UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
 

 
FORM 10-Q

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

      For the quarterly period ended   March 31, 2010

OR

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

     For the transition period from                           to                                                      

Commission File No. 000-20827
 

CASS INFORMATION SYSTEMS, INC.
(Exact name of registrant as specified in its charter)

Missouri
43-1265338
(State or other jurisdiction of incorporation or
organization)
(I.R.S. Employer Identification No.)
   
13001 Hollenberg Drive
Bridgeton, Missouri
63044
(Address of principal executive offices)
(Zip Code)
   
(314) 506-5500
(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           x                      No           ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
Yes           ¨                      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 definitions 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 x
     
 
Non-Accelerated Filer ¨
Smaller 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           x

The number of shares outstanding of registrant's only class of stock as of May 3, 2010: Common stock, par value $.50 per share – 9,393,578 shares outstanding.

 
 

 
 
TABLE OF CONTENTS
 
PART I – Financial Information
 
       
 
Item 1.
FINANCIAL STATEMENTS
 
       
   
Consolidated Balance Sheets
 
   
March 31, 2010 (unaudited) and December 31, 2009
3
       
   
Consolidated Statements of Income
 
   
Three months ended March 31, 2010 and 2009 (unaudited)
4
       
   
Consolidated Statements of Cash Flows
 
   
Three months ended March 31, 2010 and 2009 (unaudited)
5
       
   
Notes to Consolidated Financial Statements (unaudited)
6
       
 
Item 2.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
14
       
 
Item 3.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
23
       
 
Item 4.
CONTROLS AND PROCEDURES
23
       
PART II – Other Information – Items 1. – 6.
24
       
 
SIGNATURES
25

Forward-looking Statements - Factors That May Affect Future Results

This report may contain or incorporate by reference forward-looking statements made pursuant to the safe harbor provisions of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended.  Although we believe that, in making any such statements, our expectations are based on reasonable assumptions, forward-looking statements are not guarantees of future performance and involve risks, uncertainties, and other factors beyond our control, which may cause future performance to be materially different from expected performance summarized in the forward-looking statements.  These risks, uncertainties and other factors are discussed in the section Part I, Item 1A, “Risk Factors” of the Company’s 2009 Annual Report on Form 10-K, filed with the Securities and Exchange Commission (“SEC”), which may be updated from time to time in our future filings with the SEC.   We undertake no obligation to publicly update or revise any forward-looking statements to reflect changed assumptions, the occurrence of anticipated or unanticipated events, or changes to future results over time.

 
-2-

 

PART I. 
FINANCIAL INFORMATION

ITEM 1. 
FINANCIAL STATEMENTS

CASS INFORMATION SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
 (Dollars in Thousands except Share and Per Share Data)

   
March 31,
2010
(Unaudited)
   
December 31,
2009
 
Assets
           
Cash and due from banks
  $ 6,633     $ 5,763  
Interest-bearing deposits in other financial institutions
    18,989       33,426  
Federal funds sold and other short-term investments
    85,172       40,105  
Cash and cash equivalents
    110,794       79,294  
Securities available-for-sale, at fair value
    226,183       224,597  
Loans
    664,824       641,957  
Less: Allowance for loan losses
    8,999       8,284  
Loans, net
    655,825       633,673  
Premises and equipment, net
    10,101       10,451  
Investments in bank-owned life insurance
    13,779       13,644  
Payments in excess of funding
    28,150       22,637  
Goodwill
    7,471       7,471  
Other intangible assets, net
    348       375  
Other assets
    20,510       20,839  
Total assets
  $ 1,073,161     $ 1,012,981  
                 
Liabilities and Shareholders’ Equity
               
Liabilities:
               
Deposits
               
Noninterest-bearing
  $ 116,319     $ 113,151  
Interest-bearing
    327,620       324,725  
Total deposits
    443,939       437,876  
Accounts and drafts payable
    479,779       430,251  
Short-term borrowings
    18       26  
Other liabilities
    14,941       15,260  
Total liabilities
    938,677       883,413  
                 
Shareholders’ Equity:
               
Preferred stock, par value $.50 per share; 2,000,000 shares authorized and no shares issued
           
Common stock, par value $.50 per share; 20,000,000 shares authorized and 9,949,324 shares issued at March 31, 2010 and December 31, 2009
    4,975       4,975  
Additional paid-in capital
    45,910       45,696  
Retained earnings
    95,835       92,401  
Common shares in treasury, at cost (563,920 shares at March 31, 2010 and 564,119 shares at December 31, 2009)
    (13,376 )     (13,323 )
Accumulated other comprehensive income (loss)
    1,140       (181 )
Total shareholders’ equity
    134,484       129,568  
Total liabilities and shareholders’ equity
  $ 1,073,161     $ 1,012,981  

See accompanying notes to unaudited consolidated financial statements.

 
-3-

 

CASS INFORMATION SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
(Dollars in Thousands except Per Share Data)

   
Three Months Ended
March 31,
 
   
2010
   
2009
 
Fee Revenue and Other Income:
           
Information services payment and processing revenue
  $ 12,745     $ 11,944  
Bank service fees
    341       404  
Gains on sales of securities
 
      119  
Other
    139       135  
Total fee revenue and other income
    13,225       12,602  
                 
Interest Income:
               
Interest and fees on loans
    9,427       8,617  
Interest and dividends on securities:
               
Taxable
    14       2  
Exempt from federal income taxes
    2,098       1,858  
Interest on federal funds sold and other short-term investments
    89       16  
Total interest income
    11,628       10,493  
                 
Interest Expense:
               
Interest on deposits
    1,176       934  
Interest on short-term borrowings
 
      18  
Interest on subordinated convertible debentures
 
      39  
Total interest expense
    1,176       991  
Net interest income
    10,452       9,502  
Provision for loan losses
    900       400  
Net interest income after provision for loan losses
    9,552       9,102  
Total net revenue
    22,777       21,704  
                 
Operating Expense:
               
Salaries and employee benefits
    12,490       12,449  
Occupancy
    572       615  
Equipment
    898       841  
Amortization of intangible assets
    27       70  
Other operating
    2,210       2,315  
Total operating expense
    16,197       16,290  
Income before income tax expense
    6,580       5,414  
Income tax expense
    1,831       1,491  
Net Income
  $ 4,749     $ 3,923  
                 
Basic Earnings Per Share
  $ .51     $ .43  
Diluted Earnings Per Share
    .50       .42  

See accompanying notes to unaudited consolidated financial statements.

 
-4-

 

CASS INFORMATION SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
 (Dollars in Thousands)

   
Three Months Ended
March 31,
 
   
2010
   
2009
 
Cash Flows From Operating Activities:
           
Net income
  $ 4,749     $ 3,923  
Adjustments to reconcile net income to net cash provided by operating activities:
               
Depreciation and amortization
    1,031       1,055  
Gains on sales of securities
          (119 )
Provision for loan losses
    900       400  
Stock-based compensation expense
    392       308  
(Decrease) increase in income tax liability
    (649 )     494  
Increase in pension liability
    198       186  
Other operating activities, net
    (387 )     (531 )
Net cash provided by operating activities
    6,234       5,716  
                 
Cash Flows From Investing Activities:
               
Proceeds from sales of securities available-for-sale
          4,277  
Proceeds from maturities of securities available-for-sale
          2,680  
Purchase of securities available-for-sale
          (2,877 )
Net increase in loans
    (23,052 )     (9,414 )
Increase in payments in excess of funding
    (5,512 )     (1,015 )
Purchases of premises and equipment, net
    (207 )     (396 )
Net cash used in investing activities
    (28,771 )     (6,745 )
                 
Cash Flows From Financing Activities:
               
Net increase (decrease) in noninterest-bearing demand deposits
    3,168       (8,383 )
Net (decrease) increase in interest-bearing demand and savings deposits
    (22,573 )     2,006  
Net increase in time deposits
    25,468       39,680  
Net increase (decrease) in accounts and drafts payable
    49,528       (52,087 )
Net (decrease) increase in short-term borrowings
    (8 )     12,857  
Cash dividends paid
    (1,315 )     (1,199 )
Distribution of  stock awards, net
    (251 )      
Other financing activities, net
    20       19  
Net cash provided by (used in) financing activities
    54,037       (7,107 )
Net increase (decrease) in cash and cash equivalents
    31,500       (8,136 )
Cash and cash equivalents at beginning of period
    79,294       29,485  
Cash and cash equivalents at end of period
  $ 110,794     $ 21,349  
                 
Supplemental information:
               
Cash paid for interest
  $ 1,125     $ 910  
Cash paid for income taxes
    2,501       1,030  

See accompanying notes to unaudited consolidated financial statements.

 
-5-

 

CASS INFORMATION SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Note 1 – Basis of Presentation

The accompanying unaudited consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X.  Accordingly, they do not include all of the information and footnotes required by U.S. generally accepted accounting principles for complete financial statements.  In the opinion of management, all adjustments, consisting of normal recurring accruals, considered necessary for a fair presentation have been included.  Certain amounts in the 2009 consolidated financial statements have been reclassified to conform to the 2010 presentation.  For further information, refer to the audited consolidated financial statements and related footnotes included in Cass Information System, Inc.’s (the “Company” or “Cass”) Annual Report on Form 10-K for the year ended December 31, 2009.

Note 2 – Intangible Assets

The Company accounts for intangible assets in accordance with Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 350, “Goodwill and Other Intangible Assets,” which requires that intangibles with indefinite useful lives be tested annually for impairment and those with finite useful lives be amortized over their useful lives.  Details of the Company’s intangible assets are as follows:

   
March 31, 2010
   
December 31, 2009
 
(In thousands)
 
Gross Carrying
Amount
   
Accumulated
Amortization
   
Gross Carrying
Amount
   
Accumulated
Amortization
 
Assets eligible for amortization:
                       
Software
  $ 862     $ (862 )   $ 862     $ (862 )
Customer List
    750       (402 )     750       (375 )
Total
    1,612       (1,264 )     1,612       (1,237 )
Unamortized intangible assets:
                               
Goodwill
    7,698       (227 )     7,698       (227 )
Total unamortized intangibles
    7,698       (227 )     7,698       (227 )
Total intangible assets
  $ 9,310     $ (1,491 )   $ 9,310     $ (1,464 )

Software is amortized over four to five years and the customer list is amortized over seven years.  Amortization of intangible assets amounted to $27,000 and $70,000 for the three-month periods ended March 31, 2010 and 2009, respectively.  Estimated amortization of intangibles over the next five years is as follows:  $107,000 in 2010, 2011 and 2012, $54,000 in 2013 and $0 in 2014.

Note 3 – Equity Investments in Non-Marketable Securities

Non-marketable equity investments in low-income housing projects are included in other assets on the Company’s consolidated balance sheets.  The total balance of these investments at March 31, 2010 and December 31, 2009 were $499,000 and $520,000, respectively.

Note 4 – Earnings Per Share

Basic earnings per share are computed by dividing net income by the weighted-average number of common shares outstanding.  Diluted earnings per share is computed by dividing net income, adjusted for the net income effect of the interest expense on the outstanding convertible debentures, by the sum of the weighted-average number of common shares outstanding and the weighted-average number of potential common shares outstanding.  There were no antidilutive shares in the three months ended March 31, 2010 or 2009.  The calculations of basic and diluted earnings per share are as follows:

   
Three Months Ended
March 31,
 
(In thousands, except per share data)
 
2010
   
2009
 
Basic
           
Net income
  $ 4,749     $ 3,923  
Weighted-average common shares outstanding
    9,328,697       9,135,326  
                 
Basic earnings per share
  $ .51     $ .43  
Diluted
               
Basic net income
  $ 4,749     $ 3,923  
Net income effect of 5.33% convertible debentures
          20  
Diluted net income
    4,749       3,943  
                 
Weighted-average common shares outstanding
    9,328,697       9,135,326  
Effect of dilutive restricted stock, stock options and stock appreciation rights
    94,039       89,889  
Effect of convertible debentures
          153,630  
Weighted-average common shares outstanding assuming dilution
    9,422,736       9,378,845  
                 
Diluted earnings per share
  $ .50     $ .42  
 
 
-6-

 

Note 5 – Stock Repurchases

The Company maintains a treasury stock buyback program pursuant to which the Board of Directors has authorized the repurchase of up to 300,000 shares of the Company’s common stock.  The Company did not repurchase any shares during the three-month periods ended March 31, 2010 and 2009.  As of March 31, 2010, 180,000 shares remained available for repurchase under the program.  Repurchases are made in the open market or through negotiated transactions from time to time depending on market conditions.

Note 6 – Comprehensive Income

For the three-month periods ended March 31, 2010 and 2009, unrealized gains and losses on securities available-for-sale and reclassification adjustments for gains included in net income were the Company’s other comprehensive income components.  Comprehensive income is summarized as follows:

 
 
Three Months Ended
March 31,
 
(In thousands)
 
2010
   
2009
 
             
Net income
  $ 4,749     $ 3,923  
                 
Other comprehensive income:
               
Reclassification adjustments for gains included in net income, net of tax
          (77 )
Net unrealized gain on securities available-for-sale, net of tax
    1,321       4,728  
                 
Total comprehensive income
  $ 6,070     $ 8,574  

Note 7 – Industry Segment Information

The services provided by the Company are classified into two reportable segments: Information Services and Banking Services.  Each of these segments provides distinct services that are marketed through different channels.  They are managed separately due to their unique service, processing and capital requirements.

The Information Services segment provides freight, utility and telecommunication invoice processing and payment services to large corporations.  The Banking Services segment provides banking services primarily to privately-held businesses and churches.

The Company’s accounting policies for segments are the same as those described in the summary of significant accounting policies in the Company’s Annual Report on Form 10-K for the year ended December 31, 2009.  Management evaluates segment performance based on net income after allocations for corporate expenses and income taxes.  Transactions between segments are accounted for at what management believes to be fair value.

All revenue originates from and all long-lived assets are located within North America, and no revenue from any customer of any segment exceeds 10% of the Company’s consolidated revenue.

 
-7-

 

Assets represent actual assets owned by Information Services and there is no allocation methodology used.  Loans are sold by Banking Services to Information Services to create liquidity when the Bank’s loan-to-deposit ratio is greater than 100%.  Segment interest from customers is the actual interest earned on the loans owned by Information Services and Banking Services, respectively.

Summarized information about the Company’s operations in each industry segment is as follows:

(In thousands)
 
Information
Services
   
Banking
Services
   
Corporate,
Eliminations
and Other
   
Total
 
Quarter Ended March 31, 2010
                       
Total Revenues:
                       
Revenue from customers
  $ 17,228     $ 5,549     $     $ 22,777  
Intersegment income (expense)
    2,275       380       (2,655 )      
Net income
    2,904       1,845             4,749  
Goodwill
    7,335       136             7,471  
Other intangible assets, net
    348                   348  
Total assets
    579,766       498,105       (4,710 )     1,073,161  
Quarter Ended March 31, 2009
                               
Total Revenues:
                               
Revenue from customers
  $ 17,383     $ 4,321     $     $ 21,704  
Intersegment income (expense)
    1,615       357       (1,972 )      
Net income
    2,834       1,089             3,923  
Goodwill
    7,335       136             7,471  
Other intangible assets, net
    527                   527  
Total assets
    556,709       419,592       (89,031 )     887,270  

Note 8 – Loans by Type

(In thousands)
 
March 31,
2010
   
December 31,
2009
 
Commercial and industrial
  $ 108,243     $ 93,371  
Real estate (commercial and church):
               
Mortgage
    494,523       469,097  
Construction
    57,891       74,407  
Industrial revenue bonds
    2,596       2,676  
Other
    1,571       2,406  
Total loans
  $ 664,824     $ 641,957  

Note 9 – Commitments and Contingencies

In the normal course of business, the Company is party to activities that contain credit, market and operational risks that are not reflected in whole or in part in the Company’s consolidated financial statements.  Such activities include traditional off-balance sheet credit-related financial instruments and commitments under operating leases.  These financial instruments include commitments to extend credit, commercial letters of credit and standby letters of credit. The Company’s maximum potential exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit, commercial letters of credit and standby letters of credit is represented by the contractual amounts of those instruments.  At March 31, 2010 and December 31, 2009, no amounts have been accrued for any estimated losses for these instruments.

Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract.  Commercial and standby letters of credit are conditional commitments issued by the Company or its subsidiaries to guarantee the performance of a customer to a third party. These off-balance sheet financial instruments generally have fixed expiration dates or other termination clauses and may require payment of a fee.  At March 31, 2010 the balance of unused loan commitments, standby and commercial letters of credit were $23,379,000, $15,959,000, and $2,538,000, respectively.  Since some of the financial instruments may expire without being drawn upon, the total amounts do not necessarily represent future cash requirements. Commitments to extend credit and letters of credit are subject to the same underwriting standards as those financial instruments included on the consolidated balance sheets. The Company evaluates each customer’s credit worthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary upon extension of the credit, is based on management’s credit evaluation of the borrower. Collateral held varies, but is generally accounts receivable, inventory, residential or income-producing commercial property or equipment.  In the event of nonperformance, the Company or its subsidiaries may obtain and liquidate the collateral to recover amounts paid under its guarantees on these financial instruments.

 
-8-

 
 
The following table summarizes contractual cash obligations of the Company related to operating lease commitments and time deposits at March 31, 2010:

   
Amount of Commitment Expiration per Period
 
(In thousands)
 
Total
   
Less than
1 year
   
1-3
Years
   
3-5
Years
   
Over 5
Years
 
Operating lease commitments
  $ 2,917     $ 877     $ 968     $ 600     $ 472  
Time deposits
    141,210       130,894       9,268       1,048        
Total
  $ 144,127     $ 131,771     $ 10,236     $ 1,648     $ 472  

The Company and its subsidiaries are involved in various pending legal actions and proceedings in which claims for damages are asserted. Management, after discussion with legal counsel, believes the ultimate resolution of these legal actions and proceedings will not have a material effect upon the Company’s consolidated financial position or results of operations.

Note 10 – Stock-Based Compensation

In 2007, the Board and the Company’s shareholders approved the 2007 Omnibus Incentive Stock Plan (the “Omnibus Plan”).  The Omnibus Plan permits the issuance of up to 880,000 shares of the Company’s common stock in the form of stock options, stock appreciation rights (“SARs”), restricted stock, restricted stock units and performance awards.  The Company issues shares out of treasury stock for these awards.  During the three months ended March 31, 2010, 7,049 restricted shares and 23,311 SARs were granted under the Omnibus Plan.

The Company also continues to maintain its other stock-based incentive plans for the restricted common stock previously awarded and the options previously issued and still outstanding.  These plans have been superseded by the Omnibus Plan and accordingly, any available restricted stock and stock option grants not yet issued have been cancelled.

Restricted Stock
Restricted shares are amortized to expense over the three-year vesting period. As of March 31, 2010, the total unrecognized compensation expense related to non-vested common stock was $1,095,000 and the related weighted-average period over which it is expected to be recognized is approximately 1.1 years.

Following is a summary of the activity of the restricted stock:

   
Three Months Ended
March 31, 2010
 
   
Shares
   
Fair Value
 
Balance at December 31, 2009
    75,965     $ 28.97  
Granted
    7,049       30.16  
Vested
    (34,118 )     29.99  
Forfeited
           
Balance at March 31, 2010
    48,896     $ 28.43  

Stock Options
Stock options vest and expire over a period not to exceed seven years.  As of March 31, 2010, the total unrecognized compensation expense related to non-vested stock options was $51,000, and the related weighted-average period over which it is expected to be recognized is approximately 2.3 years.  Following is a summary of the activity of the stock options during the three-month period ended March 31, 2010:

 
-9-

 

         
Weighted-
Average
   
Average
Remaining
   
Aggregate
Intrinsic
 
         
Exercise
   
Contractual
   
Value
 
   
Shares
   
Price
   
Term Years
   
(In thousands)
 
Outstanding at December 31, 2009
    44,120     $ 17.65              
Exercised
    (1,631 )     12.82              
Outstanding at March 31, 2010
    42,489     $ 17.83       2.15     $ 565  
Exercisable at March 31, 2010
    30,048     $ 17.03       1.96     $ 424  

The total intrinsic value of options exercised was $29,000, and $231,000, for the three-month periods ended March 31, 2010 and 2009, respectively.  Following is a summary of the activity of the non-vested stock options during the three-month period ended March 31, 2010:

   
Shares
   
Weighted-
Average
Grant Date
Fair Value
 
Non-vested at December 31, 2009
    27,586     $ 2.81  
Vested
    (15,145 )     2.70  
Non-vested at March 31, 2010
    12,441     $ 2.94  

SARs
SARs vest over a three-year period, with one-third of the shares vesting and becoming exercisable each year on the anniversary date of the grant, and they expire 10 years from the original grant date.  As of March 31, 2010, the total unrecognized compensation expense was $895,000 and the related weighted-average period over which it is expected to be recognized is 1.5 years.  Following is a summary of the activity of the Company’s SARs program for the three-month period ended March 31, 2010:
         
Weighted-
Average
   
Average
Remaining
   
Aggregate
Intrinsic
 
         
Exercise
   
Contractual
   
Value
 
   
Shares
   
Price
   
Term Years
   
(In thousands)
 
Outstanding at December 31, 2009
    231,262     $ 27.02              
Granted
    23,311       30.16              
Outstanding at March 31, 2010
    254,573     $ 27.31       8.60     $ 979  
Exercisable at March 31, 2010
    113,372     $ 27.46       5.35     $ 418  

Following is a summary of the activity of non-vested SARs during the three-month period ended March 31, 2010:

   
Shares
   
Weighted-
Average
Grant Date
Fair Value
 
Non-vested at December 31, 2009
    195,119     $ 6.74  
Granted
    23,311       9.12  
Vested
    (77,229 )     6.89  
Non-vested at March 31, 2010
    141,201     $ 7.06  

The Company uses the Black-Scholes pricing model to determine the fair value of the SARs at the date of grant.  Following are the assumptions used to estimate the per share fair value of SARs granted:

   
Three Months Ended
March 31,
 
   
2010
   
2009
 
Risk-free interest rate
    3.33 %     1.94 %
Expected life
 
7 yrs.
   
7 yrs.
 
Expected volatility
    30.00 %     27.00 %
Expected dividend yield
    1.86 %     2.02 %

 
-10-

 

The risk-free interest rate is based on the zero-coupon U.S. Treasury yield for the period equal to the expected life of the SARs at the time of the grant.  The expected life was derived using the historical exercise activity.  The Company uses historical volatility for a period equal to the expected life of the rights using average monthly closing market prices of the Company’s stock as reported on The Nasdaq Global Market.  The expected dividend yield is based on the Company’s current rate of annual dividends.

Note 11 – Defined Pension Plans

The Company has a noncontributory defined benefit pension plan, which covers most of its employees. The Company accrues and makes contributions designed to fund normal service costs on a current basis using the projected unit credit with service proration method to amortize prior service costs arising from improvements in pension benefits and qualifying service prior to the establishment of the plan over a period of approximately 30 years.  Disclosure information is based on a measurement date of December 31 of the corresponding year.  The following table represents the components of the net periodic pension costs:

(In thousands)
 
Estimated
2010
   
Actual
2009
 
Service cost – benefits earned during the year
  $ 1,796     $ 1,606  
Interest cost on projected benefit obligation
    2,251       2,080  
Expected return on plan assets
    (2,443 )     (1,880 )
Net amortization and deferral
    563       873  
Net periodic pension cost
  $ 2,167     $ 2,679  

Pension costs recorded to expense were $542,000 and $671,000 for the three-month periods ended March 31, 2010 and 2009, respectively.  The decrease in pension costs is primarily due to the asset gain in the year ended December 31, 2009.  The Company made a contribution of $450,000 to the plan during the three-month period ended March 31, 2010 and expects to contribute at least an additional $1,350,000 in 2010.

In addition to the above funded benefit plan, the Company has an unfunded supplemental executive retirement plan which covers key executives of the Company. This is a noncontributory plan in which the Company and its subsidiaries make accruals designed to fund normal service costs on a current basis using the same method and criteria as its defined benefit plan.  The following table represents the components of the net periodic pension costs for 2009 and an estimate for 2010:

(In thousands)
 
Estimated
2010
   
Actual
2009
 
Service cost – benefits earned during the year
  $ 78     $ 33  
Interest cost on projected benefit obligation
    315       278  
Net amortization
    257       130  
Net periodic pension cost
  $ 650     $ 441  

Pension costs recorded to expense were $162,000 and $114,000 for the three-month periods ended March 31, 2010 and 2009, respectively.

Note 12 – Income Taxes

During the first quarter of 2010, unrecognized tax benefits increased by $97,000 and related accrued interest increased by $12,000.  As of December 31, 2009, the Company’s unrecognized tax benefits were approximately $1,750,000, of which $1,466,000 would, if recognized, affect the Company’s effective tax rate.  During the next twelve months, the Company may realize a reduction of its unrecognized tax benefits of approximately $401,000 due to the lapse of federal and state statutes of limitations.

The Company recognizes interest and penalties related to uncertain tax positions in income tax expense.  At December 31, 2009, before any tax benefits, the Company had $147,000 of accrued interest on unrecognized tax benefits.  There were no penalties for unrecognized tax benefits accrued at December 31, 2009.

The Company is subject to income tax in the U.S. federal jurisdiction and numerous state jurisdictions.  U.S. federal income tax returns for tax years 2006 through 2008 remain subject to examination by the Internal Revenue Service.  In addition, the Company is subject to state tax examinations for the tax years 2005 through 2008.

 
-11-

 

Note 13 – Investment Securities Available for Sale

Effective July 1, 2009, the Company adopted FASB ASC 820, “Fair Value Measurements and Disclosures.”  Investment securities available-for-sale are recorded at fair value on a recurring basis.  The Company’s investment securities available-for-sale are measured at fair value using Level 2 valuations.  The market evaluation utilizes several sources which include “observable inputs” rather than “significant unobservable inputs” and therefore falls into the Level 2 category.  The amortized cost, gross unrealized gains, gross unrealized losses and fair value of investment securities are summarized as follows:

   
March 31, 2010
 
(In thousands)
 
Amortized
Cost
   
Gross
Unrealized
Gains
   
Gross
Unrealized
Losses
   
Fair Value
 
State and political subdivisions
  $ 212,204     $ 13,999     $ 20     $ 226,183  

   
December 31, 2009
 
(In thousands)
 
Amortized
Cost
   
Gross
Unrealized
Gains
   
Gross
Unrealized
Losses
   
Fair Value
 
State and political subdivisions
  $ 212,651     $ 11,970     $ 24     $ 224,597  

The fair values of securities with unrealized losses are as follows:

   
March 31, 2010
 
   
Less than 12 months
 
12 months or more
 
Total
 
   
Estimated
 
Unrealized
 
Estimated
 
Unrealized
 
Estimated
 
Unrealized
 
(In thousands)
 
fair value
 
losses
 
fair value
 
losses
 
Fair value
 
losses
 
State and political subdivisions
  $ 1,415     $ 20     $     $     $ 1,415     $ 20  

   
December 31, 2009
 
   
Less than 12 months
   
12 months or more
   
Total
 
   
Estimated
   
Unrealized
   
Estimated
   
Unrealized
   
Estimated
   
Unrealized
 
(In thousands)
 
fair value
   
losses
   
fair value
   
losses
   
Fair value
   
losses
 
State and political subdivisions
  $ 1,415     $ 24     $     $     $ 1,415     $ 24  

There were two securities (none greater than 12 months) in an unrealized loss position as of March 31, 2010.   There were two securities (none greater than 12 months) in an unrealized loss position as of December 31, 2009.   All unrealized losses were reviewed to determine whether the losses were other than temporary.  Management believes that all unrealized losses are temporary since they were market driven, and the Company has the ability and intent to hold these securities until maturity.

The amortized cost and fair value of investment securities by contractual maturity are shown in the following table. Expected maturities may differ from contractual maturities because borrowers have the right to prepay obligations with or without prepayment penalties.

   
March 31, 2010
 
(In thousands)
 
Amortized Cost
   
Fair Value
 
Due in 1 year or less
  $ 8,752     $ 8,930  
Due after 1 year through 5 years
    43,069       46,094  
Due after 5 years through 10 years
    103,024       111,401  
Due after 10 years
    57,359       59,758  
Total
  $ 212,204     $ 226,183  

The amortized cost of investment securities pledged to secure public deposits and for other purposes at March 31, 2010 was $18,207,000.

 
-12-

 

Proceeds from sales of investment securities classified as available for sale were $0 and $4,277,000 for the first three months of 2010 and 2009, respectively.  Gross realized gains were $0 and $119,000 for the first three months of 2010 and 2009, respectively.

Note 14 – Fair Value of Financial Instruments

Effective July 1, 2009, the Company adopted FASB ASC 270, “Interim Reporting.”  Following is a summary of the carrying amounts and fair values of the Company’s financial instruments:

   
March 31, 2010
   
December 31, 2009
 
(In thousands)
 
Carrying
Amount
   
Fair Value
   
Carrying
Amount
   
Fair Value
 
Balance sheet assets:
                       
Cash and cash equivalents
  $ 110,794     $ 110,794     $ 79,294     $ 79,294  
Investment securities
    226,183       226,183       224,597       224,597  
Loans, net
    655,825       656,774       633,673       634,598  
Accrued interest receivable
    5,245       5,245       5,294       5,294  
Total
  $ 998,047     $ 998,996     $ 942,858     $ 943,783  
                                 
Balance sheet liabilities:
                               
Deposits
  $ 443,939     $ 443,939     $ 437,876     $ 437,876  
Accounts and drafts payable
    479,779       479,779       430,251       430,251  
Short-term borrowings
    18       18       26       26  
Accrued interest payable
    278       278       227       227  
Total
  $ 924,014     $ 924,014     $ 868,380     $ 868,380  

The following methods and assumptions were used to estimate the fair value of each class of financial instruments for which it is practicable to estimate that value:

Cash and Other Short-term Instruments – For cash and cash equivalents, accrued interest receivable, accounts and drafts payable, short-term borrowings and accrued interest payable, the carrying amount is a reasonable estimate of fair value because of the demand nature or short maturities of these instruments.

Loans – The Company does not record loans at fair value on a recurring basis other than loans that are considered impaired.  Once a loan is identified as impaired, management measures impairment in accordance with FASB ASC 310, “Allowance for Credit Losses.”  At March 31, 2010, all impaired loans were evaluated based on the fair value of the collateral.  The fair value of the collateral is based upon an observable market price or current appraised value and therefore, the Company classifies these assets as nonrecurring Level 2.  The total principal balance of impaired loans measured at fair value at March 31, 2010 and December 31, 2009 were $1,000,000 and $1,115,000, respectively.  The fair value of loans in the above table is estimated by discounting the future cash flows using the current rates at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities.

Deposits – The fair value of demand deposits, savings deposits and certain money market deposits is the amount payable on demand at the reporting date. The fair value of fixed-maturity certificates of deposit is estimated using the rates currently offered for deposits of similar remaining maturities. The fair value estimates above do not include the benefit that results from the low-cost funding provided by the deposit liabilities compared to the cost of borrowing funds in the market or the benefit derived from the customer relationship inherent in existing deposits.

Note 15 – Subsequent Events

In accordance with FASB ASC 855, “Subsequent Events,” the Company has evaluated subsequent events after the consolidated balance sheet date of March 31, 2010 and there were no events identified that would require additional disclosures to prevent the Company’s consolidated financial statements from being misleading.

 
-13-

 

ITEM 2.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Overview

Cass provides payment and information processing services to large manufacturing, distribution and retail enterprises from its offices/locations in St. Louis, Missouri, Columbus, Ohio, Boston, Massachusetts, Greenville, South Carolina and Wellington, Kansas.  The Company’s services include transportation invoice rating, payment processing, auditing, and the generation of accounting and transportation information.  Cass also processes and pays utility invoices, which includes electricity, gas and telecommunications expenses, and is a provider of telecom expense management solutions.  Cass extracts, stores and presents information from transportation, utility and telecommunication invoices, assisting its customers’ transportation, energy and information technology managers in making decisions that will enable them to improve operating performance.  The Company receives data from multiple sources, electronic and otherwise, and processes the data to accomplish the specific operating requirements of its customers.  It then provides the data in a central repository for access and archiving.  The data is finally transformed into information through the Company’s databases that allow client interaction as required and provide Internet-based tools for analytical processing.  The Company also, through Cass Commercial Bank, its St. Louis, Missouri based bank subsidiary (the “Bank”), provides banking services in the St. Louis metropolitan area, Orange County, California and other selected cities in the United States.  In addition to supporting the Company’s payment operations, the Bank provides banking services to its target markets, which include privately-owned businesses and churches and church-related ministries.

The specific payment and information processing services provided to each customer are developed individually to meet each customer’s requirements, which can vary greatly.  In addition, the degree of automation such as electronic data interchange, imaging, and web-based solutions varies greatly among customers and industries.  These factors combine so that pricing varies greatly among the customer base.  In general, however, Cass is compensated for its processing services through service fees and investment of account balances generated during the payment process.  The amount, type and calculation of service fees vary greatly by service offering, but generally follow the volume of transactions processed.  Interest income from the balances generated during the payment processing cycle is affected by the amount of time Cass holds the funds prior to payment and the dollar volume processed.  Both the number of transactions processed and the dollar volume processed are therefore key metrics followed by management.  Other factors will also influence revenue and profitability, such as changes in the general level of interest rates, which have a significant effect on net interest income.  The funds generated by these processing activities are invested in overnight investments, investment grade securities and loans generated by the Bank.  The Bank earns most of its revenue from net interest income, or the difference between the interest earned on its loans and investments and the interest paid on its deposits and other borrowings.  The Bank also assesses fees on other services such as cash management services.

Industry-wide factors that impact the Company include the willingness of large corporations to outsource key business functions such as transportation, utility and telecommunication payment and audit.  The benefits that can be achieved by outsourcing transaction processing and the management information generated by Cass’ systems can be influenced by factors such as the competitive pressures within industries to improve profitability, the general level of transportation costs, deregulation of energy costs and consolidation of telecommunication providers.  Economic factors that impact the Company include the general level of economic activity that can affect the volume and size of invoices processed, the ability to hire and retain qualified staff and the growth and quality of the loan portfolio. As lower levels of economic activity are encountered, such as those experienced in 2009, the number and total dollar amount of transactions processed by the Company may decline, thereby reducing fee revenue, interest income, and possibly liquidity.  Conversely, improving economic conditions, as those experienced in early 2010, will tend to increase fee revenue, interest income and liquidity.  The general level of interest rates also has a significant effect on the revenue of the Company.  As discussed in greater detail in Item 7A, “Quantitative and Qualitative Disclosures about Market Risk” in the Company’s 2009 Annual Report on Form 10-K, a decline in the general level of interest rates can have a negative impact on net interest income.

Currently, management views Cass’ major opportunity as the continued expansion of its payment and information processing service offering and customer base. While the current economic slow-down may reduce the short-term growth rate, management remains optimistic about the long-term prospects for growth.

 
-14-

 
 
Critical Accounting Policies

The Company has prepared all of the consolidated financial information in this report in accordance with U.S. generally accepted accounting principles (“U.S. GAAP”).  In preparing the consolidated financial statements in accordance with U.S. GAAP, management makes estimates and assumptions that affect the reported amount of assets and liabilities, disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenue and expenses during the reporting period.  These estimates have been generally accurate in the past, have been consistent and have not required any material changes.  There can be no assurances that actual results will not differ from those estimates.  Certain accounting policies that require significant management estimates and are deemed critical to our results of operations or financial position have been discussed with the Audit Committee of the Board of Directors and are described below.

Allowance for Loan Losses.  The Company performs periodic and systematic detailed reviews of its loan portfolio to assess overall collectability.  The level of the allowance for loan losses reflects management’s estimate of the collectability of the loan portfolio.  Although these estimates are based on established methodologies for determining allowance requirements, actual results can differ significantly from estimated results.  These policies affect both segments of the Company.  The impact and associated risks related to these policies on the Company’s business operations are discussed in the “Provision and Allowance for Loan Losses” section of this report.  The Company’s estimates have been materially accurate in the past, and accordingly, we expect to continue to utilize the present processes.

Impairment of Assets.  The Company periodically evaluates certain long-term assets such as intangible assets including goodwill, foreclosed assets and investments in private equity securities and assets held for sale for impairment.  Generally, these assets are initially recorded at cost, and recognition of impairment is required when events and circumstances indicate that the carrying amounts of these assets will not be recoverable in the future.  If impairment occurs, various methods of measuring impairment may be called for depending on the circumstances and type of asset, including quoted market prices, estimates based on similar assets, and estimates based on valuation techniques such as discounted projected cash flows.  The Company had no impairment of goodwill and intangible assets for the three months ended March 31, 2010 or for the fiscal year ended December 31, 2009, and management does not anticipate any future impairment loss.  Investment securities available-for-sale are measured at fair value using Level 2 valuations calculated by an independent research firm.  The market evaluation utilizes several sources which include “observable inputs” rather than “significant unobservable inputs.” These policies affect both segments of the Company and require significant management assumptions and estimates that could result in materially different results if conditions or underlying circumstances change.

Income Taxes.  The objectives of accounting for income taxes are to recognize the amount of taxes payable or refundable for the current year and deferred tax liabilities and assets for the future tax consequences of events that have been recognized in an entity's financial statements or tax returns.  Judgment is required in addressing the future tax consequences of events that have been recognized in the Company’s financial statements or tax returns such as the realization of deferred tax assets or changes in tax laws or interpretations thereof.  In addition, the Company is subject to the continuous examination of its income tax returns by the Internal Revenue Service and other taxing authorities.  In accordance with ASC 740, “Income Taxes,” the Company has unrecognized tax benefits related to tax positions taken or expected to be taken.  See Note 12 to the financial statements.  The audit of the Company’s federal consolidated tax returns conducted by the Internal Revenue Service for fiscal years 2004 and 2005 resulted in no material adjustments.

Pension Plans.  The amounts recognized in the consolidated financial statements related to pension plans are determined from actuarial valuations.  Inherent in these valuations are assumptions, including expected return on plan assets, discount rates at which the liabilities could be settled at December 31, 2009, rate of increase in future compensation levels and mortality rates.  These assumptions are updated annually and are disclosed in Note 11 to the consolidated financial statements filed with the Company’s Annual Report on Form 10-K for the year ended December 31, 2009.   There have been no significant changes in the Company’s long-term rate of return assumptions for the past three fiscal years ended December 31 and management believes they are not reasonably likely to change in the future. Pursuant to ASC 715, “Compensation – Retirement Benefits,” the Company has recognized the funded status of its defined benefit postretirement plan in its statement of financial position and has recognized changes in that funded status through comprehensive income.  The funded status is measured as the difference between the fair value of the plan assets and the benefit obligation as of the date of its fiscal year-end.
 
 
-15-

 

Results of Operations

The following paragraphs more fully discuss the results of operations and changes in financial condition for the three-month period ended March 31, 2010 (“First Quarter of 2010”) compared to the three-month period ended March 31, 2009 (“First Quarter of 2009”).   The following discussion and analysis should be read in conjunction with the consolidated financial statements and related notes and with the statistical information and financial data appearing in this report as well as the Company's 2009 Annual Report on Form 10-K. Results of operations for the First Quarter of 2010 are not necessarily indicative of the results to be attained for any other period.

Net Income

The following table summarizes the Company’s operating results:

   
First Quarter of
 
(In thousands except per share data)
 
2010
   
2009
   
% Change
 
Net income
  $ 4,749     $ 3,923       21.1 %
Diluted earnings per share
  $ .50     $ .42       19.0 %
Return on average assets
    1.80 %     1.79 %      
Return on average equity
    14.71 %     14.35 %      

Fee Revenue and Other Income

The Company’s fee revenue is derived mainly from transportation and utility processing and payment fees.  As the Company provides its processing and payment services, it is compensated by service fees which are typically calculated on a per-item basis and by the accounts and drafts payable balances generated in the payment process which can be used to generate interest income.  Processing volumes related to fees and accounts and drafts payable were as follows:

   
First Quarter of
 
(In thousands)
 
2010
   
2009
   
% Change
 
Freight Core Invoice Transaction Volume*
    6,017       5,395       11.5 %
Freight Invoice Dollar Volume
  $ 3,768,941     $ 3,386,740       11.3 %
Utility Transaction Volume
    3,055       2,830       8.0 %
Utility Transaction Dollar Volume
  $ 2,608,099     $ 2,495,697       4.5 %
Payment and Processing Fees
  $ 12,745     $ 11,944       6.7 %
*Core invoices exclude parcel shipments.

First Quarter of 2010 compared to First Quarter of 2009:

Transportation and utility transaction volumes were up 12% and 8%, respectively, and dollar volumes were up 11% and 5%, respectively, due to new business and improved activity from existing customers.

Bank service fees decreased $63,000, or 16%, due to a decline in account analysis fees as more customers chose to pay for services with compensating balances rather than fees and a decline in fees from the sale of mutual funds.  Other income increased $4,000, or 3%.  There were no gains on sales of securities in the First Quarter of 2010.

Net Interest Income

Net interest income is the difference between interest earned on loans, investments, and other earning assets and interest expense on deposits and other interest-bearing liabilities.  Net interest income is a significant source of the Company’s revenues.  The following table summarizes the changes in net interest income and related factors:

   
First Quarter of
 
(In thousands)
 
2010
   
2009
   
% Change
 
Average earnings assets
  $ 984,700     $ 803,943       22.5 %
Average interest-bearing liabilities
    323,253       203,095       59.2 %
Net interest income*
    11,595       10,522       10.2 %
Net interest margin*
    4.78 %     5.31 %      
Yield on earning assets*
    5.26 %     5.81 %      
Rate on interest bearing liabilities
    1.48 %     1.98 %      
*Presented on a tax-equivalent basis assuming a tax rate of 35%.

 
-16-

 

First Quarter of 2010 compared to First Quarter of 2009:

First Quarter 2010 average earning assets increased approximately 22% compared to the same period in the prior year (see discussion in the following paragraphs). The yield on earning assets and the tax equivalent net interest margin both decreased in 2010 as the general level of interest rates declined; however, the significant increase in average earning assets caused net interest income to increase 10%.

Total average loans increased $56,215,000, or 9%, to $648,448,000 for the First Quarter of 2010 as compared to the First Quarter of 2009. This increase was attributable to the continuing successful implementation of new marketing efforts by the Company’s lending staff.  Average investment securities increased $21,547,000, or 11%, to $213,284,000.

Total average interest-bearing deposits for the First Quarter of 2010 increased $133,552,000, or 70%, to $323,213,000 compared to the First Quarter of 2009.  This increase was primarily the result of both new and existing customers transferring funds from lower-yielding investments at other institutions.  Accounts and drafts payable increased $30,051,000, or 7%, as freight and utility payment processing activities increased.

For more information on the changes in net interest income, please refer to the tables that follow.

Distribution of Assets, Liabilities and Shareholders' Equity; Interest Rate and Interest Differential

The following table shows the condensed average balance sheets for each of the periods reported, the tax-equivalent interest income and expense on each category of interest-earning assets and interest-bearing liabilities, and the average yield on such categories of interest-earning assets and the average rates paid on such categories of interest-bearing liabilities for each of the periods reported.

 
-17-

 
 
   
First Quarter of 2010
   
First Quarter of 2009
 
(In thousands)
 
Average
Balance
   
Interest
Income/
Expense
   
Yield/
Rate
   
Average
Balance
   
Interest
Income/
Expense
 
 
Yield/
Rate
 
Assets1
                                   
Earning assets
                                   
Loans2, 3:
                                   
Taxable
  $ 645,818     $ 9,402       5.90 %   $ 588,912     $ 8,580       5.91 %
Tax-exempt4
    2,630       38       5.86       3,321       57       6.91  
Investment securities5:
                                               
Taxable
    792       14       7.17       3,559       2       .22  
Tax-exempt4
    212,492       3,228       6.16       188,178       2,858       6.16  
Interest-bearing deposits in other financial institutions
    21,406       13       .25       13,498       8       .24  
Federal funds sold and other short-term investments
    101,562       76       .30       6,475       8       .50  
Total earning assets
    984,700       12,771       5.26       803,943       11,513       5.81  
Non-earning assets
                                               
Cash and due from banks
    9,414                       9,067                  
Premises and equipment, net
    10,324                       11,678                  
Bank-owned life insurance
    13,710                       13,168                  
Goodwill and other intangibles
    7,835                       8,039                  
Other assets
    54,801                       48,856                  
Allowance for loan losses
    (8,386 )                     (6,569 )                
Total assets
  $ 1,072,398                     $ 888,182                  
Liabilities and Shareholders’ Equity1
                                               
Interest-bearing liabilities
                                               
Interest-bearing demand deposits
  $ 169,486     $ 510       1.22 %   $ 82,085     $ 302       1.49 %
Savings deposits
    24,967       72       1.17       20,281       69       1.38  
Time deposits >=$100
    49,953       204       1.66       41,516       287       2.80  
Other time deposits
    78,807       390       2.01       45,779       276       2.45  
Total interest-bearing deposits
    323,213       1,176       1.48       189,661       934       2.00  
Short-term borrowings
    40                   10,443       18       .69  
Subordinated debentures
                      2,991       39       5.33  
Total interest bearing liabilities
    323,253       1,176       1.48       203,095       991       1.98  
Non-interest bearing liabilities
                                               
Demand deposits
    110,722                       93,464                  
Accounts and drafts payable
    491,821                       461,770                  
Other liabilities
    15,661                       18,963                  
Total liabilities
    941,457                       777,292                  
Shareholders’ equity
    130,941                       110,890                  
Total liabilities and shareholders’ equity
  $ 1,072,398                     $ 888,182                  
Net interest income
          $ 11,595                     $ 10,522          
Net interest margin
                    4.78 %                     5.31 %
Interest spread
                    3.78                       3.83  
1.
Balances shown are daily averages.
2.
For purposes of these computations, nonaccrual loans are included in the average loan amounts outstanding.  Interest on nonaccrual loans is recorded when received as discussed further in Note 1 to the Company’s 2009 consolidated financial statements, filed with the Company’s 2009 Annual Report on Form 10-K.
3.
Interest income on loans includes net loan fees of $74,000 and $136,000 for the First Quarter of 2010 and 2009, respectively.
4.
Interest income is presented on a tax-equivalent basis assuming a tax rate of 35%.  The tax-equivalent adjustment was approximately $1,143,000 and $1,020,000 for the First Quarter of 2010 and 2009, respectively.
5.
For purposes of these computations, yields on investment securities are computed as interest income divided by the average amortized cost of the investments.

 
-18-

 
 
Analysis of Net Interest Income Changes

The following table presents the changes in interest income and expense between periods due to changes in volume and interest rates.  That portion of the change in interest attributable to the combined rate/volume variance has been allocated to rate and volume changes in proportion to the absolute dollar amounts of the change in each.

   
First Quarter of 2010 Over
First Quarter of 2009
 
(In thousands)
 
Volume
   
Rate
   
Total
 
Increase (decrease) in interest income:
                 
Loans1, 2:
                 
Taxable
  $ 828     $ (6 )   $ 822  
Tax-exempt3
    (11 )     (8 )     (19 )
Investment securities:
                       
Taxable
    (3 )     15       12  
Tax-exempt3
    369       1       370  
Interest-bearing deposits in other financial institutions
    5             5  
Federal funds sold and other short-term investments
    72       (4 )     68  
Total interest income
    1,260       (2 )     1,258  
Interest expense on:
                       
Interest-bearing demand deposits
    272       (64 )     208  
Savings deposits
    14       (11 )     3  
Time deposits >=$100
    50       (133 )     (83 )
Other time deposits
    171       (57 )     114  
Short-term borrowings
    (9 )     (9 )     (18 )
Subordinated debentures
    (20 )     (19 )     (39 )
Total interest expense
    478       (293 )     185  
Net interest income
    782       291       1,073  
1.
Average balances include nonaccrual loans.
2.
Interest income includes net loan fees.
3.
Interest income is presented on a tax-equivalent basis assuming a tax rate of 35%.

Provision and Allowance for Loan Losses

A significant determinant of the Company's operating results is the provision f