HopFed Bancorp 10-Q 2006
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
For the quarterly period ended June 30, 2006
Commission File Number: 000-23667
HOPFED BANCORP, INC.
(Exact name of registrant as specified in its charter)
Registrants telephone number, including area code: (270) 889-2999
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 ninety days. Yes x No ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer or a non-accelerated filer. See definition of accelerated filer and large accelerated filer in Rule 12b-2 of the Exchange Act: (Check One)
Indicate by check mark whether the registrant is a shell company (as defined by Rule 12b-2 of the Exchange Act). Yes ¨ No x
As of August 12, 2006, the Registrant had issued and outstanding 3,660,010 shares of the Registrants common stock, par value $0.01 per share.
Item 1. Financial Statements
Consolidated Condensed Statements of Financial Condition
The balance sheet at December 31, 2005 has been derived from the audited financial statements of that date but does not include all of the information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements.
See accompanying Notes to Unaudited Consolidated Condensed Financial Statements.
Consolidated Condensed Statements of Income
See accompanying Notes to Unaudited Consolidated Condensed Financial Statements.
Consolidated Condensed Statements of Comprehensive Income
See accompanying Notes to Unaudited Consolidated Condensed Financial Statements
Consolidated Condensed Statements of Cash Flows
See accompanying Notes to Unaudited Consolidated Condensed Financial Statements.
NOTES TO UNAUDITED CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
Note (1) BASIS OF PRESENTATION
HopFed Bancorp, Inc. (the Company) was formed at the direction of Heritage Bank, formerly known as Hopkinsville Federal Bank (the Bank) to become the holding company of the Bank upon the conversion of the Bank from a federally chartered mutual savings bank to a federally chartered stock savings bank. The conversion was consummated on February 6, 1998. The Companys primary asset is the outstanding capital stock of the converted Bank, and its sole business is that of the converted Bank. The Bank owns 100% of the stock of Fall and Fall Insurance Agency (Fall & Fall) of Fulton, Kentucky. Fall & Falls sells life and casualty insurance to both individuals and businesses. The majority of Fall and Falls customer bases lies within the geographic footprint of the Bank. The Bank operates a financial services division in Murray, Kentucky, under the name of Heritage Solutions. The Bank operates a full service mortgage division in Clarksville, Tennessee, under the name Heritage Mortgage Services.
The accompanying unaudited consolidated condensed financial statements have been prepared in accordance with generally accepted accounting principles (GAAP) for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by GAAP in the United States of America for complete financial statements. In the opinion of management, all adjustments (consisting of only normal recurring accruals) necessary for fair presentation have been included. The results of operations and other data for the three and six month periods ended June 30, 2006, are not necessarily indicative of results that may be expected for the entire fiscal year ending December 31, 2006.
The accompanying unaudited financial statements should be read in conjunction with the Consolidated Financial Statements and the Notes thereto included in the Companys Annual Report on Form 10-K for the year ended December 31, 2005. The accounting policies followed by the Company are set forth in the Summary of Significant Accounting Policies in the Companys December 31, 2005 Consolidated Financial Statements.
Note (2) EARNINGS PER SHARE
The following schedule reconciles the numerators and denominators of the basic and diluted earnings per share (EPS) computations for the three and six-months ending June 30, 2006, and June 30, 2005. Diluted common shares arise from the potentially dilutive effect of the Companys stock options outstanding.
Note (3) STOCK COMPENSATION
On January 1, 2006, the Company, adopted SFAS 123R, Share-Based Payment (as amended). SFAS 123R establishes accounting requirements for share-based compensation to employees and carries forward prior guidance on share-based awards to non-employees. SFAS 123R eliminates the ability to account for share-based compensation transactions, as the Company did, using the intrinsic value method as prescribed by Accounting Principles Board (APB), Opinion No. 25, Accounting for Stock Issued to Employees, and generally requires that such transactions be accounted for using a fair-value-based method and recognized as an expense in the accompanying consolidated statement of income.
The Company adopted SFAS 123R using the modified prospective method which requires the application of the accounting standard as of January 1, 2006. The consolidated condensed financial statement dated March 31, 2006, was the first to reflect the impact of adopting SFAS 123R. In accordance with the modified prospective method, the consolidated financial statements for prior periods have not been restated to reflect, and do not include, the impact of SFAS 123R. For the three and six month periods ending June 30, 2006, the Company incurred additional compensation expense related to adopting SFAS 123R of $8,300 and $16,600 respectively. At June 30, 2006, the Company has 12,500 unvested stock options. A total of 5,000 stock options will vest in May 2007 and May 2008, respectively. A total of 2,500 stock options will vest in September 2006. All other options are fully vested. As a result of adopting SFAS 123R, the Company will incur additional after tax expense related to stock option vesting of approximately $8,500 in 2006, approximately $14,400 in 2007 and approximately $6,000 in and 2008. No stock options were issued, forfeited, or exercised in the three and six month periods ending June 30, 2006, and June 30, 2005.
The Company utilized the Black-Scholes valuation model to determine the fair value of stock options on the date of grant. The model derives the fair value of stock options based on certain assumptions related to the expected stock prices volatility, expected option life, risk-free rate of return and the dividend yield of the stock. The expected lives of options granted are estimated based on historical employee exercise behavior. The risk free rate of return coincides with the expected life of the options and is based on the ten year Treasury note rate at the time the options are issued. The historical volatility levels of the Companys common stock are used to estimate the stock price volatility. The set dividend yield is used to estimate the expected dividend yield of the stock.
SFAS 123R, requires certain additional disclosures beyond what was included in the Companys 2005 Annual Report. The value of vested options outstanding at June 30, 2006 was $1.6 million for options issued under the 1999 Plan and $145,000 for options issued under the 2000 Plan. The fair value of options vesting in 2006 is $33,250. Shares issued for option exercises are expected to come from authorized but unissued shares. At June 30, 2006, the Company has stock options totaling 246,723 that are eligible to be awarded. Additional stock option information at June 30, 2006 includes:
For the three and six month periods ended June 30, 2005, the Companys net income per share would have been adjusted to the pro forma amounts indicated below:
The Companys Compensation Committee granted 10,932 shares of restricted stock during the second quarter of 2006, 9,795 shares of restricted stock in 2005 and 8,887 shares of restricted stock in 2004. These shares vest over a four-year period but vesting may be accelerated as a result of factors outlined in the award agreement. For the three and six month periods ending June 30, 2006, the Company incurred compensation cost related to the HopFed Bancorp Inc. 2004 Long Term Incentive Plan of $20,000 and $39,000. For the three and six month periods ending June 30, 2005, the Company incurred compensation cost related to the HopFed Bancorp Inc. 2004 Long Term Incentive Plan of $11,000 and $20,000 respectively. The table below outlines the Companys future compensation expense related to the HopFed Bancorp, Inc. 2004 Long Term Incentive Plan for the years indicated:
The compensation committee may make additional awards of restricted stock, thereby increasing the future expense related to this plan. The early vesting of restricted stock awards due to factors outlined in the award agreement may accelerate future compensation expenses related to the plan but would not change the total amount of future compensation expense. At June 30, 2006, an additional 170,386 shares of the Companys common stock may be award through the HopFed Bancorp, Inc. 2004 Long Term Incentive Plan.
Effective January 1, 2006, the contra equity account Unearned Restricted Stock with a balance of $230,000 was transferred to Additional Paid in Capital.
NOTE (4) SECURITIES
Management evaluates securities for other-than-temporary impairment at least on a quarterly basis, and more frequently when economic or market concerns warrant such evaluations. Consideration is given to (1) the length of time and the extent to which the fair value has been less than cost, (2) the financial condition and near-term prospects of the issuer, and (3) the intent and ability of the Company to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value.
At June 30, 2006, the Company has 172 securities with unrealized losses. Management believes these unrealized losses relate to changes in interest rates and not credit quality with the exception of $5 million (par value) in commercial paper consisting of $2 million in General Motors Acceptance Corporation (GMAC) maturing in August 2007 and $3 million in Ford Motor Credit (FMAC) maturing in increments of $1 million each in January 2007, October 2008 and October 2009. After conducting an analysis of the regulatory filings of both General Motors (parent company of GMAC) and Ford Motor Company (parent company of FMAC), management believes that both companies have adequate levels of liquidity to meet their debt service obligations for the foreseeable future despite a difficult operating environment for the parent companies. Both GMAC and FMAC are profitable subsidiaries of their parent companies and appear to be highly valued in the marketplace in the event that either parent may wish to sell all or part of these subsidiaries. During the first quarter of 2006, General Motors announced that it has agreed to sell a majority interest in GMAC to a group of outside investors.
This announcement appears to bode well for the future of GMAC and may result in future upgrades by bond rating agencies. During the six-month period ending June 30, 2006, the overnight Federal Funds rate increased 0.75%. At the same time, the market value of the Companys commercial bond portfolio increased by more than $242,000. The Company continues to believe that it has the ability and intent to hold these securities until maturity, or for the foreseeable future and therefore no declines are deemed to be other than temporary. The carrying amount of securities available for sale and their estimated fair values at June 30, 2006, is as follows:
The carrying amount of securities held to maturity and their estimated fair values at June 30, 2006 is as follows:
At June 30, 2006, securities with a book value of approximately $109.4 million and a market value of approximately $105.4 million were pledged to various municipalities for deposits in excess of FDIC limits as required by law. Securities with a market value of approximately $21.0 million were sold to customers under an overnight repurchase agreement.
Note (5) INVESTMENT IN AFFILIATED COMPANIES
Investments in affiliated companies accounted for under the equity method consist of 100% of the common stock of Hopfed Capital Trust 1 (Trust), a wholly-owned statutory business trust. The Trust was formed on September 25, 2003. Summary financial information for the Trust follows (dollars in thousands):
Summary Balance Sheet
Summary Income Statement
Summary Statement of Stockholders Equity
Note (6) ACQUISITION
The Companys wholly-owned subsidiary, Heritage Bank, completed the acquisition of four offices of AmSouth Bank located in Cheatham and Houston counties in Tennessee (Middle Tennessee Division) on June 29, 2006. This acquisition enhances the Companys position in the northern portion of the Nashville, Tennessee Metropolitan Statistical Area. The consolidated statement of income includes the results of operations for the Middle Tennessee Division for one day in June 2006. As discussed below, the Company is in the process of finalizing the allocation of the purchase price to the acquired new assets noted below. Accordingly, the above allocations should be considered preliminary as of June 30, 2006.
In accordance with FASB No. 141, Accounting for Business Combinations (SFAS 141) and SFAS No. 142, Goodwill and Intangible Assets (SFAS 142), HopFed Bancorp Inc, recorded at fair value the following assets and liabilities of four AmSouth Bank offices assumed as of June 29, 2006:
The amount allocated to the core deposit intangible was determined by a valuation conducted by an independent third party and is being amortized over the estimated useful life of nine years using the sum of the years digit method.
An independent third party has completed a valuation analysis of the estimated fair market value of the acquired loan portfolio. This analysis was based on the portfolio balances, yields, and market rates on June 29, 2006. As a result, the bank will accrete approximately $210,000 in loan yield differential over the estimated average life of the individual portions of the purchased loan portfolios on an accelerated basis.
Management has completed an analysis of the credit quality of the purchased loan portfolio. As a result of this analysis, management has reduced the market value of the purchased loan portfolio by $185,000 for estimated loan losses not specifically identified by current classification.
The following table presents pro forma information as if the acquisition had occurred at the beginning of 2006. The pro forma includes adjustment for interest income on loans, amortization of intangibles arising from the transaction, depreciation expense on property acquired, interest expense on deposits assumed, and related income tax affects. The pro forma financial information is not necessarily indicative of the results of operations as they would have been had the transaction been affected on the assumed dates (All dollars are in thousands, except per share data):
Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
Critical Accounting Policies
The consolidated condensed financial statements as of and for the three and six-month periods ended June 30, 2006, and June 30, 2005, included herein have been prepared by the Company, without an audit, pursuant to the rules and regulations of the Securities and Exchange Commission. Certain information and footnote disclosures normally included in interim financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted pursuant to such rules and regulations. These financial statements should be read in conjunction with the financial statements and notes thereon included in the Companys 2005 Annual Report to Stockholders on Form 10-K.
Certain of the Companys accounting policies are important to the portrayal of the Companys financial condition, since they require management to make difficult, complex or subjective judgments, some of which may relate to matters that are inherently uncertain. Estimates associated with these policies are susceptible to material changes as a result of changes in facts and circumstances. Facts and circumstances, which could affect these material judgments, include, but without limitation, changes in interest rates, in the performance of the economy or in the financial condition of borrowers. Management believes that its critical accounting policies include determining the allowance for loan losses and determining the fair value of securities and other financial instruments and assessing other than temporary impairments of securities.
Comparison of Financial Condition at June 30, 2006 and December 31, 2005
Total assets increased by $108.4 million, from $639.6 million at December 31, 2005, to $748.0 million at June 30, 2006. Securities available for sale decreased from $172.9 million at December 31, 2005, to $170.7 million at June 30, 2006. Federal funds sold decreased from $2.3 million at December 31, 2005, to $1.9 million at June 30, 2006. In the second quarter of 2006, the Company began offering business customers the opportunity to sell overnight funds to the Bank. At June 30, 2006, the Company sold securities with a market value of $21.0 million to customers under a repurchase agreement.
At June 30, 2006, investments classified as held to maturity were carried at an amortized cost of $18.1 million and had an estimated fair market value of $17.5 million, and securities classified as available for sale had an estimated fair market value of $170.7 million. As a member of the Federal Home Loan Bank of Cincinnati (FHLB), the Company is required to purchase stock based on the Companys usage of FHLB services. At June 30, 2006, the Company owns $3.5 million (at cost) of FHLB stock.
The loan portfolio increased $75.6 million during the six months ended June 30, 2006. Net loans totaled $472.9 million and $397.3 million at June 30, 2006 and December 31, 2005, respectively. For the six months ended June 30, 2006, the average yield on loans was 6.76%, compared to 5.96% for the year ended December 31, 2005.
Set forth below is selected data relating to the composition of the loan portfolio by type of loans at the dates indicated. At June 30, 2006, December 31, 2005, and June 30, 2005, there were no concentrations of loans exceeding 10% of total loans other than as disclosed below:
The allowance for loan losses totaled $4.2 million at June 30, 2006, $4.0 million at December 31, 2005, and $3.7 million at June 30, 2005. The ratio of the allowance for loan losses to loans was 0.88%, 1.00%, and 0.99% at June 30, 2006, December 31, 2005, and June 30, 2005, respectively. Also at June 30, 2006, non-performing loans were $678,000, or 0.14% of total loans, compared to $996,000, or 0.25% of total loans, at December 31, 2005, and $693,000, or 0.19% of total loans, at June 30, 2005, respectively. Non-performing assets, which include other real estate owned and other assets owned, were $1,132,000, or 0.15% of total assets at June 30, 2006, compared to $1,224,000, or 0.19% of total assets, at December 31, 2005 and $873,000, or 0.15% of total assets, at June 30, 2005.
The Companys annualized net charge off ratio for the six-month periods ended June 30, 2006, June 30, 2005, and the year ended December 31, 2005, was 0.20%, 0.12%, and 0.14%, respectively. The ratio of allowance for loan losses to non-performing loans at June 30, 2006, December 31, 2005, and June 30, 2005, was 617.9%, 402.0% and 528.7%, respectively. The following table sets forth an analysis of the Companys allowance for loan losses for the six-month periods ended:
Various factors are considered in determining the necessary allowance for loan losses, including the market value of the underlying collateral, growth and composition of the loan portfolio, the relationship of the allowance for loan losses to outstanding loans, historical loss experience, delinquency trends and prevailing economic conditions.
Although management believes the allowance for loan losses is adequate, there can be no assurance that additional provisions for loan losses will not be required or that losses on loans will not be incurred. The Company had $424,000 in real estate owned and $30,000 of other assets owned at June 30, 2006.
At June 30, 2006, the Company had $659,000 in loans classified as special mention, $959,000 classified as substandard and $600,000 classified as doubtful. At June 30, 2005, the Company had no loans classified as special mention, $1.6 million classified as substandard and $487,000 classified as doubtful.
At June 30, 2006, deposits increased to $540.2 million from $482.7 million at December 31, 2005, an increase of $57.5 million. The average cost of all deposits during the three and six-month periods ended June 30, 2006 and the year ended December 31, 2005 was 3.21%, 3.07%, and 2.60%, respectively.
Management continually evaluates the investment alternatives available to customers and adjusts the pricing on its deposit products to more actively manage its funding cost while remaining competitive in its market area. Managements current business plan focuses on growing the Companys deposit base for non-interest bearing and demand deposit accounts and maintaining a lesser dependence on high cost time deposit accounts.
Comparison of Operating Results for the Six-Months Ended June 30, 2006 and 2005
Net Income. Net income for the six months ended June 30, 2006, was $ 2,050,000, compared to net income of $2,058,000 for the six months ended June 30, 2005. Despite the marginal change in net income, the various components influencing net income have changed significantly.
Net Interest Income. The most significant source of earnings is net interest income, which is the difference between interest income on interest earning assets and interest expense paid on interest bearing liabilities. Factors influencing net interest income include both the volume and changes in volume of interest earning assets and interest bearing liabilities, the amount of non-interest earning assets and non-interest bearing liabilities, and the level and changes of market interest rates. At June 30, 2006, and June 30, 2005, the level of interest bearing assets to interest bearing liabilities was 107.5% and 108.3%. In general, a financial company with higher ratio of interest bearing assets as compared to interest bearing liabilities is more likely to have a higher level of net interest income.
Average Balances, Yields and Interest Expenses. The following table sets forth certain information relating to the Companys consolidated average interest-earning assets and interest bearing liabilities and reflects the average yield on assets and average cost of liabilities for the six month periods ended June 30, 2006, and June 30, 2005. Dividing income or expense by the average daily balance of assets or liabilities, respectively, derives such yields and cost for the periods presented. During the periods indicated, non-accruing loans are included in the loan category. For the six months ended June 30, 2006, and June 30, 2005, the table adjusts tax-free investment income by $119 and $162, respectively, for a tax equivalent rate. All dollars are in thousands.
Interest Income. Increases in interest income were driven by both increases in market interest rates and the increase in the volume of loans outstanding. In the last twelve months, the Federal Reserve Bank has increased Fed Funds a total of eight times, or 2.0%. A large percentage of the Companys assets are variable rate and tied to either One Year Constant Maturity Treasury (One Year CMT) or the Prime Rate as published in the Wall Street Journal. While the yield on these assets may change, all loans do not re-price at the same time and many may not adjust for up to five years.
Interest Expense. Interest expense has also increased as a result of increases in both the volume of interest bearing liabilities and market rates. In the last six months, the Company has
increased its borrowings from the FHLB to fund loan growth. In general, these borrowing are more expensive as compared to time deposits. The benefit of borrowing from the FHLB is that access to capital is more easily available and the maturities of borrowed funds are more easily managed as compared to time deposits. Other factors influencing the level of borrowings include the competitive nature of the Companys deposit market and the limited amount of non-interest bearing deposits currently on hand.
The Company remains focused on growing its level of non-interest bearing deposits, both organically and through acquisition. The Companys June 29, 2006, acquisition of four retail offices in Tennessee was attractive to management due to the high percentage of non-interest bearing checking accounts and demand deposit accounts. An additional benefit to growth in this area is that non-interest income typically increases along with growth in the number of demand deposit accounts. The Companys focus on growing demand deposit balances is a significant factor in the decisions to construct additional retail offices, increase the number of ATM locations, and acquire new locations through acquisition.
Non-Interest Income. For the six-month period ending June 30, 2006, non-interest income increased by $29,000 as compared to the same period last year. The small increase was achieved despite a $328,800 gain on the sale on Intrieve, Inc. stock realized in April 2005. Income from both deposit and other income have increased by $178,000 and $223,000, respectively as compared to the six-month period June 30, 2005. Income from the Companys financial services division is lower despite the addition of a mortgage origination division in April 2006 as fee income from insurance and brokerage services are down significantly.
Non-Interest Expenses. There was an increase in total non-interest expenses of approximately $1.5 million for the six months ended June 30, 2006, compared to the same period in 2005. Compensation expense increased more than $600,000 due to increases in staffing levels required by the addition of retail offices. The Companys professional expense increased by approximately $400,000 during the same time frame, largely the result of a $300,000 charge to fund expenses related to the Companys recent acquisition.
Provision for Loan Losses. The Company determined that $417,000 of provision for loan loss expense was necessary for the six month period ending June 30, 2006 as compared to $600,000 for the same period in 2005.
Income Taxes. The effective tax rate for the six months ended June 30, 2006, was 30.2%, compared to 30.0% for the same period in 2005.
Comparison of Operating Results for the Three-Months Ended June 30, 2006 and 2005
Net Income. Net income for the three months ended June 30, 2006, was $ 849,000 compared to net income of $1,065,000 for the three months ended June 30, 2005. Net income for the three-month periods ending June 30, 2006, and June 30, 2005, were strongly influenced by significant one-time events. The three-month period ended June 30, 2005, included a $328,800 investment gain on the sale of stock. During the three month period ended June 30, 2006, the Company incurred approximately $300,000 in operating expenses in preparation for an acquisition.
Net Interest Income. Net interest income increased by approximately $640,000 for the three-month period ending June 30, 2006, as compared to June 30, 2005. This increase was the result of higher loan and deposit balances. For the three-month period ending June 30, 2006, the Companys net interest margin and net yield on earning assets improved 0.08% and 0.10%, respectively, as compared to the same period in 2005.
Average Balances, Yields and Interest Expenses. The following table sets forth certain information relating to the Companys consolidated average interest-earning assets and interest bearing liabilities and reflects the average yield on assets and average cost of liabilities for the three month periods ended June 30, 2006, and June 30, 2005. Dividing income or expense by the average daily balance of assets or liabilities, respectively, derives such yields and cost for the periods presented. During the periods indicated, non-accruing loans are included in the loan category. For the three months ended June 30, 2006, and June 30, 2005, the table adjusts tax-free investment income by $56 and $70, respectively, for a tax equivalent rate. All dollars are in thousands.
Interest Expense. Interest expense increased approximately $1.8 million, to $5.4 million for the three months ended June 30, 2006, as compared to the same period in 2005. The increase was attributable to a higher cost of funding interest-bearing deposits and borrowings as well as
higher balances of interest bearing deposits. The Companys market for deposits remains competitive and additional increases are possible despite the additional deposits acquired on June 29, 2006.
Non-Interest Income. For the three-month period ending June 30, 2006, non-interest income declined by $50,000 as compared to the same period last year. The decline is the result of a $328,800 gain on the sale on Intrieve, Inc. stock realized in April 2005. Income from both deposits and other income have increased by $128,000 and $122,000, respectively as compared to the three-month period June 30, 2005. Income from subsidiary activities was higher due to the addition of a mortgage origination company.
Non-Interest Expenses. There was an increase in total non-interest expenses of approximately $1.0 million for the three months ended June 30, 2006 compared to the same period in 2005. Compensation expense increased almost $400,000 due to increases in staffing levels required by the addition of retail offices. The Companys professional expense increased by approximately $300,000 during the same time frame as a result of a charge to fund expenses related to the Companys recent acquisition. Data processing, occupancy, and other expenses rose significantly over the same period last year.
Provision for Loan Losses. The Bank determined that an additional $204,000 and $300,000 of provision for loan losses was required for the three months ended June 30, 2006 and June 30, 2005, respectively.
Income Taxes. The effective tax rate for the three months ended June 30, 2006 was 28.5%, compared to 30.3% for the same period in 2005.
Liquidity and Capital Resources
The Company has no business other than that of the Bank. Management believes that dividends that may be paid by the Bank to the Company will provide sufficient funds for its initial operations and liquidity needs. However, no assurance can be given that the Company will not have a need for additional funds in the future. The Bank is subject to certain regulatory limitations with respect to the payment of dividends to the Company. The primary regulators of the Bank and the Company are the Office of Thrift Supervision and the Federal Deposit Insurance Corporation.
The Banks principal sources of funds for operations are deposits from its primary market areas, principal and interest payments on loans, proceeds from maturing investment securities and the net conversion proceeds received by it. The principal uses of funds by the Bank include the origination of mortgage and consumer loans and the purchase of investment securities.
The Bank must satisfy three capital standards: a ratio of core capital to adjusted total assets of 4.0%, a tangible capital standard expressed as 1.5% of total adjusted assets, and a combination of core and supplementary capital equal to 8.0% of risk-weighted assets. At June 30, 2006, the Bank exceeded all regulatory capital requirements. The table below presents certain information relating to the Banks capital compliance at June 30, 2006.
At June 30, 2006, the Bank had the following outstanding commitments related to its loan portfolio:
Management believes that the Banks sources of funds are sufficient to fund all of its outstanding commitments. At June 30, 2006, time deposits which are scheduled to mature in one year or less from June 30, 2006 totaled $186.6 million. Management believes that a significant percentage of such deposits will remain with the Bank. At June 30, 2006, the Bank had non-cancelable purchase obligations incurred in connection with the construction and purchase of new retail locations of approximately $4.5 million.
At June 30, 2006, the Company has outstanding borrowings of $122.9 million from the Federal Home Loan Bank of Cincinnati with maturities ranging from overnight borrowings to ten years. These borrowings are secured by a blanket security agreement pledging the Companys 1-4 family first mortgages and non-residential real estate. At June 30, 2006, the Company has approximately $235.6 million in 1-4 family first mortgages and $127.4 million in non-residential real estate that may be pledged under this agreement. At June 30, 2006, these borrowing have a weighted average maturity of 3.1 years and a weighted average cost of 4.67%.
This Quarterly Report on Form 10-Q contains forward-looking statements. Additional written or oral forward-looking statements may be made by the Company from time to time in filings with the Securities and Exchange Commission or otherwise. The words believe, expect, seek, and intend and similar expressions identify forward-looking statements, which speak only as of the date the statement is made. Such forward-looking statements are within the meaning of that term in Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended.
Such statements may include, but are not limited to, projections of income or loss, expenditures, acquisitions, plans for future operations, financing needs or plans relating to services of the Company, as well as assumptions relating to the foregoing. Forward-looking statements are inherently subject to risks and uncertainties, some of which cannot be predicted or quantified. Future events and actual results could differ materially from those set forth in, contemplated by or underlying the forward-looking statements.
The Company does not undertake, and specifically disclaims, any obligation to publicly release the results of revisions, which may be made to forward-looking statements to reflect the occurrence of anticipated or unanticipated events or circumstances after the date of such statements.
Effect of New Accounting Standards
In November 2005, FSP FAS Nos. 115-1 and FAS 124-1 The Meaning of Other-Than-Temporary Impairment and its Application to Certain Investment was issued. The FSP nullifies certain requirements of Issue 03-01 and supersedes EITF Topic No. D-44, Recognition of Other-Than-Temporary Impairment upon the Planned Sale of a Security Whose Cost Exceeds Fair Value. This FSP nullified the requirements of paragraphs 10-18 of Issue 03-01 and related examples. The guidance in this FSP shall be applied to reporting periods beginning after December 15, 2005. The initial adoption of this FSP in 2006 did not have a material impact on the financial condition, the results of operations, or cash flows of the Company.
In May 2005, the FASB issued SFAS 154, Accounting Changes and Error Corrections a Replacement of APB Opinion No. 20 and FASB Statement No. 3. This Statement replaces APB Opinion No. 20, Accounting Changes, and FASB Statement No. 3, Reporting Accounting Changes in Interim Financial Statements, and changes the requirements for the accounting for and reporting of a change in accounting principle.
This Statement requires retrospective application to prior accounting periods financial statements of changes in accounting principle, unless it is impracticable to determine either the period-specific effects or the cumulative effect of the accounting principle. It also applies to changes required by accounting pronouncements in the unusual instance that the pronouncement does not include specific transition provisions. This Statement was effective for accounting changes and error corrections made in fiscal years beginning after December 15, 2005.
In February 2006, the FASB issued SFAS No. 155, Accounting for Certain Hybrid Financial Instruments (SFAS 155). SFAS 155 amends FASB Statement No. 133 and FASB Statement No. 140, and improves the financial reporting of certain hybrid financial instruments by requiring more consistent accounting that eliminates exemptions and provides embedded derivatives to be accounted for as a whole (eliminating the need to bifurcate the derivative from the host) if the holder elects to account for the whole instrument on a fair value basis. The Company is required to adopt the provisions of SFAS 155, as applicable, beginning in 2007. Management does not believe that the adoption of SFAS 155 will have a material impact on the Companys consolidated financial position and results of operations.
In March 2006, SFAS No. 156, Accounting for Servicing of Financial Assets, an amendment of FASB Statement No. 140, was issued. SFAS No. 156 amends SFAS No. 140, Accounting Transfers and Servicing of Financial Assets and Extinguishments of Liabilities, with respect to the accounting for separately recognized servicing assets and servicing liabilities. SFAS 156 (1) requires an entity to recognize a servicing asset or servicing liability each time it undertakes an obligation to service a financial asset; (2) requires all separately recognized servicing assets and servicing liabilities to be initially measured a fair value; (3) if practicable, it permits an entity to chose either the amortization or fair value method following subsequent measurement methods for each class of separately recognized servicing assets and servicing liabilities; (4) and at its initial adoption, permits a one-time reclassification of available-for-sale securities to trading securities under SFAS No. 115, Accounting for Certain Investments in Debt and Equity Securities, provided that the servicing assets or servicing liabilities that a servicing Company elects to subsequently measured at fair value in the statement of financial position and additional disclosures for all separately recognized servicing assets and servicing liabilities.
SFAS No. 156 is effective for the fiscal year beginning after December 15, 2006. The Company will adopt SFAS No. 156 beginning in the first quarter of 2007. The impact of adopting SFAS No. 156 is not anticipated to have a material impact on the Companys financial statements.
In June 2006, the FASB issued Interpretation No. 48, Accounting for Uncertainty in Income Taxes an interpretation of FASB Statement No. 109 (FIN 48). Fin 48 requires companies to recognize in their financial statements the impact of a tax position, taken or expected to be taken, if that position is more likely than not of being sustained on audited based on the technical merits of the position. The provisions of FIN 48 are effective for the Company as of January 1, 2007, and is not anticipated to have a material impact on the Companys financial statements.
Item 3. Quantitative and Qualitative Disclosures about Market Risk
The Company monitors whether material changes in market risk have occurred since year-end. The Company is unable to predict future changes in market rates and their impact on the Companys profitability. However, the Company models its balance sheet and income statement in an effort to manage its interest rate risk.
The Companys analysis of interest rate risk assumes parallel shifts in interest rates (rates rising uniformly over the entire spectrum of the interest rate curve). At June 30, 2006, the Companys analysis of the change in net interest income over the next twelve months resulting from changes in interest rates is as follows:
Changes in net interest income may not be uniform during the twelve-month period due to the uneven nature of loan repricings and time deposit maturities.
During the first six months of 2006, short-term market interest rates increased significantly while longer-term rates (identified by the five and ten year treasury bills) have remained relatively unchanged, resulting in a flat yield curve.
As a result, the Company has experienced a substantial shift in customer demand for fixed rate first mortgages sold on the secondary market and away from adjustable rate 1-4 family mortgages. Given the current yield curve, long term fixed rate mortgages are substantially less expensive than the Companys current adjustable rate loan offerings.
The Companys goal is for the Banks net interest expense to increase at a rate much slower than that of its peer group and competitors in a rising interest rate environment due to a decreasing reliance on time deposits. The Companys June 29, 2006, acquisition allowed it to increase its percentage of lower cost deposits.
However, the Company remains highly dependent on time deposits for funding. To significantly reduce its cost of funds, the Company must increase its percentage of non-interest bearing deposits to total deposits, currently at 9.99%. The Companys intermediate goal of non-interest bearing deposits to total deposits is 12% with a long-term goal of 17.50%. To increase its non-interest deposit balances, the Company is investing in new products, locations, and automated teller machines. However, non-interest deposit growth completed without the assistance of an acquisition is slow, may take several years and may never reach the goals set forth by management and is likely to result in higher non-interest expenses.
Item 4. Controls and Procedures
Evaluation of disclosure controls and procedures.
In accordance with Rule 13a-15(b) of the Securities and Exchange Act of 1934 (the Exchange Act), an evaluation was carried out with the participation of the Companys management, including the Companys Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Companys disclosure controls and procedures (as defined in Rule 13a-14(c) and 15d-14(c) under the Exchange Act) as of the end of the quarter ended June 30, 2006.
Based upon their evaluation of these disclosure controls and procedures, the Chief Executive Officer and Chief Financial Officer concluded that the disclosure controls and procedures were effective as of the end of the three and six month periods ended June 30, 2006, to ensure that material information relating to the Company, including its consolidated subsidiaries, was made known to them by others within those entities, particularly during the period in which this quarterly report on Form 10-Q was being prepared.
Any control system, no matter how well conceived and operated, can provide only reasonable assurance that its objectives are achieved. The design of a control system inherently has limitations, including the controls cost relative to their benefits. Additionally, controls can be circumvented. No cost-effective control system can provide absolute assurance that all control issues and instances of fraud will be detected.
Effective in 2007, the Company will become subject to Section 404 of The Sarbanes-Oxley Act of 2002. Section 404 requires management to assess and report on the effectiveness of the Companys internal control over financial reporting. Additionally, it requires the Companys independent registered public accounting firm to report on managements assessment as well as report on its own assessment of the effectiveness of the Companys internal controls over financial reporting.
Management is currently establishing policies and procedures to assess and report on internal control over financial reporting, and has retained an outside firm to assist it in determining the effectiveness of the Companys internal control over financial reporting.
Changes in Internal Control Over Financial Reporting
There were no changes in the Companys internal control over financial reporting during the Companys fiscal quarter ended June 30, 2006, that have materially affected, or are reasonably likely to materially affect, the Companys internal control over financial reporting
Item 1A. Risk Factors
The Companys Annual Report on Form 10K for the fiscal year ended December 31, 2005, describes various risk that may materially affect its business. This section updates that discussion to reflect material developments since the 10K was filed.
The Company may face risks with respect to current and future acquisition and expansions.
The Company has engaged, and may continue to engage, in de novo branch expansion as well as the acquisition of other financial institutions or parts of those institutions. The Company may also consider and enter into new lines of business or offer new products or services. In addition, the Company may receive future inquiries and have discussions with potential acquirers of the Company. Acquisitions and mergers involve a number of risks, including:
The Company may incur substantial costs to expand. There can be no assurance that integration efforts for any future mergers or acquisitions will be successful. Also, the Company may issue equity securities, including common stock and securities convertible into shares of the Companys common stock in connection with future acquisitions, which could cause ownership and economic dilution to the Companys stockholders. There is no assurance that, following any future mergers or acquisitions, the Companys integration efforts will be successful or the Company, after giving effect to the acquisition, will achieve profits comparable to or better than its historical experience.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
On March 26, 2001, the Company announced that its Board of Directors had approved the repurchase of 300,000 shares of Common Stock. The purchases are being made from time to time on the Nasdaq Stock Market at prices prevailing on that market or in privately negotiated transactions at managements discretion, depending on market conditions, prices of the Companys Common Stock, corporate cash requirements and other factors. As of June 30, 2006, a total of 208,909 shares of Common Stock had been repurchased under the current program. No shares were repurchased during the quarter ended June 30, 2006. The current stock repurchase program remains open until the Company completes the purchase of all fully authorized shares.
Item 4. Submission of Matters to a Vote of Security Holders
On May 18, 2006, the Company held its Annual Meeting of Stockholders at which the following matter was considered and voted on:
Proposal I Election of Directors:
There were no abstentions or broker non-votes.
Item 6. Exhibits
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.