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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q

(Mark One)
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2012

o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from to

Commission file number 0-11535
CITY NATIONAL BANCSHARES CORPORATION
(Exact name of registrant as specified in its charter)

New Jersey
22-2434751
(State or other jurisdiction of
incorporation or organization)
(I.R.S. Employer
Identification No.)
 
 
900 Broad Street,
Newark, New Jersey
07102
(Address of principal executive offices)
(Zip Code)

Registrant's telephone number, including area code: (973) 624-0865
Securities Registered Pursuant to Section 12(b) of the Act: None
Securities Registered Pursuant to Section 12(g) of the Act:
Title of each class
Common stock, par value $10 per share

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes x    No o
Indicate by check mark whether the Registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the Registrant was required to submit and post such files).
Yes x    No o
Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act). (Check one):
Large accelerated filer o
Accelerated filer o
Non-accelerated filer x
Smaller reporting company o

Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes o    No x
On June 29, 2012 (the last business day of the registrant's most recently completed second fiscal quarter), there was no public trading market for the registrant's common stock, consequently, the registrant was not able to determine the aggregate market value held by non-affiliates as of such date, based upon the price at which its common equity was last sold or the average bid and ask price of such common equity as of such date. There were 142,842 shares of common stock outstanding at November 1, 2012.


Table of Contents

Index
 
Page
Part I. Financial Information
 
 
Item 1. Financial Statements
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 


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CITY NATIONAL BANCSHARES CORPORATION AND SUBSIDIARY

Consolidated Balance Sheets

 
(Unaudited)
 
Dollars in thousands, except per share data
June 30,
2012
December 31,
2011
Assets
 
 
Cash and due from banks
$
27,507

$
5,960

Federal funds sold

32,600

Interest-bearing deposits with banks
1,629

1,940

Investment securities available for sale
100,550

95,058

Loans
194,868

208,715

Less: Allowance for loan losses
9,999

10,870

Net loans
184,869

197,845

Premises and equipment
2,733

2,686

Accrued interest receivable
1,505

1,561

Bank-owned life insurance
6,010

5,920

Other real estate owned
2,178

1,524

Other assets
4,190

13,348

Total assets
$
331,171

$
358,442

Liabilities and Stockholders' Equity
 
 
Deposits:
 
 
Demand
$
36,562

$
37,379

Savings
103,200

114,675

Time
149,992

147,217

Total deposits
289,754

299,271

Accrued expenses and other liabilities
4,459

20,200

Short-term portion of long-term debt
5,000

5,000

Long-term debt
14,200

14,200

Total liabilities
313,413

338,671

Commitments and contingencies


Stockholders' equity
 
 
Preferred stock, no par value: Authorized 100,000 shares;
 
 
Series A , issued and outstanding 8 shares in 2012 and 2011
200

200

Series C , issued and outstanding 108 shares in 2012 and 2011
27

27

Series D , issued and outstanding 3,280 shares in 2012 and 2011
820

820

Preferred stock, no par value, perpetual noncumulative: Authorized 200 shares;
 
 
Series E, issued and outstanding 49 shares in 2012 and 2011
2,450

2,450

Preferred stock, no par value, perpetual noncumulative: Authorized 7,000 shares;
 
 
Series F, issued and outstanding 7,000 shares in 2012 and 2011
6,790

6,790

Preferred stock, no par value, perpetual cumulative: Authorized 9,439 shares;
 
 
Series G, issued and outstanding 9,439 shares,
10,771

10,504

Common stock, par value $10: Authorized 400,000 shares
 
 
141,911 and 134,530 shares issued in 2012 and 2011, respectively,
 
 
141,911 shares outstanding in 2012 and 134,530 in 2011
1,419

1,345

Surplus
88

601

Accumulated deficit
(5,031
)
(3,163
)
Accumulated other comprehensive income
224

423

Treasury stock, at cost - no common shares in 2012 and 3,204 common shares in 2011

(226
)
Total stockholders' equity
17,758

19,771

Total liabilities and stockholders' equity
$
331,171

$
358,442


See accompanying notes to unaudited consolidated financial statements.

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CITY NATIONAL BANCSHARES CORPORATION AND SUBSIDIARY
Consolidated Statements of Operations (Unaudited)
 
Three Months Ended
Six Months Ended
 
June 30,
June 30,
Dollars in thousands, except per share data
2012
2011
2012
2011
Interest income
 
 
 
 
Interest and fees on loans
$
2,365

$
2,984

$
4,881

$
5,945

Interest on federal funds sold and securities purchased under agreements to resell

8

4

19

Interest on deposits with banks
76

59

136

118

Interest and dividends on investment securities:
 
 
 
 
Taxable
677

945

1,430

1,928

Tax-exempt

61


123

Total interest income
3,118

4,057

6,451

8,133

Interest expense
 
 
 
 
Interest on deposits
834

1,074

1,692

2,195

Interest on long-term debt
206

201

422

401

Total interest expense
1,040

1,275

2,114

2,596

Net interest income
2,078

2,782

4,337

5,537

Provision for loan losses
1,125

814

1,250

2,014

Net interest income after provision for loan losses
953

1,968

3,087

3,523

Other operating income
 
 
 
 
Service charges on deposit accounts
249

289

502

571

ATM fees
68

75

136

151

Undistributed income from unconsolidated subsidiary
14

32

218

130

Earnings from cash surrender of life insurance
63

64

126

127

Income on other real estate owned
32

49

92

49

Other income
99

109

196

227

Net gains on securities transactions (Notes 4 and 5)
556


556


Net gains on sale of other real estate owned


2


Net gains on sale of other assets
500


525


Total other operating income
1,581

618

2,353

1,255

Other operating expenses
 
 
 
 
Salaries and other employee benefits
1,619

1,483

3,186

2,918

Occupancy expense
258

258

616

626

Equipment expense
122

112

253

245

Data processing expense
133

94

261

188

Professional fees
334

185

512

379

Marketing expense
120

63

239

122

Management consulting fees
380

554

754

1,039

Regulatory expense
10

395

261

690

Insurance claim recovery
1

2

(149
)
2

Foreclosure expenses
68

108

130

130

OREO expense
93

47

186

74

Loss on disposal of fixed assets
18


18

30

Loss on other real estate owned
113

169

113

169

Other expenses
481

214

898

807

Total other operating expenses
3,750

3,684

7,278

7,419

Loss before income tax expense
(1,216
)
(1,098
)
(1,838
)
(2,641
)
Income tax expense
8

19

30

31

Net loss
$
(1,224
)
$
(1,117
)
$
(1,868
)
$
(2,672
)
Net loss per common share
 
 
 
 
Basic
$
(9.80
)
$
(9.48
)
$
(15.82
)
$
(22.28
)
Diluted
(9.80
)
(9.48
)
(15.82
)
(22.28
)
Basic average common shares outstanding
138,654

131,326

134,990

131,313

Diluted average common shares outstanding
138,654

131,326

134,990

131,313


See accompanying notes to unaudited consolidated financial statements.

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CITY NATIONAL BANCSHARES CORPORATION AND SUBSIDIARY

Consolidated Statements of Comprehensive Income (Unaudited)

 
Three Months Ended
Six Months Ended
 
June 30,
June 30,
In thousands
2012
2011
2012
2011
Net loss
$
(1,224
)
$
(1,117
)
$
(1,868
)
$
(2,672
)
Other comprehensive income (loss), net of tax:
 
 
 
 
Net gains arising during the period
541

1,415

991

1,156

Less reclassification adjustment for net gains included in net income
(1,108
)

(1,190
)

Total other comprehensive (loss) income
(567
)
1,415

(199
)
1,156

Total comprehensive (loss) income
$
(1,791
)
$
298

$
(2,067
)
$
(1,516
)

See accompanying notes to unaudited consolidated financial statements.


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CITY NATIONAL BANCSHARES CORPORATION AND SUBSIDIARY

Consolidated Statements of Cash Flows (Unaudited)

 
Six Months Ended
 
June 30,
In thousands
2012
2011
Operating activities
 
 
Net loss
$
(1,868
)
$
(2,672
)
Adjustments to reconcile net loss to net cash from operating activities:
 
 
Stock compensation
298


Depreciation and amortization
184

213

Provision for loan losses
1,250

2,014

Premium amortization of investment securities
486

54

Net gain on sales of investments
(556
)

Net gain on sales of OREO
(2
)

Net gain on sales of other assets
(525
)

Writedowns on other real estate owned
113

169

Loss on disposal of fixed assets
18

30

Decrease in accrued interest receivable
56

228

Increase in bank-owned life insurance
(90
)
(94
)
Proceeds from the sale of other assets
3,369


Decrease in other real estate owned
48

9

Decrease in other assets
6,314

4,311

Decrease in accrued expenses and other liabilities
(15,741
)
(1,342
)
Net cash (used in) provided by operating activities
(6,646
)
2,920

Investing activities
 
 
Decrease in loans, net
10,913

17,862

Decrease in interest-bearing deposits with banks
311

1,155

Proceeds from maturities of investment securities available for
 
 
sale, including principal repayments and early redemptions
14,739

10,223

Proceeds from sales of investment securities available for sale
7,253


Purchases of investment securities available for sale
(27,613
)
(3,334
)
Purchases of premises and equipment
(249
)
(45
)
Net cash provided by investing activities
5,354

25,861

Financing activities
 
 
Decrease in deposits
(9,517
)
(18,219
)
Issuance of treasury stock
2

2

Additional paid-in capital upon issuance of common stock
(246
)

Net cash used in financing activities
(9,761
)
(18,217
)
Net (decrease) increase in cash and cash equivalents
(11,053
)
10,564

Cash and cash equivalents at beginning of period
38,560

20,778

Cash and cash equivalents at end of period
$
27,507

$
31,342

Cash paid during the year
 
 
Interest
$
1,945

$
2,495

Income taxes
46

66

Non-cash transactions
 
 
Transfer of loans to other real estate owned
$
813

$
140


See accompanying notes to unaudited consolidated financial statements.


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CITY NATIONAL BANCSHARES CORPORATION AND SUBSIDIARY

Notes to Consolidated Financial Statements (Unaudited)

1. Principles of consolidation

The accompanying consolidated financial statements include the accounts of City National Bancshares Corporation (the “Corporation” or “CNBC”) and its subsidiaries, City National Bank of New Jersey (the “Bank” or “CNB”) and City National Bank of New Jersey Capital Statutory Trust II (the "Trust"). All intercompany accounts and transactions have been eliminated in consolidation.

The words “we,” “our” and “us” refer to City National Bancshares Corporation and its wholly-owned subsidiaries, unless we indicate otherwise.

2. Basis of presentation

The accompanying unaudited consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) for interim financial information and assuming the Corporation and Bank will continue as going concerns. See Note 3 for discussion with respect to going concern. Accordingly, they do not include all the information required by U.S. generally accepted accounting principles for complete financial statements. These consolidated financial statements should be reviewed in conjunction with the financial statements and notes thereto included in the Corporation's December 31, 2011 Annual Report to Stockholders.

In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation of the financial statements have been included. Operating results for the three and six months ended June 30, 2012 are not necessarily indicative of the results that may be expected for the year ended December 31, 2012. In preparing the financial statements, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent liabilities as of the date of the balance sheet and revenues and expenses for related periods. Actual results could differ significantly from those estimates.

3. Going concern/regulatory compliance

The consolidated financial statements of the Corporation as of and for the three and six months ended June 30, 2012 have been prepared on a going concern basis, which contemplates the realization of assets and the discharge of liabilities in the normal course of business for the foreseeable future.

The Bank was subject to a Formal Agreement with the Office of the Comptroller of the Currency (the “OCC”) which was entered into on June 29, 2009 (the “Formal Agreement”). The Formal Agreement required, among other things, the enhancement and implementation of certain programs to reduce the Bank's credit risk, along with the development of a capital and profit plan, the development of a contingency funding plan and the correction of deficiencies in the Bank's loan administration. The Bank failed to comply with certain provisions of the Formal Agreement and failed to comply with the higher leverage ratio of 8% required to be maintained.

Due to the Bank's condition, the OCC has required that the Board of Directors of the Bank (the “Bank Board”) sign a formal enforcement action with the OCC, which mandates specific actions by the Bank to address certain findings from OCC's examination and to address the Bank's current financial condition. The Bank entered into a Consent Order (“Order” or “Consent Order”) with the OCC on December 22, 2010, which contains a list of requirements. The Order supersedes and replaces the Formal Agreement. The Order also contains restrictions on future extensions of credit and requires the development of various programs and procedures to improve the Bank's asset quality as well as routine reporting on the Bank's progress toward compliance with the Order to the Bank Board and the OCC. As a result of the Order, the Bank may not be deemed “well capitalized.” The description of the Consent Order is only a summary.

Specifically, the Order imposes the following requirements on the Bank:

within five (5) days of the Order, the Bank Board must appoint a Compliance Committee to be comprised of at least three directors, none of whom may be an employee, former employee or controlling shareholder of the Bank or any of its affiliates, to monitor and coordinate the Bank's adherence to the Order.

within ninety (90) days of the Order, the Bank Board must develop and submit to the OCC for review a written strategic plan covering at least a three-year period, establishing objectives for the overall risk profile, earnings performance, growth, balance sheet mix, off-balance sheet activities, liability structure, capital adequacy, reduction in volume of nonperforming assets, product

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line development and market segments that the Bank intends to promote or develop, together with strategies to achieve those objectives.

by March 31, 2011, and thereafter, the Bank must maintain total capital at least equal to 13% of risk-weighted assets and tier 1 leverage capital at least equal to 9% of adjusted total assets; this requirement means that the Bank may not be considered “well capitalized” as otherwise defined in applicable regulations.

within ninety (90) days of the Order, the Bank Board must submit to the OCC a written capital plan for the Bank covering at least a three-year period, including specific plans for the achievement and maintenance of adequate capital, projections for growth and capital requirements, based upon a detailed analysis of the Bank's assets, liabilities, earnings, fixed assets and off-balance sheet activities; identification of the primary sources from which the Bank will maintain an appropriate capital structure to meet the Bank's future needs, as set forth in the strategic plan; specific plans detailing how the Bank will comply with restrictions or requirements set forth in the Order and with the restrictions against brokered deposits in 12 C.F.R. § 337.6; contingency plans that identify alternative methods to strengthen capital, should the primary source(s) not be available; and a prohibition on the payment of director fees unless the Bank is in compliance with the minimum capital ratios previously identified in the prior paragraph or express written authorization is provided by the OCC.

the Bank is restricted on the payment of dividends.

to ensure the Bank has competent management in place at all times, including: within ninety (90) days of the Order, the Bank Board shall provide to the OCC qualified and capable candidates for the positions of President, Senior Credit Officer, Consumer Compliance Officer and Bank Secrecy Officer; within ninety (90) days of the date of the Order, the Bank Board (with the exception of Bank executive officers) shall prepare a written assessment of the Bank's executive officers to perform present and anticipated duties; prior to appointment of any individual to an executive position provide notice to the OCC, who shall have the power to veto such appointment; and the Bank Board shall at least annually perform a written performance appraisal for each Bank executive officer.

within sixty (60) days of the Order, the Bank Board shall develop and the Bank shall implement, and thereafter ensure compliance with, a written credit policy to ensure the Bank's compliance with written programs to improve the Bank's loan portfolio management.

within ninety (90) days of the Order, the Bank Board shall develop, implement and thereafter ensure Bank adherence to a written program to improve the Bank's loan portfolio management, including: requiring that extensions of credit are granted, by renewal or otherwise, to any borrower only after obtaining, performing and documenting a global analysis of current and satisfactory credit information; requiring that existing extensions of credit structured as single pay notes are revised upon maturity to conform to the Bank's revised loan policy; ensuring satisfactory and perfected collateral documentation; tracking and analyzing credit, collateral, and policy exceptions; providing for accurate risk ratings consistent with the classification standards contained in the Comptroller's Handbook on “Rating Credit Risk”; providing for identification, measurement, monitoring and control of concentrations of credit; ensuring compliance with Call Report instructions, the Bank's lending policies and laws, rules and regulations pertaining to the Bank's lending function; ensuring the accuracy of internal management information systems; and providing adequate training of Bank personnel performing credit analyses in cash flow analysis, particularly analysis using information from tax returns, and implement processes to ensure that additional training is provided as needed.

within sixty (60) days of the Order, the Bank Board must establish a written performance appraisal and salary administration process for loan officers that adequately consider performance relative to job descriptions, policy compliance, documentation standards, accuracy in credit grading and other loan administration matters.

the Bank must implement and maintain an effective, independent and ongoing loan review program to review, at least quarterly, the Bank's loan and lease portfolios, to assure the timely identification and categorization of problem credits.

the Bank is also required to implement and adhere to a written program for the maintenance of an adequate Allowance for Loan and Lease Losses, providing for review of the allowance by the Bank Board at least quarterly.

within sixty (60) days of the Order, the Bank Board shall adopt and the Bank (subject to Bank Board review and ongoing monitoring) shall implement and thereafter ensure adherence to a written program designed to protect the Bank's interest in those assets criticized in the most recent Report of Examination (“ROE”) by the OCC, in any subsequent ROE, by any internal or external loan review or in any list provided to management by the national bank examiners during any examination as “doubtful,” “substandard" or “special mention.”

within one hundred twenty (120) days of the Order, the Bank Board must revise and maintain a comprehensive liquidity risk

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management program, which assesses, on an ongoing basis, the Bank's current and projected funding needs, and ensures that sufficient funds or access to funds exist to meet those needs, and which includes effective methods to achieve and maintain sufficient liquidity and to measure and monitor liquidity risk.

within ninety (90) days of the Order, the Bank Board shall identify and propose for appointment a minimum of two (2) new independent directors who have a background in banking, credit, accounting or financial reporting, and such appointment will be subject to veto power of the OCC.

within ninety (90) days of the Order, the Bank Board shall adopt, implement and thereafter ensure adherence to a written consumer compliance program designed to ensure that the Bank is operating in compliance with all applicable consumer protection laws, rules and regulations.

within ninety (90) days of the Order, the Bank Board shall develop, implement and thereafter ensure Bank adherence to written program of policies and procedures to provide for compliance with the Bank Secrecy Act, as amended (31 U.S.C. §§ 5311 et seq.), the regulations promulgated there under and regulations of the Office of Foreign Assets Control (“OFAC”), 31 C.F.R. Chapter V, as amended (collectively referred to as the “Bank Secrecy Act” or “BSA”) and for the appropriate identification and monitoring of transactions that pose greater than normal risk for compliance with the BSA.

within ninety (90) days of the Order, the Bank Board shall develop, implement and thereafter ensure Bank adherence to an independent, internal audit program sufficient to detect irregularities and weak practices in the Bank's operations; determine the Bank's level of compliance with all applicable laws, rules and regulations; assess and report the effectiveness of policies, procedures, controls and management oversight relating to accounting and financial reporting; evaluate the Bank's adherence to established policies and procedures, with particular emphasis directed to the Bank's adherence to its loan, consumer compliance and BSA policies and procedures; evaluate and document the root causes for exceptions; and establish an annual audit plan using a risk-based approach sufficient to achieve these objectives.

within ninety (90) days of the Order, the Bank Board must develop and implement a comprehensive compliance audit function to include an independent review of all products and services offered by the Bank, including without limitation, a risk-based audit program to test for compliance with consumer protection laws, rules and regulations that include an adequate level of transaction testing; procedures to ensure that exceptions noted in the audit reports are corrected and responded to by the appropriate Bank personnel; and periodic reporting of the results of the consumer compliance audit to the Bank Board or a committee thereof.

the Bank Board shall require and the Bank shall immediately take all necessary steps to correct each violation of law, rule or regulation cited in any ROE, or brought to the Bank Board's or Bank's attention in writing by management, regulators, auditors, loan review or other compliance efforts.

The Order permits the OCC to extend the time periods under the Order upon written request. Any material failure to comply with the Order could result in further enforcement actions by the OCC. In addition, if the OCC does not accept the capital plan or the Bank fails to achieve and maintain the minimum capital levels, the Order specifically states that the OCC may require the Corporation to sell, merge or liquidate the Bank.

As a result of the Consent Order, the Bank may not accept, renew or roll over any brokered deposit. This affects the Bank's ability to obtain funding. In addition the Bank may not solicit deposits by offering an effective yield that exceeds by more than 75 basis points the prevailing effective yields on insured deposits of comparable maturity in such institution's normal market area or in the market area in which such deposits are being solicited.

As of June 30, 2012, when considering deadline extensions granted, the Corporation has been informed by the OCC that it has fully complied with only two of the thirteen articles of the Consent Order. The two articles in full compliance are Article II - Compliance Committee and Article XIII - Internal Audit Program. The remaining articles are in various stages of compliance and management continues to work diligently to achieve full compliance. Refer to the capital section of the Management's Discussion and Analysis of Financial Condition and Results of Operations for further discussion.

On December 14, 2010, the Corporation entered into a written agreement (the “FRBNY Agreement”) with the Federal Reserve Bank of New York (“FRBNY”). The following is only a summary of the FRBNY Agreement. Pursuant to the FRBNY Agreement, the Corporation's Board of Directors is to take appropriate steps to utilize fully the Corporation's financial and managerial resources to serve as a source of strength to the Bank, including causing the Bank to comply with the Formal Agreement (now superseded) and any other supervisory action taken by the OCC, such as the Order.

In the FRBNY Agreement, the Corporation agreed that it would not declare or pay any dividends without prior written approval of the FRBNY and the Director of the Division of Banking Supervision and Regulation of the Board of Governors of the Federal Reserve

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System (the “Banking Director”). It further agreed that it would not take dividends or any other form of payment representing a reduction in capital from the Bank without the FRBNY's prior written approval. The FRBNY Agreement also provides that neither the Corporation nor its nonbank subsidiary will make any distributions of interest, principal or other amounts on subordinated debentures or trust preferred securities without the prior written approval of the FRBNY and the Banking Director.

The FRBNY Agreement further provides that the Corporation shall not incur, increase or guarantee any debt without FRBNY approval. In addition, the Corporation must obtain the prior approval of the FRBNY for the repurchase or redemption of its shares of stock. Additionally, the FRBNY Agreement further provides that in appointing any new director or senior executive officer or changing the responsibilities of any senior executive officer so that the officer would assume a different senior position, the Corporation must notify the Board of Governors of the Federal Reserve System and such board or the FRBNY or the OCC may veto such appointment or change. Finally, the FRBNY Agreement further provides that the Corporation is restricted in making certain severance and indemnification payments. The failure of the Corporation to comply with the FRBNY Agreement could have severe adverse consequences on the Bank and the Corporation.

The Corporation recorded a net loss of $1,868,000 in the first six months of 2012 compared to a net loss of $2.7 million in the comparable 2011 periods. The reduced net loss was primarily due to a reduction in the provision for loan losses and gains on sales of investment securities and other assets, offset in part by a decline in net interest income. However, we are currently not generating sufficient operating income to cover operating expenses before consideration of the provision for loan losses. These ongoing losses will hamper management's ability to achieve compliance with the required capital ratios.

The decrease in real estate values in the Bank's market, as well as other macroeconomic factors such as unemployment levels, has contributed to the current credit quality issues and the continuing necessity of the Bank to provide for loan loss provisions. Additionally, collateral requirements for municipal deposit letters of credit ("MULOC") issued by the Federal Home Loan Bank have increased. While the Bank and the Corporation are implementing steps to improve their financial performance, there can be no assurance they will be successful. These deteriorating financial results and the failure of the Bank to comply with the OCC's higher mandated capital ratios under the Consent Order, and the actions that the OCC may take as a result thereof, raise substantial doubt about the Corporation's and the Bank's ability to continue as going concerns.

Management has developed a plan to address the compliance matters raised by the OCC and the ability to maintain future financial viability and submitted the plan to the OCC for approval. The plan provides for the addition of new lines of business and strategic growth initiatives, a restructuring of staff where necessary and the preparation and use of investor presentation to assist in a capital raise. We have formed a strategic alliance with a third-party online deposit vendor, which has provided alternative sources of deposits. We are also in the process of a capital raise and are expanding into new lines of business primarily to increase fee income and become less dependent on spread income. However, there can be no assurances that this plan, including the capital raise, can be successfully achieved.

4. Net loss per common share

The following table presents the computation of net loss per common share.

 
Three Months Ended
Six Months Ended
 
June 30,
June 30,
In thousands, except per share data
2012
2011
2012
2011
Net loss
$
(1,224
)
$
(1,117
)
$
(1,868
)
$
(2,672
)
Accrued dividends on preferred stock
134

128

267

254

Net loss applicable to basic common shares
(1,358
)
(1,245
)
(2,135
)
(2,926
)
Dividends applicable to convertible preferred stock


147

147

Net loss applicable to diluted common shares
$
(1,358
)
$
(1,245
)
$
(1,988
)
$
(2,779
)
Number of average common shares
 
 
 
 
Basic
138,654

131,326

134,990

131,313

Diluted
138,654

131,326

134,990

131,313

Net loss per common share
 
 
 
 
Basic
$
(9.80
)
$
(9.48
)
$
(15.82
)
$
(22.28
)
Diluted
(9.80
)
(9.48
)
(15.82
)
(22.28
)

Basic loss per common share is calculated by dividing net loss plus dividends accrued on preferred stock by the weighted average

11

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number of common shares outstanding. On a diluted basis, both net loss and common shares outstanding are adjusted to assume the conversion of the convertible preferred stock, if conversion is deemed dilutive. For both 2012 and 2011, the assumption of the conversion would have been anti-dilutive.

On April 10, 2009, the Corporation issued 9,439 shares of fixed-rate cumulative perpetual preferred stock to the U.S. Department of Treasury in connection with the Corporation’s participation in the Treasury’s TARP Capital Purchase Program. These shares require cumulative dividends at a rate of 5% per annum until the fifth anniversary of the date of issuance, after which the rate increases to 9% per annum. Dividends are paid quarterly in arrears and unpaid dividends are accrued over the period the preferred shares are outstanding.

During 2011 and the first six months of 2012, City National Bancshares Corporation deferred the payment of its regular quarterly cash dividend on its Series G fixed-rate cumulative perpetual preferred stock issued to the U.S. Treasury. In addition, the Corporation deferred its regularly scheduled quarterly interest payments on its junior subordinated debentures issued by the City National Bank of New Jersey Capital Statutory Trust II (the “Trust”) for the same periods.

The Series G preferred stock and the junior subordinated debentures issued in favor of the Trust provide for cumulative dividends and interest, respectively. Accordingly, the Corporation may not pay dividends on any of its common or preferred stock until the dividends on Series G preferred stock and the interest on such debentures are paid up currently. There were no dividend payments made on preferred stock in 2011 or 2012, although such dividends have been accrued because they are cumulative.

The Corporation did not pay a dividend on common stock in 2012 and is currently unable to determine when dividend payments may be resumed, and does not expect to pay common stock dividends for the foreseeable future. Whether cash dividends will be paid in the future depends upon various factors, including the earnings and financial condition of the Bank and the Corporation at this time. Additionally, federal and state laws and regulations contain restrictions on the ability of the Bank and the Corporation to pay dividends. Finally, the Consent Order stipulates that the Bank not pay dividends until it is in compliance with the provisions of the capital plan.

Subject to applicable law, the Board of Directors of the Bank and of the Corporation may provide for the payment of dividends when it is determined that dividend payments are appropriate, taking into account factors including net income, capital requirements, financial condition, alternative investment options, tax implications, prevailing economic conditions, industry practices and other factors deemed to be relevant at the time. Because the Bank is a national banking association, it is subject to regulatory limitation on the amount of dividends it may pay to the Corporation. Prior approval of the OCC is required if the total dividends declared by the Bank in any calendar year exceeds net profit, as defined, for that year combined with the retained net profits from the preceding two calendar years, although currently such approval is required to pay any dividend. Based upon this limitation, no funds were available for the payment of dividends to the Corporation at June 30, 2012.

5. Comprehensive income (loss)

Total comprehensive income (loss) includes net loss and other comprehensive income or loss, which is comprised of unrealized gains and losses on investment securities available for sale, net of taxes. The Corporation's total accumulated other comprehensive income as of June 30, 2012 and June 30, 2011 was $224,000 and $1.1 million, respectively. The difference between the Corporation's net loss and total comprehensive gain or loss for these periods relates to the change in net unrealized gains and losses on investment securities available for sale during the applicable period of time.
 
6. Recent accounting pronouncements

ASU No. 2011-04, “Fair Value Measurements (Topic 820) - Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRS,” was issued as a result of the effort to develop common fair value measurement and disclosure requirements in U.S. GAAP and International Financial Reporting Standards (“IFRS”). While ASU No. 2011-04 is largely consistent with existing fair value measurement principles in U.S. GAAP, it expands the existing disclosure requirements for fair value measurements and clarifies the existing guidance or wording changes to align with IFRS No. 13. Many of the requirements for the amendments in ASU No. 2011-04 do not result in a change in the application of the requirements in Topic 820. ASU No. 2011-04 was effective for all interim and annual periods beginning after December 15, 2011. The adoption of ASU No. 2011-04 did not have a significant impact on the consolidated financial statements.

ASU No. 2011-05, “Comprehensive Income (Topic 220) - Presentation of Comprehensive Income,” requires an entity to present components of comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements. In the two-statement approach, the first statement should present total net income and its components followed consecutively by a second statement that should present total other comprehensive income, the components of other comprehensive income and the total of comprehensive income. ASU No. 2011-05 must be applied retrospectively and was effective

12

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for all interim and annual periods beginning on or after December 15, 2011. The adoption of ASU No. 2011-05 did not have a significant impact on the consolidated financial statements. The Corporation has included separate Consolidated Statements of Comprehensive Income as part of these financial statements.

7. Investment securities available for sale

The amortized cost and fair values of investment securities available for sale were as follows:

June 30, 2012
Amortized
Cost
Gross
Unrealized
Gains
Gross
Unrealized
Losses
Fair
Value
In thousands
U.S. Treasury securities and obligations of U.S. government agencies
$
9,733

$
231

$

$
9,964

Obligations of U.S. government-sponsored entities
24,529

227

62

24,694

Obligations of state and political subdivisions
3,318

257


3,575

Mortgage-backed securities
52,696

1,570

65

54,201

Other debt securities
7,402

34

1,948

5,488

Equity securities:
 
 
 
 
Marketable securities
800


20

780

Non-marketable securities
115



115

Federal Reserve Bank and Federal Home Loan Bank stock
1,733



1,733

Total
$
100,326

$
2,319

$
2,095

$
100,550


December 31, 2011
Amortized
Cost
Gross
Unrealized
Gains
Gross
Unrealized
Losses
Fair
Value
In thousands
U.S. Treasury securities and obligations of U.S. government agencies
$
9,005

$
146

$

$
9,151

Obligations of U.S. government-sponsored entities
12,805

233

11

13,027

Obligations of state and political subdivisions
3,326

174


3,500

Mortgage-backed securities
58,373

2,059


60,432

Other debt securities
8,366

31

2,190

6,207

Equity securities:
 
 
 
 
Marketable securities
783


19

764

Non-marketable securities
115



115

Federal Reserve Bank and Federal Home Loan Bank stock
1,862



1,862

Total
$
94,635

$
2,643

$
2,220

$
95,058


The amortized cost and the fair value of investment securities available for sale are distributed by contractual maturity without regard to normal amortization, excluding mortgage-backed securities, which will have shorter estimated lives as a result of prepayments of the underlying mortgages.



13

Table of Contents

June 30, 2012
Amortized
Cost
Fair
Value
In thousands
Due after one year but within five years:
 
 
U.S. Treasury securities and obligations of U.S. government agencies
$
38

$
38

Obligations of U.S. government-sponsored entities
56

56

Mortgage-backed securities
285

296

Other debt securities
1,000

961

Due after five years but within ten years:
 
 
U.S. Treasury securities and obligations of U.S. government agencies
37

37

Obligations of state and political subdivisions
1,673

1,807

Obligations of U.S. government-sponsored entities
146

147

Mortgage-backed securities
327

346

Due after ten years:
 
 
U.S. Treasury securities and obligations of U.S. government agencies
9,658

9,889

Obligations of state and political subdivisions
1,645

1,768

Obligations of U.S. government-sponsored entities
24,327

24,491

Mortgage-backed securities
52,084

53,559

Other debt securities
6,402

4,527

Total debt securities
97,678

97,922

Equity securities
2,648

2,628

Total
$
100,326

$
100,550


Investment securities available for sale that have had continuous unrealized losses as of June 30, 2012 and December 31, 2011 are set forth below.

 
Less than 12 Months
12 Months or More
Total
June 30, 2012
Fair
Value
Gross
Unrealized Losses
Fair
Value
Gross
Unrealized Losses
Fair
Value
Gross
Unrealized Losses
In thousands
Obligations of U.S. government-sponsored entities
$
4,974

$
56

$
1,703

$
6

$
6,677

$
62

Mortgage-backed securities
6,258

65



6,258

65

Other debt securities


4,950

1,948

4,950

1,948

Equity securities


800

20

800

20

Total
$
11,232

$
121

$
7,453

$
1,974

$
18,685

$
2,095


 
Less than 12 Months
12 Months or More
Total
December 31, 2011
Fair
Value
Gross
Unrealized Losses
Fair
Value
Gross
Unrealized Losses
Fair
Value
Gross
Unrealized Losses
In thousands
Obligations of U.S. government-sponsored entities
$
1,527

$

$
1,824

$
11

$
3,351

$
11

Other debt securities
831

104

4,809

2,086

5,640

2,190

Equity securities


783

19

783

19

Total
$
2,358

$
104

$
7,416

$
2,116

$
9,774

$
2,220


The gross unrealized losses set forth above as of June 30, 2012 were attributable primarily to single-issue trust preferred securities (“TRUPS”) issued by financial institutions, CDOs collateralized by TRUPS issued by banks and other corporate debt, all of which are included with other debt securities. The fair value of these securities has been negatively impacted by the lack of liquidity in the overall TRUPS and corporate debt markets although all issuers continue to perform. The decline in investment securities with continuing unrealized losses was a result of improved valuations in our other debt securities portfolio.

During the first six months of 2012 and 2011, respectively, we recorded no other-than-temporary-impairment (“OTTI") charges.

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Table of Contents


The Bank owns a collateralized debt obligation (“CDO”) with a book value of $996,000 and market value of $384,000 on which no impairment losses have been recorded because it is expected that this security will perform in accordance with its original terms and that the book value is fully recoverable based on the investment's payment performance, and our conclusion that the investment will continue to be fully performing and be fully recoverable in accordance with the terms of the agreement. Additional information about the CDO is presented below.



In thousands
June 30,
2012
Par value
$
1,000

Book value
996

Fair value
384

Unrealized loss
612

Number of original issuers
50

Number of currently paying banks in issuance
34

Number of defaulting and deferring banks
12

Percentage of remaining banks expected to default or defer payment (annually)
0

Subordination
28.20
%

The 28.20% subordination means that the tranche that we own has excess collateral providing additional collateral support to the tranche. Additionally, the Bank owns a portfolio of six TRUPS with a book value of $4.4 million and a market value of $3.3 million. Finally, the Bank also owns two corporate securities with a book value of $1.9 million and a market value of $1.7 million that are rated below investment grade. All values are as of June 30, 2012. None of these securities is considered impaired as they are all fully performing and are expected to continue performing.

Available-for-sale securities in unrealized loss positions are analyzed as part of the Corporation's ongoing assessment of OTTI. When the Corporation intends to sell available-for-sale securities, the Corporation recognizes an impairment loss equal to the full difference between the amortized cost basis and fair value of those securities. When the Corporation does not intend to sell available-for-sale securities in an unrealized loss position, potential OTTI is considered based on a variety of factors, including the length of time and extent to which the fair value has been less than cost; adverse conditions specifically related to the industry, the geographic area or financial condition of the issuer or the underlying collateral of a security; the payment structure of the security; changes to the rating of the security by rating agencies; the volatility of the fair value changes; and changes in fair value of the security after the balance sheet date. For debt securities, the Corporation estimates cash flows over the remaining lives of the underlying collateral to assess whether credit losses exist and to determine if any adverse changes in cash flows have occurred. The Corporation's cash flow estimates take into account expectations of relevant market and economic data as of the end of the reporting period.

Other factors considered in determining whether a loss is temporary include the length of time and the extent to which fair value has been below cost; the severity of the impairment; the cause of the impairment; the financial condition and near-term prospects of the issuer; activity in the market of the issuer which may indicate adverse credit conditions; and the forecasted recovery period using current estimates of volatility in market interest rate (including liquidity and risk premiums).

Management's assertion regarding its intent not to sell or that it is not more likely than not that the Corporation will be required to sell the security before its anticipated recovery considers a number of factors, including a quantitative estimate of the expected recovery period (which may extend to maturity), and management's intended strategy with respect to the identified security or portfolio. If management does have the intent to sell or believes it is more likely than not that the Corporation will be required to sell the security before its anticipated recovery, the gross unrealized loss is charged directly to earnings in the Consolidated Statements of Operations.

As of June 30, 2012, the Corporation does not intend to sell the securities with an unrealized loss position in accumulated other comprehensive loss (“AOCL”), and it is not more likely than not that the Corporation will be required to sell these securities before recovery of their amortized cost basis. The Corporation believes that the securities with an unrealized loss in AOCL are not other than temporarily impaired as of June 30, 2012.

8. Investment securities held to maturity

The Bank transferred its entire held-to-maturity (“HTM”) portfolio to available for sale (“AFS”) in March 2010. This transfer was

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Table of Contents

made in conjunction with a deleveraging program to reduce total asset levels and improve capital ratios. As a result, purchases of securities were not able to be classified as HTM through March 2012. At June 30, 2012, the company did not have any HTM investments.

9. Loans

Loans, net of unearned discount and net deferred origination fees and costs, were as follows:

(In thousands)
June 30,
2012
December 31,
2011
Commercial
$
23,951

$
26,516

Real estate
170,383

181,531

Installment
609

720

Total loans
194,943

208,767

Less: Unearned income
75

52

Loans
$
194,868

$
208,715


The Corporation categorizes loans into risk categories based on relevant information about the ability of borrowers to service their debt, such as: current financial information, historical payment experience, credit documentation, public information and current economic trends, among other factors. For non-homogeneous loans, such as commercial and industrial and commercial real estate loans, the Corporation analyzes the loans individually by classifying the loans as to credit risk and assesses the probability of collection for each type of class. The Corporation uses the following definitions for risk ratings:

Pass – Pass assets are well protected by the current net worth and paying capacity of the obligor (or guarantors, if any) or by the fair value, less cost to acquire and sell, of any underlying collateral in a timely manner.

Special Mention – A special mention asset has potential weaknesses that deserve management’s close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the asset or in the institution’s credit position at some future date. Special mention assets are not adversely classified and do not expose an institution to sufficient risk to warrant adverse classification.

Substandard – A substandard asset is inadequately protected by the current sound worth and paying capacity of the obligor or by the collateral pledged, if any. Assets so classified must have a well-defined weakness, or weaknesses, that jeopardizes the liquidation of the debt. They are characterized by the distinct possibility that we will sustain some loss if the deficiencies are not corrected.

Doubtful – An asset classified doubtful has all the weaknesses inherent in one classified substandard with the added characteristic that the weaknesses make collection or liquidation in full questionable and improbable on the basis of currently known facts, conditions and values.

Loss – An asset or portion thereof, classified loss is considered uncollectible and of such little value that its continuance on the institution’s books as an asset, without establishment of a specific valuation allowance or charge-off, is not warranted. This classification does not necessarily mean that an asset has no recovery or salvage value; but rather, there is significant doubt about whether, how much or when the recovery will occur. As such, it is not practical or desirable to defer the write-off.

As of June 30, 2012, and based on the most recent analysis performed, the risk category of loans by class of loans is as follows:


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Table of Contents

June 30, 2012
 
Special
Mention
 
 
 
 
(In thousands)
Pass
Substandard
Doubtful
Loss
Total
Commercial loans
$
20,340

$
1,124

$
2,436

$
51

$

$
23,951

Real estate loans
 
 
 
 
 
 
Church
29,259

5,865

20,175

528


55,827

Construction - other than third-party originated
2,104


7,932



10,036

Construction - third-party originated


6,692

1,047


7,739

Multifamily
8,655


1,844

273


10,772

Other
41,724

3,534

17,167

435


62,860

Residential
20,383

158

2,608



23,149

Installment
592

2

15



609

 
$
123,057

$
10,683

$
58,869

$
2,334

$

$
194,943


December 31, 2011
 
Special
Mention
 
 
 
 
(In thousands)
Pass
Substandard
Doubtful
Loss
Total
Commercial loans
$
23,560

$
1,084

$
1,656

$
216

$

$
26,516

Real estate loans
 
 
 
 
 
 
Church
30,133

7,105

20,220



57,458

Construction - other than third-party originated
3,115


7,333



10,448

Construction - third-party originated


6,990

1,047


8,037

Multifamily
10,594

66

1,673

273


12,606

Other
41,903

6,907

19,878

958


69,646

Residential
20,359


2,977



23,336

Installment
718

1

1



720

 
$
130,382

$
15,163

$
60,728

$
2,494

$

$
208,767


The following tables present the aging of the recorded investment in past due loans.

June 30, 2012
 
30-60
Days
60-90
Days
More than
90 Days
Total Past Due
 
 
(In thousands)
0-30 Days
Current
Total
Commercial loans
$
441

$
846

$
3,283

$
3,761

$
8,331

$
15,620

$
23,951

Real estate loans
 
 
 
 
 
 
 
Church
189

4,514

4,798

7,686

17,187

38,640

55,827

Construction - other than third-party originated

1,163


6,769

7,932

2,104

10,036

Construction - third-party originated



6,764

6,764

975

7,739

Multifamily

2,594

63

1,541

4,198

6,574

10,772

Other
1,475

3,693

915

9,494

15,577

47,283

62,860

Residential
1,931

605


2,484

5,020

18,129

23,149

Installment

3

1

15

19

590

609

 
$
4,036

$
13,418

$
9,060

$
38,514

$
65,028

$
129,915

$
194,943



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Table of Contents

December 31, 2011
 
30-60
Days
60-90
Days
More than
90 Days
Total Past Due
 
 
(In thousands)
0-30 Days
Current
Total
Commercial loans
$
177

$
1,743

$
784

$
2,248

$
4,952

$
21,564

$
26,516

Real estate loans
 
 
 
 
 
 
 
Church

8,127

8,694

6,478

23,299

34,159

57,458

Construction - other than third-party originated

437


6,157

6,594

3,854

10,448

Construction - third-party originated
108



7,929

8,037


8,037

Multifamily

106

608

1,404

2,118

10,488

12,606

Other
1,986

1,632

3,837

9,639

17,094

52,552

69,646

Residential
89

1,299


2,557

3,945

19,391

23,336

Installment
16

1

1

2

20

700

720

 
$
2,376

$
13,345

$
13,924

$
36,414

$
66,059

$
142,708

$
208,767


The following tables present the recorded investment in impaired loans by class of loans.
June 30, 2012
Recorded
Investment
Unpaid
Principal
Balance
Related
Allowance
In thousands
Commercial loans
$
1,212

$
1,233

$
226

Real estate loans
 
 
 
Church
9,774

10,391

545

Construction - other than third-party originated
6,687

8,180


Construction - third-party originated
7,739

10,557


Multifamily
1,461

2,308


Other
12,513

14,253

64

Residential
2,403

2,462


 
$
41,789

$
49,384

$
835


December 31, 2011
Recorded
Investment
Unpaid
Principal
Balance
Related
Allowance
In thousands
Commercial loans
$
363

$
463

$
216

Real estate loans
 
 
 
Church
9,586

9,973

545

Construction - other than third-party originated
6,070

7,509

311

Construction - third-party originated
8,037

10,815

346

Multifamily
1,308

1,951


Other
15,027

16,265

65

Residential
2,583

2,266

38

 
$
42,974

$
49,242

$
1,521


Nonperforming loans include loans that are contractually past due 90 days or more for which interest income is still being accrued, and non-accrual loans. Nonperforming loans were as follows:

In thousands
June 30,
2012
December 31,
2011
Non-accrual loans
$
41,428

$
42,008

Loans with interest or principal 90 days or more past due and still accruing
1,123

2,218

Total nonperforming loans
$
42,551

$
44,226



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Table of Contents

Nonperforming assets are generally secured by small commercial real estate properties, including church loans, which are secured by traditional and non-traditional church buildings.

At June 30, 2012, there were no commitments to lend additional funds to borrowers for loans that were on non-accrual or contractually past due in excess of 90 days and still accruing interest, or to borrowers whose loans have been restructured. A majority of the Bank’s portfolio is concentrated in the New York City metropolitan area and is secured by commercial properties. The borrowers’ abilities to repay their obligations are dependent upon various factors including the borrowers’ income, net worth, cash flows generated by the underlying collateral, the value of the underlying collateral and priority of the Bank’s lien on the related property. Such factors are dependent upon various economic conditions and individual circumstances beyond the Bank’s control. Accordingly, the Bank may be subject to risk of credit losses.

Impaired loans totaled $41.8 million at June 30, 2012, compared to $43.0 million at December 31, 2011. The related allocation of the allowance for loan losses amounted to $835,000 and $1.5 million at June 30, 2012 and December 31, 2011, respectively. Charge-offs of impaired loans in the first six months of 2012 totaled $1.9 million, while $38.1 million of impaired loans have no allowance allocated to them as sufficient collateral exists.

The average balance of impaired loans in the second quarter and the first half of 2012 was $42.3 million and $42.4 million, respectively, compared to $38.5 million and $36.8 million in the similar periods in 2011. Most of the impaired loans are secured by small commercial real estate properties. There was no interest income recognized on impaired loans in the first half of 2012 or 2011.

Included in impaired loans are loans to churches totaling $10.4 million with a related allowance of $545,000. Additionally, impaired loans include $7.7 million of construction loan participations acquired from a third-party lender with no related allowance.

We may extend, restructure or otherwise modify the terms of existing loans on a case-by-case basis to remain competitive or to assist other customers who may be experiencing financial difficulty. If a concession has been made to a borrower experiencing financial difficulty, the loan is then classified as a troubled debt restructuring (“TDR”). The majority of concessions made for TDRs involve lowering the monthly payments on the loans either through a reduction in the interest rate below a market rate, an extension of the term of the loan or a combination of the two methods. They seldom result in the forgiveness of principal or accrued interest; in addition, we attempt to obtain additional collateral or guarantees when modifying such loans. If the borrower demonstrates the ability to perform under the restructured terms, the loan will be returned to accrual status. Non-accrual restructured loans may be returned to accrual status when there has been a sustained period of repayment performance (generally six consecutive months of payments) and both principal and interest are considered collectible.

As a result of the adoption of ASU 2011-02, the Bank reassessed all loan restructurings that occurred on or after January 1, 2011 for potential identification as TDRs and has concluded that the adoption of ASU 2011-02 did not materially impact the number of TDRs or the specific reserves for such loans included in our allowance for loan losses.

Troubled debt restructured loans (“TDRs”) totaled $5.2 million, with a related allowance of $81,000 at June 30, 2012 and included seven borrowers. TDRs to five borrowers amounting to $3.8 million were accruing at June 30, 2012. The remaining two loans continue to be on non-accrual status due to delinquent payments. All TDRs are included in the balance of impaired loans.

The Corporation did not have any loans modified as TDRs during the first six months of 2012.

The following tables present loans by loan class modified as TDRs as of June 30, 2012. The pre-modification and post-modification outstanding recorded investments disclosed in the tables below represent carrying amounts immediately prior to the modification and at June 30, 2012, respectively. There were no charge-offs resulting from loans modified as TDRs during the first six months of 2012.

 
At June 30, 2012
Troubled Debt Restructurings (in thousands)
Number of
Contracts
Pre-Modification
Outstanding
Post-Modification
Outstanding
Churches
3

$
3,100

$
2,532

Commercial real estate:
 
 
 
Other
2

3,225

1,883

Total commercial real estate
5

6,325

4,415

Residential mortgage
3

939

743

Total
8

$
7,264

$
5,158


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Table of Contents


10. Provision and allowance for loan losses

The following tables present the allowance for loan losses by portfolio segment along with the related recorded investment in loans based on impairment method.

 
Allowance for Loan Losses
Recorded Investments
June 30, 2012
Individually
Evaluated
Collectively
Evaluated
Unallocated
Total
Allowance
Individually
Evaluated
Collectively
Evaluated
Total
Recorded Investment
(In thousands)
Commercial loans
$
226

$
1,200

$

$
1,426

$
1,212

$
22,739

$
23,951

Real estate loans
 
 
 
 
 
 
 
Church
545

1,275


1,820

9,774

46,053

55,827

Construction - other than third-party

329


329

6,687

3,349

10,036

Construction - third-party originated




7,739


7,739

Multifamily

411


411

1,461

9,311

10,772

Commercial
64

3,026


3,090

12,513

50,347

62,860

Residential

705


705

2,403

20,746

23,149

Installment

33


33


609

609

Unallocated


2,185

2,185




 
$
835

$
6,979

$
2,185

$
9,999

$
41,789

$
153,154

$
194,943





 
Allowance for Loan Losses
Recorded Investments
December 31, 2011
Individually
Evaluated
Collectively
Evaluated
Unallocated
Total
Allowance
Individually
Evaluated
Collectively
Evaluated
Total
Recorded Investment
(In thousands)
Commercial loans
$
216

$
1,089

$

$
1,305

$
363

$
26,153

$
26,516

Real estate loans
 
 
 
 
 
 
 
Church
545

1,537


2,082

9,586

47,872

57,458

Construction - other than third-party
311

687


998

6,070

4,378

10,448

Construction - third-party originated
346



346

8,037


8,037

Multifamily

285


285

1,308

11,298

12,606

Commercial
65

1,876


1,941

15,027

54,619

69,646

Residential
38

802


840

2,583

20,753

23,336

Installment

51


51


720

720

Unallocated


3,022

3,022




 
$
1,521

$
6,327

$
3,022

$
10,870

$
42,974

$
165,793

$
208,767


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The changes in allowance for loan losses are set forth below:
 
Balance,
Provision for Loan
Losses
 
 
Balance,
(In thousands)
December 31,
2011
Recoveries
Charge-offs
June 30,
2012
Commercial loans
$
1,305

$
415

$
73

$
367

$
1,426

Real estate loans
 
 
 
 
 
Church
2,082

(115
)

147

1,820

Construction - other than third-party originated
998

(657
)
2

14

329

Construction - third-party originated
346

(346
)



Multifamily
285

330


204

411

Other
1,941

2,525

91

1,467

3,090

Residential
840

(46
)
31

120

705

Installment
51

(19
)
1


33

Unallocated
3,022

(837
)


2,185

 
$
10,870

$
1,250

$
198

$
2,319

$
9,999


Management believes that the unallocated allowance is appropriate given the uncertain economic outlook, the size of the loan portfolio and level of loan delinquencies at June 30, 2012.



11. Long-term debt

At June 30, 2012, long-term debt included a $5 million, 5% senior note due in February 2022 issued under a Credit Agreement (as defined below). Interest is payable quarterly for the first ten years and payable thereafter at a fixed rate based on the yield of the ten-year U.S. Treasury note plus 150 basis points in effect on the tenth anniversary of the Credit Agreement. Quarterly principal payments of $250 thousand commence in the eleventh year of the loan. As an additional condition for receiving the loan, the Bank is required to contribute $100 thousand annually for the first five years the loan is outstanding to a nonprofit lending institution formed jointly by the Bank and the lender to provide financing to small businesses that would not qualify for bank loans.

On November 3, 2010, the Corporation entered into a First Amendment to Credit Agreement (the “Amendment”) with the lender amending and modifying that certain Credit Agreement by and between the Corporation and the lender, dated as of February 21, 2007.

The purpose of the Amendment was to: (a) modify the use of proceeds provisions of the Credit Agreement governing Prudential’s $5.0 million unsecured term loan to the Corporation so that the Corporation could convert its $5.0 million subordinated loan to the Bank into equity of the Bank that will be treated by the OCC as Tier I regulatory capital; (b) waive certain events of default resulting from the Bank’s entry into the Formal Agreement with the OCC and failure to meet certain other material obligations, including deferral of dividends to its Series F and G preferred stockholders and deferral of certain obligations to holders of debentures related to its trust preferred securities; (c) waive any default interest that may have accrued during the pendency of such events of default; and (d) amend and restate the financial covenants of the Credit Agreement. On November 30, 2010, upon receipt of OCC approval the subordinated loan was converted into equity, thereby increasing the Bank’s Tier I leverage capital. However, as a result of the Consent Order entered into on December 22, 2010 and the failure to achieve certain capital ratios required by the OCC, the Corporation was in default under this Amendment and is attempting to obtain a waiver from the lender. As a result of the default, the loan has been reclassified to short-term portion of long-term debt on the accompanying Consolidated Balance Sheets.

The Corporation has been in violation of certain covenants of the loan agreement. Although the loan becomes immediately payable as a result of these violations, which are considered an event of default, the lender has verbally indicated that no action will be taken as a result of these violations.

12. Fair value measurement of assets and liabilities

The fair value hierarchy established by ASC Topic 820, “Fair Value Measurements and Disclosures” prioritizes inputs to valuation techniques used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (level 1 measurement) and the lowest priority to unobservable inputs (level 3 measurements). The three levels of the fair value hierarchy are described below.

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Level 1 – Unadjusted quoted prices in active markets that are accessible at the measurement date for identical unrestricted assets or liabilities.

Level 2 – Quoted prices in markets that are not active, or inputs that are observable either directly or indirectly, for substantially the full term of the assets or liabilities.

Level 3 – Prices or valuation techniques that require inputs that are both significant to the fair value measurement and unobservable (i.e., supported by little or no market activity).

Level 1 securities include securities issued by the U.S. Treasury Department based upon quoted market prices. Level 2 securities include fair value measurements obtained from various sources including the utilization of matrix pricing, dealer quotes, market spreads, live trading levels, credit information and the bond's terms and conditions, among other things. Any investment security not valued based on the aforementioned criteria are considered level 3. Level 3 fair values are determined using unobservable inputs and include corporate debt obligations for which there are no readily available quoted market values as discussed under “Management's Discussion and Analysis of Financial Condition and Results of Operations - Investments.” For such securities, market values have been provided by the trading desk of an investment bank, which compares characteristics of the securities with those of similar securities and evaluates credit events in underlying collateral or obtained from an external pricing specialist, which utilized a discounted cash flow model.

The fair value of financial instruments is the amount at which an asset or obligation could be exchanged in a current transaction between willing parties, other than in a forced liquidation. Fair value estimates are made at a specific point in time based on the type of financial instrument and relevant market information.

Because no quoted market price exists for a significant portion of the Corporation's financial instruments, the fair values of such financial instruments are derived based on the amount and timing of future cash flows, estimated discount rates, as well as management's best judgment with respect to current economic conditions. Many of these estimates involve uncertainties and matters of significant judgment and cannot be determined with precision.

The fair value information provided is indicative of the estimated fair values of those financial instruments and should not be interpreted as an estimate of the fair market value of the Corporation taken as a whole. The disclosures do not address the value of recognized and unrecognized non-financial assets and liabilities or the value of future anticipated business. In addition, tax implications related to the realization of the unrealized gains and losses could have a substantial impact on these fair value estimates and have not been incorporated into any of the estimates.

The following methods and assumptions were used to estimate the fair values of significant financial instruments at June 30, 2012 and December 31, 2011.

Cash, short-term investments and interest-bearing deposits with banks

These financial instruments have relatively short maturities or no defined maturities but are payable on demand, with little or no credit risk. For these instruments, the carrying amounts represent a reasonable estimate of fair value.

Investment securities

Investment securities are reported at their fair values based on prices obtained from a nationally recognized pricing service, where available. Otherwise, fair value measurements are obtained from various sources including dealer quotes, matrix pricing, market spreads, live trading levels, credit information and the bond's terms and conditions, among other things. Management reviews all prices obtained for reasonableness on a quarterly basis.

Loans

Fair values were estimated for performing loans by discounting the future cash flows using market discount rates that reflect the credit and interest-rate risk inherent in the loans, reduced by the allowance for loan losses. This method of estimating fair value does not incorporate the exit price concept of fair value prescribed by the FASB ASC Topic for Fair Value Measuring and Disclosure.

Deposit liabilities

The fair values of demand deposits, savings deposits and money market accounts were the amounts payable on demand at June 30, 2012 and December 31, 2011. The fair value of time deposits was based on the discounted value of contractual cash flows. The

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discount rate was estimated utilizing the rates currently offered for deposits of similar remaining maturities.

These fair values do not include the value of core deposit relationships that comprise a significant portion of the Bank's deposit base. Management believes that the Bank's core deposit relationships provide a relatively stable, low-cost funding source that has a substantial value separate from the deposit balances.

Long-term debt

The fair value of long-term debt was estimated based on rates currently available to the Corporation for debt with similar terms and remaining maturities.

Commitments to extend credit and letters of credit

The estimated fair value of financial instruments with off-balance sheet risk is not significant at June 30, 2012 and December 31, 2011.

The following tables present the assets that are measured at fair value on a recurring and nonrecurring basis by level within the fair value hierarchy and on the consolidated statements of financial condition at June 30, 2012 and December 31, 2011. The assets presented under “nonrecurring fair value measurements” in the table below are not measured at fair value on an ongoing basis but are subject to fair value adjustments under certain circumstances (e.g., when an impairment loss is recognized).

 
 
 
 
 
Fair Value Measurements at Reporting Date Using:
 
 
 
 
 
Quoted Prices
 
Significant
 
 
 
 
 
in Active Markets
Significant Other
Unobservable
 
 
 
 
June 30,
For Identical Assets
Observable Inputs
Inputs
 
 
 
 
 2012
(Level 1)
(Level 2)
(Level 3)
 
 
 
 
(in thousands)
Recurring fair value measurements:
 
 
 
 
Assets
 
 
 
 
 
 
 
Investment securities:
 
 
 
 
 
Available for sale:
 
 
 
 
 
U.S. government agency securities
$
9,964

$
9,964

$

$

 
Obligations of U.S. government-sponsored entities
24,694


24,694


 
Obligations of state and political subdivisions
3,575


3,575


 
Mortgage-backed securities
54,201


54,201


 
Corporate and other debt securities
5,488


5,104

384

 
Equity securities
2,628


2,628


   Total available for sale
 
 
100,550

9,964

90,202

384

Total assets
 
 
$
100,550

$
9,964

$
90,202

$
384

Nonrecurring fair value measurements:
 
 
 
 
Collateral-dependent impaired loans
$
14,296

$

$

$
14,296

Other real estate owned
2,178



2,178

Total
 
 
 
$
16,474

$

$

$
16,474



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Table of Contents

 
 
 
 
 
Fair Value Measurements at Reporting Date Using:
 
 
 
 
 
Quoted Prices
 
Significant
 
 
 
 
 
in Active Markets
Significant Other
Unobservable
 
 
 
 
December 31,
For Identical Assets
Observable Inputs
Inputs
 
 
 
 
2011
(Level 1)
(Level 2)
(Level 3)
 
 
 
 
(in thousands)
Recurring fair value measurements:
 
 
 
 
Assets
 
 
 
 
 
 
 
Investment securities:
 
 
 
 
 
Available for sale:
 
 
 
 
 
U.S. government agency securities
$
9,151

$
9,151

$

$

 
Obligations of U.S. government-sponsored entities
13,027


13,027


 
Obligations of state and political subdivisions
3,500


3,500


 
Mortgage-backed securities
60,432


60,432


 
Corporate and other debt securities
6,207


5,795

412

 
Equity securities
2,741


2,741


   Total available for sale
 
 
95,058

9,151

85,495

412

Total assets
 
 
$
95,058

$
9,151

$
85,495

$
412

Nonrecurring fair value measurements:
 
 
 
 
Collateral-dependent impaired loans
$
12,632

$

$

$
12,632

Other real estate owned
1,524



1,524

Total
 
 
 
$
14,156

$

$

$
14,156



The following table presents the carrying amounts and estimated fair values of financial instruments not measured and not reported at fair value on the consolidated balance sheets at June 30, 2012 and December 31, 2011.
 
 
June 30, 2012
December 31, 2011
(In thousands)
Fair Value Hierarchy
Carrying
Value
Fair
Value
Carrying
Value
Fair
Value
Financial assets
 
 
 
 
 
Cash and other short-term investments
Level 1
$
27,507

$
27,507

$
38,560

$
38,560

Interest-bearing deposits with banks
Level 1
1,629

1,629

1,940

1,940

Net loans
Level 3
194,868

194,954

208,715

203,084

Accrued interest receivable
Level 1
1,505

1,505

1,561

1,561

Financial liabilities
 
 
 
 
 
Deposits without stated maturities
Level 1
139,762

139,762

152,054

152,054

Deposits with stated maturities
Level 2
149,992

152,989

147,217

150,753

Long-term debt
Level 2
19,200

20,591

19,200

20,436

Accrued interest payable (1)
Level 1
850

850

681

681

(1) Included in accrued expenses and other liabilities.

The following methods and assumptions were used to estimate the fair value of other financial assets and financial liabilities in the table above:

Cash and due from banks and interest-bearing deposits with banks. The carrying amount is considered to be a reasonable estimate of that value because of the short maturity of these items.

Loans. Fair value of loans are estimated by discounting the projected future cash flows using market discount rates that reflect the credit and interest-rate risk inherent in the loan. Projected future cash flows are calculated based upon contractual maturity or call dates, projected repayments and prepayments of principal. Fair values estimated in this manner do not fully incorporate an exit price to fair value, but instead are based on a comparison to current market rates for comparable loans.

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Table of Contents


Accrued interest receivable and payable. The carrying amounts of accrued interest approximate their fair value due to the short-term nature of these items.

Deposits without stated maturities. The current carrying amounts approximate the estimated fair value of demand deposits and savings accounts.

Deposits with stated maturities. The fair value of time deposits is based on the discounted value of contractual cash flows using estimated rates currently offered for alternative funding sources of similar remaining maturity.

Long-term debt. The fair value of long-term debt was estimated based on rates currently available to the Corporation for debt with similar terms and remaining maturities.

13. Subsequent events

As defined in FASB ASC 855-10, “Subsequent Events,” subsequent events are events or transactions that occur after the balance sheet date but before financial statements are issued or available to be issued. Financial statements are considered issued when they are widely distributed to shareholders and other financial statement users for general use and reliance in a form and format that complies with GAAP, the Corporation has evaluated subsequent events through November 7, 2012, which is the date that the Corporation’s financial statements are being issued.

Based on the evaluation, City National Bancshares Corporation deferred the payment of its regular quarterly cash dividend on its Series G fixed-rate cumulative perpetual preferred stock issued to the U.S. Treasury in connection with the Corporation’s participation in the Treasury’s TARP Capital Purchase Program.

The Corporation deferred its regularly scheduled quarterly interest payment on its junior subordinated debentures issued by the Trust.

The Series G preferred stock and the junior subordinated debentures issued in favor of the Trust provide for cumulative dividends and interest, respectively.  Accordingly, the Corporation may not pay dividends on any of its common or preferred stock until the dividends on Series G preferred stock and the interest on such debentures are paid up currently.

On October 29 and 30, 2012, the Corporation's market area experienced unprecedented damage due to Hurricane Sandy. Although the extent of the damage and its impact on the Corporation cannot be determined at this time, the storm is expected to impair the ability of some borrowers to repay their loans and also adversely impact collateral values. As a result, the Corporation may experience increased levels of non-performing loans and loan losses which may negatively impact earnings.


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

The purpose of this analysis is to provide information relevant to understanding and assessing the Corporation’s results of operations for the second quarter of the current and previous years and financial condition at the end of the current quarter and previous year-end.

Cautionary statement concerning forward-looking statements

This management’s discussion and analysis contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Such statements are not historical facts and include expressions about management’s expectations about new and existing programs and products, relationships, opportunities and market conditions. Such forward-looking statements involve certain risks and uncertainties. These include, but are not limited to, unanticipated changes in the direction of interest rates, effective income tax rates, loan prepayments assumptions, deposit growth, the direction of the economy in New Jersey and New York, continued levels of loan quality, continued relationships with major customers as well as the effects of general economic conditions and legal and regulatory issues, and changes in tax regulations. Actual results may differ materially from such forward-looking statements. The Corporation assumes no obligations for updating any such forward-looking statement at any time.

Executive summary

The primary source of the Corporation's income comes from net interest income, which represents the excess of interest earned on interest-earning assets over the interest paid on interest-bearing liabilities. This income is subject to interest-rate risk resulting from changes in interest rates. The most significant component of the Corporation's interest-earning assets is the loan portfolio. In addition to the aforementioned interest-rate risk, the portfolio is subject to credit risk. Certain components of the investment portfolio are subject to credit risk as well.

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Table of Contents


The Federal Reserve Bank maintained and continued to support a target range of zero to .25% for the federal funds rate. Management believes that the current low interest rate environment, coupled with persistent high unemployment and depressed commercial real estate prices in our market area, will continue to challenge our business operations during the remainder of 2012.

The Bank is subject to a Consent Order with the OCC, and the Corporation is a party to the FRBNY Agreement, each as described in Note 3 of the Notes to Consolidated Financial Statements. The Bank is currently not in compliance with the capital ratio requirements of the Consent Order and is taking steps to remedy its noncompliance with the Consent Order; however, there is no assurance that it will be able to do so.

The Corporation recorded a $1.2 million net loss for the second quarter ended June 30, 2012 compared to a net loss of $1.1 million for the same period in 2011, and net losses for the six month periods ending June 30, 2012 and June 30, 2011 of $1.9 million and $2.7 million, respectively. The increase in the loss included a higher loan loss provision from $814,000 for the three months ended June 30, 2011 to $1.1 million for the three months ended June 30, 2012, a decline interest expense from $1.3 million for the three months ended June 30, 2011 to $1.0 million for the three months ended June 30, 2012, and gains on the sale of investments of $556,000 and $500,000 from the sale of an unconsolidated leasing subsidiary, respectively, recorded during the second quarter of 2012, offset in part by a decline in interest income of $939,000 from $4.1 million for the three months ended June 30, 2011, to $3.1 million for the three months ended June 30, 2012.

The loss reductions for the six month periods ended June 30, 2012 and June 30, 2011 occurred primarily from reduced loan loss provisions of $764,000 and interest expense of $482,000 and net gains from the sale of investments and other assets of $556,000 and $525,000, respectively, which occurred in the second quarter of 2012, offset by a decline in interest income of $1.6 million from $8.1 million recorded in the first six months of 2011 to $6.5 million recorded for the same period of 2012. Driving the recurring losses from operations were higher credit costs and expenses incurred in connection with complying with the provisions of the Consent Order.

We expect to record operating losses for the remainder of 2012 due to costs related to consultants and increased staffing retained to achieve compliance with the Consent Order, elevated credit costs and lower net interest income. Additionally, we expect increased additional costs in conjunction with the establishment of various strategic initiatives to ultimately return to profitability.

Financial condition

At June 30, 2012, total assets decreased by $26.2 million to $331.2 million, from $358.4 million at December 31, 2011, while total deposits declined $9.5 million to $289.8 million at June 30, 2012 from $299.3 million at December 31, 2011. Average assets declined by $42.1 million for the first six months of 2012 to $351.5 million from $393.6 million a year earlier.

Federal funds sold

There were no federal funds sold at June 30, 2012 compared to $32.6 million at December 31, 2011, as all the federal funds sold balances were transferred into an interest-bearing account at the Federal Reserve Bank of New York.

Cash and due from banks

This category grew significantly as we moved our federal funds balances into an interest-bearing account at the Federal Reserve Bank of New York, earning a higher rate than other correspondents. The account balance in the Federal Reserve Bank of New York totaled $24.1 million at June 30, 2012.

Investments

The investment portfolio increased $5.5 million, or 5.8%, to $100.6 million at June 30, 2012 from $95.1 million at December 31, 2011. The portfolio was relatively active for the six-month period ending June 30, 2012 with purchases of $27.6 million, offset by maturities, calls and repayments of $14.7 million and sales of $6.7 million. The purchases were necessary to replace investments pledged as collateral for municipal deposits.

Loans

Loans declined $13.8 million, or 6.6%, to $194.9 million at June 30, 2012 from $208.7 million at December 31, 2011, while average loans of $202.1 million in the first six months of 2012 were down from $236.5 million for the first six months of 2011. The declines resulted primarily from pay downs and principal payments. We are presently originating very few loans, which are primarily to existing customers. We expect to resume originations as well as purchases in the secondary market in the fourth quarter of 2012, and

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Table of Contents

will diversify the concentration in commercial real estate (“CRE”) loans by seeking commercial or residential mortgage loans, as well as consumer credit. This will improve our concentration ratios, which will remain high in CRE loans and may even increase as our total portfolio is shrinking and capital levels are declining due to operating losses.

Allowance requirements for several categories of loans declined at June 30, 2012 compared to 2011 year-end, reflecting improvements in the criticized portion of the loan portfolio as evidenced by reductions in special mention and substandard loans and a small increase in the doubtful categories. Additionally, total past due loans declined slightly from $66.1 million at the end of 2011 to $65.0 million at June 30, 2012, with the largest decline occurring in church loans.

Provision and allowance for loan losses

Changes in the allowance for loan losses are set forth below.

(In thousands)
Balance,
December 31, 2011
Provision for Loan Losses
Recoveries
Charge-offs
Balance,
June 30, 2012
Commercial loans
$
1,305

$
415

$
73

$
367

$
1,426

Real estate loans
 
 
 
 
 
Church
2,082

(115
)

147

1,820

Construction - other than third-party originated
998

(657
)
2

14

329

Construction - third-party originated
346

(346
)



Multifamily
285

330


204

411

Other
1,941

2,525

91

1,467

3,090

Residential
840

(46
)
31

120

705

Installment
51

(19
)
1


33

Unallocated
3,022

(837
)


2,185

 
$
10,870

$
1,250

$
198

$
2,319

$
9,999


(In thousands)
Three Months Ended
June 30, 2012
Six Months Ended
June 30, 2012
Three Months Ended
June 30, 2011
Six Months Ended
June 30, 2011
Balance at beginning of period
$
10,610

$
10,870

$
10,830

$
10,626

Provision for loan losses
1,125

1,250

814

2,014

Recoveries of previous charge-offs
54

198

43

134

 
11,789

12,318

11,687

12,774

Less: Charge-offs
1,790

2,319

792

1,879

 
$
9,999

$
9,999

$
10,895

$
10,895



The allowance for loan losses (“ALLL”) is a critical accounting policy and is maintained at a level determined by management to be adequate to provide for inherent losses in the loan portfolio. The allowance is increased by provisions charged to operations and recoveries of loan charge-offs. Generally, losses on loans are charged against the allowance for loan losses when it is believed that the collection of all or a portion of the principal balance is unlikely and the collateral is not adequate to fully discharge the debt.

Certain inherent, but unconfirmed losses are probable within the loan portfolio. The Bank's operations and lending activities are centered in urban communities that are more vulnerable to economic downturns. Unanticipated events, including political, economic and regulatory changes, could cause changes in the credit characteristics of the portfolio and result in an unanticipated increase in the allowance.

The Bank's current methodology for determining the projected level of losses is based on historical loss rates, current credit grades, specific reserve allocations on loans modified as TDRs and impaired commercial credits above specified thresholds, and other qualitative adjustments. Due to the heavy reliance on realized historical losses and the credit grade rating process, the calculated

27

Table of Contents

reserves required under the model may tend to slightly lag the deterioration in the portfolio in a stable or deteriorating credit environment and may tend not to be as responsive when improved conditions have presented themselves.
 
The allowance is maintained at a level estimated to absorb probable credit losses inherent in the loan portfolio as well as other credit risk-related charge-offs. The allowance is based on ongoing evaluations of the probable estimated losses inherent in the loan portfolio. The Bank's methodology for evaluating the appropriateness of the allowance includes segmentation of the loan portfolio into its various components, tracking the historical levels of classified loans and delinquencies, applying economic outlook factors, assigning specific incremental reserves where necessary, providing specific reserves on impaired loans and assessing the nature and trend of loan charge-offs. Additionally, the volume of nonperforming loans, concentration risks by size, type and geography, new markets, collateral adequacy and economic conditions are taken into consideration.

The allowance established for probable losses on specific loans is based on a regular analysis and evaluation of classified loans. Loans are classified based on an internal credit risk grading process that evaluates, among other things: (i) the obligor's ability to repay; (ii) the underlying collateral, if any; and (iii) the economic environment and industry in which the borrower operates. Loans with a grade that is below a predetermined grade are adversely classified. Any change in the credit risk grade of performing and/or nonperforming loans affects the amount of the related allowance.

Once a loan is classified, the loan is analyzed to determine whether the loan is impaired and, if impaired, the need to specifically allocate a portion of the allowance for loan losses to the loan. Specific valuation allowances are determined by analyzing the borrower's ability to repay amounts owed, collateral deficiencies, the relative risk grade of the loan and economic conditions affecting the borrower's industry, among other things.

Additionally, management individually evaluates non-accrual loans and all troubled debt restructured loans for impairment based on the underlying anticipated method of payment consisting of either the expected future cash flows from the borrower or the proceeds from the disposition of the related collateral. If payment is expected solely based on the underlying collateral, an appraisal is completed to assess the fair value of the collateral. Collateral-dependent impaired loan balances are written down to the current fair value of each loan's underlying collateral, resulting in an immediate charge-off to the allowance, excluding any consideration for personal guarantees that may be pursued in the Bank's collection process. If repayment is based upon future expected cash flows, the present value of the expected future cash flows discounted at the loan's original effective interest rate is compared to the carrying value of the loan, and any shortfall is recorded as a specific valuation allowance in the allowance for loan losses.

The allowance also contains unallocated reserves to cover inherent losses within a given loan category, which have not been otherwise reviewed or measured on an individual basis. This unallocated portion of the allowance reflects management's best estimate of the elements of imprecision and estimation risk inherent in the calculation of the overall allowance. Due to the subjectivity involved in determining the overall allowance, including the unallocated portion, the portion considered unallocated may fluctuate from period to period based on management's evaluation of the factors affecting the assumptions used in calculating the overall allowance, including historical loss experience, current economic conditions and industry or borrower concentrations. Changes may also occur due to the necessity of maintaining consistent loss coverage ratios for the various loan risk components.

Management believes that the allowance for loan losses is adequate. While management uses available information to determine the adequacy of the allowance, future additions may be necessary based on changes in economic conditions or subsequent events unforeseen at the time of evaluation. Additionally, to the extent that actual results differ from forecasts or management's judgment, the ALLL may be greater or less than future charge-offs.

In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Bank's allowance for loan losses. Such agencies may require the Bank to increase the allowance based on their judgment of information available to them at the time of their examination.

Most loan risk categories experienced declines in the related ALLL allocations at June 30, 2012 due to reductions in the related unpaid principal balances, as excess allowance balances were transferred to the CRE loan category.

The allowance represented 5.13% of total loans at June 30, 2012 compared to 5.21% at December 31, 2011, while the allowance represented 23.50% of total nonperforming loans at June 30, 2012 compared to 24.58% at the end of 2011 due to a decline during the first half of 2012 in total loans and nonperforming loans, respectively.


Allowance for loan losses as a percentage of:


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Table of Contents

 
June 30, 2012
December 31, 2011
June 30, 2011
Allowance for loan losses as a percentage of:
 
 
 
Total loans
5.13
%
5.21
%
4.84
%
Total nonperforming loans
23.50
%
24.58
%
25.78
%
Year-to-date net charge-offs as a percentage of average loans (annualized)
2.10
%
1.22
%
1.48
%

Nonperforming loans

Nonperforming loans inclu