Jefferson Bancshares 10-Q 2010
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
For the quarterly period ended September 30, 2010
For the transition period from to
Commission File Number 00-50347
JEFFERSON BANCSHARES, INC.
(Exact name of registrant as specified in its charter)
(Registrants telephone number, including area code)
(Former name, former address and former fiscal year, if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (Section 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ¨ No ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definition 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 Exchange Act). Yes ¨ No x
Indicate the number of shares outstanding of each of the issuers classes of common stock as of the latest practicable date:
At November 12, 2010, the registrant had 6,645,777 shares of common stock, $0.01 par value per share, outstanding.
Consolidated Balance Sheets
(Dollars in Thousands)
See accompanying notes to financial statements.
Consolidated Statements of Earnings (Unaudited)
(Dollars in Thousands, Except Net Earnings Per Share)
See accompanying notes to financial statements.
Consolidated Statements of Changes in Stockholders Equity
Three Months Ended September 30, 2010 and 2009
(Dollars in Thousands)
Consolidated Statements of Cash Flows (Unaudited)
(Dollars in Thousands)
See accompanying notes to financial statements.
Notes To Consolidated Financial Statements
The condensed consolidated financial statements include the accounts of Jefferson Bancshares, Inc. (the Company or Jefferson Bancshares) and its wholly-owned subsidiary, Jefferson Federal Bank (the Bank or Jefferson Federal). The accompanying interim condensed consolidated financial statements, presented in accordance with accounting principles generally accepted in the United States of America (GAAP), are unaudited and reflect all adjustments which, in the opinion of management, are necessary for a fair statement of financial condition and results of operations for the interim periods. The results of operations for the period ended September 30, 2010 are not necessarily indicative of the results which may be expected for the entire fiscal year. These unaudited consolidated financial statements should be read in conjunction with the Companys Annual Report on Form 10-K for the year ended June 30, 2010, which was filed with the Securities and Exchange Commission on September 24, 2010. All dollar amounts, other than per-share amounts, are in thousands unless otherwise noted. The Company has adopted FASB ASC Topic 855 for Subsequent Events which did not significantly change the subsequent events the Company reports either through recognition or disclosure.
The consolidated financial statements include the accounts of Jefferson Bancshares, Inc. and its wholly-owned subsidiary, Jefferson Federal Bank. All significant intercompany balances and transactions have been eliminated in consolidation.
In preparing the consolidated financial statements, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the statement of condition dates and revenues and expenses for the periods shown. Actual results could differ from the estimates and assumptions used in the consolidated financial statements. Material estimates that are particularly susceptible to significant change in the near term relate to the determination of the allowance for loan losses, the valuation of foreclosed real estate and deferred tax assets.
Jefferson Federal may not pay dividends on its capital stock if its regulatory capital would thereby be reduced below the amount then required for the liquidation account established for the benefit of certain depositors of Jefferson Federal at the time of its conversion to stock form.
Under applicable regulations, Jefferson Federal is prohibited from making any capital distributions if, after making the distribution, the Bank would have: (i) total risk-based capital ratio of less than 8.0%; (ii) Tier 1 risk-based capital ratio of less than 4.0%; or (iii) a leverage ratio of less than 4.0%.
Under the banking laws of the State of Tennessee, a Tennessee chartered savings bank may not declare dividends in any calendar year in which the dividend would exceed the total of
its net income for that year, combined with its retained net income for the preceding two years, without the prior approval of the Commissioner of the Tennessee Department of Financial Institutions.
Earnings per common share and diluted earnings per common share have been computed on the basis of dividing net earnings by the weighted-average number of shares of common stock outstanding, exclusive of unallocated employee stock ownership plan (ESOP) shares. Diluted earnings per common share reflect additional common shares that would have been outstanding if dilutive potential common shares had been issued. Potential common shares that may be issued by the Company relate to outstanding stock options and are determined using the treasury stock method. For the period ended September 30, 2010, stock options to purchase 551,490 shares were not included in the computation of diluted net income per share as their effect would have been anti-dilutive. The following table illustrates the number of weighted-average shares of common stock used in each corresponding earnings per common share calculation:
Impairment of loans having a recorded investment of $41.6 million at September 30, 2010 and an average investment of $38.4 million during the three month period ended September 30, 2010 has been recognized. The valuation allowance related to impaired loans was $6.2 million at September 30, 2010. Total nonaccrual loans at September 30, 2010 were approximately $20.6 million. Interest income from impaired loans included in the Companys interest income amounted to approximately $437,000 for the three months ended September 30, 2010.
The following table summarizes the activity in the allowance for loan losses for the three months ended September 30, 2010:
Jefferson Bancshares is a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments generally include commitments to originate mortgage loans. These instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the balance sheet. The Companys maximum exposure to credit loss in the event of nonperformance by the borrower is represented by the contractual amount and related accrued interest receivable of those instruments. The Company minimizes this risk by evaluating each borrowers creditworthiness on a case-by-case basis. Collateral held by the Company consists of a first or second mortgage on the borrowers property. The amount of collateral obtained is based upon an appraisal of the property.
At September 30, 2010, we had approximately $14.2 million in commitments to extend credit, consisting of commitments to fund real estate loans. In addition to commitments to originate loans, we had $5.1 million in unused letters of credit and approximately $32.7 million in unused lines of credit.
On February 2, 2010, the Company announced that the Board of Directors had voted to suspend the payment of the quarterly cash dividend on the Companys common stock in an effort to conserve capital.
The Company maintains stock-based benefit plans under which certain employees and directors are eligible to receive stock grants or options. Under the 2004 Stock-Based Benefit Plan, a maximum of 279,500 shares may be granted as restricted stock and a maximum of 698,750 shares may be issued through the exercise of nonstatutory or incentive stock options. The exercise price of each option equals the market price of the Companys stock on the date of grant and an options maximum term is ten years.
Restricted stock grants aggregating 45,000 shares and having a fair value of $597,000 were awarded in 2006. Restrictions on the grants lapse in annual increments over five years. The market value as of the grant date of the restricted stock grants is charged to expense as the restrictions lapse.
In connection with the Companys previously announced acquisition of State of Franklin Bancshares, Inc. (State of Franklin) on October 31, 2008, each outstanding State of Franklin non-qualified option with an exercise price of $13.50 or less was converted into an option to purchase shares of Jefferson Bancshares common stock with an expiration date of October 31, 2011.
The table below summarizes the status of the Companys stock option plans as of September 30, 2010.
The following information applies to options outstanding at September 30, 2010:
The estimated fair value of stock options at grant date was determined using the Black-Scholes option-pricing model based on market data as of January 29, 2004. An expected dividend yield of 1.17% and expected volatility of 7.01% were used to model the value. The risk free rate of return equaled 4.22%, which was based on the yield of a U.S. Treasury note with a term of ten years. The estimated time remaining before the expiration of the options equaled ten years.
Investment securities are summarized as follows:
At September 30, 2010
At June 30, 2010
Securities with unrealized losses not recognized in income are as follows:
The Company evaluates its securities with significant declines in fair value on a quarterly basis to determine whether they should be considered temporarily or other than
temporarily impaired. The company has recognized all of the foregoing unrealized losses in other comprehensive income. The company neither has the intent to sell nor is forecasting the need or requirement to sell the securities before their anticipated recovery.
Maturities of debt securities at September 30, 2010, are summarized as follows:
Fair value is defined as the price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. The Company utilizes fair value measurements to record fair value adjustments to certain assets and liabilities and to determine fair value disclosures. When measuring fair value, the Company uses valuation techniques that are appropriate and consistently applied. A hierarchy is also established under the standard and is used to prioritize valuation inputs into the following three levels used to measure fair value:
Quoted prices in active markets for identical assets or liabilities. Level 1 assets and liabilities include debt and equity securities and derivative contracts that are traded in an active exchange market, as well as certain U.S. Treasury, other U.S. Government and agency mortgage-backed debt securities that are highly liquid and are actively traded in over-the-counter markets.
Observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities. Level 2 assets and liabilities include debt securities with quoted prices that are traded less frequently than exchange-traded instruments and derivative contracts whose value is determined using a pricing model with inputs that are observable in the market or can be derived principally from or corroborated by observable market data. This category generally includes certain U.S. Government and agency mortgage-backed debt securities, corporate debt securities, derivative contracts and residential mortgage loans held-for-sale.
Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. Level 3 assets and liabilities include financial instruments whose value is determined using pricing models, discounted cash flow methodologies, or similar techniques, as well as instruments for which the determination of fair value requires significant management judgment or estimation. This category generally includes certain private equity investments, retained residual interests in securitizations, residential mortgage servicing rights, and highly structured or long-term derivative contracts.
The following is a description of valuation methodologies used for assets recorded at fair value.
Investment Securities Available for Sale
Level 2 investment securities classified as available-for-sale are recorded at fair value on at least a monthly basis. Fair value measurements are based upon independent pricing models or other model-based valuation techniques with inputs that are observable in the market or that can be derived principally from or corroborated by observable market data. Level 2 securities include mortgage-backed securities issued by government-sponsored entities, municipal bonds, bonds issued by government agencies, and corporate debt securities. Level 3 investment securities classified as available-for-sale are recorded at fair value on at least a semi-annual basis. Fair value measurements are based upon independent pricing models based upon unobservable inputs which require significant management judgment or estimation. Level 3 includes certain mortgage-backed securities and other debt securities.
The Company does not record loans at fair value on a recurring basis. However, from time to time, a loan is considered impaired and an allowance for loan losses is established. Loans for which it is probable that payment of interest and principal will not be made in accordance with the contractual terms of the loan agreement are considered impaired. Once a loan is identified as individually impaired, management measures impairment using one of several methods, including collateral value, market value of similar debt, enterprise value, liquidation value and discounted cash flows.
Those impaired loans not requiring an allowance represent loans for which the fair value of the expected repayments or collateral exceed the recorded investments in such loans. At September 30, 2010, substantially all of the total impaired loans were evaluated based on either the fair value of the collateral or its liquidation value. Impaired loans where an allowance is established based on the fair value of collateral require classification in the fair
value hierarchy. When the fair value of the collateral is based on an observable market price or a current appraised value, the Company records the impaired loan as nonrecurring Level 2. When an appraised value is not available or management determines the fair value of the collateral is further impaired below the appraised value and there is no observable market price, the Company records the impaired loan as nonrecurring Level 3.
Assets and Liabilities Recorded at Fair Value on a Recurring Basis
Below is a table that presents information about certain assets and liabilities measured at fair value:
Assets and Liabilities Recorded at Fair Value on a Nonrecurring Basis
The Company may be required, from time to time, to measure certain assets at fair value on a nonrecurring basis in accordance with GAAP. These include assets that are measured at the lower of cost or market that were recognized at fair value below cost at the end of the period. Assets measured at fair value on a nonrecurring basis are included in the table below.
The carrying value and estimated fair value of the Companys financial instruments are as follows:
On October 31, 2008, the Company completed the acquisition of State of Franklin. State of Franklin was headquartered in Johnson City, Tennessee, which is approximately 70 miles northeast of the Companys headquarters. State of Franklin operated six offices in Johnson City and Kingsport, Tennessee with a branch under construction in Bristol, Tennessee. The primary reason for the acquisition of State of Franklin was to expand the Companys presence into upper East Tennessee. Under the terms of the merger agreement, the Company issued a combination of shares of Company common stock and cash for the outstanding common shares of State of Franklin. State of Franklin shareholders were given the option of receiving $10.00 in cash or 1.1287 shares of Company common stock for each share of State of Franklin common stock, or a combination of stock and cash for each share of State of Franklin common stock, provided that 60% of the aggregate shares of State of Franklin common stock would be exchanged for Company common stock and subject to the allocation and proration formula set forth in the merger agreement. However, all State of Franklin common stockholders residing outside of Tennessee were only eligible to receive cash consideration. Based on this structure, the aggregate merger consideration totaled approximately $4.3 million in cash and 736,000 shares of Company common stock. The Company also incurred $557,000 in merger costs that were capitalized into goodwill. The acquisition was accounted for using the purchase method of accounting in accordance with generally accepted accounting principles for business combinations.
As part of the State of Franklin acquisition, the Company acquired State of Franklin Statutory Trust II (the Trust) and assumed the Trusts obligation with respect to certain capital securities described below. On December 13, 2006, State of Franklin issued $10.3 million of junior subordinated debentures to the Trust, a Delaware business trust wholly owned by State of Franklin. The Trust (a) sold $10.0 million of capital securities through its underwriters to institutional investors and upstreamed the proceeds to State of Franklin and (b) issued $310,000 of common securities to State of Franklin. The sole assets of the Trust are the $10.3 million of junior subordinated debentures issued by State of Franklin. The securities are redeemable at par after January 30, 2012, and have a final maturity of January 30, 2037. The interest is payable quarterly at a floating rate equal to 3-month LIBOR plus 1.7%.
The company has evaluated subsequent events for potential recognition and disclosure for the three months ended September 30, 2010 through November 8, 2010. No items were identified during this evaluation that required adjustment to or disclosure in the accompanying financial statements.
Managements discussion and analysis of financial condition and results of operations is intended to assist in understanding the financial condition and results of operations of Jefferson Bancshares. The information contained in this section should be read in conjunction with the financial statements and accompanying notes thereto. For further information, refer to the financial statements and footnotes included in the Companys Annual Report on Form 10-K for the year ended June 30, 2010, which was filed with the Securities and Exchange Commission on September 24, 2010.
Jefferson Bancshares, Inc. (also referred to as the Company or Jefferson Bancshares) is the holding company for Jefferson Federal Bank (the Bank or Jefferson Federal).
The Company has no significant assets, other than all of the outstanding shares of the Bank, and no significant liabilities. Management of the Company and the Bank are substantially similar and the Company neither owns nor leases any property, but instead uses the premises, equipment and furniture of the Bank. Accordingly, the information set forth in this report, including the consolidated financial statements and related financial data, relates primarily to the Bank.
Jefferson Federal is a community oriented financial institution offering traditional financial services to its local communities. The Bank is engaged primarily in the business of attracting deposits from the general public and using such funds to originate loans secured by first mortgages on owner-occupied, one-to four- family residential properties, as well as originate commercial real estate and multi-family mortgage loans, construction loans, consumer loans, commercial non-real estate loans and make other investments permitted by applicable laws and regulations.
The Banks savings accounts are insured up to the applicable legal limits by the Federal Deposit Insurance Corporation (FDIC) through the Deposit Insurance Fund. Jefferson Federal is a member of the Federal Home Loan Bank (FHLB) System.
Private Securities Litigation Reform Act Safe Harbor Statement
This Quarterly Report may contain forward-looking statements within the meaning of the federal securities laws. These statements are not historical facts; but rather, are statements based on Jefferson Bancshares current expectations regarding its business strategies and their intended results and the Companys future performance. Forward-looking statements are preceded by terms such as expects, believes, anticipates, intends and similar expressions.
Managements ability to predict results or the effect of future plans or strategies is inherently uncertain. These factors include, but are not limited to, general economic conditions, changes in the interest rate environment, legislative or regulatory changes that may adversely affect our business, changes in accounting policies and practices, changes in competition and demand for financial services, adverse changes in the securities markets and changes in the quality or composition of the Companys loan or investment portfolios. Additional factors that may affect our results are discussed in our Annual Report on Form 10-K for the year ended June 30, 2010 under Item 1A. Risk Factors. These factors should be considered in evaluating the forward-looking statements and undue reliance should not be placed on such statements. Jefferson Bancshares assumes no obligation to update any forward-looking statements.
Results of Operations for the Three Months Ended September 30, 2010 and 2009
Net income for the three months ended September 30, 2010 was $259,000, or $0.04 per diluted share, compared to net income of $484,000, or $0.08 per diluted share, for the corresponding period in 2009. The decrease in net income for the quarter ended September 30, 2010 was primarily the result of write-downs and losses on other real estate owned (OREO).
Net Interest Income
Net interest income before loan loss provision decreased $347,000 to $4.3 million for the quarter ended September 30, 2010 compared to $4.7 million for the same period in 2009. The interest rate spread and net interest margin for the quarter ended September 30, 2010 were 3.00% and 3.08%, respectively, compared to 3.17% and 3.31%, respectively, for the same period in 2009.
The following table summarizes changes in interest income and expense for the three month periods ended September 30, 2010 and 2009:
The following table summarizes average balances and average yields and costs for the three months ended September 30, 2010 and 2009. For purposes of this table nonaccrual loan balances and related accrued interest income have been excluded.
The following table sets forth the effects of changing rates and volumes on our net interest income. The rate column shows the effects attributable to changes in rate (changes in rate multiplied by prior volume). The volume column shows the effects attributable to changes in volume (changes in volume multiplied by prior rate). The net column represents the sum of the prior columns. For purposes of this table, changes attributable to changes in both rate and volume that cannot be segregated have been allocated proportionately based on the changes due to rate and the changes due to volume.
Total interest income decreased $1.1 million, or 13.7%, to $6.9 million for the three months ended September 30, 2010 primarily due to a change in the mix of average earning assets. The average volume of earning assets decreased $2.4 million to $562.0 million for the quarter ended September 30, 2010 while the average yield on earning assets declined 75 basis points to 4.85% compared to the same period in 2009.
Interest on loans decreased $847,000, or 11.9%, to $6.3 million for the three months ended September 30, 2010 primarily due to a lower average balance of loans. The average balance of loans decreased $58.8 million, or 12.3%, to $418.2 million, due to the combination of reduced loan demand, normal paydowns on existing loans, transfers to OREO and charge-offs. Reduced loan demand has resulted from continued economic weakness in the Banks market areas. The average yield on loans was 5.96% for the three months ended September 30, 2010 compared to 5.93% for the same period in 2009.
Interest on investment securities decreased $263,000 to $482,000 for the three months ended September 30, 2010 due primarily to a lower average yield on investment securities. The average yield on investment securities decreased to 3.64% for the three months ended September 30, 2010 compared to 7.07% for the same period in 2009 due to lower market interest rates and changes in the composition of the portfolio. A portion of the proceeds from called securities has been reinvested in similar securities but with lower yields. The average balance of investment securities increased $11.8 million, to $54.6 million, during the three months ended September 30, 2010 compared to the same period in 2009 period due to the investment of a portion of the Companys excess liquidity into short- and intermediate-term U.S. agency securities.
Total interest expense decreased $742,000 to $2.5 million for the three months ended September 30, 2010. The average balance of interest-bearing liabilities increased $5.3 million, to $536.5 million during the quarter ended September 30, 2010, while the rate paid on interest-bearing liabilities declined 57 basis points to 1.85%. The Company experienced an increase in average interest-bearing deposits of $10.2 million, or 2.4%, to $443.2 million, primarily due to an increase in the average balance of transaction accounts more than offsetting a decrease in the average balance of time deposits. The average rate paid on deposits decreased 66 basis points to 1.49% for the three months ended September 30, 2010, primarily as a result of declining market interest rates as well as a shift in the mix of deposits towards more transaction accounts. Average FHLB borrowings decreased slightly to $85.1 million for the three months ended September 30, 2010 compared to $90.3 million for the three months ended September 30, 2009, while the average rate paid on borrowings remained stable at 3.60%.
Provision for Loan Losses
There was no provision for loan losses for the quarter ended September 30, 2010, compared to $5.5 million for the quarter ended June 30, 2010 and $300,000 for quarter ended September 30, 2009. During the fourth quarter of fiscal 2010, management took aggressive action to increase the allowance for loan losses following its quarterly analysis of the loan portfolio, including its analysis of net charge-offs, delinquency levels, nonperforming assets, nonaccrual loans and other subjective factors which identified additional weaknesses in the loan portfolio. The determination not to record a provision for loan losses for the quarter ended September 30, 2010 reflects stabilizing asset quality metrics.
Management reviews the level of the allowance for loan losses on a monthly basis and establishes the provision for loan losses based on changes in the nature and volume of the loan portfolio, the amount of impaired and classified loans, historical loan loss experience and other qualitative factors. In addition, the Federal Deposit Insurance Corporation and Tennessee Department of Financial Institutions, as an integral part of their examination process, periodically review our allowance for loan losses and may require the Company to recognize adjustments to the allowance for loan losses based on their judgments about information available to them at the time of their examination.
Noninterest income decreased $508,000 to $390,000 for the three months ended September 30, 2010 compared to $898,000 for the corresponding period in 2009 due primarily to an increase in loss on sale of foreclosed property. Loss on sale of foreclosed property increased $338,000 to $347,000 for the three months ended September 30, 2010. Service charges and fees declined $90,000, or 20.2% primarily due to decreases in late fees and overdraft fees. Management believes fee revenue decreased due to heightened customer awareness of fees and a resultant increased management of account balances in the current economic downturn. In addition, recently enacted legislation requiring customer opt-in for point-of-sale overdrafts became effective in mid-August 2010. This legislation may have a negative impact on future noninterest income.
The following table summarizes the dollar amounts for each category of noninterest income, and the dollar and percent changes for the three months ended September 30, 2010 compared to the same period in 2009.
Noninterest expense decreased $248,000, or 5.4%, to $4.4 million for the three months ended September 30, 2010 compared to the corresponding 2009 period. Compensation expense decreased $247,000, or 12.4%, to $1.7 million for the three months ended September 30, 2010 compared to the same period in 2009 due to an overall reduction in number of employees. The number of full-time equivalent employees was 130 at September 30, 2010 compared to 157 for
the same period in 2009. The number of employees decreased from period to period primarily due to the integration of the State of Franklin acquisition. Expenses related to other real estate owned increased to $531,000 for the three months ended September 30, 2010 due to valuation adjustments and expenses related to the maintenance and disposition of foreclosed real estate. Occupancy expense decreased $184,000 to $364,000 due to lower leasehold expenses for the three months ended September 30, 2010.
The following table summarizes the dollar amounts for each category of noninterest expense, and the dollar and percent changes for the three months ended September 30, 2010 compared to the same period in 2009.
Income tax expense for the three months ended September 30, 2010 was $126,000 compared to $208,000 for the same period in 2009 due to lower taxable income.
Cash, Cash Equivalents and Interest-Earning Deposits
Cash, cash equivalents, and interest-earning deposits increased $44.0 million to $113.3 million at September 30, 2010 compared to $69.3 million at June 30, 2010 due to decreases in loan and investment balances combined with an increase in deposits. Management has maintained higher than usual levels of liquidity during the current economic downturn. The higher level of interest earning deposits at September 30, 2010 also reflects the anticipation of maturing FHLB advances totaling $20.0 million during the second quarter of fiscal 2011.
The Companys investment security portfolio primarily consists of U.S. Government agency obligations, mortgage-backed securities issued by government-sponsored entities, and municipal bonds. Investment securities decreased to $45.8 million at September 30, 2010 compared to $63.0 million at June 30, 2010. Investments classified as available-for-sale are carried at fair market value and reflect an unrealized gain of $1.9 million, or $1.1 million net of taxes. The $17.1 million decrease in the investment portfolio is due to calls of U.S. agency securities exceeding new purchases.
Net loans decreased $11.6 million to $422.7 million at September 30, 2010 compared to $434.4 million at June 30, 2010 due primarily to reduced loan demand combined with normal paydowns on existing loans, transfers to OREO and charge-offs. Reduced loan demand has resulted from continued economic weakness in the Banks market areas.
Loans receivable, net, are summarized as follows:
Loan Loss Allowance
The allowance for loan losses is a valuation allowance for probable losses inherent in the loan portfolio. We evaluate the need to establish reserves against losses on loans on a monthly basis. When additional reserves are necessary, a provision for loan losses is charged to earnings.
In connection with assessing the allowance, we have established a systematic methodology for determining the adequacy of the allowance for loan losses. The methodology utilizes a loan grading system which segments loans with similar risk characteristics. Management performs a monthly assessment of the allowance for loan losses based on the nature and volume of the loan portfolio, the amount of impaired and classified loans and historical loan loss experience. In addition, management considers other qualitative factors, including delinquency trends, economic conditions and loan considerations.
The FDIC and the Tennessee Department of Financial Institutions, as an integral part of their examination process, periodically review our allowance for loan losses. The FDIC and/or the Tennessee Department of Financial Institutions may require us to make additional provisions for loan losses based on judgments different from ours.
The allowance for loan losses was $8.7 million at September 30, 2010 compared to $9.6 million at June 30, 2010. Our allowance for loan losses represented 2.03% of total loans and 42.43% of nonperforming loans at September 30, 2010 compared to 2.17% of total loans and 51.38% of nonperforming loans at June 30, 2010.
We consider repossessed assets and nonaccrual loans to be nonperforming assets. Loans are reviewed on a monthly basis and are generally placed on nonaccrual status when the loan becomes more than 90 days delinquent. Nonaccrual loans totaled $20.6 million at September 30, 2010 compared to $18.8 million at June 30, 2010. The increase in nonaccrual loans is primarily due to an increase in both nonaccrual residential and commercial real estate loans. Foreclosed real estate amounted to $5.6 million at September 30, 2010 compared to $6.9 million at June 30, 2010. Foreclosed real estate is initially recorded at the lower of the amount of the loan or the fair value of the foreclosed real estate, less estimated selling costs. Any initial writedown to fair value is charged to the allowance for loan losses. Any subsequent writedown of foreclosed real estate is charged against earnings. Foreclosed real estate at September 30, 2010 consisted of vacant land totaling $964,000, residential property totaling $3.1 million and commercial real estate totaling $1.5 million.
Bank Owned Life Insurance
We hold bank owned life insurance (BOLI) to help offset the cost of employee benefit plans. BOLI provides earnings from accumulated cash value growth and provides tax advantages inherent in a life insurance contract. The cash surrender value of the BOLI at September 30, 2010 was $6.5 million.
Total deposits increased $13.4 million to $492.6 million at September 30, 2010 due primarily to customer preference for higher yielding time deposits during a period of economic uncertainty. Time deposits increased $10.2 million, or 4.3%, to $250.4 million at September 30, 2010.
Federal Home Loan Bank of Cincinnati (FHLB) advances remained virtually unchanged at $85.0 million at September 30, 2010, compared to $84.8 million at June 30, 2010.
Stockholders equity amounted to $56.8 million at September 30, 2010 compared to $56.5 million at June 30, 2010. On November 13, 2008, the Company announced its third stock repurchase program pursuant to which up to 620,770 shares of the Companys outstanding common stock may be repurchased. At September 30, 2010, 454,118 shares remained eligible for repurchase under the current stock repurchase program. Unrealized gains and losses, net of taxes, in the available-for-sale investment portfolio are reflected as an adjustment to stockholders equity. At September 30, 2010, the adjustment to stockholders equity was a net unrealized gain of $1.1 million compared to a net unrealized gain of $1.2 million at June 30, 2010.
Liquidity and Capital Resources
Liquidity is the ability to meet current and future financial obligations of a short-term nature. Our primary sources of funds consist of deposit inflows, loan repayments, maturities and sales of investment securities and borrowings from the FHLB of Cincinnati. While maturities and scheduled amortization of loans and securities are predictable sources of funds, deposit flows and mortgage prepayments are greatly influenced by general interest rates, economic conditions and competition.
Investments in liquid assets are regularly adjusted based on our assessment of expected loan demand, expected deposit flows, yields available on interest-earning deposits and securities, and the objectives of our asset/liability management program. Excess liquid assets are invested generally in interest-earning deposits and short- and intermediate-term U.S. Government agency obligations.
Our most liquid assets are cash and cash equivalents and marketable investment securities that are not pledged as collateral. The levels of these assets are dependent on operating, financing, lending and investing activities during any given period. At September 30, 2010, cash and cash equivalents totaled $113.3 million compared to $69.3 million at June 30, 2010. Securities classified as available-for-sale, which provide additional sources of liquidity, totaled $45.8 million at September 30, 2010 compared to $63.0 million at June 30, 2010. At September 30, 2010, approximately $24.9 million of the investment portfolio was pledged as collateral for municipal deposits, FHLB borrowings and repurchase agreements. At September 30, 2010, FHLB advances were $85.0 million and represented full utilization of the Companys borrowing capacity with the FHLB. Additional eligible collateral may be transferred to the FHLB to increase borrowing capacity. The Company also maintains federal funds lines with two banks totaling $20.0 million under which no borrowings were outstanding. In addition, the Company had approximately $10.9 million of unused borrowing capacity with the Federal Reserve Bank of Atlanta at September 30, 2010.
The Company anticipates that it will have sufficient funds available to meet current loan commitments. At September 30, 2010, we had approximately $14.2 million in loan commitments, consisting of commitments to fund real estate loans. In addition to commitments to originate loans, we had $5.1 million in unused letters of credit and approximately $32.7 million in unused lines of credit. At September 30, 2010, we had $205.2 million in certificates
of deposit due within one year and $242.2 million in other deposits without specific maturities. We believe, based on past experience, that a significant portion of those deposits will remain with us. Deposit flows are affected by the overall level of interest rates and products offered by us and our local competitors and other factors. We generally manage the pricing of our deposits to be competitive and to increase deposits. Occasionally, we offer promotional rates on certain deposit products in order to attract deposits. We experienced a net increase in total deposits of $13.4 million during the three-month period ended September 30, 2010.
Jefferson Bancshares is a separate entity and apart from Jefferson Federal and must provide for its own liquidity. In addition to its operating expenses, Jefferson Bancshares is responsible for the payment of dividends declared for its shareholders, and interest and principal on outstanding debt. At times, Jefferson Bancshares has repurchased and retired outstanding shares of its stock pursuant to share repurchase programs adopted by the Board of Directors. Substantially all of Jefferson Bancshares revenues are obtained from dividends. Payment of such dividends to Jefferson Bancshares by Jefferson Federal is limited under Tennessee law. The amount that can be paid in any calendar year, without prior approval from the Tennessee Department of Financial Institutions, cannot exceed the total of Jefferson Federals net income for the year combined with its retained net income for the preceding two years. Jefferson Bancshares believes that such restriction will not have an impact on its ability to meet its ongoing cash obligations.
Off-Balance Sheet Arrangements
In the normal course of operations, we engage in a variety of financial transactions that, in accordance with generally accepted accounting principles, are not recorded in our financial statements. These transactions involve, to varying degrees, elements of credit, interest rate and liquidity risk. Such transactions are used primarily to manage customers requests for funding and take the form of loan commitments, unused lines of credit, amounts due mortgagors on construction loans, amounts due on commercial loans and commercial letters of credit.
For the three months ended September 30, 2010, we engaged in no off-balance sheet transactions reasonably likely to have a material effect on our financial condition, results of operations or cash flows.
The Bank is subject to various regulatory capital requirements administered by the banking regulatory agencies. As of September 30, 2010, Jefferson Federal met each of its capital requirements. The following table presents our capital position relative to our regulatory capital requirements at September 30, 2010 and June 30, 2010:
Under the capital regulations of the FDIC, Jefferson Federal must satisfy various capital requirements. Banks supervised by the FDIC must maintain a minimum leverage ratio of core (Tier I) capital to average adjusted assets of at least 3.00% if a particular institution has the highest examination rating and at least 4.00% for all others. At September 30, 2010, Jefferson Federals leverage capital ratio was 7.54%. The FDICs risk-based capital rules require banks supervised by the FDIC to maintain a ratio of risk-based capital to risk-weighted assets of at least 8.00%. Risk-based capital for Jefferson Federal is defined as Tier 1 capital plus Tier 2 capital. At September 30, 2010, Jefferson Federal had a ratio of total capital to risk-weighted assets of 12.07%. At September 30, 2010, the Bank met the minimum regulatory capital requirements, and the Bank was well-capitalized within the meaning of federal regulatory requirements.
For a discussion of the Companys asset and liability management policies, as well as the potential impact of interest rate changes upon the market value of the Companys portfolio equity, see Item 7A in the Companys Annual Report on Form 10-K for the year ended June 30, 2010. Management, as part of its regular practices, performs periodic reviews of the impact of interest rate changes upon net interest income and the market value of the Companys portfolio equity. Based on, among other factors, such reviews, management believes that there have been no material changes in the market risk of the Companys asset and liability position since June 30, 2010.
The Companys management, including the Companys principal executive officer and principal financial officer, have evaluated the effectiveness of the Companys disclosure controls and procedures, as such term is defined in Rule 13a-15(e) promulgated under the Securities Exchange Act of 1934, as amended (the Exchange Act). Based upon their evaluation, the principal executive officer and principal financial officer concluded that, as of the end of the period covered by this report, the Companys disclosure controls and procedures were effective for the purpose of ensuring that the information required to be disclosed in the reports that the Company files or submits under the Exchange Act with the Securities and Exchange Commission (the SEC) (1) is recorded, processed, summarized and reported within the time periods specified in the SECs rules and forms, and (2) is accumulated and communicated to the Companys management, including its principal executive and principal financial officers, as appropriate to allow timely decisions regarding required disclosure. In addition, based on that evaluation, no change in the Companys internal control over financial reporting occurred during the quarter ended September 30, 2010 that has materially affected, or is reasonably likely to materially affect, the Companys internal control over financial reporting.
PART II. OTHER INFORMATION
Jefferson Bancshares is not a party to any pending legal proceedings. Periodically, there have been various claims and lawsuits involving Jefferson Federal, such as claims to enforce liens, condemnation proceedings on properties in which Jefferson Federal holds security interests, claims involving the making and servicing of real property loans and other issues incident to Jefferson Federals business. Jefferson Federal is not a party to any pending legal proceedings that it believes would have a material adverse effect on the financial condition or operations of the Company or the Bank.
There have been no material changes to the risk factors previously disclosed in the Companys Annual Report on Form 10-K for the year ended June 30, 2010.
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.