Monarch Community Bancorp 10-Q 2013
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
For the quarterly period ended March 31, 2013
For the transition period from to
Commission file number: 000-49814
MONARCH COMMUNITY BANCORP, INC.
(Exact name of registrant as specified in its charter)
375 North Willowbrook Road, Coldwater, MI 49036
(Address of principal executive offices)
(Registrants telephone number)
Indicate by check mark whether the registrant (1) filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the past 12 months (or for shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes: 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):
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 issuers classes of common equity, as of the latest practical date: At May 3, 2013, there were 2,049,485 shares of the issuers Common Stock outstanding.
Monarch Community Bancorp, Inc.
Condensed Consolidated Balance Sheets
See accompanying notes to condensed consolidated financial statements.
See accompanying notes to condensed consolidated financial statements.
See accompanying notes to condensed consolidated financial statements.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Monarch Community Bancorp, Inc. (the Corporation) was incorporated in 2002 under Maryland law to hold all of the common stock of Monarch Community Bank (the Bank), formerly known as Branch County Federal Savings and Loan Association. The Bank converted to a stock savings institution effective August 29, 2002. In connection with the conversion, the Corporation sold 2,314,375 shares of its common stock in a subscription offering.
Monarch Community Bank provides a broad range of banking services to its primary market area of Branch, Calhoun and Hillsdale counties in Michigan. The Bank operates 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 Banks customers. The Bank also owns a 24.98% interest in a limited partnership formed to construct and operate multi-family housing units.
BASIS OF PRESENTATION
The condensed consolidated financial statements of the Corporation include the accounts of Monarch Community Bank and First Insurance Agency. All significant intercompany balances and transactions have been eliminated in consolidation. The condensed consolidated financial statements for interim periods are unaudited; however, in the opinion of the Corporations management, all adjustments, consisting only of normal recurring accruals, necessary for a fair presentation of the Corporations financial position and results of operations have been included.
The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements. Actual results could differ from those estimates and assumptions.
The accompanying financial statements have been prepared in accordance with the instructions for Form 10-Q and, therefore, do not include all information and footnotes required by generally accepted accounting principles in annual consolidated financial statements. These condensed consolidated financial statements should be read in conjunction with the Corporations Form 10-K for the year ended December 31, 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 Corporations 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 Corporations 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, managements estimate of the effect of this condition may be reflected as a specific allowance applicable to this credit or portfolio segment.
The allowance for loan losses is based on estimates of losses inherent in the loan portfolio. Actual losses can vary significantly from the estimated amounts. Our methodology as described permits adjustments to any loss factor used in the computation of the formula allowance in the event that, in managements judgment, significant factors which affect the collectability of the portfolio as of the evaluation date are not reflected in the loss factors. By assessing the estimated losses inherent in the loan portfolio on a quarterly basis, we are able to adjust specific and inherent loss estimates based upon any more recent information that has become available.
Certain 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):
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.
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):
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 Corporations assessment of the significance of particular inputs to these fair value measurements requires judgment and considers factors specific to each asset or liability.
The following table presents information about the Corporations 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.
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 Corporations assets carried at fair value on a nonrecurring basis as of March 31, 2013 and December 31, 2012 (000s omitted):
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 Corporations various financial instruments. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. Accordingly, the fair value estimates may not be realized in an immediate settlement of the instrument. 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.
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 Corporations Federal Home Loan Bank advances are estimated using discounted cash flow analyses based on the Corporations current incremental borrowing rates for similar types of borrowing arrangements.
The estimated fair values, and related carrying or notional amounts, of the Corporations financial instruments are as follows (000s omitted):
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:
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.
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:
As of March 31, 2013 and December 31, 2012 we have no loans that are 90 plus days delinquent and still accruing.
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:
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):
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.
The following table presents loans individually evaluated for impairment by class of loans as of March 31, 2013 and December 31, 2012 (in thousands).
The following table presents loans individually evaluated for impairment by class of loans as of March 31, 2013 and March 31, 2012 (in thousands).
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
Financing Receivables on Nonaccrual Status
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 customers favorable past and current performance and credit risk do not constitute a TDR loan and are not monitored.
In order to maximize the collection of loan balances, we evaluate troubled loans on a case-by-case basis to determine if a loan modification would be appropriate. We pursue loan modifications when there is a reasonable chance that an appropriate modification would allow our client to continue servicing the debt. For loans secured by either commercial or residential real estate, if the client demonstrates a loss of income such that the client cannot reasonably support even a modified loan, we may pursue foreclosure, short sales and/or deed-in-lieu arrangements. For all troubled loans, we review a number of factors, including cash flows, loan structures, collateral values, and guarantees. Based on our review of these factors and our assessment of overall risk, we evaluate the benefits of renegotiating the terms of the loans so that they have a higher likelihood of continuing to perform. To date, we have restructured loans in a variety of ways to help our clients service their debt and to mitigate the potential for additional losses. The primary restructuring methods being offered to our clients are reductions in interest rates and extensions in terms. Loans that, after being restructured, remain in compliance with their modified terms and whose modified interest rate yielded a market rate at the time the loan was restructured, are reviewed annually and may be reclassified as non-TDR, provided they conform with the prevailing regulatory criteria. As of 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.
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 loans 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 loans observable market price, or (3) the fair value of the collateral. If the present value of expected future cash flows discounted at the loans 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 borrowers financial condition and expectations for repayment under the revised terms.
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:
Analysis related to the allowance for credit losses (in thousands) as of March 31, 2013 and December 31, 2012 is as follows:
The Corporations 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. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion and analysis should be read in conjunction with the condensed consolidated financial statements of the Corporation and the accompanying notes.
In addition to historical information, the following discussion contains forward-looking statements that involve risks and uncertainties. All statements regarding the expected financial position, business and strategies are forward-looking statements and the Corporation intends for them to be covered by the safe harbor provisions for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995. The words anticipates, believes, estimates, seeks, expects, plans, intends, and similar expressions, as they relate to the Corporation or management, are intended to identify forward-looking statements. The Corporation believes that the expectations reflected in these forward-looking statements are reasonable based on our current beliefs and assumptions; however, these expectations may prove to be incorrect.
Factors which could have a material adverse effect on our operations include, but are not limited to, changes in interest rates, changes in the relative difference between short and long-term interest rates, general economic conditions, legislative/regulatory changes, monetary and fiscal policies of the U.S. Government, including policies of the U.S. Treasury and the Federal Reserve Board, the quality or composition of the loan or investment portfolios, including levels of non-performing assets, demand for loan products, deposit flows, competition, demand for financial services in our market area, our operating costs and accounting principles and guidelines. These risks and uncertainties should be considered in evaluating forward-looking statements and you should not 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 managements knowledge.
Allowance for Loan Losses. Accounting for loan classifications, accrual status, and determination of the allowance for loan losses is based on regulatory guidance. This guidance includes, but is not limited to, generally accepted accounting principles, the uniform retail credit classification and account management policy issued by the Federal Financial Institutions Examination Council, the joint policy statement on the allowance for loan losses methodologies issued by the Federal Financial Institutions Examination Council and guidance issued by the Securities and Exchange Commission. Accordingly, the allowance for loan losses includes a reserve calculation based on an evaluation of loans determined to be impaired, risk ratings, historical losses, loans past due, collateral values and cost of disposal and other subjective factors.
Foreclosed Assets. Assets acquired through, or in lieu of, loan foreclosure are held for sale and are initially recorded at fair value at the date of the foreclosure, establishing a new cost basis. Subsequent to foreclosure, valuations are periodically performed by management and the assets are carried at the lower of carrying amount or fair value less estimated selling expenses, which consist primarily of commissions that will be paid to an independent real estate agent upon sale of the property. Revenue and expenses from operations and changes in the valuation allowance are included in net expenses from foreclosed assets.
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.
Following Monarch Community Banks 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 Banks 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:
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 Banks 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 Banks policies and procedures.
In addition to the enhanced loan review and audit functions, the Bank has continued to focus on the reduction of problem loans. As a result, the Banks 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 (LPOs) 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 LPOs. These markets offer higher growth demographics and access to contiguous strong markets. We anticipate placement of additional commercial lenders in our LPOs 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 LPOs, 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.
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 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.
The Banks 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:
One-to-four family loans decreased $2.7 million from year end 2012 as a result of the Banks 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 managements 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.
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 Banks 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 Banks 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.
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.
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 Banks ability to maintain its net interest margin is heavily dependent on future loan demand and its ability to attract core deposits to offset the effect of higher cost certificates of deposits and borrowings. The Bank continues to be challenged in its efforts to increase lower costing core deposits. Management continues to put its efforts towards meeting this challenge.
The following table presents, for the periods indicated, the total dollar amount of interest income from average interest-earning assets and the resultant yields, as well as the interest expense on average interest-bearing liabilities, expressed both in dollars and rates. No tax equivalent adjustments were made.
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.
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 managements 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.
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.
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.
The Banks liquidity, represented by cash, overnight funds and investments, is a product of our operating, investing, and financing activities. The Banks primary sources of funds are deposits, amortization, prepayments and maturities of outstanding loans, and funds provided from operations. While scheduled payments from the amortization of loans are a relatively predictable source of funds, deposit flows and loan prepayments are greatly influenced by general interest rates, economic conditions and competition. The Bank also generates cash through borrowings. The Bank utilizes Federal Home Loan Bank advances to leverage its capital base and provide funds for its lending and investment activities, and to enhance its interest rate risk management.
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 Banks 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 Banks 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 Corporations 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.
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: