FIRST OTTAWA BANCSHARES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINACIAL STATEMENTS
(Table dollars in thousands)
September 30, 2006 and 2005
NOTE 1 — BASIS OF PRESENTATION
The accounting policies followed in the preparation of the interim condensed consolidated financial statements are consistent with those used in the preparation of annual consolidated financial statements. The interim condensed consolidated financial statements reflect all normal and recurring adjustments, which are necessary, in the opinion of management, for a fair statement of results for the interim periods presented. Results for the three months and nine months ended September 30, 2006 are not necessarily indicative of the results that may be expected for the year ended December 31, 2006.
The accompanying unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America for the interim financial period and with the instructions to Form 10-Q. Accordingly, they do not include all the information and footnotes required by generally accepted accounting principles for complete financial statements. These condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and notes included in the Company’s annual report on Form 10-K for 2005 filed with the U.S. Securities and Exchange Commission. The condensed consolidated balance sheet of the Company as of December 31, 2005 has been derived from the audited consolidated balance sheet as of that date.
First National Bank of Ottawa (the Bank), a national banking association headquartered in Ottawa, Illinois, is a wholly — owned subsidiary of the Company. The Bank’s wholly-owned subsidiary, First Ottawa Financial Corporation, sells insurance and investment products.
NOTE 2 — EARNINGS PER SHARE
The number of shares used to compute basic and diluted earnings per share were as follows:
| | Three Months Ended
September 30, | | Nine Months Ended
September 30, | |
| | 2006 | | 2005 | | 2006 | | 2005 | |
| | | | | | | | | |
Net income (in thousands) | | $ | 655 | | $ | 660 | | $ | 1,611 | | $ | 1,726 | |
Weighted Average Shares outstanding | | 649,783 | | 651,627 | | 649,557 | | 649,992 | |
Effect of dilutive securities: | | | | | | | | | |
Stock options | | 1,303 | | 2,107 | | 1,303 | | 2,107 | |
Shares used to compute diluted earnings per share | | 651,086 | | 651,706 | | 650,860 | | 652,099 | |
| | | | | | | | | | | | | |
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Earnings per share:
| | Three Months Ended
September 30, | | Nine Months Ended
September 30, | |
| | 2006 | | 2005 | | 2006 | | 2005 | |
| | | | | | | | | |
Basic | | $ | 1.01 | | $ | 1.02 | | $ | 2.48 | | $ | 2.66 | |
Diluted | | 1.01 | | 1.01 | | 2.48 | | 2.65 | |
| | | | | | | | | | | | | |
NOTE 3 — CAPITAL RATIOS
At the end of the period, the Company’s and Bank’s capital ratios were materially the same and were:
| | September 30, 2006 | | December 31, 2005 | |
| | Amount | | Ratio | | Amount | | Ratio | |
| | | | | | | | | |
Total capital (to risk-weighted assets) | | $ | 23,126 | | 12.1 | % | $ | 21,786 | | 11.9 | % |
Tier I capital (to risk-weighted assets) | | 21,692 | | 11.4 | % | 20,442 | | 11.2 | % |
Tier I capital (to average assets) | | 21,692 | | 7.6 | % | 20,442 | | 7.2 | % |
| | | | | | | | | | | |
At September 30, 2006, the Company and the Bank were categorized as well capitalized and management is not aware of any conditions or events since the most recent notification that would change the Company’s or Bank’s categories.
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NOTE 4 — DERIVATIVES
The Company uses derivatives to fix future cash flows for interest payments on some of its floating rate certificates of deposit. In this regard, the Company has entered into an interest rate swap with the Federal Home Loan Bank of Chicago to fix the interest rate on a specific certificate of deposit product. At September 30, 2006, the Company had $2.8 million of certificates of deposit, which mature in 2006 through 2011, in which it pays the Federal Home Loan Bank a weighted average interest rate of 3.98% and will receive an interest rate from the Federal Home Loan Bank based on the appreciation of the S&P 500 Index. This interest received from the Federal Home Loan Bank will be paid to the customer. The assets and liabilities in this transaction are being netted and the expense recorded in interest expense on deposits.
In addition to the above, the Company also purchased $5.0 million of certificates of deposit, which are included in the certificates of deposit caption on the consolidated balance sheet. These investments mature in 2006 through 2010. The investments individually do not exceed $100,000 and are secured by the FDIC. The initial investment is not at risk, but the return on the investment is based on a calculation of the appreciation in the S&P 500 Index. The fair value of this embedded derivative is recorded in investment certificates of deposit and the fair value adjustment is included in other income. At September 30, 2006, the Bank had allocated $1.2 million to this asset and recorded a valuation expense of $91,000 for the current year.
NOTE 5 — CHANGE IN ACCOUNTING PRINCIPLE
Share Based Payment
The Company has a stock-based employee compensation plan, which is described in Notes of Financial Statements included in the December 31, 2005 Annual Report to shareholders.
Effective January 1, 2006, the Company adopted Statement of Financial Accounting Standards No. 123(R), Share-Based Payment (“SFAS 123(R)”). SFAS 123(R) addresses all forms of share-based payment awards, including shares under employee stock purchase plans, stock options, restricted stock and stock appreciation rights. SFAS 123(R) requires all share-based payments to be recognized as expense, based upon their fair values, in the financial statements over the vesting period of the awards.
Since the Company previously accounted for its stock options in accordance with SFAS No. 123, the adoption of SFAS No. 123(R) did not have a significant impact on the Company’s financial condition or results of operation. Certain disclosures required by SFAS No. 123(R), have been omitted due to their immaterial nature.
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Servicing Assets and Liabilities
In March 2006, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standard (SFAS) No. 156. This Statement amends SFAS 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities, with respect to the accounting for separately recognized servicing assets and servicing liabilities.
SFAS No. 156 requires an entity to initially recognize a servicing asset or servicing liability at fair value each time it undertakes an obligation to service a financial asset by entering into a servicing contract in other specific situations.
In addition, SFAS No. 156 permits an entity to choose either of the following subsequent measurement methods for each class of separately recognized servicing assets and servicing liabilities:
· Amortization method—Amortize servicing assets or servicing liabilities in proportion to and over the period of estimated net servicing income or net servicing loss and assess servicing assets or servicing liabilities for impairment or increased obligation based on fair value at each reporting date.
· Fair value measurement method—Measure servicing assets or servicing liabilities at fair value at each reporting date and report changes in fair value in earnings in the period in which the changes occur.
SFAS No. 156 is effective at the beginning of an entity’s first fiscal year that begins after September 15, 2006 and should be applied prospectively for recognition and initial measurement of servicing assets and servicing liabilities. Earlier 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.
The Company did not early adopt SFAS No. 156 on January 1, 2006. Adoption of SFAS No. 156 is not expected to have a significant impact on the Company’s financial condition or results of operation.
Future Accounting Pronouncements
Emerging Issues Task Force Issue 06-4. In September 2006, the Emerging Issues Task Force (EITF) reached a consensus regarding the accounting for entities with split-dollar life insurance arrangements that provide an employee with a specified benefit that is not limited to an employee’s active service period. In reaching its consensus, the EITF determined that an employer should recognize as a liability the future benefits to be provided to employees beyond the employees active service period. In the case of split-dollar plan that provides a death benefit to the employees designated beneficiary and the benefit is provided to the employee beyond their active service period, an entity should accrue a liability during the employee’s
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active service period for the cost of maintaining the life insurance policy during the employee’s retirement period. EITF 06-4 is effective for fiscal years beginning after December 15, 2007 with earlier application permitted. Entities should recognize the effects of applying EITF 06-4 either as a change in accounting principle through a cumulative-effect adjustment to retained earnings or other components of equity as of the beginning of the year of adoption or as a change in accounting principle through retrospective application to all prior periods.
Statement of Financial Accounting Standards (SFAS) No. 158, Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plan—an amendment of SFAS No. 87, 88, 106 and 132(r).
In September, 2006, the Financial Accounting Standards Board (FASB) issued SFAS No. 158. This statement requires an entity that sponsors one or more single-employer defined benefit plans to recognize the funded status of a benefit plan (measured as the difference between the fair value of plan assets and the benefit obligation) in its statement of financial position. For a pension plan, the benefit obligation is the projected benefit obligation and for any other plan the benefit obligation is the accumulated postretirement benefit obligation. Additionally, all items previously deferred when applying SFAS No. 87 or SFAS No. 106 will now be recognized as a component of accumulated other comprehensive income, net of applicable taxes. SFAS No. 158 will not change the components of net periodic benefit cost. SFAS No. 158 will require plan asset and benefit obligations to be measured primarily as of the balance sheet date. The effective date for the recognition of the funded status on the balance sheet is for fiscal years ending after December 15, 2006 while the effective date for the requirement that the measurement date of plan assets and the benefit obligation be the same as the balance sheet date is for fiscal years ending after December 15, 2008.
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FIRST OTTAWA BANCSHARES, INC. AND SUBSIDIARY
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion and analysis is intended as a review of significant factors affecting the financial condition and results of operations of the Company for the periods indicated. The discussion should be read in conjunction with the Condensed Consolidated Financial Statements and Notes. In addition to historical information, the following Management’s Discussion and Analysis of Financial Condition and Results of Operations contains forward-looking statements that involve risks and uncertainties. The Company’s actual results could differ significantly from those anticipated in these forward-looking statements as a result of certain factors discussed elsewhere in this report.
Overview
First Ottawa Bancshares, Inc. is the holding company for First National Bank of Ottawa. The Company is headquartered in Ottawa, Illinois and operates four offices in Ottawa, two branches in Streator, a branch in Yorkville, a branch in Morris, and a loan production office in Minooka. The Company continues to explore expansion opportunities within its existing market area and in surrounding areas.
The Company’s principal business is conducted by the Bank and consists of a full range of community-based financial services, including commercial and retail banking. The profitability of the Company’s operations depends primarily on its net interest income, provision for loan losses, other income, and other expenses. Net interest income is the difference between the income the Company receives on its loan and securities portfolios and its cost of funds, which consists of interest paid on deposits and borrowings. The provision for loan losses reflects the cost of credit risk in the Company’s loan portfolio. Other income consists of service charges on deposit accounts, trust and farm management fee income, securities gains (losses), gains (losses) on sales of loans, and other income. Other expenses include salaries and employee benefits, as well as occupancy and equipment expenses and other non-interest expenses.
Net interest income is dependent on the amounts and yields of interest-earning assets as compared to the amounts of and rates on interest-bearing liabilities. Net interest income is sensitive to changes in market rates of interest and the Company’s asset/liability management procedures in coping with such changes. The provision for loan losses is dependent upon management’s assessment of the collectibility of the loan portfolio under current economic conditions.
The Company’s net income for the nine months ended September 30, 2006, was $1.6 million, or $2.48 per common share, compared to net income of $1.7 million, or $2.66 per common share for the nine months ended September 30, 2005. The decrease in net income was due primarily to a decrease in net interest income, partially offset by a decrease in noninterest expenses.
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The Company’s assets at September 30, 2006 were $286.5 million contrasted to $278.7 million at December 31, 2005, an increase of $7.8 million, or 2.8%.
CRITICAL ACCOUNTING POLICIES
The accounting and reporting policies of the Company are in accordance with accounting principles generally accepted in the United States and conform to general practices within the banking industry. The Company’s significant accounting policies are described in detail in the notes to the Company’s consolidated financial statements for the year ended December 31, 2005. The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions. The financial position and results of operations can be affected by these estimates and assumptions and are integral to the understanding of reported results. Critical accounting policies are those policies that management believes are the most important to the portrayal of the Company’s financial condition and results, and they require management to make estimates that are difficult, subjective, or complex.
Allowance for Credit Losses- The allowance for credit losses provides coverage for probable losses inherent in the Company’s loan portfolio. Management evaluates the adequacy of the allowance for credit losses each quarter based on changes, if any, in underwriting activities, the loan portfolio composition (including product mix and geographic, industry or customer-specific concentrations), trends in loan performance, regulatory guidance and economic factors. This evaluation is inherently subjective, as it requires the use of significant management estimates. Many factors can affect management’s estimates of specific and expected losses, including volatility of default probabilities, rating migrations, loss severity and economic and political conditions. The allowance is increased through provisions charged to operating earnings and reduced by net charge-offs.
The Company determines the amount of the allowance based on relative risk characteristics of the loan portfolio. The allowance recorded for commercial loans is based on reviews of individual credit relationships and an analysis of the migration of commercial loans and actual loss experience. The allowance recorded for homogeneous consumer loans is based on an analysis of loan mix, risk characteristics of the portfolio, fraud loss and bankruptcy experiences, and historical losses, adjusted for current trends, for each homogeneous category or group of loans. The allowance for credit losses relating to impaired loans is based on the loan’s observable market price, the collateral for certain collateral-dependent loans, or the discounted cash flows using the loan’s effective interest rate.
Regardless of the extent of the Company’s analysis of customer performance, portfolio trends or risk management processes, certain inherent but undetected losses are probable within the loan portfolio. This is due to several factors including inherent delays in obtaining information regarding a customer’s financial condition or changes in their unique business conditions, the judgmental nature of individual loan evaluations, collateral assessments and the interpretation of economic trends. Volatility of economic or customer-specific conditions affecting the identification and estimation of losses for larger non-homogeneous credits and the sensitivity of assumptions utilized to establish allowances for homogenous groups of loans are among other factors. The Company estimates a range of inherent losses related to the existence of these
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exposures. The estimates are based upon the Company’s evaluation of imprecision risk associated with the commercial and consumer allowance levels and the estimated impact of the current economic environment.
Mortgage Servicing Rights- Mortgage servicing rights (“MSRs”) associated with loans originated and sold, where servicing is retained, are capitalized and included in other intangible assets in the consolidated balance sheet. The value of the capitalized servicing rights represents the present value of the future servicing fees arising from the right to service loans in the portfolio. Critical accounting policies for MSRs relate to the initial valuation and subsequent impairment tests. The methodology used to determine the valuation of MSRs requires the development and use of a number of estimates, including anticipated principal amortization and prepayments of that principal balance. Events that may significantly affect the estimates used are changes in interest rates, mortgage loan prepayment speeds and the payment performance of the underlying loans. The carrying value of the MSRs is periodically reviewed for impairment based on a determination of fair value. For purposes of measuring impairment, the servicing rights are compared to a valuation prepared based on a discounted cash flow methodology, utilizing current prepayment speeds and discount rates. Impairment, if any, is recognized through a valuation allowance and is recorded as amortization of intangible assets.
Derivatives- As a part of the Company’s funding strategy, derivative financial instruments, all of which are interest rate swap arrangements, are used to reduce exposure to changes in interest rates for certain financial instruments. These derivatives are accounted for by recognizing the fair value of the contracts on the balance sheet. The valuation of these derivatives is considered critical because carrying assets and liabilities at fair value inherently results in more financial statement volatility. The fair values and the information used to record valuation adjustments for the interest rate swaps and related deposit products are provided by third parties.
Additionally, the Company has purchased certificate of deposits which contain an equity related embedded derivative component. The initial investment in the certificate of deposit is not at risk but the return on the investment is based on appreciation in the S&P 500 Index.
Accordingly, the fair value of the embedded derivative is recorded at fair value as an adjustment to the certificate of deposit and other income.
Stock Compensation- Grants under the Company’s stock incentive plan are accounted for under the provisions of Statement of Accounting Standards (SFAS) No. 123(R), applying the fair value method and the use of an option pricing model to estimate the value of the options granted. The stock options are granted with an exercise price equal to the market price at the date of grant. Resulting compensation expense, relating to the stock options is measured and recorded based on the estimated value of the options.
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CONSOLIDATED FINANCIAL CONDITION
Total assets at September 30, 2006 were $286.5 million contrasted to $278.7 million at December 31, 2005, an increase of $7.8 million, or 2.8%. This increase was the result of an increase in cash and cash equivalents, federal funds sold, loans, and other assets. These increases were partially offset by decreases in certificates of deposits at other financial institutions and securities available for sale. Proceeds from maturing certificates of deposits at other financial institutions and available for sale securities were used to fund loan growth of $9.7 million. Cash and cash equivalents increased as a result of a $10.1 million increase in federal funds sold. This increase was primarily funded through deposit growth from local municipalities as a result of real estate tax collections. Other assets increased by $510,000, due primarily to the increase in the deferred tax asset associated with the market value fluctuations in the investment portfolio.
Total liabilities at September 30, 2006 were $262.5 million compared to $255.9 million at December 31, 2005, an increase of $6.6 million, or 2.6%. This increase was primarily the result of an increase in money market accounts holding public funds. Deposits increased by $19.9 million, from $239.9 million at December 31, 2005, to $259.8 million at September 30, 2006, primarily due to increases in short term deposits of a local municipality and county funds resulting from real estate tax payments. As a result of the growth in deposits the bank was able to decrease federal funds purchased. Other liabilities remained relatively stable, with a slight decrease due to decreased dividends payable.
Total equity increased to $24.0 million at September 30, 2006 compared to $22.9 million at December 31, 2005. This increase was due primarily to a decrease in accumulated other comprehensive loss of $134,000, net of tax, relating to the Company’s investment portfolio coupled with dividends in the amount of $650,000, payable to shareholders in July 2006 that were declared in June 2006, all of which were netted against net income of $1.6 million for the period ended September 30, 2006.
CONSOLIDATED RESULTS OF OPERATIONS
Net income for the third quarter of 2006 was $655,000, or $1.01 per share, an 0.8% decrease compared to $660,000, or $1.02 per share, in the third quarter of 2005. The decrease in net income for the quarter was primarily the result of a decrease in net interest income of $214,000. This change was offset by a decrease in the provision for loan losses of $30,000 from the third quarter of 2005. Other income increased $47,000, and other expense decreased by $151,000 compared to the third quarter of 2005. The increase in income before taxes also resulted in a increase in the income tax provision of $19,000.
During the nine months ended September 30, 2006, net income was $1.61 million, or $2.48 per share, compared to $1.73 million, or $2.66 per share during the first nine months of 2005. This 6.7% decrease in net income for the nine month period was primarily due to a $356,000 decrease in net interest income after the provision for loan losses, or 5.3%. Non interest income was relatively flat with an increase of $34,000. Decreases in noninterest expense of $191,000, and in the provision for loan losses of $90,000, or 40.0%, partially offset the decrease in net interest
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income. The decrease in the Company’s pretax income also resulted in a decrease in the tax provision of $16,000.
The annualized return on average assets was 0.75% for the nine months ended Septemebr 30, 2006, compared to 0.78% in 2005. The annualized return on average equity decreased to 8.7% for the nine months ended September 30, 2006, from 9.5% in 2005.
NET INTEREST INCOME
Net interest income decreased by 8.9% to $2.2 million for the three months ended September 30, 2006 as compared to 2005. Total interest income increased to $3.9 million for the three months ended September 30, 2006, compared to $3.6 million for the three months ended September 30, 2005. This change was primarily the result of an increase in interest income from loans to $2.9 million for the three months ended September 30, 2006 from $2.4 million for the same period a year earlier. This increase was the result of loan growth and an increasing rate environment during the first three quarters of 2006. In addition, a decrease in interest income from investment certificates of deposits of $90,000 and a decline in interest income from securities of $154,000 compared to prior year resulted in a change of $237,000 in total interest income. Interest expense increased to $1.7 million for the three months ended September 30, 2006 from $1.2 million for the same period ended September 30, 2005, a 36.8% increase, contributed to the decrease in net interest income for the three month period as liabilities repriced at higher interest rates more quickly than assets during the period
Net interest income for the nine months ended September 30, 2006 and 2005 was $6.5 and $6.9 million, respectively. This decrease was primarily the result of a $1.2 million increase in interest expense which was partially offset by a $771,000 increase in interest income compared to prior year. The Company’s net interest margin was 3.53% for the nine months ended September 30, 2006 and 3.58% a year earlier. Loan and securities income is reflected on a fully tax equivalent basis utilizing a 34% rate for municipal securities and tax exempt loans. Net interest income on a fully taxable equivalent basis was $6.8 million for the nine months ending September 30, 2006 and $7.1 million for the same period in 2005. The tax equivalent yield on average earning assets of $258.4 million in 2006 and $266.6 million for the same period in 2005, increased to 5.89% for the nine months ended September 30, 2006 from 5.31% for the same period ended September 30, 2005, an increase of 58 basis points. This increase was offset by a corresponding increase in the cost of funds to 2.69% from 1.96% paid for the same period ended September 30, 2005, a 73 basis point increase. These increases were a result of ongoing repricing of assets and liabilities as they matured in the rising rate environment in late 2005 and during the first nine months of 2006.
PROVISION FOR LOAN LOSSES
The provision for loan losses was $45,000 during the third quarter of 2006 as compared to $75,000 during the third quarter of 2005. The year to date provision for loan losses was $135,000 in 2006 and $225,000 in 2005. As of September 30, 2006, the allowance for loan losses totaled $1.4 million, or .88% of total loans, which was unchanged from .88% as of December 31, 2005. Nonaccrual loans increased from none at December 31, 2005 to $683,000 at September 30, 2006. This increase was primarily due to two commercial real estate loans, which made up 94% of the nonaccrual loan balance. Nonperforming loans, including nonaccrual loans, increased $383,000
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to $1.7 million over the same period. Management feels that the Bank is well collateralized on the nonperforming loans, which significantly reduces the Company’s exposure to losses on the credits.
The amounts of the provision and allowance for loan losses are influenced by current economic conditions, actual loss experience, industry trends and other factors, including real estate values in the Company’s market area and management’s assessment of current collection risks within the loan portfolio. While the general economy has showed signs of improvement, borrowers may continue to experience difficulty, and the level of non-performing loans, charge-offs, and delinquencies could rise and require increases in the provision. The allowance for loan losses represents management’s estimate of probable incurred losses based on information available as of the date of the financial statements. The allowance for loan losses is based on management’s evaluation of the collectibility of the loan portfolio, including past loan loss experience, known and inherent risks in the nature and volume of the portfolio, information about specific borrower situations and estimated collateral values, and economic conditions.
Management has concluded that the allowance for loan losses was adequate at September 30, 2006. However, there can be no assurance that the allowance for loan losses will be adequate to cover all losses.
NONINTEREST INCOME
The Company’s noninterest income totaled $754,000 for the three months ended September 30, 2006 compared to $707,000 for the same period in 2005, an increase of $47,000, or 6.6%. The increase in noninterest income was primarily due to increases in trust and farm management fees of $21,000, and other income of $55,000. These increases were partially offset by decreases in deposit service charges of $26,000 and gains on the sale of loans of $3,000. The decrease in deposit service charges was a result of decreased overdraft charges compared to the prior year. Other income decreased due to market value adjustments associated with the derivative portion of Certificates of Deposit held for investment purposes.
For the nine months ended September 30, 2006, noninterest income increased by 1.8% or $34,000 to $1.9 million. Service charges on deposit accounts decreased by $116,000, or 13.9%, due to lower overdraft volume. Gains on the sale of investment securities decreased $67,000 compared to prior year. Gains on loan sales to the secondary market decreased $51,000 due to decreased origination and refinancing volume. Other income increased $205,000 due to increased loan late fees and ATM fees compared to the prior year. Trust fees also increased $63,000, due to increased volume compared to prior year.
NONINTEREST EXPENSE
The Company’s noninterest expense was $2.0 million for the three months ended September 30, 2006 and $2.1 million for the same period in 2005. Noninterest expense decreased by $151,000 for the three months ended September 30, 2006, compared to 2005. Salaries and benefits, the largest component of noninterest expense, decreased $2,000, or 0.2%, to $1.2 million. Decreases in occupancy expense of $5,000, professional fees of $37,000, amortization of core deposit
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intangible of $16,000, and supplies expense of $36,000, data processing expense of $3,000 and other expense of $52,000, contributed to the overall decrease.
For the nine months ended September 30, 2006, noninterest expense decreased $191,000 to $6.2 million, or 3.0%, compared to the year earlier period. Salaries and benefits increased $5,000, or 0.1%, to $3.5 million. Decreases in professional fees of $44,000, occupancy expense of $14,000, amortization of the core deposit intangible of $47,000, and other expense of $63,000 were partially offset by increased data processing expense of $10,000. Other expense was reduced due to decreased collection expenses, decreased directors’ fees, and decreased miscellaneous expenses.
LIQUIDITY AND CAPITAL RESOURCES
The Company’s primary sources of funds are deposits, repurchase agreements, and proceeds from principal and interest payments on loans and securities. While maturities and scheduled amortization of loans and securities and calls of securities are predictable sources of funds, deposit flows and mortgage prepayments are greatly influenced by general interest rates, economic conditions, and competition. The Company generally manages the pricing of its deposits to be competitive and to increase core deposit relationships.
Liquidity management is both a daily and long-term responsibility of management. The Company adjusts its investments in liquid assets based upon management’s assessment of (i) expected loan demand, (ii) expected deposit flows, (iii) yields available on interest-earning deposits and securities, and (iv) the objectives of its asset/liability management program. Excess liquid assets are invested generally in interest-earning overnight deposits and short- and intermediate-term U.S. government and agency obligations.
The Company’s most liquid assets are cash and short-term investments. The levels of these assets are dependent on the Company’s operating, financing, lending, and investing activities during any given year. At September 30, 2006, cash and short-term investments totaled $17.1 million. The Company has other sources of liquidity if a need for additional funds arises, including securities maturing within one year and the repayment of loans. The Company may also utilize the sale of securities available-for-sale, federal funds lines of credit from correspondent banks, and borrowings from the Federal Home Loan Bank of Chicago and M&I Marshall & Ilsley Bank.
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The following table discloses material contractual obligations and commercial commitments of the Company as of September 30, 2006:
| | Total | | Less Than
1 Year | | 1 - 3 Years | | 4 - 5 Years | | After
5 Years | |
Lines of credit(1) | | $ | 15,485 | | $ | 10,794 | | $ | 3,370 | | $ | 87 | | $ | 1,234 | |
Data processing contract payable | | 543 | | 245 | | 298 | | — | | — | |
Standby letters of credit(1) | | 577 | | 577 | | — | | — | | — | |
| | $ | 16,605 | | $ | 11,616 | | $ | 3,668 | | $ | 87 | | $ | 1,234 | |
(1) Represents amounts committed to customers.
IMPACT OF INFLATION AND CHANGING PRICES
The financial statements and related data presented herein have been prepared in accordance with accounting principles generally accepted in the United States of America, which require the measurement of financial position and operating results in terms of historical dollars without considering changes in the relative purchasing power of money over time due to inflation. The primary impact of inflation on the operations of the Company is reflected in increased operating costs. Unlike most industrial companies, virtually all of the assets and liabilities of a financial institution are monetary in nature. As a result, interest rates, generally, have a more significant impact on a financial institution’s performance than does inflation. Interest rates do not necessarily move in the same direction or to the same extent as the prices of goods and services.
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SAFE HARBOR STATEMENT
This document (including information incorporated by reference) contains, and future oral and written statements of the Company and its management may contain, forward-looking statements, within the meaning of such term in the Private Securities Litigation Reform Act of 1995, with respect to the financial condition, results of operations, plans, objectives, future performance and business of the Company. Forward-looking statements, which may be based upon beliefs, expectations and assumptions of the Company’s management and on information currently available to management, are generally identifiable by the use of words such as “believe,” “expect,” “anticipate,” “plan,” “intend,” “estimate,” “may,” “will,” “would,” “could,” “should” or other similar expressions. Additionally, all statements in this document, including forward-looking statements, speak only as of the date they are made, and the Company undertakes no obligation to update any statement in light of new information or future events.
The Company’s ability to predict results or the actual effect of future plans or strategies is inherently uncertain. The factors which could have a material adverse effect on the operations and future prospects of the Company and its subsidiaries are detailed in the “Risk Factors” section included under Item 1a. of Part I of our Form 10-K. In addition to the risk factors described in that section, there are other factors that may impact any public company, including ours, which could have a material adverse effect on the operations and future prospects of the Company and its subsidiaries. These risks and uncertainties should be considered in evaluating forward-looking statements and undue reliance should not be placed on such statements.
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