Pursuant to collateral agreements, FHLB–IN advances are secured by the following assets:
The Company’s short-term borrowings include its Repo Sweeps which are treated as financings; the obligation to repurchase securities sold is reflected as short-term borrowings. The securities underlying these Repo Sweeps continue to be reflected as assets of the Company.
During 2004, the Company completed a restructuring of its FHLB advances by prepaying $400.0 million of callable fixed-rate advances with an average cost of 5.92% and an average remaining term of 64.2 months. These prepaid advances were replaced with $325.0 million of new non-callable FHLB advances. These new advances included an aggregate $271.0 million of non-callable fixed-rate FHLB advances with an average cost of 3.64% and an average term of 34.3 months in a laddered portfolio with maturities ranging from 21 to 60 months.
In conjunction with the FHLB debt restructuring, the Company paid $42.0 million of prepayment penalties related to the prepaid advances and recognized $9.8 million on the early extinguishment of debt as a charge to non-interest expense during 2004. The remaining $32.2 million of prepayment penalties was deferred as an adjustment to the carrying value of the borrowings and are recognized in interest expense as an adjustment to the cost of the new borrowings over their remaining life. At December 31, 2008, the Company has a total of $175,000 of deferred premium on the early extinguishment of debt remaining from the 2004 FHLB debt restructure which will be fully amortized by December 31, 2009.
Interest expense on borrowed money totaled $6.6 million, $11.9 million and $20.5 million for the years ended December 31, 2008, 2007 and 2006, respectively. Included in interest expense was $1.5 million, $4.5 million and $9.6 million, respectively, of amortization of the deferred premium on the early extinguishment of debt for the years ended December 31, 2008, 2007 and 2006.
At December 31, 2008, the Company had two lines of credit with a maximum of $30.0 million in unsecured overnight federal funds at the federal funds market rate at the time of any borrowing. At December 31, 2008, the Company borrowed $10.8 million on these lines at 0.45%. The maximum amount borrowed during the years ended December 31, 2008 and 2007 was $19.6 million and $11.3 million, respectively, and the weighted-average rate paid during the year was 2.42% and 5.17%, respectively.
At December 31, 2008, the Company also had a $5.0 million revolving line of credit. Each borrowing under the line of credit carries an interest rate of either the Prime Rate minus 75 basis points or the three month London Interbank Offered Rate, at the Company’s option. The line of credit was obtained by the Company and is secured by all of the stock of the Bank held by the Company. The Company has not borrowed any funds under this line of credit. The Company received notice on December 31, 2008 from the lender that it will not be renewing the line which matures on March 21, 2009. The Company is currently in discussions with other potential lenders to replace the maturing line; however, given current economic conditions and the de-leveraging taking place in the financial services industry, there are no assurances the Company will be able to secure a replacement facility.
The Company participates in an industry-wide, multi-employer, defined benefit pension plan, which covers full-time employees who have attained at least 21 years of age and completed one year of service. Benefits were frozen under this plan effective March 1, 2003. In addition, employees who would have been eligible after March 1, 2003 are not eligible to enter the plan. Although no further benefits will accrue while the freeze remains in place, the freeze does not reduce the benefits accrued to date.
CFS BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
Calculations to determine full-funding status are made annually as of June 30. Pension expense for the years ended December 31, 2008, 2007 and 2006 was $872,000, $455,000 and $1.9 million, respectively. Asset and plan benefit information is not available for participating associations on an individual basis.
The Company also participates in a single-employer defined contribution plan, which qualifies under Section 401(k) of the Internal Revenue Code. Beginning in 2008, all employees who have attained at least 21 years of age are eligible to participate in this Plan after three months of employment. Prior to 2008, employees also had to meet an eligibility requirement of working 250 hours during a three month period.
Effective January 1, 2008, the Company matches 100% of the employee’s contribution on the first 1% of the employee’s compensation, and 50% of the employee’s contribution on the next 5% of the employee’s compensation. In addition, employees are able to defer up to 100% of their compensation. Employees fully vest in the Company’s matching contribution after two years of service. Plan expense for the year ended December 31, 2008 was $359,000. Prior to 2008, the 401(k) plan allowed for employee contributions up to 12% of their compensation, which were then matched equal to 50% of the first 6% of the compensation contributed. The Company’s matching contribution for the 2007 Plan year was made to the 401(k) plan directly in the form of a supplemental contribution during the first quarter of 2008. Plan expense for the year ended December 31, 2007 was $267,000. Prior to 2007, the Company amended this Plan to allow for the Company match to be paid to eligible employees annually as shares distributed through the Company’s ESOP. Accordingly, the Company did not incur any expense under this Plan for the year ended December 31, 2006.
The Company provides supplemental retirement benefits for certain senior officers in the form of payments upon retirement, death, or disability. The annual benefit is based on actuarial computations of existing plans without imposing Internal Revenue Service limits. This plan was frozen in 2003 along with the Company’s pension plan. There was no expense related to this plan in 2008, 2007 and 2006.
9. SHARE-BASED COMPENSATION
The Company accounts for its stock options in accordance with Statement of Financial Accounting Standards No. 123(R),Share-Based Payment (SFAS 123(R)). SFAS 123(R) addresses all forms of share-based payment awards, including shares under employee stock purchase plans, stock options, restricted stock and stock appreciation rights. SFAS 123(R) requires all share-based payments to be recognized as expense, based upon their fair values, in the financial statements over the vesting period of the awards.
Omnibus Equity Incentive Plan
On April 29, 2008, the shareholders of the Company approved at the Annual Meeting the CFS Bancorp, Inc. 2008 Omnibus Equity Incentive Plan (Equity Incentive Plan) which had been approved by the Company’s Board of Directors on March 17, 2008. In connection with the approval of the Equity Incentive Plan, the Board of Directors froze the CFS Bancorp, Inc. 2003 Stock Option Plan and the CFS Bancorp, Inc. 1998 Recognition and Retention Plan such that no new awards will be made under either of those plans.
The Equity Incentive Plan authorizes the issuance of 270,000 shares of common stock of the Company. In addition, the 32,000 shares that had not yet been issued under the 2003 Stock Option Plan plus any shares subject to outstanding stock options under the 2003 Stock Option Plan that lapse or are unexercised at the end of the option term will be available for any type of stock-based awards in the future under the Equity Incentive Plan. Since January 1, 2008, there were a total of 32,500 stock options that lapsed under the 2003 Stock Option Plan, and these shares are eligible for awards under the Equity Incentive Plan. No more than 25,000 shares will be available for grant during any fiscal year to any one participant and no more than 120,000 shares in the aggregate will be granted in any single year. At December 31, 2008, 225,153 shares were available for future grants under the Equity Incentive Plan.
84
CFS BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
Awards under the Equity Incentive Plan may be subject to the achievement of performance goals based on specific business criteria set forth in the Equity Incentive Plan. If the performance goals are achieved, then continued service with the Company or one of its affiliates also will generally be required before the award becomes fully vested. Awards that are not subject to the achievement of performance goals will require continued service with the Company or one of its affiliates for specific time periods prior to full vesting of the award. The Compensation Committee will determine whether an award will be subject to the achievement of performance goals and, if so, which performance goals must be achieved. For further details about the Equity Incentive Plan and for a copy of the complete Equity Incentive Plan, see the Company’s Proxy Statement dated and filed with the Securities and Exchange Commission on March 17, 2008.
Restricted Stock
During 2008, the Compensation Committee of the Board of Directors granted awards under the Equity Incentive Plan. A total of 110,926 shares of restricted stock were granted to officers, directors and key employees of the Company. The awards included 65,034 shares of restricted stock as performance-based awards to a total of thirty-six officers and key employees. These awards are subject to the Company’s achievement of its performance targets for the year ended December 31, 2008. The awards also included 45,892 shares of restricted stock as service-based awards to eighteen key employees and the Company’s directors. The Company reissued treasury shares to satisfy the restricted stock awards.
The weighted-average fair market value of the restricted stock awards was $14.02 per share based on the fair market value on the grant dates and totaled $1.6 million. These restricted stock awards vest (and, with respect to performance-based awards, if earned) 33%, 33% and 34% on May 1, 2010, 2011 and 2012, respectively. The expense for these awards is being recorded over their requisite service period which is approximately 48 months from the date of grant. The Company estimates the impact of forfeitures based on its historical experience with previously granted restricted stock and will consider the impact of the forfeitures when determining the amount of expense to record for the restricted stock granted. The Company estimates the probable outcome of achieving its performance target related to the performance-based awards and revises the related expense accordingly.
The Company also has 105 shares of unvested restricted stock under the 1998 Recognition and Retention Plan which was established in February 1999 with shareholder approval. The Bank contributed $7.5 million to the RRP to purchase an aggregate total of 714,150 shares of Company common stock. On April 1, 1999, the Compensation Committee of the Board of Directors granted an aggregate of 707,000 shares under this plan to 92 participants. On April 1, 2003, the Compensation Committee made an additional grant of an aggregate of 21,000 shares to five participants. On April 1, 2004, the remaining 1,050 shares were granted to two participants. This plan was frozen effective January 1, 2008 and the 1,000 shares available at December 31, 2007 are no longer available for grant. The unvested shares remaining will vest on April 1, 2009. Expense for this plan is being recorded over a 60-month period from the date of grant and is based on the fair market value of the Company’s stock as of that date.
The compensation expense related to restricted stock for the years ended December 31, 2008, 2007 and 2006 totaled $109,000, $35,000 and $48,000, respectively. At December 31, 2008, the remaining unamortized cost of the restricted stock awards is reflected as a reduction in additional paid-in capital and totaled $1.5 million. This cost is expected to be recognized over a weighted-average period of 3.3 years.
The following table presents the activity for restricted stock for the year ended December 31, 2008.
| | | | | | Weighted-Average |
| | Number of | | Grant-Date Fair |
| | Shares | | Value |
| Unvested at December 31, 2007 | | 2,610 | | | $ | 13.87 | |
| Granted | | 110,926 | | | | 14.02 | |
| Vested | | (2,505 | ) | | | 13.84 | |
| Forfeited | | (1,579 | ) | | | 14.27 | |
| Unvested as of December 31, 2008 | | 109,452 | | | $ | 14.02 | |
85
CFS BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
Subsequent to December 31, 2008, 63,455 shares of performance-based restricted stock granted on May 1, 2008 was deemed unearned by the Compensation Committee of the Board of Directors due to the Company not meeting its performance targets for the year ended December 31, 2008. There was no expense recorded on these restricted stock shares during 2008.
On January 26, 2009, the Compensation Committee of the Board of Directors granted awards under the Equity Incentive Plan. A total of 113,772 shares of restricted stock were granted to officers and key employees of the Company. The grants included 93,572 shares of restricted stock as performance-based awards to a total of thirty officers and key employees. These awards are subject to the achievement of “core” diluted earnings per share targets of the Company for the year ended December 31, 2009. The grants also included 20,200 shares of restricted stock as service-based awards to twelve officers and key employees. Both the earned performance-based awards and the service-based awards will vest as follows:
| | Cumulative Percent |
| Date | | Vested |
| May 1, 2011 | | 33 | % |
| May 1, 2012 | | 66 | |
| May 1, 2013 | | 100 | |
Stock Options
The Company has stock option plans under which shares of Company common stock are reserved for the grant of both incentive and non-qualified stock options to directors, officers and employees. These plans were frozen in conjunction with the approval of the Equity Incentive Plan such that no new awards will be made under either of these plans. The dates the stock options are first exercisable and expire were determined by the Compensation Committee of the Company’s Board of Directors at the time of the grant. The exercise price of the stock options was equal to the fair market value of the common stock on the grant date. All of the Company’s options were fully vested as of December 31, 2005.
The following table presents the activity related to options under the Company’s stock option plans for the years ended 2008, 2007 and 2006.
| | 2008 | | 2007 | | 2006 |
| | | | | Weighted- | | | | | Weighted- | | | | | Weighted- |
| | Number of | | Average | | Number of | | Average | | Number of | | Average |
| | Shares | | Exercise Price | | Shares | | Exercise Price | | Shares | | Exercise Price |
| Outstanding at beginning of year | | 1,253,295 | | | $ | 12.23 | | 1,495,951 | | | $ | 12.09 | | 1,822,771 | | | $ | 11.78 |
| Granted | | — | | | | — | | — | | | | — | | — | | | | — |
| Exercised | | (67,050 | ) | | | 12.39 | | (242,456 | ) | | | 11.39 | | (320,820 | ) | | | 10.29 |
| Forfeited | | (56,000 | ) | | | 13.60 | | (200 | ) | | | 14.00 | | (6,000 | ) | | | 13.48 |
| Outstanding at end of year | | 1,130,245 | | | $ | 12.15 | | 1,253,295 | | | $ | 12.23 | | 1,495,951 | | | $ | 12.09 |
There were no stock options granted during 2008, 2007 or 2006.
86
CFS BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
Options outstanding and exercisable at December 31, 2008 are presented in the table below.
| | As of December 31, 2008 |
| | Outstanding and Exercisable |
| | | | Weighted- | | |
| | | | Average | | Weighted- |
| | | | Remaining | | Average |
| | | | Contractual | | Exercise |
| Range of Exercise Prices: | | Number | | Life | | Price |
| $8.19 — $8.99 | | 63,800 | | 1.3 | | $ | 8.48 | |
| $10.00 — $10.99 | | 338,950 | | 0.3 | | | 10.00 | |
| $11.00 — $11.99 | | 145,000 | | 2.3 | | | 11.25 | |
| $13.00 — $13.99 | | 374,445 | | 5.1 | | | 13.72 | |
| $14.00 — $14.76 | | 208,050 | | 4.9 | | | 14.58 | |
| Outstanding | | 1,130,245 | | 3.1 | | | 12.15 | |
At December 31, 2008, all of the Company’s outstanding stock options were out-of-the-money.
The aggregate intrinsic value of options exercised at the time of exercise during the years ended December 31, 2008, 2007 and 2006 was $134,000, $813,000 and $1.4 million, respectively. Cash received from option exercises during the years ended December 31, 2008, 2007 and 2006 totaled $830,000, $2.8 million and $3.3 million, respectively. The actual tax benefit realized for the tax deduction from option exercises totaled $46,000, $288,000 and $463,000, respectively, for the years ended December 31, 2008, 2007 and 2006.
The Company reissues treasury shares to satisfy option exercises.
Employee Stock Ownership Plan
In 1998, the Company established an internally leveraged ESOP for the employees of the Company and the Bank. The ESOP is a qualified benefit plan under Internal Revenue Service guidelines. It covers all full-time employees who have attained at least 21 years of age and completed one year of service. Upon formation, the ESOP borrowed $14.3 million from the Company and purchased 1,428,300 shares of common stock. During March 2007, the Company renegotiated the terms of the loan to the ESOP with the plan’s trustee which reduced the interest rate from 8.50% to 4.64% and extended the term of the loan by an additional eight years from 2009 to 2017. The modification also included event protection if the ESOP is terminated before the new maturity date of the loan due to a merger, sale or otherwise. In the event the ESOP is terminated due to one of these events, employees become fully vested and any unallocated stock will be distributed to the Plan participants instead of being applied to the repayment of the ESOP loan. In addition, the loan modification included a minimum funding requirement in which the market value of Company shares released from the ESOP suspense account must equal at least 4.1% of the aggregate eligible compensation of ESOP participants for the plan year allocated.
The Bank made contributions to the ESOP plan in order to pay down the outstanding loan totaling $3.1 million, $514,000 and $1.4 million during the years 2008, 2007 and 2006, respectively. Compensation expense related to the Company’s ESOP was $853,000, $288,000 and $1.4 million, respectively, for the years ended December 31, 2008, 2007 and 2006. The increase in the contributions to pay down the outstanding ESOP loan related to a principal prepayment of $2.8 million made to satisfy the above mentioned minimum funding requirement and to minimize the impact of this funding requirement in 2009.
87
CFS BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
The following table summarizes shares of Company common stock held by the ESOP:
| December 31, |
| 2008 | | 2007 |
| (Dollars in thousands) |
| Shares allocated to participants | | 836,960 | | | 775,345 |
| Unallocated and unearned shares | | 83,519 | | | 312,604 |
| | | 920,479 | | | 1,087,949 |
| Fair value of unallocated and unearned ESOP shares | $ | 326 | | $ | 4,592 |
During the first quarter of 2009, the Bank paid the remainder of the $1.2 million ESOP loan in full. The additional payment was made to take advantage of the low stock price existing during the 2009 period. As a result of the loan being paid in full, the remaining 83,519 shares were allocated to the participants and the Company recorded $235,000 in ESOP expense.
The Company also provides supplemental retirement benefits for certain senior officers under the ESOP. This benefit is also based on computations for the existing plan exclusive of Internal Revenue Service limits. Compensation expense related to this supplemental plan for the years ended December 31, 2008, 2007 and 2006, was $2,000, $31,000 and $31,000, respectively.
10. INCOME TAXES
The total income tax provision (benefit) was allocated as follows:
| Year Ended December 31, |
| 2008 | | 2007 | | 2006 |
| (Dollars in thousands) |
| Income (loss) from operations | $ | (8,673 | ) | | $ | 2,310 | | | $ | 618 | |
| Stockholders’ equity for compensation expense for | | | | | | | | | | | |
| tax purposes in excess of amounts recognized for | | | | | | | | | | | |
| financial reporting purposes | | (497 | ) | | | (288 | ) | | | (463 | ) |
| $ | (9,170 | ) | | $ | 2,022 | | | $ | 155 | |
The income tax provision (benefit) consists of the following:
| Year Ended December 31, |
| 2008 | | 2007 | | 2006 |
| (Dollars in thousands) |
| Current tax expense: | | | | | | | | | | |
| Federal | $ | 62 | | | $ | 1,338 | | $ | 948 | |
| State | | — | | | | — | | | — | |
| Deferred tax expense (benefit): | | | | | | | | | | |
| Federal | | (7,413 | ) | | | 942 | | | (88 | ) |
| State | | (1,322 | ) | | | 30 | | | (242 | ) |
| $ | (8,673 | ) | | $ | 2,310 | | $ | 618 | |
88
CFS BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
A reconciliation of the statutory federal income tax rate to the effective income tax rate is as follows:
| | Year Ended December 31, |
| | 2008 | | 2007 | | 2006 |
| Statutory rate | (34.0 | )% | | 34.0 | % | | 34.0 | % |
| State taxes | (4.4 | ) | | 0.2 | | | (2.7 | ) |
| Bank-owned life insurance | (2.2 | ) | | (5.7 | ) | | (9.4 | ) |
| Low-income housing tax credits | (1.8 | ) | | (4.0 | ) | | (5.6 | ) |
| Reversal of allocated tax reserves | — | | | — | | | (8.8 | ) |
| Other | (1.0 | ) | | (1.0 | ) | | 2.9 | |
| Effective rate | (43.4 | )% | | 23.5 | % | | 10.4 | % |
The Company’s effective tax rate benefit for 2008 was 43.4% compared to an effective tax rate expense of 23.5% for 2007. The significant change from income tax expense to an income tax benefit during 2008 was mainly a result of the pre-tax losses recognized during 2008. The overall effective tax rates continue to benefit from the Company’s investment in bank-owned life insurance and the application of available tax credits.
Significant components of deferred tax assets and liabilities are as follows:
| | December 31, |
| | 2008 | | 2007 |
| | (Dollars in thousands) |
| Deferred tax assets: | | | | | | |
| Allowance for losses on loans | $ | 5,812 | | $ | 3,061 | |
| Deferred compensation | | 222 | | | 919 | |
| Deferred loan fees | | 401 | | | 625 | |
| Depreciation/amortization | | 562 | | | 64 | |
| Net operating loss carryforwards | | 4,529 | | | 817 | |
| Alternative minimum tax carryforwards | | 821 | | | 821 | |
| General business tax credits | | 1,763 | | | 1,298 | |
| Other-than-temporary impairments on available-for-sale securities | | 1,709 | | | 90 | |
| Other | | 635 | | | 84 | |
| | | 16,454 | | | 7,779 | |
| Deferred tax liabilities: | | | | | | |
| Unamortized deferred premium on early extinguishment of debt | | 65 | | | 608 | |
| FHLB stock dividends | | 1,030 | | | 1,030 | |
| Other | | 336 | | | 350 | |
| | | 1,431 | | | 1,988 | |
| Net deferred tax asset | | 15,023 | | | 5,791 | |
| Tax effect of adjustment related to unrealized depreciation on available-for-sale securities | | 471 | | | (1,014 | ) |
| Net deferred tax assets including adjustments | $ | 15,494 | | $ | 4,777 | |
Based upon historical taxable income as well as projections of future taxable income, management believes that it is more likely than not that the deferred tax assets will be realized. Therefore, no valuation reserve was recorded at December 31, 2008 or 2007. Failure to achieve sufficient projected taxable income might affect the ultimate realization of the net deferred tax assets.
Prior to 1988, the Bank qualified as a bank under provisions of the Internal Revenue Code which permitted it to deduct from taxable income an allowance for bad debts, which differed from the provision for such losses charged to income. Retained earnings at December 31, 2008 and 2007 included approximately $12.5 million, for which no provision for income taxes has been made. If in the future this portion of retained earnings is distributed, or the Bank no longer qualifies as a bank for tax purposes, income taxes may be imposed at the then applicable rates. The unrecorded deferred tax liability at December 31, 2008 and 2007 would have been approximately $4.9 million.
89
CFS BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
At December 31, 2008, the Company had federal and state net operating losses of $33.4 million which are being carried forward to reduce future taxable income. The carryforwards expire between 2016 and 2028.
11. RELATED PARTY DISCLOSURES
The Company has no material related party transactions which would require disclosure. In compliance with applicable banking regulations, the Company may extend credit to certain officers and directors of the Company and its subsidiaries in the ordinary course of business under substantially the same terms as comparable third-party lending arrangements.
12. STOCKHOLDERS’ EQUITY AND REGULATORY CAPITAL
During 2008, the Company completed its 600,000 share repurchase plan announced in February 2007 by repurchasing 126,725 shares remaining under this plan at an average price of $14.41. In March 2008, the Company announced a new share repurchase plan for an additional 530,000 shares. Total shares available for repurchase under this plan are 448,612 at December 31, 2008.
The following table presents information with respect to the Company’s 2008 and 2007 share repurchase plans.
| 2008 Repurchase Plan | | 2007 Repurchase Plan |
| Shares | | Cost of | | Average | | Shares | | Cost of | | Average |
| Repurchased | | Shares | | Cost | | Repurchased | | Shares | | Cost |
| in Period | | Repurchased | | per Share | | in Period | | Repurchased | | per Share |
| (Dollars in thousands) |
| Years ended: | | | | | | | | | | | | | | | |
| 2007 | — | | $ | — | | $ | — | | 473,275 | | $ | 6,967 | | $ | 14.72 |
| 2008 | 81,388 | | | 1,171 | | | 14.39 | | 126,725 | | | 1,826 | | | 14.41 |
| Plan to date | 81,388 | | $ | 1,171 | | $ | 14.39 | | 600,000 | | $ | 8,793 | | $ | 14.66 |
OTS regulations impose limitations upon all capital distributions by a savings institution if the institution would not be “well-capitalized” after the distributions. Capital distributions include cash dividends, payments to repurchase or otherwise acquire its own stock, payments to shareholders of another institution in a cash-out merger and other distributions charged against capital. The regulations provide that an institution must submit an application to the OTS to receive approval of the capital distributions if the institution (i) is not eligible for expedited treatment; or (ii) for which its total amount of capital distributions for the applicable calendar year exceeds its net income for that year to date plus its retained income for the preceding two years; or (iii) would not be at least adequately capitalized following the distribution; or (iv) would violate a prohibition contained in a statute, regulation or agreement between the institution and the OTS by performing the capital distribution. Under any other circumstances, the institution would be required to provide a written notice to the OTS prior to the capital distribution. Based on its retained income for the preceding two years, the Bank is currently restricted from making any capital distributions without prior written approval from the OTS.
The principal sources of cash flow for the Company are dividends from the Bank and payments from the Bank on the ESOP loan. Various federal banking regulations and capital guidelines limit the amount of dividends that may be paid to the Company by the Bank. Future payments of dividends by the Bank are largely dependent upon individual regulatory capital requirements and levels of profitability.
The Bank is subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum requirements can initiate certain mandatory and possible additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Bank’s financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of the Bank’s assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices. The Bank’s capital amounts and classification are also subject to quantitative judgments by the regulators about components, risk weightings, and other factors.
90
CFS BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
Quantitative measures established by regulation to ensure capital adequacy require the Bank to maintain minimum amounts and ratios, set forth in the table below of the total risk-based, tangible, and core capital, as defined in the regulations. As of December 31, 2008, the Bank met all capital adequacy requirements to which it is subject.
As of December 31, 2008, the Bank is categorized as “well-capitalized” under the regulatory framework for prompt corrective action. To be categorized as “well-capitalized,” the Bank must maintain minimum total risk-weighted, tangible, and core ratios as set forth in the following table. There are no conditions or events since that date that management believes have changed the institution’s category. At December 31, 2008, the Bank’s adjusted total assets were $1.1 billion and its risk-weighted assets were $847.2 million.
| | | | | | | | | | | | | | | To Be Well-Capitalized |
| | | | | | | | For Capital Adequacy | | Under Prompt Corrective |
| | Actual | | Purposes | | Action Provisions |
| | Amount | | Ratio | | Amount | | Ratio | | Amount | | Ratio |
| | (Dollars in thousands) |
| As of December 31, 2008: | | | | | | | | | | | | | | | | | | | |
| Total capital to risk-weighted assets | $ | 111,941 | | 13.21 | % | | $ | 67,777 | | > | 8.00 | % | | $ | 84,722 | | > | 10.00 | % |
| Tier 1 (core) capital to risk-weighted assets | | 101,289 | | 11.96 | | | | 33,889 | | > | 4.00 | | | | 50,833 | | > | 6.00 | |
| Tier 1 (core) capital to adjusted total assets | | 101,289 | | 9.07 | | | | 44,683 | | > | 4.00 | | | | 55,854 | | > | 5.00 | |
| Tangible capital to adjusted total assets | | 101,289 | | 9.07 | | | | 16,756 | | > | 1.50 | | | | 22,341 | | > | 2.00 | |
| |
| As of December 31, 2007: | | | | | | | | | | | | | | | | | | | |
| Total capital to risk-weighted assets | $ | 128,225 | | 13.93 | % | | $ | 73,661 | | > | 8.00 | % | | $ | 92,077 | | > | 10.00 | % |
| Tier 1 (core) capital to risk-weighted assets | | 120,227 | | 13.06 | | | | 36,831 | | > | 4.00 | | | $ | 55,246 | | > | 6.00 | |
| Tier 1 (core) capital to adjusted total assets | | 120,227 | | 10.50 | | | | 45,782 | | > | 4.00 | | | | 57,227 | | > | 5.00 | |
| Tangible capital to adjusted total assets | | 120,227 | | 10.50 | | | | 17,168 | | > | 1.50 | | | | 22,891 | | > | 2.00 | |
91
CFS BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
13. COMMITMENTS
| December 31, |
| 2008 | | 2007 |
| (Dollars in thousands) |
| Type of commitment | | | | | |
| To originate retail loans: | | | | | |
| Fixed rates (5.63% - 6.50% in 2008 and 5.75% – 11.75% in 2007) | $ | 2,569 | | $ | 6,443 |
| Variable rates | | 760 | | | 968 |
| To originate commercial real estate non-owner occupied loans: | | | | | |
| Fixed rates (5.25% – 7.00% in 2008 and 6.25% – 8.38% in 2007) | | 7,010 | | | 12,322 |
| Variable rates | | 2,631 | | | 14,691 |
| To originate commercial real estate owner occupied loans: | | | | | |
| Fixed rates (6.95% – 7.50% in 2008) | | 1,115 | | | — |
| Variable rates | | 1,000 | | | — |
| To originate commercial real estate multifamily loans: | | | | | |
| Fixed rates (6.50% in 2008) | | 1,350 | | | — |
| To originate commercial and industrial loans: | | | | | |
| Fixed rates (5.00% – 8.00% in 2008 and 4.85% – 9.00% in 2007) | | 5,856 | | | 5,577 |
| Variable rates | | 11,765 | | | 1,291 |
| To originate commercial construction and land development loans: | | | | | |
| Fixed rates (5.68% – 7.50% in 2008) | | 2,100 | | | — |
| Variable rates | | 3,160 | | | — |
| Unused lines of credit and construction loans | | 106,473 | | | 155,345 |
| Letters of credit: | | | | | |
| Secured by cash | | 774 | | | 639 |
| Real estate | | 10,436 | | | 6,892 |
| Business assets | | 415 | | | 690 |
| Unsecured | | 313 | | | — |
| Other – Credit enhancements | | 27,086 | | | 31,257 |
The commitments listed above do not necessarily represent future cash requirements, in that these commitments often expire without being drawn upon. All commitments to extend credit or to purchase loans expire within the following year. Letters of credit expire at various times through 2012. Credit enhancements expire at various times through 2018.
The Company also has commitments to fund community investments through investments in limited partnerships, which represent future cash outlays for the construction and development of properties for low-income housing, small business real estate, and historic tax credit projects that qualify under the Community Reinvestment Act. These commitments include $793,000 to be funded over six years. The timing and amounts of these commitments are projected based upon the financing arrangements provided in each project’s partnership agreement, and could change due to variances in the construction schedule, project revisions, or the cancellation of the project. These commitments are not included in the commitment table above. See additional disclosures in Note 14.
Credit enhancements are related to the issuance by municipalities of taxable and nontaxable revenue bonds. The proceeds from the sale of such bonds are loaned to for-profit and not-for-profit companies for economic development projects. In order for the bonds to receive a triple-A rating, which provides for a lower interest rate, the FHLB-IN issues, in favor of the bond trustee, an Irrevocable Direct Pay Letter of Credit (IDPLOC) for the account of the Bank. Since the Bank, in accordance with the terms and conditions of a Reimbursement Agreement between the FHLB-IN and the Bank, would be required to reimburse the FHLB-IN for draws against the IDPLOC, these facilities are analyzed, appraised, secured by real estate mortgages, and monitored as if the Bank had funded the project initially.
92
CFS BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
The letters of credit and credit enhancements provided by the Company are considered financial guarantees under FASB Interpretation 45Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Othersand were carried at a fair value of $325,000 in the aggregate as of December 31, 2008.
14. VARIABLE INTEREST ENTITIES
The Company has investments in nine low-income housing tax credit limited partnerships and one limited liability partnership for the development of shopping centers, for-sale housing, and the restoration of historic properties in low- and moderate income areas. Although these partnerships generate operating losses, the Company realizes a return on its investment through reductions in income tax expense that result from tax credits and the deductibility of the entities’ operating losses. These investments were acquired at various times between 1996 and 2004 and are accounted for under the equity method. These entities are considered variable interest entities in accordance with FASB Interpretation No. 46 (Revised December 2003),Consolidation of Variable Interest Entities (FIN 46(R)). Since the Company is not considered the primary beneficiary of these entities, it is not required to consolidate these investments. The Company’s exposure is limited to its current recorded investment of $1.9 million plus $793,000 that the Company is obligated to pay over the next six years but has not yet funded.
15. FAIR VALUE OF FINANCIAL INSTRUMENTS
Effective January 1, 2008, the Company adopted Statement of Financial Accounting Standards No. 157,Fair Value Measurements (SFAS 157) which defines and establishes a framework for measuring fair value, when required or elected, and expands fair value disclosure requirements. At the same time, the Company also adopted Statement of Financial Accounting Standards No. 159,The Fair Value Option for Financial Assets and Financial Liabilities – Including an Amendment of FASB Statement No. 115 (SFAS 159) which permits the election of the fair value measurement method for certain financial assets and liabilities.
SFAS 157 establishes a fair value hierarchy that prioritizes the inputs used in valuation techniques, but not the valuation techniques themselves. The fair value hierarchy is designed to indicate the relative reliability of the fair value measure. The highest priority is given to quoted prices in active markets and the lowest to unobservable data such as the Company’s internal information. SFAS 157 defines fair value as “the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.” There are three levels of inputs into the fair value hierarchy (Level 1 being the highest priority and Level 3 being the lowest priority):
Level 1 – Unadjusted quoted prices for identical instruments in active markets;
Level 2 – Quoted prices for similar instruments in active markets; quoted prices for identical or similar instruments in markets that are not active; and model-derived valuations whose inputs are observable or whose significant value drivers are observable; and
Level 3 – Instruments whose significant value drivers or assumptions are unobservable and that are significant to the fair value of the assets or liabilities.
A financial instrument’s level within the fair value hierarchy is based on the lowest level of input that is significant to the fair value measurement.
93
CFS BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
The following table sets forth the Company’s financial assets by level within the fair value hierarchy that were measured at fair value on a recurring basis during 2008.
| | | | | | Fair Value Measurements Using |
| | | | | | Quoted Prices in | | | | | | | | |
| | | | | | Active Markets for | | Significant Other | | Significant Unobservable |
| | | | | | Identical Assets | | Observable Inputs | | Inputs |
| | Fair Value | | (Level 1) | | (Level 2) | | (Level 3) |
| | (Dollars in thousands) |
| Securities available-for-sale | $ | 251,270 | | | $ | — | | | $ | 227,137 | | | $ | 24,133 | |
Securities available-for-sale are measured at fair value on a recurring basis. Level 2 securities are valued by a third party pricing service commonly used in the banking industry utilizing observable inputs. The pricing provider utilizes evaluated pricing models that vary based on asset class. These models incorporate available market information including quoted prices of securities with similar characteristics and, because many fixed-income securities do not trade on a daily basis, apply available information through processes such as benchmark curves, benchmarking of like securities, sector groupings and matrix pricing. In addition, model processes, such as an option adjusted spread model is used to develop prepayment and interest rate scenarios for securities with prepayment features. Changes in the fair market value of the Company’s securities available-for-sale are recorded in other comprehensive income.
Level 3 models are utilized when quoted prices are not available for certain securities or in markets where trading activity has slowed or ceased. When quoted prices are not available and are not provided by third party pricing services, management judgment is necessary to determine fair value. As such, fair value is determined using discounted cash flow analysis models, incorporating default rates, estimation of prepayment characteristics and implied volatilities.
The Company determined that Level 3 pricing models should be utilized for valuing its investments in pooled trust preferred securities. The market for these securities at December 31, 2008 was not active and markets for similar securities were also not active. The inactivity was evidenced first by a significant widening of the bid-ask spread in the brokered markets in which pooled trust preferred securities trade and then by a significant decrease in the volume of trades relative to historical levels. During 2008, bid-ask spreads on these securities climbed as high as $25.00 from bid-ask spreads of less than $1.00 from when securities were actively traded. The new issue market is also inactive as no new trust preferred securities have been issued since 2007. There are currently very few market participants who are willing and or able to transact for these securities.
The market values for these securities (and any securities other than those issued or guaranteed by the U.S. Treasury) were very depressed at December 31, 2008 relative to historical levels. For example, the yield spreads for the broad market of investment grade and high yield corporate bonds reached all time wide levels versus U.S. Treasury securities at the end of November 2008 and remained near those levels at December 31, 2008. Thus in the current market, a low market price for a particular bond may only provide evidence of stress in the credit markets in general versus being an indicator of credit problems with a particular issuer.
Given conditions in the debt markets today and the absence of observable transactions in the secondary and new issue markets, management determined:
- the few observable transactions and market quotations that are available are not reliable for purposes of determining fair value at December 31, 2008; and
- an income valuation approach technique (present value technique) that maximizes the use of relevant observable inputs and minimizes the use of unobservable inputs will be equally or more representative of fair value than the market approach valuation technique.
All pooled trust preferred securities were issued between November 2004 and November 2007 and mature between December 2035 and March 2038. Of the five pooled trust preferred securities held by the Company, all are “Super Senior” and at December 31, 2008 are rated AAA. Subsequent to year end, four were downgraded to AA- and one was downgraded to A+.
94
CFS BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
Each of the securities held has at least one AAA-rated subordinate tranche and several other subordinate tranches supporting the Company’s “Super Senior” tranches. Interest payments are current on all of the securities held. Principal returns are increasingly directed to senior tranches as deferrals and defaults on the underlying collateral increase.
The Company’s internal model estimates expected future cash flows discounted using a rate management believes is representative of current market conditions. In determining expected cash flows, the Company assumed any defaulted underlying issues will not have any recovery and underlying issues that are currently deferring or in receivership or conservatorship will eventually default and not have any recovery. In addition, the Company’s internal model estimates cash flows to maturity and assumes no early redemptions of principal due to call options or successful auctions.
The following is a reconciliation of the beginning and ending balances of recurring fair value measurements recognized in the accompanying consolidated statement of condition using Level 3 inputs:
| | Available-for-sale Securities |
| | (Dollars in thousands) |
| Beginning balance December 31, 2007 | | $ | — | |
| Total realized and unrealized gains and losses: | | — | |
| Included in net income | | — | |
| Included in accumulated other comprehensive income | | (578 | ) |
| Purchases, sales, issuances and settlements, net | | (139 | ) |
| Transfers in and/or out of Level 3 | | | 24,850 | |
| Ending balance December 31, 2008 | | $ | 24,133 | |
The following table sets forth the Company’s financial assets by level within the fair value hierarchy that were measured at fair value on a non-recurring basis during 2008.
| | Fair Value Measurements Using |
| | | | | | Quoted Prices in | | | | | | | | |
| | | | | | Active Markets for | | Significant Other | | Significant Unobservable |
| | | | | | Identical Assets | | Observable Inputs | | Inputs |
| | Fair Value | | (Level 1) | | (Level 2) | | (Level 3) |
| | (Dollars in thousands) |
| Impaired loans | $ | 31,734 | | | $ | — | | | $ | — | | | $ | 31,734 | |
Fair value measurements for impaired loans are performed pursuant to Statement of Financial Accounting Standards (SFAS) No. 114,Accounting by Creditors for Impairment of a Loan, and are measured on a non-recurring basis. Certain impaired loans were partially charged-off or re-evaluated during 2008. These impaired loans were carried at fair value as estimated using current and prior appraisals, discounting factors, the borrowers’ financial results, estimated cash flows generated from the property and other factors. The change in fair value of impaired loans that were valued based upon Level 3 inputs was approximately $24.5 million for the year ended December 31, 2008. This loss is not recorded directly as an adjustment to current earnings or comprehensive income, but rather as a component in determining the overall adequacy of the allowance for losses on loans. These adjustments to the estimated fair value of impaired loans may result in increases or decreases to the provision for losses on loans recorded in current earnings.
The adoption of SFAS 159 permits entities to elect to measure many financial instruments and certain other assets and liabilities at fair value on an instrument-by-instrument basis (theFair Value Option) at specified election dates. At each subsequent reporting date, an entity is required to report unrealized gains and losses on items for which the fair value option has been elected in earnings at each subsequent reporting date. The objective of the statement is to provide entities with the opportunity to mitigate volatility in earnings caused by measuring related assets and liabilities differently without having to apply complex accounting provisions.
The Company is not currently engaged in any hedging activities and as a result did not elect to measure any financial instruments at fair value under SFAS 159.
95
CFS BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
Disclosure of fair value information about financial instruments, whether or not recognized in the consolidated statement of condition, for which it is practicable to estimate their value, is summarized below. The aggregate fair value amounts presented do not represent the underlying value of the Company.
The carrying amounts and fair values of financial instruments consist of the following:
| December 31, |
| 2008 | | 2007 |
| Carrying | | Fair | | Carrying | | Fair |
| Amount | | Value | | Amount | | Value |
| (Dollars in thousands) |
| Financial Assets | | | | | | | | | | | |
| Cash and cash equivalents | $ | 19,106 | | $ | 19,106 | | $ | 38,909 | | $ | 38,909 |
| Securities, available-for-sale | | 251,270 | | | 251,270 | | | 224,594 | | | 224,594 |
| Securities, held-to-maturity | | 6,940 | | | 7,101 | | | 3,940 | | | 3,978 |
| Federal Home Loan Bank stock | | 23,944 | | | 23,944 | | | 23,944 | | | 23,944 |
| Loans receivable, net of allowance for losses on loans | | 734,415 | | | 741,440 | | | 785,110 | | | 788,681 |
| Interest receivable | | 4,325 | | | 4,325 | | | 5,505 | | | 5,505 |
| Total financial assets | $ | 1,040,000 | | $ | 1,047,186 | | $ | 1,082,002 | | $ | 1,085,611 |
| Financial Liabilities | | | | | | | | | | | |
| Deposits | $ | 824,097 | | $ | 827,389 | | $ | 863,272 | | $ | 864,437 |
| Borrowed money | | 172,937 | | | 177,087 | | | 135,459 | | | 138,087 |
| Interest payable | | 370 | | | 370 | | | 755 | | | 755 |
| Total financial liabilities | $ | 997,404 | | $ | 1,004,846 | | $ | 999,486 | | $ | 1,003,279 |
The carrying amount is the estimated fair value for cash and cash equivalents, Federal Home Loan Bank stock, and accrued interest receivable and payable. Securities fair values are based on quotes received from a third-party pricing source and discounted cash flow analysis models.
The Company determined that for both variable-rate and fixed-rate loans, fair values are estimated using discounted cash flow analyses, with interest rates currently being offered for loans with similar terms and collateral to borrowers of similar credit quality.
The fair value of checking, savings, and money market accounts is the amount payable on demand at the reporting date. The fair value of fixed-maturity certificates of deposit is estimated by discounting the future cash flows using the rates currently offered for deposits of similar remaining maturities.
The fair value of borrowed money is estimated based on rates currently available to the Company for debt with similar terms and remaining maturities.
The fair value of the Company’s off-balance sheet instruments is nominal.
96
CFS BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
16. EARNINGS PER SHARE
The following table sets forth the computation of basic and diluted earnings per share:
| Year Ended December 31, |
| 2008 | | 2007 | | 2006 |
| (Dollars in thousands except per share data) |
| Net income (loss) | $ | (11,295 | ) | | $ | 7,525 | | $ | 5,340 |
| Weighted-average common shares outstanding | | 10,307,879 | | | | 10,547,853 | | | 11,045,857 |
| Weighted-average common share equivalents (1) | | 200,427 | | | | 294,929 | | | 348,006 |
| Weighted-average common shares and common share equivalents | | | | | | | | | |
| outstanding | | 10,508,306 | | | | 10,842,782 | | | 11,393,863 |
| Basic earnings (loss) per share | $ | (1.10 | ) | | $ | 0.71 | | $ | 0.48 |
| Diluted earnings (loss) per share | | (1.10 | ) | | | 0.69 | | | 0.47 |
| |
| Number of anti-dilutive stock options excluded from the diluted | | | | | | | | | |
| earnings per share calculation | | 657,100 | | | | 105,000 | | | 114,000 |
| Weighted-average exercise price of anti-dilutive option shares | $ | 12.63 | | | $ | 14.66 | | $ | 14.66 |
____________________
| (1) | | Assumes exercise of dilutive stock options, a portion of the unearned awards under the RRP and treasury shares held in Rabbi Trust accounts. |
17. OTHER COMPREHENSIVE INCOME (LOSS)
The related income tax effect and reclassification adjustments to the components of other comprehensive income for the periods indicated are as follows:
| Year Ended December 31, |
| 2008 | | 2007 | | 2006 |
| (Dollars in thousands) |
| Unrealized holding gains (losses) arising during the period: | | | | | | | | | | | |
| Unrealized net gains (losses) | $ | (8,389 | ) | | $ | 3,780 | | | $ | 2,744 | |
| Related tax (expense) benefit | | 3,078 | | | | (1,370 | ) | | | (1,035 | ) |
| Net | | (5,311 | ) | | | 2,410 | | | | 1,709 | |
| Less: reclassification adjustment for net gains (losses) realized during the period: | | | | | | | | | | | |
| Realized net gains (losses) | | (4,265 | ) | | | 536 | | | | 750 | |
| Related tax (expense) benefit | | 1,593 | | | | (200 | ) | | | (289 | ) |
| Net | | (2,672 | ) | | | 336 | | | | 461 | |
| Total other comprehensive income (loss) | $ | (2,639 | ) | | $ | 2,074 | | | $ | 1,248 | |
18. LEGAL PROCEEDINGS
A complaint was filed in September 2007 against Citizens Financial Bank in connection with an incident that occurred in February 2007 in which funds were electronically advanced on a line of credit to a checking account, and then wire transferred to a bank in another state. The complaint seeks compensation for actual damages, statutory damages, punitive damages, costs and reasonable attorney’s fees. The complaint also seeks the Bank to cease and desist from any and all attempts to collect the funds that were allegedly transferred from the accounts by unauthorized and fraudulent means and interest on those funds. The complaint also seeks the Bank to cease and desist any inaccurate credit reporting and correct any past inaccurate credit reporting related to this matter. In the event that judgment is entered for the plaintiffs, insurance would not be able to indemnify the Bank for punitive damages should they be assessed. The total potential exposure to the Bank is not quantifiable at this time insofar as the amount of damages being sought was not specifically set forth in the complaint and no other written demand has been made by the plaintiffs to the Bank.
97
CFS BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
A complaint was filed against Citizens Financial Bank in early 2009 arising from a lending relationship. The plaintiff is seeking unspecified damages based upon lender liability and breach of fiduciary duty theories. The Bank denies the claims asserted in the complaint. This case is in the early stages and is in discovery. The likelihood of an unfavorable outcome is neither probable nor remote, and as such, no conclusion can be made at this time. The Bank believes this complaint is a routine legal proceeding occurring in the ordinary course of its business as a lender.
Other than the above-referenced matters, the Company is involved in routine legal proceedings occurring in the ordinary course of its business, which, in the aggregate, are believed to be immaterial to the financial condition of the Company.
19. CONDENSED PARENT COMPANY FINANCIAL STATEMENTS
The following tables represent the condensed statement of condition as of December 31, 2008 and 2007 and condensed statements of operations and cash flows for the three years ended December 31, 2008 for CFS Bancorp, Inc., the parent company.
Condensed Statements of Condition
(Parent Company Only)
| December 31, |
| 2008 | | 2007 |
| (Dollars in thousands) |
| ASSETS |
| Cash on hand and in banks | $ | 3,667 | | $ | 3,011 |
| Securities available-for-sale | | — | | | 134 |
| Investment in subsidiary | | 106,275 | | | 125,956 |
| Loan receivable from ESOP | | 1,153 | | | 4,299 |
| Other assets | | 2,990 | | | 172 |
| Total assets | $ | 114,085 | | $ | 133,572 |
| LIABILITIES AND STOCKHOLDERS’ EQUITY |
| Liabilities: | | | | | |
| Accrued taxes and other liabilities | $ | 2,276 | | $ | 3,158 |
| Total stockholders’ equity | | 111,809 | | | 130,414 |
| Total liabilities and stockholders’ equity | $ | 114,085 | | $ | 133,572 |
Condensed Statements of Operations
(Parent Company Only)
| Year Ended December 31, |
| 2008 | | 2007 | | 2006 |
| (Dollars in thousands) |
| Dividends from subsidiary | $ | 7,750 | | | $ | 9,000 | | | $ | 13,134 | |
| Interest income | | 198 | | | | 251 | | | | 490 | |
| Net realized gains (losses) on the sale of available-for-sale investment securities | | (168 | ) | | | — | | | | 878 | |
| Non-interest expense | | (667 | ) | | | (636 | ) | | | (728 | ) |
| Net income before income taxes and equity in earnings of subsidiary | | 7,113 | | | | 8,615 | | | | 13,774 | |
| Income tax benefit (expense) | | 238 | | | | 146 | | | | (244 | ) |
| Net income before equity in undistributed earnings of subsidiary | | 7,351 | | | | 8,761 | | | | 13,530 | |
| Equity in undistributed loss of subsidiary | | (18,646 | ) | | | (1,236 | ) | | | (8,190 | ) |
| Net income (loss) | $ | (11,295 | ) | | $ | 7,525 | | | $ | 5,340 | |
98
CFS BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
Condensed Statements of Cash Flows
(Parent Company Only)
| | Year Ended December 31, |
| | 2008 | | 2007 | | 2006 |
| | (Dollars in thousands) |
| Operating activities: | | | | | | | | | | | | |
| Net income (loss) | | $ | (11,295 | ) | | $ | 7,525 | | | $ | 5,340 | |
| Adjustments to reconcile net income (loss) to net cash provided by operating activities: | | | | | | | | | | | | |
| Impairment of securities | | | 168 | | | | — | | | | — | |
| Equity in undistributed loss of subsidiary | | | 18,646 | | | | 1,236 | | | | 8,190 | |
| Net gains on the sale of available-for-sale investment securities | | | — | | | | — | | | | (878 | ) |
| (Increase) decrease in other assets | | | (2,818 | ) | | | 217 | | | | 812 | |
| Increase in other liabilities | | | 127 | | | | 593 | | | | 667 | |
| Net cash provided by operating activities | | | 4,828 | | | | 9,571 | | | | 14,131 | |
| Investing activities: | | | | | | | | | | | | |
| Proceeds from paydowns and sales of securities | | | — | | | | — | | | | 963 | |
| Principal payment on loan | | | 3,146 | | | | 514 | | | | 1,364 | |
| Net cash provided by investing activities | | | 3,146 | | | | 514 | | | | 2,327 | |
| Financing activities: | | | | | | | | | | | | |
| Purchase of treasury stock | | | (2,997 | ) | | | (9,751 | ) | | | (15,730 | ) |
| Net purchase of Rabbi Trust shares | | | 41 | | | | (139 | ) | | | (18 | ) |
| Proceeds from exercise of stock options | | | 830 | | | | 2,763 | | | | 3,300 | |
| Dividends paid on common stock | | | (5,192 | ) | | | (5,311 | ) | | | (5,604 | ) |
| Net cash used by financing activities | | | (7,318 | ) | | | (12,438 | ) | | | (18,052 | ) |
| Increase (decrease) in cash and cash equivalents | | | 656 | | | | (2,353 | ) | | | (1,594 | ) |
| Cash and cash equivalents at beginning of year | | | 3,011 | | | | 5,364 | | | | 6,958 | |
| Cash and cash equivalents at end of year | | $ | 3,667 | | | $ | 3,011 | | | $ | 5,364 | |
20. QUARTERLY FINANCIAL DATA (UNAUDITED)
The following table reflects summarized quarterly data for the periods presented (unaudited):
| | | | | Net | | Net | | Earnings (Loss) |
| | Interest | | Interest | | Income | | per Share |
| | Income | | Income | | (Loss) | | Basic | | Diluted |
| | (Dollars in thousands except per share data) |
| 2008 | | | | | | | | | | | | | | | | | | |
| First quarter | | $ | 16,314 | | $ | 8,565 | | $ | 1,779 | | | $ | 0.17 | | | $ | 0.17 | |
| Second quarter | | | 15,032 | | | 8,697 | | | (2,295 | ) | | | (0.22 | ) | | | (0.22 | ) |
| Third quarter | | | 14,364 | | | 8,907 | | | (1,039 | ) | | | (0.10 | ) | | | (0.10 | ) |
| Fourth quarter | | | 13,829 | | | 8,714 | | | (9,740 | ) | | | (0.95 | ) | | | (0.95 | ) |
| |
| 2007 | | | | | | | | | | | | | | | | | | |
| First quarter | | $ | 18,651 | | $ | 8,524 | | $ | 1,313 | | | $ | 0.12 | | | $ | 0.12 | |
| Second quarter | | | 18,484 | | | 8,638 | | | 2,281 | | | | 0.22 | | | | 0.21 | |
| Third quarter | | | 17,866 | | | 8,550 | | | 1,896 | | | | 0.18 | | | | 0.18 | |
| Fourth quarter | | | 17,240 | | | 8,395 | | | 2,035 | | | | 0.20 | | | | 0.19 | |
The significant decrease in net income for the fourth quarter of 2008 was primarily a result of the additional expense related to the Company’s provision for losses on loans.
99
CFS BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
21. FEDERAL DEPOSIT INSURANCE CORPORATION (FDIC) SPECIAL ASSESSMENT
Subsequent to December 31, 2008, the Board of Directors of the FDIC voted to adopt an interim rule that would impose a special assessment on insured institutions based upon the institutions’ outstanding deposits as of June 30, 2009. This assessment is to be collected on September 30, 2009. The interim rule would also permit the Board to impose an emergency special assessment after June 30, 2009 if deemed necessary by the FDIC Board.
100
| ITEM 9. | | CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURES |
None.
ITEM 9A. CONTROLS AND PROCEDURES
EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES
Management evaluated, with the participation of the Company’s Chief Executive Officer and Chief Financial Officer, the effectiveness of its disclosure controls and procedures (as defined in Rules 13a-15(e) or 15(d)-15(e) under the Securities Exchange Act of 1934, as amended) as of the end of the period covered by this report. Based on such evaluation, the Chief Executive Officer and Chief Financial Officer have concluded that the Company’s disclosure controls and procedures are designed to ensure that information required to be disclosed by the Company in the reports that it files or submits under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and regulations and are operating in an effective manner.
CHANGES IN INTERNAL CONTROL OVER FINANCIAL REPORTING
No change in the Company’s internal control over financial reporting (as defined in Rules 13a-15(f) or 15d-15(f) under the Securities Exchange Act of 1934, as amended) occurred during the quarter ended December 31, 2008 that has materially affected or is reasonable likely to materially affect, the Company’s internal control over financial reporting.
MANAGEMENT’S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING
The management of the Company is responsible for establishing and maintaining adequate internal control over financial reporting.
The Company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements in accordance with United States generally accepted accounting principles. The Company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the Company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with United States generally accepted accounting principles, and that receipts and expenditures of the Company are being made in accordance with authorizations of management and directors of the Company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the Company’s assets that could have a material effect on its financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. All internal control systems, no matter how well designed, have inherent limitations, including the possibility of human error and the circumvention of overriding controls. Accordingly, even effective internal control over financial reporting can provide only reasonable assurance with respect to financial statement preparation. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions or that the degree of compliance with the policies and procedures may deteriorate.
The Company’s management assessed its internal control over financial reporting as of December 31, 2008, as required by Section 404 of the Sarbanes-Oxley Act of 2002, based on the criteria for effective internal control over financial reporting described in the Internal Control-Integrated Framework adopted by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Based on this assessment, management concludes that, as of December 31, 2008, the Company’s internal controls over financial reporting are effective.
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The Company’s independent registered public accounting firm that audited the Company’s consolidated financial statements for the year ended December 31, 2008 has issued an attestation report on the effectiveness of the Company’s internal control over financial reporting. The report appears below.
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Audit Committee, Board of Directors and Stockholders
CFS Bancorp, Inc.
Munster, Indiana
We have audited CFS Bancorp, Inc.'s internal control over financial reporting as of December 31, 2008, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company's management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on the Company's internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of reliable financial statements in accordance with accounting principles generally accepted in the United States of America. Because management’s assessment and our audit were conducted to meet the reporting requirements of Section 112 of the Federal Deposit Insurance Corporation Improvement Act (FDICIA), our examination of CFS Bancorp, Inc.’s internal control over financial reporting included controls over the preparation of financial statement sin accordance with accounting principles generally accepted in the United States of America and with the instructions to the Consolidated financial Statements for Bank Holding Companies (Form FR Y-9C).(A). A company's internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with accounting principles generally accepted in the United States of America, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention, or timely detection and correction of unauthorized acquisition, use or disposition of the company's assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, CFS Bancorp, Inc. maintained, in all material respects, effective internal control over financial reporting as of December 31, 2008, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).
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We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated financial statements of CFS Bancorp, Inc. and our report dated March 5, 2009, expressed an unqualified opinion thereon.
Indianapolis, Indiana
March 5, 2009
ITEM 9B. OTHER INFORMATION
On January 26, 2009, the Compensation Committee of the Board of Directors granted awards under the Company’s 2008 Omnibus Equity Incentive Plan to the following named executive officers as identified in its Proxy Statement to be filed on or about March 16, 2009 who are currently employed by the Company as set forth in the following table. The performance-based awards are subject to the achievement of “core” diluted earnings per share targets of the Company for the year ended December 31, 2009.
| | | Maximum Number of | | |
| | | Performance-Based | | Number of Service- |
| Name | | Shares | | Based Shares |
| Daryl D. Pomranke | | 9,486 | | 4,800 |
| Charles V. Cole | | 6,828 | | 2,000 |
| Dale S. Clapp | | 6,186 | | 2,000 |
| Daniel J. Zimmer | | 4,638 | | 2,000 |
PART III.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
The information required herein is incorporated by reference from the sections of the Registrant’s Proxy Statement which is expected to be filed on or about March 16, 2009 (Proxy Statement) titledElection of Directors, Information Concerning Continuing Directors and Executive Officers, Section 16(a) Beneficial Ownership Reporting Complianceand Report of the Audit Committee. Information related to the Company’s Code of Conduct and Ethics is incorporated by reference from the Proxy Statement under the headingCode of Conduct and Ethics.
ITEM 11. EXECUTIVE COMPENSATION
The information required herein is incorporated by reference from the sections of the Registrant’s Proxy Statement titledExecutive Compensation, Director Compensation, Compensation Committee Interlocks and Insider ParticipationandReport of the Compensation Committee.
| ITEM 12. | | SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS |
The information required herein by Item 403 of Regulation S-K is incorporated by reference from the section of the Registrant’s Proxy Statement titledBeneficial Ownership of Common Stock by Certain Beneficial Owners and Management.
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Equity Compensation Plan Information. The following table sets forth certain information for all equity compensation plans and individual compensation arrangements (whether with employees or non-employees, such as directors), in effect as of December 31, 2008.
| | | | | | | | | | Number of Shares |
| | Number of Shares to Be | | | | | | Remaining Available |
| | Issued Upon the | | | | | | for Future Issuance |
| | Exercise of Outstanding | | Weighted-Average | | (Excluding Shares |
| | Options, Warrants and | | Exercise Price of | | Reflected in the |
| Plan Category | | Rights | | Outstanding Options | | First Column) |
| Equity Compensation Plans Approved by Security Holders | | | 1,239,697 | (1) | | $ | 12.15 | (2) | | | 225,153 | (3) |
| Equity Compensation Plans Not Approved by SecurityHolders | | | — | | | | — | | | | — | |
| Total | | | 1,239,697 | | | $ | 12.15 | | | | 225,153 | |
____________________
| (1) | | This amount includes 1,130,245 shares issuable upon the exercise of outstanding stock options and 109,452 shares of restricted stock that have been issued but not yet earned or vested. |
| |
| (2) | | Only outstanding stock options are included in this price. The outstanding restricted shares are not included in the weighted-average exercise price because these shares do not have an exercise price. |
| |
| (3) | | This amount represents the total number of shares available for issuance in the future pursuant to stock options and other stock-based awards under the 2008 Omnibus Equity Incentive Plan. |
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS AND DIRECTOR INDEPENDENCE
The information required herein is incorporated by reference from the sections of the Registrant’s Proxy Statement titledDirector Independenceand Related Party Transactions.
ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES
The information required herein is incorporated by reference from the section of the Registrant’s Proxy Statement titledFees Paid to the Independent Registered Public Accounting Firm.
PART IV.
ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
(a) Documents filed as part of this Report:
(1) The following consolidated financial statements of the Company are filed with this Form 10-K under Item 8:
| | Description | Page |
| Report of Independent Registered Public Accounting Firm | 65 |
| Consolidated Statements of Financial Condition at December 31, 2008 and 2007 | 66 |
| Consolidated Statements of Operations for the years ended December 31, 2008, 2007 and 2006 | 67 |
| Consolidated Statements of Changes in Stockholders’ Equity for the years ended December 31, 2008, 2007 and 2006 | 68 |
| Consolidated Statements of Cash Flows for the years ended December 31, 2008, 2007 and 2006 | 69 |
| Notes to Consolidated Financial Statements | 70 |
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(2) All schedules for which provision is made in the applicable accounting regulation of the SEC are omitted because they are not applicable or the required information is included in the Consolidated Financial Statements or notes thereto.
(3) The following exhibits are filed with the SEC as part of this Form 10-K or are incorporated herein by reference, and this list includes the Exhibit Index.
| 3.1 | | Articles of Incorporation of CFS Bancorp, Inc. (1) |
| 3.2 | | Bylaws of CFS Bancorp, Inc. (2) |
| 4.0 | | Form of Stock Certificate of CFS Bancorp, Inc. (3) |
| 10.1* | | Employment Agreement entered into between Citizens Financial Bank and Thomas F. Prisby (4) |
| 10.2* | | Employment Agreement entered into between CFS Bancorp, Inc. and Thomas F. Prisby (4) |
| 10.3* | | CFS Bancorp, Inc. Amended and Restated 1998 Stock Option Plan (5) |
| 10.4* | | CFS Bancorp, Inc. Amended and Restated 1998 Recognition and Retention Plan and Trust Agreement (5) |
| 10.5* | | CFS Bancorp, Inc. 2003 Stock Option Plan (6) |
| 10.6* | | Employment Agreement entered into between Citizens Financial Bank and Charles V. Cole (4) |
| 10.7* | | Employment Agreement entered into between CFS Bancorp, Inc. and Charles V. Cole (4) |
| 10.8* | | Amended and Restated Supplemental ESOP Benefit Plan of CFS Bancorp, Inc. and Citizens Financial Services, FSB (7) |
| 10.9* | | CFS Bancorp, Inc. Directors’ Deferred Compensation Plan (8) |
| 10.10* | | Separation Agreement entered into between CFS Bancorp, Inc., Citizens Financial Bank and Zoran Koricanac (8) |
| 10.11* | | Separation Agreement entered into between CFS Bancorp, Inc., Citizens Financial Bank and Thomas L. Darovic (9) |
| 10.12* | | CFS Bancorp, Inc. 2008 Omnibus Equity Incentive Plan (10) |
| 10.13* | | Employment Agreement entered into between Citizens Financial Bank and Daryl D. Pomranke (4) |
| 10.14* | | Employment Agreement entered into between CFS Bancorp, Inc. and Daryl D. Pomranke (4) |
| 10.15* | | CFS Bancorp, Inc. 2008 Cash Incentive Compensation Program (4) |
| 23.0 | | Consent of BKD, LLP |
| 31.1 | | Rule 13a-14(a) Certification of Chief Executive Officer |
| 31.2 | | Rule 13a-14(a) Certification of Chief Financial Officer |
| 32.0 | | Section 1350 Certifications |
____________________
| (1) | | Incorporated by Reference from the Company’s Definitive Proxy Statement from the Annual Meeting of Stockholders filed on March 25, 2005. |
| (2) | | Incorporated by Reference from the Company’s Form 8-K filed on October 25, 2007. |
| (3) | | Incorporated by Reference from the Company’s Annual Report on Form 10-K for the year ended December 31, 2006. |
| (4) | | Incorporated by Reference from the Company’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2008. |
| (5) | | Incorporated by Reference from the Company’s Definitive Proxy Statement for the Annual Meeting of Stockholders filed with the SEC on March 23, 2001. |
| (6) | | Incorporated by Reference from the Company’s Definitive Proxy Statement for the Annual Meeting of Stockholders filed with the SEC on March 31, 2003. |
| (7) | | Incorporated by Reference from the Company’s Annual Report on Form 10-K for the year ended December 31, 2004. |
| (8) | | Incorporated by Reference from the Company’s Form 8-K filed on November 16, 2007. |
| (9) | | Incorporated by Reference from the Company’s Form 8-K filed on January 3, 2008. |
| (10) | | Incorporated by Reference from the Company’s Definitive Proxy Statement for the Annual Meeting of Stockholders filed with the SEC on March 17, 2008. |
| | |
| * | | Indicates management contract or compensatory plan or arrangement required to be filed as an exhibit to this report. |
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SIGNATURES
In accordance with the requirements of Section 13 or 15(d) 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.
| | | CFS BANCORP, INC. |
| |
| Date: March 9, 2009 | By: | /s/ THOMAS F. PRISBY | |
| | | THOMASF. PRISBY |
| | | Chairman of the Board and |
| | | Chief Executive Officer |
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
| Name | | Title | | Date |
| /s/ THOMAS F. PRISBY | | Chairman of the Board and Chief Executive Officer | | |
| THOMAS F. PRISBY | | (principal executive officer) | | March 9, 2009 |
| |
| /s/ CHARLES V. COLE | | Executive Vice President and Chief Financial Officer | | |
| CHARLES V. COLE | | (principal financial and accounting officer) | | March 9, 2009 |
| |
| /s/ GREGORY W. BLAINE | | Director | | March 9, 2009 |
| GREGORY W. BLAINE | | | | |
| |
| /s/ GENE DIAMOND | | Director | | March 9, 2009 |
| GENE DIAMOND | | | | |
| |
| /s/ FRANK D. LESTER | | Director | | March 9, 2009 |
| FRANK D. LESTER | | | | |
| |
| /s/ ROBERT R. ROSS | | Director | | March 9, 2009 |
| ROBERT R. ROSS | | | | |
| |
| /s/ JOYCE M. SIMON | | Director | | March 9, 2009 |
| JOYCE M. SIMON | | | | |
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