SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
_________________
FORM 10-QSB
[X] QUARTERLY REPORT UNDER SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2005
OR
[ ] TRANSITION REPORT UNDER SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from _______ to ________
Commission file number: 333-63685
CLARKSTON FINANCIAL CORPORATION
(Exact name of small business issuer as specified in its charter)
| MICHIGAN (State of other jurisdiction of incorporation or organization) | 38-3412321 (I.R.S. Employer Identification No.) |
6600 Highland Road, Waterford, MI 48327
(Address of principal executive offices) (Zip Code)
Registrant’s telephone number, including area code: (248) 922-6940
_________________
Check whether the issuer: (1) has 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 [__]
The number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date:1,235,307 shares of the Corporation’s Common Stock (no par value) were outstanding as of November 14, 2005.
Transitional Small Business Disclosure Format (check one): Yes [__] No [X]
INDEX
| Page Number(s) | ||
| Part I | Financial Information (unaudited): | |
| Item 1. Condensed Consolidated Financial Statements Notes to Condensed Consolidated Financial Statements | 3 7 | |
| Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations | 14 | |
| Item 3. Controls & Procedures | 24 | |
| Part II. | Other Information | |
| Item 1. Legal Proceedings | 25 | |
| Item 2. Changes in Securities and Use of Proceeds | 25 | |
| Item 3. Defaults Upon Senior Securities | 25 | |
| Item 4. Submission of Matters to a Vote of Securities Holders | 25 | |
| Item 5. Other Information | 25 | |
| Item 6. Exhibits and Reports on Form 8-K | 25 | |
| Signatures | 26 |
Part I Financial Information (unaudited)
CLARKSTON FINANCIAL CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEET
September 30, 2005 (unaudited) and December 31, 2004
(dollars in thousands)
| September 30, 2005 | December 31, 2004 | ||||||||
|---|---|---|---|---|---|---|---|---|---|
| (Unaudited) | |||||||||
| ASSETS | |||||||||
| Cash and cash equivalents | |||||||||
| Total cash and due from banks | $ | 3,200 | $ | 1,949 | |||||
| Federal funds sold | 7,492 | 1,916 | |||||||
| Total cash and cash equivalents | 10,692 | 3,865 | |||||||
| Securities available for sale, at fair value | 43,071 | 44,384 | |||||||
| Loans held for sale | 621 | 644 | |||||||
| Loans | |||||||||
| Total loans | 130,610 | 111,542 | |||||||
| Less: Allowance for loan losses | (1,879 | ) | (1,280 | ) | |||||
| Net loans | 128,731 | 110,262 | |||||||
| Banking premises and equipment | 2,861 | 2,395 | |||||||
| Deferred tax asset | 478 | 384 | |||||||
| Interest receivable and other assets | 1,809 | 1,445 | |||||||
| Total assets | $ | 188,265 | $ | 163,379 | |||||
| LIABILITIES AND SHAREHOLDERS' EQUITY | |||||||||
| Deposits | |||||||||
| Noninterest-bearing | 22,666 | 19,766 | |||||||
| Interest-bearing | 134,564 | 113,500 | |||||||
| Total deposits | 157,230 | 133,266 | |||||||
| Advances from Federal Home Loan Bank of Indianapolis | 7,200 | 12,200 | |||||||
| Junior subordinated debentures held by | |||||||||
| unconsolidated subsidiary trust | 4,000 | 4,000 | |||||||
| Interest payable and other liabilities | 1,301 | 1,712 | |||||||
| Total liabilities | 169,731 | 151,178 | |||||||
| Minority interest in consolidated subsidiary | 3,507 | -- | |||||||
| Shareholders' equity | |||||||||
| Common stock, no par value: 10,000,000 shares authorized; | |||||||||
| 1,235,307 and 1,045,909 shares issued and outstanding as of | |||||||||
| September 30, 2005 and December 31, 2004 | 6,152 | 4,444 | |||||||
| Capital surplus | 6,152 | 4,444 | |||||||
| Restricted stock - unearned compensation | (99 | ) | (80 | ) | |||||
| Retained earnings | 3,244 | 3,634 | |||||||
| Accumulated other comprehensive loss | (422 | ) | (241 | ) | |||||
| Total shareholders' equity | 15,027 | 12,201 | |||||||
| Total liabilities and shareholders' equity | $ | 188,265 | $ | 163,379 | |||||
See accompanying notes to consolidated financial statements
CLARKSTON FINANCIAL CORPORATION
CONDENSED CONSOLIDATED STATEMENT OF INCOME
Three and Nine Month Periods Ended September 30, 2005 and September 30, 2004
(dollars in thousands, except per share data)
(unaudited)
| Three Months Ended September 30, 2005 | Three Months Ended September 30, 2004 | Nine Months Ended September 30, 2005 | Nine Months Ended September 30, 2004 | |||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Interest Income | ||||||||||||||
| Loans, including fees | $ | 2,370 | $ | 1,681 | $ | 6,756 | $ | 4,532 | ||||||
| Securities | ||||||||||||||
| Taxable | 308 | 184 | 899 | 724 | ||||||||||
| Tax-exempt | 74 | 169 | 242 | 567 | ||||||||||
| Federal funds sold | 78 | 34 | 132 | 55 | ||||||||||
| Total interest income | 2,830 | 2,068 | 8,029 | 5,878 | ||||||||||
| Interest Expense | ||||||||||||||
| Deposits | 1,159 | 663 | 3,030 | 1,925 | ||||||||||
| Borrowings | 143 | 87 | 461 | 177 | ||||||||||
| Total Interest Expense | 1,302 | 750 | 3,491 | 2,102 | ||||||||||
| Net Interest Income | 1,528 | 1,318 | 4,538 | 3,776 | ||||||||||
| Provision for loan losses | 908 | 110 | 1,263 | 295 | ||||||||||
| Net interest income | ||||||||||||||
| After provision for loan losses | 620 | 1,208 | 3,275 | 3,481 | ||||||||||
| Noninterest income | ||||||||||||||
| Gain/(loss) on sale of securities | -- | (20 | ) | 1 | (34 | ) | ||||||||
| Gain on sale of loans | 34 | 43 | 109 | 78 | ||||||||||
| Service charges and other fees | 175 | 164 | 587 | 426 | ||||||||||
| Other income | 1 | -- | 10 | -- | ||||||||||
| Total noninterest income | 210 | 187 | 707 | 470 | ||||||||||
| Noninterest expense | ||||||||||||||
| Salaries and benefits | 692 | 473 | 2,219 | 1,366 | ||||||||||
| Occupancy expense | 209 | 125 | 593 | 355 | ||||||||||
| Computer and data processing expenses | 101 | 80 | 266 | 225 | ||||||||||
| Advertising and public relations | 87 | 38 | 189 | 116 | ||||||||||
| Professional fees | 129 | 84 | 297 | 224 | ||||||||||
| State taxes | 27 | 27 | 73 | 51 | ||||||||||
| Other expense | 304 | 137 | 659 | 393 | ||||||||||
| Total noninterest expense | 1,549 | 964 | 4,296 | 2,730 | ||||||||||
| Income/(loss) before federal income tax expense and minority interest | (719 | ) | 431 | (314 | ) | 1,221 | ||||||||
| Federal income tax expense | 22 | 115 | 132 | 271 | ||||||||||
| Income/(loss) before minority interest | (741 | ) | 316 | (446 | ) | 950 | ||||||||
| Minority interest in net loss of consolidated subsidiary | (56 | ) | -- | (56 | ) | -- | ||||||||
| Net income/(loss) | $ | (685 | ) | $ | 316 | $ | (390 | ) | $ | 950 | ||||
| Basic earnings/(loss) per share | $ | (0.58 | ) | $ | 0.30 | $ | (0.36 | ) | $ | 0.92 | ||||
| Diluted earnings/(loss) per share | $ | (0.57 | ) | $ | 0.30 | $ | (0.36 | ) | $ | 0.89 | ||||
See accompanying notes to consolidated financial statements.
CLARKSTON FINANCIAL CORPORATION
CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY
Nine Month Period ended September 30, 2005
(dollars in thousands)
(Unaudited)
| Common Stock | Capital Surplus | Unearned Comp. | Retained Earnings | Accumulated Other Comprehensive Income/(loss) | Total Stockholders' Equity | |||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Balance December 31, 2004 | $ | 4,444 | $ | 4,444 | $ | (80 | ) | $ | 3,634 | $ | (241 | ) | $ | 12,201 | ||||||
| Issuance of stock | 1,680 | 1,680 | -- | -- | -- | 3,360 | ||||||||||||||
| Issuance of restricted stock | 28 | 28 | (56 | ) | -- | -- | -- | |||||||||||||
| Recognition of compensation for | ||||||||||||||||||||
| restricted stock award | -- | -- | 37 | -- | -- | 37 | ||||||||||||||
| Comprehensive income: | ||||||||||||||||||||
| Net income/(loss) for nine months | ||||||||||||||||||||
| ended September 30, 2005 | -- | -- | -- | (390 | ) | -- | (390 | ) | ||||||||||||
| Change in unrealized loss on | ||||||||||||||||||||
| securities available for sale | ||||||||||||||||||||
| net of tax of ($93) | -- | -- | -- | -- | (181 | ) | (181 | ) | ||||||||||||
| Net comprehensive loss | (571 | ) | ||||||||||||||||||
| Balance September 30, 2005 | $ | 6,152 | $ | 6,152 | $ | (99 | ) | $ | 3,244 | $ | (422 | ) | $ | 15,027 | ||||||
CLARKSTON FINANCIAL CORPORATION
CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS
Three and Nine Month Periods ended September 30, 2005 and September 30, 2004
(dollars in thousands)
(unaudited)
| Three Months Ended September 30, 2005 | Three Months Ended September 30, 2004 | Nine Months Ended September 30, 2005 | Nine Months Ended September 30, 2004 | |||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Net Cash Provided by Operating Activities: | ||||||||||||||
| Net cash provided by/(used in) operating activities | $ | 561 | $ | (492 | ) | $ | 828 | $ | 628 | |||||
| Cash Flows from Investing Activities: | ||||||||||||||
| Net increase in loans | (2,251 | ) | (8,496 | ) | (20,000 | ) | (18,851 | ) | ||||||
| Purchase of available-for-sale securities | (7,445 | ) | (12,947 | ) | (10,700 | ) | (27,902 | ) | ||||||
| Proceeds from sales of available-for-sale securities | 1,475 | 10,761 | 11,548 | 32,040 | ||||||||||
| Property and equipment expenditures | (120 | ) | (379 | ) | (680 | ) | (531 | ) | ||||||
| Net cash used in investing activities | (8,341 | ) | (11,061 | ) | (19,832 | ) | (15,244 | ) | ||||||
| Cash Flows from Financing Activities: | ||||||||||||||
| Increase in deposits | 1,249 | 12,650 | 23,964 | 8,528 | ||||||||||
| Proceeds from advances from Federal Home Loan Bank | -- | -- | -- | 9,000 | ||||||||||
| Repayments of advances from Federal Home Loan Bank | (5,000 | ) | -- | (5,000 | ) | -- | ||||||||
| Proceeds from sale of stock | 3,360 | -- | 3,360 | -- | ||||||||||
| Resources provided by minority interest | 3,507 | -- | 3,507 | -- | ||||||||||
| Net cash provided by financing activities | 3,116 | 12,650 | 25,831 | 17,528 | ||||||||||
| Net increase/(decrease) in cash and cash equivalents | (4,664 | ) | 1,097 | 6,827 | 2,912 | |||||||||
| Cash and cash equivalents at beginning of period | 15,356 | 9,747 | 3,865 | 7,932 | ||||||||||
| Cash and cash equivalents at end of period | $ | 10,692 | $ | 10,844 | $ | 10,692 | $ | 10,844 | ||||||
| Supplemental Cash Flow Information - Cash paid for: | ||||||||||||||
| Interest | 1,310 | 690 | 3,460 | 2,013 | ||||||||||
| Taxes | 44 | 183 | 255 | 459 | ||||||||||
| Significant Noncash Activities: | ||||||||||||||
| Transfers from loans to repossessed assets | 268 | -- | 268 | -- | ||||||||||
See accompanying notes to consolidated financial statements.
NOTE 1 – BASIS OF FINANCIAL STATEMENT PRESENTATION
The accompanying unaudited consolidated interim financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America with the instructions to Form 10-QSB. Accordingly, certain information and disclosures required by accounting principles generally accepted in the United States of America for complete financial statements are not included herein. The interim financial statements should be read in conjunction with the financial statements of Clarkston Financial Corporation (the “Corporation”) and the notes thereto included in the Corporation’s annual report on Form 10-KSB for the year ended December 31, 2004.
All adjustments, consisting of normal recurring adjustments, which in the opinion of management are necessary for a fair presentation of financial position, results of operations, and cash flows, have been made. The results of operations for the three and nine month periods ended September 30, 2005 are not necessarily indicative of the results that may be expected for the year ended December 31, 2005.
Certain amounts in prior period’s financial statements have been reclassified to conform to the current period’s presentation.
NOTE 2 – PRINCIPLES OF CONSOLIDATION
The Corporation is a Michigan Corporation and the holding company for Clarkston State Bank (CSB) and Huron Valley State Bank (HVSB). The consolidated financial statements include the accounts of the Corporation, its wholly owned subsidiary Clarkston State Bank and its majority owned subsidiary Huron Valley State Bank. All significant intercompany transactions are eliminated in consolidation.
The Corporation also owns all of the common stock of Clarkston Capital Trust I. This is a grantor trust that issued trust preferred securities and is not consolidated with the Company per FASB Interpretation No. 46.
NOTE 3 – STOCK BASED COMPENSATION
The Corporation applies the provisions of APB Opinion No. 25,Accounting for Stock-based Compensation, accounting for all employee stock option grants using the intrinsic value method. Disclosure of proforma net income and earnings per share amounts as if the fair value-based method has been applied in measuring compensation costs is provided below.
The Corporation has two stock-based compensation plans. Under the employees’ Stock Compensation Plan (“Employee Plan”), the Corporation may grant options or issue restricted stock to key employees for up to 21,495 shares of common stock. Under the 1998 Founding Directors Stock Option Plan (“Director Plan”), the Corporation may grant options for up to 72,693 shares of common stock. Under both plans, there is a minimum vesting period of between one to three years before the options may be exercised, and all options expire 10 years after the date of their grant. Certain options (contingent options) under both plans vest on an accelerated basis upon the achievement of various future financial and operational goals. All such options vest 9.5 years after the date of grant regardless of achievement of future goals. Under both plans, the exercise price of each option equals the market price of the Corporation’s common stock on the date of grant.
NOTE 3 – STOCK BASED COMPENSATION (CONTINUED)
The Corporation’s as reported and pro forma information is as follows:
(dollars in thousands, except per share data)
| Three Months Ended September 30, | Nine Months Ended September 30, | |||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2005 | 2004 | 2005 | 2004 | |||||||||||
| As reported net income/(loss) available | ||||||||||||||
| to common stockholders | $ | (685 | ) | $ | 316 | $ | (390 | ) | $ | 950 | ||||
| Less stock-based compensation expense | ||||||||||||||
| determined under fair value method - | ||||||||||||||
| net of tax | 4 | 4 | 12 | 12 | ||||||||||
| Pro forma net income/(loss) | $ | (689 | ) | $ | 312 | $ | (402 | ) | $ | 938 | ||||
| As reported earnings/(loss) per share | $ | (0.58 | ) | $ | 0.30 | $ | (0.36 | ) | $ | 0.92 | ||||
| Pro forma earnings/(loss) per share | $ | (0.58 | ) | $ | 0.30 | $ | (0.37 | ) | $ | 0.91 | ||||
| As reported earnings/(loss) per diluted share | $ | (0.57 | ) | $ | 0.30 | $ | (0.35 | ) | $ | 0.89 | ||||
| Pro forma earnings/(loss) per diluted share | $ | (0.57 | ) | $ | 0.29 | $ | (0.36 | ) | $ | 0.88 | ||||
Compensation expense in the pro forma disclosures is not indicative of future amounts, as options vest over several years and additional grants may be made each year.
The following table summarizes stock option transactions for both plans and the related average exercise prices for the three month periods ended September 30:
| 2005 | 2004 | |||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Number of shares | Weighted Average Exercise Price | Number of shares | Weighted Average Exercise Price | |||||||||||
| Options Outstanding - Beginning of Year | 49,536 | $ | 9.09 | 49,536 | $ | 9.09 | ||||||||
| Options granted - Employee Plan | - | - | - | - | ||||||||||
| Options exercised | - | - | - | - | ||||||||||
| Options expired | - | - | - | - | ||||||||||
| Options Outstanding - End of Period | 49,536 | $ | 9.09 | 49,536 | $ | 9.09 | ||||||||
The following table shows summary information about fixed stock options outstanding at September 30, 2005:
| Stock Options Outstanding | Stock Options Exercisable | ||||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Range of Exercise Prices | Number of Shares | Weighted Average Remaining Contractual Life | Weighted Average Exercise Price | Number of shares exercisable | Weighted Average Exercise Price | ||||||||||||||||
| Contingent | $ | 9.09 | 24,060 | 3.9 years | $ | 9.09 | 14,436 | $ | 9.09 | ||||||||||||
| Non-contingent | 9.09 | 25,476 | 3.9 years | 9.09 | 25,476 | 9.09 | |||||||||||||||
NOTE 3 – STOCK BASED COMPENSATION (CONTINUED)
The Corporation has adopted the disclosure-only provisions of SFAS No. 123,Accounting for Stock-Based Compensation, but applies the intrinsic value method to account for its plan. The Corporation has estimated fair market value of the options granted in 2000 at $2.34 per share, using a “minimum value” concept. The value was calculated using an assumed interest rate of 6.5 percent and estimated life of five years.
Shares of restricted stock issued to employees were valued at the market price of the stock at the award date. Compensation expense is being recognized over the three year vesting period for the restricted stock.
NOTE 4 – EARNINGS PER SHARE
Basic earnings per share represents income available to common stockholders divided by the weighted-average number of common shares outstanding during the period. Diluted earnings per share reflects additional common shares that would have been outstanding if dilutive potential common 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 Corporation relate solely to outstanding stock options and are determined using the treasury stock method.
Earnings per share have been computed based on the following: (in dollars in thousands)
| Three Months Ended September 30, | Nine Months Ended September 30, | |||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2005 | 2004 | 2005 | 2004 | |||||||||||
| Net income/(loss) available to common stockholders | $ | (685 | ) | $ | 316 | $ | (390 | ) | $ | 950 | ||||
| Average number of common shares | ||||||||||||||
| outstanding | 1,178 | 1,037 | 1,091 | 1,036 | ||||||||||
| Effect of dilutive options | 24 | 27 | 27 | 27 | ||||||||||
| Average number of common shares | ||||||||||||||
| outstanding used to calculate diluted | ||||||||||||||
| earnings/(loss) per common share | 1,202 | 1,064 | 1,118 | 1,063 | ||||||||||
| Number of antidilutive stock options excluded | ||||||||||||||
| from diluted earnings per share computation | -- | -- | -- | -- | ||||||||||
NOTE 5 — SECURITIES
The Bank does not have any securities in its portfolio that are classified as held to maturity. All securities are classified as available for sale and the amortized cost and fair values of those securities are as follows (dollars in thousands):
Available for Sale
| Amortized Cost | Gross Unrealized Gains | Gross Unrealized Losses | Estimated Market Value | |||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| September 30, 2005 (Unaudited) | ||||||||||||||
| U.S. Treasury securities and obligations of | ||||||||||||||
| U.S. government corporations and agencies | $ | 29,265 | $ | 4 | $ | 384 | $ | 28,885 | ||||||
| Collateralized mortgage obligations | 3,746 | -- | 56 | 3,690 | ||||||||||
| Obligations of state and political subdivisions | 10,699 | 1 | 204 | 10,496 | ||||||||||
| $ | 43,710 | $ | 5 | $ | 644 | $ | 43,071 | |||||||
| December 31, 2004 | ||||||||||||||
| U.S. Treasury securities and obligations of | ||||||||||||||
| U.S. government corporations and agencies | $ | 26,330 | $ | 6 | $ | 225 | $ | 26,111 | ||||||
| Collateralized mortgage obligations | 3,495 | 3 | 16 | 3,482 | ||||||||||
| Obligations of state and political subdivisions | 14,924 | 14 | 147 | 14,791 | ||||||||||
| $ | 44,749 | $ | 23 | $ | 388 | $ | 44,384 | |||||||
NOTE 6 - LOANS
Loans are as follows (dollars in thousands):
| September 30, 2005 (unaudited) | December 31, 2004 | |||||||
|---|---|---|---|---|---|---|---|---|
| Commercial | $ | 23,265 | $ | 22,820 | ||||
| Real estate: | ||||||||
| Commercial | 62,527 | 57,593 | ||||||
| Residential | 15,925 | 12,847 | ||||||
| Construction | 26,298 | 15,942 | ||||||
| Total real estate | 104,750 | 86,382 | ||||||
| Consumer | 2,595 | 2,789 | ||||||
| Total | $ | 130,610 | $ | 111,542 | ||||
Activity in the allowance for loan losses is as follows (dollars in thousands):
| Three Months Ended September 30, | Nine Months Ended September 30, | |||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2005 | 2004 | 2005 | 2004 | |||||||||||
| Balance - Beginning of period | $ | 1,506 | $ | 1,152 | $ | 1,280 | $ | 1,092 | ||||||
| Provision charged to operations | 908 | 110 | 1,263 | 295 | ||||||||||
| Charge-offs | (535 | ) | (48 | ) | (665 | ) | (222 | ) | ||||||
| Recoveries | -- | -- | 1 | 49 | ||||||||||
| Balance - End of year | $ | 1,879 | $ | 1,214 | $ | 1,879 | $ | 1,214 | ||||||
| Allowance for loan losses to total loans | 1.44% | 1.39% | 1.44% | 1.39% | ||||||||||
NOTE 7 — DEPOSITS
Deposits are summarized as follows (dollars in thousands):
| September 30, 2005 (unaudited) | December 31, 2004 | |||||||
|---|---|---|---|---|---|---|---|---|
| Non-interest bearing demand deposit accounts | $ | 22,666 | $ | 19,766 | ||||
| Interest-bearing demand deposit accounts | 6,366 | 8,653 | ||||||
| Savings accounts | 4,752 | 4,784 | ||||||
| Money market accounts | 64,368 | 49,894 | ||||||
| Certificates of deposit | 59,078 | 50,169 | ||||||
| Total deposits | $ | 157,230 | $ | 133,266 | ||||
NOTE 8 – FHLB ADVANCES
Advances from the Federal Home Loan Bank (FHLB) were as follows (dollars in thousands):
| September 30, 2005 (unaudited) | December 31, 2004 | |||||||
|---|---|---|---|---|---|---|---|---|
| Maturity in July 2005, variable rate at 3.46% $ | $ | -- | $ | 5,000 | ||||
| Maturities from April 2005 through October 2009, fixed rates | ||||||||
| ranging from 1.83% to 3.75%, weighted average of 2.76% | 7,200 | 7,200 | ||||||
| Total FHLB Advances | $ | 7,200 | $ | 12,200 | ||||
Advances from the FHLB are collateralized by qualifying investments securities with estimated market values of $12,921,000 and $14,127,000 at September 30, 2005 and December 31, 2004. The advances are due in full at maturity and the fixed rate advances are subject to a prepayment penalty if repaid prior to maturity.
NOTE 9 – MINIMUM REGULATORY CAPITAL REQUIREMENTS
Banks and bank holding companies are subject to regulatory capital requirements administered by federal banking agencies. Capital adequacy guidelines and, additionally for Banks, prompt corrective action regulations, involve quantitative measures of assets, liabilities, and certain off-balance-sheet items calculated under regulatory accounting practices. Capital amounts and classifications are also subject to qualitative judgments by regulators. Failure to meet capital requirements can initiate regulatory action. The prompt corrective action regulations provide five classifications, well capitalized, adequately capitalized, undercapitalized and critical undercapitalized, although these terms are not used to represent overall financial condition. If adequately capitalized, regulatory approval is required to accept brokered deposits. If undercapitalized, capital distributions are limited, as is asset growth and expansion, and plans for capital restoration are required. The Banks and the Corporation were well-capitalized as of September 30, 2005 and December 31, 2004.
NOTE 9 – MINIMUM REGULATORY CAPITAL REQUIREMENTS (CONTINUED)
The Banks’ and Corporation’s actual capital amounts and ratios as of September 30, 2005 and December 31, 2004 are presented in the following table (dollars in thousands):
| Actual | For Capital Adequacy Purposes | To be Well-Capitalized | ||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Amount | Ratio (Percent) | Amount | Ratio (Percent) | Amount | Ratio (Percent) | |||||||||||||||
| As of September 30, 2005: | ||||||||||||||||||||
| Total risk-based capital | ||||||||||||||||||||
| (to risk-weighted assets) | ||||||||||||||||||||
| CSB | $ | 14,900 | 10.84 | $ | 11,000 | 8.00 | $ | 13,750 | 10.00 | |||||||||||
| HVSB | 7,986 | 187.86 | 340 | 8.00 | 425 | 10.00 | ||||||||||||||
| Consolidated | 21,718 | 15.27 | 11,375 | 8.00 | 14,219 | 10.00 | ||||||||||||||
| Tier I Capital | ||||||||||||||||||||
| (to risk weighted assets) | ||||||||||||||||||||
| CSB | $ | 13,180 | 9.59 | $ | 5,500 | 4.00 | $ | 8,250 | 6.00 | |||||||||||
| HVSB | 7,963 | 187.31 | 170 | 4.00 | 255 | 6.00 | ||||||||||||||
| Consolidated | 19,839 | 13.95 | 5,688 | 4.00 | 8,532 | 6.00 | ||||||||||||||
| Tier I Capital | ||||||||||||||||||||
| (to average assets) | ||||||||||||||||||||
| CSB | $ | 13,180 | 7.29 | $ | 7,234 | 4.00 | $ | 9,043 | 5.00 | |||||||||||
| HVSB | 7,963 | 76.62 | 416 | 4.00 | 520 | 5.00 | ||||||||||||||
| Consolidated | 19,839 | 10.61 | 7,477 | 4.00 | 9,347 | 5.00 | ||||||||||||||
| As of December 31, 2004: | ||||||||||||||||||||
| Total risk-based capital | ||||||||||||||||||||
| (to risk-weighted assets) | ||||||||||||||||||||
| CSB | $ | 14,613 | 12.04 | $ | 9,713 | 8.00 | $ | 12,142 | 10.00 | |||||||||||
| HVSB | - | 0.00 | - | 8.00 | - | 10.00 | ||||||||||||||
| Consolidated | 17,688 | 14.50 | 9,761 | 8.00 | 12,202 | 10.00 | ||||||||||||||
| Tier I Capital | ||||||||||||||||||||
| (to risk weighted assets) | ||||||||||||||||||||
| CSB | $ | 13,333 | 10.98 | $ | 4,857 | 4.00 | $ | 7,285 | 6.00 | |||||||||||
| HVSB | - | 0.00 | - | 4.00 | - | 6.00 | ||||||||||||||
| Consolidated | 16,408 | 13.45 | 4,881 | 4.00 | 7,321 | 6.00 | ||||||||||||||
| Tier I Capital | ||||||||||||||||||||
| (to average assets) | ||||||||||||||||||||
| CSB | $ | 13,333 | 8.29 | $ | 6,433 | 4.00 | $ | 8,041 | 5.00 | |||||||||||
| HVSB | - | 0.00 | - | 4.00 | - | 5.00 | ||||||||||||||
| Consolidated | 16,408 | 10.06 | 6,524 | 4.00 | 8,155 | 5.00 | ||||||||||||||
NOTE 10 — STANDBY AND COMMERCIAL LETTERS OF CREDIT AND FINANCIAL GUARANTEES
The Corporation is a party to credit-related financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit, commercial and standby letters of credit, and unfunded commitments under lines of credit. Such commitments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the consolidated balance sheet. The Corporation’s exposure to credit loss is represented by the contractual amount of these commitments. The Corporation follows the same credit policies in making commitments as it does for on-balance-sheet instruments.
At September 30, 2005 and December 31, 2004, the following financial instruments were outstanding whose contract amounts represent credit risk (dollars in thousands):
| September 30, 2005 (Unaudited) | December 31, 2004 | |||||||
|---|---|---|---|---|---|---|---|---|
| Commitments to grant loans | $ | 5,492 | $ | 9,763 | ||||
| Unfunded commitments under lines of credit | 21,962 | 22,384 | ||||||
| Commercial and standby letters of credit | 278 | 320 | ||||||
NOTE 11 – RECENT ACCOUNTING PRONOUNCEMENTS
In May 2005, the Financial Accounting Standards Board issued SFAS No. 154,“Accounting Changes and Error Corrections.” This Statement replaces APB Opinion No. 20,“Accounting Changes,” and FASB Statement No. 3,“Reporting Accounting Changes in Interim Financial Statements.” SFAS 154 carries forward the guidance contained in Opinion 20 for reporting the correction of an error in previously issued financial statements and a change in accounting estimate. However, SFAS 154 changes the requirements for the accounting for and reporting of a change in accounting principle. Under this Statement, every voluntary change in accounting principle requires retrospective application to prior periods’ financial statements, unless it is impracticable. It also applies to changes required by an accounting pronouncement in the unusual instance that the pronouncement does not include specific transition provisions. When a pronouncement includes specific transition provisions, those provisions should be followed. This Statement is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005, although earlier application is permitted for changes and corrections made in fiscal years beginning after June 1, 2005. The Corporation expects no significant effect on its financial statements as a result of the adoption of this Statement.
Item 2
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
The following analysis discusses changes in the financial condition and results of operations of the Corporation for the periods presented and should be read in conjunction with the Corporation’s Consolidated Financial Statements and notes thereto, appearing in Part I, Item 1 of this document.
Forward Looking Statements
This report contains certain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. The Corporation intends such forward-looking statements to be covered by the safe harbor provisions for forward-looking statements contained in the Private Securities Reform Act of 1995, and is including this statement for purposes of these safe harbor provisions. Forward-looking statements, which are based on certain assumptions and describe future plans, strategies and expectations of the Corporation, are generally identifiable by use of the words “believe,” “expect,” “intend,” “anticipate,” “estimate,” “project” or similar expressions. Our ability to predict results or the actual effect of future plans or strategies is inherently uncertain. Factors which could have a material adverse affect on our operations and future prospects include, but are not limited to, changes in: interest rates, general economic conditions, legislative/regulatory changes, monetary and fiscal policies of the U.S. Government, including policies of the U.S. Treasury and the Federal Reserve Board, the quality or composition of the loan or investment portfolios, demand for loan products, deposit flows, competition, demand for financial services in our market area and accounting principles, policies and guidelines. These risks and uncertainties should be considered in evaluating forward-looking statements and undue reliance should not be placed on such statements. Further information about us and our business, including additional factors that could materially affect our financial results, is included in our filings with the Securities and Exchange Commission.
General
Clarkston Financial Corporation (the “Corporation”) is a Michigan corporation incorporated on May 18, 1998. The Corporation is the bank holding company for Clarkston State Bank (“CSB”) and Huron Valley State Bank (“HVSB”) (collectively the “Banks”). CSB commenced operations on January 4, 1999, and HVSB commenced operations on August 15, 2005. The Banks are chartered by the State of Michigan with depository accounts insured by the Federal Deposit Insurance Corporation. They provide a full range of commercial and consumer banking services, primarily in Clarkston and Milford, Michigan and the surrounding market area primarily located in north Oakland County, Michigan. Together, the banks operate eight customer service locations including six full service branches.
Critical Accounting Policies
The Corporation’s critical accounting policies are described in the financial section of our 2004 annual report. Management believes our critical accounting policies relate to the allowance for loan losses, income taxes and stock based compensation.
Comparison of Financial Condition at September 30, 2005 and December 31, 2004
Our total assets increased by $24.9 million or 15.2% to $188.3 million at September 30, 2005, from $163.4 million at December 31, 2004. The continued growth is attributable to ongoing marketing efforts for deposits and an increase in lending relationships. These efforts were bolstered in the 3rd quarter by the opening of Huron Valley State Bank. We anticipate that our assets will continue to grow during 2005.
Cash and cash equivalents, which include federal funds sold and short-term investments, increased $6.8 million or 174.4% to $10.7 million at September 30, 2005 from $3.9 million at December 31, 2004. The increase is due primarily to increased deposits, which funds have not yet been reinvested in loans or investment securities. These funds are anticipated to be placed in higher-yielding investments and loans in the coming quarters.
Securities decreased $1.3 million or 2.9% to $43.1 million at September 30, 2005 from $44.4 million at December 31, 2004. Total securites have increased from the prior quarter by $5.7 million, or 15.2%. This increase is due in large part to the investment of HVSB’s initial capital, but is also indicative of a difficult lending climate in the Bank’s primary market areas. The Corporation continues to have excellent liquidity and will monitor its level of securities to ensure proper liquidity is maintained.
Total portfolio loans increased by $19.1 million or 17.1% to $130.6 million at September 30, 2005 from $111.5 million at December 31, 2004. This growth rate is lower than our business plan and a similar, or slightly slower rate is expected to continue throughout 2005. This reduced growth rate is largely due to competitive market pressures and a difficult economic climate in Michigan. Approximately $2.7 million of the growth was from Huron Valley State Bank. Total loan growth continues to be driven by the commercial real estate and construction portfolios which increased $4.9 million, or 8.5% and $10.8 million, or 69.7%, respectively over the balances at December 31, 2005. Commercial and industrial loans saw a slight increase of $500,000, or 2.2% over the first nine months of the year. The residential real estate portfolio also contributed positively showing a 24.2%, or $3.1 million increase over December 31, 2004. There was a slight decrease in consumer loans over December 31, 2004. We continue to focus on commercial lending as evidenced by the fact that commercial and construction loans make up 85.8% of the loan portfolio, with residential loans making up 12.2% and consumer loans 2.0%.
Nonperforming assets have increased markedly from December 31, 2004. The nonperforming loan balances are the result of 3 commercial relationships. Management only anticipates losses on one of these relationships, with this amount being 100% reserved for in the current quarter. A contract employee has been added at the affiliate to work through the existing watch credits and review the remainder of the portfolio for any other asset quality issues. In addition, a new senior lender was added who has a strong credit background and is currently in the process of implementing new and more rigorous credit procedures along with revising the credit policy. Management believes that these issues are isolated and that the credit quality of the portfolio as a whole remains strong.
The table below shows the composition and amount of our nonperforming assets.
| September 30, 2005 | December 31, 2004 | |||||||
|---|---|---|---|---|---|---|---|---|
| (Unaudited) | ||||||||
| (dollars in thousands) | ||||||||
| Nonaccrual loans | $ | 236 | $ | -- | ||||
| Loans 90 past due and still accruing | 1,656 | 531 | ||||||
| Total nonperforming loans | 1,892 | 531 | ||||||
| Foreclosed and repossessed assets | 268 | -- | ||||||
| Total nonperforming assets | $ | 2,160 | $ | 531 | ||||
| Nonperforming assets to total loans | 1.65% | 0.5% | ||||||
| Nonperforming assets to total assets | 1.15% | 0.3% | ||||||
The allowance for loan losses as of September 30, 2005 was $1.9 million representing approximately 1.45% of total loans outstanding, compared to $1.3 million, or 1.15% of loans outstanding as of December 31, 2004. The Bank had three charge-offs in the quarter totaling approximately $535,000, and a large specific reserve of $625,000 was required on one other commercial relationship. In the 1st nine months of the year total charge-offs were $665,000. The large specific reserve is 100% of the balance of the relationship, therefore, no additional reserves against this credit are expected. The combination of the charged off credits, the large specific reserve and deteriorating economic conditions in the local marketplace necessitated the additional provision for loan loss and elevated allowance balance. We believe that the allowance for loan losses is sufficient to cover losses inherent in the portfolio.
The loan loss allowance represents management’s assessment of both current and future losses inherent within the loan portfolio. Consideration is also given to off-balance sheet items that may involve credit risk, such as commitments to extend credit. This analysis is conducted on a quarterly basis utilizing a methodology that has been employed since our inception. The methodology employed utilizes several factors to determine the appropriateness of the allowance. Specifically, historical loss experience, financial condition of borrowers, collateral adequacy, credit risk rating system and current economic conditions are incorporated in this analysis.
The primary risk element considered by management regarding each installment and residential real estate loan is the lack of timely payments. We have a reporting system that monitors past due loans and have adopted policies to pursue our creditor’s rights in order to preserve our position. The primary risk elements concerning commercial loans are the financial condition of the borrower, the sufficiency of the collateral and lack of timely payment. Management has a policy of requesting and reviewing annual financial statements from its commercial loan customers and periodically reviews the existence and value of collateral for selected loans.
The adequacy of the allowance is based on the application of our credit risk rating system which identifies problem credits and ranks loans by specific categories. Moreover, we use peer comparisons and industry data for similar type loans to further assess the proper level of the loan loss allowance. Going forward, we will closely monitor the performance of the loan portfolio as it becomes more seasoned.
Total premises and equipment increased $500,000, or 20.8% to $2.9 million at September 30, 2005 from $2.4 million at December 31, 2004. This increase is due largely to the equipment and leasehold improvements utilized by Huron Valley State Bank and the mortgage operation.
Other assets increased $300,000, or 37.5% to $1.1 million at September 30, 2005 from $800,000 at December 31, 2004. The primary cause of this increase is repossessed assets valued at $268,000. Management anticipates that these assets will be disposed of via sale by December 2005.
Total deposit balances increased $23.9 million or 17.9% to $157.2 million at September 30, 2005 from $133.3 million at December 31, 2004. The largest increase in terms of percentage was seen in the money market portfolio which increased 29.1%, or $14.5 million since December 31, 2004. Time deposits have shown a healthy $8.8 million, or 17.7% increase over December 31, 2004. Growth in non-interest bearing checking account balances has also been strong in the current year, with totals increasing $2.9 million, or 14.6%. Our continued focus on commercial accounts resulted in 120 new non-interest bearing accounts during the 3rd quarter. We anticipate that as these new accounts grow into full relationships they will contribute further to our deposit growth. Our new branch in the Clarkston Business District has been a large contributor to the growth in non-time deposits. Currently the new branch has approximately $9.3 million in non-time deposits as of September 30, 2005, compared to $500,000 at December 31, 2004. We anticipate that the opening of Huron Valley State Bank will add to the growth in both total and non-time deposits in the 4th quarter and beyond.
CSB is a member of the Federal Home Loan Bank of Indianapolis, and utilizes advances from this institution to bolster liquidity. At September 30, 2005, we have $7.2 million in advances outstanding, a decrease of $5.0 million from December 31, 2004. Excess liquidity in the current quarter allowed us to pay down this variable rate advance. The Corporation continues to view the FHLB as a source of liquidity and may borrow additional funds as market conditions dictate.
We have no other off-balance sheet liabilities other than commitments to extend credit in the form of letters and lines of credit.
As of September 30, 2005, we had retained earnings of $3.2 million compared to $3.6 million at December 31, 2004 which was a result of net loss of $391,000. Accumulated other comprehensive income saw a decrease of $181,000, or 75.1%. This decrease was primarily the result of changes in interest rates causing a decrease in the market value of the Corporation’s security portfolio. We do not believe that the value of any of the securities in the portfolio are permanently impaired. Common stock and paid-in capital saw increases of $1.8 million each, which resulted primarily from the Corporation’s rights offering which was completed during the quarter. Management’s focus on strong expense discipline and increases in the net interest margin, due to increases in underlying rates and changes in the asset mix, continues to enhance profitability, notwithstanding the large provisions for loan losses.
Comparison of Operating Results for the Three Months Ended September 30, 2005 and 2004
Our net loss was $685,000, or ($0.57) per diluted share for the third quarter of 2005 compared to net profit of $316,000, or $0.30 per diluted share for the third quarter of 2004. The net loss was due to a large provision for loan loss and increased operating expenses and offset by increases in net interest income and non interest income. Operating results related to Huron Valley State Bank and our entrance into the mortgage business decreased net income $186,900, or $0.16 per diluted share and $81,500, or $0.07 per diluted share, respectively in the quarter ended September 30, 2005. Steps have been taken in regard to the mortgage banking operation to substantially reduce operating costs, and management does not anticipate that the mortgage banking operation will negatively influence operating results in 2006. The losses since the opening of Huron Valley State Bank have been in line with the initial projections.
Net interest income increased 15.4% or $210,000 from $1.32 million in the third quarter of 2004 to $1.53 million for 2005. The primary contributor to the increase was elevated balances in earning assets, which increased by 21.3% to $182 million at September 30, 2005 from $150 million at December 31, 2004. This effectively added $423,000 to the margin. Increasing rates reduced net interest income by $213,000, as the cost of funds increased 113 basis points, while the yield on earning assets only increased by 69 basis points. A new, more flexible pricing structure was put in place on money market accounts subsequent to the end of the quarter which should significantly reduce interest expense on these accounts, while remaining competitive in the marketplace. Also positively affecting the margin was the aforementioned increase in non-interest bearing deposits. The net interest margin decreased from 3.52% for the quarter ended September 30, 2004 compared to 3.36% for the same period in 2005, mostly as a result of the inflated money market cost.
The following schedule presents the average daily balances, interest income, interest expense and average rates earned and paid for the Corporation’s major categories of assets, liabilities, and shareholders’ equity for the periods indicated (dollars in thousands):
| 3 Months ended September 30, 2005 | 3 Months ended September 30, 2004 | |||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Average Balance | Interest | Yield/ Cost | Average Balance | Interest | Yield/ Cost | |||||||||||||||
| Assets: | ||||||||||||||||||||
| Short term investment | $ | 8,979 | $ | 78 | 3.47 | % | $ | 8,670 | $ | 34 | 1.57 | % | ||||||||
| Securities: | ||||||||||||||||||||
| Taxable | 31,560 | 308 | 3.90 | % | 21,833 | 184 | 3.37 | % | ||||||||||||
| Tax-exempt | 9,725 | 74 | 3.04 | % | 20,289 | 169 | 3.33 | % | ||||||||||||
| Loans | 131,610 | 2,370 | 7.20 | % | 98,969 | 1,681 | 6.79 | % | ||||||||||||
| Total earning assets/total | ||||||||||||||||||||
| interest income | 181,874 | 2,830 | 6.22 | % | 149,761 | 2,068 | 5.52 | % | ||||||||||||
| Cash and due from banks | 3,004 | 3,552 | ||||||||||||||||||
| Unrealized Gain (Loss) | (630 | ) | (602 | ) | ||||||||||||||||
| Allowance for loan loss | (1,644 | ) | (1,192 | ) | ||||||||||||||||
| All other assets | 4,330 | 2,520 | ||||||||||||||||||
| Total assets | 186,933 | 2,830 | 154,039 | 2,068 | ||||||||||||||||
| Liabilities and Stockholders' Equity | ||||||||||||||||||||
| Interest bearing deposits: | ||||||||||||||||||||
| MMDA, Savings/NOW accounts | 74,814 | 615 | 3.29 | % | 61,569 | 283 | 1.84 | % | ||||||||||||
| Time | 58,137 | 544 | 3.74 | % | 46,373 | 380 | 3.28 | % | ||||||||||||
| Fed Funds Purchased | -- | -- | 0.00 | % | -- | -- | 0.00 | % | ||||||||||||
| FHLB Advances | 7,200 | 77 | 4.28 | % | 9,047 | 41 | 1.81 | % | ||||||||||||
| Trust Preferred Securities | 4,000 | 66 | 6.60 | % | 4,000 | 46 | 4.60 | % | ||||||||||||
| Other borrowings | -- | -- | 0.00 | % | -- | -- | 0.00 | % | ||||||||||||
| Total interest bearing | ||||||||||||||||||||
| liabilities/interest expense | 144,151 | 1,302 | 3.61 | % | 120,989 | 750 | 2.48 | % | ||||||||||||
| Noninterest bearing deposits | 23,441 | 20,001 | ||||||||||||||||||
| All other liabilities | 4,001 | 1,933 | ||||||||||||||||||
| Stockholders' Equity: | ||||||||||||||||||||
| Unrealized Holding Gain/(Loss) | (416 | ) | (686 | ) | ||||||||||||||||
| Common Stock, Surplus, Retained Earnings | 15,756 | 11,802 | ||||||||||||||||||
| Total liabilities and stockholders' equity | 186,933 | 154,039 | ||||||||||||||||||
| Interest spread | 1,528 | 2.61 | % | 1,318 | 3.04 | % | ||||||||||||||
| Net Interest Margin as a | ||||||||||||||||||||
| Percentage of Average | ||||||||||||||||||||
| Earnings Assets - FTE | 181,874 | 1,528 | 3.36 | % | 149,761 | 1,318 | 3.52 | % | ||||||||||||
Rate / Volume Analysis of Net Interest Income.The following schedule presents the dollar amount of changes in interest income and expense for major components of earning assets and interest-bearing liabilities, distinguishing between changes related to outstanding balances and changes due to interest rates.
| 2005 Compared to 2004 | |||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|
| Change Due to Rate | Change Due to Volume | Total Change | |||||||||
| (Dollars in thousands) | |||||||||||
| Short term investment | $ | 43 | $ | 1 | $ | 44 | |||||
| Investment securities--taxable | 32 | 92 | 124 | ||||||||
| Investment securities--tax-exempt | (13 | ) | (82 | ) | (95 | ) | |||||
| Loans, net of unearned income | 106 | 583 | 689 | ||||||||
| Total interest income | 168 | 594 | 762 | ||||||||
| Interest bearing deposits | 319 | 177 | 496 | ||||||||
| Federal funds borrowed | -- | -- | -- | ||||||||
| FHLB advances | 42 | (6 | ) | 36 | |||||||
| Trust preferred securities | 20 | -- | 20 | ||||||||
| Other borrowings | -- | -- | -- | ||||||||
| Total interest expense | 381 | 171 | 552 | ||||||||
| Net interest income | $ | (213 | ) | $ | 423 | $ | 210 | ||||
The provision for loan loss for the third quarter of 2005 was $908,000, compared to $110,000 for the 3rd quarter of 2004. As discussed in more detail above, the large provision for the quarter was due to deteriorating economic conditions and the indirect effects of the charge-offs on the allowance calculation, along with the large specific reserve noted in the balance sheet discussion. Management believes the current rate of providing for the loan loss reserve is adequate.
Non-interest income increased $23,000, or 12.3% for the third quarter of 2005 compared to the same period in 2004. The largest portion of the change in non-interest income was due to losses on the sale of securities in the 3rd quarter of 2004. Fees on deposit accounts increased $11,000, or 6.7% over the same quarter in the prior year. The Corporation’s focus on checking accounts and the implementation of a bounce protection product in the fourth quarter of 2004 continues to increase these fees.
Non-interest expense was $1.5 million for the third quarter of 2005, a $585,000 or 60.6% increase over the third quarter of 2004 when non-interest expense was $964,000. The increase is primarily attributable to higher salary and benefit costs of $219,000, or 46.3% due to the increase in full time equivalents needed to manage the growth of the Corporation. Occupancy expense has increased $84,000, or 67.2% as a result of the two new ventures discussed above and also due to the new full service branch which opened for business in the fourth quarter of 2004. Professional fees are 53.6%, or $45,000 higher than the same period last year, mostly due to legal costs related to the start-up of Huron Valley State Bank. Advertising expense is elevated from the 3rdquarter of 2004 due to the opening of the new Bank and various marketing programs related to the mortgage operation. As Huron Valley State Bank and the mortgage operation gain critical mass, we anticipate our efficiency ratio to improve to the levels more common throughout our history. The ratio for the quarter ended September 30, 2005 increased to 85.90% from 64.05% at September 30, 2004.
Comparison of Operating Results for the Nine Months Ended September 30, 2005 and 2004
Our net loss was $390,000, or $0.35 per diluted share year to date 2005 compared to net profit of $950,000, or $0.89 per diluted share for the same period in 2004. The net loss was due to a large provision for loan loss and increased operating expenses and offset by increases in net interest income and non interest income. Operating results related to Huron Valley State Bank and our entrance into the mortgage business decreased net income $403,700, or $0.36 per diluted share and $244,000, or $0.22 per diluted share, respectively in the 9 months ended September 30, 2005. Steps have been taken in regard to the mortgage banking operation to substantially reduce operating costs, and management does not anticipate that the mortgage banking operation will negatively influence operating results in 2006. The losses since the opening of Huron Valley State Bank have been in line with the initial projections.
Net interest income increased 18.4% or $700,000 from $3.8 million year to date 2004 to $4.5 million for 2005. Higher balances in total earning assets, which increased 23.76% to $174.5 million for the nine months ended September 30, 2005 from $141.0 million for the same period in 2004, effectively increased the interest margin by $2.0 million year over year. This increase was offset by compression of the interest margin, which fell to 3.47% from 3.57%. The decreased margin was due to liabilities repricing faster than assets. The cost of interest bearing liabilities increased 85 basis points over this period, while the yield on earning assets increased by only 57 basis points. Continued growth in non-interest bearing accounts mitigated some of this effect. The money market pricing structure was the largest contributor to the reduced margin. A new, more flexible pricing structure was put in place on money market accounts subsequent to the end of the quarter which should significantly reduce interest expense on these accounts, while remaining competitive in the marketplace.
The following schedule presents the average daily balances, interest income, interest expense and average rates earned and paid for the Corporation’s major categories of assets, liabilities, and shareholders’ equity for the periods indicated (dollars in thousands):
| 9 Months ended September 30, 2005 | 9 Months ended September 30, 2004 | |||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Average Balance | Interest | Yield/ Cost | Average Balance | Interest | Yield/ Cost | |||||||||||||||
| Assets: | ||||||||||||||||||||
| Short term investment | $ | 6,690 | $ | 132 | 2.63 | % | $ | 4,453 | $ | 55 | 1.65 | % | ||||||||
| Securities: | ||||||||||||||||||||
| Taxable | 30,045 | 899 | 3.99 | % | 26,514 | 724 | 3.64 | % | ||||||||||||
| Tax-exempt | 9,962 | 242 | 3.24 | % | 22,468 | 567 | 3.36 | % | ||||||||||||
| Loans | 127,789 | 6,756 | 7.05 | % | 87,570 | 4,532 | 6.90 | % | ||||||||||||
| Total earning assets/total | ||||||||||||||||||||
| interest income | 174,486 | 8,029 | 6.14 | % | 141,005 | 5,878 | 5.56 | % | ||||||||||||
| Cash and due from banks | 3,399 | 2,672 | ||||||||||||||||||
| Unrealized Gain (Loss) | (545 | ) | 5 | |||||||||||||||||
| Allowance for loan loss | (1,475 | ) | (1,092 | ) | ||||||||||||||||
| All other assets | 3,902 | 2,914 | ||||||||||||||||||
| Total assets | 179,767 | 8,029 | 145,504 | 5,878 | ||||||||||||||||
| Liabilities and Stockholders' Equity | ||||||||||||||||||||
| Interest bearing deposits: | ||||||||||||||||||||
| MMDA, Savings/NOW accounts | 69,112 | 1,515 | 2.92 | % | 62,525 | 799 | 1.70 | % | ||||||||||||
| Time | 56,983 | 1,515 | 3.54 | % | 43,932 | 1,125 | 3.41 | % | ||||||||||||
| Fed Funds Purchased | 944 | 13 | 1.84 | % | 27 | 1 | 4.94 | % | ||||||||||||
| FHLB Advances | 10,533 | 264 | 3.34 | % | 4,187 | 68 | 2.17 | % | ||||||||||||
| Trust Preferred Securities | 4,000 | 184 | 6.13 | % | 4,000 | 109 | 3.63 | % | ||||||||||||
| Other borrowings | -- | -- | 0.00 | % | -- | -- | 0.00 | % | ||||||||||||
| Total interest bearing | ||||||||||||||||||||
| liabilities/interest expense | 141,572 | 3,491 | 3.29 | % | 114,671 | 2,102 | 2.44 | % | ||||||||||||
| Noninterest bearing deposits | 22,502 | 17,910 | ||||||||||||||||||
| All other liabilities | 2,364 | 1,520 | ||||||||||||||||||
| Stockholders' Equity: | ||||||||||||||||||||
| Unrealized Holding Gain/(Loss) | (360 | ) | (17 | ) | ||||||||||||||||
| Common Stock, Surplus, Retained Earnings | 13,689 | 11,420 | ||||||||||||||||||
| Total liabilities and stockholders' equity | 179,767 | 145,504 | ||||||||||||||||||
| Interest spread | 4,538 | 2.85 | % | 3,776 | 3.11 | % | ||||||||||||||
| Net Interest Margin as a | ||||||||||||||||||||
| Percentage of Average | ||||||||||||||||||||
| Earnings Assets - FTE | 174,486 | 4,538 | 3.47 | % | 141,005 | 3,776 | 3.57 | % | ||||||||||||
Rate / Volume Analysis of Net Interest Income.The following schedule presents the dollar amount of changes in interest income and expense for major components of earning assets and interest-bearing liabilities, distinguishing between changes related to outstanding balances and changes due to interest rates.
| 2005 Compared to 2004 | |||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|
| Change Due to Rate | Change Due to Volume | Total Change | |||||||||
| (Dollars in thousands) | |||||||||||
| Short term investment | $ | 42 | $ | 35 | $ | 77 | |||||
| Investment securities--taxable | 73 | 102 | 175 | ||||||||
| Investment securities--tax-exempt | (20 | ) | (305 | ) | (325 | ) | |||||
| Loans, net of unearned income | 100 | 2,124 | 2,224 | ||||||||
| Total interest income | 195 | 1,956 | 2,151 | ||||||||
| Interest bearing deposits | 709 | 397 | 1,106 | ||||||||
| Federal funds borrowed | -- | -- | -- | ||||||||
| FHLB advances | 52 | 144 | 196 | ||||||||
| Trust preferred securities | 75 | -- | 75 | ||||||||
| Other borrowings | -- | -- | -- | ||||||||
| Total interest expense | 836 | 541 | 1,377 | ||||||||
| Net interest income | $ | (641 | ) | $ | 1,415 | $ | 774 | ||||
The provision for loan loss year to date at September 30, 2005 was $1.3 million, a 44.4% increase over the $900,000 posted for the same period in 2004. As discussed in more detail above, the large provision year to date was due to deteriorating economic conditions and the indirect effects of the charge-offs on the allowance calculation, along with the large specific reserve noted in the balance sheet discussion. Management believes the current rate of providing for the loan loss reserve is adequate.
Non-interest income was $707,000 year to date 2005, a $237,000, or 50.4% increase over the same period in 2004 when non-interest income was $470,000. The largest portion of the increase in non-interest income was seen in service charges and other fee income, which increased $161,000, or 37.8% over the same period last year. The Corporation’s continued focus on checking accounts and the implementation of a bounce protection product increased these fees significantly.
Non-interest expense was $4.2 million year to date 2005, a $1.5 million or 55.6% increase over the same period in 2004 when non-interest expense was $2.7 million. The increase is primarily attributable to higher salary and benefit costs of $853,000, or 62.5% due to the increase in full time equivalents needed to manage the growth of the Corporation, primarily to staff the new ventures. Occupancy expense has increased $238,000, or 67.0%, as a result of the two new ventures discussed above and also due to the new full service branch which opened for business late in the fourth quarter of 2004. Professional fees are 32.6%, or $73,000 higher than the same period last year, mostly due to legal costs related to the start-up of Huron Valley State Bank. Advertising expense is elevated from the 3rd quarter of 2004 due to the opening of the new Bank and various marketing programs related to the mortgage operation. As Huron Valley State Bank and the mortgage operation gain critical mass, we anticipate our efficiency ratio to improve to the levels more common throughout our history. The ratio for the quarter ended September 30, 2005 increased to 80.8% from 64.5% at September 30, 2004.
Liquidity and Capital Resources
The Corporation obtained its initial equity capital in an initial public offering of its common stock in November 1998. We have successfully grown through our first five years of operation. In December 2003, we completed an offering of $4.0 million of cumulative preferred securities (“Trust Preferred Securities”) to further support the Corporation’s growth.
In July 2005, the Corporation completed a rights offering which allowed each holder of the Corporation’s common stock as of the June 6, 2005 record date to purchase 1 additional share of common stock for every 4 shares held, while also offering an opportunity to purchase a limited number of shares above their basic subscription right (the over-subscription privilege). A total of 165,776 shares were purchased in the rights offering (63.2% of the 262,192 shares offered). Of the 165,776 shares purchased, 127,183 shares were basic subscriptions and 38,593 shares were over-subscriptions. The Corporation received approximately $2,856,000 in net proceeds in connection with the rights offering, which was used to purchase a majority interest in Huron Valley State Bank.
Also in July 2005, 28,000 shares were sold to one investor through the community offering provisions of the rights offering. These shares were sold at $18.00, netting the corporation $504,000.
Management believes that its current capital will provide us with adequate capital to support our expected level of deposit and loan growth and to otherwise meet our capital requirements for the next year. One of the growth strategies we intend to pursue, which could have an effect on our equity and or require additional capital, is growth through acquisition or the start up of additional DeNovo banks.
Capital Resources at September 30, 2005 (in thousands)
| Tier 1 Leverage Ratio | Tier 1 Capital Ratio | Total Risk-Based Capital Ratio | ||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Minimum regulatory requirement for | ||||||||||||
| Capital adequacy | 4 | .00% | 4 | .00% | 8 | .00% | ||||||
| Well capitalized regulatory level | 5 | .00% | 6 | .00% | 10 | .00% | ||||||
| CSB | 7 | .29% | 9 | .59% | 10 | .84% | ||||||
| HVSB | 76 | .62% | 187 | .31% | 187 | .86% | ||||||
| Consolidated | 10 | .61% | 13 | .95% | 15 | .27% | ||||||
The following table shows the dollar amounts by which the Corporation’s capital (on a consolidated basis) exceeds current regulatory requirements on a dollar-enumerated basis:
| Tier 1 Leverage | Tier 1 Capital | Total Risk-Based Capital | |||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|
| (in thousands of dollars) | |||||||||||
| Capital balances at September 30, 2005 | |||||||||||
| Required regulatory capital | $ | 7,477 | $ | 5,688 | $ | 11,375 | |||||
| Capital in excess of regulatory minimums | 12,362 | 14,151 | 10,343 | ||||||||
| Actual capital balances | $ | 19,839 | $ | 19,839 | $ | 21,718 | |||||
The liquidity of a financial institution reflects its ability to provide funds to meet loan requests, to accommodate possible outflows of deposits and to take advantage of interest rate market opportunities. Our sources of liquidity include our borrowing capacity with the Federal Home Loan Bank, loan payments by our borrowers, maturity and sales of our securities available for sale, growth of our deposits and deposit equivalents and various capital resources. Liquidity management involves the ability to meet the cash flow requirements of our customers. Our customers may be either borrowers with credit needs or depositors wanting to withdraw funds. We believe our liquidity position is sufficient to meet these needs.
As indicated by the consolidated statement of cash flows for the 9 months ended September 30, 2005, deposits continue to be the primary source of funding for loan growth with an increase of $24.0 million, in cash flows from deposits over the same period last year. In addition, equity and minority interest have provided $6.9 million year to date. These funds were deployed primarily into loans and used to pay off debt, where the cash outflows were $19.7 million and $5.0 million, respectively. We anticipate that future loan growth will be funded primarily with deposit growth, and secondarily with other wholesale sources of funding, not through the liquidation of the security portfolio.
Item 3 CONTROLS AND PROCEDURES
| (a) | Evaluation of Disclosure Controls and Procedures. The Corporation’s Chief Executive Officer and Chief Financial Officer, after evaluating the effectiveness of the Corporation’s disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) as of the end of the period covered by this Form 10-QSB Quarterly Report, have concluded that the Corporation’s disclosure controls and procedures were adequate and effective to ensure that material information relating to the Corporation would be made known to them by others within the Corporation, particularly during the period in which this Form 10-QSB Quarterly Report was being prepared. |
| (b) | Changes in Internal Controls. During the period covered by this report, there have been no changes in the Corporation’s internal control over financial reporting that have materially affected or are reasonably likely to materially affect the Corporation’s internal control over financial reporting. |
PART II — OTHER INFORMATION
Item 1. Legal Proceedings.
From time to time, we may be involved in various legal proceedings that are incidental to our business. In our opinion, we are not a party to any current legal proceedings that are material to our financial condition, either individually or in the aggregate.
Item 2. Changes in Securities and Use of Proceeds.
None.
Item 3. Defaults Upon Senior Securities.
None.
Item 4. Submission of Matters to a Vote of Securities Holders
None.
Item 5. Other Information.
None.
Item 6. Exhibits.
Exhibits
| 31.1 | Certificate of the Chief Executive Officer of Clarkston Financial Corporation pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. |
| 31.2 | Certificate of the Chief Financial Officer of Clarkston Financial Corporation pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. |
| 32.1 | Certificate of the Chief Executive Officer and Chief Financial Officer of Clarkston Financial Corporation pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
SIGNATURES
In accordance with the requirements of the Securities Exchange Act of 1934, as amended, the Registrant has duly caused this Quarterly Report on Form 10-QSB for the quarter ended September 30, 2005, to be signed on its behalf by the undersigned, thereunto duly authorized.
| CLARKSTON FINANCIAL CORPORATION /s/ Edwin L. Adler —————————————— Edwin L. Adler Chairman of the Board and Chief Financial Officer /s/ J. Grant Smith —————————————— J. Grant Smith Chief Financial Officer and Chief Operating Officer |
DATE: November 14, 2005
EXHIBIT LIST
| 31.1 | Certificate of the Chief Executive Officer of Clarkston Financial Corporation pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. |
| 31.2 | Certificate of the Chief Financial Officer of Clarkston Financial Corporation pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. |
| 32.1 | Certificate of the Chief Executive Officer and Chief Financial Officer of Clarkston Financial Corporation pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |