130 1 - 4 family residential 4,015 4,248 Multifamily - - Non-farm non-residential 6,466 7,539 Total Real Estate 10,693 11,990 Non-Real Estate: Agricultural 370 526 Commercial and industrial 1,878 1,946 Consumer and other 7 23 Total Non-Real Estate 2,555 2,495 Total nonaccrual loans 12,948 14,485 Loans 90 days and greater delinquent & accruing: Real Estate: Construction and land development - - Farmland - - 1 - 4 family residential 187 414 Multifamily - - Non-farm non-residential - - Total Real Estate 187 414 Non-Real Estate: Agricultural - - Commercial and industrial - - Consumer and other - - Total Non-Real Estate - - Total loans 90 days and greater delinquent & accruing 187 414 Total non-performing loans $ 13,135$ 14,899 Real Estate Owned: Real Estate Loans: Construction and land development 463 754 Farmland - - 1 - 4 family residential 1,480 1,803 Multifamily - - Non-farm non-residential 800 800 Total Real Estate 2,743 3,357 Non-Real Estate Loans: Agricultural - - Commercial and industrial - - Consumer and other - - Total Non-Real Estate - - Total Real Estate Owned 2,743 3,357 Total non-performing assets $ 15,878$ 18,256 Non-performing assets to total loans 2.2 % 2.6 % Non-performing assets to total assets 1.1 % 1.27 % 27

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December 31, (in thousands) March 31, 2014 2013 Restructured Loans: In Compliance with Modified Terms $ 3,006$ 3,006 Past Due 30 through 89 days and still accruing - - Past Due 90 days and greater and still accruing - - Nonaccrual 230 230 Restructured Loans that subsequently defaulted - Total Restructured Loans $ 3,236$ 3,236 At March 31, 2014, nonperforming assets totaled $15.9 million compared to $18.3 million at December 31, 2013; a decrease of 13.1% or $2.4 million. Management has not identified additional information on any loans not already included in impaired loans or the nonperforming assets that indicates possible credit problems that could cause doubt as to the ability of borrowers to comply with the loan repayment terms in the future. Nonperforming assets consist of loans 90 days or greater delinquent and still accruing, nonaccrual loans, and other real estate. At March 31, 2014 loans 90 days or greater delinquent and still accruing totaled $0.2 million; a decrease of $0.2 million or 50.0% compared to the $0.4 million total at December 31, 2013.



At March 31, 2014 nonaccrual loans totaled $12.9 million; a decrease of $1.5 million or 10.6% compared to December 31, 2013 nonaccrual loans of $14.5 million. Nonaccrual loans were concentrated in 4 credit relationships for a total of $6.4 million or 49.1% of nonaccrual loans at March 31, 2014.

Other real estate owned at March 31, 2014 totaled $2.7 million; a decrease of $0.7 million from $3.4 million at December 31, 2013.

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Allowance for Loan Losses.

The allowance for loan losses is maintained to absorb potential losses embedded in the loan portfolio. The allowance is increased by the provision for anticipated loan losses as well as recoveries of previously charged off loans and is decreased by loan charge-offs. The provision is the necessary charge to current expense to provide for current loan losses and to maintain the allowance commensurate with Management's evaluation of the risks inherent in the loan portfolio. Various factors are taken into consideration when determining the amount of the provision and the adequacy of the allowance. These factors include but are not limited to:



? past due and nonperforming assets;

? specific internal analysis of loans requiring special

attention;

? the current level of regulatory classified and criticized

assets and the associated risk factors with each;

? changes in underwriting standards or lending procedures and

policies;

? charge off and recovery practices;

? national and local economic and business conditions;

? nature and volume of loans;

? overall portfolio quality;

? adequacy of loan collateral;

? quality of loan review system and degree of oversight by

its Board of Directors;

? competition and legal and regulatory requirements on

borrowers;

? examinations of the loan portfolio by federal and state

regulatory agencies and examinations;

? and review by our internal loan review department and

independent accountants.

The data collected from all sources in determining the adequacy of the allowance is evaluated on a regular basis by Management with regard to current national and local economic trends, prior loss history, underlying collateral values, credit concentrations and industry risks. An estimate of potential loss on specific loans is developed in conjunction with an overall risk evaluation of the total loan portfolio. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as new information becomes available. The allowance consists of specific, general, and unallocated components. The specific component relates to loans that are classified as doubtful, substandard, and impaired. For such loans that are also classified as impaired, an allowance is established when the discounted cash flows (or collateral value or observable market price) of the impaired loan is lower than the carrying value of that loan. Also, a specific reserve is allocated for our syndicated loans. The general component covers non-classified loans and special mention loans and is based on historical loss experience adjusted for qualitative factors. An unallocated component is maintained to cover uncertainties that could affect Management's estimate of probable losses. Provisions made pursuant to these processes totaled $0.3 million in the first three months of 2014 as compared to $0.9 million for the same period in 2013. The provisions made in the first three months of 2014 were taken to provide for current loan losses and to maintain the allowance proportionate to risks inherent in the loan portfolio. Total charge-offs were $1.1 million for first three months of 2014 as compared to $1.9 million for the same period in 2013. Recoveries totaled $0.1 million during the first three months of 2014 and $0.1 million during the first three months of 2013. For more information, see Note 5 to Consolidated Financial Statements. Comparing March 31, 2014 to March 31, 2013, the decline in allowance provision is attributed to improvement in the credit quality of the loan portfolio and to the fact that the impaired loan portfolio did not suffer additional declines in estimated fair value. The credit quality improvements were across most loan portfolio types with the largest improvement in non-farm non-residential loans, commercial and industrial loans, and construction and land development. The Company charged off $1.1 million in loan balances for the first quarter of 2014. The amounts were partial charge offs concentrated in two loan relationships which totaled $0.9 million or 81.9% of the total charged off amount. The charge offs were provided for in prior periods as specific reserves for these loans. The details of the charged off loans in excess of $0.3 million are as follows:



1. The Company charged of $0.4 million on a non-farm non-residential loan

secured by a hotel. The non-accrual loan had further deterioration in

value which required the additional write down.

2. The Company charged of $0.5 million on a non-farm non-residential loan

secured by a hotel. The non-accrual loan had further deterioration in value which required the additional write down.



The remaining $0.2 million of charge-offs for the first quarter of 2014 were comprised of smaller loans and overdrawn deposit accounts.

As of March 31, 2014, the Company had classified $27.3 million in loans as impaired compared to $29.9 million as of December 31, 2013. The $2.6 million reduction in impaired loans was principally due to a $0.6 million credit relationship that was no longer considered impaired in the first quarter of 2014. $0.9 million of the reduction in impaired loans was due to charge-offs. $0.6 million was due to principal payments on impaired loans. 29 -------------------------------------------------------------------------------- All accrued but uncollected interest related to a loan is deducted from income in the period the loan is placed on nonaccrual. During the period a loan is in nonaccrual status, any cash receipts are first applied to the principal balance. Once the principal balance has been fully recovered, any residual amounts are applied to expenses resulting from the collection of the payment and to the recovery of any reversed interest income and interest income that would have been due had the loan not been nonaccrual. As of March 31, 2014 and December 31, 2013 the Company had nonaccrual loans totaling $12.9 million and $14.5 million, respectively. The allowance for loan losses at March 31, 2014 was $9.6 million or 1.35% of total loans and 73.3% of nonperforming loans. See Note 4 and 5 of the Notes to Consolidated Financial Statements for more information on loans and the allowance for loan losses. Other information relating to loans, the allowance for loan losses and other pertinent statistics follows. (in thousands) March 31, 2014 March 31, 2013



Loans:

Average outstanding balance $ 703,725$ 629,753 Balance at end of period $ 709,911$ 653,285

Allowance for Loan Losses: Balance at beginning of year $ 10,355$ 10,342 Charge offs (1,137 ) (1,929 ) Recoveries 99 90 Provision 300 904 Balance at end of period $ 9,617 $ 9,407 30



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Deposits.

Managing the mix and pricing the maturities of deposit liabilities is an important factor affecting our ability to maximize our net interest margin. The strategies used to manage interest-bearing deposit liabilities are designed to adjust as the interest rate environment changes. In this regard, management regularly assesses our funding needs, deposit pricing and interest rate outlooks. From December 31, 2013 to March 31, 2014, total deposits decreased $6.3 million, or 0.5%, to $1.3 billion at March 31, 2014. Average Noninterest-bearing demand deposits decreased $6.0 million from December 31, 2013 to March 31, 2014. Average Interest-bearing demand deposits increased by $70.9 million when comparing March 31, 2014 to December 31, 2013. Average time deposits decreased $12.8 million, or 2.0% to $638.2 million at March 31, 2013, compared to $648.4 million at December 31, 2012. At March 31, 2014, public fund deposits totaled $516.9 million. During the first three months of 2014, public fund deposits increased $13.4 million. This increase is due to the seasonal fluctuation of public funds. The Company has developed a program for the development and management of public fund deposits. Since 2007, the Company has maintained public fund deposits in excess of $175.0 million. These deposits are from local government entities such as school districts, hospital districts, sheriff departments and other municipalities. Several of these accounts are under contracts with terms up to three years. Public funds deposit accounts are collateralized by FHLB letters of credit and by eligible government agency securities such as those issued by the FHLB, FFCB, FNMA, and FHLMC. Management believes that public funds provide a low cost and stable source of funding for the Company.



As of March 31, 2014, the aggregate amount of outstanding certificates of deposit in amounts greater than or equal to $100,000 was approximately $436.8 million. At March 31, 2014, approximately $226.4 million of the Company's certificates of deposit had a remaining term greater than one year.

As we seek to maintain a strong net interest margin and improve our earnings, attracting core noninterest-bearing deposits will remain a primary emphasis. Management will continue to evaluate and update our product mix in its efforts to attract additional core customers. We currently offer a number of noninterest-bearing deposit products that are competitively priced and designed to attract and retain customers with primary emphasis on core deposits. We have also offered several different time deposit promotions in an effort to increase our core deposits and to increase liquidity. Average Balance Average Balance Increase/(Decrease) (in thousands except for %) March 31, 2014 December 31, 2013 Amount Percent Noninterest-bearing demand $ 190,566 $ 196,589 $ (6,023 ) (3.1) % Interest-bearing demand 405,461 334,573 70,888 21.2 % Savings 68,116 64,639 3,477 5.4 % Time 638,156 650,540 (12,840 ) (2.0) % Total deposits $ 1,302,299$ 1,252,612$ 49,687 4.0 % The following table sets forth the distribution of our time deposit accounts. (in thousands) March 31, 2014 Time deposits of less than $100,000$ 203,110 Time deposits of $100,000 through $250,000$ 163,241 Time deposits of more than $250,000$ 273,552 Total Time Deposits $ 639,903 The following table sets forth public funds as a percent of total deposits. (in thousands except for March 31, 2014 December 31, December 31, 2012 December 31, 2011 December 31, 2010 %) 2013 Total Public Funds $ 516,903$ 503,495$ 470,498$ 431,905$ 356,153 Total Deposits $ 1,296,769$ 1,303,099$ 1,252,612$ 1,207,302$ 1,007,383 Total Public Funds as a percent of Total 39.9 % 38.6 % 37.6 % 35.8 % 35.4 % Deposits 31



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Borrowings.

The Company maintains borrowing relationships with other financial institutions as well as the Federal Home Loan Bank on a short and long-term basis to meet liquidity needs. At March 31, 2014, short-term borrowings totaled $10.2 million which is an increase of $4.4 million from December 31, 2013, and consisted of repurchase agreements of $8.4 million and a line of credit totaling $1.8 million. The increase in short term borrowings was concentrated in the change in repurchase agreements. Overnight repurchase agreement balances are monitored daily for sufficient collateralization. The Company had long-term borrowings totaling $0.4 million as of March 31, 2014 and $0.5 million at December 31, 2013. The average amount of total short-term borrowings for the three months ended March 31, 2014 totaled $13.1 million, compared to $15.8 million for the three months ended March 31, 2013. At March 31, 2014, the Company had $100.0 million in Federal Home Loan Bank letters of credit outstanding obtained solely for collateralizing our public deposits.



Equity.

Stockholders' equity provides a source of permanent funding, allows for future growth and the ability to absorb unforeseen adverse developments. Total equity increased to $129.5 million as of March 31, 2014 from $123.4 million at December 31, 2013. The increase in stockholders' equity was primarily the result of the increase in other comprehensive income totaling $4.4 million and net earnings of $2.8 million. The earnings for the quarter are reduced by common dividends of $1.0 million and preferred dividends of $0.1 million for a total addition to the Company's retained earnings of $1.7 million.



Results of Operations for the Three Months Ended March 31, 2014 and 2013 Net Income.

Net Income for the three months ended March 31, 2014 was $2.8 million, a increase of $0.7 million or 33.3% from $2.1 million for the three months ended March 31, 2013. Net income available to common shareholders for the three months ended March 31, 2014 was $2.7 million which is a increase of $0.9 million from $1.8 million for the same period in 2013. The increase in income can mainly be attributed to an increase in loan interest income of $0.4 million, a reduction in interest expense of $0.6 million and a decrease in provision expense of $0.6 million. Interest and fee income on loans was $9.5 million for the three month period ended March 31, 2014; an increase of $0.4 million from $9.1 million for the same period in 2013. The increase in loan interest income can be mainly attributed to an increase in the volume of loans originated when compared to March 31, 2013. Interest expense for the first three months of 2013 totaled $2.4 million, a decrease of $0.6 million from $2.9 million for the first three months of 2013. The changes in interest earnings and expenses resulted in a net interest income increase of $0.9 million to $10.5 million for the first quarter of 2014 when compared to $9.6 million for the same period in 2013. The provision for loan losses decreased $0.6 million from $0.9 million for the first quarter of 2013 to $0.3 million in the first quarter of 2014. Net gains on securities for the first quarter of 2014 and 2013 were $0.2 million and $0.8 million, respectively. Noninterest expense decreased $0.1 million primarily from decreased expenses associated with other real estate and various other non-interest expenses. The provision for income tax expense increased by $0.3 million to $1.4 million for the first quarter of 2014 compared to $1.1 million for the same period in 2013. The increase in tax expense is a result of the increase in income for the quarter. Earnings per common share for the three months ended March 31, 2014 were $0.43, an increase of $0.14, or 48.3% per common share from $0.29 per common share for the three months ended March 31, 2013. Net Interest Income. Net interest income is the largest component of our earnings, and is calculated by subtracting the cost of interest-bearing liabilities from the income earned on interest-earning assets. This represents the earnings from our primary business of gathering deposits, and making loans and investments. Our long-term objective is to manage this income to generate optimal income that balances interest rate risk, credit risk, and liquidity risks. A financial institution's asset and liability structure is substantially different from that of a non-financial company, in that virtually all assets and liabilities are monetary in nature. Accordingly, changes in interest rates, which are generally impacted by inflation rates, may have a significant impact on a financial institution's performance. The impact of interest rate changes depends on the sensitivity to the change of our interest-earning assets and interest-bearing liabilities. The effects of the varying interest rate environment in recent years and our interest sensitivity position is discussed below. Net interest income in the first quarter of 2014 was $10.5 million, an increase of $0.9 million or 9.8%, when compared to $9.6 million in 2013. For the first quarter of 2014, loans and securities made up 49.8% and 45.5% of the average interest-earning assets, respectively; 47.0% of our loans are floating rate loans which are primarily tied to the prime lending rate or the London Inter-Bank Offered Rate (LIBOR). For the same period in 2013 loans and securities represented 46.2% and 47.9% of interest-earning assets, respectively. The cost of our interest-bearing liabilities reflects a lower cost of funds paid on interest-bearing deposits. As of March 31, 2014, time deposits represented 49.3% of total deposits, which is a decrease from 53.0% of total deposits at March 31, 2013. 32

-------------------------------------------------------------------------------- The average yield on interest-earning assets decreased from 3.72% at March 31, 2013 to 3.69% at March 31, 2014. This is largely attributable to the 0.38% decrease in the average yield on loans from 5.86% at March 31, 2013 to 5.48% at March 31, 2014. The interest-bearing liabilities average cost decreased to 0.85% at March 31, 2014, compared to 1.11% at March 31, 2013. The average borrowing costs decreased slightly from 0.98% at March 31, 2013 to 0.96% at March 31, 2014. The net yield on interest-earning assets was 2.84% for the three months ended March 31, 2014, compared to 2.61% for the same period in 2013. The net interest income yield shown below in the average balance sheet is calculated by dividing net interest income by average interest-earning assets and is a measure of the efficiency of the earnings from balance sheet activities. It is affected by changes in the difference between interest on interest-earning assets and interest-bearing liabilities and the percentage of interest-earning assets funded by interest-bearing liabilities. The following tables set forth average balance sheets, average yields and costs, and certain other information for the periods indicated. No tax-equivalent yield adjustments were made, as the effect thereof was not material. All average balances are daily average balances. Nonaccrual loans were included in the computation of average balances, but have been reflected in the table as loans carrying a zero yield. The yields set forth below include the effect of deferred fees, discounts and premiums that are amortized or accreted to interest income or expense. March 31, 2014 March 31, 2013 (in thousands except for %) Average Balance Interest Yield/Rate Average Balance Interest Yield/Rate Assets Interest-earning assets: Interest-earning deposits with banks $ 66,169$ 32 0.20 % $ 78,610 $ 40 0.21 % Securities (including FHLB stock) 643,433 3,341 2.09 % 653,150 3,368 2.09 % Federal funds sold 387 - - % 2,930 - - % Loans, net of unearned income 703,725 9,508 5.48 % 629,753 9,096 5.86 % Total interest-earning assets $ 1,413,714$ 12,881 3.69 % $ 1,364,443$ 12,504 3.72 % Noninterest-earning assets: Cash and due from banks $ 5,402 $ 9,869 Premises and equipment, net 19,549 19,539 Other assets 8,951 7,099 Total Assets $ 1,447,616$ 1,400,950 Liabilities and Stockholders' Equity Interest-bearing liabilities: Demand deposits $ 405,461$ 351 0.35 % $ 341,175$ 362 0.43 % Savings deposits 68,116 8 0.05 % 63,897 14 0.09 % Time deposits 638,156 1,967 1.25 % 650,558 2,506 1.56 % Borrowings 13,033 30 0.96 % 15,787 38 0.98 % Total interest-bearing liabilities $ 1,124,766$ 2,356 0.85 % $ 1,071,417$ 2,920 1.11 % Noninterest-bearing liabilities: Demand deposits $ 190,566$ 189,832 Other 4,043 5,096 Total Liabilities $ 1,319,375$ 1,266,345 Stockholders' equity $ 128,241$ 134,605 Total Liabilities and Stockholders' $ 1,447,616$ 1,400,950 Net interest income $ 10,525$ 9,584 Net interest rate spread (1) 2.84 % 2.61 % Net interest-earning assets (2) $ 288,948$ 293,026 Net interest margin (3) 2.98 % 2.85 % Average interest-earning assets to interest-bearing liabilities 125.69 % 127.3 %



(1) Net interest rate spread represents the difference between the yield on

average interest-earning assets and the cost of average interest-bearing

liabilities.

(2) Net interest-earning assets represents total interest-earning assets less

total interest-bearing liabilities. (3) Net interest margin represents net interest income divided by average total

interest-earning assets. 33



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Provision for Loan Losses.

The provision for loan losses was $0.3 million and $0.9 million for the first quarter of 2014 and 2013, respectively. The lower 2014 provision was based on an assessment of the loan portfolio as well as other qualitative and quantitative factors considered by the Company's management team. The allowance for loan losses at March 31, 2014 was $9.6 million, compared to $10.4 million at December 31, 2013, and was 1.35% and 1.48% of total loans, respectively. The allowance for loan losses decreased due to the charge-off of loans that had specific allowances reserved. Management believes that the current level of the allowance is adequate to cover losses in the loan portfolio given the current economic conditions, expected net charge-offs and nonperforming asset levels.



Noninterest Income.

Noninterest income totaled $1.6 million for the three months ended March 31, 2014; a decrease of $0.6 million when compared to $2.2 million for the three months ended March 31, 2013. Service charges, commissions and fees totaled $1.1 million for the three months ended March 31, 2014 and $1.2 million for the three months ended March 31, 2013. Net securities gains were $0.2 million for the first quarter of 2014 compared to $0.8 million for the first quarter of 2013.



Noninterest Expense.

Noninterest expense includes salaries and employee benefits, occupancy and equipment expense, net cost from other real estate and repossessions, regulatory assessments and other types of expenses. Noninterest expense totaled $7.6 million in the first quarter of 2014 and $7.7 million for the same period in 2013. Salaries and benefits increased $0.3 million in the first quarter of 2014 to $3.8 million compared to $3.5 million in the first quarter of 2013. Occupancy and equipment expense totaled $1.0 million for the first quarter of 2014 and $1.0 million in first quarter of 2013. Other noninterest expense totaled $2.8 million in the first quarter of 2014, compared to $3.2 million the first quarter of 2013. The following is a summary of the significant components of other noninterest expense: As of March As of March (in thousands) 31, 2014 31, 2013 Other noninterest expense: Legal and professional fees $ 457$ 522 Data processing 274 330 Marketing and public relations 251 244 Taxes - sales, capital, and franchise 172 147 Operating supplies 100 159 Travel and lodging 133 145 Net costs from other real estate and repossessions 184 267 Regulatory assessment 361 476 Other 869 907 Total other expense $ 2,801$ 3,197 Income Taxes. The provision for income taxes for the three months ended March 31, 2014 and 2013 was $1.4 million and $1.1 million, respectively. The increase in the provision for income taxes is a result of higher income for the first quarter of 2014 when compared to the first quarter of 2013. The Company's statutory tax rate for the three month period ended March 31, 2014 was 34.5%; this is relatively unchanged from 34.5% for the first quarter of 2013. 34



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Source: Edgar Glimpses


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