BEAR STATE FINANCIAL, INC. 10-K 2009
Documents found in this filing:
Washington, D.C. 20549
For the fiscal year ended December 31, 2008
For the transition period from to
Commission File No.: 0-28312
First Federal Bancshares of Arkansas, Inc.
(Exact name of registrant as specified in its charter)
Registrants telephone number, including area code: (870) 741-7641
Securities registered pursuant to Section 12(b) of the Act:
Securities registered pursuant to Section 12(g) of the Act
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes o No x
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 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 Registrants 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 the definitions of large accelerated filer, accelerated filer, and smaller reporting company in Rule 12b-2 of the Exchange Act. (Check one):
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12B-2 of the Act). Yes o No x
As of June 30, 2008, the aggregate value of the 4,048,264 shares of Common Stock of the Registrant issued and outstanding on such date, which excludes 800,121 shares held by directors and officers of the Registrant as a group, was approximately $35.0 million. This figure is based on the last sales price of $8.65 per share of the Registrants Common Stock on June 30, 2008.
Number of shares of Common Stock outstanding as of February 20, 2009: 4,846,785
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 2009 Annual Meeting of Stockholders are incorporated into Part III, Items 10 through 14 of this Form 10-K.
For the Year Ended December 31, 2008
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, 2008, the Company had $795.2 million in total assets, $618.0 million in total deposits and $73.1 million in stockholders equity.
The Companys 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 nineteen 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 Federals 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 Banks 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 Companys 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.
The Bank had 268 full-time employees and 44 part-time employees at December 31, 2008, compared to 279 full-time employees and 50 part-time employees at December 31, 2007. None of these employees is represented by a collective bargaining agent, and the Bank believes that it enjoys good relations with its personnel.
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).
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 Banks 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 twenty offices located in twelve 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 6.87% of the deposit market share at June 30, 2008 compared to 5.94% at June 30, 2007. Of the 38 banks in this market area, we are the third largest in our combined market area. We are striving to make gains in market share at all our locations with our branching operations.
General. At December 31, 2008, the Banks portfolio of net loans receivable amounted to $568.1 million or 71.4% of the Companys total assets. The Bank has traditionally concentrated its lending activities on loans collateralized by real estate. Consistent with such approach, $541.8 million or 92.5% of the Banks total portfolio of loans receivable (total loan portfolio) consisted of loans collateralized by real estate at December 31, 2008.
Loan Composition. The following table sets forth certain data relating to the composition of the Banks loan portfolio by type of loan at the dates indicated.
Loan Maturity and Interest Rates. The following table sets forth certain information at December 31, 2008, regarding the dollar amount of loans maturing in the Banks 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.
(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 Banks loans at December 31, 2008, due after one year from such date which have fixed interest rates or which have floating or adjustable interest rates.
Scheduled contractual maturities of loans do not necessarily reflect the actual term of the Banks 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 Banks board of directors and management. Loan originations are obtained from a variety of sources, including realtor referrals, walk-in customers to the Banks branch locations, solicitation by loan officers, radio, television and newspaper advertising, and to a lesser extent, through the Banks 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 Banks secure website. Applications received over the Banks website are forwarded to loan officers. All loans exceeding an individual officers 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.
During 2008, the Bank purchased a participation in one commercial mortgage loan totaling $2.3 million. 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.
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 todays market, while not exposing the Bank to undue interest rate risk. These loans are originated subject to Fannie Mae, Freddie Mac and the specific investors 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 2008, 2007, and 2006, the Banks secondary market loan sales amounted to $25.0 million, $58.1 million, and $69.4 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 Banks 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, 2008, 2007, and 2006, such loans sold amounted to approximately $4.0 million, $7.2 million, and $3.4 million, respectively. At December 31, 2008, 2007, and 2006, the balances of loans sold with servicing retained were approximately $28.5 million, $27.8 million, and $22.2 million, respectively. Loan servicing fee income for the years ended December 31, 2008, 2007, and 2006, was approximately $117,000, $110,000, and $121,000, respectively.
The following table shows the Banks originations, sales, purchases, and repayments of loans during the periods indicated.
(1) Gross of undisbursed loan funds, unearned discounts and net loan fees and the allowance for loan losses.
(2) Includes internal refinancing loans of $52.0 million, $26.1 million and $43.4 million for each of the years ended December 31, 2008, 2007, and 2006, respectively.
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, 2008, the Banks limit on loans to one borrower was approximately $11.1 million. At December 31, 2008, the Banks largest loan or group of loans to one borrower, including persons or entities related to the borrower, amounted to $11.0 million, including undisbursed loan funds. The Banks ten largest loans or groups of loans to one borrower, including persons or entities related to the borrower, including unfunded commitments, totaled $91.8 million at December 31, 2008. Of the $91.8 million, one $692,000 loan is on nonaccrual status at December 31, 2008. See Asset Quality. This borrower also has one loan of $2.8 million that is 90 days past due and still accruing. See Potential Problem Loans. This borrower has one other loan and it is current at December 31, 2008.
One- to Four-Family Residential Real Estate Loans. At December 31, 2008, $243.3 million or 41.5% of the Banks total loan portfolio consisted of one- to four-family residential real estate loans. Of the $243.3 million of such loans at December 31, 2008, $185.5 million or 76.3% had adjustable rates of interest (including $31.8 million of seven-year adjustable rate loans) and $57.8 million or 23.7% had fixed rates of interest.
The Bank currently originates both fixed rate and adjustable rate one- to four-family residential mortgage loans. The Banks 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 Banks 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 Banks fixed rate loans typically include due on sale clauses.
The Banks 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 Banks 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 Banks 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 Banks 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 Banks 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 Banks 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, 2008, the Bank had $8.5 million of nonaccrual one- to four-family residential loans. See Asset Quality.
Home Equity and Second Mortgage Loans. At December 31, 2008, $31.7 million or 5.4% of the Banks total loan portfolio consisted of home equity and second mortgage loans. At December 31, 2008, the unused portion of home equity lines of credit was $10.5 million. At December 31, 2008, the Bank had nonaccrual home equity and second mortgage loans totaling $927,000. See Asset Quality.
The Banks 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 borrowers 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.
Multifamily Residential Real Estate Loans. The Bank offers mortgage loans for the acquisition and refinancing of multifamily residential properties. At December 31, 2008, $24.1 million or 4.1% of the Banks 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 Banks multifamily real estate loans are currently limited to 80%. It is also the Banks 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, 2008, the Bank had $441,000 of 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, 2008, $115.9 million or 19.8% of the Banks total loan portfolio consisted of loans collateralized by existing commercial real estate properties.
Many of the Banks 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 Banks 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 Banks 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 Banks 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 an oversupply of residential lots and residential housing. The region is currently in a correction mode but is still an economically viable area for the future, in the Banks opinion. This region is the home of the worlds largest retailer, Wal-Mart; as well as the nations largest meat company, Tyson Foods; the trucking firm J. B. Hunt; and the University of Arkansas. Unemployment rates lower than state and national rates, population growth, and job growth add additional support to the Banks lending in the area. At December 31, 2008, the Bank had $6.7 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 $49.4 million, or 8.4% of the Banks total loan portfolio, as of December 31, 2008, and included of $10.6 million of developed residential lots, $15.6 million of land acquired for future development and $5.4 million of developed commercial property. Generally, these loans are collateralized by properties in the Banks market areas. At December 31, 2008, the Bank had nonaccrual land loans totaling $2.5 million. See Asset Quality.
Land Development Loans. The Bank has also offered loans for the acquisition and development of land into residential subdivisions. At December 31, 2008, $18.5 million or 3.2% of the Banks 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. 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, 2008, the Bank had nonaccrual land development loans totaling $2.6 million representing one subdivision in the Benton county area and land acquired for development in the 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, 2008. The table represents accruing land development loans over $1 million as of December 31, 2008 (dollars in thousands). These loans represent approximately 73% of the accruing land development loans based on commitment amount.
(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 first section of phase one is nearing final plat approval. The lots in this subdivision were pre-sold to an investor who is now attempting to withdraw from the contract. The contract issues between the investor and our borrower will be going into arbitration.
(2) This subdivision is not complete. Subdivision is expected to be paid off from the proceeds of a bond issuance in the second quarter of 2009.
(3) This loan was paid off after December 31, 2008.
Construction Loans. The Bank originates one- to four-family residential, multifamily, and commercial real estate construction loans. However, the Banks primary emphasis has been residential construction lending. The Banks construction lending activities are typically limited to the Banks primary market areas. At December 31, 2008, construction loans, including land development loans, amounted to $77.3 million or 13.2% of the Banks 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 to $39.0 million in 2007 and $15.1 million in 2008.
The Banks 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.
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 2008 compared to 2007 and 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, 2008, the Banks portfolio of speculative single-family loans consisted of 83 loans with an average balance of approximately $206,000. Fifty-eight percent of the Banks $17.1 million in speculative single-family loans was concentrated with five borrowers who had 45 loans totaling $9.9 million. None of the top five borrowers loans was adversely classified or on nonaccrual status at December 31, 2008. At December 31, 2008, the Bank had nonaccrual speculative one- to four-family construction loans totaling $1.5 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, 2008, such loans amounted to $23.1 million or 3.9% of the total loan portfolio. At December 31, 2008, the Bank had nonaccrual commercial loans totaling $2.1 million. See Asset Quality.
The Banks 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 Banks 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 $20.9 million or 3.6% of the total loan portfolio at December 31, 2008, of which $8.6 million and $12.3 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 Banks 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 borrowers 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, 2008, the Bank had $170,000 of nonaccrual consumer loans. See Asset Quality.
Generally, when a borrower fails to make a loan payment before the expiration of the loans 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 Banks policies and procedures provide for frequent contact with the 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 loans assigned grace days. The Banks collectors also have weekly phone conferences with loan officers to review the respective officers 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, 2008 and 2007, in dollar amounts and as a percentage of the Banks 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 decrease in delinquent loans between 2007 and 2008 was primarily due to decreases in the 30-59 day and 60-89 day categories, partially offset by an increase in loans over 90 days past due. While the trend in 30-59 day and 60-89 day past due categories is encouraging and would seem to indicate a downward trend in loans eventually expected to migrate to nonperforming status, there can be no assurance that this will actually be the case. The state of the broader economy, including increasing unemployment and bankruptcy filings, may cause an increase in nonperforming loans not indicated by this delinquency trend data.
Interest income that would have been recorded under the original terms of the Banks nonaccruing loans for the year ended December 31, 2008, amounted to $1.8 million, and the interest recognized during this period amounted to $415,000.
The following table sets forth the amounts and categories of the Banks nonperforming assets at the dates indicated.
The decrease in nonaccrual loans is primarily related to the transfer of nonaccrual land development and speculative single family construction loans to real estate owned, which was offset somewhat by an increase in nonaccrual one- to four-family residential, commercial real estate, land, and commercial loans. The Northwest Arkansas market continues to experience an oversupply of lots and speculative homes. Certain of the Banks homebuilders are experiencing extended marketing times for the sale of their homes which has resulted in inadequate cash flow to service the interest carry on their loans. The specific loan loss allowance related to loans to builders and developers was approximately $1.6 million at December 31, 2008.
We expect a significant amount of the nonaccrual real estate loans to eventually migrate to real estate owned as $17.4 million of the nonaccrual real estate loans reported above are in some stage of the foreclosure process as of December 31, 2008. Therefore, we expect real estate owned and associated expenses to continue to increase in future periods as such loans migrate from loans to real estate owned.
The level of nonaccrual speculative one- to four-family residential loans, commercial real estate loans, land loans, land development loans and commercial loans is attributable primarily to eight loan relationships totaling $11.2 million, or 44.0% of nonaccrual loans. These relationships are described in more detail in the paragraphs that follow.
The first relationship totaled $2.2 million with a specific loan loss allowance of $981,000 at December 31, 2008, and is comprised of a completed 42 lot subdivision located in Cave Springs, Arkansas. The borrowers have been attempting to find a buyer for the subdivision since it matured in July 2007. We are exercising forbearance with this borrower due to their cooperation and maintenance of the subdivision such as mowing and other upkeep while they try to find a buyer. 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 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 specific allowance recorded as of December 31, 2008.
The second relationship totaled $2.0 million at December 31, 2008, and consists of a $1.3 million commercial loan secured by commercial real estate, franchise rights, inventory and equipment, a $650,000 loan on the borrowers primary residence, and a $20,000 unsecured loan. The loans in this relationship are currently in foreclosure and a specific loan loss allowance of $579,000 has been recorded as of December 31, 2008.
The third relationship totaled $2.1 million and represents a single commercial real estate loan secured by a convenience store, car wash, and retail space located in Bentonville, Arkansas. This loan is in foreclosure. As of December 31, 2008, based on the then current estimated fair value of the collateral, the Bank estimates it will incur no loss.
The fourth relationship totaled $1.6 million at December 31, 2008, and consists of a $668,000 commercial real estate loan secured by an office building located in Pea Ridge, Arkansas, five loans totaling $665,000 secured by single family rental properties located in Pea Ridge, Arkansas and Washburn, Missouri, and a $230,000 loan secured by an apartment building located in Pea Ridge, Arkansas. The borrower has filed for bankruptcy protection. At December 31, 2008, based on the estimated fair value of the collateral, the Bank estimates it will incur no loss.
The fifth relationship totaled $1.1 million at December 31, 2008 with a specific loan loss allowance of $59,000. This relationship is comprised of a $773,000 commercial real estate loan secured by a car wash and an eight-plex located in Farmington, Arkansas, two speculative single family homes totaling $236,000 located in Bella Vista, Arkansas, and land totaling $120,000 located in Fayetteville and Bella Vista, Arkansas. The loans are all in foreclosure.
The sixth relationship totaled $800,000 at December 31, 2008, and is comprised of a single commercial real estate loan secured by a car wash. At December 31, 2008, based on the then current appraised value of the property, the Bank estimates a specific loan loss allowance of $8,000. This borrower is attempting to cure the delinquency so the Bank is exercising a degree of forbearance.
The seventh relationship consists of a commercial real estate loan totaling $661,000 at December 31, 2008 secured by a restaurant located in Fayetteville, Arkansas. The restaurant is under contract with certain contingent items pending. Based on the current estimated fair value of the collateral at December 31, 2008, the Bank estimates that it will incur no loss.
The eighth relationship totaled $692,000 at December 31, 2008 and consists of a real estate loan secured by land in Fayetteville, Arkansas. The borrower is attempting to sell the collateral. Based on the current estimated fair value of the collateral, the Bank estimates it will incur no loss as of December 31, 2008.
Accruing loans 90 days or more past due at December 31, 2008, consisted of five relationships whose past due interest is expected to be paid or was paid after December 31, 2008. See Potential Problem Loans.
The following table sets forth the amounts and categories of the Banks real estate owned at the dates indicated.
(1) At December 31, 2008, $4.0 million of these properties were 100% complete. The remainder range from 79% to 84% complete.
(2) At December 31, 2008, $10.0 million of the land balance represented 273 finished subdivision lots. The remainder consisted of raw land.
The increase in real estate owned from December 31, 2007 to December 31, 2008 is primarily related to four subdivisions. The first totaled $3.7 million, and represents two phases of the same subdivision located in Lowell, Arkansas, one of which is complete and the other is approximately 10% complete. Phase one contains 66 lots. The second subdivision totaled $4.0 million for a 110 lot subdivision in Springdale, Arkansas. The third totaled $3.9 million, and represents two phases of a subdivision located in Elm Springs, Arkansas. The first phase consists of 48 completed lots and the second phase consists of undeveloped land. The fourth subdivision totaled $926,000 for 35 completed lots located in Pea Ridge, Arkansas. During 2008, seventeen single family residential properties were transferred to REO and fifteen were sold.
During the same period, eighteen speculative single family properties were transferred to REO and twenty-eight were sold. At December 31, 2008, the Bank owned ten foreclosed one- to four-family residential properties and eighteen speculative single family residential properties compared to eight and twenty-eight properties, respectively, at December 31, 2007.
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 Banks 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, market research reports, and our own market evaluations to make pricing and selling decisions. The Banks Chief Lending Officer, loan officers, credit manager, special assets officer, and team members in the collections department all work together in this endeavor. The Banks goal is to liquidate these properties in an orderly and efficient manner without incurring extraordinary losses due to quick sale pricing. During 2008, the Bank sold real estate owned totaling $10.0 million and originated loans to facilitate such sales totaling $6.9 million. The Bank offers attractive rates and financing options to prospective buyers of real estate owned to help facilitate sales.
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, 2008, the Bank had $54.4 million of classified assets, $51.5 million of which were classified as substandard and $2.9 million of which were classified as loss, consisting of $25.4 million of nonaccrual loans, $22.4 million of real estate owned and $6.6 million of loans 90 days or more past due and still accruing. In addition, at such date, the Bank had $34.8 million of assets designated as special mention. Special mention assets have potential weaknesses that deserve managements close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the asset or the institutions credit position at some future date.
Potential Problem Loans. Based on the oversupply of lots in Northwest Arkansas, our land development portfolio poses a higher risk of default. These loans are typically structured with interest due at maturity and lot sales as the source of repayment. Since lot sales in the Northwest Arkansas market are significantly slower than when these loans were originated, our borrowers typically must rely on a secondary source of funds to pay the interest as it becomes due. Due to the relatively large balances of these types of loans, the interest due at maturity is usually significant. At December 31, 2008, gross land development loans totaled $18.5 million with $1.1 million of accrued interest. Of this total, $2.6 million is on nonaccrual status with $566,000 in accrued interest, $11.4 million with $200,000 in accrued interest is classified as special mention, and $4.4 million with $332,000 in accrued interest is on our watch list. There was only one matured land development loan on accrual status at December 31, 2008 with a principal balance of $2.4 million and accrued interest of $317,000 and it was paid in full subsequent to December 31, 2008.
At December 31, 2008, the Bank had $9.0 million in loans that were 90 days or more past due and still accruing. One of such loans totaling $2.4 million discussed above was paid off subsequent to December 31, 2008. The remaining $6.6 million consists of the following loans:
A $2.8 million first mortgage loan secured by the Belclaire subdivision located in Fayetteville, Arkansas. Bonds were sold on this property by the Belclaire Improvement District without satisfying the first mortgage with our Bank. The loan is in default and we have filed foreclosure. This property is also the subject of various litigation. We believe our first mortgage will prevail and absent that, believe the guarantors will satisfy the obligation.
A $2.0 million portfolio of single family rental properties located in Fayetteville, Springdale, and Bethel Heights, Arkansas. The borrower has made several payments on these loans since December 31, 2008.
A $1.2 million loan on a church building located in Fayetteville, Arkansas. The church is attempting to lease the building to another church, which would provide cash flow to service the loan. Negotiations are ongoing.
A $640,000 matured construction loan. We expect the interest to be paid and the construction loan to be rolled over to a permanent loan.
The loans discussed above were maintained on accrual status and not classified or judged to be impaired at December 31, 2008, based on our assessment of facts and circumstances existing at that time. If any of the facts or circumstances change, our treatment of these loans might be different in future reporting periods.
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 managements estimate of incurred credit losses inherent in the Companys 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 Companys 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 borrowers prior payment record, and the amount of the short fall in relation to the principal and interest owed. Impairment is measured on a loan by loan basis by either the present value of expected future cash flows discounted at the loans effective interest rate, the loans 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 borrowers 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. 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 $6.4 million adequate to cover losses inherent in our loan portfolio at December 31, 2008, 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.
The following table summarizes changes in the allowance for loan losses and other selected statistics for the periods indicated.
(1) Consumer loan charge-offs include overdraft charge-offs of $480,000, $575,000, $600,000, $522,000, and $323,000, for the years ended December 31, 2008, 2007, 2006, 2005, and 2004, respectively. Consumer loan recoveries include recoveries of overdraft charge-offs of $140,000, $162,000, $151,000, $114,000, and $85,000, for the years ended December 31, 2008, 2007, 2006, 2005, and 2004, respectively.
The following table presents the allocation of the Banks allowance for loan losses by the type of loan at each of the dates indicated.
Investment Securities. The investment policy of the Bank, as established by the board of directors, is designed primarily to provide and maintain liquidity, to provide collateral for pledging requirements, to complement the Banks interest rate risk strategy and to generate a favorable return on investments. The Banks investment policy is currently implemented by the Banks Chief Executive Officer within the parameters set by the asset/liability management committee and the board of directors. The Bank is authorized to invest in obligations issued or fully guaranteed by the U.S. Government, certain federal agency obligations, certain time deposits, negotiable certificates of deposit issued by commercial banks and other insured financial institutions, municipal securities, and other specified investments.
Investment securities that management has the positive intent and ability to hold to maturity are classified as held to maturity and are reported at amortized cost. Investment securities classified as available for sale are reported at fair value, with unrealized gains and losses excluded from earnings and reported net of tax in other comprehensive income. At December 31, 2008, all of the Banks investment securities were classified as held to maturity. At December 31, 2008, approximately $76.4 million of the Banks investment securities were pledged as collateral for certain deposits in excess of $250,000 as well as for advances from FHLB of Dallas and the Federal Reserve Bank. At December 31, 2008, investments in the debt and/or equity securities of any one issuer, other than those issued by U.S. Government agencies, did not exceed more than 10% of the Companys stockholders equity.
The following table sets forth the amount of investment securities held to maturity that contractually mature during each of the periods indicated and the weighted average yields for each range of maturities at December 31, 2008. Weighted average yields for municipal obligations have not been adjusted to a tax-equivalent basis. Expected maturities may differ from contractual maturities because issuers may have the right to call or prepay the obligation without prepayment penalties.
As of December 31, 2008, there were approximately $135.8 million of investment securities at an average interest rate of 5.36% with issuer call options, of which approximately $124.8 million at an average interest rate of 5.44% are callable within one year.
The following table sets forth the carrying value of the Companys investment securities classified as held to maturity. The Company held no investment securities as available for sale at the dates indicated.
As a member of the FHLB of Dallas, the Bank is required to maintain an investment in FHLB stock. At December 31, 2008, the Banks investment in FHLB stock amounted to $4.8 million. No ready market exists for such stock and it has no quoted market value.
Sources of Funds
General. Deposits are the primary source of the Banks funds for lending and other investment purposes. In addition to deposits, the Bank derives funds from loan principal repayments and prepayments and interest payments, maturities and calls of investment securities, advances from the FHLB of Dallas, and borrowings from the Federal Reserve Bank Discount Window Primary Credit Program. Loan repayments are a relatively stable source of funds, while deposit inflows and outflows are significantly influenced by general interest rates and money market conditions. Borrowings are used when funds from loan and deposit sources are insufficient to meet funding needs. FHLB advances are the primary source of borrowings.
Deposits. The Banks deposit products include a broad selection of deposit instruments, including checking accounts, money market accounts, savings accounts and term certificate accounts. Deposit account terms vary, with the principal differences being the minimum balance required, the time period the funds must remain on deposit, early withdrawal penalties and the interest rate.
The Bank considers its primary market area to be Northcentral and Northwest Arkansas. The Bank utilizes traditional marketing methods to attract new customers and savings deposits. The Bank does not advertise for deposits outside of its primary market area and management believes that non-residents of Arkansas held an insignificant number of deposit accounts at December 31, 2008. Services of deposit brokers have been used on a limited basis with less than 1% of certificates of deposit at December 31, 2008, obtained through a broker.
The Bank has been competitive in the types of accounts and in interest rates it has offered on its deposit products but does not necessarily seek to match the highest rates paid by competing institutions. Although market demand generally dictates which deposit maturities and rates will be accepted by the public, the Bank intends to continue to offer longer-term deposits to the extent possible and consistent with its asset and liability management goals.
The following table shows the distribution of, and certain other information relating to, the Banks deposits by type of deposit, as of the dates indicated.