First Mid Bancshares - 10-Q quarterly report FY

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes [X]  No [  ]

Indicate by check mark whether the Registrant 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):

Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Act).  [  ] Yes  [X] No

As of November 7, 2007, 6,291,336 common shares, $4.00 par value, were outstanding.

The unaudited condensed consolidated financial statements include the accounts of First Mid-Illinois Bancshares, Inc. (“Company”) and the following wholly-owned subsidiaries: Mid-Illinois Data Services, Inc. (“MIDS”), The Checkley Agency, Inc. (“Checkley”), and First Mid-Illinois Bank & Trust, N.A. (“First Mid Bank”).  All significant intercompany balances and transactions have been eliminated in consolidation.  The financial information reflects all adjustments which, in the opinion of management, are necessary for a fair presentation of the results of the interim periods ended September 30, 2007 and 2006, and all such adjustments are of a normal recurring nature.  Certain amounts in the prior year’s consolidated financial statements have been reclassified to conform to the September 30, 2007 presentation and there was no impact on net income or stockholders’ equity.  The results of the interim period ended September 30, 2007 are not necessarily indicative of the results expected for the year ending December 31, 2007. The Company operates as a one-segment entity for financial reporting purposes.

The 2006 year-end consolidated balance sheet data was derived from audited financial statements, but does not include all disclosures required by generally accepted accounting principles.

The unaudited condensed consolidated financial statements have been prepared in accordance with the instructions to Form 10-Q and Article 10 of Regulation S-X and do not include all of the information required by U.S. generally accepted accounting principles for complete financial statements and related footnote disclosures although the Company believes that the disclosures made are adequate to make the information not misleading.  These financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in the Company’s 2006 Annual Report on Form 10-K.

At the Annual Meeting of Stockholders held May 23, 2007, the stockholders approved the First Mid-Illinois Bancshares, Inc. 2007 Stock Incentive Plan (“SI Plan”).  The SI Plan was implemented to succeed the Company’s 1997 Stock Incentive Plan, which had a ten-year term that expired October 21, 2007. The SI Plan is intended to provide a means whereby directors, employees, consultants and advisors of the Company and its Subsidiaries may sustain a sense of proprietorship and personal involvement in the continued development and financial success of the Company and its Subsidiaries, thereby advancing the interests of the Company and its stockholders.  Accordingly, directors and selected employees, consultants and advisors may be provided the opportunity to acquire shares of Common Stock of the Company on the terms and conditions established herein in the SI Plan.

A maximum of 300,000 shares may be issued under the SI Plan.  As of September 30, 2007, no shares have been awarded.

On June 29, 2007, the Company effected a three-for-two stock split in the form of a 50% stock dividend for all shareholders of record as of June 18, 2007. Accordingly, an entry was made for $9,493,000 to increase the common stock account and decrease the retained earnings account. Par value remained at $4 per share.  All current and prior period share and per share amounts have been restated giving retroactive recognition to the stock split.

On May 23, 2007, the Company retired 1,500,000 shares of its treasury stock (after adjustment for stock split), the cost of which was determined using the first-in, first-out method.  Accordingly, an entry was made to decrease the treasury stock account for $21,021,000, the common stock account for $4,000,000 and the retained earnings account for $17,021,000.

The Company maintains a website at www.firstmid.com. All periodic and current reports of the Company and amendments to these reports filed with the Securities and Exchange Commission (“SEC”) can be accessed, free of charge, through this website as soon as reasonably practicable after these materials are filed with the SEC.

The Company’s comprehensive income for the three and nine-month periods ended September 30, 2007 and 2006 was as follows (in thousands):

In September 2006, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards No. 157 (FAS 157), “Fair Value Measurements,” which provides enhanced guidance for using fair value to measure assets and liabilities.  FAS 157 establishes a common definition of fair value, provides a framework for measuring fair value under U.S. Generally Accepted Accounting Principles and expands disclosures requirements about fair value measurements.  FAS 157 is effective for financial statements issued in fiscal years beginning after November 15, 2007, and interim periods within those fiscal years.  The Company is currently evaluating the impact, if any, the adoption of FAS 157 will have on its financial reporting and disclosures.

In September 2006, the FASB issued Statement of Financial Accounting Standards No. 158 (FAS 158), “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans—an amendment of FASB Statements No. 87, 88, 106, and 132(R),” which requires recognition of a net liability or asset to report the funded status of defined benefit pension and other postretirement plans on the balance sheet and recognition (as a component of other comprehensive income) of changes in the funded status in the year in which the changes occur.  Additionally, FAS 158 requires measurement of a plan’s assets and obligations as of the balance sheet date and additional disclosures in the notes to the financial statements.  The recognition and disclosure provisions of FAS 158 are effective for fiscal years ending after December 15, 2006, while the requirement to measure a plan’s assets and obligations as of the balance sheet date is effective for fiscal years ending after December 15, 2008. There was no material impact in regard to adoption of the recognition and disclosure provisions of FAS 158. The Company is currently evaluating the impact the adoption of the remaining provisions of FAS 158 will have on its financial reporting and disclosures.

In February 2007, the FASB issued Statement of Financial Accounting Standards No. 159 (FAS 159), “The Fair Value Option for Financial Assets and Financial Liabilities – Including amendment of FASB Statement No. 115.” FAS 159 allows companies to report selected financial assets and liabilities at fair value.  The changes in fair value are recognized in earnings and the assets and liabilities measured under this methodology are required to be displayed separately in the balance sheet.  The main intent of FAS 159 is to mitigate the difficulty in determining reported earnings caused by a “mixed-attribute model” (that is, reporting some assets at fair value and others using a different valuation method such as amortized cost). The project is separated into two phases. This first phase addresses the creation of a fair value option for financial assets and liabilities.  A second phase will address creating a fair value option for selected non-financial items. FAS 159 is effective for all financial statements issued for fiscal years beginning after November 15, 2007.  The Company is currently evaluating the impact, if any, the adoption of FAS 159 would have on its financial reporting and disclosures.

A three-for-two common stock split was effected on June 29, 2007, in the form of a 50% stock dividend for the stockholders of record at the close of business on June 18, 2007.  Accordingly, information with respect to shares of common stock and earnings per share has been restated for current and prior periods presented to fully reflect the stock split. Basic earnings per share (“EPS”) is calculated as net income divided by the weighted average number of common shares outstanding.  Diluted EPS is computed using the weighted average number of common shares outstanding, increased by the assumed conversion of the Company’s stock options, unless anti-dilutive.

The components of basic and diluted earnings per common share for the three and nine-month periods ended September 30, 2007 and 2006 were as follows:

Stock options for 94,500 shares of common stock were not considered in computing diluted earnings per share for 2007 because they were anti-dilutive.

On May 1, 2006, the Company completed the acquisition, for $24 million in cash, of all of the outstanding common stock of Mansfield Bancorp, Inc. (“Mansfield”) and its wholly-owned subsidiary, Peoples State Bank of Mansfield (“Peoples State Bank”), located in Mansfield, Mahomet and Weldon, Illinois, in order to expand its market presence in this area. The Company financed the purchase price through a dividend of $5 million from First Mid Bank, an issuance of $10 million of trust preferred securities and a $9.5 million draw on the Company’s line of credit with The Northern Trust Company. Following the completion of the acquisition during the third quarter of 2006, Mansfield merged with and into Peoples State Bank and Peoples State Bank merged with and into First Mid Bank. Following the completion of these mergers, Mansfield and Peoples State Bank ceased to exist and Peoples State Bank’s operations were merged into First Mid Bank’s.

 

The transaction has been accounted for as a purchase, and the results of operations of Mansfield and Peoples since the acquisition date have been included in the consolidated financial statements.  The following table summarizes the estimated fair values of the assets acquired and liabilities assumed at the date of this transaction (in thousands):

Transaction costs related to the completion of the transaction were approximately $255,000.  The fair value of deposits acquired in the transaction exceeded the book value, resulting in a core deposit intangible asset of $3,132,000, which is being amortized over 10 years.  The total fair value of the assets and liabilities acquired exceeded the book value, resulting in goodwill of $8,329,000, which is not subject to amortization.  The core deposit intangibles and goodwill are not deductible for tax purposes.

 

The following unaudited pro forma condensed combined financial information presents the results of operations of the Company, including the effects of the purchase accounting adjustments, issuance of trust preferred securities and bank loan, had the acquisition taken place at the beginning of 2006 (in thousands):

The unaudited pro forma condensed combined financial statements do not reflect any anticipated cost savings and revenue enhancements.  Additionally, the income statement for the first three months of 2006 includes merger-related expenses.  Accordingly, the pro forma results of operations of the Company as of and after the merger may not be indicative of the results that actually would have occurred if the merger had been in effect during the period presented or of the results that may be attained in the future.

The Company has goodwill from business combinations, intangible assets from branch acquisitions, and identifiable intangible assets assigned to core deposit relationships and customer lists of Checkley.

The following table presents gross carrying value and accumulated amortization by major intangible asset class as of September 30, 2007 and December 31, 2006 (in thousands):

Total amortization expense for the nine months ended September 30, 2007 and 2006 was as follows (in thousands):

Aggregate amortization expense for the current year and estimated amortization expense for each of the five succeeding years is shown in the table below (in thousands):

 

In accordance with the provisions of SFAS 142, the Company performed testing of goodwill for impairment as of September 30, 2007 and determined that, as of that date, goodwill was not impaired.  Management also concluded that the remaining amounts and amortization periods were appropriate for all intangible assets.

The Company owns approximately $3.7 million of Federal Home Loan Bank stock included in other assets. During the third quarter of 2007, the Federal Home Loan Bank of Chicago received a Cease and Desist Order from their regulator, the Federal Housing Finance Board.  The draft order prohibits capital stock repurchases and redemptions until a time to be determined by the Federal Housing Finance Board. The Federal Home Loan Bank will continue to provide liquidity and funding through advances and the purchases of mortgages through the MPF Program.  With regard to dividends, the Federal Home Loan Bank will continue to access their dividend capacity each quarter and make appropriate request for approval.

Securities sold under agreements to repurchase had seasonal declines of $7.8 million during the first nine months of 2007. Other borrowings increased $26.2 million during the nine-month period ended September 30, 2007. This increase was primarily due to an increase of $28 million in Federal Home Loan Bank advances which were used to offset the decline in federal funds purchased and repurchase agreement balances.

The following discussion and analysis is intended to provide a better understanding of the consolidated financial condition and results of operations of the Company and its subsidiaries as of, and for the three and nine month periods ended, September 30, 2007 and 2006.  This discussion and analysis should be read in conjunction with the consolidated financial statements, related notes and selected financial data appearing elsewhere in this report.

This report contains certain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), such as discussions of the Company’s pricing and fee trends, credit quality and outlook, liquidity, new business results, expansion plans, anticipated expenses and planned schedules.  The Company intends such forward-looking statements to be covered by the safe harbor provisions for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995, and is including this statement for purposes of these safe harbor provisions.  Forward-looking statements, which are based on certain assumptions and describe future plans, strategies and expectations of the Company, are identified by use of the words “believe”, “expect”, “intend”, “anticipate”, “estimate”, “project”, or similar expressions.  Actual results could differ materially from the results indicated by these statements because the realization of those results is subject to many risks and uncertainties including: changes in interest rates, general economic conditions, legislative/regulatory changes, monetary and fiscal policies of the U.S. government, including policies of the U.S. Treasury and the Federal Reserve Board, the quality or composition of the loan or investment portfolios, demand for loan products, deposit flows, competition, demand for financial services in the Company’s market area and accounting principles, policies and guidelines.  These risks and uncertainties should be considered in evaluating forward-looking statements and undue reliance should not be placed on such statements.  Further information concerning the Company and its business, including  a discussion of these and additional factors that could materially affect the Company’s financial results, is included in the Company’s 2006 Annual Report on Form 10-K under the headings ”Item 1. Business” and “Item 1A. Risk Factors."

On September 29, 2007, the Company closed its facilities located at 435 South Hamilton, Sullivan, Illinois in the IGA and at 220 North Highway Avenue, DeLand, Illinois. The customers and operations of both of these facilities were moved to other facilities in Sullivan and Monticello, Illinois. The Company does not expect the closing or moving of these facilities to have a material impact on its other operations or on its financial reporting and disclosures.

This overview of management’s discussion and analysis highlights selected information in this document and may not contain all of the information that is important to you. For a more complete understanding of trends, events, commitments, uncertainties, liquidity, capital resources, and critical accounting estimates which have an impact on the Company’s financial condition and results of operations you should carefully read this entire document.

Net income was $7,470,000 and $7,359,000 and diluted earnings per share was $1.15 and $1.11 for the nine months ended September 30, 2007 and 2006, respectively. The following table shows the Company’s annualized performance ratios for the nine months ended September 30, 2007 and 2006, compared to the performance ratios for the year ended December 31, 2006:

Total assets at September 30, 2007 and December 31, 2006 were $1,020.6 million and $980.6 million, respectively. The increase in net assets was primarily due to an increase in federal funds sold, available-for-sale securities and commercial real estate and commercial and agricultural operating loans.  Net loan balances were $734.5 million at September 30, 2007, an increase of $19 million, or 2.7%, from $715.5 million at December 31, 2006. Total deposit balances increased to $790.9 million at September 30, 2007 from $770.6 million at December 31, 2006.

Net interest margin, defined as net interest income divided by average interest-earning assets, was 3.39% for the nine months ended September 30, 2007, down from 3.52% for the same period in 2006. The decrease in the net interest margin is attributable to a greater increase in borrowing and deposit rates compared to the increase in interest-earning asset rates.  Net interest income before the provision for loan losses was $23.2 million compared to net interest income of $22.7 million for the same period in 2006. The increase was due to growth in average earning assets of $51 million for the nine months ended September 30, 2007 compared to the same period in 2006.

Noninterest income increased $1.2 million, or 11.9%, to $11 million for the nine months ended September 30, 2007 compared to $9.8 million for the nine months ended September 30, 2006. The increase in income is primarily due to the acquisition of Mansfield accounts that led to increased service charges and greater ATM and debit card fees.

Noninterest expense increased 7.2%, or $1.5 million, to $22.4 million for the nine months ended September 30, 2007 compared to $20.9 million during the same period in 2006.  In addition to increases in noninterest expense due to the acquisition of Mansfield, other factors in the expense increase were increased salaries and benefits expense that resulted from merit increases for continuing employees and an increase in legal and professional expenses.

Following is a summary of the factors that contributed to the changes in net income (in thousands):

Credit quality is an area of importance to the Company. Total nonperforming loans were $7.1 million at September 30, 2007, compared to $3.6 million at September 30, 2006 and $3.7 million at December 31, 2006.  This increase was primarily due to insufficient cash flow on commercial real estate loans to one borrower which totaled $3 million. The Company’s provision for loan losses for the nine months ended September 30, 2007 and 2006 was $598,000 and $575,000, respectively.  At September 30, 2007, the composition of the loan portfolio remained similar to the same period last year. During the nine months ended September 30, 2007, annualized net charge-offs were .06% of average loans compared to .13% for the same period in 2006. Loans secured by both commercial and residential real estate comprised 70% of the loan portfolio as of September 30, 2007 and 2006.

The Company owns approximately $3.7 million of Federal Home Loan Bank stock included in other assets. During the third quarter of 2007, the Federal Home Loan Bank of Chicago received a Cease and Desist Order from their regulator, the Federal Housing Finance Board.  The draft order prohibits capital stock repurchases and redemptions until a time to be determined by the Federal Housing Finance Board. The Federal Home Loan Bank will continue to provide liquidity and funding through advances and the purchases of mortgages through the MPF Program.  With regard to dividends, the Federal Home Loan Bank will continue to access their dividend capacity each quarter and make appropriate for approval.

The Company’s capital position remains strong and the Company has consistently maintained regulatory capital ratios above the “well-capitalized” standards. The Company’s Tier 1 capital to risk weighted assets ratio calculated under the regulatory risk-based capital requirements at September 30, 2007 and 2006 was 10.34% and 9.98%, respectively. The Company’s total capital to risk weighted assets ratio calculated under the regulatory risk-based capital requirements at September 30, 2007 and 2006 was 11.16% and 10.80%, respectively.

The Company’s liquidity position remains sufficient to fund operations and meet the requirements of borrowers, depositors, and creditors. The Company maintains various sources of liquidity to fund its cash needs. See discussion under the heading “Liquidity” for a full listing of sources and anticipated significant contractual obligations. The Company enters into financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include lines of credit, letters of credit and other commitments to extend credit.  The total outstanding commitments at September 30, 2007 and 2006 were $148 million and $125.7 million, respectively.  This increase is primarily attributable to increases in commercial real estate lines of credit.

The Company has established various accounting policies that govern the application of U.S. generally accepted accounting principles in the preparation of the Company’s financial statements. The significant accounting policies of the Company are described in the footnotes to the consolidated financial statements included in the Company’s 2006 Annual Report on Form 10-K. Certain accounting policies involve significant judgments and assumptions by management that have a material impact on the carrying value of certain assets and liabilities; management considers such accounting policies to be critical accounting policies. The judgments and assumptions used by management are based on historical experience and other factors, which are believed to be reasonable under the circumstances. Because of the nature of the judgments and assumptions made by management, actual results could differ from these judgments and assumptions, which could have a material impact on the carrying values of assets and liabilities and the results of operations of the Company.

The Company believes the allowance for loan losses is the critical accounting policy that requires the most significant judgments and assumptions used in the preparation of its consolidated financial statements. In estimating the allowance for loan losses, management utilizes historical experience, as well as other factors, including the effect of changes in the local real estate market on collateral values, the effect on the loan portfolio of current economic indicators and their probable impact on borrowers, and increases or decreases in nonperforming and impaired loans. Changes in these factors may cause management’s estimate of the allowance for loan losses to increase or decrease and result in adjustments to the Company’s provision for loan losses. See heading “Loan Quality and Allowance for Loan Losses” for a more detailed description of the Company’s estimation process and methodology related to the allowance for loan losses.

The largest source of revenue for the Company is net interest income. Net interest income represents the difference between total interest income earned on earning assets and total interest expense paid on interest-bearing liabilities.  The amount of interest income is dependent upon many factors, including the volume and mix of earning assets, the general level of interest rates and the dynamics of changes in interest rates.  The cost of funds necessary to support earning assets varies with the volume and mix of interest-bearing liabilities and the rates paid to attract and retain such funds.  The Company’s average balances, interest income and expense and rates earned or paid for major balance sheet categories are set forth in the following table (dollars in thousands):

 

Changes in net interest income may also be analyzed by segregating the volume and rate components of interest income and interest expense.  The following table summarizes the approximate relative contribution of changes in average volume and interest rates to changes in net interest income for the nine months ended September 30, 2007, compared to the same period in 2006 (in thousands):

Net interest income increased $.5 million, or 2.1%, to $23.2 million for the nine months ended September 30, 2007, from $22.7 million for the same period in 2006. The increase in net interest income was due to growth in earning assets, primarily composed of loan growth, partially offset by a reduction in the net interest margin.

For the nine months ended September 30, 2007, average earning assets increased by $51 million, or 5.9%, and average interest-bearing liabilities increased $42.8 million, or 5.8%, compared with average balances for the same period in 2006. The changes in average balances for these periods are shown below:

 

 

 

 

 

To compare the tax-exempt yields on interest-earning assets to taxable yields, the Company also computes non-GAAP net interest income on a tax equivalent basis (TE) where the interest earned on tax-exempt securities is adjusted to an amount comparable to interest subject to normal income taxes assuming a federal tax rate of 34% (referred to as the tax equivalent adjustment). The net yield on interest-earning assets (TE) was 3.45% for the first nine months of 2007 and 3.57% for the first nine months of 2006. The TE adjustments to net interest income for September 30, 2007 and 2006 were $270,000 and $299,000, respectively.

The provision for loan losses for the nine months ended September 30, 2007 and 2006 was $598,000 and $575,000, respectively.  Nonperforming loans were $7.1 million and $3.6 million as of September 30, 2007 and 2006, respectively.  Net charge-offs were $338,000 for the nine months ended September 30, 2007 compared to $652,000 during the same period in 2006.  For information on loan loss experience and nonperforming loans, see discussion under the “Nonperforming Loans” and “Loan Quality and Allowance for Loan Losses” sections below.

An important source of the Company’s revenue is derived from other income.  The following table sets forth the major components of other income for the three and nine months ended September 30, 2007 and 2006 (in thousands):

Following are explanations of the changes in these other income categories for the three months ended September 30, 2007 compared to the same period in 2006:

First Mid Bank generally releases the servicing rights on loans sold into the secondary market.

Following are explanations of the changes in these other income categories for the nine months ended September 30, 2007 compared to the same period in 2006:

First Mid Bank generally releases the servicing rights on loans sold into the secondary market.

The major categories of other expense include salaries and employee benefits, occupancy and equipment expenses and other operating expenses associated with day-to-day operations.  The following table sets forth the major components of other expense for the three and nine months ended September 30, 2007 and 2006 (in thousands):

Following are explanations for the changes in these other expense categories for the three months ended September 30, 2007 compared to the same period in 2006:

Following are explanations for the changes in these other expense categories for the nine months ended September 30, 2007 compared to the same period in 2006:

Total income tax expense amounted to $3,693,000 (33.1% effective tax rate) for the nine months ended September 30, 2007, compared to $3,691,000 (33.4% effective tax rate) for the same period in 2006.

The loan portfolio (net of unearned interest) is the largest category of the Company’s earning assets.  The following table summarizes the composition of the loan portfolio, including loans held for sale, as of September 30, 2007 and December 31, 2006 (in thousands):

Overall loans increased $18.5 million, or 2.6%.  The increase was primarily a result of increases in commercial real estate, commercial and agricultural operating loans and installment loans. Total real estate mortgage loans have averaged approximately 70% of the Company’s total loan portfolio for the past several years.  This is the result of the Company’s focus on commercial real estate lending and long-term commitment to residential real estate lending.  The balance of real estate loans held for sale amounted to $1,459,000 and $2,234,000 as of September 30, 2007 and December 31, 2006, respectively.

At September 30, 2007, the Company had loan concentrations in agricultural industries of $109.7 million, or 14.8%, of outstanding loans and $109.7 million, or 15.2%, at December 31, 2006.  In addition, the Company had loan concentrations in the following industries as of September 30, 2007 compared to December 31, 2006 (dollars in thousands):

The change in the lessors of non-residential buildings category is due to a change in the classification system used which resulted in several loans being reclassified into this category, as well as increased balances of several loans. The Company had no further loan concentrations in excess of 25% of total risk-based capital.

The following table presents the balance of loans outstanding as of September 30, 2007, by maturities (in thousands):

As of September 30, 2007, loans with maturities over one year consisted of approximately $360 million in fixed rate loans and $64 million in variable rate loans. The loan maturities noted above are based on the contractual provisions of the individual loans.  Rollovers and borrower requests are handled on a case-by-case basis.

Nonperforming loans are defined as: (a) loans accounted for on a nonaccrual basis; (b) accruing loans contractually past due ninety days or more as to interest or principal payments; and (c) loans not included in (a) and (b) above which are defined as "renegotiated loans".  The Company’s policy is to cease accrual of interest on all loans that become ninety days past due as to principal or interest.  Nonaccrual loans are returned to accrual status when, in the opinion of management, the financial position of the borrower indicates there is no longer any reasonable doubt as to the timely collection of interest or principal.

The following table presents information concerning the aggregate amount of nonperforming loans at September 30, 2007 and December 31, 2006 (in thousands):

The $3,466,000 increase in nonaccrual loans during the nine months ended September 30, 2007 resulted from the net of $5,269,000 of additional loans put on nonaccrual status, $1,626,000 of loans brought current or paid-off, $141,000 of loans transferred to other real estate owned and $36,000 of loans charged-off. The increase in loans put on nonaccrual status was primarily due to the addition of commercial real estate loans to one borrower which totaled $3 million.

Interest income that would have been reported if nonaccrual and renegotiated loans had been performing totaled $95,000 and $0 for the three-month periods ended September 30, 2007 and 2006, respectively and $364,000 and $65,000 for the nine-month periods ended September 30, 2007 and 2006, respectively.

The allowance for loan losses represents management’s estimate of the reserve necessary to adequately account for probable losses attributable to current loan exposures. The provision for loan losses is the charge against current earnings that is determined by management as the amount needed to maintain an adequate allowance for loan losses.  In determining the adequacy of the allowance for loan losses, and therefore the provision to be charged to current earnings, management relies predominantly on a disciplined credit review and approval process that extends to the full range of the Company’s credit exposure.  The review process is directed by overall lending policy and is intended to identify, at the earliest possible stage, borrowers who might be facing financial difficulty.  Once identified, the magnitude of exposure to individual borrowers is quantified in the form of specific allocations of the allowance for loan losses.  Management considers collateral values and guarantees in the determination of such specific allocations.  Additional factors considered by management in evaluating the overall adequacy of the allowance include historical net loan losses, the level and composition of nonaccrual, past due and renegotiated loans, trends in volumes and terms of loans, effects of changes in risk selection and underwriting standards or lending practices, lending staff changes, concentrations of credit, industry conditions and the current economic conditions in the region where the Company operates.  Management considers the allowance for loan losses a critical accounting policy.

Management recognizes there are risk factors that are inherent in the Company’s loan portfolio.  All financial institutions face risk factors in their loan portfolios because risk exposure is a function of the business.  The Company’s operations (and therefore its loans) are concentrated in east central Illinois, an area where agriculture is the dominant industry.  Accordingly, lending and other business relationships with agriculture-based businesses are critical to the Company’s success.  At September 30, 2007, the Company’s loan portfolio included $109.7 million of loans to borrowers whose businesses are directly related to agriculture.  The balance did not change from $109.7 million at December 31, 2006.  While the Company adheres to sound underwriting practices, including collateralization of loans, any extended period of low commodity prices, significantly reduced yields on crops and/or reduced levels of government assistance to the agricultural industry could result in an increase in the level of problem agriculture loans and potentially result in loan losses within the agricultural portfolio.

In addition, the Company has $29.5 million of loans to motels, hotels and tourist courts.  The performance of these loans is dependent on borrower specific issues as well as the general level of business and personal travel within the region.  While the Company adheres to sound underwriting standards, a prolonged period of reduced business or personal travel could result in an increase in non-performing loans to this business segment and potentially in loan losses. The Company also has $66.2 million of loans to lessors of non-residential buildings, $54.4 million of loans to lessors of residential buildings and dwellings and $20.1 million of loans to land subdividers. A significant widespread decline in real estate values could result in an increase in non-performing loans to this segment and potentially in loan losses.

Analysis of the allowance for loan losses as of September 30, 2007 and 2006, and of changes in the allowance for the three and nine-month periods ended September 30, 2007 and 2006, is as follows (dollars in thousands):