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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
x | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended September 30, 2007
OR
¨ | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the transition period from to
Commission file number: 0-51296
COMMUNITY FINANCIAL SHARES, INC.
(Exact name of registrant as specified in its charter)
Delaware | 36-4387843 | |
(State or other jurisdiction of incorporation or organization) | (I.R.S. Employer Identification No.) | |
357 Roosevelt Road Glen Ellyn, Illinois | 60137 | |
(Address of principal executive offices) | (Zip Code) |
(630) 545-0900
(Registrant’s telephone number, including area code)
None
(Former name, former address and former fiscal year, if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.
Large accelerated filer ¨ Accelerated filer ¨ Non-accelerated filer x
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.
Class | Outstanding at November 1, 2007 | |
Common Stock, no par value per share | 1,249,580 shares |
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Table of Contents
PART I | ||||
Item 1. | Financial Statements | 3 | ||
Item 2. | Management’s Discussion and Analysis of Financial Condition and Results of Operations | 9 | ||
Item 3. | Quantitative and Qualitative Disclosures about Market Risk | 22 | ||
Item 4. | Controls and Procedures | 23 | ||
PART II | ||||
Item 1. | Legal Proceedings | 24 | ||
Item 1A. | Risk Factors | 24 | ||
Item 2. | Unregistered Sales of Equity Securities and Use of Proceeds | 24 | ||
Item 3. | Defaults Upon Senior Securities | 24 | ||
Item 4. | Submission of Matters to a Vote of Security Holders | 24 | ||
Item 5. | Other Information | 24 | ||
Item 6. | Exhibits | 24 | ||
Signatures | 25 |
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ITEM 1. | FINANCIAL STATEMENTS |
COMMUNITY FINANCIAL SHARES, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands)
September 30, 2007 | December 31, 2006 | ||||||
(Unaudited) | |||||||
ASSETS | |||||||
Cash and due from banks | $ | 6,127 | $ | 6,532 | |||
Interest bearing deposits | 2,853 | 2,097 | |||||
Federal funds sold | — | 2,000 | |||||
Cash and cash equivalents | 8,980 | 10,629 | |||||
Securities available-for-sale | 36,171 | 34,924 | |||||
Loans, less allowance for loan losses of $1,554 and $1,549 at September 30, 2007 and December 31, 2006, respectively | 212,797 | 199,820 | |||||
Loans held for sale | 949 | — | |||||
Federal Home Loan Bank stock | 5,398 | 5,398 | |||||
Premises and equipment, net | 15,234 | 13,544 | |||||
Cash value of life insurance | 5,198 | 5,462 | |||||
Interest receivable and other assets | 2,211 | 1,964 | |||||
Total assets | $ | 286,938 | $ | 271,741 | |||
LIABILITIES AND SHAREHOLDERS’ EQUITY | |||||||
Deposits | $ | 241,888 | $ | 234,725 | |||
Federal Home Loan Bank advances | 17,500 | 10,500 | |||||
Subordinated debentures | 3,609 | 3,609 | |||||
Interest payable and other liabilities | 2,138 | 2,306 | |||||
Total liabilities | 265,135 | 251,140 | |||||
Commitments and contingent liabilities (See Note 4) | |||||||
Shareholders’ equity | |||||||
Common stock—no par value, 5,000,000 shares authorized; 1,375,278 and 1,375,228 issued and outstanding at September 30, 2007 and December 31, 2006, respectively | — | — | |||||
Paid-in capital | 8,245 | 8,231 | |||||
Retained earnings | 13,769 | 12,361 | |||||
Accumulated other comprehensive income (loss) | (211 | ) | 9 | ||||
Total shareholders’ equity | 21,803 | 20,601 | |||||
Total liabilities and shareholders’ equity | $ | 286,938 | $ | 271,741 | |||
See accompanying notes to condensed consolidated financial statements.
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COMMUNITY FINANCIAL SHARES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
Three and Nine Months Ended September 30, 2007 and 2006
(In thousands, except share and per share data)
(Unaudited)
Three Months Ended September 30, | Nine Months Ended September 30, | |||||||||||
2007 | 2006 | 2007 | 2006 | |||||||||
Interest income | ||||||||||||
Loans | $ | 3,855 | $ | 3,708 | $ | 11,263 | $ | 10,757 | ||||
Securities: | ||||||||||||
Taxable | 324 | 167 | 904 | 545 | ||||||||
Exempt from federal income tax | 160 | 155 | 479 | 463 | ||||||||
Federal funds sold | 4 | — | 33 | — | ||||||||
Federal Home Loan Bank dividends and other | 61 | 65 | 232 | 219 | ||||||||
Total interest income | 4,404 | 4,095 | 12,911 | 11,984 | ||||||||
Interest expense | ||||||||||||
Deposits | 1,793 | 1,399 | 5,127 | 3,980 | ||||||||
Federal Funds Purchased | 12 | 18 | 25 | 65 | ||||||||
Federal Home Loan Bank advances and other borrowed funds | 216 | 132 | 480 | 358 | ||||||||
Subordinated debentures | 62 | 82 | 224 | 231 | ||||||||
Total interest expense | 2,083 | 1,631 | 5,856 | 4,634 | ||||||||
Net interest income | 2,321 | 2,464 | 7,055 | 7,350 | ||||||||
Provision for loan losses | 10 | 45 | 10 | 315 | ||||||||
Net interest income after provision for loan losses | 2,311 | 2,419 | 7,045 | 7,035 | ||||||||
Non-interest income | ||||||||||||
Service charges on deposit accounts | 143 | 135 | 421 | 372 | ||||||||
Mortgage origination fees | 67 | 23 | 274 | 106 | ||||||||
Gain on sale of securities | 13 | — | 50 | — | ||||||||
Life insurance death benefit | — | — | 478 | — | ||||||||
Other non-interest income | 154 | 142 | 456 | 404 | ||||||||
Total non-interest income | 377 | 300 | 1,679 | 882 | ||||||||
Non-interest expense | ||||||||||||
Salaries and employee benefits | 1,223 | 1,101 | 3,665 | 3,231 | ||||||||
Net occupancy and equipment expense | 264 | 230 | 780 | 707 | ||||||||
Data processing expense | 172 | 151 | 507 | 425 | ||||||||
Advertising and promotions | 118 | 101 | 318 | 267 | ||||||||
Professional fees | 121 | 65 | 302 | 242 | ||||||||
Other operating expenses | 334 | 258 | 1,113 | 833 | ||||||||
Total non-interest expense | 2,232 | 1,906 | 6,685 | 5,705 | ||||||||
Income before income taxes | 456 | 813 | 2,039 | 2,212 | ||||||||
Provision for income taxes | 98 | 241 | 383 | 631 | ||||||||
Net income | $ | 358 | $ | 572 | $ | 1,656 | $ | 1,581 | ||||
Earnings per share | ||||||||||||
Basic | $ | 0.26 | $ | 0.42 | $ | 1.20 | $ | 1.15 | ||||
Diluted | 0.26 | 0.41 | 1.20 | 1.15 | ||||||||
Average shares outstanding basic | 1,375,278 | 1,374,328 | 1,375,268 | 1,372,749 | ||||||||
Average shares outstanding diluted | 1,380,983 | 1,380,126 | 1,380,294 | 1,378,474 | ||||||||
Dividends per share | $ | 0.06 | $ | 0.035 | $ | 0.18 | $ | 0.105 |
See accompanying notes to condensed consolidated financial statements.
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COMMUNITY FINANCIAL SHARES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY
Nine Months Ended September 30, 2007 and 2006
(In thousands, except share data)
(Unaudited)
Number of | Paid-In Capital | Retained Earnings | Accumulated Other Comprehensive Income (Loss) | Total Shareholders’ Equity | |||||||||||||
Balance at January 1, 2007 | 1,375,228 | $ | 8,231 | $ | 12,361 | $ | 9 | $ | 20,601 | ||||||||
Net income | — | — | 1,656 | — | 1,656 | ||||||||||||
Unrealized net loss on securities available-for-sale, net of reclassifications and tax effects | — | — | — | (220 | ) | (220 | ) | ||||||||||
Total comprehensive income | 1,436 | ||||||||||||||||
Cash dividends | — | — | (248 | ) | — | (248 | ) | ||||||||||
Stock option expense | — | 13 | — | — | 13 | ||||||||||||
Stock options exercised | 50 | 1 | — | — | 1 | ||||||||||||
Balance at September 30, 2007 | 1,375,278 | $ | 8,245 | $ | 13,769 | $ | (211 | ) | $ | 21,803 | |||||||
Balance at January 1, 2006 | 1,371,078 | $ | 8,148 | $ | 10,402 | $ | (81 | ) | $ | 18,469 | |||||||
Net income | — | — | 1,581 | — | 1,581 | ||||||||||||
Unrealized net gain on securities available-for-sale, net of reclassifications and tax effects | — | — | — | 50 | 50 | ||||||||||||
Total comprehensive income | 1,631 | ||||||||||||||||
Cash dividends | — | — | (144 | ) | — | (144 | ) | ||||||||||
Stock option expense | — | 10 | — | — | 10 | ||||||||||||
Stock options exercised | 3,250 | 31 | — | — | 31 | ||||||||||||
Balance at September 30, 2006 | 1,374,328 | $ | 8,189 | $ | 11,839 | $ | (31 | ) | $ | 19,997 | |||||||
See accompanying notes to condensed consolidated financial statements.
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COMMUNITY FINANCIAL SHARES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
Nine Months Ended September 30, 2007 and 2006
(In thousands)
(Unaudited)
September 30, | ||||||||
2007 | 2006 | |||||||
CASH FLOWS FROM OPERATING ACTIVITIES | ||||||||
Net income | $ | 1,656 | $ | 1,581 | ||||
Adjustments to reconcile net income to net cash from operating activities | ||||||||
Provision for loan losses | 10 | 315 | ||||||
Depreciation and amortization | 403 | 358 | ||||||
Premium amortization on securities, net | 55 | 100 | ||||||
Gain on sale of securities | (50 | ) | — | |||||
Compensation cost of stock options | 13 | 10 | ||||||
Change in cash value of life insurance | (743 | ) | (166 | ) | ||||
Change in interest receivable and other assets | 421 | (542 | ) | |||||
Change in interest payable and other liabilities | (168 | ) | (288 | ) | ||||
Net cash from operating activities | 1,597 | 1,368 | ||||||
CASH FLOWS FROM INVESTING ACTIVITIES | ||||||||
Proceeds from maturities and calls of securities | 3,909 | 7,987 | ||||||
Purchases of securities available-for-sale | (12,952 | ) | (257 | ) | ||||
Proceeds from sales of securities | 7,431 | — | ||||||
Proceeds from Federal Home Loan Bank stock redemptions | — | 3,669 | ||||||
Proceeds of life insurance death benefit | 478 | �� | — | |||||
Net change in loans receivable | (13,936 | ) | (6,258 | ) | ||||
Property and equipment expenditures | (2,093 | ) | (2,148 | ) | ||||
Net cash from (used in) investing activities | (17,163 | ) | 2,993 | |||||
CASH FLOWS FROM FINANCING ACTIVITIES | ||||||||
Change in deposits | 7,164 | (1,000 | ) | |||||
Change in federal funds purchased | — | (5,000 | ) | |||||
Proceeds of borrowings | 10,609 | 2,000 | ||||||
Repayments of borrowings | (3,609 | ) | — | |||||
Exercise of stock options | 1 | 32 | ||||||
Dividends paid | (248 | ) | (144 | ) | ||||
Net cash from (used in) financing activities | 13,917 | (4,112 | ) | |||||
Change in cash and cash equivalents | (1,649 | ) | 249 | |||||
Cash and cash equivalents at beginning of period | 10,629 | 7,794 | ||||||
CASH AND CASH EQUIVALENTS AT END OF PERIOD | $ | 8,980 | $ | 8,043 | ||||
See accompanying notes to condensed consolidated financial statements.
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COMMUNITY FINANCIAL SHARES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Table dollars in thousands)
September 30, 2007 and 2006
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 of Community Financial Shares, Inc. (the Company), for a fair statement of results for the interim periods presented. Results for the three and nine months ended September 30, 2007 are not necessarily indicative of the results that may be expected for the year ended December 31, 2007.
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 2006 filed with the U.S. Securities and Exchange Commission. The condensed consolidated balance sheet of the Company as of December 31, 2006 has been derived from the audited consolidated balance sheet as of that date.
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, | |||||||||||
2007 | 2006 | 2007 | 2006 | |||||||||
Net income (in thousands) | $ | 358 | $ | 572 | $ | 1,656 | $ | 1,581 | ||||
Weighted Average Shares outstanding | 1,375,278 | 1,374,328 | 1,375,268 | 1,372,749 | ||||||||
Effect of dilutive securities: | ||||||||||||
Stock options | 5,705 | 5,798 | 5,026 | 5,725 | ||||||||
Shares used to compute diluted earnings per share | 1,380,983 | 1,380,126 | 1,380,294 | 1,378,474 | ||||||||
Earnings per share: | ||||||||||||
Basic | $ | 0.26 | $ | 0.42 | $ | 1.20 | $ | 1.15 | ||||
Diluted | 0.26 | 0.41 | 1.20 | 1.15 |
There were no anti-dilutive shares excluded from the above tables.
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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Table dollars in thousands)
September 30, 2007 and 2006
NOTE 3 – CAPITAL RATIOS
At the dates indicated, the Company’s capital ratios were:
September 30, 2007 | December 31, 2006 | |||||||||||
Amount | Ratio | Amount | Ratio | |||||||||
Total capital (to risk-weighted assets) | $ | 27,068 | 11.7 | % | $ | 25,641 | 12.0 | % | ||||
Tier I capital (to risk-weighted assets) | 25,514 | 11.1 | % | 24,092 | 11.2 | % | ||||||
Tier I capital (to average assets) | 25,514 | 8.9 | % | 24,092 | 8.9 | % |
At the dates indicated, the Company and Community Bank Wheaton/Glen Ellyn (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.
NOTE 4 – COMMITMENTS
The Company purchased land for the construction of a new branch facility at the corner of Gary and Geneva Roads in Wheaton, Illinois on April 7, 2006 for $1,424,591. The new facility will be part of a development containing a bank building, a medical office and a strip mall. The Company will be sharing in the common area development costs of the project on a pro rata basis. A contract for the building construction was executed on April 9, 2007 totaling $2.3 million. Construction is scheduled to be completed in the fourth quarter of 2007.
NOTE 5 – CHANGE IN ACCOUNTING PRINCIPLE
The Company or one of its subsidiaries files income tax returns in the U.S. federal and Illinois jurisdictions. With few exceptions, the Company is no longer subject to U.S. federal, state and local examinations by tax authorities for years before 2004.
The Company adopted the provisions of the Financial Accounting Standards Board (FASB) Interpretation No. 48 (FIN 48),Accounting for Uncertainty in Income Taxes—an interpretation of FASB Statement No. 109, on January 1, 2007. FIN 48 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. FIN 48 also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. As a result of the implementation of FIN 48, the Company did not identify any uncertain tax positions that it believes should be recognized in the financial statements.
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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
Community Financial Shares, Inc. (the “Company”) is the holding company for Community Bank Wheaton/Glen Ellyn (the “Bank”). The Company is headquartered in Glen Ellyn, Illinois and operates three offices in its market. One location is in Glen Ellyn and two are located in Wheaton. The Company purchased land to build the fourth full-service banking facility at the corner of Gary and Geneva Avenues in the Northwest portion of Wheaton, Illinois. Construction of the new facility began in April 2007 with a projected opening date in the fourth quarter of 2007. The new facility will help to solidify the Company’s market presence in Wheaton as well as provide access to the Carol Stream and Winfield markets.
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, mortgage origination fees, securities gains (losses), and other income. Other expenses include salaries and employee benefits, as well as occupancy and equipment expenses and other noninterest 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.
On June 21, 2007, the Company and its newly formed financing trust subsidiary, Community Financial Shares Statutory Trust II, a Delaware statutory trust, consummated the issuance and sale of an aggregate amount of $3,500,000 of the Trust’s floating rate capital securities in a pooled trust preferred transaction. The subordinated debentures accrue interest at a variable rate based on three-month LIBOR plus 1.62%, reset and payable quarterly. No underwriting commissions or placement fees were paid in connection with the issuance. The Company has guaranteed the Trust’s obligations with respect to the debentures. Proceeds from the June 26, 2007 trust preferred offering were used to redeem the trust preferred securities issued by Community Financial Shares Statutory Trust I. The redemption price was at 100% of the liquidation amount of $1,000 per Preferred Security, plus accrued and unpaid interest to the redemption date which was June 26, 2007. These debentures accrued interest at three-month LIBOR plus 3.45%. As a result of the redemption and issuance of trust preferred securities discussed above the Company will save approximately $66,000 in interest expense annually.
On August 14, 2007, the Company commenced a self-tender offer to purchase up to 200,000 shares of its common stock. Company shareholders were given the opportunity to sell part or all of their shares to the Company at a price of $26.00 per share. The offer to purchase shares expired on September 28, 2007. On October 1, 2007, the Company announced that it accepted for purchase 125,698 shares of its common stock representing 9.1% of the outstanding shares of common stock, at a purchase price of $26.00 for a total cost of $3.3 million, excluding fees and expenses relating to the offer. The impact of the self-tender offer will be reflected in the results of operations for the fourth quarter of fiscal 2007.
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Comparison of Financial Condition at September 30, 2007 and December 31, 2006
Total assets at September 30, 2007 were $286.9 million, which represented an increase of $15.2 million, or 5.6%, compared to $271.7 million at December 31, 2006. The change in total assets was primarily due to increases in loans receivable, securities available-for-sale and premises and equipment. Loans receivable increased by $13.0 million, or 6.5%, to $212.8 million at September 30, 2007. The increase in loans receivable is due to continued strong business relationships maintained by our loan staff. Securities available-for-sale increased by $1.3 million, or 3.6%, to $36.2 million at September 30, 2007 as compared to $34.9 million at December 31, 2006. The increase in securities was attributable to attractive opportunities in the market. Premises and equipment, net increased $1.7 million, or 12.5%, to $15.2 million at September 30, 2007 as compared to $13.5 million at December 31, 2006, which is primarily due to the Company’s costs associated with its continued branch expansion. These increases were partially offset by decreases in cash and cash equivalents and cash value of life insurance. Cash and cash equivalents decreased by $1.6 million, or 15.5%, to $9.0 million at September 30, 2007 from $10.6 million at December 31, 2006. Cash value of life insurance decreased $264,000, or 4.8%, to $5.2 million at September 30, 2007 as compared to $5.5 million at December 31, 2006. This decrease was partially due to the receipt of a $478,000 claim.
Total liabilities at September 30, 2007 were $265.1 million, which represented an increase of $14.0 million, or 5.6%, compared to $251.1 million at December 31, 2006. Deposits increased $7.2 million, or 3.1%, to $241.9 million at September 30, 2007 as compared to $234.7 million at December 31, 2006. Deposits increased primarily due to the success of recent promotions to attract additional deposits. FHLB advances increased $7.0 million, or 66.7%, to $17.5 million at September 30, 2007 from $10.5 million at December 31, 2006. The increase in borrowings was necessary to assist in funding loan growth during the period. The Company continues to experience continued pressure of competition for deposits from other financial institutions as well as more attractive market investments for consumers. The opening of the facility in north Wheaton, which is planned for the fourth quarter of 2007, will provide a new source of deposits.
Shareholders’ equity increased by $1.2 million, or 5.8%, to $21.8 million at September 30, 2007 as compared to $20.6 million at December 31, 2006. The increase in shareholders’ equity was primarily the result of $1.7 million of additional retained earnings from net income for the nine months ended September 30, 2007, which was partially offset by dividends paid of $248,000 and a decrease of $220,000 in accumulated other comprehensive loss, net of tax.
Comparison of Operating Results for the Three Months Ended September 30, 2007 and 2006
General.The Company’s net income decreased $214,000 to $358,000 for the three months ended September 30, 2007, from $572,000 for the three months ended September 30, 2006. This represents a 36.6% decrease in diluted earnings per share to $0.26 per share for the three months ended September 30, 2007 from $0.41 per share for the three months ended September 30, 2006.
Net interest income.The following table summarizes interest and dividend income and interest expense for the three months ended September 30, 2007 and 2006.
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Three months ended September 30, | |||||||||||||
2007 | 2006 | $ change | % change | ||||||||||
(Dollars in thousands) | |||||||||||||
Interest and dividend income: | |||||||||||||
Interest and fees on loans | $ | 3,855 | $ | 3,708 | $ | 147 | 3.96 | % | |||||
Securities: | |||||||||||||
Taxable | 324 | 167 | 157 | 94.01 | |||||||||
Exempt from federal tax | 160 | 155 | 5 | 3.23 | |||||||||
Federal funds sold | 4 | — | 4 | — | |||||||||
Federal Home Loan Bank dividends and other | 61 | 65 | (4 | ) | (6.15 | ) | |||||||
Total interest and dividend income | 4,404 | 4,095 | 309 | 7.55 | |||||||||
Interest expense: | |||||||||||||
Deposits | 1,793 | 1,399 | 394 | 28.16 | |||||||||
Federal funds purchased | 12 | 18 | (6 | ) | (33.33 | ) | |||||||
Federal Home Loan Bank advances | 216 | 132 | 84 | 63.64 | |||||||||
Subordinated debentures | 62 | 82 | (20 | ) | (24.39 | ) | |||||||
Total interest expense | 2,083 | 1,631 | 452 | 27.71 | |||||||||
Net interest income | $ | 2,321 | $ | 2,464 | $ | (143 | ) | (5.80 | ) | ||||
The following table summarizes average balances and annualized average yield or cost for the three months ended September 30, 2007 and 2006.
Three months ended September 30, | ||||||||||||||||
2007 | 2006 | |||||||||||||||
Average Balance | Interest | Average Cost | Average Balance | Interest | Average Yield/ Cost | |||||||||||
(Dollars in thousands) | ||||||||||||||||
Interest-earning assets: | ||||||||||||||||
Federal funds sold | $ | 283 | 3 | 4.86 | % | $ | — | — | — | % | ||||||
Taxable securities | 25,129 | 324 | 5.12 | 17,521 | 167 | 3.77 | ||||||||||
Tax-exempt securities | 14,968 | 160 | 4.25 | 14,455 | 155 | 4.26 | ||||||||||
Loan receivables, net | 209,193 | 3,855 | 7.31 | 200,202 | 3,708 | 7.35 | ||||||||||
Interest-bearing deposits | 1,624 | 22 | 5.29 | 522 | 7 | 5.20 | ||||||||||
FHLB stock | 5,398 | 39 | 2.86 | 7,073 | 59 | 3.31 | ||||||||||
Total interest-earning assets | 256,596 | 4,404 | 6.81 | 239,773 | 4,095 | 6.78 | ||||||||||
Interest-bearing liabilities: | ||||||||||||||||
NOW accounts | 33,742 | 60 | 0.70 | 36,394 | 51 | 0.55 | ||||||||||
Regular savings | 26,124 | 47 | 0.72 | 30,264 | 57 | 0.75 | ||||||||||
Money market accounts | 44,196 | 361 | 3.24 | 41,382 | 247 | 2.36 | ||||||||||
Certificates of deposit | 105,502 | 1,325 | 4.98 | 90,276 | 1,045 | 4.59 | ||||||||||
FHLB advances | 16,522 | 216 | 5.18 | 10,500 | 132 | 4.98 | ||||||||||
Federal funds purchased | 917 | 12 | 5.39 | 1,228 | 17 | 5.64 | ||||||||||
Subordinated debentures | 3,609 | 62 | 6.79 | 3,609 | 82 | 9.03 | ||||||||||
Total interest-bearing deposits | $ | 230,612 | 2,083 | 3.58 | $ | 213,653 | 1,631 | 3.03 | ||||||||
Net interest income | 2,321 | 2,464 | ||||||||||||||
Net interest spread | 3.23 | % | 3.75 | % | ||||||||||||
Net interest income to average interest-earning assets | 3.59 | % | 4.08 | % | ||||||||||||
Interest Income. Interest income increased $309,000, or 7.5%, to $4.4 million for the three months ended September 30, 2007, compared to $4.1 million in the same period in 2006. This increase resulted primarily from an increase in average interest-earning assets and a slight increase in average yield. The largest component was an
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increase of $157,000 in interest income from taxable securities for the three months ended September 30, 2007 compared to the comparable prior year period. This resulted from a combination of an increase in average balance of $7.6 million and an increase in average yield of 135 basis points to 5.12% for the three months ended September 30, 2007 from 3.77% for the comparable prior year period. The increases are directly related to the purchase of higher yielding securities.
Loan interest income increased $147,000, or 4.0%, to $3.9 million for the three months ended September 30, 2007, compared to $3.7 million for the comparable prior year period. This increase resulted from an increase in the average balance of $9.0 million to $209.2 million for the three months ended September 30, 2007 from $200.2 million for the comparable prior year period. The increase was partially offset by a decrease in average yield of 4 basis points to 7.31% for the three months ended September 30, 2007 from 7.35% for the comparable prior year period.
Interest Expense.Interest expense increased by $452,000, or 27.7%, to $2.1 million for the three months ended September 30, 2007, from $1.6 million for the three months ended September 30, 2006. This increase resulted from both an increase in the average balance of interest-bearing liabilities and the average rate paid on interest-bearing liabilities. The average balance of deposits increased $11.3 million, or 5.7%, to $209.6 million for the three months ended September 30, 2007 from $198.3 million for the comparable period in 2006. In addition, the average rate paid on deposits increased 69 basis points to 3.49% for the three months ended September 30, 2007 from 2.80% for the comparable prior year period. Interest expense resulting from Federal Home Loan Bank advances increased $84,000. The average rate paid on these borrowings increased 20 basis points to 5.18% for the three months ended September 30, 2007 from 4.98% for the comparable period in 2006. In addition to rising market rates, interest rate expense has been impacted by increased competition as well as a general migration from lower cost deposits to higher cost certificates of deposit.
Net Interest Income before Provision for Loan Losses.Net interest income before provision for loan losses decreased $143,000, or 5.8%, to $2.3 million for the three months ended September 30, 2007 from $2.5 million for the comparable period in 2006. Due to the increase in interest expense, the Company’s net interest margin expressed as a percentage of average earning assets fell to 3.59% for the three months ended September 30, 2007 as compared to 4.08% a year earlier. The yield on average earning assets increased to 6.81% for the three months ended September 30, 2007 from 6.78% for the period ended September 30, 2006, a 3 basis point increase. This increase in yield on earning assets was partially due to an increase in higher yielding taxable securities. The increase in yield on earning assets was offset by an increase in the cost of interest-bearing liabilities during the quarter which totaled 3.58% for the three months ended September 30, 2007. This represents an increase of 55 basis points from 3.03% for the corresponding period in 2006. The general shift from NOW and regular savings accounts to more expensive certificates of deposit contributed to the increase in the average cost of interest-bearing liabilities.
Provision for Loan Losses.The Bank’s provision for loan losses decreased to $10,000 for the three months ended September 30, 2007 from $45,000 for the comparable period in 2006. At September 30, 2007, December 31, 2006 and September 30, 2006, non-performing loans totaled $156,000, $669,000 and $308,000, respectively. At September 30, 2007, the ratio of the allowance for loan losses to non-performing loans was 995.7% compared to 231.4% at December 31, 2006 and 557.1% at September 30, 2006, respectively. The ratio of the allowance to total loans was 0.73%, 0.77% and 0.86%, at September 30, 2007, December 31, 2006 and September 30, 2006, respectively. As of the end of the third quarter nonaccrual loans decreased from $107,000 at September 30, 2006 to $27,000 at September 30, 2007, which is basically unchanged from December 31, 2006 and continue to remain a small percentage of total loans.
The amounts of the provision and allowance for loan losses are influenced by a number of factors, including 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. Even though there have been various signs of continued strength in the economy, it is not certain that this strength will be sustainable. Should the economic climate begin to deteriorate, borrowers may 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 is
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adequate at September 30, 2007. However, there can be no assurance that the allowance for loan losses will be adequate to cover all losses. The FDIC examines the Bank periodically and, accordingly, as part of this examination, the allowance is reviewed utilizing specific guidelines. Based upon their review, the regulators may from time to time require reserves in addition to those previously provided.
Three months ended September 30, | ||||||||||||
2007 | 2006 | $ change | % change | |||||||||
(Dollars in thousands) | ||||||||||||
Non-interest income: | ||||||||||||
Service charges on deposit accounts | $ | 143 | $ | 135 | $ | 8 | 5.93 | % | ||||
Mortgage origination fees | 67 | 23 | 44 | 191.30 | ||||||||
Gain on sale of securities | 13 | — | 13 | — | ||||||||
Other non-interest income | 154 | 142 | 12 | 8.45 | ||||||||
Total non-interest income | $ | 377 | $ | 300 | $ | 77 | 25.67 | |||||
Noninterest Income.Noninterest income totaled $377,000 and $300,000 for the three months ended September 30, 2007 and 2006, respectively. Mortgage origination fees increased $44,000 to $67,000 for the three months ended September 30, 2007 from $23,000 for the comparable prior year period. This increase is due to a greater emphasis placed on this area which included an expansion of the mortgage department. In addition, service charges on deposit accounts increased $8,000 to $143,000 for the three months ended September 30, 2007 from $135,000 for the comparable prior year period. This increase is partially due to an increase in the number of deposit accounts.
Three months ended September 30, | ||||||||||||
2007 | 2006 | $ change | % change | |||||||||
(Dollars in thousands) | ||||||||||||
Non-interest expenses: | ||||||||||||
Salaries and employee benefits | $ | 1,223 | $ | 1,101 | $ | 122 | 11.08 | % | ||||
Net occupancy and equipment expense | 264 | 230 | 34 | 14.78 | ||||||||
Data processing expense | 172 | 151 | 21 | 13.91 | ||||||||
Advertising and promotions | 118 | 101 | 17 | 16.83 | ||||||||
Professional fees | 121 | 65 | 56 | 86.15 | ||||||||
Other operating expenses | 334 | 258 | 76 | 29.46 | ||||||||
Total non-interest expenses | $ | 2,232 | $ | 1,906 | $ | 326 | 17.10 | |||||
Noninterest Expense.Noninterest expense increased by $326,000, to $2.2 million for the three months ended September 30, 2007 from $1.9 million for the comparable prior year period. Salaries and employee benefits increased by $122,000, or 11.1%, to $1.2 million for the three months ended September 30, 2007 compared to $1.1 million for the three months ended September 30, 2006. This increase is primarily due to a combination of annual salary increases and the addition of staff. The additional staff expenses are partially due to the expansion of the mortgage department. Other operating expenses, including occupancy, data processing, and marketing and advertising, increased by a combined $204,000, or 25.3%, to $1.0 million for the three months ended September 30, 2007 from $805,000 for the prior year period. Of this increase $21,000 is related to data processing, which is partially due to increased costs associated with on-line banking, $17,000 is related to marketing and advertising, due to a higher level of contributions and $34,000 is related to occupancy expenses, which is primarily due to higher real estate taxes. In addition, the Company incurred expenses for the three months ended September 30, 2007 of $46,000 relating to the Company’s self-tender offer, which was announced August 14, 2007. Management continues to emphasize the importance of expense management and control in order to continue to provide expanded banking services to a growing market base.
Income Tax Expense.Income tax expense totaled $98,000 and $241,000 for the three months ended September 30, 2007 and 2006, respectively. The decrease in income tax expense is primarily the result of a decrease in income before income taxes of $357,000 to $456,000 for the three months ended September 30, 2007 compared to $813,000 for the comparable prior year period.
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Comparison of Operating Results for the Nine Months Ended September 30, 2007 and 2006
General.The Company’s net income increased $75,000 to $1.7 million for the nine months ended September 30, 2007, from $1.6 million for the nine months ended September 30, 2006. This represents a 4.3% increase in diluted earnings per share to $1.20 per share for the nine months ended September 30, 2007 from $1.15 per share for the nine months ended September 30, 2006.
Net interest income.The following table summarizes interest and dividend income and interest expense for the nine months ended September 30, 2007 and 2006.
Nine months ended September 30, | |||||||||||||
2007 | 2006 | $ change | % change | ||||||||||
(Dollars in thousands) | |||||||||||||
Interest and dividend income: | |||||||||||||
Interest and fees on loans | $ | 11,263 | $ | 10,757 | $ | 506 | 4.70 | % | |||||
Securities: | |||||||||||||
Taxable | 904 | 545 | 359 | 65.87 | |||||||||
Exempt from federal tax | 479 | 463 | 16 | 3.46 | |||||||||
Federal funds sold | 33 | — | 33 | — | |||||||||
Federal Home Loan Bank dividends and other | 232 | 219 | 13 | 5.94 | |||||||||
Total interest and dividend income | 12,911 | 11,984 | 927 | 7.73 | |||||||||
Interest expense: | |||||||||||||
Deposits | 5,127 | 3,980 | 1,147 | 28.82 | |||||||||
Federal funds purchased | 25 | 65 | (40 | ) | (61.54 | ) | |||||||
Federal Home Loan Bank advances | 480 | 358 | 122 | 34.08 | |||||||||
Subordinated debentures | 224 | 231 | (7 | ) | (3.03 | ) | |||||||
Total interest expense | 5,856 | 4,634 | 1,222 | 26.37 | |||||||||
Net interest income | $ | 7,055 | $ | 7,350 | $ | (295 | ) | (4.01 | ) | ||||
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The following table summarizes average balances and annualized average yield or cost for the nine months ended September 30, 2007 and 2006.
Nine months ended September 30, | ||||||||||||||||
2007 | 2006 | |||||||||||||||
Average Balance | Interest | Average Yield/ Cost | Average Balance | Interest | Average Yield/ Cost | |||||||||||
(Dollars in thousands) | ||||||||||||||||
Interest-earning assets: | ||||||||||||||||
Federal funds sold | $ | 841 | 33 | 5.18 | % | $ | — | — | — | % | ||||||
Taxable securities | 23,952 | 904 | 5.05 | 19,881 | 545 | 3.66 | ||||||||||
Tax-exempt securities | 14,750 | 479 | 4.35 | 14,408 | 463 | 4.30 | ||||||||||
Loan receivables, net | 202,211 | 11,263 | 7.45 | 199,268 | 10,757 | 7.22 | ||||||||||
Interest-bearing deposits | 2,702 | 108 | 5.34 | 399 | 15 | 4.91 | ||||||||||
FHLB stock | 5,398 | 124 | 3.07 | 9,349 | 205 | 2.93 | ||||||||||
Total interest-earning assets | 249,854 | 12,911 | 6.91 | 243,305 | 11,985 | 6.59 | ||||||||||
Interest-bearing liabilities: | ||||||||||||||||
NOW accounts | 35,194 | 161 | 0.61 | 36,494 | 154 | 0.56 | ||||||||||
Regular savings | 27,423 | 147 | 0.72 | 31,726 | 173 | 0.73 | ||||||||||
Money market accounts | 40,713 | 913 | 3.00 | 43,947 | 755 | 2.30 | ||||||||||
Certificates of deposit | 104,538 | 3,905 | 4.99 | 88,998 | 2,899 | 4.35 | ||||||||||
FHLB advances | 12,566 | 480 | 5.11 | 10,361 | 358 | 4.62 | ||||||||||
Federal funds purchased | 562 | 25 | 5.95 | 1,637 | 65 | 5.28 | ||||||||||
Subordinated debentures | 3,688 | 224 | 8.13 | 3,609 | 231 | 8.56 | ||||||||||
Total interest-bearing deposits | $ | 224,684 | 5,856 | 3.48 | $ | 216,772 | 4,634 | 2.86 | ||||||||
Net interest income | 7,055 | 7,350 | ||||||||||||||
Net interest spread | 3.43 | % | 3.73 | % | ||||||||||||
Net interest income to average interest-earning assets | 3.77 | % | 4.04 | % | ||||||||||||
Interest Income. Interest income increased $927,000, or 7.7%, to $12.9 million for the nine months ended September 30, 2007, compared to $12.0 million in the same period in 2006. This increase resulted primarily from an increase in average yield and an increase in average interest-earning assets. The largest component was an increase of $506,000 in interest income from loans for the nine months ended September 30, 2007. This resulted primarily from an increase in average yield of 23 basis points to 7.45% for the nine months ended September 30, 2007 from 7.22% for the comparable prior year period. The average balance of loans increased by $2.9 million to $202.2 million for the nine months ended September 30, 2007 from $199.3 million for the comparable prior year period.
Interest income on taxable investment securities increased $359,000 to $904,000 for the nine months ended September 30, 2007, compared to $545,000 for the comparable prior year period. This increase resulted from an increase in average yield and an increase in the average balance of taxable investment securities. The average yield increased 139 basis points to 5.05% for the nine months ended September 30, 2007 from 3.66% for the prior year period. In addition, the average balance of taxable investment securities increased $4.1 million to $24.0 million for the nine months ended September 30, 2007 from $19.9 million for the prior year period.
Interest Expense.Interest expense increased by $1.3 million, or 26.4%, to $5.9 million for the nine months ended September 30, 2007, from $4.6 million for the nine months ended September 30, 2006. This increase resulted from both an increase in the average balance of interest-bearing liabilities and the average rate paid on interest-bearing liabilities. The average balance of deposits increased $6.7 million, or 3.3%, to $207.9 million for the nine months ended September 30, 2007 from $201.2 million for the comparable period in 2006. In addition, the average
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rate paid on deposits increased 66 basis points to 3.30% for the nine months ended September 30, 2007 from 2.64% for the prior year period. Interest expense resulting from Federal Home Loan Bank advances increased $122,000. The average rate paid on these borrowings increased 49 basis points to 5.11% for the nine months ended September 30, 2007 from 4.62% for the comparable period in 2006. In addition to rising rates, interest rate expense has been impacted by increased competition as well as a general migration from lower cost deposits to higher cost certificates of deposit.
Net Interest Income before Provision for Loan Losses.Net interest income before provision for loan losses decreased $295,000, or 4.0%, to $7.1 million for the nine months ended September 30, 2007 from $7.4 million for the comparable period in 2006. Due to the significant increase in interest expense, the Company’s net interest margin expressed as a percentage of average earning assets fell to 3.77% for the nine months ended September 30, 2007 as compared to 4.04% a year earlier. The yield on average earning assets increased to 6.91% for the nine months ended September 30, 2007 from 6.59% for the period ended September 30, 2006, a 32 basis point increase. This increase in yield on earning assets was partially due to an increase in higher yielding loans and taxable securities. The increase in yield on earning assets was offset by an increase in the cost of interest-bearing liabilities during the nine months which totaled 3.48% for the nine months ended September 30, 2007. This represents an increase of 62 basis points from 2.86% for the corresponding period in 2006. The general shift from money market accounts to more expensive certificates of deposit contributed to the increase in the average cost of interest-bearing liabilities.
Provision for Loan Losses.The Bank’s provision for loan losses decreased to $10,000 for the nine months ended September 30, 2007 from $315,000 for the comparable period in 2006. At September 30, 2007, December 31, 2006 and September 30, 2006, non-performing loans totaled $156,000, $669,000 and $308,000, respectively. At September 30, 2007, the ratio of the allowance for loan losses to non-performing loans was 995.7% compared to 231.4% at December 31, 2006 and 557.1% at September 30, 2006, respectively. The ratio of the allowance to total loans was 0.73%, 0.77% and 0.86%, at September 30, 2007, December 31, 2006 and September 30, 2006, respectively. As of the end of the third quarter nonaccrual loans decreased from $107,000 at September 30, 2006 to $27,000 at September 30, 2007, which is basically unchanged from December 31, 2006 and continue to remain a small percentage of total loans.
The amounts of the provision and allowance for loan losses are influenced by a number of factors, including 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. Even though there have been various signs of continued strength in the economy, it is not certain that this strength will be sustainable. Should the economic climate begin to deteriorate, borrowers may 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 is adequate at September 30, 2007. However, there can be no assurance that the allowance for loan losses will be adequate to cover all losses. The FDIC examines the Bank periodically and, accordingly, as part of this examination, the allowance is reviewed utilizing specific guidelines. Based upon their review, the regulators may from time to time require reserves in addition to those previously provided.
Nine months ended September 30, | ||||||||||||
2007 | 2006 | $ change | % change | |||||||||
(Dollars in thousands) | ||||||||||||
Non-interest income: | ||||||||||||
Service charges on deposit accounts | $ | 421 | $ | 372 | $ | 49 | 13.17 | % | ||||
Mortgage origination fees | 274 | 106 | 168 | 158.49 | ||||||||
Gain on sale of securities | 50 | — | 50 | — | ||||||||
Life insurance benefit | 478 | — | 478 | — | ||||||||
Other non-interest income | 456 | 404 | 52 | 12.87 | ||||||||
Total non-interest income | $ | 1,679 | $ | 882 | $ | 797 | 90.36 | |||||
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Noninterest Income.Noninterest income totaled $1.7 million and $882,000 for the nine months ended September 30, 2007 and 2006, respectively. The increase is primarily due to a life insurance death benefit in the amount of $478,000 for the nine months ended September 30, 2007. Mortgage origination fees increased $168,000 to $274,000 for the nine months ended September 30, 2007 from $106,000 for the comparable prior year period. This increase is due to a greater emphasis placed on this area which included an expansion of the mortgage department. Gain on sale of securities totaled $50,000 and $0 for the nine months ended September 30, 2007 and 2006, respectively. In addition, service charges on deposit accounts increased $49,000 to $421,000 for the nine months ended September 30, 2007 from $372,000 for the comparable prior year period. This increase is partially due an increase in the number of deposit accounts.
Nine months ended September 30, | ||||||||||||
2007 | 2006 | $ change | % change | |||||||||
(Dollars in thousands) | ||||||||||||
Non-interest expenses: | ||||||||||||
Salaries and employee benefits | $ | 3,665 | $ | 3,231 | $ | 434 | 13.43 | % | ||||
Net occupancy and equipment expense | 780 | 707 | 73 | 10.32 | ||||||||
Data processing expense | 507 | 425 | 82 | 19.29 | ||||||||
Advertising and promotions | 318 | 267 | 51 | 19.10 | ||||||||
Professional fees | 302 | 242 | 60 | 24.79 | ||||||||
Other operating expenses | 1,113 | 833 | 280 | 33.61 | ||||||||
Total non-interest expenses | $ | 6,685 | $ | 5,705 | $ | 980 | 17.18 | |||||
Noninterest Expense.Noninterest expense increased by $980,000, to $6.7 million for the nine months ended September 30, 2007 from $5.7 million for the comparable prior year period. Salaries and employee benefits increased by $434,000, or 13.4%, to $3.7 million for the nine months ended September 30, 2007 compared to $3.2 million for the nine months ended September 30, 2006. This increase is primarily due to a combination of annual salary increases and the addition of staff. The additional staff expenses are partially due to the expansion of the mortgage department. Other operating expenses, including occupancy, data processing, and marketing and advertising increased by a combined $546,000, or 22.1%, to $3.0 million for the nine months ended September 30, 2007 from $2.5 million for the prior year period. Of this increase $82,000 is related to data processing due to a higher level of information technology services, $51,000 is related to marketing and advertising due to an increase in contributions, and $73,000 is related to occupancy expenses, which is primarily due to higher real estate taxes. In addition, as a result of the Company redeeming the trust preferred securities issued by, Community Financial Shares Statutory Trust I, the unamortized costs totaling approximately $80,000 was expensed in the current period. The Company also incurred expenses for the nine months ended September 30, 2007 of $46,000 relating to the self-tender offer to purchase shares, which was announced August 14, 2007. Management continues to emphasize the importance of expense management and control in order to continue to provide expanded banking services to a growing market base.
Income Tax Expense.Income tax expense totaled $383,000 and $631,000 for the nine months ended September 30, 2007 and 2006, respectively. The decrease in income tax expense is partially the result of a decrease in income before income taxes of $173,000 to $2.0 million for the nine months ended September 30, 2007 compared to $2.2 million for the comparable prior year period. The decrease in income tax expense is also the result of the $478,000 life insurance benefit received in the first quarter of 2007, which is exempt from taxes.
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 consolidated financial statements in the Company’s Form 10-K for the year ended December 31, 2006. 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.
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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 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.
Accounting Matters
In September 2006, the FASB issued SFAS No. 157,Fair Value Measurements. SFAS No. 157 defines fair value, establishes a framework for measuring fair value in generally accepted accounting standards, and expands disclosures about fair value measurements. SFAS No. 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. The Company is currently determining the impact that the adoption of SFAS No. 157 will have on our financial condition or results of operations.
On February 15, 2007, the FASB issued its Statement No. 159,The Fair Value Option for Financial Assets and Financial Liabilities—Including an Amendment of FASB Statement No. 115. FAS 159 permits entities to elect to report most financial assets and liabilities at their fair value with changes in fair value included in net income. The fair value option may be applied on an instrument-by-instrument or instrument class-by-class basis. The option is not available for deposits withdrawable on demand, pension plan assets and obligations, leases, instruments classified as stockholders’ equity, investments in consolidated subsidiaries and variable interest entities and certain insurance policies. The new standard is effective at the beginning of the Company’s fiscal year beginning January 1, 2008, and early application may be elected in certain circumstances. The Company expects to first apply the new standard at the beginning of its 2008 fiscal year. The Company does not expect that the adoption of SFAS No. 159 will have a material impact on financial condition or results of operations.
Liquidity and Capital Resources
The Company’s primary sources of funds are deposits, FHLB advances, 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.
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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. 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.
Contractual Obligations
The following table discloses contractual obligations of the Company as of September 30, 2007:
(Dollars in Thousands) | 2007 | 2008 | 2009 | 2010 | 2011 | 2012 and after | Total | ||||||||||||||
Federal Home Loan Bank advances | $ | 6,500 | $ | 7,000 | $ | 4,000 | — | — | — | $ | 17,500 | ||||||||||
Subordinated debentures | — | — | — | — | — | 3,609 | 3,609 | ||||||||||||||
Branch construction costs | 500 | — | — | — | — | — | 500 | ||||||||||||||
Data Processing (1), (2) | 126 | 523 | 541 | 561 | 581 | 601 | 2,933 | ||||||||||||||
Total | $ | 7,126 | $ | 7,523 | $ | 4,541 | $ | 561 | $ | 581 | $ | 4,210 | $ | 24,542 | |||||||
(1) | Estimated contract amount based on transaction volume. Actual expense was $444,000 and $500,000 in 2006 and 2005 respectively. |
(2) | Contract expires September 30, 2012. |
Off-Balance Sheet Arrangements
In the normal course of operations, we engage in a variety of financial transactions that, in accordance with U.S. generally accepted accounting principles, are not recorded in our financial statements. These transactions involve, to varying degrees, elements of credit, interest rate and liquidity risk. Such transactions are used primarily to manage customers’ requests for funding and take the form of loan commitments, letters of credit and lines of credit. For information about our loan commitments and unused lines of credit, see Note 15 of the notes to the consolidated financial statements included in our Annual Report on Form 10-K for the year ended December 31, 2006, as filed with the SEC. We currently have no plans to engage in hedging activities in the future. For the year ended December 31, 2006 and for the nine months ended September 30, 2007, we engaged in no off-balance sheet transactions reasonably likely to have a material effect on our financial condition, results of operations or cash flows.
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. Factors which could have a material adverse effect on the operations and future prospects of the Company and its subsidiaries include, but are not limited to, the following:
• | The strength of the United States economy in general and the strength of the local economies in which the Company conducts its operations which may be less favorable than expected and may result in, among other things, a deterioration in the credit quality and value of the Company’s assets. |
• | The economic impact of past and any future terrorist attacks, acts of war or threats thereof and the response of the United States to any such threats and attacks. |
• | The effects of, and changes in, federal, state and local laws, regulations and policies affecting banking, securities, insurance and monetary and financial matters. |
• | The effects of changes in interest rates (including the effects of changes in the rate of prepayments of the Company’s assets) and the policies of the Board of Governors of the Federal Reserve System. |
• | The ability of the Company to compete with other financial institutions as effectively as the Company currently intends due to increases in competitive pressures in the financial services sector. |
• | The inability of the Company to obtain new customers and to retain existing customers. |
• | The timely development and acceptance of products and services, including products and services offered through alternative delivery channels such as the Internet. |
• | Technological changes implemented by the Company and by other parties, including third party vendors, which may be more difficult or more expensive than anticipated or which may have unforeseen consequences to the Company and its customers. |
• | The ability of the Company to develop and maintain secure and reliable electronic systems. |
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Safe Harbor Statement(Continued)
• | The ability of the Company to retain key executives and employees and the difficulty that the Company may experience in replacing key executives and employees in an effective manner. |
• | Consumer spending and saving habits which may change in a manner that affects the Company’s business adversely. |
• | Business combinations and the integration of acquired businesses which may be more difficult or expensive than expected. |
• | The costs, effects and outcomes of existing or future litigation. |
• | Changes in accounting policies and practices, as may be adopted by state and federal regulatory agencies and the Financial Accounting Standards Board. |
• | The ability of the Company to manage the risks associated with the foregoing as well as anticipated. |
These risks and uncertainties should be considered in evaluating forward-looking statements and undue reliance should not be placed on such statements. Additional information concerning the Company and its business, including other factors that could materially affect the Company’s financial results, is included in the Company’s filings with the Securities and Exchange Commission.
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ITEM 3: | QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK |
Interest Rate Risk
The Company monitors and manages risks associated with changes in interest rates and mismatched asset and deposit maturities. Significant changes in rates can adversely affect net interest income, market value of securities, and the economic value of equity. Based on the Company’s current simulation model, the following schedule indicates the estimated effects of an immediate upward rate shift of 100, 200 and 300 basis points as of September 30, 2007:
100 Basis Point Rate Shift Up | 200 Basis Point Rate Shift Up | 300 Basis Point Rate Shift Up | |||||||
Net interest income | +4.3 | % | +8.6 | % | +12.9 | % | |||
Market value of securities | -5.4 | % | -10.3 | % | -14.7 | % |
Based on the Company’s current simulation model, the following schedule indicates the estimated effects of an immediate downward rate shift of 100, 200 and 300 basis points as of September 30, 2007:
100 Basis Point Rate Shift Down | 200 Basis Point Rate Shift Down | 300 Basis Point Rate Shift Down | |||||||
Net interest income | -1.6 | % | -5.1 | % | -9.1 | % | |||
Market value of securities | +5.4 | % | +11.3 | % | +17.8 | % |
All measures of interest rate risk are within policy guidelines.
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ITEM 4: | CONTROLS AND PROCEDURES |
Evaluation of Disclosure Controls and Procedures
An evaluation was performed under the supervision and with the participation of the Company’s management, including the Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures (as defined in Rule 13a-15(e) promulgated under the Securities and Exchange Act of 1934, as amended) as of September 30, 2007. Based on that evaluation, the Company’s management, including the Chief Executive Officer and Chief Financial Officer, concluded that the Company’s disclosure controls and procedures were effective. There have been no significant changes in the Company’s internal controls or in other factors that could significantly affect internal controls.
Changes in Internal Control
There have been no changes in the Company’s internal controls over financial reporting during the Company’s last fiscal quarter ending September 30, 2007, that have affected or are reasonably likely to affect, the Company’s internal controls over financial reporting.
Company management has always understood and accepted responsibility for our financial statements and related disclosures and the effectiveness of internal control over financial reporting (“internal control”). Just as we do throughout all aspects of our business, we continuously strive to identify opportunities to enhance the effectiveness and efficiency of internal control.
Based on our assessment as of September 30, 2007, we make the following assertion:
• | Management is responsible for establishing and maintaining effective internal control over financial reporting of the Company. The internal control contains monitoring mechanisms, and actions are taken to correct deficiencies identified. |
• | There are inherent limitations in the effectiveness of any internal control, including the possibility of human error and the circumvention or overriding of controls. Accordingly, even effective internal controls can provide only reasonable assurance with respect to financial statement preparation. Further, because of changes in conditions, the effectiveness of internal control may vary over time. |
• | Management evaluated the Company’s internal control over financial reporting as of September 30, 2007. The assessment was based on the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control-Framework. |
Based on this assessment, management believes that the Company maintained effective internal control over financial reporting as of September 30, 2007.
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ITEM 1. | LEGAL PROCEEDINGS |
There are no material pending legal proceedings to which the Company or its subsidiaries are a party other than ordinary routine litigation incidental to their respective businesses.
ITEM 1A. | RISK FACTORS |
There are no material changes to the risk factors disclosed in the Company’s Form 10-K for the year ended December 31, 2006.
ITEM 2. | UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS |
None
ITEM 3. | DEFAULTS UPON SENIOR SECURITIES |
None
ITEM 4. | SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS |
None
ITEM 5. | OTHER INFORMATION |
None
ITEM 6. | EXHIBITS |
31.1 | Certification of Chief Executive Officer Pursuant to Rule 13a-14(a)/15d-14(a) | |
31.2 | Certification of Chief Financial Officer Pursuant to Rule 13a-14(a)/15d-14(a) | |
32.1 | Certification of Chief Executive Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. | |
32.2 | Certification of Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
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Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
COMMUNITY FINANCIAL SHARES, INC. |
(Registrant) |
/s/ Scott W. Hamer |
Scott W. Hamer |
Dated: November 14, 2007 |
President and Chief Executive Officer |
(Principal Executive Officer) |
/s/ Eric J. Wedeen |
Eric J. Wedeen |
Dated: November 14, 2007 |
Chief Financial Officer |
(Principal Financial Officer) |
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