Monarch Community Bancorp 10-Q 2009
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
For the quarterly period ended June 30, 2009 or
For the transition period from ________ to ________
Commission file number: 000-49814
MONARCH COMMUNITY BANCORP, INC.
(Exact name of registrant as specified in its charter)
375 North Willowbrook Road, Coldwater, MI 49036
(Address of principal executive offices)
(Registrants telephone number)
Indicate by check mark whether the registrant (1) filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the past 12 months (or for 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: þ No: o
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 during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes o No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of large accelerated filer, accelerated filer and smaller reporting company in Rule 12b-2 of the Exchange Act. (Check one):
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes: o No: þ
State the number of shares outstanding of each of the issuers classes of common equity, as of the latest practical date: At July 31, 2009, there were 2,046,102 shares of the issuers Common Stock outstanding.
Monarch Community Bancorp, Inc.
PART IFINANCIAL INFORMATION
Condensed Consolidated Balance Sheets
Condensed Consolidated Statements of Income (Unaudited)
Condensed Consolidated Statements of Changes in Stockholders Equity (Unaudited)
Condensed Consolidated Statements of Cash Flows (Unaudited)
MONARCH COMMUNITY BANCORP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Monarch Community Bancorp, Inc. (the Corporation) was incorporated in 2002 under Maryland law to hold all of the common stock of Monarch Community Bank (the Bank), formerly known as Branch County Federal Savings and Loan Association. The Bank converted to a stock savings institution effective August 29, 2002. In connection with the conversion, the Corporation sold 2,314,375 shares of its common stock in a subscription offering.
Monarch Community Bank provides a broad range of banking services to its primary market area of Branch, Calhoun and Hillsdale counties in Michigan. The Bank operates six full service offices. The Bank owns 100% of First Insurance Agency. First Insurance Agency is a licensed insurance agency established to allow for the receipt of fees on insurance services provided to the Banks customers. The Bank also owns a 24.98% interest in a limited partnership formed to construct and operate multi-family housing units.
BASIS OF PRESENTATION
The condensed consolidated financial statements of the Corporation include the accounts of Monarch Community Bank and First Insurance Agency. All significant intercompany balances and transactions have been eliminated in consolidation. The condensed consolidated financial statements for interim periods are unaudited; however, in the opinion of the Corporations management, all adjustments, consisting only of normal recurring accruals, necessary for a fair presentation of the Corporations financial position and results of operations have been included.
The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements. Actual results could differ from those estimates and assumptions.
The accompanying financial statements have been prepared in accordance with the instructions for Form 10-Q and, therefore, do not include all information and footnotes required by generally accepted accounting principles in annual consolidated financial statements. These condensed consolidated financial statements should be read in conjunction with the Corporations Form 10-K for the year ended December 31, 2008 filed with the Securities and Exchange Commission.
The results of operations for the three and six month periods ended June 30, 2009 are not necessarily indicative of the results to be expected for the full year period.
ALLOWANCE FOR LOAN LOSSES
The appropriateness of the allowance for loan losses is reviewed by management based upon our evaluation of then-existing economic and business conditions affecting our key lending areas and other conditions, such as credit quality trends (including trends in delinquencies, nonperforming loans and foreclosed assets expected to result from existing conditions), collateral values, loan volumes and concentrations, specific industry conditions within portfolio segments and recent loss experience in particular segments of the portfolio that existed as of the balance sheet date and the impact that these conditions were believed to have had on the collectability of the loan. Senior management reviews these conditions at least quarterly.
To the extent that any of these conditions is evidenced by a specifically identifiable problem credit or portfolio segment as of the evaluation date, managements estimate of the effect of this condition may be reflected as a specific allowance applicable to this credit or portfolio segment.
The allowance for loan losses is based on estimates of losses inherent in the loan portfolio. Actual losses can vary significantly from the estimated amounts. Our methodology as described permits adjustments to any loss factor used in the computation of the formula allowance in the event that, in managements judgment, significant factors which affect the collectability of the portfolio as of the evaluation date are not reflected in the loss factors. By assessing the estimated losses inherent in the loan portfolio on a quarterly basis, we are able to adjust specific and inherent loss estimates based upon any more recent information that has become available.
Certain 2009 amounts have been reclassified to conform to the 2008 presentation.
EARNINGS PER SHARE
A reconciliation of the numerators and denominators used in the computation of the basic earnings per share and diluted earnings per share is presented below (000s omitted except per share data):
RECENT ACCOUNTING PRONOUNCEMENTS
In April 2009, the FASB issued the following three FSPs intended to provide additional application guidance and enhance disclosures regarding fair value measurements and impairments of securities:
FSP FAS 157-4, Determining Fair Value When the Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly, provides additional guidance for estimating fair value in accordance with SFAS No. 157 when the volume and level of activity for the asset or liability have decreased significantly. FSP FAS 157-4 also provides guidance on identifying circumstances that indicate a transaction is not orderly. The provisions of FSP FAS 157-4 became effective for the Companys interim period ending on June 30, 2009 and did not effect the Companys financial statements.
FSP FAS 107-1 and APB 28-1, Interim Disclosures about Fair Value of Financial Instruments, requires disclosures about fair value of financial instruments in interim reporting periods of publicly traded companies that were previously only required to be disclosed in annual financial statements. The provisions of FSP FAS 107-1 and APB 28-1 are effective for the Companys interim period ending on June 30, 2009. The Company has complied with the disclosure requirements.
FSP FAS 115-2 and FAS 124-2, Recognition and Presentation of Other-Than-Temporary Impairments, amends current other-than-temporary impairment guidance in GAAP for debt securities to make the guidance more operational and to improve the presentation and disclosure of other-than-temporary impairments on debt and equity securities in the financial statements. This FSP does not amend existing recognition and measurement guidance related to other-than-temporary impairments of equity securities. The provisions of FSP FAS 115-2 and FAS 124-2 became effective for the Companys interim period ending on June 30, 2009 and did not effect the Companys financial statements.
In May 2009, the FASB issued SFAS No. 165, Subsequent Events. SFAS 165 establishes general standards of accounting for and disclosure of events that occur after the balance sheet date but before financial statements are issued or are available to be issued. Although there is new terminology, the standard is based on the same principles as those that currently exist in the auditing standards. The standard also includes a required disclosure of the date through which the entity has evaluated subsequent events and whether the evaluation date is the date of issuance or the date the financial statements were available to be issued. The standard is effective for interim or annual periods ending after June 15, 2009. The Company has complied with the disclosure requirements.
FAIR VALUE MEASUREMENTS
In general, fair values determined by Level 1 inputs use quoted prices in active markets for identical assets or liabilities that the Company has the ability to access.
Fair values determined by Level 2 inputs use other inputs that are observable, either directly or indirectly. These Level 2 inputs include quoted prices for similar assets and liabilities in active markets, and other inputs such as interest rates and yield curves that are observable at commonly quoted intervals.
Level 3 inputs are unobservable inputs, including inputs that are available in situations where there is little, if any, market activity for the related asset or liability.
In instances where inputs used to measure fair value fall into different levels in the above fair value hierarchy, fair value measurements in their entirety are categorized based on the lowest level input that is significant to the valuation. The Companys assessment of the significance of particular inputs to these fair value measurements requires judgment and considers factors specific to each asset or liability.
The following table present information about the Companys assets and liabilities measured at fair value on a recurring basis at June 30, 2009, and the valuation techniques used by the Company to determine those fair values.
The Company also has assets that under certain conditions are subject to measurement at fair value on a non-recurring basis. These assets include loans and foreclosed assets. These assets are not measured at fair value on an ongoing basis, but are subject to fair value adjustments in certain circumstances (for example, when there is evidence of impairment). The following table presents the Corporations assets at fair value on a nonrecurring basis as of June 30, 2009. (000s omitted).
Assets Measured at Fair Value on a Nonrecurring Basis
Fair Value of Financial Instruments
The fair value of a financial instrument is the current amount that would be exchanged between willing parties, other than in a forced liquidation. Fair value is best determined based upon quoted market prices. However, in many instances, there are no quoted market prices for the Corporations various financial instruments. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. Accordingly, the fair value estimates may not be realized in an immediate settlement of the instrument. SFAS 107 excludes certain financial instruments and all nonfinancial instruments from its disclosure requirements. Accordingly, the aggregate fair value amounts presented may not necessarily represent the underlying fair value of the Corporation.
The fair value of all financial instruments not discussed below (Cash and cash equivalents, Federal funds sold, Federal Home Loan Bank stock, Accrued interest receivable, Federal funds purchased and Interest payable) are estimated to be equal to their carrying amounts as of June 30, 2009 and December 31, 2008. The following methods and assumptions were used by the Corporation in estimating fair value disclosures for financial instruments:
Securities - Fair values for securities are based on quoted market prices.
Mortgage Loans Held for Sale - Fair values of mortgage loans held for sale are based on commitments on hand from investors or prevailing market prices.
Loans Receivable - For variable-rate loans that reprice frequently and with no significant change in credit risk, fair values are based on carrying values. Fair values for other loans are estimated using discounted cash flows analyses using current market rates applied to the estimated life. Fair values for non-performing loans are estimated using discounted cash flow analyses or underlying collateral values, where applicable.
Deposit Liabilities - The fair values disclosed for demand deposits (e.g., interest and non-interest checking, passbook savings, and certain types of money market accounts) are, by definition, equal to the amount payable on demand at the reporting date (i.e., their carrying amounts). The carrying amounts of variable-rate, fixed term money market accounts and certificates of deposit approximate their fair values at the reporting date. Fair values for fixed-rate certificates of deposit are estimated using a discounted cash flow calculation that applies interest rates currently being offered on certificates to a schedule of aggregated expected monthly maturities on time deposits.
Federal Home Loan Bank Advances - The fair values of the Corporations Federal Home Loan Bank advances are estimated using discounted cash flow analyses based on the Corporations current incremental borrowing rates for similar types of borrowing arrangements.
The estimated fair values, and related carrying or notional amounts, of the Corporations financial instruments are as follows (000s omitted):
ITEM 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion and analysis should be read in conjunction with the condensed consolidated financial statements of the Corporation and the accompanying notes.
The Corporation is not aware of any market or institutional trends, events, or circumstances that will have or are likely to have a material effect on liquidity, capital resources, or results of operations except as discussed herein. Also, the Corporation is not aware of any current recommendations by regulatory authorities that will have such effect if implemented.
In addition to historical information, the following discussion contains forward-looking statements that involve risks and uncertainties. All statements regarding the expected financial position, business and strategies are forward-looking statements and the Corporation intends for them to be covered by the safe harbor provisions for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995. The words anticipates, believes, estimates, seeks, expects, plans, intends, and similar expressions, as they relate to the Corporation or management, are intended to identify forward-looking statements. The Corporation believes that the expectations reflected in these forward-looking statements are reasonable based on our current beliefs and assumptions; however, these expectations may prove to be incorrect.
Factors which could have a material adverse effect on our operations include, but are not limited to, changes in interest rates, changes in the relative difference between short and long-term interest rates, general economic conditions, legislative/regulatory changes, monetary and fiscal policies of the U.S. Government, including policies of the U.S. Treasury and the Federal Reserve Board, the quality or composition of the loan or investment portfolios, including levels of non-performing assets, demand for loan products, deposit flows, competition, demand for financial services in our market area, our operating costs and accounting principles and guidelines. These risks and uncertainties should be considered in evaluating forward-looking statements and you should not rely too much on these statements.
CRITICAL ACCOUNTING POLICIES
The nature of the financial services industry is such that, other than described below, the use of estimates and management judgment is not likely to present a material risk to the financial statements. In cases where estimates or management judgment are required, internal controls and processes are established to provide assurance that such estimates and management judgments are materially correct to the best of managements knowledge.
Allowance for Loan Losses. Accounting for loan classifications, accrual status, and determination of the allowance for loan losses is based on regulatory guidance. This guidance includes, but is not limited to, generally accepted accounting principles, the uniform retail credit classification and account management policy issued by the Federal Financial Institutions Examination Council, the joint policy statement on the allowance for loan losses methodologies issued by the Federal Financial Institutions Examination Council and guidance issued by the Securities and Exchange Commission. Accordingly, the allowance for loan losses includes a reserve calculation based on an evaluation of loans determined to be impaired, risk ratings, historical losses, loans past due, collateral values and cost of disposal and other subjective factors.
Foreclosed Assets. Assets acquired through, or in lieu of, loan foreclosure are held for sale and are initially recorded at fair value at the date of the foreclosure, establishing a new cost basis. Subsequent to foreclosure, valuations are periodically performed by management and the assets are carried at the lower of carrying amount or fair value less estimated selling expenses, which consist primarily of commissions that will be paid to an independent real estate agent upon sale of the property. Revenue and expenses from operations and changes in the valuation allowance are included in net expenses from foreclosed assets.
Goodwill and Other Intangible Assets. Goodwill represents the excess of the cost of an acquisition over the fair value of net identifiable tangible and intangible assets acquired. Under the provisions of SFAS 142, goodwill is no longer amortized into the income statement over an estimated life, but rather is tested at least annually for impairment. Impairment of goodwill is evaluated by reporting unit and is based on a comparison of the recorded balance of goodwill to the applicable market value or discounted cash flows. To the extent that impairment may exist, the current carrying amount is reduced by the estimated shortfall. Intangible assets which have finite lives are amortized over their estimated useful lives and are subject to impairment testing.
Total assets increased $9.9 million, or 3.4%, to $301.7 million at June 30, 2009 compared to $291.8 million at December 31, 2008. Management attributes this growth to a strategy for 2009 that emphasizes growth in our investment portfolio. The increase in assets is also a by product of managements continued focus on the growth of core deposits which has generated increased cash balances.
Securities increased to $20.5 million at June 30, 2009 compared to $8.9 million at December 31, 2008. The increase was attributable to $11.6 million in securities being purchased primarily to offset costs associated with the Capital Purchase Program (CPP). Those costs include an annual dividend of 5%, and amortization of the discount on the preferred stock of .16%. The tax equivalent cost of the capital is 8%. See Equity for further discussion on the Capital Purchase Program (CPP) The yield on investment securities has decreased to 3.59% during the six month ended June 30, 2009 from 4.34% for the same period a year ago. Management has slowed further purchasing of securities due to the decline in the current market yield. With the increase in securities we have continued to maintain a diversified securities portfolio, which includes obligations of U.S. government-sponsored agencies, securities issued by states and political subdivisions and mortgage-backed securities. We regularly evaluate asset/liability management needs and attempt to maintain a portfolio structure that provides sufficient liquidity and cash flow.
The Banks net loan portfolio decreased by $11.4 million, or 4.6%, from $247.5 million at December 31, 2008 to $236.1 million at June 30, 2009. The following table presents information concerning the composition of our loan portfolio in dollar amounts and in percentages as of the dates indicated:
One-to-four family loans decreased $10.5 million from year end 2008 as a result of the Banks continued strategy to sell a large portion of new one to four family loan originations. Historically low rates on residential mortgages have provided us the opportunity to refinance loans and increase our gains on sale of mortgages substantially. Commercial real estate loans increased $5.5 million or 7.3%. The Bank expects future loan growth to come primarily from commercial lending with a focus on in-market lending, however, we remain cautiously optimistic about the Banks potential for loan growth during the remainder of the year, given the difficult economic conditions that we are facing in our market.
The allowance for loan losses was $5.5 million at June 30, 2009 compared to $2.7 million at December 31, 2008, an increase of $2.8 million. The increase was necessitated by the increases in net charge offs and nonperforming assets which are directly related to the continued overall weakness in the Michigan economy. Year to date 2009 net charge offs totaled $1.3 million compared to $575,000 for the same period a year ago. Net charge offs year to date consisted of 56% one to four family residential mortgages, 29% commercial real estate, 10% consumer and the remaining 5% included construction, commercial and industrial and home equity lines of credit. See Provision for Loan Losses below for further explanation regarding charge-offs and non-performing loans. We continue to be diligent in review of our loan portfolios for problem loans and believe that early detection of troubled credits is critical. We maintain the allowance for loan losses at a level considered adequate to cover losses within the loan portfolio. The allowance balance is established after considering past loan loss experience, current economic conditions, composition of the loan portfolio, delinquencies, and other relevant factors.
Total deposits increased $10.2 million, or 5.3%, from $192.2 million at December 31, 2008 to $202.4 million at June 30, 2009. The increase can be attributed to an increase of $8.8 million in local certificates of deposit, an increase of $3.1 million in demand and Now accounts, an increase in money market accounts of $2.6 million and an increase of $1.1 million in savings accounts. Brokered deposits decreased $5.4 million as management continues to try to reduce its reliance on wholesale funding. The increase in local certificates of deposits and money market accounts is largely due to managements efforts to remain competitive with interest rates in these categories of deposits. The increase in money market accounts has provided funding so it has not been necessary for management to borrow additional FHLB advances or increase brokered deposits. Brokered deposits have been managed to provide additional liquidity or reduce excess liquidity depending on current conditions. Management expects future deposit growth to come from increased sales and marketing efforts to attract lower cost savings and checking accounts as well as product enhancement.
Federal Home Loan Bank Advances
Total Federal Home Loan Bank (FHLB) advances decreased to $56.7 million as of June 30, 2009 from $60.2 at December 31, 2008. The decrease is attributable to the repayment of $3.5 million of FHLB advances during the six months ended June 30, 2009. Management is attempting to reduce its reliance on borrowed funds through the growth of low cost core deposits. Should this strategy not succeed, management anticipates the need for future borrowings to fund loan growth. See Net Interest Income below, and also see Liquidity later in this report regarding available borrowings.
Total equity was $40.9 million at June 30, 2009 compared to $36.3 million at December 31, 2008. This represents 13.6% and 12.4% of total assets at June 30, 2009 and December 31, 2008, respectively. Increases in equity primarily resulted from the issuance of preferred stock in the amount of $6.8 million associated with the Capital Purchase Program. Decreases in equity for the six months ended June 30, 2009 included a net loss of $1.6 million and $460,000 in dividend payments, which included dividends to common shareholders of $367,000 and $93,000 on the Preferred stock. The annual 5% dividend on the Preferred Stock together with the amortization of the discount will reduce net income (or increase the net loss) applicable to common stock by approximately $350,000 annually. Management intends to utilize funds provided by the issuance of the preferred stock to invest in securities and pursue lending opportunities. Management considers its equity position to be strong.
RESULTS OF OPERATIONS
Net Interest Income
Net interest income before any provision for loan losses decreased $43,000 for the quarter ended June 30, 2009 compared to the same period in 2008. The Banks net interest margin decreased to 3.07% for the quarter ended June 30, 2009 from 3.33% for the quarter ended June 30, 2008 as a result of a the yield on earning assets declining faster that the cost of funds. This is attributable to the falling rate environment consistent through 2008 and 2009. Interest income from loans represented 96% of total interest income for the three months ended June 30, 2009 compared to 95.4% for the same period in 2008.
Net interest income before any provision for loan losses decreased $19,000 for the six months ended June 30, 2009 compared to the same period in 2008. The Banks net interest margin decreased to 3.06% for the six months ended June 30, 2009 from 3.29% for the six months ended June 30, 2008 as our loan yields decreased more than our deposit costs compared to the same period a year ago as a result of falling rate environment mentioned previously.
The Banks ability to maintain its net interest margin is heavily dependent on future loan demand and its ability to attract core deposits to offset the effect of higher cost certificates of deposits and borrowings. The Bank continues to be challenged in its efforts to increase lower costing core deposits. Management continues to put its efforts towards meeting this challenge.
The following table presents, for the periods indicated, the total dollar amount of interest income from average interest-earning assets and the resultant yields, as well as the interest expense on average interest-bearing liabilities, expressed both in dollars and rates. No tax equivalent adjustments were made.
Provision for Loan Losses
The provision for loan losses was $3.4 million in the second quarter of 2009, compared to $448,000 in the second quarter of 2008 and $4.2 million for the six month period ended June 30, 2009, compared to $757,000 in the same period of 2008. Net charge-offs for the quarter ended June 30, 2009 totaled $1.1 million, compared to $228,000 for the quarter ended June 30 , 2008 and $1.3 million for the six months ended June 30, 2009, compared to $575,000 for the same period a year ago. The significant increase in the provision was primarily driven by the continued deteriorating economic conditions in Michigan and weaknesses in the local real estate markets which resulted in downgrades to the credit ratings of certain loans in the portfolio and a significant increase in the balances of nonperforming loans.
Nonperforming assets including the amount of real estate in judgment and foreclosed and repossessed properties, increased from $4.6 million at the end of 2008 to $11.3 million as of June 30, 2009. This increase was largely due to an increase nonperforming loans, specifically in commercial real estate and one to four family residential mortgage loans. Management also classified a large commercial loan relationship in the amount of $4 million as non-performing during the quarter.
The following table presents non-performing assets and certain asset quality ratios at June 30, 2009 and December 31, 2008.
The Bank had 35 non-performing loan relationships as of June 30, 2009 compared to 24 non-performing loan relationships as of December 31, 2008.
Non-interest income for the quarter ended June 30, 2009 increased $530,000, or 56.3%, from $941,000 to $1.5 million compared to the same period a year ago. This increase is attributable to an increase in gain on sale of loans offset by a decrease in fees and services charges.
Net gain on sale loans increased $553,000 for the quarter ended June 30, 2009 from $195,000 to $748,000 compared to the same period a year ago. The increase is largely due to the falling rate environment which has generated a significant amount of one to four family residential mortgage refinancing. Management expects this trend to decline through the latter half of 2009. Fees and service charges decreased $24,000 for the quarter ended June 30, 2009 from $573,000 to $549,000 compared to the same period a year ago. This decrease was a result of a decrease in overdraft fees of $26,000 offset by an increase of $2,000 in all other fees and charges. Future increases in this source of income are dependent on the Bank increasing the number of checking account customers. Management does not expect significant increases in Bounce Protection income from its existing customer base.
Non-interest income for the six months ended June 30, 2009 increased $903,000, or 46.5%, from $1.9 million to $2.8 million for the same period in 2008. Net gain on sale loans increased $996,000 for the six months ended June 30, 2009 from $461,000 to $1.4 million compared to the same period a year ago. Fees and Service charges decreased $80,000 for the six months ended June 30, 2009 from $1.1 million to $1.06 million compared to the same period a year ago. As mentioned previously the decrease in fees and service charges is primarily due to the decrease in overdraft fees of $74,000, and a decrease of $6,000 in all other fees.
Noninterest expense increased $254,000, or 11%, for the three months ended June 30, 2009 compared to the same period ending a year ago. Amortization of mortgage servicing rights increased $24,000 as a result of a continued increase in mortgage loan payoffs due to refinancing associated with the decrease of interest rates in the fourth quarter of 2008. Other general and administrative expenses increased $164,000, from $540,000 to $376,000; reflecting the increase of $188,000 in the quarterly FDIC assessment and the one-time special assessment of $140,000 on all insured financial institutions equal to approximately 5 basis points of total assets, less tier one equity. Foreclosed property expense increased $50,000, from $27,000 to $77,000 to due increases in loan collection costs, and losses and impairment charges associated with the disposition of other real estate. Professional services increased $59,000 from $193,000 to $252,000 primarily due to increases in legal fees associated with non-performing loans.
Noninterest expense increased $444,000, or 9.6%, for the six months ended June 30, 2009 compared to the same period ending a year ago. Other general and administrative expenses increased $240,000, from $677,000 to $917,000; this is primarily due to the increase in FDIC insurance as mentioned previously. Amortization of mortgage servicing rights increased $104,000, from $231,000 to $335,000, also for reasons mentioned previously. Professional services increased $59,000, from $193,000 to $252,000 primarily due to increases in legal fees associated with non-performing loans and legal fees associated with the issuance of preferred stock and common stock warrants as part of the Capital Purchase Program transaction. Other operating expenses increased $41,000. The increase in other operating expenses was due to increases in loan collection costs, and losses and impairment charges associated with the disposition of other real estate and additional costs associated with the reissuance of atm/debit cards associated with a compromised card processing vendor.
Federal Income Tax Expense
An income tax benefit totaling $607,000 was recorded in the second quarter of 2009, an effective rate of approximately 25% of the pretax loss. A significant component of income tax expense is made up of general tax credit generated each year. Due to the current year loss, these tax credits may not be fully utilized. Accordingly, in the second quarter of 2009, a valuation allowance of $300,000 was established on general business tax credit carry forward that are not expected to be utilized.
An income tax benefit totaling $547,000 was recorded for six months ended June 30, 2009 compared to a provision for federal income tax of $195,000 for the same period a year ago. The effective tax rate for the six months ended June 30, 2009 was 25.0% compared to 25.1% for the same period in 2008. The difference between the effective tax rates and the federal corporate income tax rate of 34% is attributable to the low income housing credits available to the Bank from the investment in the limited partnership as well as fluctuation of permanent book and tax differences such as non-taxable income and non-deductible expenses.
The Banks liquidity, represented by cash, overnight funds and investments, is a product of our operating, investing, and financing activities. The Banks primary sources of funds are deposits, amortization, prepayments and maturities of outstanding loans, and funds provided from operations. While scheduled payments from the amortization of loans are a relatively predictable source of funds, deposit flows and loan prepayments are greatly influenced by general interest rates, economic conditions and competition. The Bank also generates cash through borrowings. The Bank utilizes Federal Home Loan Bank advances to leverage its capital base and provide funds for its lending and investment activities, and to enhance its interest rate risk management.
Liquidity management is both a daily and long-term function of business management. Excess liquidity is generally invested in short-term investments such as overnight deposits. On a longer-term basis, the Bank maintains a strategy of investing in various investments and lending products. The Bank uses its sources of funds primarily to meet its ongoing commitments, to pay maturing certificates of deposit and savings withdrawals and to fund loan commitments. Certificates of deposit scheduled to mature in one year or less at June 30, 2009 totaled $57.4 million. Management believes that a significant portion of these certificates of deposit will remain with the Bank provided the Bank pays a rate of interest that is competitive both in the local and national markets.
If necessary, additional funding sources include additional deposits and Federal Home Loan Bank advances. Deposits can be obtained in the local market area and from out of market sources; however, this may require the Bank to offer interest rates higher than those of the competition. At June 30, 2009 and based on current collateral levels, the Bank could borrow an additional $15.9 million from the Federal Home Loan Bank at prevailing interest rates. This borrowing capacity can be increased in the future if the Bank pledges additional collateral to the Federal Home Loan Bank. The Company anticipates that it will continue to have sufficient funds, through deposits and borrowings, to meet its current commitments.
The Banks total cash and cash equivalents increased by $6.6 million during the six months ended June 30, 2009 compared to a $5 million decrease for the same period in 2008. The primary sources of cash for the six months ended June 30, 2009 were $6.8 million increase in cash generated by the issuance of preferred stock, $10.2 million increase in deposits, $66.4 million in proceeds from the sale of mortgage loans, $6.1 million in maturities of available-for-sale investment securities and $5.4 of principal loan collections in excess of loan originations compared to $14.1 million increase in deposits, $21.2 million in proceeds from the sale of mortgage loans, $8.5 million in proceeds from FHLB advances and $2.4 million in maturities of available-for-sale investment securities. The primary uses of cash for the six months ended June 30, 2009 were $65.3 million of mortgage loans originated for sale, $3.5 million in repayments of FHLB advances, $1.0 million in repayment of Fed funds purchased, and $17.8 million in purchases of available-for-sale investment securities compared to $21.7 million of mortgage loans originated for sale, $13.0 million in repayments of FHLB advances, $13.7 million loan originations in excess of principal collections and $2.3 million in purchases of available-for-sale investment securities.
CONTRACTUAL OBLIGATIONS AND OFF BALANCE SHEET ARRANGEMENTS
The Corporation has certain obligations and commitments to make future payments under contracts. At June 30, 2009, the aggregate contractual obligations and commitments are:
Commitments to grant loans are governed by the Banks credit underwriting standards, as established by the Banks Loan Policy. The Banks policy is to grant Home Equity Lines of Credits (HELOCs) for periods of up to 15 years.
The Bank is subject to various regulatory capital requirements. As of June 30, 2009, the Bank met the regulatory standards to be classified as well capitalized. The Banks regulatory capital ratios as of June 30, 2009 were as follows: Tier 1 leverage ratio 9.19%, Tier 1 risk-based capital ratio 11.45%; and total risk-based capital, 12.67%. The regulatory capital requirements to be considered well capitalized are 5.0%, 6.0%, and 10.0%, respectively. Management considers the Banks capital to be adequate for current and projected needs at both the Bank and Corporation.
The Corporations primary market risk exposure is interest rate risk (IRR). Interest rate risk refers to the risk that changes in market interest rates might adversely affect the Corporations net interest income or the economic value of its portfolio of assets, liabilities, and off-balance sheet contracts. Interest rate risk is primarily the result of an imbalance between the price sensitivity of the Corporations assets and its liabilities (including off-balance sheet contracts). Such imbalances can be caused by differences in the maturity, repricing and coupon characteristics of assets and liabilities, and options, such as loan prepayment options, interest rate caps and floors, and deposit withdrawal options. These imbalances, in combination with movement in interest rates, will alter the pattern of the Corporations cash inflows and outflows, affecting the earnings and economic value of the Corporation.
The Corporations primary tool for assessing IRR is a model that uses scenario analysis to evaluate the IRR exposure of the Bank by estimating the sensitivity of the Banks portfolios of assets, liabilities, and off-balance sheet contracts to changes in market interest rates. To measure the sensitivity of the Banks Net Portfolio Value (NPV) to changes in interest rates, the (NPV) model estimates what would happen to the economic value of each type of asset, liability, and off-balance sheet contract under six different interest rate scenarios. The model estimates the NPV that would result following instantaneous, parallel shifts in the Treasury yield curve of -300, -200, -100, +100, +200, +300 basis points. Management then compares the resulting NPV and the magnitude of change in NPA to regulatory and industry guidelines to determine if the companys IRR is acceptable. Management believes, based on data from the model, as of June 30, 2009, and indicates that the Banks IRR level remains minimal.
An evaluation of the Corporations disclosure controls and procedures (as defined in Rule 13a-15(e) of the Securities Exchange Act of 1934 (the Exchange Act)) as of June 30, 2009 was carried out under the supervision and with the participation of the Corporations Chief Executive Officer, Chief Financial Officer and several other members of the Corporations senior management. The Companys Chief Executive Officer and Chief Financial Officer concluded that the Corporations disclosure controls and procedures as currently in effect are effective in ensuring that the information required to be disclosed by the Corporation in the reports it files or submits under the Exchange Act is (i) accumulated and communicated to the Corporations management (including the Chief Executive Officer and Chief Financial Officer) in a timely manner, and (ii) recorded, processed, summarized and reported within time periods specified in the SECs rules and forms. There have been no changes in our internal control over financial reporting (as defined in Rule 13a-15(f) of the Exchange Act) that occurred during the quarter ended June 30, 2009, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
The Corporation intends to continually review and evaluate the design and effectiveness of its disclosure controls and procedures and to improve its controls and procedures over time and to correct any deficiencies that it may discover in the future. The goal is to ensure that senior management has timely access to all material financial and non-financial information concerning the Corporations business. While the Corporation believes the present design of its disclosure controls and procedures is effective to achieve its goal, future events affecting its business may cause the Corporation to modify its disclosure controls and procedures.
PART II-OTHER INFORMATION
The Corporation and the Bank are from time-to-time involved in legal proceedings arising out of, and incidental to, their business. Management, based on its review with counsel of all actions and proceedings affecting the Corporation and the Bank, has concluded that the aggregate loss, if any, resulting from the disposition of these proceedings should not be material to the Corporations financial condition or results of operations.
In addition to the other information set forth in this report, you should carefully consider the factors discussed in Part I, Item 1A. Risk Factors in our Annual Report on Form 10-K for the year ended December 31, 2008, which could materially affect our business, financial condition or future results. The risks described in our Annual Report on Form 10-K are not the only risks facing our
Corporation. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial also may materially adversely affect our business, financial condition and/or operating results.
The following are the names of the directors (and remaining terms) whose terms continued after the meeting:
See the index to exhibits.
In accordance with the requirements of the Securities Exchange Act of 1934, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
INDEX TO EXHIBITS