_________________
[X] QUARTERLY REPORT UNDER SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 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 or 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 November 14, 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 | 27 | ||||||
| Part II. | Other Information | ||||||
| Item 1. | |||||||
| Legal Proceedings | 28 | ||||||
| Item 2. | |||||||
| Changes in Securities and Use of Proceeds | 28 | ||||||
| Item 3. | |||||||
| Defaults Upon Senior Securities | 28 | ||||||
| Item 4. | |||||||
| Submission of Matters to a Vote of Securities Holders | 28 | ||||||
| Item 5. | |||||||
| Other Information | 28 | ||||||
| Item 6. | |||||||
| Exhibits and Reports on Form 8-K | 28 | ||||||
| Signatures | 29 | ||||||
2
CLARKSTON FINANCIAL CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEET
September 30, 2007 (unaudited) and December 31, 2006
(dollars in thousands)
| September 30, 2007 | December 31, 2006 | |||||||
|---|---|---|---|---|---|---|---|---|
| (Unaudited) | ||||||||
| ASSETS | ||||||||
| Cash and cash equivalents | ||||||||
| Total cash and due from banks | $ | 4,340 | $ | 5,848 | ||||
| Federal funds sold | 4,276 | 7,472 | ||||||
| Total cash and cash equivalents | 8,616 | 13,320 | ||||||
| Securities available for sale, at fair value | 37,372 | 43,864 | ||||||
| Loans held for sale | 645 | 120 | ||||||
| Loans | ||||||||
| Total loans | 148,483 | 157,715 | ||||||
| Less: Allowance for loan losses | (2,766 | ) | (2,750 | ) | ||||
| Net loans | 145,717 | 154,965 | ||||||
| Banking premises and equipment | 7,227 | 4,730 | ||||||
| Deferred tax asset | 970 | 757 | ||||||
| Interest receivable and other assets | 3,156 | 2,622 | ||||||
| Total assets | $ | 203,703 | $ | 220,378 | ||||
| LIABILITIES AND SHAREHOLDERS' EQUITY | ||||||||
| Deposits | ||||||||
| Noninterest-bearing | $ | 24,401 | $ | 23,922 | ||||
| Interest-bearing | 147,041 | 158,119 | ||||||
| Total deposits | 171,442 | 182,041 | ||||||
| Advances from Federal Home Loan Bank of Indianapolis | 10,700 | 15,200 | ||||||
| Junior subordinated debentures held by | ||||||||
| unconsolidated subsidiary trust | 4,000 | 4,000 | ||||||
| Interest payable and other liabilities | 994 | 1,176 | ||||||
| Total liabilities | 187,136 | 202,417 | ||||||
| Minority interest in consolidated subsidiary | 3,014 | 3,195 | ||||||
| Shareholders' equity | ||||||||
| Common stock, no par value: 10,000,000 shares authorized; 1,273,734 | ||||||||
| shares issued and outstanding as of September 30, 2007 and December 31, | ||||||||
| 2006 | 6,297 | 6,245 | ||||||
| Capital surplus | 6,297 | 6,245 | ||||||
| Restricted stock - unearned compensation | (19 | ) | (38 | ) | ||||
| Retained earnings | 1,435 | 2,898 | ||||||
| Accumulated other comprehensive loss | (457 | ) | (584 | ) | ||||
| Total shareholders' equity | 13,553 | 14,766 | ||||||
| Total liabilities and shareholders' equity | $ | 203,703 | $ | 220,378 | ||||
See accompanying notes to consolidated financial statements
3
CLARKSTON FINANCIAL CORPORATION
CONDENSED CONSOLIDATED STATEMENT OF INCOME
Three and Nine Month Periods Ended September 30, 2007 and September 30, 2006
(dollars in thousands, except per share data)
(unaudited)
| Three Months Ended Sept 30, 2007 | Three Months Ended Sept 30, 2006 | Nine Months Ended Sept 30, 2007 | Nine Months Ended Sept 30, 2006 | |||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Interest Income | ||||||||||||||
| Loans, including fees | $ | 2,720 | $ | 2,820 | $ | 8,620 | $ | 7,838 | ||||||
| Securities | ||||||||||||||
| Taxable | 355 | 435 | 1,134 | 1,318 | ||||||||||
| Tax-exempt | 72 | 86 | 215 | 260 | ||||||||||
| Federal funds sold | 64 | 122 | 213 | 278 | ||||||||||
| Total interest income | 3,211 | 3,463 | 10,182 | 9,694 | ||||||||||
| Interest Expense | ||||||||||||||
| Deposits | 1,567 | 1,571 | 4,784 | 4,253 | ||||||||||
| Borrowings | 238 | 215 | 759 | 660 | ||||||||||
| Total interest expense | 1,805 | 1,786 | 5,543 | 4,913 | ||||||||||
| Net Interest Income | 1,406 | 1,677 | 4,639 | 4,781 | ||||||||||
| Provision for loan losses | 2,561 | 269 | 2,638 | 1,635 | ||||||||||
| Net interest income | ||||||||||||||
| After provision for loan losses | (1,155 | ) | 1,408 | 2,001 | 3,146 | |||||||||
| Noninterest income | ||||||||||||||
| Gain on sale of securities | -- | -- | (2 | ) | 3 | |||||||||
| Gain on sale of loans | 50 | 82 | 196 | 201 | ||||||||||
| Service charges and other fees | 198 | 184 | 600 | 557 | ||||||||||
| Other income | 12 | (8 | ) | 29 | (5 | ) | ||||||||
| Total noninterest income | 260 | 258 | 823 | 756 | ||||||||||
| Noninterest expense | ||||||||||||||
| Salaries and benefits | 783 | 808 | 2,754 | 2,438 | ||||||||||
| Occupancy expense | 212 | 259 | 658 | 793 | ||||||||||
| Computer and data processing expenses | 129 | 103 | 393 | 322 | ||||||||||
| Advertising and public relations | 49 | 57 | 193 | 198 | ||||||||||
| Professional fees | 231 | 141 | 524 | 395 | ||||||||||
| Other expense | 271 | 173 | 746 | 590 | ||||||||||
| Total noninterest expense | 1,675 | 1,541 | 5,268 | 4,736 | ||||||||||
| Income/(loss) before federal income tax expense and minority interest | (2,570 | ) | 125 | (2,444 | ) | (834 | ) | |||||||
| Federal income tax expense/(benefit) | (873 | ) | 86 | (785 | ) | (194 | ) | |||||||
| Income/(loss) before minority interest | (1,697 | ) | 39 | (1,659 | ) | (640 | ) | |||||||
| Minority interest in net loss of consolidated subsidiary | (55 | ) | (66 | ) | (196 | ) | (193 | ) | ||||||
| Net income/(loss) | $ | (1,642 | ) | $ | 105 | $ | (1,463 | ) | $ | (447 | ) | |||
| Basic earnings/(loss) per share | $ | (1.29 | ) | $ | 0.08 | $ | (1.16 | ) | $ | (0.36 | ) | |||
| Diluted earnings/(loss) per share | $ | (1.28 | ) | $ | 0.08 | $ | (1.15 | ) | $ | (0.36 | ) | |||
See accompanying notes to consolidated financial statements.
4
CLARKSTON FINANCIAL CORPORATION
CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS’ EQUITY
Nine Month Period ended September 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 | ||||||
| Issuance of stock | 52 | 52 | 104 | |||||||||||||||||
| Recognition of compensation for | ||||||||||||||||||||
| restricted stock award | 19 | 19 | ||||||||||||||||||
| Comprehensive income: | ||||||||||||||||||||
| Net loss for the nine months ended | ||||||||||||||||||||
| September 30, 2007 | (1,463 | ) | (1,463 | ) | ||||||||||||||||
| Change in unrealized loss on | ||||||||||||||||||||
| securities available for sale | ||||||||||||||||||||
| net of tax of ($52) | 127 | 127 | ||||||||||||||||||
| Net comprehensive loss | (1,463 | ) | (127 | ) | (1,590 | ) | ||||||||||||||
| Balance, September 30, 2007 | $ | 6,297 | $ | 6,297 | $ | (19 | ) | $ | 1,435 | $ | (457 | ) | $ | 13,553 | ||||||
5
CLARKSTON FINANCIAL CORPORATION
CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS
Nine Month Periods ended September 30, 2007 and September 30, 2006
(dollars in thousands)
(unaudited)
| Nine Months Ended Sept 30, 2007 | Nine Months Ended Sept 30, 2006 | |||||||
|---|---|---|---|---|---|---|---|---|
| Net Cash Provided by Operating Activities: | ||||||||
| Net cash provided by operating activities | $ | 1,139 | $ | 1,417 | ||||
| Cash Flows from Investing Activities: | ||||||||
| Net (increase)/decrease in loans | 5,682 | (20,474 | ) | |||||
| Purchase of available-for-sale securities | -- | (3,214 | ) | |||||
| Proceeds from sales of available-for-sale securities | 6,546 | 4,531 | ||||||
| Property and equipment expenditures | (2,791 | ) | (1,131 | ) | ||||
| Net cash (used in)/provided by investing activities | 9,437 | (20,288 | ) | |||||
| Cash Flows from Financing Activities: | ||||||||
| Increase/(decrease) in deposits | (10,599 | ) | 20,578 | |||||
| Increase in federal funds purchased | -- | 3,500 | ||||||
| Advances from Federal Home Loan Bank | 10,500 | -- | ||||||
| Repayments of advances from Federal Home Loan Bank | (15,000 | ) | -- | |||||
| Proceeds from sale of stock | -- | -- | ||||||
| Resources used by minority interest | (181 | ) | (184 | ) | ||||
| Net cash provided by/(used in) financing activities | (15,280 | ) | 23,894 | |||||
| Net increase/(decrease) in cash and cash equivalents | (4,704 | ) | 5,023 | |||||
| Cash and cash equivalents at beginning of period | 13,320 | 8,090 | ||||||
| Cash and cash equivalents at end of period | $ | 8,616 | $ | 13,113 | ||||
| Supplemental Cash Flow Information - Cash paid for: | ||||||||
| Interest | 5,441 | 4,393 | ||||||
| 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 nine month periods ended September 30, 2007 are not necessarily indicative of the results that may be expected for the year ended December 31, 2006.
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 per 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 15,153 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 10,580 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 Company recognizes compensation expense related to restricted stock awards over the period the services are performed. No options were granted during 2007. The Company determined that implementation of SFAS No. 123(R) did not have a material impact on the financial results of the Company.
The following table summarizes stock option transactions for both plans and the related average exercise prices for the three month periods ended September 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 | ) | -- | -- | -- | |||||||||
| Options expired | -- | -- | -- | -- | ||||||||||
| Options Outstanding - End of Period | 24,018 | $ | 9.09 | 49,536 | $ | 9.09 | ||||||||
8
The following table shows summary information about fixed stock options outstanding at September 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 | 1.2 years | $ | 9.09 | $ | 28,992 | |||||||||
| Non-contingent | 9.09 | 11,988 | 1.2 years | 9.09 | 28,891 | ||||||||||||
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, | |||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2007 | 2006 | 2007 | 2006 | |||||||||||
| (unaudited) | ||||||||||||||
| Net income/(loss) available to common | ||||||||||||||
| stockholders | $ | (1,642 | ) | $ | 105 | $ | (1,464 | ) | $ | (447 | ) | |||
| Average number of common shares | ||||||||||||||
| outstanding | 1,274 | 1,246 | 1,267 | 1,246 | ||||||||||
| Effect of dilutive options | 6 | 16 | 7 | 18 | ||||||||||
| Average number of common shares | ||||||||||||||
| outstanding used to calculate diluted | ||||||||||||||
| earnings/(loss) per common share | 1,280 | 1,262 | 1,274 | 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 | |||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| September 30, 2007 (unaudited) | ||||||||||||||
| U.S. Treasury securities and obligations of | ||||||||||||||
| U.S. government corporations and agencies | $ | 4,906 | $ | 10 | $ | 7 | $ | 4,909 | ||||||
| Mortgage-backed securities | 21,624 | 13 | 430 | 21,207 | ||||||||||
| Collateralized mortgage obligations | 2,684 | -- | 67 | 2,617 | ||||||||||
| Obligations of state and political subdivisions | 8,839 | -- | 200 | 8,639 | ||||||||||
| $ | 38,053 | $ | 23 | $ | 704 | $ | 37,372 | |||||||
| 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):
| September 30, 2007 (unaudited) | December 31, 2006 | |||||||
|---|---|---|---|---|---|---|---|---|
| Commercial | $ | 16,676 | $ | 23,917 | ||||
| Real estate: | ||||||||
| Commercial | 92,824 | 91,007 | ||||||
| Residential | 18,271 | 19,331 | ||||||
| Construction | 18,350 | 21,206 | ||||||
| Total real estate | 129,445 | 131,544 | ||||||
| Consumer | 2,362 | 2,254 | ||||||
| Total | $ | 148,483 | $ | 157,715 | ||||
10
Activity in the allowance for loan losses is as follows (dollars in thousands):
| Three Months Ended September 30, | Nine Months Ended September 30, | |||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2007 | 2006 | 2007 | 2006 | |||||||||||
| Balance - Beginning of period | $ | 1,733 | $ | 1,560 | $ | 2,750 | $ | 1,930 | ||||||
| Provision charged to operations | 2,561 | 269 | 2,638 | 1,635 | ||||||||||
| Charge-offs | (1,542 | ) | (17 | ) | (3,034 | ) | (1,783 | ) | ||||||
| Recoveries | 13 | 243 | 412 | 273 | ||||||||||
| Balance - End of period | $ | 2,766 | $ | 2,055 | $ | 2,766 | $ | 2,055 | ||||||
| Allowance for loan losses to total | ||||||||||||||
| loans | 1.86 | % | 1.35 | % | 1.86 | % | 1.35 | % | ||||||
Deposits are summarized as follows (dollars in thousands):
| September 30, 2007 (Unaudited) | December 31, 2006 | |||||||
|---|---|---|---|---|---|---|---|---|
| Non-interest bearing demand deposit accounts | $ | 24,401 | $ | 23,922 | ||||
| Interest-bearing demand deposit accounts | 4,133 | 5,418 | ||||||
| Savings accounts | 3,868 | 4,183 | ||||||
| Money market accounts | 46,613 | 52,004 | ||||||
| Certificates of deposit | 92,427 | 96,514 | ||||||
| Total deposits | $ | 171,442 | $ | 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 4.86% at September 30, 2007 and December 31, 2006. The weighted average interest rate at September 30, 2007 is 4.18%. Maturity dates range from November 2007 to October 2010. The weighted average remaining maturity at September 30, 2007 is 499 days, or February 10, 2009. Advances from the FHLB are collateralized by qualifying investment securities with estimated market values of $18,900,000 and $16,300,000 at September 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 September 30, 2007 and December 31, 2006.
The Banks’ and Corporation’s actual capital amounts and ratios as of September 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 September 30, 2007: | ||||||||||||||||||||
| Total risk-based capital | ||||||||||||||||||||
| (to risk weighted assets) | ||||||||||||||||||||
| CSB | $ | 14,637 | 10.02 | $ | 11,684 | 8.00 | $ | 14,605 | 10.00 | |||||||||||
| HVSB | 6,989 | 36.60 | 1,527 | 8.00 | 1,910 | 10.00 | ||||||||||||||
| Tier I Capital | ||||||||||||||||||||
| (to risk weighted assets) | ||||||||||||||||||||
| CSB | $ | 12,798 | 8.76 | $ | 5,842 | 4.00 | $ | 8,763 | 6.00 | |||||||||||
| HVSB | 6,833 | 35.78 | 764 | 4.00 | 1,146 | 6.00 | ||||||||||||||
| Tier I Capital | ||||||||||||||||||||
| (to average assets) | ||||||||||||||||||||
| CSB | $ | 12,798 | 7.28 | $ | 7,033 | 4.00 | $ | 8,792 | 5.00 | |||||||||||
| HVSB | 6,833 | 24.55 | 1,113 | 4.00 | 1,391 | 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 September 30, 2007 and December 31, 2006, the following financial instruments were outstanding whose contract amounts represent credit risk (dollars in thousands):
| September 30, 2007 (Unaudited) | December 31, 2006 | |||||||
|---|---|---|---|---|---|---|---|---|
| Commitments to grant loans | $ | 15,064 | $ | 11,933 | ||||
| Unfunded commitments under lines of credit | 20,125 | 25,238 | ||||||
| Commercial and standby letters of credit | 90 | 108 | ||||||
In February 2006, the FASB issued SFAS No. 155, Accounting for Certain Hybrid Instruments, which is an amendment of SFAS No: 133 and 140. SFAS No. 155 allows financial instruments that have embedded derivatives to be accounted for as a whole (eliminating the need to bifurcate the derivative from its host) if the holder elects to account for the whole instrument on a fair value basis. The Statement also establishes a requirement to evaluate interests in securitized financial assets to identify interests that are freestanding derivatives or that are hybrid financial instruments that contain an embedded derivative requiring bifurcation and clarifies that concentrations of credit risk in the form of subordination are not embedded derivatives. SFAS No. 155 is effective for all financial instruments acquired or issued after the beginning of an entity’s first fiscal year that begins after September 15, 2006. Adoption of this statement is not expected to have a material effect on results of operations or financial condition of the Company.
In March 2006, the FASB issued SFAS No. 156, Accounting for Servicing of Financial Assets- an amendment of FASB Statement No. 140 . SFAS No.156 requires an entity to recognize a servicing asset or servicing liability each time it undertakes an obligation to service a financial asset by entering into a servicing contract in specific situations. Additionally, the servicing asset or servicing liability shall be initially measured at fair value; however, an entity may elect the “amortization method” or “fair value method” for subsequent balance sheet reporting periods. SFAS No.156 is effective as of an entity’s first fiscal year beginning after September 15, 2006. Early adoption is permitted as of the beginning of an entity’s fiscal year, provided the entity has not yet issued financial statements, including interim financial statements, for any period of that fiscal year. Adoption of this statement is not expected to have a material effect on results of operations or financial condition of the Company.
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.
13
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 6 locations in or near their communities. The Banks do not have any material foreign assets or income.
14
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 year to date in 2007 compared to 75.0% year to date in 2006. The share of total revenue from interest and fees on loans increased in the current year due to the combination or continued loan growth and decreased investment security balances. Revenue share of interest from investments (including Federal Funds sold), decreased to 14.2%, from 17.8% year over year. Noninterest income was relatively flat, increasing to 7.5%, compared to 7.2% 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 September 30, 2007, there have been no material changes in the disclosures regarding critical accounting policies as disclosed in the Company’s Form 10-K for the year ended December 31, 2006. The Company’s critical accounting policies are described in the financial section of its 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 September 30, 2007 and December 31, 2006
Our total assets decreased by $16.7 million or 7.6% to $203.7 million at September 30, 2007, from $220.4 million at December 31, 2006. On a consolidated basis, cash, investment securities and loans all decreased, while fixed assets and other assets showed increases over year end.
Cash and cash equivalents, which include federal funds sold and short-term investments, decreased $4.7 million or 35.3% to $8.6 million at September 30, 2007 from $13.3 million at December 31, 2006. This decrease is directly related to the paydown of variable rate FHLB advances. In the current rate environment the spread between fed funds sold and variable rate FHLB advances is negative, and as a result, management paid down the borrowings with excess cash to increase the net interest margin.
Securities decreased $6.5 million or 14.8% to $37.4 million at September 30, 2007 from $43.9 million at December 31, 2006. The decrease in securities was due primarily to principal paydowns on mortgage backed securities. The Corporation continues 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, the value of these securities have not been written down as of September 30, 2007. All of the Corporation’s mortgage backed securities were issued by either FHLMC, FNMA or GNMA, and therefore carry the implicit guarantee (explicit in the part of GNMA) of the US Treasury. The Corporation does not have any exposure to sub-prime loans in it’s security portfolio.
Total portfolio loans decreased by $9.2 million or 5.8% to $148.5 million at September 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. HVSB’s portfolio increased $2.4 million over December 31, 2007, while CSB’s portfolio decreased $11.7 million over the same period. The loan production at both of the subsidiary banks is well behind the original budget, largely caused by the stagnant lending market and tighter credit standards. The large decrease at CSB is the result of charge-offs as well as the non-renewal of a number of deals which fit a risk profile that the Bank no longer was willing to lend to. Given the current market conditions, no significant loan production is expected in the near term. The trend in the mix of loans within the portfolio continued as it has for the prior few quarters, with commercial real estate increasing to 62.5% of the portfolio, up from 57.7%, while commercial non-real estate loans declined to 11.2% from 15.2%. The other portfolios were relatively flat. The aforementioned non-renewal of particular concentrations is the primary cause of the decrease in commercial non-real estate loans. This decrease caused the change in share, as the commercial real estate portfolio was relatively flat in dollars.
15
Nonperforming loans increased $3.3 million during the quarter and are made up of sixteen relationships at September 30, 2007, an increase of nine relationships compared to the prior quarter. Activity on nonperforming loans is shown in the table below.
| (dollars in thousands) | Nonaccrual | 90 days past due and still accruing | Total Nonperforming | ||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|
| (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 | -- | 688 | ||||||||
| 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 | |||||
| Charge offs | (868 | ) | -- | (868 | ) | ||||||
| Transferred to repossessed assets | -- | -- | -- | ||||||||
| Migrated from 90 days to nonaccrual | 113 | (113 | ) | -- | |||||||
| Paid off | (2 | ) | -- | (2 | ) | ||||||
| Brought current by borrower | (1 | ) | -- | (1 | ) | ||||||
| Loan sold | -- | -- | -- | ||||||||
| Collateral sold | -- | -- | -- | ||||||||
| Principal paydowns | -- | -- | -- | ||||||||
| Additions | 3,895 | 199 | 4,094 | ||||||||
| Balance, June 30, 2007 | $ | 5,353 | $ | 199 | $ | 5,552 | |||||
16
Management believes that the 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.
| September 30, 2007 | December 31, 2006 | |||||||
|---|---|---|---|---|---|---|---|---|
| (unaudited) | ||||||||
| (dollars in thousands) | ||||||||
| Nonaccrual loans | ||||||||
| Secured by real estate | $ | 4,929 | $ | 2,216 | ||||
| Secured by other than real estate | 424 | 215 | ||||||
| Loans 90 days past due and still accruing | ||||||||
| Secured by real estate | 199 | 835 | ||||||
| Secured by other than real estate | - | 20 | ||||||
| Total nonperforming loans | 5,552 | 3,286 | ||||||
| Foreclosed and repossessed assets | 555 | 3 | ||||||
| Total nonperforming assets | $ | 6,107 | $ | 3,289 | ||||
| Nonperforming assets to total loans | 4.11 | % | 2.08 | % | ||||
| Nonperforming assets to total assets | 3.00 | % | 1.49 | % | ||||
The allowance for loan losses as of September 30, 2007 was $2.8 million representing approximately 1.86% of total loans outstanding, compared to $2.8 million, or 1.74% of loans outstanding as of December 31, 2006. 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.
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.
17
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 $2.5 million, or 53.2% to $7.2 million at September 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 $10.6 million or 5.8% to $171.4 million at September 30, 2007 from $182.0 million at December 31, 2006. Noninterest bearing deposits increased $479,000, or 2.0% compared to December 31, 2006, while interest bearing deposits decreased $11.1 million, or 7.0% over the same period. All of the interest bearing deposit portfolios decreased during 2007, with time deposits falling 4.3%, or $4.1 million, money market accounts falling 10.4%, or $5.4 million and savings and interest bearing checking falling $1.6 million, or 16.7% 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 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 September 30, 2007, we have $10.7 million in advances outstanding. Advances of $10.5 million and repayments of $15.0 million combined to cause the $4.5 million decrease in total advances outstanding. 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, 2007, we had retained earnings of $1.4 million compared to $2.9 million at December 31, 2006 which was the result of a net loss of $1.5 million. Accumulated other comprehensive loss saw a decrease of $127,000, or 21.8%. This decrease was the result of changes in interest rates causing an increase 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.
18
Comparison of Operating Results for the Three Months Ended September 30, 2007 and 2006
Our net loss was $1.6 million, or $1.28 per diluted share for the third quarter of 2007 compared to net income of $105,000, or $0.08 per diluted share for the third quarter of 2006. The net loss was caused primarily by decreased net interest margin, increased loan loss provisions and other collection related expenses.
Net interest income decreased 16.2% or $271,000 from $1.67 million in the third quarter of 2006 to $1.41 million for 2007. The primary contributor to the decrease was the reversal of interest on loans that were placed on non-accrual status during the quarter and the increased balances on loans that were not accruing interest. Non-accrual loans increased from $1.7 million at September 30, 2006 to $5.4 million at September 30, 2007. While earning assets in total decreased by 4.9% to $194.3 million at September 30, 2007 from $204.2 million at September 30, 2006, the change in the mix of earning assets actually added $182,000 to the margin. The decrease in earning assets was primarily caused by decreases in cash and investments, while the loan portfolio increased a modest 3.1%. This decrease in earning assets allowed us to decrease interest bearing deposits, which fell by 4.2%, or $6.4 million. This decrease effectively added $36,000 to the net interest margin. Changes in rates reduced net interest income by $489,000, as the cost of interest bearing funds increased 20 basis points, while the yield on earning assets fell by 17 basis points. The margin also benefited from non-interest bearing funds remaining flat. While the competitive market for deposits in the Banks’ primary market areas suggests that time deposits will continue to increase as a percent of total funding sources, the banks are devising marketing strategies to counteract this trend and raise non-time deposits.
19
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 Sept. 30, 2007 | 3 Months ended Sept. 30, 2006 | |||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Average Balance | Interest | Yield/ Cost | Average Balance | Interest | Yield/ Cost | |||||||||||||||
| Assets: | ||||||||||||||||||||
| Short term investment | $ | 4,719 | $ | 64 | 5.38 | % | $ | 9,046 | $ | 122 | 5.35 | % | ||||||||
| Securities: | ||||||||||||||||||||
| Taxable | 31,039 | 355 | 4.57 | % | 39,328 | 435 | 4.42 | % | ||||||||||||
| Tax-exempt | 8,852 | 72 | 3.25 | % | 10,620 | 86 | 3.24 | % | ||||||||||||
| Loans | 149,675 | 2,720 | 7.21 | % | 145,204 | 2,820 | 7.71 | % | ||||||||||||
| Total earning assets/total | ||||||||||||||||||||
| interest income | 194,284 | 3,211 | 6.56 | % | 204,199 | 3,463 | 6.73 | % | ||||||||||||
| Cash and due from banks | 4,894 | 4,504 | ||||||||||||||||||
| Unrealized (loss) on AFS securities | (1,084 | ) | (1,673 | ) | ||||||||||||||||
| Allowance for loan loss | (1,716 | ) | (1,598 | ) | ||||||||||||||||
| All other assets | 9,761 | 7,284 | ||||||||||||||||||
| Total assets | 206,139 | 212,716 | ||||||||||||||||||
| Liabilities and Stockholders' Equity | ||||||||||||||||||||
| Interest bearing deposits: | ||||||||||||||||||||
| MMDA, Savings/NOW accounts | 55,704 | 417 | 2.97 | % | 65,124 | 517 | 3.15 | % | ||||||||||||
| Time | 91,047 | 1,150 | 5.01 | % | 88,067 | 1,054 | 4.75 | % | ||||||||||||
| Fed Funds Purchased | 937 | 12 | 5.08 | % | 1,375 | 17 | 4.90 | % | ||||||||||||
| FHLB Advances | 10,972 | 134 | 4.85 | % | 10,200 | 111 | 4.32 | % | ||||||||||||
| Trust Preferred Securities | 4,000 | 92 | 9.12 | % | 4,000 | 87 | 8.63 | % | ||||||||||||
| Other borrowings | -- | -- | 0.00 | % | -- | -- | 0.00 | % | ||||||||||||
| Total interest bearing | ||||||||||||||||||||
| liabilities/interest expense | 162,661 | 1,805 | 4.40 | % | 168,767 | 1,786 | 4.20 | % | ||||||||||||
| Noninterest bearing deposits | 24,105 | 24,103 | ||||||||||||||||||
| All other liabilities | 4,523 | 5,620 | ||||||||||||||||||
| Stockholders' Equity: | ||||||||||||||||||||
| Unrealized holding (loss) | (749 | ) | (1,165 | ) | ||||||||||||||||
| Common Stock, Surplus, Retained | 15,598 | 15,392 | ||||||||||||||||||
| Earnings | ||||||||||||||||||||
| Total liabilities and stockholders' equity | 206,139 | 212,716 | ||||||||||||||||||
| Interest spread | 1,406 | 2.15 | % | 1,677 | 2.53 | % | ||||||||||||||
| Net Interest Margin as a | ||||||||||||||||||||
| Percentage of Average | ||||||||||||||||||||
| Earnings Assets | 2.87 | % | 3.26 | % | ||||||||||||||||
20
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.
| Three Months Ended September 30, 2007 Compared to 2006 | |||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|
| (dollars in thousands) | Change Due to Rate | Change Due to Volume | Total Change | ||||||||
| Short term investment | $ | 5 | $ | (63 | ) | $ | (58 | ) | |||
| Investment securities - taxable | 91 | (171 | ) | (80 | ) | ||||||
| Investment securities - tax exempt | 3 | (17 | ) | (14 | ) | ||||||
| Loans, net of unearned income | (533 | ) | 433 | (100 | ) | ||||||
| Total interest income | (434 | ) | 182 | 252 | |||||||
| Interest bearing deposits | 32 | (72 | ) | (4 | ) | ||||||
| Federal funds borrowed | 4 | 36 | (5 | ) | |||||||
| FHLB advances | 14 | (9 | ) | 23 | |||||||
| Trust preferred securities | 5 | 9 | 5 | ||||||||
| Other borrowings | -- | -- | -- | ||||||||
| Total interest expense | 55 | (36 | ) | 19 | |||||||
| Net interest income | $ | (489 | ) | $ | 218 | $ | (271 | ) | |||
Total provision for loan losses was $2.6 million for the third quarter ended September 30, 2007, compared to $300,000 for the third quarter of 2006. During the quarter the Corporation obtained detrimental information regarding a number of impaired credits which not only resulted in significant charge-offs, but also required significant additional reserves against other impaired credits. As stated previously, our analysis indicates that the allowance for loan losses is adequate to absorb the losses inherent in the portfolio as of September 30, 2007, but economic conditions in the Corporation’s primary markets could lead to further significant losses in the future.
Non-interest income was virtually flat, increasing $2,000, or less than 1% for the third quarter of 2007 compared to the same period in 2006. Fees on deposit accounts increased by 7.6% over the prior year. Other income also increased over the prior year, primarily due to increased rental income at the holding company. Gains on sales of loans declined 39.0% from the prior year, due to decreased originations of mortgage loans.
Non-interest expense was $1.67 million for the third quarter of 2007, a $134,000 or 8.6% increase over the third quarter of 2006 when non-interest expense was $1.5 million. The largest percentage increase in non-interest expense was seen in professional fees, which increased $90,000, or 63.8% over the prior year. Collection efforts on problem credits and preparation for compliance with Sarbanes Oxley Section 404 were the primary catalysts of this increase. Other expense showed the largest dollar variance, increasing $98,000, or 56.7%. Increased FDIC premiums and assessments made up almost 50% of this variance, with directors fees, and amortization of debt issue costs also showing somewhat significant increases. The increased premiums and assessments are due to required contributions to the bank insurance fund and the acceleration of the debt issue cost reflects changes in the trust preferred market pricing structure and our view that we may be able to reduce our interest cost by refinancing this debt in 2008. Salaries and benefits shows a decrease year over year primarily due to the reversal of the incentive compensation accrual in the current quarter. The Corporation’s financial results will most likely preclude any significant incentive compensation payouts. Occupancy expense declined in the current quarter relative to the same period last year by $47,000 or 18.2% mostly due to the closing of a retail branch and loan center at Clarkston State Bank.
21
Comparison of Operating Results for the Nine Months Ended September 30, 2007 and 2006
Our net loss was $1.5 million, or $1.15 per diluted share for the nine months ended September 30, 2007 compared to a net loss of $447,000, or $0.36 per diluted share for the same period in 2006. The net loss was caused primarily by increased loan loss provisions..
Net interest income decreased 4.2% or $142,000 from $4.78 million in 2006 to $4.64 million for 2007. The primary contributor to the decrease was the changes in interest rates on our various portfolios. The yield on earning assets increased 19 basis points over the prior year while the cost of funds increased 39 basis points. This negative variance reduced net interest income by $234,000. Continued reliance on time deposits as the source of funding, and the related competitive environment for gathering these deposits was the main reason for the increase in cost of funds, as on a net basis the cost of non-time deposit funding sources actually declined. Unfortunately, the competitive market for demand deposits in the Banks’ primary market areas suggests that time deposits will continue to increase as a percent of total funding sources. Changes in volume of the portfolios effectively added $92,000 to the net interest margin, with increases in loans more than offsetting declines in investments and increases in time deposits.
22
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 Sept. 30, 2007 | 9 Months ended Sept. 30, 2006 | |||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Average Balance | Interest | Yield/ Cost | Average Balance | Interest | Yield/ Cost | |||||||||||||||
| Assets: | ||||||||||||||||||||
| Short term investment | $ | 5,262 | $ | 213 | 5.41 | % | $ | 6,962 | $ | 278 | 5.34 | % | ||||||||
| Securities: | ||||||||||||||||||||
| Taxable | 33,500 | 1,134 | 4.51 | % | 40,027 | 1,318 | 4.39 | % | ||||||||||||
| Tax-exempt | 8,872 | 215 | 3.23 | % | 10,643 | 260 | 3.26 | % | ||||||||||||
| Loans | 153,963 | 8,620 | 7.49 | % | 139,880 | 7,838 | 7.49 | % | ||||||||||||
| Total earning assets/total | ||||||||||||||||||||
| interest income | 201,597 | 10,182 | 6.75 | % | 197,512 | 9,694 | 6.56 | % | ||||||||||||
| Cash and due from banks | 4,255 | 5,277 | ||||||||||||||||||
| Unrealized (loss) on AFS securities | (943 | ) | (1,500 | ) | ||||||||||||||||
| Allowance for loan loss | (2,376 | ) | (1,845 | ) | ||||||||||||||||
| All other assets | 8,922 | 7,053 | ||||||||||||||||||
| Total assets | 211,455 | 206,497 | ||||||||||||||||||
| Liabilities and Stockholders' Equity | ||||||||||||||||||||
| Interest bearing deposits: | ||||||||||||||||||||
| MMDA, Savings/NOW accounts | 58,336 | 1,302 | 2.98 | % | 67,127 | 1,581 | 3.15 | % | ||||||||||||
| Time | 92,868 | 3,482 | 5.01 | % | 78,831 | 2,672 | 4.53 | % | ||||||||||||
| Fed Funds Purchased | 538 | 20 | 4.97 | % | 2,292 | 81 | 4.73 | % | ||||||||||||
| FHLB Advances | 13,192 | 485 | 4.92 | % | 10,200 | 335 | 4.39 | % | ||||||||||||
| Trust Preferred Securities | 4,000 | 254 | 8.49 | % | 4,000 | 243 | 8.12 | % | ||||||||||||
| Other borrowings | -- | -- | 0.00 | % | 10 | 1 | 13.22 | % | ||||||||||||
| Total interest bearing | ||||||||||||||||||||
| liabilities/interest expense | 162,460 | 5,543 | 4.39 | % | 162,460 | 4,913 | 4.04 | % | ||||||||||||
| Noninterest bearing deposits | 22,633 | 23,811 | ||||||||||||||||||
| All other liabilities | 5,040 | 5,631 | ||||||||||||||||||
| Stockholders' Equity: | ||||||||||||||||||||
| Unrealized holding (loss) | (645 | ) | (1,009 | ) | ||||||||||||||||
| Common Stock, Surplus, Retained Earnings | 15,492 | 15,604 | ||||||||||||||||||
| Total liabilities and stockholders' equity | 211,455 | 206,497 | ||||||||||||||||||
| Interest spread | 4,639 | 2.37 | % | 4,781 | 2.52 | % | ||||||||||||||
| Net Interest Margin as a | ||||||||||||||||||||
| Percentage of Average | ||||||||||||||||||||
| Earnings Assets | 3.08 | % | 3.24 | % | ||||||||||||||||
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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.
| Nine Months Ended September 30, 2007 Compared to 2006 | |||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|
| (dollars in thousands) | Change Due to Rate | Change Due to Volume | Total Change | ||||||||
| Short term investment | $ | 6 | $ | (71 | ) | $ | (65 | ) | |||
| Investment securities - taxable | 57 | (241 | ) | (184 | ) | ||||||
| Investment securities - tax exempt | (2 | ) | (43 | ) | (45 | ) | |||||
| Loans, net of unearned income | (11 | ) | 793 | 782 | |||||||
| Total interest income | 50 | 438 | 488 | ||||||||
| Interest bearing deposits | 223 | (308 | ) | (85 | ) | ||||||
| Federal funds borrowed | 7 | (68 | ) | (61 | ) | ||||||
| FHLB advances | 43 | 107 | 150 | ||||||||
| Trust preferred securities | 11 | -- | 11 | ||||||||
| Other borrowings | -- | (1 | ) | (1 | ) | ||||||
| Total interest expense | 284 | 346 | 630 | ||||||||
| Net interest income | $ | (234 | ) | $ | 92 | $ | (142 | ) | |||
Total provision for loan losses was $2.6 million for the nine months ended September 30, 2007, compared to $1.6 million for the same period in 2006. Poor economic conditions in the Corporation's primary market areas have caused increased charge-offs and also required significant additional reserves against other impaired credits. As stated previously, our analysis indicates that the allowance for loan losses is adequate to absorb the losses inherent in the portfolio as of September 30, 2007, but economic conditions in the Corporation’s primary markets could lead to further significant losses in the future.
Non-interest income increased $67,000, or 8.9% for the nine months ended September 30, 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 $43,000, or 7.7% relative to the same quarter in the prior year. Over 50% of this variance was due to increased volume of non-sufficient funds fees, with the rest spread somewhat evenly over a variety of fees. Gains on sale of mortgage loans were relatively flat in the current year compared to the prior year. Local real estate market conditions are very poor contributing to very low purchase business, and long-term rates are still above those seen in the preceding few years reducing chances for refinance business. Management expects that as local market conditions stabilize and rates begin to fall this volume will pick up providing more opportunities for fee income.
Non-interest expense was $5.3 million for the nine months ended September 30, 2007, a $600,000 or 12.8% increase over the nine months ended September 30, 2006 when non-interest expense was $3.2 million. Salary costs and recruiting fees related to 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. Occupancy expense was reduced by $135,000, or 17.0% due mostly to the closing of a grocery store branch and loan operations center at CSB. Professional fees increased $129,000, or 32.7% primarily due to costs related to Sarbanes-Oxley Section 404 and the workout area. The majority of the 22.1%, or $71,000 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 causes of the $157,000, or 26.7% increase in other expense are increased deposit premiums assessed to the Banks by the FDIC, director compensation expense (which was suspended for most of 2006) and accelerated amortization of the debt issuance cost to ensure that the costs are fully amortized at the call date.
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Liquidity and Capital Resources
The Corporation obtained its initial equity capital in an initial public offering of its common stock in November 1998. 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 is evaluating a number of capital raising options in order to support our expected level of deposit and loan growth and to otherwise meet our capital requirements for the foreseeable future.
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Capital Resources at September 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 | % | 5.00 | % | 8.00 | % | |||||
| Well capitalized regulatory level | 5.00 | % | 6.00 | % | 10.00 | % | |||||
| CSB | 7.28 | % | 8.76 | % | 10.02 | % | |||||
| HVSB | 24.55 | % | 35.78 | % | 36.60 | % | |||||
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, 2007 | |||||||||||
| Required regulatory capital | $ | 8,246 | $ | 6,653 | $ | 13,305 | |||||
| Capital in excess of regulatory minimums | 9,765 | 11,358 | 6,797 | ||||||||
| Actual capital balances | $ | 18,011 | $ | 18,011 | $ | 20,102 | |||||
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 nine months ended September 30, 2007, operating activities generated $1,139,000. Normal operations were the primary generator of cash in the current year. Principal paydowns and sales of securities provided $6.5 million year to date, while decreases in the loan portfolio provided $5.7 million. The primary use of funds during the current year was payoffs in the deposit portfolio, which used $10.6 million and net repayment of FHLB advances of $4.5 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. |
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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 September 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.
None.
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 September 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: November 14, 2007
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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. |
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