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Monarch Community Bancorp 10-Q 2013

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 March 31, 2013

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 May 3, 2013, 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 – March 31, 2013 And December 31, 2012

  

Condensed Consolidated Statements of Income – Three Months Ended March 31, 2013 and 2012

     2   

Condensed Consolidated Statements of Cash Flows – Three Months Ended March 31, 2013 and 2012

     3   

Notes to Condensed Consolidated Financial Statements

     4-25   

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

     25-33   

Item 3 – Quantitative and Qualitative Disclosures about Market Risk

     34   

Item 4 – Controls and Procedures

     34   

PART II – OTHER INFORMATION

  

Item 1 – Legal Proceedings

     35   

Item 1A – Risk Factors

     35   

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

     35   

Item 3 – Defaults Upon Senior Securities

     35   

Item 4 – Mine Safety Disclosures

     35   

Item 5 – Other Information

     35   

Item 6 – Exhibits

     35   

SIGNATURES

     36   

CERTIFICATIONS

     38-40   


Table of Contents

PART I - FINANCIAL INFORMATION

 

Item 1. CONDENSED FINANCIAL STATEMENTS

Condensed Consolidated Balance Sheets

 

     (Unaudited)
March 31,
2013
    December 31,
2012
 
    

(Dollars in thousands,

except per share data)

 
Assets     

Cash and due from banks

   $ 9,634      $ 8,978   

Federal Home Loan Bank overnight time and other interest bearing deposits

     34,925        19,766   
  

 

 

   

 

 

 

Total cash and cash equivalents

     44,559        28,744   

Securities - Available for sale

     10,113        10,047   

Securities - Held to maturity

     2,229        1,981   

Other securities

     3,370        3,370   

Loans held for sale

     1,634        2,045   

Loans, net

     122,567        128,000   

Foreclosed assets, net

     925        1,244   

Premises and equipment

     3,933        3,980   

Core deposit intangible

     72        107   

Other assets

     7,266        10,805   
  

 

 

   

 

 

 

Total assets

   $ 196,668      $ 190,323   
  

 

 

   

 

 

 
Liabilities and Stockholders’ Equity     

Liabilities

    

Deposits:

    

Non-interest bearing

   $ 25,302      $ 17,610   

Interest bearing

     151,055        151,850   
  

 

 

   

 

 

 

Total deposits

     176,357        169,460   

Federal Home Loan Bank advances

     7,059        7,059   

Accrued expenses and other liabilities

     3,208        3,337   
  

 

 

   

 

 

 

Total liabilities

     186,624        179,856   

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 as of March 31, 2013 and December 31, 2012

     6,776        6,773   

Common stock - $0.01 par value, 20,000,000 shares authorized, 2,049,485 shares issued and outstanding at March 31, 2013 and December 31, 2012

     20        20   

Additional paid-in capital

     20,994        20,994   

Accumulated deficit

     (17,502     (17,075

Accumulated other comprehensive income

     123        122   

Unearned stock compensation

     (367     (367
  

 

 

   

 

 

 

Total stockholders’ equity

     10,044        10,467   
  

 

 

   

 

 

 

Total liabilities and stockholders’ equity

   $ 196,668      $ 190,323   
  

 

 

   

 

 

 

See accompanying notes to condensed consolidated financial statements.


Table of Contents

Condensed Consolidated Statements of Income (Unaudited)

 

      Three Months
Ended

March  31,
2013
    Three Months
Ended
March 31,
2012
 
     (Dollars in thousands, except per share data)  

Interest Income

    

Loans, including fees

   $ 1,854      $ 2,202   

Investment securities

     85        93   

Federal funds sold and overnight deposits

     12        10   
  

 

 

   

 

 

 

Total interest income

     1,951        2,305   

Interest Expense

    

Deposits

     302        419   

Federal Home Loan Bank advances

     73        214   
  

 

 

   

 

 

 

Total interest expense

     375        633   
  

 

 

   

 

 

 

Net Interest Income

     1,576        1,672   

Provision for Loan Losses

     —          28   
  

 

 

   

 

 

 

Net Interest Income After Provision for Loan Losses

     1,576        1,644   

Non-interest Income

    

Fees and service charges

     443        437   

Loan servicing fees

     101        106   

Net gain on sale of loans

     620        288   

Net gain (loss) on sale of securities

     —          —     

Other income

     54        9   
  

 

 

   

 

 

 

Total non-interest income

     1,218        840   

Non-interest Expense

    

Salaries and employee benefits

     1,588        1,283   

Occupancy and equipment

     303        245   

Data processing

     235        236   

Mortgage banking

     138        119   

Professional services

     225        203   

Amortization of core deposit intangible

     36        35   

NOW account processing

     52        47   

ATM/Debit card processing

     53        63   

Foreclosed property expense

     64        242   

Other general and administrative

     428        412   
  

 

 

   

 

 

 

Total non-interest expense

     3,122        2,885   
  

 

 

   

 

 

 

Income (Loss) - Before income taxes

     (328     (401

Income Taxes

     —          —     
  

 

 

   

 

 

 

Net Income (Loss)

   $ (328   $ (401
  

 

 

   

 

 

 

Dividends and amortization of discount on preferred stock

   $ 99      $ 100   

Net Income (loss) available to common stock

   $ (427   $ (501
  

 

 

   

 

 

 

Comprehensive Loss

    

Net Income

   $ (328   $ (401

Change in unrealized gain on securities, net of tax

   $ 1      $ (20
  

 

 

   

 

 

 

Comprehensive Loss

   $ (327   $ (421
  

 

 

   

 

 

 

Earnings (Loss) Per Share

    

Basic

   $ (0.21   $ (0.25
  

 

 

   

 

 

 

Diluted

   $ (0.21   $ (0.25
  

 

 

   

 

 

 

See accompanying notes to condensed consolidated financial statements.

 

 

2


Table of Contents

Condensed Consolidated Statements of Cash Flows (Unaudited)

 

     Three Months Ended  
     March, 31  
     2013     2012  
     (Dollars in thousands)  

Cash Flows From Operating Activities

    

Net Income (Loss)

   $ (328   $ (401

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

    

Depreciation and amortization

     298        279   

Provision for loan losses

     —          28   

Write down on foreclosed assets

     216        468   

Gain on sale of foreclosed assets

     14        29   

Mortgage loans originated for sale

     (19,090     (9,393

Proceeds from sale of mortgage loans

     19,501        8,807   

Gain on sale of mortgage loans

     (620     (288

Earned Stock Compensation

     —          —     

Net change in:

    

Accrued interest receivable

     50        (34

Other assets

     3,351        1,588   

Accrued expenses and other liabilities

     (228     86   
  

 

 

   

 

 

 

Net cash provided by (used in) operating activities

     3,164        1,169   

Cash Flows From Investing Activities

    

Activity in available for sale securities:

    

Purchases

     (501     (1,008

Proceeds from maturities of securities

     416        261   

Activity in held to maturity securities:

    

Purchases

     (248     —     

Proceeds from maturities of securities

     —          —     

Loan originations and principal collections, net

     5,172        4,510   

Proceeds from sale of foreclosed assets

     973        637   

Purchase of premises and equipment

     (58     (26
  

 

 

   

 

 

 

Net cash provided by investing activities

     5,754        4,374   

Cash Flows From Financing Activities

    

Net increase in deposits

     6,897        10,490   

Repayment of FHLB advances

     —          (3,000
  

 

 

   

 

 

 

Net cash provided by financing activities

     6,897        7,490   
  

 

 

   

 

 

 

Net Increase (Decrease) in Cash and Cash Equivalents

     15,815        13,033   

Cash and Cash Equivalents - Beginning

     28,744        24,111   
  

 

 

   

 

 

 

Cash and Cash Equivalents - End

   $ 44,559      $ 37,144   
  

 

 

   

 

 

 

Supplemental Cash Flow Information:

    

Cash paid for:

    

Interest

     359        615   

Income taxes

     —          —     

Noncash investing activities:

    

Loans transferred to foreclosed assets

     884        307   

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, 2012 filed with the Securities and Exchange Commission.

The accompanying consolidated financial statements have been prepared in conformity with generally accepted accounting principles, which contemplate continuation of the Corporation as a going concern. However, the Corporation has sustained substantial operating losses in recent years and has incurred additional losses in 2013. The Bank has developed plans for growth to improve profitability, but accomplishing those plans is dependent upon the Corporation’s ability to raise capital. Without additional capital sufficient to meet requirements of Bank regulators, it will not be possible to grow the Bank sufficiently to return to profitability. These matters raise substantial doubt about the Corporation’s ability to continue as a going concern. The consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty.

The results of operations for the three month period ended March 31, 2013 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 can vary significantly from the estimated amounts. Our methodology as described permits adjustments to any loss factor used in the computation of the formula allowance in the event that, in management’s judgment, significant factors which affect the collectability of the portfolio as of the evaluation date are not reflected in the loss factors. By assessing the estimated losses inherent in the loan portfolio on a quarterly basis, we are able to adjust specific and inherent loss estimates based upon any more recent information that has become available.

 

4


Table of Contents

RECLASSIFICATIONS

Certain 2012 amounts have been reclassified to conform to the 2013 presentation.

NOTE 2 - SECURITIES

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

 

     Amortized
Cost
     Gross
Unrealized
Gains
     Gross
Unrealized
Losses
     Estimated
Market Value
 

March 31, 2013

                           

Available-for-sale securities:

           

Collateralized Mortgage obligations

   $ 6,206       $ 117       $ —         $ 6,323   

U.S. government agency obligations

     2,007         23         —           2,030   

Mortgage-backed securities

     554         40            594   

Obligations of states and political subdivisions

     1,160         6         —           1,166   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total available-for-sale securities

   $ 9,927       $ 186       $ —         $ 10,113   
  

 

 

    

 

 

    

 

 

    

 

 

 

Held-to-maturity securities:

           

Certificates of Deposit

   $ 2,229       $ —         $ —         $ 2,229   
  

 

 

    

 

 

    

 

 

    

 

 

 
     Amortized
Cost
     Gross
Unrealized
Gains
     Gross
Unrealized
Losses
     Estimated
Market Value
 

December 31, 2012

                           

Available-for-sale securities:

           

Collateralized Mortgage obligations

   $ 6,586       $ 113       $ —         $ 6,699   

U.S. government agency obligations

     2,007         24         —           2,031   

Mortgage-backed securities

     609         44            653   

Obligations of states and political subdivisions

     660         4         —           664   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total available-for-sale securities

   $ 9,862       $ 185       $ —         $ 10,047   
  

 

 

    

 

 

    

 

 

    

 

 

 

Held-to-maturity securities:

           

Certificates of Deposit

   $ 1,981       $ —         $ —         $ 1,981   
  

 

 

    

 

 

    

 

 

    

 

 

 

There were no proceeds from sales of securities available for sale in the three months ended March 31, 2013 and 2012, respectively.

The amortized cost and fair value of securities available for sale at March 31, 2013 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.

 

     March 31, 2013  
     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

   $ 989       $ 989         —           —     

Due from one to five years

     1,240         1,240         3,000         3,027   

Due from five to ten years

     —           —           167         169   

Due after ten years

     —           —           6,206         6,323   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 2,229       $ 2,229         9,373         9,519   
  

 

 

    

 

 

       

Mortgage-backed securities

           554         594   
        

 

 

    

 

 

 

Total available-for-sale securities

         $ 9,927       $ 10,113   
        

 

 

    

 

 

 

 

5


Table of Contents

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 March 31, 2013.

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
March 31,
2013
    Three Months
Ended
March 31,
2012
 

Basic earnings per share

    

Numerator:

    

Net income

   $ (328   $ (401

Dividends and amortization of discount on preferred stock

     99        100   
  

 

 

   

 

 

 

Net (Loss) allocated to common stock

     (427     (501
  

 

 

   

 

 

 

Denominator:

    

Weighted average common shares outstanding

     2,049        2,049   

Less: Average unallocated ESOP shares

     (37     (46

Less: Average non-vested RRP shares

     —          —     
  

 

 

   

 

 

 

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

     2,012        2,003   
  

 

 

   

 

 

 

Basic earnings (loss) per share

   $ (0.21   $ (0.25
  

 

 

   

 

 

 

Diluted earnings per share

    

Numerator:

    

Net (Loss) allocated to common stock

     (427     (501
  

 

 

   

 

 

 

Denominator:

    

Weighted average common shares outstanding for basic earnings per share

     2,012        2,003   

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

     —          —     
  

 

 

   

 

 

 

Weighted average common shares and dilutive potential common shares outstanding

     2,012        2,003   
  

 

 

   

 

 

 

Diluted earnings (loss) per share

   $ (0.21   $ (0.25
  

 

 

   

 

 

 

NOTE 4 - 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.

 

6


Table of Contents

The following table presents information about the Corporation’s assets and liabilities measured at fair value on a recurring basis at March 31, 2013, and December 31, 2012, and the valuation techniques used by the Corporation to determine those fair values. Investment securities with fair value determined by Level 2 inputs include mortgage backed securities, collateralized mortgage obligations, 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 March 31,
2013
 

Assets:

       

Investment Securities

       

Collateralized Mortgage obligations

  $ —        $ 6,323      $ —        $ 6,323   

U.S. government agency obligations

    —          2,030        —          2,030   

Mortgage-backed securities

    —          594        —          594   

Obligations of states and political subdivisions

    —          1,166        —          1,166   
 

 

 

   

 

 

   

 

 

   

 

 

 
  $ —        $ 10,113      $ —        $ 10,113   
 

 

 

   

 

 

   

 

 

   

 

 

 
    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,
2012
 

Assets:

       

Investment Securities

       

Collateralized Mortgage obligations

  $ —        $ 6,699      $ —        $ 6,699   

U.S. government agency obligations

    —          2,031        —          2,031   

Mortgage-backed securities

    —          653        —          653   

Obligations of states and political subdivisions

    —          664        —          664   
 

 

 

   

 

 

   

 

 

   

 

 

 
  $ —        $ 10,047      $ —        $ 10,047   
 

 

 

   

 

 

   

 

 

   

 

 

 

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). The following table presents the Corporation’s assets carried at fair value on a nonrecurring basis as of March 31, 2013 and December 31, 2012 (000s omitted):

 

Assets Measured at Fair Value on a Nonrecurring Basis  
    Balance at
March 31, 2013
    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

  $ 12,013      $ —        $ —        $ 12,013   

Foreclosed Assets

  $ 925      $ —        $ —        $ 925   
Assets Measured at Fair Value on a Nonrecurring Basis  
    Balance at
December 31, 2012
    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

  $ 13,347      $ —        $ —        $ 13,347   

Foreclosed Assets

  $ 1,244      $ —        $ —        $ 1,244   

 

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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 three months ended March 31, 2013 the Corporation charged off $31,000 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

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 March 31, 2013 and December 31, 2012. The following methods and assumptions were used by the Corporation in estimating fair value disclosures for financial instruments:

Securities - Fair values for securities, excluding Federal Home Loan Bank stock, are based on 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.

 

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Table of Contents

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 flow 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.

 

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Table of Contents

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

 

     March 31, 2013  
     Carrying Amount      Level 1      Level 2      Level 3      Total Estimated
Fair Value
 

Assets:

              

Cash and cash equivalents

   $ 44,559       $ 44,559       $ —         $ —         $ 44,559   

Securities - Held to maturity

     2,229         —           2,229         —           2,229   

Securities - Available for sale

     10,113         —           10,113         —           10,113   

Other securities

     3,370         —           3,370         —           3,370   

Loans and loans held for sale, net

     124,201         —           —           129,799         129,799   

Liabilities:

              

Deposits

     176,357         —           177,403            177,403   

Federal Home Loan Bank advances

   $ 7,059       $ —         $ 7,144          $ 7,144   
     December 31, 2012  
     Carrying Amount      Level 1      Level 2      Level 3      Total Estimated
Fair Value
 

Assets:

              

Cash and cash equivalents

   $ 28,744       $ 28,744       $ —         $ —         $ 28,744   

Securities - Held to maturity

     1,981         —           1,981         —           1,981   

Securities - Available for sale

     10,047         —           10,047         —           10,047   

Other securities

     3,370         —           3,370         —           3,370   

Loans and loans held for sale, net

     130,045         —           —           134,944         134,944   

Liabilities:

              

Deposits

     169,460         —           171,129         —           171,129   

Federal Home Loan Bank advances

   $ 7,059       $ —         $ 7,194       $ —         $ 7,194   

 

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NOTE 5 - LOANS

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

 

     March 31, 2013     December 31, 2012  
     Amount      Percent     Amount      Percent  
     (Dollars in thousands)  

Real Estate Loans:

          

One-to-four family

   $ 66,313         52.85      $ 69,043         52.60   

Multi-family

     1,551         1.24        1,183         0.90   

Commercial

     41,628         33.18        43,952         35.03   

Construction or development

     3,223         2.57        3,446         1.08   
  

 

 

    

 

 

   

 

 

    

 

 

 

Total real estate loans

     112,715         89.84        117,624         89.61   

Other loans:

          

Consumer loans:

          

Home equity

     7,098         5.66        8,058         6.14   

Other

     1,746         1.39        1,885         1.43   
  

 

 

    

 

 

   

 

 

    

 

 

 

Total consumer loans

     8,844         7.05        9,943         7.57   

Commercial Business Loans

     3,896         3.11        3,709         2.82   
  

 

 

    

 

 

   

 

 

    

 

 

 

Total other loans

     12,740         10.16        13,652         10.39   
  

 

 

    

 

 

   

 

 

    

 

 

 

Total Loans

     125,455         100.00     131,276         100.00
     

 

 

      

 

 

 

Allowance for loan losses

     2,645           3,035      

Less: Net deferred loan fees

     243           241      
  

 

 

      

 

 

    

Total Loans, net

   $ 122,567         $ 128,000      
  

 

 

      

 

 

    

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.

A loan is considered impaired when it is probable that the Corporation 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.

 

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Table of Contents

An age analysis of past due loans including nonaccrual loans, segregated by class of loans, as of March 31, 2013 and December 31, 2012 are as follows:

 

March 31, 2013   

30-59

Days Past

Due

    

60-89

Days Past

Due

    

Loans 90

Days or More

Past Due

    

Total Past

due Loans

     Current
Loans
     Total Loans  

Commercial

   $ —         $ —         $ 119       $ 119       $ 3,777       $ 3,896   

Commercial Real Estate:

                 

Multi-family

     —           —           —           —           1,551         1,551   

Commercial Real Estate - other

     —           —           204         204         41,424         41,628   

Consumer:

                 

Consumer - Helocs and other

     98         57         —           155         8,689         8,844   

Residential:

                 

Residential - prime

     916         269         264         1,449         50,850         52,299   

Residential - subprime

     563         411         151         1,125         12,889         14,014   

Construction:

                 

Construction - prime

     —           —           —           —           3,223         3,223   

Construction - subprime

     —           —           —           —           —           —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 1,577       $ 737       $ 738       $ 3,052       $ 122,403       $ 125,455   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
December 31, 2012    30-59
Days Past
Due
     60-89
Days Past
Due
     Loans 90
Days or More
Past Due
     Total Past
due Loans
     Current
Loans
     Total Loans  

Commercial

   $ 197       $ —         $ 120       $ 317       $ 3,392       $ 3,709   

Commercial Real Estate:

                 

Multi-family

     450         —           —           450         733         1,183   

Commercial Real Estate - other

     —           —           1,560         1,560         42,392         43,952   

Consumer:

                 

Consumer - Helocs and other

     184         7         10         201         9,742         9,943   

Residential:

                 

Residential - prime

     993         619         203         1,815         52,856         54,671   

Residential - subprime

     702         236         113         1,051         13,321         14,372   

Construction:

                 

Construction - prime

     98         —           —           98         2,880         2,978   

Construction - subprime

     —           —                   —           468         468   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 2,624       $ 862       $ 2,006       $ 5,492       $ 125,784       $ 131,276   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

As of March 31, 2013 and December 31, 2012 we have no loans that are 90 plus days delinquent and still accruing.

 

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Table of Contents

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.

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.

 

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

 

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.

 

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.

 

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Table of Contents
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.

 

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.

 

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Table of Contents

The following table represents the risk category of loans by class based on the analysis performed as of March 31, 2013 and December 31, 2012 (in thousands):

 

            March 31, 2013         
Credit Rating    Commercial      Commercial Real Estate
Multi-family
     Commercial Real Estate
Other
 

0

   $ —         $ 30       $ 311   

1-2

     —           —           256   

3

     724         375         4,878   

4

     2,608         596         21,225   

5

     163         100         1,943   

6

     401         450         13,015   

7

     —           —           —     
  

 

 

    

 

 

    

 

 

 

Total

   $ 3,896       $ 1,551       $ 41,628   
  

 

 

    

 

 

    

 

 

 
     Commercial      December 31, 2012
Commercial Real Estate
Multi-family
    

Commercial Real Estate

Other

 

0

   $ —         $ 31       $ 314   

1-2

     —           —           6   

3

     521         —           2,890   

4

     2,610         601         24,564   

5

     163         101         2,135   

6

     415         450         14,043   

7

     —           —           —     
  

 

 

    

 

 

    

 

 

 

Total

   $ 3,709       $ 1,183       $ 43,952   
  

 

 

    

 

 

    

 

 

 

 

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Table of Contents

For consumer residential real estate, and consumer loans, the Corporation 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 March 31, 2013 and December 31, 2012.

 

     March 31, 2013  
     Residential - Prime      Residential - Subprime  

Grade

     

Pass

   $ 51,032       $ 12,899   

Substandard

     1,267         1,115   
  

 

 

    

 

 

 

Total

   $ 52,299       $ 14,014   
  

 

 

    

 

 

 
            Consumer - Helocs and other  

Performing

      $ 8,617   

Nonperforming

        227   
     

 

 

 

Total

      $ 8,844   
     

 

 

 
            Construction  

Performing

      $ 3,223   

Nonperforming

          
     

 

 

 

Total

      $ 3,223   
     

 

 

 
     December 31, 2012  
     Residential - Prime      Residential - Subprime  

Grade

  

Pass

   $ 52,980       $ 13,325   

Substandard

     1,691         1,047   
  

 

 

    

 

 

 

Total

   $ 54,671       $ 14,372   
  

 

 

    

 

 

 
            Consumer - Helocs and other  

Performing

      $ 9,641   

Nonperforming

        302   
     

 

 

 

Total

      $ 9,943   
     

 

 

 
            Construction  

Performing

      $ 3,348   

Nonperforming

        98   
     

 

 

 

Total

      $ 3,446   
     

 

 

 

 

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Table of Contents

The following table presents loans individually evaluated for impairment by class of loans as of March 31, 2013 and December 31, 2012 (in thousands).

 

March 31, 2013  
     Recorded
Investment
     Unpaid
Principal
Balance
     Related
Allowance
 

With no related allowance recorded:

        

Commercial

   $ 306       $ 378       $ —     

Commercial Real Estate:

        

Commercial Real Estate - Multi-family

     —           —           —     

Commercial Real Estate - other

     9,447         14,661         —     

Consumer:

        

Consumer - Helocs and other

     —           —           —     

Residential:

        

Residential - prime

     208         221         —     

Residential - subprime

     —           —           —     

With an allowance recorded:

        

Commercial

     49         49         —     

Commercial Real Estate:

        

Commercial Real Estate - Multi-family

     450         464         71   

Commercial Real Estate - other

     105         105         9   

Consumer:

        

Consumer - Helocs and others

     —           —           —     

Residential:

        

Residential - prime

     1,628         1,640         359   

Residential - subprime

     —           —           —     

Construction:

        

Construction - prime

     297         297         38   

Construction - subprime

     —           —           —     
  

 

 

    

 

 

    

 

 

 

Total

        

Commercial

   $ 10,654       $ 15,954       $ 118   
  

 

 

    

 

 

    

 

 

 

Consumer

   $ —         $ —         $ —     
  

 

 

    

 

 

    

 

 

 

Residential

   $ 1,836       $ 1,861       $ 359   
  

 

 

    

 

 

    

 

 

 

 

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Table of Contents
December 31, 2012  
     Recorded
Investment
     Unpaid
Principal
Balance
     Related
Allowance
 

With no related allowance recorded:

        

Commercial

   $ 315       $ 382       $ —     

Commercial Real Estate:

        

Commercial Real Estate - Multi-family

     —           —           —     

Commercial Real Estate - other

     10,724         16,429         —     

Consumer:

        

Consumer - Helocs and others

     —           —           —     

Residential:

        

Residential - prime

     62         78         —     

Residential - subprime

     —           —           —     

With an allowance recorded:

        

Commercial

     50         50         5   

Commercial Real Estate:

        

Commercial Real Estate - Multi-family

     450         464         71   

Commercial Real Estate - other

     107         107         25   

Consumer:

        

Consumer - Helocs and others

     —           —           —     

Residential:

        

Residential - prime

     1,790         1,820         313   

Residential - subprime

     —           —           —     

Construction:

        

Construction - prime

     301         301         38   

Construction - subprime

     —           —           —     
  

 

 

    

 

 

    

 

 

 

Total

        

Commercial

   $ 11,947       $ 17,733       $ 139   
  

 

 

    

 

 

    

 

 

 

Consumer

   $ —         $ —         $ —     
  

 

 

    

 

 

    

 

 

 

Residential

   $ 1,852       $ 1,898       $ 313   
  

 

 

    

 

 

    

 

 

 

 

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Table of Contents

The following table presents loans individually evaluated for impairment by class of loans as of March 31, 2013 and March 31, 2012 (in thousands).

 

Three Months Ended March 31, 2013  
    Average Recorded
Investment
    Interest Income  

With no related allowance recorded:

   

Commercial

  $ 378      $ —     

Commercial Real Estate:

   

Commercial Real Estate - Multi-family

    —          —     

Commercial Real Estate - other

    14,679        58   

Consumer:

   

Consumer - Helocs and other

    —          —     

Residential:

   

Residential - prime

    222        —     

Residential - subprime

    —          —     

With an allowance recorded:

   

Commercial

    49        1   

Commercial Real Estate:

   

Commercial Real Estate - Multi-family

    464        6   

Commercial Real Estate - other

    106        —     

Consumer:

   

Consumer - Helocs and others

    —          —     

Residential:

   

Residential - prime

    1,690        6   

Residential - subprime

    —          —     

Construction:

   

Construction - prime

    298        3   

Construction - subprime

    —          —     
 

 

 

   

 

 

 

Total

   

Commercial

  $ 15,974      $ 68   
 

 

 

   

 

 

 

Consumer

  $ —        $ —     
 

 

 

   

 

 

 

Residential

  $ 1,912      $ 6   
 

 

 

   

 

 

 

 

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Table of Contents
Three Months Ended March 31, 2012  
    Average Recorded
Investment
    Interest Income  

With no related allowance recorded:

   

Commercial

  $ 450      $ —     

Commercial Real Estate:

   

Commercial Real Estate - Multi-family

    —          —     

Commercial Real Estate - other

    10,945        —     

Consumer:

   

Consumer - Helocs and other

    —          —     

Residential:

   

Residential - prime

    174        —     

Residential - subprime

    —          —     

With an allowance recorded:

   

Commercial

    4        —     

Commercial Real Estate:

   

Commercial Real Estate - Multi-family

    450        6   

Commercial Real Estate - other

    6,268        54   

Consumer:

   

Consumer - Helocs and others

    —          —     

Residential:

   

Residential - prime

    228        —     

Residential - subprime

    —          —     

Construction:

   

Construction - prime

    312        3   

Construction - subprime

    —          —     
 

 

 

   

 

 

 

Total

   

Commercial

  $ 18,429      $ 63   
 

 

 

   

 

 

 

Consumer

  $ —        $ —     
 

 

 

   

 

 

 

Residential

  $ 402      $ —     
 

 

 

   

 

 

 

 

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Table of Contents

Non-performing assets include loans which are on non accrual status, or non-performing loans, and other repossessed assets. Payments received on loans in nonaccrual status are typically applied to reduce the recorded investment in the asset. While a 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. The following presents, by class, the recorded investment in loans and leases on non-accrual status as of March 31, 2013 and December 31, 2012.

Financing Receivables on Nonaccrual Status

 

     March 31, 2012  

Commercial

   $ 306   

Commercial real estate:

  

Commercial Real Estate - multi-family

     —     

Commercial Real Estate - other

     577   

Consumer:

  

Consumer - Helocs and other

     —     

Residential:

  

Residential - prime

     1,599   

Residential - subprime

     323   

Construction

  

Construction - prime

     —     

Construction - subprime

     —     
  

 

 

 

Total

   $ 2,805   
  

 

 

 

Financing Receivables on Nonaccrual Status

 

     December 31, 2012  

Commercial

   $ 316   

Commercial real estate:

  

Commercial Real Estate - multi-family

     —     

Commercial Real Estate - other

     5,008   

Consumer:

  

Consumer - Helocs and other

     9   

Residential:

  

Residential - prime

     2,108   

Residential - subprime

     329   

Construction

  

Construction - prime

     —     

Construction - subprime

     —     
  

 

 

 

Total

   $ 7,770   
  

 

 

 

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.

 

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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 March 31, 2013 there have been no loans in which the TDR designation has been removed.

The following table represents the modifications completed during the first quarter of 2013.

 

            Modifications
As of March 31

2013
        
     Number of
Contracts
     Pre-Modification
Outstanding Recorded
Investment
     Post-Modification
Outstanding
Recorded
Investment
 

Troubled Debt Restructurings

        

Commercial

     —           —           —     

Commercial real estate:

        

Commercial Real Estate - multi-family

     —           —           —     

Commercial Real Estate - other

     1         212         212   

Consumer:

        

Consumer - Heloc and other

     —           —           —     

Residential:

        

Residential - prime

     1         55         55   

Residential - subprime

     2         104         104   

Construction

        

Construction - prime

     —           —           —     

Construction - subprime

     —           —           —     
  

 

 

    

 

 

    

 

 

 

Total

     4       $ 371       $ 371   
  

 

 

    

 

 

    

 

 

 
            Modifications
As of March 31

2012
        
     Number of
Contracts
     Pre-Modification
Outstanding Recorded
Investment
     Post-Modification
Outstanding
Recorded
Investment
 

Troubled Debt Restructurings

        

Commercial

     —           —           —     

Commercial real estate:

        

Commercial Real Estate - multi-family

     —           —           —     

Commercial Real Estate - other

     —           —           —     

Consumer:

        

Consumer - Heloc and other

     —           —           —     

Residential:

        

Residential - prime

     3         556         558   

Residential - subprime

     —           —           —     

Construction

        

Construction - prime

     —           —           —     

Construction - subprime

     —           —           —     
  

 

 

    

 

 

    

 

 

 

Total

     3       $ 556       $ 558   
  

 

 

    

 

 

    

 

 

 

 

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Table of Contents
     Modifications  That
Subsequently

Defaulted
As of March 31
2013
        
     Number of
Contracts
     Recorded
Investment
 

Troubled Debt Restructurings That Subsequently Defaulted

     

Commercial

     —           —     

Commercial real estate:

     

Commercial Real Estate - multi-family

     —           —     

Commercial Real Estate - other

     1         212   

Consumer:

     

Consumer - Heloc and other

     —           —     

Residential:

     

Residential - prime

     —           —     

Residential - subprime

     —           —     

Construction

     

Construction - prime

     —           —     

Construction - subprime

     —           —     
  

 

 

    

 

 

 
     1       $ 212   
  

 

 

    

 

 

 
     Modifications That
Subsequently
Defaulted

As of March 31
2012
        
     Number of
Contracts
     Recorded
Investment
 

Troubled Debt Restructurings That Subsequently Defaulted

     

Commercial

     —           —     

Commercial real estate:

     

Commercial Real Estate - multi-family

     —           —     

Commercial Real Estate - other

     —           —     

Consumer:

     

Consumer - Heloc and other

     —           —     

Residential:

     

Residential - prime

     2         98   

Residential - subprime

     —           —     

Construction

     

Construction - prime

     —           —     

Construction - subprime

     —           —     
  

 

 

    

 

 

 
     2       $ 98   
  

 

 

    

 

 

 

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.

 

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Table of Contents

NOTE 6 - ALLOWANCE FOR LOAN LOSSES

The allowance for loan losses was $2.6 million at March 31, 2013 representing 2.16% of total loans, compared to $3.0 million at December 31, 2012 or 2.37% of total loans and $4.1 million at March 31, 2012 or 2.81% of total loans. The allowance for loan losses to non-performing loans ratio was 94.3% at March 31, 2013 compared to 39.1% at December 31, 2012 and 49.1% at March 31, 2012. At March 31, 2013 we believe that our allowance appropriately considers incurred losses in our loan portfolio. Analysis related to the allowance for credit losses (in thousands) as of March 31, 2013 and March 31, 2012 is as follows:

 

As of  
March 31, 2013  
    Commercial     Commercial
Real Estate
Other
    Multi Family     Consumer     Residential -
Prime
    Residential -
Subprime
    Construction     Total  

ALLOWANCE FOR CREDIT LOSSES:

               

Beginning Balance

  $ 12      $ 695      $ 81      $ 230      $ 1,444      $ 521      $ 52      $ 3,035   

Charge-Offs

    —          (121     —          (90     (277     (9     —          (497

Recoveries

    2        25        1        70        9        —          —          107   

Provision

    —          —          —          —          —          —          —          —     
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ending Balance

    14        599        82        210        1,176        512        52        2,645   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ending Balance: individually evaluated for impairment

    —          9        71        —          359               38        477   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ending Balance: collectively evaluated for impairment

  $ 14      $ 590      $ 11      $ 210      $ 817      $ 512      $ 14      $ 2,168   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 
As of  
March 31, 2012  
    Commercial     Commercial
Real Estate
Other
    Multi Family     Consumer     Residential -
Prime
    Residential -
Subprime
    Construction     Total  

ALLOWANCE FOR CREDIT LOSSES:

               

Beginning Balance

  $ 45      $ 1,262      $ 45      $ 259      $ 2,280      $ 664      $ 101      $ 4,656   

Charge-Offs

    —          (172     —          (57     (398     (75     —          (702

Recoveries

    3        14        —          58        4        —          —          79   

Provision

    (13     280        29        (55     (257     90        (46     28   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ending Balance

    35        1,384        74        205        1,629        679        55        4,061   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ending Balance: individually evaluated for impairment

    —          294        54        —          123        —          —          471   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ending Balance: collectively evaluated for impairment

  $ 35      $ 1,090      $ 20      $ 205      $ 1,506      $ 679      $ 55      $ 3,590   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

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Table of Contents

Analysis related to the allowance for credit losses (in thousands) as of March 31, 2013 and December 31, 2012 is as follows:

 

As of  
March 31, 2013  
    Commercial     Commercial
Real Estate
Other
    Multi Family     Consumer     Residential -
Prime
    Residential -
Subprime
    Construction     Total  

FINANCING RECEIVABLES:

               

Ending Balance

  $ 3,896      $ 41,628      $ 1,551      $ 8,844      $ 52,299      $ 14,014      $ 3,223      $ 125,455   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ending Balance: individually evaluated for impairment

    355        9,552        450        —          1,836        —          297        12,490   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ending Balance: collectively evaluated for impairment

  $ 3,541      $ 32,076      $ 1,101      $ 8,844      $ 50,463      $ 14,014      $ 2,926      $ 112,965   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 
As of  
December 31, 2012  
    Commercial     Commercial
Real Estate
Other
    Multi Family     Consumer     Residential -
Prime
    Residential -
Subprime
    Construction     Total  

FINANCING RECEIVABLES:

               

Ending Balance

  $ 3,709      $ 43,952      $ 1,183      $ 9,943      $ 54,671      $ 14,372      $ 3,446      $ 131,276   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ending Balance: individually evaluated for impairment

    365        10,831        450        —          1,852        —          301        13,799   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ending Balance: collectively evaluated for impairment

  $ 3,344      $ 33,121      $ 733      $ 9,943      $ 52,819      $ 14,372      $ 3,145      $ 117,477   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

The Corporation’s charge-off policy (which meets regulatory minimums) has not required any revisions since the second quarter of 2010. 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.

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 place undue influence 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 expected to be realized.

OVERVIEW

Following Monarch Community Bank’s Safety and Soundness examination which was completed in early 2010, the Board of Directors of the 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 the 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 - Assets and liabilities of the Bank have decreased significantly since the inception of the Order, which has facilitated an improvement in the Bank’s capital ratios. Assets however, have increased slightly during the quarter due to an increase in cash attributable to an increase in deposits. Cash is typically a lower risk rated asset which does not weigh as heavily on the capital ratios as other assets such as loans.

 

  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 second quarter of 2013.

Management continues to focus on the improvement of credit quality at the Bank, and has completed four comprehensive external loan reviews over the last twenty four 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 Rehmann Consulting to conduct the Bank’s internal audit function, a task which had previously been performed by a Bank employee. Since retaining Rehmann, 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.

 

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Table of Contents

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 which are discussed in Note 5, have declined from $11.9 million at March 31, 2012 to $3.7 million at March 31, 2013. This constitutes a 68.9% 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 new residential loan production offices (LPO’s) in Portage, East Lansing, St. Joseph, Battle Creek, Grand Rapids, Brighton, Adrian and Jackson, Michigan, with an additional loan production office in Angola, Indiana. Each of these offices also have the potential to add commercial lenders and investment advisors as the market conditions may merit. Commercial lenders have been added to the Grand Rapids, Battle Creek and East Lansing, Michigan offices.

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. As previously mentioned, we now have commercial lenders located in Grand Rapids, Battle Creek and East Lansing LPO’s. These markets offer higher growth demographics and access to contiguous strong markets. We anticipate placement of additional commercial lenders in our LPO’s in the future. The growth of our commercial banking franchise will assist in the continued expansion of our wealth management business, through Investment Professionals, Inc. In late 2011 we established our relationship with Investment Professionals, Inc. (IPI), replacing our previous relationship with Prudential. IPI provides compliance, sales, research and clearing support for investment advisors that are employed by the Bank and provide investment services under the name of Monarch 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

Our total assets increased by $6.3 million, or 3.33%, to $196.7 million at March 31, 2013 compared to $190.3 million at December 31, 2012. Loans, excluding loans held for sale, totaled $122.6 million at March 31, 2013, down 4.22% from $128.0 million at December 31, 2012.

Securities

Securities increased to $12.3 million at March 31, 2013 compared to $12.0 million at December 31, 2012. The yield on investment securities has decreased to 1.80% during the three months ended March 31, 2012 from 1.90% 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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Table of Contents

Loans

The Bank’s net loan portfolio decreased by $5.4 million, or 4.22%, from $128.0 million at December 31, 2012 to $122.6 million at March 31, 2013. The following table presents information concerning the composition of our loan portfolio in dollar amounts and in percentages as of the dates indicated:

 

     March 31, 2013     December 31, 2012  
     Amount      Percent     Amount      Percent  
     (Dollars in thousands)  

Real Estate Loans:

          

One-to-four family

   $ 66,313         52.85      $ 69,043         52.60   

Multi-family

     1,551         1.24        1,183         0.90   

Commercial

     41,628         33.18        43,952         35.03   

Construction or development

     3,223         2.57        3,446         1.08   
  

 

 

    

 

 

   

 

 

    

 

 

 

Total real estate loans

     112,715         89.84        117,624         89.61   

Other loans:

          

Consumer loans:

          

Home equity

     7,098         5.66        8,058         6.14   

Other

     1,746         1.39        1,885         1.43   
  

 

 

    

 

 

   

 

 

    

 

 

 

Total consumer loans

     8,844         7.05        9,943         7.57   

Commercial Business Loans

     3,896         3.11        3,709         2.82   
  

 

 

    

 

 

   

 

 

    

 

 

 

Total other loans

     12,740         10.16        13,652         10.39   
  

 

 

    

 

 

   

 

 

    

 

 

 

Total Loans

     125,455         100.00     131,276         100.00
     

 

 

      

 

 

 

Allowance for loan losses

     2,645           3,035      

Less: Net deferred loan fees

     243           241      
  

 

 

      

 

 

    

Total Loans, net

   $ 122,567         $ 128,000      
  

 

 

      

 

 

    

One-to-four family loans decreased $2.7 million from year end 2012 as a result of the Bank’s continued strategy to sell a greater portion of new one- to-four family loan originations. Commercial real estate loans including multi-family loans decreased $2.0 million or 4.33%.

The allowance for loan losses was $2.6 million at March 31, 2013 compared to $3.0 million at December 31, 2012, a decrease of $400,000. Net charge offs totaled $390,000 compared to $623,000 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 increased $6.9 million, or 4.1%, from $169.5 million at December 31, 2012 to $176.4 million at March 31, 2013. The rise in deposits included increases of $7.7 million in demand checking and savings accounts, $1.7 million in interest bearing checking, $1.3 million in savings account, and $700,000 in money market accounts. Offsetting the increase in checking and savings accounts was a decrease of $4.6 million in certificates of deposits (CDS) which consisted mainly of $2.1 million in brokered CDS and $1.5 million in internet CDS and $900,000 in all other CDS.

We have used brokered certificates of deposit to diversify 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. Brokered deposits totaled $100,000 at March 31, 2013 compared to $2.2 million at December 31, 2012. Due to the fact that the Bank’s regulatory capital ratios are less than the levels necessary to be considered “well capitalized”, it 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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Federal Home Loan Bank Advances

Total Federal Home Loan Bank (FHLB) advances remained unchanged at $7.1 million at March 31, 2013 and December 31, 2012. 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 was $10.0 million at March 31, 2013 compared to $10.5 million at December 31, 2012. This represents 5.11% and 5.5% of total assets at March 31, 2013 and December 31, 2012, respectively. Decreases in equity for the three months ended March 31, 2013 included net losses of $328,000 and $99,000 in accrued dividend payments and accrued interest on dividend payments on the Preferred stock. 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 March 31, 2013 the dividend payable and interest payable on the missed dividend to the Treasury Department totaled $1.2 million. 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 would trigger board of director appointment rights for the holder of the Series A Preferred Stock (see further discussion under “Capital Resources”).

RESULTS OF OPERATIONS

Net Interest Income

Net interest income before any provision for loan losses decreased $96,000 for the quarter ended March 31, 2013 compared to the same period in 2012.

The net interest margin for the first quarter of 2013 increased 20 basis points to 3.55% compared to 3.35% for the same period in 2012. The improvement in the margin is largely due to reduction in wholesale funding. The bank has focused on repaying Federal Home Loan Bank Advances and allowing Brokered Certificates of Deposit to mature.

The Bank’s ability to maintain its net interest margin is heavily dependent on future loan demand and its ability to attract core deposits to offset the effect of higher cost certificates of deposits and borrowings. The Bank continues to be challenged in its efforts to increase lower costing core deposits. Management continues to put its efforts towards meeting this challenge.

 

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Table of Contents

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.

 

     Three Months Ended March 31,
2013
    Three Months Ended March 31,
2012
 
     Average
Outstanding
Balance
     Interest
Earned/
Paid
     Yield/
Rate
    Average
Outstanding
Balance
     Interest
Earned/
Paid
     Yield/
Rate
 
     (dollars in thousands)  

Fed Funds and overnight deposits

   $ 33,790       $ 12         0.14   $ 27,866       $ 10         0.14

Investment securities

     11,745         52         1.80        14,775         70         1.90   

Other securities

     3,269         33         4.09        3,346         23         2.76   

Loans receivable

     128,745         1,854         5.84        153,662         2,202         5.75   
  

 

 

    

 

 

      

 

 

    

 

 

    

Total earning assets

   $ 177,549       $ 1,951         4.46      $ 199,649       $ 2,305         4.63   
  

 

 

    

 

 

      

 

 

    

 

 

    

Demand and NOW Accounts

     45,757         2         0.02        48,132         2         0.02   

Money market accounts

     34,961         9         0.10        35,740         33         0.36   

Savings accounts

     23,587         3         0.05        21,747         5         0.09   

Certificates of deposit

     63,773         288         1.83        76,687         379         1.98   

Federal Home Loan Bank Advances

     6,978         73         4.18        18,594         214         4.62   
  

 

 

    

 

 

      

 

 

    

 

 

    

Total interest bearing liabilities

   $ 175,056       $ 375         0.87      $ 200,900       $ 633         1.26   
  

 

 

    

 

 

      

 

 

    

 

 

    

Net interest income

      $ 1,576            $ 1,672      
     

 

 

         

 

 

    

Net interest spread

           3.59           3.37
        

 

 

         

 

 

 

Net interest margin

           3.55           3.35
        

 

 

         

 

 

 

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.

 

     Three Months Ended March 31,
2013 vs. 2012
 
                       Total  
     Increase (Decrease) Due to     Increase  
     Rate     Volume     Mix     (Decrease)  
     (in thousands)  

Interest-earning assets

        

Fed funds and overnight deposits

   $ 0      $ 9        (7     2   

Investment securities

   $ (15   $ (58     55        (18

Other securities

   $ 45      $ (2     (33     10   

Loans receivable

   $ 142      $ (1,432     942        (348
  

 

 

   

 

 

   

 

 

   

 

 

 

Total interest-earning assets

   $ 172      $ (1,483   $ 957      $ (354
  

 

 

   

 

 

   

 

 

   

 

 

 

Interest-bearing liabilities

        

Demand and NOW accounts

   $ 1      $ —          (1     —     

Money market accounts

   $ (91   $ (3     71        (23

Savings accounts

   $ (9   $ 2        5        (2

Certificates of deposit

   $ (116   $ (256     281        (91

Federal Home Loan Bank advances

   $ (80   $ (536     474        (142
  

 

 

   

 

 

   

 

 

   

 

 

 

Total interest-bearing liabilities

   $ (295   $ (793   $ 830      $ (258
  

 

 

   

 

 

   

 

 

   

 

 

 

Net interest income

         $ (96
        

 

 

 

 

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Provision for Loan Losses

No provision for loan losses was required for the first quarter of 2013 compared to $28,000 in the first quarter of 2012. 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 $2.8 million at the end of the first quarter of 2013, decreasing from $7.8 million at December 31, 2012. Net charge offs for the quarter ended March 31, 2013 were $390,000 compared to $623,000 for the same period in 2012.

Nonperforming assets, including the amount of real estate in judgment and foreclosed and repossessed properties, decreased from $9.0 million at the end of 2012 to $3.7 million as of March 31, 2013. This decrease was largely due to a decrease in non-performing loans, which was attributable to several large commercial real estate loans being returned to accrual status. These loans have been restructured, demonstrated sufficient repayment history and continued ability to repay.

The following table presents non-performing assets and certain asset quality ratios at March 31, 2013 and December 31, 2012.

 

     March 31,2013     December 31,2012  
           (In thousands)  

Non-performing loans

   $ 2,805      $ 7,770   

Real estate in judgement

     90        434   

Foreclosed and repossessed assets

     835        810   
  

 

 

   

 

 

 

Total non-performing assets

   $ 3,730      $ 9,014   
  

 

 

   

 

 

 

Non-performing loans to total loans

     2.29     6.07

Non-performing assets to total assets

     1.90     4.74

Allowance for loan losses to non-performing loans

     94.30     39.10

Allowance for loan losses to net loans receivable

     2.16     2.37

Non-interest Income

Non-interest income for the quarter ended March 31, 2013 increased $378,000, or 45%, from $840,000 to $1.2 million compared to the same period a year ago. This increase is largely attributable to an increase in the gain on sale of loans which is a result of the additional loan origination offices and the low rate environment.

Net gain on sale of loans increased $332,000 for the quarter ended March 31, 2013 from $288,000 to $620,000 compared to the same period a year ago. The increase is largely due to the increase in one-to-four family residential mortgage refinancing activity. Other income increased $45,000 due to lower losses associated with the sale of other repossessed properties and implementing the accounting for derivative activity associated with the sale of loans into the secondary market.

Non-interest Expense

Noninterest expense increased $237,000 for the quarter ended March 31, 2013 compared to the same period a year ago. Salaries and employee benefits increased $305,000 for the quarter. The increase in personnel expense was primarily attributable to the addition of loan originators. Occupancy and equipment expense also increased $58,000 as a result of our plan to open offices and employ additional staff for residential lending. Foreclosed property expense decreased $178,000, mainly due to a decrease in repossessed properties. Professional services increased $22,000. Mortgage banking expense (which is the amortization of capitalized mortgage servicing rights) increased $19,000 due to an increase in amortization of mortgage servicing rights associated with the refinancing of residential mortgages. All other expenses increased $11,000.

Federal Income Tax Expense

An income tax benefit was not recognized for the first three months of 2013. A $111,000 tax benefit for the first three months of 2013, primarily associated with the $328,000 net losses before income taxes, was offset by a corresponding increase in the valuation allowance on deferred tax assets. A significant component of income tax expense is made up of general tax credits generated each year. Our 2009 tax return is under audit; however there were no findings as of March 31, 2013.

 

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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 March 31, 2013, the Bank was considered “well capitalized” under regulatory guidelines. While the Bank was considered “well capitalized” it was still subject to restrictions under FDIC which prohibit the Bank from accepting, renewing, or rolling over brokered deposits without a waiver from the FDIC. These regulations also subject 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 March 31, 2013 totaled $38.1 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 March 31, 2013 and based on current collateral levels, the Bank could borrow an additional $17.7 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 $15.8 million during the three months ended March 31, 2013 compared to a $12.6 million increase for the same period in 2012. The primary sources of cash for the three months ended March 31, 2013 were $19.5 million in proceeds from the sale of mortgage loans, $416,000 maturities of available-for-sale investment securities and $5.2 million of principal loan collections in excess of loan originations and an increase in deposits of $6.9 million compared to $4.5 million increase in deposits, $8.8 million in proceeds from the sale of mortgage loans, $4.5 million of principal loan collections in excess of loan originations and $261,000 in the sale and maturities of available-for-sale investment securities for the three months ended March 31, 2012. The primary uses of cash for the three months ended March 31, 2013 were $19.1 million of mortgage loans originated for sale, compared to $9.4 million of mortgage loans originated for sale and $3.0 million in repayment of FHLBI advances.

Banking regulations place certain restrictions on dividends paid and loans or advances made by the Bank to the Corporation. The primary source of liquidity for the Corporation is from dividends paid by the Bank. The total amount of dividends which may be paid at any date is generally limited to the retained earnings of the Bank. However, dividends paid by the Bank would be prohibited if the effect thereof would cause the Bank’s capital to be reduced below applicable minimum standards. At March 31, 2013, the Bank had no retained earnings available for the payment of dividends. Accordingly, the Corporation’s entire investment in the Bank was restricted at March 31, 2013.

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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CONTRACTUAL OBLIGATIONS AND OFF BALANCE SHEET ARRANGEMENTS

The Corporation has certain obligations and commitments to make future payments under contracts. At March 31, 2013, 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

   $ 62,672       $ 38,073       $ 20,376       $ 4,223       $ —     

FHLB advances

     7,059         7,059         —           —           —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 69,731       $ 45,132       $ 20,376       $ 4,223       $ —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
     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