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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20529
FORM 10-Q
þ | Quarterly Report Pursuant to Section 13 or 15(d) of The Securities Exchange Act of 1934 |
For the quarterly period ended September 30, 2005
o | 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 000-32955
LSB Corporation
(Exact name of Registrant as specified in its Charter)
Massachusetts | 04-3557612 | |
(State or other jurisdiction of incorporation or organization) | (I.R.S. Employer Identification Number) | |
30 Massachusetts Avenue, North Andover, MA (Address of principal executive offices) | 01845 (Zip Code) |
(978) 725-7500
(Registrant’s telephone number, including area code)
(Registrant’s telephone number, including area code)
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 report), and (2) has been subject to such filing requirements for the past 90 days.
Yesþ Noo
Indicate by a check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).
Yeso Noþ
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yeso Noþ
Indicate the number of shares outstanding of each of the registrant’s classes of common stock, as of the latest practicable date.
Class | Outstanding as of October 31, 2005 | |
Common Stock, par value $.10 per share | 4,464,033 shares |
LSB CORPORATION AND SUBSIDIARY
INDEX
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PART 1 — FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
LSB CORPORATION AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
September 30, | December 31, | |||||||
2005 | 2004 | |||||||
(In thousands, except share data) | ||||||||
ASSETS | ||||||||
Assets: | ||||||||
Cash and due from banks | $ | 10,269 | $ | 7,193 | ||||
Federal funds sold | 2,883 | 209 | ||||||
Total cash and cash equivalents | 13,152 | 7,402 | ||||||
Investment securities held to maturity (market value of $218,073 in 2005 and $198,716 in 2004) | 221,569 | 200,264 | ||||||
Investment securities available for sale (amortized cost of $48,845 in 2005 and $63,706 in 2004) | 47,656 | 63,039 | ||||||
Federal Home Loan Bank stock, at cost | 10,097 | 7,887 | ||||||
Loans, net of allowance for loan losses | 229,697 | 228,670 | ||||||
Bank premises and equipment | 3,332 | 3,486 | ||||||
Accrued interest receivable | 2,760 | 2,894 | ||||||
Deferred income tax asset | 3,501 | 3,067 | ||||||
Other assets | 1,544 | 1,768 | ||||||
Total assets | $ | 533,308 | $ | 518,477 | ||||
LIABILITIES AND STOCKHOLDERS’ EQUITY | ||||||||
Liabilities: | ||||||||
Interest bearing deposits | $ | 288,513 | $ | 284,309 | ||||
Non-interest bearing deposits | 19,963 | 14,797 | ||||||
Federal Home Loan Bank advances | 121,899 | 105,102 | ||||||
Other borrowed funds | 36,000 | 49,000 | ||||||
Securities sold under agreements to repurchase | 3,847 | 3,161 | ||||||
Advance payments by borrowers for taxes and insurance | 628 | 506 | ||||||
Other liabilities | 3,592 | 3,764 | ||||||
Total liabilities | 474,442 | 460,639 | ||||||
Stockholders’ equity: | ||||||||
Preferred stock, $.10 par value per share: | ||||||||
5,000,000 shares authorized, none issued | — | — | ||||||
Common stock, $.10 par value per share; | ||||||||
20,000,000 shares authorized; | ||||||||
4,683,333 and 4,556,742 shares issued at September 30, 2005 and December 31, 2004, respectively, and 4,464,033 and 4,337,442 shares outstanding at September 30, 2005 and December 31, 2004, respectively | 468 | 456 | ||||||
Additional paid-in capital | 59,856 | 59,145 | ||||||
Retained earnings | 2,004 | 1,389 | ||||||
Treasury stock, at cost (219,300 shares) | (2,758 | ) | (2,758 | ) | ||||
Accumulated other comprehensive loss | (704 | ) | (394 | ) | ||||
Total stockholders’ equity | 58,866 | 57,838 | ||||||
Total liabilities and stockholders’ equity | $ | 533,308 | $ | 518,477 | ||||
The accompanying notes are an integral part of these unaudited Consolidated Financial Statements.
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LSB CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED)
Three months ended | Nine months ended | |||||||||||||||
September 30, | September 30, | |||||||||||||||
2005 | 2004 | 2005 | 2004 | |||||||||||||
(In Thousands, Except Share Data) | ||||||||||||||||
Interest and dividend income: | ||||||||||||||||
Loans | $ | 3,789 | $ | 3,242 | $ | 11,066 | $ | 9,797 | ||||||||
Investment securities held to maturity | 2,078 | 1,680 | 6,136 | 5,058 | ||||||||||||
Investment securities available for sale | 465 | 489 | 1,505 | 1,375 | ||||||||||||
Federal Home Loan Bank stock | 108 | 69 | 299 | 141 | ||||||||||||
Other interest and dividend income | 27 | 8 | 65 | 20 | ||||||||||||
Total interest and dividend income | 6,467 | 5,488 | 19,071 | 16,391 | ||||||||||||
Interest expense: | ||||||||||||||||
Deposits | 1,339 | 964 | 3,595 | 2,662 | ||||||||||||
Federal Home Loan Bank advances | 1,249 | 1,025 | 3,644 | 3,187 | ||||||||||||
Other borrowed funds | 411 | 103 | 1,257 | 351 | ||||||||||||
Securities sold under agreements to repurchase | 13 | 4 | 35 | 10 | ||||||||||||
Total interest expense | 3,012 | 2,096 | 8,531 | 6,210 | ||||||||||||
Net interest income | 3,455 | 3,392 | 10,540 | 10,181 | ||||||||||||
Provision (credit) for loan losses | — | — | — | (300 | ) | |||||||||||
Net interest income after provision (credit) for loan losses | 3,455 | 3,392 | 10,540 | 10,481 | ||||||||||||
Non-interest income: | ||||||||||||||||
Loan servicing fees | 33 | 19 | 109 | 162 | ||||||||||||
Deposit account fees | 220 | 236 | 639 | 668 | ||||||||||||
Gains (losses) on sales of mortgage loans, net | 13 | (5 | ) | 35 | 64 | |||||||||||
Lawsuit judgment collected | — | — | — | 2,275 | ||||||||||||
Other income | 115 | 98 | 350 | 281 | ||||||||||||
Total non-interest income | 381 | 348 | 1,133 | 3,450 | ||||||||||||
Non-interest expense: | ||||||||||||||||
Salaries and employee benefits | 1,524 | 1,655 | 4,708 | 4,904 | ||||||||||||
Occupancy and equipment expenses | 229 | 219 | 708 | 658 | ||||||||||||
Professional expenses | 111 | 141 | 407 | 472 | ||||||||||||
Data processing expenses | 230 | 237 | 668 | 670 | ||||||||||||
Other expenses | 413 | 454 | 1,357 | 1,261 | ||||||||||||
Total non-interest expenses | 2,507 | 2,706 | 7,848 | 7,965 | ||||||||||||
Income before income tax expense | 1,329 | 1,034 | 3,825 | 5,966 | ||||||||||||
Income tax expense | 472 | 337 | 1,351 | 2,126 | ||||||||||||
Net income | $ | 857 | $ | 697 | $ | 2,474 | $ | 3,840 | ||||||||
Average shares outstanding | 4,455,652 | 4,312,649 | 4,415,223 | 4,293,362 | ||||||||||||
Common stock equivalents | 76,434 | 169,426 | 108,213 | 159,041 | ||||||||||||
Average diluted shares outstanding | 4,532,086 | 4,482,075 | 4,523,436 | 4,452,403 | ||||||||||||
Basic earnings per share | $ | 0.19 | $ | 0.16 | $ | 0.56 | $ | 0.89 | ||||||||
Diluted earnings per share | $ | 0.19 | $ | 0.16 | $ | 0.55 | $ | 0.86 | ||||||||
The accompanying notes are an integral part of these unaudited Consolidated Financial Statements
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LSB CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2005 AND 2004
(UNAUDITED)
(Accumulated | Accumulated | |||||||||||||||||||||||
Additional | Deficit)/ | Other | Total | |||||||||||||||||||||
Common | Paid-In | Retained | Treasury | Comprehensive | Stockholders’ | |||||||||||||||||||
Stock | Capital | Earnings | Stock | Income(Loss) | Equity | |||||||||||||||||||
(In thousands, except per share data) | ||||||||||||||||||||||||
Balance at December 31, 2003 | $ | 445 | $ | 58,350 | $ | (1,055 | ) | $ | (2,758 | ) | $ | 20 | $ | 55,002 | ||||||||||
Net income | — | — | 3,840 | — | — | 3,840 | ||||||||||||||||||
Other comprehensive income: | ||||||||||||||||||||||||
Unrealized loss on securities available for sale (tax effect $81) | — | — | — | — | (124 | ) | (124 | ) | ||||||||||||||||
Total comprehensive income | 3,716 | |||||||||||||||||||||||
Exercise of stock options | 9 | 443 | — | — | — | 452 | ||||||||||||||||||
Dividends declared and paid ($0.39 per share) | — | — | (1,673 | ) | — | — | (1,673 | ) | ||||||||||||||||
Balance at September 30, 2004 | $ | 454 | $ | 58,793 | $ | 1,112 | $ | (2,758 | ) | $ | (104 | ) | $ | 57,497 | ||||||||||
Accumulated | ||||||||||||||||||||||||
Additional | Other | Total | ||||||||||||||||||||||
Common | Paid-In | Retained | Treasury | Comprehensive | Stockholders’ | |||||||||||||||||||
Stock | Capital | Earnings | Stock | Loss | Equity | |||||||||||||||||||
(In thousands, except per share data) | ||||||||||||||||||||||||
Balance at December 31, 2004 | $ | 456 | $ | 59,145 | $ | 1,389 | $ | (2,758 | ) | $ | (394 | ) | $ | 57,838 | ||||||||||
Net income | — | — | 2,474 | — | — | 2,474 | ||||||||||||||||||
Other comprehensive income: | ||||||||||||||||||||||||
Unrealized loss on securities available for sale (tax effect $212) | — | — | — | — | (310 | ) | (310 | ) | ||||||||||||||||
Total comprehensive income | 2,164 | |||||||||||||||||||||||
Exercise of stock options | 12 | 500 | — | — | — | 512 | ||||||||||||||||||
Tax benefit of stock options exercised | — | 211 | — | — | — | 211 | ||||||||||||||||||
Dividends declared and paid ($0.42 per share) | — | — | (1,859 | ) | — | — | (1,859 | ) | ||||||||||||||||
Balance at September 30, 2005 | $ | 468 | $ | 59,856 | $ | 2,004 | $ | (2,758 | ) | $ | (704 | ) | $ | 58,866 | ||||||||||
The accompanying notes are an integral part of these unaudited Consolidated Financial Statements.
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LSB CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
Nine months ended | ||||||||
September 30, | ||||||||
2005 | 2004 | |||||||
(In thousands) | ||||||||
Cash flows from operating activities: | ||||||||
Net income | $ | 2,474 | $ | 3,840 | ||||
Adjustments to reconcile net income to net cash provided by operating activities: | ||||||||
Credit for loan losses | — | (300 | ) | |||||
Gains on sales of mortgage loans | (35 | ) | (64 | ) | ||||
Net amortization of investment securities | 1,123 | 1,276 | ||||||
Depreciation of premises and equipment | 330 | 318 | ||||||
Loans originated for sale | (3,437 | ) | (3,596 | ) | ||||
Proceeds from sales of mortgage loans | 3,322 | 3,998 | ||||||
Decrease (increase) in accrued interest receivable | 134 | (344 | ) | |||||
(Increase) decrease in deferred income tax asset | (222 | ) | 844 | |||||
Decrease in other assets | 224 | 188 | ||||||
Increase in advance payments by borrowers | 122 | 168 | ||||||
Increase (decrease) in other liabilities | 39 | (1,115 | ) | |||||
Net cash provided by operating activities | 4,074 | 5,213 | ||||||
Cash flows from investing activities: | ||||||||
Proceeds from maturities of investment securities held to maturity | 47,970 | 14,800 | ||||||
Proceeds from maturities of investment securities available for sale | 25,000 | 14,585 | ||||||
Purchases of investment securities held to maturity | (65,952 | ) | (47,353 | ) | ||||
Purchases of mortgage-backed securities held to maturity | (23,971 | ) | — | |||||
Purchases of investment securities available for sale | (14,198 | ) | (30,102 | ) | ||||
Purchase of other equity securities available for sale | (72 | ) | — | |||||
Purchases of Federal Home Loan Bank stock | (2,210 | ) | (1,101 | ) | ||||
Principal payments of securities held to maturity | 19,697 | 15,148 | ||||||
Principal payments of securities available for sale | 3,959 | 3,477 | ||||||
Increase in loans, net | (877 | ) | (5,284 | ) | ||||
Purchases of Bank premises and equipment | (176 | ) | (992 | ) | ||||
Net cash used in investing activities | (10,830 | ) | (36,822 | ) | ||||
Cash flows from financing activities: | ||||||||
Net increase in deposits | 9,370 | 29,141 | ||||||
Additions to Federal Home Loan Bank advances | 48,900 | 38,345 | ||||||
Payments on Federal Home Loan Bank advances | (32,103 | ) | (15,079 | ) | ||||
Net increase in agreements to repurchase securities | 686 | 1,176 | ||||||
Net decrease in other borrowed funds | (13,000 | ) | (20,250 | ) | ||||
Dividends paid | (1,859 | ) | (1,673 | ) | ||||
Proceeds from exercise of stock options | 512 | 452 | ||||||
Net cash provided by financing activities | 12,506 | 32,112 | ||||||
Net increase in cash and cash equivalents | 5,750 | 503 | ||||||
Cash and cash equivalents, beginning of period | 7,402 | 8,761 | ||||||
Cash and cash equivalents, end of period | $ | 13,152 | $ | 9,264 | ||||
Cash paid during the period for: | ||||||||
Interest on deposits | $ | 3,601 | $ | 2,660 | ||||
Interest on borrowed funds | 4,918 | 3,551 | ||||||
Income taxes | 1,810 | 2,451 | ||||||
Cash received during the period for: | ||||||||
Income taxes | 215 | — | ||||||
Supplemental schedule of non-cash activities: | ||||||||
Net change in valuation of investment securities available for sale | (522 | ) | (205 | ) | ||||
Tax benefit relating to stock options exercised | 211 | — | ||||||
The accompanying notes are an integral part of these unaudited Consolidated Financial Statements.
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LSB CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2005
(UNAUDITED)
1. BASIS OF PRESENTATION
LSB Corporation (the “Corporation” or the “Company”) is a Massachusetts corporation and the holding company of its wholly-owned subsidiary Lawrence Savings Bank (the “Bank”) a state-chartered Massachusetts savings bank. The Corporation was organized by the Bank on July 1, 2001 to be a bank holding company and to acquire all of the capital stock of the Bank.
The Corporation is supervised by the Board of Governors of the Federal Reserve System (“FRB”), and it is also subject to the jurisdiction of the Massachusetts Division of Banks, while the Bank is subject to the regulations of, and periodic examination by, the Federal Deposit Insurance Corporation (“FDIC”) and the Massachusetts Division of Banks. The Bank’s deposits are insured by the Bank Insurance Fund of the FDIC up to $100,000 per account, as defined by the FDIC, and the Depositors Insurance Fund (“DIF”) for customer deposit amounts in excess of $100,000. The Consolidated Financial Statements include the accounts of LSB Corporation and its wholly-owned consolidated subsidiary, Lawrence Savings Bank, and its wholly-owned subsidiaries, Shawsheen Security Corporation, Shawsheen Security Corporation II, Pemberton Corporation, and Spruce Wood Realty Trust. All inter-company balances and transactions have been eliminated in consolidation. The Company has one reportable operating segment. In the opinion of management, the accompanying Consolidated Financial Statements reflect all necessary adjustments consisting of normal recurring accruals for fair presentation. Certain amounts in prior periods have been re-classified to conform to the current presentation.
The Corporation’s Consolidated Financial Statements have been prepared in conformity with accounting principles generally accepted in the United States of America. Accordingly, management is required to make estimates and assumptions that affect amounts reported in the balance sheets and statements of income. Actual results could differ significantly from those estimates and judgments. Material estimates that are particularly susceptible to change relate to the allowance for loan losses.
The interim results of consolidated income are not necessarily indicative of the results for any future interim period or for the entire year. These interim Consolidated Financial Statements do not include all disclosures associated with annual financial statements and, accordingly, should be read in conjunction with the annual Consolidated Financial Statements and accompanying notes included in the Company’s Annual Report on Form 10-K as of and for the year ended December 31, 2004 filed with the Securities and Exchange Commission.
2. STOCK OPTIONS
The Corporation measures compensation cost for stock-based plans using the intrinsic value method. The intrinsic value method measures compensation cost, if any, as the fair market value of the Company’s stock at the grant date over the exercise price. All options granted have an exercise price equivalent to the fair market value at the date of grant and, accordingly, no compensation cost has been recorded. If the fair value based method of accounting for stock options had been used, the Company’s net income and earnings per share would have been reduced to the pro forma amounts for the three months and nine months ended September 30, are presented in the table which follows:
Three months ended | Nine months ended | |||||||||||||||
9/30/05 | 9/30/04 | 9/30/05 | 9/30/04 | |||||||||||||
(In Thousands, Except Share Data) | ||||||||||||||||
Net income: | ||||||||||||||||
As Reported | $ | 857 | $ | 697 | $ | 2,474 | $ | 3,840 | ||||||||
Less: Pro forma stock based compensation cost (net of taxes) | (31 | ) | (78 | ) | (91 | ) | (286 | ) | ||||||||
Pro forma | $ | 826 | $ | 619 | $ | 2,383 | $ | 3,554 | ||||||||
Basic earnings per share: | ||||||||||||||||
As Reported | $ | 0.19 | $ | 0.16 | $ | 0.56 | $ | 0.89 | ||||||||
Pro forma | 0.19 | 0.14 | 0.54 | 0.83 | ||||||||||||
Diluted earnings per share: | ||||||||||||||||
As Reported | $ | 0.19 | $ | 0.16 | $ | 0.55 | $ | 0.86 | ||||||||
Pro forma | 0.18 | 0.14 | 0.53 | 0.80 |
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The fair value of each option grant is estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted average assumptions used for grants in 2005: expected volatility of 23.8%, expected average life of 4.3 years, risk-free interest rate of 3.8% and expected dividend yield of 3.21%.
3. DEFINED BENEFIT PLAN
The Company provides pension benefits for its employees through membership in the Savings Bank Employees’ Retirement Association (the “Plan”). The Plan is a multiple-employer, non-contributory, defined benefit plan. Bank employees become eligible after attaining 21 years of age and completing one year of service. Additionally, benefits become fully vested after three years of eligible service. The Company’s annual contribution to the Plan is based upon standards established by the Employee Retirement Income Security Act. The contribution is based on an actuarial method intended to provide not only for benefits attributable to service date, but also for those expected to be earned in the future. The Company does not expect to contribute to the Plan for the Plan year ending October 31, 2005.
Net pension cost components for the three months and nine months ended September 30, follow:
Three months ended | Nine months ended | |||||||||||||||
9/30/05 | 9/30/04 | 9/30/05 | 9/30/04 | |||||||||||||
(In Thousands) | ||||||||||||||||
Service cost | $ | 87 | $ | 104 | $ | 260 | $ | 311 | ||||||||
Interest cost | 107 | 106 | 322 | 317 | ||||||||||||
Expected return on plan assets | (136 | ) | (122 | ) | (407 | ) | (364 | ) | ||||||||
Net amortization and deferrals | (1 | ) | (1 | ) | (3 | ) | (3 | ) | ||||||||
Net periodic pension cost | $ | 57 | $ | 87 | $ | 172 | $ | 261 | ||||||||
4. CONTINGENCIES
The Bank is involved in various legal proceedings incidental to its business. After review with legal counsel, management does not believe resolution of such litigation will have a material adverse effect on the financial condition and operating results of the Company.
In one litigation matter, the Bank was awarded a $4.2 million judgment against the debtor in 1997. On February 13, 2002, the debtor filed a petition in bankruptcy under Chapter 7 of the Bankruptcy Code. Post-judgment interest calculated from the date of judgment to the date of the bankruptcy filing is approximately $1.9 million. In the Bankruptcy case, the Company’s wholly owned subsidiary, Lawrence Savings Bank (the ‘Bank”), is the only secured creditor.
On June 15, 2004, the Company reported the receipt of $2.5 million interim distribution in the case on the order of the U.S. Bankruptcy Judge. The $2.5 million distribution was recorded as income by the Bank on June 15, 2004. The Bank has agreed to return any of the interim distribution as may be necessary to pay additional taxes imposed on the bankruptcy estate in the event reserves set aside for expenses and taxes are insufficient.
The Bankruptcy Trustee has sold various assets during 2004 and 2005, and is currently holding approximately $2.2 million in cash (net of various expenses). The distribution date and the amount of the remaining assets held by the Bankruptcy Trustee to the Bank are not known at this time. Accordingly, no recognition of the remaining assets currently held by the Bankruptcy Trustee has been recorded in the Consolidated Financial Statements.
It is management’s opinion that collection of any remaining amounts owed to the Bank beyond the amount of the interim distribution and assets currently held by the Bankruptcy Trustee are uncertain and are not susceptible to meaningful estimation at this time.
5. RECENT ACCOUNTING DEVELOPMENTS
The Financial Accounting Standards Board (“FASB”) Emerging Issues Task Force (“EITF”) Issue 03-1: “The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments.” In November 2003 and March 2004, the FASB’s EITF issued a consensus on EITF Issue 03-1. EITF 03-1 contains new guidance on other-than-temporary impairments of investment securities. The guidance dictates when impairment is deemed to exist, provides guidance on determining if impairment is other than temporary, and directs how to calculate impairment loss. Issue 03-1 also details
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5. RECENT ACCOUNTING DEVELOPMENTS (Continued)
expanded annual disclosure rules. In September 2004, the FASB’s EITF issued EITF Issue No. 03-1-1 “Effective Date of Paragraphs 10-20 of EITF Issue 03-1 The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments”, which delays the effective date for the measurement and recognition guidance contained in paragraphs 10-20 of EITF 03-1 to be concurrent with the final issuance of EITF 03-1-a “Implementation Guidance for the Application of Paragraph 16 of EITF 03-1 The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments”. EITF 03-1-a is currently being debated by the FASB in regards to final guidance and effective date with a comment period that ended October 29, 2004. EITF 03-1, as issued, was originally effective for periods beginning after June 15, 2004 and the disclosure requirements of this issuance remain in effect. The adoption of the original EITF 03-1 (excluding paragraphs 10-20) did not have a material impact on the Company’s financial position or results of operations.
On June 29, 2005, the FASB met and decided not to provide additional guidance on the meaning of other-than-temporary impairment. The FASB will issue the proposed FSP EITF 03-1-a as final and the final FSP will supersede EITF Issue No. 03-1 and EITF Topic No. D-44, “Recognition of Other-Than-Temporary Impairment upon the Planned Sale of a Security Whose Cost Exceeds Fair Value,” and will replace guidance set forth in paragraphs 10-18 of EITF Issue No. 03-1 with references to existing other-than temporary impairment guidance. When issued, the final FSP will be titled, “FSP FAS 115-1 “The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments.” The new FSP will be effective for other-than-temporary impairment analysis conducted in periods beginning after September 15, 2005. The adoption of the original EITF 03-1 (excluding paragraphs 10-20) did not have a material impact on the Company’s financial position or results of operations nor does the Company believe that the adoption of FSP FASB 115-1 will have a material impact on the Company’s financial position or results of operations.
Statement of Position 03-3 (“SOP 03-3”): “Accounting for Certain Loans or Debt Securities Acquired in a Transfer.” In December 2003, the American Institute of Certified Public Accountants (“AICPA”) issued SOP 03-3. SOP 03-3 requires loans acquired through a transfer, such as a business combination, where there are differences in expected cash flows and contractual cash flows due in part to credit quality, be recognized at their fair value. The yield that may be accreted is limited to the excess of the investor’s estimate of undiscounted expected principal, interest and other cash flows over the investor’s initial investment in the loan. The excess of contractual cash flows over expected cash flows is not to be recognized as an adjustment of yield, loss accrual, or valuation allowance. Valuation allowances can not be created nor “carried over” in the initial accounting for loans acquired in a transfer of loans with evidence of deterioration of credit quality since origination. However, valuation allowances for non-impaired loans acquired in a business combination can be carried over. This SOP is effective for loans acquired in fiscal years beginning after December 15, 2004, with early adoption encouraged. The adoption of SOP 03-3 did not have a material impact on the Company’s financial position or results of operations.
SFAS No. 123 (revised 2004) (“SFAS 123R”), “Share-Based Payment.” In December 2004, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards No. 123 (revised 2004). SFAS No. 123R replaces SFAS No. 123 “Accounting for Stock-Based Compensation” and supersedes Accounting Principles Board Opinion No. 25 (“APB 25”), “Accounting for Stock Issued to Employees”. SFAS No. 123R will require that the compensation cost relating to share-based payment transactions be recognized in the Company’s financial statements, eliminating pro forma disclosure as an alternative. That cost will be measured based on the grant-date fair value of the equity or liability instruments issued. SFAS No. 123R was effective for public entities as of the first interim or annual period that begins after June 15, 2005. The impact of the Company adopting such accounting can be seen in Note 2, Stock-Based Compensation, of the Notes to Consolidated Financial Statements. On April 14, 2005 the Securities and Exchange Commission (“SEC”) deferred the effective date for the adoption of SFAS 123R to annual periods that begin after June 15, 2005. Therefore, the Company will adopt SFAS 123R beginning January 1, 2006. The Company is in the process of determining the impact to the financial statements for 2006.
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ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
FORWARD-LOOKING STATEMENTS
In this report, the Company has made forward-looking statements (within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities and Exchange Act of 1934 as amended) that are subject to risks and uncertainties. Forward-looking statements include information concerning possible or assumed future results of operations of the Company, projected or anticipated benefits, or events related to other future developments involving the Company or the industry in which it operates. Also, when verbs in the future or present tense such as “believes,” “expects,” “anticipates,” “continues,” “attempts” or similar expressions are used, forward-looking statements are being made. Stockholders should note that many factors, some of which are discussed elsewhere in this document and in the documents which we incorporate herein by reference, could affect the future financial results of the Company and could cause results to differ materially from those expressed in or incorporated by reference in this document. Those factors include fluctuations in interest rates, disruptions in credit markets, inflation, changes in the regulatory environment, government regulations and changes in regional and local economic conditions and changes in the competitive environment in the geographic and business areas in which the Company conducts its operations. As a result of such risks and uncertainties, the Company’s actual results may differ materially from such forward-looking statements. The Company does not undertake, and specifically disclaims any obligation to publicly release revisions to any such forward-looking statements to reflect the occurrence of anticipated or unanticipated events or circumstances after the date of such statements.
EXECUTIVE LEVEL OVERVIEW
LSB Corporation (the “Corporation” or the “Company”) is a one bank-holding company principally conducting business through Lawrence Savings Bank (the “Bank”). The Corporation became the holding company for the Bank on July 1, 2001 pursuant to a plan of reorganization in which each share of Bank common stock then outstanding (and accompanying preferred stock purchase rights) was converted into and exchanged for one share of the Corporation’s common stock (and accompanying preferred stock purchase rights). The principal source of funds for the Corporation is dividends from its Bank subsidiary. The principal sources of funds for the Bank’s lending and investment activities are deposits, loan payments and prepayments, investment securities payments and maturities, advances from the Federal Home Loan Bank, Federal funds purchased and securities sold under agreements to repurchase.
The Bank was established as a Massachusetts savings bank in 1868; the Bank converted from mutual to stock form on May 9, 1986. The Bank has four wholly-owned subsidiaries at September 30, 2005. Shawsheen Security Corporation and Shawsheen Security Corporation II engage exclusively in buying, selling, dealing in and holding securities for their own accounts. Pemberton Corporation and Spruce Wood Realty Trust, respectively, hold foreclosed real estate and real estate used in the ordinary course of the Bank’s business.
The Corporation is subject to regulation and supervision by the Board of Governors of the Federal Reserve System (“FRB”), and Massachusetts Division of Banks. The Bank is subject to supervision and regulation of, and periodic examination by, the Federal Deposit Insurance Corporation (“FDIC”) and the Massachusetts Division of Banks.
The Bank’s primary market area is the Merrimack Valley in Massachusetts and southern New Hampshire. The Bank has six banking offices in the communities of Andover, Lawrence, Methuen (2), North Andover, Massachusetts and Salem, New Hampshire.
The Company’s financial results are dependent on the following areas of the income statement: net interest income, provision for loan losses, non-interest income, non-interest expense and provision for income taxes. Net interest income is the primary earnings of the Company and the main focus of management. Management’s efforts are to increase the commercial loan portfolios, which include construction, commercial real estate and commercial loans. Management’s efforts for funding are to increase core deposit accounts, which are lower interest bearing accounts. Net interest income is the difference between interest earned on loans and investment securities and interest paid on deposits and borrowings. Deposits and borrowings have short durations and the costs of these funds do not necessarily rise and fall concurrent with earnings from loans and investment securities. There are many risks involved in managing net interest income including, but not limited to credit risk, interest rate risk and duration risk. These risks have a direct impact on the level of net interest income. The Company manages these risks through its internal credit and underwriting function, a credit review by an outside firm and review at meetings of the Asset and Liability Management Committee (“ALCO”) on a regular basis. The credit review process reviews loans for underwriting and grading of loan quality
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while ALCO reviews the liquidity, interest rate risk, duration risk and allocation of capital resources. Loan quality has a direct impact on the amount of provisions for loan losses the Company reports.
During the first quarter 2005, the Bank implemented a $40.0 million leverage program by purchasing investment securities funded by Federal Home Loan Bank advances. This decision was made for the following reasons:
• | To take advantage of profitable investment opportunities. | ||
• | The 2005 Budget process revealed compression of net interest income due to a probable higher funding cost. | ||
• | Adequate capital is available to implement the leverage program. The Equity to Asset ratio was 11.15% and 10.35% at December 31, 2004 and March 31, 2005, respectively. |
Results of the leverage program for the nine months ended September 30, 2005 were:
• | Lower yields on assets even though yields on loans and investment securities increased from first quarter 2005 due to the change in asset mix. | ||
• | Maintained net interest income levels consistent with fourth quarter 2004 and first and second quarters in 2005. | ||
• | Purchased Federal Home Loan Bank stock in connection with and required due to increased advances from Federal Home Loan Bank. |
During the second and third quarters of 2005 the Company paid off approximately $21.0 million and $14 million, respectively, of FHLB advances with cash flows from investment securities maturities not associated with the leverage program due to the recent changes in interest rates.
The provision for loan losses was zero for the nine months ended September 30, 2005 based on management’s assessment of the adequacy of the allowance based on an evaluation of the Bank’s loan portfolio and the level of non-performing loans.
Non-interest income includes various fees. Customers’ loan and deposit accounts generate various amounts of fee income depending on the product selected. The Company generates gains on sales of mortgage loans and receives fee income from servicing loans sold. Non-interest income is primarily impacted by the volume of customer transactions, which could change in response to changes in interest rates, pricing and competition.
Non-interest expenses include salaries and employee benefits, occupancy and equipment, professional, data processing and other expenses of the Company which generally are directly related to business volume and are controlled by a budget process.
Provisions for income taxes are directly related to earnings of the Company. Changes in the statutory tax rates and the earnings of the Company, the Bank and its subsidiaries, would affect the amount of income tax expense reported.
FINANCIAL CONDITION
OVERVIEW
The Company has maintained risk assets below 1% of total assets for the past several years. The Company maintains its commitment to servicing the banking needs of the local community in the Merrimack Valley area of Massachusetts and southern New Hampshire. The Company had total assets of $533.3 million at September 30, 2005 compared to $518.5 million at December 31, 2004. The Bank implemented a $40.0 million leverage program during the quarter ended March 31, 2005. The purchase of mortgage-backed securities (“MBSs”) and collateralized mortgage obligations (“CMOs”) was funded with Federal Home Loan Bank advances. The program was implemented to take advantage of profitable investment opportunities. The financial impact of the program is being monitored closely by management. The increase in asset size at September 30, 2005 from December 31, 2004 is mainly attributable to an increase of $5.9 million in investment securities, an increase of $2.7 million in federal funds sold, $2.2 million in Federal Home Loan Bank stock and $1.0 million in loan growth. The funding for these assets came from an increase in deposits of $9.4 million and borrowed funds of $4.5 million during the first nine months of 2005.
INVESTMENTS
The investment securities portfolio totaled $269.2 million or 50.5% of total assets at September 30, 2005, compared to $263.3 million, or 50.8% of total assets at December 31, 2004, an increase of $5.9 million from year-end. The change in mix in the investment securities portfolio was the result of maturities and calls of U.S. Government Agency
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obligations, maturities and payments on asset-backed securities, payments on MBSs and maturities of corporate obligations. Purchases and reinvested funds were in MBSs, and asset-backed securities (collateralized mortgage obligations “CMO”). The increase in investment securities was directly related to the leverage program implemented in the first quarter of 2005.
The following table reflects the components and carrying values of the investment securities portfolio at September 30, 2005 and December 31, 2004:
9/30/05 | 12/31/04 | |||||||
(In thousands) | ||||||||
Investment securities held to maturity (at amortized cost): | ||||||||
US Government Agency obligations | $ | 87,468 | $ | 104,042 | ||||
Mortgage-backed securities | 46,478 | 31,193 | ||||||
Asset-backed securities | 74,049 | 50,829 | ||||||
Corporate obligations | 12,036 | 12,624 | ||||||
Municipal obligations | 1,538 | 1,576 | ||||||
Total investment securities held to maturity | $ | 221,569 | $ | 200,264 | ||||
Investment securities available for sale (at market value): | ||||||||
US Treasury obligations | $ | 4,894 | $ | 4,845 | ||||
US Government Agency obligations | 9,753 | 34,907 | ||||||
Mortgage-backed securities | 3,640 | 4,582 | ||||||
Asset-backed securities | 25,089 | 14,452 | ||||||
Corporate obligations | 3,086 | 3,120 | ||||||
Mutual Funds | 961 | 972 | ||||||
Equity securities | 233 | 161 | ||||||
Total investment securities available for sale | $ | 47,656 | $ | 63,039 | ||||
Total investment securities portfolio | $ | 269,225 | $ | 263,303 | ||||
LOANS
Total loans increased to $233.8 million or 43.8% of total assets at September 30, 2005 from $232.8 million or 44.9% of total assets at December 31, 2004. The residential mortgage loan balances have increased slightly compared to year-end 2004 as the refinancing activity of existing mortgages and sales into the secondary market have slowed during the first nine months of 2005. Construction loans have increased $6.1 million while commercial real estate loans, commercial loans and consumer loans have decreased $1.7 million, $5.0 million and $188 thousand, respectively, in the first nine months of 2005.
The following table reflects the loan portfolio at September 30, 2005 and December 31, 2004:
9/30/05 | 12/31/04 | |||||||
(In thousands) | ||||||||
Residential mortgage loans | $ | 60,615 | $ | 60,057 | ||||
Loans held for sale | 150 | — | ||||||
Equity loans | 9,931 | 8,869 | ||||||
Construction loans | 21,302 | 15,211 | ||||||
Commercial real estate loans | 129,926 | 131,605 | ||||||
Commercial loans | 11,395 | 16,369 | ||||||
Consumer loans | 511 | 699 | ||||||
Total loans | 233,830 | 232,810 | ||||||
Allowance for loan losses | (4,133 | ) | (4,140 | ) | ||||
Total loans, net | $ | 229,697 | $ | 228,670 | ||||
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ALLOWANCE FOR LOAN LOSSES
The following table summarizes changes in the allowance for loan losses for the three months and nine months ended September 30, 2005 and 2004:
Three months ended | Nine months ended | |||||||||||||||
9/30/05 | 9/30/04 | 9/30/05 | 9/30/04 | |||||||||||||
(In Thousands) | ||||||||||||||||
Beginning balance | $ | 4,135 | $ | 4,168 | $ | 4,140 | $ | 4,220 | ||||||||
Provision (credit) charged to operations | — | — | — | (300 | ) | |||||||||||
Recoveries on loans previously charged-off | 3 | 2 | 8 | 258 | ||||||||||||
Loans charged-off | (5 | ) | (31 | ) | (15 | ) | (39 | ) | ||||||||
Ending balance | $ | 4,133 | $ | 4,139 | $ | 4,133 | $ | 4,139 | ||||||||
In the second quarter of 2004, the Bank recognized $253 thousand of the interim distribution of a legal judgment previously obtained by the Bank as a recovery to the allowance for loan losses on amounts previously charged off. The Bank also recorded a credit provision for loan losses of $300 thousand for the same three month period in 2004. The balance of the allowance for loan losses reflects management’s assessment of losses and is based on a review of the risk characteristics of the loan portfolio. The Company considers many factors in determining the adequacy of the allowance for loan losses. Collateral value on a loan by loan basis, trends of loan delinquencies on a portfolio segment level, risk classification identified in the Company’s regular review of individual loans, and economic conditions are primary factors in establishing allowance levels. Management believes the allowance level is adequate to absorb estimated credit losses associated with the loan portfolio. The allowance for loan losses reflects information available to management at the end of each period.
RISK ASSETS
Risk assets consist of non-performing loans and other real estate owned. Non-performing loans consist of both a) loans 90 days or more past due, and b) loans placed on non-accrual because full collection of the principal balance is in doubt. Other real estate owned (OREO) is comprised of foreclosed properties where the Company has formally received title or has possession of the collateral. Properties are carried at the lower of the investment in the related loan or the estimated fair value of the property or collateral less selling costs. Fair value of such property or collateral is determined based upon independent appraisals and other relevant factors. Management periodically reviews property values and makes adjustments as required. Gains from sales of properties, net operating expenses and any subsequent provisions to increase the allowance for losses on real estate acquired by foreclosure are charged to other real estate owned expenses. Losses are charged to the allowance.
Total risk assets were $33 thousand at September 30, 2005. This represents an increase of $33 thousand from December 31, 2004. The slight increase is attributable to one non-performing loan for $33 thousand at September 30, 2005 from zero at December 31, 2004. The Company had no impaired loans at September 30, 2005, December 31, 2004 and September 30, 2004.
The following table summarizes the Company’s risk assets at September 30, 2005, December 31, 2004 and September 30, 2004:
9/30/05 | 12/31/04 | 9/30/04 | ||||||||||
(Dollars in thousands) | ||||||||||||
Non-performing loans | $ | 33 | $ | — | $ | 247 | ||||||
Other real estate owned | — | — | — | |||||||||
Total risk assets | $ | 33 | $ | — | $ | 247 | ||||||
Risk assets as a percent of total assets | 0.01 | % | 0.00 | % | 0.05 | % | ||||||
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\
The following table shows the allowance for loan losses as a percent of total loans at September 30, 2005, December 31, 2004 and September 30, 2004:
9/30/05 | 12/31/04 | 9/30/04 | ||||||||||
(Dollars in thousands) | ||||||||||||
Allowance for loan losses | $ | 4,133 | $ | 4,140 | $ | 4,139 | ||||||
Allowance for loan losses as a percent of total loans | 1.77 | % | 1.78 | % | 1.91 | % |
The allowance for loan losses has remained consistent at $4.1 million at September 30, 2005, December 31, 2004 and September 30, 2004. However, the allowance for loan losses as a percent of total loans has decreased slightly to 1.77% at September 30, 2005 down from 1.78% at December 31, 2004, due to an increase in total loans outstanding at September 30, 2005 compared to December 31, 2004. The loan portfolio has grown $17.2 million or 7.9% since September 30, 2004, without a significant change in credit risk to the Company.
DEPOSITS
Total interest bearing deposits amounted to $288.5 million at September 30, 2005 compared to $284.3 million at December 31, 2004, an increase of $4.2 million. The change from December 31, 2004 is due primarily to increases in certificates of deposit accounts of $5.3 million and NOW accounts of $1.7 million, partially offset by a decrease in money market investment accounts of $2.3 million.
The following table reflects the components of interest bearing deposits at September 30, 2005 and December 31, 2004:
9/30/05 | 12/31/04 | |||||||
(In thousands) | ||||||||
NOW and Super NOW accounts | $ | 39,718 | $ | 38,061 | ||||
Savings accounts | 43,962 | 44,673 | ||||||
Money market investment accounts | 80,605 | 82,877 | ||||||
Certificates of deposit | 94,918 | 89,649 | ||||||
Retirement accounts | 29,310 | 29,049 | ||||||
Total interest bearing deposits | $ | 288,513 | $ | 284,309 | ||||
BORROWINGS
Borrowings consist of Federal Home Loan Bank advances, other borrowed funds (short term FHLB advances) and securities sold under agreements to repurchase. Total borrowings amounted to $161.7 million at September 30, 2005 compared to $157.3 million at December 31, 2004, an increase of $4.5 million. The overall increase was due to the leverage program entered into by the Company in the first quarter of 2005.
The following table reflects the components of borrowings at September 30, 2005 and December 31, 2004:
9/30/05 | 12/31/04 | |||||||
(In thousands) | ||||||||
Federal Home Loan Bank advances | $ | 121,899 | $ | 105,102 | ||||
Other borrowed funds | 36,000 | 49,000 | ||||||
Securities sold under agreements to repurchase | 3,847 | 3,161 | ||||||
Total borrowings | $ | 161,746 | $ | 157,263 | ||||
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RESULTS OF OPERATIONS
THREE MONTHS ENDED SEPTEMBER 30, 2005 AND 2004
OVERVIEW
The Company reported net income of $857 thousand or $0.19 diluted earnings per share and $697 thousand or $0.16 diluted earnings per share for the three months ended September 30, 2005 and 2004, respectively. Net income rose by $160 thousand or 23.0% for the three months ended September 30, 2005 compared to the same period in 2004. Net interest income increased by $63 thousand or 1.9% to $3.5 million compared to the same period in 2004. Non-interest income decreased by $33 thousand in 2005 compared to 2004. Non-interest expenses decreased by $199 thousand in 2005 from 2004.
NET INTEREST INCOME FROM OPERATIONS
Net interest income for the three months ended September 30, 2005 and 2004 increased by $63 thousand or 1.9% to $3.5 million from $3.4 million, respectively. The net interest rate spread decreased to 2.27% for the three months ended September 30, 2005 versus 2.59% for the same period of 2004. Interest income for the three months ended September 30, 2005 experienced an increase of $875 thousand primarily due to higher average investment security and loan balances from the same period of 2004. Interest expense increased $732 thousand mainly due to higher average balances of deposits and borrowings.
The following table presents the components of net interest income and net interest rate spread for the three months ended September 30, 2005 and 2004:
Income/Expense | Yield/Rate | |||||||||||||||
Three Months Ended | ||||||||||||||||
9/30/05 | 9/30/04 | 9/30/05 | 9/30/04 | |||||||||||||
(Dollars in thousands) | ||||||||||||||||
Interest income and average yield: | ||||||||||||||||
Loans | $ | 3,789 | $ | 3,242 | 6.38 | % | 6.01 | % | ||||||||
Investments, mortgage-backed securities and other earning assets | 2,678 | 2,246 | 3.67 | 3.50 | ||||||||||||
Total | 6,467 | 5,488 | 4.89 | 4.65 | ||||||||||||
Interest expense and average rate paid: | ||||||||||||||||
Deposits | 1,339 | 964 | 1.84 | 1.38 | ||||||||||||
Federal Home Loan Bank advances | 1,249 | 1,025 | 4.18 | 4.16 | ||||||||||||
Securities sold under agreements to repurchase and other borrowed funds | 424 | 107 | 3.39 | 1.40 | ||||||||||||
Total | 3,012 | 2,096 | 2.62 | 2.06 | ||||||||||||
Net interest income | $ | 3,455 | $ | 3,392 | ||||||||||||
Net interest rate spread | 2.27 | % | 2.59 | % | ||||||||||||
Net interest margin | 2.61 | % | 2.87 | % | ||||||||||||
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INTEREST INCOME
Interest income for the three months ended September 30, 2005 was $6.5 million as compared to $5.5 million for the same period of 2004. The increase of $1.0 million in interest income is primarily due to higher average investment security balances and higher average loan balances, which impacted interest income by $875 thousand. Higher yields had a $104 thousand impact on interest income.
Yields on loans were 6.38% and 6.01% for the three months ended September 30, 2005 and 2004, respectively. The contribution to interest income due to higher loan yields was an increase of $65 thousand. Higher average loan balances of $235.6 million versus $214.5 million for the three months ended September 30, 2005 and 2004, respectively, increased interest income by $482 thousand.
The following table lists the components of loan interest income for the three months ended September 30, 2005 and 2004:
Three months ended | ||||||||
9/30/05 | 9/30/04 | |||||||
(In thousands) | ||||||||
Residential mortgage loans | $ | 782 | $ | 779 | ||||
Loans held for sale | 2 | 1 | ||||||
Equity loans | 129 | 117 | ||||||
Construction loans | 396 | 181 | ||||||
Commercial real estate loans | 2,249 | 1,952 | ||||||
Commercial loans | 222 | 201 | ||||||
Consumer loans | 9 | 11 | ||||||
Total loan interest income | $ | 3,789 | $ | 3,242 | ||||
Yields on investment securities were 3.67% and 3.50% for the three months ended September 30, 2005 and 2004, respectively, impacting interest income by $39 thousand. Higher average investment security balances of $289.6 million during the three months ended September 30, 2005 versus $255.0 million for the same period in 2004, increased interest income by $393 thousand.
INTEREST EXPENSE
Interest expense for the three months ended September 30, 2005 totaled $3.0 million, an increase of $916 thousand from the same period of 2004. This increase is due to higher average balances of interest bearing liabilities, which increased interest expense by $732 thousand, and higher rates paid on interest bearing liabilities which increased interest expense by $184 thousand.
Rates on deposits were 1.84% and 1.38% for the three months ended September 30, 2005 and 2004, respectively. This rate increase resulted in interest expense increasing by $101 thousand. Average deposit balances were $288.7 million for the three months ended September 30, 2005 versus $277.0 million for the same period in 2004, which resulted in an increase of $274 thousand to interest expense.
The following table lists the components of deposit interest expense for the three months ended September 30, 2005 and 2004:
Three months ended | ||||||||
9/30/05 | 9/30/04 | |||||||
(In thousands) | ||||||||
NOW and Super NOW accounts | $ | 12 | $ | 11 | ||||
Savings deposit accounts | 56 | 40 | ||||||
Money market investment accounts | 385 | 249 | ||||||
Certificates of deposit | 647 | 447 | ||||||
Retirement accounts | 239 | 217 | ||||||
Total deposit interest expense | $ | 1,339 | $ | 964 | ||||
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Rates on FHLB advances were 4.18% and 4.16% for the three months ended September 30, 2005 and 2004, respectively. The increase in rates paid on FHLB advances increased interest expense by $2 thousand. The average balances of FHLB advances increased to $118.5 million in the three months ended September 30, 2005 from $98.1 million for the same period of 2004, which resulted in an increase in interest expense of $222 thousand. Rates on repurchase agreements and other borrowed funds (which include FHLB advances less than 90 days) were 3.39% and 1.40% for the three months ended September 30, 2005 and 2004, respectively. The increase in rates paid on these interest bearing liabilities resulted in interest expense increasing by $81 thousand. The average balance increased to $49.6 million in 2005 from $30.4 million in 2004 which increased interest expense by $236 thousand.
PROVISION FOR LOAN LOSSES
The provision for loan losses was zero for the three months ended September 30, 2005. The absence of a provision for loan losses was based on management’s assessment of the adequacy of the allowance based on an evaluation of the Bank’s loan portfolio and the level of non-performing loans. The balance of the allowance for loan losses has remained fairly consistent at $4.1 million at both September 30, 2005 and December 31, 2004. The coverage of the allowance for loan losses has decreased slightly to 1.77% at September 30, 2005 from 1.78% at December 31, 2004 due to the loan growth during 2005.
NON-INTEREST INCOME
Non-interest income was $381 thousand and $348 thousand for the three months ended September 30, 2005 and 2004, respectively. The increase was primarily attributable to loan fees increasing by $14 thousand in 2005 compared to 2004. The increase in loan fees from the third quarter of 2004 can be attributed $54 thousand of increased fair value of mortgage servicing rights (“MSR”) in 2005 from 2004 partially offset by a decrease in late fees and prepayment penalties on commercial real estate loans of $37 thousand during 2005. Deposit account fees decreased $16 thousand to $220 thousand in the third quarter of 2005 due to a decrease in NOW account fees. Gains on the sale of mortgage loans increased $18 thousand due to an increase in the volume of loans sold in the third quarter 2005 versus same period in 2004 totaling $870 thousand and $223 thousand, respectively. Other non-interest income increased to $115 thousand from $98 thousand in the third quarter of 2005 compared to 2004, respectively, due primarily to an increase in ATM and debit card related fee income.
NON-INTEREST EXPENSE
Non-interest expense totaled $2.5 million and $2.7 million for the three months ended September 30, 2005 and 2004. Salaries and employee benefits totaled $1.5 million compared to $1.7 million in the three months ended September 30, 2005 and 2004, respectively, and decreased by $131 thousand in the third quarter of 2005 mainly due to a reduction in pension expense. Occupancy and equipment expenses totaled $229 thousand in 2005, an increase of $10 thousand over 2004 mainly due to an increase in rent expense. Professional expenses decreased by $30 thousand in the third quarter 2005 down from $141 thousand in the same period of 2004 primarily due to a reduction in the accrual for audit fees and consulting fees of $22 thousand and $7 thousand, respectively. The accrual for audit fees was reduced due to the delayed implementation date of Sarbares-Oxley Section 404 until 2007. Data processing expenses decreased to $230 thousand in the third quarter of 2005 compared to $237 thousand in the same quarter in 2004 due to a reduction in service bureau charges as a result of new communications lines installed during 2004. Other operating expenses decreased $41 thousand during 2005 from 2004 mainly attributable to a reduction in stockholder expenses for costs associated with printing and legal services.
INCOME TAXES
The Company reported an income tax expense of $472 thousand for the three months ended September 30, 2005 or an effective income tax rate of 35.5%. This compares to an income tax expense of $337 thousand for the three months ended September 30, 2004 or effective income tax rate of 32.6%. Income tax expense increased $135 thousand from quarter to quarter primarily due to an increase in taxable earnings within the consolidated group. Subsidiaries within the consolidated group pay various state income tax rates and the mix of taxable income within the group can change. The effective tax rate for the third quarter of 2005 reflects the forecasted rate for the year 2005 and is in line with the year 2004 effective tax rate.
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RESULTS OF OPERATIONS
NINE MONTHS ENDED SEPTEMBER 30, 2005 AND 2004
OVERVIEW
The Bank reported net income of $2.5 million or $0.55 diluted earnings per share and $3.8 million or $0.86 diluted earnings per share for the nine months ended September 30, 2005 and 2004, respectively. During the first nine months of 2005, net income decreased by $1.4 million due to the Company’s receipt of $2.5 million recognized in 2004 on a U.S. Bankruptcy Judge’s Order on the Trustee’s Motion for authorization to make an interim distribution in a case in which the company’s wholly-owned subsidiary, Lawrence Savings Bank, is a secured creditor. The Bank recognized $253 thousand of the interim distribution as a recovery to the allowance for loan losses on amounts previously charged-off and the remaining $2.3 million as a lawsuit judgment collected in non-interest income. Net interest income increased $359 thousand or 3.5% for the nine months ended September 30, 2005 versus 2004. Excluding the lawsuit judgment collected, non-interest income decreased by $42 thousand. Non-interest expense decreased by $117 thousand and the provision for income taxes decreased approximately $775 thousand primarily attributable to the recognition of the lawsuit judgment collected in 2004.
NET INTEREST INCOME FROM OPERATIONS
Net interest income for the nine months ended September 30, 2005 increased by $359 thousand or 3.5% to $10.5 million from $10.2 million, for the corresponding period in 2004. The net interest rate spread decreased to 2.35% from 2.64%. The following table presents the components of net interest income and net interest spread:
Income/Expense | Yield/Rate | |||||||||||||||
Nine Months Ended | ||||||||||||||||
9/30/05 | 9/30/04 | 9/30/05 | 9/30/04 | |||||||||||||
(Dollars in Thousands) | ||||||||||||||||
Interest income and average yield: | ||||||||||||||||
Loans | $ | 11,066 | $ | 9,797 | 6.31 | % | 6.07 | % | ||||||||
Investments, mortgage-backed securities and other earning assets | 8,005 | 6,594 | 3.64 | 3.51 | ||||||||||||
Total | 19,071 | 16,391 | 4.82 | 4.69 | ||||||||||||
Interest expense and average rate paid: | ||||||||||||||||
Deposits | 3,595 | 2,662 | 1.68 | 1.32 | ||||||||||||
Federal Home Loan Bank advances | 3,644 | 3,187 | 4.16 | 4.56 | ||||||||||||
Securities sold under agreements to repurchase and other borrowed funds | 1,292 | 361 | 2.93 | 1.14 | ||||||||||||
Total | 8,531 | 6,210 | 2.47 | 2.05 | ||||||||||||
Net interest income | $ | 10,540 | $ | 10,181 | ||||||||||||
Net interest rate spread | 2.35 | % | 2.64 | % | ||||||||||||
Net interest margin | 2.66 | % | 2.91 | % | ||||||||||||
INTEREST INCOME
Interest income for the first nine months of 2005 was $19.1 million as compared to $16.4 million for the same period of 2004. The increase in interest income of $2.7 million is due mainly to higher average investment security and average loan balances contributing $2.0 million to interest income.
Yields on loans increased to 6.31% from 6.07% for the nine months ended September 30, 2005 and 2004, respectively. The impact on interest income due to higher yields was an increase of $410 thousand. Higher average loan balances of $234.5 million in 2005 versus $215.7 million in 2004 resulted in interest income increasing by $859 thousand.
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The following table lists the components of loan interest income for the nine months ended September 30, 2005 and 2004:
Nine months ended | ||||||||
9/30/05 | 9/30/04 | |||||||
(In Thousands) | ||||||||
Residential mortgage loans | $ | 2,356 | $ | 2,325 | ||||
Loans held for sale | 6 | 21 | ||||||
Equity loans | 348 | 374 | ||||||
Construction loans | 972 | 578 | ||||||
Commercial real estate loans | 6,707 | 5,848 | ||||||
Commercial loans | 648 | 618 | ||||||
Consumer loans | 29 | 33 | ||||||
Total loan interest income | $ | 11,066 | $ | 9,797 | ||||
Yields on investment securities increased to 3.64% for the nine months ended September 30, 2005 compared to yields on investment securities of 3.51% for the same period in 2004. As a result, interest income increased by $275 thousand. Higher average investment securities balances of $294.3 million in 2005 versus $250.9 million in 2004 resulted in interest income increasing by $1.1 million.
INTEREST EXPENSE
Interest expense for the first nine months of 2005 and 2004 was $8.5 million and $6.2 million, respectively. The increase of $2.3 million in interest expense is due to higher average interest bearing liabilities balances, which increased interest expense by $1.2 million, and higher rates paid on interest bearing liabilities, which increased interest expense by $1.1 million.
Rates on deposits were 1.68% and 1.32% for the first nine months of 2005 and 2004, respectively. This increase resulted in interest expense increasing by $708 thousand. Average deposit balances were $286.1 million in 2005 up from $269.4 million in 2004, which increased interest expense by $225 thousand.
The following table lists the components of deposit interest expense for the nine months ended September 30, 2005 and 2004:
Nine months ended | ||||||||
9/30/05 | 9/30/04 | |||||||
(In Thousands) | ||||||||
NOW and Super NOW accounts | $ | 35 | $ | 30 | ||||
Savings deposit accounts | 168 | 122 | ||||||
Money market investment accounts | 954 | 725 | ||||||
Certificates of deposit | 1,745 | 1,149 | ||||||
Retirement accounts | 693 | 636 | ||||||
Total deposit interest expense | $ | 3,595 | $ | 2,662 | ||||
Rates on FHLB advances were 4.16% and 4.56% resulting in interest expense decreasing by $350 thousand in 2005 from 2004. The average balances of these interest bearing liabilities increased to $117.2 million in 2005 from $93.4 million in 2004, resulting in an increase to interest expense of $807 thousand.
Rates paid on repurchase agreements and other borrowed funds were 2.93% and 1.14% for the first nine months of 2005 and 2004, respectively. This increase in rates paid resulted in an increase of $787 thousand in interest expense. The average balances of repurchase agreements and other borrowed funds increased to $59.0 million in 2005 compared to $42.2 million in 2004 resulting in an increase of $144 thousand in interest expense.
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PROVISION FOR LOAN LOSSES
The Company made no provision for loan losses in 2005. The zero provision for loan losses in 2005 was due to the overall asset quality of the Company and low level of delinquent loans. The Company recognized a credit provision for loan losses in the amount of $300 thousand for the nine months ended September 30, 2004 due to the $253 thousand recovery to the allowance for loan losses in the second quarter of 2004 and the continued low level of non-performing loans.
NON-INTEREST INCOME
Excluding the previously discussed interim distribution from the lawsuit, non-interest income decreased by $42 thousand to $1.1 million from $1.2 million for the nine months ended September 30, 2005 and 2004, respectively. This decrease is primarily attributable to a reduction of $53 thousand in loan fees in 2005 compared to 2004. The decrease of $53 thousand in loans fees can be attributed to a decrease of $99 thousand in prepayment penalties on commercial real estate loan payoffs in 2004 which did not occur in 2005. Deposit account fees totaled $639 thousand in the first nine months in 2005 versus $668 thousand in the first nine months in 2004 due to a reduction in NOW account fees and overdraft fees of $19 thousand and $8 thousand, respectively. Gains on the sale of mortgage loans decreased $29 thousand to $35 thousand in 2005 from $64 thousand in 2004 due to a reduction in the volume of loan sales in 2005 from 2004 totaling $3.3 million and $3.9 million, respectively. Other income increased $69 thousand in 2005 from 2004 due to ATM and Debit card fees increasing $38 thousand in 2005 versus 2004 and official check income increasing by $18 thousand in 2005 versus 2004.
NON-INTEREST EXPENSE
Non-interest expense totaled $7.8 million and $8.0 million for the nine months ended September 30, 2005 and 2004. Salaries and employee benefits decreased by $196 thousand to $4.7 million for the first nine months in 2005 compared to $4.9 million in the same period of 2004 mainly attributable to a reduction in pension and other post-retirement expenses in 2005 from 2004. Occupancy and equipment expenses have risen by $50 thousand to $708 thousand for the first nine months in 2005 from $658 thousand in 2004 due to increased rent expense and depreciation expense associated with the new branch in Salem, NH which incurred nine months of depreciation expense in 2005 versus three months in 2004 after opening on June 14, 2004. Professional expenses declined to $407 thousand for the nine months in 2005 from $472 thousand over the same period in 2004 as the Bank’s legal expenses have decreased associated with collection efforts. Other expenses totaled $1.4 million in the first nine months in 2005 compared to $1.3 million in the same period of 2004 mainly due to an increase of $57 thousand in marketing expense and the reimbursement of $100 thousand in legal fees as part of an insurance claim recovery in the amount of $197 thousand recognized in 2004.
INCOME TAXES
The Bank reported an income tax expense of $1.4 million and $2.1 million for the nine months ended September 30, 2005 and 2004, respectively, representing an effective income tax rate of 35.3% and 35.6%, respectively. The decrease in the provision for income taxes of $775 thousand was primarily attributable to the previously mentioned lawsuit recovery. Subsidiaries within the consolidated group pay various state income tax rates, which could change the Company’s effective income tax rate. The effective tax rate for the first nine months in 2005 reflects the forecasted income tax rate for the year 2005 and is in line with the final year end 2004 effective income tax rate.
LIQUIDITY AND CAPITAL RESOURCES
The Company’s primary source of funds is cash dividends from its wholly-owned subsidiary, Lawrence Savings Bank. The Bank paid dividends to the Company in the amount of $1.8 million and $3.6 million during the first nine months of 2005 and 2004, respectively. The Company made cash payments of dividends to shareholders in the amount of $1.9 million and $1.7 million in the first nine months of 2005 and 2004, respectively.
The Bank’s primary sources of funds include collections of principal payments and repayments on outstanding loans, increases in deposits, advances from the Federal Home Loan Bank of Boston (“FHLB”) and securities sold under agreements to repurchase. The Bank has a line of credit of $6.8 million with the FHLB. The Bank currently has two $5 million unsecured Federal funds lines of credit. At September 30, 2005, the entire $16.8 million was available.
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The FHLB requires member banks to maintain qualified collateral for its advances. Collateral is comprised of the Bank’s investments in FHLB stock, its residential mortgage portfolio and the portion of the investment portfolio which meets FHLB qualifying collateral requirements and has been designated as such. The Bank’s borrowing capacity at the FHLB at September 30, 2005 was $279.7 million, of which $157.9 million had been borrowed.
At September 30, 2005, the Company’s stockholders’ equity was $58.9 million as compared to $57.8 million at December 31, 2004. The change during the first nine months of 2005 occurred due to net income of $2.5 million, a tax benefit associated with the exercise of stock options of $211 thousand and proceeds of $512 thousand from the exercise of stock options. Stockholders’ equity was reduced by the declaration of cash dividends to shareholders of $1.9 million and a $310 thousand decrease in the market value of investment securities available for sale, net of taxes. The Company’s leverage ratio at September 30, 2005 and December 31, 2004 was 10.87% and 11.25%, respectively. The Company’s and the Bank’s total risk based capital ratios were 19.64% and 18.68% at September 30, 2005, respectively, compared with 19.63% and 18.74% at December 31, 2004, respectively. The Company exceeds all regulatory minimum capital ratio requirements set forth by the FRB, and the Bank exceeds all minimum capital ratio requirements as defined by the FDIC.
ITEM 3: QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
The response is incorporated herein by reference to the discussion under the sub-caption “Interest Rate Sensitivity” of the caption “MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS” on pages 18 and 19 of the LSB Corporation’s Annual Report for the fiscal year ended December 31, 2004.
ITEM 4: CONTROLS AND PROCEDURES
The Company’s chief executive officer and chief financial officer, after evaluating the effectiveness of the Company’s “disclosure controls and procedures” (as defined in the Securities Exchange Act of 1934 Rules 13a-15(e) and 15d-15(e)) as of the end of the period covered by this quarterly report (the “Evaluation Date”), have concluded that as of the Evaluation Date the Company’s disclosure controls and procedures were effective and designed to ensure that material information relating to the Company and its subsidiary would be made known to them by others within those entities.
During the period covered by this quarterly report, there were no significant changes in the Company’s internal controls that have materially affected, or are reasonable likely to materially affect the internal controls over financial reporting.
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PART II — OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
The Bank is involved in various legal proceedings incidental to its business. After review with legal counsel, management does not believe resolution of such litigation will have a material adverse effect on the financial condition and operating results of the Company.
In one litigation matter, the Bank was awarded a $4.2 million judgment against the debtor in 1997. On February 13, 2002, the debtor filed a petition in bankruptcy under Chapter 7 of the Bankruptcy Code. Post-judgment interest calculated from the date of judgment to the date of the bankruptcy filing is approximately $1.9 million. In the Bankruptcy case, the Company’s wholly owned subsidiary, Lawrence Savings Bank (the ‘Bank”), is the only secured creditor.
On June 15, 2004, the Company reported the receipt of $2.5 million interim distribution in the case on the order of the U.S. Bankruptcy Judge. The $2.5 million distribution was recorded as income by the Bank on June 15, 2004. The Bank has agreed to return any of the interim distribution as may be necessary to pay additional taxes imposed on the bankruptcy estate in the event reserves set aside for expenses and taxes are insufficient.
The Bankruptcy Trustee has sold various assets during 2004 and 2005, and is currently holding approximately $2.2 million in cash (net of various expenses). The distribution date and the amount of the remaining assets held by the Bankruptcy Trustee to the Bank are not known at this time. Accordingly, no recognition of the remaining assets currently held by the Bankruptcy Trustee has been recorded in the Consolidated Financial Statements.
It is management’s opinion that collection of any remaining amounts owed to the Bank beyond the amount of the interim distribution and assets currently held by the Bankruptcy Trustee are uncertain and are not susceptible to meaningful estimation at this time.
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
Please see the Exhibit Index attached hereto.
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SIGNATURES
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.
LSB CORPORATION | ||||
November 14, 2005 | /s/ Paul A. Miller | |||
Paul A. Miller | ||||
President and | ||||
Chief Executive Officer | ||||
November 14, 2005 | /s/ John E. Sharland | |||
John E. Sharland | ||||
Senior Vice President | ||||
Chief Financial Officer |
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LSB CORPORATION AND SUBSIDIARY
Quarterly Report on Form 10-Q for the Quarter Ended September 30, 2005
EXHIBIT INDEX
Page | ||||||
31.1 | Certification of Chief Executive Officer under Section 302 of the Sarbanes-Oxley Act of 2002 | 25 | ||||
31.2 | Certification of Chief Financial Officer under Section 302 of the Sarbanes-Oxley Act of 2002 | 26 | ||||
32.1 | Certification of Chief Executive Officer Pursuant to 18 U.S.C. Section 1350, as added by Section 906 of the Sarbanes-Oxley Act of 2002 | 27 | ||||
32.2 | Certification of Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as added by Section 906 of the Sarbanes-Oxley Act of 2002 | 28 |
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