UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2013.
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:000-53935
HARVARD ILLINOIS BANCORP, INC.
(Exact name of registrant as specified in its charter)
Maryland | 27-2238553 |
(State or other jurisdiction of | (I.R.S. Employer |
incorporation or organization) | Identification Number) |
58 North Ayer Street, Harvard Illinois | 60033 |
(Address of principal executive offices) | (Zip Code) |
Registrant's telephone number, including area code:(815) 943-5261
Securities registered pursuant to Section 12(b) of the Act:None
Securities registered pursuant to Section 12(g) of the Act:Common Stock, $0.01 par value
Indicate by check mark if the Registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. YES [ ] NO [X]
Indicate by check mark if the Registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. YES [ ] NO [X]
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 has submitted electronically and posted on its corporate website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the Registrant was required to submit and post such files). YES [X] NO [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of Registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [X]
Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer [ ] | Accelerated filer [ ] |
Non-accelerated filer [ ] | Smaller reporting company [X] |
(Do not check if a smaller reporting company) |
Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Act). YES [ ] NO [X]
The aggregate market value of the voting and non-voting common equity held by non-affiliates of the Registrant, computed by reference to the last sale price on June 30, 2013, as reported by the OTC Bulletin Board, was approximately $8.0 million.
As of March 25, 2014, there were issued and outstanding 839,585shares of the Registrant’s Common Stock with a par value of $0.01 per share.
DOCUMENTS INCORPORATED BY REFERENCE:
(1) Proxy Statement for the 2014 Annual Meeting of Stockholders of the Registrant (Part III).
TABLE OF CONTENTS
ITEM 1. | BUSINESS | 1 |
ITEM 1A. | RISK FACTORS | 44 |
ITEM 1B. | UNRESOLVED STAFF COMMENTS | 44 |
ITEM 2. | PROPERTIES | 45 |
ITEM 3. | LEGAL PROCEEDINGS | 45 |
ITEM 4. | MINE SAFETY DISCLOSURE | 45 |
ITEM 5. | MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES | 46 |
ITEM 6. | SELECTED FINANCIAL DATA | 47 |
ITEM 7. | MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS | 47 |
ITEM 7A. | QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK | 61 |
ITEM 8. | FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA | 61 |
ITEM 9. | CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE | 61 |
ITEM 9A. | CONTROLS AND PROCEDURES | 61 |
ITEM 9B. | OTHER INFORMATION | 62 |
ITEM 10. | DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE | 62 |
ITEM 11. | EXECUTIVE COMPENSATION | 62 |
ITEM 12. | SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS | 63 |
ITEM 13. | CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS AND DIRECTOR INDEPENDENCE | 63 |
ITEM 14. | PRINCIPAL ACCOUNTANT FEES AND SERVICES | 63 |
ITEM 15. | EXHIBITS AND FINANCIAL STATEMENTS SCHEDULES | 64 |
| CONSOLIDATED FINANCIAL STATEMENTS | F-1 |
PART I
ITEM 1. Business
This Annual Report contains forward-looking statements, which can be identified by the use of words such as “estimate,” “project,” “believe,” “intend,” “anticipate,” “plan,” “seek,” “expect,” “will,” “may” and words of similar meaning. These forward-looking statements include, but are not limited to:
● | statements of our goals, intentions and expectations; |
● | statements regarding our business plans, prospects, growth and operating strategies; |
● | statements regarding the asset quality of our loan and investment portfolios; and |
● | estimates of our risks and future costs and benefits. |
These forward-looking statements are based on our current beliefs and expectations and are inherently subject to significant business, economic and competitive uncertainties and contingencies, many of which are beyond our control. In addition, these forward-looking statements are subject to assumptions with respect to future business strategies and decisions that are subject to change. We are under no duty to and do not take any obligation to update any forward-looking statements after the date of this Annual Report.
The following factors, among others, could cause actual results to differ materially from the anticipated results or other expectations expressed in the forward-looking statements:
● | our ability to manage our operations under the current adverse economic conditions (including real estate values, loan demand, inflation, commodity prices and employment levels) nationally and in our market areas; |
● | adverse changes in the financial industry, securities, credit and national and local real estate markets (including real estate values); |
● | significant increases in our loan losses, including as a result of our inability to resolve delinquent loans and non-performing and classified assets, changes in the underlying cash flows of our borrowers, and management’s assumptions in determining the adequacy of the allowance for loan losses; |
● | credit risks of lending activities, including changes in the level and trend of loan delinquencies and write-offs and in our allowance for loan losses and provision for loan losses; |
● | increased competition among depository and other financial institutions; |
● | our ability to successfully diversify our loan portfolio without experiencing a significant decrease in asset quality; |
● | our ability to attract and maintain deposits; |
● | expenses and diversion of management’s time and attention resulting from our efforts to oppose stockholder nominations that we do not believe are in the best interests of stockholders; |
● | changes in interest rates generally, including changes in the relative difference between short term and long term in test rates and in deposit interest rates, that may affect our net interest margin and funding sources; |
● | declines in the yield on our assets resulting from the current low interest rate environment; |
● | fluctuations in the demand for loans, which may be affected by the number of unsold homes, land and other properties in our market areas and by declines in the value of real estate in our market area; |
● | risks related to high concentration of loans secured by real estate located in our market areas; |
● | the results of examinations by our regulators, including the possibility that our regulators may, among other things, require us to increase our allowance for loan losses, write down assets, change our regulatory capital position, limit our ability to borrow funds or maintain or increase deposits, or prohibit us from paying dividends, which could adversely affect our dividends and earnings; |
● | possible increases in deposit and premium assessments; |
● | legislative or regulatory changes, including increased compliance costs resulting from the recently enacted financial reform legislation, that adversely affect our business and earnings; |
● | changes in the level of government support of housing finance; |
● | our ability to enter new markets successfully and capitalize on growth opportunities; |
● | our reliance on a small executive staff; |
● | changes in consumer spending, borrowing and savings habits; |
● | changes in accounting policies and practices, as may be adopted by the bank regulatory agencies, the Financial Accounting Standards Board, the Securities and Exchange Commission and the Public Company Accounting Oversight Board; |
● | risks and costs related to operating as a publicly traded company; |
● | changes in our organization, compensation and benefit plans; |
● | loan delinquencies and changes in the underlying cash flows of our borrowers; |
● | our ability to control costs and expenses, particularly those associated with operating as a publicly traded company |
● | the failure or security breaches of computer systems on which we depend; |
● | the ability of key third-party service provider to perform their obligations to us; |
● | changes in the financial condition or future prospects of issuers of securities that we own; and |
● | other economic, competitive, governmental, regulatory and operational factors affecting our operations, pricing, products and services. |
Because of these and a wide variety of other uncertainties, our actual future results may be materially different from the results indicated by these forward-looking statements.
Harvard Savings Bank
Harvard Savings Bank is an Illinois-chartered savings bank headquartered in Harvard, Illinois. Harvard Savings Bank was organized in 1934, and reorganized into the mutual holding company structure in 2005 by forming Harvard Savings, MHC.
In April 2008, Morris Building & Loan, s.b., a mutual institution, merged into Harvard Savings Bank. Morris Building & Loan, s.b., which had $36 million in assets at the time of the merger, currently operates as a branch of Harvard Savings Bank. We provide financial services to individuals, families and businesses through our three banking offices located in the Illinois counties of McHenry and Grundy. See “Business of Harvard Savings Bank.”
On April 8, 2010, Harvard Savings, MHC converted from mutual to stock form and, as part of that transaction, Harvard Savings Bank became a wholly owned subsidiary of Harvard Illinois Bancorp, Inc.
Harvard Savings Bank’s executive offices are located at 58 North Ayer Street, Harvard, Illinois 60033. Our telephone number at this address is (815) 943-5261. Our website address is www.harvardsavingsbank.com.
Harvard Illinois Bancorp, Inc.
Harvard Illinois Bancorp, Inc. was incorporated as a Maryland corporation on September 14, 2009 and owns all of the outstanding shares of common stock of Harvard Savings Bank as a result of the conversion from mutual to stock form of Harvard Savings, MHC on April 8, 2010. Harvard Illinois Bancorp, Inc. has not engaged in any business to date other than owning the common stock of Harvard Savings Bank.
On April 8, 2010, Harvard Illinois Bancorp, Inc. completed its initial public offering of common stock. In the offering, Harvard Illinois Bancorp, Inc. issued a total of 784,689 shares of its common stock for an aggregate of $7,846,890 in total offering proceeds.
Our executive offices are located at 58 North Ayer Street, Harvard, Illinois 60033. Our telephone number at this address is (815) 943-5261. Our website address is www.harvardsavingsbank.com. Information on our website is not incorporated into this Annual Report and should not be considered part of this Annual Report.
Market Area and Competition
We conduct business through our main office and one branch office located in Harvard, Illinois and an additional branch office located approximately 80 miles away in Morris, Illinois. All three of our offices are located in McHenry and Grundy Counties, Illinois. Harvard, Illinois is located approximately 70 miles to the Northwest of Chicago while Morris, Illinois is located approximately 60 miles to the Southwest of Chicago.
Our primary market area consists ofMcHenry, Grundy and, to a lesser extent, Boone Counties, Illinois, and Walworth County, Wisconsin. This area includes small towns, rural communities as well as bedroom communities of Chicago. The regional economy is fairly diversified, with services, wholesale/retail trade, manufacturing and government providing the primary support for the area economy. AlthoughHarvard is a small, relatively rural community with a relatively small population base, it is located next to faster-growing commercial and bedroom communities near the Northwest collar counties of Chicago. Morris also is a small town with a relatively small population base, located close to faster-growing commercial and bedroom communities near the Southwest collar counties of Chicago.
The local economy has been significantly affected by the recession. According to the Illinois Department of Employment Security, McHenry and Grundy Counties’ and Illinois’ respective December 2013 unemployment rates, not seasonally adjusted, were 7.4%, 9.1% and 8.6%, as compared to U.S. unemployment rate of 6.5%. According to the 2010 U.S. Census, per capita income forMcHenry and Grundy Counties were $31,838 and $27,895, respectively, and the median household incomes were $76,482 and $64,297, respectively, compared to per capita income for the United States and the State of Illinois of $27,334 and $28,782, respectively, and median household income of $51,914 and $55,735, respectively.
We face competition within our market area both in making loans and attracting deposits. Our market area has a significant concentration of financial institutions including large money center and regional banks, community banks and credit unions. Some of our competitors offer products and services that we currently do not offer, such as trust services and private banking. As of June 30, 2013, based on the most recent available FDIC data, our market share of deposits represented 1.7% and 2.7% of FDIC-insured deposits in McHenry and Grundy Counties, Illinois, respectively.
Competition for financial services in our primary market area is significant, particularly in light of the large number of institutions that maintain a presence in the counties. Among our competitors are much larger and more diversified institutions, which have greater resources than we maintain. Financial institution competitors in our primary market area include other locally based thrifts and banks, as well as regional, super regional and money center banks. To meet our competition, we seek to emphasize our community orientation, local and timely decision making and superior customer service.
Lending Activities
General.We focus our lending activities primarily on one- to four-family residential mortgage, commercial real estate, farmland, commercial and industrial, home equity, agricultural and purchased indirect automobile loans, and, to a lesser extent, multi-family, construction and land development, and other consumer loans. Home equity lending activities include the origination of lines of credit and second mortgage loans. In recent years, we have adopted a strategy focused on managing our loan portfolio to minimize concentrations and diversify the types of loans within the portfolio, and in a manner that manages credit risk to minimize the risk of loss and interest rate risk to optimize our net interest margin. The implementation of this strategy involves achieving and maintaining a portfolio balance that is less dependent on loans secured by real estate, particularly one- to four-family residential and commercial real estate loans and more focused on commercial and industrial, agricultural and farmland loans, with an appropriate balance of home equity lines of credit and other second mortgage loans and purchased indirect automobile loans. We have focused our efforts on developing a portfolio of commercial and industrial, agriculture and farmland loans with borrowers seeking loans of $2.5 million or less. During 2013, the commercial and industrial, agriculture, and farmland loan portfolios increased $1.0 million, $4.2 million and $2.1 million respectively, to totals of $6.4 million, $24.3 million, and $13.9 million at December 31, 2013. Those portfolios represented 5.38%, 20.40% and 11.65%, respectively, of total loans at December 31, 2013. During 2013, we continued to curtail our commercial real estate lending activity, and continued to sell most of the one- to four-family residential loans that we originated. Our one – to four – family real estate loan portfolio decreased $2.4 million to $39.5 million or 33.09% of total loans at December 31, 2013. Our commercial real estate loan portfolio decreased $745,000 to $19.2 million or 16.12% of total loans at December 31, 2013. At December 31, 2013, the commercial real estate loan portfolio was within our approved concentration limit, and subject to future market, economic and regulatory conditions, is expected to be an area of loan growth in 2014. The majority of our loan activity historically has been, and during 2013 continued to be, loan origination activity in our market area. As a long-standing community lender, we believe we can effectively compete for this business by emphasizing superior customer service and local underwriting, which differentiates us from larger commercial banks in our primary market area. Historically, we also have purchased a significant number of indirect automobile loans, with a target portfolio of $6-$8 million. At December 31, 2013, our purchased indirect automobile loan portfolio totaled $7.6 million or 6.37% of total loans. Subject to future market, economic and regulatory conditions, we expect commercial and industrial, farmland, agricultural, and purchased indirect automobile loans will continue to be an area of loan growth.
Loan Portfolio Composition.The following table sets forth the composition of our loan portfolio by type of loan at the dates indicated.
At December 31, | ||||||||||||||||
2013 | 2012 | |||||||||||||||
Amount | Percent | Amount | Percent | |||||||||||||
(Dollars in thousands) | ||||||||||||||||
Real estate loans: | ||||||||||||||||
One- to four-family | $ | 39,489 | 33.09 | % | $ | 41,842 | 35.61 | % | ||||||||
Home equity line of credit and other 2nd mortgage | 7,749 | 6.49 | 9,431 | 8.02 | ||||||||||||
Multi-family | 117 | 0.10 | 51 | 0.04 | ||||||||||||
Commercial | 19,244 | 16.12 | 19,989 | 17.01 | ||||||||||||
Farmland | 13,900 | 11.65 | 11,765 | 10.01 | ||||||||||||
Construction and land development | 354 | 0.30 | 1,837 | 1.56 | ||||||||||||
Total real estate loans | 80,853 | 67.75 | 84,915 | 72.25 | ||||||||||||
Commercial and industrial | 6,424 | 5.38 | 5,407 | 4.60 | ||||||||||||
Agriculture | 24,343 | 20.40 | 20,096 | 17.10 | ||||||||||||
Consumer loans: | ||||||||||||||||
Purchased indirect automobile | 7,616 | 6.37 | 6,987 | 5.95 | ||||||||||||
Other | 115 | 0.10 | 117 | 0.10 | ||||||||||||
Total consumer loans | 7,731 | 6.47 | 7,104 | 6.05 | ||||||||||||
Total loans | 119,351 | 100.00 | % | 117,522 | 100.00 | % | ||||||||||
Deferred loan costs (fees) | 8 | 4 | ||||||||||||||
Loans in process | (26 | ) | — | |||||||||||||
Allowance for losses | (2,475 | ) | (2,550 | ) | ||||||||||||
Loans, net | $ | 116,858 | $ | 114,976 |
Contractual Maturities and Interest Rate Sensitivity.The following table sets forth the contractual maturities of our total loan portfolio at December 31, 2013. Demand loans, loans having no stated repayment schedule or maturity, and overdraft loans are reported as being due in one year or less. The table presents contractual maturities and does not reflect repricing or the effect of prepayments. Actual maturities may differ.
One- to Four-Family Residential | HELOC & Other 2nd Mortgage | Multi-Family | Commercial Real Estate | Farmland | Construction & Land Development | Commercial & Industrial | Agriculture | Purchased Indirect Automobile | Other Consumer | Total | ||||||||||||||||||||||||||||||||||
(In thousands) | ||||||||||||||||||||||||||||||||||||||||||||
Amounts due in: | ||||||||||||||||||||||||||||||||||||||||||||
One year or less | $ | 3,002 | $ | 633 | $ | — | $ | 1,904 | $ | 2,900 | $ | 354 | $ | 3,203 | $ | 19,655 | $ | 140 | $ | 63 | $ | 31,854 | ||||||||||||||||||||||
More than one to two years | 2,431 | 407 | — | 3,907 | 1,158 | — | 146 | 1,055 | 249 | 19 | 9,372 | |||||||||||||||||||||||||||||||||
More than two to three years | 1,869 | 1,292 | — | 2,053 | 5,058 | — | 1,240 | 389 | 785 | — | 12,686 | |||||||||||||||||||||||||||||||||
More than three to five years | 2,388 | 1,996 | — | 10,883 | 2,019 | — | 1,835 | 3,200 | 3,738 | 33 | 26,092 | |||||||||||||||||||||||||||||||||
More than five to ten years | 4,541 | 3,299 | — | 428 | 216 | — | — | 44 | 2,704 | — | 11,232 | |||||||||||||||||||||||||||||||||
More than ten to fifteen years | 2,859 | 52 | — | — | 322 | — | — | — | — | — | 3,233 | |||||||||||||||||||||||||||||||||
More than fifteen years | 22,399 | 70 | 117 | 69 | 2,227 | — | — | — | — | — | 24,882 | |||||||||||||||||||||||||||||||||
Total | $ | 39,489 | $ | 7,749 | $ | 117 | $ | 19,244 | $ | 13,900 | $ | 354 | $ | 6,424 | $ | 24,343 | $ | 7,616 | $ | 115 | $ | 119,351 |
The following table sets forth our fixed and adjustable-rate loans at December 31, 2013 that are contractually due after December 31, 2014.
One- to Four-Family Residential | HELOC & Other 2nd Mortgage | Multi-Family | Commercial Real Estate | Farmland | Construction & Land Development | Commercial & Industrial | Agriculture | Purchased Indirect Automobile | Other Consumer | Total | ||||||||||||||||||||||||||||||||||
(In thousands) | ||||||||||||||||||||||||||||||||||||||||||||
Interest rate terms on amounts due after one year: | ||||||||||||||||||||||||||||||||||||||||||||
Fixed-rate loans | $ | 32,970 | $ | 766 | $ | — | $ | 16,623 | $ | 9,559 | $ | — | $ | 3,191 | $ | 4,589 | $ | 7,476 | $ | 52 | $ | 75,226 | ||||||||||||||||||||||
Adjustable-rate loans | 3,517 | 6,350 | 117 | 717 | 1,441 | — | 30 | 99 | — | — | 12,271 | |||||||||||||||||||||||||||||||||
Total | $ | 36,487 | $ | 7,116 | $ | 117 | $ | 17,340 | $ | 11,000 | $ | — | $ | 3,221 | $ | 4,688 | $ | 7,476 | $ | 52 | $ | 87,497 |
Loan Approval Procedures and Authority. Pursuant to applicable law, the aggregate amount of loans that we are permitted to make to any one borrower or a group of related borrowers is generally limited to 25% of our total capital plus the allowance for loan losses. At December 31, 2013, our loan-to-one-borrower limit was approximately $5.3 million. Our largest loan totaled $2.5 million and was secured by a mortgage on a nonowner-occupied office building in our market area in McHenry County, Illinois. At December 31, 2013, this loan was performing in accordance with its terms. Our largest loan relationship totaled $3.7 million with a farming operation located in our market area. At December 31, 2013, these loans were performing in accordance with their terms.
Our lending is subject to written underwriting standards and origination procedures. Decisions on loan applications are made on the basis of detailed applications submitted by the prospective borrower and property valuations (consistent with our appraisal policy) prepared by outside independent licensed appraisers approved by our board of directors as well as internal evaluations, where permitted by regulations. The loan applications are designed primarily to determine the borrower’s ability to repay the requested loan, and the more significant items on the application are verified through use of credit reports, financial statements and tax returns.
Under our loan policy, the individual processing an application is responsible for ensuring that all documentation is obtained prior to the submission of the application to the loan committee for approval. The loan committee then reviews these materials and verifies that the requested loan meets our underwriting guidelines described below.
All one- to four-family residential loans up to $500,000, vacant land loans up to $250,000, and any consumer loans require approval of a quorum of our retail loan committee consisting of four officers. All such loan approvals are reported at the next board meeting following said approval. All secured commercial loans, including agricultural loans, up to $1,500,000 and unsecured loans up to $250,000 must be approved by our commercial credit management committee, which currently consists of our President, Executive Vice President/Secretary-Treasurer and our Vice President – Commercial Loan Officer. These approvals are reported at the next board meeting following said approval. All other loans must be approved by the board.
Generally, we require title insurance or title searches on our mortgage loans as well as fire and extended coverage casualty insurance in amounts at least equal to the principal amount of the loan or the value of improvements on the property, depending on the type of loan.
One- to Four-Family Residential Real Estate Lending. We originate long-term permanent loans secured by mortgages on owner-occupied one- to four-family residences. At December 31, 2013, $39.5 million, or 33.09% of our total loan portfolio consisted of permanent loans on one- to four-family residences. At that date, our average outstanding one- to four-family residential loan balance was $96,000. Virtually all of the residential loans we originate are secured by properties located in our market area. See “—Originations, Purchases and Sales of Loans.”
Due to consumer demand in the current low market interest rate environment, most of our recent originations are 10- to 30-year fixed-rate loans secured by one- to four-family residential real estate. We generally originate our fixed-rate one- to four-family residential loans in accordance with secondary market standards to permit their sale. During the last several years, consistent with our asset-liability management strategy, we have sold most of the fixed rate one- to four-family residential loans we originated with original terms to maturity of ten years or more.
For the past several years, as a part of our asset/liability management policy, we have also originated seven-year balloon loans with up to 30-year amortization schedules secured by one- to four-family real estate. At December 31, 2013, we had $9.6 million of such loans.
In order to reduce the term to repricing of our loan portfolio, we also originate adjustable-rate one- to four-family residential mortgage loans. However, our ability to originate such loans is limited in the current low interest rate environment due to low consumer demand. Our current adjustable-rate mortgage loans carry interest rates that adjust annually at a margin over the one year U.S. Treasury index. Many of our adjustable-rate one- to four-family residential mortgage loans have fixed rates for initial terms of three to five years. Such loans carry terms to maturity of up to 30 years. The adjustable-rate mortgage loans currently offered by us generally provide for a 200 basis point annual interest rate change cap and a lifetime cap of 600 basis points over the initial rate.
Although adjustable-rate mortgage loans may reduce to an extent our vulnerability to changes in market interest rates because they periodically reprice as interest rates increase, the required payments due from the borrower also increase (subject to rate caps), increasing the potential for default by the borrower. At the same time, the marketability of the underlying collateral may be adversely affected by higher interest rates. Upward adjustments of the contractual interest rate are also limited by the maximum periodic and lifetime rate adjustments permitted by our loan documents. Moreover, the interest rates on many of our adjustable-rate loans do not adjust for the first three to five years. As a result, the effectiveness of adjustable-rate mortgage loans may be limited during periods of rapidly rising interest rates. At December 31, 2013, $3.5 million, or 8.91% of our one- to four-family residential loans, had adjustable rates of interest.
We evaluate both the borrower’s ability to make principal, interest and escrow payments and the value of the property that will secure the loan. Our one- to four-family residential mortgage loans do not currently include prepayment penalties, are non-assumable and do not produce negative amortization. Our one- to four-family residential mortgage loans customarily include due-on-sale clauses giving us the right to declare the loan immediately due and payable in the event that, among other things, the borrower sells the property subject to the mortgage. We currently originate residential mortgage loans for our portfolio with loan-to-value ratios of up to 75% for one- to four-family homes, with higher limits applicable to loans with private mortgage insurance on owner-occupied residences.
At December 31, 2013, we had $2.2 million of one- to four-family residential mortgage loans that were 60 days or more delinquent.
Commercial Real Estate Lending. We also originate or purchase commercial real estate loans. At December 31, 2013, we had $19.2 million in commercial real estate loans, representing 16.12% of our total loan portfolio.At December 31, 2013, the commercial real estate was within our approved concentration limit and subject to future market, economic and regulatory conditions, is expected to be an area of loan growth in 2014.
Most of our commercial real estate loans have balloon loan terms of three to ten years with amortization terms of 15 to 25 years and fixed interest rates.The maximum loan-to-value ratio of our commercial real estate loans is generally 75%. At December 31, 2013, our largest commercial real estate loan totaled $2.5 million and was secured by a mortgage on a nonowner-occupied office building in our market area in McHenry County, Illinois. At December 31, 2013, this loan was performing in accordance with its terms. Set forth below is information regarding our commercial real estate loans at December 31, 2013.
Type of Loan | Number of Loans | Balance | ||||||
(In thousands) | ||||||||
Auto Dealership | 1 | $ | 2,236 | |||||
Retail, Other | 6 | 3,024 | ||||||
Industrial | 2 | 270 | ||||||
Mixed Use | 54 | 10,738 | ||||||
Other | 8 | 2,976 | ||||||
Total | 71 | $ | 19,244 |
We consider a number of factors in originating commercial real estate loans. We evaluate the qualifications and financial condition of the borrower, including credit history, profitability and expertise, as well as the value and condition of the property securing the loan. When evaluating the qualifications of the borrower, we consider the financial resources of the borrower, the borrower’s experience in owning or managing similar property and the borrower’s payment history with us and other financial institutions. In evaluating the property securing the loan, the factors we consider include the net operating income of the mortgaged property before debt service and depreciation, the ratio of the loan amount to the appraised value of the mortgaged property and the debt service coverage ratio (the ratio of net operating income to debt service). All commercial real estate loans are appraised by outside independent appraisers approved by the board of directors or by internal evaluations, where permitted by regulation. Personal guarantees are generally obtained from the principals of commercial real estate loans.
Loans secured by commercial real estate generally are larger than one- to four-family residential loans and involve greater credit risk. Commercial real estate loans often involve large loan balances to single borrowers or groups of related borrowers. Repayment of these loans depends to a large degree on the results of operations and management of the properties securing the loans or the businesses conducted on such property, and may be affected to a greater extent by adverse conditions in the real estate market or the economy in general. Accordingly, the nature of these loans makes them more difficult for management to monitor and evaluate.
Multi-Family Real Estate Lending. We make a limited number of loans on multi-family residences in our market area. Such loans have terms and are underwritten similarly to our commercial real estate loans and are subject to similar risks.
Home Equity Lending.We originate variable-rate home equity lines-of-credit and, to a lesser extent, fixed- and variable-rate loans secured by liens on the borrower’s primary residence. Our home equity products are limited to 75% of the property value less any other mortgages on fixed-rate amortizing second mortgage loans, and 70% of the property value less any other mortgages on variable-rate home equity lines of credit. Prior to 2009, we originated home equity loans up to 90% of the property value to our customers where we serviced their first lien mortgage loan. We use the same underwriting standards for home equity lines-of-credit and loans as we use for one- to four-family residential mortgage loans. Our home equity line-of-credit product carries an interest rate tied to the prime rate published in the Wall Street Journal. The product has a rate ceiling of 18%. Our home equity line-of-credit loans originated in 2009 had a rate floor of 4 - 4.25%. In 2010, we increased the floor on these loans to 4.50%, and remained unchanged at 4.50% in 2012 and 2013. We currently offer home equity loans with fixed-rate terms that amortize over a period of up to 20 years. Our home equity lines-of-credit provide for an initial draw period of up to five years, with monthly payments of interest calculated on the outstanding balance. At the end of the initial five years, the line may be paid in full or restructured at our then current home equity program.
At December 31, 2013, we had $7.7 million or 6.49% of total loans in home equity loans and outstanding advances under home equity lines and an additional $4.3 million of funds committed, but not advanced, under the home equity lines-of-credit.
Construction and Land Lending. We make construction loans to builders and developers for the construction of one- to four- and multi-family residential units and to individuals for the construction of their primary or secondary residence. We also make a limited amount of land loans to developers, primarily for the purpose of developing residential subdivisions.
At December 31, 2013, we had 2 outstanding one- to four-family construction loans totaling $0, with outstanding commitments to fund of $432,000.
The application process includes a submission to us of plans, specifications and costs of the project to be constructed or developed. These items are used as a basis to determine the appraised value of the subject property. Loans are based on the lesser of current appraised value and/or the cost of construction (land plus building). Our construction loan agreements generally provide that loan proceeds are disbursed in increments as construction progresses. Outside independent licensed appraisers or title company representatives under a construction loan escrow agreement inspect the progress of the construction of the dwelling before disbursements are made.
We no longer make loans to builders and developers “on speculation” to finance the construction of residential property. At December 31, 2013, we had no construction loans secured by one- to four-family residential properties built on speculation.
We also make construction loans for commercial development projects such as multi-family, apartment and other commercial buildings. These loans generally have an interest-only phase during construction then convert to permanent financing. Disbursements of construction loan funds are at our discretion based on the progress of construction. The maximum loan-to-value ratio limit applicable to these loans is generally 75%. At December 31, 2013, we had no construction loans outstanding which were secured by multi-family property.
We also make loans to builders and developers for the development of one- to four-family lots in our market area. These loans have terms of five years or less. Land loans are generally made in amounts up to a maximum loan-to-value ratio of 65% on raw land and up to 75% on developed building lots based upon an independent appraisal. We obtain personal guarantees for our land loans. At December 31, 2013, we had no land development loans.
We occasionally make loans to builders and developers for the development of vacant commercial land in our market area. These loans have terms of five years or less. Land loans are generally made in amounts up to a maximum loan-to-value ratio of 50% on raw land and up to 75% on developed building lots based upon an independent appraisal. We obtain personal guarantees for our commercial land development loans. At December 31, 2013, we had one commercial land development loan totaling $354,000 to builders/developers representing 0.30% of our total loan portfolio on commercial development properties. That loan was located in our market area.
Loans to individuals for the construction of their residences typically run for seven to twelve months and then convert to permanent loans. These construction loans have rates and terms comparable to one- to four-family residential loans offered by us. During the construction phase, the borrower pays interest only at a fixed rate. The maximum loan-to-value ratio of owner-occupied single-family construction loans is 80%. Residential construction loans are generally underwritten pursuant to the same guidelines used for originating permanent residential loans.
The following table sets forth the composition of our portfolio of construction, land and land development loans by loan type at December 31, 2013.
Number of Loans | Net Principal Balance | Non-Performing | ||||||||||
(Dollars in thousands) | ||||||||||||
One-to-four- family construction | 2 | $ | — | $ | — | |||||||
Non-residential construction | — | — | — | |||||||||
Residential land and land development | — | — | — | |||||||||
Non-residential land and land development | 1 | 354 | 354 | |||||||||
Total | 3 | $ | 354 | $ | 354 |
Construction and land lending generally affords us an opportunity to receive higher origination and other loan fees. In addition, such loans are generally made for relatively short terms. Nevertheless, construction and land lending to persons other than owner-occupants is generally considered to involve a higher level of credit risk than one- to four-family residential lending due to the concentration of principal in a limited number of loans and borrowers and the effects of general economic conditions (including the current adverse real estate market) on construction projects, real estate developers and managers. In addition, the nature of these loans is such that they are more difficult to evaluate and monitor. Our risk of loss on a construction or land loan is dependent largely upon the accuracy of the initial estimate of the property’s value upon completion of the project and the estimated cost (including interest) of the project. If the estimate of value proves to be inaccurate, we may be confronted, at or prior to the maturity of the loan, with a project with a value which is insufficient to assure full repayment and/or the possibility of having to make substantial investments to complete and sell the project. Because defaults in repayment may not occur during the construction period, it may be difficult to identify problem loans at an early stage. When loan payments become due, the cash flow from the property may not be adequate to service the debt. In such cases, we may be required to modify the terms of the loan.
We have significantly decreased our construction loan originations in light of adverse conditions in our local real estate market and economy.
Farmland.At December 31, 2013, our loans secured by farmland amounted to $13.9million or 11.65% of the total loan portfolio. These loans are primarily secured by farmland located in our market area. Our adjustable rate farmland loans have interest rates that generally adjust every one, three or five years in accordance with a designated index and are generally amortized over 15-25 years. Our fixed rate farmland loans generally are for terms of up to 15 years, although many are amortized over longer periods, and include a balloon payment at maturity. Our lending policies on such loans generally limit the maximum loan-to-value ratio to 75% of the lesser of the appraised value or purchase price of the property. At December 31, 2013, our largest farmland loan totaled $1.6million and was secured by farmland in our market area, and was performing in accordance with its terms.
While we may earn higher yields on agricultural mortgage loans than on single-family residential mortgage loans, agricultural-related lending involves a greater degree of risk than single-family residential mortgage loans because of the typically larger loan amounts and potential volatility in the market. In addition, repayments on agricultural loans are substantially dependent on the successful operation of the underlying business and the value of the property collateralizing the loan, both of which are affected by many factors, such as weather and changing market prices, outside the control of the borrower. Finally, some commentators believe that the recent sharp increases in farm land prices could make a price correction more likely.
Substantially all our farmland loans are underwritten to conform to agency guidelines to qualify for a government guarantee of up to 90% of the original loan amount, which in turn qualifies them to be sold to a variety of investors in the secondary market. Once the government guarantee is secured from Federal Agricultural Mortgage Corporation, the guarantee covers up to 90% of any loss on the loan. We may sell into the secondary market longer-term fixed rate agricultural mortgage loans, which we service for the secondary market purchasers, which are generally Farmer Mac and Farmer Mac participating banks. We sell agricultural loans primarily to mitigate concentration risk, and also to allow borrowers to avail themselves of lower interest rates that may be offered by Farmer Mac and participating banks.
Commercial and Industrial Lending. We originate commercial and industrial loans and lines of credit to small- and medium-sized companies in our primary market area. Our commercial and industrial loans are generally used for working capital purposes or for acquiring equipment, inventory or furniture. Our commercial and industrial loans generally carry a floating-rate indexed to the prime rate as published inThe Wall Street Journal and a one-year term. All of our commercial and industrial loans are secured. Subject to future economic, market and regulatory conditions, we intend to focus on this kind of lending. At December 31, 2013, we had $6.4 million in commercial and industrial loans, representing 5.38% of our total loan portfolio.
The following table sets forth the composition of our commercial and industrial loan portfolio by loan type at December 31, 2013. The balances set forth below do not include $3.8 million of committed but undrawn lines of credit on commercial and industrial loans.
Type of Loan | Number of Loans | Balance | ||||||
(In thousands) | ||||||||
Industrial secured, term loan | 7 | $ | 1,404 | |||||
Industrial secured, line of credit | 3 | 3 | ||||||
Retail secured, term loan | 13 | 411 | ||||||
Retail secured, line of credit | 11 | 466 | ||||||
Healthcare secured, term loan | 7 | 361 | ||||||
Mixed use secured, term loan | 28 | 1,616 | ||||||
Mixed use secured, line of credit | 15 | 2,163 | ||||||
Total | 84 | $ | 6,424 |
When making commercial and industrial loans, we consider the financial statements of the borrower, the lending history of the borrower, the debt service capabilities of the borrower, the projected cash flows of the business, the value of the collateral, if any, and whether the loan is guaranteed by the principals of the borrower. Commercial and industrial loans are generally secured by accounts receivable, inventory, equipment and personal guarantees.
Commercial and industrial loans generally have a greater credit risk than residential mortgage loans. Unlike residential mortgage loans, which generally are made on the basis of the borrower’s ability to make repayment from his or her employment and other income, and which are secured by real property whose value tends to be more easily ascertainable, commercial and industrial loans are of higher risk and typically are made on the basis of the borrower’s ability to make repayment from the cash flow of the borrower’s business. As a result, the availability of funds for the repayment of commercial and industrial loans may be substantially dependent on the success of the business itself. Further, the collateral securing the loans may depreciate over time, may be difficult to appraise and may fluctuate in value based on the success of the business. We seek to minimize these risks through our underwriting standards and personal guarantees.
At December 31, 2013, our largest commercial and industrial loan relationship was with a producer of pet food products in our market area with unpaid principal balances and total commitment of $909,000 and $1.7 million, respectively. At December 31, 2013, these loans were performing in accordance with their terms.
Agricultural Lending. We also originate agricultural operating lines of credit and intermediate-term loans. Our agricultural operating lines of credit generally have terms of one year and are secured by growing crops, livestock and equipment, and mortgages on the farmland. Our intermediate-term loans have terms of 2-7 years and will be secured by machinery and equipment. Generally these loans are extended to farmers in our market area for the purchase of equipment, seed, fertilizer, insecticide and other purposes in connection with agricultural production. The maximum term for equipment secured loans is tied to the useful life of the underlying collateral but cannot exceed 10 years. The interest rate is generally increased with respect to the longer terms loans due to the rate exposure of these loans. The amount of the commitment is based on management’s review of the borrower’s business plan, prior performance, marketability of crops, and current market prices. We examine recent financial statements and evaluate cash flow analysis and debt-to-net worth, and liquidity ratios. Loans for crop production generally require 75% or more crop insurance coverage. At December 31, 2013, we had $24.3million in agriculture loans, representing 20.40% of our total loan portfolio.
The repayment of agricultural business loans generally is dependent on the successful operation of a farm and can be adversely affected by fluctuations in crop prices, increase in interest rates, and changes in weather conditions. These developments may result in smaller harvests and less income for farmers which may adversely affect such borrower’s ability to repay a loan. Many of our borrowers also have more than one agricultural business loan outstanding with us. Consequently, an adverse development with respect to one loan or one credit relationship can expose us to significantly greater risk of loss compared to an adverse development with respect to a one- to four-family residential mortgage loan. Finally, if we foreclose on an agricultural commercial loan, our holding period for the collateral, if any, typically is longer than for one- to four-family residential mortgage loans because there are fewer potential purchasers of the collateral.
The following table sets forth the composition of our agriculture loan portfolio by loan type at December 31, 2013. The balances set forth below do not include $6.6million of committed but undrawn lines of credit on agriculture loans.
Number of Loans | Balance | |||||||
(In thousands) | ||||||||
Crop production secured, term loan | 59 | $ | 4,426 | |||||
Crop production secured, line of credit | 43 | 10,905 | ||||||
Dairy and other livestock secured, term loan | 32 | 2,770 | ||||||
Dairy and other livestock secured, line of credit | 22 | 6,242 | ||||||
Total | 156 | $ | 24,343 |
At December 31, 2013, our largest agriculture loan relationship was $3.7 million with a farming operation in our market area. At December 31, 2013, those loans were performing in accordance with their terms.
Consumer Lending. We make secured loans to consumers. In 1999, in an effort to expand and diversify our loan portfolio and increase the overall yield on our loan portfolio, we began purchasing indirect loans on new and used automobiles located primarily in Cook County, Illinois. Although we do not separately underwrite each purchased loan, we thoroughly review the knowledge and experience of the originators’ management teams, their underwriting standards, and their historical loss rates. Our target portfolio for these loans is currently $6-$8 million.
Under the loan purchase arrangement, the seller aggregates indirect automobile loans into separate loan pools. The pools are then segregated into risk categories with each category having predefined limits as to the maximum amounts allowed. Generally, the pools are sold without recourse. We receive a listing of the individual loans in the pool, including loan and borrower information prior to funding the purchase but we are not generally permitted to substitute loans in a pool or purchase part of a pool.
The seller is responsible for dealer relationships and the monitoring of their performance. The seller performs all servicing functions including the collection of principal, interest, and fees as well as repossessions and recoveries. Thus, we are not involved in the sale of repossessed vehicles.
We perform semi-annual reviews of newly purchased loan files and review operational procedures as part of our internal audit function. We purchased $3.7 million and $4.3 million of loans, respectively, in 2013 and 2012. At December 31, 2013, we had $7.6 million of purchased indirect automobile loans outstanding, representing 6.37% of our gross loan portfolio. Included in the balance at December 31, 2013 was $2.2 million of automobile loans with no credit score or a credit score below 660 (which loans are considered by the FDIC to have certain features of subprime lending).
Consumer loans may entail greater credit risk than residential mortgage loans, particularly in the case of consumer loans which are unsecured or are secured by rapidly depreciable assets, such as automobiles. In addition, consumer loan collections are dependent on the borrower’s continuing financial stability, and thus are more likely to be affected by adverse personal circumstances as well as the current slowing economy. Furthermore, the application of various federal and state laws, including bankruptcy and insolvency laws, may limit the amount which can be recovered on such loans. For the years ended December 31, 2013 and December 31, 2012, we had net charge-offs of $24,000 and $47,000, respectively, on consumer loans.At December 31, 2013 and December 31, 2012 we had no nonperforming consumer loans.At December 31, 2013 and 2012, we had $0 and $83,000, respectively, of repossessed automobiles. At December 31, 2013 and 2012, there were purchased indirect automobile loans totaling $4,000 and $25,000, respectively, that were delinquent 30 days or more.
Originations, Purchases and Sales of Loans
We originate real estate and other loans through marketing efforts, our customer base, walk-in customers and referrals from real estate brokers, builders and attorneys. All loans originated by us are underwritten pursuant to our policies and procedures.
We may sell certain loans we originate into the secondary market. We consider our own balance sheet as well as market conditions in making decisions as to whether to hold the mortgage loans we originate for investment or to sell such loans to investors, choosing the strategy that is most advantageous to us from a profitability and risk management standpoint. We generally do not make loan sale commitments until we receive a corresponding borrower commitment. To date, all of our loan sales have been on a servicing-retained basis. At December 31, 2013, we serviced $79.5 million of loans held by other institutions.
From time to time, to diversify our risk, we purchase interests in various types of loans. We underwrite our participation portion of the loan according to our own underwriting criteria and procedures. At December 31, 2013, we had $3.0 million in loan participation interests, $2.6 million or 87.99% of which are in our market area. As discussed above under “—Consumer Lending,” we had $7.6 million of purchased indirect automobile loans, all of which were outside of our primary market area, at December 31, 2013.
Delinquencies and Non-Performing Assets
Delinquency Procedures. When a borrower fails to make a required monthly loan payment by the end of the applicable grace period, a late notice is generated stating the payment and late charges due. Our policies provide that borrowers that become 30 days or more delinquent are contacted by phone or mail to determine the reason for nonpayment and to discuss future payments. If repayment is not possible or doubtful, the loan will be brought to the appropriate loan committee for possible foreclosure. Once a loan has been declared due and payable, a certified letter is sent to the borrower explaining that the entire balance of the loan is due and payable. If the loan is reinstated, foreclosure proceedings will be discontinued and the borrower will be permitted to continue to make payments. If the borrower does not respond, we will initiate foreclosure proceedings.
When we acquire real estate as a result of foreclosure or by deed in lieu of foreclosure, the real estate is classified foreclosed real estate until it is sold. The real estate is recorded at estimated fair value at the date of acquisition less estimated costs to sell, and any write-down resulting from the acquisition is charged to the allowance for loan losses. Estimated fair value is based on a new appraisal which is obtained as soon as practicable, typically after the foreclosure process has begun but no later than 30 days after acquisition. Subsequent decreases in the value of the property are charged to operations through the creation of a valuation allowance. After acquisition, all costs incurred in maintaining the property are expensed. Costs relating to the development and improvement of the property, however, are capitalized to the extent of estimated fair value less estimated costs to sell.
While delinquencies and repossession of purchased indirect automobile loans are handled by the loan seller, we selectively audit this process to ensure that our interests are protected.
Troubled Debt Restructurings. As further discussed in Note 4 to the financial statements included herein, we periodically modify loans to extend the term or make other concessions to help a borrower stay current on his or her loan and to avoid foreclosure. We generally do not forgive principal or interest on loans. We will modify the terms of loans to lower interest rates (which may be at below market rates), and/or to provide for longer amortization schedules (up to 40 years), and/or provide for interest-only terms. These modifications are made only when there is a reasonable and attainable workout plan that has been agreed to by the borrower and that is in our best interests. Troubled debt restructurings are considered impaired at the time of restructuring and typically are returned to accrual status after considering the borrower’s sustained repayment performance for a reasonable period of at least six to twelve months. As further discussed under “—Non-Performing Assets”, we had seven nonaccrual loans totaling $1.3 million that were classified as troubled debt restructurings at December 31, 2013.
During the year ended December 31, 2013, the Company modified one residential real estate loan, with a recorded investment of $245,000 prior to modification, which was deemed a TDR. The modification was to lower the interest rate and extend the maturity date. This resulted in specific allowances of $16,000 based upon the fair value of the collateral and impairment losses of $16,000 based upon the present value of expected future cash flows, discounted at the contractual interest rate of the original loan agreement.
As of December 31, 2013, the Company had two loans totaling $76,000 in default that had been modified within the previous twelve months as TDRs. As of December 31, 2013, there were four TDRs secured by one- to four-family real estate loans totaling $669,000 and one TDR secured by commercial land for development of $354,000, all of which were in default. Default occurs when a loan or lease is 90 days or more past due, transferred to nonaccrual or charged-off and is within 12 months of restructuring.
Delinquent Loans. The following table sets forth our loan delinquencies, including non-accrual loans, by type and amount at the dates indicated.
At December 31, | ||||||||||||||||||||||||
2013 | 2012 | |||||||||||||||||||||||
30-59 Days Past Due | 60-89 Days Past Due | 90 Days or More Past Due | 30-59 Days Past Due | 60-89 Days Past Due | 90 Days or More Past Due | |||||||||||||||||||
(In thousands) | ||||||||||||||||||||||||
Real estate loans: | ||||||||||||||||||||||||
One- to four-family | $ | 770 | $ | 607 | $ | 1,608 | $ | 1,464 | $ | 808 | $ | 1,122 | ||||||||||||
Home equity line of credit and other 2nd mortgage | 26 | 40 | 44 | 51 | 14 | 35 | ||||||||||||||||||
Multi-family | — | — | — | — | — | — | ||||||||||||||||||
Commercial | 33 | — | — | — | — | — | ||||||||||||||||||
Farmland | — | — | — | — | — | — | ||||||||||||||||||
Construction and land development | — | — | 354 | — | — | — | ||||||||||||||||||
Total real estate loans | 829 | 647 | 2,006 | 1,515 | 822 | 1,157 | ||||||||||||||||||
Commercial and industrial | 135 | 11 | 3 | — | — | 7 | ||||||||||||||||||
Agriculture | — | — | — | — | — | — | ||||||||||||||||||
Consumer loans: | ||||||||||||||||||||||||
Purchased indirect automobile | 4 | — | — | 25 | — | — | ||||||||||||||||||
Other | — | — | — | — | — | — | ||||||||||||||||||
Total consumer loans | 4 | — | — | 25 | — | — | ||||||||||||||||||
Total | $ | 968 | $ | 658 | $ | 2,009 | $ | 1,540 | $ | 822 | $ | 1,164 |
Total delinquencies increased $109,000 or 3.09% to $3.6 million at December 31, 2013 from $3.5 million at December 31, 2012. Total delinquencies as a percent of total loans were 3.05% and 3.00% at December 31, 2013 and 2012, respectively. The largest category of delinquencies was one- to four–family real estate loans which decreased $409,000 million or 12.05% to $3.0 million at December 31, 2013 from $3.4 million at December 31, 2012.
Classified Assets. Federal regulations provide for the classification of loans and other assets, such as debt and equity securities considered by the Federal Deposit Insurance Corporation to be of lesser quality, as “substandard,” “doubtful” or “loss.” An asset is considered “substandard” if it is inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any. “Substandard” assets include those characterized by the “distinct possibility” that the insured institution will sustain “some loss” if the deficiencies are not corrected. Assets classified as “doubtful” have all of the weaknesses inherent in those classified “substandard,” with the added characteristic that the weaknesses present make “collection or liquidation in full,” on the basis of currently existing facts, conditions, and values, “highly questionable and improbable.” Assets classified as “loss” are those considered “uncollectible” and of such little value that their continuance as assets without the establishment of a specific loss reserve is not warranted. Assets which do not currently expose the insured institution to sufficient risk to warrant classification in one of the aforementioned categories but possess weaknesses are designated as “special mention” by our management.
When an insured institution classifies problem assets as either substandard or doubtful, it may establish general allowances in an amount deemed prudent by management to cover probable accrued losses. General allowances represent loss allowances which have been established to cover probable accrued losses associated with lending activities, but which, unlike specific allowances, have not been allocated to particular problem assets. When an insured institution classifies problem assets as “loss,” it is required either to establish a specific allowance for losses equal to 100% of that portion of the asset so classified or to charge-off such amount. An institution’s determination as to the classification of its assets and the amount of its valuation allowances is subject to review by the regulatory authorities, which may require the establishment of additional general or specific loss allowances.
In connection with the filing of our periodic reports and in accordance with our classification of assets policy, we regularly review the problem loans in our portfolio to determine whether any loans require classification in accordance with applicable regulations. Loans are listed on the “watch list” initially because of delinquency status, typically when a loan becomes 60 days past due and collection proceedings begin, or if a loan possesses the minimum level of acceptable credit risk and servicing requirements and the borrower has the capacity to perform according to the terms and repayment is expected, but one or more elements of uncertainty exist. The watch list describes the action plan and nature and type of underlying collateral for each problem loan, as well as the date and amount of the most recent appraisal for real estate loans. Management reviews the status of each loan on our watch list on a monthly basis and then with the board of directors. If a loan deteriorates in asset quality, the classification is changed to “special mention,” “substandard,” “doubtful” or “loss” depending on the circumstances and the evaluation. Generally, loans 90 days or more past due are placed on nonaccrual status and classified substandard, unless the loan is well secured and in the process of collection.
On the basis of this review of our assets, our classified and special mention and other watch assets at the dates indicated were as follows:
At December 31, | ||||||||
2013 | 2012 | |||||||
(In thousands) | ||||||||
Watch loans | $ | 5,400 | $ | 5,590 | ||||
Special mention loans | 5,152 | 1,104 | ||||||
Substandard assets | 3,096 | 5,901 | ||||||
Doubtful assets | — | — | ||||||
Loss assets | — | — | ||||||
Total watch and classified assets | $ | 13,648 | $ | 12,595 |
Total watch and classified assets increased $1.0 million or 8.36% to $13.6 million at December 31, 2013 from $12.6 million at December 31, 2012. The largest decrease was in substandard assets which decreased $2.8 million or 47.53% to $3.1 million at December 31, 2013 from $5.9 million at December 31, 2012. Substandard assets at December 31, 2013 consisted of $331,000 in foreclosed assets held for sale and loans of $2.8 million. Substandard assets at December 31, 2012 consisted of $886,000 in foreclosed assets held for sale and loans of $5.0 million. The largest increase was in special mention loans which increased $4.1 million or 366.67% to $5.2 million at December 31, 2013 from $1.1 million at December 31, 2012. A commercial real estate loan totaling $2.5 million at December 31, 2013 was upgraded from substandard to special mention during 2013. As further discussed in Note 4 to the financial statements included herein, troubled debt restructurings decreased to $2.3 million at December 31, 2013, of which $1.3 million were classified substandard, compared to $4.2 million at December 31, 2012, of which $3.2 million were classified substandard.
Non-Performing Assets.We generally cease accruing interest on our loans when contractual payments of principal or interest have become 90 days past due or management has serious doubts about further collectibility of principal or interest, even though the loan is currently performing. A loan may remain on accrual status if it is in the process of collection and is either guaranteed or well secured. When a loan is placed on nonaccrual status, unpaid interest credited to income is reversed. Interest received on nonaccrual loans generally is applied against principal. Generally, loans are restored to accrual status when the obligation is brought current, has performed in accordance with the contractual terms for a reasonable period of time and the ultimate collectibility of the total contractual principal and interest is no longer in doubt. Restructured loans are restored to accrual status when the obligation is brought current, has performed in accordance with the revised contractual terms for a reasonable period of time (typically six to twelve months) and the ultimate collectibility of the total contractual principal and interest is reasonably assured.
The following table sets forth information regarding our nonperforming assets, including troubled debt restructurings, at the dates indicated. See our discussion on troubled debt restructurings under “—Troubled Debt Restructurings.”
At December 31, | ||||||||
2013 | 2012 | |||||||
(Dollars in thousands) | ||||||||
Non-Accrual: | ||||||||
Real estate loans: | ||||||||
One- to four-family | $ | 2,284 | $ | 2,484 | ||||
Home equity lines of credit and other 2nd mortgage | 120 | 166 | ||||||
Multi-family | — | — | ||||||
Commercial | — | 1,482 | ||||||
Farmland | — | — | ||||||
Construction and land development | 354 | 851 | ||||||
Total real estate loans | 2,758 | 4,983 | ||||||
Commercial and industrial | 3 | 7 | ||||||
Agriculture | — | — | ||||||
Consumer loans: | ||||||||
Purchased indirect automobile | — | — | ||||||
Other | — | — | ||||||
Total consumer loans | — | — | ||||||
Total nonaccrual loans | 2,761 | 4,990 | ||||||
Accruing loans past due 90 days or more: | ||||||||
Real estate loans: | ||||||||
One- to four-family | — | — | ||||||
Home equity line of credit and other 2nd mortgage | — | — | ||||||
Multi-family | — | — | ||||||
Farmland | — | — | ||||||
Commercial | — | — | ||||||
Construction and land development | — | — | ||||||
Total real estate loans | — | — | ||||||
Commercial and industrial | — | — | ||||||
Agriculture | — | — | ||||||
Consumer loans: | ||||||||
Purchased indirect automobile | — | — | ||||||
Other | — | — | ||||||
Total consumer loans | — | — | ||||||
Total accruing loans past due 90 days or more | — | — | ||||||
Total of non-accrual and 90 days or more past due loans | 2,761 | 4,990 | ||||||
Other real estate owned: | ||||||||
One- to four-family | 331 | 187 | ||||||
Commercial | — | 616 | ||||||
Total other real estate owned | 331 | 803 | ||||||
Repossessed automobiles | — | 83 | ||||||
Total non-performing assets | 3,092 | 5,876 | ||||||
Troubled debt restructurings (not included in non-accrual loans above)(1) | 1,009 | 934 | ||||||
Total non-performing assets, including troubled debt restructurings | $ | 4,101 | $ | 6,810 | ||||
Total non-performing loans to total loans | 2.31 | % | 4.25 | % | ||||
Total non-performing assets to total assets | 1.82 | % | 3.47 | % | ||||
Total non-performing loans, including troubled debt restructurings to total loans | 3.16 | % | 5.04 | % | ||||
Total non-performing assets, including troubled debt restructurings to total assets | 2.41 | % | 4.02 | % |
(1) | Troubled debt restructurings included in nonaccrual loans totaled $1.3 million and $3.2 million at December 31, 2013 and 2012, respectively. |
Total non-performing assets, including troubled debt restructurings, decreased $2.7 million or 39.8% to $4.1 million at December 31, 2013 from $6.8 million at December 31, 2012. Total non-performing assets, including troubled debt restructurings, to total assets were 2.4% and 4.0% at December 31, 2013 and 2012, respectively. Troubled debt restructurings included in nonaccrual loans totaled $1.3 million at December 31, 2013, compared to $3.2 million at December 31, 2012.
Non-accrual one- to four-family real estate loans totaled $2.3 million at December 31, 2013 and consisted of 19 loans secured by properties located in our market area. Those loans included 5 loans that totaled $905,000 that are troubled debt restructurings, which resulted in charge-offs of $124,000 in fiscal 2013. Only one of those troubled debt restructurings totaling $236,000 was performing according to the terms of the restructuring. Non-accrual one- to four-family real estate loans at December 31, 2013 included 6 loans totaling $625,000 that were in the process of foreclosure, and resulted in charge-offs of $55,000 in fiscal 2013. Non-accrual one- to four-family real estate loans at December 31, 2013 included 8 other loans totaling $754,000 that were in the process of collection, and resulted in charge-offs of $13,000 in fiscal 2013. We have established impairment allowances of $63,000 on the non-performing one- to four-family real estate loans at December 31, 2013. There was 1 one-to four - family real estate loan totaling $90,000 at December 31, 2013, which was previously modified in a troubled debt restructuring, and was returned to accrual status duringfiscal 2013 and reclassified as a watch loan from a substandard loan.
Non-accrual home equity lines of credit and other second mortgage loans totaled $120,000 at December 31, 2013 and consisted of 8 loans secured by properties located in our market area, including4 loans which have been completely charged off that were in the process of foreclosure and resulted in charge-offs of $69,000 in fiscal 2013. Non-accrual home equity lines of credit and other second mortgage loans included 4 other loans in the process of collection totaling $120,000, that resulted in no charge-offs in fiscal2013. We have established impairment allowances of $29,000 on the non-performing home equity lines of credit and other second mortgage loans at December 31, 2013.
Non-accrual construction and land development loans totaled $354,000 at December 31, 2013 and consisted of a commercial land development loan secured by property in our market area that was refinanced in a troubled debt restructuring in 2011 which provided for both interest rate and maturity concessions. The loan was not performing according to the terms of the restructuring and was in the process of foreclosure, and resulted in charge-offs of $74,000 in fiscal 2013.
Other non-performing loans totaled $3,000 at December 31, 2013. We have established impairment allowances of $3,000 on those loans at December 31, 2013.
Other real estate owned totaled $331,000 at December 31, 2013, which consisted of 3 single-family homes. All the properties are located in our market area. The properties are carried at estimated fair value less costs to sell. The properties resulted in no losses from writedowns subsequent to acquisition in 2013.
There were no other loans at December 31, 2013 that are not already disclosed where there is information about possible credit problems of borrowers that caused us serious doubts about the ability of the borrowers to comply with present loan repayment terms and that may result in disclosure of such loans in the future.
Interest income that would have been recorded for the year ended December 31, 2013, had non-accruing loans been current according to their original terms, amounted to $116,000. Interest of $70,000 was recognized on these loans and is included in net income for the year ended December 31, 2013.
Allowance for Loan Losses
Analysis and Determination of the Allowance for Loan Losses. Our allowance for loan losses is the amount considered necessary to reflect probable incurred losses in our loan portfolio. We evaluate the need to establish allowances against losses on loans on a quarterly basis. When additional allowances are necessary, a provision for loan losses is charged to earnings.
Our methodology for assessing the appropriateness of the allowance for loan losses consists of two key elements: (1) specific allowances for identified problem loans; and (2) a general valuation allowance on the remainder of the loan portfolio. Although we determine the amount of each element of the allowance separately, the entire allowance for loan losses is available for the entire portfolio.
We identify loans that may need to be charged off as a loss by reviewing all delinquent loans, classified loans, and other loans about which management may have concerns about collectability. For individually reviewed loans, the borrower’s inability to make payments under the terms of the loan as well as the shortfall in collateral value would result in our charging off the loan or the portion of the loan that was impaired.
Among other factors, we consider current general economic conditions, including current housing price depreciation, in determining the appropriateness of the allowance for loan losses for our residential real estate portfolio. We use evidence obtained from our own loan portfolio as well as published housing data on our local markets from third party sources we believe to be reliable as a basis for assumptions about the impact of housing depreciation. The amount of general and specific allowances for our residential real estate loans have been impacted, in part, because the values of residential real estate in our local markets securing our portfolio have declined significantly.
Substantially all of our loans are secured by collateral. At December 31, 2013, 67.75% of our loan portfolio was secured by real estate, including 39.68% that was secured by residential real estate. Loans 90 days past due and other classified loans are evaluated for impairment and general or specific allowances are established. Typically for a nonperforming real estate loan in the process of collection, the value of the underlying collateral is estimated using the original independent appraisal, adjusted for current economic conditions and other factors, and related general or specific reserves are adjusted on a quarterly basis. If a nonperforming real estate loan is in the process of foreclosure and/or there are serious doubts about further collectability of principal or interest, and there is uncertainty about the value of the underlying collateral, we will order a new independent appraisal. Any shortfall would result in immediately charging off the portion of the loan that was impaired.
Specific Allowances for Identified Problem Loans.We establish a specific allowance when loans are determined to be impaired. Loss is measured by determining the present value of expected future cash flows or, for collateral-dependent loans, the fair value of the collateral adjusted for market conditions and selling expenses. Factors in identifying a specific problem loan include: (1) the strength of the customer’s personal or business cash flows; (2) the availability of other sources of repayment; (3) the amount due or past due; (4) the type and value of collateral; (5) the strength of our collateral position; (6) the estimated cost to sell the collateral; and (7) the borrower’s effort to cure the delinquency. In addition, for loans secured by real estate, we consider the extent of any past due and unpaid property taxes applicable to the property serving as collateral on the mortgage.
General Valuation Allowance on Certain Identified Problem Loans. Groups of loans with similar risk characteristics, including individually evaluated loans not determined to be impaired, are collectively evaluated for impairment based on the group’s historical loss experience adjusted for changes in trends, conditions, and other relevant factors that affect repayment of the loans. Accordingly, we generally do not separately identify individual residential and consumer loans for impairment measurements. Instead, we provide for general valuation allowances on certain homogeneous pools of residential and consumer loans classified as substandard.
General Valuation Allowance on the Remainder of the Loan Portfolio. We establish a general allowance for loans that are not classified as substandard to recognize the inherent losses associated with lending activities, but which, unlike specific allowances, has not been allocated to particular problem assets. This general valuation allowance is determined by segregating the loans by loan category and assigning allowance percentages based on our historical loss experience, delinquency trends and management’s evaluation of the collectibility of the loan portfolio. The allowance may be adjusted for significant factors that, in management’s judgment, affect the collectibility of the portfolio as of the evaluation date. These significant factors may include changes in lending policies and procedures, changes in existing general economic and business conditions affecting our primary market area, credit quality trends, collateral value, loan volumes and concentrations, seasoning of the loan portfolio, recent loss experience in particular segments of the portfolio, duration of the current business cycle and bank regulatory examination results. The applied loss factors are re-evaluated quarterly to ensure their relevance in the current real estate environment.
As an integral part of their examination process, the Federal Deposit Insurance Corporation and the Illinois Department of Financial and Professional Regulation periodically review our allowance for loan losses. Such agencies may require that we recognize additions to the allowance based on their judgments of information available to them at the time of their examination.
Allowance for Loan Losses. The following table sets forth activity in our allowance for loan losses for the years indicated.
Year Ended December 31, | ||||||||
2013 | 2012 | |||||||
(Dollars in thousands) | ||||||||
Allowance at beginning of year | $ | 2,550 | $ | 2,575 | ||||
Provision for loan losses | 453 | 599 | ||||||
Charge offs: | ||||||||
Real estate loans | ||||||||
One- to four-family | 330 | 365 | ||||||
Home equity line of credit and other 2nd mortgage | 69 | 24 | ||||||
Multi-family | — | — | ||||||
Commercial | — | — | ||||||
Farmland | — | — | ||||||
Construction and land | 151 | 172 | ||||||
Total charge-offs, real estate loans | 550 | 561 | ||||||
Commercial and industrial | — | 16 | ||||||
Agriculture | — | — | ||||||
Consumer loans: | ||||||||
Purchased indirect automobile | 33 | 59 | ||||||
Other | — | — | ||||||
Total charge-offs, consumer loans | 33 | 59 | ||||||
Total charge-offs | 583 | 636 | ||||||
Recoveries: | ||||||||
Real estate loans | ||||||||
One- to four-family | 29 | — | ||||||
Home equity line of credit and other 2nd mortgage | — | — | ||||||
Multi-family | — | — | ||||||
Commercial | — | — | ||||||
Farmland | — | — | ||||||
Construction and land | 17 | — | ||||||
Total recoveries, real estate loans | 46 | — | ||||||
Commercial and industrial | — | — | ||||||
Agriculture | — | — | ||||||
Consumer loans: | ||||||||
Purchased indirect automobile | 3 | 10 | ||||||
Other | 6 | 2 | ||||||
Total recoveries, consumer loans | 9 | 12 | ||||||
Total recoveries | 55 | 12 | ||||||
Net charge-offs | (528 | ) | (624 | ) | ||||
Allowance at end of year | $ | 2,475 | $ | 2,550 | ||||
Allowance for loan losses to total non-performing loans, including troubled debt restructurings | 65.58 | % | 43.05 | % | ||||
Allowance to nonperforming loans | 89.51 | % | 51.10 | % | ||||
Allowance to total loans outstanding at the end of the period | 2.07 | % | 2.17 | % | ||||
Net charge-offs (recoveries) to average (annualized) loans outstanding during the year | 0.45 | % | 0.52 | % |
The allowance as a percent of total loans decreased modestly to 2.07% at December 31, 2013 from 2.17% at December 31, 2012. Loan categories experiencing the most charge-offs in 2013 involved owner-occupied one- to four-family residential real estate, construction and land development, and home equity line of credit and other second mortgage loan categories. Non-performing loans decreased $2.2 million, or 44.67%, to $2.8 million at December 31, 2013 from $5.0 million at December 31, 2012. All non-performing loans were also classified substandard and specific reserves for substandard loans totaled $96,000 and $431,000 at December 31, 2013 and 2012, respectively. The lower level of non-performing loans impacted the allowance for loan losses as a percent of non-performing loans which increased to 89.51% at December 31, 2013 from 51.10% at December 31, 2012.
Allocation of Allowance for Loan Losses.The following table sets forth the allowance for loan losses allocated by loan category, the percent of allowance in each loan category to the total allowance, and the percent of loans in each category to total loans at the dates indicated. The allowance for loan losses allocated to each category is not necessarily indicative of future losses in any particular category and does not restrict the use of the allowance to absorb losses in other categories.
At December 31, | ||||||||||||||||||||||||
2013 | 2012 | |||||||||||||||||||||||
Amount | % of Allowance to Total Allowance | % of Loans in Category to Total Loans | Amount | % of Allowance to Total Allowance | % of Loans in Category to Total Loans | |||||||||||||||||||
(Dollars in thousands) | ||||||||||||||||||||||||
Real estate loans: | ||||||||||||||||||||||||
One- to four-family | $ | 644 | 26.02 | % | 33.09 | % | $ | 668 | 26.20 | % | 35.61 | % | ||||||||||||
Home equity line of credit and other 2nd mortgage | 318 | 12.85 | 6.49 | 333 | 13.06 | 8.02 | ||||||||||||||||||
Multi-family | 6 | 0.24 | 0.10 | 3 | 0.12 | 0.04 | ||||||||||||||||||
Commercial | 694 | 28.04 | 16.12 | 530 | 20.78 | 17.01 | ||||||||||||||||||
Farmland | 208 | 8.40 | 11.65 | 176 | 6.90 | 10.01 | ||||||||||||||||||
Construction and land development | — | — | 0.30 | 275 | 10.78 | 1.56 | ||||||||||||||||||
Total real estate loans | 1,870 | 75.55 | 67.75 | 1,985 | 77.84 | 72.25 | ||||||||||||||||||
Commercial and industrial | 110 | 4.45 | 5.38 | 151 | 5.93 | 4.60 | ||||||||||||||||||
Agriculture | 377 | 15.23 | 20.40 | 301 | 11.80 | 17.10 | ||||||||||||||||||
Consumer loans: | ||||||||||||||||||||||||
Purchased indirect automobile | 117 | 4.73 | 6.37 | 112 | 4.39 | 5.95 | ||||||||||||||||||
Other | 1 | 0.04 | 0.10 | 1 | 0.04 | 0.10 | ||||||||||||||||||
Total consumer loans | 118 | 4.77 | 6.47 | 113 | 4.43 | 6.05 | ||||||||||||||||||
Unallocated | — | — | — | — | — | — | ||||||||||||||||||
Total allowance for loan losses | $ | 2,475 | 100.00 | % | 100.00 | % | $ | 2,550 | 100.00 | % | 100.00 | % |
At December 31, 2013, our allowance for loan losses represented 2.07% of total loans and 89.51% of nonperforming loans. The allowance for loan losses decreased $75,000 to $2.5 million at December 31, 2013 from $2.6 million at December 31, 2012, due to a provision for loan losses of $453,000, offset by net charge-offs of $528,000.
Although we believe that we use the best information available to establish the allowance for loan losses, future adjustments to the allowance for loan losses may be necessary and results of operations could be adversely affected if circumstances differ substantially from the assumptions used in making the determinations. Furthermore, while we believe we have established our allowance for loan losses in conformity with accounting principles generally accepted in the United States of America, regulators, in reviewing our loan portfolio, may request us to increase our allowance for loan losses. In addition, because future events affecting borrowers and collateral cannot be predicted with certainty, the existing allowance for loan losses may not be adequate and increases may be necessary should the quality of any loan deteriorate as a result of the factors discussed above. Any material increase in the allowance for loan losses may adversely affect our financial condition and results of operations.
Investment Activities
General. The goals of our investment policy are to provide and maintain liquidity to meet deposit withdrawal and loan funding needs, to help mitigate our interest rate risk, and to generate a favorable return on idle funds within the context of our interest rate and credit risk objectives.
Our board of directors is responsible for adopting our investment policy. The investment policy is reviewed annually by management and any changes to the policy are recommended to and subject to the approval of the board of directors. Authority to make investments under the approved investment policy guidelines is delegated to our Chief Executive Officer and Chief Financial Officer. All investment transactions are reviewed at regularly scheduled monthly meetings of the board of directors.
Our current investment policy permits, with certain limitations, investments in securities issued by the United States Government and its agencies or government sponsored enterprises, mortgage-backed securities and, to a lesser extent, corporate debt securities, commercial paper, certificates of deposits in other financial institutions, investments in bank-owned life insurance, collateralized mortgage obligations, asset-backed securities, real estate mortgage investment conduits, securities sold under agreements to repurchase, and debt securities of state and political subdivisions.
With the exception of obligations of the U.S. Treasury and other U.S. government agencies and corporations, we held no securities at December 31, 2013, that exceeded 10% of our total stockholders’ equity.
U.S. Government and Federal Agency Obligations. At December 31, 2013, our U.S. Government and federal agency securities portfolio had an amortized cost and fair value of $1.5 million. While these securities generally provide lower yields than other investments in our securities investment portfolio, we maintain these investments, to the extent appropriate, for liquidity purposes, as collateral for borrowings and for prepayment protection.
Mortgage-Backed Securities. At December 31, 2013, the amortized cost and fair value of our mortgage-backed securities portfolio totaled $627,000 and $640,000, respectively. Mortgage-backed securities are securities issued in the secondary market that are collateralized by pools of mortgages. Certain types of mortgage-backed securities are commonly referred to as “pass-through” certificates because the principal and interest of the underlying loans is “passed through” to investors, net of certain costs, includingservicing and guarantee fees.Mortgage-backed securities typically are collateralized by pools of one- to four-family or multifamily mortgages, although we invest primarily in mortgage-backed securities backed by one- to four-family mortgages. The issuers of such securities pool and resell the participation interests in the form of securities to investors such as Harvard Savings Bank. The interest rate of the security is lower than the interest rates of the underlying loans to allow for payment of servicing and guaranty fees.Mortgage-backed securities are more liquid than individual mortgage loans since there is an active trading market for such securities. In addition, mortgage-backed securities may be used to collateralize our borrowings.
Ginnie Mae, a United States Government agency, and government-sponsored enterprises, such as Fannie Mae and Freddie Mac, either guarantee the payments or guarantee the timely payment of principal and interest to investors. In September 2008, the Federal Housing Finance Agency placed Freddie Mac and Fannie Mae into conservatorship. The U.S. Treasury Department has established financing agreements to ensure that Freddie Mac and Fannie Mae meet their obligations to holders of mortgage-backed securities that they have issued or guaranteed. These actions have not affected the markets for mortgage-backed securities issued by Freddie Mac or Fannie Mae.
Investments in mortgage-backed securities involve a risk that actual payments will be greater or less than the prepayment rate estimated at the time of purchase, which may require adjustments to the amortization of any premium or accretion of any discount relating to such interests, thereby affecting the net yield on our securities. Current prepayment speeds determine whether prepayment estimates require modification that could cause amortization or accretion adjustments.
Collateralized Mortgage Obligations. Collateralized mortgage obligations are backed by mortgages but differ from pass through mortgage-backed securities because the principal and interest payments of the underlying mortgages are financially engineered to be paid to the security holders of pre-determined classes or tranches of these securities at a faster or slower pace. The receipt of these principal and interest payments, which depends on the proposed average life for each class, is contingent on a prepayment speed assumption assigned to the underlying mortgages. Variances between the assumed payment speed and actual payments can significantly alter the average lives of such securities. To quantify and mitigate this risk, we undertake a high level of payment analysis before purchasing these securities. The collateralized mortgage obligations in our portfolio have been packaged by U.S. financial institutions. We purchase only seasoned AAA-rated senior CMO classes or tranches in which the payments on the underlying mortgages are passed along at a pace fast enough to provide an average life of one to ten years with no change in market interest rates. At December 31, 2013, our CMO portfolio, which were all classified held-to-maturity and rated A, had an amortized cost and fair value of $320,000 and $323,000, respectively.
State and Political Subdivision Debt Securities. At December 31, 2013, we had state and political subdivision securities with an amortized cost and fair value of $3.5 million and $3.4 million, respectively, all classified as available-for-sale. We have purchased bank-qualified general obligation and revenue bonds of certain state and political subdivisions which provide interest income that is exempt from federal income taxation. Our investment policy permits purchases of these securities so long as they are rated in the top three investment grades, with maximum term to maturity and duration of 15 and 10 years, respectively.
Mutual Funds and Other Equity Securities.Purchases of mutual funds and other equity securities are not permitted by our current investment policy; however, such purchases were permitted prior to 2009. At December 31, 2013, our mutual fund portfolio had an amortized cost and fair value of $443,000 and $458,000, respectively, all of which was classified as available-for-sale and all of which was invested in two Shay Asset Management mutual funds, the AMF Ultra Short Mortgage Fund and AMF Ultra Short Fund. Both funds invest primarily in mortgage-related securities. For the years ended December 31, 2013 and 2012, we recognized no loss for other-than-temporary impairment on our mutual funds.
At December 31, 2013, we held common stock of Freddie Mac and community banks with an amortized cost and fair value of $12,000 and $50,000, respectively, all of which were classified as available-for-sale. For the years ended December 31, 2013 and 2012, we recognized a loss for other-than-temporary impairment on these equity securities of $0 and $1,000, respectively, due to a decline in fair value below our cost.
Federal Home Loan Bank Stock. We hold common stock of the Federal Home Loan Bank of Chicago in connection with our borrowing activities totaling $870,000 at December 31, 2013. The common stock of such entity is carried at cost and classified as restricted equity securities.
During 2013, we received $534,000 at our carrying amount, from net redemptions of Federal Home Loan Bank of Chicago common stock. In 2013, we received $4,000 in dividends on our investment in Federal Home Loan Bank of Chicago stock.
Bank-Owned Life Insurance. We invest in bank-owned life insurance to provide us with a funding source for our benefit plan obligations. Bank-owned life insurance also generally provides us non-interest income that is non-taxable. The purchase of bank-owned life insurance is limited as outlined in the Interagency Statement on the Purchase and Risk Management of Life Insurance (“Statement”), which highlights five areas of guidance for use by institutions in the purchase and ongoing risk management of bank-owned life insurance (“BOLI”). These areas include a comprehensive risk management process, effective senior management and board oversight, policies and procedures with risk limits, sound pre-purchase analysis, and an ongoing monitoring of BOLI risks. The Statement also recommends limiting BOLI holdings to 25% or less of Tier 1 capital. We performed a comprehensive pre-purchase analysis prior to the purchase of our BOLI assets. Our Board of Directors has adopted policies and procedures that prohibit our purchase of additional BOLI until our holdings decrease to 25% or less of Tier 1 capital and the value of policies, and limits our BOLI holdings from any one insurance carrier to 15% of Tier 1 capital. As of December 31, 2013, we held approximately $4.5 million in cash surrender value of life insurance issued by 5 separate insurance companies, which totaled 25.80% of Tier 1 capital.We also conduct an annual risk assessment and monitor the performance of our insurance carriers on a regular basis.
Securities Purchased Under Agreements to Repurchase. At December 31, 2013, we held securities under agreements to repurchase totaling $25.1 million. These agreements represent a short-term overnight cash investment alternative. These agreements are over-collateralized at no less than 103% with collateral consisting of securities and loans guaranteed by the “full faith and credit” of the United States Government.
Securities Portfolio Composition. The following table sets forth the amortized cost and fair value of our securities portfolio at the dates indicated. Securities available for sale are carried at fair value, while securities held to maturity are carried at amortized cost.
At December 31, | ||||||||||||||||
2013 | 2012 | |||||||||||||||
Amortized Cost | Fair Value | Amortized Cost | Fair Value | |||||||||||||
(In thousands) | ||||||||||||||||
Securities available for sale: | ||||||||||||||||
U.S. Government and federal agency | $ | 990 | $ | 982 | $ | 3,194 | $ | 3,185 | ||||||||
Mortgage-backed | 614 | 626 | 758 | 779 | ||||||||||||
State and political subdivisions | 3,461 | 3,429 | 3,467 | 3,449 | ||||||||||||
Total debt securities | 5,065 | 5,037 | 7,419 | 7,413 | ||||||||||||
Shay Asset Management mutual funds | 443 | 458 | 438 | 447 | ||||||||||||
Other equity securities | 12 | 50 | 12 | 19 | ||||||||||||
Total equity securities | 455 | 508 | 450 | 466 | ||||||||||||
Total available for sale | $ | 5,520 | $ | 5,545 | $ | 7,869 | $ | 7,879 | ||||||||
Securities held to maturity: | ||||||||||||||||
U.S. Government and federal agency | $ | 500 | $ | 502 | $ | 500 | $ | 521 | ||||||||
Mortgage-backed (1) | 13 | 14 | 17 | 18 | ||||||||||||
Collateralized mortgage obligations, privately issued | 320 | 323 | 746 | 775 | ||||||||||||
Total securities held to maturity | $ | 833 | $ | 839 | $ | 1,263 | $ | 1,314 | ||||||||
Total | $ | 6,353 | $ | 6,384 | $ | 9,132 | $ | 9,193 |
Securities Portfolio Maturities and Yields. The following table sets forth the stated maturities and weighted average yields of our securities at December 31, 2013. Securities held to maturity are carried at amortized cost, and securities available for sale are carried at fair value. Mortgage-backed securities, including collateralized mortgage obligations, are anticipated to be repaid in advance of their contractual maturities as a result of projected mortgage loan repayments. Certain securities have interest rates that are adjustable and will reprice annually within the various maturity ranges. These repricing schedules have not been reflected in the table below.
One Year or Less | More than One Year to Five Years | More than Five Years to Ten Years | More than Ten Years | Equity Securities | Total | |||||||||||||||||||||||||||||||||||||||||||
Amortized Cost | Weighted Average Yield | Amortized Cost | Weighted Average Yield | Amortized Cost | Weighted Average Yield | Amortized Cost | Weighted Average Yield | Amortized Cost | Weighted Average Yield | Amortized Cost | Weighted Average Yield | |||||||||||||||||||||||||||||||||||||
(Dollars in thousands) | ||||||||||||||||||||||||||||||||||||||||||||||||
Securities available-for-sale: | ||||||||||||||||||||||||||||||||||||||||||||||||
U.S. Government and federal agency | $ | 500 | 0.20 | % | $ | 490 | 0.85 | % | $ | — | — | % | $ | — | — | % | $ | — | — | % | $ | 990 | 0.52 | % | ||||||||||||||||||||||||
Mortgage-backed | — | — | 27 | 4.43 | 375 | 1.64 | 212 | 1.63 | — | — | 614 | 1.76 | ||||||||||||||||||||||||||||||||||||
State and political subdivisions | 146 | 1.21 | 2,467 | 1.17 | 848 | 0.95 | — | — | — | — | 3,461 | 1.12 | ||||||||||||||||||||||||||||||||||||
Total debt securities | 646 | 0.43 | 2,984 | 1.15 | 1,223 | 1.16 | 212 | 1.63 | — | — | 5,065 | 1.08 | ||||||||||||||||||||||||||||||||||||
Shay Asset Management mutual funds | — | — | — | — | — | — | — | — | 443 | 1.20 | 443 | 1.20 | ||||||||||||||||||||||||||||||||||||
Other equity securities | — | — | — | — | — | — | — | — | 12 | — | 12 | — | ||||||||||||||||||||||||||||||||||||
Total equity securities | — | — | — | — | — | — | — | — | 455 | 1.17 | 455 | 1.17 | ||||||||||||||||||||||||||||||||||||
Total securities available for sale | $ | 646 | 0.43 | % | $ | 2,984 | 1.15 | % | $ | 1,223 | 1.16 | % | $ | 212 | 1.63 | % | $ | 455 | $ | 1.17 | $ | 5,520 | 1.09 | % | ||||||||||||||||||||||||
Securities held to maturity: | ||||||||||||||||||||||||||||||||||||||||||||||||
U.S. Government and federal agency | $ | 500 | 4.00 | % | $ | — | — | % | $ | — | — | % | $ | — | — | % | $ | — | — | % | $ | 500 | 4.00 | % | ||||||||||||||||||||||||
Mortgage-backed | — | �� | 7 | 2.20 | 6 | 3.54 | — | — | — | — | 13 | 2.84 | ||||||||||||||||||||||||||||||||||||
Collateralized mortgage obligations, privately issued | — | — | 320 | 6.84 | — | — | — | — | — | — | 320 | 6.84 | ||||||||||||||||||||||||||||||||||||
Total securities held to maturity | $ | 500 | 4.00 | % | $ | 327 | 6.74 | % | $ | 6 | 3.54 | % | $ | — | — | % | $ | — | — | % | $ | 833 | 5.07 | % | ||||||||||||||||||||||||
Total | $ | 1,146 | 1.99 | % | $ | 3,311 | 1.70 | % | $ | 1,229 | 1.17 | % | $ | 212 | 1.63 | % | $ | 455 | 1.17 | % | $ | 6,353 | 1.61 | % |
Sources of Funds
General.Deposits have traditionally been our primary source of funds for use in lending and investment activities. We also use borrowings, primarily Federal Home Loan Bank of Chicago advances, to supplement cash flow needs, lengthen the maturities of liabilities for interest rate risk purposes and to manage the cost of funds. In addition, we receive funds from scheduled loan payments, investment maturities, loan prepayments, retained earnings and income on earning assets. While scheduled loan payments and income on earning assets are relatively stable sources of funds, deposit inflows and outflows can vary widely and are influenced by prevailing interest rates, market conditions and levels of competition.
Deposits.Our deposits are generated primarily from residents within our primary market area. We offer a selection of deposit accounts, including demand accounts, NOW accounts, money market accounts, savings accounts and certificates of deposit.Deposit account terms vary, with the principal differences being the minimum balance required, the amount of time the funds must remain on deposit and the interest rate. We occasionally utilize brokered deposits to fund our operations based on our analysis of available rates and maturities, alternative sources of funds and investment opportunities. At December 31, 2013, the Bank had no brokered deposits.
Interest rates paid, maturity terms, service fees and withdrawal penalties are established on a periodic basis. Deposit rates and terms are based primarily on current operating strategies and market rates, liquidity requirements, rates paid by competitors and growth goals. Personalized customer service, long-standing relationships with customers, and the favorable image of Harvard Savings Bank in the community are relied upon to attract and retain deposits.
The flow of deposits is influenced significantly by general economic conditions, changes in interest rates and competition. Our ability to gather deposits is impacted by the competitive market in which we operate which includes numerous financial institutions of varying sizes offering a wide range of products. We often use promotional rates to meet asset/liability and market segment goals.
The variety of deposit accounts offered allows us to be competitive in obtaining funds and responding to changes in consumer demand. Based on our experience, we believe that statement savings, demand, NOW and money market accounts may be somewhat more stable sources of deposits than certificates of deposits. Also, we believe that our deposits allow us a greater opportunity to connect with our customers and offer them other financial services and products. As a result, we have used marketing and other initiatives to increase such accounts. However, it can be difficult to attract and maintain such deposits at favorable interest rates under current market conditions.
The following table sets forth the distribution of total deposits by account type, at the dates indicated.
At December 31, | ||||||||||||||||||||||||
2013 | 2012 | |||||||||||||||||||||||
Balance | Percent | Weighted Average Rate | Balance | Percent | Weighted Average Rate | |||||||||||||||||||
(Dollars in thousands) | ||||||||||||||||||||||||
Demand deposit accounts | $ | 6,463 | 4.83 | % | — | % | $ | 6,278 | 4.69 | % | — | % | ||||||||||||
NOW accounts | 17,610 | 13.17 | 0.13 | 18,633 | 13.91 | 0.12 | ||||||||||||||||||
Savings accounts | 17,256 | 12.90 | 0.14 | 17,071 | 12.74 | 0.13 | ||||||||||||||||||
Money market accounts | 16,928 | 12.66 | 0.27 | 15,867 | 11.84 | 0.24 | ||||||||||||||||||
Certificates of deposit | 75,493 | 56.44 | 1.47 | 76,136 | 56.82 | 1.60 | ||||||||||||||||||
Broker certificates of deposit | — | — | — | — | — | — | ||||||||||||||||||
Total deposits | $ | 133,750 | 100.00 | % | 0.90 | % | $ | 133,985 | 100.00 | % | 0.97 | % |
As of December 31, 2013, the aggregate amount of all our certificates of deposit in amounts greater than or equal to $100,000 was approximately $28.6 million. The following table sets forth the maturity of these certificates as of December 31, 2013.
Certificates of Deposit of $100,000 or more | ||||
(In thousands) | ||||
Three months or less | $ | 4,931 | ||
Over three through six months | 3,211 | |||
Over six through twelve months | 4,682 | |||
Over twelve months | 15,812 | |||
Total | $ | 28,636 |
The following table sets forth all our certificates of deposit classified by interest rate as of the dates indicated.
At December 31, | |||||||||||
2013 | 2012 | ||||||||||
(In thousands) | |||||||||||
Less than 1% | $ | 20,118 | $ | 18,111 | |||||||
1.00% | - | 1.99% | 37,985 | 40,118 | |||||||
2.00% | - | 2.99% | 9,272 | 9,823 | |||||||
3.00% | - | 3.99% | 7,930 | 7,776 | |||||||
4.00% | - | 4.99% | 188 | 308 | |||||||
5.00% | - | 5.99% | — | — | |||||||
Total | $ | 75,493 | $ | 76,136 |
The following table sets forth the amount and maturities of all our certificates of deposit by interest rate at December 31, 2013.
At December 31, 2013 | |||||||||||||||||||||||||||||||||||
Period to Maturity | |||||||||||||||||||||||||||||||||||
Less Than One Year | Over One Year to Two Years | Over Two Years to Three Years | Over Three Years to Four Years | Over Four Years to Five Years | Over Five Years | Total | Percentage of Total Certificate Accounts | ||||||||||||||||||||||||||||
(Dollars in thousands) | |||||||||||||||||||||||||||||||||||
Less than 1% | $ | 15,297 | $ | 4,014 | $ | 807 | $ | — | $ | — | $ | — | $ | 20,118 | 26.66 | % | |||||||||||||||||||
1.00% | - | 1.99% | 11,719 | 7,996 | 8,479 | 9,791 | — | — | 37,985 | 50.32 | |||||||||||||||||||||||||
2.00% | - | 2.99% | 3,415 | 5,857 | — | — | — | — | 9,272 | 12.28 | |||||||||||||||||||||||||
3.00% | - | 3.99% | 2,419 | 5,511 | — | — | — | — | 7,930 | 10.50 | |||||||||||||||||||||||||
4.00% | - | 4.99% | 91 | 96 | 1 | — | — | 188 | 0.25 | ||||||||||||||||||||||||||
5.00% | - | 5.99% | — | — | — | — | — | — | — | — | |||||||||||||||||||||||||
Total | $ | 32,941 | $ | 23,474 | $ | 9,287 | $ | 9,791 | $ | — | $ | — | $ | 75,493 | 100.00 | % |
Borrowings. We may obtain advances from the Federal Home Loan Bank of Chicago upon the security of our capital stock in the Federal Home Loan Bank of Chicago and certain of our loans. Such advances may be made pursuant to several different credit programs, each of which has its own interest rate and range of maturities. To the extent such borrowings have different terms to repricing than our deposits, they can change our interest rate risk profile.
From time to time during recent years, we have utilized short-term borrowings to fund loan demand. To a limited extent, we have also used borrowings where market conditions permit to purchase securities of a similar duration in order to increase our net interest income by the amount of the spread between the asset yield and the borrowing cost. From time to time, we have obtained advances with terms of more than one year to extend the term of our liabilities.
The following table sets forth certain information regarding our borrowed funds at and for the years indicated. Average balances are predominantly derived from daily balances, and to a lesser extent, from month end balances. Management does not believe that the limited use of month end balances rather than daily balances has caused any material differences in the information presented.
At or for the Year Ended December 31, | ||||||||
2013 | 2012 | |||||||
(Dollars in thousands) | ||||||||
Federal Home Loan Bank advances: | ||||||||
Balance at end of year | $ | 12,206 | $ | 12,357 | ||||
Average balances outstanding during the year | 12,954 | 12,896 | ||||||
Maximum balance outstanding at any month end | 15,147 | 16,839 | ||||||
Weighted average interest rate during the year | 1.93 | % | 2.64 | % | ||||
Weighted average interest rate at the end of year | 1.52 | % | 2.37 | % |
The following table sets forth certain information regarding our borrowed funds that have an original term of maturity of one year or less at or for the years indicated. Average balances are predominantly derived from daily balances, and to a lesser extent, from month end balances. Management does not believe that the limited use of month end balances rather than daily balances has caused any material differences in the information presented.
At or for the Year Ended December 31, | ||||||||
2013 | 2012 | |||||||
(Dollars in thousands) | ||||||||
Federal Home Loan Bank advances: | ||||||||
Balance at end of year | $ | 4,200 | $ | 3,000 | ||||
Average balances outstanding during the year | 3,392 | 2,480 | ||||||
Maximum balance outstanding at any month end | 6,650 | 5,000 | ||||||
Weighted average interest rate during the year | 0.25 | % | 0.26 | % | ||||
Maximum balance outstanding at any month end | 0.30 | % | 0.22 | % |
Subsidiary andOther Activities
Harvard Illinois Bancorp, Inc. owns 100% of the outstanding shares of common stock of Harvard Savings Bank. Harvard Savings Bank has no subsidiaries.
SUPERVISION AND REGULATION
General
Harvard Savings Bank is examined and supervised by the Division of Banking of the Illinois Department of Financial and Professional Regulation and the Federal Deposit Insurance Corporation. This regulation and supervision establishes a comprehensive framework of activities in which an institution may engage and is intended primarily for the protection of the Federal Deposit Insurance Corporation’s deposit insurance fund and depositors. These regulators are not, however, generally charged with protecting the interests of shareholders of Harvard Illinois Bancorp, Inc. Under this system of state and federal regulation, financial institutions are periodically examined to ensure that they satisfy applicable standards with respect to their capital adequacy, assets, management, earnings, liquidity and sensitivity to market interest rates. Harvard Savings Bank also is a member of and owns stock in the Federal Home Loan Bank of Chicago, which is one of the twelve regional banks in the Federal Home Loan Bank System. Harvard Savings Bank’s relationship with its depositors and borrowers also is regulated to a great extent by both federal and state laws, especially in matters concerning the ownership of deposit accounts and the form and content of Harvard Savings Bank’s mortgage documents.
The Illinois Department of Financial and Professional Regulation and the Federal Deposit Insurance Corporation have extensive enforcement authority over Illinois-chartered savings banks, such as Harvard Savings Bank. This enforcement authority includes, among other things, the ability to issue cease-and-desist or removal orders, to assess civil money penalties and to initiate injunctive actions. In general, these enforcement actions may be initiated for violations of laws and regulations and unsafe and unsound banking practices.
The Illinois Department of Financial and Professional Regulation has established a schedule for the assessment of “supervisory fees” for all Illinois savings banks to fund the operations of the Illinois Department of Financial and Professional Regulation. These supervisory fees are computed on the basis of each savings bank’s total assets (including consolidated subsidiaries) and are payable at the end of each calendar quarter. A schedule of fees has also been established for certain filings made by Illinois savings banks with the Illinois Department of Financial and Professional Regulation. The Illinois Department of Financial and Professional Regulation also assesses fees for examinations conducted by the Illinois Department of Financial and Professional Regulation’s staff, based upon the number of hours spent by the staff performing the examination. During the year ended December 31, 2013, Harvard Savings Bank paid approximately $8,000 in supervisory fees and paid approximately $35,000 in examination fees. In 2012, we received a credit of approximately $16,000 from the Illinois Department of Financial and Professional Regulation pursuant to a state statute, $12,000 of which was utilized in 2012 and $4,000 utilized 2013, to offset supervisory fees assessed. The Federal Deposit Insurance Corporation does not assess fees for its examination and supervisory activities.
Certain regulatory requirements applicable to Harvard Savings Bank and Harvard Illinois Bancorp, Inc. are referred to below or appear elsewhere in this Annual Report on Form 10-K. The regulatory discussion, however, does not purport to be an exhaustive treatment of applicable laws and regulations and is qualified in its entirety be reference to the actual statutes and regulations.Any change in these laws or regulations, whether by the Federal Deposit Insurance Corporation, the Illinois Department of Financial and Professional Regulation, the Federal Reserve Board or Congress, could have a material adverse impact on Harvard Illinois Bancorp, Inc. and Harvard Savings Bank, and their operations.
Dodd-Frank Act
The Dodd-Frank Act made significant changes to the regulatory structure for depository institutions and their holding companies. However, the Dodd-Frank Act’s changes go well beyond that and affect the lending, investments and other operations of all depository institutions. The Dodd-Frank Act required the Federal Reserve Board to set minimum capital levels for both bank holding companies and savings and loan holding companies that are as stringent as those required for the insured depository subsidiaries, and the components of Tier 1 capital for holding companies were restricted to capital instruments that were then currently considered to be Tier 1 capital for insured depository institutions. The legislation also established a floor for capital of insured depository institutions that cannot be lower than the standards in effect upon passage, and directed the federal banking regulators to implement new leverage and capital requirements that take into account off-balance sheet activities and other risks, including risks relating to securitized products and derivatives.
The Dodd-Frank Act created a new Consumer Financial Protection Bureau with broad powers to supervise and enforce consumer protection laws. The Consumer Financial Protection Bureau has broad rule-making authority for a wide range of consumer protection laws that apply to all banks and savings institutions such as Harvard Savings Bank, including the authority to prohibit “unfair, deceptive or abusive” acts and practices. The Consumer Financial Protection Bureau has examination and enforcement authority over all banks and savings institutions with more than $10 billion in assets. Banks and savings institutions with $10 billion or less in assets are still examined for compliance by their applicable bank regulators. The new legislation also weakened the federal preemption available for national banks and federal savings associations, and gave state attorneys general the ability to enforce applicable federal consumer protection laws.
The Dodd-Frank Act broadened the base for FDIC insurance assessments. Assessments are now based on the average consolidated total assets less tangible equity capital of a financial institution, rather than on total deposits. The legislation also permanently increased the maximum amount of deposit insurance for banks, savings institutions and credit unions to $250,000 per depositor, retroactive to January 1, 2008. The Dodd-Frank Act increased stockholder influence over boards of directors by requiring companies to give stockholders a non-binding vote on executive compensation and so-called “golden parachute” payments. The legislation also directs the Federal Reserve Board to promulgate rules prohibiting excessive compensation paid to bank holding company executives, regardless of whether the company is publicly traded or not. Further, the legislation requires that originators of securitized loans retain a percentage of the risk for transferred loans, directs the Federal Reserve Board to regulate pricing of certain debit card interchange fees and contains a number of reforms related to mortgage origination.
The Dodd-Frank Act also required the Consumer Financial Protection Board to issue regulations requiring lenders to make a reasonable good faith determination as to a prospective borrower’s ability to repay a residential mortgage loan. The final “Ability to Repay” rules, which are effective January 4, 2013, establish a “qualified mortgage” safe harbor for loans whose terms and features are deemed to make the loan less risky.
Many provisions of the Dodd-Frank Act involve delayed effective dates and/or require implementing regulations or have not been issued in final form. Their impact on our operations cannot yet fully be assessed. However, there is a significant possibility that the Dodd-Frank Act will result in an increased regulatory burden and compliance, operating and interest expense for Harvard Savings Bank and Harvard Illinois Bancorp, Inc.
Savings Bank Regulation
As an Illinois savings bank, Harvard Savings Bank is subject to federal regulation and supervision by the Federal Deposit Insurance Corporation and to state regulation and supervision by the Illinois Department of Financial and Professional Regulation. Harvard Savings Bank’s deposit accounts are insured by Deposit Insurance Fund, which is administered by the Federal Deposit Insurance Corporation.
Under Federal Deposit Insurance Corporation regulations, an insured state-chartered bank, such as Harvard Savings Bank, is prohibited from engaging as principal in activities that are not permitted for national banks, unless: (i) the Federal Deposit Insurance Corporation determines that the activity would pose no significant risk to the appropriate deposit insurance fund and (ii) the bank is, and continues to be, in compliance with all applicable capital standards.
Branching and Interstate Banking.The establishment of branches by Harvard Savings Bank is subject to approval of the Illinois Department of Financial and Professional Regulation and Federal Deposit Insurance Corporation and geographic limits established by state laws. Federal law facilitates the interstate expansion and consolidation of banking organizations by permitting, among other things, (i) bank holding companies that are adequately capitalized and managed to acquire banks located in states outside their home state regardless of whether such acquisitions are authorized under the law of the host state, (ii) the interstate merger of banks, subject to the right of individual states to “opt out” of this authority, and (iii) the establishment of de novo branches on an interstate basis provided that the law of the host state authorizes banks chartered by it to similarly branch within its borders.
Capital Requirements. The FDIC requires federally-insured state-chartered banks that are not members of the Federal Reserve System (“state non-member banks”) to meet minimum capital standards: a 4% core capital to total assets leverage ratio (3% for institutions receiving the highest rating on the CAMELS rating system), a 4% core capital to risk-based assets ratios, and an 8% total capital to risk-based assets ratio.
As noted, the risk-based capital standard requires the maintenance of core capital (also referred to as Tier 1 capital) and total capital (which is defined as core capital and supplementary capital) to risk-weighted assets of at least 4% and 8%, respectively. In determining the amount of risk-weighted assets, all assets, including certain off-balance sheet assets, are multiplied by a risk-weight factor of 0% to 200%, assigned by the regulations, based on the risks believed inherent in the type of asset. Core capital is defined as common stockholders’ equity (including retained earnings), certain noncumulative perpetual preferred stock and related surplus and minority interests in equity accounts of consolidated subsidiaries, less intangibles other than certain mortgage servicing rights and credit card relationships. The components of supplementary capital (also referred to as Tier 2 capital) include cumulative preferred stock, long-term perpetual preferred stock, mandatory convertible securities, subordinated debt and intermediate preferred stock, the allowance for loan and lease losses limited to a maximum of 1.25% of risk-weighted assets and up to 45% of net unrealized gains on available-for-sale equity securities with readily determinable fair market values. Overall, the amount of supplementary capital included as part of total capital cannot exceed 100% of core capital. Additionally, an institution that retains credit risk in connection with an asset sale is required to maintain additional regulatory capital because of the purchaser’s recourse against the institution. In assessing an institution’s capital adequacy, the FDIC takes into consideration not only these numeric factors, but qualitative factors as well and has the authority to establish higher capital requirements for individual associations where necessary.
At December 31, 2013, Harvard Savings Bank’s capital exceeded all applicable requirements.
New Capital Rule.On July 9, 2013, the federal bank regulatory agencies issued a final rule that will revise their risk-based capital requirements and the method for calculating risk-weighted assets to make them consistent with agreements that were reached by the international Basel Committee on Banking Supervision and certain provisions of the Dodd-Frank Act. The final rule applies to all depository institutions, top-tier bank holding companies with total consolidated assets of $500 million or more and top-tier savings and loan holding companies.
The rule establishes a new common equity core (Tier 1) minimum capital requirement (4.5% of risk-weighted assets), increases the minimum core capital to risk-based assets requirement (from 4.0% to 6.0% of risk-weighted assets) and assigns a higher risk weight (150%) to exposures that are more than 90 days past due or are on nonaccrual status and to certain commercial real estate facilities that finance the acquisition, development or construction of real property. The minimum leverage ratio will be established at a uniform 4%.
The rule also includes changes in what constitutes regulatory capital. Tier 2 capital will no longer be limited to the amount of Tier 1 capital included in total capital. Mortgage servicing rights, certain deferred tax assets and investments in unconsolidated subsidiaries over designated percentages of common stock are subject to deduction above more stringent limits than the existing regulations. Core capital generally will include accumulated other comprehensive income (which includes all unrealized gains and losses on available for sale debt and equity securities). Harvard Savings Bank has the one-time option in the first quarter of 2015 to permanently opt out of the inclusion of accumulated other comprehensive income in its regulatory capital calculation. Harvard Savings Bank is considering whether to opt out in order to reduce the impact of market volatility on its regulatory capital levels.
As noted, the new capital requirements also include changes in the risk weights of assets designed to better reflect credit risk and other risk exposures. These include a 150% risk weight (up from 100%) for certain high volatility commercial real estate acquisition, development and construction loans and non-residential mortgage loans that are 90 day past due or otherwise on non-accrual status, a 20% (up from 0%) credit conversion factor for the unused portion of a commitment with an original maturity of one year or less that is not unconditionally cancellable; a 250% risk weight (up from 100%) for mortgage servicing and deferred tax assets that are not deducted from capital; and increased risk-weights (a range of 0% to 600%) for certain equity exposures.
The rule limits an institution’s capital distributions and certain discretionary bonus payments to executives if the banking organization does not hold a “capital conservation buffer” consisting of 2.5% of common equity Tier 1 capital to risk-weighted assets in addition to the amount necessary to meet its minimum risk-based capital requirements.
The final rule becomes effective for Harvard Savings Bank on January 1, 2015. More stringent deduction requirements are subject to transition through January 1, 2018. The capital conservation buffer requirement will be phased in beginning January 1, 2016 at 0.625% of risk-weighted assets increasing each year until fully implemented at 2.5% on January 1, 2019.
Harvard Savings Bank has conducted a pro forma analysis of the application of these new capital requirements as of December 31, 2013. We have determined that Harvard Savings Bank meets all of these new requirements, except for the full 2.5% capital conservation buffer, as if these new requirements had been in effect on that date.
A state non-member bank may not make a capital distribution that would reduce its regulatory capital below the amount required by the FDIC’s regulatory capital regulations or for the liquidation account established in connection with its conversion to stock form. In addition, beginning in 2016, Harvard Savings Bank’s ability to pay dividends will be limited if Harvard Savings Bank does not have the capital conservation buffer required by the new capital rules, which may limit the ability of Harvard Illinois Bancorp, Inc. to pay dividends to its stockholders.
Loans-to-One Borrower.Generally, an institution may not make a loan or extend credit to a single or related group of borrowers in excess of 15% of unimpaired capital and surplus. An additional amount may be loaned, equal to 10% of unimpaired capital and surplus, if the loan is secured by readily marketable collateral, which generally does not include real estate. As of December 31, 2013, Harvard Savings Bank was in compliance with the loans-to-one borrower limitations.
Qualified Thrift Lender Test.In order for Harvard Illinois Bancorp, Inc. to be regulated as a savings and loan holding company (rather than as a bank holding company) by the Federal Reserve Board, Harvard Savings Bank must qualify as a “qualified thrift lender” under applicable regulations or satisfy the “domestic building and loan association” test under the Internal Revenue Code. Under the qualified thrift lender test, an institution is required to maintain at least 65% of its “portfolio assets” (total assets less: (i) specified liquid assets up to 20% of total assets; (ii) goodwill and other intangible assets; and (iii) the value of property used to conduct business) in certain “qualified thrift investments” (primarily residential mortgages and related investments, including certain mortgage-backed and related securities) in at least nine out of each 12 month period. Harvard Savings Bank currently maintains the majority of its portfolio assets in qualified thrift investments and has met the qualified thrift lender test in each of the last 12 months.
Transactions with Related Parties. A savings bank’s authority to engage in transactions with its affiliates is limited by Sections 23A and 23B of the Federal Reserve Act and Regulation W promulgated by the Board of Governors of the Federal Reserve System. An affiliate is generally a company that controls, is controlled by, or is under common control with an insured depository institution such as Harvard Savings Bank. Harvard Illinois Bancorp, Inc. is an affiliate of Harvard Savings Bank. In general, transactions between an insured depository institution and its affiliates are subject to certain quantitative and collateral requirements. In addition, applicable regulations prohibit a savings bank from lending to any of its affiliates that are engaged in activities that are not permissible for bank holding companies and from purchasing the securities of any affiliate, other than a subsidiary. Finally, transactions with affiliates must be consistent with safe and sound banking practices, not involve low-quality assets and be on terms that are as favorable to the institution as comparable transactions with non-affiliates. Applicable regulations require savings banks to maintain detailed records of all transactions with affiliates.
Harvard Savings Bank’s authority to extend credit to its directors, executive officers and 10% or greater stockholders, as well as to entities controlled by such persons, is governed by the requirements of Sections 22(g) and 22(h) of the Federal Reserve Act and Regulation O promulgated by the Board of Governors of the Federal Reserve System. Among other things, these provisions require that extensions of credit to insiders:
(i) | be made on terms that are substantially the same as, and follow credit underwriting procedures that are not less stringent than, those prevailing for comparable transactions with unaffiliated persons and that do not involve more than the normal risk of repayment or present other unfavorable features, and |
(ii) | not exceed certain limitations on the amount of credit extended to such persons, individually and in the aggregate, which limits are based, in part, on the amount of Harvard Savings Bank’s capital. |
In addition, extensions of credit in excess of certain limits must be approved in advance by Harvard Savings Bank’s Board of Directors. Extensions of credit to executive officers are subject to additional limits based on the type of extension involved.
Enforcement. The FDIC has primary enforcement responsibility over state-chartered savings banks and has authority to bring enforcement action against all “institution-affiliated parties,” including directors, officers, stockholders, attorneys, appraisers and accountants who knowingly or recklessly participate in wrongful action likely to have an adverse effect on a savings bank. Formal enforcement action by the FDIC may range from the issuance of a capital directive or cease and desist order to removal of officers and/or directors of the institution and the appointment of a receiver or conservator. Civil penalties cover a wide range of violations and actions, and range up to $25,000 per day, unless a finding of reckless disregard is made, in which case penalties may be as high as $1 million per day. The FDIC also has the authority to terminate deposit insurance with respect to a particular savings bank.
Standards for Safety and Soundness. Federal law requires each federal banking agency to prescribe certain standards for all insured depository institutions. These standards relate to, among other things, internal controls, information systems and audit systems, loan documentation, credit underwriting, interest rate risk exposure, asset growth, compensation and other operational and managerial standards as the agency deems appropriate. Interagency guidelines set forth the safety and soundness standards that the federal banking agencies use to identify and address problems at insured depository institutions before capital becomes impaired. If the appropriate federal banking agency determines that an institution fails to meet any standard prescribed by the guidelines, the agency may require the institution to submit to the agency an acceptable plan to achieve compliance with the standard. If an institution fails to meet these standards, the appropriate federal banking agency may require the institution to implement an acceptable compliance plan. Failure to implement such a plan can result in further enforcement action, including the issuance of a cease and desist order or the imposition of civil money penalties.
Dividend Limitations.Harvard Illinois Bancorp, Inc. is a legal entity separate and distinct from Harvard Savings Bank. The primary source of the cash flow of Harvard Illinois Bancorp, including cash flow to pay dividends on Harvard Illinois Bancorp, Inc.’s common stock, is the payment of dividends to Harvard Illinois Bancorp, Inc. by Harvard Savings Bank. Under Illinois law, Harvard Savings Bank may pay dividends of so much of its undivided profits (generally, earnings less losses, bad debts, taxes and other operating expenses) as is considered expedient by Harvard Savings Bank’s board. However, Harvard Savings Bank must obtain the approval of the Illinois Department of Financial and Professional Regulation for the payment of a dividend if the total of all dividends declared by Harvard Savings Bank during the current year, including the proposed dividend, would exceed the sum of retained net income for the year to date plus its retained net income for the previous two years. For this purpose, “retained net income” means net income as calculated for call report purposes, less all dividends declared for the applicable period. Also, the Federal Deposit Insurance Corporation has the supervisory authority to prohibit Harvard Savings Bank from paying dividends if, in its opinion, the payment of dividends would constitute an unsafe or unsound banking practice in light of the financial condition of Harvard Savings Bank.
Even if an application is not otherwise required, every savings bank that is a subsidiary of a savings and loan holding company, such as Harvard Savings Bank, must still file a notice with the Federal Reserve Board at least 30 days before the board of directors declares a dividend or approves a capital distribution.
A notice or application related to a capital distribution may be disapproved if:
● | the savings bank would be undercapitalized following the distribution; |
● | the proposed capital distribution raises safety and soundness concerns; or |
● | the capital distribution would violate a prohibition contained in any statute, regulation or agreement. |
In addition, the Federal Deposit Insurance Act provides that an insured depository institution may not make any capital distribution if, after making such distribution, the institution would fail to meet any applicable regulatory capital requirement. In addition, beginning in 2016, Harvard Savings Bank’s ability to pay dividends will be limited if Harvard Savings Bank does not have the capital conservation buffer required by the new capital rules, which may limit the ability of Harvard Illinois Bancorp, Inc. to pay dividends to its stockholders. See “—New Capital Rule.”
Insurance of Deposit Accounts.The Deposit Insurance Fund of the FDIC insures deposits at FDIC-insured financial institutions such asHarvard Savings Bank. Deposit accounts inHarvard Savings Bank are insured by the FDIC generally up to a maximum of $250,000 per separately insured depositor and up to a maximum of $250,000 for self-directed retirement accounts. The FDIC charges insured depository institutions premiums to maintain the Deposit Insurance Fund.
Under the FDIC’s risk-based assessment system, insured institutions are assigned to one of four risk categories based on supervisory evaluations, regulatory capital levels and certain other risk factors. Rates are based on each institution’s risk category and certain specified risk adjustments. Stronger institutions pay lower rates while riskier institutions pay higher rates. Assessments are based on an institution’s average consolidated total assets minus average tangible equity instead of total deposits. Assessment rates (inclusive of possible adjustments) currently range from 2 1/2 to 45 basis points of each institution’s total assets less tangible capital. The FDIC may increase or decrease the scale uniformly, except that no adjustment can deviate more than two basis points from the base scale without notice and comment rulemaking. The FDIC’s current system represents a change, required by the Dodd-Frank Act, from its prior practice of basing the assessment on an institution’s volume of deposits.
In addition to the FDIC assessments, the Financing Corporation (“FICO”) is authorized to impose and collect, with the approval of the FDIC, assessments for anticipated payments, issuance costs and custodial fees on bonds issued by the FICO in the 1980s to recapitalize the former Federal Savings and Loan Insurance Corporation. The bonds issued by the FICO are due to mature in 2017 through 2019. For the quarter ended December 31, 2013, the annualized FICO assessment was equal to 0.64 basis points of total assets less tangible capital.
The Dodd-Frank Act increased the minimum target Deposit Insurance Fund ratio from 1.15% of estimated insured deposits to 1.35% of estimated insured deposits. The FDIC must seek to achieve the 1.35% ratio by September 30, 2020. Insured institutions with assets of $10 billion or more are supposed to fund the increase. The Dodd-Frank Act eliminated the 1.5% maximum fund ratio, instead leaving it to the discretion of the Federal Deposit Insurance Corporation and the Federal Deposit Insurance Corporation has exercised that discretion by establishing a long range fund of 2.0%.
The FDIC has authority to increase insurance assessments. Any significant increases would have an adverse effect on the operating expenses and results of operations of Harvard Savings Bank. Management cannot predict what assessment rates will be in the future.
Insurance of deposits may be terminated by the FDIC upon a finding that an institution has engaged in unsafe or unsound practices, is in an unsafe or unsound condition to continue operations or has violated any applicable law, regulation, rule, order or condition imposed by the FDIC. We do not currently know of any practice, condition or violation that may lead to termination of our deposit insurance.
Federal Home Loan Bank System. Harvard Savings Bank is a member of the Federal Home Loan Bank System, which consists of 12 regional Federal Home Loan Banks. The Federal Home Loan Bank System provides a central credit facility primarily for member institutions as well as other entities involved in home mortgage lending. As a member of the Federal Home Loan Bank of Chicago, Harvard Savings Bank is required to acquire and hold shares of capital stock in the Federal Home Loan Bank. As of December 31, 2013, Harvard Savings Bank was in compliance with this requirement.
Community Reinvestment Act and Fair Lending Laws. All depository institutions have a responsibility under the Community Reinvestment Act and related regulations to help meet the credit needs of their communities, including low- and moderate-income borrowers. In connection with its examination of a state savings bank, the FDIC is required to assess the institution’s record of compliance with the Community Reinvestment Act. An institution’s failure to comply with the provisions of the Community Reinvestment Act could, at a minimum, result in denial of certain corporate applications such as branches or mergers, or in restrictions on its activities. In addition, the Equal Credit Opportunity Act and the Fair Housing Act prohibit lenders from discriminating in their lending practices on the basis of characteristics specified in those statutes. The failure to comply with the Equal Credit Opportunity Act and the Fair Housing Act could result in enforcement actions by the FDIC, as well as other federal regulatory agencies and the Department of Justice.
The Community Reinvestment Act requires all institutions insured by the FDIC to publicly disclose their rating. Harvard Savings Bank received a “satisfactory” Community Reinvestment Act rating in its most recent federal examination.
Prompt Corrective Regulatory Action. The Federal Deposit Insurance Corporation Improvement Act requires, among other things, that federal bank regulatory authorities take “prompt corrective action” with respect to institutions that do not meet minimum capital requirements.
Under FDIC prompt corrective action regulations Harvard Savings Bank must have a Tier 1 leverage ratio of at least 5.0%, a Tier 1 risk-based capital ratio of at least 6.0%, and a total risk-based capital ratio of at least 10.0% in order to be classified as “well-capitalized.” An institution that has total risk-based capital of less than 8.0% or a leverage ratio or a Tier 1 risk-based capital ratio that generally is less than 4.0% is considered to be undercapitalized. An institution that has total risk-based capital less than 6.0%, a Tier 1 core risk-based capital ratio of less than 3.0% or a leverage ratio that is less than 3.0% is considered to be “significantly undercapitalized.” An institution that has a tangible capital to assets ratio equal to or less than 2% is deemed to be “critically undercapitalized.”
Generally, a receiver or conservator must be appointed for an institution that is “critically undercapitalized” within specific time frames. The regulations also provide that a capital restoration plan must be filed with the FDIC within 45 days of the date that an institution is deemed to have received notice that it is “undercapitalized,” “significantly undercapitalized” or “critically undercapitalized.” Any holding company of an institution that is required to submit a capital restoration plan must guarantee performance under the plan in an amount of up to the lesser of 5% of the institution’s assets at the time it was deemed to be undercapitalized by the FDIC or the amount necessary to restore the institution to adequately capitalized status. This guarantee remains in place until the FDIC notifies the institution that it has maintained adequately capitalized status for each of four consecutive calendar quarters.Institutions that are undercapitalized become subject to certain mandatory measures such as a restrictions on capital distributions and asset growth. The FDIC may also take any one of a number of discretionary supervisory actions against undercapitalized institutions, including the issuance of a capital directive and the replacement of senior executive officers and directors.
At December 31, 2013, Harvard Savings Bank met the criteria for being considered “well capitalized.”
The final capital rule adopted in July 2013 modifies the prompt corrective action categories to incorporate the revised minimum capital requirements of that rule when it becomes effective. Under the new standards, in order to be considered well-capitalized, Harvard Savings Bank would have to have a common equity Tier 1 ratio of at least 6.5% (new), a Tier 1 risk-based capital ratio of at least 8.0% more (increased from 6.0%), a total risk-based capital ratio of at least 10.0% (unchanged), and a Tier 1 leverage ratio of 5.0% (unchanged). Harvard Savings Bank has conducted a pro forma analysis of the application of these new capital requirements as of December 31, 2013. We have determined that Harvard Savings Bank is well-capitalized under these new standards, as if these new requirements had been in effect on Harvard Savings Bank at that date. See “—New Capital Rule.”
Prohibitions Against Tying Arrangements. Savings banks are prohibited, subject to some exceptions, from extending credit to or offering any other service, or fixing or varying the consideration for such extension of credit or service, on the condition that the customer obtain some additional service from the institution or its affiliates or not obtain services of a competitor of the institution.
Other Regulations
Interest and other charges collected or contracted for by Harvard Savings Bank are subject to state usury laws and federal laws concerning interest rates. Harvard Savings Bank’s operations are also subject to federal and state laws applicable to credit transactions, such as the:
● | Truth-In-Lending Act, governing disclosures of credit terms to consumer borrowers; |
● | Real Estate Settlement Procedures Act, requiring that borrowers for mortgage loans for one- to four-family residential real estate receive various disclosures, including good faith estimates of settlement costs, lender servicing and escrow account practices, and prohibiting certain practices that increase the cost of settlement services; |
● | Home Mortgage Disclosure Act, requiring financial institutions to provide information to enable the public and public officials to determine whether a financial institution is fulfilling its obligation to help meet the housing needs of the community it serves; |
● | Equal Credit Opportunity Act, prohibiting discrimination on the basis of race, creed or other prohibited factors in extending credit; |
● | Fair Credit Reporting Act, governing the use and provision of information to credit reporting agencies; |
● | Fair Debt Collection Act, governing the manner in which consumer debts may be collected by collection agencies; |
● | Truth in Savings Act; |
● | Illinois High Risk Home Loan Act, which protects borrowers who enter into high risk home loans; |
● | Illinois Predatory Lending Database Program, which helps provide counseling for homebuyers in connection with certain loans; and |
● | Rules and regulations of the various federal and state agencies charged with the responsibility of implementing such laws. |
In addition, the Consumer Financial Protection Bureau issues regulations and standards under these federal consumer protection laws that affect our consumer businesses. These include regulations setting “ability to repay” and “qualified mortgage” standards for residential mortgage loans and mortgage loan servicing and originator compensation standards. Harvard Savings Bank is evaluating recent regulations and proposals, and devotes significant compliance, legal and operational resources to compliance with consumer protection regulations and standards.
The operations of Harvard Savings Bank also are subject to the:
● | Right to Financial Privacy Act, which imposes a duty to maintain confidentiality of consumer financial records and prescribes procedures for complying with administrative subpoenas of financial records; |
● | Electronic Funds Transfer Act and Regulation E promulgated thereunder, which govern automatic deposits to and withdrawals from deposit accounts and customers’ rights and liabilities arising from the use of automated teller machines and other electronic banking services; |
● | Check Clearing for the 21st Century Act (also known as “Check 21”), which gives “substitute checks,” such as digital check images and copies made from that image, the same legal standing as the original paper check; |
● | The USA PATRIOT Act, which requires savings banks operating to, among other things, establish broadened anti-money laundering compliance programs, due diligence policies and controls to ensure the detection and reporting of money laundering. Such required compliance programs are intended to supplement existing compliance requirements, also applicable to financial institutions, under the Bank Secrecy Act and the Office of Foreign Assets Control regulations; and |
● | The Gramm-Leach-Bliley Act, which places limitations on the sharing of consumer financial information by financial institutions with unaffiliated third parties. Specifically, the Gramm-Leach-Bliley Act requires all financial institutions offering financial products or services to retail customers to provide such customers with the financial institution’s privacy policy and provide such customers the opportunity to “opt out” of the sharing of certain personal financial information with unaffiliated third parties. |
Holding Company Regulation
General. Harvard Illinois Bancorp, Inc. is a non-diversified unitary savings and loan holding company within the meaning of the Home Owners’ Loan Act. As such, Harvard Illinois Bancorp, Inc. is registered with and subject to regulations, examinations and supervision by and reporting to the Federal Reserve Board. In addition, the Federal Reserve Board has enforcement authority over Harvard Illinois Bancorp, Inc. and its subsidiaries. Among other things, this authority permits the Federal Reserve Board to restrict or prohibit activities that are determined to be a serious risk to the subsidiary savings institution. The Dodd-Frank Act transferred the responsibility for regulating and supervising savings and loan holding companies to the Federal Reserve Board from the Office of Thrift Supervision on July 21, 2011.
Permissible Activities.Under present law, the business activities of Harvard Illinois Bancorp, Inc. are generally limited to those activities permissible for financial holding companies under Section 4(k) of the Bank Holding Company Act of 1956, as amended (provided certain criteria are met), and for multiple savings and loan holding companies. A financial holding company may engage in activities that are financial in nature, including underwriting equity securities and insurance as well as activities that are incidental to financial activities or complementary to a financial activity. A multiple savings and loan holding company is generally limited to activities permissible for bank holding companies under Section 4(c)(8) of the Bank Holding Company Act, subject to the prior approval of the Federal Reserve Board, and certain additional activities authorized by Federal Reserve Board regulations.
Federal law prohibits a savings and loan holding company, including Harvard Illinois Bancorp, Inc., directly or indirectly, or through one or more subsidiaries, from acquiring more than 5% of another savings institution or holding company thereof, without prior written approval of the Federal Reserve Board. It also prohibits the acquisition or retention of, with certain exceptions, more than 5% of a nonsubsidiary company engaged in activities that are not closely related to banking or financial in nature, or acquiring or retaining control of an institution that is not federally insured. In evaluating applications by holding companies to acquire savings institutions, the Federal Reserve Board must consider the financial and managerial resources, future prospects of the company and institution involved, the effect of the acquisition on the risk to the federal deposit insurance fund, the convenience and needs of the community and competitive factors.
The Federal Reserve Board is prohibited from approving any acquisition that would result in a multiple savings and loan holding company controlling savings institutions in more than one state, subject to two exceptions:
(i) | the approval of interstate supervisory acquisitions by savings and loan holding companies; and |
(ii) | the acquisition of a savings institution in another state if the laws of the state of the target savings institution specifically permit such acquisition. |
The states vary in the extent to which they permit interstate savings and loan holding company acquisitions.
Capital. Savings and loan holding companies historically have not been subject to consolidated regulatory capital requirements. The Dodd-Frank Act, however, requires the Federal Reserve Board to establish for all depository institution holding companies minimum consolidated capital requirements that are as stringent as those required for the insured depository subsidiaries. Under regulations recently enacted by the Federal Reserve Board, Harvard Illinois Bancorp, Inc. will be subject to regulatory capital requirements that generally are the same as the new capital requirements for Harvard Savings Bank. These new capital requirements include provisions that might limit the ability of Harvard Illinois Bancorp, Inc. to pay dividends to its stockholders or repurchase its shares. See “—Federal Banking Regulation—New Capital Rule.” Harvard Illinois Bancorp, Inc. has conducted a pro forma analysis of the application of these new capital requirements as of December 31, 2013, assuming the conversion and stock offering are completed, and has determined that it will meet all of these new requirements, including the full 2.5% capital conservation buffer, and will remain well-capitalized, if these new requirements had been in effect on that date.
Source of Strength.The Dodd-Frank Act codified the “source of strength” doctrine to savings and loan holding companies. The Federal Reserve Board has issued regulations requiring that all savings and loan holding companies serve as a source of managerial and financial strength to their subsidiary savings banks by providing capital, liquidity and other support in times of financial stress.
Dividends. The Federal Reserve Board has issued a policy statement regarding the payment of dividends and the repurchase of shares of common stock by bank holding companies and savings and loan holding companies. In general, the policy provides that dividends should be paid only out of current earnings and only if the prospective rate of earnings retention by the holding company appears consistent with the organization’s capital needs, asset quality and overall financial condition. Regulatory guidance provides for prior regulatory consultation with respect to capital distributions in certain circumstances such as where the company’s net income for the past four quarters, net of dividends previously paid over that period, is insufficient to fully fund the dividend or the company’s overall rate or earnings retention is inconsistent with the company’s capital needs and overall financial condition. The ability of a savings and loan holding company to pay dividends may be restricted if a subsidiary savings bank becomes undercapitalized. The policy statement also states that a savings and loan holding company should inform the Federal Reserve Board supervisory staff prior to redeeming or repurchasing common stock or perpetual preferred stock if the savings and loan holding company is experiencing financial weaknesses or if the repurchase or redemption would result in a net reduction, as of the end of a quarter, in the amount of such equity instruments outstanding compared with the beginning of the quarter in which the redemption or repurchase occurred. These regulatory policies may affect the ability of Harvard Illinois Bancorp, Inc. to pay dividends, repurchase shares of common stock or otherwise engage in capital distributions.
Acquisition.Under the Federal Change in Bank Control Act, a notice must be submitted to the Federal Reserve Board if any person (including a company), or group acting in concert, seeks to acquire direct or indirect “control” of a savings and loan holding company. Under certain circumstances, a change of control may occur, and prior notice is required, upon the acquisition of 10% or more of the company’s outstanding voting stock, unless the Federal Reserve Board has found that the acquisition will not result in control of the company. A change in control definitively occurs upon the acquisition of 25% or more of the company’s outstanding voting stock. Under the Change in Bank Control Act, the Federal Reserve Board generally has 60 days from the filing of a complete notice to act, taking into consideration certain factors, including the financial and managerial resources of the acquirer and the competitive effects of the acquisition.
Federal Securities Laws
Our common stock is registered with the Securities and Exchange Commission under the Securities Exchange Act of 1934. We are subject to the information, proxy solicitation, insider trading restrictions and other requirements under the Securities Exchange Act of 1934.
Sarbanes-Oxley Act of 2002
The Sarbanes-Oxley Act of 2002 addresses, among other issues, corporate governance, auditing and accounting, executive compensation, and enhanced and timely disclosure of corporate information. As directed by the Sarbanes-Oxley Act, our Chief Executive Officer and Chief Financial Officer are required to certify that our quarterly and annual reports do not contain any untrue statement of a material fact. The rules adopted by the Securities and Exchange Commission under the Sarbanes-Oxley Act have several requirements, including having these officers certify that: they are responsible for establishing, maintaining and regularly evaluating the effectiveness of our internal control over financial reporting; they have made certain disclosures to our auditors and the audit committee of the Board of Directors about our internal control over financial reporting; and they have included information in our quarterly and annual reports about their evaluation and whether there have been changes in our internal control over financial reporting or in other factors that could materially affect internal control over financial reporting.
TAXATION
Federal Taxation
General. Harvard Illinois Bancorp, Inc. and Harvard Savings Bank are subject to federal income taxation in the same general manner as other corporations, with some exceptions discussed below. The following discussion of federal taxation is intended only to summarize material federal income tax matters and is not a comprehensive description of the tax rules applicable to Harvard Illinois Bancorp, Inc. and Harvard Savings Bank.
Method of Accounting. For federal income tax purposes, we currently report our income and expenses on the accrual method of accounting and use a tax year ending December 31st for filing our consolidated federal income tax returns. The Small Business Protection Act of 1996 eliminated the use of the reserve method of accounting for bad debt reserves by savings institutions, effective for taxable years beginning after 1995.
Minimum Tax. The Internal Revenue Code of 1986, as amended, imposes an alternative minimum tax at a rate of 20% on a base of regular taxable income plus certain tax preferences, referred to as “alternative minimum taxable income.” The alternative minimum tax is payable to the extent alternative minimum taxable income is in excess of an exemption amount. Net operating losses can, in general, offset no more than 90% of alternative minimum taxable income. Certain payments of alternative minimum tax may be used as credits against regular tax liabilities in future years. At December 31, 2013, we had no minimum tax credit carryforwards.
Capital Loss Carryovers. We may carry back unused capital losses to the preceding three taxable years and forward to the succeeding five years to offset any net capital gains in those years. At December 31, 2013, we had no capital loss carryforwards.
Net Operating Loss Carryovers. We may carry back net operating losses to the preceding two taxable years, and forward to the succeeding 20 taxable years. At December 31, 2013, we had net operating loss carryforwards for federal income tax purposes totaling $689,000 which expire in varying amounts between 2024 and 2029.
Corporate Dividends. We may exclude from our income 100% of dividends received from Harvard Savings Bank as a member of the same affiliated group of corporations.
Audit of Tax Returns.Our federal income tax returns have not been audited in the most recent five-year period.
State Taxation
Illinois State Taxation. We are required to file Illinois income tax returns and pay tax at a stated tax rate of 9.50% of Illinois taxable income. For these purposes, Illinois taxable income generally means federal taxable income subject to certain modifications, primarily the exclusion of interest income on United States obligations. As of December 31, 2013, we have net operating losses of approximately $3.2 million that are being carried forward and available to reduce future taxable income. These carryforwards expire beginning 2015 through 2021. The use of these net operating losses was suspended for calendar years 2012 and 2013. The State of Illinois is allowing up to $100,000 of loss carryforwards to be utilized in each of calendar years 2012 and 2013. Management has not recorded a deferred tax asset for the State portion of its net operating loss carryforwards.
Personnel
As of December 31, 2013, we had 30 full-time equivalent employees. Our employees are not represented by any collective bargaining group. Management believes that we have good relations with our employees.
Availability of Annual Report on Form 10-K
This Annual Report on Form 10-K is available on our website at www.harvardsavingsbank.com. Information on the website is not incorporated into, and is not otherwise considered a part of, this Annual Report on Form 10-K.
ITEM 1A. Risk Factors
The presentation of Risk Factors is not required for smaller reporting companies like Harvard Illinois Bancorp, Inc.
ITEM 1B. Unresolved Staff Comments
Not applicable.
ITEM 2. Properties
As of December 31, 2013, the net book value of our office properties was $3.2 million. The following table sets forth information regarding our offices.
Location | Leased or Owned | Year Acquired or Leased | Square Footage | Net Book Value of Real Property | ||||||||
(In thousands) | ||||||||||||
Main Office: | ||||||||||||
58 North Ayer Street Harvard, Illinois 60033 | Owned | 1959 | 6,800 | $ | 1,195 | |||||||
Branch Offices: | ||||||||||||
1400 North Division Street Harvard, Illinois 60033 | Owned | 1998 | 2,500 | 773 | ||||||||
211 East Jefferson Street Morris, Illinois 60450 | Owned | 2008 | 16,948 | 1,184 | ||||||||
Total | $ | 3,152 |
We believe that our current facilities are adequate to meet our present and foreseeable needs, subject to possible future expansion.
ITEM 3. Legal Proceedings
At December 31, 2013, we were not involved in any pending legal proceedings other than routine legal proceedings occurring in the ordinary course of business which, in the aggregate, involve amounts which management believes will materially adversely affect our financial condition, our results of operations and our cash flows.
ITEM 4. Mine Safety Disclosure.
None.
PART II
ITEM 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
(a) Market, Holder and Dividend Information. Our common stock is traded on the OTC Bulletin Board under the symbol “HARI.” The approximate number of holders of record of Harvard Illinois Bancorp, Inc.’s common stock as of March 18, 2014, was 281. Certain shares of Harvard Illinois Bancorp, Inc. are held in “nominee” or “street” name and accordingly, the number of beneficial owners of such shares is not known or included in the foregoing number.The following table sets forth the range of the high and low sales prices of Harvard Illinois Bancorp, Inc.’s common stock for each quarter of 2013 and 2012, and is based upon information provided by the OTC Bulletin Board. The high and low “bid” price, as required to be disclosed by Regulation S-K, was not available for certain periods because either there were not two-sided quotes by market makers, which is the minimum required to calculate a priced bid and ask, or there was only one market maker with a two-sided quote.
High | Low | Cash Dividend Declared | ||||||||||
Quarter ended December 31, 2013 | $ | 18.00 | $ | 14.20 | — | |||||||
Quarter ended September 30, 2013 | $ | 14.50 | $ | 13.75 | — | |||||||
Quarter ended June 30, 2013 | $ | 14.12 | $ | 13.28 | — | |||||||
Quarter ended March 31, 2013 | $ | 14.12 | $ | 13.10 | $ | 0.10 | ||||||
Quarter ended December 31, 2012 | $ | 14.00 | $ | 10.01 | — | |||||||
Quarter ended September 30, 2012 | $ | 11.00 | $ | 9.30 | — | |||||||
Quarter ended June 30, 2012 | $ | 13.00 | $ | 10.05 | — | |||||||
Quarter ended March 31, 2012 | $ | 12.95 | $ | 8.00 | — |
Harvard Illinois Bancorp, Inc. does not currently pay regular cash dividends on its common stock. However, on February 20, 2013, with the consent of the Federal Reserve Board, the Company paid a special cash dividend of $0.10 per share of the Company’s common stock to stockholders of record as of February 6, 2013. In addition, on January 30, 2014, Harvard Illinois Bancorp, Inc. paid a special dividend of $0.20 per share of the Company’s common stock to stockholders of record as of January 15, 2014. Dividend payments by Harvard Illinois Bancorp, Inc. are dependent on dividends it receives from Harvard Savings Bank, because Harvard Illinois Bancorp, Inc. has no source of income other than dividends from Harvard Savings Bank, earnings from the investment of proceeds from the sale of shares of common stock retained by Harvard Illinois Bancorp, Inc. and interest payments with respect to Harvard Illinois Bancorp, Inc.’s loan to the Employee Stock Ownership Plan. See “Item 1. Business—Supervision and Regulation—Savings Bank Regulation—Dividend Limitations.”
(b) | Sales of Unregistered Securities. Not applicable. | |
(c) | Use of Proceeds.Not applicable | |
(d) |
| Securities Authorized for Issuance Under Equity Compensation Plans. See “Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.” |
(e) | Stock Repurchases. Not applicable. | |
(f) | Stock Performance Graph. Not required for smaller reporting companies. |
ITEM 6. Selected Financial Data
Not required for smaller reporting companies.
ITEM 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Overview
Harvard Illinois Bancorp, Inc. (the “Company”) is a savings and loan holding company and is subject to regulation by the Board of Governors of the Federal Reserve System. The Company’s business activities are limited to oversight of its investment in Harvard Savings Bank (the “Bank”).
The Bank is primarily engaged in providing a full range of banking and mortgage services to consumer and business customers in McHenry County, Grundy County, and to a lesser extent Boone County, Illinois and Walworth County in Wisconsin. The Bank is subject to regulation by the Federal Deposit Insurance Corporation and the Illinois Department of Financial and Professional Regulation.
On April 8, 2010, the Company reorganized from a two-tier mutual holding company to a stock holding company and completed its initial public offering. A total of 784,689 shares, par value of $0.01 per share, were sold at $10 per share, raising $6.8 million of proceeds, net of conversion expenses. The Company established an employee stock ownership plan that purchased 8% of the total shares, or a total of 62,775 shares in the offering, for a total of $627,750. The Company’s common stock began trading on the over-the-counter bulletin board under the symbol “HARI” on April 9, 2010.
On May 26, 2011, the stockholders approved the Harvard Illinois Bancorp, Inc. 2011 Equity Incentive Plan (the “Equity Incentive Plan”) for employees and directors of the Company. The Equity Incentive Plan authorizes the issuance of up to 109,856 shares of the Company’s common stock, with no more than 31,387 of shares as restricted stock awards and 78,469 as stock options, either incentive stock options or non-qualified stock options. The exercise price of options granted under the Equity Incentive Plan may not be less than the fair market value on the date the stock option is granted. The compensation committee of the board of directors has sole discretion to determine the amount and to whom equity incentive awards are granted.
On June 23, 2011, the compensation committee of the board of directors approved the awards of 73,761 options to purchase Company stock and 31,387 shares of restricted stock. Stock options and restricted stock vest ratably over a five year period, and stock options expire ten years after issuance. Apart from the vesting schedule for both stock options and restricted stock, there are no performance-based conditions or any other material conditions applicable to the awards issued. The remaining 4,708 options available under this plan were awarded on November 29, 2012.
During the year ended December 31, 2013, the Bank paid the Company dividends totaling $373,000 to fund expenses and operating activities of the Company.
On February 20, 2013, with the consent of the Federal Reserve Board, the Company paid a special cash dividend of $0.10 per share of the Company’s common stock to stockholders of record as of February 6, 2013. In addition, on January 30, 2014, the Company paid a special dividend of $0.20 per share of the Company’s common stock to stockholders of record as of January 15, 2014.
Our results of operations depend primarily on our net interest income. Net interest income is the difference between the interest income we earn on our interest-earning assets, consisting primarily of loans, investment securities and other interest-earning assets, and the interest paid on our interest-bearing liabilities, consisting primarily of savings and transaction accounts, certificates of deposit, and Federal Home Loan Bank of Chicago advances. Our results of operations also are affected by our provision for loan losses, noninterest income and noninterest expense. Noninterest income consists primarily of customer service fees, net realized gains on loan sales, loan servicing fees, and net income on bank-owned life insurance, offset by impairment charges on securities. Noninterest expense consists primarily of compensation and benefits, occupancy, data processing, professional fees, marketing, office supplies, federal deposit insurance premiums, indirect automobile loan servicing fees, and foreclosed assets.
Our results of operations also may be affected significantly by general and local economic and competitive conditions, changes in market interest rates, governmental policies and actions of regulatory authorities. The recession which began in 2008 had a severe impact on the entire banking industry resulting in increased bank failures nationwide. Continuing adverse conditions in the national and local economies have resulted in a challenging operating environment for financial institutions, particularly in Illinois and the local economies within our market areas, which showed improvement in 2013 but remain weak. The national and local unemployment rates have shown some improvement in 2013, but remain high. According to the Illinois Department of Employment Security, the December 2013 unemployment rate, not seasonally adjusted, for our market areas of McHenry County and Grundy County, and Illinois improved to 7.4%, 9.1% and 8.6%, respectively, from December 2012 rates of 8.2%, 9.8% and 8.6%, as compared to the U.S. unemployment rate which improved to 6.5% for December 2013 from 7.6% for December 2012.
As further discussed in Note 4 to the audited financial statements included herein, the Company originates agricultural operating lines of credit, which generally have terms of one year and are secured by growing crops, livestock and equipment, and mortgages on farmland. At December 31, 2013 and 2012, the Company held $24.3 million and $20.1 million in agricultural production loans and $13.9 million and $11.8 million, respectively in agricultural real estate loans in the Company’s geographic lending area. The repayment of agriculture loans generally is dependent on the successful operation of a farm and can be adversely affected by fluctuations in crop prices, increase in interest rates, and changes in weather conditions such as the drought conditions that reduced the 2012 crop yields in the United States. We generally require 75% or more crop insurance coverage for our loans for crop production, which provides protection against loss due to lower crop yields as a result of drought conditions or other factors. Weather conditions in 2013 did not have a significant adverse impact on our agricultural and farmland loan customers, which made their required payments on loans. At December 31, 2013, none of our agricultural and farmland loans were 30 days or more past due, or classified substandard or non-performing. We had no charge-offs on our agricultural and farmland loan portfolios in 2013, and the requirement for additional provisions for loan losses for those portfolios was primarily due to the increase in size of those portfolios year over year.
At December 31, 2013, the Bank was categorized as “well capitalized” under regulatory capital requirements.
Business Strategy
Our long-term business strategy is to operate Harvard Savings Bank as a community-oriented financial institution, offering one- to four-family residential real estate, commercial real estate, farmland, commercial and industrial, home equity, agricultural and purchased indirect automobile loans, and to a lesser extent, multi-family, construction and land development, and other consumer loans along with a diversified platform of deposit and other products and services to individuals, agriculture and other businesses in our market areas. In order to offset the rising overhead costs related to community banking, we intend to grow our assets and liabilities in a disciplined manner, subject to market conditions. We believe that execution of our long-term business strategy will create long-term shareholder value.
We intend to accomplish this strategy by leveraging our established name and franchise, capital strength and loan production capability by:
● | Leveraging the knowledge of our market areas to deliver a consistent high quality level of professional banking service to our retail and business customers, attracting new customers and expanding our presence in the geographical area we serve; |
● | Offering a complete platform of deposit products at competitive rates and terms, focusing on growing deposits, in particular lower-cost core deposits, and diversifying the deposit mix, in order to provide for replacing long-term FHLB advances as they mature and providing lower cost funding for lending activities; |
● | Managing our loan portfolio to minimize concentrations and diversify the types of loans in the portfolio; |
● | Managing the credit risk within our loan portfolio to minimize the risk of loss; |
● | Managing interest rate risk to optimize our net interest margin; and |
● | Improving our overall efficiency and profitability. |
Critical Accounting Policies and Use of Significant Estimates
In the ordinary course of business, we have made a number of estimates and assumptions relating to the reporting of results of operations and financial condition in preparing our financial statements in conformity with accounting principles generally accepted in the United States of America. Actual results could differ significantly from those estimates under different assumptions and conditions. Management believes the following discussion addresses our most critical accounting policies and significant estimates, which are those that are most important to the portrayal of our financial condition and results and require management’s most difficult, subjective and complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain.
Allowance for Loan Losses.Our allowance for loan losses is the estimated amount considered necessary to reflect probable incurred credit losses in the loan portfolio at the balance sheet date. The allowance is established through the provision for loan losses, which is charged against income. In determining the allowance for loan losses, management makes significant estimates and has identified this policy as one of the most critical for the Company. The methodology for determining the allowance for loan losses is considered a critical accounting policy by management due to the high degree of judgment involved, the subjectivity of the assumptions utilized, and the potential for changes in the economic environment that could result in changes to the amount of the recorded allowance for loan losses.
Since a substantial amount of our loan portfolio is collateralized by real estate, appraisals of the underlying value of property securing loans and discounted cash flow valuations of properties are critical in determining the amount of the allowance required for specific loans. Assumptions for appraisals and discounted cash flow valuations are instrumental in determining the value of properties. Overly optimistic assumptions or negative changes to assumptions could significantly impact the valuation of a property securing a loan and the related allowance determined. The assumptions supporting such appraisals and discounted cash flow valuations are carefully reviewed by management to determine that the resulting values reasonably reflect amounts realizable on the related loans.
Management performs a quarterly evaluation of the allowance for loan losses. Consideration is given to a variety of factors in establishing this estimate including, but not limited to, current economic conditions, delinquency statistics, geographic and industry concentrations, the value of the underlying collateral, the financial strength of the borrower, results of internal loan reviews and other relevant factors. This evaluation is inherently subjective as it requires material estimates that may be susceptible to significant revision based on changes in economic and real estate market conditions.
The analysis of the allowance for loan losses has two components: specific and general allocations. Specific allocations are made for loans that are determined to be impaired. Impairment loss is measured by determining the present value of expected future cash flows or, for collateral-dependent loans, the fair value of the collateral adjusted for market conditions and selling expenses. The general allocation is determined by segregating classified loans from the remaining loans, and then categorizing each group by type of loan. Loans within each type exhibit common characteristics including terms, collateral type, and other risk characteristics. We also analyze historical loss experience, delinquency trends, general economic conditions and geographic and industry concentrations. This analysis establishes factors that are applied to the loan groups to determine the amount of the general allocations. The Illinois Department of Financial and Professional Regulation and the Federal Deposit Insurance Corporation require the recognition of adjustments to the allowance for loan losses based on their judgment of information available to them at the time of their examinations. Actual loan losses may be significantly more than the allowance for loan losses we have established, which could have a material negative effect on our financial results.
Other Real Estate Owned. Other real estate owned acquired through loan foreclosure is initially recorded at fair value less costs to sell when acquired, establishing a new cost basis. The adjustment at the time of foreclosure is recorded through the allowance for loan losses. Due to the subjective nature of establishing the fair value when the property is acquired, the actual fair value of the other real estate owned or foreclosed asset could differ from the original estimate. If it is determined that fair value declines subsequent to foreclosure, a charge to operations through noninterest expense is recorded. Operating costs associated with the asset after acquisition are also recorded as noninterest expense. Gains and losses on the disposition of other real estate owned and foreclosed assets are netted and posted to other noninterest expense.
Deferred Income Taxes. We use the asset and liability method of accounting for income taxes. Under this method, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. If current available information raises doubt as to the realization of the deferred tax assets, a valuation allowance is established. These judgments and estimates are reviewed on a continual basis as regulatory and business factors change.
Additionally, we review our uncertain tax positions annually. An uncertain tax position is recognized as a benefit only if it is “more likely than not” that the tax position would be sustained in a tax examination, with a tax examination being presumed to occur. The amount actually recognized is the largest amount of tax benefit that is greater than 50% likely to be recognized on examination. For tax positions not meeting the “more likely than not” test, no tax benefit is recorded. A significant amount of judgment is applied to determine both whether the tax position meets the “more likely than not” test as well as to determine the largest amount of tax benefit that is greater than 50% likely to be recognized. Differences between the position taken by management and that of taxing authorities could result in a reduction of a tax benefit or increase to tax liability, which could adversely affect future income tax expense.
Comparison of Financial Condition at December 31, 2013 and December 31, 2012
Assets. Total assets at December 31, 2013 increased $753,000, or 0.4%, to $170.1 million at December 31, 2013 from $169.4 million at December 31, 2012. The modest changes in total assets and liabilities were consistent with our strategy to limit growth of our balance sheet in the current economic environment. Cash and cash equivalents increased $5.2 million to $28.1 million at December 31, 2013 from $22.9 million at December 31, 2012. Cash and cash equivalents includes securities purchased under agreements to resell which increased $6.1 million to $25.1 million at December 31, 2013 from $19.0 million at December 31, 2012. These agreements represent short-term cash investment alternatives that are over-collateralized with collateral that is guaranteed by the “full faith and credit” of the United States government. Interest-bearing deposits decreased $2.9 million to $6.2 million at December 31, 2013 from $9.1 million at December 31, 2012. These deposits are certificates of deposit we have placed with other financial institutions with terms from three months to five years; all are fully covered by FDIC insurance. Available-for-sale securities decreased $2.4 million to $5.5 million at December 31, 2013 from $7.9 million at December 31, 2012. The decrease was primarily due to $1.1 million in purchases of debt securities, more than offset by pay-downs, maturities and sales of $3.4 million of this portfolio. Held-to-maturity securities totaled $833,000 at December 31, 2013, a decrease of $430,000 from $1.3 million at December 31, 2012 primarily as a result of maturities and pay-downs on those securities and no purchases. The investment in those deposits and securities were based on liquidity and yield considerations.
The net loan portfolio increased $1.9 million, or 1.6%, to $116.9 million at December 31, 2013 from $115.0 million at December 31, 2012. In 2013, loan originations, advances and purchases were $76.1 million, which were offset by $18.1 million in loans sold, $55.1 million of loan repayments and payoffs, net of $583,000 in charge offs, and transfers to foreclosed assets of $567,000. The increase in loans during 2013 was due primarily to increases of $2.1 million, $4.2 million, $1.0 million and $629,000 in the farmland, agricultural, commercial and industrial loan, and purchased indirect automobile portfolios, respectively, offset partially by decreases in one-to-four family, home equity lines of credit and other second mortgage, construction and land development, and commercial real estate loan portfolios of $2.4 million, $1.7 million, $1.5 million and $745,000, respectively. The decrease in our one- to four-family loans during 2013 was primarily due to repayments, early payoffs and $9.8 million in loans sold to Fannie Mae, which generated $146,000 in net gains on loan sales, partially offset by loan originations of $15.8 million. The decrease in the one- to four-family loan portfolio reflects our strategy to sell substantially all our conforming one-to four-family loans based on yield and duration considerations in order to decrease the concentration of one- to four-family loans in our portfolio. Our portfolio of one- to four-family loans serviced for others decreased $2.3 million to $61.3 million at December 31, 2013 from $63.6 million at December 31, 2012. The changes in composition of our loan portfolio reflect the continued execution of our business strategy to minimize concentrations and diversify the types of loans in the portfolio, while managing credit and interest rate risk to optimize our net interest margin.
All other assets, consisting of premises and equipment, Federal Home Loan Bank stock, foreclosed assets held for sale, accrued interest receivable, deferred income taxes, bank-owned life insurance, mortgage servicing rights and other decreased $709,000 to $12.6 million at December 31, 2013 from $13.3 million at December 31, 2012. The largest component of other assets was our investment in bank-owned life insurance which increased $115,000 to $4.5 million at December 31, 2013 from $4.4 million at December 31, 2012. Bank-owned life insurance provides us with a funding source for our benefit plan obligations and is a source for tax-exempt income. The largest change in other assets was in our investment in Federal Home Loan Bank stock, which decreased $534,000 to $870,000 at December 31, 2013 from $1.4 million at December 31, 2012, resulting from the net repurchases of shares by the Federal Home Loan Bank, at par. Deferred income taxes increased $38,000 in 2013 and totaled $1.9 million at December 31, 2013 and 2012, respectively. At December 31, 2013, the Company’s deferred tax asset relating to unused capital loss carryovers and unrealized capital losses on other than temporary impairment of equity securities totaled $218,000. Management has established a valuation allowance for portions of that deferred tax asset of $129,000 at December 31, 2013, a non-recurring decrease of $89,000 from the balance of $218,000 at December 31, 2012. The decrease in the valuation allowance in 2013 was due to the reversal of a previous valuation allowance related to capital losses. The Company now believes it has capital gains to enable a portion of those capital losses to be utilized prior to expiration.
Liabilities.Deposits decreased $235,000, or 0.2%, to $133.8 million at December 31, 2013 from $134.0 million at December 31, 2012. Certificates of deposit decreased $643,000, or 0.8%, to $75.5 million at December 31, 2013 from $76.1 million at December 31, 2012. Savings,NOW and money market accounts increased $223,000, or 0.4 %, to$51.8 million at December 31, 2013 from $51.6 million at December 31, 2012. Interest-bearing deposits decreased modestly as we continued to follow our pricing discipline in a competitive environment to lower our cost of funds. Demand deposits increased $185,000, or 2.9%, to$6.5 million at December 31, 2013 from $6.3 million at December 31, 2012, primarily due to commercial account growth. Federal Home Loan Bank advances decreased $151,000 to $12.2 million at December 31, 2013 from $12.4 million at December 31, 2012. Non-interest bearing liabilities increased $310,000, or 9.1%, to$3.7 million at December 31, 2013 from $3.4 million at December 31, 2012. The largest component of non-interest bearing liabilities was deferred compensation which increased $95,000, or 4.1%, to$2.4 million at December 31, 2013 from $2.3 million at December 31, 2012. The largest change was in other liabilities which increased $249,000 to$908,000 at December 31, 2013 from $659,000 at December 31, 2012 primarily due to unremitted collections on loans sold and serviced for others.
Stockholders’Equity. Total stockholders’ equity increased by $829,000, or 4.2%, to $20.4 million at December 31, 2013 from $19.6 million at December 31, 2012. The increase in stockholders’ equity for the year ended December 31, 2013 resulted primarily from net income of $683,000, the exercise of stock options of $145,000, the recognition of ESOP compensation expense of $60,000, the recognition of stock – based compensation expense related to the 2011 Incentive Equity Plan of $114,000 and by the increase in other accumulated comprehensive income of $9,000, offset partially by the increase in the contingent repurchase obligation for the ESOP of $105,000 and dividends paid of $77,000.
Comparison of Operating Results for the Years Ended December 31, 2013 and December 31, 2012
General. Net income for the year ended December 31, 2013 was $683,000, compared to $888,000 for the year ended December 31, 2012, a decrease of $205,000. The decrease was due to a decrease in net interest income of $525,000 and an increase of $40,000 in the provision for income taxes, partially offset by an increase in noninterest income of $38,000, and decreases in the provision for loan losses and noninterest expense of $146,000 and $176,000, respectively.
Interest and Dividend Income. Total interest and dividend income decreased $763,000, or 10.6%, to $6.4 million at December 31, 2013 from $7.2 million for the year ended December 31, 2012. Although average interest-earning assets increased $1.4 million to $158.8 million for the year ended December 31, 2013 from $157.4 million for the year ended December 31, 2012, the average yield decreased 52 basis points to 4.06% from 4.58%. This decrease reflected a decline in the interest rate environment for most asset categories during the period. Interest and fees on loans decreased $773,000, or 11.4%, to $6.0 million for the year ended December 31, 2013 from $6.8 million for the year ended December 31, 2012, as the average yield on loans decreased 54 basis points to 5.08% from 5.62%, and as the average balance of loans decreased $2.5 million to $118.6 million primarily due to repayments and sales of loans outpacing originations and purchases of loans. The decrease in interest income on loans was partially offset by interest income on securities and other interest-earning assets which increased $10,000, or 2.5%, to $411,000 for the year ended December 31, 2013 from $401,000 for the year ended December 31, 2012, as the average balances of those assets increased $3.9 million to $40.2 million from $36.3 million, primarily due to weaker loan demand, offset partially by the decrease in average yield on those assets of 8 basis points to 1.02% from 1.10%.
Interest Expense. Total interest expense decreased $238,000 or 13.6%, to $1.5 million for the year ended December 31, 2013 from $1.8 million for the year ended December 31, 2012. Interest expense on deposit accounts decreased $148,000 or 10.5%, to $1.3 million for the year ended December 31, 2013 from $1.4 million for the year ended December 31, 2012. This decrease was primarily due to a decrease in interest expense on certificates of deposit and brokered certificate accounts of $171,000, offset partially by an increase in interest expense on savings, NOW and money market accounts of $23,000. The average balance in certificates of deposits and brokered certificates of deposit decreased $2.2 million, with the cost of these deposits decreasing 17 basis points to 1.55% from 1.72%. The average balances of savings, NOW and money market accounts increased $1.6 million, and the cost of these deposits increased 4 basis points to 0.20% from 0.16%. The movement in deposit accounts and reduction in the cost of these funds was the result of our competitive pricing, and the declining market interest rates for deposits. Interest expense on Federal Home Loan Bank advances decreased $90,000 to $250,000 for the year ended December 31, 2013 from $340,000 for the year ended December 31, 2012. The average cost of FHLB advances decreased 71 basis points to 1.93% from 2.64%, offset partially by an increase in the average balance of FHLB advances of $58,000. The modest increase in the average balance of FHLB advances was due to adhering to our capital and liquidity plans to lessen our reliance on FHLB advances. The decrease in the cost of these funds was a reflection of the lower market interest rate environment in 2013 compared to 2012.
Net Interest Income. Net interest income decreased $525,000, or 9.6%, to $4.9 million for the year ended December 31, 2013 from $5.4 million for the year ended December 31, 2012, primarily as a result of a decrease in our net interest rate spread of 35 basis points to 2.98% from 3.33%. Our net interest margin decreased 36 basis points to 3.10% from 3.46%.The decreases in our net interest rate spread and net interest margin reflected the significant decrease in interest and fees on loans due to repricing at current market interest rates as well as the decrease in average balance for loans in 2013 compared to 2012 due to weaker loan demand. The decreases in our net interest rate spread and net interest margin were offset partially by the ratio of our average interest-earning assets to average interest-bearing liabilities which increased to 113.10% for the year ended December 31, 2013 from 111.71% for the year ended December 31, 2012.
Provision for Loan Losses. The allowance for loan losses is established as losses are estimated to have occurred through a provision for loan losses charged to income. Loan losses are charged against the allowance when we believe the uncollectibility of a loan balance is confirmed. Subsequent recoveries, if any, are credited to the allowance.
We evaluate the allowance for loan losses on a regular basis and the provision is based upon our periodic review of the collectability of the loans in light of historical experience, the nature and volume of the loan portfolio, adverse situations that may affect the borrower’s ability to repay, estimated value of any underlying collateral and prevailing economic conditions. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available.
A loan is considered impaired when, based on current information and events, it is probable that we will be unable to collect the scheduled payments of principal and interest when due according to the contractual terms of the loan agreement. The factors we considered in determining impairment include payment status, collateral value and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. We determine the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record and the amount of the shortfall in relation to the principal and interest owed. Impairment is measured on a loan-by-loan basis for commercial loans by either the present value of expected future cash flows discounted at the loans effective interest rate, the loan’s obtainable market price, or the fair value of the collateral if the loan is collateral dependent.
Groups of loans with similar loan characteristics, including individually evaluated loans not determined to be impaired, are collectively evaluated for impairment based on the group’s historical loss experience adjusted for changes in trends, conditions and other relevant factors that affect repayment of the loans. Accordingly, we do not separately identify individual consumer and residential loans for impairment measurements.
Based upon our evaluation of these factors, a provision of $453,000 was recorded for the year ended December 31, 2013, a decrease of $146,000, or 24.4%, from $599,000 for the year ended December 31, 2012. The provision for loan losses reflected net charge offs of $528,000 or 0.45% of average total loans for 2013, compared to $624,000 or 0.52% of average total loans for 2012. Substandard loans decreased $2.2 million to $2.8 million for the year ended December 31, 2013 from $5.0 million for the year ended December 31, 2012, while the related specific loss allowances for those loans decreased $335,000 to $96,000. We used the same methodology in assessing the allowance for each period.
The allowance as a percent of nonperforming loans increased to 89.51% at December 31, 2013 from 51.10% at December 31, 2012, primarily due to nonperforming loans which decreased to $2.8 million at December 31, 2013 compared to $5.0 million at December 31, 2012. Net charge-offs as a percent of average total loans outstanding decreased to 0.45% for the year ended December 31, 2013 from 0.52% for the year ended December 31, 2012, primarily due to a decrease in net charge-offs of $96,000 to $528,000 from $624,000, offset partially by a $2.5 million decrease in average loans outstanding to $118.6 million from $121.1 million. To the best of our knowledge, we have recorded all losses that are both probable and reasonably estimable for the years ended December 31, 2013 and 2012, respectively.
Noninterest Income. Noninterest income increased $38,000, or 4.0%, to $979,000 for the year ended December 31, 2013 from $941,000 for the year ended December 31, 2012. The increase was primarily related to net gains on loan sales which increased $55,000 to $354,000 for the year ended December 31, 2013 from $299,000 for the year ended December 31, 2012. Net realized gains of $146,000 and $197,000 were recognized on loans sold of $18.1 million and $16.7 million for the years ended December 31, 2013 and 2012, respectively. Gains on loan sales included the net increase in fair value of loan servicing rights of $208,000 in 2013 compared to $102,000 in 2012, an increase of $106,000. The increase in fair value of loan servicing rights in 2013 was primarily due to the decrease in prepayment speeds for the servicing portfolio during 2013 compared to 2012. Brokerage commission income decreased $30,000 to $1,000 for the year ended December 31, 2013 compared to $31,000 for the same period in 2012, primarily due to the Company exiting that line of business in 2013.Other noninterest income categories increased by $13,000, or 2.1%, to $624,000 for the year ended December 31, 2013 from $611,000 for the year ended December 31, 2012. The increase was primarily related to a $26,000 increase in customer service fees in 2013 to $296,000 from $270,000 in 2012, due to an increase in fees associated with deposit accounts.
Noninterest Expense.Noninterest expense decreased $176,000, or 3.7%, to $4.6 million for the year ended December 31, 2013 from $4.8 million for the year ended December 31, 2012. Decreases in data processing, professional fees, office supplies, indirect automobile loan servicing fees, foreclosed assets, net, and other expense for the year ended December 31, 2013 compared to the same period in 2012 of $39,000, $5,000, $5,000, $5,000, $178,000 and $13,000, respectively, were partially offset by increases in compensation and benefits, occupancy, marketing and federal deposit insurance of $34,000, $16,000, $18,000, and $1,000, respectively. The decrease in data processing expense in 2013 was due primarily to lower costs associated with the long-term contract renewal with our data center in 2012.The decrease in foreclosed assets, net reflected lower realized losses on sales and write-downs of other real estate owned which decreased $198,000 to $57,000 in 2013. The increase in compensation and benefits in 2013 was primarily due to higher benefit costs. The increase in marketing expense in 2013 was primarily due to the introduction of a new checking account product.
Provision for Income Taxes.The provision for income taxes was $184,000 for the year ended December 31, 2013, compare to $144,000 for the year ended December 31, 2012, an increase of $40,000. The effective tax provision as a percent of pre-tax income or loss was 21.2% and 14.0% for the years ended December 31, 2013 and 2012, respectively. The higher provision in 2013 reflects the decrease of $30,000 to $89,000 in 2013 in non-recurring decreases in valuation allowances recorded for deferred tax assets related to capital losses on equity securities from $119,000 in 2012.
Analysis of Net Interest Income
Net interest income represents the difference between the income we earn on interest-earning assets and the interest expense we pay on interest-bearing liabilities. Net interest income also depends upon the relative amounts of interest-earning assets and interest-bearing liabilities and the interest rates earned or paid on them. The following tables set forth average balance sheets, average yields and costs, and certain other information at or for the periods indicated. Average balances are predominantly derived from daily average balances, and to a lesser extent, from month end balances. Management does not believe that the limited use of month end balances rather than daily balances has caused any material differences in the information presented. Non-accrual loans were included in the computation of average balances, but have been reflected in the tables as loans carrying a zero yield. No tax equivalent yield adjustments have been made. The yields set forth below include the effect of loan fees, discounts and premiums that are amortized or accreted to interest income.
At December 31, | For the Years Ended December 31, | |||||||||||||||||||||||||||||||||||||||||||
2013 | 2013 | 2012 | 2011 | |||||||||||||||||||||||||||||||||||||||||
Actual Balance | Yield/Cost | Average Balance | Interest Income / Expense | Yield/Cost | Average Balance | Interest Income / Expense | Yield/Cost | Average Balance | Interest Income / Expense | Yield/Cost | ||||||||||||||||||||||||||||||||||
Assets: | (Dollars in thousands) | |||||||||||||||||||||||||||||||||||||||||||
Interest-earning assets: | ||||||||||||||||||||||||||||||||||||||||||||
Interest-earning deposits | $ | 7,500 | 0.75 | % | $ | 8,939 | $ | 76 | 0.85 | % | $ | 9,532 | $ | 87 | 0.91 | % | $ | 8,571 | $ | 118 | 1.38 | % | ||||||||||||||||||||||
Securities purchased under agreementsto resell | 25,117 | 1.11 | 22,559 | 204 | 0.90 | 15,544 | 139 | 0.89 | 18,304 | 183 | 1.00 | |||||||||||||||||||||||||||||||||
Securities, tax-exempt (1) | 3,461 | 1.12 | 3,744 | 38 | 1.01 | 1,481 | 16 | 1.08 | 195 | 9 | 4.62 | |||||||||||||||||||||||||||||||||
Securities, taxable (1) | 2,892 | 2.20 | 4,016 | 89 | 2.22 | 6,757 | 152 | 2.25 | 6,801 | 185 | 2.72 | |||||||||||||||||||||||||||||||||
Loans (2) | 119,333 | 5.05 | 118,618 | 6,030 | 5.08 | 121,109 | 6,803 | 5.62 | 115,911 | 6,760 | 5.83 | |||||||||||||||||||||||||||||||||
Federal Home Loan Bank stock | 870 | 0.30 | 910 | 4 | 0.44 | 3,019 | 7 | 0.23 | 6,549 | 7 | 0.11 | |||||||||||||||||||||||||||||||||
Total interest-earning assets | 159,173 | 4.02 | % | 158,786 | 6,441 | 4.06 | % | 157,442 | 7,204 | 4.58 | % | 156,331 | 7,262 | 4.65 | % | |||||||||||||||||||||||||||||
Noninterest-earning assets | 10,947 | 11,423 | 11,366 | 11,900 | ||||||||||||||||||||||||||||||||||||||||
Total assets | $ | 170,120 | $ | 170,209 | $ | 168,808 | $ | 168,231 | ||||||||||||||||||||||||||||||||||||
Liabilities and equity: | ||||||||||||||||||||||||||||||||||||||||||||
Interest-bearing liabilities: | ||||||||||||||||||||||||||||||||||||||||||||
Savings accounts | $ | 17,256 | 0.14 | % | $ | 17,430 | 22 | 0.13 | % | $ | 17,063 | 21 | 0.12 | % | $ | 15,744 | 38 | 0.24 | % | |||||||||||||||||||||||||
NOW and money market accounts | 34,538 | 0.20 | 34,812 | 81 | 0.23 | 33,538 | 59 | 0.18 | 32,607 | 89 | 0.27 | |||||||||||||||||||||||||||||||||
Certificates of deposit | 75,493 | 1.47 | 75,196 | 1,164 | 1.55 | 76,141 | 1,270 | 1.67 | 78,447 | 1,626 | 2.07 | |||||||||||||||||||||||||||||||||
Brokered certificates of deposit | — | — | — | — | — | 1,300 | 65 | 5.00 | 1,499 | 75 | 5.00 | |||||||||||||||||||||||||||||||||
Federal Home Loan Bank advances | 12,206 | 1.52 | 12,954 | 250 | 1.93 | 12,896 | 340 | 2.64 | 13,630 | 426 | 3.13 | |||||||||||||||||||||||||||||||||
Total interest-bearing liabilities | 139,493 | 1.00 | % | 140,392 | 1,517 | 1.08 | % | 140,938 | 1,755 | 1.25 | % | 141,926 | 2,254 | 1.59 | % | |||||||||||||||||||||||||||||
Non-interest-bearing deposits | 6,463 | 6,044 | 5,099 | 4,419 | ||||||||||||||||||||||||||||||||||||||||
Other non-interest-bearing liabilities | 3,718 | 3,782 | 3,445 | 3,197 | ||||||||||||||||||||||||||||||||||||||||
Total liabilities | 149,674 | 150,218 | 149,482 | 149,543 | ||||||||||||||||||||||||||||||||||||||||
Total equity | 20,446 | 19,991 | 19,326 | 18,688 | ||||||||||||||||||||||||||||||||||||||||
Total liabilities and equity | $ | 170,120 | $ | 170,209 | $ | 168,808 | $ | 168,231 | ||||||||||||||||||||||||||||||||||||
Net interest income | $ | 4,924 | $ | 5,449 | $ | 5,008 | ||||||||||||||||||||||||||||||||||||||
Interest rate spread (3) | 2.98 | % | 3.33 | % | 3.06 | % | ||||||||||||||||||||||||||||||||||||||
Net interest margin (4) | 3.10 | % | 3.46 | % | 3.20 | % | ||||||||||||||||||||||||||||||||||||||
Average interest-earning assets to average interest-bearing liabilities | 113.10 | % | 111.71 | % | 110.15 | % |
_________________________
(1) | Securities include unamortized premiums and unaccreted discounts. Securities include both available-for-sale and held-to-maturity securities. Fair value adjustments on available-for-sale securities have been included in the average balance for non-interest earning assets. |
(2) | The allowance for loan losses has been included in the average balance for non-interest earning assets. |
(3) | The interest rate spread represents the difference between the weighted average yield on average interest-earning assets and the weighted average cost of interest-bearing liabilities. |
(4) | The net interest margin represents net interest income as a percent of average interest-earning assets. |
Rate/Volume Analysis
The following table presents the dollar amount of changes in interest income and interest expense for the major categories of our interest-earning assets and interest-bearing liabilities for the years ended December 31, 2013 and 2012. Information is provided for each category of interest-earning assets and interest-bearing liabilities with respect to (i) changes attributable to changes in volume (i.e., changes in average balances multiplied by the prior-period average rate) and (ii) changes attributable to rate (i.e., changes in average rate multiplied by prior-period average balances). For purposes of this table, changes attributable to both rate and volume, which cannot be segregated, have been allocated proportionately to the change due to volume and the change due to rate.
2013 Compared to 2012 | Rate | Volume | Net | |||||||||
(In thousands) | ||||||||||||
Interest income: | ||||||||||||
Interest-earning deposits | $ | (6 | ) | $ | (5 | ) | $ | (11 | ) | |||
Securities purchased under agreements to resell | 2 | 63 | 65 | |||||||||
Securities, tax-exempt | (1 | ) | 23 | 22 | ||||||||
Securities, taxable | (2 | ) | (61 | ) | (63 | ) | ||||||
Loans | (635 | ) | (138 | ) | (773 | ) | ||||||
Federal Home Loan Bank stock | 4 | (7 | ) | (3 | ) | |||||||
Total | (639 | ) | (124 | ) | (763 | ) | ||||||
Interest expense: | ||||||||||||
Savings accounts | 1 | — | 1 | |||||||||
NOW and money market accounts | 20 | 2 | 22 | |||||||||
Certificates of deposit | (90 | ) | (16 | ) | (106 | ) | ||||||
Brokered certificates of deposit | (33 | ) | (32 | ) | (65 | ) | ||||||
Federal Home Loan Bank advances | (92 | ) | 2 | (90 | ) | |||||||
Total | (194 | ) | (44 | ) | (238 | ) | ||||||
Increase (decrease) in net interest income | $ | (445 | ) | $ | (80 | ) | $ | (525 | ) |
2012 Compared to 2011 | Rate | Volume | Net | |||||||||
(In thousands) | ||||||||||||
Interest income: | ||||||||||||
Interest-earning deposits | $ | (43 | ) | $ | 12 | $ | (31 | ) | ||||
Securities purchased under agreements to resell | (18 | ) | (26 | ) | (44 | ) | ||||||
Securities, tax-exempt | (12 | ) | 19 | 7 | ||||||||
Securities, taxable | (32 | ) | (1 | ) | (33 | ) | ||||||
Loans | (254 | ) | 297 | 43 | ||||||||
Federal Home Loan Bank stock | 5 | (5 | ) | — | ||||||||
Total | (354 | ) | 296 | (58 | ) | |||||||
Interest expense: | ||||||||||||
Savings accounts | (20 | ) | 3 | (17 | ) | |||||||
NOW and money market accounts | (32 | ) | 2 | (30 | ) | |||||||
Certificates of deposit | (309 | ) | (47 | ) | (356 | ) | ||||||
Brokered certificates of deposit | — | (10 | ) | (10 | ) | |||||||
Federal Home Loan Bank advances | (64 | ) | (22 | ) | (86 | ) | ||||||
Total | (425 | ) | (74 | ) | (499 | ) | ||||||
Increase (decrease) in net interest income | $ | 71 | $ | 370 | $ | 441 |
Management of Market Risk
Our most significant form of market risk is interest rate risk because, as a financial institution, the majority of our assets and liabilities are sensitive to changes in interest rates. Therefore, a principal goal of our operations is to manage interest rate risk and limit the exposure of our net interest income to changes in market interest rates.
Our board of directors is responsible for the review and oversight of our asset/liability strategies. The Asset/Liability Committee of the board of directors meets quarterly and is charged with developing an asset/liability management plan. Our board of directors has established an Asset/Liability Management Committee, consisting of senior management. This committee meets twice per month to review pricing and liquidity needs and to assess our interest rate risk. This committee is responsible for evaluating the interest rate risk inherent in our assets and liabilities, for determining the level of risk that is appropriate, given our business strategy, operating environment, capital, liquidity and performance objectives, and for managing this risk consistent with the guidelines approved by the board of directors.
Among the techniques we are currently using to manage interest rate risk are: (i) originating , and selling into the secondary mortgage market a significant portion of, our fixed-rate one- to four-family residential mortgage loan originations; (ii) originating agricultural and commercial and industrial operating lines of credit that generally have terms of one year or less and are variable-rate loans; (iii) originating commercial real estate and other intermediate-term agricultural production and commercial and industrial loans, as they generally reprice more quickly than one- to four-family residential mortgages; (iv) purchasing indirect automobile loans as they generally reprice more quickly than one-to four-family residential mortgages; and (v) emphasizing less interest rate sensitive and lower-cost “core deposits.” We also maintain a portfolio of other short-term or adjustable-rate assets and in addition, we have used fixed-rate Federal Home Loan Bank advances and longer-term certificate of deposit promotions to extend the term to repricing of our liabilities.
While we believe these strategies have helped manage our interest rate exposure, they do pose risks. For example, commercial real estate, commercial and industrial, agricultural real estate and production and indirect automobile loans generally present a higher level of credit risk than residential one- to four-family loans. In addition, core deposit accounts generally cost more to maintain and market than certificates of deposit.
An important measure of interest rate risk is the amount by which the net present value of an institution’s cash flow from assets, liabilities and off balance sheet items changes in the event of a range of assumed changes in market interest rates. We have utilize a computer simulation model to provide an analysis of estimated changes to our net portfolio value (“NPV”) under the assumed parallel instantaneous changes in the United States treasury yield curve. The financial model uses a discounted cash flow analysis and an option-based pricing approach to measuring the interest rate sensitivity of the NPV.
Set forth below is an analysis of the changes to the economic value of our equity that would occur to our NPV as of December 31, 2013 in the event of designated changes in the United States treasury yield curve. At December 31, 2013, our economic value of equity exposure related to these hypothetical changes in market interest rates was within the current guidelines we have established.
Change in | Estimate Increase (Decrease) in NPV | NPV as a Percentage of Present Value of Assets(1) | |||||||||||||||||||
Interest Rates (Basis Points)(2) | Estimates NPV (3) | Amount | Percent | NPV Ratio(4) | Change in Basis Points | ||||||||||||||||
(Dollars in thousands) | |||||||||||||||||||||
300+ | $ | 28,380 | $ | 1,928 | 7.29 | % | 17.25 | % | 194 | ||||||||||||
200+ | 27,958 | 1,506 | 5.69 | 16.71 | 140 | ||||||||||||||||
100+ | 27,423 | 971 | 3.67 | 16.12 | 80 | ||||||||||||||||
— | 26,452 | — | — | 15.32 | — | ||||||||||||||||
100- | 24,703 | (1,749 | ) | (6.61 | ) | 14.14 | (118 | ) |
(1) | Present value of assets represents the discounted present value of incoming cash flows on interest-earning assets. |
(2) | Estimated NPV assumes an instantaneous uniform change in interest rates at all maturities. |
(3) | NPV is the discounted present value of expected cash flows from assets, liabilities and off balance sheet contracts. |
(4) | NPV Ratio represents NPV divided by the present value of assets. |
In addition to modeling changes in NPV, we also analyze estimated changes to net interest income (“NII”) for a prospective twelve-month period under the interest rate scenarios set forth above. The following table sets forth our NII model as of December 31, 2013.
Change in Interest Rates | Estimated Net | Increase (Decrease) in Estimated Net Interest Income | |||||||||||||
(Basis Points) | Interest Income(1) (2) | Amount | Percent | ||||||||||||
(Dollars in thousands) | |||||||||||||||
300+ | $ | 6,465 | $ | 1,329 | 25.88 | % | |||||||||
200+ | 6,003 | 867 | 16.88 | ||||||||||||
100+ | 5,557 | 421 | 8.20 | ||||||||||||
— | 5,136 | — | — | ||||||||||||
100- | 4,779 | (357 | ) | (6.95 | ) |
(1) | Estimated net interest income assumes an instantaneous uniform change in interest rates at all maturities. |
(2) | Estimated net interest income is before provisions for loan losses. |
Certain shortcomings are inherent in the methodology used in the above interest rate risk measurement. Modeling changes in net portfolio value requires making certain assumptions that may or may not reflect the manner in which actual yields and costs respond to changes in market interest rates. In this regard, the tables presented assume that the composition of our interest-sensitive assets and liabilities existing at the beginning of a period remains constant over the period being measured and assumes that a particular change in interest rates is reflected uniformly across the yield curve regardless of the duration or repricing of specific assets and liabilities. The tables also do not measure the changes in credit and liquidity risk that may occur as a result of changes in general interest rates. Accordingly, although the tables provide an indication of our interest rate risk exposure at a particular point in time, such measurements are not intended to and do not provide a precise forecast of the effect of changes in market interest rates on our NPV and net interest income and will differ from actual results.
Liquidity and Capital Resources
Our primary sources of funds are deposits, principal and interest payments on loans and securities, proceeds from maturities and calls of securities, and Federal Home Loan Bank advances. While maturities and scheduled amortization of loans and securities are predictable sources of funds, deposit flows and mortgage prepayments are greatly influenced by general interest rates, economic conditions, and competition. Our most liquid assets are cash and short-term investments including securities repurchase agreements. The levels of these assets are dependent on our operating, financing, lending, and investing activities during any given period.
Our cash flows are comprised of three primary classifications: cash flows from operating activities, investing activities, and financing activities. Net cash provided by operating activities were $1.4 million and $2.3 million for the years ended December 31, 2013 and 2012, respectively. Net cash from investing activities consisted primarily of disbursements for loan originations and the purchase of securities and interest-bearing deposits in other financial institutions, offset by principal collections on loans, and proceeds from redemption of Federal Home Loan Bank stock, proceeds from maturing securities, interest-bearing deposits and pay downs on mortgage-backed securities. Net cash provided by (used in) investing activities were $4.1 million and $(533,000) for the years ended December 31, 2013 and 2012, respectively. Net cash provided by (used in) financing activities consisted primarily of the activity in deposit accounts and proceeds from Federal Home Loan Bank advances, offset by repayment of Federal Home Loan Bank advances. The net cash used in financing activities was $(342,000) and $(1.1 million) for the years ended December 31, 2013 and 2012, respectively.
At December 31, 2013, the Bank exceeded all of our regulatory capital requirements with a Tier 1 (core) capital level of $17.3 million, or 10.3% of adjusted total assets, which is above the required level of $6.7 million, or 4.0%; and total risk-based capital of $19.0 million, or 14.5% of risk-weighted assets, which is above the required level of $10.5 million, or 8.0%. Accordingly Harvard Savings Bank was categorized as well-capitalized at December 31, 2013. Management is not aware of any conditions or events since the most recent notification that would change our category.
At December 31, 2013, we had outstanding commitments to originate loans of $784,000, and commitments under unused lines of credit of $15.1 million. In addition, we had outstanding letters of credit of $130,000 at December 31, 2013. We anticipate that we will have sufficient funds available to meet our current loan origination commitments. Certificates of deposit that are scheduled to mature in less than one year from December 31, 2013 totaled $32.9 million.Management expects that a substantial portion of the maturing certificates of deposit will be renewed. However, if a substantial portion of these deposits is not retained, we may utilize Federal Home Loan Bank advances or raise interest rates on deposits to attract new accounts, which may result in higher levels of interest expense.
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, lines of credit and standby letters of credit. For information about our loan commitments, unused lines of credit and standby letters of credit, see Note 20 of the Notes to our Consolidated Financial Statements.
We have not engaged in any other off-balance-sheet transactions in the normal course of our lending activities.
Recent Accounting Pronouncements
For a discussion of the impact of recent accounting pronouncements, see Note 1 of the notes to our consolidated financial statements.
Impact of Inflation and Changing Prices
The financial statements and related data presented herein have been prepared in accordance with generally accepted accounting principles 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 our operations 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.
ITEM 7A. Quantitative and Qualitative Disclosures about Market Risk
Not required for smaller reporting companies.
ITEM 8. Financial Statements and Supplementary Data
The Company’s Consolidated Financial Statements are presented in this Annual Report on Form 10-K beginning at page F-1.
ITEM 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
None.
ITEM 9A. Controls and Procedures
(a) Disclosure Controls and Procedures.An evaluation was performed under the supervision and with the participation of the Company’s management, including the President and Chief Executive Officer and the Vice President 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 December 31, 2013. Based on that evaluation, the Company’s management, including the President and Chief Executive Officer and the Vice President and Chief Financial Officer, concluded that the Company’s disclosure controls and procedures were effective.
(b) Internal Control Over Financial Reporting. Management of the Company is responsible for establishing and maintaining adequate internal control over financial reporting (as defined in Rule 13a-15(f) promulgated under the Securities and Exchange Act of 1934, as amended).
The Company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with accounting principles generally accepted in the United States of America. The Company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the Company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with accounting principles generally accepted in the United States of America, and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the Company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the Company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
Management, including the President and Chief Executive Officer and Vice President and Chief Financial Officer, assessed the effectiveness of the Company’s internal control over financial reporting as of December 31, 2013, based on the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”) in “Internal Control-Integrated Framework.” Based on such assessment, management believes that, as of December 31, 2013, the Company’s internal control over financial reporting is effective, based on those criteria. During the year ended December 31, 2013, there have been no changes in the Company’s internal control over financial reporting that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.
This annual report does not include an attestation report of the Company’s registered public accounting firm regarding internal control over financial reporting because the attestation report is not required pursuant to the Dodd-Frank Act.
ITEM 9B. Other Information
None.
PART III
ITEM 10. Directors, Executive Officers and Corporate Governance
The Company has adopted a Code of Ethics that applies to the Company’s principal executive officer, principal financial officer, principal accounting officer or controller or persons performing similar functions. The Code of Ethics is posted on the Company’s website at www.harvardsavingsbank.com. A copy of the Code will be furnished without charge upon written request to the Secretary of the Company, 58 North Ayer Street, Harvard, Illinois 60033.
Information concerning directors and executive officers of the Company and certain board committee members is incorporated herein by reference from our definitive Proxy Statement for the 2014 Annual Meeting of Stockholders (the “Proxy Statement”), specifically the section captioned “Proposal I — Election of Directors.”
ITEM 11. Executive Compensation
Information concerning executive compensation is incorporated herein by reference from our Proxy Statement, specifically the section captioned “Proposal I — Election of Directors.”
ITEM 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
(a) Securities Authorized for Issuance Under Stock-Based Compensation Plans. The information required by this item is incorporated herein by reference from our Proxy Statement, specifically the section captioned “Proposal I—Election of Directors” in the Proxy Statement.
(b) Security Ownership of Certain Beneficial Owners. The information required by this item is incorporated herein by referencefrom our Proxy Statement, specifically the sections captioned “Voting Securities and Principal Holders Thereof” and “Proposal I — Election of Directors.”
(c) Security Ownership of Management. The information required by this item is incorporated herein by reference from our Proxy Statement, specifically the section captioned “Proposal I—Election of Directors” in the Proxy Statement.
(d) Changes in Control. Management of the Company knows of no arrangements, including any pledge by any person of securities of the Company, the operation of which may at a subsequent date result in a change in control of the registrant.
ITEM 13. Certain Relationships and Related Transactions and Director Independence
Information concerning relationships and transactions is incorporated herein by reference from our Proxy Statement, specifically the section captioned “Transactions with Certain Related Persons.” Information concerning director independence is incorporated herein by reference from our Proxy Statement, specifically the section captioned “Proposal I — Election of Directors.”
ITEM 14. Principal Accountant Fees and Services
Information concerning principal accountant fees and services is incorporated herein by reference from our Proxy Statement, specifically the section captioned “Proposal II — Ratification of Appointment of Independent Registered Public Accountants.”
PART IV
ITEM 15. Exhibits and Financial Statement Schedules
(a)(1) | Financial Statements |
The documents filed as a part of this Form 10-K are:
(A) | Report of Independent Registered Public Accounting Firm; |
(B) | Consolidated Balance Sheets - December 31, 2013 and 2012 |
(C) | Consolidated Statements of Income - years ended December 31, 2013 and 2012 |
(D) | Consolidated Statements of Comprehensive Income – years ended December 31, 2013 and 2012; |
(E) | Consolidated Statements of Stockholders’ Equity - years ended December 31, 2013 and 2012; |
(F) | Consolidated Statements of Cash Flows- years ended December 31, 2013 and 2012; |
(G) | Notes to Consolidated Financial Statements. |
(a)(2) | Financial Statement Schedules |
All financial statement schedules have been omitted as the required information is inapplicable or has been included in the Notes to Consolidated Financial Statements.
(a)(3) Exhibits | |
3.1 | Articles of Incorporation of Harvard Illinois Bancorp, Inc.* |
3.2 | Amended and Restated Bylaws of Harvard Illinois Bancorp, Inc.** |
4 | Form of Common Stock Certificate of Harvard Illinois Bancorp, Inc.* |
10.1 | Form of Employee Stock Ownership Plan* |
10.2 | Employment Agreement between Harvard Savings Bank and Duffield J. Seyller, III* |
10.3 | Employment Agreement between Harvard Savings Bank and Donn L. Claussen* |
10.4 | Change in Control Agreement between Harvard Savings Bank and Richard J. Lipinsky*** |
10.5 | Employment Agreement between Harvard Savings Bank and Donn L. Claussen* |
10.6 | Amended and Restated Salary Continuation Agreement with Duffield J. Seyller, III*** |
10.7 | Salary Continuation Agreement with Michael T. Neese * |
10.8 | Amended and Restated Salary Continuation Agreement with Donn L. Claussen*** |
10.9 | Split Dollar Life Insurance Agreement with Donn L. Claussen* |
10.10 | Form of Director Deferred Fee Agreements* |
10.11 | Form of 2009 Director Deferred Fee Agreement* |
10.12 | Employment Agreement between Harvard Savings Bank and David Dobson. |
21 | Subsidiaries |
31.1 | Certification required pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. |
31.2 | Certification required pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. |
32.1 | Certification of Chief Executive Officer and Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
101 | The following materials from the Company’s Annual Report on Form 10-K for the year ended December 31, 2013, formatted in XBRL (Extensible Business Reporting Language): (i) Consolidated Balance Sheets; (ii) Consolidated Statements of Income; (iii) Consolidated Statements of Comprehensive Income; (iv) Consolidated Statements of Stockholders Equity; (v) Consolidated Statements of Cash Flows; and (vi) Notes to Consolidated Financial Statements |
___________________
* | Incorporated by reference to the Registration Statement on Form S-1 (file no. 333-161931), initially filed September 15, 2009. |
** | Incorporated by reference to the Current Report on Form 8-K filed November 1, 2011. |
*** | Incorporated by reference to the Current Report on Form 8-K filed February 1, 2012. |
Signatures
Pursuant to the requirements of Section 13 of the Securities Exchange Act of 1934, the Company has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
Harvard Illinois Bancorp, Inc. | ||
Date: March 28, 2014 | By: | /s/ Donn L. Claussen |
Donn L. Claussen, President | ||
and Chief Executive Officer |
Pursuant to the requirements of the Securities Exchange of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
Signatures | Title | Date | ||
/s/ Donn L. Claussen Donn L. Claussen | President and Chief Executive Officer (Principal Executive Officer) | March 28, 2014 | ||
/s/ David Dobson David Dobson | Vice President and Chief Financial Officer (Principal Financial and Accounting Officer) | March 28, 2014 | ||
/s/ Duffield J. Seyller, III Duffield J. Seyller, III | Chairman of the Board | March 28, 2014 | ||
/s/ William D. Schack William D. Schack | Director | March 28, 2014 | ||
/s/ Michael P. Feeney Michael P. Feeney | Director | March 28, 2014 | ||
/s/ John W. Rebhorn John W. Rebhorn | Director | March 28, 2014 | ||
/s/ Steven D. Garrels Steven D. Garrels | Director | March 28, 2014 | ||
/s/ Richard L. Walker Richard L. Walker | Director | March 28, 2014 |
EXHIBIT INDEX
10.12 | Employment Agreement between Harvard Savings Bank and David Dobson. |
21 | Subsidiaries |
31.1 | Certification required pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. |
31.2 | Certification required pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. |
32.1 | Certification of Chief Executive Officer and Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
101 | The following materials from the Company’s Annual Report on Form 10-K for the year ended December 31, 2013, formatted in XBRL (Extensible Business Reporting Language): (i) Consolidated Balance Sheets; (ii) Consolidated Statements of Income; (iii) Consolidated Statements of Comprehensive Income; (iv) Consolidated Statements of Stockholders Equity; (v) Consolidated Statements of Cash Flows; and (vi) Notes to Consolidated Financial Statements |
Harvard Illinois Bancorp, Inc.
Report of Independent Registered Public Accounting Firm
and Consolidated Financial Statements
December 31, 2013 and 2012
Harvard Illinois Bancorp, Inc. and Subsidiary
December 31, 2006 and 2005
Contents
Report of Independent Registered Public Accounting Firm | F-1 |
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Consolidated Financial Statements |
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Balance Sheets | F-2 |
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Statements of Income | F-4 |
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Statements of Comprehensive Income | F-6 |
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Statements of Stockholders’ Equity | F-7 |
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Statements of Cash Flows | F-8 |
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Notes to Consolidated Financial Statements | F-10 |
Report of Independent Registered Public Accounting Firm
Audit Committee and Board of Directors
Harvard Illinois Bancorp, Inc.
Harvard, Illinois
We have audited the accompanying consolidated balance sheets of Harvard Illinois Bancorp, Inc. (Company) as of December 31, 2013 and 2012, and the related consolidated statements of income, comprehensive income, stockholders’ equity, and cash flows for the years then ended. The Company’s management is responsible for these financial statements. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing auditing procedure that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Harvard Illinois Bancorp, Inc. as of December 31, 2013 and 2012, and the results of its operations and its cash flows for the years then ended, in conformity with accounting principles generally accepted in the United States of America.
/sig/BKD, LLP
Decatur, Illinois
March 28, 2014
Harvard Illinois Bancorp, Inc.
Consolidated Balance Sheets
December 31, 2013 and 2012
(dollars in thousands, except share data)
Assets
2013 | 2012 | |||||||
Cash and due from banks | $ | 1,712 | $ | 1,102 | ||||
Interest-bearing demand deposits in banks | 1,260 | 2,743 | ||||||
Securities purchased under agreements to resell | 25,117 | 19,014 | ||||||
Cash and cash equivalents | 28,089 | 22,859 | ||||||
Interest-bearing deposits with other financial institutions | 6,240 | 9,126 | ||||||
Available-for-sale securities | 5,545 | 7,879 | ||||||
Held-to-maturity securities, at amortized cost (estimated fair value of $839 and $1,314 at December 31, 2013 and 2012) | 833 | 1,263 | ||||||
Loans, net of allowance for loan losses of $2,475 and $2,550 at December 31, 2013 and 2012 | 116,858 | 114,976 | ||||||
Premises and equipment, net of accumulated depreciation of $4,756 and $5,753 at December 31, 2013 and 2012 | 3,366 | 3,395 | ||||||
Federal Home Loan Bank stock, at cost | 870 | 1,404 | ||||||
Foreclosed assets held for sale | 331 | 886 | ||||||
Accrued interest receivable | 786 | 612 | ||||||
Deferred income taxes | 1,897 | 1,859 | ||||||
Bank-owned life insurance | 4,472 | 4,357 | ||||||
Loan servicing rights | 620 | 412 | ||||||
Other | 213 | 339 | ||||||
Total assets | $ | 170,120 | $ | 169,367 |
Harvard Illinois Bancorp, Inc.
Consolidated Balance Sheets
December 31, 2013 and 2012
(dollars in thousands, except share data)
Liabilities and Stockholders’ Equity
2013 | 2012 | |||||||
Liabilities | ||||||||
Deposits | ||||||||
Demand | $ | 6,463 | $ | 6,278 | ||||
Savings, NOW and money market | 51,794 | 51,571 | ||||||
Certificates of deposit | 75,493 | 76,136 | ||||||
Total deposits | 133,750 | 133,985 | ||||||
Federal Home Loan Bank advances | 12,206 | 12,357 | ||||||
Advances from borrowers for taxes and insurance | 358 | 382 | ||||||
Deferred compensation | 2,433 | 2,338 | ||||||
Accrued interest payable | 19 | 29 | ||||||
Other | 908 | 659 | ||||||
Total liabilities | 149,674 | 149,750 | ||||||
Commitments and Contingencies | — | — | ||||||
Stockholders’ Equity | ||||||||
Preferred stock, $.01 par value, 1,000,000 shares authorized, no shares issued or outstanding | — | — | ||||||
Common stock, $.01 par value, 30,000,000 shares authorized; issued and outstanding 2013 – 833,851 shares and 2012 – 816,076 shares | 8 | 8 | ||||||
Additional paid-in capital | 7,253 | 6,976 | ||||||
Unearned ESOP shares, at cost; 2013 – 46,035 shares; 2012 – 50,220 shares | (460 | ) | (502 | ) | ||||
Amount reclassified on ESOP shares | (268 | ) | (163 | ) | ||||
Retained earnings | 13,897 | 13,291 | ||||||
Accumulated other comprehensive income, net of tax | 16 | 7 | ||||||
Total stockholders’ equity | 20,446 | 19,617 | ||||||
Total liabilities and stockholders’ equity | $ | 170,120 | $ | 169,367 |
See Notes to Consolidated Financial Statements
Harvard Illinois Bancorp, Inc.
ConsolidatedStatements of Income
Years Ended December 31, 2013 and 2012
(dollars in thousands, except share data)
2013 | 2012 | |||||||
Interest and Dividend Income | ||||||||
Interest and fees on loans | $ | 6,030 | $ | 6,803 | ||||
Securities | ||||||||
Taxable | 89 | 152 | ||||||
Tax-exempt | 38 | 16 | ||||||
Securities purchased under agreements to resell | 204 | 139 | ||||||
Other | 80 | 94 | ||||||
Total interest and dividend income | 6,441 | 7,204 | ||||||
Interest Expense | ||||||||
Deposits | 1,267 | 1,415 | ||||||
Federal Home Loan Bank advances | 250 | 340 | ||||||
Total interest expense | 1,517 | 1,755 | ||||||
Net Interest Income | 4,924 | 5,449 | ||||||
Provision for Loan Losses | 453 | 599 | ||||||
Net Interest Income After Provision for Loan Losses | 4,471 | 4,850 | ||||||
Noninterest Income | ||||||||
Customer service fees | 296 | 270 | ||||||
Brokerage commission income | 1 | 31 | ||||||
Net realized gains on loan sales | 354 | 299 | ||||||
Net realized gains on sales of available-for-sale securities | — | 2 | ||||||
Losses on other than temporary impairment of equity securities | — | (1 | ) | |||||
Loan servicing fees | 207 | 207 | ||||||
Bank-owned life insurance income, net | 112 | 121 | ||||||
Other | 9 | 12 | ||||||
Total noninterest income | 979 | 941 |
See Notes to Consolidated Financial Statements
Harvard Illinois Bancorp, Inc.
Consolidated Statements of Income
Years Ended December 31, 2013 and 2012
(dollars in thousands, except share data)
2013 | 2012 | |||||||
Noninterest Expense | ||||||||
Compensation and benefits | $ | 2,550 | $ | 2,516 | ||||
Occupancy | 503 | 487 | ||||||
Data processing | 309 | 348 | ||||||
Professional fees | 382 | 387 | ||||||
Marketing | 87 | 69 | ||||||
Office supplies | 46 | 51 | ||||||
Federal deposit insurance | 149 | 148 | ||||||
Indirect automobile loan servicing fees | 107 | 112 | ||||||
Foreclosed assets, net | 80 | 258 | ||||||
Other | 370 | 383 | ||||||
Total noninterest expense | 4,583 | 4,759 | ||||||
Income Before Income Taxes | 867 | 1,032 | ||||||
Provision for Income Taxes | 184 | 144 | ||||||
Net Income | $ | 683 | $ | 888 | ||||
Basic Earnings Per Share | $ | 0.87 | $ | 1.20 | ||||
Diluted Earnings Per Share | 0.87 | 1.18 | ||||||
Dividends Paid | $ | 0.10 | $ | — |
See Notes to Consolidated Financial Statements
Harvard Illinois Bancorp, Inc.
Consolidated Statements of Comprehensive Income
December 31, 2013 and 2012
(dollars in thousands, except share data)
2013 | 2012 | |||||||
Net Income | $ | 683 | $ | 888 | ||||
Other Comprehensive Income (Loss) | ||||||||
Unrealized appreciation (depreciation) on available-for-sale securities, net of taxes of $5 and $(8) for 2013 and 2012, respectively | 9 | (15 | ) | |||||
Less: reclassification adjustment for realized gains included in net income, net of taxes of $0 for the 2013 and 2012 | — | 2 | ||||||
Less: reclassification adjustment for loss on other-than-temporary impairment of equity securities included in net income, net of taxes of $0 for 2013 and 2012, respectively | — | (1 | ) | |||||
9 | (16 | ) | ||||||
Comprehensive Income | $ | 692 | $ | 872 |
See Notes to Consolidated Financial Statements
Harvard Illinois Bancorp, Inc.
Consolidated Statements of Stockholders' Equity
Years Ended December 31, 2013 and 2012
(dollars in thousands, except share data)
Common Stock | Additional Paid-In Capital | Unearned ESOP Shares | Amount Reclassified On ESOP Shares | Retained Earnings | Accumulated Other Comprehensive Income | Total | ||||||||||||||||||||||
Balance, January 1, 2012 | 8 | 6,852 | (544 | ) | (80 | ) | 12,403 | 23 | 18,662 | |||||||||||||||||||
Net income | — | — | — | — | 888 | — | 888 | |||||||||||||||||||||
Other comprehensive income (loss) | — | — | — | — | — | (16 | ) | (16 | ) | |||||||||||||||||||
Stock-based compensation expense | — | 121 | — | — | — | — | 121 | |||||||||||||||||||||
ESOP shares earned, 4,185 shares | — | 3 | 42 | — | — | — | 45 | |||||||||||||||||||||
Reclassification due to change in fair value of common stock ESOP subject to contingent repurchase obligation | — | — | — | (83 | ) | — | — | (83 | ) | |||||||||||||||||||
Balance, December 31, 2012 | 8 | 6,976 | (502 | ) | (163 | ) | 13,291 | 7 | 19,617 | |||||||||||||||||||
Net income | — | — | — | — | 683 | — | 683 | |||||||||||||||||||||
Other comprehensive income | — | — | — | — | — | 9 | 9 | |||||||||||||||||||||
Stock-based compensation expense | — | 114 | — | — | — | — | 114 | |||||||||||||||||||||
ESOP shares earned, 4,185 shares | — | 18 | 42 | — | — | — | 60 | |||||||||||||||||||||
Reclassification due to change in fair value of common stock ESOP subject to contingent repurchase obligation | — | — | — | (105 | ) | — | — | (105 | ) | |||||||||||||||||||
Exercise of stock options, 17,775 shares | — | 145 | — | — | — | — | 145 | |||||||||||||||||||||
Dividends on common stock $.10 per share | — | — | — | — | (77 | ) | — | (77 | ) | |||||||||||||||||||
Balance, December 31, 2013 | 8 | 7,253 | (460 | ) | (268 | ) | 13,897 | 16 | 20,446 |
See Notes to Consolidated Financial Statements
Harvard Illinois Bancorp, Inc.
Consolidated Statements of Cash Flows
Years Ended December 31, 2013 and 2012
(dollars in thousands, except share data)
2013 | 2012 | |||||||
Operating Activities | ||||||||
Net income | $ | 683 | $ | 888 | ||||
Items not requiring (providing) cash | ||||||||
Depreciation | 209 | 204 | ||||||
Provision for loan losses | 453 | 599 | ||||||
Amortization (accretion) of premiums and discounts on securities | 37 | (1 | ) | |||||
Deferred income taxes | (44 | ) | (48 | ) | ||||
Net realized gains losses on loan sales | (354 | ) | (299 | ) | ||||
Net realized gains on sales of available-for-sale securities | — | (2 | ) | |||||
Losses on other than temporary impairment of equity securities | — | 1 | ||||||
Losses and write down on foreclosed assets held for sale | 57 | 255 | ||||||
Bank-owned life insurance income, net | (112 | ) | (121 | ) | ||||
Originations of loans held for sale | (18,098 | ) | (16,698 | ) | ||||
Proceeds from sales of loans held for sale | 18,244 | 16,895 | ||||||
ESOP compensation expense | 60 | 45 | ||||||
Stock-based compensation expense | 114 | 121 | ||||||
Changes in | ||||||||
Accrued interest receivable | (174 | ) | 79 | |||||
Other assets | 123 | 135 | ||||||
Accrued interest payable | (10 | ) | (8 | ) | ||||
Deferred compensation | 95 | 96 | ||||||
Other liabilities | 144 | 159 | ||||||
Net cash provided by operating activities | 1,427 | 2,300 | ||||||
Investing Activities | ||||||||
Net change in interest-bearing deposits | 2,886 | (2,891 | ) | |||||
Purchases of available-for-sale securities | (1,083 | ) | (8,536 | ) | ||||
Proceeds from the sales of available-for-sale securities | — | 8 | ||||||
Proceeds from maturities and pay-downs of available-for-sale securities | 3,379 | 5,169 | ||||||
Proceeds from maturities and pay-downs of held-to-maturity securities | 446 | 478 | ||||||
Net change in loans | (2,925 | ) | (252 | ) | ||||
Purchases of premises and equipment | (180 | ) | (74 | ) | ||||
Purchases of FHLB stock | (426 | ) | — | |||||
Proceeds from redemption of Federal Home Loan | ||||||||
Bank stock | 960 | 5,145 | ||||||
Proceeds from sale of foreclosed assets | 1,088 | 420 | ||||||
Net cash provided by (used in) investing activities | 4,145 | (533 | ) |
See Notes to Consolidated Financial Statements
Harvard Illinois Bancorp, Inc.
Consolidated Statements of Cash Flows
Years Ended December 31, 2013 and 2012
(dollars in thousands, except share data)
2013 | 2012 | |||||||
Financing Activities | ||||||||
Net increase in demand deposits, money market, NOW and savings accounts | $ | 408 | $ | 3,620 | ||||
Net decrease in certificates of deposit including brokered certificates | (643 | ) | (4,704 | ) | ||||
Net decrease in advances from borrowers for taxes and insurance | (24 | ) | (6 | ) | ||||
Proceeds from Federal Home Loan Bank advances | 43,750 | 5,500 | ||||||
Repayments of Federal Home Loan Bank advances | (43,901 | ) | (5,545 | ) | ||||
Dividends paid | (77 | ) | — | |||||
Stock options exercised | 145 | — | ||||||
Net cash used in financing activities | (342 | ) | (1,135 | ) | ||||
Net Increase in Cash and Cash Equivalents | 5,230 | 632 | ||||||
Cash and Cash Equivalents, Beginning of Year | 22,859 | 22,227 | ||||||
Cash and Cash Equivalents, End of Year | $ | 28,089 | $ | 22,859 | ||||
Supplemental Cash Flows Information | ||||||||
Interest paid | $ | 1,527 | $ | 1,763 | ||||
Income taxes paid | 228 | 157 | ||||||
Foreclosed assets acquired in settlement of loans | 567 | 371 |
Supplemental disclosure of noncash financing activities: | ||||||||
With the initial public offering in April 2010, the Company loaned $628 to the Employee Stock Ownership Plan, which was used to acquire 62,775 shares of the Company’s common stock. The loan is secured by the shares purchased and is shown as unearned ESOP shares in the consolidated balance sheets. Payments on the loan were $36 and $35 in 2013 and 2012, respectively. |
See Notes to Consolidated Financial Statements
Harvard Illinois Bancorp, Inc.
Notes to Consolidated Financial Statements
December 31, 2013 and 2012
(dollars in thousands, except share data)
Note 1: Nature of Operations and Summary of Significant Accounting Policies
Nature of Operations
Harvard Illinois Bancorp, Inc. (Company) owns 100% of the outstanding shares of common stock of Harvard Savings Bank (Bank). The Company is primarily engaged in providing a full range of banking and mortgage services to individual and corporate customers in McHenry, Grundy, and to a lesser extent Boone Counties, Illinois and Walworth County in Wisconsin. The Company and Bank are subject to competition from other financial institutions. The Company and Bank also are subject to the regulation of certain federal and state agencies and undergoes periodic examinations by those regulatory authorities.
Principles of Consolidation
The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiary, Harvard Savings Bank. All significant intercompany accounts and transactions have been eliminated in consolidation.
Operating Segment
The Company provides community banking services, including such products and services as loans, certificates of deposits, savings accounts, mortgage originations and brokerage services. These activities are reported as a single operating segment.
The Company does not derive revenues from, or have assets located in, foreign countries, nor does it derive revenues from any single customer that represents 10% or more of the Company’s total revenues.
Use of Estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Material estimates that are particularly susceptible to significant change relate to the determination of the allowance for loan losses, valuation of real estate acquired in connection with foreclosures or in satisfaction of loans, loan servicing rights, valuation of deferred taxes and other-than-temporary impairment (OTTI) and fair values of securities.
Harvard Illinois Bancorp, Inc.
Notes to Consolidated Financial Statements
December 31, 2013 and 2012
(dollars in thousands, except share data)
Cash Equivalents
The Company considers all liquid investments with original maturities of three months or less to be cash equivalents. At December 31, 2013 and 2012, cash equivalents consisted primarily of interest-bearing demand deposits and securities purchased under agreements to resell.
At December 31, 2013 and 2012, none of the Company’s cash accounts exceeded federally insured limits.
Interest-bearing Deposits With Other Financial Institutions
Interest-bearing deposits with other financial institutions have original maturities of more than three months to five years and are carried at cost.
Securities
Certain debt securities that management has the positive intent and ability to hold to maturity are classified as “held to maturity” and recorded at amortized cost. Securities not classified as held to maturity are classified as “available for sale” and recorded at fair value, with unrealized gains and losses excluded from earnings and reported in other comprehensive income. Purchase premiums and discounts are recognized in interest income using a method that approximates the interest method over the terms of the securities. Gains and losses on the sale of securities are recorded on the trade date and are determined using the specific identification method.
For debt securities with fair value below amortized cost when the Company does not intend to sell a debt security, and it is more likely than not, the Company will not have to sell the security before recovery of its cost basis, it recognizes the credit component of an other-than-temporary impairment of a debt security in earnings and the remaining portion in other comprehensive income. For held-to-maturity debt securities, the amount of an other-than-temporary impairment recorded in other comprehensive income for the noncredit portion of a previous other-than-temporary impairment is amortized prospectively over the remaining life of the security on the basis of the timing of future estimated cash flows of the security.
For equity securities, when the Company has decided to sell an impaired available-for-sale security and the entity does not expect the fair value of the security to fully recover before the expected time of sale, the security is deemed other-than-temporarily impaired in the period in which the decision to sell is made. The Company recognizes an impairment loss when the impairment is deemed other than temporary even if a decision to sell has not been made.
Harvard Illinois Bancorp, Inc.
Notes to Consolidated Financial Statements
December 31, 2013 and 2012
(dollars in thousands, except share data)
Loans Held for Sale
Mortgage loans originated and intended for sale in the secondary market are carried at the lower of cost or fair value in the aggregate. Net unrealized losses, if any, are recognized through a valuation allowance by charges to noninterest income. Gains and losses on loan sales are recorded in noninterest income.
Loans
Loans that management has the intent and ability to hold for the foreseeable future or until maturity or payoffs are reported at their outstanding principal balances adjusted for unearned income, charge-offs, the allowance for loan losses, and any unamortized deferred fees or costs on originated loans.
For loans amortized at cost, interest income is accrued based on the unpaid principal balance. Loan origination fees, net of certain direct origination costs, as well as premiums and discounts, are deferred and amortized as a level yield adjustment over the respective term of the loan.
The accrual of interest on loans is discontinued at the time the loan is 90 days past due unless the credit is well-secured and in process of collection. Past due status is based on contractual terms of the loan. In all cases, loans are placed on nonaccrual or charged off at an earlier date if collection of principal or interest is considered doubtful.
All interest accrued but not collected for loans that are placed on nonaccrual or charged off are reversed against interest income. The interest on these loans is accounted for on the cash-basis or cost-recovery method, until qualifying for return to accrual. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured.
Allowance for Loan Losses
The allowance for loan losses is established as losses are estimated to have occurred through a provision for loan losses charged to income. Loan losses are charged against the allowance when management believes the uncollectibility of a loan balance is confirmed. Subsequent recoveries, if any, are credited to the allowance.
The allowance for loan losses is evaluated on a regular basis by management and is based upon management’s periodic review of the collectibility of the loans in light of historical experience, the nature and volume of the loan portfolio, adverse situations that may affect the borrower’s ability to repay, estimated value of any underlying collateral and prevailing economic conditions. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available.
Harvard Illinois Bancorp, Inc.
Notes to Consolidated Financial Statements
December 31, 2013 and 2012
(dollars in thousands, except share data)
The allowance consists of allocated and general components. The allocated component relates to loans that are classified as impaired. For those loans that are classified as impaired, an allowance is established when the discounted cash flows (or collateral value or observable market price) of the impaired loan is lower than the carrying value of that loan. The general component covers nonclassified loans and is based on historical charge-off experience and expected loss given default derived from the Company’s internal risk rating process. Other adjustments may be made to the allowance for pools of loans after an assessment of internal or external influences on credit quality that are not fully reflected in the historical loss or risk rating data.
A loan is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record and the amount of the shortfall in relation to the principal and interest owed. Impairment is measured on a loan-by-loan basis for commercial loans by either the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s obtainable market price, or the fair value of the collateral if the loan is collateral dependent.
Groups of loans with similar risk characteristics are collectively evaluated for impairment based on the group’s historical loss experience adjusted for changes in trends, conditions and other relevant factors that affect repayment of the loans. Accordingly, the Company does not separately identify individual consumer loans for impairment measurements, unless such loans are the subject of a restructuring agreement due to financial difficulties of the borrower.
Premises and Equipment
Depreciable assets are stated at cost less accumulated depreciation. Depreciation is charged to expense using the straight-line method over the estimated useful lives of the assets.
The estimated useful lives for each major depreciable classification of premises and equipment are as follows:
Buildings and improvements (years) | 5 | - | 50 |
Equipment (years) | 3 | - | 10 |
Federal Home Loan Bank Stock
Federal Home Loan Bank stock is a required investment for institutions that are members of the Federal Home Loan Bank system. The required investment in the common stock is based on a predetermined formula.
Harvard Illinois Bancorp, Inc.
Notes to Consolidated Financial Statements
December 31, 2013 and 2012
(dollars in thousands, except share data)
Foreclosed Assets Held for Sale
Assets acquired through, or in lieu of, loan foreclosure are held for sale and are initially recorded at fair value less cost to sell at the date of foreclosure, establishing a new cost basis. Subsequent to foreclosure, valuations are periodically performed by management and the assets are carried at the lower of carrying amount or fair value less cost to sell. Revenue and expenses from operations and changes in the valuation allowance are included in net income or expense from foreclosed assets.
Bank-owned Life Insurance
Bank-owned life insurance policies are reflected on the consolidated balance sheets at the estimated cash surrender value. Changes in the cash surrender value are reflected in noninterest income in the consolidated statements of income.
Fee Income
Loan origination fees, net of direct origination costs, are recognized as income using the level-yield method over the term of the loans. Brokerage commissions represent fees earned on brokerage activities and are recognized when earned.
Loan Servicing Rights
Loan servicing assets are recognized separately when rights are acquired through purchase or through sale of financial assets. Under the servicing assets and liabilities accounting guidance (ASC 860-50), servicing rights resulting from the sale or securitization of loans originated by the Company are initially measured at fair value at the date of transfer. The Company subsequently measures each class of servicing asset using either the fair value or the amortization method. The Company has elected to initially and subsequently measure the loan servicing rights for consumer and agricultural loans using the fair value method. Under the fair value method, the servicing rights are carried in the balance sheet at fair value and the changes in fair value are reported in earnings in the period in which the changes occur.
Fair value is based on market prices for comparable loan servicing contracts, when available, or alternatively, is based on a valuation model that calculates the present value of estimated future net servicing income. The valuation model incorporates assumptions that market participants would use in estimating future net servicing income, such as the cost to service, the discount rate, the custodial earnings rate, an inflation rate, ancillary income, prepayment speeds and default rates and losses. These variables change from quarter to quarter as market conditions and projected interest rates change, and may have an adverse impact on the value of the loan servicing right and may result in a reduction to noninterest income.
Harvard Illinois Bancorp, Inc.
Notes to Consolidated Financial Statements
December 31, 2013 and 2012
(dollars in thousands, except share data)
Servicing fee income is recorded for fees earned for servicing loans. The fees are based on a contractual percentage of the outstanding principal or a fixed amount per loan and are recorded as income when received in loan servicing fees in non-interest income.
Stock Options
At December 31, 2013, the Company has a stock-based employee compensation plan, which is described more fully in Note 16.
Transfers of Financial Assets
Transfers of financial assets are accounted for as sales, when control over the assets has been surrendered. Control over transferred assets is deemed to be surrendered when (1) the assets have been isolated from the Company—put presumptively beyond the reach of the transferor and its creditors, even in bankruptcy or other receivership, (2) the transferee obtains the right (free of conditions that constrain it from taking advantage of that right) to pledge or exchange the transferred assets and (3) the Company does not maintain effective control over the transferred assets through an agreement to repurchase them before their maturity or the ability to unilaterally cause the holder to return specific assets.
Income Taxes
The Company accounts for income taxes in accordance with income tax accounting guidance (ASC 740,Income Taxes). The income tax accounting guidance results in two components of income tax expense: current and deferred. Current income tax expense reflects taxes to be paid or refunded for the current period by applying the provisions of the enacted tax law to the taxable income or excess of deductions over revenues. The Company determines deferred income taxes using the liability (or balance sheet) method. Under this method, the net deferred tax asset or liability is based on the tax effects of the differences between the book and tax bases of assets and liabilities, and enacted changes in tax rates and laws are recognized in the period in which they occur.
Deferred income tax expense results from changes in deferred tax assets and liabilities between periods. Deferred tax assets are reduced by a valuation allowance if, based on the weight of evidence available, it is more likely than not that some portion or all of a deferred tax asset will not be realized.
Tax positions are recognized if it is more likely than not, based on the technical merits, that the tax position will be realized or sustained upon examination. The term more likely than not means a likelihood of more than 50 percent; the terms examined and upon examination also include resolution of the related appeals or litigation processes, if any. A tax position that meets the more-likely-than-not recognition threshold is initially and subsequently measured as the largest amount of tax benefit that has a greater than 50 percent likelihood of being realized upon settlement with a taxing authority that has full knowledge of all relevant information. The determination of whether or not a tax position has met the more-likely-than-not recognition threshold considers the facts, circumstances and information available at the reporting date and is subject to management’s judgment. With a few exceptions, the Company is no longer subject to U.S. federal, state and local or non-U.S. income tax examinations by tax authorities for years before 2010.
Harvard Illinois Bancorp, Inc.
Notes to Consolidated Financial Statements
December 31, 2013 and 2012
(dollars in thousands, except share data)
The Company recognizes interest and penalties on income taxes as a component of income tax expense.
The Company files consolidated income tax returns with its subsidiary.
Earnings Per Share
Basic earnings per share represents income available to common stockholders divided by the weighted-average number of common shares outstanding during each year. Diluted earnings per share reflects additional potential common shares that would have been outstanding if dilutive potential common shares had been issued, as well as any adjustment to income that would result from the assumed issuance. Potential common shares that may be issued by the Company relate solely to outstanding stock options and restricted stock awards and are determined using the treasury stock method.
Comprehensive Income
Comprehensive income consists of net income and other comprehensive income, net of applicable income taxes. Other comprehensive income includes unrealized appreciation (depreciation) on available-for-sale securities.
Transfers Between Fair Value Hierarchy Levels
Transfers in and out of Level 1 (quoted market prices), Level 2 (other significant observable inputs) and Level 3 (significant unobservable inputs) are recognized on the period ending date.
Recent and Future Accounting Requirements
In July 2013, the FASB issued guidance within ASU 2013-11, Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists. The amendments in ASU 2013-11 to Topic 740, Income Taxes, provide guidance on the financial statement presentation of unrecognized tax benefits when a net operating loss carryforward, a similar tax loss, or a tax credit carryforward exists. The amendments are effective for fiscal years, and interim periods within those years, beginning after December 15, 2013. The adoption of this guidance is not expected to have a material impact on the Company’s Consolidated Financial Statements.
In January 2014, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2014-04, Troubled Debt Restructurings by Creditors (Subtopic 310-40: Reclassification of Residential Real Estate Collateralized Consumer Mortgage Loans Upon Foreclosure, which affects all creditors who obtain physical possession (resulting from an in substance repossession or foreclosure) of residential real estate property collateralizing a consumer mortgage loan in satisfaction of a receivable. The ASU is effective for annual periods beginning after December 15, 2014, and interim periods within annual periods beginning after December 15, 2015 which the entity’s annual or interim financial statements have not been made available for issuance. The adoption of this guidance is not expected to have a material impact on the Company’s Consolidated Financial Statements.
Harvard Illinois Bancorp, Inc.
Notes to Consolidated Financial Statements
December 31, 2013 and 2012
(dollars in thousands, except share data)
Note 2: Securities
The amortized cost and approximate fair values, together with gross unrealized gains and losses, of securities are as follows:
Amortized Cost | Gross Unrealized Gains | Gross Unrealized Losses | Fair Value | |||||||||||||
Available-for-sale Securities: | ||||||||||||||||
December 31, 2013 | ||||||||||||||||
U.S. Government and federal agency | $ | 990 | $ | — | $ | (8 | ) | $ | 982 | |||||||
Mortgage-backed: | ||||||||||||||||
Government-sponsored enterprises (GSE) – residential | 614 | 12 | — | 626 | ||||||||||||
State and political subdivisions | 3,461 | 7 | (39 | ) | 3,429 | |||||||||||
Equity securities | 455 | 53 | — | 508 | ||||||||||||
$ | 5,520 | $ | 72 | $ | (47 | ) | $ | 5,545 |
Harvard Illinois Bancorp, Inc.
Notes to Consolidated Financial Statements
December 31, 2013 and 2012
(dollars in thousands, except share data)
Amortized Cost | Gross Unrealized Gains | Gross Unrealized Losses | Fair Value | |||||||||||||
Available-for-sale Securities: | ||||||||||||||||
December 31, 2012 | ||||||||||||||||
U.S. Government and federal agency | $ | 3,194 | $ | 5 | $ | (14 | ) | $ | 3,185 | |||||||
Mortgage-backed: | ||||||||||||||||
Government-sponsored enterprises (GSE) – residential | 758 | 21 | — | 779 | ||||||||||||
State and political subdivisions | 3,467 | 5 | (23 | ) | 3,449 | |||||||||||
Equity securities | 450 | 16 | — | 466 | ||||||||||||
$ | 7,869 | $ | 47 | $ | (37 | ) | $ | 7,879 |
Amortized Cost | Gross Unrealized Gains | Gross Unrealized Losses | Fair Value | |||||||||||||
Held-to-maturity Securities: | ||||||||||||||||
December 31, 2013: | ||||||||||||||||
U.S. Government agencies | $ | 500 | $ | 2 | $ | — | $ | 502 | ||||||||
Mortgage-backed: | ||||||||||||||||
Government-sponsored enterprises (GSE) – residential | 13 | 1 | — | 14 | ||||||||||||
Private-label residential | 320 | 3 | — | 323 | ||||||||||||
$ | 833 | $ | 6 | $ | — | $ | 839 |
Harvard Illinois Bancorp, Inc.
Notes to Consolidated Financial Statements
December 31, 2013 and 2012
(dollars in thousands, except share data)
Amortized Cost | Gross Unrealized Gains | Gross Unrealized Losses | Fair Value | |||||||||||||
Held-to-maturity Securities: | ||||||||||||||||
December 31, 2012: | ||||||||||||||||
U.S. Government agencies | $ | 500 | $ | 21 | $ | — | $ | 521 | ||||||||
Mortgage-backed: | ||||||||||||||||
Government-sponsored enterprises (GSE) – residential | 17 | 1 | — | 18 | ||||||||||||
Private-label residential | 746 | 29 | — | 775 | ||||||||||||
$ | 1,263 | $ | 51 | $ | — | $ | 1,314 |
With the exception of obligations of U.S. Treasury and other U.S. government agencies and corporations, the Company held no securities at December 31, 2013 with a book value that exceeded 10% of total equity.
Available for sale equity securities consist of shares in the Shay Asset Management mutual funds, shares of FHLMC and FNMA common stock, and shares in other financial institutions.
The Company recorded no other-than-temporary impairment on the FNMA and FHLMC common stock included in equity securities in 2013 and 2012, respectively. As of December 31, 2013 and 2012, the Company held investments in FNMA and FHLMC common stock with an amortized cost of $2. The Company realized gains on sales of FNMA and FHLMC common stock of $2 on sales proceeds of $8 for 2012. There were no sales in 2013. The investments in FNMA and FHLMC common stock are valued using available market prices. Management performed an analysis and deemed the remaining investment in FNMA and FHLMC common stock was not other than temporarily impaired as of December 31, 2013.
The Company recorded no other than temporary impairment on the Shay Asset Management mutual funds included in equity securities for 2013 and 2012, respectively. As of December 31, 2013 and 2012, the Company held investments in the mutual funds with an amortized cost of $443 and $438, respectively. The investments in mutual funds are valued using available market prices. Management performed an analysis and deemed the remaining investment in the mutual funds was not other than temporarily impaired as of December 31, 2013.
Harvard Illinois Bancorp, Inc.
Notes to Consolidated Financial statements
December 31, 2013 and 2012
(dollars in thousands, except share data)
The Company recorded an other-than-temporary impairment on other equity securities of $0 and $1 for 2013 and 2012, respectively. As of December 31, 2013 and 2012, the Company held investments in other equity securities with an amortized cost of $10.
Other-than-temporary impairment recorded for 2013 and 2012 totaled $0 and $1, respectively as previously described.
The amortized cost and fair value of available-for-sale securities and held-to-maturity securities at December 31, 2013, by contractual maturity, are shown below. Expected maturities will differ from contractual maturities because issuers may have the right to call or prepay obligations with or without call or prepayment penalties.
Available-for-sale | Held-to-maturity | |||||||||||||||
Amortized | Fair | Amortized | Fair | |||||||||||||
Within one year | $ | 646 | $ | 646 | $ | 500 | $ | 502 | ||||||||
One to five years | 2,957 | 2,941 | — | — | ||||||||||||
Five to ten years | 848 | 824 | — | — | ||||||||||||
After ten years | — | — | — | — | ||||||||||||
4,451 | 4,411 | 500 | 502 | |||||||||||||
Mortgage-backed securities | 614 | 626 | 333 | 337 | ||||||||||||
Equity securities | 455 | 508 | — | — | ||||||||||||
Totals | $ | 5,520 | $ | 5,545 | $ | 833 | $ | 839 |
Gross gains of $2 resulting from sales of available-for-sale securities were realized for 2012. There were no tax benefits applicable to these gains. There were no sales of securities in 2013.
The carrying value of securities pledged as collateral, to secure public deposits and for other purposes, was $1,120 at December 31, 2013 and $934 at December 31, 2012.
Certain investments in debt and marketable equity securities are reported in the financial statements at an amount less than their historical cost. Total fair value of these investments at December 31, 2013 and 2012, was $2,292 and $2,846, respectively, which is approximately 36% and 31% of the Company’s available-for-sale and held-to-maturity investment portfolio. These declines primarily resulted from recent increases in market interest rates. Management believes the declines in fair value for these securities are temporary.
Harvard Illinois Bancorp, Inc.
Notes to Consolidated Financial Statements
December 31, 2013 and 2012
(dollars in thousands, except share data)
The following table shows the Company’s investments’ gross unrealized losses and fair value of the Company’s investments with unrealized losses that are not deemed to be other-than-temporarily impaired, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position at December 31, 2013 and 2012:
December 31, 2013 | ||||||||||||||||||||||||
Less than 12 Months | 12 Months or More | Total | ||||||||||||||||||||||
Description of | Fair Value | Unrealized | Fair Value | Unrealized | Fair Value | Unrealized | ||||||||||||||||||
Available-for-sale: | ||||||||||||||||||||||||
U.S. government and federal agency | $ | 500 | $ | (1 | ) | $ | 482 | $ | (7 | ) | $ | 982 | $ | (8 | ) | |||||||||
State and political subdivisions | 555 | (13 | ) | 755 | (26 | ) | 1,310 | (39 | ) | |||||||||||||||
Total temporarily impaired securities | $ | 1,055 | $ | (14 | ) | $ | 1,237 | $ | (33 | ) | $ | 2,292 | $ | (47 | ) |
December 31, 2012 | ||||||||||||||||||||||||
Less than 12 Months | 12 Months or More | Total | ||||||||||||||||||||||
Description of | Fair Value | Unrealized | Fair Value | Unrealized | Fair Value | Unrealized | ||||||||||||||||||
Available-for-sale: | ||||||||||||||||||||||||
U.S. government and federal agency | $ | 472 | $ | (14 | ) | $ | — | $ | — | $ | 472 | $ | (14 | ) | ||||||||||
State and political subdivisions | 2,374 | (23 | ) | — | — | 2,374 | (23 | ) | ||||||||||||||||
Total temporarily impaired securities | $ | 2,846 | $ | (37 | ) | $ | — | $ | — | $ | 2,846 | $ | (37 | ) |
Note 3: Securities Purchased Under Agreements to Resell
The Company enters into purchases of securities under agreements to resell. The amounts advanced under these agreements were $25,117 and $19,014 at December 31, 2013 and 2012, respectively, and represent short-term cash investment alternatives. These agreements are over-collateralized by 103% with collateral consisting of securities and loans guaranteed by the “full faith and credit” of the United States government. During the period, the collateral was delivered by appropriate entry into the third-party custodian’s account designated by the Company under a written custodial agreement that explicitly recognizes the Company’s interest in the securities. At December 31, 2013 and 2012, these agreements mature by notice by the Company or 30 days by the custodian.
Harvard Illinois Bancorp, Inc.
Notes to Consolidated Financial Statements
December 31, 2013 and 2012
(dollars in thousands, except share data)
The Company’s policy requires that all securities purchased under agreements to resell be fully collateralized.
At December 31, 2013 and 2012, agreements to resell securities purchased were outstanding with the following entities:
2013 | 2012 | |||||||
ESI Investors III, LLC | $ | 1,500 | $ | — | ||||
BCM High Income Fund, LP | 6,040 | 8,053 | ||||||
HEC Opportunity Fund LLC | 500 | 453 | ||||||
Coastal Securities | 2,266 | 10,508 | ||||||
First Farmers Financial, LLC | 14,811 | — | ||||||
Total | $ | 25,117 | $ | 19,014 |
Note 4: Loans and Allowance for Loan Losses
Classes of loans include:
December 31, | ||||||||
2013 | 2012 | |||||||
Mortgage loans on real estate | ||||||||
One-to-four family | $ | 39,489 | $ | 41,842 | ||||
Home equity lines of credit and other 2nd mortgages | 7,749 | 9,431 | ||||||
Multi-family residential | 117 | 51 | ||||||
Commercial | 19,244 | 19,989 | ||||||
Farmland | 13,900 | 11,765 | ||||||
Construction and land development | 354 | 1,837 | ||||||
Total mortgage loans on real estate | 80,853 | 84,915 | ||||||
Commercial and industrial | 6,424 | 5,407 | ||||||
Agricultural | 24,343 | 20,096 | ||||||
Purchased indirect automobile, net of dealer reserve | 7,616 | 6,987 | ||||||
Other consumer | 115 | 117 | ||||||
119,351 | 117,522 | |||||||
Less | ||||||||
Loans in process | 26 | — | ||||||
Net deferred loan fees and costs | (8 | ) | (4 | ) | ||||
Allowance for loan losses | 2,475 | 2,550 | ||||||
Net loans | $ | 116,858 | $ | 114,976 |
Harvard Illinois Bancorp, Inc.
Notes to Consolidated Financial Statements
December 31, 2013 and 2012
(dollars in thousands, except share data)
The Company believes that sound loans are a necessary and desirable means of employing funds available for investment. Recognizing the Company’s obligations to its depositors and to the communities it serves, authorized personnel are expected to seek to develop and make sound, profitable loans that resources permit and that opportunity affords. The Company maintains lending policies and procedures in place designed to focus our lending efforts on the types, locations, and duration of loans most appropriate for our business model and markets. The Company’s principal lending activity is the origination of one-to four-family residential mortgage loans but also includes, commercial real estate loans, commercial and industrial, home equity, construction, agricultural and other loans. The primary lending market is McHenry, Grundy and to a lesser extent Boone Counties in Illinois and Walworth County in Wisconsin. Generally, loans are collateralized by assets, primarily real estate, of the borrowers and guaranteed by individuals. The loans are expected to be repaid from cash flows of the borrowers or from proceeds from the sale of selected assets of the borrowers.
Pursuant to applicable law, the aggregate amount of loans that the Company is permitted to make to any one borrower or a group of related borrowers is generally limited to 25% of our total capital plus the allowance for loan losses.
Our lending is subject to written underwriting standards and origination procedures. Decisions on loan applications are made on the basis of detailed applications submitted by the prospective borrower and property valuations (consistent with our appraisal policy) prepared by outside independent licensed appraisers approved by our board of directors as well as internal evaluations, where permitted by regulations. The loan applications are designed primarily to determine the borrower’s ability to repay the requested loan, and the more significant items on the application are verified through use of credit reports, financial statements and tax returns.
Under our loan policy, the individual processing an application is responsible for ensuring that all documentation is obtained prior to the submission of the application to an officer for approval. An officer then reviews these materials and verifies that the requested loan meets our underwriting guidelines described below.
All one-to-four family residential loans up to $500,000, vacant land loans up to $250,000, and any consumer loans require approval of a quorum of our loan committee consisting of five officers. All such loan approvals are reported at the next board meeting following said approval. All secured commercial loans, including agricultural loans, up to $1,500,000 and unsecured loans up to $250,000 must be approved by our commercial credit management committee, which currently consists of our Chief Executive Officer, Executive Vice President, Secretary-Treasurer, and our Vice President – Commercial Loan Officer. These approvals are reported at the next board meeting following said approval. All other loans must be approved by the board.
Generally, title insurance or title searches on our mortgage loans are required as well as fire and extended coverage casualty insurance in amounts at least equal to the principal amount of the loan or the value of improvements on the property, depending on the type of loan.
Harvard Illinois Bancorp, Inc.
Notes to Consolidated Financial Statements
December 31, 2013 and 2012
(dollars in thousands, except share data)
One-to-Four Family Residential Mortgage Loans
The cornerstone of our lending program has long been the origination of long-term permanent loans secured by mortgages on owner-occupied one-to-four family residences. Virtually all of the residential loans originated are secured by properties located in our market area.
Due to consumer demand in the current low market interest rate environment, many of our recent originations are 10- to 30-year fixed-rate loans secured by one-to-four family residential real estate. The Company generally originates fixed-rate one-to-four family residential loans in accordance with secondary market standards to permit their sale. During the last several years, consistent with our asset-liability management strategy, most of the fixed rate one-to-four family residential loans we originated with original terms to maturity in excess of ten years were sold in the secondary market.
During recent years, as a part of our asset/liability management policy, seven-year balloon loans with up to 30-year amortization schedules secured by one-to-four family real estate have been originated, to a lesser extent.
In order to reduce the term to repricing of the loan portfolio, adjustable-rate one-to-four family residential mortgage loans were originated. However, our ability to originate such loans is limited in the current low interest rate environment due to low consumer demand. Our current adjustable-rate mortgage loans carry interest rates that adjust annually at a margin over the one year U.S. Treasury index. Many of our adjustable-rate one-to-four family residential mortgage loans have fixed rates for initial terms of three to five years. Such loans carry terms to maturity of up to 30 years. The adjustable-rate mortgage loans currently offered by the Company generally provide for a 200 basis point annual interest rate change cap and a lifetime cap of 600 basis points over the initial rate.
Although adjustable-rate mortgage loans may reduce to an extent our vulnerability to changes in market interest rates because they periodically reprice as interest rates increase, the required payments due from the borrower also increase (subject to rate caps), increasing the potential for default by the borrower. At the same time, the marketability of the underlying collateral may be adversely affected by higher interest rates. Upward adjustments of the contractual interest rate are also limited by the maximum periodic and lifetime rate adjustments permitted by our loan documents. Moreover, the interest rates on many of our adjustable-rate loans do not adjust for the first three to five years. As a result, the effectiveness of adjustable-rate mortgage loans may be limited during periods of rapidly rising interest rates.
The Company evaluates both the borrower’s ability to make principal, interest and escrow payments and the value of the property that will secure the loan. One-to-four family residential mortgage loans do not currently include prepayment penalties, are non-assumable and do not produce negative amortization. One-to-four family residential mortgage loans customarily include due-on-sale clauses giving the Company the right to declare the loan immediately due and payable in the event that, among other things, the borrower sells the property subject to the mortgage. Residential mortgage loans are originated for our portfolio with loan-to-value ratios of up to 75% for one-to-four family homes, with higher limits applicable to loans with private mortgage insurance on owner-occupied residences.
Harvard Illinois Bancorp, Inc.
Notes to Consolidated Financial Statements
December 31, 2013 and 2012
(dollars in thousands, except share data)
Commercial Real Estate Loans
In an effort to enhance the yield and reduce the term to maturity of the loan portfolio, the Company has originated or purchased commercial real estate loans. Most of the commercial real estate loans have balloon loan terms of three to five years with amortization terms of 15 to 25 years and fixed interest rates. The maximum loan-to-value ratio of the commercial real estate loans is generally 75%.
The Company considers a number of factors in originating commercial real estate loans. The qualifications and financial condition of the borrower are evaluated, including credit history, profitability and expertise, as well as the value and condition of the property securing the loan. When evaluating the qualifications of the borrower, the financial resources of the borrower, the borrower’s experience in owning or managing similar property and the borrower’s payment history with the Company and other financial institutions are considered. In evaluating the property securing the loan, the factors considered include the net operating income of the mortgaged property before debt service and depreciation, the ratio of the loan amount to the appraised value of the mortgaged property and the debt service coverage ratio (the ratio of net operating income to debt service). All commercial real estate loans are appraised by outside independent appraisers approved by the board of directors or by internal evaluations, where permitted by regulation. Personal guarantees are generally obtained from the principals of commercial real estate loans.
Loans secured by commercial real estate generally are larger than one-to-four family residential loans and involve greater credit risk. Commercial real estate loans often involve large loan balances to single borrowers or groups of related borrowers. Repayment of these loans depends to a large degree on the results of operations and management of the properties securing the loans or the businesses conducted on such property, and may be affected to a greater extent by adverse conditions in the real estate market or the economy in general. Accordingly, the nature of these loans makes them more difficult for management to monitor and evaluate.
Multi Family Real Estate Loans
The Company has a limited number of loans on multi-family residences in our market area. Such loans have terms and are underwritten similarly to our commercial real estate loans and are subject to similar risks.
Home Equity Loans
The Company originates variable-rate home equity lines-of-credit and, to a lesser extent, fixed- and variable-rate loans secured by liens on the borrower’s primary residence. Home equity products are generally limited to 75% of the property value less any other mortgages. Prior to 2009, home equity loans were originated up to 90% of the property value to our customers where we serviced their first lien mortgage loan. The same underwriting standards are used for home equity lines-of-credit and loans as used for one-to-four family residential mortgage loans. The home equity line-of-credit product carries an interest rate tied to the prime rate published in the Wall Street Journal. The product has a rate ceiling of 18%. Home equity loans with fixed-rate terms typically amortize over a period of up to 20 years. Home equity lines-of-credit provide for an initial draw period of up to five years, with monthly payments of interest calculated on the outstanding balance. At the end of the initial five years, the line may be paid in full or restructured at our then current home equity program.
Harvard Illinois Bancorp, Inc.
Notes to Consolidated Financial Statements
December 31, 2013 and 2012
(dollars in thousands, except share data)
Construction and Land Development Loans
The Company has construction loans to builders and developers for the construction of one- to four- and multi-family residential units and to individuals for the construction of their primary or secondary residence. The Company has a limited amount of land loans to developers, primarily for the purpose of developing residential subdivisions.
The application process includes a submission of plans, specifications and costs of the project to be constructed or developed. These items are used as a basis to determine the appraised value of the subject property. Loans are based on the lesser of current appraised value and/or the cost of construction (land plus building). Construction loan agreements generally provide that loan proceeds are disbursed in increments as construction progresses. Outside independent licensed appraisers or title company representatives under a construction loan escrow agreement inspect the progress of the construction of the dwelling before disbursements are made.
The Company has construction loans for commercial development projects such as multi-family, apartment and other commercial buildings. These loans generally have an interest-only phase during construction then convert to permanent financing. Disbursements of construction loan funds are at our discretion based on the progress of construction. The maximum loan-to-value ratio limit applicable to these loans is generally 75%.
The Company has loans to builders and developers for the development of one-to-four family lots in our market area. These loans have terms of five years or less. Land loans are generally made in amounts up to a maximum loan-to-value ratio of 65% on raw land and up to 75% on developed building lots based upon an independent appraisal. Personal guarantees are obtained for land loans.
Loans to individuals for the construction of their residences typically run for up to seven months and then convert to permanent loans. These construction loans have rates and terms comparable to one-to-four family residential loans offered. During the construction phase, the borrower pays interest only at a fixed rate. The maximum loan-to-value ratio of owner-occupied single-family construction loans is 75%, 80% if the permanent loan has been approved to be sold in the secondary market. Residential construction loans are generally underwritten pursuant to the same guidelines used for originating permanent residential loans.
Harvard Illinois Bancorp, Inc.
Notes to Consolidated Financial Statements
December 31, 2013 and 2012
(dollars in thousands, except share data)
Construction and land lending generally affords the Company an opportunity to receive higher origination and other loan fees. In addition, such loans are generally made for relatively short terms. Nevertheless, construction and land lending to persons other than owner-occupants is generally considered to involve a higher level of credit risk than one-to-four family residential lending due to the concentration of principal in a limited number of loans and borrowers and the effects of general economic conditions on construction projects, real estate developers and managers. In addition, the nature of these loans is such that they are more difficult to evaluate and monitor. Risk of loss on a construction or land loan is dependent largely upon the accuracy of the initial estimate of the property’s value upon completion of the project and the estimated cost (including interest) of the project. If the estimate of value proves to be inaccurate, the Company may be confronted, at or prior to the maturity of the loan, with a project with a value which is insufficient to assure full repayment and/or the possibility of having to make substantial investments to complete and sell the project. Because defaults in repayment may not occur during the construction period, it may be difficult to identify problem loans at an early stage. When loan payments become due, the cash flow from the property may not be adequate to service the debt. In such cases, the Company may be required to modify the terms of the loan.
Farmland
These loans are primarily secured by farmland located in our market area. Adjustable rate farmland loans have interest rates that generally adjust every one, three or five years in accordance with a designated index and are generally amortized over 15-25 years. Fixed-rate farmland loans generally are for terms of up to 15 years, although many are amortized over longer periods, and include a balloon payment at maturity. Lending policies on such loans generally limit the maximum loan-to-value ratio to 75% of the lesser of the appraised value or purchase price of the property.
While earning higher yields on agricultural mortgage loans than on single-family residential mortgage loans, agricultural-related lending involves a greater degree of risk than single-family residential mortgage loans because of the typically larger loan amounts and potential volatility in the market. In addition, repayments on agricultural loans are substantially dependent on the successful operation of the underlying business and the value of the property collateralizing the loan, both of which are affected by many factors, such as weather and changing market prices, outside the control of the borrower. Finally, some commentators believe that the recent sharp increases in farm land prices could make a price correction more likely.
Substantially all farmland loans are underwritten to conform to agency guidelines to qualify for a government guarantee of up to 90% of the original loan amount, which in turn qualifies them to be sold to a variety of investors in the secondary market. Once the government guarantee is secured from Farmers Home Loan Administration, the guarantee covers up to 90% of any loss on the loan. Longer-term fixed-rate agricultural mortgage loans may be sold in the secondary market, which the Company services for the secondary market purchaser.
Harvard Illinois Bancorp, Inc.
Notes to Consolidated Financial Statements
December 31, 2013 and 2012
(dollars in thousands, except share data)
Commercial and Industrial Loans
Commercial and industrial loans and lines of credit are originated to small and medium-sized companies in our primary market area. Commercial and industrial loans are generally used for working capital purposes or for acquiring equipment, inventory or furniture. Commercial and industrial loans generally carry a floating-rate indexed to the prime rate as published in The Wall Street Journal and a one-year term. All commercial and industrial loans are secured.
When making commercial and industrial loans, the financial statements of the borrower, the lending history of the borrower, the debt service capabilities of the borrower, the projected cash flows of the business, the value of the collateral, if any, and whether the loan is guaranteed by the principals of the borrower are considered. Commercial and industrial loans are generally secured by accounts receivable, inventory, equipment and personal guarantees.
Commercial and industrial loans generally have a greater credit risk than residential mortgage loans. Unlike residential mortgage loans, which generally are made on the basis of the borrower’s ability to make repayment from his or her employment and other income, and which are secured by real property whose value tends to be more easily ascertainable, commercial and industrial loans are of higher risk and typically are made on the basis of the borrower’s ability to make repayment from the cash flow of the borrower’s business. As a result, the availability of funds for the repayment of commercial and industrial loans may be substantially dependent on the success of the business itself. Further, the collateral securing the loans may depreciate over time, may be difficult to appraise and may fluctuate in value based on the success of the business. These risks are minimized through underwriting standards and personal guarantees.
Agricultural Loans
Agricultural operating lines of credit generally have terms of one year and are secured by growing crops, livestock and equipment, and mortgages on the farmland. Intermediate-term loans have terms of 2-7 years and are secured by machinery and equipment. Generally these loans are extended to farmers in our market area for the purchase of equipment, seed, fertilizer, insecticide and other purposes in connection with agricultural production. The maximum term for equipment secured loans is tied to the useful life of the underlying collateral but generally does not exceed 10 years. The interest rate is generally increased with respect to the longer terms loans due to the rate exposure of these loans. The amount of the commitment is based on management’s review of the borrower’s business plan, prior performance, marketability of crops, and current market prices. Recent financial statements are examined and evaluate cash flow analysis and debt-to-net worth, and liquidity ratios. Loans for crop production generally require 75% or more crop insurance coverage.
Harvard Illinois Bancorp, Inc.
Notes to Consolidated Financial Statements
December 31, 2013 and 2012
(dollars in thousands, except share data)
The repayment of agricultural business loans generally is dependent on the successful operation of a farm and can be adversely affected by fluctuations in crop prices, increase in interest rates, and changes in weather conditions. These developments may result in smaller harvests and less income for farmers which may adversely affect such borrower’s ability to repay a loan. Many borrowers also have more than one agricultural business loan outstanding with us. Consequently, an adverse development with respect to one loan or one credit relationship can expose the Company to significantly greater risk of loss compared to an adverse development with respect to a one-to-four family residential mortgage loan. Finally, if the Company forecloses on an agricultural business loan, our holding period for the collateral, if any, typically is longer than for one-to-four family residential mortgage loans because there are fewer potential purchasers of the collateral.
Consumer Loans
The Company has secured and unsecured loans to consumers. However, during recent years, most consumer lending efforts were focused on purchases of indirect automobile loans.
In an effort to expand and diversify our loan portfolio and increase the overall yield on our loan portfolio, since 1999 the Company has purchased indirect loans on new and used automobiles located primarily in Cook County, Illinois. Although we do not separately underwrite each purchased loan, we thoroughly review the knowledge and experience of the originators’ management teams, their underwriting standards, and their historical loss rates.
Under the loan purchase arrangement, the seller aggregates indirect automobile loans into separate loan pools. The pools are then segregated into risk categories with each category having predefined limits as to the maximum amounts allowed. Generally, the pools are sold without recourse. The Company receives a listing of the individual loans in the pool, including loan and borrower information prior to funding the purchase but the Company is not generally permitted to substitute loans in a pool or purchase part of a pool.
The seller is responsible for dealer relationships and the monitoring of their performance. The seller performs all servicing functions including the collection of principal, interest, and fees as well as repossessions and recoveries. Thus, the Company is not involved in the sale of repossessed vehicles.
The Company performs semi-annual reviews of newly purchased loan files and reviews operational procedures as part of our internal audit function.
Consumer loans may entail greater credit risk than residential mortgage loans, particularly in the case of consumer loans which are unsecured or are secured by rapidly depreciable assets, such as automobiles. In addition, consumer loan collections are dependent on the borrower’s continuing financial stability, and thus are more likely to be affected by adverse personal circumstances as well as the economy. Furthermore, the application of various federal and state laws, including bankruptcy and insolvency laws, may limit the amount which can be recovered on such loans.
Harvard Illinois Bancorp, Inc.
Notes to Consolidated Financial Statements
December 31, 2013 and 2012
(dollars in thousands, except share data)
The following tables present the balance in the allowance for loan losses and the recorded investment in loans based on the portfolio segment and impairment method as of December 31, 2013 and 2012:
2013 | ||||||||||||||||||||||||
Mortgage Loans on Real Estate | ||||||||||||||||||||||||
1-4 Family | HELOC and | Multi-Family Residential | Commercial | Farmland | Construction | |||||||||||||||||||
Allowance for loan losses: | ||||||||||||||||||||||||
Balance, beginning of year | $ | 668 | $ | 333 | $ | 3 | $ | 530 | $ | 176 | $ | 275 | ||||||||||||
Provision charged to expense | 277 | 54 | 3 | 164 | 32 | (141 | ) | |||||||||||||||||
Losses charged off | (330 | ) | (69 | ) | — | — | — | (151 | ) | |||||||||||||||
Recoveries | 29 | — | — | — | — | 17 | ||||||||||||||||||
Balance, end of year | $ | 644 | $ | 318 | $ | 6 | $ | 694 | $ | 208 | $ | — | ||||||||||||
Ending balance: individually evaluated for impairment | $ | 63 | $ | 29 | $ | — | $ | — | $ | — | $ | — | ||||||||||||
Ending balance: collectively evaluated for impairment | $ | 581 | $ | 289 | $ | 6 | $ | 694 | $ | 208 | $ | — | ||||||||||||
Loans: | ||||||||||||||||||||||||
Ending balance | $ | 39,489 | $ | 7,749 | $ | 117 | $ | 19,244 | $ | 13,900 | $ | 354 | ||||||||||||
Ending balance: individually evaluated for impairment | $ | 2,284 | $ | 120 | $ | — | $ | — | $ | — | $ | 354 | ||||||||||||
Ending balance: collectively evaluated for impairment | $ | 37,205 | $ | 7,629 | $ | 117 | $ | 19,244 | $ | 13,900 | $ | — |
2013 (Continued) | ||||||||||||||||||||||||
Commercial and Industrial | Agricultural | Purchased Indirect Automobile, Net | Other Consumer | Unallocated | Total | |||||||||||||||||||
Allowance for loan losses: | ||||||||||||||||||||||||
Balance, beginning of year | $ | 151 | $ | 301 | $ | 112 | $ | 1 | $ | — | $ | 2,550 | ||||||||||||
Provision charged to expense | (41 | ) | 76 | 35 | (6 | ) | — | 453 | ||||||||||||||||
Losses charged off | — | — | (33 | ) | — | — | (583 | ) | ||||||||||||||||
Recoveries | — | — | 3 | 6 | — | 55 | ||||||||||||||||||
Balance, end of year | $ | 110 | $ | 377 | $ | 117 | $ | 1 | $ | — | $ | 2,475 | ||||||||||||
Ending balance: individually evaluated for impairment | $ | 3 | $ | — | $ | 1 | $ | — | $ | — | $ | 96 | ||||||||||||
Ending balance: collectively evaluated for impairment | $ | 107 | $ | 377 | $ | 116 | $ | 1 | $ | — | $ | 2,379 | ||||||||||||
Loans: | ||||||||||||||||||||||||
Ending balance | $ | 6,424 | $ | 24,343 | $ | 7,616 | $ | 115 | $ | — | $ | 119,351 | ||||||||||||
Ending balance: individually evaluated for impairment | $ | 3 | $ | — | $ | 4 | $ | — | $ | — | $ | 2,765 | ||||||||||||
Ending balance: collectively evaluated for impairment | $ | 6,421 | $ | 24,343 | $ | 7,612 | $ | 115 | $ | — | $ | 116,586 |
Harvard Illinois Bancorp, Inc.
Notes to Consolidated Financial Statements
December 31, 2013 and 2012
(dollars in thousands, except share data)
2012 | ||||||||||||||||||||||||
Mortgage Loans on Real Estate | ||||||||||||||||||||||||
1-4 Family | HELOC and | Multi-Family Residential | Commercial | Farmland | Construction | |||||||||||||||||||
Allowance for loan losses: | ||||||||||||||||||||||||
Balance, beginning of year | $ | 549 | $ | 248 | $ | 287 | $ | 533 | $ | 143 | $ | 374 | ||||||||||||
Provision charged to expense | 484 | 109 | (284 | ) | (3 | ) | 33 | 73 | ||||||||||||||||
Losses charged off | (365 | ) | (24 | ) | — | — | — | (172 | ) | |||||||||||||||
Recoveries | — | — | — | — | — | — | ||||||||||||||||||
Balance, end of year | $ | 668 | $ | 333 | $ | 3 | $ | 530 | $ | 176 | $ | 275 | ||||||||||||
Ending balance: individually evaluated for impairment | $ | 112 | $ | 48 | $ | — | $ | 81 | $ | — | $ | 176 | ||||||||||||
Ending balance: collectively evaluated for impairment | $ | 556 | $ | 285 | $ | 3 | $ | 449 | $ | 176 | $ | 99 | ||||||||||||
Loans: | ||||||||||||||||||||||||
Ending balance | $ | 41,842 | $ | 9,431 | $ | 51 | $ | 19,989 | $ | 11,765 | $ | 1,837 | ||||||||||||
Ending balance: individually evaluated for impairment | $ | 2,484 | $ | 166 | $ | — | $ | 1,482 | $ | — | $ | 851 | ||||||||||||
Ending balance: collectively evaluated for impairment | $ | 39,358 | $ | 9,265 | $ | 51 | $ | 18,507 | $ | 11,765 | $ | 986 |
2012 (Continued) | ||||||||||||||||||||||||
Commercial and Industrial | Agricultural | Purchased Indirect Automobile, Net | Other Consumer | Unallocated | Total | |||||||||||||||||||
Allowance for loan losses: | ||||||||||||||||||||||||
Balance, beginning of year | $ | 125 | $ | 215 | $ | 95 | $ | 6 | $ | — | $ | 2,575 | ||||||||||||
Provision charged to expense | 42 | 86 | 66 | (7 | ) | — | 599 | |||||||||||||||||
Losses charged off | (16 | ) | — | (59 | ) | — | — | (636 | ) | |||||||||||||||
Recoveries | — | — | 10 | 2 | — | 12 | ||||||||||||||||||
Balance, end of year | $ | 151 | $ | 301 | $ | 112 | $ | 1 | $ | — | $ | 2,550 | ||||||||||||
Ending balance: individually evaluated for impairment | $ | 7 | $ | — | $ | 7 | $ | — | $ | — | $ | 431 | ||||||||||||
Ending balance: collectively evaluated for impairment | $ | 144 | $ | 301 | $ | 105 | $ | 1 | $ | — | $ | 2,119 | ||||||||||||
Loans: | ||||||||||||||||||||||||
Ending balance | $ | 5,407 | $ | 20,096 | $ | 6,987 | $ | 117 | $ | — | $ | 117,522 | ||||||||||||
Ending balance: individually evaluated for impairment | $ | 7 | $ | — | $ | 25 | $ | — | $ | — | $ | 5,015 | ||||||||||||
Ending balance: collectively evaluated for impairment | $ | 5,400 | $ | 20,096 | $ | 6,962 | $ | 117 | $ | — | $ | 112,507 |
There have been no changes to the Company’s accounting policies or methodology from the prior periods.
Harvard Illinois Bancorp, Inc.
Notes to Consolidated Financial Statements
December 31, 2013 and 2012
(dollars in thousands, except share data)
Credit Quality Indicators
The Company categorizes loans into risk categories based on relevant information about the ability of borrowers to service their debt such as current financial information, historical payment experience, credit documentation, public information and current economic trends, among other factors. All commercial, agricultural and land development loans are graded at inception of the loan. Subsequently, analyses are performed on an annual basis and grade changes are made as necessary. Interim grade reviews may take place if circumstances of the borrower warrant a more timely review. The Company utilizes an internal asset classification system as a means of reporting problem and potential problem loans. Under the Company’s risk rating system, the Company classifies problem and potential problem loans as “Watch,” “Substandard,” “Doubtful,” and “Loss.” The Company uses the following definitions for risk ratings:
Pass –Loans classified as pass are well protected by the ability of the borrower to pay or by the value of the asset or underlying collateral.
Watch – Loans classified as watch represent loans with the minimum level of acceptable credit risk and servicing requirements and the borrower has the capacity to perform according to the terms and repayment is expected. However, one or more elements of uncertainty exist.
Special Mention –Loans classified as special mention have a potential weakness that deserves management’s close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the loan or of the Company’s credit position at some future date.
Substandard –Loans classified as substandard are inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any. Loans so classified have a well defined weakness or weaknesses that jeopardize the liquidation of the debt. They are characterized by the distinct possibility that the institution will sustain some loss if the deficiencies are not corrected.
Doubtful –Loans classified as doubtful have all the weaknesses inherent in those classified as substandard, with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions and values, highly questionable and improbable.
Loss – Loans classified as loss are the portion of the loan that is considered uncollectible so that its continuance as an asset is not warranted. The amount of the loss determined will be charged-off.
Harvard Illinois Bancorp, Inc.
Notes to Consolidated Financial Statements
December 31, 2013 and 2012
(dollars in thousands, except share data)
The following tables present the credit risk profile of the Company’s loan portfolio based on rating category and payment activity as of December 31, 2013 and 2012:
2013 | ||||||||||||||||||||||||
Mortgage Loans on Real Estate | ||||||||||||||||||||||||
1-4 Family | HELOC and | Multi-Family Residential | Commercial | Farmland | Construction | |||||||||||||||||||
Pass | $ | 33,676 | $ | 6,557 | $ | 117 | $ | 13,931 | $ | 13,789 | $ | — | ||||||||||||
Watch | 2,100 | 334 | — | 2,328 | 111 | — | ||||||||||||||||||
Special Mention | 1,429 | 738 | — | 2,985 | — | — | ||||||||||||||||||
Substandard | 2,284 | 120 | — | — | — | 354 | ||||||||||||||||||
Total | $ | 39,489 | $ | 7,749 | $ | 117 | $ | 19,244 | $ | 13,900 | $ | 354 |
2013 (Continued) | ||||||||||||||||||||
Commercial and Industrial | Agricultural | Purchased Indirect Automobile, Net | Other Consumer | Total | ||||||||||||||||
Pass | $ | 6,106 | $ | 24,131 | $ | 7,612 | $ | 115 | $ | 106,034 | ||||||||||
Watch | 315 | 212 | — | — | 5,400 | |||||||||||||||
Special Mention | — | — | — | — | 5,152 | |||||||||||||||
Substandard | 3 | — | 4 | — | 2,765 | |||||||||||||||
Total | $ | 6,424 | $ | 24,343 | $ | 7,616 | $ | 115 | $ | 119,351 |
2012 | ||||||||||||||||||||||||
Mortgage Loans on Real Estate | ||||||||||||||||||||||||
1-4 Family | HELOC and | Multi-Family Residential | Commercial | Farmland | Construction | |||||||||||||||||||
Pass | $ | 37,027 | $ | 9,012 | $ | 51 | $ | 16,036 | $ | 11,765 | $ | 986 | ||||||||||||
Watch | 1,460 | 218 | — | 2,386 | — | — | ||||||||||||||||||
Special Mention | 871 | 35 | — | 85 | — | — | ||||||||||||||||||
Substandard | 2,484 | 166 | — | 1,482 | — | 851 | ||||||||||||||||||
Total | $ | 41,842 | $ | 9,431 | $ | 51 | $ | 19,989 | $ | 11,765 | $ | 1,837 |
2012 (Continued) | ||||||||||||||||||||
Commercial and Industrial | Agricultural | Purchased Indirect Automobile, Net | Other Consumer | Total | ||||||||||||||||
Pass | $ | 3,761 | $ | 20,096 | $ | 6,962 | $ | 117 | $ | 105,813 | ||||||||||
Watch | 1,526 | — | — | — | 5,590 | |||||||||||||||
Special Mention | 113 | — | — | — | 1,104 | |||||||||||||||
Substandard | 7 | — | 25 | — | 5,015 | |||||||||||||||
Total | $ | 5,407 | $ | 20,096 | $ | 6,987 | $ | 117 | $ | 117,522 |
Harvard Illinois Bancorp, Inc.
Notes to Consolidated Financial Statements
December 31, 2013 and 2012
(dollars in thousands, except share data)
The following tables present the Company’s loan portfolio aging analysis as of December 31, 2013 and 2012:
2013 | ||||||||||||||||||||||||||||
30-59 Days Past Due | 60-89 Days Past Due | Greater Than 90 Days | Total Past Due | Current | Total Loans Receivable | Total Loans > 90 Days & Accruing | ||||||||||||||||||||||
Real estate loans: | ||||||||||||||||||||||||||||
One-to-four family | $ | 770 | $ | 607 | �� | 1,608 | $ | 2,985 | $ | 36,504 | $ | 39,489 | $ | — | ||||||||||||||
Home equity lines of credit and other 2nd mortgages | 26 | 40 | 44 | 110 | 7,639 | 7,749 | — | |||||||||||||||||||||
Multi-family | — | — | — | — | 117 | 117 | — | |||||||||||||||||||||
Commercial | 33 | — | — | 33 | 19,211 | 19,244 | — | |||||||||||||||||||||
Farmland | — | — | — | — | 13,900 | 13,900 | — | |||||||||||||||||||||
Construction and land development | — | — | 354 | 354 | — | 354 | — | |||||||||||||||||||||
Total real estate loans | 829 | 647 | 2,006 | 3,482 | 77,371 | 80,853 | — | |||||||||||||||||||||
Commercial and industrial | 135 | 11 | 3 | 149 | 6,275 | 6,424 | — | |||||||||||||||||||||
Agriculture | — | — | — | — | 24,343 | 24,343 | — | |||||||||||||||||||||
Consumer loans: | ||||||||||||||||||||||||||||
Purchased indirect automobile | 4 | — | — | 4 | 7,612 | 7,616 | — | |||||||||||||||||||||
Other | — | — | — | — | 115 | 115 | — | |||||||||||||||||||||
Total consumer loans | 4 | — | — | 4 | 7,727 | 7,731 | — | |||||||||||||||||||||
Total | $ | 968 | $ | 658 | $ | 2,009 | $ | 3,635 | $ | 115,716 | $ | 119,351 | $ | — |
2012 | ||||||||||||||||||||||||||||
30-59 Days Past Due | 60-89 Days Past Due | Greater Than 90 Days | Total Past Due | Current | Total Loans Receivable | Total Loans > 90 Days & Accruing | ||||||||||||||||||||||
Real estate loans: | ||||||||||||||||||||||||||||
One-to-four family | $ | 1,464 | $ | 808 | 1,122 | $ | 3,394 | $ | 38,448 | $ | 41,842 | $ | — | |||||||||||||||
Home equity lines of credit and other 2nd mortgages | 51 | 14 | 35 | 100 | 9,331 | 9,431 | — | |||||||||||||||||||||
Multi-family | — | — | — | — | 51 | 51 | — | |||||||||||||||||||||
Commercial | — | — | — | — | 19,989 | 19,989 | — | |||||||||||||||||||||
Farmland | — | — | — | — | 11,765 | 11,765 | — | |||||||||||||||||||||
Construction and land development | — | — | — | — | 1,837 | 1,837 | — | |||||||||||||||||||||
Total real estate loans | 1,515 | 822 | 1,157 | 3,494 | 81,421 | 84,915 | — | |||||||||||||||||||||
Commercial and industrial | — | — | 7 | 7 | 5,400 | 5,407 | — | |||||||||||||||||||||
Agriculture | — | — | — | — | 20,096 | 20,096 | — | |||||||||||||||||||||
Consumer loans: | ||||||||||||||||||||||||||||
Purchased indirect automobile | 25 | — | — | 25 | 6,962 | 6,987 | — | |||||||||||||||||||||
Other | — | — | — | — | 117 | 117 | — | |||||||||||||||||||||
Total consumer loans | 25 | — | — | 25 | 7,079 | 7,104 | — | |||||||||||||||||||||
Total | $ | 1,540 | $ | 822 | $ | 1,164 | $ | 3,526 | $ | 113,996 | $ | 117,522 | $ | — |
Harvard Illinois Bancorp, Inc.
Notes to Consolidated Financial Statements
December 31, 2013 and 2012
(dollars in thousands, except share data)
At December 31, 2013 and 2012, the Company held $24,343 and $20,096 in agricultural production loans and $13,900 and $11,765, respectively in agricultural real estate loans in the Company’s geographic lending area. Generally, those loans are collateralized by assets of the borrower. The loans are expected to be repaid from cash flows or from proceeds of sale of related assets of the borrower. Declines in prices for corn, beans, livestock and farm land in addition to unfavorable weather patterns, could significantly affect the repayment ability for many agricultural loan customers.
At December 31, 2013 and 2012, the Company held $19,244 and $19,989 in commercial real estate loans and $354 and $1,837 in loans collateralized by construction and development real estate primarily in the Company’s geographic lending area. Due to national, state and local economic conditions, values for commercial and development real estate have declined significantly, and the market for these properties is depressed.
A loan is considered impaired, in accordance with the impairment accounting guidance (ASC 310-10-35-16), when based on current information and events, it is probable the Company will be unable to collect all amounts due from the borrower in accordance with the contractual terms of the loan. Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loans and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record, and the amount of the shortfall in relation to the principal and interest owed.
Impairment is measured on a loan-by-loan basis by either the present value of the expected future cash flows, the loan’s observable market value, or, for collateral-dependent loans, the fair value of the collateral adjusted for market conditions and selling expenses. Significant restructured loans are considered impaired in determining the adequacy of the allowance for loan losses.
The Company actively seeks to reduce its investment in impaired loans. The primary tools to work through impaired loans are settlement with the borrowers or guarantors, foreclosure of the underlying collateral, or restructuring.
The Company will restructure loans when the borrower demonstrates the inability to comply with the terms of the loan, but can demonstrate the ability to meet acceptable restructured terms. Restructurings generally include one or more of the following restructuring options; reduction in the interest rate on the loan, payment extensions, forgiveness of principal, forbearance, or other actions intended to maximize collection. Restructured loans in compliance with modified terms are initially classified as impaired.
Harvard Illinois Bancorp, Inc.
Notes to Consolidated Financial Statements
December 31, 2013 and 2012
(dollars in thousands, except share data)
The following tables present impaired loans for the years ended December 31, 2013 and 2012:
2013 | ||||||||||||||||||||||||
(Dollars in thousands) | ||||||||||||||||||||||||
Recorded Balance | Unpaid Principal Balance | Specific Allowance | Average Investment in Impaired Loans | Interest Income Recognized | Interest Income Recognized Cash Basis | |||||||||||||||||||
Loans without a specific allowance | ||||||||||||||||||||||||
Real estate loans: | ||||||||||||||||||||||||
One-to-four family | $ | 1,722 | $ | 2,159 | $ | — | $ | 1,746 | $ | 32 | $ | 32 | ||||||||||||
Home equity lines of credit and other 2nd mortgages | 45 | 135 | — | 75 | 1 | 1 | ||||||||||||||||||
Multi-family | — | — | — | — | — | — | ||||||||||||||||||
Commercial | — | — | — | — | — | — | ||||||||||||||||||
Farmland | — | — | — | — | — | — | ||||||||||||||||||
Construction and land development | 354 | 501 | — | 178 | 3 | 3 | ||||||||||||||||||
Total real estate loans | 2,121 | 2,795 | — | 1,999 | 36 | 36 | ||||||||||||||||||
Commercial and industrial | — | — | — | — | — | — | ||||||||||||||||||
Agriculture | — | — | — | — | — | — | ||||||||||||||||||
Consumer loans: | ||||||||||||||||||||||||
Purchased indirect automobile | — | — | — | — | — | — | ||||||||||||||||||
Other | — | 27 | — | — | — | — | ||||||||||||||||||
Total consumer loans | — | 27 | — | — | — | — | ||||||||||||||||||
Total | $ | 2,121 | $ | 2,822 | $ | — | $ | 1,999 | $ | 36 | $ | 36 | ||||||||||||
Loans with a specific allowance | ||||||||||||||||||||||||
Real estate loans: | ||||||||||||||||||||||||
One-to-four family | $ | 562 | $ | 602 | $ | 63 | $ | 638 | $ | 12 | $ | 12 | ||||||||||||
Home equity lines of credit and other 2nd mortgages | 75 | 84 | 29 | 67 | 1 | 1 | ||||||||||||||||||
Multi-family | — | — | — | — | — | — | ||||||||||||||||||
Commercial | — | — | — | 741 | 13 | 13 | ||||||||||||||||||
Farmland | — | — | — | — | — | — | ||||||||||||||||||
Construction and land development | — | — | — | 426 | 8 | 8 | ||||||||||||||||||
Total real estate loans | 637 | 686 | 92 | 1,872 | 34 | 34 | ||||||||||||||||||
Commercial and industrial | 3 | 3 | 3 | 5 | — | — | ||||||||||||||||||
Agriculture | — | — | — | — | — | — | ||||||||||||||||||
Consumer loans: | ||||||||||||||||||||||||
Purchased indirect automobile | 4 | 4 | 1 | 14 | — | — | ||||||||||||||||||
Other | — | — | — | — | — | — | ||||||||||||||||||
Total consumer loans | 4 | 4 | 1 | 14 | — | — | ||||||||||||||||||
Total loans | 644 | 693 | 96 | 1,891 | 34 | 34 | ||||||||||||||||||
Total | $ | 2,765 | $ | 3,515 | $ | 96 | $ | 3,890 | $ | 70 | $ | 70 |
Harvard Illinois Bancorp, Inc.
Notes to Consolidated Financial Statements
December 31, 2013 and 2012
(dollars in thousands, except share data)
2012 | ||||||||||||||||||||||||
(Dollars in thousands) | ||||||||||||||||||||||||
Recorded Balance | Unpaid Principal Balance | Specific Allowance | Average Investment in Impaired Loans | Interest Income Recognized | Interest Income Recognized Cash Basis | |||||||||||||||||||
Loans without a specific allowance | ||||||||||||||||||||||||
Real estate loans: | ||||||||||||||||||||||||
One-to-four family | $ | 1,770 | $ | 2,130 | $ | — | $ | 1,439 | $ | 24 | $ | 24 | ||||||||||||
Home equity lines of credit and other 2nd mortgages | 106 | 127 | — | 109 | 2 | 2 | ||||||||||||||||||
Multi-family | — | — | — | — | — | — | ||||||||||||||||||
Commercial | — | — | — | 695 | 11 | 11 | ||||||||||||||||||
Farmland | — | — | — | — | — | — | ||||||||||||||||||
Construction and land development | — | �� | — | — | — | — | — | |||||||||||||||||
Total real estate loans | 1,876 | 2,257 | — | 2,243 | 37 | 37 | ||||||||||||||||||
Commercial and industrial | — | 17 | — | — | — | — | ||||||||||||||||||
Agriculture | — | — | — | — | — | — | ||||||||||||||||||
Consumer loans: | ||||||||||||||||||||||||
Purchased indirect automobile | — | — | — | — | — | — | ||||||||||||||||||
Other | — | 23 | — | — | — | — | ||||||||||||||||||
Total consumer loans | — | 23 | — | — | — | — | ||||||||||||||||||
Total | $ | 1,876 | $ | 2,297 | $ | — | $ | 2,243 | $ | 37 | $ | 37 | ||||||||||||
Loans with a specific allowance | ||||||||||||||||||||||||
Real estate loans: | ||||||||||||||||||||||||
One-to-four family | $ | 714 | $ | 722 | $ | 112 | $ | 1,690 | $ | 28 | $ | 28 | ||||||||||||
Home equity lines of credit and other 2nd mortgages | 60 | 60 | 48 | 108 | 2 | 2 | ||||||||||||||||||
Multi-family | — | — | — | 459 | 8 | 8 | ||||||||||||||||||
Commercial | 1,482 | 1,482 | 81 | 741 | 12 | 12 | ||||||||||||||||||
Farmland | — | — | — | — | — | — | ||||||||||||||||||
Construction and land development | 851 | 1,103 | 176 | 939 | 15 | 15 | ||||||||||||||||||
Total real estate loans | 3,107 | 3,367 | 417 | 3,937 | 65 | 65 | ||||||||||||||||||
Commercial and industrial | 7 | 7 | 7 | 29 | 1 | 1 | ||||||||||||||||||
Agriculture | — | — | — | — | — | — | ||||||||||||||||||
Consumer loans: | ||||||||||||||||||||||||
Purchased indirect automobile | 25 | 25 | 7 | 17 | — | — | ||||||||||||||||||
Other | — | — | — | 2 | — | — | ||||||||||||||||||
Total consumer loans | 25 | 25 | 7 | 19 | — | — | ||||||||||||||||||
Total loans | 3,139 | 3,399 | 431 | 3,985 | 66 | 66 | ||||||||||||||||||
Total | $ | 5,015 | $ | 5,696 | $ | 431 | $ | 6,228 | $ | 103 | $ | 103 |
Harvard Illinois Bancorp, Inc.
Notes to Consolidated Financial Statements
December 31, 2013 and 2012
(dollars in thousands, except share data)
The following table presents the Company’s nonaccrual loans at December 31, 2013 and 2012. This table excludes performing troubled debt restructurings.
2013 | 2012 | |||||||
Mortgages on real estate: | ||||||||
One-to-four family | $ | 2,284 | $ | 2,484 | ||||
Home equity lines of credit and other 2nd mortgages | 120 | 166 | ||||||
Commercial | — | 1,482 | ||||||
Construction and land development | 354 | 851 | ||||||
Commercial and industrial | 3 | 7 | ||||||
Total | $ | 2,761 | $ | 4,990 |
The following table presents the recorded balance of troubled debt restructurings, as of December 31, 2013 and 2012:
2013 | 2012 | |||||||
Real estate loans: | ||||||||
One-to-four family | $ | 1,914 | $ | 1,814 | ||||
Home equity lines of credit and other 2nd mortgages | — | 6 | ||||||
Multi-family | — | — | ||||||
Commercial | — | 1,482 | ||||||
Farmland | — | — | ||||||
Construction and land development | 354 | 851 | ||||||
Total real estate loans | 2,268 | 4,153 | ||||||
Commercial and industrial | — | — | ||||||
Agriculture | — | — | ||||||
Consumer loans: | ||||||||
Purchased indirect automobile | — | — | ||||||
Other | — | — | ||||||
Total consumer loans | — | — | ||||||
Total | $ | 2,268 | $ | 4,153 |
Harvard Illinois Bancorp, Inc.
Notes to Consolidated Financial Statements
December 31, 2013 and 2012
(dollars in thousands, except share data)
The following table presents the recorded balance of troubled debt restructurings, which were performing according to the terms of the restructuring, as of December 31, 2013 and 2012.
2013 | 2012 | |||||||
Real estate loans: | ||||||||
One-to-four family | $ | 1,245 | $ | 1,126 | ||||
Home equity lines of credit and other 2nd mortgages | — | — | ||||||
Multi-family | — | — | ||||||
Commercial | — | 1,482 | ||||||
Farmland | — | — | ||||||
Construction and land development | — | 851 | ||||||
Total real estate loans | 1,245 | 3,459 | ||||||
Commercial and industrial | — | — | ||||||
Agriculture | — | — | ||||||
Consumer loans: | ||||||||
Purchased indirect automobile | — | — | ||||||
Other | — | — | ||||||
Total consumer loans | — | — | ||||||
Total | $ | 1,245 | $ | 3,459 |
Troubled debt restructurings resulted in charge-offs of $264 and $219 during the years ended December 31, 2013 and 2012, respectively. The allowance for loan losses included specific allowances for troubled debt restructurings of $16 and $311 at December 31, 2013 and 2012, respectively.
Harvard Illinois Bancorp, Inc.
Notes to Consolidated Financial Statements
December 31, 2013 and 2012
(dollars in thousands, except share data)
The following table represents loans modified as troubled debt restructurings during the years ended December 31, 2013 and 2012:
Year Ended December 31, 2013 | Year Ended December 31, 2012 | |||||||||||||||
Number of Modifications | Recorded Investment | Number of Modifications | Recorded Investment | |||||||||||||
Real estate loans: | ||||||||||||||||
One-to-four family | 1 | $ | 245 | 3 | $ | 257 | ||||||||||
Home equity lines of credit and other 2nd mortgages | — | — | 1 | 6 | ||||||||||||
Multi-family | — | — | — | — | ||||||||||||
Commercial | — | — | 2 | 1,482 | ||||||||||||
Farmland | — | — | — | — | ||||||||||||
Construction and land development | — | — | — | — | ||||||||||||
Total real estate loans | 1 | 245 | 6 | 1,745 | ||||||||||||
Commercial and industrial | — | — | — | — | ||||||||||||
Agriculture | — | — | — | — | ||||||||||||
Consumer loans: | ||||||||||||||||
Purchased indirect automobile | — | — | — | — | ||||||||||||
Other | — | — | — | — | ||||||||||||
Total consumer loans | — | — | — | — | ||||||||||||
Total | 1 | $ | 245 | 6 | $ | 1,745 |
During the year ended December 31, 2013, the Company modified one residential real estate loan, with a recorded investment of $245 prior to modification, which was deemed a TDR. The modification involved both an interest rate and maturity concession, which resulted in an impairment loss of $16 based upon the present value of expected future cash flows.
During the year ended December 31, 2012, the Company modified three residential real estate loans, with a recorded investment of $257 prior to modification, which were deemed TDRs. All three of the modifications were to lower the interest rate and extend the maturity date. This resulted in specific allowances of $40 based upon the fair value of the collateral and impairment losses of $9 based upon the present value of expected future cash flows, discounted at the contractual interest rate of the original loan agreement.
The Company modified one second mortgage during 2012, which has a recorded investment of $6 prior to modification and was deemed a TDR. The Company extended the maturity date on that loan, which resulted in a specific allowance of $6 and no impairment loss. The Company modified two commercial real estate loans during the year, which had a recorded investment of $1,482 prior to modification and were deemed TDRs. The Company extended the maturity date on those loans, which resulted in specific allowances of $81 based upon the fair value of the collateral and no impairment losses.
Harvard Illinois Bancorp, Inc.
Notes to Consolidated Financial Statements
December 31, 2013 and 2012
(dollars in thousands, except share data)
Specific loss allowances are included in the calculation of estimated future loss ratios, which are applied to the various loan portfolios for purposes of estimating future losses.
Management considers the level of defaults within the various portfolios when evaluating qualitative adjustments used to determine the adequacy of the allowance for loan losses.
As of December 31, 2013 and 2012, the Company had two loans totaling $76 and no loans, respectively, in default that had been modified within the previous 12 months as TDRs. As of December 31, 2013, there were four TDRs secured by one-to-four family real estate totaling $669 and one TDR secured by commercial land for development of $354, all of which were in default. Default occurs when a loan or lease is 90 days or more past due, transferred to nonaccrual or charged-off and is within 12 months of restructuring.
Note 5: Premises and Equipment
Major classifications of premises and equipment, stated at cost, are as follows:
December 31, | ||||||||
2013 | 2012 | |||||||
Land | $ | 396 | $ | 403 | ||||
Buildings and improvements | 6,259 | 6,164 | ||||||
Furniture and equipment | 1,467 | 2,581 | ||||||
8,122 | 9,148 | |||||||
Less accumulated depreciation | 4,756 | 5,753 | ||||||
Net premises and equipment | $ | 3,366 | $ | 3,395 |
Harvard Illinois Bancorp, Inc.
Notes to Consolidated Financial Statements
December 31, 2013 and 2012
(dollars in thousands, except share data)
Note 6: Loan Servicing
Loans serviced for others are not included in the accompanying consolidated balance sheets. The unpaid principal balances of loans serviced for others consist of the following:
December 31, | ||||||||
2013 | 2012 | |||||||
One-to-four family residential loans | ||||||||
FHLB | $ | 10,542 | $ | 12,403 | ||||
FNMA | 50,709 | 51,184 | ||||||
Agricultural loans | ||||||||
Farmer Mac | 15,106 | 8,808 | ||||||
Commercial loans | ||||||||
Other financial institutions | 3,147 | 3,005 | ||||||
$ | 79,504 | $ | 75,400 |
The Company has a credit enhancement obligation to individual loan losses, to the limit of $927 at December 31, 2013 and 2012, respectively. Management has determined that the allowance for loan losses is adequate to cover possible future losses from its credit enhancement obligation.
The following summarizes the activity in loan servicing rights measured using the fair value method for the years ended December 31, 2013 and 2012:
December 31, | ||||||||
2013 | 2012 | |||||||
Fair value, beginning of year | $ | 412 | $ | 310 | ||||
Additions | ||||||||
Servicing rights that result from asset transfers | 191 | 159 | ||||||
Less loans refinanced | (110 | ) | (72 | ) | ||||
Changes in fair value, due to changes in valuation inputs or assumptions | 127 | 15 | ||||||
Fair value, end of year | $ | 620 | $ | 412 |
Comparable market values and a valuation model that calculates the present value of future cash flows were used to estimate fair value. The valuation model incorporates assumptions that market participants would use in estimating future net servicing income, such as costs to service, a discount rate, custodial earnings rate, default rates and losses and prepayment speeds.
Harvard Illinois Bancorp, Inc.
Notes to Consolidated Financial Statements
December 31, 2013 and 2012
(dollars in thousands, except share data)
Note 7: Interest-bearing Deposits
Interest-bearing deposits in denominations of $100 or more were $47,234 and $47,420 on December 31, 2013 and 2012, respectively.
The following table represents deposit interest expense by deposit type:
December 31, | ||||||||
2013 | 2012 | |||||||
Savings | $ | 22 | $ | 21 | ||||
NOW and Money Market | 81 | 59 | ||||||
Certificates of deposit | 1,164 | 1,270 | ||||||
Brokered certificates of deposit | — | 65 | ||||||
Total deposit interest expense | $ | 1,267 | $ | 1,415 |
At December 31, 2013, the scheduled maturities of certificates of deposit are as follows:
2014 | $ | 32,941 | ||
2015 | 23,474 | |||
2016 | 9,287 | |||
2017 | 9,791 | |||
$ | 75,493 |
Note 8: Federal Home Loan Bank Advances
The Federal Home Loan Bank (“FHLB”) advances and lines of credit consisted of the following components:
December 31, | ||||||||
2013 | 2012 | |||||||
Open line of credit, 0.30% at December 31, 2013 and 2012 | $ | 4,200 | $ | 2,000 | ||||
Advances | 8,006 | 10,357 | ||||||
Total | $ | 12,206 | $ | 12,357 |
Harvard Illinois Bancorp, Inc.
Notes to Consolidated Financial Statements
December 31, 2013 and 2012
(dollars in thousands, except share data)
The Federal Home Loan Bank advances and line of credit are secured by loans totaling $94,317 and $74,429 at December 31, 2013 and 2012, respectively. Advances at December 31, 2013 at interest rates from 0.66% to 5.16% are subject to restrictions or penalties in the event of prepayment.
Annual maturities of the advances at December 31, 2013, are:
2014 | $ | 2,457 | ||
2015 | 1,333 | |||
2016 | 2,076 | |||
2017 | 377 | |||
2018 | 1,763 | |||
$ | 8,006 |
Note 9: Income Taxes
The Company and its subsidiary file income tax returns in the U.S. federal and state of Illinois jurisdictions. During the years ended December 31, 2013 and 2012, the Company did not recognize expense for interest or penalties.
The expense for income taxes includes these components:
December 31, | ||||||||
2013 | 2012 | |||||||
Taxes currently payable | $ | 228 | $ | 192 | ||||
Deferred income taxes | (44 | ) | (48 | ) | ||||
Income tax expense | $ | 184 | $ | 144 |
Harvard Illinois Bancorp, Inc.
Notes to Consolidated Financial Statements
December 31, 2013 and 2012
(dollars in thousands, except share data)
A reconciliation of income tax expense at the statutory rate to the Company’s actual income tax expense is shown below:
December 31, | ||||||||
2013 | 2012 | |||||||
Computed at the statutory rate (34%) | $ | 295 | $ | 351 | ||||
Increase (decrease) resulting from | ||||||||
Tax exempt interest | (10 | ) | (4 | ) | ||||
Changes in deferred tax valuation allowance | (89 | ) | (119 | ) | ||||
Cash surrender value of life insurance | (38 | ) | (41 | ) | ||||
Other | 26 | (43 | ) | |||||
Actual tax expense | $ | 184 | $ | 144 | ||||
Income tax expense as a percentage of pre-tax income | 21.2 | % | 14.0 | % |
Harvard Illinois Bancorp, Inc.
Notes to Consolidated Financial Statements
December 31, 2013 and 2012
(dollars in thousands, except share data)
The tax effects of temporary differences related to deferred taxes shown on the balance sheets were:
December 31, | |||||||||
2013 | 2012 | ||||||||
Deferred tax assets | |||||||||
Allowance for loan losses | $ | 842 | $ | 867 | |||||
Accrued compensation and employee benefits | 827 | 802 | |||||||
Net operating loss | 234 | 296 | |||||||
Loss on other than temporary impairment of equity securities not sold | 218 | 218 | |||||||
Write-down on foreclosed assets for sale | — | 107 | |||||||
Other | 291 | 172 | |||||||
2,412 | 2,462 | ||||||||
Deferred tax liabilities | |||||||||
Depreciation | (167 | ) | (153 | ) | |||||
FHLB stock dividends | — | (89 | ) | ||||||
Unrealized gains on available-for-sale securities | (9 | ) | (3 | ) | |||||
Loan servicing rights | (210 | ) | (140 | ) | |||||
(386 | ) | (385 | ) | ||||||
Net deferred tax asset before valuation allowance | 2,026 | 2,077 | |||||||
Valuation allowance | |||||||||
Beginning balance | 218 | 337 | |||||||
Decrease during the period | (89 | ) | (119 | ) | |||||
Ending balance | 129 | 218 | |||||||
Net deferred tax asset | $ | 1,897 | $ | 1,859 |
Harvard Illinois Bancorp, Inc.
Notes to Consolidated Financial Statements
December 31, 2013 and 2012
(dollars in thousands, except share data)
At December 31, 2013 and 2012, the Company’s deferred tax asset relating to realized losses and losses on other-than-temporary impairment of equity securities resulted in capital losses. Management has established a valuation allowance for a portion of that deferred tax asset for which realization of the asset does not meet the “more likely than not” criteria. The carryback period on these losses is three years and the carryforward period is five years from the date of sale.
At December 31, 2013 and 2012, the Company had federal net operating loss carryforwards totaling approximately $689 and $871, respectively, which expire in varying amounts between 2024 and 2029.
At December 31, 2013 and 2012, the Company had Illinois net operating loss carryforwards totaling approximately $3,190 and $3,290, respectively, which will expire in varying amounts between 2015 and 2021. Management has not recorded a deferred tax asset for the state net operating loss carryforwards.
The decreases in the valuation allowance in 2013 and 2012 are due to the reversal of the previous valuation allowance related to the capital losses. Management believes they have capital gains to enable a portion of the capital losses to be utilized prior to expiration.
Retained earnings at December 31, 2013 and 2012, include approximately $2,216 for which no deferred federal income tax liability has been recognized. This amount represents an allocation of income to bad debt deductions for tax purposes only. Reduction of amounts so allocated for purposes other than tax bad debt losses or adjustments arising from carryback of net operating losses would create income for tax purposes only, which would be subject to the then-current corporate income tax rate. The deferred income tax liability on the preceding amount that would have been recorded if the allocations were expected to reverse into taxable income in the foreseeable future was approximately $753 at December 31, 2013 and 2012.
Note 10: Accumulated Other Comprehensive Income
The components of accumulated other comprehensive income, included in stockholders’ equity, are as follows:
December 31, | ||||||||
2013 | 2012 | |||||||
Net unrealized gain on available-for-sale securities | $ | 25 | $ | 10 | ||||
Tax effect | (9 | ) | (3 | ) | ||||
Net-of-tax amount | $ | 16 | $ | 7 |
Harvard Illinois Bancorp, Inc.
Notes to Consolidated Financial Statements
December 31, 2013 and 2012
(dollars in thousands, except share data)
Note 11: Changes in Accumulated Other Comprehensive Income (AOCI) by Component
Amounts reclassified from AOCI and the affected line items in the statements of income during the years ended December 31, 2013 and 2012, were as follows:
Amounts Reclassified | Affected Line Item in the | ||||||||
2013 | 2012 | Statements of Income | |||||||
Unrealized gains (losses) on available-for-sale securities | |||||||||
$ | — | $ | 2 | Realized gain on sale of securities | |||||
Total reclassified amount before tax | |||||||||
— | — | Tax (expense) benefit | |||||||
$ | — | $ | 2 | Net reclassified amount |
Note 12: Regulatory Matters
The Bank is subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Company’s financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of the Bank’s assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices. The Bank’s capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings and other factors. Furthermore, the Company’s regulators could require adjustments to regulatory capital not reflected in these financial statements.
Quantitative measures established by regulation to ensure capital adequacy require the Bank to maintain minimum amounts and ratios (set forth in the table below) of total and Tier I capital (as defined in the regulations) to risk-weighted assets (as defined) and of Tier I capital to average assets (as defined). Management believes, as of December 31, 2013 and 2012, that the Bank meets all capital adequacy requirements to which it is subject.
As of December 31, 2013, the most recent notification from regulators categorized the Bank as well capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized, the Bank must maintain minimum total risk-based, Tier I risk-based and Tier I leverage ratios as set forth in the table. There are no conditions or events since that notification that management believes have changed the Bank’s category.
Harvard Illinois Bancorp, Inc.
Notes to Consolidated Financial Statements
December 31, 2013 and 2012
(dollars in thousands, except share data)
The Bank’s actual capital amounts and ratios are also presented in this table:
Actual | Minimum Capital Requirements | Minimum to Be Well Capitalized Under Prompt Corrective Action Provisions | ||||||||||||||||||||||
Amount | Ratio | Amount | Ratio | Amount | Ratio | |||||||||||||||||||
As of December 31, 2013 | ||||||||||||||||||||||||
Total capital (to risk-weighted assets) | $ | 18,996 | 14.5 | % | $ | 10,489 | 8.0 | % | $ | 13,112 | 10.0 | % | ||||||||||||
Tier I capital (to risk-weighted assets) | 17,332 | 13.2 | % | 5,245 | 4.0 | % | 7,867 | 6.0 | % | |||||||||||||||
Tier I capital (to average assets) | 17,332 | 10.3 | % | 6,741 | 4.0 | % | 8,246 | 5.0 | % | |||||||||||||||
As of December 31, 2012 | ||||||||||||||||||||||||
Total capital (to risk-weighted assets) | $ | 18,393 | 14.5 | % | $ | 10,129 | 8.0 | % | $ | 12,662 | 10.0 | % | ||||||||||||
Tier I capital (to risk-weighted assets) | 16,794 | 13.3 | % | 5,065 | 4.0 | % | 7,597 | 6.0 | % | |||||||||||||||
Tier I capital (to average assets) | 16,794 | 10.2 | % | 6,602 | 4.0 | % | 8,253 | 5.0 | % |
The following is a reconciliation of the Bank equity amount included in the consolidated balance sheets to the amounts reflected above for regulatory capital purposes:
December 31, | ||||||||
2013 | 2012 | |||||||
Bank equity | $ | 18,597 | $ | 18,038 | ||||
Less net unrealized gains | 3 | 3 | ||||||
Less disallowed servicing amounts | 62 | 41 | ||||||
Less disallowed deferred tax assets | 1,200 | 1,200 | ||||||
Tier 1 capital | 17,332 | 16,794 | ||||||
Add allowance for loan losses subject to limit | 1,649 | 1,595 | ||||||
Add unrealized gains on available-for-sale equity securities | 15 | 4 | ||||||
Total risk-based capital | $ | 18,996 | $ | 18,393 |
Harvard Illinois Bancorp, Inc.
Notes to Consolidated Financial Statements
December 31, 2013 and 2012
(dollars in thousands, except share data)
Note 13: Restriction on Dividends
Without prior approval, the Bank is restricted by Illinois law and regulations of the Illinois Department of Financial and Professional Regulation, State of Illinois, and the Federal Deposit Insurance Corporation as to the maximum amount of dividends it can pay to the Company to the balance of the undivided profits account, adjusted for defined bad debts. As a practical matter, the Bank restricts dividends to a lesser amount because of the need to maintain an adequate capital structure.
Note 14: Related Party Transactions
At December 31, 2013 and 2012, the Company had loans outstanding to executive officers, directors and their affiliates (related parties). Changes in loans to executive officers and directors are summarized as follows:
December 31, | ||||||||
2013 | 2012 | |||||||
Balance beginning of year | $ | 1,080 | $ | 1,178 | ||||
New loans | 150 | 322 | ||||||
Repayments | (493 | ) | (420 | ) | ||||
Balance, end of year | $ | 737 | $ | 1,080 |
Deposits from related parties held by the Company at December 31, 2013 and 2012 totaled $1,523 and $1,308, respectively.
The Company also has an employee loan program which is described more fully in Note 15.
In management’s opinion, such loans and other extensions of credit and deposits were made in the ordinary course of business and were made on substantially the same terms (including interest rates and collateral) as those prevailing at the time for comparable transactions with other persons. Further, in management’s opinion, these loans did not involve more than normal risk of collectibility or present other unfavorable features.
Harvard Illinois Bancorp, Inc.
Notes to Consolidated Financial Statements
December 31, 2013 and 2012
(dollars in thousands, except share data)
Note 15: Employee Benefit Plans
The Company contributes to a multiemployer defined benefit retirement plan (Pentegra DB Plan) covering all employees under 65 years of age. The Pentegra DB Plan’s Employer Identification Number is 13-5645888 and the plan number is 333. Although employees will receive defined benefits under the multiemployer plan, the multiemployer plan does not provide for the accrual of defined pension benefits for the future services of the present employees. The Pentegra DB Plan operates as a multi-employer plan for accounting purposes and as a multiemployer plan under theEmployee Retirement Income Security Act of 1974 and the Internal Revenue Code. There are no collective bargaining agreements in place that require contributions to the Pentegra DB Plan.
The Pentegra DB Plan is a single plan under the Internal Revenue Code Section 413(c) and, as a result, all of the assets stand behind all of the liabilities. Accordingly, under the Pentegra DB Plan contributions made by a participating employer may be used to provide benefits to participants of other participating employers. The risks of participating in these multiemployer plans are different from single-employer plans in the following aspects:
1. | Assets contributed to the multiemployer plan by one employer may be used to provide benefits to employees of other participating employers. |
2. | If a participating employer stops contributing to the plan, the unfunded obligations of the plan may be borne by the remaining participating employers. |
3. | If the Company chooses to stop participating in some of its multiemployer plans, the Company may be required to pay those plans an amount based on the underfunded status of the plan, referred to as a withdrawal liability. |
Effective January 1, 2008, the Board approved to close the plan to new employees. In 2010, the Company elected to freeze its defined benefit retirement plan. Effective July 1, 2010, all benefit accruals under the Plan ceased.
Total contributions made to the Pentegra DB Plan, as reported on Form 5500, equal $196,473 and $299,729 for the plan years ending June 30, 2012 and June 30, 2011, respectively. The Company’s contributions to the Pentegra DB Plan totaled $83 and $45, respectively, for the years ended December 31, 2013 and 2012 and do not represent more than 5% of the total contributions to the Pentegra DB Plan. There have been no significant changes that affect the comparability of the 2012 and 2013 contributions.
The Company has a retirement savings 401(k) profit sharing plan covering substantially all employees. The Company matches 50% of the employee’s contribution on the first 6% of the employee’s compensation. Employer contributions charged to expense for 2013 and 2012 were $41.
Harvard Illinois Bancorp, Inc.
Notes to Consolidated Financial Statements
December 31, 2013 and 2012
(dollars in thousands, except share data)
The Company has a liability of $1,081 and $1,085 as of December 31, 2013 and 2012, respectively, for deferred compensation agreements with current and former directors of the Company. The agreements provide for 120 monthly payments upon retirement of the directors. The charge to expense for the agreements was $106 for 2013 and $110 for 2012. Such charges reflect the deferred director fees plus the interest accrued at the rate of 3.97% – 8.50% on the contributions to the deferred compensation accounts.
The Company has a supplemental employee retirement plan with certain officers of the Company. The plan provides for benefits to be paid upon retirement of the officers. The charge to the expense for the plan was $225 and $221 in 2013 and 2012, respectively. Such charges reflect the straight-line accrual over the period until full eligibility of the present value of benefits due each participant on the full eligibility date, using a 3.97% to 8.50% discount factor. The liability for the plan was $1,352 and $1,253 at December 31, 2013 and 2012, respectively.
The Company has adopted a lending policy which provides eligible employees, officers, and directors of the Company the opportunity to obtain one mortgage loan (primary residence only) at an interest rate below what is offered to customers in the normal course of business. The interest rate is based upon 1% below the Fannie Mae rate on the date of entering the program or the date the loan is scheduled to re-price. Employees who have been employed full-time for 3 months or have accumulated 1000 hours of employment are eligible to participate in the plan. The interest rate on those loans revert back to the contract rate when the employee is no longer employed by the Company. The outstanding balance of such loans totaled approximately $1,047 and $1,484 at December 31, 2013 and 2012, respectively. Approximately $319 and $391, respectively, were loans to executive officers and directors. Effective April 2008, directors were no longer eligible to obtain new loans through this program.
Note 16: Stock-based Compensation
In connection with the conversion to stock form, the Bank established an ESOP for the exclusive benefit of eligible employees (all salaried employees who have completed at least 1,000 hours of service in a twelve-month period and have attained the age of 18). The ESOP borrowed funds from the Company in an amount sufficient to purchase 62,775 shares (approximately 8% of the Common Stock issued in the stock offering). The loan is secured by the shares purchased and will be repaid by the ESOP with funds from contributions made by the Bank and dividends received by the ESOP, with funds from any contributions on ESOP assets. Contributions will be applied to repay interest on the loan first, then the remainder will be applied to principal. The loan is expected to be repaid over a period of up to 15 years. Shares purchased with the loan proceeds are held in a suspense account for allocation among participants as the loan is repaid. Contributions to the ESOP and shares released from the suspense account are allocated among participants in proportion to their compensation, relative to total compensation of all active participants. Participants will vest 100% in their accrued benefits under the employee stock ownership plan after three vesting years, with no prorated vesting prior to reaching three vesting years. Vesting is accelerated upon retirement, death or disability of the participant or a change in control of the Bank. Forfeitures will be reallocated to remaining plan participants. Benefits may be payable upon retirement, death, disability, separation from service, or termination of the ESOP. Since the Bank’s annual contributions are discretionary, benefits payable under the ESOP cannot be estimated.
Harvard Illinois Bancorp, Inc.
Notes toConsolidatedFinancial Statements
December 31, 2013 and 2012
(dollars in thousands, except share data)
Participants receive the shares at the end of employment. Because the Company’s stock is not traded on an established market, as of December 31, 2013, it is required to provide the participants in the Plan with a put option to repurchase their shares. This repurchase obligation is reflected in the Company’s financial statements in other liabilities and reduces shareholders’ equity by the estimated fair value of the earned shares.
The Company is accounting for its ESOP in accordance with ASC Topic 718,Employers Accounting for Employee Stock Ownership Plans. Accordingly, the debt of the ESOP is eliminated in consolidation and the shares pledged as collateral are reported as unearned ESOP shares in the consolidated balance sheet. Contributions to the ESOP shall be sufficient to pay principal and interest currently due under the loan agreement. As shares are committed to be released from collateral, the Company reports compensation expense equal to the average market price of the shares for the respective period, and the shares become outstanding for earnings per shares computations. Dividends, if any, on unallocated ESOP shares are recorded as a reduction of debt and accrued interest. ESOP compensation expense for the years ended December 31, 2013 and 2012 was $60 and $45, respectively.
A summary of the ESOP shares at December 31, 2013 and 2012 is as follows:
2013 | 2012 | |||||||
Allocated shares | 12,555 | 8,370 | ||||||
Shares released for allocation | 4,185 | 4,185 | ||||||
Unearned shares | 46,035 | 50,220 | ||||||
Total ESOP shares | 62,775 | 62,775 | ||||||
Fair value of unearned shares at December 31 | $ | 609 | $ | 452 |
The Company is obligated at the option of each beneficiary to repurchase shares of the ESOP upon the beneficiary’s termination or after retirement. At December 31, 2013, the fair value of the 16,740 allocated shares held by the ESOP is $268. The fair value of all shares subject to the repurchase obligation is $268.
Harvard Illinois Bancorp, Inc.
Notes toConsolidatedFinancial Statements
December 31, 2013 and 2012
(dollars in thousands, except share data)
On May 26, 2011, the stockholders approved the Harvard Illinois Bancorp, Inc. 2011 Equity Incentive Plan (the “Equity Incentive Plan”) for employees and directors of the Company. The Equity Incentive Plan authorizes the issuance of up to 109,856 shares of the Company’s common stock, with no more than 31,387 of shares as restricted stock awards and 78,469 as stock options, either incentive stock options or non-qualified stock options. The Company believes that such awards better align the interests of its employees with those of its shareholders. The exercise price of options granted under the Equity Incentive Plan may not be less than the fair market value on the date the stock option is granted. The compensation committee of the board of directors has sole discretion to determine the amount and to whom equity incentive awards are granted. Certain option awards provide for accelerated vesting if there is a change of control (as defined in the Equity Incentive Plan).
On June 23, 2011, the compensation committee of the board of directors approved the awards of 73,761 options to purchase Company stock and 31,387 shares of restricted stock. Of the 73,761 stock options granted, 63,167 were qualified stock options and 10,594 were nonqualified. The remaining 4,708 shares were awarded on November 29, 2012. Stock options and restricted stock vest over a five year period, and stock options expire ten years after issuance. Apart from the vesting schedule for both stock options and restricted stock, there are no performance-based conditions or any other material conditions applicable to the awards issued.
The fair value of each option award is estimated on the date of grant using a Black-Scholes option valuation model that uses the assumptions noted in the following table. Expected volatility is based on historical volatility of the Company’s stock and other factors. The Company uses historical data to estimate option exercise and employee termination within the valuation model; separate groups of employees that have similar historical exercise behavior are considered separately for valuation purposes. The expected term of options granted represents the period of time that options are expected to be outstanding; the range given below results from certain groups of employees exhibiting different behavior. The risk-free rate for periods within the contractual life of the option is based on the U.S. Treasury yield curve in effect at the time of grant.
The weighted-average assumptions used in the Black-Scholes option pricing model for the years indicated were as follows:
2012 | ||||
Expected volatility | 47.53 | % | ||
Expected dividends | 0.00 | % | ||
Expected term (in years) | 7 | |||
Risk-free rate | 1.04 | % |
Harvard Illinois Bancorp, Inc.
Notes toConsolidatedFinancial Statements
December 31, 2013 and 2012
(dollars in thousands, except share data)
A summary of the option activity under the Equity Incentive Plan as of December 31, 2013 and 2012, and changes during the years then ended, is presented below (dollars in thousands):
2013 | ||||||||||||||||
Shares | Weighted-Average Exercise Price | Weighted-Average Remaining Contractual Term | Aggregate Intrinsic Value | |||||||||||||
Outstanding, beginning of year | 78,469 | $ | 8.27 | |||||||||||||
Granted | — | — | ||||||||||||||
Exercised | (17,775 | ) | 8.10 | |||||||||||||
Forfeited or expired | — | — | ||||||||||||||
Outstanding, end of year | 60,694 | $ | 8.32 | 7.59 | $ | 466 | ||||||||||
Exercisable, end of year | 12,671 | $ | 8.31 | 7.59 | $ | 97 |
2012 | ||||||||||||||||
Shares | Weighted-Average Exercise Price | Weighted-Average Remaining Contractual Term | Aggregate Intrinsic Value | |||||||||||||
Outstanding, beginning of year | 73,761 | $ | 8.10 | |||||||||||||
Granted | 4,708 | 10.95 | ||||||||||||||
Exercised | — | — | ||||||||||||||
Forfeited or expired | — | — | ||||||||||||||
Outstanding, end of year | 78,469 | $ | 8.27 | 8.59 | $ | 379 | ||||||||||
Exercisable, end of year | 14,752 | $ | 8.10 | 8.48 | $ | 74 |
Harvard Illinois Bancorp, Inc.
Notes toConsolidatedFinancial Statements
December 31, 2013 and 2012
(dollars in thousands, except share data)
The weighted-average grant-date fair value of options granted during 2012 was $5.36. There were no options granted during 2013. The total intrinsic value of options exercised during the year ended December 31, 2013 was $108. There were no options exercised during 2012.
Stock-based compensation expense for stock options for the years ended December 31, 2013 and 2012 was $66 and $60, respectively.
As of December 31, 2013 there was $172 of total unrecognized compensation costs related to nonvested stock options. That cost is expected to be recognized over a weighted-average period of 2.59 years. The total fair value of shares vested during the years ended December 31, 2013 and 2012 were $66 and $61, respectively. The recognized tax benefit related thereto was $22 and $21 for the years ended December 31, 2013 and 2012, respectively.
A summary of the status of the Company’s nonvested shares as of December 31, 2013 and 2012, and changes during the years then ended, is presented below:
December 31, 2013 | ||||||||
Shares | Weighted-Average Grant-Date Fair Value | |||||||
Nonvested, beginning of year | 63,717 | $ | 4.20 | |||||
Granted | — | — | ||||||
Vested | (15,694 | ) | 4.19 | |||||
Forfeited | — | — | ||||||
Nonvested, end of year | 48,023 | $ | 4.21 |
December 31, 2012 | ||||||||
Shares | Weighted-Average Grant-Date Fair Value | |||||||
Nonvested, beginning of year | 73,761 | $ | 4.11 | |||||
Granted | 4,708 | 5.36 | ||||||
Vested | (14,752 | ) | 4.11 | |||||
Forfeited | — | — | ||||||
Nonvested, end of year | 63,717 | $ | 4.20 |
Harvard Illinois Bancorp, Inc.
Notes toConsolidatedFinancial Statements
December 31, 2013 and 2012
(dollars in thousands, except share data)
The following table summarizes restricted stock activity for the years ended December 31, 2013 and 2012:
2013 | 2012 | |||||||||||||||
Shares | Weighted Average Grant-Date Fair Value | Shares | Weighted Average Grant-Date Fair Value | |||||||||||||
Balance, beginning of year | 29,818 | $ | 8.10 | 31,387 | $ | 8.10 | ||||||||||
Granted | — | — | — | — | ||||||||||||
Forfeited | — | — | — | — | ||||||||||||
Earned and issued | — | — | (1,569 | ) | 8.10 | |||||||||||
Balance, end of year | 29,818 | $ | 8.10 | 29,818 | $ | 8.10 |
The fair value of the restricted stock awards is amortized to compensation expense over the vesting period (five years) and is based on the market price of the Company’s common stock at the date of grant multiplied by the number of shares granted that are expected to vest. At the date of grant the par value of the shares granted was recorded in equity as a credit to common stock and a debit to paid-in capital. The weighted-average grant date fair value of restricted stock granted during the year ended December 31, 2011 was $8.10 per share or $254. Stock-based compensation expense for restricted stock for the years ended December 31, 2013 and 2012 was $48 and $61, respectively. Unrecognized compensation expense for nonvested restricted stock awards was $121 at December 31, 2013 and is expected to be recognized over a weighted average period of 2.48 years.
Total compensation expense for both plans for the years ended December 31, 2013 and 2012 was $114 and $121, respectively.
Harvard Illinois Bancorp, Inc.
Notes toConsolidated Financial Statements
December 31, 2013 and 2012
(dollars in thousands, except share data)
Note 17: Earnings Per Share
Earnings per share (EPS) were computed as follows:
December 31, 2013 | December 31, 2012 | |||||||
Net income | $ | 683 | $ | 888 | ||||
Basic weighted average shares outstanding | 813,412 | 794,131 | ||||||
Less: Average unallocated ESOP shares | (47,952 | ) | (52,138 | ) | ||||
Basic average shares outstanding | 765,460 | 741,993 | ||||||
Diluted effect of stock options | 6,482 | — | ||||||
Diluted effect of restricted stock awards | 15,015 | 8,091 | ||||||
Diluted average shares outstanding | 786,957 | 750,084 | ||||||
Basic earnings per share | $ | 0.87 | $ | 1.20 | ||||
Diluted earnings per share | $ | 0.87 | $ | 1.18 |
Options to purchase 78,469 shares were outstanding at December 31, 2012, but were not included in the computation of diluted earnings per share as the options were considered antidilutive for the year ended December 31, 2012.
Note 18: Disclosures About Fair Value of Assets and Liabilities
Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Fair value measurements must maximize the use of observable inputs and minimize the use of unobservable inputs. There is a hierarchy of three levels of inputs that may be used to measure fair value:
Level 1 | Quoted prices in active markets for identical assets or liabilities |
Level 2 | Observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities |
Level 3 | Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities |
Harvard Illinois Bancorp, Inc.
Notes toConsolidatedFinancial Statements
December 31, 2013 and 2012
(dollars in thousands, except share data)
Recurring Measurements
The following table presents the fair value measurements of assets recognized in the accompanying consolidated balance sheets measured at fair value on a recurring basis and the level within the fair value hierarchy in which the fair value measurements fall at December 31, 2013 and 2012:
Fair Value Measurements Using | ||||||||||||||||
Fair Value | Quoted Prices in Active Markets for Identical Assets (Level 1) | Significant Other Observable Inputs (Level 2) | Significant Unobservable Inputs (Level 3) | |||||||||||||
December 31, 2013: | ||||||||||||||||
Available-for-sale securities: | ||||||||||||||||
US Government and federal agency | $ | 982 | $ | — | $ | 982 | $ | — | ||||||||
Mortgage-backed securities – GSE residential | 626 | — | 626 | — | ||||||||||||
State and political subdivisions | 3,429 | — | 3,429 | — | ||||||||||||
Equity securities | 508 | 28 | 480 | — | ||||||||||||
Loan servicing rights | 620 | — | — | 620 |
Harvard Illinois Bancorp, Inc.
Notes toConsolidatedFinancial Statements
December 31, 2013 and 2012
(dollars in thousands, except share data)
Fair Value Measurements Using | ||||||||||||||||
Fair Value | Quoted Prices in Active Markets for Identical Assets (Level 1) | Significant Other Observable Inputs (Level 2) | Significant Unobservable Inputs (Level 3) | |||||||||||||
December 31, 2012: | ||||||||||||||||
Available-for-sale securities: | ||||||||||||||||
US Government and federal agency | $ | 3,185 | $ | — | $ | 3,185 | $ | — | ||||||||
Mortgage-backed securities – GSE residential | 779 | — | 779 | — | ||||||||||||
State and political subdivisions | 3,449 | — | 3,449 | — | ||||||||||||
Equity securities | 466 | 18 | 448 | — | ||||||||||||
Loan servicing rights | 412 | — | — | 412 |
Following is a description of the valuation methodologies and inputs used for assets measured at fair value on a recurring basis and recognized in the accompanying balance sheets, as well as the general classification of such assets pursuant to the valuation hierarchy. There have been no significant changes in the valuation techniques during the year ended December 31, 2013. For assets classified within Level 3 of the fair value hierarchy, the process used to develop the reported fair value is described below.
Available-for-sale Securities
Where quoted market prices are available in an active market, securities are classified within Level 1 of the valuation hierarchy. If quoted market prices are not available, then fair values are estimated by using quoted prices of securities with similar characteristics or independent asset pricing services and pricing models, the inputs of which are market-based or independently sourced market parameters, including, but not limited to, yield curves, interest rates, volatilities, prepayments, defaults, cumulative loss projections and cash flows. Such securities are classified in Level 2 of the valuation hierarchy. In certain cases where Level 1 or Level 2 inputs are not available, securities are classified within Level 3 of the hierarchy.
Harvard Illinois Bancorp, Inc.
Notes toConsolidatedFinancial Statements
December 31, 2013 and 2012
(dollars in thousands, except share data)
Loan Servicing Rights
Loan servicing rights do not trade in an active, open market with readily observable prices. Accordingly, fair value is estimated using discounted cash flow models. Due to the nature of the valuation inputs, loan servicing rights are classified within Level 3 of the hierarchy.
Management measures mortgage servicing rights through the completion of a proprietary model. Inputs to the model are developed by the accounting staff and are reviewed by management. The model is tested annually using baseline data to check its accuracy.
Level 3 Reconciliation
The following is a reconciliation of the beginning and ending balances of recurring fair value measurements recognized in the accompanying balance sheet using significant unobservable (Level 3) inputs:
Loan Servicing Rights | ||||
Balance, January 1, 2013 | $ | 412 | ||
Total realized and unrealized gains and lossesincluded in net income | 127 | |||
Servicing rights that result from asset transfers | 191 | |||
Loans refinanced | (110 | ) | ||
Balance, December 31, 2013 | $ | 620 | ||
Total gains or losses for the period included in net income attributable to the change in unrealized gains or losses related to assets and liabilities still held at the reporting date | $ | — |
Harvard Illinois Bancorp, Inc.
Notes toConsolidatedFinancial Statements
December 31, 2013 and 2012
(dollars in thousands, except share data)
Loan Servicing Rights | ||||
Balance, January 1, 2012 | $ | 310 | ||
Total realized and unrealized gains and lossesincluded in net income | 15 | |||
Servicing rights that result from asset transfers | 159 | |||
Loans refinanced | (72 | ) | ||
Balance, December 31, 2012 | $ | 412 | ||
Total gains or losses for the period included in net income attributable to the change in unrealized gains or losses related to assets and liabilities still held at the reporting date | $ | — |
Nonrecurring Measurements
The following table presents the fair value measurement of assets measured at fair value on a nonrecurring basis and the level within the fair value hierarchy in which the fair value measurements fall at December 31, 2013 and 2012:
Fair Value Measurements Using | ||||||||||||||||
Fair Value | Quoted Prices in Active Markets for Identical Assets (Level 1) | Significant Other Observable Inputs (Level 2) | Significant Unobservable Inputs (Level 3) | |||||||||||||
December 31, 2013: | ||||||||||||||||
Impaired loans (collateral dependent) | $ | 549 | $ | — | $ | — | $ | 549 | ||||||||
December 31, 2012: | ||||||||||||||||
Impaired loans (collateral dependent) | $ | 2,570 | $ | — | $ | — | $ | 2,570 | ||||||||
Foreclosed assets | 616 | — | — | 616 |
Harvard Illinois Bancorp, Inc.
Notes toConsolidatedFinancial Statements
December 31, 2013 and 2012
(dollars in thousands, except share data)
Following is a description of the valuation methodologies used for assets measured at fair value on a nonrecurring basis and recognized in the accompanying balance sheets, as well as the general classification of such assets pursuant to the valuation hierarchy. For assets classified within Level 3 of the fair value hierarchy, the process used to develop the reported fair value is described below.
Collateral-dependent Impaired Loans, Net of ALLL
The estimated fair value of collateral-dependent impaired loans is based on the appraised fair value of the collateral, less estimated cost to sell. Collateral-dependent impaired loans are classified within Level 3 of the fair value hierarchy.
The Company considers the appraisal or evaluation as the starting point for determining fair value and then considers other factors and events in the environment that may affect the fair value. Appraisals of the collateral underlying collateral-dependent loans are obtained when the loan is determined to be collateral-dependent and subsequently as deemed necessary by management. Appraisals are reviewed for accuracy and consistency by management.
Appraisers are selected from the list of approved appraisers maintained by management. The appraised values are reduced by discounts to consider lack of marketability and estimated cost to sell if repayment or satisfaction of the loan is dependent on the sale of the collateral. These discounts and estimates are developed by management by comparison to historical results. Fair value adjustments on impaired loans were $(55) at December 31, 2013 compared to $(65) at December 31, 2012.
Foreclosed Assets
Foreclosed assets consist primarily of real estate owned. Real estate owned (OREO) is carried at the lower of fair value at acquisition date or current estimated fair value, less estimated cost to sell when the real estate is acquired. Estimated fair value of OREO is based on appraisals or evaluations. OREO is classified within Level 3 of the fair value hierarchy.
Appraisals of OREO are obtained when the real estate is acquired and subsequently as deemed necessary. Appraisals are reviewed for accuracy and consistency. Appraisers are selected from the list of approved appraisers maintained by management. Fair value adjustments on foreclosed assets were $0 at December 31, 2013 compared to $(209) at December 31, 2012.
Harvard Illinois Bancorp, Inc.
Notes toConsolidatedFinancial Statements
December 31, 2013 and 2012
(dollars in thousands, except share data)
Unobservable (Level 3) Inputs
The following table presents quantitative information about unobservable inputs used in recurring and nonrecurring Level 3 fair value measurements.
Fair Value at December 31, 2013 | Valuation Technique | Unobservable Inputs | Range (Weighted Average) | |||||||
Collateral-dependent impaired loans | $ | 549 | Market comparable properties | Marketability discount | 20% | - | 40% | (25%) | ||
Mortgage servicing rights | 620 | Discounted cash flow | Discount rate | 8% | - | 12.5% | (10.43%) | |||
PSA standard prepayment model rate | 100 | - | 369 | (194) |
Fair Value at December 31, 2012 | Valuation Technique | Unobservable Inputs | Range (Weighted Average) | |||||||
Collateral-dependent impaired loans | $ | 2,570 | Market comparable properties | Marketability discount | 10% | - | 30% | (22%) | ||
Foreclosed assets | 616 | Market comparable properties | Comparability adjustments (%) | 10% | - | 40% | (27%) | |||
Mortgage servicing rights | 412 | Discounted cash flow | Discount rate | 9% | - | 11% | (10%) | |||
PSA standard prepayment model rate | 421 |
Harvard Illinois Bancorp, Inc.
Notes toConsolidatedFinancial Statements
December 31, 2013 and 2012
(dollars in thousands, except share data)
Fair Value of Financial Instruments
The following table presents estimated fair values of the Company’s other financial instruments and the level within the fair value hierarchy in which the fair value measurements fall at December 31, 2013 and 2012
Fair Value Measurements Using | ||||||||||||||||
Carrying Amount | Quoted Prices in Active Markets for Identical Assets (Level 1) | Significant Other Observable Inputs (Level 2) | Significant Unobservable Inputs (Level 3) | |||||||||||||
December 31, 2013 | ||||||||||||||||
Financial assets | ||||||||||||||||
Cash and cash equivalents | $ | 28,089 | $ | 28,089 | $ | — | $ | — | ||||||||
Interest-bearing deposits with other financial institutions | 6,240 | — | 6,240 | — | ||||||||||||
Held-to-maturity securities | 833 | — | 839 | — | ||||||||||||
Loans, net of allowance for loan losses | 116,858 | — | 119,462 | — | ||||||||||||
Federal Home Loan Bank stock | 870 | — | 870 | — | ||||||||||||
Accrued interest receivable | 786 | — | 786 | — | ||||||||||||
Financial liabilities | ||||||||||||||||
Deposits | 133,750 | — | 130,206 | — | ||||||||||||
Federal Home Loan Bank advances | 12,206 | — | 12,377 | — | ||||||||||||
Advances from borrowers for taxes and insurance | 358 | — | 358 | — | ||||||||||||
Accrued interest payable | 19 | — | 19 | — | ||||||||||||
Unrecognized financial instruments (net of contract amount) | ||||||||||||||||
Commitments to originate loans | — | — | — | — | ||||||||||||
Letters of credit | — | — | — | — | ||||||||||||
Lines of credit | — | — | — | — |
Harvard Illinois Bancorp, Inc.
Notes toConsolidatedFinancial Statements
December 31, 2013 and 2012
(dollars in thousands, except share data)
Fair Value Measurements Using | ||||||||||||||||
Carrying Amount | Quoted Prices in Active Markets for Identical Assets (Level 1) | Significant Other Observable Inputs (Level 2) | Significant Unobservable Inputs (Level 3) | |||||||||||||
December 31, 2012 | ||||||||||||||||
Financial assets | ||||||||||||||||
Cash and cash equivalents | $ | 22,859 | $ | 22,859 | $ | — | $ | — | ||||||||
Interest-bearing deposits with other financial institutions | 9,126 | — | 9,126 | — | ||||||||||||
Held-to-maturity securities | 1,263 | — | 1,314 | — | ||||||||||||
Loans, net of allowance for loan losses | 114,976 | — | 117,099 | — | ||||||||||||
Federal Home Loan Bank stock | 1,404 | — | 1,404 | — | ||||||||||||
Accrued interest receivable | 612 | — | 612 | — | ||||||||||||
Financial liabilities | ||||||||||||||||
Deposits | 133,985 | — | 136,816 | — | ||||||||||||
Federal Home Loan Bank advances | 12,357 | — | 12,682 | — | ||||||||||||
Advances from borrowers for taxes and insurance | 382 | — | 382 | — | ||||||||||||
Accrued interest payable | 29 | — | 29 | — | ||||||||||||
Unrecognized financial instruments (net of contract amount) | ||||||||||||||||
Commitments to originate loans | — | — | — | — | ||||||||||||
Letters of credit | — | — | — | — | ||||||||||||
Lines of credit | — | — | — | — |
Harvard Illinois Bancorp, Inc.
Notes toConsolidatedFinancial Statements
December 31, 2013 and 2012
(dollars in thousands, except share data)
The following methods were used to estimate the fair value of all other financial instruments recognized in the accompanying consolidated balance sheets at amounts other than fair value.
Cash and Cash Equivalents, Interest-Bearing Deposits with Other Institutions, Federal Home Loan Bank Stock, Accrued Interest Receivable, Accrued Interest Payable and Advances from Borrowers for Taxes and Insurance
The carrying amount approximates fair value.
Held-to-maturity Securities
Fair value is based on quoted market prices, if available. If a quoted market price is not available, fair value is estimated using quoted market prices for similar securities.
Loans
The fair value of loans is estimated by discounting the future cash flows using the current rates at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities. Loans with similar characteristics were aggregated for purposes of the calculations.
Deposits
Deposits include demand deposits, savings accounts, NOW accounts and certain money market deposits. The carrying amount approximates fair value. The fair value of fixed-maturity time deposits is estimated using a discounted cash flow calculation that applies the rates currently offered for deposits of similar remaining maturities.
Federal Home Loan Bank Advances
Rates currently available to the Company for debt with similar terms and remaining maturities are used to estimate the fair value of existing debt.
Commitments to Originate Loans, Letters of Credit and Lines of Credit
The fair value of commitments to originate loans is estimated using the fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the present creditworthiness of the counterparties. For fixed-rate loan commitments, fair value also considers the difference between current levels of interest rates and the committed rates. The fair values of letters of credit and lines of credit are based on fees currently charged for similar agreements or on the estimated cost to terminate or otherwise settle the obligations with the counterparties at the reporting date.
Harvard Illinois Bancorp, Inc.
Notes toConsolidatedFinancial Statements
December 31, 2013 and 2012
(dollars in thousands, except share data)
Note 19: Significant Estimates and Concentrations
Accounting principles generally accepted in the United States of America require disclosure of certain significant estimates and current vulnerabilities due to certain concentrations. Estimates related to the allowance for loan losses are reflected in the footnote regarding loans. Current vulnerabilities due to certain concentrations of credit risk are discussed in the footnote on commitments and credit risk. Other significant estimates and concentrations not discussed in those footnotes include:
General Litigation
The Company is subject to claims and lawsuits that arise primarily in the ordinary course of business. It is the opinion of management that the disposition or ultimate resolution of such claims and lawsuits will not have a material adverse effect on the consolidated financial position, results of operations and cash flows of the Company.
Investments
The Company invests in various investment securities. Investment securities are exposed to various risks such as interest rate, market and credit risks. Due to the level of risk associated with certain investment securities, it is at least reasonably possible that changes in the values of investment securities will occur in the near term and that such change could materially affect the amounts reported in the accompanying consolidated balance sheet.
Deferred Income Taxes
The Company has maintained net deferred tax assets for deductible temporary differences. The Company evaluated the recoverability of the deferred tax asset and established a valuation allowance of $129 for certain capital loss carryforwards that are not expected to be fully recognized. Management believes that it is more likely than not that the remainder of the deferred tax assets will be fully realized. The Company has determined that no further valuation allowance is required for any other deferred tax assets as of December 31, 2013, although there is no guarantee that those assets will be recognizable in future periods.
Current Economic Conditions
At December 31, 2013 and 2012, the Company held $24,343 and $20,096 in agricultural production loans and $13,900 and $11,765, respectively in agricultural real estate loans in the Company’s geographic lending area. Generally, those loans are collateralized by assets of the borrower. The loans are expected to be repaid from cash flows or from proceeds of sale of related assets of the borrower. Declines in prices for corn, beans, livestock and farm land could significantly affect the repayment ability for many agricultural loan customers.
Harvard Illinois Bancorp, Inc.
Notes toConsolidatedFinancial Statements
December 31, 2013 and 2012
(dollars in thousands, except share data)
At December 31, 2013 and 2012, the Company held $19,244 and $19,989 in commercial real estate loans and $354 and $1,837 in loans collateralized by commercial and development real estate in the Company’s geographic lending area. Due to national, state and local economic conditions, values for commercial and development real estate have declined significantly, and the market for these properties is depressed.
The accompanying financial statements have been prepared using values and information currently available to the Company.
Note 20: Commitments and Credit Risk
The Company generates commercial, mortgage and consumer loans and receives deposits from customers located primarily in McHenry, Grundy, and to a lesser extent Boone Counties, Illinois and Walworth County in Wisconsin. The Company’s loans are generally secured by specific items of collateral including real property, consumer assets and business assets. Although the Company has a diversified loan portfolio, a substantial portion of its debtors’ ability to honor their contracts is dependent upon economic conditions in the Company’s markets.
Commitments to Originate Loans
Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since a portion of the commitments may expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. Each customer’s creditworthiness is evaluated on a case-by-case basis. The amount of collateral obtained, if deemed necessary, is based on management’s credit evaluation of the counterparty. Collateral held varies, but may include accounts receivable, inventory, property, plant and equipment, commercial real estate and residential real estate.
At December 31, 2013 and 2012, the Company had outstanding commitments to originate loans aggregating approximately $784 and $1,684, respectively. The commitments extended over varying periods of time with the majority being disbursed within a one-year period. Loan commitments at fixed rates of interest amounted to $784 and $50 at December 31, 2013 and 2012, respectively, with the remainder at floating market rates. The range of fixed rates was 4.50% to 6.00% at December 31, 2013 and 4% to 4.75% as of December 31, 2012.
Harvard Illinois Bancorp, Inc.
Notes toConsolidatedFinancial Statements
December 31, 2013 and 2012
(dollars in thousands, except share data)
Standby Letters of Credit
Standby letters of credit are irrevocable conditional commitments issued by the Company to guarantee the performance of a customer to a third party. Financial standby letters of credit are primarily issued to support public and private borrowing arrangements, including commercial paper, bond financing and similar transactions. Performance standby letters of credit are issued to guarantee performance of certain customers under non-financial contractual obligations. The credit risk involved in issuing standby letters of credit is essentially the same as that involved in extending loans to customers. Should the Company be obligated to perform under the standby letters of credit, the Company may seek recourse from the customer for reimbursement of amounts paid.
The Company had total outstanding standby letters of credit amounting to $130 and $6 at December 31, 2013 and 2012, respectively. The term of the standby letters of credit outstanding at December 31, 2013 expire in 2014. At December 31, 2013 and 2012, the Company’s deferred revenue under standby letters of credit agreements was nominal.
Lines of Credit
Lines of credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Lines of credit generally have fixed expiration dates. Since a portion of the line may expire without being drawn upon, the total unused lines do not necessarily represent future cash requirements. Each customer’s creditworthiness is evaluated on a case-by-case basis. The amount of collateral obtained, if deemed necessary, is based on management’s credit evaluation of the counterparty. Collateral held varies but may include accounts receivable, inventory, property, plant and equipment, commercial real estate and residential real estate. Management uses the same credit policies in granting lines of credit as it does for on-balance-sheet instruments.
At December 31, 2013, the Company had granted unused lines of credit to borrowers aggregating approximately $10,784 and $4,296 from commercial lines and open-end consumer lines, respectively. At December 31, 2012, the Company had granted unused lines of credit to borrowers aggregating approximately $10,884 and $4,866 for commercial lines and open-end consumer lines, respectively.
Other Credit Risk
The Company had a concentration of funds on deposit with the Federal Home Loan Bank totaling $1,260 and $2,743 at December 31, 2013 and 2012, respectively.
The Company had a concentration of funds in securities purchased under agreements to resell with First Farmers Financial, LLC totaling $14,811 at December 31, 2013. The remainder of the agreements totaling $10,306 as of December 31, 2013 were with HEC Opportunity Fund LLC, Coastal Securities, ESI Investors III LLC and BCM High Income Fund, LP.
Harvard Illinois Bancorp, Inc.
Notes toConsolidatedFinancial Statements
December 31, 2013 and 2012
(dollars in thousands, except share data)
The Company had a concentration of funds in securities purchased under agreements to resell with Coastal Securities totaling $10,508 at December 31, 2012. The remainder of the agreements totaling $8,506 as of December 31, 2012 were with HEC Opportunity Fund LLC and BCM High Income Fund, LP.
Note 21: Condensed Financial Information (Parent Company Only)
Presented below is condensed financial information as to financial position, results of operations and cash flows of the Company:
Condensed Balance Sheets
December 31, | ||||||||
2013 | 2012 | |||||||
Assets | ||||||||
Cash and due from banks | $ | 1,256 | $ | 947 | ||||
Investment in common stock of subsidiary | 18,596 | 18,038 | ||||||
ESOP loan | 484 | 521 | ||||||
Other assets | 134 | 136 | ||||||
Total assets | $ | 20,470 | $ | 19,642 | ||||
Liabilities | ||||||||
Other liabilities | $ | 24 | $ | 25 | ||||
Total liabilities | 24 | 25 | ||||||
Stockholders' Equity | 20,446 | 19,617 | ||||||
Total liabilities and stockholders' equity | $ | 20,470 | $ | 19,642 |
Harvard Illinois Bancorp, Inc.
Notes toConsolidatedFinancial Statements
December 31, 2013 and 2012
(dollars in thousands, except share data)
Condensed Statements of Income and Comprehensive Income
Years Ending December 31, | ||||||||
2013 | 2012 | |||||||
Income | ||||||||
Dividends from subsidiary | $ | 373 | $ | 1,114 | ||||
Interest on ESOP loan | 17 | 18 | ||||||
Losses on other-than-temporary impairment of equity securities | — | (1 | ) | |||||
Total income | 390 | 1,131 | ||||||
Expense | ||||||||
Noninterest expense | 286 | 385 | ||||||
Income Before Income Tax and Equity in Undistributed Income of Subsidiary | 104 | 746 | ||||||
Benefit for Income Taxes | (92 | ) | (123 | ) | ||||
Income Before Equity in Undistributed Income of Subsidiary | 196 | 869 | ||||||
Equity in Undistributed Income of Subsidiary | 487 | 19 | ||||||
Net Income | $ | 683 | $ | 888 | ||||
Comprehensive Income | $ | 692 | $ | 872 |
Harvard Illinois Bancorp, Inc.
Notes to ConsolidatedFinancial Statements
December 31, 2013 and 2012
(dollars in thousands, except share data)
Condensed Statements of Cash Flows
Years Ending December 31, | ||||||||
2013 | 2012 | |||||||
Cash flows from operating activities | ||||||||
Net income | $ | 683 | $ | 888 | ||||
Adjustments | ||||||||
Loss on other-than-temporary impairment of equity securities | — | 1 | ||||||
ESOP compensation expense | 60 | 45 | ||||||
Stock-based compensation expense | 114 | 121 | ||||||
Equity in undistributed subsidiary income | (487 | ) | (19 | ) | ||||
Change in other assets | (164 | ) | (228 | ) | ||||
Change in other liabilities | (1 | ) | 25 | |||||
Net cash provided by operating activities | 205 | 833 | ||||||
Cash flows from investing activities | ||||||||
Payments on ESOP loan | 36 | 35 | ||||||
Net cash provided by investing activities | 36 | 35 | ||||||
Cash flows from financing activities | ||||||||
Dividends paid | (77 | ) | — | |||||
Stock options exercised | 145 | — | ||||||
Net cash provided by financing activities | 68 | — | ||||||
Net Change in Cash and Cash Equivalents | 309 | 868 | ||||||
Cash and Cash Equivalents at Beginning of Year | 947 | 79 | ||||||
Cash and Cash Equivalents at End of Year | $ | 1,256 | $ | 947 |
F-72