UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-QSB
(Mark One)
| x | QUARTERLY REPORT UNDER SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended December 31, 2006
| ¨ | TRANSITION REPORT UNDER SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the transition period from to
Commission File Number 0-24935
SERVICE BANCORP, INC.
(Exact name of small business issuer as specified in its charter)
| Massachusetts | 04-3430806 | |
| (State or other jurisdiction of incorporation or organization) | (I.R.S. Employer Identification Number) |
81 Main Street,
Medway, Massachusetts 02053
(Address of principal executive offices)
(888) 578-7282
(Issuer’s telephone number, including area code)
Not Applicable
(Former name, former address and former fiscal year, if changed since last report)
Check whether the issuer (1) filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the past 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days.
YES x NO ¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act)
YES ¨ NO x
State the number of shares outstanding of each of the issuer’s classes of common equity, as of the latest practical date: At January 31, 2007, there were 1,652,379 shares of common stock outstanding, par value $0.01 per share.
Transitional Small Business Disclosure Format (Check one): YES ¨ NO x
SERVICE BANCORP, INC. AND SUBSIDIARY
FORM 10-QSB
| Page | ||||
| PART I | FINANCIAL INFORMATION | |||
| Item 1. | ||||
Consolidated Balance Sheets as of December 31, 2006 and June 30, 2006 | 1 | |||
Consolidated Statements of Income for the quarter and six months ended December 31, 2006 and 2005 | 2 | |||
| 3 | ||||
Consolidated Statements of Cash Flows for the six months ended December 31, 2006 and 2005 | 5 | |||
| 6 | ||||
| Item 2. | 12 | |||
| Item 3. | 18 | |||
| PART II | OTHER INFORMATION | |||
| Item 1. | 19 | |||
| Item 2. | 19 | |||
| Item 3. | 19 | |||
| Item 4. | 19 | |||
| Item 5. | 19 | |||
| Item 6. | 20 | |||
| 21 | ||||
| ITEM 1. | Financial Statements |
SERVICE BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS (unaudited)
(Dollars in thousands, except share amounts)
December 31, 2006 | June 30, 2006 | |||||||
ASSETS | ||||||||
Cash and due from banks | $ | 6,318 | $ | 8,758 | ||||
Short-term investments | 1,199 | 5 | ||||||
Total cash and cash equivalents | 7,517 | 8,763 | ||||||
Securities available for sale, at fair value | 51,660 | 50,670 | ||||||
Securities held to maturity, at amortized cost | 1,723 | 2,392 | ||||||
Federal Home Loan Bank stock, at cost | 5,721 | 5,308 | ||||||
Loans | 334,335 | 325,028 | ||||||
Less allowance for loan losses | (3,346 | ) | (2,870 | ) | ||||
Loans, net | 330,989 | 322,158 | ||||||
Premises and equipment, net | 4,032 | 3,591 | ||||||
Accrued interest receivable | 1,947 | 1,746 | ||||||
Bank-owned life insurance | 4,934 | 4,845 | ||||||
Net deferred tax asset | 1,511 | 1,599 | ||||||
Other assets | 1,085 | 1,094 | ||||||
Total assets | $ | 411,119 | $ | 402,166 | ||||
LIABILITIES AND STOCKHOLDERS’ EQUITY | ||||||||
Deposits | $ | 262,439 | $ | 268,719 | ||||
Borrowings | 114,517 | 100,765 | ||||||
Subordinated debentures | 3,093 | 3,093 | ||||||
Other liabilities | 2,006 | 1,919 | ||||||
Total liabilities | 382,055 | 374,496 | ||||||
Stockholders’ equity: | ||||||||
Preferred stock, $.01 par value; 5,000,000 shares authorized, none issued | — | — | ||||||
Common stock, $.01 par value; 12,000,000 shares authorized, 1,712,630 issued | 17 | 17 | ||||||
Additional paid-in capital | 8,417 | 8,319 | ||||||
Retained earnings | 22,005 | 21,350 | ||||||
Accumulated other comprehensive income (loss) | (122 | ) | (721 | ) | ||||
Treasury stock, at cost – (60,251 and 59,451 shares, respectively) | (1,053 | ) | (1,023 | ) | ||||
Unearned ESOP shares – (1,807 and 5,026 shares, respectively) | (18 | ) | (51 | ) | ||||
Unearned restricted stock – (7,140 and 9,545 shares, respectively) | (182 | ) | (221 | ) | ||||
Total stockholders’ equity | 29,064 | 27,670 | ||||||
Total liabilities and stockholders’ equity | $ | 411,119 | $ | 402,166 | ||||
See accompanying notes to consolidated financial statements.
-1-
SERVICE BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF INCOME (unaudited)
(Dollars in thousands, except share amounts)
Quarter Ended December, 31, | Six Months Ended December, 31, | |||||||||||
| 2006 | 2005 | 2006 | 2005 | |||||||||
Interest and dividend income: | ||||||||||||
Interest and fees on loans | $ | 5,304 | $ | 4,426 | $ | 10,482 | $ | 8,533 | ||||
Interest and dividends on securities and Federal Home Loan Bank stock | 757 | 671 | 1,577 | 1,356 | ||||||||
Interest on short-term investments | 12 | — | 13 | 2 | ||||||||
Total interest and dividend income | 6,073 | 5,097 | 12,072 | 9,891 | ||||||||
Interest expense: | ||||||||||||
Interest on deposits | 1,812 | 1,067 | 3,526 | 2,011 | ||||||||
Interest on borrowings | 1,433 | 991 | 2,794 | 1,809 | ||||||||
Interest on subordinated debentures | 66 | 56 | 132 | 107 | ||||||||
Total interest expense | 3,311 | 2,114 | 6,452 | 3,927 | ||||||||
Net interest income | 2,762 | 2,983 | 5,620 | 5,964 | ||||||||
Provision for loan losses | 228 | 68 | 528 | 200 | ||||||||
Net interest income, after provision for loan losses | 2,534 | 2,915 | 5,092 | 5,764 | ||||||||
Non-interest income: | ||||||||||||
Customer service fees | 258 | 264 | 524 | 533 | ||||||||
Mortgage banking gains, net | 24 | 21 | 79 | 30 | ||||||||
Securities sales gains, net | 196 | 5 | 231 | 247 | ||||||||
Other income | 136 | 127 | 251 | 232 | ||||||||
Total non-interest income | 614 | 417 | 1,085 | 1,042 | ||||||||
Non-interest expense: | ||||||||||||
Salaries and employee benefits | 1,406 | 1,705 | 2,935 | 3,062 | ||||||||
Occupancy | 262 | 265 | 530 | 525 | ||||||||
Data processing | 231 | 205 | 457 | 411 | ||||||||
Equipment | 83 | 95 | 167 | 183 | ||||||||
Professional fees | 112 | 109 | 229 | 220 | ||||||||
Advertising | 80 | 89 | 171 | 178 | ||||||||
Other general and administrative | 377 | 345 | 716 | 671 | ||||||||
Total non-interest expense | 2,551 | 2,813 | 5,205 | 5,250 | ||||||||
Income before income taxes | 597 | 519 | 972 | 1,556 | ||||||||
Provision for income taxes | 191 | 191 | 317 | 548 | ||||||||
Net income | $ | 406 | $ | 328 | $ | 655 | $ | 1,008 | ||||
Weighted average shares outstanding (basic) | 1,642,093 | 1,622,266 | 1,640,829 | 1,621,059 | ||||||||
Weighted average shares outstanding (diluted) | 1,663,941 | 1,643,890 | 1,662,362 | 1,643,092 | ||||||||
Earnings per share (basic) | $ | 0.25 | $ | 0.20 | $ | 0.40 | $ | 0.62 | ||||
Earnings per share (diluted) | $ | 0.24 | $ | 0.20 | $ | 0.39 | $ | 0.61 | ||||
See accompanying notes to consolidated financial statements.
-2-
SERVICE BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY (unaudited)
SIX MONTHS ENDED DECEMBER 31, 2006 AND 2005
(Dollars in thousands, except share amounts)
| Common Stock | Additional Paid-in Capital | Retained Earnings | Accumulated Other Comprehensive Income (Loss) | Treasury Stock | Unearned ESOP Shares | Unearned Restricted Stock | Total | |||||||||||||||||||||||
Balance at June 30, 2006 | $ | 17 | $ | 8,319 | $ | 21,350 | $ | (721 | ) | $ | (1,023 | ) | $ | (51 | ) | $ | (221 | ) | $ | 27,670 | ||||||||||
Comprehensive income: | ||||||||||||||||||||||||||||||
Net income | — | — | 655 | — | — | — | — | 655 | ||||||||||||||||||||||
Net unrealized gain on securities available for sale, net of tax and reclassification adjustment | — | — | — | 599 | — | — | — | 599 | ||||||||||||||||||||||
Total comprehensive income | 1,254 | |||||||||||||||||||||||||||||
Common stock held by ESOP released and committed to be released (3,219 shares) | — | 64 | — | — | — | 33 | — | 97 | ||||||||||||||||||||||
Purchase of treasury stock (1,200 shares) | — | — | — | — | (37 | ) | — | — | (37 | ) | ||||||||||||||||||||
Stock option exercises (400 shares) | — | (1 | ) | — | — | 7 | — | — | 6 | |||||||||||||||||||||
Income tax benefit on options exercised | — | 3 | — | — | — | — | — | 3 | ||||||||||||||||||||||
Stock option compensation | — | 21 | — | — | — | — | — | 21 | ||||||||||||||||||||||
Amortization of restricted stock (2,405 shares) | — | 11 | — | — | — | — | 39 | 50 | ||||||||||||||||||||||
Balance at December 31, 2006 | $ | 17 | $ | 8,417 | $ | 22,005 | $ | (122 | ) | $ | (1,053 | ) | $ | (18 | ) | $ | (182 | ) | $ | 29,064 | ||||||||||
See accompanying notes to consolidated financial statements.
-3-
SERVICE BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY (unaudited)
SIX MONTHS ENDED DECEMBER 31, 2006 AND 2005 (concluded)
(Dollars in thousands, except share amounts)
| Common Stock | Additional Paid-in Capital | Retained Earnings | Accumulated Other Comprehensive Income (Loss) | Treasury Stock | Unearned ESOP Shares | Unearned Restricted Stock | Total | |||||||||||||||||||||||
Balance at June 30, 2005 | $ | 17 | $ | 7,930 | $ | 19,480 | $ | 480 | $ | (1,250 | ) | $ | (115 | ) | $ | (27 | ) | $ | 26,515 | |||||||||||
Comprehensive income: | ||||||||||||||||||||||||||||||
Net income | — | — | 1,008 | — | — | — | — | 1,008 | ||||||||||||||||||||||
Net unrealized loss on securities available for sale, net of tax and reclassification adjustment | — | — | — | (850 | ) | — | — | — | (850 | ) | ||||||||||||||||||||
Total comprehensive income | 158 | |||||||||||||||||||||||||||||
Common stock held by ESOP released and committed to be released (3,220 shares) | — | 56 | — | — | — | 32 | — | 88 | ||||||||||||||||||||||
Purchase of treasury stock (900 shares) | — | — | — | — | (27 | ) | — | — | (27 | ) | ||||||||||||||||||||
Stock option exercises (900 shares) | — | (5 | ) | — | — | 15 | — | — | 10 | |||||||||||||||||||||
Income tax benefit on options exercised | — | 6 | — | — | — | — | — | 6 | ||||||||||||||||||||||
Amortization of restricted stock (12,729 shares) | — | 19 | — | — | — | — | 307 | 326 | ||||||||||||||||||||||
Restricted stock grants (20,000 shares) | — | 214 | — | — | 326 | — | (540 | ) | — | |||||||||||||||||||||
Balance at December 31, 2005 | $ | 17 | $ | 8,220 | $ | 20,488 | $ | (370 | ) | $ | (936 | ) | $ | (83 | ) | $ | (260 | ) | $ | 27,076 | ||||||||||
See accompanying notes to consolidated financial statements.
-4-
SERVICE BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited)
(Dollars in thousands)
Six Months Ended December 31, | ||||||||
| 2006 | 2005 | |||||||
Cash flows from operating activities: | ||||||||
Net income | $ | 655 | $ | 1,008 | ||||
Adjustments to reconcile net income to net cash provided by operating activities: | ||||||||
Provision for loan losses | 528 | 200 | ||||||
Securities sales gains, net | (231 | ) | (247 | ) | ||||
Portfolio loan sales gains, net | (5 | ) | (17 | ) | ||||
Loans originated for sale | (8,860 | ) | (879 | ) | ||||
Sales of loans originated for sale | 8,415 | 879 | ||||||
Net amortization of securities | 14 | 19 | ||||||
Depreciation and amortization expense | 161 | 185 | ||||||
Stock-based compensation | 71 | 326 | ||||||
Increase in accrued interest receivable | (201 | ) | (139 | ) | ||||
Net amortization of deferred loan costs and premiums | 70 | 124 | ||||||
Bank-owned life insurance income | (89 | ) | (81 | ) | ||||
Deferred tax benefit | (233 | ) | (92 | ) | ||||
Other, net | 196 | (118 | ) | |||||
Net cash provided by operating activities | 491 | 1,168 | ||||||
Cash flows from investing activities: | ||||||||
Activity in securities available for sale: | ||||||||
Sales | 2,900 | 4,549 | ||||||
Maturities, prepayments and calls | 2,523 | 2,281 | ||||||
Purchases | (5,274 | ) | (8,307 | ) | ||||
Activity in securities held to maturity: | ||||||||
Maturities, prepayments and calls | 667 | 941 | ||||||
Net increase in loans, excluding loan purchases and sales | (9,786 | ) | (22,718 | ) | ||||
Sale of portfolio loans | 807 | 3,332 | ||||||
Purchase of banking premises and equipment | (602 | ) | (103 | ) | ||||
Purchase of Federal Home Loan Bank stock | (413 | ) | (901 | ) | ||||
Net cash used by investing activities | (9,178 | ) | (20,926 | ) | ||||
Cash flows from financing activities: | ||||||||
Net decrease in deposits | (6,280 | ) | (8,903 | ) | ||||
Proceeds from long term borrowings | 10,000 | 17,000 | ||||||
Repayment of long term borrowings | (2,048 | ) | (6,045 | ) | ||||
Net increase in short-term borrowings | 5,800 | 17,600 | ||||||
Purchase of treasury stock | (37 | ) | (27 | ) | ||||
Stock option exercises | 6 | 10 | ||||||
Net cash provided by financing activities | 7,441 | 19,635 | ||||||
Net change in cash and cash equivalents | (1,246 | ) | (123 | ) | ||||
Cash and cash equivalents at beginning of period | 8,763 | 9,761 | ||||||
Cash and cash equivalents at end of period | $ | 7,517 | $ | 9,638 | ||||
Supplementary information: | ||||||||
Interest paid on deposits | $ | 3,491 | $ | 2,010 | ||||
Interest paid on borrowings and subordinated debentures | 2,864 | 1,824 | ||||||
Income taxes paid | 453 | 520 | ||||||
See accompanying notes to consolidated financial statements.
-5-
SERVICE BANCORP, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements (unaudited)
| (1) | Basis of Presentation and Consolidation |
The accompanying unaudited consolidated financial statements include the accounts of Service Bancorp, Inc. (the “Company”) and its wholly-owned subsidiary, Strata Bank (the “Bank”), a Massachusetts chartered savings bank, and the Bank’s wholly-owned subsidiaries, Medway Security Corporation and Franklin Village Security Corporation, both of which engage solely in the purchase and sale of securities. All significant intercompany balances and transactions have been eliminated in consolidation.
These unaudited financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) for interim financial information and the instructions for Form 10-QSB and Item 310(b) of Regulation S-B. Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements. In the opinion of management, all adjustments (consisting only of normal recurring accruals) necessary for a fair presentation have been included. Interim results are not necessarily indicative of the results that may be expected for the entire year. Certain information and footnote disclosures normally included in the financial statements prepared in accordance with GAAP have been omitted. A summary of significant accounting policies followed by the Company is set forth in the Notes to Consolidated Financial Statements of the Company’s Annual Report on Form 10-KSB for the year ended June 30, 2006.
| (2) | Earnings per Share |
Basic earnings per share represents income available to common stockholders divided by the weighted-average number of common shares outstanding for the period. Diluted earnings per share reflects additional common shares (common stock equivalents) that would have been outstanding if dilutive potential shares had been issued, as well as any adjustment to income that would result from the assumed issuance. Potential common shares that may be issued by the Company relate to outstanding stock options and unvested restricted stock and are determined using the treasury stock method. Assumed conversion of the outstanding dilutive stock options and unvested restricted stock would increase the shares outstanding, but would not require an adjustment to income as a result of the conversion.
Weighted average diluted shares outstanding have been calculated based on the following:
Quarter Ended December 31, | Six Months Ended December 31, | |||||||
| 2006 | 2005 | 2006 | 2005 | |||||
Weighted average shares outstanding | 1,642,093 | 1,622,266 | 1,640,829 | 1,621,059 | ||||
Effect of dilutive stock options | 21,159 | 20,726 | 20,842 | 21,007 | ||||
Effect of unvested shares of restricted stock | 689 | 898 | 691 | 1,026 | ||||
Weighted average diluted shares outstanding | 1,663,941 | 1,643,890 | 1,662,362 | 1,643,092 | ||||
For the quarter and six months ended December 31, 2006, an average of 735 and 867 stock options, respectively, were anti-dilutive and therefore excluded from the earnings per share calculations. For the quarter and six months ended December 31, 2005, an average of 1,000 stock options were anti-dilutive and therefore excluded from the earnings per share calculations. For the quarter and six months ended December 31, 2006 and 2005 there were no unvested shares of restricted stock that were anti-dilutive and therefore excluded from the earnings per share calculations.
| (3) | Commitments |
At December 31, 2006, the Company had outstanding commitments to originate loans of $17.2 million. Unused lines of credit and open commitments available to customers at December 31, 2006 amounted to $59.4 million, of which $31.8 million were home equity lines of credit.
-6-
SERVICE BANCORP, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements (unaudited)(continued)
| (4) | Securities |
The following table sets forth the Company’s securities at the dates indicated.
| December 31, 2006 | June 30, 2006 | |||||||||||
| Amortized Cost | Fair Value | Amortized Cost | Fair Value | |||||||||
| (Dollars in thousands) | ||||||||||||
Securities available for sale: | ||||||||||||
Government sponsored enterprise obligations | $ | 17,219 | $ | 17,058 | $ | 15,929 | $ | 15,542 | ||||
Government sponsored enterprise mortgage-backed securities | 16,552 | 16,419 | 17,147 | 16,645 | ||||||||
Other debt securities | 14,677 | 14,677 | 15,202 | 14,976 | ||||||||
Municipal securities | 1,797 | 1,789 | 1,797 | 1,716 | ||||||||
Total debt securities available for sale | 50,245 | 49,943 | 50,075 | 48,879 | ||||||||
Marketable equity securities | 1,599 | 1,717 | 1,699 | 1,791 | ||||||||
Total securities available for sale | $ | 51,844 | $ | 51,660 | $ | 51,774 | $ | 50,670 | ||||
Securities held to maturity: | ||||||||||||
Government sponsored enterprise mortgage-backed securities | $ | 1,723 | $ | 1,746 | $ | 1,983 | $ | 1,987 | ||||
Other debt securities | — | — | 409 | 410 | ||||||||
Total securities held to maturity | $ | 1,723 | $ | 1,746 | $ | 2,392 | $ | 2,397 | ||||
| (5) | Loans |
The following table presents data relating to the composition of the Company’s loan portfolio by type of loan at the dates indicated.
| December 31, 2006 | June 30, 2006 | |||||||||||||
| Amount | Percent | Amount | Percent | |||||||||||
| (Dollars in thousands) | ||||||||||||||
Real estate loans: | ||||||||||||||
One-to four-family residential | $ | 146,776 | 44.03 | % | $ | 152,085 | 46.92 | % | ||||||
Residential construction | 7,172 | 2.15 | % | 5,558 | 1.71 | % | ||||||||
Residential loans held for sale | 1,110 | 0.33 | % | 665 | 0.21 | % | ||||||||
Commercial and multi-family | 96,908 | 29.06 | % | 88,970 | 27.45 | % | ||||||||
Commercial construction | 24,312 | 7.29 | % | 21,767 | 6.72 | % | ||||||||
Total real estate loans | 276,278 | 82.86 | % | 269,045 | 83.01 | % | ||||||||
Commercial loans | 31,059 | 9.31 | % | 29,522 | 9.11 | % | ||||||||
Consumer loans: | ||||||||||||||
Home equity | 19,456 | 5.83 | % | 18,680 | 5.76 | % | ||||||||
Second mortgages | 5,592 | 1.68 | % | 5,900 | 1.82 | % | ||||||||
Passbook secured | 272 | 0.08 | % | 244 | 0.08 | % | ||||||||
Other | 788 | 0.24 | % | 718 | 0.22 | % | ||||||||
Total consumer loans | 26,108 | 7.83 | % | 25,542 | 7.88 | % | ||||||||
Total gross loans | 333,445 | 100.00 | % | 324,109 | 100.00 | % | ||||||||
Net deferred loan costs and premiums | 890 | 919 | ||||||||||||
Allowance for loan losses | (3,346 | ) | (2,870 | ) | ||||||||||
Total loans, net | $ | 330,989 | $ | 322,158 | ||||||||||
-7-
SERVICE BANCORP, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements (unaudited)(continued)
| (6) | Deposits |
The following table indicates types and balances in deposit accounts at the dates indicated.
| December 31, 2006 | June 30, 2006 | |||||||||||
| Amount | Percent | Amount | Percent | |||||||||
| (Dollars in thousands) | ||||||||||||
Demand | $ | 38,658 | 14.73 | % | $ | 37,995 | 14.14 | % | ||||
NOW | 22,411 | 8.54 | % | 34,149 | 12.71 | % | ||||||
Money market deposits | 13,931 | 5.31 | % | 18,775 | 6.99 | % | ||||||
Regular and other savings | 53,102 | 20.23 | % | 56,600 | 21.06 | % | ||||||
Total non-certificate accounts | 128,102 | 48.81 | % | 147,519 | 54.90 | % | ||||||
Term certificates of $100,000 or greater | 42,666 | 16.26 | % | 36,169 | 13.46 | % | ||||||
Term certificates less than $100,000 | 79,671 | 30.36 | % | 75,031 | 27.92 | % | ||||||
Brokered term deposits | 12,000 | 4.57 | % | 10,000 | 3.72 | % | ||||||
Total certificate accounts | 134,337 | 51.19 | % | 121,200 | 45.10 | % | ||||||
Total deposits | $ | 262,439 | 100.00 | % | $ | 268,719 | 100.00 | % | ||||
| (7) | Borrowings |
Borrowings included overnight borrowings with the Federal Home Loan Bank of Boston (“FHLB”) of $17.1 million as of December 31, 2006 and $11.3 million as of June 30, 2006. In addition, borrowings included the following advances from the FHLB. The advances are presented by the earlier of the maturity date or the date callable by the FHLB.
| December 31, 2006 | June 30, 2006 | |||||||||||
| Amount | Percent | Amount | Percent | |||||||||
| (Dollars in thousands) | ||||||||||||
Less than one year | $ | 37,500 | 38.49 | % | $ | 37,500 | 41.92 | % | ||||
One to three years | 46,000 | 47.22 | % | 34,000 | 38.00 | % | ||||||
Greater than three years | 13,917 | 14.29 | % | 17,965 | 20.08 | % | ||||||
Total | $ | 97,417 | 100.00 | % | $ | 89,465 | 100.00 | % | ||||
| (8) | Subordinated Debentures |
In March 2004, Service Capital Trust I (“Trust I”), a newly formed trust sponsored by the Company, participated in a pooled offering of trust preferred securities. In connection with this offering, Trust I issued $3.1 million of trust preferred securities and reinvested the proceeds in a 30-year $3.1 million junior subordinated debenture issued by the Company. Interest is calculated on the subordinated debenture and trust preferred securities at a rate equal to the three-month London Interbank Offering Rate plus 285 basis points. The junior subordinated debenture represents the sole asset of Trust I. The Company has guaranteed, on a subordinated basis, distribution and other payments due on the trust preferred securities (the "Guarantee"). The Guarantee, when taken together with the Company's obligations under (i) the junior subordinated debenture; (ii) the indenture pursuant to which the junior subordinated debentures was issued; and (iii) the Amended and Restated Declaration of Trust governing Trust I, constitutes a full and unconditional guarantee of Trust I’s obligations under the trust preferred securities.
Under regulatory capital guidelines, trust preferred securities, within certain limitations, qualify as regulatory capital. Trust I, consistent with the Financial Accounting Standards Board Interpretation No. 46, “Variable Interest Entities”, is not consolidated in the consolidated financial statements of the Company. Therefore, the Company presents in its consolidated financial statements junior subordinated debt as a liability and its investment in Trust I as a component of other assets.
-8-
SERVICE BANCORP, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements (unaudited)(concluded)
| (9) | Share Based Compensation |
The Company adopted Statement of Financial Accounting Standards (“SFAS”) No. 123(R), “Share-Based Payment”, effective July 1, 2006 applicable to the Company’s share based compensation plans. The Company’s share based compensation plans are described in Note 12 to the Company’s consolidated financial statements included in its Form 10-KSB for the year ended June 30, 2006. No changes have been made to the plans during the six months ended December 31, 2006. In accordance with SFAS No. 123(R), for the quarter and six months ended December 31, 2006, the Company has expensed, on a straight line basis, the previously unrecognized compensation costs related to the non-vested portion of stock option awards granted and outstanding as of July 1, 2006 based on the grant-date fair value of those awards as calculated under the provisions of Statement No. 123. Fair value has been determined using Black-Scholes option-pricing model. Compensation costs are now being recognized over the period the employee or director is required to provide service to obtain the awards. The impact of adopting SFAS No. 123(R) was a reduction of income before income taxes of $10,000 and a reduction of net income of $9,000 for the quarter ended December 31, 2006. Basic earnings per share for the quarter ended December 31, 2006 was reduced by $0.01 while diluted earnings per share was unchanged. The impact of adopting SFAS No. 123(R) was a reduction of income before income taxes of $21,000 and a reduction of net income of $18,000 for the six months ended December 31, 2006. Basic earnings per share and diluted earnings per share for the six months ended December 31, 2006 was reduced by $0.01.
Prior to the adoption of SFAS No. 123(R), the Company accounted for the plans under the recognition and measurement principles of Accounting Principles Board (“APB”) Opinion No. 25. “Accounting for Stock Issued to Employees,” and related Interpretations. Accordingly, no stock option based employee and director compensation cost was reflected in net income, as all options granted under plans had an exercise price equal to the market value of the underlying common stock on the date of grant.
The following table illustrates the effect on net income and earnings per share if the Company had applied the fair value recognition provisions of SFAS No. 123(R) to stock option based compensation for the quarter and six months ended December 31, 2005.
Quarter Ended | Six Months Ended | |||||
| 2005 | 2005 | |||||
| (Dollars in thousands, except per share amounts) | ||||||
Net income, as reported | $ | 328 | $ | 1,008 | ||
Deduct: Total stock-based compensation expense determined under the fair value method, net of taxes | 8 | 15 | ||||
Pro forma net income | $ | 320 | $ | 993 | ||
Earnings per share (basic): | ||||||
As reported | $ | 0.20 | $ | 0.62 | ||
Pro forma | $ | 0.20 | $ | 0.61 | ||
Earnings per share (diluted): | ||||||
As reported | $ | 0.20 | $ | 0.61 | ||
Pro forma | $ | 0.19 | $ | 0.60 | ||
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SERVICE BANCORP, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements (unaudited)(continued)
Stock option activity under the Company’s share based compensation plan for the six months ended December 31, 2006 follows:
| Stock Options | Weighted Average Exercise Price | Weighted Term | Aggregate Intrinsic Value | ||||||||
| (Dollars in Thousands, Except Share Amounts) | |||||||||||
Outstanding at July 1, 2006 | 42,297 | $ | 12.13 | ||||||||
Granted | — | ||||||||||
Forfeited | (400 | ) | $ | 30.85 | |||||||
Exercised | (400 | ) | $ | 15.05 | |||||||
Outstanding at December 31, 2006 | 41,497 | $ | 11.92 | 4.5 years | $ | 833 | |||||
Exercisable at December 31, 2006 | 36,236 | $ | 11.51 | 4.4 years | $ | 742 | |||||
There were no new options granted during the six months ended December 31, 2006.
A summary of the status of the Company’s nonvested stock options as of December 31, 2006 and changes during the six months ended December 31, 2006 is as follows:
| Stock Options | Weighted Average Fair Value | |||||
Nonvested at July 1, 2006 | 5,661 | $ | 8.17 | |||
Granted | — | |||||
Vested | — | |||||
Forfeited | (400 | ) | $ | 16.40 | ||
Nonvested at December 31, 2006 | 5,261 | $ | 7.54 | |||
As of December 31, 2006, there was $1,000 of total unrecognized compensation cost related to nonvested stock options granted under the plan. That cost is expected to be recognized over a weighted-average period of less than one year. There were no stock options that vested during the six months ended December 31, 2006.
A summary of the status of the Company’s nonvested restricted stock as of December 31, 2006 and changes during the six months ended December 31, 2006 is as follows:
| Restricted Stock | Weighted Average Fair Value | ||||
Nonvested at July 1, 2006 | 11,951 | $ | 24.57 | ||
Granted | — | ||||
Vested | — | ||||
Forfeited | — | ||||
Nonvested at December 31, 2006 | 11,951 | $ | 24.57 | ||
There were no new restricted stock grants or restricted stock that vested during the six months ended December 31, 2006. Compensation expense relating to restricted stock amounted to $25,000 and $317,000 for the quarters ended December 31, 2006 and 2005, respectively. Compensation expense relating to restricted stock amounted to $50,000 and $326,000 for the six months ended December 31, 2006 and 2005, respectively. As of December 31, 2006, there was $193,000 of total unrecognized compensation cost related to nonvested restricted stock granted under the plan. That cost is expected to be recognized over a weighted-average period of 3.0 years.
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SERVICE BANCORP, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements (unaudited)(continued)
| (10) | Stock Repurchase Plan |
In February 2003, the Board of Directors of the Company approved a Stock Repurchase Plan under which the Company is authorized to acquire up to 4% of the outstanding common stock, or up to approximately 65,925 shares of the issued and outstanding shares of its common stock in the open market or in private transactions. Under the Stock Repurchase Plan, shares may be repurchased from time to time and in such amounts as market conditions warrant, subject to regulatory considerations. The following table provides information on the purchases of common stock under the Stock Repurchase Plan for the quarter ended December 31, 2006.
| Repurchase Plan Information | |||||||||
Period | Total number of shares purchased | Average price paid per share | Total number of publicly | Maximum number of shares that may yet be purchased under the plan | |||||
October 1, 2006 – October 31, 2006 | — | — | 18,983 | ||||||
November 1, 2006 – November 30, 2006 | 1,200 | $ | 30.54 | 1,200 | 17,783 | ||||
December 1, 2006 – December 31, 2006 | — | — | 17,783 | ||||||
Total | 1,200 | $ | 30.54 | 1,200 | 17,783 | ||||
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| ITEM 2. | Management’s Discussion and Analysis |
General
This quarterly report on Form 10-QSB contains forward-looking statements. For this purpose, any statements contained herein that are not statements of historical fact may be deemed to be forward-looking statements. Without limiting the foregoing, the words “believe”, “anticipates”, “plans”, “expects” and similar expressions are intended to identify forward-looking statements. There are a number of important factors that could cause the Company’s actual results to differ materially from those contemplated by such forward-looking statements. These important factors include, without limitation, competitive conditions in the Bank’s marketplace generally, the Bank’s continued ability to originate quality loans, fluctuation in interest rates including fluctuations which may affect the Bank’s interest rate spread, real estate conditions in the Bank’s lending areas, changes in the securities or financial markets, changes in loan defaults and charge-off rates, general and local economic conditions, the Bank’s continued ability to attract and retain deposits, the Company’s and the Bank’s ability to control costs, new accounting pronouncements, and changing regulatory requirements. The Company undertakes no obligation to publicly release the results of any revisions to those forward-looking statements, which may be made to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events.
Comparison of Financial Condition at December 31, 2006 and June 30, 2006
Total assets were $411.1 million at December 31, 2006, an increase of $8.9 million, or 2.2%, from the $402.2 million at June 30, 2006. Net loans increased $8.8 million, or 2.7%, to $331.0 million. The investment securities portfolio increased $734,000, or 1.3%, since June 30, 2006 to $59.1 million as of December 31, 2006. Short-term investments, which consists mostly of money market mutual fund investments and overnight federal funds sold, increased $1.2 million. Total deposits decreased $6.3 million, or 2.3%, since June 30, 2006 to $262.4 million at December 31, 2006. The Company increased borrowings from the Federal Home Loan Bank of Boston (“FHLB”) by $13.8 million, or 13.6%, since June 30, 2006, which provided further funding for loan growth.
Total investment securities, excluding FHLB stock, were $53.4 million at December 31, 2006, an increase of $321,000 since June 30, 2006. Purchases of government sponsored agency obligations totaling $2.4 million, mortgage-backed securities of $1.0 million and a $1.0 million corporate bond were only partially offset by reductions in investment securities due to amortization and prepayment on mortgage-backed securities, corporate bond sales and maturities, and sales of equity securities. The Company’s investment in FHLB stock increased $413,000 to $5.7 million at December 31, 2006 consistent with the requirements for additional borrowings from the FHLB.
Residential real estate loans are originated through the residential mortgage division of the Bank, the Strata Mortgage Center. During the six months ended December 31, 2006, the Strata Mortgage Center originated $16.5 million in residential real estate loans, which was $9.4 million, or 36.4%, lower than the same period last year, which reflects the slower residential real estate market this year. Also during the six months ended December 31, 2006, the Bank sold $9.2 million in residential loans compared with residential loan sales of $4.2 million during the same period last year. Total residential mortgage loans, net of principal payments, decreased $3.3 million, or 2.1%, since June 30, 2006 to $155.1 million at December 31, 2006. The Company expects that the combination of a slower residential loan market and continued residential loan sales to result in lower net residential loan growth this year compared with the year ended June 30, 2006. Home equity and second mortgage loans increased $468,000, or 1.9%, since June 30, 2006 to $25.0 million at December 31, 2006.
The Bank originated $21.9 million in commercial, commercial real estate and construction loans and lines of credit since June 30, 2006, which was $15.5 million, or 41.4%, lower than the $37.5 million originated during the same period last year. The lower level of commercial originations reflects the slower refinance activity in the commercial real estate market due to higher interest rates and slower demand for residential construction loans by developers reflecting, the Bank believes, an increase in the developer’s inventory of unsold residential homes. The net increase in the total commercial loan portfolio since June 30, 2006 was $12.0 million, or 8.6%.
Total deposits decreased $6.3 million, or 2.3%, since June 30, 2006 to $262.4 million at December 31, 2006. Demand deposits increased $663,000 since June 30, 2006 to $38.7 million. NOW deposits decreased $11.7 million due almost entirely to lower balances in certain NOW accounts used by attorneys in connection with residential loan closings. Money market and savings deposits decreased $4.8 million and $3.5 million, respectively. Certificates of deposit increased $13.1 million, or 10.8%, to $134.3 million due to certificate promotions during the period and a $2.0 million increase in brokered certificates of deposit.
Borrowings from the FHLB increased $13.8 million, or 13.6%, since June 30, 2006 to $114.5 million at December 31, 2006, and provided the additional funding for this year’s loan growth. The Company expects to utilize several sources of funds to support loan growth, including, but not limited to, running aggressive promotional campaigns for both core deposits and certificates of deposit, additional borrowings from the FHLB and correspondent banks as well as brokered certificates of deposit.
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Stockholders’ equity increased from $27.7 million, or 6.88% of total assets at June 30, 2006, to $29.1 million, or 7.07% of total assets at December 31, 2006. The increase in stockholders’ equity was due to the Company’s retained earnings since the beginning of the fiscal year and change in accumulated other comprehensive loss. Accumulated other comprehensive loss, which consists almost entirely of unrealized gains and losses on securities available for sale, decreased $599,000 during the six months ended December 31, 2006 due mostly to a decrease in market interest rates and resulting increase in the market value of debt securities.
Non-Performing Assets and Allowance for Loan Losses – Critical Accounting Estimate
The following table sets forth the Company’s non-performing assets at the dates indicated.
| December 31, 2006 | June 30, 2006 | |||||||
| (Dollars in thousands) | ||||||||
Non-accrual loans: | ||||||||
Residential real estate | $ | — | $ | — | ||||
Commercial and multi-family real estate | 1,609 | 747 | ||||||
Consumer | 4 | — | ||||||
Commercial | 697 | 862 | ||||||
Total | 2,310 | 1,609 | ||||||
Accruing loans more than 90 days past due | — | 420 | ||||||
Foreclosed assets | — | — | ||||||
Total non-performing assets | $ | 2,310 | $ | 2,029 | ||||
Total as a percentage of total assets | 0.56 | % | 0.50 | % | ||||
For the six months ended December 31, 2006, the Bank’s provision for loan losses was $528,000, compared to $200,000 recorded for the same period last year. The allowance for loan losses as a percentage of loans was 1.00% at December 31, 2006, compared to 0.88% at June 30, 2006. This year’s higher loan loss provision and increase in allowance as a percentage of total loans were due mostly to a required allowance for loan losses allocation during the six months ended December 31, 2006 to certain commercial relationships deemed by the Company to be impaired. During the six months ended December 31, 2006, recoveries from previously charged-off loans of $32,000 were received and $84,000 of loans were charged-off. For a further discussion of the allowance refer to the Company’s Annual Report on Form 10-KSB for the year ended June 30, 2006 under “Allowance for Loan Losses”. Nonperforming assets at December 31, 2006 were $2.3 million, or 0.56% of total assets, compared to $2.0 million or 0.50% at June 30, 2006. Non-accrual loans at December 31, 2006 included two commercial real estate loans, which required a corresponding valuation allowance of $25,000, and one commercial loan that required a corresponding valuation allowance of $317,000.
While management believes that, based on information currently available, the allowance for loan losses is sufficient to cover losses in the Bank’s loan portfolio at this time, no assurances can be given that the level of the allowance will be sufficient to cover loan losses or that future adjustments to the allowance will not be necessary if economic and/or other conditions differ substantially from the economic and other conditions considered by management in evaluating the adequacy of the current level of the allowance.
Comparison of Operating Results for the Quarter and Six Months Ended December 2006 and 2005
Overview
Operating results are primarily dependent on the Bank’s net interest income, which is the difference between the interest earned on the Bank’s earning assets (short-term investments, loans, and securities) and the interest paid on deposits and borrowings. Operating results are also affected by provisions for loan losses, the level of income from non-interest sources such as fees and sales of securities and residential loans, operating expenses and income taxes. Operating results are also significantly affected by general economic conditions, particularly changes in interest rates, as well as government policies and actions of regulatory authorities.
Net income for the quarter ended December 31, 2006 was $406,000 compared with $328,000 for the quarter ended December 31, 2005, an increase of $78,000, or 23.8%. The increase in net income was due to a higher non-interest income of $197,000, or 47.2%, and lower non-interest expense of $262,000, or 9.3%. Partially offsetting these increases to net income was a decrease in net interest income of $221,000, or 7.4%, and an increase in provision for loan loss of $160,000 compared with the same quarter a year ago. Net income for the six months ended December 31, 2006 was $655,000 compared with the $1.0 million for the six months ended December 31, 2005, a decrease of $353,000, or 35.0%. The lower net income was due to a decrease in net interest income of $344,000, or 5.8%, and a higher provision for loan loss by $328,000. Partially offsetting these decreases to net income was higher non-interest income by $43,000, or 4.1%, and a decrease in non-interest expense by $45,000, or 0.9%.
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Earnings per share for the quarter ended December 31, 2006 were $0.25 per share (basic) and $0.24 per share (diluted) compared with $0.20 per share (basic and diluted) for the quarter ended December 31, 2005. Earnings per share for the six months ended December 31, 2006 were $0.40 per share (basic) and $0.39 per share (diluted) compared with $0.62 per share (basic) and $0.61 per share (diluted) for the six months ended December 31, 2005.
Interest and Dividend Income
Total interest and dividend income for the quarter ended December 31, 2006 was $6.1 million, which was $976,000, or 19.1%, higher than the same quarter a year ago. Total interest and dividend income for the six months ended December 31, 2006 was $12.1 million, which was $2.2 million, or 22.1%, higher than the same period a year ago. Increases in average interest-earning assets of $41.5 million and $43.6 million to $388.5 million and $384.7 million for the quarter and six-month periods, respectively, were major contributors to the higher interest and dividend income. The yields on earning assets for the quarter and six months ended December 31, 2006 were 6.22% and 6.25%, 37 and 47 basis points higher, respectively, than the same periods last year.
Interest and fees on loans increased $878,000, or 19.8%, and $1.9 million, or 22.8% for the quarter and six months ended December 31, 2006, respectively, compared to the same periods last year. Average net loans for the quarter increased $35.5 million, or 12.1%, to $327.6 million, while the yield on loans increased 41 basis points to 6.44%. Average net loans for the six-month period increased $38.6 million, or 13.5%, while the yield on loans increased 49 basis points to 6.43%. The increase in yield on loans this quarter and the six-month period reflects the increase over the past year in index rates used to set interest rates for new loans and for loan re-pricing, particularly home equity and certain commercial loans which are tied to prime and re-price daily or monthly.
Interest and dividends on securities increased $86,000, or 12.8%, and $221,000, or 16.3%, for the quarter and six months ended December 31, 2006, respectively, compared to the same periods last year. The average securities portfolio balance increased $5.1 million, or 9.4%, this quarter, and the yield on the securities portfolio increased 15 basis points to 5.04%. Average securities for the six-month period increased $4.6 million, or 8.4%, and the yield on investment securities increased 36 basis points to 5.30%.
Interest Expense
Total interest expense increased $1.2 million, or 56.6%, for the quarter ended December 31, 2006 to $3.3 million compared to the same quarter last year due to an increase in average interest-bearing liabilities of $40.7 million, or 13.6%, to $339.2 million and an increase in the cost of interest-bearing liabilities of 106 basis points to 3.85%. Total interest expense increased $2.5 million, or 64.3%, for the six-months ended December 31, 2006 to $6.5 million compared to the same period last year due to an increase in average interest-bearing liabilities of $43.8 million, or 15.0%, to $336.7 million and an increase in the cost of interest-bearing liabilities of 114 basis points to 3.78%.
Interest expense on deposits increased $745,000, or 69.8%, to $1.8 million for the quarter ended December 31, 2006 and increased $1.5 million, or 75.3%, to $3.5 million for the six months ended December 31, 2006 compared with the same periods last year due to higher average deposits and cost of deposits. Average interest-bearing deposits increased $14.7 million and $13.1 million for the quarter and six months ended December 31, 2006, respectively, compared with the same periods last year. The average cost of deposits increased 120 basis points to 3.24% and 124 basis points to 3.15% for the quarter and six-months ended December 31 2006 compared with the same periods last year. The higher cost of deposits reflects the combination of the rising short-term market interest rate environment, the competitive market that the Bank operates in for certain deposits, and increased use of higher cost certificates of deposit as a source of funding.
Interest expense on borrowings and subordinated debt increased $452,000, or 43.2%, to $1.5 million for the quarter ended December 31, 2006 and increased $1.0 million, or 52.7%, to $2.9 million for the six months ended December 31, 2006 compared with the same periods last year due mainly to an increased level of FHLB borrowings in support of funding for loan growth. Average borrowings increased $26.0 million and $30.7 million for the quarter and six months ended December 31, 2006, respectively, compared with the same periods last year. The average cost of borrowings increased 51 basis points to 5.01% and 53 basis points to 4.98% for the quarter and six months ended December 31, 2006, compared to last year.
Net Interest Income
Net interest income for the quarter and six months ended December 31, 2006 decreased $221,000, or 7.4%, and $344,000, or 5.8%, respectively, compared with the same periods last year. The positive effect on interest income from the earning asset growth and higher asset yield was more than offset by the increase in interest expense due to an increase in interest-bearing liabilities, an increase in the cost of liabilities as well as a change in the mix of liabilities, reflecting increased reliance upon borrowings and higher-cost certificates of deposit. While a rising rate environment for short-term interest rates over the past year resulted in the increases in
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earning asset yield and cost of liabilities, this change in market interest rates disproportionately affected the Company’s interest expense, as certain of the Company’s liability costs have risen faster than yields on earning assets. The effect of the rising rate environment, together with the Company’s greater reliance on higher cost funding resulted in a decline in interest rate spread (the difference between yields earned on earning assets and rates paid on deposits and borrowings) of 69 basis points to 2.37% and decreased 67 basis points to 2.47% and decreased in interest rate margin (net interest income divided by average earning assets) of 59 basis points to 2.86% and 57 basis points to 2.94% for the quarter and six months ended December 31, 2006, respectively.
Although the Bank would prefer to rely primarily on, and intends to continue to seek, growth in core deposits to fund future loan growth, management expects that during the current fiscal year the Bank will need to rely more on higher-cost certificates and borrowings from the FHLB to meet its future funding requirements. The current unfavorable market interest rate conditions and continued competition from other financial institutions together with the aforementioned growth in retail certificates and borrowings would likely cause further tightening in the Bank’s interest rate spread for at least the next several quarters. The unfavorable effect on the Bank’s net interest income from a decline in its interest rate spread may more than offset the positive effect on the Bank’s net interest income from expected future loan growth.
The interest rate spread and margin for the periods indicated are as follows:
| Quarter Ended December 31, | Six Months Ended December 31, | |||||||||||
| 2006 | 2005 | 2006 | 2005 | |||||||||
Weighted average yield earned on: | ||||||||||||
Short-term investments | 5.21 | % | — | % | 5.19 | % | 3.05 | % | ||||
Securities | 5.04 | % | 4.89 | % | 5.30 | % | 4.94 | % | ||||
Total loans, net | 6.44 | % | 6.03 | % | 6.43 | % | 5.94 | % | ||||
All interest-earning assets | 6.22 | % | 5.85 | % | 6.25 | % | 5.78 | % | ||||
Weighted average rate paid on: | ||||||||||||
Deposits | 3.24 | % | 2.04 | % | 3.15 | % | 1.91 | % | ||||
Borrowed funds | 5.01 | % | 4.50 | % | 4.98 | % | 4.45 | % | ||||
All interest-bearing liabilities | 3.85 | % | 2.79 | % | 3.78 | % | 2.64 | % | ||||
Weighted average rate spread | 2.37 | % | 3.06 | % | 2.47 | % | 3.14 | % | ||||
Net interest margin | 2.86 | % | 3.45 | % | 2.94 | % | 3.51 | % | ||||
Non-interest Income
Total non-interest income was $614,000 for the quarter ended December 31, 2006, which was $197,000, or 47.2%, higher than the same quarter last year due mostly to higher gains from the sale of securities. Gains from the sale of securities for the quarter ended December 31, 2006 totaled $196,000 as the Company realized gains from the sale of several equity securities and a corporate bond. Gains from the sale of securities for the quarter ended December 31, 2005 totaled $5,000. Total non-interest income for the six months ended December 31, 2006 increased $43,000, or 4.1%, compared with the same period last year due mostly to an increase in mortgage banking gains of $49,000 due to an increase in residential loan sales this period compared with the same period last year. Partially offsetting this increase in non-interest income was a decrease in net gains on the sale of securities of $16,000.
Non-interest Expense
Total non-interest expense decreased $262,000, or 9.3%, to $2.6 million for the quarter ended December 31, 2006 and decreased $45,000, or 0.9%, for the six months ended December 31, 2006 compared with the same periods last year. Salary and benefits expense decreased $299,000 and $127,000 compared with the quarter and six-month periods, respectively, last year, which included higher equity compensation expenses by $281,000 and $255,000, respectively. The higher equity compensation expenses last year related mostly to restricted stock awards in December 2005. Data processing expense increased $26,000, or 12.7%, and $46,000, or 11.2%, for the quarter and six months ended December 31, 2006 compared with the same periods as last year, due to higher processing volumes and higher processing charges. Equipment expense was lower by $12,000, or 12.6%, and $16,000, or 8.7%, compared with the same periods last year due mostly to lower depreciation expense as older capital assets reached their depreciation lives. While spending on advertising is slightly behind the last year’s levels for the quarter and six-month periods, the increase in the other non-interest expense categories is consistent with the growth in operations of the Company over last year.
The operating efficiency ratio (total non-interest expense divided by the sum of net interest income plus total non-interest income) for the quarter ended December 31, 2006 was 75.6% compared with 82.7% for the same quarter a year ago. The operating
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efficiency ratio for the six months ended December 31, 2006 was 77.6% compared with 74.9% for the same six-month period a year ago.
Income Taxes
Income tax expense was $191,000 for the quarters ended December 31, 2006 and 2005. Income tax expense decreased $231,000 to $317,000 for the six months ended December 31, 2006. The effective income tax rates were 32.0% and 32.6% for the quarter and six months ended December 31, 2006, respectively, compared with 36.8% and 35.2%, respectively, for the same periods last year. The effective tax rates reflect the utilization by the Company of certain tax preference items such as bank-owned life insurance, dividends received deductions and security corporation subsidiaries to reduce the statutory corporate tax rates. Due to this year’s lower pre-tax income, tax preference items as a percentage of pre-tax income has increased, which has resulted in the decrease in effective tax rates for the quarter and six months ended December 31, 2006 compared with the same periods last year.
Asset/Liability Management
A principal operating objective of the Bank is to produce stable earnings by achieving a favorable interest rate spread that can be sustained during fluctuations in prevailing interest rates. Since the Bank’s principal interest-earning assets generally have longer terms to maturity than its primary source of funds, i.e., deposit liabilities, increases in general interest rates will generally result in an increase in the Bank’s cost of funds before the yield on its asset portfolio adjusts upward. Financial institutions have generally sought to reduce their exposure to adverse changes in interest rates by attempting to achieve a closer match between the repricing periods of interest rate sensitive assets and liabilities. Such matching, however, is carefully monitored so as not to sacrifice net interest margin performance for the perfect matching of these interest rate sensitive instruments. The Bank has established an Asset/Liability Management Committee (“ALCO”) made up of the chief executive officer, the chief financial officer, the senior loan officer, and others to assess the asset/liability mix and recommend strategies that will enhance income while managing the Bank’s vulnerability to changes in interest rate. This committee meets regularly to discuss interest rate conditions and potential product lines that would enhance the Bank’s income performance.
Certain strategies have been implemented to improve the match between interest rate sensitive assets and liabilities. These strategies include, but are not limited to: daily monitoring of the Bank’s cash requirements, originating adjustable and fixed rate mortgage loans, both residential and commercial, for the Bank’s own portfolio, selling loans, managing the cost and structure of deposits, short and long-term borrowings and using matched borrowings to fund specific purchases of loan packages and large loan originations. Occasionally, management may choose to deviate from specific matching of maturities of assets and liabilities if an attractive opportunity to enhance yield becomes available.
ALCO modeling is performed quarterly with the assistance of an outside advisor which projects the Bank’s financial performance over the next twenty four months using loan and deposit projections, projections of changes in interest rates, and anticipated changes in other income and operating expenses to reveal the full impact of the Bank’s operating strategies on financial performance. The results of the ALCO process are reported to the Board of Directors at least on a quarterly basis.
Liquidity and Capital Resources
The Bank’s primary sources of funds consist of deposits, borrowings, repayment and prepayment of loans, sales of loans and securities, maturities and early calls of securities, and funds provided from operations. While scheduled repayments of loans and maturities of securities are predictable sources of funds, deposit flows and loan prepayments are greatly influenced by the general level of interest rates, economic conditions, and competition. The Bank primarily uses its liquidity resources to fund existing and future loan commitments, to fund net deposit outflows, to invest in other interest-earning assets, to maintain liquidity, and to pay operating expenses.
The Bank utilizes advances from the FHLB primarily in connection with its management of the interest rate sensitivity of its assets and liabilities. Total advances outstanding at December 31, 2006 amounted to $114.5 million. The Bank’s ability to borrow from the FHLB is dependent upon the amount and type of collateral the Bank has to secure the loans. Such collateral consists of, but is not limited to, one-to-four family owner-occupied residential property and certain investment securities. As of December 31, 2006, the Bank had a borrowing capacity with the FHLB to borrow an additional $14.3 million, for a total of $128.8 million. The Bank also has additional capacity to borrow federal funds from other banks.
A significant portion of the Bank’s liquidity consists of cash and cash equivalents, short-term investments and investment securities. The level of these assets is dependent upon the Bank’s operating, lending, and financing activities during any given period.
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At December 31, 2006, the Bank had $17.2 million of outstanding commitments to originate loans and unused lines of credit and open commitments available to customers totaling $59.4 million. The Bank anticipates that it will have sufficient funds available to meet these commitments. Certificates of deposit, which are scheduled to mature in one year or less, totaled $122.7 million at December 31, 2006. Based upon historical experience, management believes that a significant portion of such deposits will remain with the Bank.
At December 31, 2006, the Company and the Bank continued to exceed all regulatory capital requirements.
In February 2003, the Board of Directors of the Company approved a Stock Repurchase Plan under which the Company is authorized to acquire up to 4% of the outstanding common stock, or up to approximately 65,925 shares of the issued and outstanding shares of its common stock in the open market or in private transactions. Under the Stock Purchase Plan, shares may be repurchased from time to time and in such amounts as market conditions warrant, and subject to regulatory considerations. The repurchased shares are expected to be used by the Company for general corporate purposes. As of December 31, 2006, 48,142 shares of the Company’s common stock had been repurchased under the Stock Purchase Plan at an average price of $24.67 per share.
Recent Accounting Pronouncement
In September 2006, the Securities and Exchange Commission issued Staff Accounting Bulletin 108 “Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements”. This standard addresses quantifying the financial statement effect of misstatements, specifically, how the effects of prior year uncorrected errors must be considered in quantifying misstatements in the current year financial statements. This standard is effective for fiscal years ending after November 15, 2006. The Company does not expect this standard to have a material effect on its consolidated financial statements.
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| ITEM 3. | Controls and Procedures |
| (a) | Evaluation of disclosure controls and procedures. |
As required by Rule 13a-15 under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), the Company’s management conducted an evaluation with the participation of the Company’s Chief Executive Officer and Chief Financial Officer, regarding the effectiveness of the Company’s disclosure controls and procedures, as of the end of the last fiscal quarter. Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that they believe the Company’s disclosure controls and procedures were effective as of December 31, 2006 to ensure that information required to be disclosed by the Company in the reports it files or submits under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the Securities and Exchange Commission’s rules and forms. We intend to continue to review and document our disclosure controls and procedures, including our internal controls and procedures for financial reporting, and we may from time to time make changes to the disclosure controls and procedures to enhance their effectiveness and to ensure that our systems evolve with our business. In designing and evaluating the Company’s disclosure controls and procedures, the Company and its management recognize that any controls and procedures, no matter how well designed and operated, can provide only a reasonable assurance of achieving the desired control objectives, and management necessarily was required to apply its judgment in evaluating and implementing possible controls and procedures.
| (b) | Changes in internal controls over financial reporting. |
There were no changes in the Company’s internal controls over financial reporting identified in connection with the Company’s evaluation of its disclosure controls and procedures that occurred during the Company’s last fiscal quarter that have materially affected, or are reasonably likely to materially affect the Company’s internal control over financial reporting.
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| ITEM 1. | Legal Proceedings |
The Company is not involved in any pending legal proceedings other than legal proceedings occurring in the ordinary course of business which, in the aggregate, involve amounts believed by management to be immaterial to the financial condition and operations of the Company.
| ITEM 2. | Unregistered Sales of Equity Securities and Use of Proceeds |
| (a) | Not applicable. |
| (b) | Not applicable. |
| (c) | A description of the Company’s Stock Purchase Plan is incorporated herein by reference to Note 10 of the Consolidated Financial Statements, included in Part I, Item 1 of this report. |
| ITEM 3. | Defaults Upon Senior Securities |
Not applicable.
| ITEM 4. | Submission of Matters to a Vote of Security Holders |
On October 24, 2006, the Company held its annual meeting of stockholders for the purposes of (i) electing three Directors for three-year terms and (ii) ratifying Wolf & Company, P.C. as the Company’s independent auditors for the fiscal year ending June 30, 2007.
The number of votes cast at the meeting as to each matter acted upon was as follows:
| NO. OF VOTES FOR | NO. OF VOTES WITHHELD | |||||
| 1. | Election of Directors: | |||||
| Paul V. Kenney | 1,500,098 | 54,475 | ||||
| Lawrence E. Novick | 1,518,648 | 35,925 | ||||
| Michael J. Sheehan | 1,499,248 | 55,325 |
| NO. OF VOTES FOR | NO. OF VOTES AGAINST | NO. OF VOTES ABSTAINING | ||||||
| 2. | Ratification of the Appointment of Wolf & Company, P.C. as the Company’s independent registered public accounting firm | 1,548,062 | 6,436 | 75 |
| ITEM 5. | Other Information |
Not applicable.
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| ITEM 6. | Exhibits |
Exhibits
| 31.1 | Certification of Chief Executive Officer pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934. | |
| 31.2 | Certification of Chief Financial Officer pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934. | |
| 32.1 | Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. | |
| 32.2 | Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. | |
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In accordance with the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
| SERVICE BANCORP, INC. | ||||
Date: February 14, 2007 | By: | /s/ PAMELA J. MONTPELIER | ||
| Pamela J. Montpelier | ||||
| President and Chief Executive Officer | ||||
Date: February 14, 2007 | By: | /s/ DANA S. PHILBROOK | ||
| Dana S. Philbrook | ||||
| Chief Financial Officer |
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