Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
.
Management's discussion and analysis of financial condition and results of operations (“MD&A”) is intended to assist a reader in understanding the consolidated financial condition and results of operations of the Company for the periods presented. The information contained in this section should be read in conjunction with the Condensed Consolidated Financial Statements and the accompanying Notes to the Condensed Consolidated Financial Statements and the other sections contained herein. References to the Company and the Bank throughout MD&A are made using the first person notations of “we”, “us” or “our”.
The Bank is a federally chartered stock savings and loan association that was formed in 1934. As of June 30, 2013, the Bank conducted business from its home office, one limited service office, twelve full service branch offices located in a five county area in Arkansas (comprised of Benton and Washington counties in Northwest Arkansas; Boone, Marion and Baxter counties in North-central Arkansas) and a loan production office located in Little Rock, Arkansas. The Company also has executive offices in Little Rock, Arkansas. The Bank sold its Berryville, Arkansas branch in June 2013 and plans to close its Rogers Elm Street branch in August 2013 and has entered into an agreement to sell its Farmington, Arkansas branch, which is estimated to close in the third quarter of 2013. The branch sales and closure are part of the Bank’s overall strategy to improve operational efficiency and to support its expansion into other areas of the state.
The Bank is a community-oriented financial institution offering a wide range of retail and commercial deposit accounts, including noninterest-bearing and interest-bearing checking, savings and money market accounts, certificates of deposit, and individual retirement accounts. Loan products offered by the Bank include residential real estate, consumer, construction, lines of credit, commercial real estate and commercial business loans. Other financial services include automated teller machines; 24-hour telephone banking; online banking, including account access, e-statements, and bill payment; mobile banking, including remote deposit capture and funds transfer; Bounce Protection
TM
overdraft service; debit cards; and safe deposit boxes.
OVERVIEW
The Company’s net income was $84,000 and $387,000 for the three and six months ended June 30, 2013, respectively, compared to net income of $709,000 and $901,000 for the same periods in 2012, respectively. The primary reason for the decrease in net income during each comparative period was a decrease in gains on sales of investment securities. The decrease in net income for each of the comparative periods was also due to decreases in net interest income and deposit fee income, partially offset by decreases in operating expenses.
The Bank continued to reduce its level of nonperforming assets during the first half of 2013. Total nonperforming assets at June 30, 2013, including nonaccrual loans and real estate owned, totaled $25.7 million, or 4.98% of total assets, a reduction of $9.8 million compared to December 31, 2012, and a reduction of $21.4 million compared to June 30, 2012. The Bank also reduced its level of classified loans to $18.3 million at June 30, 2013 compared to $34.5 million at December 31, 2012 and $38.0 million at June 30, 2012.
While the Bank is continuing its focus on reducing nonperforming assets, it is equally focused on improving its operational performance through improving its net interest margin, increasing noninterest income, and controlling noninterest expense.
MERGER AGREEMENT
On July 1, 2013, the Company entered into an Agreement and Plan of Merger (the “Merger Agreement”) with First National Security Company (“FNSC”) of Hot Springs, Arkansas, pursuant to which FNSC will merge with and into the Company (the “Merger”). Pursuant to the Merger Agreement, shareholders of FNSC will receive, in the aggregate, 6,252,400 shares of Company common stock and $74 million in cash in exchange for their shares of FNSC common stock. Consummation of the Merger is subject to certain conditions, including, among others, approval of the Merger by Company and FNSC shareholders, the receipt of all required governmental regulatory approvals, accuracy of specified representations and warranties of each party, the performance in all material respects by each party of its obligations under the Merger Agreement, effectiveness of the registration statement to be filed by the Company with the SEC to register shares of Company common stock to be offered to FNSC shareholders, FNSC’s receipt of a tax opinion, and the absence of any injunctions or other legal restraints.
The Merger Agreement contains termination rights which may be exercised by the Company or FNSC in specific circumstances, such as the following: a required regulatory approval has been denied by final, non-appealable action of a governmental entity; the parties are unable to complete the Merger by March 31, 2014; the other party has committed a breach of a representation, warranty or covenant which would prevent a closing condition from being satisfied and the breach is not or cannot be cured within 30 days; or the other party’s board of directors has withdrawn or modified its recommendation of the Merger to its shareholders. If the Merger Agreement is terminated under certain circumstances and either party closes a “superior competing transaction” by March 31, 2015, such party will pay the other party a termination fee of $3 million.
Also on July 1, 2013, an independent special committee of the Board of Directors of the Company authorized management of the Company to (i) sell up to 2,531,645 shares of Company common stock at a price per share equal to $7.90 (the closing price of the Company’s common stock on June 28, 2013) in a private placement to certain accredited investors that have pre-existing relationships with the Company, including Bear State Financial Holdings, LLC (“Bear State”) and certain members of Bear State (the “Private Placement”) and (ii) enter into commitment letter agreements (each a “Commitment Letter”) with five members of Bear State (the “Investors”), which Investors include Richard N. Massey, the Company’s Chairman, and Scott T. Ford, a director of the Company, whereby each Investor agreed to “backstop” a portion of the Private Placement and agreed to purchase up to 506,329 shares of Company common stock in the event the Company is unable to cause the Private Placement to be fully subscribed or is otherwise unable to raise sufficient funds from other sources. The Company anticipates that the proceeds from the Private Placement will be applied to the cash portion of the Merger consideration to be paid by the Company in the Merger. In exchange for providing a Commitment Letter, each Investor was issued warrants to purchase 35,443 shares of common stock on the same terms as in the Private Placement. The Investors will be entitled to customary registration rights with respect to the shares of common stock to be issued pursuant to the Commitment Letters as well as the shares of common stock underlying the warrants. On July 12, 2013, the Company approached Bear State and inquired as to Bear State’s interest in participating in the Private Placement. In the event that Bear State agrees to purchase less than the full 2,531,645 shares in the Private Placement, the Company intends to utilize the commitments of the Investors to backstop the Private Placement. The Company anticipates the closing of the Private Placement will occur immediately prior to the closing of the Merger.
The foregoing summary of the Merger Agreement and terms of the Commitment Letters and the warrants are qualified in their entirety by reference to the full text of the Merger Agreement and the form of Commitment Letter, which are attached as Exhibit 2.1 and Exhibit 10.1, respectively, to the Current Report on Form 8-K filed with the SEC on July 3, 2013, and are incorporated herein by reference.
CRITICAL ACCOUNTING POLICIES
Various elements of our accounting policies, by their nature, are inherently subject to estimation techniques, valuation assumptions and other subjective assessments. In particular, the following estimates, due to the judgments, estimates and assumptions inherent in those policies, are critical to preparation of our financial statements:
|
|
●
|
Determination of our allowance for loan and lease losses (“ALLL”)
|
|
|
●
|
Valuation of real estate owned
|
|
|
●
|
Valuation of investment securities
|
|
|
●
|
Valuation of our deferred tax assets
|
These policies and the judgments, estimates and assumptions are described in greater detail in subsequent sections of this Management’s Discussion and Analysis of Financial Condition and Results of Operations and in the Notes to the Condensed Consolidated Financial Statements included herein. We believe that the judgments, estimates and assumptions used in the preparation of our condensed consolidated financial statements are appropriate given the factual circumstances at the time. However, given the sensitivity of our condensed consolidated financial statements to these critical accounting policies, the use of other judgments, estimates and assumptions could result in material differences in our results of operations or financial condition.
In estimating the amount of credit losses inherent in the loan portfolio, various judgments and assumptions are made. For example, when assessing the overall economic environment, assumptions are made regarding market conditions and their impact on the loan portfolio. In the event the economy were to sustain a prolonged downturn, the loss factors applied to the portfolios may need to be revised, which may significantly impact the measurement of the allowance for loan and lease losses. For impaired loans that are collateral dependent and for real estate owned, the estimated fair value of the collateral may deviate significantly from the proceeds received when the collateral is sold.
The Company has classified all of its investment securities as available for sale. Accordingly, its investment securities are stated at estimated fair value in the consolidated financial statements with unrealized gains and losses, net of related income taxes, reported as a separate component of stockholders’ equity with any related changes included in accumulated other comprehensive income (loss). The Company utilizes independent third parties as its principal sources for determining fair value of its investment securities that are measured on a recurring basis. For investment securities traded in an active market, the fair values are based on quoted market prices if available. If quoted market prices are not
available, fair values are based on market prices for comparable securities, broker quotes or comprehensive interest rate tables, pricing matrices or a combination thereof. For investment securities traded in a market that is not active, fair value is determined using unobservable inputs. The fair values of the Company’s investment securities traded in both active and inactive markets can be volatile and may be influenced by a number of factors including market interest rates, prepayment speeds, discount rates, credit quality of the issuer, general market conditions including market liquidity conditions and other factors. Factors and conditions are constantly changing and fair values could be subject to material variations that may significantly impact the Company’s financial condition, results of operations and liquidity.
The Company recognizes deferred tax assets and liabilities for the future tax consequences related to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. The Company evaluates its deferred tax assets for recoverability using a consistent approach that considers the relative impact of negative and positive evidence, including our historical profitability and projections of future taxable income. The Company is required to establish a valuation allowance for deferred tax assets if it is determined, based on available evidence at the time the determination is made, that it is more likely than not that some portion or all of the deferred tax assets will not be realized. In evaluating the need for a valuation allowance, the Company estimates future taxable income based on management-approved business plans and ongoing tax planning strategies. This process involves significant management judgment about assumptions that are subject to change from period to period based on changes in tax laws or variances between projected operating performance, our actual results and other factors.
RESULTS OF OPERATIONS
Three and Six Months Ended June 30, 2013 Compared to Three and Six Months Ended June 30, 2012
Net Income.
Net income decreased to $84,000 for the three months ended June 30, 2013 compared to $709,000 for the three months ended June 30, 2012. Net income decreased to $387,000 for the six months ended June 30, 2013 compared to $901,000 for the six months ended June 30, 2012.
The primary reason for the decrease in net income during each comparative period was a decrease in gains on sales of investment securities. The decrease in net income for each of the comparative periods was also due to decreases in net interest income and deposit fee income, partially offset by decreases in operating expenses.
Net Interest Income.
The Company's results of operations depend primarily on its net interest income, which is the difference between interest income on interest-earning assets, such as loans and investments, and interest expense on interest-bearing liabilities, such as deposits and borrowings. Net interest income for the second quarter of 2013 was $3.6 million compared to $3.9 million for the same period in 2012. Net interest income for the six months ended June 30, 2013 was $7.3 million compared to $7.8 million for the same period in 2012. The decrease in net interest income resulted from changes in interest income and interest expense discussed below.
Interest Income.
Interest income for the second quarter of 2013 was $4.5 million compared to $5.0 million for the same period in 2012. Interest income for the six months ended June 30, 2013 was $9.0 million compared to $10.2 million for the same period in 2012. The decrease in interest income for the three and six months ended June 30, 2013 compared to comparable periods in 2012 was primarily related to a decrease in yields earned on loans receivable and, to a lesser degree, a decrease in the average balance of investment securities. The decrease in yields earned on loans receivable is due to origination during the period of high quality loans with average market rates lower than the weighted average rate of the Bank’s portfolio in the same period last year. The average balance of investment securities decreased due to calls and maturities of investment securities.
Interest Expense.
Interest expense for the second quarter of 2013 was $830,000 compared to $1.1 million for the same period in 2012. Interest expense for the six months ended June 30, 2013 was $1.7 million compared to $2.4 million for the same period in 2012. The decrease in interest expense for the three and six months ended June 30, 2013 compared to comparable periods in 2012 was primarily due to a decrease in the average rates paid on deposit accounts and, to a lesser degree, decreases in the average balances of deposits and borrowings. The decrease in the average rates paid on deposit accounts reflects decreases in market interest rates and Bank management’s pricing of its deposits at such levels to maintain deposit balances commensurate with its overall balance sheet management and liquidity position.
Rate/Volume Analysis.
The table below sets forth certain information regarding changes in interest income and interest expense of the Company for the periods indicated. For each category of interest-earning assets and interest-bearing liabilities, information is provided regarding changes attributable to (i) changes in volume (changes in average volume multiplied by prior rate); (ii) changes in rate (change in rate multiplied by prior average volume); (iii) changes in rate-volume (changes in rate multiplied by the change in average volume); and (iv) the net change.
|
|
|
Three Months Ended June 30,
|
|
|
|
|
2013 vs. 2012
|
|
|
|
|
Increase (Decrease)
Due to
|
|
|
|
|
|
|
|
|
Volume
|
|
|
Rate
|
|
|
Rate/
Volume
|
|
|
Total
Increase
(Decrease)
|
|
|
|
|
(In Thousands)
|
|
|
Interest income:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loans receivable
|
|
$
|
17
|
|
|
$
|
(468
|
)
|
|
$
|
(1
|
)
|
|
$
|
(452
|
)
|
|
Investment securities
|
|
|
(61
|
)
|
|
|
8
|
|
|
|
(1
|
)
|
|
|
(54
|
)
|
|
Other interest-earning assets
|
|
|
(7
|
)
|
|
|
(8
|
)
|
|
|
1
|
|
|
|
(14
|
)
|
|
Total interest-earning assets
|
|
|
(51
|
)
|
|
|
(468
|
)
|
|
|
(1
|
)
|
|
|
(520
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest expense:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Deposits
|
|
|
(41
|
)
|
|
|
(247
|
)
|
|
|
8
|
|
|
|
(280
|
)
|
|
Other borrowings
|
|
|
(16
|
)
|
|
|
(3
|
)
|
|
|
2
|
|
|
|
(17
|
)
|
|
Total interest-bearing liabilities
|
|
|
(57
|
)
|
|
|
(250
|
)
|
|
|
10
|
|
|
|
(297
|
)
|
|
Net change in net interest income
|
|
$
|
6
|
|
|
$
|
(218
|
)
|
|
$
|
(11
|
)
|
|
$
|
(223
|
)
|
|
|
|
Six Months Ended June 30,
|
|
|
|
|
2013 vs. 2012
|
|
|
|
|
Increase (Decrease)
Due to
|
|
|
|
|
|
|
|
|
Volume
|
|
|
Rate
|
|
|
Rate/
Volume
|
|
|
Total
Increase
(Decrease)
|
|
|
|
|
(In Thousands)
|
|
|
Interest income:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loans receivable
|
|
$
|
(13
|
)
|
|
$
|
(1,001
|
)
|
|
$
|
2
|
|
|
$
|
(1,012
|
)
|
|
Investment securities
|
|
|
(122
|
)
|
|
|
(14
|
)
|
|
|
2
|
|
|
|
(134
|
)
|
|
Other interest-earning assets
|
|
|
(33
|
)
|
|
|
33
|
|
|
|
(4
|
)
|
|
|
(4
|
)
|
|
Total interest-earning assets
|
|
|
(168
|
)
|
|
|
(982
|
)
|
|
|
--
|
|
|
|
(1,150
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest expense:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Deposits
|
|
|
(119
|
)
|
|
|
(564
|
)
|
|
|
28
|
|
|
|
(655
|
)
|
|
Other borrowings
|
|
|
(34
|
)
|
|
|
(7
|
)
|
|
|
4
|
|
|
|
(37
|
)
|
|
Total interest-bearing liabilities
|
|
|
(153
|
)
|
|
|
(571
|
)
|
|
|
32
|
|
|
|
(692
|
)
|
|
Net change in net interest income
|
|
$
|
(15
|
)
|
|
$
|
(411
|
)
|
|
$
|
(32
|
)
|
|
$
|
(458
|
)
|
Average Balance Sheets.
The following table sets forth certain information relating to the Company's average balance sheets and reflects the average yield on assets and average cost of liabilities for the periods indicated. Such yields and costs are derived by dividing interest income or interest expense by the average balance of assets or liabilities, respectively, for the periods presented. Average balances are based on daily balances during the periods.
|
|
|
Three Months Ended June 30,
|
|
|
|
|
2013
|
|
|
2012
|
|
|
|
|
Average
Balance
|
|
|
Interest
|
|
|
Average
Yield/
Cost
|
|
|
Average
Balance
|
|
|
Interest
|
|
|
Average
Yield/
Cost
|
|
|
|
|
(Dollars in Thousands)
|
|
|
Interest-earning assets:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loans receivable(1)
|
|
$
|
351,591
|
|
|
$
|
3,970
|
|
|
|
4.54
|
%
|
|
$
|
350,249
|
|
|
$
|
4,422
|
|
|
|
5.08
|
%
|
|
Investment securities(2)
|
|
|
50,225
|
|
|
|
349
|
|
|
|
2.80
|
|
|
|
59,143
|
|
|
|
403
|
|
|
|
2.74
|
|
|
Other interest-earning assets
|
|
|
86,287
|
|
|
|
138
|
|
|
|
0.64
|
|
|
|
90,181
|
|
|
|
152
|
|
|
|
0.67
|
|
|
Total interest-earning assets
|
|
|
488,103
|
|
|
|
4,457
|
|
|
|
3.67
|
|
|
|
499,573
|
|
|
|
4,977
|
|
|
|
4.01
|
|
|
Noninterest-earning assets
|
|
|
51,625
|
|
|
|
|
|
|
|
|
|
|
|
61,258
|
|
|
|
|
|
|
|
|
|
|
Total assets
|
|
$
|
539,728
|
|
|
|
|
|
|
|
|
|
|
$
|
560,831
|
|
|
|
|
|
|
|
|
|
|
Interest-bearing liabilities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Deposits
|
|
$
|
462,973
|
|
|
|
817
|
|
|
|
0.71
|
|
|
$
|
481,077
|
|
|
|
1,097
|
|
|
|
0.92
|
|
|
Other borrowings
|
|
|
2,862
|
|
|
|
13
|
|
|
|
1.77
|
|
|
|
6,251
|
|
|
|
30
|
|
|
|
1.95
|
|
|
Total interest-bearing liabilities
|
|
|
465,835
|
|
|
|
830
|
|
|
|
0.72
|
|
|
|
487,328
|
|
|
|
1,127
|
|
|
|
0.93
|
|
|
Noninterest-bearing liabilities
|
|
|
2,146
|
|
|
|
|
|
|
|
|
|
|
|
3,750
|
|
|
|
|
|
|
|
|
|
|
Total liabilities
|
|
|
467,981
|
|
|
|
|
|
|
|
|
|
|
|
491,078
|
|
|
|
|
|
|
|
|
|
|
Stockholders' equity
|
|
|
71,747
|
|
|
|
|
|
|
|
|
|
|
|
69,753
|
|
|
|
|
|
|
|
|
|
|
Total liabilities and
stockholders' equity
|
|
$
|
539,728
|
|
|
|
|
|
|
|
|
|
|
$
|
560,831
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net interest income
|
|
|
|
|
|
$
|
3,627
|
|
|
|
|
|
|
|
|
|
|
$
|
3,850
|
|
|
|
|
|
|
Net earning assets
|
|
$
|
22,268
|
|
|
|
|
|
|
|
|
|
|
$
|
12,245
|
|
|
|
|
|
|
|
|
|
|
Interest rate spread
|
|
|
|
|
|
|
|
|
|
|
2.95
|
%
|
|
|
|
|
|
|
|
|
|
|
3.08
|
%
|
|
Net interest margin
|
|
|
|
|
|
|
|
|
|
|
2.98
|
%
|
|
|
|
|
|
|
|
|
|
|
3.09
|
%
|
|
Ratio of interest-earning assets to
Interest-bearing liabilities
|
|
|
|
|
|
|
|
|
|
|
104.78
|
%
|
|
|
|
|
|
|
|
|
|
|
102.51
|
%
|
|
|
(1)
|
Includes nonaccrual loans.
|
|
|
(2)
|
Includes FHLB of Dallas stock.
|
|
|
|
Six Months Ended June 30,
|
|
|
|
|
2013
|
|
|
2012
|
|
|
|
|
Average
Balance
|
|
|
Interest
|
|
|
Average
Yield/
Cost
|
|
|
Average
Balance
|
|
|
Interest
|
|
|
Average
Yield/
Cost
|
|
|
|
|
(Dollars in Thousands)
|
|
|
Interest-earning assets:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loans receivable(1)
|
|
$
|
354,072
|
|
|
$
|
8,051
|
|
|
|
4.59
|
%
|
|
$
|
354,574
|
|
|
$
|
9,063
|
|
|
|
5.14
|
%
|
|
Investment securities(2)
|
|
|
51,311
|
|
|
|
716
|
|
|
|
2.81
|
|
|
|
59,892
|
|
|
|
850
|
|
|
|
2.85
|
|
|
Other interest-earning assets
|
|
|
79,896
|
|
|
|
271
|
|
|
|
0.68
|
|
|
|
90,714
|
|
|
|
275
|
|
|
|
0.61
|
|
|
Total interest-earning assets
|
|
|
485,279
|
|
|
|
9,038
|
|
|
|
3.76
|
|
|
|
505,180
|
|
|
|
10,188
|
|
|
|
4.05
|
|
|
Noninterest-earning assets
|
|
|
51,983
|
|
|
|
|
|
|
|
|
|
|
|
60,420
|
|
|
|
|
|
|
|
|
|
|
Total assets
|
|
$
|
537,262
|
|
|
|
|
|
|
|
|
|
|
$
|
565,600
|
|
|
|
|
|
|
|
|
|
|
Interest-bearing liabilities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Deposits
|
|
$
|
460,823
|
|
|
|
1,663
|
|
|
|
0.73
|
|
|
$
|
485,735
|
|
|
|
2,318
|
|
|
|
0.96
|
|
|
Other borrowings
|
|
|
2,966
|
|
|
|
26
|
|
|
|
1.77
|
|
|
|
6,407
|
|
|
|
63
|
|
|
|
1.98
|
|
|
Total interest-bearing liabilities
|
|
|
463,789
|
|
|
|
1,689
|
|
|
|
0.74
|
|
|
|
492,142
|
|
|
|
2,381
|
|
|
|
0.97
|
|
|
Noninterest-bearing liabilities
|
|
|
2,468
|
|
|
|
|
|
|
|
|
|
|
|
3,978
|
|
|
|
|
|
|
|
|
|
|
Total liabilities
|
|
|
466,257
|
|
|
|
|
|
|
|
|
|
|
|
496,120
|
|
|
|
|
|
|
|
|
|
|
Stockholders' equity
|
|
|
71,005
|
|
|
|
|
|
|
|
|
|
|
|
69,480
|
|
|
|
|
|
|
|
|
|
|
Total liabilities and
stockholders' equity
|
|
$
|
537,262
|
|
|
|
|
|
|
|
|
|
|
$
|
565,600
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net interest income
|
|
|
|
|
|
$
|
7,349
|
|
|
|
|
|
|
|
|
|
|
$
|
7,807
|
|
|
|
|
|
|
Net earning assets
|
|
$
|
21,490
|
|
|
|
|
|
|
|
|
|
|
$
|
13,038
|
|
|
|
|
|
|
|
|
|
|
Interest rate spread
|
|
|
|
|
|
|
|
|
|
|
3.02
|
%
|
|
|
|
|
|
|
|
|
|
|
3.08
|
%
|
|
Net interest margin
|
|
|
|
|
|
|
|
|
|
|
3.05
|
%
|
|
|
|
|
|
|
|
|
|
|
3.10
|
%
|
|
Ratio of interest-earning assets to
Interest-bearing liabilities
|
|
|
|
|
|
|
|
|
|
|
104.63
|
%
|
|
|
|
|
|
|
|
|
|
|
102.65
|
%
|
|
|
(1)
|
Includes nonaccrual loans.
|
|
|
(2)
|
Includes FHLB of Dallas stock.
|
Provision for Loan Losses.
The provision for loan losses includes charges to maintain the ALLL at a level considered adequate by the Bank to cover probable credit losses related to specifically identified loans as well as probable credit losses inherent in the remainder of the loan portfolio that have been incurred as of the balance sheet date. The adequacy of the ALLL is evaluated quarterly by management of the Bank based on the Bank’s past loan loss experience, known and inherent risks in the portfolio, adverse situations that may affect the borrower’s ability to repay, the estimated value of any underlying collateral and other qualitative factors.
Management determined that no provision for loan losses was required for the three or six months ended June 30, 2013, primarily due to decreases in nonperforming and classified loans and continued improvement in the Bank’s loan portfolio. The ALLL as a percentage of loans receivable was 3.8% at June 30, 2013, compared to 4.4% at December 31, 2012. The ALLL as a percentage of classified loans was 72.5% at June 30, 2013, compared to 45.4% at December 31, 2012. See “Allowance for Loan and Lease Losses” in the “Asset Quality” section.
Noninterest Income.
Noninterest income is generated primarily through deposit account fee income, profit on sale of loans, and earnings on life insurance policies. Total noninterest income of $1.3 million for the second quarter of 2013 decreased from $2.0 million for the second quarter of 2012. Total noninterest income of $2.6 million for the six months ended June 30, 2013 decreased from $3.7 million for the same period in 2012. These decreases were primarily due to a decrease in gains on sales of investment securities and a decrease in deposit fee income, primarily due to a decrease in insufficient funds fee revenue.
Noninterest Expense.
Noninterest expense consists primarily of employee compensation and benefits, office occupancy expense, data processing expense, real estate owned expense, and other operating expense. Total noninterest expense decreased $258,000 or 5% during the second quarter of 2013 compared to the second quarter of 2012. Total noninterest expense decreased $1.0 million or 10% during the six months ended June 30, 2013 compared to the same period in 2012. The variances in certain noninterest expense items are further explained in the following paragraphs, with the aggregate expense decrease being primarily related to the decrease in nonperforming assets and improvements in the Bank’s operational efficiency and overall staffing levels.
Real estate owned, net.
The changes in the composition of this line item are presented below (in thousands):
|
|
|
Three Months Ended
June 30,
|
|
|
|
|
|
|
Six Months Ended
June 30,
|
|
|
|
|
|
|
|
|
2013
|
|
|
2012
|
|
|
Change
|
|
|
2013
|
|
|
2012
|
|
|
Change
|
|
|
Loss provisions
|
|
$
|
33
|
|
|
$
|
280
|
|
|
$
|
(247
|
)
|
|
$
|
176
|
|
|
$
|
308
|
|
|
$
|
(132
|
)
|
|
Net gain on sales
|
|
|
(43
|
)
|
|
|
(726
|
)
|
|
|
683
|
|
|
|
(374
|
)
|
|
|
(792
|
)
|
|
|
418
|
|
|
Rental income
|
|
|
(26
|
)
|
|
|
(151
|
)
|
|
|
125
|
|
|
|
(63
|
)
|
|
|
(410
|
)
|
|
|
347
|
|
|
Taxes and insurance
|
|
|
25
|
|
|
|
132
|
|
|
|
(107
|
)
|
|
|
93
|
|
|
|
295
|
|
|
|
(202
|
)
|
|
Other
|
|
|
56
|
|
|
|
207
|
|
|
|
(151
|
)
|
|
|
117
|
|
|
|
307
|
|
|
|
(190
|
)
|
|
Total
|
|
$
|
45
|
|
|
$
|
(258
|
)
|
|
$
|
303
|
|
|
$
|
(51
|
)
|
|
$
|
(292
|
)
|
|
$
|
241
|
|
The decreases in gains on sales of REO and rental income as well as the decreases in loss provisions and REO expenses are due to decreases in the REO balances. Real estate owned expenses such as taxes, insurance and maintenance as well as rental income are expected to continue to decline as the size of the REO portfolio continues to decline. Future levels of loss provisions and net gains or losses on sales of real estate owned will depend on market conditions.
FDIC Insurance Premium.
The Bank’s FDIC insurance premium decreased $121,000 for the three months ended June 30, 2013 compared to the same period in 2012 and decreased $248,000 for the six months ended June 30, 2013 compared to the same period in 2012 due to decreases in the assessment rate and the assessment base. The base is defined as average consolidated total assets for the assessment period less average tangible equity capital with potential adjustments for unsecured debt, brokered deposits and depository institution debts. The assessment rate declined due to improvements in the Bank’s performance and financial condition.
Data Processing.
The decrease in data processing expense of $390,000 in the second quarter of 2013 and the decrease of $530,000 for the six months ended June 30, 2013 compared to the same respective periods in 2012 was primarily related to lower overall processing costs as a result of the Bank’s conversion of its operational software during the second quarter of 2012, as well as one-time costs of approximately $550,000 incurred during the six months ended June 30, 2012.
Professional Fees.
Professional fees decreased $41,000 or 21% for the quarter ended June 30, 2013 compared to the same period in 2012 and decreased $180,000 or 31% for the six months ended June 30, 2013 compared to the same periods in 2012, primarily due to a decrease in audit fees and a decrease in loan-related legal fees.
Income Taxes.
The Company had no taxable income for the three or six months ended June 30, 2013 or 2012 and recorded a valuation allowance for the full amount of its net deferred tax asset as of June 30, 2013 and December 31, 2012, respectively.
LENDING ACTIVITIES
Loans Receivable.
Changes in loan composition between June 30, 2013 and December 31, 2012, are presented in the following table (dollars in thousands).
|
|
|
June 30,
|
|
|
December 31,
|
|
|
Increase
|
|
|
|
|
|
|
|
|
2013
|
|
|
2012
|
|
|
(Decrease)
|
|
|
% Change
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
One- to four-family residential
|
|
$
|
139,137
|
|
|
$
|
157,936
|
|
|
$
|
(18,799
|
)
|
|
|
(11.9
|
)%
|
|
Multifamily residential
|
|
|
19,775
|
|
|
|
20,790
|
|
|
|
(1,015
|
)
|
|
|
(4.9
|
)
|
|
Nonfarm nonresidential
|
|
|
150,942
|
|
|
|
138,014
|
|
|
|
12,928
|
|
|
|
9.4
|
|
|
Construction and land development
|
|
|
14,243
|
|
|
|
14,551
|
|
|
|
(308
|
)
|
|
|
(2.1
|
)
|
|
Total real estate loans
|
|
|
324,097
|
|
|
|
331,291
|
|
|
|
(7,194
|
)
|
|
|
(2.2
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Commercial
|
|
|
15,912
|
|
|
|
16,083
|
|
|
|
(171
|
)
|
|
|
(1.1
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Consumer
|
|
|
4,996
|
|
|
|
5,818
|
|
|
|
(822
|
)
|
|
|
(14.1
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total loans receivable
|
|
|
345,005
|
|
|
|
353,192
|
|
|
|
(8,187
|
)
|
|
|
(2.3
|
)
|
|
Unearned discounts and net deferred
loan costs
|
|
|
(125
|
)
|
|
|
(188
|
)
|
|
|
63
|
|
|
|
(33.5
|
)
|
|
Allowance for loan and lease losses
|
|
|
(13,249
|
)
|
|
|
(15,676
|
)
|
|
|
2,427
|
|
|
|
(15.5
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loans receivable, net
|
|
$
|
331,631
|
|
|
$
|
337,328
|
|
|
$
|
(5,697
|
)
|
|
|
(1.7
|
)%
|
Total loans receivable decreased $8.2 million to $345.0 million at June 30, 2013, compared to $353.2 million at December 31, 2012. The decrease in loans was primarily due to the sale of $14.7 million of classified loans in the second quarter of 2013.
ASSET QUALITY
Nonperforming Assets.
The following table sets forth the amounts and categories of the Bank's nonperforming assets at the dates indicated (dollars in thousands).
|
|
|
June 30, 2013
|
|
|
December 31, 2012
|
|
|
|
|
|
|
|
|
Net (2)
|
|
|
% Total
Assets
|
|
|
Net (2)
|
|
|
% Total
Assets
|
|
|
Increase
(Decrease)
|
|
|
Nonaccrual Loans:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
One- to four-family residential
|
|
$
|
5,849
|
|
|
|
1.13
|
%
|
|
$
|
7,027
|
|
|
|
1.32
|
%
|
|
$
|
(1,178
|
)
|
|
Multifamily residential
|
|
|
--
|
|
|
|
--
|
|
|
|
--
|
|
|
|
--
|
|
|
|
--
|
|
|
Nonfarm nonresidential
|
|
|
4,358
|
|
|
|
0.84
|
%
|
|
|
7,236
|
|
|
|
1.37
|
%
|
|
|
(2,878
|
)
|
|
Construction and land development
|
|
|
3,481
|
|
|
|
0.67
|
%
|
|
|
4,133
|
|
|
|
0.77
|
%
|
|
|
(652
|
)
|
|
Commercial
|
|
|
28
|
|
|
|
0.01
|
%
|
|
|
402
|
|
|
|
0.08
|
%
|
|
|
(374
|
)
|
|
Consumer
|
|
|
11
|
|
|
|
0.01
|
%
|
|
|
26
|
|
|
|
0.01
|
%
|
|
|
(15
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total nonaccrual loans
|
|
|
13,727
|
|
|
|
2.66
|
%
|
|
|
18,824
|
|
|
|
3.55
|
%
|
|
|
(5,097
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Accruing loans 90 days or more past due
|
|
|
--
|
|
|
|
--
|
|
|
|
--
|
|
|
|
--
|
|
|
|
--
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Real estate owned
|
|
|
11,967
|
|
|
|
2.32
|
%
|
|
|
16,658
|
|
|
|
3.14
|
%
|
|
|
(4,691
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total nonperforming assets
|
|
|
25,694
|
|
|
|
4.98
|
%
|
|
|
35,482
|
|
|
|
6.69
|
%
|
|
|
(9,788
|
)
|
|
Performing restructured loans
|
|
|
270
|
|
|
|
0.05
|
%
|
|
|
5,816
|
|
|
|
1.10
|
%
|
|
|
(5,546
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total nonperforming assets and performing restructured loans (1)
|
|
$
|
25,964
|
|
|
|
5.03
|
%
|
|
$
|
41,298
|
|
|
|
7.79
|
%
|
|
$
|
(15,334
|
)
|
|
|
(1)
|
The table does not include substandard loans which were judged not to be impaired totaling $4.5 million and $12.1 million at June 30, 2013 and December 31, 2012, respectively.
|
|
|
(2)
|
Loan balances are presented net of undisbursed loan funds, partial charge-offs and interest payments recorded as reductions in principal balances for financial reporting purposes.
|
Nonaccrual Loans.
The composition of nonaccrual loans by status was as follows as of the dates indicated (dollars in thousands):
|
|
|
June 30, 2013
|
|
|
December 31, 2012
|
|
|
Increase (Decrease)
|
|
|
|
|
Balance
|
|
|
Percentage
of Total
|
|
|
Balance
|
|
|
Percentage
of Total
|
|
|
Balance
|
|
|
Percentage
of Total
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Bankruptcy or foreclosure
|
|
$
|
1,767
|
|
|
|
12.9
|
%
|
|
$
|
2,347
|
|
|
|
12.5
|
%
|
|
$
|
(580
|
)
|
|
|
0.4
|
%
|
|
Over 90 days past due
|
|
|
7,035
|
|
|
|
51.2
|
|
|
|
9,913
|
|
|
|
52.7
|
|
|
|
(2,878
|
)
|
|
|
(1.5
|
)
|
|
30-89 days past due
|
|
|
--
|
|
|
|
--
|
|
|
|
1,311
|
|
|
|
7.0
|
|
|
|
(1,311
|
)
|
|
|
(7.0
|
)
|
|
Not past due
|
|
|
4,925
|
|
|
|
35.9
|
|
|
|
5,253
|
|
|
|
27.8
|
|
|
|
(328
|
)
|
|
|
8.1
|
|
|
|
|
$
|
13,727
|
|
|
|
100.0
|
%
|
|
$
|
18,824
|
|
|
|
100.0
|
%
|
|
$
|
(5,097
|
)
|
|
|
--
|
|
The following table presents nonaccrual loan activity for the six months ended June 30, 2013 and 2012 (in thousands):
|
|
|
Six Months Ended
June 30, 2013
|
|
|
Six Months Ended
June 30, 2012
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance of nonaccrual loans—beginning of period
|
|
$
|
18,824
|
|
|
$
|
33,954
|
|
|
Loans added to nonaccrual status
|
|
|
1,663
|
|
|
|
7,717
|
|
|
Net cash payments
|
|
|
(3,644
|
)
|
|
|
(5,948
|
)
|
|
Loans returned to accrual status
|
|
|
(296
|
)
|
|
|
(4,801
|
)
|
|
Charge-offs to the ALLL
|
|
|
(1,597
|
)
|
|
|
(3,478
|
)
|
|
Transfers to REO
|
|
|
(1,223
|
)
|
|
|
(5,501
|
)
|
|
|
|
|
|
|
|
|
|
|
|
Balance of nonaccrual loans—end of period
|
|
$
|
13,727
|
|
|
$
|
21,943
|
|
Real Estate Owned
. Changes in the composition of real estate owned between December 31, 2012 and June 30, 2013 are presented in the following table (dollars in thousands).
|
|
|
December 31, 2012
|
|
|
Additions
|
|
|
Fair Value Adjustments
|
|
|
Net Sales Proceeds(1)
|
|
|
Net Gain (Loss)
|
|
|
June 30, 2013
|
|
|
One- to four-family residential
|
|
$
|
2,586
|
|
|
$
|
825
|
|
|
$
|
(61
|
)
|
|
$
|
(1,724
|
)
|
|
$
|
57
|
|
|
$
|
1,683
|
|
|
Land
|
|
|
6,583
|
|
|
|
108
|
|
|
|
(120
|
)
|
|
|
(1,915
|
)
|
|
|
313
|
|
|
|
4,969
|
|
|
Nonfarm nonresidential
|
|
|
7,489
|
|
|
|
303
|
|
|
|
(38
|
)
|
|
|
(2,443
|
)
|
|
|
4
|
|
|
|
5,315
|
|
|
Total
|
|
$
|
16,658
|
|
|
$
|
1,236
|
|
|
$
|
(219
|
)
|
|
$
|
(6,082
|
)
|
|
$
|
374
|
|
|
$
|
11,967
|
|
|
|
(1)
|
Net sales proceeds include $773,000 of loans made by the Bank to finance certain sales of real estate owned.
|
Classified Assets.
Federal regulations require that each insured savings association risk rate its assets on a regular basis. Substandard assets have one or more defined weaknesses and are characterized by the distinct possibility that some loss will be sustained if the deficiencies are not corrected. Doubtful assets have the weaknesses of substandard assets with the additional characteristic that the weaknesses make collection or liquidation in full on the basis of currently existing facts, conditions and values questionable, and there is a high possibility of loss. An asset classified loss is generally considered uncollectible and of such little value that continuance as an asset is not warranted. As of June 30, 2013 and December 31, 2012, the Bank did not have any assets classified as doubtful or loss. The table below summarizes the Bank’s classified assets as of the dates indicated (dollars in thousands):
|
|
|
June 30, 2013
|
|
|
December 31, 2012
|
|
|
June 30, 2012
|
|
|
Nonaccrual loans
|
|
$
|
13,727
|
|
|
$
|
18,824
|
|
|
$
|
21,943
|
|
|
Accruing classified loans
|
|
|
4,543
|
|
|
|
15,696
|
|
|
|
16,098
|
|
|
Classified loans
|
|
|
18,270
|
|
|
|
34,520
|
|
|
|
38,041
|
|
|
Real estate owned
|
|
|
11,967
|
|
|
|
16,658
|
|
|
|
25,168
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total classified assets
|
|
$
|
30,237
|
|
|
$
|
51,178
|
|
|
$
|
63,209
|
|
|
Texas Ratio (1)
|
|
|
30.9
|
%
|
|
|
42.7
|
%
|
|
|
55.8
|
%
|
|
Classified Assets Ratio (2)
|
|
|
36.3
|
%
|
|
|
61.6
|
%
|
|
|
74.8
|
%
|
|
|
(1)
|
Defined as the ratio of nonaccrual loans and real estate owned to Tier 1 capital plus the allowance for loan and lease losses.
|
|
|
(2)
|
Defined as the ratio of total classified assets to Tier 1 capital plus the allowance for loan and lease losses.
|
Classified loans decreased $16.3 million from December 31, 2012 to June 30, 2013, primarily due to the sale of $14.7 million of classified loans during the second quarter of 2013.
Allowance for Loan and Lease Losses.
The Bank maintains an allowance for loan and lease losses for known and inherent losses in the loan portfolio based on ongoing quarterly assessments of the loan portfolio. The estimated appropriate level of the ALLL is maintained through a provision for loan losses charged to earnings. Charge-offs are recorded against the ALLL when management believes the estimated loss has been confirmed. Subsequent recoveries, if any, are credited to the ALLL.
The ALLL consists of general and allocated (also referred to as specific) loan loss components. For loans that are determined to be impaired that are troubled debt restructurings (“TDRs”) and impaired loans where the relationship totals $250,000 or more, a specific loan loss allowance is established when the discounted cash flows or collateral value of the impaired loan is lower than its carrying value. The general loan loss allowance covers loans that are not impaired and impaired relationships under $250,000 and is based on historical loss experience adjusted for qualitative factors.
The ALLL represents management’s estimate of incurred credit losses inherent in the Bank’s loan portfolio as of the balance sheet date. The estimation of the ALLL is based on a variety of factors, including past loan loss experience, the current credit profile of the Bank’s borrowers, adverse situations that have occurred that may affect the borrowers’ ability to repay, the estimated value of underlying collateral, general economic conditions, and other qualitative factors. Losses are recognized when available information indicates that it is probable that a loss has been incurred and the amount of the loss can be reasonably estimated. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available or conditions change.
A loan is considered impaired when, based on current information and events, it is probable that the Bank will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the note. Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record, and the amount of the shortfall in relation to the principal and interest owed. Classified loans where the borrower’s total loan relationship exceeds $250,000 are evaluated quarterly for impairment on a loan-by-loan basis. Nonaccrual loans and TDRs are considered to be impaired loans. TDRs are restructurings in which the Bank, for economic or legal reasons related to the debtor’s financial difficulties, grants a concession to the debtor that the Bank would not otherwise consider. Impairment is measured quarterly on a loan-by-loan basis for all TDRs and impaired loans where the aggregate relationship balance exceeds $250,000 by either the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s obtainable market price, or the fair value of the collateral if the loan is collateral dependent. Impaired loans under this threshold are aggregated and included in loan pools with their ALLL calculated as described in the following paragraph.
Groups of smaller balance homogeneous loans are collectively evaluated for impairment. Homogeneous loans are those that are considered to have common characteristics that provide for evaluation on an aggregate or pool basis. The Bank considers the characteristics of (1) one- to four-family residential mortgage loans; (2) unsecured consumer loans; and (3) collateralized consumer loans to permit consideration of the appropriateness of the ALLL of each group of loans on a pool basis. The primary methodology used to determine the appropriateness of the ALLL includes segregating impaired loans from the pools of loans, valuing these loans, and then applying a loss factor to the remaining pool balance based on several factors including past loss experience, inherent risks, and economic conditions in the primary market areas.
In estimating the amount of credit losses inherent in the loan portfolio, various judgments and assumptions are made. For example, when assessing the condition of the overall economic environment, assumptions are made regarding market conditions and their impact on the loan portfolio. For impaired loans that are collateral dependent, the estimated fair value of the collateral may deviate significantly from the proceeds received when the collateral is sold in the event that the Bank has to foreclose or repossess the collateral.
The Company considers its ALLL of approximately $13.2 million to be adequate to cover losses inherent in its loan portfolio as of June 30, 2013. Actual losses may substantially differ from currently estimated losses. Adequacy of the ALLL is periodically evaluated, and the allowance could be significantly decreased or increased, which could materially affect the Company’s financial condition and results of operations.
INVESTMENT SECURITIES
The following table sets forth the carrying values of the Company's investment securities available for sale (dollars in thousands).
|
|
|
June 30,
2013
|
|
|
December 31,
2012
|
|
|
Increase
(Decrease)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Municipal securities
|
|
$
|
40,245
|
|
|
$
|
45,393
|
|
|
$
|
(5,148
|
)
|
|
Corporate debt securities
|
|
|
7,975
|
|
|
|
7,932
|
|
|
|
43
|
|
|
Total
|
|
$
|
48,220
|
|
|
$
|
53,325
|
|
|
$
|
(5,105
|
)
|
Municipal securities decreased due to calls and maturities. The overall yield of the investment portfolio was 2.69% as of June 30, 2013 compared to 2.85% at December 31, 2012.
DEPOSITS
Changes in the composition of deposits between June 30, 2013 and December 31, 2012, are presented in the following table (dollars in thousands).
|
|
|
June 30,
2013
|
|
|
December 31,
2012
|
|
|
Increase
(Decrease)
|
|
|
% Change
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Checking accounts
|
|
$
|
132,264
|
|
|
$
|
131,826
|
|
|
$
|
438
|
|
|
|
0.3
|
%
|
|
Money market accounts
|
|
|
39,597
|
|
|
|
40,818
|
|
|
|
(1,221
|
)
|
|
|
(3.0
|
)
|
|
Savings accounts
|
|
|
31,627
|
|
|
|
30,664
|
|
|
|
963
|
|
|
|
3.1
|
|
|
Certificates of deposit
|
|
|
238,405
|
|
|
|
251,743
|
|
|
|
(13,338
|
)
|
|
|
(5.3
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total deposits
|
|
$
|
441,893
|
|
|
$
|
455,051
|
|
|
$
|
(13,158
|
)
|
|
|
(2.9
|
)%
|
Deposits include $4.7 million of deposits held for sale in connection with the probable sale of our Farmington branch location, including $2.7 million of checking accounts, $1.2 million of money market accounts, and $0.8 million of savings accounts. Overall deposits decreased in the comparison period primarily due to the sale of $17.9 million of deposits in connection with the sale of the Bank’s Berryville branch on June 21, 2013. The Bank reduced the cost of its certificate of deposit accounts with the weighted average cost of funds decreasing from 1.32% at December 31, 2012 to 1.14% at June 30, 2013. The Bank manages the pricing of its deposits to maintain deposit balances commensurate with its overall balance sheet management and liquidity position. The overall cost of deposit funds decreased from 0.83% at December 31, 2012 to 0.71% at June 30, 2013.
OFF-BALANCE SHEET ARRANGEMENTS AND COMMITMENTS
In the normal course of business to meet the financing needs of its customers, the Bank is a party to financial instruments with off-balance sheet risk. These financial instruments include commitments to extend credit and standby letters of credit. Those instruments involve, to varying degrees, elements of credit risk in excess of the amount recognized in the consolidated statements of financial condition.
The Bank does not use financial instruments with off-balance sheet risk as part of its asset/liability management program or for trading purposes. The Bank’s exposure to credit loss in the event of nonperformance by the counterparty to the financial instrument for commitments to extend credit and standby letters of credit is represented by the contractual amounts of those instruments. The Bank uses the same credit policies in making commitments and conditional obligations for off-balance sheet arrangements as it does for on-balance sheet instruments.
Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses. The Bank evaluates each customer’s creditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Bank upon extension of credit, is based on management’s credit evaluation of the counterparty. Standby letters of credit are conditional commitments issued by the Bank to guarantee the performance of a customer to a third party. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers.
In the normal course of business, the Company makes commitments to buy or sell assets or to incur or fund liabilities. Commitments include, but are not limited to:
|
■
|
the origination, purchase or sale of loans;
|
|
■
|
the fulfillment of commitments under letters of credit, extensions of credit on home equity lines of credit, construction loans, and under predetermined overdraft protection limits; and
|
The funding period for construction loans is generally six to eighteen months and commitments to originate mortgage loans are generally outstanding for 60 days or less.
At June 30, 2013, the Bank’s off-balance sheet arrangements principally included lending commitments, which are described below. At June 30, 2013, the Company had no interests in non-consolidated special purpose entities.
At June 30, 2013, commitments included:
|
■
|
total approved loan origination commitments outstanding amounting to $29.2 million, including approximately $1.0 million of loans committed to sell;
|
|
■
|
rate lock agreements with customers of $6.0 million, all of which have been locked with an investor;
|
|
■
|
funded mortgage loans committed to sell of $3.4 million;
|
|
■
|
unadvanced portion of construction loans of $2.8 million;
|
|
■
|
unused lines of credit of $8.0 million;
|
|
■
|
outstanding standby letters of credit of $690,000; and
|
|
■
|
total predetermined overdraft protection limits of $8.6 million.
|
Total unfunded commitments to originate loans for sale and the related commitments to sell of $6.0 million meet the definition of a derivative financial instrument. The related asset and liability are considered immaterial at June 30, 2013.
Historically, a small percentage of predetermined overdraft limits have been used. At June 30, 2013, overdrafts of accounts with Bounce Protection
TM
represented usage of 2.28% of the limit.
Liquidity and Capital Resources
Liquidity management is both a daily and long-term function. The Bank's liquidity, represented by cash and cash equivalents and eligible investment securities, is a product of its operating, investing and financing activities. The Bank's primary sources of funds are deposits; borrowings; payments on outstanding loans; maturities, sales and calls of investment securities and other short-term investments; and funds provided from operations. While scheduled loan amortization and maturing investment securities and short-term investments are relatively predictable sources of funds, deposit flows and loan prepayments are greatly influenced by general interest rates, economic conditions and competition. Calls of investment securities are determined by the issuer and are generally influenced by the level of market interest rates at the bond’s call date compared to the coupon rate of the bond. The Bank manages the pricing of its deposits to maintain deposit balances at levels commensurate with the operating, investing and financing activities of the Bank. In addition, the Bank invests excess funds in overnight deposits and other short-term interest-earning assets that provide liquidity to meet lending requirements and pay deposit withdrawals.
When funds from the retail deposit market are inadequate for the liquidity needs of the Bank or the pricing of deposits are not as favorable as other sources, the Bank has borrowed from the FHLB of Dallas and has utilized the services of bulletin board deposit listing services and brokered deposits to acquire funds.
The Bank uses qualifying loans as collateral for FHLB advances. The FHLB retains custody and endorsement of the loans that collateralize the Bank’s outstanding borrowings with the FHLB. The FHLB currently allows an aggregate lendable value on qualifying loans (as defined) of approximately 90% of the outstanding balance of the loans pledged to the FHLB. During the six months ended June 30, 2013, FHLB borrowings decreased by $2.1 million, or 68%, from FHLB borrowings at December 31, 2012. At June 30, 2013, the Bank’s additional borrowing capacity with FHLB was $49.0 million, comprised of qualifying loans collateralized by first-lien one- to four-family mortgages with a lendable value of $50.0 million less outstanding advances at June 30, 2013 of $1.0 million. Outstanding borrowings with the FHLB are reported as “Other Borrowings” in the Company’s Condensed Consolidated Statements of Financial Condition.
The Bank uses qualifying investment securities and qualifying commercial real estate loans as collateral for the discount window. The FRB will permit only certain commercial real estate loans to be pledged as collateral for the discount window. At June 30, 2013, the Bank pledged qualifying commercial real estate loans with a collateral value of approximately $7.0 million, or 81% of the fair market value of the loans as determined by the FRB taking into consideration the rate and duration of the loans pledged. In addition, at June 30, 2013, the Bank pledged qualifying investment securities with a collateral value of approximately $7.6 million and a carrying value of approximately $8.0 million for access to the discount window. No FRB borrowings were outstanding at June 30, 2013.
At June 30, 2013, the Bank’s liquidity ratio was 24.3% which represents liquid assets as a percentage of deposits and borrowings. As of the same date, the Bank’s adjusted liquidity ratio was 37.5%, which includes liquid assets plus borrowing capacity at the FHLB and FRB as a percentage of deposits and borrowings. The Bank anticipates that it will continue to rely primarily on deposits, calls and maturities of investment securities, loan repayments, and funds provided from operations to provide liquidity. As necessary, the sources of borrowed funds described above will be used to augment the Bank’s funding sources. The Bank uses its sources of funds primarily to meet its ongoing commitments, to pay maturing savings certificates and savings withdrawals, to repay maturing borrowings, to fund loan commitments, and to purchase investment securities.
The Bank’s liquidity risk management program assesses our current and projected funding needs to ensure that sufficient funds or access to funds exist to meet those needs. The program also includes effective methods to achieve and maintain sufficient liquidity and to measure and monitor liquidity risk, including the preparation and submission of liquidity reports on a regular basis to the Board of Directors. The program also contains a Contingency Funding Plan that forecasts funding needs and sources under different stress scenarios. The Contingency Funding Plan approved by the Board of Directors is designed to respond to an overall decline in the economic environment, the banking industry or a problem specific to the Bank. A number of different contingency funding conditions may arise which may result in strains or expectation of strains in the Bank’s normal funding activities including customer reaction to negative news of the banking industry, in general, or the Bank, specifically. As a result of negative news, some depositors may reduce the amount of deposits held at the Bank if concerns persist, which could affect the level and composition of the Bank’s deposit portfolio and thereby directly impact the Bank’s liquidity, funding costs and net interest margin. The Bank’s funding costs may also be adversely affected in the event that activities of the FRB and the United States Department of the Treasury to provide liquidity for the banking system and improvement in capital markets are curtailed or are unsuccessful. Such events could reduce liquidity in the markets, thereby increasing funding costs to the Bank or reducing the availability of funds to the Bank to finance its existing operations and thereby adversely affect the Company’s results of operations, financial condition, future prospects, and stock price.
Since the Company is a holding company and does not conduct independent operations, its primary source of liquidity is dividends from the Bank. The Company has no borrowings from outside sources. The Company funds its expenses from cash deposits maintained in the Bank, which amounted to $1.2 million at June 30, 2013.
At June 30, 2013, the Bank's core and risk-based capital ratios amounted to 13.57% and 20.82%, respectively, compared to regulatory capital adequacy standards of 4% and 8%. However, the Bank has agreed with the OCC to maintain a Tier 1 (core) capital ratio of 8% and a total risk-based capital ratio of 12%.
CAUTIONARY STATEMENT ABOUT FORWARD-LOOKING STATEMENTS
This Form 10-Q contains certain forward-looking statements and information relating to the Company that are based on the beliefs of management as well as assumptions made by and information currently available to management. As used in this document, the words "anticipate," "believe," "estimate," "expect," "intend," "should" and similar expressions, or the negative thereof, as they relate to the Company or the Company's management, are intended to identify forward-looking statements.
The statements presented herein with respect to, among other things, the Company’s plans, objectives, expectations and intentions, including our pending merger with FNSC and the anticipated timing of and impact on the Company of such acquisition, anticipated changes in non-interest expenses in future periods (including changes as a result of the pending merger with FNSC), changes in earnings, continued increases in net interest income, hiring and acquisition possibilities, our belief that we have identified any problem assets and that our borrowers will continue to remain current on their loans, being well positioned to capitalize on potential opportunities in a healthy economy, impact of outstanding off-balance sheet commitments, sources of liquidity and that we have sufficient liquidity, the sufficiency of the allowance for loan losses, expected loan, asset, balance sheet and earnings growth, growth in new and existing customer relationships, potential increases in certain components of non-interest income, sale of existing other real estate owned and anticipated gains from such sales, expected losses on and our intentions with respect to our investment securities, the amount of potential problem loans, and financial and other goals and plans are forward looking.
Such statements reflect the current views of the Company with respect to future looking events and are subject to certain risks, uncertainties and assumptions, including those risk factors described in Part I, Item 1A. of the Company’s Annual Report on Form 10-K filed with the SEC on March 8, 2013 and in Part II, Item 1A. hereof. Should one or more of these risks or uncertainties materialize or should underlying assumptions prove incorrect, actual results may vary materially from those described herein as anticipated, believed, estimated, expected or intended. The Company cautions readers not to place undue reliance on any forward-looking statements. The Company does not undertake and specifically disclaims any obligation to revise any forward-looking statements to reflect the occurrence of anticipated or unanticipated events or circumstances after the date of such statements. These risks could cause actual results for the remainder of fiscal 2013 and beyond to differ materially from those expressed in any forward-looking statements made by, or on behalf of, us and could negatively affect the Company’s operating and stock performance.