The methods and assumptions used to estimate fair value are described as follows:
Carrying amount is the estimated fair value for cash and cash equivalents, accrued interest receivable and payable, demand deposits, short-term debt, and variable rate loans or deposits that reprice frequently and fully. For fixed rate loans or deposits and for variable rate loans or deposits with infrequent repricing or repricing limits, fair value is based on discounted cash flows using current market rates applied to the estimated life and credit risk. Fair value of debt is based on current rates for similar financing. It was not practicable to determine the fair value of Federal Home Loan Bank (“FHLB”) stock due to restrictions placed on its transferability. The fair value of off-balance-sheet items is not considered material.
17
FFD Financial Corporation
Item 2.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
Forward-Looking Statements
Certain statements contained in this report that are not historical facts are forward-looking statements that are subject to certain risks and uncertainties. When used herein, the terms “anticipates,” “plans,” “expects,” “believes,” and similar expressions as they relate to the Corporation or its management are intended to identify such forward looking statements. The Corporation’s actual results, performance or achievements may materially differ from those expressed or implied in the forward-looking statements. Risks and uncertainties that could cause or contribute to such material differences include, but are not limited to, general and local economic conditions, changes in the interest rate environment, competitive conditions in the financial services industry, changes in law, governmental policies and regulations, and rapidly changing technology affecting financial services.
Business Overview
The Corporation is a unitary savings and loan holding company incorporated in Ohio in 1996. Our primary business is the operation of the Bank, our principal subsidiary. The Bank is a federally chartered savings association established in 1898.
The Bank is a community-oriented financial institution offering a variety of financial services to meet the needs of the communities we serve. Its business model emphasizes personalized service, clients’ access to decision makers, solution-driven lending and quick execution, efficient use of technology and the convenience of remote deposit, telephone banking, and online internet banking. It attracts deposits from the general public and uses the deposits, together with borrowings and other funds, primarily to originate commercial and commercial real estate loans, single-family and multi-family residential mortgage loans, vehicle loans, boat loans and home equity lines of credit. The majority of its customers are consumers and small businesses.
Critical Accounting Policies
The financial condition and results of operations for the Corporation presented in the Consolidated Financial Statements, accompanying notes to the Consolidated Financial Statements and Management's Discussion and Analysis of Financial Condition and Results of Operations are, to a large degree, dependent upon the Corporation's accounting policies. The selection and application of these accounting policies involve judgments, estimates and uncertainties that are susceptible to change.
Critical accounting policies are those policies that require management's most difficult, subjective or complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain. The Corporation has identified the appropriateness of the allowance for loan losses as a critical accounting policy and an understanding of this policy is necessary to understand the financial statements. Footnote 3 (Loans), and Management Discussion and Analysis of Financial Condition and Results of Operations in the Form 10-K for the year ended June 30, 2010 provide detail regarding the Corporation's accounting for the allowance for loan losses. There have been no significant changes in the application of accounting policies since June 30, 2010.
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FFD Financial Corporation
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)
Liquidity
The objective of liquidity management is to ensure adequate cash flows to accommodate the demands of customers and provide adequate flexibility for the Corporation to take advantage of market opportunities under both normal operating conditions and under unpredictable circumstances of industry or market stress. Cash is used to fund loan purchases, the maturity of liabilities and, at times, deposit outflows and operating activities. The Corporation's principal sources of funds are deposits, amortization and prepayments of loans, maturities, sales and principal receipt from securities, borrowings, and operations. Management considers the Corporation's asset position to be sufficiently liquid to meet normal operating needs and conditions. The Corporation's earning assets are mainly comprised of loans and investment securities. Management continually strives to obtain the best mix of loans and investments to both maximize yield and insure the soundness of the portfolio, as wel l as to provide funding for loan demand.
Capital Resources
The Bank is subject to various regulatory capital requirements. Capital adequacy guidelines and prompt corrective-action regulations involve quantitative measures of assets, liabilities, and certain off-balance-sheet items calculated under regulatory accounting practices. Failure to meet various capital requirements can result in regulatory action that could have a direct material effect on the Corporation's financial statements. The Bank exceeded the regulatory requirements to be “well capitalized” at September 30, 2010. Management is not aware of any matters occurring subsequent to September 30, 2010 that would cause the Bank's capital category to change.
The Bank’s actual and required capital amounts (in thousands) and ratios are presented below at September 30, 2010.
| | | | | | | | | | | |
| Actual | | Required
For Capital
Adequacy Purposes | | To Be Well
Capitalized Under
Prompt Corrective
Action Regulations |
| Amount | | Ratio | | Amount | | Ratio | | Amount | | Ratio |
Total capital to risk
weighted assets | $20,027 | | 11.6% | | $13,804 | | 8.0% | | $17,255 | | 10.0% |
| | | | | | | | | & nbsp; | | |
Tier 1 (core) capital to risk
weighted assets | 18,556 | | 10.8% | | 6,902 | | 4.0% | | 10,353 | | 6.0% |
| | | | | | | | | & nbsp; | | |
Tier 1 (core) capital to
Adjusted assets | 18,556 | | 9.0% | | 8,229 | | 4.0% | | 10,286 | | 5.0% |
| | | | | | | | | & nbsp; | | |
Tangible capital (to adjusted
total assets) | 18,556 | | 9.0% | | 3,086 | | 1.5% | | N/A | | N/A |
General
The Corporation’s net income is dependent primarily on net interest income, which is the difference between the interest income earned on loans and securities and interest paid on deposits and borrowed funds. Net interest income is affected by regulatory, economic and competitive factors that influence interest rates, loan demand and deposit flows. Net income is also affected by, among other things, loan fee income, provisions for loan losses, service charges, gains on loan sales, operating expenses, and franchise and income taxes. Operating expenses principally consist of employee compensation and benefits, occupancy, and other general and administrative expenses. In general, results of operations are significantly affected by general economic and competitive conditions, particularly changes in market interest rates, government policies, and actions of regulatory authorities. Future changes in applicable laws, regulations or government policies may also materially im pact our performance.
19
FFD Financial Corporation
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)
General (continued)
On July 21, 2010, President Obama signed into law the Dodd-Frank Wall Street Return and Consumer Protection Act (“Dodd-Frank”). Dodd-Frank imposes new restrictions and an expanded framework of regulatory oversight for financial institutions, including depository institutions. In addition, the Dodd-Frank changes the jurisdictions of existing bank regulatory agencies, and in particular transfers the regulation of federal savings associations, such as the Bank, from the OTS to the Office of the Comptroller of the Currency (the “OCC”), effective one year from the effective date of the legislation, with a potential extension up to six months. Savings and loan holding companies, like the Corporation, will be regulated by the FRB. Because the Dodd-Frank Act requires various federal agencies to adopt a broad range of regulations with significant discretion, many of the details of the new law and the effects it will have on the Corporation will not be known for months or even years.
Many provisions of the Dodd-Frank Act will not be implemented immediately and will require interpretation and rule making by federal regulators. The Corporation is closely monitoring all relevant sections of the Dodd-Frank Act to ensure continued compliance with laws and regulations.
Management’s Discussion and Analysis represents a review of the Corporation’s consolidated financial condition and results of operations. This review should be read in conjunction with the Corporation’s Consolidated Financial Statements and related notes.
Discussion of Financial Condition Changes from June 30, 2010 to September 30, 2010
The Corporation’s total assets at September 30, 2010, were $205.8 million, a $688,000, or .3%, decrease from the total at June 30, 2010.
Cash and cash equivalents totaled $8.0 million at September 30, 2010, a decrease of $1.1 million, or 11.9%, from the total at June 30, 2010. Investment securities totaled $7.0 million at September 30, 2010, a $1.0 million, or 12.5%, decrease from the total at June 30, 2010, resulting from four investment securities that were called, which were partially offset by the purchase of three new investment securities. As a result of principal repayments, mortgage-backed securities totaled $267,000 at September 30, 2010, a $6,000, or 2.2%, decrease from the total at June 30, 2010.
Loans receivable, including loans held for sale, totaled $182.0 million at September 30, 2010, an increase of $1.8 million, or 1.0%, from the June 30, 2010 total. The portfolio of loans secured by one- to four-family residential real estate increased by $873,000, or 1.3%, to $69.0 million at September 30, 2010. Loans secured by nonresidential real estate and land totaled $81.9 million at September 30, 2010, an increase of $1.8 million, or 2.3%, from June 30, 2010. Commercial loans decreased $913,000, or 4.6%, from June 30, 2010 to a total of $19.1 million at September 30, 2010. Loan originations during the period totaling $31.6 million were substantially offset by principal repayments of $29.0 million, adjustments to the allowance for loan losses and net unamortized fees and costs. During the three-month period ended September 30, 2010, loan originations were comprised of $19.4 million of one- to four-family residential real estate loans, $7.3 million of nonresidential rea l estate loans, $1.3 million of consumer loans, $3.4 million of commercial loans, and $240,000 of multifamily real estate loans. Nonresidential real estate and commercial lending generally involve a higher degree of risk than one- to four-family residential real estate lending due to the relatively larger loan amounts and the effects of general economic conditions on the successful operation of income-producing properties and businesses. The Corporation endeavors to reduce this risk by evaluating the credit history and past performance of the borrower, the location of the real estate, the quality of the management operating the property or business, the debt service ratio, the quality and characteristics of the income stream generated by the property or business and appraisals supporting the real estate or collateral valuation.
20
FFD Financial Corporation
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)
Discussion of Financial Condition Changes from June 30, 2010 to September 30, 2010 (continued)
The allowance for loan losses totaled $2.1 million at September 30, 2010, an increase of $109,000, or 5.5%, from June 30, 2010, and represented 1.15% of total loans and 1.10% of total loans at those dates, respectively. The increase resulted from a provision of $186,000 and recoveries of $1,000, which were partially offset by charge-offs of $78,000. Management increased the allowance for loan losses despite the improving trends over the three month period with respect to lower impaired loans and lower nonaccruing loans. Management increased the allowance for loan losses despite improving trends in impaired loans and nonaccruing loans. Management felt the improved trends in credit quality should show longer sustainable results as economic conditions are still depressed and would need to improve before considering a decrease to the allowance for loan losses. Nonaccrual loans were $1.2 million at September 30, 2010 and $2.2 million at June 30, 2010, which represented .67% and 1.21% of total loans at those respective dates. Non-accruing non-residential real estate and land mortgage loans decreased by $856,000, one- to four-family properties secured by first liens increased by $31,000 and commercial and consumer loans did not change. The decrease in non-accruing non-residential real estate and land loans was partially due to the favorable resolution, resulting in no loss, of a large non-performing loan during the quarter. Delinquent loans to total loans were 1.24% at September 30, 2010 and 2.34% at June 30, 2010, due to a decrease in non-residential properties delinquent 90 days or more days, and one- to four-family properties secured by first liens delinquent 30 to 89 days. At September 30, 2010, there were no loans past due over 90 days and still on accrual. Although the Corporation experienced decreases in nonaccrual and delinquent loans from June 30, 2010 to September 30, 2010, there can be no assurance that decreases will occur in future periods. Management has reviewed these loans for loss exposure and believes they are adequately collateralized in the event of foreclosure. The composition of the loan portfolio remained relatively the same from June 30, 2010 to September 30, 2010. Residential real estate, one- to four-family and multifamily and nonresidential real estate and land loans make up most of the portfolio. Impaired loan balances were $2.8 million with an allowance of $630,000 and $3.9 million with an allowance of $582,000 at September 30, 2010 and June 30, 2010, respectively. Although management believes that the allowance for loan losses at September 30, 2010, is adequate based upon the available facts and circumstances, there can be no assurance that additions to the allowance will not be necessary in future periods, which could adversely affect the Corporation’s results of operations.
Prepaid expenses and other assets totaled $859,000 at September 30, 2010, a $457,000, or 34.7%, decrease from the June 30, 2010 balance of $1.3 million. $360,000 of the decrease resulted from the payment of a receivable from a Small Business Administration (SBA) loan in conjunction with a loan charge-off which had a SBA guarantee. The amortization of prepaid franchise tax and FDIC insurance premiums of $112,000 accounted for the remaining portion of the decrease and was offset by additional prepaid expenses in other operating accounts.
Deposits totaled $170.8 million at September 30, 2010, a $494,000, or .3%, decrease from total deposits at June 30, 2010. The Bank had a significant number of time deposits maturing during the quarter and experienced some deposit run-off due to investors pursuing higher yields. This run-off resulted in a decrease in interest bearing deposits of $1.7 million, or 1.1%, and was partially offset by an increase in non-interest bearing deposits of $1.2 million, or 9.3%. FHLB advances decreased .4% from $13.7 million at June 30, 2010 to $13.6 million at September 30, 2010. Other borrowed money, consisting of a line of credit with another financial institution, was unchanged with a balance of $630,000 at both June 30, 2010 and September 30, 2010.
Other liabilities totaled $1.6 million at September 30, 2010, a $578,000, or 26.4%, decrease from June 30, 2010. The decrease was primarily due to a $522,000 decrease in custodial payments in process accounts.
Shareholders’ equity totaled $18.5 million at September 30, 2010, an increase of $242,000, or 1.3%, from June 30, 2010. The increase was due to net earnings of $414,000, $6,000 from a stock option exercise, and partially offset by dividends of $172,000 and decreases in the unrealized gain on securities designated as available for sale of $5,000.
21
FFD Financial Corporation
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)
Comparison of Operating Results for the Three-Month Periods Ended September 30, 2010 and 2009
General
The Corporation’s net earnings totaled $414,000 for the three months ended September 30, 2010, an increase of $242,000, or 140.7%, from the net earnings of $172,000 recorded in the comparable period in 2009. The increase in net earnings resulted from increases of $297,000, or 19.3% in net interest income and $174,000, or 84.1%, in noninterest income, which were partially offset by increases of $105,000, or 129.6%, in the provision for losses on loans and $125,000, or 138.9%, in federal income tax expense.
Net Interest Income
The Bank experienced a favorable trend in net interest income this quarter as a result of its prior efforts to grow assets in its new market in Holmes county and the favorable re-pricing of a large block of time deposits. Total interest income increased $158,000, or 6.2%, to $2.7 million for the three months ended September 30, 2010, compared to the same period in 2009. The increase was due primarily to increases in average balances outstanding across all categories of interest earning assets and decreased costs of liabilities. Interest income on loans increased by $153,000, or 6.2%, due to an increase of $18.5 million, or 11.3%, in the average loan portfolio balance outstanding which was offset by a 27 basis point decrease in yield. Interest income on investment securities increased by $8,000, or 16.3%, to $57,000 due to a 20 basis point increase in yield and a $510,000, or 7.6%, increase in the average balance outstanding. Interest income on interest bearing deposits dec reased $2,000, or 6.45%, to a total of $29,000 for the three-months ended September 30, 2010, due to a $4.3 million, or 40.6%, decrease in the average balance outstanding, which was partially offset by a 68 basis point increase in yield. Interest income on mortgage-backed securities decreased by $1,000, or 33.3%, due to a decrease of $21,000, or 7.2%, in the average balance outstanding and a 129 basis point decrease in yield.
Total interest expense decreased by $139,000, or 13.9%, to $864,000 for the three months ended September 30, 2010, compared to the three months ended September 30, 2009. Interest expense on deposits decreased by $133,000, or 15.8%, due to a 51 basis point decrease in the average cost of deposits, to 1.65% for the 2010 period, which was partially offset by a $16.1 million, or 10.3%, increase in the average balance outstanding. Interest expense on borrowings decreased by $6,000, or 3.8%, due to a $155,000, or 1.1%, decrease in the average balance outstanding, and a 12 basis point decrease in the average cost.
As a result of the foregoing, net interest income increased by $297,000, or 19.3%, for the three months ended September 30, 2010, compared to the same period in 2009. The interest rate spreads were 3.62% and 3.23%, and the net interest margins were 3.72% and 3.38%, for the three-month periods ended September 30, 2010 and 2009, respectively.
Provision for Losses on Loans
The Corporation recorded a $186,000 provision for losses on loans during the three months ended September 30, 2010, and a $81,000 provision for the comparable quarter in 2009. The increase in the provision for losses on loans was due to management’s assessment of the loan portfolio, delinquency rates, net charge-offs, and current economic conditions. Net charge-offs were $77,000 for the quarter ended September 30, 2010 and $51,000 for the comparable quarter in 2009. The allowance for losses on loans as a percentage of loans receivable increased to 1.15% for September 30, 2010 compared to 1.10% at June 30, 2010. Although management believes that the provision was adequate at September 30, 2010, there can be no assurance that the loan loss allowance will be adequate to cover losses on nonperforming assets in the future, which could result in additions to the allowance and could adversely affect the Corporation’s results of operations.
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FFD Financial Corporation
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)
Comparison of Operating Results for the Three-Month Periods Ended September 30, 2010 and 2009 (continued)
Noninterest Income
Noninterest income totaled $381,000 for the three months ended September 30, 2010, an increase of $174,000, or 84.1%, from the 2009 total. Net gain on sale of loans increased by $189,000, or 266.2%, to $260,000 for the three months ended September 30, 2010, compared to $71,000 for the three months ended September 30, 2009. The increase in gain on sale of loans resulted from management’s efforts to utilize its strong mortgage banking unit during this time of significantly increased loan refinancing demand. This demand resulted in increased sales into the secondary mortgage market of newly originated loans and refinanced loans as a result of the prevailing low interest rate environment. Service charges on deposit accounts increased by $15,000, or 19.0%, to $94,000 for the three months ended September 30, 2010, compared to $79,000 for the same period in 2009. Mortgage servicing revenue decreased $28,000 in 2010 compared to the same period in 2009, due to greater amortiza tion expense and a smaller recovery of servicing rights fair value. The greater amortization expense partially resulted from the refinancing of older loans with greater original servicing rights valuation. The smaller recovery of servicing rights fair value primarily resulted from the slowing of declining interest rates.
Noninterest Expense
Noninterest expense totaled $1.4 million for the three months ended September 30, 2010, a decrease of $1,000, or .1%, compared to the same period in 2009. The decrease in noninterest expense includes decreases of $20,000, or 37.0%, in postage and stationary supplies, $14,000, or 26.4%, in advertising, $14,000, in loss on sale of real estate owned, $13,000, or 19.4%, in professional and consulting fees, $5,000, or 7.4%, in FDIC insurance expense, $4,000, or 6.9% in checking account maintenance expense and $1,000, or 2.5%, in ATM processing, which were offset by increases of $41,000, or 6.8%, in employee and director compensation and benefits, $23,000, or 18.6%, in occupancy and equipment expense, $5,000, or 2.9%, in other operating expense and $2,000, or 2.2%, in data processing. The increase in employee compensation was due to additional staffing to expand commercial loan production operations and normal merit increases. The increase in occupancy and equipment expense prim arily resulted from full operation of the Berlin office in the first quarter of 2010 as opposed to partial operations in the first quarter of 2009.
Federal Income Taxes
The Corporation recorded a provision for federal income taxes totaling $215,000 for the three months ended September 30, 2010, an increase of $125,000, or 138.9%, over the same period in 2009. The increase resulted from a $367,000, or 140.1%, increase in earnings before taxes. The Corporation’s effective tax rates were 34.2% and 34.4%, for the three-month periods ended September 30, 2010 and 2009, respectively.
ITEM 3: Quantitative and Qualitative Disclosures About Market Risk
Not required.
ITEM 4: Controls and Procedures
The Corporation’s Chief Executive Officer and Chief Financial Officer have evaluated the Corporation’s disclosure controls and procedures (as defined under Rules 13a-15 and 15d-15 of the Securities Exchange Act of 1934, as amended) as of the end of the period covered by this report. Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer have concluded that the Corporation’s disclosure controls and procedures are effective. There were no changes in the Corporation’s internal controls which materially affected, or are reasonably likely to materially effect, the Corporation’s internal controls over financial reporting.
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FFD Financial Corporation
PART II
