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BEAR STATE FINANCIAL, INC. 10-K 2008

 

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-K

 

(Mark One)

 

x

 

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

 

 

 

For the fiscal year ended December 31, 2007

 

 

 

OR

 

 

 

o

 

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

 

For the transition period from                  to                .

 

Commission file number  0-28312

 

First Federal Bancshares of Arkansas, Inc.

(Exact name of registrant as specified in its charter)

 

 

Texas

 

71-0785261

(State or other jurisdiction

of incorporation or organization)

 

(IRS Employer

Identification No.)

 

1401 Highway 62-65 North

Harrison, Arkansas

 

72601

(Address of principal executive offices)

 

(Zip Code)

 

 

Registrant’s telephone number, including area code: (870) 741-7641

 

Securities registered pursuant to Section 12(b) of the act:

 

Common Stock, (par value $.01 per share)

 

The Nasdaq Stock Market LLC

Title of Class

 

Name of each exchange on which registered

 

Securities registered pursuant to section 12(g) of the Act:  None

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.

Yes o Nox

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.

Yes o No x

 

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities

Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No o

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§ 229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. x

 

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 definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large accelerated filer o

 Accelerated filer x

Non-accelerated filer o

Smaller reporting company o

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No x

 

As of June 30, 2007, the aggregate value of the 4,173,814 shares of Common Stock of the Registrant issued and outstanding on such date, which excludes 689,475 shares held by directors and officers of the Registrant as a group, was approximately $99.4 million.  This figure is based on the last sales price of $23.82 per share of the Registrant’s Common Stock on June 30, 2007.

 

Number of shares of Common Stock outstanding as of February 20, 2008:  4,848,385

 

DOCUMENTS INCORPORATED BY REFERENCE

 

List hereunder the following documents incorporated by reference and the Part of the Form 10-K into which the document is incorporated.

 

Portions of the definitive proxy statement for the 2008 Annual Meeting of Stockholders are incorporated into Part III, Items 10 through 14 of this Form 10-K.

 



First Federal Bancshares of Arkansas, Inc.

Form 10-K

For the Year Ended December 31, 2007

 

 

PART I.

 

 

 

 

 

 

 

 

 

Item 1.

Business

 

 

1

Item 1A.

Risk Factors

 

 

27

Item 1B.

Unresolved Staff Comments

 

 

29

Item 2.

Properties

 

 

30

Item 3.

Legal Proceedings

 

 

30

Item 4.

Submission of Matters to a Vote of Security Holders

 

 

30

 

 

 

 

 

PART II.

 

 

 

 

Item 5.

Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

 

 

31

Item 6.

Selected Financial Data

 

 

33

Item 7.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

 

35

Item 7A.

Quantitative and Qualitative Disclosures About Market Risk

 

 

46

Item 8.

Financial Statements and Supplementary Data

 

 

48

Item 9.

Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

 

 

76

Item 9A.

Controls and Procedures

 

 

76

Item 9B.

Other Information

 

 

76

 

 

 

 

 

PART III.

 

 

 

 

Item 10.

Directors, Executive Officers and Corporate Governance

 

 

76

Item 11.

Executive Compensation

 

 

77

Item 12.

Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

 

 

77

Item 13.

Certain Relationships and Related Transactions, and Director Independence

 

 

77

Item 14.

Principal Accountant Fees and Services

 

 

77

 

 

 

 

 

PART IV.

 

 

 

 

Item 15.

Exhibits and Financial Statement Schedules

 

 

78

 

 

 

 

 

 

 

 


 


PART I.

 

Item 1.  Business

 

First Federal Bancshares of Arkansas, Inc.  First Federal Bancshares of Arkansas, Inc. (the “Company”) is a Texas corporation organized in January 1996 by First Federal Bank (“First Federal” or the “Bank”) for the purpose of becoming a unitary holding company of the Bank.  The significant asset of the Company is the capital stock of the Bank.  The business and management of the Company consists of the business and management of the Bank.  The Company does not presently own or lease any property, but instead uses the premises, equipment and furniture of the Bank.  At the present time, the Company does not employ any persons other than officers of the Bank, and the Company utilizes the support staff of the Bank from time to time.  Additional employees will be hired as appropriate to the extent the Company expands or changes its business in the future.  At December 31, 2007, the Company had $792.0 million in total assets, $630.4 million in total deposits and $73.7 million in stockholders’ equity.

 

The Company’s executive office is located at the home office of the Bank at 1401 Highway 62-65 North, Harrison, Arkansas 72601, and its telephone number is (870) 741-7641.

 

First Federal Bank.  The Bank is a federally chartered stock savings and loan association formed in 1934.  First Federal conducts business from its main office and seventeen full service branch offices, all of which are located in a six county area in Northcentral and Northwest Arkansas comprised of Benton, Marion, Washington, Carroll, Baxter and Boone counties.  First Federal’s deposits are insured by the Deposit Insurance Fund (“DIF”), which is administered by the Federal Deposit Insurance Corporation (“FDIC”), to the maximum extent permitted by law.

 

The Bank is a community-oriented financial institution offering a wide range of retail and business deposit accounts, including noninterest bearing and interest bearing checking, savings and money market accounts, certificates of deposit, and individual retirement accounts.  Loan products offered by the Bank include residential real estate, consumer, construction, lines of credit, commercial real estate and commercial non-real estate.  Other financial services include investment products offered through First Federal Investment Services, Inc.; automated teller machines; 24-hour telephone banking; internet banking, including account access, bill payment, e-statements and online loan applications; Bounce ProtectionTM overdraft service; debit cards; and safe deposit boxes.

 

The Bank is subject to examination and comprehensive regulation by the Office of Thrift Supervision (“OTS”), which is the Bank’s chartering authority and primary regulator.  The Bank is also regulated by the FDIC, the administrator of the DIF.  The Bank is also subject to certain reserve requirements established by the Board of Governors of the Federal Reserve System (“FRB”) and is a member of the Federal Home Loan Bank (“FHLB”) of Dallas, which is one of the 12 regional banks comprising the FHLB System.

 

This Form 10-K contains certain forward-looking statements and information relating to the Company that are based on the beliefs of management as well as assumptions made by and information currently available to management.  In addition, in those and other portions of this document, the words “anticipate,” “believe,” “estimate,” “expect,” “intend,” “should” and similar expressions, or the negative thereof, as they relate to the Company or the Company’s management, are intended to identify forward-looking statements.  Such statements reflect the current views of the Company with respect to future looking events and are subject to certain risks, uncertainties and assumptions.  Should one or more of these risks or uncertainties materialize or should underlying assumptions prove incorrect, actual results may vary materially from those described herein as anticipated, believed, estimated, expected or intended.  The Company does not intend to update these forward-looking statements.

 

Employees

 

The Bank had 279 full-time employees and 50 part-time employees at December 31, 2007 and 2006.   None of these employees is represented by a collective bargaining agent, and the Bank believes that it enjoys good relations with its personnel.

 

Available Information

 

The Company makes available free of charge its annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and all amendments to such reports filed pursuant to Sections 13(a) or 15(d) of the Securities Exchange Act of 1934, as soon as reasonably practicable on or through its website located at www.ffbh.com after filing with the United States Securities and Exchange Commission (“SEC”).

 

 

 

1



 

Competition

 

The Bank faces strong competition both in attracting deposits and making loans.  Its most direct competition for deposits has historically come from other savings associations, community banks, credit unions and commercial banks, including many large financial institutions that have greater financial and marketing resources available to them.  In addition, the Bank has faced additional significant competition for investors’ funds from short-term money market securities, mutual funds and other corporate and government securities.  The ability of the Bank to attract and retain savings and certificates of deposit depends on its ability to generally provide a rate of return, liquidity and risk comparable to that offered by competing investment opportunities.  The Bank’s ability to increase checking deposits depends on offering competitive checking accounts and promoting these products through effective channels.  Additionally, the Bank offers convenient hours, locations and online services to maintain and attract customers.

 

The Bank experiences strong competition for loans principally from savings associations, community banks, commercial banks and mortgage companies.  Banks new to the market, as well as those institutions who are well-established in the market, such as our bank, continue to open branches in their respective branch networks, albeit at a slower pace than in previous years. The Bank competes for loans principally through the interest rates and loan fees it charges and the efficiency and quality of services it provides borrowers.

 

With eighteen offices located in eleven cities and towns in Northwest and Northcentral Arkansas, the Bank is positioned to be a leader in providing financial services. In our combined market area of Washington, Marion, Carroll, Boone, Benton, and Baxter Counties, we had a 5.94% of the deposit market share at June 30, 2007. Of the 38 banks in this market area, we are the third largest in our combined market area. At June 30, 2007, the Bank had the largest deposit market share for the Harrison and Boone County market area, and we are striving to make gains in market share at our other locations with our branching operations.

 

 

 

2



 

Lending Activities

 

General.  At December 31, 2007, the Bank’s portfolio of net loans receivable amounted to $601.3 million or 75.9% of the Company’s total assets.  The Bank has traditionally concentrated its lending activities on loans collateralized by real estate.  Consistent with such approach, $596.2 million or 92.72% of the Bank’s total portfolio of loans receivable (“total loan portfolio”) consisted of loans collateralized by mortgage loans at December 31, 2007.

 

The table below summarizes the changes in the composition of the loan portfolio between December 31, 2003, which is the earliest year presented in the loan composition table, and December 31, 2007 (dollars in thousands):

 

 

 

2007 vs 2003

 

December 31,

 

 

 

Increase (Decrease)

 

2007

 

2003

 

 

 

Amount

 

Percentage
of Loans

 

Amount

 

Percentage
of Loans

 

Amount

 

Percentage
of Loans

 

Mortgage loans:

 

 

 

 

 

 

 

 

 

 

 

 

 

One-to four-family residences

 

$

(39,780

)

(13.26

)%

$

230,005

 

35.77

%

$

269,785

 

49.03

%

Home equity and second mortgage

 

10,278

 

0.97

 

34,315

 

5.34

 

24,037

 

4.37

 

Multifamily residential

 

7,943

 

1.04

 

15,616

 

2.43

 

7,673

 

1.39

 

Commercial real estate

 

18,882

 

0.30

 

119,681

 

18.62

 

100,799

 

18.32

 

Land loans

 

28,087

 

3.98

 

42,843

 

6.66

 

14,756

 

2.68

 

Construction loans

 

64,392

 

7.66

 

153,724

 

23.90

 

89,332

 

16.24

 

Total mortgage loans

 

89,802

 

0.69

 

596,184

 

92.72

 

506,382

 

92.03

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Commercial loans

 

11,747

 

1.55

 

22,713

 

3.54

 

10,966

 

1.99

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Consumer loans

 

(8,799

)

(2.24

)

24,068

 

3.74

 

32,867

 

5.98

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total (1)

 

$

92,750

 

0.00

%

$

642,965

 

100.00

%

$

550,215

 

100.00

%

 


 (1) Gross of undisbursed loan funds, unearned discounts and net deferred loan fees and the allowance for loan losses.

 

Since 2003, mortgage loans as a percentage of the loan portfolio is relatively unchanged.  However, the composition of mortgage loans has shifted, with a decrease in one- to four-family residential loans and an increase in land loans and construction loans.  This shift has occurred for several reasons.  The one- to four-family portfolio as a percentage of the total loan portfolio has been gradually declining since 1997, when such loans comprised approximately 83% of the loan portfolio.  This decline can be attributed to a number of factors such as increased competition in the Northwest and Northcentral Arkansas market and the growth of secondary market lending and related securitizations of mortgage loans, which allow qualifying borrowers to obtain a longer term and lower rate than the Bank would be willing to hold in its portfolio for interest rate risk  and other reasons.  Further, we believe the borrowers who did not qualify for the secondary market who might otherwise have obtained loans from us which we would have held in portfolio were likely able to obtain option ARMs, teaser rates, or other alternative financing products at other institutions who were willing to take the risks that these loans present.  Our Bank does not and has not originated these types of loans. The Bank is still actively seeking quality one- to four-family residential loans for portfolio and plans to continue to originate these loans as prudent opportunities arise.  However, based on economic conditions nationally and the changes in the market brought on by competition and the secondary market, we do not anticipate these loans to grow significantly as a percentage of the loan portfolio in the future.  During the 2001 and 2002 timeframe, opportunities began to arise in the Northwest Arkansas market for construction, land, and commercial real estate loans and these loans as a percentage of our total loan portfolio began to grow significantly.  These types of lending are generally considered to involve a higher degree of risk than residential real estate lending due to the relatively larger loan amounts and the effect of general economic conditions on the successful operation of the related business and/or income-producing properties.  The Bank has attempted to reduce such risk by evaluating the credit history and past performance of the borrower, the quality of the borrower’s management, the debt service ratio, the quality and characteristics of the income stream generated by the business or the property and appraisals supporting the property’s valuation as applicable.  However, these types of loans have largely been the reason for the Bank’s significant increase in nonaccrual loans between 2005 and 2007.  See “Asset Quality.”

 

 

 

3


 


Loan Composition.  The following table sets forth certain data relating to the composition of the Bank’s loan portfolio by type of loan at the dates indicated.

 

 

 

December 31,

 

 

 

2007

 

2006

 

2005

 

2004

 

2003

 

 

 

Amount

 

Percentage
of Loans

 

Amount

 

Percentage
of Loans

 

Amount

 

Percentage
of Loans

 

Amount

 

Percentage
of Loans

 

Amount

 

Percentage
of Loans

 

 

 

(Dollars in Thousands)

 

Mortgage loans:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

One-to four-family residences

 

$

230,005

 

35.77

%

$

257,867

 

35.05

%

$

280,900

 

35.53

%

$

292,228

 

41.79

%

$

269,785

 

49.03

%

Home equity and second mortgage

 

34,315

 

5.34

 

35,192

 

4.78

 

29,210

 

3.69

 

27,059

 

3.87

 

24,037

 

4.37

 

Multifamily residential

 

15,616

 

2.43

 

12,203

 

1.66

 

12,900

 

1.63

 

9,454

 

1.35

 

7,673

 

1.39

 

Commercial real estate

 

119,681

 

18.62

 

134,647

 

18.30

 

131,181

 

16.59

 

126,151

 

18.04

 

100,799

 

18.32

 

Land loans

 

42,843

 

6.66

 

47,590

 

6.48

 

47,585

 

6.02

 

39,036

 

5.58

 

14,756

 

2.68

 

Total permanent loans

 

442,460

 

68.82

 

487,499

 

66.27

 

501,776

 

63.46

 

493,928

 

70.63

 

417,050

 

75.79

 

Construction loans

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

One- to four-family residences

 

20,815

 

3.23

 

32,146

 

4.37

 

51,579

 

6.52

 

29,006

 

4.15

 

23,825

 

4.33

 

Speculative one- to four-family residences

 

40,893

 

6.35

 

80,311

 

10.92

 

104,001

 

13.16

 

82,709

 

11.83

 

38,207

 

6.94

 

Multifamily residential

 

18,632

 

2.90

 

14,120

 

1.92

 

20,919

 

2.65

 

21,938

 

3.14

 

15,121

 

2.75

 

Commercial real estate

 

31,239

 

4.86

 

21,896

 

2.98

 

22,331

 

2.83

 

11,436

 

1.64

 

12,179

 

2.22

 

Land development

 

42,145

 

6.56

 

47,439

 

6.45

 

40,232

 

5.09

 

14,022

 

2.01

 

 

 

Total construction loans

 

153,724

 

23.90

 

195,912

 

26.64

 

239,062

 

30.25

 

159,111

 

22.77

 

89,332

 

16.24

 

Total mortgage loans

 

596,184

 

92.72

 

683,411

 

92.91

 

740,838

 

93.71

 

653,039

 

93.40

 

506,382

 

92.03

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Commercial loans

 

22,713

 

3.54

 

26,281

 

3.57

 

20,835

 

2.64

 

16,380

 

2.34

 

10,966

 

1.99

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Consumer loans:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Automobile

 

9,531

 

1.48

 

12,086

 

1.64

 

15,748

 

1.99

 

19,101

 

2.73

 

22,087

 

4.01

 

Other consumer

 

14,537

 

2.26

 

13,815

 

1.88

 

13,149

 

1.66

 

10,685

 

1.53

 

10,780

 

1.97

 

Total consumer loans

 

24,068

 

3.74

 

25,901

 

3.52

 

28,897

 

3.65

 

29,786

 

4.26

 

32,867

 

5.98

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total loans receivable

 

642,965

 

100.00

%

735,593

 

100.00

%

790,570

 

100.00

%

699,205

 

100.00

%

550,215

 

100.00

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Less:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Undisbursed loan funds

 

(36,868

)

 

 

(40,069

)

 

 

(69,086

)

 

 

(62,661

)

 

 

(35,181

)

 

 

Unearned discounts and net deferred loan costs (fees)

 

321

 

 

 

143

 

 

 

(156

)

 

 

(481

)

 

 

(657

)

 

 

Allowance for losses

 

(5,162

)

 

 

(2,572

)

 

 

(2,114

)

 

 

(1,846

)

 

 

(1,621

)

 

 

Total loans receivable, net

 

$

601,256

 

 

 

$

693,095

 

 

 

$

719,214

 

 

 

$

634,217

 

 

 

$

512,756

 

 

 

 

 

 

4



 

Loan Maturity and Interest Rates.  The following table sets forth certain information at December 31, 2007, regarding the dollar amount of loans maturing in the Bank’s loan portfolio based on their contractual terms to maturity.  Demand loans and loans having no stated schedule of repayments and no stated maturity are reported as due in one year or less. All other loans are included in the period in which the final contractual repayment is due.

 

 

 

Within
One Year

 

One Year

Through

Five Years

 

After Five

Years

 

Total

 

 

 

(In Thousands)

 

 

Mortgage loans:

 

 

 

 

 

 

 

 

 

One- to four-family residential

 

$

7,140

 

$

17,981

 

$

204,884

 

$

230,005

 

Home equity and second mortgage

 

18,518

 

13,454

 

2,343

 

34,315

 

Multifamily residential

 

1,472

 

11,544

 

2,600

 

15,616

 

Commercial real estate

 

38,208

 

68,299

 

13,174

 

119,681

 

Land loans

 

31,334

 

10,229

 

1,280

 

42,843

 

Construction

 

124,178

 

29,546

 

 

153,724

 

Commercial loans

 

15,761

 

6,117

 

835

 

22,713

 

Consumer loans

 

7,834

 

14,709

 

1,525

 

24,068

 

Total (1)

 

$

244,445

 

$

171,879

 

$

226,641

 

$

642,965

 

 


(1)     Gross of undisbursed loan funds, unearned discounts and net deferred loan fees and the allowance for loan losses.

 

The following table sets forth the dollar amount of the Bank’s loans at December 31, 2007, due after one year from such date which have fixed interest rates or which have floating or adjustable interest rates.

 

 

 

Fixed Rates

 

Floating or
Adjustable Rates

 

Total

 

 

 

(In Thousands)

 

Mortgage loans:

 

 

 

 

 

 

 

One- to four-family residential

 

$

48,301

 

$

174,564

 

$

222,865

 

Home equity and second mortgage

 

9,642

 

6,155

 

15,797

 

Multifamily residential

 

13,124

 

1,020

 

14,144

 

Commercial real estate

 

73,400

 

8,073

 

81,473

 

Land loans

 

10,223

 

1,286

 

11,509

 

Construction

 

15,462

 

14,084

 

29,546

 

Commercial loans

 

6,591

 

361

 

6,952

 

Consumer loans

 

14,496

 

1,738

 

16,234

 

Total

 

$

191,239

 

$

207,281

 

$

398,520

 

 

Scheduled contractual maturities of loans do not necessarily reflect the actual term of the Bank’s loan portfolio. The average life of mortgage loans is substantially less than their average contractual terms because of loan prepayments and refinancing.  The average life of mortgage loans tends to increase, however, when current mortgage loan rates substantially exceed rates on existing mortgage loans and, conversely, decrease when rates on existing mortgage loans substantially exceed current mortgage loan rates.

 

Origination, Purchase and Sale of Loans.  The lending activities of the Bank are subject to the written, non-discriminatory underwriting standards and policies established by the Bank’s board of directors and management.  Loan originations are obtained from a variety of sources, including realtor referrals, walk-in customers to the Bank’s branch locations, solicitation by loan officers, radio, television and newspaper advertising, and to a lesser extent, through the Bank’s Internet website.  The Bank continually emphasizes its community ties and its practice of quick and efficient underwriting and loan approval processes, made possible in part through the use of automated underwriting software.  The Bank believes it provides exceptional personalized service to its customers.  The Bank requires hazard insurance, title insurance, and, to the extent applicable, flood insurance on all secured real property.

 

Applications are initially received by loan officers or from the Bank’s secure website.   Applications received over the Bank’s website are forwarded to loan officers.  All loans exceeding an individual officer’s approval authority are subject to review by members of the appropriate loan committee. The Bank has three loan committees (Senior Loan Committee, Executive Loan Committee, and Director Loan Committee) that review and make a decision based upon type, size, and classification.

 

 

 

5



 

During 2007, the Bank purchased participations in four commercial construction loans with a total commitment amount of $18.7 million as well as a $1.6 million participation in a commercial loan.  During 2006, the Bank purchased a commercial construction loan with a commitment amount of $100,000.  During 2005, the Bank purchased a $397,000 participation in a commercial real estate loan.

 

To minimize interest rate risk, fixed rate loans with terms of fifteen years or greater are typically sold to specific investors in the secondary mortgage market.  The rights to service such loans are typically sold with the loans. This allows the Bank to provide its customers competitive long-term fixed rate mortgage products, which are very popular financing products for homebuyers in today’s market, while not exposing the Bank to undue interest rate risk.  These loans are originated subject to Fannie Mae, Freddie Mac and the specific investor’s underwriting guidelines and are typically underwritten and validated by a third party prior to loan closing.  The Secondary Market Department of the Bank typically locks and confirms the purchase price of the loan on the day of the loan application, which protects the Bank from market price movements and ensures that the Bank will receive a fair and reasonable price on the sale of the respective loan.  Due to the loans being underwritten by a third party, the underwriter substantially assumes the repurchase risk associated with these loans. The Bank believes it has minimal risk of repurchase of these loans based upon the contracts with the specific investors.  This risk typically involves potential early prepayments of the mortgage or an early default of a loan.  In 2007, 2006, and 2005, the Bank’s secondary market loan sales amounted to $58.1 million,  $69.4 million, and $55.4 million, respectively.  The Bank is not involved in loan hedging or other speculative mortgage loan origination activities.

 

In addition to sales of loans on the secondary market, the Bank periodically sells larger commercial loans or participations in such loans in order to comply with the Bank’s loans to one borrower limit or for credit concentration purposes.  In such situations the loans are typically sold with servicing retained.  During the years ended December 31, 2007, 2006, and 2005, such loans sold amounted to approximately $7.2 million, $3.4 million, and $1.8 million, respectively.  At December 31, 2007, 2006, and 2005, the balances of loans sold with servicing retained were approximately $27.8 million, $22.2 million, and $19.6 million, respectively.   Loan servicing fee income for the years ended December 31, 2007, 2006, and 2005, was approximately $110,000, $121,000, and $100,000, respectively.

 

The following table shows the Bank’s originations, sales, purchases, and repayments of loans during the periods indicated.

 

 

 

Year Ended December 31,

 

 

 

2007

 

2006

 

2005

 

 

 

(In Thousands)

 

 

 

 

 

 

 

 

 

Loans receivable at beginning of period

 

$

735,593

 

$

790,570

 

$

699,205

 

Loan originations:

 

 

 

 

 

 

 

Mortgage loans:

 

 

 

 

 

 

 

One- to four-family residential

 

86,814

 

119,859

 

121,270

 

Home equity and second mortgage loans

 

20,914

 

46,258

 

41,661

 

Multifamily residential

 

6,427

 

3,034

 

6,341

 

Commercial real estate

 

18,356

 

46,370

 

61,248

 

Land loans

 

5,880

 

8,583

 

7,867

 

Construction

 

39,016

 

93,557

 

195,784

 

Commercial loans

 

12,395

 

21,861

 

29,862

 

Consumer:

 

 

 

 

 

 

 

Automobile

 

5,916

 

7,678

 

9,537

 

Other

 

13,347

 

13,008

 

11,710

 

Total loan originations

 

209,065

 

360,208

 

485,280

 

Loan purchases

 

20,365

 

100

 

397

 

Repayments

 

(242,230

)

(336,927

)

(336,427

)

Loan sales

 

(65,287

)

(72,857

)

(57,150

)

Transfers to real estate owned

 

(13,037

)

(6,284

)

(1,002

)

Other

 

(1,504

)

783

 

267

 

Net loan activity

 

(92,628

)

(54,977

)

91,365

 

Loans receivable at end of period (1)

 

$

642,965

 

$

735,593

 

$

790,570

 

 


(1)     Gross of undisbursed loan funds, unearned discounts and net loan fees and the allowance for loan losses.

 

 

 

6



 

Loans to One Borrower.  A savings institution generally may not make loans to one borrower and related entities in an amount which exceeds 15% of its unimpaired capital and surplus, although loans in an amount equal to an additional 10% of unimpaired capital and surplus may be made to a borrower if the loans are fully secured by readily marketable securities.  At December 31, 2007, the Bank’s limit on loans to one borrower was approximately $11.3 million.  At December 31, 2007, the Bank’s largest loan or group of loans to one borrower, including persons or entities related to the borrower, amounted to $10.9 million, including undisbursed loan funds.  The Bank’s ten largest loans or groups of loans to one borrower, including persons or entities related to the borrower, including unfunded commitments, totaled $92.6 million at December 31, 2007.  None of these loans were 90 days or more past due at December 31, 2007.

 

One- to Four-Family Residential Real Estate Loans.  At December 31, 2007, $230.0 million or 35.8% of the Bank’s total loan portfolio consisted of one- to four-family residential real estate loans.   Of the $230.0 million of such loans at December 31, 2007, $175.4 million or 76.2% had adjustable rates of interest (including $37.9 million of seven-year adjustable rate loans) and $54.6 million or 23.8% had fixed rates of interest.

 

The Bank currently originates both fixed rate and adjustable rate one- to four-family residential mortgage loans.  The Bank’s fixed rate loans to be held in portfolio are typically originated with maximum terms of fifteen years and are typically fully amortizing with monthly payments sufficient to repay the total amount of the loan with interest by the end of the loan term.  The Bank does offer fixed rate loans with terms exceeding fifteen years and such loans are typically sold in the secondary market.  The Bank’s one- to four-family loans are typically originated under terms, conditions and documentation that permit them to be sold to U.S. Government-sponsored agencies such as Fannie Mae or Freddie Mac. However, as stated above, such loans with terms of less than fifteen years are generally originated for portfolio while substantially all of such loans with terms of fifteen years or longer are sold in the secondary market.  The Bank’s fixed rate loans typically include “due on sale” clauses.

 

The Bank’s adjustable rate mortgage loans that are held in the portfolio typically provide for an interest rate which adjusts every one, three, five or seven years in accordance with a designated index plus a margin.  Such loans are typically based on a 15-, 20-, 25- or 30-year amortization schedule.  The Bank generally does not offer below market rates, and the amount of any increase or decrease in the interest rate per one- or three-year period is generally limited to 2%, with a limit of 6% over the life of the loan.  The Bank’s five-year adjustable rate loans provide that any increase or decrease in the interest rate per period is limited to 3%, with a limit of 6% over the life of the loan.  The Bank’s seven-year adjustable rate loans provide that any increase or decrease in the interest rate per period is limited to 5%, with a limit of 5% over the life of the loan.  The Bank’s adjustable rate loans are assumable (generally without release of the initial borrower), do not contain prepayment penalties and do not provide for negative amortization.  The Bank’s adjustable rate mortgage loans typically include “due on sale” clauses. The Bank generally underwrites its one- and three-year adjustable rate loans on the basis of the borrowers’ ability to pay at the rate after the first interest rate adjustment.  Adjustable rate loans decrease the risks associated with changes in interest rates but involve other risks, primarily because as interest rates rise, the payment by the borrower rises to the extent permitted by the terms of the loan, thereby increasing the potential for default. At the same time, the marketability of the underlying property may be adversely affected by higher interest rates.

 

The Bank’s residential mortgage loans generally do not exceed 80% of the appraised value of the secured property. However, pursuant to the underwriting guidelines adopted by the board of directors, the Bank may lend up to 100% of the appraised value of the property securing a one- to four-family residential loan with private mortgage insurance to protect the portion of the loan that exceeds 80% of the appraised value.  The Bank may, on occasion, extend a loan up to 90% of the appraised value of the secured property without private mortgage insurance coverage.  However, these exceptions are minimal and are only approved on loans with exceptional credit scores, sizeable asset reserves, or other compensating factors.  At December 31, 2007, the Bank had $6.8 million of nonaccrual one- to four-family residential loans.  See “Asset Quality.”

 

Home Equity and Second Mortgage Loans.   At December 31, 2007, $34.3 million or 5.3% of the Bank’s total loan portfolio consisted of home equity and second mortgage loans.  At December 31, 2007, the unused portion of home equity lines of credit was $12.5 million.  At December 31, 2007, the Bank had nonaccrual home equity and second mortgage loans totaling $1.2 million.  The increase in nonaccrual home equity and second mortgage loans relates primarily to borrowers in the construction industry.  See “Asset Quality.”

 

The Bank’s home equity and second mortgage loans are fixed rate loans with fully amortized terms of up to fifteen years, variable rate interest-only loans with terms up to three years, or home equity lines of credit.  The variable rate loans are typically tied to Wall Street Journal Prime, plus a margin commensurate with the risk as determined by the borrower’s credit score.  Longer-term amortizing loans typically have a balloon feature in five, seven, or ten years.  The home equity lines of credit are typically either fixed rate for a term of no longer than one year or variable rate with terms typically up to three years.  The Bank generally limits the total loan-to-value on these mortgages to 90% of the value of the secured property.

 

 

 

7



 

 

Multifamily Residential Real Estate Loans.  The Bank offers mortgage loans for the acquisition and refinancing of multifamily residential properties.  At December 31, 2007, $15.6 million or 2.4% of the Bank’s total loan portfolio consisted of loans collateralized by existing multifamily residential real estate properties.

 

The Bank currently originates both fixed rate and adjustable rate multifamily loans.  Fixed rate loans are generally originated with amortization periods not to exceed 30 years, and typically have balloon periods of three, five or seven years.  Adjustable rate loans are typically amortized over terms up to 30 years, with interest rate adjustments every three to seven years.  Loan-to-value ratios on the Bank’s multifamily real estate loans are currently limited to 80%.  It is also the Bank’s general policy to obtain corporate or personal guarantees, as applicable, on its multifamily residential real estate loans from the principals of the borrower.

 

Multifamily real estate lending entails significant additional risks as compared with one- to four-family residential property lending.  Such loans typically involve large loan balances to single borrowers or groups of related borrowers.  The payment experience on such loans is typically dependent on the successful operation of the real estate project.  The success of such projects is sensitive to changes in supply and demand conditions in the market for multifamily real estate as well as regional and economic conditions generally.  At December 31, 2007, the Bank did not have any nonaccrual multifamily real estate loans.  See “Asset Quality.”

 

Commercial Real Estate Loans.  The Bank originates mortgage loans for the acquisition and refinancing of commercial real estate properties.  At December 31, 2007, $119.7 million or 18.6% of the Bank’s total loan portfolio consisted of loans collateralized by existing commercial real estate properties.

 

Many of the Bank’s commercial real estate loans are collateralized by properties such as office buildings, convenience stores, service stations, mini-storage facilities, motels, churches, small shopping malls, and strip centers.  The Bank  underwrites commercial real estate loans specifically in relation to the type of property being collateralized.  Cash flows and occupancy rates are primary considerations when underwriting loans collateralized by office buildings, mini-storage facilities and motels.  Loans with borrowers that are corporations, limited liability companies, trusts, or other such legal entities are also typically personally guaranteed by the principals of the respective entity.  The financial strength of the individuals who are personally guaranteeing the loan is also a primary underwriting factor.

 

The Bank’s policy requires real estate appraisals of all properties securing commercial real estate loans by licensed real estate appraisers pursuant to state licensing requirements.  The Bank considers the quality and location of the real estate, the creditworthiness of the borrower, the cash flow of the project, and the quality of management involved with the property.  The Bank’s commercial real estate loans are generally originated with amortization periods not to exceed 25 years and typically have three-, five-, or seven-year balloon terms.  As part of the criteria for underwriting multifamily and commercial real estate loans, the Bank generally estimates a cash flow analysis that includes a vacancy rate projection, expenses for taxes, insurance, maintenance and repair reserves as well as debt coverage ratios.  This information is also estimated and included in commercial real estate appraisals.

 

Commercial real estate lending entails additional risks as compared to the Bank’s one- to four-family residential property loans. Commercial real estate loans generally involve larger loan balances to single borrowers or groups of related borrowers.  The payment experience on such loans is typically dependent on the successful operation of the real estate project. The success of such projects is sensitive to changes in supply and demand conditions in the market for commercial real estate, as well as regional and economic conditions generally.  Within the last several years, reports have ranked the Northwest Arkansas as one of the top performing economic areas in the country.   During these periods of economic expansion the Bank focused on commercial real estate activities within the market in order to take advantage of growth. More recently, this economic expansion resulted in a severe oversupply of residential lots, and to a lesser degree residential housing.    The region is currently in a correction mode but is still an economically viable area for the future, in the Bank’s opinion.  This region is the home of the world’s largest retailer, Wal-Mart; as well as the nation’s largest meat company, Tyson Foods; the trucking firm J. B. Hunt; and the University of Arkansas.   Population growth, job growth and low unemployment rates in this region add additional support to the Bank’s lending in the area.  At December 31, 2007, the Bank had $6.2 million of nonaccrual commercial real estate loans. See “Asset Quality.”

 

Land loans.  Land loans include loans for the acquisition or refinancing of land for consumer or commercial purposes.  This segment of the portfolio totaled $42.8 million, or 6.7% of the Bank’s total loan portfolio, as of December 31, 2007, and was comprised of $13.3 million of developed residential lots, $9.2 million of land acquired for future development, $7.0 million of developed commercial land, and $13.3 million of other improved and unimproved land.  The Bank has experienced an aggregate increase in this loan portfolio since 2003, primarily due to opportunities resulting from the growth and development of the Benton and Washington county areas.  Generally, these loans are collateralized by properties in the Bank’s market areas.  At December 31, 2007, the Bank had nonaccrual land loans totaling $1.3 million.  See “Asset Quality.”

 

 

 

8



 

 

Land Development Loans.  The Bank has also offered loans for the acquisition and development of land into residential subdivisions. At December 31, 2007, $42.1 million or 6.6% of the Bank’s total loan portfolio consisted of land development loans.  However, no new land development loans have been originated since the fourth quarter of 2006 due to local real estate market conditions.  This segment of the market in Northwest Arkansas has been heavily impacted by the housing market slowdown.  According to market data estimates, as of the end of the third quarter of 2007, it would take 72 months and 54 months to absorb lots currently in the pipeline in Benton County and Washington County, respectively.   As a result of slowing lot sales, borrowers have been unable to rely on lot sales to repay their loans and have had to rely on secondary sources of repayment.  For the most part, borrowers have been able to pay the interest due at maturity and the Bank has extended the loan maturity upon payment of interest.  As long as these borrowers are willing to work with the Bank on a plan to repay their loans, the Bank intends to attempt to accommodate borrowers’ workout plans.  So far, except for the nonaccrual land development loans described in “Asset Quality”, the borrowers in our land development portfolio have demonstrated a willingness to work with the Bank.  However, given the current market conditions, it is possible at any time for any one of these borrowers to default on their loans.  At December 31, 2007, the Bank had nonaccrual land development loans totaling $11.4 million representing three subdivisions in the Benton and Washington county area.  See “Asset Quality.”

 

Some of the larger loans in the land development portfolio are described in more detail below.  None of these loans was adversely classified at December 31, 2007.  The table represents accruing land development loans over $1 million as of December 31, 2007 (dollars in thousands).  These loans represent approximately 90% of the accruing land development loans based on commitment amount.

 

Origination Date

 

Maturity

Date

 

Commitment Amount

 

Funded

Amount

 

Accrued

 Interest

 

Number of

Lots

 

Status

 

County

 

01/03/2006

 

01/03/2008

 

$

6,720

 

$

6,519

 

$

498

 

208

 

(1)

 

Washington

 

06/06/2005

 

06/06/2008

 

5,570

 

5,570

 

270

 

137

 

Complete

 

Benton

 

06/03/2005

 

06/03/2008

 

4,860

 

2,185

 

111

 

80

 

(2)

 

Washington

 

12/28/2006

 

12/28/2008

 

3,413

 

3,238

 

229

 

124

 

(3)

 

Washington

 

08/05/2005

 

08/05/2008

 

2,617

 

2,617

 

97

 

43

 

Complete

 

Washington

 

04/10/2006

 

04/10/2008

 

2,216

 

644

 

41

 

76

 

(4)

 

Washington

 

08/05/2005

 

08/05/2008

 

2,102

 

2,102

 

76

 

48

 

Complete

 

Benton

 

 


(1)    This loan represents two phases of a 208-lot subdivision containing 116 lots nearing completion in phase one and 92 lots in phase two.  The principals are attempting to obtain financing to fund the interest payment. The lots in this subdivision were pre-sold to an investor who is now attempting to withdraw from the contract.

 

(2)    The development of lots is currently on hold.  The balance primarily represents land acquisition and engineering costs.

 

(3)    This subdivision is not complete.  Completion money for the project is held in escrow pending clearing of liens, which the borrower is trying to settle.  Interest was paid after December 31, 2007, $174,000 of which was funded from the loan and $53,000 paid in cash.

 

(4)    This subdivision is on hold and the borrower has informed the Bank of their intention to move the loan to another financial institution for a better rate.

 

Construction Loans.  The Bank originates one- to four-family residential, multifamily, and commercial real estate construction loans.  However, the Bank’s primary emphasis has been residential construction lending.  The Bank’s construction lending activities are typically limited to the Bank’s primary market areas.  At December 31, 2007, construction loans, including land development loans, amounted to $153.7 million or 23.9% of the Bank’s total loan portfolio.  As discussed previously, our market areas of Benton and Washington counties have experienced tremendous growth over the past several years and provided the Bank with increased lending opportunities, which can be demonstrated by the significant growth in construction lending over the past five to seven years.  However, beginning in late 2005, the Bank began to note an oversupply of homes and lots in the Northwest Arkansas market and limited its construction loan origination activity accordingly.  Construction loan originations dropped from $195.8 million in 2005 to $93.6 million in 2006 and $39.0 million in 2007.  Our speculative single-family portfolio peaked during the year ended December 31, 2005, and by December 31, 2007, had dropped to a level comparable to December 31, 2003.

 

The Bank’s construction loans generally have fixed interest rates or variable rates that float with Wall Street Journal Prime and are typically issued for terms of six to eighteen months. However, the Bank is permitted to originate construction loans with terms up to two years under its loan policy.  This practice is generally limited to larger projects that cannot be completed in the typical six- to eighteen-month period.  Construction loans are typically made with a maximum loan-to-value ratio of 80% on an as-completed basis.

 

 

 

9



 

The Bank originates construction loans to individual homeowners and local builders and developers for the purpose of constructing one- to four-family residences.  The Bank typically requires that permanent financing with the Bank or some other lender be in place prior to closing any non-speculative construction loan.  Interest on construction/permanent loans is due upon completion of the construction phase of the loan.  At such time, the loan will convert to a permanent loan at the interest rate established at the initial closing of the construction/permanent loan.

 

The Bank makes construction loans to local builders for the purpose of construction of speculative (or unsold) residential properties, and for the construction of pre-sold one- to four-family homes.  These loans are subject to credit review, analysis of personal and, if applicable, corporate financial statements, and an appraisal of the property to be constructed. The Bank also reviews and inspects the project prior to the disbursement of funds (draws) during the construction term.  Loan proceeds are disbursed after a satisfactory inspection of the project has been made based upon percentage of completion.  Interest on these construction loans is due upon maturity.  The Bank may extend the term of a construction loan upon payment of interest accrued if the property has not been sold by the maturity date.  During 2006 the Bank began to experience an increase in the incidence of builders who were unable to pay their interest at maturity due to a softening of the housing market in Northwest Arkansas.  Market data indicates an overall decrease in the number of home sales in Benton and Washington counties in 2007 compared to 2006.

 

Construction lending is generally considered to involve a higher level of risk as compared to one- to four-family residential loans.  This is due, in part, to the concentration of principal in a limited number of loans and borrowers, and the effects of general economic conditions on developers and builders.  In addition, construction loans to a builder for construction of homes that are not pre-sold possess a greater potential risk to the Bank than construction loans to individuals on their personal residences or on houses that are pre-sold prior to the inception of the loan.  The Bank analyzes each borrower involved in speculative building and limits the principal amount and number of unsold speculative homes at any one time with such borrower.  At December 31, 2007, the Bank’s portfolio of speculative single-family loans consisted of 195 loans with an average balance of approximately $210,000.  Thirty-five percent of the Bank’s $40.9 million in speculative single-family loans was concentrated with five borrowers who had 76 loans totaling $14.3 million.  None of the top five borrowers’ loans was adversely classified or on nonaccrual status at December 31, 2007.  At December 31, 2007, the Bank had nonaccrual speculative one- to four-family construction loans totaling $4.9 million.  See “Asset Quality.”

 

Commercial Loans.  The Bank also offers commercial loans, which primarily consist of equipment and inventory loans that are typically cross-collateralized by commercial real estate.  At December 31, 2007, such loans amounted to $22.7 million or 3.5% of the total loan portfolio.  At December 31, 2007, the Bank had nonaccrual commercial loans totaling $1.2 million.  See “Asset Quality.”

 

The Bank’s commercial loans are typically originated with fixed interest rates and call provisions between one and five years.  These loans are typically based on a maximum fifteen-year amortization schedule.  The Bank also originates interest-only commercial loans and variable rate commercial loans.  The Bank’s commercial loans do not provide for negative amortization.

 

Consumer Loans.  The Bank offers consumer loans in order to provide a full range of financial services to its customers while increasing the yield on its overall loan portfolio and decreasing its interest rate risk due to the relatively shorter-term nature of consumer loans. The consumer loans offered by the Bank primarily include automobile loans, deposit account secured loans, and unsecured loans.  Consumer loans amounted to $24.1 million or 3.7% of the total loan portfolio at December 31, 2007, of which $9.5 million and $14.6 million consisted of automobile loans and other consumer loans, respectively.  The Bank intends to continue its emphasis on consumer loans in furtherance of its role as a community-oriented financial institution.

 

The Bank’s automobile loans are typically originated for the purchase of new and used cars and trucks.  Such loans are generally originated with a maximum term of five years.  The Bank does offer extended terms on automobile loans to some customers based upon their creditworthiness.

 

Other consumer loans consist primarily of deposit account loans and unsecured loans.  Loans secured by deposit accounts are originated for up to 95% of the deposit account balance, with a hold placed on the account restricting the withdrawal of the deposit account balance.

 

Consumer loans entail greater risk than do residential mortgage loans, particularly in the case of consumer loans that are unsecured or secured by rapidly depreciating assets such as automobiles.  In such cases, any repossessed collateral for a defaulted consumer loan may not provide an adequate source of repayment of the outstanding loan balance as a result of the greater likelihood of damage, loss or depreciation.  In addition, consumer loan collections are dependent on the borrower’s continuing financial stability, and thus are more likely to be adversely affected by job loss, divorce, illness or personal bankruptcy.  Furthermore, the application of various federal and state laws, including federal and state bankruptcy and insolvency laws, may limit the amount which can be recovered on such loans.  At December 31, 2007, the Bank had $268,000 of nonaccrual consumer loans.  See “Asset Quality.”

 

 

 

10



 

Asset Quality

 

Generally, when a borrower fails to make a loan payment before the expiration of the loan’s assigned grace period, a late charge is assessed and a late charge notice is mailed. Collection personnel review all delinquent accounts and attempt to cure the delinquency by contacting the borrower.  The Bank’s policies and procedures provide for frequent contact with borrower until the delinquency is cured or until an acceptable repayment plan has been agreed upon.  Contact, by phone and mail, with delinquent borrowers begins immediately after the expiration of the loan’s assigned grace days.  The Bank’s collectors also have weekly phone conferences with loan officers to review the respective officer’s delinquent lists. Generally, when a consumer loan is 60 days past due and the borrower has not indicated a willingness to work with the bank to bring the account current within a reasonable period of time, the collector will mail a letter giving the borrower 10 days to bring the account current or make acceptable arrangements.  If they fail to cure the default, the collateral will be repossessed.  We attempt to work with troubled borrowers to return their loans to performing status where possible.  The decision on when to proceed with foreclosure action is made on a case-by-case basis.  The Bank recognizes that this will cause the delinquency rate on the mortgage portfolio to be elevated for an extended period of time.

 

Loans are placed on nonaccrual status when, in the judgment of management, the probability of collection of interest is deemed to be insufficient to warrant further accrual.  When a loan is placed on nonaccrual status, previously accrued but unpaid interest is deducted from interest income.  The Bank generally does not accrue interest on loans past due 90 days or more.  Loans may be reinstated to accrual status when payments are made to bring the loan less than 90 days past due and, in the opinion of management, collection of the remaining balance can be reasonably expected.  The Bank may continue to accrue interest on certain loans that are 90 days past due or more if such loans are in the process of collection and collection is reasonably assured.

 

Real estate properties acquired through foreclosure are initially recorded at fair value less estimated selling costs.   Fair value is typically determined based on the lower of appraised value or the anticipated listing price of the property. Valuations of real estate owned are performed at least quarterly.  Real estate is carried at the lower of carrying amount or fair value less cost to sell.

 

Delinquent Loans.  The following table sets forth information concerning delinquent loans at December 31, 2007 and 2006, in dollar amounts and as a percentage of the Bank’s total loan portfolio.  The amounts presented represent the total outstanding principal balances of the related loans, rather than the actual payment amounts that are past due.  The increase in delinquent loans between 2006 and 2007 was primarily due to an increase in loans over 90 days past due.  This increase was primarily in the categories of one- to four-family residential, commercial real estate, and construction loans.  Such increases are described in more detail under the nonperforming assets table that follows.

 

 

 

Loans Delinquent at December 31, 2007

 

 

 

30-59 Days

 

60-89 Days

 

Over 90 Days

 

Total

 

One- to four-family residential

 

$

6,114

 

$

1,351

 

$

5,138

 

$

12,603

 

Home equity and second mortgage

 

299

 

331

 

1,376

 

2,006

 

Commercial real estate

 

4,887

 

1,938

 

6,993

 

13,818

 

Land

 

189

 

40

 

1,027

 

1,256

 

Construction

 

753

 

1,683

 

13,389

 

15,825

 

Commercial

 

229

 

366

 

799

 

1,394

 

Consumer

 

321

 

145

 

169

 

635

 

Total

 

$

12,792

 

$

5,854

 

$

28,891

 

$

47,537

 

Percentage of total loans

 

1.99

%

0.91

%

4.49

%

7.39

%

 

 

 

Loans Delinquent at December 31, 2006

 

 

 

30-59 Days

 

60-89 Days

 

Over 90 Days

 

Total

 

One- to four-family residential

 

$

3,480

 

$

1,062

 

$

2,305

 

$

6,847

 

Home equity and second mortgage

 

173

 

210

 

724

 

1,107

 

Commercial real estate

 

2,221

 

301

 

20

 

2,542

 

Land

 

258

 

168

 

825

 

1,251

 

Construction

 

2,351

 

1,666

 

9,853

 

13,870

 

Commercial

 

251

 

113

 

721

 

1,085

 

Consumer

 

351

 

54

 

199

 

604

 

Total

 

$

9,085

 

$

3,574

 

$

14,647

 

$

27,306

 

Percentage of total loans

 

1.24

%

0.49

%

1.99

%

3.71

%

 

 

 

11



 

Interest income that would have been recorded under the original terms of the Bank’s nonaccruing loans for the year ended December 31, 2007, amounted to $2.6 million, and the interest recognized during this period amounted to $458,000.

 

The following table sets forth the amounts and categories of the Bank’s nonperforming assets at the dates indicated.

 

 

 

December 31,

 

 

 

2007

 

2006

 

2005

 

2004

 

2003

 

 

 

(Dollars in Thousands)

 

Nonaccrual loans:

 

 

 

 

 

 

 

 

 

 

 

One- to four-family residential

 

$

6,800

 

$

3,689

 

$

2,630

 

$

2,619

 

$

1,537

 

Home equity and second mortgage

 

1,194

 

994

 

269

 

406

 

341

 

Multifamily residential

 

 

 

 

 

 

Commercial real estate

 

6,160

 

738

 

707

 

 

99

 

Land

 

1,311

 

1,372

 

 

 

 

Speculative one- to four-family construction

 

4,934

 

5,417

 

1,177

 

634

 

 

Land development

 

11,428

 

5,324

 

 

 

 

Commercial

 

1,234

 

1,268

 

236

 

186

 

131

 

Consumer

 

268

 

213

 

287

 

317

 

223

 

Total nonaccrual loans

 

33,329

 

19,015

 

5,306

 

4,162

 

2,331

 

 

 

 

 

 

 

 

 

 

 

 

 

Accruing loans 90 days or more past due

 

2,412

 

668

 

1,600

 

 

 

Restructured loans

 

 

 

6,264

 

3,790

 

1,352

 

Real estate owned

 

8,120

 

3,858

 

892

 

563

 

822

 

 

 

 

 

 

 

 

 

 

 

 

 

Total nonperforming assets

 

$

43,861

 

$

23,541

 

$

14,062

 

$

8,515

 

$

4,505

 

 

 

 

 

 

 

 

 

 

 

 

 

Total nonaccrual, accruing loans 90 days

 

 

 

 

 

 

 

 

 

 

 

or more past due and restructured loans

 

 

 

 

 

 

 

 

 

 

 

as a percentage of total loans receivable

 

5.56

%

2.68

%

1.67

%

1.14

%

0.67

%

 

 

 

 

 

 

 

 

 

 

 

 

Total nonperforming assets as a percentage

 

 

 

 

 

 

 

 

 

 

 

 of total assets

 

5.54

%

2.76

%

1.65

%

1.13

%

0.65

%

 

The increase in nonaccrual loans from December 31, 2006 to December 31, 2007 is primarily related to increases of $6.1 million in nonaccrual land development loans, $5.4 million in nonaccrual commercial real estate loans and $3.1 million in nonaccrual one- to four-family residential loans, offset by a decrease of $483,000 in nonaccrual speculative one- to four-family construction loans.  The Northwest Arkansas market continues to experience an oversupply of lots and speculative homes. Certain of the Bank’s homebuilders and developers are experiencing extended marketing times for the sale of their homes and lots which has resulted in inadequate cash flow to service the interest carry on their loans.  Further, we have begun to see developers experiencing longer marketing times for lots as well as lower lot prices than projected at the time the projects were begun.  Developers who were dependent on the sale of lots to pay the interest due on their loans have also been unable to service the interest carry on their loans. The specific loan loss allowance related to loans to builders and developers was approximately $2.6 million, or 90% of total specific loan loss allowances, at December 31, 2007.

 

The level of nonaccrual speculative construction loans, land development loans and commercial real estate loans is attributable primarily to six loan relationships totaling $19.5 million, or 58% of nonaccrual loans.  Approximately $11.2 million of these loans are new to nonaccrual in 2007.  These relationships are described in more detail in the paragraphs that follow.

 

The first relationship totaled $5.9 million at December 31, 2007, and is comprised of two subdivision loans totaling $5.4 million and the borrower’s primary residence totaling approximately $520,000.  Foreclosure proceedings have begun on the subdivision and the borrower has filed for bankruptcy protection.  The subdivision loans represent two phases of the same subdivision located in Lowell, Arkansas, one of which is complete and the other is approximately 10% complete.  At December 31, 2006, we estimated no loss on the subdivision based on estimated sales prices of the lots and the estimated costs to complete the incomplete phase of the subdivision.  Since that time, market conditions have deteriorated and a subdivision across the street from this subdivision has gone into default.  We are aware that the financial institution that obtained those lots liquidated them in bulk at a substantial discount, which had an adverse effect

 

 

 

12



 

on the value of the lots in this subdivision.  As a result, we obtained new appraisals on both phases of the subdivision which used discounted cash flow analysis for the complete phase, given the extended selling period that would be necessary under current market conditions, and a land only valuation on the incomplete phase given the decreasing likelihood that these lots would be developed.  The new appraisals resulted in a specific loan loss allowance totaling $1.4 million on this subdivision recorded in the first quarter of 2007.  These subdivision loans are also the subject of litigation alleging fraud and negligence, among other complaints, that the Bank has filed against various parties to the loan.  The Bank may be able to recover some of its loss through this litigation, although at this time the Bank cannot give any assurances as to the amount of a recovery, if any.  Due to the nature of these loans, the uncertain nature of the legal process, and the possibility of continued adverse changes in market conditions, we may incur losses in the future in excess of the amount estimated as of December 31, 2007.

 

The second relationship totaled $2.2 million at December 31, 2007, and is comprised of a subdivision located in Cave Springs, Arkansas.  The subdivision is 100% complete.  The Bank obtained an updated valuation on the subdivision using discounted cash flow analysis.  Due to the market conditions and the oversupply of lots in Northwest Arkansas, the valuation indicated lower lot prices and an extended marketing time over that in the original appraisal obtained when the loan was originated.  Based on the estimated fair value of the collateral, a specific loan loss allowance totaling $885,000 was recorded during the third quarter of 2007.  Based on the nature of this loan and the possibility of continued adverse changes in the market conditions, we may incur losses in the future in excess of the amount estimated as of December 31, 2007.

 

The third relationship totaled $2.4 million at December 31, 2007, and is comprised of $840,000 of speculative single-family construction loans on two properties, a $560,000 single-family construction loan, approximately $395,000 of land and lot loans, approximately $280,000 of commercial loans and the borrower’s primary residence totaling $360,000.  All of the real estate loans are in foreclosure.  The commercial loans consist of a fully reserved unsecured loan of approximately $75,000, and junior liens on the lots and speculative homes totaling approximately $205,000, with an estimated loss allowance of $90,000.  Additionally, there is an approximate $15,000 loss allowance on the land and lot loans.  Based on factors such as the complexity of this relationship, the difficulty in estimating completion costs, and potential adverse changes in market conditions, we may incur losses in the future in excess of the amount estimated at December 31, 2007.

 

The fourth relationship totaled $2.8 million, $2.2 million of which was on nonaccrual status at December 31, 2007. The loans in this relationship became over 90 days past due during the third quarter of 2007.  Based on the borrower’s workout plans, these loans were maintained on accrual status at that time.  However, due to passage of time with no progress on the workout plan, we placed certain of the loans on nonaccrual status during the fourth quarter of 2007.  We are still hopeful the liquidation plans will work out and expect to be paid in full for all principal and interest due if the workout plan is successful.  The nonaccrual loans consist of a commercial loan secured by commercial real estate, franchise rights, inventory and equipment and an unsecured loan.  The borrower’s residence was kept on accrual status due to the existence of large junior liens behind the Bank’s first lien.  However, since that time we have learned that it is likely the junior lien holders will not buy the Bank’s note.  The total loan-to-value ratio, including accrued interest and late charges due, is approximately 81% using the most recent appraisal.  As of December 31, 2007, a $21,000 specific reserve was recorded, for this relationship, which represents the balance of the unsecured loan.

 

The fifth relationship totaled $2.1 million and represents a single commercial real estate loan secured by a convenience store, car wash, and retail space.  This loan became over 90 days past due during the third quarter of 2007.  Based on our expectation that the guarantors would cooperate with us on a workout plan and our assessment of their financial strength, these loans were maintained on accrual status at that time.  However, due to passage of time with no progress on a workout plan, we placed this loan on nonaccrual status during the fourth quarter of 2007.  In the event of a foreclosure and a possible deficiency judgment, we believe sufficient net worth exists among the guarantors to satisfy their obligation.  As of December 31, 2007, based on the then current estimated fair value of the collateral, the Bank estimates it will incur no loss.

 

The sixth relationship totaled $4.7 million at December 31, 2007, and is comprised primarily of $3.8 million in land development loans for a 110 lot subdivision in Springdale, Arkansas, as well as 7 loans totaling approximately $935,000 for a speculative single-family residence, a pre-sold custom home, a single family residence, a rental property, and land. This borrower has filed for bankruptcy protection. We have estimated losses of $10,000 at December 31, 2007. However, based on factors such as the potential adverse changes in market conditions, we may incur losses greater than that amount.

 

Accruing loans 90 days or more past due at December 31, 2007, primarily consisted of loans whose past due interest was paid after December 31, 2007.

 

The increase in real estate owned was primarily due to foreclosures on properties related to three borrowers.  The first borrower had properties totaling $3.0 million, which was comprised of $1.3 million in single-family rental properties and $1.7 million in speculative single-family homes under construction.  The speculative homes are in various stages of

 

 

 

13



 

completion ranging from approximately 85% to 100%.  Of the $3.0 million added, $1.6 million was sold prior to December 31, 2007.  The second borrower had properties totaling $2.2 million comprised of 18 speculative single-family construction loans.  The homes are complete and the Bank is actively selling these properties.  Of the $2.2 million added, approximately $600,000 was sold prior to December 31, 2007.  The third borrower had loans totaling $1.1 million comprised of three speculative single-family construction loans in various stages of completion ranging from approximately 85% to 100%.  Construction costs on the real estate owned are added to the real estate balance to the extent that the resulting balance does not exceed the estimated fair value of the property less estimated selling costs.  Since December 31, 2006, approximately $12.6 million was added to real estate owned, $6.0 million was sold, and $2.6 million was transferred to office properties and equipment for a future branch location.  The property transferred is a shopping center in Lowell, Arkansas.  The Bank plans to occupy approximately 25% of the space and lease the rest to tenants.   As discussed above, certain nonaccrual loans are in various stages of the foreclosure process at December 31, 2007.  To the extent that these loans are foreclosed and ownership transferred to the Bank, real estate owned and associated expenses could continue to increase in the future.

 

The Bank is diligently working to dispose of its REO and has dedicated an experienced special assets officer who is working full-time to liquidate the Bank’s properties in the Northwest Arkansas market. Each property is evaluated on a case-by-case basis to determine the best course of action with respect to liquidation.  Properties are marketed directly by the Bank or listed with local real estate agents utilizing appraisals, market information from realtors, the Streetsmart report, and our own market evaluations to make pricing and selling decisions.   The Bank’s Chief Lending Officer, loan officer, credit manager, special assets officer, and team members in the collections department all work together in this endeavor.   The Bank’s goal is to liquidate these properties as soon as possible without incurring extraordinary losses due to quick sale pricing.

 

Classified Assets.  Federal regulations require that each insured savings association classify its assets on a regular basis.  In addition, in connection with examinations of insured institutions, federal examiners have authority to identify problem assets and, if appropriate, classify them.  There are three classifications for problem assets: “substandard,” “doubtful” and “loss.”  Substandard assets have one or more defined weaknesses and are characterized by the distinct possibility that the insured institution will sustain some loss if the deficiencies are not corrected.  Doubtful assets have the weaknesses of substandard assets with the additional characteristic that the weaknesses make collection or liquidation in full on the basis of currently existing facts, conditions and values questionable, and there is a high possibility of loss.  An asset classified loss is considered uncollectible and of such little value that continuance as an asset of the institution is not warranted.  At December 31, 2007, the Bank had $41.4 million of classified assets, $38.5 million of which were classified as substandard and $2.9 million of which were classified as loss, consisting of $33.3 million of nonaccrual loans and $8.1 million of real estate owned.  In addition, at such date, the Bank had $8.4 million of assets designated as special mention. Special mention assets have potential weaknesses that deserve management’s close attention.  If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the asset or the institution’s credit position at some future date.

 

Allowance for Loan Losses.   The allowance for loan losses is established as losses are estimated to have occurred through a provision for loan losses charged to earnings.  Loan losses are charged against the allowance when management believes it is likely that a loan balance is uncollectible.  Subsequent recoveries, if any, are credited to the allowance.

 

The allowance for loan losses represents management’s estimate of incurred credit losses inherent in the Company’s loan portfolio as of the balance sheet date.  The estimation of the allowance is based on a variety of factors, including past loan loss experience, the current credit profile of the Company’s borrowers, adverse situations that have occurred that may affect the borrowers’ ability to repay, the estimated value of underlying collateral, and general economic conditions.  Losses are recognized when available information indicates that it is probable that a loss has been incurred and the amount of the loss can be reasonably estimated. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available or conditions change.

 

In determining the allowance for loan losses, the Company allocates a portion of the allowance to its various loan categories based on an analysis of individual loans and pools of loans.  However, the entire allowance is available to absorb credit losses inherent in the total loan portfolio as of the balance sheet date.

 

A loan is considered impaired when, based on current information and events, it is probable that the Bank will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record, and the amount of the short fall in relation to the principal and interest owed. Impairment is measured on

 

 

 

14



 

a loan by loan basis by either the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s obtainable market price, or the fair value of the collateral if the loan is collateral dependent.  Multifamily residential, commercial real estate, land and land development, and commercial loans that are delinquent or where the borrower’s total loan relationship exceeds $1 million are evaluated on a loan-by-loan basis at least annually.

 

Large groups of smaller balance homogeneous loans are collectively evaluated for impairment. Accordingly, the Bank does not separately identify individual consumer and residential loans for impairment disclosures.  Homogeneous loans are those that are considered to have common characteristics that provide for evaluation on an aggregate or pool basis. The Bank considers the characteristics of (1) one- to four-family residential mortgage loans; (2) unsecured consumer loans; and (3) collateralized consumer loans to permit consideration of the appropriateness of the allowance for losses of each group of loans on a pool basis. The primary methodology used to determine the appropriateness of the allowance for losses includes segregating certain specific, poorly performing loans based on their performance characteristics from the pools of loans as to type, valuing these loans, and then applying a loss factor to the remaining pool balance based on several factors including past loss experience, inherent risks, and economic conditions in the primary market areas.

 

In estimating the amount of credit losses inherent in our loan portfolio, various judgments and assumptions are made.  For example, when assessing the condition of the overall economic environment, assumptions are made regarding market conditions and their impact on the loan portfolio.  In the event the national or local economy were to sustain a prolonged downturn, the loss factors applied to our portfolios may need to be revised, which may significantly impact the measurement of the allowance for loan losses.  For impaired loans that are collateral dependent, the estimated fair value of the collateral may deviate significantly from the proceeds received when the collateral is sold in the event that the Bank has to foreclose or repossess the collateral.

 

Although we consider the allowance for loan losses of approximately $5.2 million adequate to cover losses inherent in our loan portfolio at December 31, 2007, no assurance can be given that we will not sustain loan losses that are significantly different from the amount recorded, or that subsequent evaluations of the loan portfolio, in light of factors then prevailing, would not result in a significant change in the allowance for loan losses.

 

 

 

15



 

 

The following table summarizes changes in the allowance for loan losses and other selected statistics for the periods indicated.

 

 

 

Year Ended December 31,

 

 

 

2007

 

2006

 

2005

 

2004

 

2003

 

 

 

(Dollars in Thousands)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total loans outstanding at end of period

 

$

642,965

 

$

735,593

 

$

790,570

 

$

699,205

 

$

550,215

 

Average loans outstanding

 

$

649,062

 

$

726,642

 

$

687,373

 

$

573,520

 

$

492,492

 

Allowance at beginning of period

 

$

2,572

 

$

2,114

 

$

1,846

 

$

1,621

 

$

1,529

 

Charge-offs:

 

 

 

 

 

 

 

 

 

 

 

One- to four-family residential

 

(75

)

(25

)

(74

)

(152

)

(73

)

Home equity and second mortgage

 

(175

)

(2

)

(49

)

(3

)

(11

)

Multifamily residential

 

 

 

 

 

 

Commercial real estate

 

(18

)

 

 

(71

)

 

Land

 

(20

)

 

 

 

 

Cnstruction

 

(401

)

(239

)

(77

)

 

 

Commercial

 

(132

)

(234

)

(41

)

(184

)

(109

)

Consumer (1)

 

(798

)

(695

)

(715

)

(488

)

(485

)

Total charge-offs

 

(1,619

)

(1,195

)

(956

)

(898

)

(678

)

Recoveries:

 

 

 

 

 

 

 

 

 

 

 

One- to four-family residential

 

5

 

 

 

2

 

1

 

Home equity and second mortgage

 

 

 

2

 

 

 

Multifamily residential

 

 

 

 

 

 

Commercial real estate

 

 

 

1

 

2

 

 

Land

 

 

 

 

 

 

Construction

 

5

 

7

 

 

 

 

Commercial

 

 

 

 

 

 

Consumer (1)

 

171

 

164

 

120

 

99

 

79

 

Total recoveries

 

181

 

171

 

123

 

103

 

80