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Monarch Community Bancorp 10-Q 2011

Documents found in this filing:

  1. 10-Q
  2. Ex-31.1
  3. Ex-31.2
  4. Ex-32
  5. Ex-32
Form 10-Q
Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

 

 

FORM 10-Q

 

 

 

x Quarterly report under Section 13 or 15(d) of the Securities Exchange Act of 1934

For the quarterly period ended September 30, 2011

or

 

¨ Transition report under Section 13 or 15(d) of the Exchange Act

For the transition period from                      to                     

Commission file number: 000-49814

 

 

MONARCH COMMUNITY BANCORP, INC.

(Exact name of registrant as specified in its charter)

 

 

 

Maryland   04-3627031

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. employer

identification no.)

375 North Willowbrook Road, Coldwater, MI 49036

(Address of principal executive offices)

517-278-4566

(Registrant’s 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:  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 during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    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 definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large Accelerated Filer   ¨    Accelerated Filer   ¨
Non-Accelerated Filer   ¨    Smaller reporting company   x

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

State the number of shares outstanding of each of the issuer’s classes of common equity, as of the latest practical date: At November 1, 2011, there were 2,049,485 shares of the issuer’s Common Stock outstanding.

 

 

 


Table of Contents

Monarch Community Bancorp, Inc.

Index

 

PART I – FINANCIAL INFORMATION

  

Item 1 – Condensed Financial Statements:

  

Condensed Consolidated Balance Sheets – September 30, 2011 and December 31, 2010

  

Condensed Consolidated Statements of Income – Three and Nine Months Ended September 30, 2011 and 2010

     2   

Condensed Consolidated Statements of Cash Flows – Nine Months Ended September 30, 2011 and 2010

     3   

Notes to Condensed Consolidated Financial Statements

     4-22   

Item 2 – Management’s Discussion and Analysis of Financial Condition and Results of Operations

     22 -30   

Item 3 – Quantitative and Qualitative Disclosures about Market Risk

     30 -31   

Item 4 – Controls and Procedures

     31   

PART II – OTHER INFORMATION

  

Item 1 – Legal Proceedings

     31   

Item 1A – Risk Factors

  

Item 2 – Unregistered Sales of Equity Securities and Use of Proceeds

     31   

Item 3 – Defaults Upon Senior Securities

     31   

Item 4 – [Reserved]

     31   

Item 5 – Other Information

     31   

Item 6 – Exhibits

     31   

SIGNATURES

     32   

CERTIFICATIONS

     34-36   


Table of Contents

PART I—FINANCIAL INFORMATION

 

Item 1. CONDENSED FINANCIAL STATEMENTS

Condensed Consolidated Balance Sheets

 

     (Unaudited)        
     September 30,     December 31,  
     2011     2010  
     (Dollars in thousands,  
     except per share data)  
Assets     

Cash and due from banks

   $ 13,905      $ 7,065   

Federal Home Loan Bank overnight time and other interest bearing deposits

     28,722        34,909   
  

 

 

   

 

 

 

Total cash and cash equivalents

     42,627        41,974   

Securities - Available for sale

     6,412        11,466   

Securities - Held to maturity

     —          10   

Other securities

     3,370        3,865   

Loans held for sale

     607        693   

Loans, net

     154,918        182,768   

Foreclosed assets, net

     4,482        2,972   

Premises and equipment

     4,002        4,122   

Core deposit intangible

     284        390   

Other assets

     7,227        8,608   
  

 

 

   

 

 

 

Total assets

   $ 223,929      $ 256,868   
  

 

 

   

 

 

 
Liabilities and Stockholders’ Equity     

Liabilities

    

Deposits:

    

Non-interest bearing

   $ 21,147      $ 15,394   

Interest bearing

     165,777        190,634   
  

 

 

   

 

 

 

Total deposits

     186,924        206,028   

Federal Home Loan Bank advances

     22,350        36,350   

Accrued expenses and other liabilities

     2,696        2,472   
  

 

 

   

 

 

 

Total liabilities

     211,970        244,850   

Stockholders’ Equity

    

Preferred stock-$.01 par value, 5,000,000 shares authorized, and 6,785 shares, fixed rate cumulative perpetual preferred stock, series A, $1,000 per share liquidation preference, issued and outstanding at September 30, 2011 and December 31, 2010

     6,759        6,750   

Common stock - $0.01 par value, 20,000,000 shares authorized, 2,049,485 shares issued and outstanding at September 30, 2011 and December 31, 2010

     20        20   

Additional paid-in capital

     21,153        21,146   

Accumulated deficit

     (15,471     (15,591

Accumulated other comprehensive income

     58        257   

Unearned compensation

     (560     (564
  

 

 

   

 

 

 

Total stockholders’ equity

     11,959        12,018   
  

 

 

   

 

 

 

Total liabilities and stockholders’ equity

   $ 223,929      $ 256,868   
  

 

 

   

 

 

 

See accompanying notes to condensed consolidated financial statements.


Table of Contents

Condensed Consolidated Statements of Income (Unaudited)

 

     Three Months     Three Months     Nine Months      Nine Months  
     Ended     Ended     Ended      Ended  
     September 30,     September 30,     September 30,      September 30,  
     2011     2010     2011      2010  
     (Dollars in thousands, except per share data)         

Interest Income

         

Loans, including fees

   $ 2,417      $ 2,971      $ 7,722       $ 9,399   

Investment securities

     109        127        340         421   

Federal funds sold and overnight deposits

     5        1        20         2   
  

 

 

   

 

 

   

 

 

    

 

 

 

Total interest income

     2,531        3,099        8,082         9,822   

Interest Expense

         

Deposits

     579        787        1,901         2,638   

Federal Home Loan Bank advances

     301        504        988         1,496   
  

 

 

   

 

 

   

 

 

    

 

 

 

Total interest expense

     880        1,291        2,889         4,134   
  

 

 

   

 

 

   

 

 

    

 

 

 

Net Interest Income

     1,651        1,808        5,193         5,688   

Provision for Loan Losses

     41        2,724        304         11,609   
  

 

 

   

 

 

   

 

 

    

 

 

 

Net Interest Income After Provision for Loan Losses

     1,610        (916     4,889         (5,921

Non-interest Income

         

Fees and service charges

     484        439        1,387         1,548   

Loan servicing fees

     114        119        332         358   

Net gain on sale of loans

     245        236        675         585   

Net gain on sale of securities

     469        39        469         76   

Other income

     (91     47        133         240   
  

 

 

   

 

 

   

 

 

    

 

 

 

Total non-interest income

     1,221        880        2,996         2,807   

Non-interest Expense

         

Salaries and employee benefits

     1,164        1,074        3,268         3,279   

Occupancy and equipment

     233        235        680         700   

Data processing

     213        198        635         605   

Amortization of mortgage servicing rights

     105        113        293         281   

Professional services

     198        207        541         603   

Amortization of core deposit intangible

     35        35        106         106   

NOW account processing

     50        53        149         158   

ATM/Debit card processing

     62        64        185         181   

Foreclosed property expense

     221        63        455         328   

Other general and administrative

     382        440        1,187         1,215   
  

 

 

   

 

 

   

 

 

    

 

 

 

Total non-interest expense

     2,663        2,482        7,499         7,456   
  

 

 

   

 

 

   

 

 

    

 

 

 

Income (Loss) - Before income taxes

     168        (2,518     386         (10,570

Income Taxes

     —          —          —           —     
  

 

 

   

 

 

   

 

 

    

 

 

 

Net Income (Loss)

   $ 168      $ (2,518   $ 386       $ (10,570
  

 

 

   

 

 

   

 

 

    

 

 

 

Dividends and amortization of discount on preferred stock

   $ 89      $ 90      $ 266       $ 266   

Net Income (loss) available to common stock

   $ 79      $ (2,608   $ 120       $ (10,836
  

 

 

   

 

 

   

 

 

    

 

 

 

Income (Loss) Per Share

         

Basic

   $ 0.04      $ (1.32   $ 0.06       $ (5.48
  

 

 

   

 

 

   

 

 

    

 

 

 

Diluted

   $ 0.04      $ (1.32   $ 0.06       $ (5.48
  

 

 

   

 

 

   

 

 

    

 

 

 

See accompanying notes to condensed consolidated financial statements.

 

2


Table of Contents

Condensed Consolidated Statements of Cash Flows (Unaudited)

 

     Nine Months Ended  
     September, 30  
     2011     2010  
     (Dollars in thousands)  

Cash Flows From Operating Activities

    

Net Income (Loss)

   $ 386      $ (10,570

Adjustments to reconcile net income (loss) to net cash from operating activities

    

Depreciation and amortization

     749        827   

Provision for loan losses

     304        11,609   

Stock option expense

     8        7   

Gain on sale of foreclosed assets

     (153     (105

Mortgage loans originated for sale

     (22,472     (17,972

Proceeds from sale of mortgage loans

     22,558        18,174   

Gain on sale of mortgage loans

     (675     (585

(Gain) Loss on sale of available for sale securities

     (469     (76

Earned Stock Compensation

     —          —     

Net change in:

    

Deferred loan fees

     (74     72   

Accrued interest receivable

     57        492   

Other assets

     836        (501

Accrued expenses and other liabilities

     642        278   
  

 

 

   

 

 

 

Net cash provided by (used in) operating activities

     1,697        1,650   

Cash Flows From Investing Activities

    

Activity in available for sale securities:

    

Purchases of available for sale securities

     (4,855     (4,217

Proceeds from maturities of securities

     1,477        3,620   

Proceeds from sale of securities

     8,550        4,808   

Activity in held-to-maturity securities:

    

Proceeds from maturities of securities

     10        13   

Loan originations and principal collections, net

     24,681        10,773   

Proceeds from sale of foreclosed assets

     2,150        2,030   

Proceeds from sale of FHLB Stock

     495        —     

Purchase of premises and equipment

     (182     (65
  

 

 

   

 

 

 

Net cash provided by investing activities

     32,326        16,962   

Cash Flows From Financing Activities

    

Net decrease in deposits

     (19,104     (11,468

Cash Dividends-preferred stock

     (266     (266

Proceeds from FHLB advances

     —          —     

Repayment of FHLB advances

     (14,000     (2,000
  

 

 

   

 

 

 

Net cash provided by financing activities

     (33,370     (13,734
  

 

 

   

 

 

 

Net Increase (Decrease) in Cash and Cash Equivalents

     653        4,878   

Cash and Cash Equivalents - Beginning

     41,974        23,354   
  

 

 

   

 

 

 

Cash and Cash Equivalents - End

   $ 42,627      $ 28,232   
  

 

 

   

 

 

 

Supplemental Cash Flow Information:

    

Cash paid for:

    

Interest

     3,015        4,186   

Noncash investing activities:

    

Loans transferred to foreclosed assets

     3,614        1,639   

See accompanying notes to condensed consolidated financial statements.

 

3


Table of Contents

MONARCH COMMUNITY BANCORP, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

ORGANIZATION

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 five 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 Bank’s 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 Corporation’s management, all adjustments, consisting only of normal recurring accruals, necessary for a fair presentation of the Corporation’s 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 Corporation’s Form 10-K for the year ended December 31, 2010 filed with the Securities and Exchange Commission.

The results of operations for the nine month period ended September 30, 2011 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, management’s 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 which cover a twenty –four month historical period and are carried at a weighted average with the most recent twelve months weighted 60% and the later weighted 40%, can vary 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 management’s judgment, significant factors which affect the collectability of the portfolio as of the evaluation date are not reflected in the loss factors. Management estimates probable losses by evaluating quantitative and qualitative factors for each loan portfolio segment, including net charge-off trends, internal risk ratings, changes in internal risk ratings, loss forecasts, collateral values, geographic location, delinquency rates, nonperforming and restructured loans, origination channel, product mix, underwriting practices, industry conditions, and economic trends.

 

4


Table of Contents

As of September 30, 2011 the residential loan historical loss ratios were increased by .08% to .27% based on the particular segment. Multi-family real estate loan historical loss ratios were increased by .07% to 2.40%. All other commercial real estate loan historical loss ratios were increased .02% to .99%. Construction loan historical loss ratios were increased .04% to .43%, Consumer loan historical loss ratios, .50% to .60% and commercial and industrial loan historical loss ratios were increased by .03% to .28%. As of September 30, 2011 7% of the allowance for loan loss reserve was attributable to adjustments to the loss factors. No adjustments were made to the loss factors in the fourth quarter of 2010 or in the first six months of 2011. Factors regarding changes in experience, ability and depth of lending management and changes in the quality of loan review system and the degree of oversight by the Board of Directors were decreased in the third quarter of 2011. 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.

RECLASSIFICATIONS

Certain 2010 amounts have been reclassified to conform to the 2011 presentation.

NOTE 2 - SECURITIES

The amortized cost and fair value of securities at period-end were as follows (dollars in thousands):

 

September 30, 2011

   Amortized
Cost
     Gross
Unrealized
Gains
     Gross
Unrealized
Losses
     Estimated
Market Value
 

Available-for-sale securities:

           

Collateralized Mortgage obligations

   $   4,832       $ 14       $ —         $   4,846   

U.S. government agency obligations

     —           —           —           —     

Mortgage-backed securities

     1,014         67            1,081   

Obligations of states and political subdivisions

     478         7         —           485   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total available-for-sale securities

   $ 6,324       $   88       $ —         $ 6,412   
  

 

 

    

 

 

    

 

 

    

 

 

 

Held-to-maturity securities:

           

Municipal securities

   $ —         $ —         $ —         $ —     
  

 

 

    

 

 

    

 

 

    

 

 

 

 

December 31, 2010

   Amortized
Cost
     Gross
Unrealized
Gains
     Gross
Unrealized
Losses
     Estimated
Market Value
 

Available-for-sale securities:

           

Collateralized Mortgage obligations

   $ —         $ —         $ —         $ —     

U.S. government agency obligations

     1,619         63         —           1,682   

Mortgage-backed securities

     3,914         110         —           4,024   

Obligations of states and political subdivisions

     5,543         217         —           5,760   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total available-for-sale securities

   $ 11,076       $ 390       $ —         $ 11,466   
  

 

 

    

 

 

    

 

 

    

 

 

 

Held-to-maturity securities:

           

Municipal securities

   $ 10       $ —         $ —         $ 10   
  

 

 

    

 

 

    

 

 

    

 

 

 

Proceeds from sales of securities available for sale were $8.6 and $4.8 million for the nine months ended September 30, 2011 and 2010, respectively. Gross gains of $469,000 and $76,000 were realized on these sales during 2011 and 2010, respectively.

 

5


Table of Contents

The amortized cost and fair value of securities available for sale at September 30, 2011 by contractual maturity follow (dollars in thousands). The actual maturity may differ from the contractual maturity because issuers may have a right to call or prepay obligations.

 

     September 30, 2011  
     Held to Maturity Securities      Available for Sale Securities  
     Amortized
Cost
     Fair
Value
     Amortized
Cost
     Fair
Value
 
     (Dollars in Thousands)  

Due in one year or less

   $ —         $ —         $ 400       $ 401   

Due from one to five years

     —           —           78         84   

Due from five to ten years

     —           —           —           —     

Due after ten years

     —           —           —           —     
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ —         $ —           478         485   
  

 

 

    

 

 

       

Mortgage-backed securities

           1,014         1,081   

CMO securities

           4,832         4,846   
        

 

 

    

 

 

 

Total available-for-sale securities

         $ 6,324       $ 6,412   
        

 

 

    

 

 

 

There were no securities with unrealized losses at September 30, 2011.

Other-Than Temporary-Impairment

Our portfolio of available for sale securities is reviewed quarterly for other-than-temporary-impairment (OTTI) in value. In performing this review many factors are considered including: (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 prospect of the issuer, (3) the impact of changes in market interest rates on the market value of the security and (4) an assessment of whether management intends to sell the security, or it is more likely than not that management will be required to sell the security at a loss before anticipated recovery.

Management determined that there were no securities with OTTI at September 30, 2011.

 

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Table of Contents

NOTE 3 - 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):

 

     Three Months
Ended
September 30, 2011
    Three Months
Ended
September 30, 2010
    Nine Months
Ended
September 30, 2011
    Nine Months
Ended
September 30, 2010
 

Basic earnings per share

        

Numerator:

        

Net Income (Loss)

   $ 168      $ (2,518   $ 386      $ (10,570

Dividends and amortization of discount on preferred stock

   $ 89      $ 90      $ 266      $ 266   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net Income (Loss) available to common stock

   $ 79      $ (2,608   $ 120      $ (10,836
  

 

 

   

 

 

   

 

 

   

 

 

 

Denominator:

        

Weighted average common shares outstanding

     2,049        2,045        2,049        2,045   

Less: Average unallocated ESOP shares

     (56     (65     (56     (65

Less: Average non-vested RRP shares

     (1     (1     (1     (2
  

 

 

   

 

 

   

 

 

   

 

 

 

Weighted average common shares outstanding for basic earnings (loss) per share

     1,992        1,979        1,992        1,978   
  

 

 

   

 

 

   

 

 

   

 

 

 

Basic earnings (loss) per share

   $ 0.04      $ (1.32   $ 0.06      $ (5.48
  

 

 

   

 

 

   

 

 

   

 

 

 

Diluted earnings per share

        

Numerator:

        

Net Income (Loss) available to common stock

   $ 79      $ (2,608   $ 120      $ (10,836
  

 

 

   

 

 

   

 

 

   

 

 

 

Denominator:

        

Weighted average common shares outstanding for basic earnings per share

     1,992        1,979        1,992        1,978   

Add: Dilutive effects of restricted stock, stock options and warrants

     —          —          —          —     
  

 

 

   

 

 

   

 

 

   

 

 

 

Weighted average common shares and dilutive potential common shares outstanding

     1,992        1,979        1,992        1,978   
  

 

 

   

 

 

   

 

 

   

 

 

 

Diluted earnings (loss) per share

   $ 0.04      $ (1.32   $ 0.06      $ (5.48
  

 

 

   

 

 

   

 

 

   

 

 

 

NOTE 4 - RECENT ACCOUNTING PRONOUNCEMENTS

FASB ASU 2010-06, Improving Disclosures about Fair Value Measurements. The Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2010-06 to amend ASC 820, Fair Value Measurement and Disclosures (“ASC 820”), to require additional disclosures regarding fair value measurements. Specifically, the ASU requires disclosure of the amounts of significant transfers between Level 1 and Level 2 of the fair value hierarchy and the reasons for these transfers; the reasons for any transfers in or out of Level 3; and information in the reconciliation of recurring Level 3 measurements about gross purchases, sales, issuances and settlements. Except for the requirement to disclose purchases, sales, issuances and settlements in the reconciliation of recurring Level 3 measurements on a gross basis, all the amendments to ASC 820 made by ASU 2010-06 were effective for the Corporation on January 1, 2010. The requirement to separately disclose purchases, sales, issuances and settlements of recurring Level 3 measurements was effective for the Corporation as of January 1, 2011. All required disclosures are incorporated into Note 5.

 

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FASB ASU 2010-20, Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses. In July 2010, the FASB issued ASU 2010-20, which requires new qualitative and quantitative disclosures on the allowance for credit losses, credit quality, impaired loans, modifications and nonaccrual and past due financing receivables. The guidance requires that an entity provide disclosures facilitating financial statement users’ evaluation of the nature of credit risk inherent in the entity’s portfolio of financing receivables (i.e., loans), how that risk is analyzed and assessed in arriving at the allowance for credit losses, and the changes and reasons for those changes in the allowance for credit losses. These required disclosures are to be presented on a disaggregated basis at the portfolio segment and the class of financing receivables level. As it relates to disclosures as of the end of a reporting period, ASU 2010-20 was effective for the Corporation as of December 31, 2010. Disclosures that relate to activity during a reporting period were required for the Corporation in the period beginning January 1, 2011 and are incorporated into Note 6 and Note 7. In January 2011, the FASB temporarily deferred the effective date for disclosures about troubled debt restructurings under ASU 2010-20. See ASU 2011-2 below which requires disclosures about troubled debt restructurings under ASU 2010-20 on a prospective basis beginning in the quarter ended September 30, 2011.

FASB ASU 2011-02, A Creditor’s Determination of Whether a Restructuring Is a Troubled Debt Restructuring. In April 2011, the FASB issued ASU 2011-02, which provides additional guidance to help creditors in determining whether a creditor has granted a concession and whether a debtor is experiencing financial difficulties for purposes of determining whether a restructuring constitutes a troubled debt restructuring. The amendments in this update are effective for the Corporation beginning in the quarter ended September 30, 2011 and are to be applied retrospectively to January 1, 2011. In addition, the modification disclosures described in ASU 2010-20, which were subsequently deferred by ASU 2011-01, Deferral of the Effective Date of Disclosures about Troubled Debt Restructurings, were effective on a prospective basis beginning in the quarter ended September 30, 2011. The Corporation has included the evaluation of the impact of ASU 2011-02 on its consolidated financial statements in Note 6.

The FASB has issued ASU 2011-04, Fair Value Measurement (Topic 820): Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs. This ASU represents the converged guidance of the FASB and the IASB (the Boards) on fair value measurement. The collective efforts of the Boards and their staffs, reflected in ASU 2011-04, have resulted in common requirements for measuring fair value and for disclosing information about fair value measurements, including a consistent meaning of the term “fair value.” The Boards have concluded the common requirements will result in greater comparability of fair value measurements presented and disclosed in financial statements prepared in accordance with U.S. GAAP and IFRSs. The amendments to the Codification in this ASU are to be applied prospectively. For public entities, the amendments are effective during interim and annual periods beginning after December 15, 2011. Early application by public entities is not permitted. The impact of adoption of this ASU is not expected to be material.

FASB ASU 2011-05, Presentation of Comprehensive Income. In September 2011, the FASB issued ASU 2011-05, which provides entities with the option to present the total of comprehensive income, the components of net income, and the components of other comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements. In both choices, an entity is required to present each component of net income along with total net income, each component of other comprehensive income, along with a total for other comprehensive income, and a total amount for comprehensive income. Regardless of whether an entity chooses to present comprehensive income in a single continuous statement or in two separate but consecutive statements, the entity is required to present on the face of the financial statements reclassification adjustments for items that are reclassified from other comprehensive income to net income in the statement(s) where the components of net income and the components of other comprehensive income are presented. This update should be applied retrospectively effective for fiscal years, and interim periods within those years, beginning after December 15, 2011. We anticipate this statement will be adopted with our 2012 annual financial statements.

 

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NOTE 5 - 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 Corporation 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 Corporation’s 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 presents information about the Corporation’s assets and liabilities measured at fair value on a recurring basis at September 30, 2011, and December 31, 2010, and the valuation techniques used by the Corporation to determine those fair values. Investment securities with fair value determined by Level 1 input include U.S. Treasury securities. Investment securities with fair value determined by Level 2 inputs include mortgage backed securities, obligations of states and political subdivisions and U.S Government Agency obligations.

 

     Quoted Prices in
Active Markets for
Identical Assets
(Level  1)
     Significant
Other
Observable
Inputs
(Level 2)
     Significant
Unobservable
Inputs
(Level 3)
     Balance at
September 30,
2011
 

Assets:

           

September 30, 2011-Investment Securities

           

Collateralized Mortgage obligations

     —           4,846         —           4,846   

U.S. government agency obligations

     —           —           —           —     

Mortgage-backed securities

     —           1,081         —           1,081   

Obligations of states and political subdivisions

     —           485         —           485   
  

 

 

    

 

 

    

 

 

    

 

 

 
   $ —         $ 6,412       $ —         $ 6,412   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

     Quoted Prices in
Active Markets for
Identical Assets
(Level  1)
     Significant
Other
Observable
Inputs
(Level 2)
     Significant
Unobservable
Inputs
(Level 3)
     Balance at
December 31,
2010
 

Assets:

           

December 31, 2010-Investment Securities

           

Collateralized Mortgage obligations

     —           —           —           —     

U.S. government agency obligations

     —           1,682         —           1,682   

Mortgage-backed securities

     —           4,024         —           4,024   

Obligations of states and political subdivisions

     —           5,760         —           5,760   
  

 

 

    

 

 

    

 

 

    

 

 

 
   $ —         $ 11,466       $ —         $ 11,466   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

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The Corporation 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). Adjustments in 2011 and 2010 to the impaired loans were recorded as additional allocations to the allowance for loan and lease losses. Adjustments in 2011 to foreclosed assets were recorded as additional allocations to the allowance for loan and lease losses. The following table presents the Corporation’s assets at fair value on a nonrecurring basis as of September 30, 2011 and December 31, 2010 (000s omitted):

 

Assets Measured at Fair Value on a Nonrecurring Basis  
     Balance at
September 30,
2011
     Quoted Prices in
Active Markets for
Identical Assets
(Level 1)
     Significant
Other
Observable
Inputs
(Level 2)
     Significant
Unobservable
Inputs
(Level 3)
 

Impaired Loans accounted for under FASB ASC 310

   $ 8,415       $ —         $ —         $ 8,415   

Foreclosed Assets

   $ 4,482       $ —         $ —         $ 4,482   

 

Assets Measured at Fair Value on a Nonrecurring Basis  
     Balance at
December 31,
2010
     Quoted Prices in
Active Markets for
Identical Assets
(Level 1)
     Significant
Other
Observable
Inputs
(Level 2)
     Significant
Unobservable
Inputs
(Level 3)
 

Impaired Loans accounted for under FASB ASC 310

   $ 11,433       $ —         $ —         $ 11,433   

Foreclosed Assets

   $ 2,972       $ —         $ —         $ 2,972   

The fair value of impaired loans is estimated using either discounted cash flows or collateral value. 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. Impaired loans where a specific reserve is established based on the fair value of the collateral require classification in the fair value hierarchy. Impaired loans are categorized as level 3 assets because the values are based on available collateral (typically based on outside appraisals obtained at least annually) and discounted based on internal loan to value limits which typically range from 50% to 80% based on the collateral. Management reviews the impaired loans no less than quarterly for potential additional impairment and when there is little prospect of collecting principal or interest, loans or portions thereof may be charged off to the allowance for loan losses. Losses are recognized in the period a debt becomes uncollectible. The recognition of a loss does not mean that the loan has no recovery or salvage value, but rather it is not practical or desirable to defer writing off the loan even though a partial recovery may occur in the future. During the nine months ended September 30, 2011 the Company charged off $455,000 of impaired loans to the allowance for loan losses. The change in fair value of impaired loans is accounted for in the allowance for loan losses (see Note 6).

Foreclosed assets, which include real estate owned and real in estate in judgment and subject to redemption, 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 performed annually 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. The valuations consist of obtaining a broker price opinion or a new appraisal depending on the value of the asset. Revenue and expenses from operations and changes in the valuation allowance are included in net expenses from foreclosed assets. Assets held as real estate in judgment may be subject to redemption for a period of six to twelve months depending on the collateral, following the foreclosure sale. Assets may be redeemed by the borrower for the foreclosure sale price, accrued interest and foreclosure costs. Any asset redeemed would be treated as a paid off loan. As of September 30, 2011 the Company held $4.5 million in foreclosed assets owned as a result of foreclosure or the acceptance of a deed in lieu and $3.0 million in foreclosed assets as of December 31, 2010. No assets were redeemed in 2010 or in the nine months of 2011.

 

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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 Corporation’s 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. Financial Accounting Standards Board (FASB), Accounting Standards Codification (ASC), FASB ASC 820-10-50, Fair Value Measurements and Disclosures, 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 September 30, 2011 and December 31, 2010. 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 Corporation’s Federal Home Loan Bank advances are estimated using discounted cash flow analyses based on the Corporation’s current incremental borrowing rates for similar types of borrowing arrangements.

The estimated fair values, and related carrying or notional amounts, of the Corporation’s financial instruments are as follows (000s omitted):

 

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     September 30, 2011      December 31, 2010  
     Carrying Amount      Fair Value      Carrying Amount      Fair Value  

Assets:

           

Cash and cash equivalents

   $ 42,627       $ 42,627       $ 41,974       $ 41,974   

Securities - Held to maturity

     —           —           10         10   

Securities - Available for sale

     6,412         6,412         11,466         11,466   

Other securities

     3,370         3,370         3,865         3,865   

Loans held for sale

     607         618         693         703   

Net loans

     154,918         157,044         182,768         185,268   

Accrued interest and late charges receivable

     390         390         264         264   

Liabilities:

           

Deposits

     186,924         186,743         206,028         206,400   

Federal Home Loan Bank advances

     22,350         23,878         36,350         38,532   

Accrued interest payable

     215         215         341         341   

NOTE 6 - LOANS

The following table presents information concerning the composition of our loan portfolio in dollar amounts and in percentages as of the dates indicated:

 

     September 30, 2011     December 31, 2010  
     Amount      Percent     Amount      Percent  
     (Dollars in thousands)  

Real Estate Loans:

          

One-to-four family

   $ 82,126         51.2      $ 93,294         49.1   

Multi-family

     767         0.5        4,783         2.5   

Commercial

     55,812         34.8        62,998         33.1   

Construction or development

     1,835         1.1        3,873         2.0   
  

 

 

    

 

 

   

 

 

    

 

 

 

Total real estate loans

     140,540         87.6        164,948         86.8   

Other loans:

          

Consumer loans:

          

Home equity

     11,657         7.3        14,814         7.8   

Other

     2,674         1.7        3,403         1.8   
  

 

 

    

 

 

   

 

 

    

 

 

 

Total consumer loans

     14,331         9.0        18,217         9.6   

Commercial Business Loans

     5,502         3.4        6,882         3.6   
  

 

 

    

 

 

   

 

 

    

Total other loans

     19,833         12.4        25,099         13.2   
  

 

 

    

 

 

   

 

 

    

 

 

 

Total Loans

     160,373         100.0     190,047         100.0
     

 

 

      

 

 

 

Allowance for loan losses

     5,158           6,850      

Less: Net deferred loan fees

     297           429      
       

 

 

    

Total Loans, net

   $ 154,918         $ 182,768      
  

 

 

      

 

 

    

Loans are considered past due if the required principal and interest payments have not been received as of the date such payments were due. All loan classes on which principal or interest is in default for 90 days or more are put on nonaccrual status, unless there is sufficient documentation to conclude that the loan is well secured and in the process of collection. Loans will also be placed on nonaccrual status if the Bank cannot reasonably expect full and timely repayment. All nonaccrual loans are also deemed to be impaired unless they are residential loans whose status as nonaccrual loans is based solely on having reached 90 days past due, are in the process of collection, but whose status as well secured has not yet been established.

 

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A loan is considered impaired when it is probable that the Company will be unable to collect all amounts due, including principal and interest, according to the contractual terms of the agreement. All impaired loans are also classified as nonaccrual loans unless they are deemed to be impaired solely due to their status as a troubled debt restructure and, 1) the borrower is not past due or, 2) there is verifiable adequate cash flow to support the restructured debt service or, 3) there is an adequate collateral valuation supporting the restructured loan.

An age analysis of past due loans including nonaccrual loans, segregated by class of loans, as of September 30, 2011 and December 31, 2010 are as follows:

 

September 30, 2011  
     30-69
DaysPast
Due
     60-89
DaysPast
Due
     Loans 90 Days or More
Past Due
     Total Past
due Loans
     Current
Loans
     Total Loans  

Commercial

   $ 98       $ —         $ 1,334       $ 1,432       $ 4,070       $ 5,502   

Commercial Real Estate:

                 

Multi-family

     454         —           —         $ 454         313         767   

Commercial Real Estate - other

     1,465         152         3,015       $ 4,632         51,180         55,812   

Consumer:

                 

Consumer - other

     58         110         169       $ 337         13,832         14,169   

Consumer - auto

     —           —           —         $ —           162         162   

Residential:

                 

Residential - prime

     906         272         742       $ 1,920         64,215         66,135   

Residential - subprime

     388         354         153       $ 895         15,096         15,991   

Construction:

                 

Construction - prime

     18         —           —         $ 18         1,817         1,835   

Construction - subprime

     —           —           —         $ —           —           —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 3,387       $ 888       $ 5,413       $ 9,688       $ 150,685       $ 160,373   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

December 31, 2010  
    

30-69

DaysPast
Due

     60-89
DaysPast
Due
     Loans 90 Days or More
Past Due
     Total Past
due Loans
     Current
Loans
     Total Loans  

Commercial

   $ 89       $ —         $ 1,118       $ 1,207       $ 5,675       $ 6,882   

Commercial Real Estate:

                 

Multi-family

     —           —           339         339         4,444         4,783   

Commercial Real Estate - other

     125         2,752         3,751         6,628         56,370         62,998   

Consumer:

                 

Consumer - other

     239         19         192         450         17,437         17,887   

Consumer - auto

     7         —           —           7         323         330   

Residential:

                 

Residential - prime

     1,090         797         935         2,822         73,729         76,551   

Residential - subprime

     284         91         163         538         16,205         16,743   

Construction:

                 

Construction - prime

     169         —           —           169         3,704         3,873   

Construction - subprime

     —           —           —           —           —           —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 2,003       $ 3,659       $ 6,498       $ 12,160       $ 177,887       $ 190,047   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

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All commercial loans will be assigned a risk rating by the Credit Analyst at inception. The risk rating system is composed of eight levels of quality and utilizes the following definitions. The risk rating system was last updated in June 2010. No changes have been made to the risk ratings in the third quarter of 2011.

Risk Rating Scores by definition:

 

1. Zero (0) Unclassified. Any loan which has not been assigned a classification.

 

2. One (1) Excellent. A well structured credit relationship to an established borrower. Loans to entities with a strong financial condition and solid earnings history, characterized by:

 

   

High liquidity, strong cash flow, low leverage.

 

   

Unquestioned ability to meet all obligations when due.

 

   

Experienced management, with management succession in place.

 

   

Debt to worth ratio of 1:1 or less.

 

   

Steady and above average earnings history.

 

   

If loan is secured, collateral is of high quality and readily marketable.

 

   

Readily accessible to capital markets and alternative financing.

 

   

Industry is mature with favorable outlook.

 

   

Loan structure within policy guidelines.

 

   

Loan is performing as agreed.

 

   

The probability of serious, rapid financial deterioration is extremely small.

 

   

Outstanding primary and secondary sources of repayment.

 

3. Two (2) Above Average Quality. Loans to borrowers with a sound financial condition and positive trend in earnings supplemented by:

 

   

Favorable liquidity and leverage and strong cash flow.

 

   

Ability to meet all obligations when due.

 

   

Management has successful track record.

 

   

Debt to worth ratio of 1.5:1 or less.

 

   

Steady and satisfactory earnings history.

 

   

If loan is secured, collateral is of high quality and readily marketable.

 

   

Access to alternative financing.

 

   

Excellent prospects for continued growth.

 

   

Industry outlook is favorable.

 

   

Loan structure is within policy guidelines.

 

   

Loan is performing to terms.

 

   

Probability of serious financial deterioration is unlikely.

 

   

Well defined primary and secondary source of repayment.

 

   

If supported by a guaranty, the financial strength and liquidity of the guarantor(s) are clearly evident.

 

4. Three (3) Acceptable. Loans to entities with a satisfactory financial condition and further characterized by:

 

   

Working capital adequate to support operations.

 

   

Cash flow sufficient to pay debts as scheduled.

 

   

Management experience and depth appear favorable.

 

   

Debt to worth ratio of 2.50:1 or less.

 

   

Acceptable sales and steady earning history.

 

   

Industry outlook is stable.

 

   

Loan structure within policy guidelines.

 

   

Loan performing according to terms.

 

   

If loan is secured, collateral is acceptable and loan is fully protected.

 

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Table of Contents
5. Four (4) Average. Loans to entities which are considered bankable risks, although some signs of weaknesses are shown:

 

   

Marginal liquidity and working capital.

 

   

Short or unstable earnings history.

 

   

Would include most start-up businesses.

 

   

Would be enrolled in Small Business Administration or Michigan Strategic Fund programs.

 

   

Occasional instances of trade slowness or repayment delinquency – may have been 10-30 days slow within the past 12 months.

 

   

Management abilities are apparent yet unproven.

 

   

Debt to worth ratio of 3.50 or less.

 

   

Weakness in primary source of repayment with adequate secondary source of repayment.

 

   

If secured, loan is protected but collateral is marginal.

 

   

Industry outlook is uncertain; may be cyclical or highly competitive.

 

   

Loan structure generally in accordance with policy.

 

6. Five (5) Special Mention. Special Mention loans have potential weaknesses which may, if not checked or corrected, weaken the asset or inadequately protect the Bank’s credit position at some future date. Loans to entities that constitute an undue and unwarranted credit risk but not to the point of justifying or classification of substandard. The credit risk may be relatively minor yet constitute an unwarranted risk in light of the circumstances surrounding a specific loan. The following characteristics may apply:

 

   

Downward trend in sales, profit levels and margins.

 

   

Impaired working capital positions.

 

   

Cash flow is strained in order to meet debt repayment.

 

   

Loan delinquency (30-60 days) and overdrafts may occur.

 

   

Management abilities are questionable.

 

   

Highly leveraged, debt to worth ratio over 3.50:1.

 

   

Industry conditions are weak.

 

   

Inadequate or outdated financial information.

 

   

Litigation pending against borrower.

 

   

Loan may need to be restructured to improve collateral position and/or reduce payment amount.

 

   

Collateral / guaranty offers limited protection.

 

7. Six (6) Substandard. A substandard loan is inadequately protected by the current sound worth and repayment capacity of the borrower. Loans so classified must have a well-defined weakness that jeopardizes the liquidation of the debt. There is a distinct possibility that the Bank will implement collection procedures if the loan deficiencies are not corrected. The following characteristics may apply:

 

   

Sustained losses have severely eroded the equity and cash flow.

 

   

Deteriorating liquidity.

 

   

Serious management problems.

 

   

Chronic trade slowness; may be placed on COD by vendors.

 

   

Likelihood of bankruptcy.

 

   

Inability to access other funding sources.

 

   

Reliance on secondary source of repayment.

 

   

Interest non-accrual may be warranted.

 

   

Collateral provided is of little or no value.

 

   

Repayment dependent upon the liquidation of non-current assets.

 

   

Repayment may require litigation.

 

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Table of Contents
8. Seven (7) Doubtful. A doubtful loan has all the weakness inherent in a substandard loan with the added characteristic that collection and/or liquidation is pending. Loans or portions of loans with one or more weaknesses which, on the basis of currently existing facts, conditions, and values, makes ultimate collection of all principal highly questionable. The possibility of loss is high and specific loan loss reserve allocations should be made or charge offs taken on anticipated collateral shortfalls. However, the amount or the certainty of eventual loss may not allow for a specific reserve or charge off because of specific pending factors. Pending factors include proposed merger or acquisition, completion or liquidation in progress, injection of new capital in progress, refinancing plans in progress, etc. “Pending Factors” not resolved after six months must be disregarded. The following characteristics may apply:

 

   

Normal operations are severely diminished or have ceased.

 

   

Seriously impaired cash flow.

 

   

Secondary source of repayment is inadequate.

 

   

Survivability as a “going concern” is impossible.

 

   

Placement on interest non-accrual

 

   

Collection process has begun.

 

   

Bankruptcy petition has been filed.

 

   

Judgments have been filed.

 

   

Portion of the loan balance has been charged-off.

 

9. Eight (8) Loss. Loans classified loss are considered uncollectible and of such little value that their continuance as bankable asset is not warranted. This classification is for charged-off loans but does not mean that the asset has absolutely no recovery or salvage value. Further characterized by:

 

   

Liquidation or reorganization under bankruptcy, with poor prospects of collection.

 

   

Fraudulently overstated assets and/or earnings.

 

   

Collateral has marginal or no value.

 

   

Debtor cannot be located.

The following table represents the risk category of loans by class based on the most recent analysis performed as of September 30, 2011 and December 31, 2010 (in thousands):

 

            September 30, 2011         
Credit Rating    Commercial      Commercial Real Estate
Multi-family
     Commercial Real Estate
Other
 
   2011      2011      2011  

0-2

     —           35         2,954   

3

     103         154         2,162   

4

     3,267         18         30,700   

5

     323         106         2,306   

6

     523         454         15,946   

7

     1,286         —           1,744   
  

 

 

    

 

 

    

 

 

 

Total

   $ 5,502       $ 767       $ 55,812   
  

 

 

    

 

 

    

 

 

 

 

            December 31, 2010         
      Commercial      Commercial Real Estate
Multi-family
     Commercial Real Estate
Other
 
   2010      2010      2010  

0-2

     —           37         3,509   

3

     14         209         4,993   

4

     3,698         131         17,537   

5

     1,533         3,603         18,849   

6

     427         464         13,741   

7

     1,210         339         4,369   
  

 

 

    

 

 

    

 

 

 

Total

   $ 6,882       $ 4,783       $ 62,998   
  

 

 

    

 

 

    

 

 

 

 

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Table of Contents

For consumer residential real estate, and other, the Company also evaluates credit quality based on the aging status of the loan which was previously stated, and by payment activity. The following tables present the recorded investment in those classes based on payment activity and assigned grades as of September 30, 2011 and December 31, 2010.

 

     September 30, 2011         
     Residential - Prime      Residential - Subprime  
     2011  

Grade

     

Pass

     65,314         15,463   

Substandard

     821         528   
  

 

 

    

 

 

 

Total

   $ 66,135       $ 15,991   
  

 

 

    

 

 

 

 

     Consumer - Other      Consumer - Auto  
     2011  

Performing

     13,925         162   

Nonperforming

     244         —     
  

 

 

    

 

 

 

Total

   $ 14,169       $ 162   
  

 

 

    

 

 

 

 

     Construction - Prime  
     2011  

Performing

     1,835   

Nonperforming

     —     
  

 

 

 

Total

   $ 1,835   
  

 

 

 

 

     December 31, 2010         
     Residential - Prime      Residential - Subprime  
     2010  

Grade

     

Pass

     75,616         16,580   

Substandard

     935         163   
  

 

 

    

 

 

 

Total

   $ 76,551       $ 16,743   
  

 

 

    

 

 

 

 

     Consumer - Other      Consumer - Auto  
     2010  

Performing

     17,695         330   

Nonperforming

     192         —     
  

 

 

    

 

 

 

Total

   $ 17,887       $ 330   
  

 

 

    

 

 

 

 

     Construction - Prime  

Performing

     3,873   

Nonperforming

     —     
  

 

 

 

Total

   $ 3,873   
  

 

 

 

 

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Table of Contents

The following table presents loans individually evaluated for impairment by class of loans as of September 30, 2011 and December 31, 2010 (in thousands).

 

September 30, 2011  
     Recorded
Investment
     Unpaid
Principal
Balance
     Related
Allowance
     Average
Recorded
Investment
     Interest
Income
 

With no related allowance recorded:

              

Commercial

   $ 1,797       $ 1,920       $ —         $ 1,881       $ —     

Commercial Real Estate:

              

Commercial Real Estate - Mulit-family

     454         467         —           454         32   

Commercial Real Estate - other

     13,727         20,099         —           19,576         398   

Consumer:

              

Consumer - other

     357         357         —           357         21   

Consumer - auto

     —           —           —           —           —     

Residential:

              

Residential - prime

     2,087         2,907         —           3,009         124   

Residential - subprime

     4,950         4,950         —           4,950         335   

With an allowance recorded:

              

Commercial

     —           —           —           —           —     

Commercial Real Estate:

              

Commercial Real Estate - Multi-family

     —           —           —           —           —     

Commercial Real Estate - other

     563         603         246         608         —     

Consumer:

              

Consumer - other

     —           —           —           —           —     

Consumer - auto

     —           —           —           —           —     

Residential:

              

Residential - prime

     495         648         306         655         —     

Residential - subprime

     —           —           —           —           —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

              

Commercial

   $ 16,541       $ 23,089       $ 246       $ 22,519       $ 430   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Consumer

   $ 357       $ 357       $ —         $ 357       $ 21   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Residental

   $ 7,532       $ 8,505       $ 306       $ 8,614       $ 459   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

December 31, 2010  
     Recorded
Investment
     Unpaid
Principal
Balance
     Related
Allowance
     Average
Recorded
Investment
     Interest
Income
 

With no related allowance recorded:

              

Commercial

   $ 1,463       $ 1,492       $ —         $ 1,486       $ —     

Commercial Real Estate:

              

Commercial Real Estate - Mulit-family

     —           —           —           —           —     

Commercial Real Estate - other

     15,862         22,183         —           15,689         403   

Consumer:

              

Consumer - other

     346         346         —           350         15   

Consumer - auto

     —           —           —           —           —     

Residential:

              

Residential - prime

     3,367         3,965         —           3,665         139   

Residential - subprime

     4,993         4,993         —           4,586         358   

With an allowance recorded:

              

Commercial

     162         165         109         173         —     

Commercial Real Estate:

              

Commercial Real Estate - Multi-family

     803         808         366         765         —     

Commercial Real Estate - other

     341         354         147         357         —     

Consumer:

              

Consumer - other

     —           —           —           —           —     

Consumer - auto

     —           —           —           —           —     

Residential:

              

Residential - prime

     502         643         236         575         —     

Residential - subprime

     —           —           —           —           —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

              

Commercial

   $ 18,631       $ 25,002       $ 622       $ 18,470       $ 403   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Consumer

   $ 346       $ 346       $ —         $ 350       $ 15   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Residental

   $ 8,862       $ 9,601       $ 236       $ 8,826       $ 497   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

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Payments received on loans in nonaccrual status are typically applied to reduce the recorded investment in the asset. While an loan is in nonaccrual status, some or all of the cash interest payments received may be treated as interest income on a cash basis as long as the remaining recorded investment in the asset (i.e., after charge-off of identified losses, if any) is deemed to be fully collectible. As of September 30, 2011 and December 31, 2010 the Company had not recognized any interest income on a cash basis. The following presents by class, the recorded investment in loans and leases on non-accrual status as of September 30, 2011 and December 31, 2010.

Financing Receivables on Nonaccrual Status

 

     September 30, 2011  

Commercial

   $ 1,797   

Commercial real estate:

  

Commercial Real Estate - mulit-family

     —     

Commercial Real Estate - other

     6,406   

Consumer:

  

Consumer - other

     170   

Consumer - auto

     —     

Residential:

  

Residential - prime

     1,502   

Residential - subprime

     496   

Construction

  

Construction - prime

     —     

Construction - subprime

     —     
  

 

 

 

Total

   $ 10,371   
  

 

 

 

Financing Receivables on Nonaccrual Status

 

     December 31, 2010  

Commercial

   $ 1,625   

Commercial real estate:

  

Commercial Real Estate - mulit-family

     803   

Commercial Real Estate - other

     7,949   

Consumer:

  

Consumer - other

     89   

Consumer - auto

     —     

Residential:

  

Residential - prime

     3,007   

Residential - subprime

     263   

Construction

  

Construction - prime

     339   

Construction - subprime

     —     
  

 

 

 

Total

   $ 14,075   
  

 

 

 

Loans in which the Bank elects to grant a concession, providing terms more favorable than those prevalent in the market (e.g., rate, amortization term), and are formally restructured due to the weakening credit status of a borrower are reported as trouble debt restructure ( TDR). All other modifications in which the new terms are at current market conditions and are granted to clients due to competitive pressures and because of the customer’s favorable past and current performance and credit risk do not constitute a TDR loan and are not monitored.

In order to maximize the collection of loan balances, we evaluate troubled loans on a case-by-case basis to determine if a loan modification would be appropriate. We pursue loan modifications when there is a reasonable chance that an appropriate modification would allow our client to continue servicing the debt. For loans secured by either commercial or residential real estate, if the client demonstrates a loss of income such that the client cannot reasonably support even a modified loan, we may pursue foreclosure, short sales and/or deed-in-lieu arrangements. For all troubled loans, we review a number of factors, including cash flows, loan structures, collateral values, and guarantees. Based on our review of these factors and our assessment of overall risk, we evaluate the benefits of renegotiating the terms of the loans so that they have a higher likelihood of continuing to perform. To date, we have restructured loans in a variety of ways to help our clients service their debt and to mitigate the potential for additional losses. The primary restructuring methods being offered to our clients are reductions in interest rates and extensions in terms. Loans that, after being restructured, remain in compliance with their modified terms and whose modified interest rate yielded a market rate at the time the loan was restructured, are reviewed annually and may be reclassified as non-TDR, provided they conform with the prevailing regulatory criteria. As of September 30, 2011 there have been no loans in which the TDR designation has been removed.

 

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Table of Contents

The following table represents the level of TDRs as of September 30, 2011.

 

            Modifications
As of September 30
2011
        
     Number of
Contracts
     Pre-Modification
Outstanding Recorded
Investment
     Post-Modification
Outstanding Recorded
Investment
 

Troubled Debt Restructurings

        

Commercial

     4         1,379         1,337   

Commercial real estate:

        

Commercial Real Estate - mulit-family

     1         425         454   

Commercial Real Estate - other

     14         17,000         12,299   

Consumer:

        

Consumer - other

     22         467         428   

Consumer - auto

     —           —           —     

Residential:

        

Residential - prime

     36         3,955         2,701   

Residential - subprime

     82         5,139         5,037   

Construction

        

Construction - prime

     —           —           —     

Construction - subprime

     —           —           —     
  

 

 

    

 

 

    

 

 

 

Total

     159       $ 28,365       $ 22,256   
  

 

 

    

 

 

    

 

 

 

 

     Number of
Contracts
     Recorded Investment  

Troubled Debt Restructurings That Subsequently Defaulted

     

Commercial

     5         1,197   

Commercial real estate:

     

Commercial Real Estate - mulit-family

     1         187   

Commercial Real Estate - other

     14         5,559   

Consumer:

     

Consumer - other

     3         134   

Consumer - auto

     1         3   

Residential:

     

Residential - prime

     12         1,264   

Residential - subprime

     4         352   

Construction

     

Construction - prime

     —           —     

Construction - subprime

     —           —     
  

 

 

    

 

 

 
     40       $ 8,696   
  

 

 

    

 

 

 

 

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Table of Contents

All TDR loans are considered impaired. When individually evaluating loans for impairment, we may measure impairment using (1) the present value of expected future cash flows discounted at the loan’s effective interest rate (i.e., the contractual interest rate adjusted for any net deferred loan fees or costs, premium, or discount existing at the origination or acquisition of the loan), (2) the loan’s observable market price, or (3) the fair value of the collateral. If the present value of expected future cash flows discounted at the loan’s effective interest rate is used as the means of measuring impairment the change in the present value attributable to the passage time is recognized as bad-debt expense. As previously mentioned all impaired loans are also classified as nonaccrual loans unless they are deemed to be impaired solely due to their status as a troubled debt restructure and, 1) the borrower is not past due or, 2) there is verifiable adequate cash flow to support the restructured debt service or, 3) there is an adequate collateral valuation supporting the restructured loan. Nonaccruing TDR loans that demonstrate a history of repayment performance in accordance with their modified terms are reclassified to accruing restructured status, typically after six months of repayment performance and are supported by a current credit evaluation of the borrower’s financial condition and expectations for repayment under the revised terms. Included in the troubled debt restructured balances above were $14.2 million of accruing TDRs at September 30, 2011 and $15.8 million at December 31, 2010. Also included in the troubled debt restructured balances above $14.9 million are paying in accordance with modified terms at September 30, 2011 and $15.4 million at December 31, 2010.

NOTE 7 - ALLOWANCE FOR LOAN LOSSES

Changes in the allowance for loan losses were as follows for the nine months ended September 30, 2011.

Summary of Allowance for Loan Losses

 

     Three Months Ended
September 30
    Nine Months Ended
September 30
 
     2011     2010     2011     2010  

Beginning Balance

   $ 5,917      $ 9,783      $ 6,850      $ 5,783   

Loans Charged off

     (848     (2,940     (2,460     (7,951

Recoveries

     48        112        464        238   

Provision for loan losses

     41        2,724        304        11,609   
  

 

 

   

 

 

   

 

 

   

 

 

 

Ending Balance

   $ 5,158      $ 9,679      $ 5,158      $ 9,679   
  

 

 

   

 

 

   

 

 

   

 

 

 

The allowance for loan losses was $5.2 million at September 30, 2011 representing 3.3% of total loans, compared to $6.9 million at December 31, 2010 or 3.74% of total loans and $9.7 million at September 30, 2010 or 4.9% of total loans. The allowance for loan losses to non-performing loans ratio was 49.7% at September 30, 2011 compared to 48.7% at December 31, 2010 and 40.5% at September 30, 2010. At September 30, 2011 we believe that our allowance appropriately considers incurred losses in our loan portfolio.

 

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Table of Contents

Analysis related to the allowance for credit losses (in thousands) as of September 30, 2011 is as follows:

 

     SEPTEMBER 30, 2011                          
     Commercial     Comercial
Real Estate
Other
    Multi Family     Consumer     Residential -
Prime
    Residential -
Subprime
    Construction     Total  

ALLOWANCE FOR CREDIT LOSSES:

                

Beginning Balance

     71        1,790        474        503        3,495        458        59        6,850   

Charge-Offs

     (80     (449     (286     (263     (1,056     (313     (13     (2,460

Recoveries

     7        228        2        153        31        41        2        464   

Provision

     66        (374     (160     (131     313        601        (11     304   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ending Balance

     64        1,195        30        262        2,783        787        37        5,158   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ending Balance: individually evaluated for impairment

     —          246        —          —          306        —          —          552   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ending Balance: collectively evaluated for impairment

     64        949        30        262        2,477        787        37        4,606   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

FINANCING RECEIVABLES:

                

Ending Balance

     5,502        55,812        767        14,331        66,135        15,991        1,835        160,373   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ending Balance: individually evaluated for impairment

     1,797        14,290        454        357        2,582        4,950        —          24,430   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ending Balance: collectively evaluated for impairment

     3,705        41,522        313        13,974        63,553        11,041        1,835        135,943   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

The Company’s charge-off policy which meets regulatory minimums has not required any revisions during the third quarter of 2011. Losses on unsecured consumer loans are recognized at or before 120 days past due. Secured consumer loans, including residential real estate, are typically charged-off between 120 and 180 days past due, depending on the collateral type, in compliance with the FFIEC guidelines. Specific loan reserves are established based on credit and or collateral risks on an individual loan basis. When the probability for full repayment of a loan is unlikely the Bank will initiate a full charge-off or a partial write down of a loan based upon the status of the loan. Impaired loans or portions thereof are charged-off when deemed uncollectible. Loans that have been partially charged-off remain on nonperforming status, regardless of collateral value, until specific borrower performance criteria are met. Total impaired loans as reported above were $24.4 million as of September 30, 2011 and $27.8 million as of December 31, 2010. Partial charge-offs associated with the impaired loans totaled $6.3 million as of September 30, 2011 and $7.1 million as of December 31, 2010.

 

ITEM 2. MANAGEMENT’S 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.

FORWARD-LOOKING STATEMENTS

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.

 

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Table of Contents

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 management’s 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.

Income Taxes - Deferred income tax assets and liabilities are determined using the liability (or balance sheet) method. Under this method, the net deferred tax asset or liability is determined based on the tax effects of the various temporary differences between the book and tax bases of the various balance sheet assets and liabilities and gives current recognition to changes in tax rates and laws. A valuation allowance, if needed, reduces deferred tax assets to the amount expect to be realized.

OVERVIEW

Following Monarch Community Bank’s Safety and Soundness examination which was completed in early 2010, the Board of Directors of Monarch Community Bank stipulated to the terms of a formal enforcement action (“Consent Order”) with Federal Deposit Insurance Corporation (“FDIC”) and the Office of Financial and Insurance Regulation for the State of Michigan (“OFIR”). The Consent Order, which was effective May 6, 2010, contains specific actions needed to address certain findings from their examination and to address our current financial condition. Following Monarch Community Bank’s most recent Safety and Soundness examination, there were no changes to the existing formal enforcement action (“Consent Order”).

Since stipulating to the terms of the Consent Order, we have complied with all of the required actions, with the exception of fully raising our capital levels to the required levels. Management continues to work toward the achievement of the required capital levels through:

 

  1. Returning the Bank to profitability – As the bank returns to profitability, net income increases the level of capital in the Bank, resulting in improved capital ratios.

 

  2. Reducing the size of the Bank. – With a decrease in the assets and liabilities of the Bank, capital as a percent of assets increases. This contributes to the improvement of the capital ratios.

 

  3. Conducting a formal capital raise – the Bank is working with investment banking firms to develop a strategy for a formal capital raise. The timing of the capital raise will be affected by the status of the economy and the private equity markets. Based on current conditions, the Bank anticipates initiating the formal capital raise no earlier than the first quarter of 2012.

 

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Table of Contents

Management continues to focus on the improvement of credit quality at the Bank, and has completed three comprehensive external loan reviews over the last twelve months, with no recommendations for additional loan loss provisions or charge-offs, and no identification of material weaknesses in the credit approval or administration processes. Likewise, the Bank retained the services of Rehman Consulting to conduct the Bank’s internal audit function, a task which had previously been performed by a Bank employee. Since retaining Rehman, the firm has performed three comprehensive internal audits, in compliance with Sarbanes Oxley standards, and has found no material weaknesses in the Bank’s policies and procedures.

In addition to the enhanced loan review and audit functions, the Bank has continued to focus on the reduction of problem loans. As a result, the Bank’s total non-performing assets have declined from $26.4 million at September 30, 2010 to $14.9 million at September 30, 2011. This constitutes a 44% drop in non-performing assets over a 12 month period.

While continuing the focus on the reduction in problem loans, the Bank has also pursued the development of additional sources of fee income. Since January of 2011, the Bank has opened three new residential loan production offices in Portage, Okemos, and St. Joseph, Michigan. Management has identified a number of additional markets in Michigan and Indiana where residential loan production offices will be opened over the next six to twelve months. Each of these offices also has the potential to add commercial lenders and investment advisors as the market conditions may merit.

Improved growth and profitability will be derived from the following ongoing initiatives:

1. The reduction in non-performing assets and classified loans. As demonstrated in the aforementioned data, non-performing assets have declined significantly over the past 12 months. Our intent is to continue our disciplined, aggressive approach to further reducing non-performing and classified loans.

2. Organic growth, focusing on commercial lending, residential mortgage lending in existing markets and the expansion of our wealth management revenue. We recently established a new relationship with Investment Professionals, Inc., (IPI) replacing our previous relationship with Prudential. IPI will provide compliance, sales, research and clearing support for investment advisors that will be employed by the Bank and will provide investment services under the name of Monarch Investment Services. This will provide for enhanced branding of the Monarch name and increased fee income potential from investment services.

3. De novo LPO’s, opened in markets across the state and across state lines that have strong demographic features. The offices are opened with at least two residential mortgage originators. This can be followed by the addition of a commercial lender and, where appropriate, a Monarch Investment Services Advisor.

4. A continued exploration of acquisition opportunities, where markets and synergies combine for the potential of enhanced shareholder value.

FINANCIAL CONDITION

Summary. Total assets decreased by $32.9 million, or 12.8%, to $223.9 million at September 30, 2011 compared to $256.9 million at December 31, 2010. Loans, excluding loans held for sale, totaled $154.9 million at September 30, 2011, down 15.2% from $182.8 million at December 31, 2010.

Securities

Securities decreased to $6.4 million at September 30, 2011 compared to $11.5 million at December 31, 2010. The decrease was attributable to the Bank selling a portion of the portfolio to improve overall quality of the portfolio. The yield on investment securities has increased to 3.51% during the nine months ended September 30, 2011 from 3.06% for the same period a year ago. Management has 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. Management regularly evaluates asset/liability management needs and attempts to maintain a portfolio structure that provides sufficient liquidity and cash flow.

 

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Loans

The Bank’s net loan portfolio decreased by $27.9 million, or 15.2%, from $182.8 million at December 31, 2010 to $154.9 million at September 30, 2011. The following table presents information concerning the composition of our loan portfolio in dollar amounts and in percentages as of the dates indicated:

 

     September 30, 2011     December 31, 2010  
     Amount      Percent     Amount      Percent  
     (Dollars in thousands)  

Real Estate Loans:

          

One-to-four family

   $ 82,126         51.2      $ 93,294         49.1   

Multi-family

     767         0.5        4,783         2.5   

Commercial

     55,812         34.8        62,998         33.1   

Construction or development

     1,835         1.1        3,873         2.0   
  

 

 

    

 

 

   

 

 

    

 

 

 

Total real estate loans

     140,540         87.6        164,948         86.8   

Other loans:

          

Consumer loans:

          

Home equity

     11,657         7.3        14,814         7.8   

Other

     2,674         1.7        3,403         1.8   
  

 

 

    

 

 

   

 

 

    

 

 

 

Total consumer loans

     14,331         9.0        18,217         9.6   

Commercial Business Loans

     5,502         3.4        6,882         3.6   
  

 

 

    

 

 

   

 

 

    

Total other loans

     19,833         12.4        25,099         13.2   
  

 

 

    

 

 

   

 

 

    

 

 

 

Total Loans

     160,373         100.0     190,047         100.0
     

 

 

      

 

 

 

Allowance for loan losses

     5,158           6,850      

Less: Net deferred loan fees

     297           429      
       

 

 

    

Total Loans, net

   $ 154,918         $ 182,768      
  

 

 

      

 

 

    

One-to-four family loans decreased $11.2 million from year end 2010 as a result of the Bank’s continued strategy to sell a large portion of the one-to-four family refinanced loans as well as normal paydowns. Commercial real estate loans and construction loans decreased $9.2 million or 13.8% due to the Bank’s efforts to reduce the size of the Bank and to reduce particular concentrations of the commercial loan portfolio including lessors of residential properties.

The allowance for loan losses was $5.2 million at September 30, 2011 compared to $6.9 million at December 31, 2010, a decrease of $1.7 million. Net charge-offs year to date totaled $2.0 million compared to $7.7 million for the same period a year ago. Net charge-offs year-to-date consisted of primarily one-to-four family residential mortgages. See “Provision for Loan Losses” below for further explanation regarding charge-offs and non-performing loans. The current level of the allowance for loan losses is the result of management’s assessment of the risks within the portfolio based on the information revealed in credit monitoring processes.

The allowance balance is established after considering past loan loss experience, current economic conditions, composition of the loan portfolio, delinquencies, and other relevant factors. We continue to be diligent in reviewing 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.

Deposits

Total deposits decreased $19.1 million, or 9.3%, from $206.0 million at December 31, 2010 to $186.9 million at September 30, 2011. The decline in deposits reflects the reduction in higher cost brokered certificates of deposit. During the first nine months of 2011, certificates of deposits decreased $21.0 million, interest bearing checking decreased $1.2 million and money market accounts decreased $4.0 million, offsetting an increase in demand and savings accounts of $7.1 million.

We have used brokered certificates of deposit to diversity our sources of funds and improve pricing at certain terms compared to the local market and advances available from Federal Home Loan Bank of Indianapolis. However, due to the fact that the Bank’s regulatory capital ratios are less than the levels necessary to be considered “well capitalized”, we may not obtain new brokered funds as a funding source without prior approval of the FDIC and is subject to rate restrictions that limit the amount that can be paid on all types of retail deposits. The maximum rates the Bank can pay on all types of retail deposits are limited to the national average rate, plus 75 basis points. We have compared the Bank’s current rates with the national rate caps and reduced any rates over the rate cap to fall within those caps. There has been no material impact to our deposit balances resulting from the rate caps.

 

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Table of Contents

Federal Home Loan Bank Advances

Total Federal Home Loan Bank (FHLB) advances decreased $14.0 million to $22.3 million during the nine months ended September 30, 2011 compared $36.3 million at December 31, 2010. 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.

Equity

Total equity decreased $59,000 at September 30, 2011 compared to December 31, 2010. The decrease in equity for the nine months ended September 30, 2011 was attributable to the decrease in the accumulated other comprehensive income of $199,000 due to the sale of securities in the third quarter and the accrued dividend payments on the Preferred stock of $257,000. Net earnings of $386,000 offset the change in accumulated other comprehensive income and accrued dividend. The annual 5% dividend on the Preferred Stock with the amortization of the discount will reduce net income (or increase the net loss) applicable to common stock by approximately $350,000 annually. Effective February 2010, the Corporation deferred regularly scheduled dividend payments on the $6.7 million in par outstanding on its Series A fixed rate, cumulative perpetual preferred stock (aggregate liquidation preference of $6.8 million) which was issued to the U.S. Treasury in February 2009. At September 30, 2011 the dividend payable to the Treasury Department totaled $644,000. The suspension of dividend payments is permissible under the terms of the TARP Capital Purchase Program, but the dividend is a cumulative dividend and failure to pay dividends for six dividend periods could trigger board of director appointment rights for the holder of the Series A Preferred Stock. As of September 30, 2011 the Corporation has deferred the payment of six dividend payments and is subject to additional oversight.

RESULTS OF OPERATIONS

Net Interest Income

Net interest income before any provision for loan losses decreased $157,000 for the quarter ended September 30, 2011 compared to the same period in 2010. The net interest margin for the third quarter of 2011 increased 3 basis points to 2.99% compared to 2.96% for the same period in 2010. The improvement in the margin is largely due to the decline in cost of funds as management continues to monitor cost of funds. Management believes that the cost of funds will continue to decline as higher cost funding sources are eliminated or reduced. The decrease in nonperforming loans and the reduced associated nonaccrual interest adjustment have also significantly impacted the margin. The yield on loans has increased from 5.56% in the third quarter of 2010 to 5.74% for the same period in 2011.

Net interest income before any provision for loan losses decreased $495,000 for the nine months ended September 30, 2011 compared to the same period in 2010. The net interest margin increased 2 basis points to 2.98% compared to 2.96% for the same period in 2010. The yield on loans has increased to 5.82% for the nine months ended September 30, 2011 compared to 5.73% for the same period in 2010.

The Bank’s ability to maintain its net interest margin is heavily dependent on reduction of non-performing loans, 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.

 

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Table of Contents
     Nine Months Ended September 30,
2011
    Nine Months Ended September 30,
2010
 
     Average
Outstanding
Balance
     Interest
Earned/
Paid
     Yield/
Rate
    Average
Outstanding
Balance
     Interest
Earned/
Paid
     Yield/
Rate
 
     (dollars in thousands)  

Fed Funds and overnight deposits

   $ 40,506       $ 20         0.07   $ 16,901       $ 2         0.02

Investment securities

   $ 10,563       $ 277         3.51        15,918         364         3.06   

Other securities

   $ 3,599       $ 62         2.30        4,174         57         1.83   

Loans receivable

   $ 177,400       $ 7,723         5.82        219,495         9,399         5.73   
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

    

 

 

 

Total earning assets

   $ 232,068       $ 8,082         4.66      $ 256,488       $ 9,822         5.12   
  

 

 

    

 

 

      

 

 

    

 

 

    

Demand and NOW Accounts

   $ 43,967       $ 23         0.07      $ 40,351       $ 80         0.27   

Money market accounts

   $ 39,609       $ 144         0.49        52,377         353         0.90   

Savings accounts

   $ 21,825       $ 19         0.12        21,153         39         0.25   

Certificates of deposit

   $ 96,221       $ 1,715         2.38        93,679         2,166         3.09   

Federal Home Loan Bank Advances

   $ 29,784       $ 988         4.44        44,510         1,496         4.49   

Fed Funds Purchased

   $ —         $ —           0.00        4         —           0.00   
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

    

 

 

 

Total interest bearing liabilities

   $ 231,406       $ 2,889         1.67      $ 252,074       $ 4,134         2.19   
  

 

 

    

 

 

      

 

 

    

 

 

    

Net interest income

      $ 5,193            $ 5,688      

Net interest spread

           2.99           2.93

Net interest margin

           2.98           2.96

Rate/Volume Analysis

The following table presents the dollar amount of changes in interest income and interest expense for major components of interest-earning assets and interest-bearing liabilities. For each category of interest-earning assets and interest-bearing liabilities, information is provided on changes attributable to (1) changes in volume, which are changes in volume multiplied by the old rate, and (2) changes in rate, which are changes in rate multiplied by the old volume. Changes attributable to both rate and volume are shown as mixed.

 

     Nine Months Ended September 30,
2011 vs. 2010
 
     Increase (Decrease) Due to    

Total

Increase

 
     Rate     Volume     Mix     (Decrease)  
     (in thousands)  

Interest-earning assets

        

Fed funds and overnight deposits

   $ 8      $ 4        6        18   

Investment securities

   $ 71      $ (164     5        (87

Other securities

   $ 20      $ (10     (4     5   

Loans receivable

   $ 209      $ (2,410     525        (1,676
  

 

 

   

 

 

   

 

 

   

 

 

 

Total interest-earning assets

   $ 309      $ (2,580   $ 531      $ (1,740
  

 

 

   

 

 

   

 

 

   

 

 

 

Interest-bearing liabilities

        

Demand and NOW accounts

   $ (79   $ 10        12        (57

Money market accounts

   $ (217   $ (115     123        (209

Savings accounts

   $ (28   $ 2        6        (20

Certificates of deposit

   $ (664   $ 79        134        (451

Fed Funds Purchased

   $ —        $ —          —          —     

Federal Home Loan Bank advances

   $ (26   $ (662     180        (508
  

 

 

   

 

 

   

 

 

   

 

 

 

Total interest-bearing liabilities

   $ (1,013   $ (687   $ 455      $ (1,245
  

 

 

   

 

 

   

 

 

   

 

 

 

Net interest income

         $ (495
        

 

 

 

 

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Table of Contents

Provision for Loan Losses

For the three months ended September 30, 2011, the Bank recorded a provision for loan losses of $41,000 compared to $2.7 million recorded in the third quarter of 2010. The reduced level of provision is reflective of management’s efforts in previous periods to identify potential problem loans and establish adequate reserves and/or charge-offs to address those problems. The Corporation continues to monitor real estate dependent loans and focus on asset quality. Non-performing loans totaled $10.4 million at the end of the third quarter of 2011, a decrease of $3.7 million from December 31, 2010. Net charge offs for the quarter ended September 30, 2011 were $799,000 compared to $2.8 million for the same period in 2010.

The Bank recorded a provision for loan losses of $304,000 for the nine months ended September 30, 2011 compared to $11.6 million for the same period in 2010. Year to date 2011 net charge offs totaled $2.0 million compared to $7.7 million for the same period a year ago. Net charge offs year to date consisted of 65% one to four family residential mortgages, 32% commercial real estate including multifamily, and the remaining 3% included construction, commercial and industrial and consumer.

Nonperforming assets including the amount of real estate in judgment and foreclosed and repossessed properties, decreased from $17.0 million at the end of 2010 to $14.9 million as of September 30, 2011. This decrease was largely due to a decrease in nonperforming loans, specifically in commercial real estate loans.

The following table presents non-performing assets and certain asset quality ratios at September 30, 2011 and December 31, 2010.

 

     September 30, 2011     December 31, 2010  

Non-performing loans

   $ 10,371      $ 14,075   

Real estate in judgement

     2,165        1,430   

Foreclosed and repossessed assets

     2,317        1,542   
  

 

 

   

 

 

 

Total non-performing assets

   $ 14,853      $ 17,047   
  

 

 

   

 

 

 

Non-performing loans to total loans

     6.69     7.70

Non-performing assets to total assets

     6.63     6.64

Allowance for loan losses to non-performing loans

     49.70     48.70

Allowance for loan losses to net loans receivable

     3.33     3.75

Non-interest Income

Non-interest income for the quarter ended September 30, 2011 increased $341,000, or 38.75%, from $880,000 to $1.2 million compared to the same period a year ago. This increase is primarily attributable to the gain of $469,000 on the sale of $8.6 million in securities offsetting a decrease in other income which was due to the write down of the investment in a low cost housing project of $218,000.

Fees and Service charges increased $45,000 for the three months ended September 30, 2011 compared to the same period a year ago primarily due to an increase in fees from the late charges assessed on delinquent loans. Net gain on sale of loans increased $9,000 for the quarter ended September 30, 2011 compared to the same period a year ago. Other income decreased $138,000 compared to the same period a year ago due to the reason mentioned previously. Loan servicing fees decreased $5,000 for the quarter due to the decrease in the secondary market portfolio.

Non-interest income for the nine months ended September 30, 2011 increased $189,000, or 6.7%, compared to the same period in 2010. Fees and Service charges decreased $161,000 for the nine months ended September 30, 2011 compared to the same period a year ago primarily due to a decrease of $98,000 in nsf fee income. Loan servicing fees decreased $26,000 due to the decrease in the secondary market portfolio. An increase of $430,000 on the sale of investments compared to the same period a year ago was recognized in 2011 as management continues to replace securities to improve the overall quality of the portfolio. Net gain on sale of loans increased $90,000 for the nine months ended September 30, 2011 due to the addition of loan originators and to the implementation of a new lending approach. Other income decreased $107,000 primarily due to the write down of the low cost housing project.

 

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Non-interest Expense

Noninterest expense increased $181,000, or 7.3% for the quarter ended September 30, 2011 compared to the same period a year ago. Salaries and employee benefits increased $90,000. The increase in personnel expense was primarily attributable to the addition of loan originators for the new offices opened during the quarter. Foreclosed property expense increased $158,000 for the quarter due to increased expenses from maintenance costs and taxes on a higher level of properties in other repossessed property. Other general administrative expenses decreased $58,000 primarily due to a decrease in FDIC insurance premiums. All other expenses decreased $9,000.

Noninterest expense increased $43,000, or .58%, for the nine months ended September 30, 2011 compared to the same period ending a year ago. Foreclosed property expense increased $127,000 year to date for reasons mentioned previously. Data processing expense increased $30,000. Salaries and employee benefits decreased $11,000. Professional services decreased $62,000 primarily due to decreases in legal fees associated with nonperforming loans. Occupancy and equipment expense decreased $20,000. Other general and administrative expenses decreased $28,000 due to reasons mentioned previously. All other expenses increased $7,000.

Federal Income Tax Expense

An income tax benefit was not recognized for the first nine months of 2011. A $73,000 tax benefit for the nine months of 2011, primarily associated with the $386,000 net earnings before income taxes, was offset by a corresponding decrease in the valuation allowance on deferred tax assets.

LIQUIDITY

The Bank’s liquidity, represented by cash, overnight funds and investments, is a product of our operating, investing, and financing activities. The Bank’s 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.

At September 30, 2011, the Bank was considered “adequately capitalized” under regulatory guidelines which subjects the Bank to restrictions under the FDIC. These restrictions prohibit the Bank from accepting, renewing, or rolling over brokered deposits except with a waiver from the FDIC. This act also subjects the Bank to restrictions on the interest rates that can be paid on deposits.

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 September 30, 2011 totaled $44.9 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 local core deposits, certificates of deposit gathered via the internet, Federal Home Loan Bank advances and securities available for sale. At September 30, 2011 and based on current collateral levels, the Bank could borrow an additional $8.8 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 Corporation anticipates that it will continue to have sufficient funds, through deposits, and borrowings, to meet its current commitments.

The Bank’s total cash and cash equivalents increased by $653,000 during the nine months ended September 30, 2011 compared to a $4.9 million increase for the same period in 2010. The primary sources of cash for the nine months ended September 30, 2011 were $22.6 million in proceeds from the sale of mortgage loans, $8.6 million in the sale of available for sale securities, $1.5 million maturities of available-for-sale investment securities, and $24.7 of principal loan collections in excess of loan originations compared to $18.2 million in proceeds from the sale of mortgage loans, $4.8 million in the sale of available for sale securities, $3.6 million in the maturities of available-for-sale investment securities and $10.8 million of principal loan collections in excess of loan originations. The primary uses of cash for the nine months ended September 30, 2011 were $22.5 million of mortgage loans originated for sale, $14.0 million in repayments of FHLB advances and a decrease in deposits of $19.1 million compared to a decrease in deposits of $11.5 million, $18.0 million of mortgage loans originated for sale, $4.2 million in purchases of available-for-sale investment securities and $2.0 million in repayment of FHLB advances.

Effective February 2010, the Corporation deferred regularly scheduled dividend payments on the $6.7 million in principal outstanding on its Series A fixed rate, cumulative perpetual preferred stock (aggregate liquidation preference of $6.8 million) which was issued to the U.S. Treasury in February 2009. By taking this action, the Corporation expects to save approximately $339,250 in annual cash payments.

 

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Table of Contents

CONTRACTUAL OBLIGATIONS AND OFF BALANCE SHEET ARRANGEMENTS

The Corporation has certain obligations and commitments to make future payments under contracts. At September 30, 2011, the aggregate contractual obligations and commitments are:

 

     Payments Due by Period  
     Total      Less than
1 year
     1-3
years
     3-5
years
     After
5 years
 
     (Dollars in Thousands)  

Certificates of deposit

   $ 84,018       $ 38,682       $ 37,055       $ 8,281       $ —     

FHLB advances

     22,350         15,175         7,175         —           —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 106,368       $ 53,857       $ 44,230       $ 8,281       $ —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

     Amount of commitment expiration per period  
     Total      Less than
1 year
     1-3
years
     3-5
years
     After
5 years
 
     (Dollars in Thousands)  

Commitments to grant loans

   $ 3,494       $ 3,494       $ —         $ —         $ —     

Unfunded commitments under HELOCs

     10,920         1,910         2,271         1,861         4,878   

Unfunded commitments under Contruction loans

     878         851         6         16         5   

Unfunded commitments under

              

Commercial LOCs

     207         90         117         —           —     

Letters of credit

     —           —           —           —           —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 15,499       $ 6,345       $ 2,394       $ 1,877       $ 4,883   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Commitments to grant loans are governed by the Bank’s credit underwriting standards, as established by the Bank’s Loan Policy. The Bank’s policy is to grant Home Equity Lines of Credits (HELOCs) for periods of up to 15 years.

CAPITAL RESOURCES

The Bank is subject to various regulatory capital requirement administered by federal and state banking agencies. The Bank’s regulatory capital ratios as of September 30, 2011 were as follows: Tier 1 leverage ratio 5.17%, Tier 1 risk-based capital ratio 8.35%, and total risk-based capital 9.63%.

In May 2010, the Bank agreed with the FDIC to increase the Bank’s Tier 1 risk-based capital ratio to at least 9%, and its total risk-based capital ratio to at least 11.0%. At September 30, 2011, these capital ratio requirements had not been met. The Board of Directors and management remain committed to reaching the capital requirements and continue to evaluate different capital raising alternatives. For additional information, please refer to Note 2 to the Company’s financial statements included in its Form 10-K for the year ended December 31, 2010 in connection with uncertainty about the Company’s ability to continue as a going concern.

RECENT DEVELOPMENTS

On September 21, 2010 the Company entered into a Written Agreement with the Federal Reserve Bank of Chicago (the “FRB”). Among other things, the Written Agreement requires that the Company obtain the approval of the FRB prior to paying a dividend; prohibits the Company from purchasing or redeeming any shares of its stock without the prior written approval of the FRB, and; requires the Company to submit cash flow projections for the Company to the FRB on a quarterly basis. A Form 8-K was issued on September 27, 2010 with the complete details of the Written Agreement.

 

ITEM 3. QUANTITATIVE AND QUALITIVE DISCLOSURES ABOUT MARKET RISK

The Corporation’s 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 Corporation’s 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 Corporation’s 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 Corporation’s cash inflows and outflows, affecting the earnings and economic value of the Corporation.

 

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The Corporation’s 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 Bank’s portfolios of assets, liabilities, and off-balance sheet contracts to changes in market interest rates. To measure the sensitivity of the Bank’s 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 NPV to regulatory and industry guidelines to determine if the Corporation’s IRR is acceptable.

 

ITEM 4. CONTROLS AND PROCEDURES

An evaluation of the Corporation’s disclosure controls and procedures (as defined in Rule 13a-15(e) of the Securities Exchange Act of 1934 (the “Exchange Act”)) as of September 30, 2011 was carried out under the supervision and with the participation of the Corporation’s Chief Executive Officer, Chief Financial Officer and several other members of the Corporation’s senior management. The Corporation’s Chief Executive Officer and Chief Financial Officer concluded that the Corporation’s 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