MBCN 10-Q Quarter ended Sept. 30, 2013

FORM 10 - Q

QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT

OF 1934

For the quarterly period ended September 30, 2013

Commission File Number 000-32561

15985 East High Street, Middlefield, Ohio 44062-9263

(Address of principal executive offices)

(440) 632-1666

(Registrant's telephone number, including area code)

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 [√] NO [ ]

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (Section 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 [√] NO [ ]

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definition of “large accelerated filer”, “accelerated filer”, and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer [ ]  Accelerated filer [ ]  Non-accelerated filer [ ]  Small reporting company [√]

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

YES [ ]   NO [√]

State the number of shares outstanding of each of the issuer's classes of common equity as of the latest practicable date:

MIDDLEFIELD BANC CORP.

INDEX

MIDDLEFIELD BANC CORP.

CONSOLIDATED BALANCE SHEET

(Dollar amounts in thousands)

(Unaudited)

See accompanying notes to unaudited consolidated financial statements.

MIDDLEFIELD BANC CORP.

CONSOLIDATED STATEMENT OF INCOME

(Dollar amounts in thousands, except per share data)

(Unaudited)

		Three Months Ended September 30,								Nine Months Ended September 30,
		2013				2012				2013				2012
INTEREST INCOME
Interest and fees on loans		$	5,754			$	5,810			$	16,876			$	16,988
Interest-bearing deposits in other institutions			6				7				23				19
Federal funds sold			4				6				12				13
Investment securities:
Taxable interest			610				749				1,909				2,455
Tax-exempt interest			782				749				2,259				2,249
Dividends on stock			18				21				56				73
Total interest income			7,174				7,342				21,135				21,797
INTEREST EXPENSE
Deposits			1,170				1,418				3,686				4,349
Short-term borrowings			41				61				140				219
Federal funds purchased			1				-				1				-
Other borrowings			41				78				131				244
Trust preferred securities			75				45				156				122
Total interest expense			1,328				1,602				4,114				4,934
NET INTEREST INCOME			5,846				5,740				17,021				16,863
Provision for loan losses			153				143				766				1,193
NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES			5,693				5,597				16,255				15,670
NONINTEREST INCOME
Service charges on deposit accounts			510				481				1,468				1,383
Investment securities gains, net			-				152				175				448
Earnings on bank-owned life insurance			66				71				209				208
Gain on sale of loans			-				-				-				85
Other income			232				164				643				555
Total noninterest income			808				868				2,495				2,679
NONINTEREST EXPENSE
Salaries and employee benefits			1,872				1,705				5,649				5,255
Occupancy expense			273				233				795				703
Equipment expense			228				186				603				557
Data processing costs			209				184				609				574
Ohio state franchise tax			164				160				467				417
Federal deposit insurance expense			135				250				353				751
Professional fees			316				270				883				670
(Gain) loss on sale of other real estate owned			(35	)			188				(40	)			238
Advertising expense			113				114				336				346
Other real estate expense			128				68				324				341
Directors fees			77				97				315				279
Other expense			635				667				1,770				1,814
Total noninterest expense			4,115				4,122				12,064				11,945
Income before income taxes			2,386				2,343				6,686				6,404
Income taxes			521				494				1,479				1,392
NET INCOME		$	1,865			$	1,849			$	5,207			$	5,012
EARNINGS PER SHARE
Basic		$	0.92			$	0.93			$	2.59			$	2.66
Diluted			0.92				0.93				2.58				2.65
DIVIDENDS DECLARED PER SHARE		$	0.26			$	0.26			$	0.78			$	0.78

See accompanying notes to unaudited consolidated financial statements.

MIDDLEFIELD BANC CORP.

CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME

(Dollar amounts in thousands, except per share data)

(Unaudited)

		Three Months Ended September 30,								Nine Months Ended September 30,
		2013				2012				2013				2012
Net income		$	1,865			$	1,849			$	5,207			$	5,012
Other comprehensive income (loss):
Net unrealized holding gain (loss) on available for sale securities			(2,277	)			838				(10,558	)			2,662
Tax effect			774				(285	)			3,589				(905	)
Reclassification adjustment for investment securities gains included in net income			-				(152	)			(175	)			(448	)
Tax effect			-				52				60				152
Total other comprehensive income (loss)			(1,503	)			453				(7,084	)			1,461
Comprehensive income (loss)		$	362			$	2,302			$	(1,877	)		$	6,473

See accompanying notes to unaudited consolidated financial statements.

MIDDLEFIELD BANC CORP.

CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS EQUITY

(Dollar amounts in thousands, except share data)

(Unaudited)

		Common Stock				Retained Earnings				Accumulated Other Comprehensive Income (Loss)				Treasury Stock				Total Stockholders' Equity
Balance, December 31, 2012		$	34,295			$	22,485			$	5,391			$	(6,734	)		$	55,437
Net income							5,207												5,207
Comprehensive loss											(7,084	)							(7,084	)
Common stock issuance (13,320 shares), net of issuance cost ($139)			74																74
Dividend reinvestment and purchase plan (21,016 shares)			590																590
Stock options exercised			(126	)															(126	)
Cash dividends ($0.78 per share)							(1,569	)											(1,569	)
Balance, September 30, 2013		$	34,833			$	26,123			$	(1,693	)		$	(6,734	)		$	52,529

See accompanying notes to unaudited consolidated financial statements.

MIDDLEFIELD BANC CORP.

CONSOLIDATED STATEMENT OF CASH FLOWS

(Dollar amounts in thousands, except per share data)

(Unaudited)

See accompanying notes to unaudited consolidated financial statements.

MIDDLEFIELD BANC CORP.

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

The consolidated financial statements of Middlefield Banc Corp. ("Company") include its two bank subsidiaries The Middlefield Banking Company (“MB”) and Emerald Bank (“EB”) and a non-bank asset resolution subsidiary EMORECO, Inc. All significant inter-company items have been eliminated.

The accompanying financial statements have been prepared in accordance with U.S. generally accepted accounting principles and the instructions for Form 10-Q and Article 10 of Regulation S-X. In management’s opinion, the financial statements include all adjustments, consisting of normal recurring adjustments, that the Company considers necessary to fairly state the Company’s financial position and the results of operations and cash flows. The consolidated balance sheet at December 31, 2012, has been derived from the audited financial statements at that date but does not include all of the necessary informational disclosures and footnotes as required by U. S. generally accepted accounting principles. The accompanying financial statements should be read in conjunction with the financial statements and notes thereto included with the Company’s Form 10-K for the year ended December 31, 2012 (File No. 000-32561). The results of the Company’s operations for any interim period are not necessarily indicative of the results of the Company’s operations for any other interim period or for a full fiscal year.

Recent Accounting Pronouncements

In April 2013, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2013-07, Presentation of Financial Statements (Topic 205): Liquidation Basis of Accounting. The amendments in this Update are being issued to clarify when an entity should apply the liquidation basis of accounting. In addition, the guidance provides principles for the recognition and measurement of assets and liabilities and requirements for financial statements prepared using the liquidation basis of accounting. The amendments require an entity to prepare its financial statements using the liquidation basis of accounting when liquidation is imminent. Liquidation is imminent when the likelihood is remote that the entity will return from liquidation and either (a) a plan for liquidation is approved by the person or persons with the authority to make such a plan effective and the likelihood is remote that the execution of the plan will be blocked by other parties or (b) a plan for liquidation is being imposed by other forces (for example, involuntary bankruptcy). If a plan for liquidation was specified in the entity’s governing documents from the entity’s inception (for example, limited-life entities), the entity should apply the liquidation basis of accounting only if the approved plan for liquidation differs from the plan for liquidation that was specified at the entity’s inception. The amendments are effective for entities that determine liquidation is imminent during annual reporting periods beginning after December 15, 2013, and interim reporting periods therein. Entities should apply the requirements prospectively from the day that liquidation becomes imminent. Early adoption is permitted. Entities that use the liquidation basis of accounting as of the effective date in accordance with other Topics (for example, terminating employee benefit plans) are not required to apply the amendments. Instead, those entities should continue to apply the guidance in those other Topics until they have completed liquidation.

In June 2013, the FASB issued ASU 2013-08, Financial Services – Investment Companies (Topic 946): Amendments to the Scope, Measurement, and Disclosure Requirements. The amendments in this Update affect the scope, measurement, and disclosure requirements for investment companies under U.S. GAAP. The amendments do all of the following: 1. Change the approach to the investment company assessment in Topic 946, clarify the characteristics of an investment company, and provide comprehensive guidance for assessing whether an entity is an investment Company. 2. Require an investment company to measure noncontrolling ownership interests in other investment companies at fair value rather than using the equity method of accounting. 3. Require the following additional disclosures: (a) the fact that the entity is an investment company and is applying the guidance in Topic 946, (b) information about changes, if any, in an entity’s status as an investment company, and (c) information about financial support provided or contractually required to be provided by an investment company to any of its investees. The amendments in this Update are effective for an entity’s interim and annual reporting periods in fiscal years that begin after December 15, 2013. Earlier application is prohibited.

In July 2013, the FASB ASU 2013-09, Fair Value Measurement (Topic 820): Deferral of the Effective Date of Certain Disclosures for Nonpublic Employee Benefit Plans in Update No. 2011-04. The amendments in this Update apply to certain quantitative disclosure requirements for an employee benefit plan, other than those plans that are subject to the Securities and Exchange Commission’s filing requirements (hereafter “nonpublic employee benefit plan”), that holds investments in its plan sponsor’s own nonpublic entity equity securities, including equity securities of its plan sponsor’s nonpublic affiliated entities and that are within the scope of the disclosure requirements contained in FASB Accounting Standards Update No. 2011-04, Fair Value Measurement (Topic 820): Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs. The amendments in this Update defer indefinitely the effective date of certain required disclosures in Update 2011-04 (Topic 820) of quantitative information about the significant unobservable inputs used in Level 3 fair value measurements for investments held by a nonpublic employee benefit plan in its plan sponsor’s own nonpublic entity equity securities, including equity securities of its plan sponsor’s nonpublic affiliated entities. The amendments in this Update do not defer the effective date for those certain quantitative disclosures for other nonpublic entity equity securities held in the nonpublic employee benefit plan or any qualitative disclosures. The deferral in this amendment is effective upon issuance for financial statements that have not been issued.

In July 2013, the FASB issued ASU 2013-10, Derivatives and Hedging (Topic 815): Inclusion of the Fed Funds Effective Swap Rate (or Overnight Index Swap Rate) as a Benchmark Interest Rate for Hedge Accounting Purposes. The amendments in this Update permit the Fed Funds Effective Swap Rate (OIS) to be used as a U.S. benchmark interest rate for hedge accounting purposes under Topic 815, in addition to UST and LIBOR. The amendments also remove the restriction on using different benchmark rates for similar hedges. The amendments are effective prospectively for qualifying new or redesignated hedging relationships entered into on or after July 17, 2013.

In July 2013, the FASB issued ASU 2013-11, Income Taxes (Topic 740): Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists. This Update applies to all entities that have unrecognized tax benefits when a net operating loss carryforward, a similar tax loss, or a tax credit carryforward exists at the reporting date. An unrecognized tax benefit, or a portion of an unrecognized tax benefit, should be presented in the financial statements as a reduction to a deferred tax asset for a net operating loss carryforward, a similar tax loss, or a tax credit carryforward, except as follows. To the extent a net operating loss carryforward, a similar tax loss, or a tax credit carryforward is not available at the reporting date under the tax law of the applicable jurisdiction to settle any additional income taxes that would result from the disallowance of a tax position or the tax law of the applicable jurisdiction does not require the entity to use, and the entity does not intend to use, the deferred tax asset for such purpose, the unrecognized tax benefit should be presented in the financial statements as a liability and should not be combined with deferred tax assets. The assessment of whether a deferred tax asset is available is based on the unrecognized tax benefit and deferred tax asset that exist at the reporting date and should be made presuming disallowance of the tax position at the reporting date. The amendments in this Update are effective for fiscal years, and interim periods within those years, beginning after December 15, 2013. For nonpublic entities, the amendments are effective for fiscal years, and interim periods within those years, beginning after December 15, 2014. Early adoption is permitted. The amendments should be applied prospectively to all unrecognized tax benefits that exist at the effective date. Retrospective application is permitted.

The Company had no unvested stock options outstanding or unrecognized stock-based compensation costs outstanding as of September 30, 2013 and 2012.

Stock option activity during the nine months ended September 30 is as follows:

The Company provides dual presentation of basic and diluted earnings per share. Basic earnings per share is calculated by dividing net income by the average shares outstanding. Diluted earnings per share adds the dilutive effects of options, warrants, and convertible securities to average shares outstanding.

The following table sets forth the composition of the weighted-average common shares (denominator) used in the basic and diluted earnings per share computation.

		For the Three Months Ended September 30,								For the Nine Months Ended September 30,
		2013				2012				2013				2012
Weighted average common shares outstanding			2,212,020				2,167,711				2,202,747				2,077,027
Average treasury stock shares			(189,530	)			(189,530	)			(189,530	)			(189,530	)
Weighted average common shares and common stock equivalents used to calculate basic earnings per share			2,022,490				1,978,181				2,013,217				1,887,497
Additional common stock equivalents (stock options) used to calculate diluted earnings per share			6,930				5,682				7,981				4,236
Weighted average common shares and common stock equivalents used to calculate diluted earnings per share			2,029,420				1,983,863				2,021,198				1,891,733

Options to purchase 58,581 shares of common stock, at prices ranging from $17.55 to $40.24, were outstanding during the three months ended September 30, 2013. Of those options, 29,633 were considered dilutive based on the market price exceeding the strike price. The remaining options had no dilutive effect on earnings per share. For the nine months ended September 30, 2013, 49,394 options were considered dilutive. The remaining options had no dilutive effect on earnings per share.

Options to purchase 88,354 shares of common stock, at prices ranging from $17.55 to $40.24, were outstanding at September 30, 2012. Of those options, 9,000 were considered dilutive based on the average market price exceeding the strike price for the nine months ended September 30, 2012. The three month period ended with 17,536 shares considered dilutive. In accordance with the subscription agreement entered into by an institutional investor, there was also an additional 11,332 shares, at $16 per share, considered dilutive for the three and nine-months ended September 30, 2012. The remaining options had no dilutive effect on the earnings per share.

Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in the principal or most advantageous market for an asset or liability in an orderly transaction between market participants at the measurement date. GAAP established a fair value hierarchy that prioritizes the use of inputs used in valuation methodologies into the following three levels:

The following tables present the assets measured on a recurring basis on the Consolidated Balance Sheet at their fair value by level within the fair value hierarchy. Financial assets and liabilities are classified in their entirety based on the lowest level of input that is significant to the fair value measurement.

The Company obtains fair values from an independent pricing service which represent either quoted market prices for the identical securities (Level I inputs) or fair values determined by pricing models using a market approach that considers observable market data, such as interest rate volatilities, LIBOR yield curve, credit spreads and prices from market makers and live trading systems (Level II).

Financial instruments are considered Level III when their values are determined using pricing models, discounted cash flow methodologies or similar techniques and at least one significant model assumption or input is unobservable. In addition to these unobservable inputs, the valuation models for Level III financial instruments typically also rely on a number of inputs that are readily observable either directly or indirectly. Level III financial instruments also include those for which the determination of fair value requires significant management judgment or estimation. The Company has no securities considered to be Level III as of September 30, 2013 or December 31, 2012.

The Company uses prices compiled by third party vendors due to the recent stabilization in the markets along with improvements in third party pricing methodology that have narrowed the variances between third party vendor prices and actual market prices.

The following tables present the assets measured on a nonrecurring basis on the Consolidated Balance Sheet at their fair value by level within the fair value hierarchy. Impaired loans that are collateral dependent are written down to fair value through the establishment of specific reserves. Techniques used to value the collateral that secure the impaired loan include: quoted market prices for identical assets classified as Level I inputs; observable inputs, employed by certified appraisers, for similar assets classified as Level II inputs. In cases where valuation techniques included inputs that are unobservable and are based on estimates and assumptions developed by management based on the best information available under each circumstance, the asset valuation is classified as Level III inputs.

The Company values other real estate owned at the estimated fair value of the underlying collateral less expected selling costs. Such values are estimated primarily using appraisals and reflect a market value approach. Due to the significance of the Level 3 inputs, other real estate owned has been classified as Level III.

						September 30, 2013
(Dollar amounts in thousands)		Level I				Level II				Level III				Total
Assets measured on a non-recurring basis:
Impaired loans		$	-			$	-			$	15,467			$	15,467
Other real estate owned			-				-				2,719				2,719

The following table presents additional quantitative information about assets measured at fair value on a non-recurring basis and for which the Company uses Level III inputs to determine fair value:

		Quantitative Information about Level III Fair Value Measurements
(unaudited, in thousands)		Fair Value Estimate							Valuation Techniques	Unobservable Input		Range (Weighted Average)
		September 30, 2013				December 31, 2012
Impaired loans		$	15,467			$	17,600		Appraisal of collateral (1)	Appraisal adjustments (2)		0%	to	-68.0%	(-30.7%)
										Liquidation expenses (2)		0%	to	-45.8%	(-2.0%)
Other real estate owned		$	2,719			$	1,846		Appraisal of collateral (1), (3)	Appraisal adjustments (2)		0%	to	-10.0%	(-7.5%)

(1) Fair value is generally determined through independent appraisals of the underlying collateral, which generally include various level 3 inputs which are not identifiable.

(2) Appraisals may be adjusted by management for qualitative factors such as economic conditions and estimated liquidation expenses. The range and weighted average of liquidation expenses and other appraisal adjustments are presented as a percent of the appraisal.

(3) Includes qualitative adjustments by management and estimated liquidation expenses.

The estimated fair value of the Company’s financial instruments is as follows:

		September 30, 2013
		Carrying Value				Level I				Level II				Level III				Total Fair Value
		(in thousands)
Financial assets:
Cash and cash equivalents		$	32,193			$	32,193			$	-			$	-			$	32,193
Investment securities
Available for sale			180,771				5				180,766				-				180,771
Net loans			411,239				-				-				413,767				413,767
Bank-owned life insurance			8,745				8,745								-				8,745
Federal Home Loan Bank stock			1,887				1,887								-				1,887
Accrued interest receivable			2,565				2,565				-				-				2,565
Financial liabilities:
Deposits		$	579,222			$	398,258			$	-			$	182,824			$	581,082
Short-term borrowings			10,575				10,575				-				-				10,575
Federal funds purchased			1,639				1,639				-				-				1,639
Other borrowings			12,261				-				-				12,469				12,469
Accrued interest payable			464				464				-				-				464

		December 31, 2012
		Carrying Value				Level I				Level II				Level III				Total Fair Value
		(in thousands)
Financial assets:
Cash and cash equivalents		$	45,346			$	45,346			$	-			$	-			$	45,346
Investment securities
Available for sale			194,472				5				194,467				-				194,472
Net loans			400,654				-				-				390,206				390,206
Bank-owned life insurance			8,536				8,536				-				-				8,536
Federal Home Loan Bank stock			1,887				1,887				-				-				1,887
Accrued interest receivable			2,163				2,163				-				-				2,163
Financial liabilities:
Deposits		$	593,335			$	396,582			$	-			$	196,122			$	592,704
Short-term borrowings			6,538				6,538				-				-				6,538
Other borrowings			12,970				-				-				13,337				13,337
Accrued interest payable			492				492				-				-				492

Financial instruments are defined as cash, evidence of ownership interest in an entity, or a contract which creates an obligation or right to receive or deliver cash or another financial instrument from/to a second entity on potentially favorable or unfavorable terms.

Fair value is defined as the amount at which a financial instrument could be exchanged in a current transaction between willing parties other than in a forced liquidation sale. If a quoted market price is available for a financial instrument, the estimated fair value would be calculated based upon the market price per trading unit of the instrument.

If no readily available market exists, the fair value estimates for financial instruments should be based upon management’s judgment regarding current economic conditions, interest rate risk, expected cash flows, future estimated losses, and other factors as determined through various option pricing formulas or simulation modeling. Since many of these assumptions result from judgments made by management based upon estimates which are inherently uncertain, the resulting estimated fair values may not be indicative of the amount realizable in the sale of a particular financial instrument. In addition, changes in assumptions on which the estimated fair values are based may have a significant impact on the resulting estimated fair values.

As certain assets such as deferred tax assets and premises and equipment are not considered financial instruments, the estimated fair value of financial instruments would not represent the full value of the Company.

The Company employed simulation modeling in determining the estimated fair value of financial instruments for which quoted market prices were not available based upon the following assumptions:

Cash and Cash Equivalents, Federal Home Loan Bank Stock, Accrued Interest Receivable, Accrued Interest Payable, Federal Funds Purchased, and Short-Term Borrowings

The fair value is equal to the current carrying value.

Bank-Owned Life Insurance

The fair value is equal to the cash surrender value of the life insurance policies.

Investment Securities Available for Sale

The fair value of investment securities is equal to the available quoted market price.  If no quoted market price is available, fair value is estimated using the quoted market price for similar securities.

Loans

The fair value is estimated by discounting future cash flows using current market inputs at which loans with similar terms and qualities would be made to borrowers of similar credit quality. Where quoted market prices were available, primarily for certain residential mortgage loans, such market rates were used as estimates for fair value.

Deposits and Other Borrowed Funds

The fair values of certificates of deposit and other borrowed funds are based on the discounted value of contractual cash flows. The discount rates are estimated using rates currently offered for similar instruments with similar remaining maturities. Demand, savings, and money market deposits are valued at the amount payable on demand as of period end.

Commitments to Extend Credit

These financial instruments are generally not subject to sale, and estimated fair values are not readily available. The carrying value, represented by the net deferred fee arising from the unrecognized commitment or letter of credit, and the fair value, determined by discounting the remaining contractual fee over the term of the commitment using fees currently charged to enter into similar agreements with similar credit risk, are not considered material for disclosure.

(a) All amounts are net of tax. Amounts in parentheses indicate debits.

The following tables present significant amounts reclassified out of each component of accumulated other comprehensive income (loss):

(a) Amounts in parentheses indicate debits to net income

(a) Amounts in parentheses indicate debits to net income

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

The amortized cost and fair value of debt securities at September 30, 2013, by contractual maturity, are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.

Proceeds from the sales of securities available for sale and the gross realized gains and losses for the three and nine months ended September 30 are as follows:

		For the Three Months Ended September 30,								For the Nine Months Ended September 30,
		2013				2012				2013				2012
Proceeds from sales		$	-			$	5,622			$	8,136			$	27,426
Gross realized gains			-				154				204				462
Gross realized losses			-				(2	)			(29	)			(14	)

Investment securities with an approximate carrying value of $73.8 million and $62.5 million at September 30, 2013 and December 31, 2012, respectively, were pledged to secure deposits and other purposes as required by law.

The following tables show the Company’s gross unrealized losses and fair value, aggregated by investment category and length of time that the individual securities have been in a continuous unrealized loss position.