Pulaski Financial 10-Q 2006
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
For the quarterly period ended December 31, 2005
For the transition period from to
Commission File Number
Pulaski Financial Corp.
(Exact name of registrant as specified in its charter)
Registrants telephone number, including area code: (314) 878-2210
(Former name, address and former fiscal year, if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Sections 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days.
Yes x No ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of accelerated filer and large accelerated filer in Rule 12b-2 of the Exchange Act.
Large accelerated filer ¨ Accelerated filer x Non-accelerated filer ¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act) Yes ¨ No x.
Indicate the number of shares outstanding of the registrants classes of common stock, as of the latest practicable date.
PULASKI FINANCIAL CORP. AND SUBSIDIARIES
DECEMBER 31, 2005
TABLE OF CONTENTS
PART I - FINANCIAL INFORMATION
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 2005 (UNAUDITED) AND SEPTEMBER 30, 2005
See accompanying notes to the unaudited consolidated financial statements.
- 1 -
CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME
THREE MONTHS ENDED DECEMBER 31, 2005 AND 2004 (UNAUDITED)
See accompanying notes to the unaudited consolidated financial statements.
- 2 -
CONSOLIDATED STATEMENT OF STOCKHOLDERS EQUITY
THREE MONTHS ENDED DECEMBER 31, 2005 (UNAUDITED)
See accompanying notes to the unaudited consolidated financial statements.
- 3 -
CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THREE MONTHS
ENDED DECEMBER 31, 2005 (UNAUDITED) AND DECEMBER 31, 2004 (UNAUDITED)
See accompanying notes to the consolidated financial statements
- 4 -
PULASKI FINANCIAL CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THREE MONTHS
ENDED DECEMBER 31, 2005 (UNAUDITED) AND DECEMBER 31, 2004 (UNAUDITED)
See accompanying notes to the unaudited consolidated financial statements.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
The unaudited consolidated financial statements include the accounts of Pulaski Financial Corp. (the Company) and its wholly owned subsidiary, Pulaski Bank (the Bank), and its wholly owned subsidiary, Pulaski Service Corporation. All significant intercompany accounts and transactions have been eliminated. The assets of the Company consist primarily of the investment in the outstanding shares of the Bank and its liabilities consist principally of subordinated debentures. Accordingly, the information set forth in this report, including the consolidated financial statements and related financial data, relates primarily to the Bank. The Company, through the Bank, operates as a single business segment, providing traditional community banking services through its full service branch network.
In the opinion of management, the unaudited consolidated financial statements contain all adjustments (consisting only of normal recurring accruals) necessary for a fair presentation of the financial condition of the Company as of December 31, 2005 and September 30, 2005 and its results of operations for the three-month periods ended December 31, 2005 and 2004. The results of operations for the period ended December 31, 2005, are not necessarily indicative of the operating results that may be expected for the entire fiscal year. These unaudited consolidated financial statements should be read in conjunction with the Companys audited consolidated financial statements for the year ended September 30, 2005 contained in the Companys 2005 Annual Report to Stockholders, which was filed as an exhibit to the Companys Annual Report on Form 10-K for the year ended September 30, 2005.
The preparation of these consolidated financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements that affect the reported amounts of revenues and expenses during the reported periods. Actual results could differ from those estimates. The allowance for loan losses and fair values of financial instruments are significant estimates reported within the consolidated financial statements.
RESTATEMENT OF PREVIOUSLY ISSUED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
In November 2004, the Company had entered into certain interest rate swap agreements to hedge the interest rate risk inherent in certain of its brokered certificates of deposit. These hedging relationships did not meet the criteria for the short-cut method of fair value hedge accounting in Statement of Financial Accounting Standards No. 133, Accounting for Derivative Instruments and Hedging Activities (SFAS No. 133).
Because the Company did not qualify for the short-cut method of hedge accounting on these swap agreements, the amounts previously recorded as an adjustment to the hedged item, brokered certificates of deposits, were recognized as losses on derivative financial instruments in the consolidated statements of income and comprehensive income for the year ended September 30, 2005.
In addition, the net cash settlements under the interest rate swaps that were originally reported in interest expense have been reclassified to loss on derivative instruments. Finally, the broker placement fees on the certificates of deposit have been recorded as an asset and are being amortized on a straight-line basis to the maturity of the certificates of deposit. This restatement had no effect on net cash used in operating activities for the three months ended December 31, 2004.
The Company has restated its consolidated financial statements to reflect these changes for the quarters ended December 31, 2004, March 31, 2005, and June 30, 2005.
The Company has also restated basic earnings per share for quarter ended December 31, 2004 to reflect unvested equity trust shares in treasury stock as not outstanding for the calculation of basic earnings per share.
The Condensed Consolidated Financial Statements included in this Form 10-Q include the effect of the adjustments required to correct these errors.
The Company maintains a number of stock-based incentive programs, which are discussed in more detail in Note 4. Prior to fiscal 2006, the Company applied the intrinsic value-based method, as outlined in Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees, (APB No. 25) and related interpretations, in accounting for stock options granted under these programs. Under the intrinsic value-based method, no compensation expense was recognized if the exercise price of the Companys employee stock options equaled the market price of the underlying stock on the date of the grant. Accordingly, prior to fiscal year 2006, no compensation cost was recognized in the accompanying consolidated statements of income on stock options granted to employees, since all options granted under the Companys share incentive programs had an exercise price equal to the market value of the underlying common stock on the date of the grant.
Effective October 1, 2005, the Company adopted Statement of Financial Accounting Standards No. 123R (SFAS No. 123R) Share-based Payment. This statement replaces SFAS No. 123, Accounting for Stock-Based Compensation, and supersedes APB No. 25. SFAS No. 123R requires that all stock-based compensation be recognized as an expense in the financial statements and that such cost be measured at the fair value of the award. This statement was adopted using the modified prospective method of application, which requires the Company to recognize compensation expense on a prospective basis. Therefore, prior period financial statements have not been restated. Under this method, in addition to reflecting compensation expense for new share-based awards, expense is also recognized to reflect the remaining service period of awards that had been included in pro forma disclosures in prior periods. SFAS No. 123R also requires that excess tax benefits related to stock option exercises be reflected as financing cash inflows instead of operating cash inflows. For the three months ended December 31, 2005, the only options exercised were incentive stock options, which did not generate any excess tax benefits for the Company.
Total stock-based compensation expense in the first fiscal quarter of 2006 was $88,000 ($55,000 after tax), or $0.01 for basic and diluted earnings per share, respectively. Included in this expense is $77,000 ($49,000 after tax), or $0.01 for basic and diluted earnings per share, respectively, attributable to the Companys adoption of SFAS 123R. As of December 31, 2005, the total unrecognized compensation expense related to non-vested stock awards was $679,000 and the related weighted average period over which it is expected to be recognized is approximately 2.2 years.
The following table illustrates the effect on net income and earnings per share as if SFAS 123R had been applied to all outstanding awards for the three months ended December 31, 2005 and 2004:
The Company awarded 11,000 options during the three months ended December 31, 2005. The fair value of stock options granted in the quarters ended December 31, 2005 and 2004 is estimated on the date of grant using the Black-Scholes option pricing model with the following average assumptions:
Options to purchase 12,772 shares and 43,069 shares were outstanding during the three months ended December 31, 2005 and 2004, respectively, and were not included in the respective computations of diluted earnings per share because the exercise price of the options when combined with the effect of the unamortized compensation expense, was greater than the average market price of the common shares. These options expire in various periods through 2015 and 2014, respectively.
Under the treasury stock method, outstanding stock options are dilutive when the average market price of the Companys common stock, when combined with the effect of any unamortized compensation expense, exceeds the option price during a period. In addition, proceeds from the assumed exercise of dilutive options along with the related tax benefit are assumed to be used to repurchase common shares at the average market price of such stock during the period. Anti-dilutive shares are those option shares with exercise prices in excess of the current market value.
On March 30, 2004, Pulaski Financial Statutory Trust I (Trust I), a Connecticut statutory trust, issued $9.0 million of adjustable-rate preferred securities. The proceeds from this issuance, along with the Companys $279,000 capital contribution for Trust Is common securities, were used to acquire $9.3 million aggregate principal amount of the Companys floating rate junior subordinated deferrable interest debentures due 2034 which constitute the sole asset of Trust I. The interest rate on the debentures and the capital securities is variable and adjustable quarterly at 2.70% over the three-month LIBOR, with an initial rate of 3.81%. The current rate at December 31, 2005 was 7.20%.
The stated maturity of the Trust I debentures is June 17, 2034. In addition, the Trust I debentures are subject to redemption at par at the option of the Company, subject to prior regulatory approval, in whole or in part on any interest payment date on or after June 17, 2009.
On December 15, 2004, Pulaski Financial Statutory Trust II (Trust II), a Delaware statutory trust, issued $10.0 million of adjustable-rate preferred securities. The proceeds from this issuance, along with the Companys $310,000 capital contribution for Trust IIs common securities, were used to acquire $10.3 million of the Companys floating rate junior subordinated deferrable interest debentures due 2034, which constitute the sole asset of Trust II. The interest rate on the debentures and the capital securities is variable and adjustable quarterly at 1.86% over the three-month LIBOR, with an initial rate of 4.31%. The current rate at December 31, 2005 was 6.35%.
The stated maturity of the debentures held by Trust II is December 15, 2034. In addition, the Trust II debentures are subject to redemption at par at the option of the Company, subject to prior regulatory approval, in whole or in part on any interest payment date on or after December 15, 2009.
The Company maintains shareholder-approved, stock-based incentive plans, which permit the grant of options to purchase common stock of the Company and awards of restricted shares of common stock. All employees, non-employee directors and consultants of the Company and its affiliates are eligible to receive awards under the plans. The
plans authorize the grant of awards in the form of options intended to qualify as incentive stock options under Section 422 of the Internal Revenue Code, options that do not so qualify (non-statutory stock options,) and grants of restricted shares of common stock. Stock option awards are granted with an exercise price equal to the market value of the Companys shares at the date of grant and generally vest over a period of three to five years. Generally, option and share awards provide for accelerated vesting if there is a change in control (as defined in the plans.).
A summary of the Companys stock option programs as of December 31, 2005 and changes during the three-month period then ended, is presented below:
The total intrinsic value of stock options exercised during the three months ended December 31, 2005 and 2004 was $199,000 and $673,000, respectively. The exercise period for all stock options generally may not exceed 10 years from the date of grant. Stock option grants to individuals generally become exercisable over a service period of three to five years.
Certain reclassifications have been made to 2004 amounts to conform to the 2005 presentation.
* * * * * *
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
FORWARD LOOKING STATEMENTS
This report contains forward-looking statements within the meaning of the federal securities laws. These statements are not historical facts, rather they are statements based on the Companys current expectations regarding its business strategies, intended results and future performance. Forward-looking statements are preceded by terms such as expects, believes, anticipates, intends and similar expressions.
Forward-looking statements are not guarantees of future performance. Numerous risks and uncertainties could cause the Companys actual results, performance and achievements to be materially different from those expressed or implied by the forward-looking statements. Factors that may cause or contribute to these differences include, without limitation, general economic conditions, including changes in market interest rates and changes in monetary and fiscal policies of the federal government; legislative and regulatory changes; changes in accounting principles and guidelines; competition, demand for loan products; deposit flows; and other factors disclosed periodically in the Companys filings with the Securities and Exchange Commission.
Because of the risks and uncertainties inherent in forward-looking statements, readers are cautioned not to place undue reliance on them, whether included in this report or made elsewhere from time to time by the Company or on its behalf. Except as required by applicable law or regulation, the Company assumes no obligation to update any forward-looking statements.
Pulaski Bank is an $806 million asset, growth-oriented bank, focused on becoming the leading community bank in St. Louis. The Banks 84-year history as a thrift servicing tens of thousands of residential, commercial and consumer customers has created years of customer goodwill that the current generation of management is leveraging to attempt to become the bank of choice in the metropolitan St. Louis community.
The Companys business strategy is to focus on the growth and efficiency of five core banking products, which include two deposit products, checking and money market accounts, and three loan products, residential, home equity and commercial loans. These five products provide the primary source of the Banks operating income and are the focus of the Companys growth in the balance sheet. Driving these relationships are more than 60 seasoned residential and commercial lenders in the Companys two market locations, St. Louis and Kansas City, which includes seven branch locations and two loan production offices. Due to important gains in the loan and deposit portfolios, net interest income rose 16.9% over the prior year to $5.9 million for the quarter ended December 31, 2005 from $5.0 million for the quarter ended December 31, 2004; however, due primarily to a $407,000 loss on derivative financial instruments and a decline in mortgage revenues of $343,000, net income declined $45,000 to $1.8 million for the quarter ended December 31, 2005 compared to $1.9 million for the quarter ended December 31, 2004. Diluted earnings per share declined $0.01 to $0.21 for the quarter ended December 31, 2005 from $0.22 diluted earnings per share for the quarter ended December 31, 2004.
The derivative financial instruments loss of $407,000, which had a net after tax impact of $256,000, or $0.03 per diluted share, is not expected to significantly impact future earnings. During the fourth quarter of fiscal 2005, we identified prior accounting errors in our treatment of certain derivative financial instruments. Specifically, we determined that certain interest rate swap agreements that we had acquired to hedge the interest rate risk inherent in brokered certificates of deposit did not qualify for the short-cut method of fair value hedge accounting under Statement of Financial Accounting Standards No. 133 (SFAS No. 133) As a result, SFAS No. 133 required us to reflect changes in the fair value of the derivative instruments as a charge to earnings and we have restated our financial statements for the quarters ended December 31, 2004, March 31, 2005 and June 30, 2005 to reflect this accounting treatment. For periods subsequent to December 31, 2005, we expect to be able to use the long-haul method of hedge accounting under SFAS No. 133, which will permit us to offset changes in value of the derivative instruments with changes in value of the hedged items.
Total assets increased $15.8 million to $805.6 million at December 31, 2005 from $789.9 million at September 30, 2005. Total assets grew primarily due to $33.3 million of growth in the retained portfolio during the three months ended December 31, 2005. Non-performing assets increased from $6.8 million at September 30, 2005 to $7.5 million at December 31, 2005. The increase in non-performing assets was due to both a rise in non-performing residential mortgages and an increase in real estate owned. The Company had an additional $1.4 million of loans past due more than 90 days that are being held at the lower of cost or market as loans held for sale, which is part of a $3.0 million delinquent pool of loans held for sale that is expected to close under a definitive agreement during the March 2006 quarter. These loans have been classified as loans held for sale at December 31, 2005 and are not included in non-performing assets. At December 31, 2005, nonperforming loans as a percent of total loans remained unchanged at 0.85% compared to September 30, 2005.
For the quarter, deposits decreased $6.4 million to $489.8 million, excluding deposits that will be transferred in connection with the pending sale of our Kansas City branch. Demand deposit accounts, including money market deposits, increased $10.8 million during the quarter to $151.6 million, with $8.4 million of the increase coming in commercial transaction accounts, which totaled $43.6 million at December 31, 2005. These increases were offset by the managed run-off of $21.5 million of brokered deposits. The increase in net loans receivable and decline in deposits were funded by a $29.0 million increase in Federal Home Loan Bank advances.
Due to the growth in the portfolio, net interest income increased 16.9% to $5.9 million for the quarter ended December 31, 2005 compared to $5.0 million for the same period a year ago. The net interest margin increased 15 basis points to 3.20% for the quarter ended December 31, 2005 from 3.05% for the quarter ended September 30, 2005 due to growth in low cost transaction accounts, a decline in the average balance of loans held for sale and upwards repricing of the loan portfolio. The net interest margin declined from 3.31% for the quarter ended December 31, 2004 to 3.20% for the quarter ended December 31, 2005 due to narrowing interest rate spreads on loans held for sale and overall asset growth outpacing core deposit growth, resulting in higher wholesale funding dependence. Our assets and liabilities remain well-matched, with approximately two-thirds of assets and liabilities set to reprice within one year.
Noninterest income declined 4.5% to $2.2 million for the three months ended December 31, 2005 compared to $2.3 million for the same period in the prior year. The most significant decline was due to a 30.8% decrease in mortgage revenues during the quarter ended December 31, 2005 to $774,000 compared to $1.1 million for the quarter ended December 31, 2004. In the quarter ended December 31, 2005, the Company sold $267.7 million of loans, compared with $209.3 million a year ago. However, compressed revenue margin, caused by rising market interest rates, reduced the profitability of loans sales in the quarter. Offsetting the decline in mortgage revenue, retail banking revenue grew 20.8% to $748,000 for the quarter ended December 31, 2005 compared to the same quarter last year of $619,000 due to changes in customer overdraft policies.
The title and investment brokerage divisions reported mixed results. The title division contributed pre-tax profit of $116,000 on revenue of $199,000 for the three months ended December 31, 2005. The investment division posted a pre-tax loss of $118,000 on revenue of $117,000. Due to the flattening yield curve, many of the divisions regular buyers of bonds are choosing not to invest in bonds until the rate environment improves.
Non-interest expense increased 23.6% to $4.9 million for the quarter ended December 31, 2005 compared to $3.9 million for the same period a year ago. The increase was primarily due to the loss of $407,000 on derivative financial instruments discussed above compared to a gain of $35,000 in last years quarter and related increases in legal, accounting and consulting expenses associated with hedge accounting issues. Also contributing to the increase in non-interest expense was greater occupancy, equipment expense and data processing, which rose $172,000 due to continued investment in our infrastructure. Increases in advertising expenses, supplies, service charges, Sarbanes-Oxley compliance and reserves for real estate owned also contributed to the increase in other non-interest expense.
On November 17, 2005, the Company announced that is was correcting prior accounting errors in its treatment of certain derivatives and would restate its net income for each of the first three quarters for fiscal 2005. For fiscal year 2005, the cumulative correction lowered net income by 6%, or $486,000 net of income taxes.
On December 27, 2005, the Company declared a quarterly cash dividend of $0.08 per share of common stock and also announced the implementation of a dividend reinvestment program (DRIP). The DRIP allows participants to have their quarterly dividends reinvested in additional shares of Pulaski Financial Corp. stock and also provides for cash contributions for the purchase of Pulaski Financial Corp. common stock.
On February 6, 2006, the Company announced the pricing of a public offering of 1,000,000 shares of its common stock at $15.25 per share. The Company expects the issuance and delivery of the shares to occur on February 10, 2006. The Company has granted the underwriters an over-allotment option for an additional 150,000 shares. The shares are being sold in an underwritten offering managed by Keefe, Bruyette & Woods and Howe Barnes Investments, Inc. with Keefe, Bruyette & Woods acting as lead manager.
Managements Discussion on Core Business Strategy
The Companys retained loan portfolio, net of allowance for loan losses increased $33.3 million, or 5.3%, to $666.5 million at December 31, 2005 from $633.2 million at September 30, 2005. The Companys strong commitment to its three core lending products, commercial, home equity lines of credit and residential mortgage loans, resulted in a growth in the average balance of loans of $119.6 million to $661.5 million for the three months ended December 31, 2005 compared to $541.9 million for the three months ended December 31, 2004.
At December 31, 2005, the Company had $97.6 million of brokered deposits, $200.0 million of FHLB advances and $19.6 million of subordinated debt, compared to $118.9 million in brokered deposits, $171.0 million in FHLB advances and $19.6 million of subordinated debt at September 30, 2005.
Commercial real estate and commercial and industrial (C&I) loans in the commercial division, increased $21.4 million to $200.7 million at December 31, 2005 compared to $179.3 million at September 30, 2005. The commercial portfolio consists of $111.6 million of commercial real estate, $34.9 million of commercial and industrial, $31.8 million of residential (multi-family and development) and $22.1 million in construction and development. For the quarter ending December 31, 2005, commercial deposits rose $8.2 million and totaled $43.6 million. The Company had substandard commercial assets totaling $711,000 and had an allowance for loan losses of $1.9 million allocated to the commercial portfolio. The Company has no charge-off history with its commercial loan portfolio.
Permanent and construction residential loan balances increased $9.0 million to $298.4 million at December 31, 2005 compared to $289.4 million at September 30, 2005. As a large-volume mortgage lender, the Bank has the opportunity to carefully select loans to retain for portfolio. Typically, loans originated for portfolio mature or reprice within three years and carry higher credit risk and interest rate yields than residential loans that are originated for sale. At December 31, 2005, the balance of residential non-performing assets was $6.4 million, including $1.3 million of real estate owned by the Bank. In part due to the historically strong collateral of the residential loan portfolio, the Company has absorbed few losses with this product, including just $6,000 during the three months ended December 31, 2005 and $44,000 for the fiscal year ended September 30, 2005. However, in an economic environment that resulted in declining residential values, the Company would be at increased risk of credit losses from non-performing loans.
Residential mortgage loans originated and sold to investors on a servicing-released basis are the Companys largest source of non-interest income and are the primary component of mortgage revenue. Mortgage revenue for the quarter ended December 31, 2005 declined $343,000 to $774,000 from $1.1 million for the quarter ended December 31, 2004 on $267.7 million and $209.3 million of sales, respectively. The decline in revenue was due to compressed revenue margin, caused by rising market interest rates, which reduced the profitability of loan sales during the quarter. Warehouse spreads on mortgage loans held for sale also declined during the year as the weighted average yield on the portfolio rose 75 basis points to 5.71% for the quarter ending December 31, 2005 from 4.96% for the quarter ended December 31, 2004, whereas the cost of FHLB borrowings used to fund this portfolio rose 145 basis points from 2.74% for the quarter ended December 31, 2004 to 4.18% for the quarter ended December 31, 2005. The Company funds loans held for sale with overnight and short term advances because the loans are typically sold within 30 days of origination. The average balance of loans held for sale totaled $45.3 million for the quarter ended December 31, 2005.
Home equity lines of credit have historically been the most consistently growing portfolio in the bank. However, higher interest rates and a flattened yield curve have prompted many borrowers to opt for fixed-rate second mortgages. The equity line balances increased $2.2 million to $197.8 million at December 31, 2005 compared to $195.6 million at September 30, 2005. Home equity loans are typically approved for qualified borrowers in conjunction with the first mortgage loan applications. The large volume of mortgage loans originated in recent years has provided many opportunities to cross-sell this product to customers. As a prime-based asset, home equity lines carry low interest rate risk characteristics and attractive yields, providing stability to the Companys net interest margin. At December 31, 2005, the Bank had $1,053,000 of non-performing home equity loans or 0.53% of the home equity portfolio and had $5,000 charge-offs during the three months ended December 31, 2005.
Total liabilities increased $14.4 million to $756.0 million at December 31, 2005 compared to $741.6 million at September 30, 2005. The Companys strategic focus on growing core liability products centers on checking account and money market deposit growth. For the three months ended December 31, 2005, transaction accounts, including money market balances increased $10.8 million to a balance of $151.6 million, excluding the deposits that will be transferred in connection with the pending sale of our Kansas City branch. Total deposits declined $6.4 million due primarily to managed run-off of $21.3 million of brokered funds.
The balance of checking accounts increased $7.2 million to $61.3 million at December 31, 2005 from $54.1 million at September 30, 2005. Checking accounts are the lowest cost deposits for the Company and are also the primary source of retail banking revenue. Retail banking revenue increased $129,000 to $748,000 for the quarter ended December 31, 2005 compared to $619,000 for the same period ended December 31, 2004. Retail banking revenue increased 20.8% primarily due to changes in customer overdraft policies, which allows for overdraft privileges at ATMs and point of sales transactions instead of just through negotiable instruments.
The balance of money market accounts increased $3.1 million to $90.3 million at December 31, 2005 from $87.2 million at September 30, 2005. The Company is in its fifth year of pursuing money market accounts as a core product and its third year of successfully marketing the Big Bertha Money Market Account. During the current quarter, the Company began offering a premium rate money market to mortgage customers in order to improve the Companys cross sales efforts on deposits. The money market product carries similar interest rate characteristics as the Companys home equity and prime adjusting commercial loans and results in an ideal source of funds for the growth of these portfolios. Money market accounts are generally less interest rate sensitive and more stable than CD balances. The Company has stayed disciplined in its pricing and has seen slower growth, but has not experienced significant runoff.
AVERAGE BALANCE SHEET
The following table sets forth information regarding average daily balances of assets and liabilities as well as the total dollar amounts of interest income from average interest-earning assets and interest expense on average interest-bearing liabilities, resultant yields, interest rate spread, net interest margin, and ratio of average interest-earning assets to average interest-bearing liabilities for the periods indicated.
ADDITIONAL DISCUSSION ON FINANCIAL CONDITION
Cash and cash equivalents decreased $10.1 million from $25.7 million at September 30, 2005 to $15.6 million at December 31, 2005. The Company restructured one of its correspondent relationships in order to carry lower balances in overnight accounts. Cash balances change daily based upon funds distributed on loan closings, cash receipts from investors on sale of loans and changes in deposits from customers. Typically excess cash inflows are used to retire daily borrowings from the Federal Home Loan Bank.
The balance of Federal Home Loan Bank advances increased $29.0 million during the quarter ended December 31, 2005 and totaled $200.0 million at December 31, 2005. The increase in advances was used to retire $21.3 million of maturing brokered funds and fund additional growth in the loan portfolio.
Balances in due to other banks decreased $2.6 million to $11.1 million at December 31, 2005 compared to $13.6 million at September 30, 2005. Due to other banks is the balance of checks drawn on a correspondent Banks checking account. On a
daily basis, the Company settles with the correspondent bank. The balances primarily represent the checks issued to fund loans on the final business day of the month.
Total stockholders equity at December 31, 2005 was $49.6 million, an increase of $1.4 million from $48.2 million at September 30, 2005. The increase was primarily attributable to net income for the three months of $1.8 million offset by dividend payments of $676,000. Treasury stock equity trust declined $2.1 million due to the release of 2.7 million shares that became fully vested during the period, which was offset by changes in additional paid in capital. The Company had eight members of its sales staff that had deferred compensation into an equity plan, which vested on October 1, 2005.
NON-PERFORMING ASSETS AND DELINQUENCIES
Total non-performing assets increased from $6.8 million at September 30, 2005 to $7.5 million at December 31, 2005. The balance of non-accrual loans increased from $166,000 to $1.1 million as several residential loans were placed on non-accrual. Accruing loans greater than 90 days past due decreased from $5.8 million at September 30, 2005 to $5.0 million at December 31, 2005. The allowance for loan losses was $6.9 million at December 31, 2005, or 0.96% of total loans and 112.93% of non-performing loans (non-accrual, accruing past due 90 days or more and troubled debt restructured loans), compared to $6.8 million at September 30, 2005, or 0.97% of total loans and 113.51% of non-performing loans.
PROVISION FOR LOAN LOSSES
The provision for loan losses was $407,000 for the three-month period ended December 31, 2005 compared to $349,000 for the three-month period ended December 31, 2004. The increase in the provision for loan losses during the quarter was due primarily to the increase in non-performing loans, which is reflective of the growth in residential lending. At December 31, 2005, the Company had entered into an agreement to sell approximately $3.0 million pool of delinquent loans. These loans are classified on the balance sheet as held for sale at lower of cost or market with a $241,000 allowance for loan losses allocated to the pool. Including the adjusted basis, the Company anticipates a small gain on the sale of this pool of loans.
The provision for loan losses is determined by management as the amount to bring the allowance for loan losses to a level that is considered adequate to absorb losses inherent in the loan portfolio. The allowance for loan losses is a critical accounting estimate reported within the consolidated financial statements. The allowance is based upon quarterly management estimates of expected losses inherent in the loan portfolio. Management estimates are determined by quantifying certain risks in the portfolio that are affected primarily by changes in the nature and volume of the portfolio combined with an analysis of past-due and classified loans, but can also be affected by the following factors: changes in lending policies and procedures, including underwriting standards and collections, charge-off and recovery practices, changes in national and local economic conditions and developments, and changes in the experience, ability, and depth of lending management staff.
Because management adheres to specific loan underwriting guidelines focusing primarily on residential and commercial real estate and home equity loans secured by one-to four-family and commercial properties, the Banks five-year historical loan loss experience has been low, totaling only $195,000. While the losses have increased slightly over the last five years, the balance of the allowance has increased dramatically, almost doubling in the last two fiscal years. The growth in allowance for loan losses was due to growth in the loan portfolio as well as loan product diversification. The Company was historically a lender of only 1-4 family conforming residential loans. Today, the Company has expanded its loan portfolio to include higher-risk home equity, commercial and construction loans. Because the Companys loan portfolio is typically collateralized by real estate, losses occur more frequently when property values are declining and borrowers are losing equity in the underlying collateral. At present, the property values in the Companys lending areas have been stable and appreciating.
The following table is a summary of our loan loss experience for the periods indicated:
The following assessments are performed quarterly in accordance with the Companys allowance for loan losses methodology:
Homogeneous residential mortgage loans are given one of five standard risk ratings at the time of origination. The risk ratings are assigned through the use of a credit scoring model, which assesses credit risk determinants from the borrowers credit history, the loan-to-value ratio, the affordability ratios or other personal history. Five-year historical loss rates and industry data for each credit rating are used to determine the appropriate allocation percentage for each loan grade. Commercial real estate loans are individually reviewed and assigned a credit risk rating on an annual basis by the internal loan committee. Consumer and home equity loans are assigned standard risk weightings that determine the allocation percentage.
When commercial real estate loans are over 30 days delinquent or residential, consumer and home equity loans are over 90 days past due, they are evaluated individually for impairment. Additionally, loans that demonstrate credit weaknesses that may impact the borrowers ability to repay or the value of the collateral are also reviewed individually for impairment. The Company considers a loan to be impaired when management believes it will be unable to collect all principal and interest due according to the contractual terms of the loan. If a loan is impaired, the Company records a loss valuation equal to the excess of the loans carrying value over the present value of estimated future cash flows or the fair value of collateral if the loan is collateral dependent.
The Companys methodology includes factors that allow the Company to adjust its estimates of losses based on the most recent information available. Historic loss rates used to determine the allowance are adjusted to reflect the impact of current conditions, including actual collection and charge-off experience. Any material increase in non-performing loans will adversely affect our financial condition and results of operation.
DISCUSSION OF OTHER INCOME AND EXPENSE FROM OPERATIONS FOR THREE MONTHS ENDED DECEMBER 31, 2005
Title policy revenues totaled $199,000 and $159,000 for the three months ended December 31, 2005 and 2004, respectively. The Title Company, which operates as a division of Pulaski Bank, contributed $116,000 and $55,000 in pre-tax income for the quarters ended December 31, 2005 and 2004, respectively. The Title Companys operations consist primarily of selling title policies to the Banks residential and commercial customers in connection with the origination of their real estate loans.
Investment division revenues totaled $117,000 and $139,000 for the three months ended December 31, 2005 and 2004, respectively. After expenses, the Investment Division generated a net loss of $118,000 and $19,000 for the quarters ended December 31, 2005 and 2004, respectively. The Investment Division operations consist principally of brokering bonds from wholesale brokerage houses to bank, municipal and individual investors. Revenues are generated on trading spreads.
Other income increased $107,000 to $351,000 for the three-month period ending December 31, 2005 compared to the three-month period ending December 31, 2004. Other income consists primarily of changes in value of the Bank Owned Life Insurance and fee income from a correspondent bank.
Salaries and employee benefits expense declined $21,000 to $2.0 million for the quarter ended December 31, 2005 compared to $2.1 million for the quarter ended December 31, 2004. The Company fully retired its ESOP loan, which resulted in $341,000 less compensation expense during the quarter compared to previous quarter ended December 31, 2004, and was partially offset by additional compensation expense for stock options under FAS 123R, which totaled $77,000 for the quarter. The Company also had lower bonus accruals during the quarter.
Occupancy, equipment and data processing expenses increased $172,000 to $1.1 million during the three-month period ended December 31, 2005 compared to the three-month period ended December 31, 2004. The Company had additional expense from fixed assets associated with its new Chesterfield Valley bank location as well as additional costs from the remodeling of its home office.
Professional services increased $142,000 to $339,000 for the quarter ended December 31, 2005 compared to $197,000 for the quarter ended December 31, 2004. Consulting expense increased $67,000 mainly as the result of costs associated with the continued implementation of the requirements of the Sarbanes Oxley Act, legal expense increased $45,000 partly as the result of the implementation of a Dividend Reinvestment Plan and audit and tax expense increased $30,000 partly as a result of additional work performed in conjunction with the Sarbanes Oxley Act.
Loss on derivative instruments increased $443,000 to $407,000 for the quarter ended December 31, 2005 compared to net gain of $35,000 for the quarter ended December 31, 2004 due to changes in market value of the underlying hedge instruments. See Note 5 to the financial statements.
Other expenses increased $131,000 to $786,000 during the three-month period ended December 31, 2005 compared to $655,000 for the quarter ended December 31, 2004. The majority of this increase related to an increase in the costs associated with loan originations.
The provision for income taxes decreased by $199,000 to $983,000 for the three-month period ended December 31, 2005 compared to $1.2 million for the three-month period ended December 31, 2004. The effective tax rates for the three-month periods were 34.7% and 38.5%, respectively. The decrease in the effective tax rate was the result of increased income from bank-owned life insurance, which is nontaxable, and decreased compensation expense related to the employee stock ownership plan, which is not deductible.
LIQUIDITY AND CAPITAL RESOURCES
At December 31, 2005, the Bank had outstanding commitments to originate loans of $68.5 million and commitments to sell loans on a best-efforts basis of $82.4 million. At the same date, certificates of deposit that are scheduled to mature in one year or less totaled $177.8 million. Based on past experience, management believes the majority of maturing certificates of deposit will remain with the Bank.
If the Bank or the Company requires funds beyond its ability to generate them internally, the Bank has the ability to borrow funds for the FHLB under a blanket agreement which assigns all investments in FHLB stock, qualifying first residential mortgage loans, residential loans held for sale and home equity loans with a 90% or greater LTV as collateral to secure the amounts borrowed. Total borrowings from the Federal Home Loan Bank are subject to limitations based upon a risk assessment of the Bank, which currently allows for a line of credit equal to 35% of the Banks assets. At December 31, 2005, the Bank had approximately $81.1 million in additional borrowing authority under the above-mentioned arrangement, after $200.0 million had been borrowed in advances from the FHLB. The Company also maintains a $12 million line of credit with a correspondent bank.
SOURCES AND USES OF CASH
The Company is a large originator of residential mortgage loans with more than 75% of the loans being sold into the secondary residential mortgage investment community. Consequently, the primary source and use of cash in operations is to originate loans for sale, which used $250.2 million in cash during the quarter ended December 31, 2005 and provided proceeds of cash of $268.3 million from loan sales. Also, the Company realized $592,000 of gains on sale of loans.
The primary use of cash from investing activities is also from loans that are originated for the portfolio. During the quarter ended December 31, 2005, the Company had a net increase in loans of $35.4 million compared to an increase of $47.4 million for the quarter ended December 31, 2004. See the Overview discussion above for a discussion on the growth of the retained loan portfolio.
With the growth in the loan portfolio, the Companys primary source of funds from financing activities came from FHLB advances which increased by $29.0 million, partially offset by a $7.3 million decrease in deposit balances during the quarter ended December 31, 2005.
The following table presents the maturity structure of time deposits and other maturing liabilities at December 31, 2005:
In addition to our owned banking facilities, the Company has entered into long-term leasing arrangements to support ongoing activities. The required payments under such commitments and other obligations at December 31, 2005 are as follows:
The Bank is required to maintain specific amounts of capital pursuant to Office of Thrift Supervision (the OTS) regulations on minimum capital standards. The OTS minimum capital standards generally require the maintenance of regulatory capital sufficient to meet each of three tests, hereinafter described as the tangible capital requirement, the Tier I (core) capital requirement and the risk-based requirement. The tangible capital requirement provides for minimum tangible capital (defined as stockholders equity less all intangible assets) equal to 1.5% of adjusted total assets. The Tier I capital requirement provides for minimum core capital (tangible capital plus certain forms of supervisory goodwill and other qualifying intangible assets) equal to 4.0% of adjusted total assets. The risk-based capital requirements provide for the maintenance of core capital plus a portion of unallocated loss allowances equal to 8.0% of risk-weighted assets. In computing risk-weighted assets, the Bank multiplies the value of each asset on its balance sheet by a defined risk-weighting factor (e.g., one-to four-family conventional residential loans carry a risk-weighted factor of 50%).
The following table illustrates the Banks regulatory capital levels compared to its regulatory capital requirements at December 31, 2005.
EFFECTS OF INFLATION
Changes in interest rates may have a significant impact on a banks performance because virtually all assets and liabilities of banks are monetary in nature. Interest rates do not necessarily move in the same direction or in the same magnitude as the prices of goods and services. Inflation does have an impact on the growth of total assets in the banking industry, often resulting in a need to increase equity capital at higher than normal rates to maintain an appropriate equity to asset ratio. The Companys operations are not currently impacted by inflation.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
There has been no material changes in the Companys quantitative or qualitative aspects of market risk during the quarter ended December 31, 2005 from that disclosed in the Companys Annual Report on Form 10-K for the year ended September 30, 2005.
The Company employs derivative financial instruments to assist in its management of interest rate sensitivity by modifying the repricing, maturity and option characteristics of certain assets and liabilities.
The Company utilizes derivative financial instruments to assist in its management of interest rate sensitivity of certain mortgage assets. Derivative financial instruments issued by the Company consist of interest rate lock commitments to originate residential loans. Commitments to originate loans consist primarily of residential real estate loans. At December 31, 2005, the Company had issued $73.8 million of unexpired interest rate lock commitments to mortgage loan customers compared to $147.1 million of unexpired commitments at September 30, 2005.
The Company typically economically hedges these derivative commitments through one of two means either by obtaining a corresponding best-efforts lock commitment with an investor to sell the loan at an agreed upon price, or by forward
selling mortgage-backed securities. The forward sale of mortgage-backed securities is a means of matching a corresponding derivative asset with similar characteristics as the bank-issued commitment but changes directly opposite in fair value from market movements. Loans hedged through forward sales of mortgaged-backed securities are sold individually or in pools on a mandatory delivery basis to investors, whereas the best efforts sales are locked on a loan-by-loan basis shortly after issuing the rate lock commitments to customers. The Company had outstanding forward sales commitments of mortgage-backed securities of $4.0 million in notional value at December 31, 2005 and $15.0 million at September 30, 2005. At December 31, 2005, this hedge was matched against $7.2 million of interest rate lock commitments that were to be sold through the mandatory delivery of loan pool sales compared to $11.5 million of interest rate lock commitments at September 30, 2005.
The carrying value of the interest rate lock commitments included in the consolidated balance sheets was $12,070 and $83,800 at December 31, 2005 and September 30, 2005, respectively. The carrying value of the forward sales commitments included in the consolidated balance sheets was $47,685 and $104,250 at December 31, 2005 and September 30, 2005, respectively.
The Company entered into interest rate swap agreements related to hedge a number of its brokered certificates of deposit in order to convert the fixed rates on the brokered CDs into variable LIBOR rates. The effect of the swap agreement is that the counterparty pays the fixed rate to the Company while the Company pays the LIBOR rate to the counterparty. The maturity date, notional amounts, interest rates paid and received and fair value of the Companys interest rate swap agreements as of December 31, 2005 were as follows:
CONTROLS AND PROCEDURES
Pulaski Financial maintains disclosure controls and procedures as such term is defined in Rule 13a-15(e) and 15d-15(e) promulgated under the Securities Exchange Act of 1934, as amended (the Exchange Act), that are designed to ensure that the information required to be disclosed in the reports that Pulaski Financial files or submits under the Exchange Act with the Securities and Exchange Commission (the SEC) (1) is recorded, processed, summarized and reported within the time periods specified in the SECs rules and forms, and (2) is accumulated and communicated to Pulaski Financials management including its principal executive and principal financial officers as appropriate to allow timely decisions regarding required disclosure.
During the quarter ended December 31, 2005, Pulaski Financialss management, including Pulaski Financials principal executive officer and principal financial officer, evaluated the effectiveness of Pulaski Financials disclosure controls and procedures as of September 30, 2005, and concluded that, because of the existence of a material weakness in Pulaski Financials internal control over financial reporting as of such date (as discussed in managements report on internal control over financial reporting in its annual report on Form 10-K, Pulaski Financials disclosure controls and procedures were not effective as of such date. To remedy the internal control deficiencies over financial reporting relating to the accounting for certain derivative instruments, Pulaski Financial is in the process of establishing procedures to provide sufficient testing and
verification that any new hedging instruments meet the criteria for hedge accounting. As of December 31, 2005, such procedures have not been finalized, and as such, a material weakness in internal controls over financial reporting still existed at December 31, 2005. However, management expects that such procedures will be finalized for periods subsequent to December 31, 2005.
IMPACT OF RECENTLY ISSUED ACCOUNTING STANDARDS
In December 2003, the Accounting Standards Executive Committee, or AcSEC, issued SOP 03-3, Accounting for Certain Loans or Debt Securities Acquired in a Transfer, effective for loans acquired in fiscal years beginning after December 15, 2004. The scope of SOP 03-3 applies to problem loans that have been acquired, either individually in a portfolio, or in an acquisition. These loans must have evidence of credit deterioration and the purchaser must not expect to collect contractual cash flows. SOP 03-3 updates Practice Bulletin No. 6, Amortization of Discounts on Certain Acquired Loans, for more recently issued literature, including FASB Statements No. 114, Accounting by Creditors for Impairment of a Loan; No. 115, Accounting for Certain Investments in Debt and Equity Securities; and No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities. Additionally, it addresses FASB Statement No. 91, Accounting for Nonrefundable Fees and Costs Associated with Originating or Acquiring Loans and Initial Direct Costs of Leases, which requires that discounts be recognized as an adjustment of yield over a loans life. SOP 03-3 states that an institution may no longer display discounts on purchased loans within the scope of SOP 03-3 on the balance sheet and may not carry over the allowance for loan losses. For those loans within the scope of SOP 03-3, this statement clarifies that a buyer cannot carry over the sellers allowance for loan losses for the acquisition of loans with credit deterioration. Loans acquired with evidence of deterioration in credit quality since origination will need to be accounted for under a new method using an income recognition model. This prohibition also applies to purchases of problem loans not included in a purchase business combination, which would include syndicated loans purchased in the secondary market and loans acquired in portfolio sales. The implementation of SOP 03-3 on October 1, 2005, did not have a material effect on our financial condition or results of operations.
In December 2004, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No 123 (Revised 2004), Share-Based Payment. This Statement addresses the accounting for transactions in which an entity exchanges its equity instruments for goods or services. The Statement eliminates the ability to account for share-based compensation transactions using APB Opinion No. 25, Accounting for Stock Issued to Employees, and generally requires instead that such transactions be accounted for using a fair-value-based method. For public entities, the cost of employee services received in exchange for an award of equity instruments, such as stock options, will be measured based on the grant-date fair value of those instruments, and that cost will be recognized over the period during which as employee is required to provide service in exchange for the award (usually the vesting period). This Statement was effective for the Company beginning on October 1, 2005. The implementation of SFAS No.123R did not have a material effect on the Companys financial condition or results of operations. See Note 4 to the financial statements.
In May 2005, the FASB issued SFAS No. 154 -Accounting Changes and Error Corrections. SFAS No. 154, a replacement of APB Opinion No. 20- Accounting Changes and FASB Statement No. 3Reporting Accounting Changes in Interim Financial Statements. SFAS No. 154 requires retrospective application for voluntary changes in accounting principles unless it is impracticable to do so. SFAS No. 154 is effective for accounting changes and corrections of errors in fiscal years beginning after December 15, 2005. Early application is permitted for accounting changes and corrections of errors during fiscal years beginning after June 1, 2005. We have evaluated the requirements of SFAS No.154 and do not expect it to have a material effect on our financial condition or results of operations.
PART II - OTHER INFORMATION
Periodically, there have been various claims and lawsuits involving the Bank, such as claims to enforce liens, condemnation proceedings on properties in which the Bank holds security interests, claims involving the making and servicing of real property loans and other issues incident to the Banks business. Neither the Bank nor the Company is a party to any pending legal proceedings that it believes would have a material adverse effect on the financial condition or operations of the Company.
There have been no material changes from the risk factors as previously disclosed in Item 1A to Part 1 of the Companys Annual Report on Form 10-K for the year ended September 30, 2005.
The following table provides information regarding the Companys purchases of its equity securities during the three months ended December 31, 2005.
ISSUER PURCHASES OF EQUITY SECURITIES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.