_________________
[X] QUARTERLY REPORT UNDER SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2007
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: 1,273,734 shares of the Corporation’s Common Stock (no par value) were outstanding as of August 13, 2007.
Transitional Small Business Disclosure Format (check one): Yes No X
1
| Page Number(s) | |||||||
|---|---|---|---|---|---|---|---|
| Part I | Financial Information (unaudited): | ||||||
| Item 1. | |||||||
| Condensed Consolidated Financial Statements | 3 | ||||||
| Notes to Condensed Consolidated Financial Statements | 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 | ||||||
2
CLARKSTON FINANCIAL CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEET
June 30, 2007 (unaudited) and December 31, 2006
(dollars in thousands)
| June 30, 2007 | December 31, 2006 | |||||||
|---|---|---|---|---|---|---|---|---|
| (unaudited) | ||||||||
| ASSETS | ||||||||
| Cash and cash equivalents | ||||||||
| Total cash and due from banks | $ | 4,721 | $ | 5,848 | ||||
| Federal funds sold | 3,432 | 7,472 | ||||||
| Total cash and cash equivalents | 8,153 | 13,320 | ||||||
| Securities available for sale, at fair value | 38,879 | 43,864 | ||||||
| Loans held for sale | 348 | 120 | ||||||
| Loans | ||||||||
| Total loans | 150,683 | 157,715 | ||||||
| Less: Allowance for loan losses | (1,733 | ) | (2,750 | ) | ||||
| Net loans | 148,950 | 154,965 | ||||||
| Banking premises and equipment | 6,505 | 4,730 | ||||||
| Deferred tax asset | 840 | 757 | ||||||
| Interest receivable and other assets | 3,092 | 2,622 | ||||||
| Total assets | $ | 206,767 | $ | 220,378 | ||||
| LIABILITIES AND SHAREHOLDERS' EQUITY | ||||||||
| Deposits | ||||||||
| Noninterest-bearing | $ | 24,085 | $ | 23,922 | ||||
| Interest-bearing | 145,249 | 158,119 | ||||||
| Total deposits | 169,334 | 182,041 | ||||||
| Advances from Federal Home Loan Bank of Indianapolis | 12,200 | 15,200 | ||||||
| Junior subordinated debentures | 4,000 | 4,000 | ||||||
| Federal funds purchased | 2,400 | -- | ||||||
| Interest payable and other liabilities | 1,020 | 1,176 | ||||||
| Total liabilities | 188,954 | 202,417 | ||||||
| Minority interest in consolidated subsidiary | 3,064 | 3,195 | ||||||
| Shareholders' equity | ||||||||
| Common stock, no par value: 10,000,000 shares authorized; | ||||||||
| 1,273,734 and 1,245,722 shares issued and outstanding as of | ||||||||
| June 30, 2007 and December 31, 2006 | 6,297 | 6,245 | ||||||
| Capital surplus | 6,297 | 6,245 | ||||||
| Restricted stock - unearned compensation | (24 | ) | (38 | ) | ||||
| Retained earnings | 3,078 | 2,898 | ||||||
| Accumulated other comprehensive loss | (899 | ) | (584 | ) | ||||
| Total shareholders' equity | 14,749 | 14,766 | ||||||
| Total liabilities and shareholders' equity | $ | 206,767 | $ | 220,378 | ||||
See accompanying notes to consolidated financial statements
3
CLARKSTON FINANCIAL CORPORATION
CONDENSED CONSOLIDATED STATEMENT OF INCOME
Three and Six Month Periods Ended June 30, 2007 and June 30, 2006
(dollars in thousands, except per share data)
(unaudited)
| Three Months Ended June 30, 2007 | Three Months Ended June 30, 2006 | Six Months Ended June 30, 2007 | Six Months Ended June 30, 2006 | |||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Interest Income | ||||||||||||||
| Loans, including fees | $ | 2,938 | $ | 2,620 | $ | 5,900 | $ | 5,024 | ||||||
| Securities | ||||||||||||||
| Taxable | 377 | 446 | 777 | 883 | ||||||||||
| Tax-exempt | 72 | 87 | 144 | 174 | ||||||||||
| Federal funds sold | 59 | 89 | 149 | 156 | ||||||||||
| Total interest income | 3,446 | 3,242 | 6,970 | 6,237 | ||||||||||
| Interest Expense | ||||||||||||||
| Deposits | 1,589 | 1,432 | 3,217 | 2,682 | ||||||||||
| Borrowings | 244 | 228 | 521 | 445 | ||||||||||
| Total interest expense | 1,833 | 1,660 | 3,738 | 3,127 | ||||||||||
| Net Interest Income | 1,613 | 1,582 | 3,232 | 3,110 | ||||||||||
| Provision for loan losses | 60 | 534 | 77 | 1,366 | ||||||||||
| Net interest income | ||||||||||||||
| After provision for loan losses | 1,553 | 1,126 | 3,155 | 1,744 | ||||||||||
| Noninterest income | ||||||||||||||
| Gain on sale of securities | -- | -- | (2 | ) | 3 | |||||||||
| Gain on sale of loans | 84 | 81 | 147 | 119 | ||||||||||
| Service charges and other fees | 195 | 166 | 402 | 373 | ||||||||||
| Other income | 10 | (3 | ) | 18 | (3 | ) | ||||||||
| Total noninterest income | 289 | 244 | 565 | 492 | ||||||||||
| Noninterest expense | ||||||||||||||
| Salaries and benefits | 1,004 | 839 | 1,971 | 1,630 | ||||||||||
| Occupancy expense | 233 | 280 | 446 | 534 | ||||||||||
| Computer and data processing expenses | 128 | 110 | 264 | 219 | ||||||||||
| Advertising and public relations | 82 | 68 | 144 | 141 | ||||||||||
| Professional fees | 147 | 120 | 293 | 254 | ||||||||||
| Other expense | 217 | 245 | 474 | 417 | ||||||||||
| Total noninterest expense | 1,811 | 1,662 | 3,592 | 3,195 | ||||||||||
| Income/(loss) before federal income tax expense and minority interest | 31 | (370 | ) | 128 | (959 | ) | ||||||||
| Federal income tax expense/(benefit) | 51 | (113 | ) | 88 | (280 | ) | ||||||||
| Income/(loss) before minority interest | (20 | ) | (257 | ) | 40 | (679 | ) | |||||||
| Minority interest in net loss of consolidated subsidiary | (67 | ) | (59 | ) | (140 | ) | (127 | ) | ||||||
| Net income/(loss) | $ | 47 | $ | (198 | ) | $ | 180 | $ | (552 | ) | ||||
| Basic earnings/(loss) per share | $ | .04 | $ | (.16 | ) | $ | .14 | $ | (.44 | ) | ||||
| Diluted earnings/(loss) per share | $ | .04 | $ | (.16 | ) | $ | .14 | $ | (.44 | ) | ||||
See accompanying notes to consolidated financial statements.
4
CLARKSTON FINANCIAL CORPORATION
CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS’ EQUITY
Six Month Period ended June 30, 2007
(dollars in thousands)
(unaudited)
| Common Stock | Capital Surplus | Unearned Comp. | Retained Earnings | Accumulated Other Comprehensive Loss | Total Stockholders' Equity | |||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Balance, December 31, 2006 | $ | 6,245 | $ | 6,245 | $ | (38 | ) | $ | 2,898 | $ | (584 | ) | $ | 14,766 | ||||||
| Stock options exercised | 52 | 52 | 104 | |||||||||||||||||
| Recognition of compensation for | ||||||||||||||||||||
| restricted stock award | - | - | 14 | - | - | 14 | ||||||||||||||
| Comprehensive income: | ||||||||||||||||||||
| Net loss for the six months ended | ||||||||||||||||||||
| June 30, 2007 | - | - | - | 180 | - | 180 | ||||||||||||||
| Change in unrealized loss on | ||||||||||||||||||||
| securities available for sale | ||||||||||||||||||||
| net of tax of ($122) | - | - | - | - | (315 | ) | (315 | ) | ||||||||||||
| Net comprehensive loss | - | - | - | 0 | (315 | ) | 0 | |||||||||||||
| Balance, June 30, 2007 | $ | 6,297 | $ | 6,297 | $ | (24 | ) | $ | 3,078 | $ | (899 | ) | $ | 14,749 | ||||||
5
CLARKSTON FINANCIAL CORPORATION
CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS
Six Month Periods ended June 30, 2007 and June 30, 2006
(dollars in thousands)
(unaudited)
| Six Months Ended June 30, 2007 | Six Months Ended June 30, 2006 | |||||||
|---|---|---|---|---|---|---|---|---|
| Net Cash Provided by Operating Activities: | ||||||||
| Net cash provided by operating activities | $ | 771 | $ | 2,029 | ||||
| Cash Flows from Investing Activities: | ||||||||
| Net decrease/(increase) in loans | 5,010 | (9,107 | ) | |||||
| Purchase of available-for-sale securities | -- | (3,214 | ) | |||||
| Proceeds from sales of available-for-sale securities . | 4,458 | 3,171 | ||||||
| Resources provided by minority interest | (131 | ) | (121 | ) | ||||
| Property and equipment expenditures | (1,968 | ) | (1,096 | ) | ||||
| Net cash (used in)/provided by investing activities | 7,845 | (10,246 | ) | |||||
| Cash Flows from Financing Activities: | ||||||||
| Increase/(decrease) in deposits | (12,707 | ) | 16,215 | |||||
| Increase in Federal Funds purchased | 2,400 | -- | ||||||
| Advances from Federal Home Loan Bank | 7,000 | -- | ||||||
| Repayment of Federal Home Loan Bank advances | (10,000 | ) | -- | |||||
| Net cash (used in)/provided by financing activities | (13,307 | ) | 16,094 | |||||
| Net increase in cash and cash equivalents | 5,167 | 7,877 | ||||||
| Cash and cash equivalents at beginning of period | 13,320 | 8,090 | ||||||
| Cash and cash equivalents at end of period | $ | 8,153 | $ | 15,967 | ||||
| Supplemental Cash Flow Information - Cash paid for: | ||||||||
| Interest | 3,657 | 2,847 | ||||||
| Taxes | -- | -- | ||||||
| Significant Noncash Activities: | ||||||||
| Transfer from loans to repossessed assets | 928 | -- | ||||||
See accompanying notes to consolidated financial statements.
6
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, 2006.
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 six month periods ended June 30, 2007 are not necessarily indicative of the results that may be expected for the year ended December 31, 2007.
Certain amounts in prior period’s financial statements have been reclassified to conform to the current period’s presentation.
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 in accordance with FASB Interpretation No. 46.
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 27,500 shares of common stock, of which 15,552 shares of common stock are available for grant. Under the 1998 Founding Directors Stock Option Plan (“Director Plan”), the Corporation may grant options for up to 82,500 shares of common stock, of which 7,920 shares of common stock are available for grant. 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.
Prior to January 1, 2007 the Company accounted for stock awards and options under the recognition and measurement principles of APB Opinion No. 25, Accounting for Stock Issued to Employees, and related interpretations. The Company has adopted the fair value recognition provisions of Statement of Financial Standards (SFAS) No. 123 (R), Share Based Payment effective January 1, 2007 using the modified-prospective transition method. SFAS No. 123(R), Share Based Payment, established a fair value method of accounting for stock options whereby compensation expense would be recognized based on the computed fair value of the options on the grant date.
7
The following table summarizes stock option transactions for both plans and the related average exercise prices for the three month periods ended June 30:
| 2007 | 2006 | |||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Number of shares | Weighted Average Exercise Price | Number of shares | Weighted Average Exercise Price | |||||||||||
| Options outstanding- Beginning of Year | 35,522 | $ | 9.09 | 49,536 | $ | 9.09 | ||||||||
| Options granted - Employee Plan | -- | -- | -- | -- | ||||||||||
| Options exercised | (11,504 | ) | $ | 9.09 | -- | -- | ||||||||
| Options expired | -- | -- | -- | -- | ||||||||||
| Options Outstanding- End of Period | 24,018 | $ | 9.09 | 49,536 | $ | 9.09 | ||||||||
The following table shows summary information about fixed stock options outstanding at June 30, 2007:
| Stock Options Outstanding and Exercisable | |||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Range of Exercise Prices | Number of Shares | Weighted Average Remaining Contractual Life | Weighted Average Exercise Price | Aggregate Intrinsic Value | |||||||||||||
| Contingent | $ | 9.09 | 12,030 | 1.4 years | $ | 9.09 | $ | 43,428 | |||||||||
| Non-contingent | $ | 9.09 | 11,988 | 1.4 years | $ | 9.09 | $ | 43,277 | |||||||||
8
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 June 30, | Six Months Ended June 30, | |||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2007 | 2006 | 2007 | 2006 | |||||||||||
| Net income/(loss) available to common | ||||||||||||||
| stockholders | $ | 47 | $ | (198 | ) | $ | 180 | $ | (552 | ) | ||||
| Average number of common shares | ||||||||||||||
| outstanding | 1,264 | 1,246 | 1,263 | 1,246 | ||||||||||
| Effect of dilutive options | 7 | 19 | 8 | 18 | ||||||||||
| Average number of common shares | ||||||||||||||
| outstanding used to calculate diluted | ||||||||||||||
| earnings/(loss) per common share | 1,271 | 1,265 | 1,271 | 1,264 | ||||||||||
| Number of antidilutive stock options excluded | ||||||||||||||
| from diluted earnings per share computation | -- | -- | -- | -- | ||||||||||
9
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):
| Amortized Cost | Gross Unrealized Gains | Gross Unrealized Losses | Estimated Market Value | |||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| June 30, 2007 (unaudited) | ||||||||||||||
| U.S. Treasury securities and obligations of | ||||||||||||||
| U.S. government corporations and agencies | $ | 5,899 | $ | -- | $ | 96 | $ | 5,803 | ||||||
| Mortgage-backed securities | 22,647 | 6 | 754 | 21,899 | ||||||||||
| Collateralized mortgage obligations | 2,774 | -- | 107 | 2,667 | ||||||||||
| Obligations of state and political subdivisions | 8,859 | -- | 349 | 8,510 | ||||||||||
| $ | 40,179 | $ | 6 | $ | 1,306 | $ | 38,879 | |||||||
| December 31, 2006 | ||||||||||||||
| U.S. Treasury securities and obligations of | ||||||||||||||
| U.S. government corporations and agencies | $ | 7,353 | $ | 8 | $ | 40 | $ | 7,321 | ||||||
| Mortgage-backed securities | 25,496 | 5 | 561 | 24,940 | ||||||||||
| Collateralized mortgage obligations | 2,977 | -- | 85 | 2,892 | ||||||||||
| Obligations of state and political subdivisions | 8,899 | 3 | 191 | 8,711 | ||||||||||
| $ | 44,725 | $ | 17 | $ | 877 | $ | 43,864 | |||||||
Loans are as follows (dollars in thousands):
| June 30, 2007 (unaudited) | December 31, 2006 | |||||||
|---|---|---|---|---|---|---|---|---|
| Commercial | $ | 19,484 | $ | 23,917 | ||||
| Real estate: | ||||||||
| Commercial | 92,068 | 91,007 | ||||||
| Residential | 18,244 | 19,331 | ||||||
| Construction | 18,611 | 21,206 | ||||||
| Total real estate | 128,923 | 131,544 | ||||||
| Consumer | 2,276 | 2,254 | ||||||
| Total | $ | 150,683 | $ | 157,715 | ||||
10
Activity in the allowance for loan losses is as follows (dollars in thousands):
| Three Months Ended June 30, | Six Months Ended June 30, | |||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2007 | 2006 | 2007 | 2006 | |||||||||||
| Balance - Beginning of period | $ | 2,593 | $ | 2,118 | $ | 2,750 | $ | 1,930 | ||||||
| Provision charged to operations | 60 | 534 | 77 | 1,366 | ||||||||||
| Charge-offs | (969 | ) | (1,115 | ) | (1,494 | ) | (1,766 | ) | ||||||
| Recoveries | 49 | 23 | 401 | 30 | ||||||||||
| Balance - End of period | $ | 1,733 | $ | 1,560 | $ | 1,733 | $ | 1,560 | ||||||
| Allowance for loan losses to total | 1.15 | % | 1.12 | % | 1.15 | % | 1.12 | % | ||||||
| Loans | ||||||||||||||
Deposits are summarized as follows (dollars in thousands):
| June 30, 2007 (unaudited) | December 31, 2006 | |||||||
|---|---|---|---|---|---|---|---|---|
| Non-interest bearing demand deposit accounts | $ | 24,085 | $ | 23,922 | ||||
| Interest-bearing demand deposit accounts | 4,994 | 5,418 | ||||||
| Savings accounts | 3,945 | 4,183 | ||||||
| Money market accounts | 47,051 | 52,004 | ||||||
| Certificates of deposit | 89,259 | 96,514 | ||||||
| Total deposits | $ | 169,334 | $ | 182,041 | ||||
The Company has various term advances from the Federal Home Loan Bank of Indianapolis (“FHLB”) with fixed and variable interest rates ranging from 3.75% to 5.43% at June 30, 2007 and December 31, 2006. The weighted average interest rate at June 30, 2007 is 4.18%. Maturity dates range from November 2007 to October 2010. The weighted average remaining maturity at June 30, 2007 is 499 days, or November 9, 2008. Advances from the FHLB are collateralized by qualifying investment securities with estimated market values of $19,100,000 and $16,300,000 at June 30, 2007 and December 31, 2006. The advances are due in full at maturity and the fixed rate advances are subject to a prepayment penalty if repaid prior to maturity.
11
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 June 30, 2007 and December 31, 2006.
The Banks’ and Corporation’s actual capital amounts and ratios as of June 30, 2007 and December 31, 2006 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 June 30, 2007: | ||||||||||||||||||||
| Total risk-based capital | ||||||||||||||||||||
| (to risk weighted assets) | ||||||||||||||||||||
| CSB | $ | 15,914 | 10.75 | $ | 11,839 | 8.00 | $ | 14,798 | 10.00 | |||||||||||
| HVSB | 7,104 | 37.70 | 1,507 | 8.00 | 1,884 | 10.00 | ||||||||||||||
| Tier I Capital | ||||||||||||||||||||
| (to risk weighted assets) | ||||||||||||||||||||
| CSB | $ | 14,332 | 9.68 | $ | 5,920 | 4.00 | $ | 8,879 | 6.00 | |||||||||||
| HVSB | 6,953 | 36.90 | 754 | 4.00 | 1,131 | 6.00 | ||||||||||||||
| Tier I Capital | ||||||||||||||||||||
| (to average assets) | ||||||||||||||||||||
| CSB | $ | 14,332 | 7.87 | $ | 7,284 | 4.00 | $ | 9,105 | 5.00 | |||||||||||
| HVSB | 6,953 | 25.16 | 1,106 | 4.00 | 1,382 | 5.00 | ||||||||||||||
| As of December 31, 2006: | ||||||||||||||||||||
| Total risk-based capital | ||||||||||||||||||||
| (to risk-weighted assets) | ||||||||||||||||||||
| CSB | $ | 15,858 | 10.05 | $ | 12,622 | 8.00 | $ | 15,778 | 10.00 | |||||||||||
| HVSB | 7,387 | 45.69 | 1,293 | 8.00 | 1,617 | 10.00 | ||||||||||||||
| Tier I Capital | ||||||||||||||||||||
| (to risk weighted assets) | ||||||||||||||||||||
| CSB | $ | 13,878 | 8.80 | $ | 6,311 | 4.00 | $ | 9,467 | 6.00 | |||||||||||
| HVSB | 7,256 | 44.88 | 674 | 4.00 | 970 | 6.00 | ||||||||||||||
| Tier I Capital | ||||||||||||||||||||
| (to average assets) | ||||||||||||||||||||
| CSB | $ | 13,878 | 7.44 | $ | 7,464 | 4.00 | $ | 9,329 | 5.00 | |||||||||||
| HVSB | 7,256 | 34.22 | 848 | 4.00 | 1,060 | 5.00 | ||||||||||||||
12
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 June 30, 2007 and December 31, 2006, the following financial instruments were outstanding whose contract amounts represent credit risk (dollars in thousands):
| June 30, 2007 (unaudited) | December 31, 2006 | |||||||
|---|---|---|---|---|---|---|---|---|
| Commitments to grant loans | $ | 8,924 | $ | 11,933 | ||||
| Unfunded commitments under lines of credit | 21,470 | 25,238 | ||||||
| Commercial and standby letters of credit | 90 | 108 | ||||||
In July 2006, the FASB issued FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes—an interpretation of FASB Statement No. 109 (FIN 48), which clarifies the accounting for uncertainty in tax positions. This Interpretation requires that the Company recognize in the financial statements, the impact of a tax position, if that position is more likely than not of being sustained on audit, based on the technical merits of the position. The provisions of FIN 48 are effective as of the beginning of our 2007 fiscal year, with the cumulative effect of the change in accounting principle recorded as an adjustment to opening retained earnings. The Company is currently evaluating the impact of adopting FIN 48 on its financial statements.
In February 2007, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 159,The Fair Value Option for Financial Assets and Financial Liabilities(SFAS 159).SFAS No. 159 provides companies with an option to report selected financial assets and liabilities at fair value. SFAS No. 159‘s objective is to reduce both complexity in accounting for financial instruments and the volatility in earnings caused by measuring related assets and liabilities differently. SFAS No. 159 also establishes presentation and disclosure requirements designed to facilitate comparisons between companies that choose different measurement attributes for similar types of assets and liabilities. SFAS No. 159 requires companies to provide additional information that will help investors and other users of financial statements to more easily understand the effect of the Corporation’s choice to use fair value on its earnings. It also requires entities to display the fair value of those assets and liabilities for which the Corporation has chosen to use fair value on the face of the balance sheet. SFAS No. 159 is effective for The Corporation on January 1, 2007. The Corporation has not determined the impact of adopting SFAS No. 157 will have on its consolidated financial statements.
In September 2006, the FASB issued SFAS No. 157,Fair Value Measurements. SFAS No. 157 enhances existing guidance for measuring assets and liabilities using fair value. Prior to the issuance of SFAS No. 157, guidance for applying fair value was incorporated in several accounting pronouncements. SFAS No. 157 provides a single definition of fair value, together with a framework for measuring it, and requires additional disclosure about the use of fair value to measure assets and liabilities. SFAS No. 157 also emphasizes that fair value is a market-based measurement, not an entity-specific measurement, and sets out a fair value hierarchy with the highest priority being quoted prices in active markets. Under SFAS No. 157, fair value measurements are disclosed by level within that hierarchy. While SFAS No. 157 does not add any new fair value measurements, it does change current practice as follows: (1) a requirement for an entity to include its own credit standing in the measurement of its liabilities; (2) a modification of the transaction price presumption; (3) a prohibition on the use of block discounts when valuing large blocks of securities for broker-dealers and investment companies; and (4) a requirement to adjust the value of restricted stock for the effect of the restriction even ifthe restriction lapses within one year. SFAS No. 157 is effective for the Corporation on January 1, 2007. The Corporation has not determined the impact of adopting SFAS No. 157 will have on its consolidated financial statements.
In June 2007, the FASB ratified an Emerging Issues Task Force (EITF) consensus regardingAccounting for Income Tax Benefits of Dividends on Share-Based Payment Awards, which becomes effective for the Corporation January 1, 2008. This Issue states that tax benefits received on dividends paid to employees associated with their unvested stock compensation awards should be recorded in additional-paid-in-capital (APIC) for awards expected to vest. Currently, such dividends are a permanent tax deduction reducing the annual effective income tax rate. This Issue also requires that such tax benefits be reclassified between APIC and income tax expense in subsequent periods for any changes in forfeiture estimates. Tax benefits for dividends recorded to APIC would be available to absorb future stock compensation tax deficiencies. This Issue is to be applied prospectively to dividends declared in fiscal years beginning after December 15, 2007. Retrospective application of this Issue is prohibited. Management has not completed its review of this new guidance, but expects the effect upon implementation will not be material to the Corporation’s consolidated financial statements.
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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 includes “forward-looking statements” as that term is used in the securities laws. All statements regarding the Corporation’s expected financial position, business and strategies are forward-looking statements. In addition, the words “anticipates,” “believes,” “estimates,” “seeks,” “expects,” “plans,” “intends,” and similar expressions, as they relate to the Corporation and its management, are intended to identify forward-looking statements. The presentation and discussion of the provision and allowance for loan and lease losses, determining the fair value of securities and other financial instruments, the valuation of mortgage servicing rights and statements concerning future profitability or future growth or increases, are examples of inherently forward looking statements in that they involve judgments and statements of belief as to the outcome of future events. The Corporation’s 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 the Corporation’s 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 the Corporation’s 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 concerning the Corporation and its business, including additional factors that could materially affect the Corporation’s financial results, is included in its filings with the Securities and Exchange Commission.
General
Clarkston Financial Corporation (the “Corporation”, “us” or “we”) 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. As such, our primary business is concentrated in a single industry segment — commercial banking. The Banks provide a full range of banking services to individuals, commercial businesses and industries located in their service areas. The Banks maintain diversified loan portfolios, including loans to individuals for home mortgages, automobiles and personal expenditures, and loans to business enterprises for current operations and expansion. The Banks also offer a variety of deposit products, including checking accounts, savings accounts, money market accounts, individual retirement accounts and certificates of deposit.
The principal markets for financial services provided are in the northern Oakland County communities in which the Banks are located and the areas immediately surrounding these communities. The Banks serve these markets through 7 locations in or near their communities. The Banks do not have any material foreign assets or income.
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Our principal source of revenue is interest and fees on loans. On a consolidated basis, interest and fees on loans accounted for 78.3% of total revenue (interest income and non-interest income) year to date in 2007 compared to 74.7% year to date in 2006. The share of total revenue from interest and fees on loans increased in the current year primarily due to increased loan balances, with increasing rates also contributing. Revenue share of interest from investments (including Federal Funds sold), decreased to 14.2%, from 18.0% year over year. Noninterest income in total as a percentage of total revenue was relatively flat at 7.3% and 7.5% in 2007 and 2006, respectively.
The formation of HVSB in 2005 was a significant event for Clarkston Financial Corporation. We own 55% of the outstanding shares of common stock of HVSB. The remaining 45% is owned by private investors. We expect to recognize operating losses from HVSB in the near term as the Bank grows out of the de novo stage.
Critical Accounting Policies
As of June 30, 2007, there have been no material changes in the disclosures regarding critical accounting policies as disclosed in our Form 10-K for the year ended December 31, 2006. Our critical accounting policies are described in the financial section of our 2006 Annual Report. Management believes its critical accounting policies relate to the valuation of the allowance for loan losses, income taxes and stock-based compensation.
Comparison of Financial Condition at June 30, 2007 and December 31, 2006
Our total assets decreased by $13.6 million or 6.2% to $206.8 million at June 30, 2007, from $220.4 million at December 31, 2006. Cash, loans and investments all declined in the current period on a consolidated basis.
Clarkston State Bank’s assets decreased $14.0 million from year end 2006, with net loans decreasing $7.9 million, investment securities falling $4.1 million and cash (including federal funds sold) showing a $2.9 million decrease. Approximately $1.0 million in charge-offs are included in the decreased loan balances, with the payoff of other credits making up the remainder. Many of these credits, while not considered impaired, were either in lines of business that the Bank no longer finds desirable or were deemed to not fit within the Bank’s current strategy and the Bank requested that they find a new lender. The decrease in investment securities and cash was due to normal principal paydowns on mortgage backed securities and more effective management of cash in an attempt to maximize net interest margin.
Huron Valley State Bank’s total assets were relatively flat through June 30, 2007, increasing $400,000. Decreases of $2.2 million and $800,000 in cash and investments, respectively, were offset by increases in net loans of $1.8 million and fixed assets of $1.6 millon.
Cash and cash equivalents, which include federal funds sold and short-term investments, decreased $5.1 million or 38.4% to $8.2 million at June 30, 2007 from $13.3 million at December 31, 2006. Decreased loan fundings have caused less of a need to maintain excess liquidity and as a result, higher yielding deposits have been allowed to roll off in order to attempt to maximize net interest margin. The roll off of these funds was the primary cause of the decrease in cash and equivalents.
Securities decreased $5.0 million or 11.4% to $38.9 million at June 30, 2007 from $43.9 million at December 31, 2006. The decrease in securities was due primarily to principal paydowns on mortgage backed securities. We continue to have excellent liquidity and will monitor its level of securities to ensure proper liquidity is maintained. While there are a number of securities that have market values less than 95% of the book value, and could be construed as impaired relative to market value, management has the intent and ability to hold these specific securities until maturity and no loss is expected to be realized on these securities. As a result, management ascertains there is no permanent impairment and the value of these securities have not been written down as of June 30, 2007.
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Total portfolio loans decreased by $7.0 million or 4.4% to $150.7 million at June 30, 2007 from $157.7 million at December 31, 2006. The difficult economic climate in Michigan and competitive pressures in the banks’ contiguous markets has created a challenging environment in which to make loans. As discussed above, HVSB’s loans grew $1.9 million, or 12.8%, while CSB’s loans declined $8.9 million, or 6.1%. Commercial real estate continues to make up the bulk of the consolidated portfolio increasing $1.1 million, or 1.2% over the balance at December 31, 2006. The consumer loan portfolio was flat relative to year end, while each of the other portfolios showed declines over the same period. The largest decline, in terms of dollars and percentage, was the commercial and industrial portfolio, which showed a $4.4 million, or 18.5% decline compared to December 31, 2006. Charge-offs of approximately $330,000 combined with the payoff of some of the undesirable credits discussed above combined to cause the decline. We view these paydowns as a positive as management believes the risk present on the balance sheet has been greatly reduced. The second largest decline was seen in the construction lending portfolio, which decreased $2.6 million, or 12.2%. Finally, the residential lending portfolio saw a $1.1 million, or 5.6% decrease from year end. Management believes that the continued focus on real estate lending is prudent given the uncertainty of the local economy, especially as it relates to small businesses.
Nonperforming loans decreased $301,000, or 11.4% during the quarter and are made up of seven relationships at June 30, 2007, a reduction of two relationships compared to the prior quarter. Activity on nonperforming loans is shown in the table below.
| Nonaccrual | 90 days past due and still accruing | Total Nonperforming | |||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|
| (dollars in thousands) | (unaudited) | (unaudited) | |||||||||
| Beginning balance, December 31, 2006 | $ | 2,431 | $ | 855 | $ | 3,286 | |||||
| Charge offs | (20 | ) | -- | (20 | ) | ||||||
| Transferred to repossessed assets | (335 | ) | -- | (335 | ) | ||||||
| Paid off | (69 | ) | -- | (69 | ) | ||||||
| Brought current by borrower | -- | (730 | ) | (730 | ) | ||||||
| Loan sold | -- | -- | -- | ||||||||
| Collateral sold | (190 | ) | -- | (190 | ) | ||||||
| Principal paydowns | -- | -- | -- | ||||||||
| Additions | 688 | -- | 684 | ||||||||
| Balance, March 31, 2007 | $ | 2,505 | $ | 125 | $ | 2,630 | |||||
| Charge offs | (330 | ) | -- | (330 | ) | ||||||
| Transferred to repossessed assets | (392 | ) | -- | (392 | ) | ||||||
| Paid off | -- | (125 | ) | (125 | ) | ||||||
| Brought current by borrower | -- | -- | -- | ||||||||
| Loan sold | -- | -- | -- | ||||||||
| Collateral sold | (351 | ) | -- | 351 | |||||||
| Principal paydowns | (14 | ) | -- | (14 | ) | ||||||
| Additions | 798 | 113 | 911 | ||||||||
| Balance, June 30, 2007 | $ | 2,216 | $ | 113 | $ | 2,329 | |||||
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Five credits, totaling $635,000, were charged off in the current quarter in addition to the $330,000 disclosed in the table above. The bulk of the $635,000 related to one credit in the amount of $475,000. This credit was to a high end builder who had exhausted his personal funds to the point that future payments were unlikely. This credit was unsecured, though we do have an assignment of the proceeds of a lawsuit that the borrower is party to. This lawsuit could provide a recovery in the future, though the amount and timing of this recovery can’t be determined at this time. It is highly unlikely that any recoveries are recognized on the remaining $160,000 in charge-offs as the collateral is minimal, if any, and the wherewithal of the borrowers is limited. Management believes that the remaining nonperforming and watch credits are adequately reserved for and that the allowance for loan loss in total is adequate. The centralization of the credit function at the holding company should allow us to mitigate the credit risk prospectively. In accordance with our policy, loans that are well secured and in the process of collection are not put on non-accrual status. All loans greater than 90 days delinquent, regardless of accrual status, are included on management’s watch list and monitored monthly. Management is working through these credits and believes that any losses inherent in these credits are adequately reserved for in the allowance for loan loss.
The table below shows the composition and amount of our nonperforming assets.
| June 30, 2007 | December 31, 2006 | |||||||
|---|---|---|---|---|---|---|---|---|
| (dollars in thousands) | (unaudited) | |||||||
| Nonaccrual loans | ||||||||
| Secured by real estate | $ | 1,445 | $ | 2,216 | ||||
| Secured by other than real estate | 770 | 215 | ||||||
| Loans 90 days past due and still accruing | ||||||||
| Secured by real estate | 111 | 835 | ||||||
| Secured by other than real estate | 2 | 20 | ||||||
| Total nonperforming loans | 2,329 | 3,286 | ||||||
| Foreclosed and repossessed assets | 584 | 3 | ||||||
| Total nonperforming assets | $ | 2,913 | $ | 3,289 | ||||
| Nonperforming loans to total loans | 1.55 | % | 2.08 | % | ||||
| Nonperforming assets to total assets | 1.41 | % | 1.49 | % | ||||
The allowance for loan losses as of June 30, 2007 was $1.7 million representing approximately 1.15% of total loans outstanding, compared to $2.6 million, or 1.68% of loans outstanding as of December 31, 2006. The charge-off of loans which had previously been reserved for was the primary cause of the decrease in the allowance balance. Management believes that the high risk credits are appropriately reserved for and are all being monitored appropriately. At the same time, the economic climate in the Banks’ home state is not favorable and the possibility for additional losses caused by this economic weakness still exists. 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.
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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.
Total premises and equipment increased $1.8 million, or 38.3% to $6.5 million at June 30, 2007 from $4.7 million at December 31, 2006. This increase is due to the purchase of land on which HVSB’s new main office is being constructed, construction in progress related to that facility and the building in which the holding company’s operations are housed and renovation of one of CSB’s branches.
Total deposit balances decreased $12.7 million or 7.0% to $169.3 million at June 30, 2007 from $182.0 million at December 31, 2006. Noninterest bearing deposits increased $163,000, or 0.68% compared to December 31, 2006, while interest bearing deposits decreased $12.9 million, or 8.1% over the same period. All of the noninterest bearing deposit portfolios decreased during 2007, with time deposits falling 7.5%, or $7.3 million, money market accounts falling 9.5%, or $5.0 million and savings and interest bearing checking falling $662,000, or 6.9% combined. The changes in the loan portfolio discussed above created excess funds over the new assets that were funded and management took advantage of this situation to allow some higher cost time deposits to roll off and also to lower the rate on the money market account which caused some runoff. To the extent we experience significant loan growth time deposits will likely be the primary source of funding, including wholesale funds, though this situation is not anticipated. We have had less than $5.0 million in wholesale funds at the end of the quarter, comprising less than 3% of total deposits. The local market for deposits is extremely competitive, and we continue to focus on gathering lower cost savings and DDA accounts to fund our future growth and reduce our reliance on higher cost time deposits. Numerous marketing campaigns have been run during the current year, to varying degrees of success, and management is attempting to focus the marketing budget on campaigns which will generate demand and savings accounts as opposed to print advertising for time deposits. When time deposit funding is needed, management feels that the total cost of wholesale funds is less than what would be required to raise a similar level of funds through retail outlets. Additionally, as noted above, we would prefer that the branch staff remain focused on gathering and servicing lower cost non-time deposits, rather than opening a large quantity of certificates. Overall, we believe that the transition to utilizing the wholesale market will contribute positively to the margin given sound execution of the other aspects of the funding plan.
CSB is a member of the Federal Home Loan Bank of Indianapolis, and utilizes advances from this institution to bolster liquidity. At June 30, 2007, we have $12.2 million in advances outstanding. Repayments of $10.0 million and additional advances of $7.0 million occurred during the quarter. We continue to view the FHLB as a source of liquidity and may borrow additional funds as market conditions dictate.
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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 June 30, 2007, we had retained earnings of $3.1 million compared to $2.9 million at December 31, 2006 which was the result of a net income of $180,000. Accumulated other comprehensive income saw a decrease of $315,000, or 53.9%. This decrease was primarily the result of changes in interest rates causing a decrease in the market value of our security portfolio. We do not believe that the value of any of the securities in the portfolio are permanently impaired.
Comparison of Operating Results for the Three Months Ended June 30, 2007 and 2006
Our net income was $47,000, or $0.04 per diluted share for the second quarter of 2007 compared to a net loss of $198,000, or $0.16 per diluted share for the second quarter of 2006. The improvement was caused primarily by decreased loan loss provisions and partially offset by increased operating expenses.
Net interest income was relatively flat at $1.6 million in the second quarter of 2006 and 2007. The net interest margin improved slightly to 3.21% from 3.20%. Net interest income remained flat in a rising rate environment due to average interest bearing liability balances increasing at a slightly higher rate than average earning assets and the interest bearing liabilities repricing faster than the earning assets.
Average earning assets increased 1.7%, or $3.4 million over the same period last year which effectively added $92,000 to the net interest margin, though this was partially offset by increased interest bearing liabilities which rose $4.7 million, or 2.9%, subtracting $56,000 from the net interest margin. On a net basis, these changes in balances caused an increase of $36,000 in net interest margin. The 10.2% increase in loan balances effectively added $270,000 to the net interest margin, but decreased balances in investment securities and federal funds purchased caused a $178,000 decrease in net interest margin. On the liability side, falling balances in non-maturity deposit and federal funds purchased balances added $131,000, though this was more than offset by the increased time deposit and FHLB advance balances.
Rising rates effectively decreased the net interest margin by $5,000, due to interest bearing liabilities repricing faster than earning assets and negative changes in the mix of funding. Time deposits share of total interest bearing liabilities increased 6% to 54.5% from 48.5%, mostly at the expense of non-maturity deposits. All portfolios of earning assets and bearing liabilities saw increases in rate over the prior year with the exception of non-maturity deposits which declined by 20 basis points due to decreases in the rate on money market accounts.
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The following schedule presents the average daily balances, interest income, interest expense and average rates earned and paid for our major categories of assets, liabilities, and shareholders’ equity for the periods indicated (dollars in thousands):
| 3 Months ended June 30, 2007 | 3 Months ended June 30, 2006 | |||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Average Balance | Interest | Yield/ Cost | Average Balance | Interest | Yield/ Cost | |||||||||||||||
| Assets: | ||||||||||||||||||||
| Short term investment | $ | 4,497 | $ | 59 | 5.26 | % | $ | 6,464 | $ | 89 | 5.52 | % | ||||||||
| Securities: | ||||||||||||||||||||
| Taxable | 33,408 | 377 | 4.51 | % | 40,511 | 446 | 4.40 | % | ||||||||||||
| Tax-exempt | 8,872 | 72 | 3.25 | % | 10,643 | 87 | 3.27 | % | ||||||||||||
| Loans | 154,771 | 2,938 | 7.61 | % | 140,492 | 2,620 | 7.48 | % | ||||||||||||
| Total earning assets/total | ||||||||||||||||||||
| interest income | 201,548 | 3,446 | 6.86 | % | 198,909 | 3,242 | 6.56 | % | ||||||||||||
| Cash and due from banks | 3,731 | 5,987 | ||||||||||||||||||
| Unrealized (loss) on AFS securities | (819 | ) | (1,710 | ) | ||||||||||||||||
| Allowance for loan loss | (2,558 | ) | (1,964 | ) | ||||||||||||||||
| All other assets | 9,325 | 7,432 | ||||||||||||||||||
| Total assets | 211,227 | 207,855 | ||||||||||||||||||
| Liabilities and Stockholders' Equity | ||||||||||||||||||||
| Interest bearing deposits: | ||||||||||||||||||||
| MMDA, Savings/NOW accounts | 58,992 | 538 | 3.16 | % | 67,405 | 537 | 3.20 | % | ||||||||||||
| Time | 91,743 | 894 | 4.98 | % | 79,260 | 895 | 4.53 | % | ||||||||||||
| Fed Funds Purchased | 70 | 33 | 4.99 | % | 2,667 | 32 | 4.81 | % | ||||||||||||
| FHLB Advances | 13,404 | 112 | 4.39 | % | 10,200 | 112 | 4.40 | % | ||||||||||||
| Trust Preferred Securities | 4,000 | 82 | 8.24 | % | 4,000 | 83 | 8.32 | % | ||||||||||||
| Other borrowings | 0 | 1 | 22.86 | % | 11 | 1 | 36.46 | % | ||||||||||||
| Total interest bearing | ||||||||||||||||||||
| liabilities/interest expense | 168,208 | 1,660 | 4.23 | % | 163,543 | 1,582 | 4.07 | % | ||||||||||||
| Noninterest bearing deposits | 22,638 | 24,482 | ||||||||||||||||||
| All other liabilities | 5,424 | 5,389 | ||||||||||||||||||
| Stockholders' Equity: | ||||||||||||||||||||
| Unrealized holding (loss) | (553 | ) | (1,134 | ) | ||||||||||||||||
| Common Stock, Surplus, Retained Earnings | 15,511 | 15,574 | ||||||||||||||||||
| Total liabilities and stockholders' | ||||||||||||||||||||
| equity | 211,227 | 207,855 | ||||||||||||||||||
| Interest spread | 1,613 | 2.69 | % | 1,582 | 2.49 | % | ||||||||||||||
| Net Interest Margin as a | ||||||||||||||||||||
| Percentage of Average | ||||||||||||||||||||
| Earnings Assets | 3.46 | % | 3.20 | % | ||||||||||||||||
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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.
| (dollars in thousands) | Three Months Ended June 30, 2007 Compared to 2006 | ||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|
| Change Due to Rate | Change Due to Volume | Total Change | |||||||||
| Short term investment | $ | (4 | ) | $ | (26 | ) | $ | (30 | ) | ||
| Investment securities - taxable | 69 | (138 | ) | (69 | ) | ||||||
| Investment securities - tax exempt | (1 | ) | (14 | ) | (15 | ) | |||||
| Loans, net of unearned income | 48 | 270 | 318 | ||||||||
| Total interest income | 112 | 92 | 204 | ||||||||
| Interest bearing deposits | 71 | 86 | 157 | ||||||||
| Federal funds borrowed | 36 | (67 | ) | (31 | ) | ||||||
| FHLB advances | 13 | 38 | 51 | ||||||||
| Trust preferred securities | (3 | ) | -- | (3 | ) | ||||||
| Other borrowings | -- | (1 | ) | (1 | ) | ||||||
| Total interest expense | 117 | 56 | 173 | ||||||||
| Net interest income | $ | (5 | ) | $ | 36 | $ | 31 | ||||
Total provision for loan losses was $60,000 for the quarter ended June 30, 2007, compared to $534,000 for the second quarter of 2006. The majority of the provision for loan loss in the prior quarter was due to charge-offs mandated by the Banks’ regulators to conform to state banking law.
The level of the provision made in connection with the loans reflects the amount necessary to maintain the allowance for loan losses at an adequate level, based upon Clarkston State Bank’s current analysis of probable incurred losses in its loan portfolio, with respect to loans held at June 30, 2007. Bank management is continuing to evaluate the financial condition of the borrowers and the value of the collateral.
Non-interest income increased $45,000, or 18.4% for the second quarter of 2007 compared to the same period in 2006. The largest portion of the change in non-interest income was due to increased fees on deposit accounts, which increased $29,000, or 17.5% relative to the same quarter in the prior year. Higher NSF fees were the primary cause of the increase in non-interest income. The Corporation’s large checking account portfolio continues to generate fees, though a review of these fees relative to our local market peers may result in the modification of our fee structure. It is, however, anticipated that any modification of the fee structure will result in increased fee income.
Non-interest expense was $1.8 million for the first quarter of 2007, a $100,000 or 5.9% increase over the first quarter of 2006 when non-interest expense was $1.7 million. Expenses related to collecting on troubled credits was the primary cause of increase, effecting both salary and benefit expense and professional fees. Salary and benefit costs increased $165,000, or 19.7%. Occupancy expense has decreased $47,000, or 16.8% as a result of the closure of two CSB facilities.
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Comparison of Operating Results for the Six Months Ended June 30, 2007 and 2006
Our net income was $180,000, or $0.14 per diluted share for the six months ended June 30, 2007 compared to a net loss of $552,000, or $0.44 per diluted share for the same period in 2006. The largest portion of the change was due to reduced provision for loan loss, with net interest income and fee income also making positive contributions. These positive numbers were partially offset by increased operating expense and income tax expense.
Net interest income increased 3.2% or $100,000 from $3.1 million in six months ended June 30, 2006 to $3.2 million for 2007. Higher average balances in earning assets and interest bearing liabilities were the primary cause of the increase in net interest income, though increasing rates also caused an increase.
Increased average balances added $167,000 to net interest margin compared to the prior year. Average balances in the earning asset portfolio increased $11.1 million, or 5.7%, with decreases in cash and investment securities of $7.9 million being more than offset by the $18.9 million increase in the loan portfolio. On a net basis, these changing average balances in earning assets added $504,000 to net interest income year to date in 2007 relative to 2006. This increase was partially offset by an effective decrease to net interest income of $337,000 caused by increased interest bearing liabilities used to fund the asset growth. Time deposits and FHLB advances increased over this time frame, subtracting $466,000 and $99,000, respectively from net interest income. Non-maturity deposits and federal funds purchased both showed declines in average balance over the prior year, which effectively increased net interest income $128,000 and $99,000, respectively.
Changes in rates of the various portfolios decreased net interest income by $45,000, with all portfolios experiencing rising rates with the exception of the non-maturity deposit portfolio, which saw a 16 basis point decrease in the cost of funds. The offering rate on money market accounts, which make up the bulk of the non-maturity deposit portfolio, has been lowered by management over the past 4 quarters. It was determined by management that a few larger accounts were driving the cost of the entire money market portfolio and the decision was made to lower the offering rates closer to the middle of the pack relative to local competition to boost the net interest margin. This decrease in rates effectively added $51,000 to the net interest margin for the period. Rising rates in the loan portfolio added $166,000 to the margin, while rising rates in investment securities and federal funds sold added $63,000. These increases were offset by increased rates in the time deposit, federal funds purchased and FHLB advance portfolios which reduced net interest income by $320,000. While management of the banks continue to focus on gathering non-maturity deposit accounts to fund asset growth, the competitive local market would indicate that time deposits (potentially including wholesale funding) will continue to make up the bulk of our new funding.
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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):
| 6 Months ended June 30, 2007 | 6 Months ended June 30, 2006 | |||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Average Balance | Interest | Yield/ Cost | Average Balance | Interest | Yield/ Cost | |||||||||||||||
| Assets: | ||||||||||||||||||||
| Short term investment | $ | 5,533 | $ | 149 | 5.43 | % | $ | 5,920 | $ | 156 | 5.31 | % | ||||||||
| Securities: | ||||||||||||||||||||
| Taxable | 34,731 | 777 | 4.47 | % | 40,377 | 883 | 4.37 | % | ||||||||||||
| Tax-exempt | 8,882 | 144 | 3.24 | % | 10,654 | 174 | 3.27 | % | ||||||||||||
| Loans | 156,108 | 5,900 | 7.62 | % | 137,218 | 5,024 | 7.38 | % | ||||||||||||
| Total earning assets/total | ||||||||||||||||||||
| interest income | 205,254 | 6,970 | 6.85 | % | 194,168 | 6,237 | 6.48 | % | ||||||||||||
| Cash and due from banks | 3,935 | 5,664 | ||||||||||||||||||
| Unrealized (loss) on AFS securities | (872 | ) | (1,413 | ) | ||||||||||||||||
| Allowance for loan loss | (2,706 | ) | (1,968 | ) | ||||||||||||||||
| All other assets | 8,503 | 6,937 | ||||||||||||||||||
| Total assets | 214,113 | 203,388 | ||||||||||||||||||
| Liabilities and Stockholders' Equity | ||||||||||||||||||||
| Interest bearing deposits: | ||||||||||||||||||||
| MMDA, Savings/NOW accounts | 59,653 | 885 | 2.99 | % | 68,129 | 1,064 | 3.15 | % | ||||||||||||
| Time | 93,778 | 2,332 | 5.01 | % | 74,213 | 1,618 | 4.40 | % | ||||||||||||
| Fed Funds Purchased | 35 | 1 | 5.76 | % | 2,750 | 64 | 4.69 | % | ||||||||||||
| FHLB Advances | 14,302 | 358 | 5.05 | % | 10,200 | 223 | 4.41 | % | ||||||||||||
| Trust Preferred Securities | 4,000 | 162 | 8.17 | % | 4,000 | 157 | 7.92 | % | ||||||||||||
| Other borrowings | -- | -- | 0.00 | % | 15 | 1 | 13.30 | % | ||||||||||||
| Total interest bearing | ||||||||||||||||||||
| liabilities/interest expense | 171,768 | 3,738 | 4.39 | % | 159,307 | 3,127 | 3.96 | % | ||||||||||||
| Noninterest bearing deposits | 21,897 | 23,665 | ||||||||||||||||||
| All other liabilities | 5,602 | 5,638 | ||||||||||||||||||
| Stockholders' Equity: | ||||||||||||||||||||
| Unrealized holding (loss) | (593 | ) | (931 | ) | ||||||||||||||||
| Common Stock, Surplus, Retained Earnings | 15,439 | 15,710 | ||||||||||||||||||
| Total liabilities and stockholders' | ||||||||||||||||||||
| equity | 214,113 | 203,388 | ||||||||||||||||||
| Interest spread | 3,232 | 2.46 | % | 3,110 | 2.52 | % | ||||||||||||||
| Net Interest Margin as a | ||||||||||||||||||||
| Percentage of Average | ||||||||||||||||||||
| Earnings Assets - FTE | 3.18 | % | 3.23 | % | ||||||||||||||||
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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.
| (dollars in thousands) | 2007 Compared to 2006 | ||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|
| Change Due to Rate | Change Due to Volume | Total Change | |||||||||
| Short term investment | $ | 9 | $ | (16 | ) | $ | (7 | ) | |||
| Investment securities - taxable | 55 | (161 | ) | (106 | ) | ||||||
| Investment securities - tax exempt | (1 | ) | (29 | ) | (30 | ) | |||||
| Loans, net of unearned income | 166 | 710 | 876 | ||||||||
| Total interest income | 229 | 504 | 733 | ||||||||
| Interest bearing deposits | 197 | 338 | 535 | ||||||||
| Federal funds borrowed | 36 | (99 | ) | (63 | ) | ||||||
| FHLB advances | 36 | 99 | 135 | ||||||||
| Trust preferred securities | 5 | -- | 5 | ||||||||
| Other borrowings | -- | (1 | ) | (1 | ) | ||||||
| Total interest expense | 274 | 337 | 611 | ||||||||
| Net interest income | $ | (45 | ) | $ | 167 | $ | 122 | ||||
Total provision for loan losses was $77,000 for the six months ended June 30, 2007, compared to $1.4 million for the same period in 2006. The large decrease is due to the prior period being abnormally high relative to the Corporation’s history. The level of provision for loan loss is dependent on growth in the loan portfolio and the quality of the loans currently in the portfolio. Management anticipates that the loan portfolio will continue to grow and that the amount currently reserved is adequate to cover losses inherent in the loan portfolio as of June 30, 2007. As such, we anticipate that the amount of provision shown in the current year is more indicative of future amounts than the amount shown in 2006, though given that the provision is largely dependent on the required reserves as indicated by the allowance for loan loss analysis, this can not be determined for certain in advance.
Non-interest income increased $73,000, or 14.8% for the six months ended June 30, 2007 compared to the same period in 2006. The increase is split somewhat evenly between fees on loan and deposit accounts, gains on sales of mortgage loans and other income, offset slightly by a decrease in gains on sales of securities. Fees on loan and deposit accounts increased $29,000 or 7.8%, due mostly to increased NSF income in the banks’ deposit portfolios. Increased mortgage sale volume increased the gains recognized on those sales 23.5%, or $28,000 over 2006. The increase in other operating income was due in part to increased rents received from tenants in the Holding Company’s offices and also the fact that a $10,000 loss on sale of ORE was included in the 2006 number.
Non-interest expense was $3.6 million for the six months ended June 30, 2007, a $400,000 or 12.5% increase over the six months ended June 30, 2006 when non-interest expense was $3.2 million. Increased personnel required by the reorganization of the credit area and in the workout area are the primary causes of the increase in salaries and benefit costs. Recruiting fees paid to fill these and other positions and the fact that the accrual for annual bonuses was eliminated during 2006 also contributed to the $400,000, or 25.0% increase in salaries and benefits. Occupancy expense was reduced by $88,000, or 16.5% due mostly to the closing of a grocery store branch and loan operations center at CSB. Professional fees increased $39,000, or 15.4% primarily due to costs related to Sarbanes-Oxley section 404 and costs related to the workout area. The majority of the 20.6%, or $45,000 increase in outside processing fees is due to core processing costs at HVSB. The fees paid to Jack Henry were greatly reduced for a portion of the first quarter of 2006 due to their DeNovo status. Finally, the primary cause of the $57,000, or 13.7% increase in other expense is due to increased deposit premiums assessed to the Banks by the FDIC.
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Liquidity and Capital Resources
We obtained our 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 our growth.
In July 2005, we 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. We 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.
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Capital Resources at June 30, 2007 (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 | 7.87 | % | 9.68 | % | 10.75 | % | |||||
| HVSB | 25.16 | % | 36.90 | % | 37.70 | % | |||||
| Consolidated | 9.30 | % | 11.68 | % | 12.72 | % | |||||
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 June 30, 2007 | |||||||||||
| Required regulatory capital | $ | 8,449 | $ | 6,727 | $ | 13,453 | |||||
| Capital in excess of regulatory minimums | 11,200 | 12,922 | 7,929 | ||||||||
| Actual capital balances | $ | 19,649 | $ | 19,649 | $ | 21,382 | |||||
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 six months ended June 30, 2007, operating activities generated $771,000. Normal operations were the primary generator of cash in the current year. Principal paydowns and sales of securities provided $4.6 million year to date, while decreases in the loan portfolio provided $5.0 million. The primary use of funds during the current year was payoffs in the deposit portfolio, which used $12.7 million.
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| (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. |
27
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.
As of June 30, 2007, there have been no material changes in the discussion pertaining to risk factors as disclosed in the Company’s Form 10-K for the year ended December 31, 2006.
None.
None.
The annual meeting was held on April 26, 2007. At the meeting, two directors were elected, each for a three year term. The votes were as follows:
| Vote | |||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|
| Director Nominee: | Term Expires | For: | Withheld: | ||||||||
| Edwin L. Adler | 2010 | 805,116 | 262,063 | ||||||||
| Thomas E. Kimble | 2010 | 805,116 | 262,063 | ||||||||
| John H. Welker | 2010 | 805,116 | 262,063 | ||||||||
None.
| 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. |
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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 June 30, 2007, 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 Executive Officer |
/s/ James W. Distelrath —————————————— James W. Distelrath Chief Financial Officer |
DATE: August 13, 2007
29
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. |
30
