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PIONEER BANKSHARES INC/VA - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations.(Edgar Glimpses Via Acquire Media NewsEdge) The discussion covers the consolidated financial condition and operations of Pioneer Bankshares, Inc. ("Company") and its subsidiary Pioneer Bank ("Bank"). Forward-Looking Statements This quarterly report on Form 10-Q contains forward-looking statements with respect to the Company's and the Bank's financial condition, results of operations and business. These forward-looking statements involve certain risks and uncertainties. When used in this quarterly report or future regulatory filings, in press releases or other public shareholder communications, or in oral statements made with the approval of an authorized executive officer, the words or phrases "will likely result," "are expected to," "will continue," "is anticipated," "estimate," "project," "believe," or similar expressions are intended to identify "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. We caution the readers and users of this information not to place undue reliance on any such forward-looking statements, which speak only as of the date made, and advise readers that various factors including regional and national economic conditions, changes in the levels of market rates of interest, credit risk and lending activities, and competitive and regulatory factors could affect the financial performance of the Company and the Bank and could cause actual results for future periods to differ materially from those anticipated or projected. The Company and the Bank do not undertake and specifically disclaim any obligation to publicly release the result of any revisions, which may be made to any forward-looking statements to reflect the occurrence of anticipated or unanticipated events or circumstances after the date of such statements. Overview The Company had net earnings as of June 30, 2011 of $623,000 compared to $784,000 for the same period last year. This represents a decrease of approximately $161,000 or 20.6%. This decrease is primarily attributed to additional allowance for loan loss provision expense, as well as other increased expenses related to professional appraisal services and foreclosure property renovations. The Company has had a decrease in assets since December 2010 of approximately $3.0 million, which is primarily attributed to loan payoffs, the repurchase of certain participation loans earlier this year by a participating institution, as well as certain investment maturities. The Company's loan portfolio reflects a net decrease of approximately $1.1 million as of June 30, 2011; however, there are additional large commercial loans currently in process, which are expected to offset these decreases over the next several months. The deposit portfolio has remained relatively stable, with a slight increase of $657,000 as of June 30, 2011. The overall changes in the bank's deposit portfolio have resulted from reductions in time deposits and increases in interest bearing demand deposits. The Company's capital position remains strong as of June 30, 2011 at $19.8 million, or 11.96% as a percentage of total assets. The company has been able to continue to pay quarterly dividend payments of $0.15 per share for the 1st and 2nd quarters of 2011, and has had sufficient cash flow to pay these dividends from the holding company, rather than directly from the bank. Management recognizes that prevailing economic conditions may have the potential to adversely impact the Company's operational results, including future earnings, liquidity, and capital resources. Management continually monitors economic factors in an effort to promptly identify specific trends that could have a direct material effect on the Company. 28-------------------------------------------------------------------------------- Table of Contents Critical Accounting Policies General The Company's consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States of America ("GAAP"). The financial information contained within our statements is, to a significant extent, financial information that is based on measures of the financial effects of transactions and events that have already occurred. A variety of factors could affect the ultimate value that is obtained either when earning income, recognizing an expense, recovering an asset, or relieving a liability. The Company uses historical loss factors as one factor in determining the inherent loss that may be present in our loan portfolio. Actual losses could differ significantly from the historical factors. In addition, GAAP itself may change from one previously acceptable method to another method. Although the economics of our transactions would be the same, the timing of events that would impact our transactions could change. Allowance for Loan Losses The allowance for loan losses is an estimate of the losses that may be sustained in our loan portfolio. The allowance is based on two basic accounting standards: 1) Accounting for Contingencies, which requires that losses be accrued when they are considered to be probable and can be reasonably estimated, and 2) Accounting by Creditors for Impairment of a Loan, which requires that losses be accrued based on the differences between the value of collateral, present value of future cash flows or values that are observable in the market and the loan balance. Management also evaluates the loan portfolio in light of national and local economic trends, changes in the nature and value of the portfolio and industry standards. Allocation factors relating to identified loan concentrations and loan growth trends are included in the calculation of the adequacy of the loan loss reserve. The periodic review of the allowance for loan loss and funding provision considers concentrations of loans in terms of geography, business type or level of risk. Management evaluates the risk elements involved in loans relative to collateral values and maintains the allowance for loan losses at a level which is adequate to absorb credit losses considered to be inherent in the loan portfolio. Management engages the services of an outside loan review firm periodically to evaluate the loan portfolio, provide an independent analysis of significant borrowers, and to assist in identifying potential problem credits. The independent loan review report is used by management as an additional tool for monitoring and minimizing risks that may be inherent in the loan portfolio. Management has also implemented an internal loan review process for the purpose of identifying and monitoring possible loan losses in the portfolio. Other factors considered in management's evaluation process are changes in lending policies, procedures and underwriting criteria; changes in the nature and volume of the loan portfolio; the experience, ability, and depth of lending management or other lending personnel; the volume and severity of past dues, non-accruals, and classified loans; and other external or regulatory requirements. Regulatory agencies, as an integral part of their examination process, periodically review the estimated losses on loans. Such agencies may require the Bank to recognize additional losses based on their judgment about information available to them at the time of their examination. The methodology used to calculate the allowance for loan losses and the provision for loan losses is a significant accounting principle, which is based on estimates that are particularly susceptible to significant changes in the economic environment and market conditions. Goodwill Goodwill is evaluated on an annual basis for impairments in value and adjusted accordingly. The accounting standards for Business Combinations, Goodwill and Other Intangible Assets require that the purchase method of accounting be used for all business combinations initiated after June 30, 2001. Additionally, it further clarifies the criteria for the initial recognition and measurement of intangible assets separate from goodwill. The provisions of these accounting standards discontinued the amortization of goodwill and intangible assets with indefinite lives. Instead, these assets are subject to an annual impairment review, which must be performed at least annually or more frequently if certain impairment indicators are in evidence. The accounting standards relating to Goodwill also require that reporting units be identified for the purpose of assessing potential future impairments. Goodwill is included in other assets and totaled $360,000 at June 30, 2011 and December 31, 2010. Goodwill is no longer amortized, but instead is tested for impairment at least annually. 29-------------------------------------------------------------------------------- Table of Contents Results of Operations Net Interest Income Total interest income decreased $33,000 or 0.71% during the first half of 2011 as compared to the same period for 2010. Total interest expense decreased $194,000 or 20.68% during the six month period ending June 30, 2011, as compared to the same period in 2010. The decreases in interest income and interest expense resulted in a net interest income increase of $161,000 or 4.34% for the period ending June 30, 2011, compared to the period ending June 30, 2010. This net increase is primarily attributed to reduced interest expense on deposits as a result of the current low interest rate environment. The reduced interest income it also attributed to lower market rates for investments and other earning assets. The average outstanding loan balances as of June 30, 2011 totaled $130.9 million, as compared to $128.8 million as of June 30, 2010. The average yield on loan balances outstanding has decreased from 6.79% as of June 30, 2010 to 6.75% as of June 30, 2011. This decrease in interest yield on loans has been impacted by lower market interest rates and scheduled loan re-pricing activities. The overall average yield on earning assets decreased from 6.12% as of June 30, 2010 to 5.80% as of June 30, 2011, and is also attributed to the low interest rate environment and previously mentioned factors. The Company's cost of liabilities decreased from 1.61% as of June 30, 2010 to 1.23% as of June 30, 2011. This is attributed to management's proactive re-pricing efforts to reduce interest expense on deposit products in conjunction with lower market rates. The Company's overall net interest margin decreased from 4.90% as of June 30, 2010 to 4.87% as of June 30, 2011. Noninterest Income During the first half of 2011, non-interest income increased by $68,000 or 12.36%, when compared to the same period last year. This increase in non-interest income is primarily related to gains on securities transactions, which are generally considered to be non-recurring income activities. The total gains on securities transactions as of June 30, 2011 were $109,000 compared to losses on securities transactions for the same period last year of $54,000. Noninterest Expense During the first half of 2011, non-interest expense increased by $217,000 or 8.26% in comparison to the same period last year. The primary factors contributing to this increase were additional professional fees related to appraisals required for certain real estate loans and OREO properties, as well as additional audit and consulting expenses, and certain expenses associated with the Company's recent change to an outsourced data processing environment. In prior years, the Company's recorded data processing expenses were primarily included in equipment and maintenance expense rather than operating expenses. Additionally, salaries and benefit expense increased by $116,000 as of June 30, 2011, when compared to the prior year. This increase is primarily attributed to the addition of new salary expenses relating to staff positions that have remained vacant for an extended period of time. Management's decisions in previous years regarding salary increases and hiring activities were of a conservative nature in an effort to control costs in the uncertain economic environment. Financial Condition Securities The Company's securities portfolio is held to assist the Company in liquidity and asset liability management as well as capital appreciation. The securities portfolio generally consists of securities held to maturity and securities available for sale. Securities are classified as held to maturity when management has the intent and ability to hold the securities to maturity. These securities are carried at amortized cost. Securities available for sale include securities that may be sold in response to general market fluctuations, general liquidity needs and other similar factors. Securities available for sale are recorded at market value. Unrealized holding gains and losses of available for sale securities are excluded from earnings and reported (net of deferred income taxes) as a separate component of shareholders' equity. 30-------------------------------------------------------------------------------- Table of Contents As of June 30, 2011, the fair market value of securities available for sale was approximately $353,000 more than the net amortized cost value as shown in Note 2 of the financial statements included in this report. Management continually monitors its securities portfolio with regard to unrealized losses and has a detailed evaluation process for assessing potential other-than-temporary impairments, should unrealized loss positions occur. As of June 30, 2011, there were no securities in an unrealized loss position. Management also recognizes that certain market condition and economic factors can cause valuation fluctuations within the securities portfolio. At this time, management does not expect these potential fluctuations in the value of these securities to have a material impact on earnings. Investments in securities, including those which were restricted, decreased by approximately $1.5 million during the first half of 2011. The Company generally invests in securities with a relatively short-term maturity due to uncertainty in the direction of interest rates. Of the investments in securities available for sale, 3.13% (based on market value) are invested in equities, most of which are dividend producing and subject to the corporate dividend exclusion for taxation purposes. The equity securities generally include common stocks, which are purchased with the objective of generating additional income. The value of these investments is sensitive to general trends in the stock market and other economic conditions. Loan Portfolio The Company operates in a service area in the western portion of Virginia in the counties of Page, Greene, Rockingham and Albemarle, as well as the City of Harrisonburg and the City of Charlottesville, Virginia. The Company does not make a significant number of loans to borrowers outside its primary service area. The Company is active in local residential construction mortgages and consumer lending. Commercial lending includes loans to small and medium sized businesses within its service area. An inherent risk in the lending of money is that the borrower will not be able to repay the loan under the terms of the original agreement. The allowance for loan losses (see subsequent section) provides for this risk and is reviewed periodically for adequacy. The risk associated with real estate and installment loans to individuals is based upon employment, the local and national economies, and consumer confidence. All of these affect the ability of borrowers to repay indebtedness. The risk associated with commercial lending is substantially based on the strength of the local and national economies in addition to the financial strength of the borrower. While lending is geographically diversified within the service area, the Company does have loan concentrations in commercial and residential real estate loans, as well as, consumer auto loans. A portion of these loans are made to borrowers who are employed by businesses outside the service area. During the first half of 2011, net loans decreased by approximately $1.1 million or 0.84%. The decrease in loan volume was primarily in the category of commercial real estate loans. A schedule of loans by type is shown in Note 3 of the consolidated financial statements included in this report. The risk elements in lending activities include non-accrual loans, loans 90 days or more past due, restructured and impaired loans. Non-accrual loans are loans on which interest accruals have been suspended or discontinued permanently as previously defined in the Company's significant accounting policies. Restructured loans are loans on which the original interest rate or repayment terms have changed due to the borrower's financial hardship and were previously discussed in Note 1. Impaired loans are those loans which have been identified by management as problem credits due to various circumstances concerning the borrower's financial condition and frequent delinquency status. These loans may not be delinquent to the extent that would warrant a non-accrual classification, however, management has classified these accounts as impaired and is monitoring the circumstances and payment status closely. In most cases, a specific allocation to the Bank's allowance for loan loss is made for an impaired loan. The total amount of impaired loans as of June 30, 2011 was $2.0 million compared to $2.8 million as of December 31, 2010. Management has placed approximately $1.5 million of the Bank's impaired loans in a nonaccrual status as of June 30, 2011. Impaired loans not in nonaccrual status as of June 30, 2011 were approximately $477,000. Specific allocations have been made to the allowance for loan loss account of approximately $662,000 as of June 30, 2011 to cover potential losses that may occur relating to impaired loans. 31 -------------------------------------------------------------------------------- Table of Contents Management continually monitors past due, non-accrual, and impaired loans and takes necessary collection actions on a consistent basis to minimize losses in the portfolio. Management monitors all non-performing assets in order to promptly identify any loss allocations that should be made. Although the potential exists for additional losses, management believes the Bank is generally well secured and continues to actively work with these customers to effect payment. Problem loans (serious doubt loans) are loans whereby information known by management indicates that the borrower may not be able to comply with present payment terms. Management was not aware of any problem loans at June 30, 2011 that are not included in the past due or non-accrual loans referred to above. Allowance for Loan Losses Management's analysis process for evaluating the adequacy of the allowance for loan loss is a continual process, which is monitored at least quarterly, or more frequently, as needed. The evaluation process consists of regular periodic reviews of the loans outstanding by loan type. Specific reviews and allocations are made for loans that have been identified as potential loss, in which the borrower's financial condition has substantially weakened or habitual past due payment activity has occurred. Specific reviews and allocations are also made for various sectors of the loan portfolio that have been identified as higher risk categories. Historical loss ratios are applied to the remaining loan portfolio by loan type, based on the most recent loss trends. Management takes into consideration expected recoveries from prior charge offs as part of its allowance and funding calculation. Management also evaluates the loan portfolio in light of national and local economic trends, changes in the nature and value of the portfolio and industry standards. Allocation factors relating to identified loan concentrations and loan growth trends are included in the calculation of the adequacy of the loan loss reserve. The periodic review of the allowance for loan loss and funding provision considers concentrations of loans in terms of geography, business type or level of risk. Management evaluates the risk elements involved in loans relative to collateral values and maintains the allowance for loan losses at a level which is adequate to absorb credit losses considered to be inherent in the loan portfolio. Management engages the services of an outside loan review firm periodically to evaluate the loan portfolio, provide an independent analysis of significant borrowers, and to assist in identifying potential problem credits. The independent loan review report is used by management as an additional tool for monitoring and minimizing risks that may be inherent in the loan portfolio. Management has also implemented an internal loan review process for the purpose of identifying and monitoring possible loan losses in the portfolio. Other factors considered in management's evaluation process are changes in lending policies, procedures and underwriting criteria; changes in the nature and volume of the loan portfolio; the experience, ability, and depth of lending management or other lending personnel; the volume and severity of past dues, non-accruals, and classified loans; and other external or regulatory requirements. Regulatory agencies, as an integral part of their examination process, periodically review the estimated losses on loans. Such agencies may require the Bank to recognize additional losses based on their judgment about information available to them at the time of their examination. The methodology used to calculate the allowance for loan losses and the provision for loan losses is a significant accounting principle which is based on estimates that are particularly susceptible to significant changes in the economic environment and market conditions. The provision for loan losses and changes in the allowance for loan losses are shown in note 4 of the financial statements included in this report. The allowance for loan loss balance of $2.3 million, at June 30, 2011, decreased by approximately $29,000 from its level at December 31, 2010. The decrease in the allowance balance is primarily related to a reduction in the total amount of impaired loans of approximately $840,000 that has occurred since December 2010. Management continues to assess its allocation factors with regard to the current economic trends, historical charge-off data, concentrations of credit within the Bank's loan portfolio, and trends in non-performing assets as a means of providing sufficient funding for possible losses. The cumulative balance in the allowance for loan loss account was equal to 1.75% and 1.76% of total loans at June 30, 2011 and December 31, 2010, respectively. This slight fluctuation in the overall allowance for loan loss percentage is considered to be directionally consistent with the changes and trends that have occurred within the portfolio and the recent reduction in impaired loan totals as noted as of June 30, 2011. 32-------------------------------------------------------------------------------- Table of Contents The allowance is deemed to be within an acceptable range based on management's evaluation of the losses inherent in the loan portfolio at the end of this reporting period. The evaluation of the allowance for loan loss account as of June 30, 2011 included specific allocations for certain borrowers, in which the payment performance and collateral value assessment indicates possible future losses. Management exercises the utmost caution and due diligence in allocating for possible loan losses, and follows a conservative methodology in order to protect its investors and to minimize the potential for large fluctuations in future provision expenses. Management's practice of funding the allowance for loan loss account is to make necessary adjustments on a quarterly basis for the foreseeable period in an attempt to effectively match expenses to loan losses as they are occurring. Large fluctuations or variances outside of the acceptable range as calculated for the necessary allowance for loan loss reserves are recorded directly to income or expense in the reporting period. The provision expense related to the allowance for loan loss as of June 30, 2011 was $732,000 as compared to $498,000 for the same period last year. This increased provision expense or $234,000 is primarily attributed to allocations that were made during the first half of the year for certain large commercial and real estate loans, one large participation loan balance that was charged off during the first half of 2011, and increases in various allocation factors deemed necessary for the potential risk of loss inherent within particular segments of the loan portfolio. Management's evaluation of the allowance for loan losses as of June 30, 2011 and December 31, 2010 concluded that the reserved amount was adequate to cover estimated losses that may occur within the portfolio. The allowance for loan loss account is monitored closely by management on an on-going basis, and is periodically adjusted to ensure that an adequate level of loss coverage is maintained. Premises, Equipment and Software During the first half 2011, the Company had purchases relating to premises, equipment or other fixed assets of approximately $105,000. These purchases were primarily related to software and equipment upgrades. The Bank continually monitors technological upgrades in the banking industry, and periodically, in order to achieve higher levels of internal operational efficiency, purchases new or additional equipment relating to such technologies. Management sets specific budget allowances on an annual basis, which are deemed to be adequate to cover expenditures that may arise throughout the year relating to technological upgrades or enhancements. The Bank executed new contracts with its core data processing vendor during 2010 for various system enhancements relating to certain daily processing functions and operational software upgrades. One major element of these new contracts was the change from an in-house daily processing system to an outsourced environment, in which the core vendor now performs selected back-office operational support functions for the bank. The implementation of these new system functions are expected to provide increased internal efficiencies to the Bank for the future. Deposits The Company's main source of funds is customer deposits received from individuals, governmental entities and businesses located within the Company's service area. Deposit accounts include demand deposits, savings, money market and certificates of deposit. The Company's total deposit portfolio has historically remained relatively stable; however, these balances fluctuate with normal daily activity. During the first half 2011, total deposits increased by approximately $657,000 or 0.48%, with the majority of this growth being attributed to demand deposit and savings accounts. Non interest-bearing demand deposits increased by $3.1 million or 11.94%, while interest-bearing demand deposits decreased by $1.6 million or 7.06%. Savings deposit accounts increased by approximately $252,000 or 1.60%, while time deposits decreased by approximately $1.0 million or 1.45%. The Company monitors its deposits carefully on an on-going basis in order to provide adequate funding for investment and loan opportunities. 33-------------------------------------------------------------------------------- Table of Contents Borrowings The Bank has a line of credit with the Federal Home Loan Bank of Atlanta upon which credit advances can be made up to 40% of total Bank assets, subject to certain eligibility requirements. FHLB advances bear interest at a fixed or floating rate depending on the terms and maturity of each advance and numerous renewal options are available. These advances are secured by the Bank's real estate loan portfolio, with a current pledge against the institution's first lien 1-4 family residential mortgages totaling $51.4 million, as of June 30, 2011. On certain fixed rate advances, the FHLB may convert the advance to an indexed floating rate at some set point in time for the remainder of the term. If the advance converts to a floating rate, the Bank may repay all or part of the advance without a prepayment penalty. At June 30, 2011, total outstanding borrowings with FHLB were $7.0 million. This outstanding balance is a fixed rate advance with scheduled principal payments due quarterly and a final maturity date of March 1, 2013. The scheduled repayments and maturities of outstanding FHLB borrowings as of June 30, 2011 are shown in TABLE II of this report. Capital The adequacy of the Company's capital is reviewed by management on an ongoing basis with reference to its size, composition, quality of assets and liability levels, and consistency with regulatory requirements and industry standards. Management seeks to maintain a capital structure that will assure an adequate level to support asset growth, shareholder dividends, and ongoing operational needs. As of June 30, 2011 and December 31, 2010, the Company's total capital-to-asset ratios were 11.96% and 11.53%, respectively. The capital ratios for both the Company and the Bank exceed the well-capitalized regulatory guidelines as of June 30, 2011 and earnings have historically been sufficient to allow for consistent dividends to be declared on a quarterly basis. Liquidity Liquidity is the ability to meet present and future financial obligations through either the sale or maturity of existing assets or the acquisition of additional funds through liability management. Liquid assets include cash, interest bearing deposits with banks, federal funds sold, investments and loans maturing within one year. The Company's ability to obtain deposits and purchase funds at favorable rates determines its liquidity exposure. As a result of the Company's management of liquid assets and the ability to generate liquidity through borrowings, management believes that the Company maintains overall liquidity sufficient to satisfy its depositors' requirements and meet its customers' credit needs. Additional sources of liquidity available to the Company include, but are not limited to, loan repayments, deposits obtained through the adjustment of interest rates, purchases of federal funds and borrowings. To further meet its liquidity needs, the Company also maintains lines of credit with the FHLB and certain correspondent banks. There are no off-balance sheet items that should impair future liquidity. Liquidity as of June 30, 2011 is considered to be adequate. Interest Rate Sensitivity The Company historically has had a stable core deposit base and, therefore, does not have to rely on volatile funding sources. Because of the stable core deposit base, changes in interest rates should not have a significant effect on liquidity. The Company also uses loan repayments and maturing investments to meet its liquidity needs. The Bank's membership in the Federal Home Loan Bank System provides additionally liquidity. The matching of long-term receivables and liabilities helps the Company reduce its sensitivity to interest rate changes. The Company reviews its interest rate gap periodically and makes adjustments as needed. 34 -------------------------------------------------------------------------------- Table of Contents As of June 30, 2011, the Company had a negative cumulative Gap Rate Sensitivity Ratio of 26.16% for the one year re-pricing period, compared with a negative cumulative Gap Rate Sensitivity of 34.19% at December 31, 2010. This negative gap position generally indicates that earnings would improve in a declining interest rate environment as liabilities re-price more quickly than assets. Conversely, earnings would probably decrease in periods during which interest rates are increasing. However, in actual practice, this may not be the case as deposits may not re-price concurrently with changes in rates within the general economy. Management constantly monitors the Company's interest rate risk and has decided the current position is acceptable for a well-capitalized community bank operating in a rural environment. Table II contains an analysis, which shows the re-pricing opportunities of earning assets and interest bearing liabilities as of June 30, 2011. Recent Accounting Pronouncements In January 2010, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2010-06, "Fair Value Measurements and Disclosures (Topic 820): Improving Disclosures about Fair Value Measurements." ASU 2010-06 amends Subtopic 820-10 to clarify existing disclosures, require new disclosures, and includes conforming amendments to guidance on employers' disclosures about postretirement benefit plan assets. ASU 2010-06 is effective for interim and annual periods beginning after December 15, 2009, except for disclosures about purchases, sales, issuances, and settlements in the roll forward of activity in Level 3 fair value measurements. Those disclosures are effective for fiscal years beginning after December 15, 2010 and for interim periods within those fiscal years. The adoption of the new guidance did not have a material impact on the Company's consolidated financial statements. In July 2010, the FASB issued ASU 2010-20, "Receivables (Topic 310) - Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses." The new disclosure guidance significantly expands the existing requirements and will lead to greater transparency into a company's exposure to credit losses from lending arrangements. The extensive new disclosures of information as of the end of a reporting period became effective for both interim and annual reporting periods ending on or after December 15, 2010. Specific disclosures regarding activity that occurred before the issuance of the ASU, such as the allowance roll forward and modification disclosures, will be required for periods beginning on or after December 15, 2010. The Company has included the required disclosures in its consolidated financial statements. In December 2010, the FASB issued ASU 2010-28, "Intangible - Goodwill and Other (Topic 350) - When to Perform Step 2 of the Goodwill Impairment Test for Reporting Units with Zero or Negative Carrying Amounts." The amendments in this ASU modify Step 1 of the goodwill impairment test for reporting units with zero or negative carrying amounts. For those reporting units, an entity is required to perform Step 2 of the goodwill impairment test if it is more likely than not that a goodwill impairment exists. The amendments in this ASU are effective for fiscal years, and interim periods within those years, beginning after December 15, 2010. Early adoption is not permitted. The adoption of the new guidance did not have a material impact on the Company's consolidated financial statements. In December 2010, the FASB issued ASU 2010-29, "Business Combinations (Topic 805) - Disclosure of Supplementary Pro Forma Information for Business Combinations." The guidance requires pro forma disclosure for business combinations that occurred in the current reporting period as though the acquisition date for all business combinations that occurred during the year had been as of the beginning of the annual reporting period. If comparative financial statements are presented, the pro forma information should be reported as though the acquisition date for all business combinations that occurred during the current year had been as of the beginning of the comparable prior annual reporting period. ASU 2010-29 is effective for business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2010. Early adoption is permitted. The adoption of the new guidance did not have a material impact on the Company's consolidated financial statements. The Securities Exchange Commission (SEC) issued Final Rule No. 33-9002, "Interactive Data to Improve Financial Reporting." The rule requires companies to submit financial statements in extensible business reporting language (XBRL) format with their SEC filings on a phased-in schedule. Large accelerated filers and foreign large accelerated filers using U.S. GAAP were required to provide interactive data reports starting with their first quarterly report for fiscal periods ending on or after June 15, 2010. All remaining filers are required to provide interactive data reports starting with their first quarterly report for fiscal periods ending on or after June 15, 2011. 35-------------------------------------------------------------------------------- Table of Contents In March 2011, the SEC issued Staff Accounting Bulletin (SAB) 114. This SAB revises or rescinds portions of the interpretive guidance included in the codification of the Staff Accounting Bulletin Series. This update is intended to make the relevant interpretive guidance consistent with current authoritative accounting guidance issued as a part of the FASB's Codification. The principal changes involve revision or removal of accounting guidance references and other conforming changes to ensure consistency of referencing through the SAB Series. The effective date for SAB 114 is March 28, 2011. The adoption of the new guidance did not have a material impact on the Company's consolidated financial statements. The Company has included the required disclosures in this 10-Q report. In April 2011, the FASB issued ASU 2011-02, "Receivables (Topic 310) - A Creditor's Determination of Whether a Restructuring Is a Troubled Debt Restructuring." The amendments in this ASU clarify the guidance on a creditor's evaluation of whether it has granted a concession to a debtor. They also clarify the guidance on a creditor's evaluation of whether a debtor is experiencing financial difficulty. The amendments in this ASU are effective for the first interim or annual period beginning on or after June 15, 2011. Early adoption is permitted. Retrospective application to the beginning of the annual period of adoption for modifications occurring on or after the beginning of the annual adoption period is required. As a result of applying these amendments, an entity may identify receivables that are newly considered to be impaired. For purposes of measuring impairment of those receivables, an entity should apply the amendments prospectively for the first interim or annual period beginning on or after June 15, 2011. The Company will adopt ASU 2011-02 and include the required disclosures in its consolidated financial statements in the third quarter 10-Q report. In April 2011, the FASB issued ASU 2011-03, "Transfers and Servicing (Topic 860) - Reconsideration of Effective Control for Repurchase Agreements." The amendments in this ASU remove from the assessment of effective control (1) the criterion requiring the transferor to have the ability to repurchase or redeem the financial assets on substantially the agreed terms, even in the event of default by the transferee and (2) the collateral maintenance implementation guidance related to that criterion. The amendments in this ASU are effective for the first interim or annual period beginning on or after December 15, 2011. The guidance should be applied prospectively to transactions or modifications of existing transactions that occur on or after the effective date. Early adoption is not permitted. The Company is currently assessing the impact that ASU 2011-03 will have on its consolidated financial statements. In May 2011, the FASB issued ASU 2011-04, "Fair Value Measurement (Topic 820) - Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs." This ASU is the result of joint efforts by the FASB and IASB to develop a single, converged fair value framework on how (not when) to measure fair value and what disclosures to provide about fair value measurements. The ASU is largely consistent with existing fair value measurement principles in U.S. GAAP (Topic 820), with many of the amendments made to eliminate unnecessary wording differences between U.S. GAAP and IFRSs. The amendments are effective for interim and annual periods beginning after December 15, 2011 with prospective application. Early application is not permitted. The Company is currently assessing the impact that ASU 2011-04 will have on its consolidated financial statements. In June 2011, the FASB issued ASU 2011-05, "Comprehensive Income (Topic 220) - Presentation of Comprehensive Income." The objective of this ASU is to improve the comparability, consistency and transparency of financial reporting and to increase the prominence of items reported in other comprehensive income by eliminating the option to present components of other comprehensive income as part of the statement of changes in stockholders' equity. The amendments require that all non-owner changes in stockholders' equity be presented either in a single continuous statement of comprehensive income or in two separate but consecutive statements. The single statement of comprehensive income should include the components of net income, a total for net income, the components of other comprehensive income, a total for other comprehensive income, and a total for comprehensive income. 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 all the components of other comprehensive income, a total for other comprehensive income, and a total for comprehensive income. The amendments do not change the items that must be reported in other comprehensive income, the option for an entity to present components of other comprehensive income either net of related tax effects or before related tax effects, or the calculation or reporting of earnings per share. The amendments in this ASU should be applied retrospectively. The amendments are effective for fiscal years and interim periods within those years beginning after December 15, 2011. Early adoption is permitted because compliance with the amendments is already permitted. The amendments do not require transition disclosures. The Company is currently assessing the impact that ASU 2011-05 will have on its consolidated financial statements. 36-------------------------------------------------------------------------------- Table of Contents Securities and Exchange Commission Web Site The Securities and Exchange Commission maintains a Web site (http://www.sec.gov) that contains reports, proxy and information statements and other information regarding registrants that file electronically with the Commission, including Pioneer Bankshares, Inc. 37 -------------------------------------------------------------------------------- Table of Contents TABLE I PIONEER BANKSHARES, INC. NET INTEREST MARGIN ANALYSIS (On a Fully Tax Equivalent Basis) (Dollar Amounts in Thousands) Six Months Ended Six Months Ended June 30, 2011 June 30, 2010 Average Income/ Average Income/ Balance Expense Rates Balance Expense Rates Interest Income Loans 1 Commercial $ 5,647 $ 187 6.62 % $ 6,817 $ 234 6.87 % Real estate 107,424 3,355 6.25 % 105,622 3,332 6.31 % Installment 17,249 827 9.59 % 15,723 754 9.59 % Credit Card 628 52 16.56 % 614 53 17.26 % Federal funds sold 5,159 6 0.23 % 2,350 3 0.26 % Interest Bearing Deposits 13,172 51 0.77 % 10,030 68 1.36 % Investments Taxable 4,307 57 2.65 % 5,777 106 3.67 % Nontaxable 2 5,530 82 2.97 % 6,347 141 4.44 % Total earning assets 159,116 4,617 5.80 % 153,280 4,691 6.12 % Interest Expense Demand deposits 25,434 86 0.68 % 19,872 67 0.67 % Savings 16,167 26 0.32 % 16,165 26 0.32 % Time deposits 70,540 585 1.66 % 70,331 796 2.26 % Borrowings 8,461 47 1.11 % 9,998 49 0.98 % Total Interest Bearing Liabilities $ 120,602 $ 744 1.23 % $ 116,366 $ 938 1.61 % Net Interest Income 3,873 3,753 Net Interest Margin 4.87 % 4.90 % 1 Nonaccrual loans are included in computing the average balances. 2 An incremental tax rate of 34% and a 70% dividend exclusion was used to calculate the tax equivalent income. 38 -------------------------------------------------------------------------------- Table of Contents PIONEER BANKSHARES, INC. NET INTEREST MARGIN ANALYSIS (On a Fully Tax Equivalent Basis) (Dollar Amounts in Thousands) Three Months Ended Three Months Ended June 30, 2011 June 30, 2010 Average Income/ Average Income/ Balance Expense Rates Balance Expense Rates Interest Income Loans 1 Commercial $ 5,815 $ 96 6.60 % $ 6,613 $ 107 6.47 % Real estate 107,340 1,687 6.29 % 106,506 1,682 6.32 % Installment 17,521 422 9.63 % 15,812 377 9.54 % Credit card 634 26 16.40 % 609 26 17.08 % Federal funds sold 4,865 3 0.25 % 1,897 1 0.21 % Interest Bearing Deposits 13,268 24 0.72 % 12,282 38 1.24 % Securities Taxable 4,824 30 2.49 % 6,252 52 3.33 % Nontaxable 2 5,499 19 1.38 % 6,296 71 4.51 % Total earning assets 159,766 2,307 5.78 % 156,267 2,354 5.91 % Interest Expense Demand deposits 25,204 42 0.67 % 20,853 32 0.61 % Savings 16,303 13 0.32 % 16,409 16 0.39 % Time deposits 71,485 292 1.63 % 69,743 372 2.13 % Borrowings 7,675 22 1.15 % 11,863 43 1.45 % Total Interest Bearing Liabilities $ 120,667 $ 369 1.22 % $ 118,868 $ 463 1.56 % Net Interest Income $ 1,938 $ 1,891 Net Interest Margin 4.85 % 4.84 % 1 Nonaccrual loans are included in computing the average balances. 2 An incremental tax rate of 34% and a 70% dividend exclusion was used to calculate the tax equivalent income. 39 -------------------------------------------------------------------------------- Table of Contents TABLE II PIONEER BANKSHARES, INC. INTEREST SENSITIVITY ANALYSIS JUNE 30, 2011 (Dollar Amounts in Thousands) 0-3 4-12 1-5 Over 5 Not Months Months Years Years Classified Total Uses of Funds: Loans1 $ 12,891 $ 9,482 $ 62,989 $ 46,636 $ - $ 131,998 Interest bearing bank deposits 5,770 3,250 2,000 - - 11,020 Investment securities2 2,500 - 3,639 2,755 815 9,709 Restricted stock - - - - 857 857 Federal funds sold 500 - - - - 500 Total 21,661 12,732 68,628 49,391 1,672 154,084 Sources of Funds: Interest bearing demand deposits 21,473 - - - - 21,473 Regular savings 15,998 - - - - 15,998 Certificates of deposit $100,000 and over 2,611 11,719 11,143 - - 25,473 Other certificates of deposit 3,369 19,537 21,954 - - 44,860 Borrowings - - 7,000 - - 7,000 Total $ 43,451 $ 31,256 $ 40,097 $ - $ - $ 114,804 Discrete Gap $ (21,790 ) $ (18,524 ) $ 28,531 $ 49,391 $ 1,672 $ 39,280 Cumulative Gap $ (21,790 ) $ (40,314 ) $ (11,783 ) $ 37,608 $ 39,280 Ratio of Cumulative Gap To Total Earning Assets at June 30, 2011 -14.14 % -26.16 % -7.65 % 24.41 % 25.49 % Ratio of Cumulative Gap To Total Earning Assets at December 31, 2010 -25.62 % -34.19 % -9.92 % 21.86 % 23.49 % 1 Nonaccrual loans are included in the loan totals. 2 Investment securities are reflected at fair value. 40 -------------------------------------------------------------------------------- Table of Contents |